SYNOPSYS INC - Quarter Report: 2020 July (Form 10-Q)

Large accelerated filer

Accelerated Filer

Non-accelerated filer

Smaller reporting company

Emerging growth company

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)



☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JULY 31, 2020



☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER: 000-19807

SYNOPSYS, INC.

(Exact name of registrant as specified in its charter)



Delaware		56-1546236
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

690 EAST MIDDLEFIELD ROAD

MOUNTAIN VIEW, CA 94043

(Address of principal executive offices, including zip code)

(650) 584-5000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:



Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock ($0.01 par value)	SNPS	Nasdaq Global Select Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ý No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ý

As of August 19, 2020, there were 151,761,689 shares of the registrant’s common stock outstanding.

SYNOPSYS, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE FISCAL QUARTER ENDED JULY 31, 2020

TABLE OF CONTENTS




		Page
PART I.	Financial Information	1
Item 1.	Financial Statements	1
	Unaudited Condensed Consolidated Balance Sheets	1
	Unaudited Condensed Consolidated Statements of Operations	2
	Unaudited Condensed Consolidated Statements of Comprehensive Income	3
	Unaudited Condensed Consolidated Statements of Stockholders’ Equity	4
	Unaudited Condensed Consolidated Statements of Cash Flows	5
	Notes to Unaudited Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	40
Item 4.	Controls and Procedures	41
PART II.	Other Information	42
Item 1.	Legal Proceedings	42
Item 1A.	Risk Factors	43
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	56
Item 6.	Exhibits	57
Signatures		58

PART I. FINANCIAL INFORMATION




Item 1.		Financial Statements

SYNOPSYS, INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value amounts)



	July 31, 2020			October 31, 2019*
ASSETS
Current assets:
Cash and cash equivalents	$	1,049,922		$	728,597
Accounts receivable, net	638,489			553,895
Inventories, net	159,813			141,518
Income taxes receivable and prepaid taxes	20,960			24,855
Prepaid and other current assets	316,831			290,052
Total current assets	2,186,015			1,738,917
Property and equipment, net	484,529			429,532
Operating lease right-of-use assets, net	472,244			—
Goodwill	3,356,407			3,171,179
Intangible assets, net	275,338			279,374
Long-term prepaid taxes	8,279			15,503
Deferred income taxes	463,894			390,129
Other long-term assets	416,544			380,526
Total assets	$	7,663,250		$	6,405,160
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued liabilities	$	549,906		$	506,459
Operating lease liabilities, current	71,861			—
Accrued income taxes	20,653			15,904
Deferred revenue	1,389,609			1,212,476
Short-term debt	24,248			17,614
Total current liabilities	2,056,277			1,752,453
Operating lease liabilities, non-current	470,215			—
Long-term accrued income taxes	27,011			29,911
Long-term deferred revenue	111,915			90,102
Long-term debt	107,104			120,093
Other long-term liabilities	289,411			323,725
Total liabilities	3,061,933			2,316,284
Stockholders’ equity:
Preferred stock, $0.01 par value: 2,000 shares authorized; none outstanding	—			—
Common stock, $0.01 par value: 400,000 shares authorized; 151,758 and 150,331 shares outstanding, respectively	1,519			1,503
Capital in excess of par value	1,623,586			1,635,455
Retained earnings	3,597,944			3,164,144
Treasury stock, at cost: 5,503 and 6,930 shares, respectively	(554,304		)	(625,642		)
Accumulated other comprehensive income (loss)	(72,820		)	(92,447		)
Total Synopsys stockholders’ equity	4,595,925			4,083,013
Non-controlling interest	5,392			5,863
Total stockholders’ equity	4,601,317			4,088,876
Total liabilities and stockholders’ equity	$	7,663,250		$	6,405,160


*	Derived from audited financial statements.

See accompanying notes to unaudited condensed consolidated financial statements.

SYNOPSYS, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)



	Three Months Ended July 31,					Nine Months Ended July 31,
	2020			2019		2020			2019
Revenue:
Time-based products	$	612,065		$	537,569	$	1,758,601		$	1,649,590
Upfront products	210,931			177,552		491,417			451,466
Maintenance and service	141,138			137,849		409,824			408,557
Total revenue	964,134			852,970		2,659,842			2,509,613
Cost of revenue:
Products	118,478			113,533		344,469			346,163
Maintenance and service	60,812			59,496		184,940			178,113
Amortization of intangible assets	13,718			13,603		40,732			45,927
Total cost of revenue	193,008			186,632		570,141			570,203
Gross margin	771,126			666,338		2,089,701			1,939,410
Operating expenses:
Research and development	322,602			284,804		939,456			846,429
Sales and marketing	156,456			157,109		455,511			471,720
General and administrative	73,516			67,382		204,734			165,794
Amortization of intangible assets	9,931			10,111		29,545			31,211
Restructuring charges	(1,977		)	19,338		36,446			33,746
Total operating expenses	560,528			538,744		1,665,692			1,548,900
Operating income	210,598			127,594		424,009			390,510
Other income (expense), net	26,256			5,317		22,584			23,373
Income before income taxes	236,854			132,911		446,593			413,883
Provision (benefit) for income taxes	(16,057		)	32,982		(20,299		)	42,230
Net income	$	252,911		$	99,929	$	466,892		$	371,653
Net income per share:
Basic	$	1.67		$	0.67	$	3.10		$	2.48
Diluted	$	1.62		$	0.65	$	3.01		$	2.42
Shares used in computing per share amounts:
Basic	151,352			150,123		150,731			149,708
Diluted	155,973			154,600		155,074			153,859

See accompanying notes to unaudited condensed consolidated financial statements.

SYNOPSYS, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)



	Three Months Ended July 31,					Nine Months Ended July 31,
	2020		2019			2020		2019
Net income	$	252,911	$	99,929		$	466,892	$	371,653
Other comprehensive income (loss):
Change in foreign currency translation adjustment	18,102		(2,123		)	14,099		(67		)
Cash flow hedges:
Deferred gains (losses), net of tax of $(4,169) and $(1,823), for the three and nine months ended July 31, 2020, respectively, and of $(464) and $(2,178) for each of the same periods in fiscal 2019, respectively.	12,399		(1,070		)	3,965		4,844
Reclassification adjustment on deferred (gains) losses included in net income, net of tax of $(134) and $(262), for the three and nine months ended July 31, 2020, respectively, and of $(702) and $(2,988) for each of the same periods in fiscal 2019, respectively.	709		3,260			1,563		11,747
Other comprehensive income (loss), net of tax effects	31,210		67			19,627		16,524
Comprehensive income	$	284,121	$	99,996		$	486,519	$	388,177

See accompanying notes to unaudited condensed consolidated financial statements.

SYNOPSYS, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands)



						Capital in Excess of Par Value			Retained Earnings			Treasury Stock			Accumulated Other Comprehensive Income (Loss)			Total Synopsys Stockholders’ Equity			Non-controlling Interest			Stockholders’ Equity
	Common Stock
	Shares		Amount
Balance at April 30, 2020	150,908		$	1,509		$	1,655,787		$	3,356,489		$	(634,669	)	$	(104,030	)	$	4,275,086		$	5,863		$	4,280,949
Net income									252,911									252,911			(471		)	252,440
Other comprehensive income (loss), net of tax effects															31,210			31,210						31,210
Purchases of treasury stock	(149	)										(20,000		)				(20,000		)				(20,000		)
Equity forward contract						20,000												20,000						20,000
Common stock issued, net of shares withheld for employee taxes	999		10			(114,038		)	(11,456		)	100,365						(25,119		)				(25,119		)
Stock-based compensation						61,837												61,837						61,837
Balance at July 31, 2020	151,758		$	1,519		$	1,623,586		$	3,597,944		$	(554,304	)	$	(72,820	)	$	4,595,925		$	5,392		$	4,601,317

Balance at October 31, 2019	150,331		$	1,503		$	1,635,455		$	3,164,144		$	(625,642	)	$	(92,447	)	$	4,083,013		$	5,863		$	4,088,876
Net income									466,892									466,892			(471		)	466,421
Other comprehensive income (loss), net of tax effects															19,627			19,627						19,627
Purchases of treasury stock	(1,380	)	(12		)	12						(200,000		)				(200,000		)				(200,000		)
Common stock issued, net of shares withheld for employee taxes	2,807		28			(182,036		)	(33,092		)	271,338						56,238						56,238
Stock-based compensation						170,155												170,155						170,155
Balance at July 31, 2020	151,758		$	1,519		$	1,623,586		$	3,597,944		$	(554,304	)	$	(72,820	)	$	4,595,925		$	5,392		$	4,601,317

						Capital in Excess of Par Value			Retained Earnings			Treasury Stock			Accumulated Other Comprehensive Income (Loss)			Total Synopsys Stockholders’ Equity			Non-controlling Interest			Stockholders’ Equity
	Common Stock
	Shares		Amount
Balance at April 30, 2019	149,982		$	1,500		$	1,659,484		$	2,912,811		$	(567,503	)	$	(96,720	)	$	3,909,572		$	5,863		$	3,915,435
Net income									99,929									99,929						99,929
Other comprehensive income (loss), net of tax effects															67			67						67
Purchases of treasury stock	(775	)	(8		)	8						(100,000		)				(100,000		)				(100,000		)
Common stock issued, net of shares withheld for employee taxes	1,166		12			(101,310		)	(9,310		)	95,399						(15,209		)				(15,209		)
Stock-based compensation						39,447												39,447						39,447
Balance at July 31, 2019	150,373		$	1,504		$	1,597,629		$	3,003,430		$	(572,104	)	$	(96,653	)	$	3,933,806		$	5,863		$	3,939,669

Balance at October 31, 2018	149,265		$	1,493		$	1,644,830		$	2,543,688		$	(597,682	)	$	(113,177	)	$	3,479,152		$	5,863		$	3,485,015
Net income									371,653									371,653						371,653
Retained earnings adjustment due to adoption of accounting standards related to revenue(1)									257,594									257,594						257,594
Retained earnings adjustment due to adoption of an accounting standard related to income taxes(2)									(130,544		)							(130,544		)				(130,544		)
Other comprehensive income (loss), net of tax effects															16,524			16,524						16,524
Purchases of treasury stock	(1,901	)	(19		)	19						(209,185		)				(209,185		)				(209,185		)
Equity forward contract						(20,000		)										(20,000		)				(20,000		)
Common stock issued, net of shares withheld for employee taxes	3,009		30			(140,841		)	(38,961		)	234,763						54,991						54,991
Stock-based compensation						113,621												113,621						113,621
Balance at July 31, 2019	150,373		$	1,504		$	1,597,629		$	3,003,430		$	(572,104	)	$	(96,653	)	$	3,933,806		$	5,863		$	3,939,669


⁽¹⁾	See Note 2. Summary of Significant Accounting Policies in the Company’s Annual Report on Form 10-K for the year ended October 31, 2019 for additional information on the retained earnings adjustment due to adoption of Accounting Standards Codification (ASC) 606 and ASC 340, “Other Assets and Deferred Costs”.


⁽²⁾	See Note 11. Income Taxes in the Company’s Annual Report on Form 10-K for the year ended October 31, 2019 for additional information on the retained earnings adjustment due to adoption of Accounting Standard Update (ASU) 2016-16.

See accompanying notes to unaudited condensed consolidated financial statements.

SYNOPSYS, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)



	Nine Months Ended July 31,
	2020			2019
Cash flows from operating activities:
Net income	$	466,892		$	371,653
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization and depreciation	159,156			152,133
Reduction of operating lease right-of-use assets	62,585			—
Amortization of capitalized costs to obtain revenue contracts	44,851			46,230
Stock-based compensation	170,155			114,826
Allowance for doubtful accounts	14,875			8,950
(Gain) loss on sale of property and investments	(1,994		)	(4,052		)
Deferred income taxes	(74,374		)	(9,664		)
Net changes in operating assets and liabilities, net of acquired assets and liabilities:
Accounts receivable	(89,667		)	89,370
Inventories	(17,040		)	(39,431		)
Prepaid and other current assets	(21,350		)	(38,224		)
Other long-term assets	(77,895		)	(114,344		)
Accounts payable and accrued liabilities	43,842			(45,200		)
Operating lease liabilities	(57,968		)	—
Income taxes	6,128			(6,963		)
Deferred revenue	160,966			53,980
Net cash provided by operating activities	789,162			579,264
Cash flows from investing activities:
Proceeds from sales of long-term investments	2,151			6,361
Purchases of long-term investments	(2,762		)	—
Purchases of property and equipment	(120,234		)	(122,358		)
Cash paid for acquisitions and intangible assets, net of cash acquired	(201,045		)	—
Capitalization of software development costs	(3,035		)	(2,245		)
Net cash used in investing activities	(324,925		)	(118,242		)
Cash flows from financing activities:
Proceeds from credit facilities	276,490			192,897
Repayment of debt	(284,218		)	(520,312		)
Issuances of common stock	123,237			107,354
Payments for taxes related to net share settlement of equity awards	(66,985		)	(52,309		)
Purchase of equity forward contract	—			(20,000		)
Purchases of treasury stock	(200,000		)	(209,185		)
Other	—			(762		)
Net cash used in financing activities	(151,476		)	(502,317		)
Effect of exchange rate changes on cash, cash equivalents and restricted cash	8,700			4,975
Net change in cash, cash equivalents and restricted cash	321,461			(36,320		)
Cash, cash equivalents and restricted cash, beginning of year	730,527			725,001
Cash, cash equivalents and restricted cash, end of period	$	1,051,988		$	688,681

See accompanying notes to unaudited condensed consolidated financial statements.

SYNOPSYS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Description of Business

Synopsys, Inc. (Synopsys or the Company) provides products and services used across the entire silicon to software spectrum, from engineers creating advanced semiconductors to software developers seeking to ensure the security and quality of their code. The Company is a global leader in supplying the electronic design automation (EDA) software that engineers use to design and test integrated circuits (ICs), also known as chips. The Company also offers semiconductor intellectual property (IP) products, which are pre-designed circuits that engineers use as components of larger chip designs rather than designing those circuits themselves. The Company provides software and hardware used to validate the electronic systems that incorporate chips and the software that runs on them. To complement these offerings, the Company provides technical services and support to help its customers develop advanced chips and electronic systems. These products and services are part of the Company’s Semiconductor & System Design segment.

The Company is also a leading provider of software tools and services that improve the security and quality of software code in a wide variety of industries, including electronics, financial services, media, automotive, medicine, energy and industrials. These tools and services are part of the Company’s Software Integrity segment.

Note 2. Summary of Significant Accounting Policies

The Company has prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Pursuant to these rules and regulations, the Company has condensed or omitted certain information and footnote disclosures it normally includes in its annual consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP). In management’s opinion, the Company has made all adjustments (consisting only of normal, recurring adjustments, except as otherwise indicated) necessary to fairly present its unaudited condensed consolidated balance sheets, results of operations, comprehensive income, stockholders’ equity and cash flows. The Company’s interim period operating results do not necessarily indicate the results that may be expected for any other interim period or for the full fiscal year. These financial statements and accompanying notes should be read in conjunction with the consolidated financial statements and notes thereto in Synopsys’ Annual Report on Form 10-K for the fiscal year ended October 31, 2019 as filed with the SEC on December 20, 2019.

Use of Estimates. To prepare financial statements in conformity with U.S. GAAP, management must make estimates and assumptions that affect the amounts reported in the unaudited condensed consolidated financial statements and accompanying notes. Actual results could differ from these estimates and may result in material effects on the Company’s operating results and financial position. In addition, the Company has considered the potential impact of the COVID-19 pandemic on the business operations. Although no material impairment or other effects have been identified to date related to the COVID-19 pandemic, there is substantial uncertainty in the nature and degree of its continued effects over time. This uncertainty affects management’s accounting estimates and assumptions, which could result in greater variability in a variety of areas that depend on these estimates and assumptions as additional events and information are known.

Principles of Consolidation. The unaudited condensed consolidated financial statements include the accounts of the Company and all of its subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Fiscal Year End. The Company’s fiscal year generally ends on the Saturday nearest to October 31 and consists of 52 weeks, with the exception that approximately every five years, the Company has a 53-week year. When a 53-week year occurs, the Company includes the additional week in the first quarter to realign fiscal quarters with calendar quarters. Fiscal 2020 and 2019 are both 52-week years. Fiscal 2020 will end on October 31, 2020. Fiscal 2019 ended on November 2, 2019. For presentation purposes, the unaudited condensed consolidated financial statements and accompanying notes refer to the closest calendar month end.

Leases. In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-02, “Leases (Topic 842),” which supersedes the previous lease requirements in Topic 840. Topic 842 was subsequently amended by several ASUs. The new guidance requires a lessee to recognize a right-of-use (ROU) asset and a lease liability for most operating leases in the consolidated balance sheets. These ASUs also made minor changes to lessor accounting and aligns key aspects of the lessor accounting model with the new

revenue recognition guidance. The new standard did not have a material impact on the unaudited condensed consolidated financial statements for arrangements in which the Company is the lessor.

The Company adopted Topic 842 at the beginning of fiscal 2020 using the modified retrospective method without restatement of comparative periods. The Company elected the package of practical expedients permitted under the transition guidance, which allows the carryforward of historical assessments about (1) lease classification, (2) whether a contract is or contains a lease, and (3) which costs qualify as initial direct costs for leases that existed prior to the adoption. The Company did not elect either the use of hindsight or land easements practical expedients available in transition.

The adoption of the standard did not have an impact on the Company’s beginning retained earnings, results of operations, or cash flows. The operating lease liabilities equaled the present value of the remaining Topic 840 minimum rental payments for those leases, discounted at the Company’s incremental borrowing rate as of the date of adoption. The ROU assets were measured at the amount of the related lease liabilities plus any prepaid rental payments and less any unamortized lease incentives such as tenant improvement allowances. The Company recognized ROU assets of $475 million and operating lease liabilities of $540 million on the unaudited condensed consolidated balance sheets.

The Company determines if a contract is or contains a lease at inception. ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make payments arising from the lease. Lease liabilities for operating and finance leases are recognized at the lease commencement date based on the present value of future lease payments over the remaining lease terms. ROU assets are derived from the carrying amount of the related lease liability plus any prepaid lease payments, less any lease incentives such as tenant improvement allowances. The Company primarily uses its incremental borrowing rate, determined as of the lease commencement date, to measure the present value of its future lease payments, as the rate implicit in the lease is generally not readily determinable. The Company uses a benchmark senior unsecured yield curve for debt instruments and considers specific credit quality, market conditions, tenor of lease arrangements, and quality of collateral to determine the incremental borrowing rate.

Operating lease expense is recognized on a straight-line basis over the lease term of each lease. Variable payments, such as for maintenance, property taxes or insurance, are recognized on our unaudited condensed consolidated statements of operations as incurred.

The Company has adopted both (1) the practical expedient to not separate lease from non-lease components and (2) the short-term lease exemption. The Company has elected the practical expedient to not separate lease from non-lease components for all classes of underlying assets and the short-term lease exemption for all classes of underlying assets except real estate leases, with terms 12 months or less.

Revenue Recognition. In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Codification (ASC 606), “Revenue from Contracts with Customers,” which the Company adopted in fiscal 2019. See Note 2. Summary of Significant Accounting Policies in the Company’s Annual Report on Form 10-K for the year ended October 31, 2019 for revenue recognition policies under the new revenue guidance ASC 606.

Note 3. Revenue

Disaggregated Revenue

The following table shows the percentage of revenue by product groups:



	Three Months Ended July 31,				Nine Months Ended July 31,
	2020		2019		2020		2019
EDA	55	%	57	%	58	%	59	%
IP & System Integration	35	%	33	%	32	%	31	%
Software Integrity Products & Services	10	%	10	%	10	%	10	%
Other	0	%	0	%	0	%	0	%
Total	100	%	100	%	100	%	100	%

Contract Balances

The contract assets indicated below are presented as prepaid and other current assets in the unaudited condensed consolidated balance sheets. The contract assets are transferred to receivables when the rights to invoice and

receive payment become unconditional. Unbilled receivables are presented as accounts receivable, net, in the unaudited condensed consolidated balance sheets.

Contract balances are as follows:



	As of
	July 31, 2020		October 31, 2019
	(in thousands)
Contract assets	$	216,516	$	210,557
Unbilled receivables	$	53,028	$	38,175
Deferred revenue	$	1,501,524	$	1,302,578

During the nine months ended July 31, 2020, the Company recognized $926.2 million of revenue that was included in the deferred revenue balance as of October 31, 2019. During the nine months ended July 31, 2019, the Company recognized $785.1 million of revenue that was included in the deferred revenue balance as of October 31, 2018.

Contracted but unsatisfied or partially unsatisfied performance obligations were approximately $4.6 billion as of July 31, 2020, which includes $604.6 million in non-cancellable Flexible Spending Account (FSA) commitments from customers where actual product selection and quantities of specific products or services are to be determined by customers at a later date. The Company has elected to exclude future sales-based royalty payments from the remaining performance obligations. The contracted but unsatisfied or partially unsatisfied performance obligations expected to be recognized over the next 12 months are approximately 58%, with the remainder recognized thereafter.

During the three and nine months ended July 31, 2020, the Company recognized $25.9 million and $78.0 million, respectively, from performance obligations satisfied from sales-based royalties earned during the periods. During the three and nine months ended July 31, 2019, the Company recognized $17.5 million and $64.8 million, respectively, from performance obligations satisfied from sales-based royalties earned during the periods.

Costs of Obtaining a Contract with Customer

The incremental costs of obtaining a contract with a customer, which consist primarily of direct sales commissions earned upon execution of the contract, are required to be capitalized under ASC 340-40 and amortized over the estimated period of which the benefit is expected to be received. As direct sales commissions paid for renewals are commensurate with the amounts paid for initial contracts, the deferred incremental costs will be recognized over the contract term. Total capitalized direct commission costs as of July 31, 2020 were $92.1 million and included in other assets in the Company’s unaudited condensed consolidated balance sheets. Amortization of these assets was $16.6 million and $44.9 million during the three and nine months ended July 31, 2020, respectively, and included in sales and marketing expense in the Company’s unaudited condensed consolidated statements of operations. Amortization of these assets was $17.8 million and $46.2 million during the three and nine months ended July 31, 2019, respectively, and included in sales and marketing expense in the Company’s unaudited condensed consolidated statements of operations.

Note 4. Business Combinations

During the nine months ended July 31, 2020, the Company completed several acquisitions for an aggregate consideration of $238.3 million, net of cash acquired as described below:


•	During the second quarter of fiscal 2020, the Company completed an acquisition for an aggregate consideration of $105.7 million; including cash consideration of $75.7 million and $30.0 million equal to the fair value of the Company’s products exchanged in connection with the acquisition.

The consideration of $105.7 million was allocated to $20.6 million of identifiable intangible assets, $4.2 million of net tangible assets, and $80.9 million in goodwill, on a preliminary basis. The fair value of these intangible assets was estimated using the income method. These transactions are not considered to be material to the Company’s unaudited condensed consolidated statements of operations. The acquisition was attributable to the Semiconductor & System Design reporting segment.

Concurrent to this transaction, the Company also executed a design service arrangement and recognized an asset of $10.7 million for the off-market component. The $10.7 million contract asset is expected to be amortized over the contractual period of the agreement of five years.

•

In addition to the above, the Company also completed several other acquisitions for an aggregate cash consideration of $132.6 million, net of cash acquired. The preliminary purchase allocations are $44.7 million of identifiable intangible assets and $92.4 million in goodwill, of which $12.9 million is attributable to the Software Integrity reporting segment. The fair value of these intangible assets and goodwill are estimated using the income method.

The preliminary fair value estimates for the assets acquired and liabilities assumed for all acquisitions completed within 12 months from the applicable acquisition date are not yet finalized and may change as additional information becomes available during the respective measurement periods. The primary areas of those preliminary estimates relate to certain tangible assets and liabilities, identifiable intangible assets, and income taxes.

The Company does not consider these acquisitions to be material, individually or in the aggregate, to the Company’s unaudited condensed consolidated statements of operations.

Note 5. Goodwill and Intangible Assets

Goodwill

The changes in the carrying amount of goodwill during the nine months ended July 31, 2020 were as follows:



	(in thousands)
Balance at October 31, 2019	$	3,171,179
Additions	173,341
Effect of foreign currency translation	11,887
Balance at July 31, 2020	$	3,356,407

Intangible Assets

In-process research and development (IPR&D) as of July 31, 2020 consisted of acquired projects that, if completed, will be reclassified to core/developed technology upon completion, or if abandoned, will be written off. Intangible assets as of July 31, 2020 consisted of the following:



	Gross Assets		Accumulated Amortization		Net Assets
	(in thousands)
Core/developed technology	$	827,232	$	692,545	$	134,687
Customer relationships	380,817		268,574		112,243
Contract rights intangible	192,757		185,357		7,400
Trademarks and trade names	43,096		28,070		15,026
In-process research and development (IPR&D)	1,214		—		1,214
Capitalized software development costs	43,112		38,344		4,768
Total	$	1,488,228	$	1,212,890	$	275,338

Intangible assets as of October 31, 2019 consisted of the following:



	Gross Assets		Accumulated Amortization		Net Assets
	(in thousands)
Core/developed technology	$	791,647	$	655,119	$	136,528
Customer relationships	358,661		242,058		116,603
Contract rights intangible	184,304		181,124		3,180
Trademarks and trade names	42,929		25,581		17,348
In-process research and development (IPR&D)	1,200		—		1,200
Capitalized software development costs	40,077		35,562		4,515
Total	$	1,418,818	$	1,139,444	$	279,374

Amortization expense related to intangible assets consisted of the following:



	Three Months Ended July 31,				Nine Months Ended July 31,
	2020		2019		2020		2019
	(in thousands)
Core/developed technology	$	12,472	$	12,825	$	37,515	$	43,229
Customer relationships	8,971		9,303		26,444		28,261
Contract rights intangible	1,272		808		3,829		2,790
Trademarks and trade names	934		778		2,489		2,858
Capitalized software development costs⁽¹⁾	947		700		2,782		2,207
Total	$	24,596	$	24,414	$	73,059	$	79,345

⁽¹⁾Amortization of capitalized software development costs is included in cost of products revenue in the unaudited condensed consolidated statements of operations.

The following table presents the estimated future amortization of intangible assets as of July 31, 2020:



Fiscal year	(in thousands)
Remainder of fiscal 2020	$	22,033
2021	75,568
2022	60,735
2023	44,733
2024	34,398
2025 and thereafter	36,657
IPR&D	1,214
Total	$	275,338

Note 6. Financial Assets and Liabilities

Cash equivalents. The Company classifies time deposits and other investments with original maturities less than three months as cash equivalents.

As of July 31, 2020, the balances of the Company’s cash equivalents were:



	Cost		Gross Unrealized Gains		Gross Unrealized Losses Less Than 12 Continuous Months		Gross Unrealized Losses 12 Continuous Months or Longer		Estimated Fair Value⁽¹⁾
	(in thousands)
Cash equivalents:
Money market funds	$	280,417	$	—	$	—	$	—	$	280,417
Total:	$	280,417	$	—	$	—	$	—	$	280,417


⁽¹⁾	See Note 7. Fair Value Measures for further discussion on fair values of cash equivalents.

As of October 31, 2019, the balances of the Company’s cash equivalents were:



	Cost		Gross Unrealized Gains		Gross Unrealized Losses Less Than 12 Continuous Months		Gross Unrealized Losses 12 Continuous Months or Longer		Estimated Fair Value⁽¹⁾
	(in thousands)
Cash equivalents:
Money market funds	$	166,024	$	—	$	—	$	—	$	166,024
Total:	$	166,024	$	—	$	—	$	—	$	166,024


⁽¹⁾	See Note 7. Fair Value Measures for further discussion on fair values of cash equivalents.

Restricted cash. The Company includes amounts generally described as restricted cash and restricted cash equivalents in cash and cash equivalents when reconciling beginning-of-period and end-of-period total amounts shown on the consolidated statements of cash flows. All restricted cash is primarily associated with office leases and has no material impact on the Company’s unaudited condensed consolidated statements of cash flows.

The following table provides a reconciliation of cash, cash equivalents and restricted cash included in the unaudited condensed consolidated balance sheets:



	As of
	July 31, 2020		October 31, 2019
	(in thousands)
Cash and cash equivalents	$	1,049,922	$	728,597
Restricted cash included in Prepaid expenses and other current assets	1,287		1,174
Restricted cash included in Other long-term assets	779		756
Total cash, cash equivalents and restricted cash	$	1,051,988	$	730,527

Non-marketable equity securities. The Company’s strategic investment portfolio consists of non-marketable equity securities in privately held companies. The investments that the Company have less than 20% equity interests and/or do not have the ability to exercise significant influence are accounted using the measurement alternative when the fair value of the investment is not readily determinable. Securities accounted for as equity method investments are recorded at cost plus the proportional share of the issuers’ income or loss, which is recorded in the Company’s other income (expense), net. The cost basis of securities sold is based on the specific identification method. See Note 7. Fair Value Measures.

Derivatives

In the first quarter of 2020, the Company adopted ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedge Activities, which amends the hedge accounting recognition and presentation requirements of ASC 815. Pursuant to the provisions of ASU 2017-12, the Company is not required to separately measure and report hedge ineffectiveness, which was previously recorded in Other income (expense), net in our unaudited condensed consolidated statements of operations. Also, prior to the adoption of ASU 2017-12, the forward point components of the Cash Flow hedges were excluded from assessing effectiveness of the hedging

relationship and were recorded on the unaudited condensed consolidated statements of operations in other income (expense), net. Upon adoption of ASU 2017-12, the Company presents the related earning impact of the Cash Flow hedges in the same income statement section as the hedged items. Also, adoption of the guidance did not impact opening retained earnings or have a material impact on our financial statements.

The Company recognizes derivative instruments as either assets or liabilities in the unaudited condensed consolidated balance sheets at fair value and provides qualitative and quantitative disclosures about such derivatives. The Company operates internationally and is exposed to potentially adverse movements in foreign currency exchange rates. The Company enters into hedges in the form of foreign currency forward contracts to reduce its exposure to foreign currency rate changes on non-functional currency denominated forecasted transactions and balance sheet positions including: (1) certain assets and liabilities, (2) shipments forecasted to occur within approximately one month, (3) future billings and revenue on previously shipped orders, and (4) certain future intercompany invoices denominated in foreign currencies.

The duration of forward contracts ranges from approximately one month to 22 months, the majority of which are short-term. The Company does not use foreign currency forward contracts for speculative or trading purposes. The Company enters into foreign exchange forward contracts with high credit quality financial institutions that are rated ‘A’ or above and to date has not experienced nonperformance by counterparties. In addition, the Company mitigates credit risk in derivative transactions by permitting net settlement of transactions with the same counterparty and anticipates continued performance by all counterparties to such agreements.

The assets or liabilities associated with the forward contracts are recorded at fair value in other current assets or accrued liabilities in the unaudited condensed consolidated balance sheets. The accounting for gains and losses resulting from changes in fair value depends on the use of the foreign currency forward contract and whether it is designated and qualifies for hedge accounting. The cash flow impact upon settlement of the derivative contracts will be included in “Net cash provided by operating activities” in the unaudited condensed consolidated statements of cash flows.

Cash Flow Hedging Activities

Certain foreign exchange forward contracts are designated and qualify as cash flow hedges. These contracts have durations of approximately 22 months or less. Certain forward contracts are rolled over periodically to capture the full length of exposure to the Company’s foreign currency risk, which can be up to three years. To receive hedge accounting treatment, all hedging relationships are formally documented at the inception of the hedge, and the hedges must be highly effective in offsetting changes to future cash flows on the hedged transactions. The related gains or losses resulting from changes in fair value of these hedges is initially reported, net of tax, as a component of other comprehensive income (loss) (OCI) in stockholders’ equity and reclassified into revenue or operating expenses, as appropriate, at the time the hedged transactions affect earnings. The Company expects a majority of the hedge balance in OCI to be reclassified to the statements of operations within the next 12 months.

The Company did not have any gains or losses related to discontinuation of cash flow hedges during the three and nine months ended July 31, 2020 and 2019.

Prior to adoption of ASU 2017-12, hedge effectiveness is evaluated monthly using spot rates, with any gain or loss caused by hedging ineffectiveness recorded in other income (expense), net. During the three and nine months ended July 31, 2020 and 2019, the amounts recognized in other income (expense) for ineffectiveness and excluded component were immaterial.

Upon adoption of ASU 2017-12, the Company elected to use the forward method to measure hedge effectiveness for its Japanese yen revenue and foreign currency expense cash flow hedges. The Company did not change the process for its backlog cash flow hedges and continues to measure hedging effectiveness on a monthly basis.

Non-designated Hedging Activities

The Company’s foreign exchange forward contracts that are used to hedge non-functional currency denominated balance sheet assets and liabilities are not designated as hedging instruments. Accordingly, any gains or losses from changes in the fair value of the forward contracts are recorded in other income (expense), net. The gains and losses on these forward contracts generally offset the gains and losses associated with the underlying assets and liabilities, which are also recorded in other income (expense), net. The duration of the forward contracts for hedging the Company’s balance sheet exposure is approximately one month.

The Company also has certain foreign exchange forward contracts for hedging certain international revenues and expenses that are not designated as hedging instruments. Accordingly, any gains or losses from changes in the fair value of the forward contracts are recorded in other income (expense), net. The gains and losses on these forward contracts generally offset the gains and losses associated with the foreign currency in operating income. The duration of these forward contracts is usually less than one year. The overall goal of the Company’s hedging program is to minimize the impact of currency fluctuations on its net income over its fiscal year.

The effects of the non-designated derivative instruments on the Company’s unaudited condensed consolidated statements of operations is summarized as follows:



	Three Months Ended July 31,				Nine Months Ended July 31,
	2020		2019		2020		2019
	(in thousands)
Gain (loss) recorded in other income (expense), net	$	2,995	$	1,179	$	1,891	$	4,314

The notional amounts in the table below for derivative instruments provide one measure of the transaction volume outstanding:



	As of
	July 31, 2020		October 31, 2019
	(in thousands)
Total gross notional amount	$	838,981	$	817,441
Net fair value	$	4,796	$	3,494

The Company’s exposure to market gain or loss will vary over time as a function of currency exchange rates. The amounts ultimately realized upon settlement of these financial instruments, together with the gains and losses on the underlying exposures, will depend on actual market conditions during the remaining life of the instruments.

The following table represents the unaudited condensed consolidated balance sheets location and amount of derivative instrument fair values segregated between designated and non-designated hedge instruments:



	Fair values of derivative instruments designated as hedging instruments		Fair values of derivative instruments not designated as hedging instruments
	(in thousands)
Balance at July 31, 2020
Other current assets	$	7,103	$	60
Accrued liabilities	$	2,268	$	100
Balance at October 31, 2019
Other current assets	$	7,327	$	53
Accrued liabilities	$	3,715	$	171

The following table represents the unaudited condensed consolidated statements of operations location in Revenue/Deferred Revenue and Operating Expenses and amount of gains and losses on derivative instrument fair values for designated hedge instruments, net of tax:



	Location of gain (loss) recognized in OCI on derivatives	Amount of gain (loss) recognized in OCI on derivatives (effective portion)			Location of gain (loss) reclassified from OCI	Amount of gain (loss) reclassified from OCI (effective portion)
	(in thousands)
Three months ended July 31, 2020
Foreign exchange contracts	Revenue	$	626		Revenue	$	466
Foreign exchange contracts	Operating expenses	11,773			Operating expenses	(1,175		)
Total		$	12,399			$	(709	)
Three months ended July 31, 2019
Foreign exchange contracts	Revenue	$	(994	)	Revenue	$	685
Foreign exchange contracts	Operating expenses	(76		)	Operating expenses	(3,945		)
Total		$	(1,070	)		$	(3,260	)
Nine months ended July 31, 2020
Foreign exchange contracts	Revenue	$	2,836		Revenue	$	648
Foreign exchange contracts	Operating expenses	1,129			Operating expenses	(2,211		)
Total		$	3,965			$	(1,563	)
Nine months ended July 31, 2019
Foreign exchange contracts	Revenue	$	(253	)	Revenue	$	1,048
Foreign exchange contracts	Operating expenses	5,097			Operating expenses	(12,795		)
Total		$	4,844			$	(11,747	)

Note 7. Fair Value Measures

Accounting Standards Codification (ASC) 820-10, Fair Value Measurements and Disclosures, defines fair value, establishes guidelines and enhances disclosure requirements for fair value measurements. The accounting guidance requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The accounting guidance also establishes a fair value hierarchy based on the independence of the source and objective evidence of the inputs used. There are three fair value hierarchies based upon the level of inputs that are significant to fair value measurement:

Level 1—Observable inputs that reflect quoted prices (unadjusted) for identical instruments in active markets;

Level 2—Observable inputs other than quoted prices included in Level 1 for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-driven valuations in which all significant inputs and significant value drivers are observable in active markets; and

Level 3—Unobservable inputs to the valuation derived from fair valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

On a recurring basis, the Company measures the fair value of certain of its assets and liabilities, which include cash equivalents, non-qualified deferred compensation plan assets, and foreign currency derivative contracts.

The Company’s cash equivalents are classified within Level 1 or Level 2 because they are valued using quoted market prices in an active market or alternative independent pricing sources and models utilizing market observable inputs.

The Company’s non-qualified deferred compensation plan assets consist of money market and mutual funds invested in domestic and international marketable securities that are directly observable in active markets and are therefore classified within Level 1.

The Company’s foreign currency derivative contracts are classified within Level 2 because these contracts are not actively traded and the valuation inputs are based on quoted prices and market observable data of similar instruments.

The Company’s borrowings under its credit and term loan facilities are classified within Level 2 because these borrowings are not actively traded and have a variable interest rate structure based upon market rates currently available to the Company for debt with similar terms and maturities. See Note 9. Credit and Term Loan Facilities for more information on these borrowings.

Assets/Liabilities Measured at Fair Value on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are summarized below as of July 31, 2020:



			Fair Value Measurement Using
Description	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(in thousands)
Assets
Cash equivalents:
Money market funds	$	280,417	$	280,417	$	—	$	—
Prepaid and other current assets:
Foreign currency derivative contracts	7,163		—		7,163		—
Other long-term assets:
Deferred compensation plan assets	269,484		269,484		—		—
Total assets	$	557,064	$	549,901	$	7,163	$	—
Liabilities
Accounts payable and accrued liabilities:
Foreign currency derivative contracts	$	2,368	$	—	$	2,368	$	—
Other long-term liabilities:
Deferred compensation plan liabilities	269,484		269,484		—		—
Total liabilities	$	271,852	$	269,484	$	2,368	$	—

Assets and liabilities measured at fair value on a recurring basis are summarized below as of October 31, 2019:



			Fair Value Measurement Using
Description	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(in thousands)
Assets
Cash equivalents:
Money market funds	$	166,024	$	166,024	$	—	$	—
Prepaid and other current assets:
Foreign currency derivative contracts	7,380		—		7,380		—
Other long-term assets:
Deferred compensation plan assets	249,822		249,822		—		—
Total assets	$	423,226	$	415,846	$	7,380	$	—
Liabilities
Accounts payable and accrued liabilities:
Foreign currency derivative contracts	$	3,886	$	—	$	3,886	$	—
Other long-term liabilities:
Deferred compensation plan liabilities	249,822		249,822		—		—
Total liabilities	$	253,708	$	249,822	$	3,886	$	—

Assets/Liabilities Measured at Fair Value on a Non-Recurring Basis

Non-Marketable Equity Securities

Equity investments in privately-held companies, also called non-marketable equity securities, are accounted for using either the alternative method or equity method of accounting.

The non-marketable equity securities are measured and recorded at fair value when an event or circumstance which impacts the fair value of these securities indicates an other-than-temporary decline in value has occurred. In such events, these equity investments would be classified within Level 3 as they are valued using significant unobservable inputs or data in an inactive market, and the valuation requires management judgment due to the absence of market price and inherent lack of liquidity. The Company monitors these investments and generally uses the income approach to assess impairments based primarily on the financial conditions of these companies.

Note 8. Liabilities and Restructuring Charges

In the second quarter of fiscal 2019, the Company initiated a restructuring plan for involuntary and voluntary employee termination and facility closure actions as part of a business reorganization to better position the Company for future growth by reallocating resources to priority areas, and to a lesser extent, eliminating operational redundancy. The total charges under the 2019 restructuring plan were $84 million and consisted primarily of severance, termination, and retirement benefits under the 2019 Voluntary Retirement Program (VRP).

During the three and nine months ended July 31, 2020, the Company adjusted restructuring charges by approximately $(2.0) million and incurred restructuring charges of $36.4 million, respectively, under the 2019 restructuring plan. These charges consisted primarily of severance, termination, and retirement benefits. During the three and nine months ended July 31, 2020, the Company made payments of $25.0 million and $55.7 million, respectively, related to the 2019 employee termination actions. As of July 31, 2020, $3.3 million remained outstanding and was recorded in accounts payable and accrued liabilities as payroll and related benefits in the unaudited condensed consolidated balance sheets. The remaining balance will be paid in fiscal 2020.

During the three and nine months ended July 31, 2019, the Company incurred restructuring charges of approximately $19.3 million and $33.7 million, respectively, for involuntary employee termination actions and the VRP. These charges consisted primarily of severance, termination and retirement benefits. As of July 31, 2019, $20.8 million remained outstanding and was recorded in accounts payable and accrued liabilities as payroll and related benefits in the unaudited condensed consolidated balance sheets. As of October 31, 2019, $22.6 million related to the 2019 employee termination actions remained outstanding and was recorded in accounts payable and accrued liabilities as payroll and related benefits in the consolidated balance sheets.

Accounts payable and accrued liabilities consist of:



	As of
	July 31, 2020		October 31, 2019
	(in thousands)
Payroll and related benefits	$	417,403	$	417,157
Other accrued liabilities	95,377		69,487
Accounts payable	37,126		19,815
Total	$	549,906	$	506,459

Other long-term liabilities consist of:



	As of
	July 31, 2020		October 31, 2019
	(in thousands)
Deferred compensation liability	$	269,484	$	249,822
Other long-term liabilities	19,927		73,903
Total	$	289,411	$	323,725

Note 9. Credit and Term Loan Facilities

On November 28, 2016, the Company entered into an amended and restated credit agreement with several lenders (the Credit Agreement) providing for (i) a $650.0 million senior unsecured revolving credit facility (the Revolver) and (ii) a $150.0 million senior unsecured term loan facility (the Term Loan). The Credit Agreement amended and restated the Company’s previous credit agreement dated May 19, 2015, in order to increase the size of the revolving credit facility from $500.0 million to $650.0 million, provide a new $150.0 million senior unsecured term loan facility, and extend the termination date of the revolving credit facility from May 19, 2020 to November 28, 2021. Subject to obtaining additional commitments from lenders, the principal amount of the loans provided under the Credit Agreement may be increased by the Company by up to an additional $150.0 million. The Credit Agreement contains financial covenants requiring the Company to operate within a maximum leverage ratio and maintain a minimum interest coverage ratio, as well as other non-financial covenants. As of July 31, 2020, the Company was in compliance with all financial covenants.

As of July 31, 2020, the Company had $106.7 million outstanding balance, net of debt issuance costs, under the Term Loan, of which $82.5 million was classified as long-term liabilities. Outstanding principal payments under the Term Loan are due as follows:



Fiscal year	(in thousands)
Remainder of fiscal 2020	$	4,688
2021	27,187
2022	75,000
Total	$	106,875

In July 2018, the Company entered into a 220.0 million RMB (approximately $33.0 million) credit agreement with a lender in China to support its facilities expansion. Borrowings bear interest at a floating rate based on the Chinese Central Bank rate plus 10% of such rate. As of July 31, 2020, the Company had $24.6 million outstanding under the agreement.

As of October 31, 2019, the Company had $119.8 million outstanding balance, net of debt issuance costs, under the Term Loan, of which $102.2 million was classified as long-term liabilities. There was no outstanding balance under the Revolver as of October 31, 2019.

There was no outstanding balance under the Revolver as of July 31, 2020. The Company expects its borrowings under the Revolver will fluctuate from quarter to quarter. Borrowings bear interest at a floating rate based on a margin over the Company’s choice of market observable base rates as defined in the Credit Agreement. As of July 31, 2020, borrowings under the Term Loan bore interest at LIBOR +1.125% and the applicable interest rate for the Revolver was LIBOR +1.000%. In addition, commitment fees are payable on the Revolver at rates between 0.125% and 0.200% per year based on the Company’s leverage ratio on the daily amount of the revolving commitment.

The carrying amount of the short-term and long-term debt approximates the estimated fair value. These borrowings under the Credit Agreement have a variable interest rate structure and are classified within Level 2 of the fair value hierarchy.

Note 10. Leases

The Company has operating lease arrangements for office space, data center, equipment and other corporate assets. These leases have various expiration dates through March 31, 2032, some of which include options to extend the leases for up to 10 years. Because the Company is not reasonably certain to exercise these renewal options, the options are not considered in determining the lease term and associated potential option payments are excluded from lease payments.

The components of the Company’s lease expense during the period presented are as follows:



	Three Months Ended July 31,		Nine Months Ended July 31,
	2020		2020
	(in thousands)
Operating lease expense	$	23,450	$	69,932
Variable lease expense ⁽¹⁾	1,447		3,439
Total lease expense	$	24,897	$	73,371

⁽¹⁾ Variable lease expense includes payments to lessors that are not fixed or determinable at lease commencement date. These payments primarily consist of maintenance, property taxes, insurance and variable indexed based payments.

Supplemental cash flow information during the period presented is as follows:



	Three Months Ended July 31,		Nine Months Ended July 31,
	2020		2020
	(in thousands)
Cash paid for amounts included in the measurement of operating lease liabilities	$	18,637	$	52,766
ROU assets obtained in exchange for operating lease liabilities	$	27,063	$	56,846

Lease term and discount rate information related to the Company’s operating leases as of the end of the period presented are as follows:



	July 31, 2020
Weighted-average remaining lease term (in years)	8.84
Weighted-average discount rate	2.56	%

The following represents the maturities of the Company’s future lease payments due under operating leases as of July 31, 2020:



	Lease Payments
Fiscal year	(in thousands)
Remainder of fiscal 2020	$	18,137
2021	86,552
2022	76,714
2023	61,045
2024	56,901
Thereafter	311,341
Total future minimum lease payments	610,690
Less: Imputed interest	68,614
Total lease liabilities	$	542,076

As of July 31, 2020, the Company has additional operating leases for facilities that have not yet commenced with future undiscounted lease payments of $57.0 million. These operating leases will commence before March 1, 2021, with lease terms between 3.0 years and 9.0 years.

As of October 31, 2019, the future minimum lease payments due under non-cancellable operating leases were as follows:



	Minimum Lease Payments⁽¹⁾
	(in thousands)
Fiscal year
2020	$	79,286
2021	79,703
2022	69,477
2023	53,909
2024	48,730
Thereafter	291,494
Total	$	622,599

⁽¹⁾ Amounts based on Topic 840, Leases.

Note 11. Accumulated Other Comprehensive Income (Loss)

Components of accumulated other comprehensive income (loss), on an after-tax basis where applicable, were as follows:



	As of
	July 31, 2020			October 31, 2019
	(in thousands)
Cumulative currency translation adjustments	$	(73,828	)	$	(87,929	)
Unrealized gain (loss) on derivative instruments, net of taxes	1,008			(4,518		)
Total accumulated other comprehensive income (loss)	$	(72,820	)	$	(92,447	)

The effect of amounts reclassified out of each component of accumulated other comprehensive income (loss) into net income was as follows:



	Three Months Ended July 31,						Nine Months Ended July 31,
	2020			2019			2020			2019
	(in thousands)
Reclassifications from accumulated other comprehensive income (loss) into unaudited condensed consolidated statements of operations:
Gain (loss) on cash flow hedges, net of taxes
Revenues	$	466		$	685		$	648		$	1,048
Operating expenses	(1,175		)	(3,945		)	(2,211		)	(12,795		)
Total reclassifications into net income	$	(709	)	$	(3,260	)	$	(1,563	)	$	(11,747	)

Note 12. Stock Repurchase Program

The Company’s Board of Directors (the Board) previously approved a stock repurchase program pursuant to which the Company was authorized to purchase up to $500.0 million of its common stock, and has periodically replenished the stock repurchase program to such amount. The Board replenished the stock repurchase program up to $500.0 million on June 19, 2020. The program does not obligate the Company to acquire any particular amount of common stock, and the program may be suspended or terminated at any time by the Company’s Chief Financial Officer or the Board. The Company repurchases shares to offset dilution caused by ongoing stock issuances from existing equity plans for equity compensation awards and issuances related to acquisitions, and when management believes it is a good use of cash. Repurchases are transacted in accordance with Rule 10b-18 of the Securities Exchange Act of 1934, as amended (the Exchange Act) and may be made through any means, including, but not limited to, open market purchases, plans executed under Rule 10b5-1(c) of the Exchange Act and

structured transactions. As of July 31, 2020, $500.0 million remained available for future repurchases under the program.

In December 2019, the Company entered into an accelerated share repurchase agreement (the December 2019 ASR) to repurchase an aggregate of $100.0 million of the Company's common stock. Pursuant to the December 2019 ASR, the Company made a prepayment of $100.0 million to receive initial share deliveries of shares valued at $80.0 million. The remaining balance of $20.0 million was settled in February 2020. Total shares purchased under the December 2019 ASR were approximately 0.7 million shares, at an average purchase price of $149.75 per share.

In February 2020, the Company entered into an accelerated share repurchase agreement (the February 2020 ASR) to repurchase an aggregate of $100.0 million of the Company’s common stock. Pursuant to the February 2020 ASR, the Company made a prepayment of $100.0 million to receive initial share deliveries of shares valued at $80.0 million. The remaining balance of $20.0 million was settled in May 2020. Total shares purchased under the February 2020 ASR were approximately 0.7 million shares, at an average purchase price of $140.41 per share.

Stock repurchase activities as well as the reissuance of treasury stock for employee stock-based compensation purposes are as follows:



	Three Months Ended July 31,				Nine Months Ended July 31,
	2020⁽³⁾		2019⁽¹⁾		2020⁽³⁾		2019⁽¹⁾⁽²⁾
	(in thousands)
Total shares repurchased	149		775		1,380		1,901
Total cost of the repurchased shares	$	20,000	$	100,000	$	200,000	$	209,185
Reissuance of treasury stock	999		1,166		2,807		3,009

⁽¹⁾Does not include the 90,202 shares or $20.0 million equity forward contract from the June 2019 ASR settled in August 2019.

⁽²⁾The third quarter of fiscal 2019 includes the settlement of the 97,601 shares or $20.0 million equity forward contract from the February 2019 ASR settled in May 2019.

⁽³⁾ The third quarter of fiscal 2020 includes the settlement of the 148,953 shares or $20.0 million equity forward contract from the February 2020 ASR settled in May 2020.

Note 13. Stock-Based Compensation

The compensation cost recognized in the unaudited condensed consolidated statements of operations for the Company’s stock compensation arrangements was as follows:



	Three Months Ended July 31,						Nine Months Ended July 31,
	2020			2019			2020			2019
	(in thousands)
Cost of products	$	6,478		$	4,493		$	18,174		$	12,684
Cost of maintenance and service	1,959			1,694			6,109			4,675
Research and development expense	31,367			19,383			86,469			55,802
Sales and marketing expense	10,863			7,360			29,483			21,790
General and administrative expense	11,170			6,523			29,920			19,876
Stock-based compensation expense before taxes	61,837			39,453			170,155			114,827
Income tax benefit	(10,562		)	(6,593		)	(29,062		)	(19,188		)
Stock-based compensation expense after taxes	$	51,275		$	32,860		$	141,093		$	95,639

As of July 31, 2020, the Company had $387.5 million of total unrecognized stock-based compensation expense relating to options and restricted stock units and awards, which is expected to be recognized over a weighted-average period of 2.4 years. As of July 31, 2020, the Company had $42.5 million of total unrecognized stock-based

compensation expense relating to the ESPP, which is expected to be recognized over a period of approximately 2.0 years.

The intrinsic values of equity awards exercised during the periods are as follows:



	Three Months Ended July 31,				Nine Months Ended July 31,
	2020		2019		2020		2019
	(in thousands)
Intrinsic value of awards exercised	$	50,087	$	37,436	$	152,397	$	96,014

Note 14. Net Income Per Share

The Company computes basic net income per share by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted net income per share reflects the dilution from potential common shares outstanding such as stock options and unvested restricted stock units and awards during the period using the treasury stock method.

The table below reconciles the weighted average common shares used to calculate basic net income per share with the weighted average common shares used to calculate diluted net income per share:



	Three Months Ended July 31,				Nine Months Ended July 31,
	2020		2019		2020		2019
	(in thousands, except per share amounts)
Numerator:
Net income	$	252,911	$	99,929	$	466,892	$	371,653
Denominator:
Weighted average common shares for basic net income per share	151,352		150,123		150,731		149,708
Dilutive effect of common share equivalents from equity-based compensation	4,621		4,477		4,343		4,151
Weighted average common shares for diluted net income per share	155,973		154,600		155,074		153,859
Net income per share:
Basic	$	1.67	$	0.67	$	3.10	$	2.48
Diluted	$	1.62	$	0.65	$	3.01	$	2.42
Anti-dilutive employee stock-based awards excluded⁽¹⁾	3		152		610		798


⁽¹⁾	These stock options and unvested restricted stock units were anti-dilutive for the respective periods and are excluded in calculating diluted net income per share. While such awards were anti-dilutive for the respective periods, they could be dilutive in the future.

Note 15. Segment Disclosure

Segment reporting is based upon the “management approach,” i.e., how management organizes the Company’s operating segments for which separate financial information is (1) available and (2) evaluated regularly by the Chief Operating Decision Makers (CODMs) in deciding how to allocate resources and in assessing performance. Synopsys’ CODMs are its two Co-Chief Executive Officers.

The Company has two reportable segments: (1) Semiconductor & System Design, which includes EDA tools, IP products, system integration solutions and other associated revenue categories, and (2) Software Integrity, which includes a comprehensive solution for building integrity—security, quality and compliance testing—into the customers’ software development lifecycle and supply chain.

The financial information provided to and used by the CODMs to assist in making operational decisions, allocating resources, and assessing performance reflects consolidated financial information as well as revenue, adjusted

operating income, and adjusted operating margin information for the Semiconductor & System Design and Software Integrity segments, accompanied by disaggregated information relating to revenue by geographic region.

Information by reportable segment was as follows:



	Three Months Ended July 31,						Nine Months Ended July 31,
	2020			2019			2020			2019
	(in thousands)
Total Segments:
Revenue	$	964,134		$	852,970		$	2,659,842		$	2,509,613
Adjusted operating income	323,553			216,581			731,890			627,369
Adjusted operating margin	34		%	25		%	28		%	25		%
Semiconductor & System Design:
Revenue	$	870,734		$	769,411		$	2,392,542		$	2,260,372
Adjusted operating income	308,730			207,773			697,273			604,497
Adjusted operating margin	35		%	27		%	29		%	27		%
Software Integrity:
Revenue	$	93,400		$	83,559		$	267,300		$	249,241
Adjusted operating income	14,823			8,808			34,617			22,872
Adjusted operating margin	16		%	11		%	13		%	9		%

Certain operating expenses are not allocated to the segments and are managed at a consolidated level. The unallocated expenses managed at a consolidated level, including amortization of intangible assets, stock compensation and other operating expenses, are presented in the table below to provide a reconciliation of the total adjusted operating income from segments to the Company’s consolidated operating income:



	Three Months Ended July 31,						Nine Months Ended July 31,
	2020			2019			2020			2019
	(in thousands)
Total segment adjusted operating income	$	323,553		$	216,581		$	731,890		$	627,369
Reconciling items:
Amortization of intangible expense	(23,649		)	(23,714		)	(70,277		)	(77,138		)
Stock-based compensation expense	(61,837		)	(39,453		)	(170,155		)	(114,827		)
Other	(27,469		)	(25,820		)	(67,449		)	(44,894		)
Total operating income	$	210,598		$	127,594		$	424,009		$	390,510

The CODMs do not use total assets by segment to evaluate segment performance or allocate resources. As a result, total assets by segment are not required to be disclosed.

In allocating revenue to particular geographic areas, the CODMs consider where individual “seats” or licenses to the Company’s products are located. Revenue is defined as revenue from external customers. Revenue related to operations in the United States and other geographic areas were:



	Three Months Ended July 31,				Nine Months Ended July 31,
	2020		2019		2020		2019
	(in thousands)
Revenue:
United States	$	432,692	$	407,408	$	1,245,570	$	1,231,951
Europe	94,297		90,074		277,951		257,502
Korea	96,344		84,968		291,175		272,486
Japan	77,819		65,709		230,586		203,486
Asia Pacific and Other	262,982		204,811		614,560		544,188
Consolidated	$	964,134	$	852,970	$	2,659,842	$	2,509,613

Geographic revenue data for multi-regional, multi-product transactions reflect internal allocations and are therefore subject to certain assumptions and to the Company’s methodology.

One customer, including its subsidiaries, accounted for greater than 10% of the Company’s total revenue for the three and nine months ended July 31, 2020 and for the three and nine months ended July 31, 2019, respectively.

Note 16. Other Income (Expense), Net

The following table presents the components of other income (expense), net:



	Three Months Ended July 31,						Nine Months Ended July 31,
	2020			2019			2020			2019
	(in thousands)
Interest income	$	780		$	1,789		$	3,137		$	5,280
Interest expense	(941		)	(2,214		)	(4,390		)	(10,608		)
Gain (loss) on assets related to deferred compensation plan	26,153			4,686			20,166			25,201
Foreign currency exchange gain (loss)	123			696			5,255			2,999
Other, net	141			360			(1,584		)	501
Total	$	26,256		$	5,317		$	22,584		$	23,373

Note 17. Income Taxes

Effective Tax Rate

The Company estimates its annual effective tax rate at the end of each fiscal quarter. The effective tax rate takes into account the Company’s estimations of annual pre-tax income, the geographic mix of pre-tax income and interpretations of tax laws and possible outcomes of audits.

The following table presents the provision (benefit) for income taxes and the effective tax rates:



	Three Months Ended July 31,						Nine Months Ended July 31,
	2020			2019			2020			2019
	(in thousands)
Income before income taxes	$	236,854		$	132,911		$	446,593		$	413,883
Provision (benefit) for income taxes	$	(16,057	)	$	32,982		$	(20,299	)	$	42,230
Effective tax rate	(6.8		)%	24.8		%	(4.5		)%	10.2		%

Beginning in the Company’s fiscal 2019, the annual statutory federal corporate tax rate is 21%.

The Company’s effective tax rate for the nine months ended July 31, 2020 is lower than the statutory federal corporate tax rate of 21.0% primarily due to U.S. federal and California tax research credits, foreign-derived intangible income deduction, excess tax benefits from stock-based compensation, and the realizability of U.S. foreign tax credits, partially offset by state taxes, the effect of non-deductible stock-based compensation, and higher taxes on certain foreign earnings.

On July 27, 2015, the United States Tax Court (Tax Court) issued an opinion (Altera Corp. et al. v. Commissioner) regarding the treatment of stock-based compensation expense in intercompany cost-sharing arrangements. In view of the Tax Court opinion, the Company amended its cost-sharing arrangement effective February 1, 2016 to exclude stock-based compensation expense on a prospective basis and reflected the corresponding benefits in its income tax expense for fiscal years 2016, 2017 and 2018. On July 24, 2018, the United States Court of Appeals for the Ninth Circuit (Ninth Circuit) reversed the decision of the Tax Court, and then subsequently withdrew its decision on August 7, 2018. A rehearing of the case was held on June 7, 2019. The Ninth Circuit subsequently overturned the July 27, 2015 Tax Court decision. In the third quarter of 2019, as a result of the Ninth Circuit decision, the Company recorded a tax expense of $18.3 million related to fiscal years 2016, 2017 and 2018. The Company's intercompany cost-sharing arrangement was terminated at the end of fiscal 2018 as part of a restructuring. During the third quarter of 2020, the U.S. Supreme Court declined to review the Ninth Circuit decision.

The Company’s effective tax rate decreased in the three months ended July 31, 2020 as compared to the same period in fiscal 2019, primarily due to federal taxation of foreign earnings offset by deemed paid foreign tax credits reported on the Company's fiscal 2019 federal tax return filed during the three months ended July 31, 2020 and the impact of the Altera Ninth Circuit decision recorded in the three months ended July 31, 2019. The Company’s effective tax rate decreased in the nine months ended July 31, 2020, as compared to the same period in fiscal 2019, primarily due to an increase in excess tax benefits from stock-based compensation and the realization of U.S. foreign tax credits.

The U.S. Treasury Department has issued proposed regulations that could impact the calculation of income taxes. While the Company continues to evaluate the potential impact on its estimated annual tax rate, certain regulations have not been finalized and are subject to change. The Company will take into account these regulations once finalized.

In response to the fiscal impact of the COVID-19 pandemic, the State of California enacted legislation on June 29, 2020 that would suspend the use of certain corporate research and development tax credits for a three-year period beginning in our fiscal 2021, which could impact the Company's tax expense.

The timing of the resolution of income tax examinations, and the amounts and timing of various tax payments that are part of the settlement process, are highly uncertain. Variations in such amounts and/or timing could cause large fluctuations in the balance sheet classification of current and non-current assets and liabilities. The Company believes that in the coming 12 months, it is reasonably possible that either certain audits and ongoing tax litigation will conclude or the statute of limitations on certain state and foreign income and withholding taxes will expire, or both. Given the uncertainty as to ultimate settlement terms, the timing of payment and the impact of such settlements on other uncertain tax positions, the range of the estimated potential decrease in underlying unrecognized tax benefits is between $0 and $43 million.

Intra-Entity Transfers of Assets

In October 2016, the FASB issued ASU 2016-16, “Income Taxes (Topic 740), Intra-Entity Transfers of Assets Other Than Inventory.” This ASU requires the immediate recognition of current and deferred income tax effects of intra-entity transfers of assets other than inventory. This ASU was adopted on the first day of fiscal 2019. As a result of the adoption, the Company recorded a decrease of approximately $130.5 million in retained earnings as of the beginning of the period of adoption, with a corresponding decrease in prepaid taxes related to the unamortized tax expense attributed to intra-entity transfers of assets other than inventory previously deferred. The Company will recognize the income tax consequences of new intra-entity transfers of assets other than inventory in the consolidated statements of operations in the period when the transaction takes place.

U.S. Examinations

In the third quarter of fiscal 2020, the Company reached a final settlement with the California Franchise Tax Board for fiscal years 2015 through 2017 and recognized $19.2 million in previously unrecognized tax benefits.

Non-U.S. Examinations

Hungarian Tax Authority

In July 2017, the Hungarian Tax Authority (the HTA) issued a final assessment against the Company’s Hungarian subsidiary (Synopsys Hungary) for fiscal years 2011 through 2013. The HTA has applied withholding taxes on certain payments made to affiliates, resulting in an aggregate tax assessment of approximately $25.0 million and interest and penalties of $11.0 million. On August 2, 2017, Synopsys Hungary filed a claim contesting the final assessment with the Hungarian Administrative Court (the Court). In the first quarter of fiscal 2018, Synopsys Hungary paid the assessments, penalties and interest as required by law and recorded these amounts as prepaid taxes on its balance sheet, while continuing its challenge to the assessment through the Court. On April 30, 2019, the Court ruled against Synopsys Hungary. The Court’s opinion was received on May 16, 2019 and Synopsys Hungary filed an appeal with the Hungarian Supreme Court on July 5, 2019. In the second quarter of 2019, as a result of the Court’s decision, the Company recorded a tax expense due to an unrecognized tax benefit of $17.4 million, which is net of estimated U.S. foreign tax credits for the tax assessments. A Hungarian Supreme Court hearing date set for April 16, 2020 was postponed due to the COVID-19 pandemic and is now rescheduled for September 10, 2020.

In the second quarter of fiscal 2020, the Company reached a final settlement with the HTA for fiscal years 2014 through 2018 and recognized a net $6.9 million in previously unrecognized tax benefits.

National Taxation Bureau of Taipei

In the first quarter of fiscal 2019, the Company reached final settlement with the National Taxation Bureau of Taipei for fiscal year 2017 and recognized $5.5 million in previously unrecognized tax benefits.

The Company is also under examination by the tax authorities in certain other jurisdictions. No material assessments have been proposed in these examinations.

Note 18. Contingencies

Legal Proceedings

The Company is subject to routine legal proceedings, as well as demands, claims and threatened litigation that arise in the normal course of its business. The ultimate outcome of any litigation is often uncertain and unfavorable outcomes could have a negative impact on the Company’s results of operations and financial condition. The Company regularly reviews the status of each significant matter and assesses its potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount is estimable, the Company accrues a liability for the estimated loss. Legal proceedings are inherently uncertain and, as circumstances change, it is possible that the amount of any accrued liability may increase, decrease, or be eliminated.

The Company has determined that, except as set forth below, no disclosure of estimated loss is required for a claim against the Company because: (1) there is not a reasonable possibility that a loss exceeding amounts already recognized (if any) may be incurred with respect to such claim; (2) a reasonably possible loss or range of loss cannot be estimated; or (3) such estimate is immaterial.

Legal Settlement

There have been no changes to the disclosure related to Mentor Graphics Corporation (now part of Siemens AG) since the Company’s Annual Report on Form 10-K for the fiscal year ended October 31, 2019 (the Annual Report). See Note 7. Commitments and Contingencies of the Annual Report for further information.

Tax Matters

The Company undergoes examination from time to time by U.S. and foreign authorities for non-income based taxes, such as sales, use and value-added taxes, and is currently under examination by tax authorities in certain jurisdictions. If the potential loss from such examinations is considered probable and the amount or the range of loss could be estimated, the Company would accrue a liability for the estimated expense.

In addition to the foregoing, the Company is, from time to time, party to various other claims and legal proceedings in the ordinary course of its business, including with tax and other governmental authorities. See Note 17. Income Taxes for a description of certain of these other matters.

Note 19. Effect of New Accounting Pronouncements

In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (ASU 2016-13) and subsequently issued amendments to the initial guidance: ASU 2018-19, ASU 2019-04 and ASU 2019-05 (collectively, Topic 326). Topic 326 requires measurement and recognition of expected credit losses for financial assets held. Topic 326 is effective for fiscal 2021, and earlier adoption is permitted beginning in the first quarter of fiscal 2020. The adoption of Topic 326 will not have material impact to the Company’s consolidated financial statements.



Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q includes forward-looking statements, which involve risks, uncertainties and other factors that could cause our actual results, time frames or achievements to differ materially from those expressed or implied in our forward-looking statements. Readers are urged to carefully review and consider the various disclosures regarding these risks and uncertainties made in this Quarterly Report on Form 10-Q, including those identified below in Part II, Item 1A. Risk Factors, and in other documents we file from time to time with the Securities and Exchange Commission (SEC). Forward-looking statements include any statements that are not statements of historical fact and include, but are not limited to, statements concerning business outlook, opportunities and strategies; customer demand and market expansion; strategies related to our products and technology; our planned product releases and capabilities; industry growth rates; software trends; planned acquisitions and buybacks; the expected impact of U.S. and foreign government actions on our financial results; the expected impact of the COVID-19 pandemic. Forward-looking statements may be identified by words such as “may,” “will,” “could,” “would,” “can,” “should,” “anticipate,” “expect,” “intend,” “believe,” “estimate,” “project,” “continue,” and “forecast,” or the negatives of such terms and similar expressions. The information included herein represents our estimates and assumptions as of the date of this filing. Unless required by law, we undertake no obligation to update publicly any forward-looking statements, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future. All subsequent written or oral forward-looking statements attributable to Synopsys or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements.

The following summary of our financial condition and results of operations should be read together with our unaudited condensed consolidated financial statements and the related notes thereto contained in Part I, Item 1 of this report and with our audited consolidated financial statements and the related notes thereto contained in our Annual Report on Form 10-K for the fiscal year ended October 31, 2019, as filed with the SEC on December 20, 2019.

Overview

Business Summary

Synopsys, Inc. provides products and services used across the entire silicon to software spectrum, from engineers creating advanced semiconductors to software developers seeking to ensure the security and quality of their code. We are a global leader in supplying the electronic design automation (EDA) software that engineers use to design and test integrated circuits (ICs), also known as chips. We also offer semiconductor intellectual property (IP) products, which are pre-designed circuits that engineers use as components of larger chip designs rather than designing those circuits themselves. We provide software and hardware used to validate the electronic systems that incorporate chips and the software that runs on them. To complement these offerings, we provide technical services and support to help our customers develop advanced chips and electronic systems. These products and services are part of our Semiconductor & System Design segment.

We are also a leading provider of software tools and services that improve the security and quality of software code in a wide variety of industries, including electronics, financial services, media, automotive, medicine, energy and industrials. These tools and services are part of our Software Integrity segment.

Our EDA and IP customers are generally semiconductor and electronics systems companies. Our solutions help these companies overcome the challenges of developing increasingly advanced electronics products while also helping them reduce their design and manufacturing costs. While our products are an important part of our customers’ development process, our sales could be affected based on their research and development budgets, and our customers’ spending decisions may be affected by their business outlook and willingness to invest in new and increasingly complex chip designs.

Our Software Integrity business delivers products and services that enable software developers to test their code - while it is being written - for known security vulnerabilities and quality defects, as well as testing for open source security vulnerabilities and license compliance. Our Software Integrity customers are software developers across many industries, including, but also well beyond, the semiconductor and systems industries. Our Software Integrity products and services form a platform that helps our customers build security into the software development lifecycle and across the entire cyber supply chain.

We have consistently grown our revenue since 2005, despite periods of global economic uncertainty. We achieved these results because of our solid execution, leading technologies and strong customer relationships, and because

we recognize our revenue for the software licenses over the arrangement period, which typically approximates three years. See Note 2 of Notes to Unaudited Condensed Consolidated Financial Statements for discussion on our revenue recognition policy. Time-based revenue consists of time-based products, maintenance and service revenue. The revenue we recognize in a particular period generally results from selling efforts in prior periods rather than the current period. As a result, decreases as well as increases in customer spending do not immediately affect our revenues in a significant way.

Our growth strategy is based on building on our leadership in our EDA products, expanding and proliferating our IP offerings, and driving growth in the software security and quality market. As we continue to expand our product portfolio and our total addressable market, for instance in the software security and quality space, we expect to experience increased variability in our total revenue. In addition, due to our adoption of ASC 606 in the beginning of fiscal 2019, the way in which we are required to account for certain types of arrangements has increased the variability in our total revenue from period to period. Nevertheless, the accounting impact has not affected our cash generated from our business. Based on our leading technologies, customer relationships, business model, diligent expense management, and acquisition strategy, we believe that we will continue to execute our strategies successfully.

COVID-19 Pandemic

The COVID-19 pandemic has caused minor disruptions to our business operations, with a limited impact on our operating results thus far. Given the unpredictable nature of the COVID-19 pandemic’s impact on the global economy, our historical results may not be an indication of future performance.

The extent to which the COVID-19 pandemic impacts our business operations in future periods will depend on multiple uncertain factors, including the duration and scope of the pandemic, its overall negative impact on the global economy generally and the semiconductor and electronics industries specifically, and continued responses by governments and businesses to COVID-19. We have not identified trends that we expect will materially impact our future operating results at this time. As we recognize our revenue for software licenses over the arrangement period, any potential impact related to COVID-19 may be delayed. We have not observed any changes in the design activity of customers, but we experienced a slowdown in customer commitments in our Software Integrity segment. We have not received any significant requests from our customers to either delay payments or modify arrangements due to COVID-19. However, this situation could change in future periods and the extent that these requests may impact our business is uncertain. We have also experienced minor disruptions in our hardware supply chain, which we have been able to address with minimal impact to our business operations to date.

We will continue to consider the potential impact of the COVID-19 pandemic on our business operations. Although no material impairment or other effects have been identified to date related to the COVID-19 pandemic, there is substantial uncertainty in the nature and degree of its continued effects over time. That uncertainty affects management’s accounting estimates and assumptions, which could result in greater variability in a variety of areas that depend on these estimates and assumptions as additional events and information become known.

See Part II, Item 1A, Risk Factors for further discussion of the possible impact of the COVID-19 pandemic on our business, operations and financial condition.

Business Segments

The CODMs regularly review disaggregated information for the following two reportable segments: (1) Semiconductor & System Design, which includes EDA tools, IP products, system integration solutions and other associated revenue categories, and (2) Software Integrity, which includes a comprehensive solution for building integrity—security, quality and compliance testing—into our customers’ software development lifecycle and supply chain.

Semiconductor & System Design. This segment includes our advanced silicon design, verification products and services, and semiconductor IP portfolio, which encompasses products and services that serve companies primarily in the semiconductor and electronics industries. EDA includes digital, custom and Field Programmable Gate Array (FPGA) IC design software, verification products, and manufacturing software products. Designers use these products to automate the highly complex IC design process and to reduce defects that could lead to expensive design or manufacturing re-spins or suboptimal end products. For IP, we are a leading provider of high-quality, silicon-proven IP solutions for system-on-chips (SoCs). This includes IP that has been optimized to address specific application requirements for the mobile, automotive, digital home, internet of things, and cloud computing markets, enabling designers to quickly develop SoCs in these areas.

Software Integrity. This segment includes a broad portfolio of products and services such as leading quality testing technologies, automated analysis, and consulting experts. Beginning in fiscal 2019, we launched the Polaris Software Integrity Platform™, an integrated cloud-based solution that unites key elements to provide an even more valuable way for developers to better develop personalized approaches for open source license compliance and detect and remediate known security vulnerabilities and quality defects early in the development process, thereby minimizing risk and maximizing productivity.

Fiscal Year End

Our fiscal year ends on the Saturday nearest to October 31 and consists of 52 weeks, with the exception that approximately every five years, we have a 53-week year. When a 53-week year occurs, we include the additional week in the first quarter to realign fiscal quarters with calendar quarters. Fiscal 2020 and 2019 are 52-week years ending on October 31, 2020 and November 2, 2019, respectively.

Our results of operations for the three and nine months of fiscal 2020 and 2019 ended on August 1, 2020 and August 3, 2019, respectively. For presentation purposes, this Form 10-Q refers to the closest calendar month end.

Financial Performance Summary

In the third quarter of fiscal 2020 compared to the same period of fiscal 2019, our financial performance reflects the following:


•	Revenues were $964.1 million, an increase of $111.2 million or 13%, primarily due to our continued organic growth.


•	Total cost of revenue and operating expenses were $753.5 million, an increase of $28.2 million, primarily due to increases in employee-related costs of $34.6 million resulting from increases in organic growth and acquisitions and higher deferred compensation expenses of $21.5 million, partially offset by a decrease in restructuring costs of $21.3 million.


•	Operating income was $210.6 million, an increase of $83.0 million or 65%.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial results under Results of Operations below are based on our unaudited condensed consolidated financial statements, which we have prepared in accordance with U.S. GAAP. In preparing these financial statements, we make assumptions, judgments and estimates that can affect the reported amounts of assets, liabilities, revenues and expenses, and net income. On an ongoing basis, we evaluate our estimates based on historical experience and various other assumptions we believe are reasonable under the circumstances. Our actual results may differ from these estimates. See Note 2 of Notes to Unaudited Condensed Consolidated Financial Statements for further information on our significant accounting policies.

The accounting policies that most frequently require us to make assumptions, judgments and estimates, and therefore are critical to understanding our results of operations, are:


•	Revenue recognition;


•	Valuation of business combinations; and


•	Income taxes.

See Critical Accounting Policies and Estimates in our Annual Report on Form 10-K for the year ended October 31, 2019 for further information.

Results of Operations

Revenue

Our revenues are generated from two business segments: the Semiconductor & System Design segment and the Software Integrity segment. See Note 15 of Notes to Unaudited Condensed Consolidated Financial Statements for additional information about our reportable segments and revenue by geographic regions.

Further disaggregation of the revenues into various products and services within these two segments is summarized as follows:

Semiconductor & System Design Segment

This segment is comprised of the following:

•

EDA software includes digital, custom and Field Programmable Gate Array (FPGA) IC design software, verification products and obligations to provide unspecified updates and support services. EDA products and services are typically sold through TSL arrangements that grant customers the right to access and use all of the licensed products at the outset of an arrangement and software updates are generally made available throughout the entire term of the arrangement, which is typically three years. Under ASC 606, we have concluded that the software licenses in TSL contracts are not distinct from the obligation to provide unspecified software updates to the licensed software throughout the license term, because the multiple software licenses represent inputs to a single, combined offering, and timely, relevant software updates are integral to maintaining the utility of the software licenses. We recognize revenue for the combined performance obligation under TSL contracts ratably over the term of the license.

•

IP & System Integration includes our DesignWare® IP portfolio and system-level products and services. Under ASC 606, these arrangements generally have two performance obligations which consist of transferring of the licensed IP and providing related support, which includes rights to technical support and software updates that are provided over the support term and are transferred to the customer over a time. Revenue allocated to the IP licenses is recognized at a point in time upon the later of the delivery date or the beginning of the license period, and revenue allocated to support is recognized over the support term. Royalties are recognized as revenue in the quarter in which the applicable customer sells its products that incorporate our IP. Payments for IP contracts are generally received upon delivery of the IP. Revenue related to the customization of certain IP is recognized as “Professional Services.”

•

In the case of arrangements involving the sale of Hardware products, we generally have two performance obligations. The first performance obligation is to transfer the hardware product, which includes software integral to the functionality of the hardware product. The second performance obligation is to provide maintenance on the hardware and its embedded software, which includes rights to technical support, hardware repairs and software updates that are all provided over the same term and have the same time-based pattern of transfer to the customer. The portion of the transaction price allocated to the hardware product is generally recognized as revenue at the time of delivery because the customer obtains control of the product at that point in time. We have concluded that control generally transfers at that point in time because the customer has title to the hardware, physical possession, and a present obligation to pay for the hardware. The portion of the transaction price allocated to the maintenance obligation is recognized as revenue ratably over the maintenance term.

•

Revenue from Professional Service contracts is recognized over time, generally using costs incurred or hours expended to measure progress. We have a history of reasonably estimating project status and the costs necessary to complete projects. A number of internal and external factors can affect these estimates, including labor rates, utilization and efficiency variances and specification and testing requirement changes.

Software Integrity Segment


•	We sell Software Integrity products in arrangements that provide customers the right to software licenses, maintenance updates and technical support. Over the term of these arrangements, the customer expects us to provide integral maintenance updates to the software licenses, which help

customers protect their own software from new critical quality defects and potential security vulnerabilities. The licenses and maintenance updates serve together to fulfill our commitment to the customer as both work together to provide the functionality to the customer and represent a combined performance obligation. We will recognize revenue for the combined performance obligation over the term of the arrangement.

Most of our customer arrangements are complex, involving hundreds of products and various license rights, and our customers bargain with us over many aspects of these arrangements. For example, they often demand a broader portfolio of solutions, support and services and seek more favorable terms such as expanded license usage, future purchase rights and other unique rights at an overall lower total cost. No single factor typically drives our customers’ buying decisions, and we compete on all fronts to serve customers in highly competitive markets. Customers generally negotiate the total value of the arrangement rather than just unit pricing or volumes.

Total Revenue



	July 31,
	2020		2019		$ Change		% Change
	(dollars in millions)
Three months ended
Semiconductor & System Design Segment	$	870.7	$	769.4	$	101.3	13	%
Software Integrity Segment	93.4		83.6		9.8		12	%
Total	$	964.1	$	853.0	$	111.1	13	%
Nine months ended
Semiconductor & System Design Segment	$	2,392.5	$	2,260.3	$	132.2	6	%
Software Integrity Segment	267.3		249.3		18.0		7	%
Total	$	2,659.8	$	2,509.6	$	150.2	6	%

The overall growth of our business has been the primary driver of the increase in our revenue. Our revenues are subject to fluctuations, primarily due to customer requirements including the timing and value of contract renewals. For example, we experience fluctuations in our revenue due to factors such as the timing of IP product sales, consulting projects, FSA drawdowns, royalties, and hardware sales. As revenue from IP products sales and hardware sales are recognized upfront, customer demand and timing requirements for such IP products and hardware have resulted in increased variability of our total revenue.

The increase in total revenue for the three months ended July 31, 2020 compared to the same period in fiscal 2019 was primarily attributable to the continued organic growth of the business in time-based and upfront IP license products, and to a lesser extent, higher maintenance and service revenue.

The increase in total revenue for the nine months ended July 31, 2020 compared to the same period in fiscal 2019 was primarily attributable to the continued organic growth of the business in time-based and upfront IP license products.

See Note 15 of Notes to Unaudited Condensed Consolidated Financial Statements for a discussion of revenue by geographic areas.

Time-Based Products Revenue



	July 31,
	2020			2019			$ Change		% Change
	(dollars in millions)
Three months ended	$	612.1		$	537.6		$	74.5	14	%
Percentage of total revenue	63		%	63		%
Nine months ended	$	1,758.6		$	1,649.6		$	109.0	7	%
Percentage of total revenue	66		%	66		%

The increase in time-based products for the three and nine months ended July 31, 2020 compared to the same periods in fiscal 2019 was primarily attributable to an increase in TSL license revenue from arrangements booked in prior periods.

Upfront Products Revenue



	July 31,
	2020			2019			$ Change		% Change
	(dollars in millions)
Three months ended	$	210.9		$	177.6		$	33.3	19	%
Percentage of total revenue	22		%	21		%
Nine months ended	$	491.4		$	451.5		$	39.9	9	%
Percentage of total revenue	19		%	18		%

Changes in upfront products revenue are generally attributable to normal fluctuations in the extent and timing of customer requirements, which can drive the amount of upfront orders and revenue in any particular period.

The increase in upfront products revenue for the three and nine months ended July 31, 2020 compared to the same periods in fiscal 2019 was primarily due to an increase in the sale of IP products driven by higher demand from customers.

Upfront products revenue as a percentage of total revenue will likely fluctuate based on the timing of IP products and hardware sales. Such fluctuations will continue to be impacted by the timing of shipments or FSA drawdowns due to customer requirements.

Maintenance and Service Revenue



	July 31,
	2020			2019			$ Change			% Change
	(dollars in millions)
Three months ended
Maintenance revenue	$	43.7		$	42.3		$	1.4		3	%
Professional services and other revenue	97.4			95.5			1.9			2	%
Total	$	141.1		$	137.8		$	3.3		2	%
Percentage of total revenue	15		%	16		%
Nine months ended
Maintenance revenue	$	128.8		$	137.1		$	(8.3	)	(6	)%
Professional services and other revenue	281.0			271.5			9.5			3	%
Total maintenance and service revenue	$	409.8		$	408.6		$	1.2		—	%
Percentage of total revenue	15		%	16		%

The increase and decrease, respectively, in maintenance revenue for the three and nine months ended July 31, 2020 compared to the same periods in fiscal 2019 were primarily due to changes in the volume and type of arrangements that include maintenance.

The increase in professional services and other revenue for the three and nine months ended July 31, 2020 compared to the same periods in fiscal 2019 was primarily due to an increase in the volume of IP consulting projects and the timing of IP consulting projects.

Cost of Revenue



	July 31,
	2020			2019			$ Change			% Change
	(dollars in millions)
Three months ended
Cost of products revenue	$	118.5		$	113.5		$	5.0		4	%
Cost of maintenance and service revenue	60.8			59.5			1.3			2	%
Amortization of intangible assets	13.7			13.6			0.1			1	%
Total	$	193.0		$	186.6		$	6.4		3	%
Percentage of total revenue	20		%	22		%
Nine months ended
Cost of products revenue	$	344.5		$	346.2		$	(1.7	)	—	%
Cost of maintenance and service revenue	184.9			178.1			6.8			4	%
Amortization of intangible assets	40.7			45.9			(5.2		)	(11	)%
Total	$	570.1		$	570.2		$	(0.1	)	—	%
Percentage of total revenue	21		%	23		%

We divide cost of revenue into three categories: cost of products revenue, cost of maintenance and service revenue, and amortization of intangible assets. We segregate expenses directly associated with consulting and training services from cost of products revenue associated with internal functions providing license delivery and post-customer contract support services. We then allocate these group costs between cost of products revenue and cost of maintenance and service revenue based on products and maintenance and service revenue reported.

Cost of products revenue. Cost of products revenue includes costs related to products sold and software licensed, allocated operating costs related to product support and distribution costs, royalties paid to third-party vendors, and the amortization of capitalized research and development costs associated with software products that had reached technological feasibility.

Cost of maintenance and service revenue. Cost of maintenance and service revenue includes operating costs related to maintaining the infrastructure necessary to operate our services and costs to deliver our consulting services, such as hotline and on-site support, production services and documentation of maintenance updates. We expect our cost of maintenance and service revenue to increase in future periods because of recent acquisitions, but we do not expect the impact to be material to our total cost of revenue.

Amortization of intangible assets. Amortization of intangible assets, which is recorded to cost of revenue and operating expenses, includes the amortization of core/developed technology, trademarks, trade names, customer relationships, covenants not to compete related to acquisitions and certain contract rights related to acquisitions.

The increase in cost of revenue for the three months ended July 31, 2020 compared to the same period in fiscal 2019 was primarily due to an increase of $2.6 million in personnel-related costs as a result of headcount increases from organic hiring and acquisitions, higher deferred compensation expenses of $2.4 million, and an increase of $2.0 million in consulting costs primarily related to servicing IP consulting arrangements.

The cost of revenue for the nine months ended July 31, 2020 remained relatively flat compared to the same period in fiscal 2019, primarily due to decreases of $15.0 million in hardware costs and $5.2 million in amortization of intangible assets, partially offset by increases of $11.1 million in personnel-related costs as a result of headcount increases from organic hiring and acquisitions, $4.0 million in depreciation and maintenance expenses, and $3.9 million in consulting costs primarily related to servicing IP consulting arrangements.

Changes in other cost of revenue categories for the above-mentioned periods were not individually material.

Operating Expenses

Research and Development



	July 31,
	2020			2019			$ Change		% Change
	(dollars in millions)
Three months ended	$	322.6		$	284.8		$	37.8	13	%
Percentage of total revenue	33		%	33		%
Nine months ended	$	939.5		$	846.4		$	93.1	11	%
Percentage of total revenue	35		%	34		%

The increase in research and development expenses for the three months ended July 31, 2020 compared to the same period in fiscal 2019 was primarily due to an increase of $25.4 million in personnel-related costs as a result of headcount increases, including those from acquisitions, higher deferred compensation expenses of $12.1 million, and increases of $2.3 million in facility expenses and $1.9 million in consultants and contractor costs.

The increase in research and development expenses for the nine months ended July 31, 2020 compared to the same period in fiscal 2019 was primarily due to increases of $77.1 million in personnel-related costs as a result of headcount increases, including those from acquisitions, $14.4 million in facility expenses, and $6.4 million in consultants and contractor costs, partially offset by lower deferred compensation expenses of $3.7 million.

Changes in other research and development expense categories for the above-mentioned periods were not individually material.

Sales and Marketing



	July 31,
	2020			2019			$ Change			% Change
	(dollars in millions)
Three months ended	$	156.5		$	157.1		$	(0.6	)	0	%
Percentage of total revenue	16		%	18		%
Nine months ended	$	455.5		$	471.7		$	(16.2	)	(3	)%
Percentage of total revenue	17		%	19		%

The sales and marketing expenses for the three months ended July 31, 2020 remained relatively flat compared to the same period in fiscal 2019, primarily due to a decrease of $8.3 million in travel and marketing expenses that included reduced expenses as a result of COVID-19 restrictions, partially offset by higher deferred compensation expenses of $4.3 million and an increase in personnel-related costs of $3.1 million.

The decrease in sales and marketing expenses for the nine months ended July 31, 2020 compared to the same period in fiscal 2019 was primarily due to a decrease of $16.0 million that included reduced travel and marketing expenses as a result of COVID-19 restrictions.

Changes in other sales and marketing expense categories for the above-mentioned periods were not individually material.

General and Administrative



	July 31,
	2020			2019			$ Change		% Change
	(dollars in millions)
Three months ended	$	73.5		$	67.4		$	6.1	9	%
Percentage of total revenue	8		%	8		%
Nine months ended	$	204.7		$	165.8		$	38.9	23	%
Percentage of total revenue	8		%	7		%

The increase in general and administrative expenses for the three months ended July 31, 2020 compared to the same period in fiscal 2019 was primarily due to increases of $3.9 million in depreciation and maintenance expenses, $3.5 million in personnel-related costs, and higher deferred compensation expenses of $2.7 million, partially offset by a decrease of $1.8 million in professional service costs.

The increase in general and administrative expenses for the nine months ended July 31, 2020 compared to the same period in fiscal 2019 was primarily due to a legal settlement of $18.0 million in our favor in the first quarter of fiscal 2019 and increases of $11.6 million in personnel-related expenses and $9.5 million in depreciation and maintenance expenses, partially offset by a decrease of $1.8 million in professional service costs.

Changes in other general and administrative expense categories for the above-mentioned periods were not individually material.

Amortization of Intangible Assets

Amortization of intangible assets includes the amortization of contract rights and the amortization of core/developed technology, trademarks, trade names, customer relationships, and in-process research and development related to acquisitions completed in prior years. Amortization expense is included in the unaudited condensed consolidated statements of operations as follows:



	July 31,
	2020			2019			$ Change			% Change
	(dollars in millions)
Three months ended
Included in cost of revenue	$	13.7		$	13.6		$	0.1		1	%
Included in operating expenses	9.9			10.1			(0.2		)	(2	)%
Total	$	23.6		$	23.7		$	(0.1	)	—	%
Percentage of total revenue	2		%	3		%
Nine months ended
Included in cost of revenue	$	40.7		$	45.9		$	(5.2	)	(11	)%
Included in operating expenses	29.5			31.2			(1.7		)	(5	)%
Total	$	70.2		$	77.1		$	(6.9	)	(9	)%
Percentage of total revenue	3		%	3		%

The decrease in amortization of intangible assets for the three and nine months ended July 31, 2020 compared to the same periods in fiscal 2019 was primarily due to intangible assets that were fully amortized, partially offset by additions of acquired intangible assets.

Restructuring Charges

In the second quarter of fiscal 2019, our management approved, committed and initiated a restructuring plan (the Plan) as part of a business reorganization. Total charges under the Plan was $84 million and consisted primarily of severance, termination, and retirement benefits under the 2019 Voluntary Retirement Program (VRP).

See Note 8 of Notes to Unaudited Condensed Consolidated Financial Statements for additional information.

Other Income (Expense), Net



July 31,
2020	2019	$ Change	% Change