Management Discussion - SNPS

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

The following summary of our financial condition and results of operations is qualified in its entirety by the more complete discussion contained in this Item 7 and by the risk factors set forth in Item 1A of this Annual Report. Please also see the cautionary language at the beginning of Part I of this Annual Report regarding forward-looking statements.

Business Summary

Synopsys, Inc. provides software, intellectual property, and services used by designers across the entire silicon to software spectrum, from engineers creating advanced semiconductors to software developers seeking to ensure the quality and security of their applications. We are a global leader in supplying the electronic design automation (EDA) software that engineers use to design and test ICs, also known as chips. We also offer intellectual property (IP) products, which are pre-designed circuits that engineers use as components of larger chip designs rather than design those circuits themselves. We provide software and hardware used to develop 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. We are also a leading provider of software tools that developers use to improve the quality and security of software code in a wide variety of industries, including electronics, financial services, energy, industrials, and automotive.

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, their research and development budget and spending decisions may be affected by their business outlook and willingness to invest in new and increasingly complex chip designs. In addition, several consolidations have taken place in the semiconductor industry recently. While we do not believe customer consolidations have had a material impact on our results, the future impact is uncertain. For a discussion of potential risks, please see the risk factor titled "Consolidation among our customers and within the industries in which we operate, as well as our dependence on a relatively small number of large customers, may negatively impact our operating results." in Part I, Item 1A, Risk Factors.

Despite global economic uncertainty, we have maintained profitability and positive cash flow on an annual basis in recent years. We achieved these results not only because of our solid execution, leading technologies and strong customer relationships, but also because of our time-based revenue business model. Under this model, a substantial majority of our customers pay over time and we typically recognize this revenue over the life of the contract, which averages approximately three years. Time-based revenue, which consists of time-based products, maintenance and service revenue, represents approximately 90% of our total revenue. The revenue we recognize in a particular period generally results from selling efforts in prior periods rather than the current period. Due to our business model, 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 quality and security market. As we continue to expand our product portfolio and our total addressable market, for instance in the software quality and security space, and hardware grows, we may experience increased variability in our revenue, though we generally expect time-based revenue to continue to represent approximately 90% of our total revenue. Overall, our business outlook remains solid based on our leading technologies, customer relationships, business model, diligent expense management, and acquisition strategy. We believe that these factors will help us continue to execute our strategies successfully.

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. Fiscal 2016, 2015, and 2014 were 52-week years ending on October 29, 2016, October 31, 2015, and November 1, 2014, respectively.

For presentation purposes, this Form 10-K refers to the closest calendar month end.

Fiscal 2016 Financial Performance Summary

In fiscal 2016, compared to fiscal 2015, our financial performance reflects the following:

•

Revenues were $2.4 billion, an increase of $180.3 million or 8%, primarily driven by the overall growth in our business mainly due to higher TSL revenues and hardware sales.

•

Total cost of revenue and operating expenses were $2.1 billion, an increase of $129.4 million or 7%, primarily due to increases in headcount, including those from acquisitions.

•

Higher operating income of $317.4 million, an increase of $50.9 million or 19%.

We derived approximately 90% of our revenue from time-based revenue in fiscal 2016. Our cash, cash equivalents and short-term investments were $1.1 billion as of October 31, 2016, of which 15% was in the U.S.

New Accounting Pronouncements

See Note 14 of Notes to Consolidated Financial Statements.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial results under Results of Operations below are based on our audited results of operations, 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. For further information on our significant accounting policies, see Note 2 of Notes to Consolidated Financial Statements.

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;

•

Valuation of intangible assets; and

•

Income taxes.

Revenue Recognition

We generate our revenue from the sale of products that include software licenses, maintenance and professional services, and to a lesser extent, hardware products. Software license revenue consists of fees associated with the licensing of our software. Maintenance and professional service revenue consists of maintenance fees associated with perpetual and term licenses and professional services fees. Hardware revenue consists of sales of Field Programmable Gate Array (FPGA)-based emulation and prototyping products.

Most of our customer arrangements are complex, involving hundreds of products and various license rights, bundled with post-contract customer support and additional meaningful rights that provide a complete end-to-end solution to the customer. Throughout the contract, our customers are typically using a myriad of products to complete each phase of a chip design and are concurrently working on multiple chip designs, or projects, in different phases of the design. During this time, the customer looks to us to release state-of-the-art technology as we keep up with the pace of change, to address requested enhancements to our tools to meet customer specifications, to provide support at each stage of the customer's design, including the final manufacturing of the chip (the tape-out stage), and other important services.

With respect to software licenses, we utilize three license types:

•

Technology Subscription Licenses (TSLs). TSLs are time-based licenses for a finite term, and generally provide the customer limited rights to receive, or to exchange certain quantities of licensed software for, unspecified future technology. The majority of our arrangements are TSLs due to the nature of the business and customer requirements. In addition to the licenses, the arrangements also include: post-contract customer support, which includes providing frequent updates and upgrades to maintain the utility of the software due to rapid changes in technology; other intertwined services such as multiple copies of the tools; assisting our customers in applying our technology in their development environment; and rights to remix licenses for other licenses.

•

Term licenses. We also infrequently enter into certain license arrangements wherein licenses are provided for a finite term without any other services or rights, including rights to receive, or to exchange licensed software for, unspecified future technology. Customers purchase maintenance separately for the first year and may renew annually for the balance of the term. The annual maintenance fee is typically calculated as a percentage of the net license fee.

•

Perpetual licenses. Perpetual licenses continue as long as the customer renews maintenance plus an additional 20 years. Perpetual licenses do not provide the customer any rights to receive, or to exchange licensed software for, unspecified future technology. Customers purchase maintenance separately for the first year and may renew annually.

For the three software license types, we recognize revenue as follows:

•

TSLs. We typically recognize revenue from TSL fees ratably over the term of the license period, or as customer installments become due and payable, whichever is later. Revenue attributable to TSLs is reported as "time-based products revenue" in the consolidated statements of operations.

•

Term licenses. We recognize revenue from term licenses in full upon shipment of the software if payment terms require the customer to pay at least 75% of the license fee and 100% of the maintenance fee within one year from shipment and all other revenue recognition criteria are met. Revenue attributable to these term licenses is reported as "upfront products revenue" in the consolidated statements of operations. For term licenses in which less than 75% of the license fee and 100% of the maintenance fee is payable within one year from shipment, we recognize revenue as customer payments become due and payable. Such revenue is reported as "time-based products revenue" in the consolidated statements of operations.

•

Perpetual licenses. We recognize revenue from perpetual licenses in full upon shipment of the software if payment terms require the customer to pay at least 75% of the license fee and 100% of the maintenance fee within one year from shipment and all other revenue recognition criteria are met. Revenue attributable to these perpetual licenses is reported as "upfront products revenue" in the consolidated statements of operations. For perpetual licenses in which less than 75% of the license fee and 100% of the maintenance fee is payable within one year from shipment, we recognize revenue as customer installments become due and payable. Such revenue is reported as "time-based products revenue" in the consolidated statements of operations.

Our maintenance and service revenue consists of maintenance fees associated with perpetual and term software licenses and professional services fees. We recognize revenue from maintenance arrangements ratably over the maintenance period to the extent cash has been received or fees become due and payable, and recognize revenue from professional services and training fees as such services are performed and accepted by the customer. Revenue attributable to maintenance, professional services and training is reported as "maintenance and service revenue" in the consolidated statements of operations.

Hardware revenue consists of sales of FPGA-based emulation and prototyping products. We recognize revenue from sales of hardware products in full upon shipment if all other revenue recognition criteria are met. Revenue attributable to these sales is reported as "upfront products revenue" in the consolidated statements of operations and is not material to our total revenue.

We also enter into arrangements in which portions of revenue are contingent upon the occurrence of uncertain future events, for example, royalty arrangements. We refer to this revenue as "contingent revenue." Contingent revenue is recognized if and when the event that removes the contingency occurs. Such revenue is reported as "time-based products revenue" in the consolidated statements of operations. These arrangements are not material to our total revenue.

We infrequently enter into multiple-element arrangements that contain both software and non-software deliverables such as hardware. We have determined that the software and non-software deliverables in our contracts are separate units of accounting. We recognize revenue for the separate units of accounting when all revenue recognition criteria are met. Revenue allocated to hardware units of accounting is recognized upon shipment when all other revenue recognition criteria are met. Revenue allocated to software units of accounting is recognized depending on the software license type (TSL, term license or perpetual license). Such arrangements have not had a material effect on our consolidated financial statements and are not expected to have a material effect in future periods.

We also enter into arrangements to deliver software products, either alone or together with other products or services that require significant modification, or customization of the software. We account for such arrangements using the percentage of completion method as we have the ability to make reasonably dependable estimates that relate to the extent of progress toward completion, contract revenues and costs. We measure the progress towards completion using the labor hours incurred to complete the project. Revenue attributable to these arrangements is reported as "maintenance and service revenue" in the consolidated statements of operations.

We determine the fair value of each element in multiple element software arrangements that only contain software and software-related deliverables based on vendor-specific objective evidence (VSOE). We limit our assessment of VSOE of fair value for each element to the price charged when such element is sold separately. We have analyzed all of the elements included in our multiple-element software arrangements and have determined that we have sufficient VSOE to allocate revenue to the maintenance components of our perpetual and term license products and to professional services. Accordingly, assuming all other revenue recognition criteria are met, we recognize license revenue from perpetual and term licenses upon delivery using the residual method, recognize revenue from maintenance ratably over the maintenance term, and recognize revenue from professional services as services are performed and accepted by the customer. With respect to TSL arrangements, due to the complexity of the tools, the complexity of the arrangement terms and intertwined services, the license, maintenance and other services are not separable and are considered as a combined unit. Additionally, we do not have sufficient VSOE of fair value to allocate the fee between these services. Therefore, we recognize revenue from TSLs ratably over the term of the license, assuming all other revenue recognition criteria are met.

We make judgments related to revenue recognition. Specifically, in connection with each transaction involving our products, we must evaluate whether: (1) persuasive evidence of an arrangement exists, (2) delivery of software or services has occurred, (3) the fee for such software or services is fixed or determinable, and (4) collectability of the

full license or service fee is probable. All four of these criteria must be met in order for us to recognize revenue with respect to a particular arrangement. We apply these revenue recognition criteria as follows:

•

Persuasive Evidence of an Arrangement Exists. Prior to recognizing revenue on an arrangement, our customary policy is to have a written contract, signed by both the customer and by us or a purchase order from those customers that have previously negotiated a standard end-user license arrangement or purchase agreement.

•

Delivery Has Occurred. We deliver our products to our customers electronically or physically. For electronic deliveries, delivery occurs when we provide access to our customers to take immediate possession of the software through downloading it to the customer's hardware. For physical deliveries, the standard transfer terms are typically Freight on Board (FOB) shipping point. We generally ship our products or license keys promptly after acceptance of customer orders. However, a number of factors can affect the timing of product shipments and, as a result, timing of revenue recognition, including the delivery dates requested by customers and our operational capacity to fulfill product orders at the end of a fiscal quarter.

•

The Fee Is Fixed or Determinable. Our determination that an arrangement fee is fixed or determinable depends principally on the arrangement's payment terms. Our standard payment terms for perpetual and term licenses require 75% or more of the license fee and 100% of the maintenance fee to be paid within one year. If the arrangement includes these terms, we regard the fee as fixed or determinable, and recognize all license revenue under the arrangement in full upon delivery (assuming all other revenue recognition criteria are met). If the arrangement does not include these terms, we do not consider the fee to be fixed or determinable and generally recognize revenue when customer installments are due and payable. In the case of a TSL, because of the right to exchange products or receive unspecified future technology and because VSOE for maintenance services does not exist for a TSL, we recognize revenue ratably over the term of the license, but not in advance of when customers' installments become due and payable.

•

Collectability Is Probable. We judge collectability of the arrangement fees on a customer-by-customer basis pursuant to our credit review policy. We typically sell to customers with whom we have a history of successful collection. For a new customer, or when an existing customer substantially expands its commitments, we evaluate the customer's financial position and ability to pay and typically assign a credit limit based on that review. We increase the credit limit only after we have established a successful collection history with the customer. If we determine at any time that collectability is not probable under a particular arrangement based upon our credit review process or the customer's payment history, we recognize revenue under that arrangement as customer payments are actually received.

Valuation of Business Combinations

We are required to allocate the purchase price to tangible assets, liabilities and contingencies assumed, and intangible assets acquired in a business combination. Any residual purchase price is recorded as goodwill. The allocation of the purchase price requires management to make estimates in determining the fair values of assets acquired and liabilities assumed, especially with respect to intangible assets which are amortized over various estimated useful lives. Our estimates may include, but are not limited to, future cash flows of an acquired business, the appropriate discounted rate, and the cost savings expected to be derived from an acquisition. These estimates are inherently difficult, subjective and unpredictable, and if different estimates were used, the purchase price allocation to the acquired assets and liabilities could be different. In addition, we make judgments and estimates when we assign useful lives to intangible assets identified as part of our acquisitions. These estimates are also inherently uncertain and if we used different estimates, the useful life over which we amortize intangible assets would be different. Therefore, our assessment of the estimated fair value of each of these assets and liabilities can have a material effect on our Consolidated Financial Statements.

Valuation of Intangible Assets

We evaluate our intangible assets for indications of impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Intangible assets consist of purchased technology, contract rights intangibles, customer relationships, trademarks and trade names, covenants not to compete, capitalized software development, and in-process research and development. Factors that could trigger an impairment review include significant under-performance relative to expected historical or projected future operating results, significant changes in the manner of our use of the acquired assets or the strategy for our overall business or significant

negative industry or economic trends. If this evaluation indicates that the value of the intangible asset may be impaired, we make an assessment of the recoverability of the net carrying value of the asset over its remaining useful life. If this assessment indicates that the intangible asset is not recoverable, based on the estimated undiscounted future cash flows of the technology over the remaining useful life, we reduce the net carrying value of the related intangible asset to fair value. Any such impairment charge could be significant and could have a material adverse effect on our reported financial results. We did not record any impairment charges on our intangible assets during fiscal 2016, 2015 or 2014.

Income Taxes

Our estimates and assumptions made in our tax provisions may differ from the actual results as reflected in our income tax returns and we record the required adjustments when they are identified or resolved.

We recognize deferred tax assets and liabilities for the temporary differences between the book and tax bases of assets and liabilities using enacted tax rates in effect for the year in which we expect the differences to reverse, and for tax loss and credit carryovers. We record a valuation allowance to reduce the deferred tax assets to the amount that is more likely than not to be realized. In evaluating our ability to utilize our deferred tax assets, we consider all available positive and negative evidence, including our past operating results, our forecast of future taxable income on a jurisdiction by jurisdiction basis, as well as feasible and prudent tax planning strategies. These assumptions require judgment about the forecasts of future taxable income and are consistent with the plans and estimates we are using to manage the underlying businesses. We believe that the net deferred tax assets of approximately $281.0 million that are recorded on our balance sheet as of October 31, 2016 will ultimately be realized. However, if we determine in the future that it is more likely than not we will not be able to realize a portion or the full amount of deferred tax assets, we would record an adjustment to the deferred tax asset valuation allowance as a charge to earnings in the period such determination is made.

We apply a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining whether it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement. An uncertain tax position is considered effectively settled on completion of an examination by a taxing authority if certain other conditions are satisfied.

The calculation of tax liabilities involves inherent uncertainty associated with the application of complex tax laws, significant assumptions, judgments and estimates including forward-looking financial projections and geographical mix of earnings. We are also subject to examination by various taxing authorities. We believe we have adequately provided in our financial statements for potential additional taxes. If we ultimately determine that these amounts are not owed, we would reverse the liability and recognize the tax benefit in the period in which we determine that the liability is no longer necessary. If an ultimate tax assessment exceeds our estimate of tax liabilities, we would record an additional charge to earnings.

Results of Operations

Revenue Background

We generate our revenue from the sale of products that include software licenses, maintenance and professional services, and to a lesser extent, hardware products. Under current accounting rules and policies, we recognize revenue from orders we receive for software licenses, services and hardware products at varying times.

•

In most instances, we recognize revenue on a TSL software license order over the license term and on a term or perpetual software license order in the quarter in which the license is delivered. The weighted-average license term of the TSLs and term licenses is typically approximately three years, but varies from quarter to quarter due to the nature and timing of the arrangements entered into during the quarter. The weighted-average license term of the TSLs and term licenses we entered into in fiscal 2016, 2015, and 2014 was 3.0 years, 2.7 years and 2.9 years, respectively.

•

Revenue on contracts requiring significant modification or development is accounted for using the percentage of completion method over the period of the development.

•

Revenue on hardware product orders is generally recognized in full at the time the product is shipped and when title is transferred.

•

Contingent revenue is recognized if and when the event that removes the contingency occurs.

•

Revenue on maintenance orders is recognized ratably over the maintenance period (normally one year).

•

Revenue on professional services orders is generally recognized as the services are performed.

Our revenue in any period is equal to the sum of our time-based products, upfront products, and maintenance and services for the period. We derive time-based products revenue largely from TSL orders received and delivered in prior quarters and to a smaller extent from contracts in which revenue is recognized as customer installments become due and payable and from contingent revenue arrangements. We derive upfront products revenue directly from term and perpetual license and hardware product orders mostly booked and shipped during the period. We derive maintenance revenue largely from maintenance orders received in prior periods since our maintenance orders generally yield revenue ratably over a term of one year. We also derive professional services revenue primarily from orders received in prior quarters, since we recognize revenue from professional services as those services are delivered and accepted or on percentage of completion for arrangements requiring significant modification of our software, and not when they are booked.

Our revenue is sensitive to the mix of TSLs and perpetual or term licenses delivered during a reporting period. A TSL order typically yields lower current quarter revenue but contributes to revenue in future periods. For example, a $120,000 order for a three-year TSL delivered on the last day of a quarter typically generates no revenue in that quarter, but $10,000 in each of the 12 succeeding quarters. Conversely, a $120,000 order for perpetual and term licenses with greater than 75% of the license fee due within one year from shipment typically generates $120,000 in revenue in the quarter the product is delivered, but no future revenue. Additionally, revenue in a particular quarter may also be impacted by perpetual and term licenses in which less than 75% of the license fees and 100% of the maintenance fees are payable within one year from shipment as the related revenue will be recognized as revenue in the period when customer payments become due and payable.

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 a highly competitive EDA market. Customers generally negotiate the total value of the arrangement rather than just unit pricing or volumes.

Total Revenue

Year Ended October 31,

$ Change

% Change

$ Change

% Change

2016

2015

2014

2015 to 2016

2014 to 2015

(dollars in millions)

2,422.5

2,242.2

2,057.5

180.3

184.7

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 payment terms and the timing and value of contract renewals. For example, we experience variability in our revenue due to factors such as the timing of IP consulting projects, royalties, variability in hardware sales and due to certain contracts where revenue is recognized when customer installment payments are due.

The sequential increase in total revenue from fiscal 2014 through fiscal 2016 was primarily attributable to the overall growth in our business mainly due to higher TSL revenues and hardware sales.

Time-Based Products Revenue

Year Ended October 31,

$ Change

% Change

$ Change

% Change

2016

2015

2014

2015 to 2016

2014 to 2015

(dollars in millions)

1,910.9

1,792.2

1,699.1

118.7

93.1

Percentage of total revenue

The increase in time-based products revenue for fiscal 2016 compared to fiscal 2015 was primarily attributable to an increase in TSL license revenue due to the overall growth in our business, including arrangements booked in prior periods and, to a lesser extent, contributions from acquisitions.

The increase in time-based products revenue for fiscal 2015 compared to fiscal 2014 was primarily attributable to an increase in TSL license revenue due to our overall growth, including contributions of revenue from acquired companies.

Upfront Products Revenue

Year Ended October 31,

$ Change

% Change

$ Change

% Change

2016

2015

2014

2015 to 2016

2014 to 2015

(dollars in millions)

248.1

197.3

135.8

50.8

61.5

Percentage of total revenue

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

The increase in upfront products revenue for fiscal 2016 compared to fiscal 2015, and for fiscal 2015 compared to fiscal 2014, was primarily attributable to an increase in the sale of hardware products driven by timing of customer requirements.

As our sales of hardware products grow, upfront products revenue may increase, but we expect it to remain consistent with our business model, in which approximately 90% of our total revenue is attributable to time-based products, maintenance and professional services revenue on an annual basis.

Maintenance and Service Revenue

Year Ended October 31,

$ Change

% Change

$ Change

% Change

2016

2015

2014

2015 to 2016

2014 to 2015

(dollars in millions)

Maintenance revenue

74.4

70.1

74.3

4.3

(4.2

)

Professional service and other revenue

189.1

182.6

148.3

6.5

34.3

Total

263.5

252.7

222.6

10.8

30.1

Percentage of total revenue

The increase in maintenance revenue for fiscal 2016 compared to fiscal 2015 was primarily due to an increase in the volume of arrangements that include maintenance.

The decrease in maintenance revenue for fiscal 2015 compared to fiscal 2014 was primarily due to the timing of contract renewals and the type of contracts that bundle maintenance.

The increase in professional services and other revenue for fiscal 2016 compared to fiscal 2015 was primarily due to the timing of IP consulting projects that are accounted for using the percentage of completion method.

The increase in professional services and other revenue for fiscal 2015 compared to fiscal 2014 was primarily due to the increase in, and timing of, IP consulting projects that are accounted for using the percentage of completion method.

Cost of Revenue and Operating Expenses

Year Ended October 31,

$ Change

% Change

$ Change

% Change

2016

2015

2014

2015 to 2016

2014 to 2015

(dollars in millions)

Cost of revenue

543.0

518.9

456.9

24.1

62.0

Operating expenses

1,562.2

1,456.8

1,351.9

105.4

104.9

Total

2,105.2

1,975.7

1,808.8

129.5

166.9

Total expenses as a percentage of total revenue

Our expenses are generally impacted by changes in personnel-related costs including salaries, benefits, stock compensation and variable compensation; changes in amortization; and changes in selling and marketing expenses. The increase in our expenses compared to prior fiscal years was primarily due to an increase in personnel-related costs, driven by increased headcount from our overall growth, including those from acquisitions, and related fixed charges including facilities, as well as higher product costs due to increased hardware sales. We allocate certain human resource programs, information technology and facility expenses among our functional income statement categories based on headcount within each functional area. Annually, or upon a significant change in headcount (such as a workforce reduction, realignment or acquisition) or other factors, management reviews the allocation methodology and expenses included in the allocation pool.

Foreign currency fluctuations, net of hedging, did not have a significant impact on expenses during fiscal 2016 as compared to fiscal 2015, or fiscal 2015 as compared to fiscal 2014. See Note 5 of Notes to Consolidated Financial Statements for details on our foreign exchange hedging programs.

Cost of Revenue

Year Ended October 31,

$ Change

% Change

$ Change

% Change

2016

2015

2014

2015 to 2016

2014 to 2015

(dollars in millions)

Cost of products revenue

346.9

303.6

268.4

43.3

35.2

Cost of maintenance and service revenue

94.0

105.3

87.2

(11.3

)

(11

18.1

Amortization of intangible assets

102.1

110.0

101.3

(7.9

)

8.7

Total

543.0

518.9

456.9

24.1

62.0

Percentage of total revenue

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 have 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.

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 fiscal 2016 compared to fiscal 2015 was primarily due to increases of $24.2 million in product costs due to increased sales, $19.7 million in personnel-related costs as a result of headcount increases, which were partially offset by decreases of $13.4 million in costs related to our professional services revenue and $7.9 million in amortization of intangible assets.

The increase in cost of revenue for fiscal 2015 compared to fiscal 2014 was primarily due to increases of $19.8 million in product costs due to increased sales, $16.8 million in costs related to our professional services revenue, $11.4 million in personnel-related costs driven by higher headcount, including those from acquisitions, $8.7 million in amortization of intangible assets, and higher functionally allocated expenses of $2.6 million.

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

Operating Expenses

Research and Development

Year Ended October 31,

$ Change

% Change

$ Change

% Change

2016

2015

2014

2015 to 2016

2014 to 2015

(dollars in millions)

856.7

776.2

718.8

80.5

57.4

Percentage of total revenue

The increase in research and development expense in fiscal 2016 compared to fiscal 2015 was primarily due to increases of $64.3 million in personnel-related costs as a result of headcount increases, including those from acquisitions, $5.7 million in consultant and contractor costs, $5.1 million in research and development supplies, and functionally allocated expenses that were higher by $3.0 million.

The increase in research and development expense in fiscal 2015 compared to fiscal 2014 was primarily due to an increase of $39.6 million in personnel-related costs driven by headcount increases, including those from acquisitions, and functionally allocated expenses that were higher by $12.0 million.

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

Sales and Marketing

Year Ended October 31,

$ Change

% Change

$ Change

% Change

2016

2015

2014

2015 to 2016

2014 to 2015

(dollars in millions)

502.4

474.4

453.1

28.0

21.3

Percentage of total revenue

Changes in commissions and other variable compensation are generally attributable to the volume of contracts and timing of shipments based on contract requirements.

The increase in sales and marketing expense for fiscal 2016 compared with fiscal 2015 was primarily due to an increase of $26.7 million in personnel costs as a result of higher headcount and higher variable compensation primarily based on timing of shipments.

The increase in sales and marketing expense for fiscal 2015 compared with fiscal 2014 was primarily due to an increase of $13.5 million in personnel-related costs driven by headcount increases, including those from acquisitions, $2.4 million in variable compensation due to higher shipments and higher functionally allocated expenses of $2.7 million.

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

General and Administrative

Year Ended October 31,

$ Change

% Change

$ Change

% Change

2016

2015

2014

2015 to 2016

2014 to 2015

(dollars in millions)

166.0

165.1

155.2

0.9

9.9

Percentage of total revenue

General and administrative expenses for fiscal 2016 compared with fiscal 2015 remained relatively flat as increases of $5.2 million in maintenance costs and $2.5 million in professional service costs were offset by $7.2 million of lower facilities expenses.

The increase in general and administrative expenses for fiscal 2015 compared with fiscal 2014 was primarily due to increases of $20.0 million in facilities and depreciation expenses including those from acquisitions, $3.9 million in

personnel-related costs primarily due to higher headcount, and $5.2 million in acquisition-related professional services costs. The increases were partially offset by higher allocations of $20.5 million in expenses to other functions compared to the same period in fiscal 2014, due to increased spending in allocated costs, resulting from increased headcount.

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

Change in Fair Value of Deferred Compensation

The income or loss arising from the change in fair value of our non-qualified deferred compensation plan obligation is recorded in cost of sales and each functional operating expense, with the offsetting change in the fair value of the related assets recorded in other income (expense), net. These assets are classified as trading securities. There is no overall impact to our net income from the income or loss of our deferred compensation plan obligation and asset.

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, covenants not to compete, and in-process research and development related to acquisitions completed in prior years. Amortization expense is included in the consolidated statements of operations as follows:

Year Ended October 31,

$ Change

% Change

$ Change

% Change

2016

2015

2014

2015 to 2016

2014 to 2015

(dollars in millions)

Included in cost of revenue

102.1

110.0

101.3

(7.9

)

8.7

Included in operating expenses

27.5

26.0

24.8

1.5

1.2

Total

129.6

136.0

126.1

(6.4

)

9.9

Percentage of total revenue

Amortization of capitalized software development costs is not presented in the above table and is included in cost of products revenue in the consolidated statements of operations.

The decrease in amortization of intangible assets for fiscal 2016 compared with fiscal 2015 was primarily due to intangible assets that were fully amortized, partially offset by additions of acquired intangible assets.

The increase in amortization of intangible assets for fiscal 2015 compared with fiscal 2014 was primarily due to the additions of acquired intangible assets, including from our fiscal 2015 acquisitions, which were partially offset by certain intangible assets being fully amortized.

Restructuring Charges

During fiscal 2016, we recorded $9.6 million of restructuring charges for severance and benefits due to involuntary employee terminations. As of October 31, 2016, there was a $5.7 million outstanding balance remaining in accounts payable and accrued liabilities in the consolidated balance sheets. The remaining balance will be paid in fiscal 2017.

During fiscal 2015, we recorded $15.1 million of restructuring charges pursuant to the fiscal 2015 restructuring program, which included a voluntary retirement program (VRP) and a minimal headcount reduction program. The fiscal 2015 restructuring program was completed as of October 31, 2015.

The following is a summary of our restructuring activities:

Balance at Beginning of Period

Costs Incurred (Reduced)

Cash Payments

Balance at End of Period

(in millions)

Fiscal 2016

9.6

(3.9

)

5.7

Fiscal 2015

15.1

(15.1

)

See Note 2 of Notes to Consolidated Financial Statements.

Other Income (Expense), Net

Year Ended October 31,

$ Change

% Change

$ Change

% Change

2016

2015

2014

2015 to 2016

2014 to 2015

(dollars in millions)

Interest income

3.7

2.8

1.3

0.9

1.5

115

Interest expense

(3.8

)

(2.8

)

(1.9

)

(1.0

)

(0.9

)

Gain (loss) on assets related to executive deferred compensation plan

4.4

3.7

10.8

0.7

(7.1

)

(66

Foreign currency exchange gain (loss)

0.2

6.3

1.2

(6.1

)

(97

5.1

425

Other, net

7.7

5.1

12.0

2.6

(6.9

)

(58

Total

12.2

15.1

23.4

(2.9

)

(19

(8.3

)

(35

The net decrease in other income (expense) in fiscal 2016 as compared to fiscal 2015 was primarily due to lower gains in foreign currency exchange as a result of the weakened U.S. dollar against the related foreign currencies, partially offset by increased income on foreign exchange hedging contracts that was recorded in Other, net.

The net decrease in other income (expense) in fiscal 2015 as compared to fiscal 2014 was primarily due to a gain from the sale of a non-marketable equity investment in fiscal 2014, and lower gains in the market value of our executive deferred compensation plan assets, which were partially offset by increased foreign currency exchange gains in the current year as a result of the strengthened U.S. dollar against the related foreign currencies.

Income Taxes

Our effective tax rate for fiscal 2016 included tax benefits from a settlement with the Internal Revenue Service (IRS) of $20.7 million for fiscal 2015 and the permanent reinstatement of the U.S. federal research tax credit of approximately $37.1 million, partially offset by tax expense from the integration of acquired technologies of $37.5 million, the impact of undistributed foreign earnings of $9.6 million, and an increase in the valuation allowance on deferred tax assets of $14.0 million as a result of changes in the expected utilization of state credits. The reinstatement of the research tax credit resulted in an additional tax credit for ten months of fiscal 2015 as well as twelve months of fiscal 2016, which was recorded in fiscal 2016. Our effective tax rate for fiscal 2015 included tax expense from the integration of acquired technologies of $33.0 million partially offset by tax benefits from the reinstatement of the U.S. federal research tax credit of approximately $12.4 million, a settlement with the IRS of $4.0 million for fiscal 2014, and a settlement with the Taiwan tax authorities of $2.3 million (net tax benefit resulting from fiscal years 2012 and 2013). The reinstatement of the research tax credit resulted in an additional tax credit for ten months of fiscal 2014 as well as two months of fiscal 2015, which was recorded in fiscal 2015. Our effective tax rate for fiscal 2014 included tax benefits from a settlement with the IRS of $15.5 million (for fiscal years 2012 through 2013), from federal statute of limitations lapses of $6.7 million, and a settlement with the Taiwan tax authorities of $3.9 million (net tax benefit resulting from fiscal years 2009 and 2010 and application of settlements to other open fiscal years).

The integration of acquired technologies represents the income tax effect resulting from the transfer of certain intangible assets among company-controlled entities. The income tax effect is generally recognized over five years. These intangible assets generally result from the acquisition of technology by a company-controlled entity as part of a business or asset acquisition. For further discussion of the provision for income taxes and settlements, see Note 11 of Notes to Consolidated Financial Statements.

Liquidity and Capital Resources

Our sources of cash, cash equivalents and short-term investments are funds generated from our business operations and funds that may be drawn down under our revolving credit and term loan facilities.

As of October 31, 2016, we held an aggregate of $165.8 million in cash, cash equivalents and short-term investments in the United States and an aggregate of $951.5 million in our foreign subsidiaries. Certain amounts held outside the U.S. could be repatriated to the U.S. (subject to local law restrictions), but under current U.S. tax law, could be subject to U.S. income taxes less applicable foreign tax credits. We have provided for the U.S. income tax liability on foreign earnings, except for foreign earnings that are considered indefinitely reinvested outside the U.S. However, in the event funds from foreign subsidiaries were needed to fund cash needs in the U.S. and if U.S. taxes have not already been previously accrued, we would be required to accrue and pay additional U.S. taxes in order to repatriate these funds.

The following sections discuss changes in our consolidated balance sheets and statements of cash flow, and other commitments of our liquidity and capital resources during fiscal 2016.

Cash, Cash Equivalents and Short-Term Investments

Year Ended October 31,

$ Change

% Change

2016

2015

(dollars in millions)

Cash and cash equivalents

976.6

836.2

140.4

Short-term investments

140.7

128.7

12.0

Total

1,117.3

964.9

152.4

Cash, cash equivalents and short-term investments increased primarily due to cash generated from our operations and cash received from employee stock option exercises. Cash generated was partially offset by cash used for purchases of treasury stock under our stock repurchase program, purchases of property and equipment, cash paid for acquisitions and intangible assets and payments for taxes related to net share settlement of equity awards.

Cash Flows

Year Ended October 31,

$ Change

2016

2015

2014

2015 to 2016

2014 to 2015

(dollars in millions)

Cash provided by operating activities

586.6

495.2

551.0

91.4

(55.8

)

Cash used in investing activities

(142.7

)

(559.6

)

(497.3

)

416.9

(62.3

)

Cash used in financing activities

(306.9

)

(62.1

)

(73.7

)

(244.8

)

11.6

Cash Provided by Operating Activities

We expect cash from our operating activities to fluctuate as a result of a number of factors, including the timing of our billings and collections, our operating results, and the timing and amount of tax and other liability payments. Cash provided by our operations is dependent primarily upon the payment terms of our license agreements. We generally receive cash from upfront arrangements much sooner than from time-based products revenue, in which the license fee is typically paid either quarterly or annually over the term of the license.

Fiscal 2016 compared to fiscal 2015. The increase in cash provided by operating activities was primarily driven by higher cash collections, partially offset by higher disbursements for operations, including vendors.

Fiscal 2015 compared to fiscal 2014. The decrease in cash provided by operating activities was primarily driven by higher disbursements for operations, including vendors, which were partially offset by higher cash collections.

Cash Used in Investing Activities

Fiscal 2016 compared to fiscal 2015. The decrease in cash used in investing activities was primarily driven by lower cash paid for acquisitions and intangible assets of $280.1 million, lower purchases of short-term investments of $70.2 million, higher proceeds from the sales and maturities of short-term investments of $47.2 million, and lower purchases of property and equipment of $20.1 million.

Fiscal 2015 compared to fiscal 2014. The increase in cash used in investing activities was primarily driven by purchases of short-term investments, net of proceeds from the sales of our short-term investments, of $129.7 million, partially offset by a decrease in cash paid for acquisitions and intangible assets, net of cash acquired, of $54.5 million.

Cash Used in Financing Activities

Fiscal 2016 compared to fiscal 2015. The increase in cash used in financing activities was primarily due to lower proceeds from the drawdown of our senior unsecured revolving credit facility of $275.0 million and higher stock repurchase activities of $120.0 million, partially offset by lower debt repayments of $145.4 million.

Fiscal 2015 compared to fiscal 2014. The decrease in cash used in financing activities was primarily due to an increase of proceeds from our senior unsecured revolving credit facility of $260.0 million which was partially offset by an increase of $160.3 million for our stock repurchase activities and an increase of $99.5 million for repayment of debt.

Accounts Receivable, net

Year Ended October 31,

2016

2015

$ Change

% Change

(dollars in millions)

$438.9

$385.7

$53.2

14%

Our accounts receivable and days sales outstanding (DSO) are primarily driven by our billing and collections activities. Our DSO was 63 days at October 31, 2016 and 60 days at October 31, 2015. The increase in DSO is primarily due to the timing of billings and contract renewals.

Working Capital

Working capital is comprised of current assets less current liabilities, as shown on our consolidated balance sheets:

Year Ended October 31,

2016

2015

$ Change

% Change

(dollars in millions)

Current assets

1,716.9

1,468.8

248.1

Current liabilities

1,714.9

1,578.4

136.5

Working capital

2.0

(109.6

)

111.6

(102

Working capital at the end of fiscal 2016 was higher than at the end of fiscal 2015 primarily due to a $152.4 million increase in cash, cash equivalents and short-term investments, and a $53.2 million increase in accounts receivable. These changes in working capital were partially offset primarily due to a $117.6 million increase in deferred revenue.

Other

Our available-for-sale securities as of October 31, 2016 consisted of investment-grade U.S. government agency securities, asset-backed securities, corporate debt securities, commercial paper, certificates of deposit, money market funds, and others. We follow an established investment policy and set of guidelines to monitor, manage and limit our exposure to interest rate and credit risk. The policy sets forth credit quality standards and limits our exposure to any one issuer. As of October 31, 2016, we had no direct holdings in structured investment vehicles, sub-prime mortgage-backed securities or collateralized debt obligations and no exposure to these financial instruments through our indirect holdings in money market mutual funds. During fiscal 2016, we had no impairment charge associated with our available-for-sale securities portfolio. While we cannot predict future market conditions or market liquidity, we regularly review our investments and associated risk profiles, which we believe will allow us to effectively manage the risks of our investment portfolio.

We proactively manage our cash equivalents and short-term investments balances and closely monitor our capital and stock repurchase expenditures to ensure ample liquidity. Additionally, we believe the overall credit quality of our portfolio is strong, with our global excess cash, and our cash equivalents and fixed income portfolio, invested in banks and securities with a weighted-average credit rating exceeding AA. The majority of our investments are classified as Level 1 or Level 2 investments, as measured under fair value guidance. See Notes 5 and 6 of Notes to Consolidated Financial Statements.

We believe that our current cash and cash equivalents, short-term investments, cash generated from operations, and available credit under our Revolver (defined below) will satisfy our routine business requirements for at least the next 12 months and the foreseeable future.

Other Commitments - Credit and Term Loan Facilities

On February 17, 2012, we entered into an agreement with several lenders (the Credit Agreement) providing for (i) a $350.0 million senior unsecured revolving credit facility (the Revolver) and (ii) a $150.0 million senior unsecured term loan facility (the Term Loan). Principal payments on a portion of the Term Loan were due in equal quarterly installments of $7.5 million, with the remaining balance paid in October 2016. On May 19, 2015, the Credit Agreement was amended and restated in order to increase the size of the Revolver from $350.0 million to $500.0 million and to extend the termination date of the Revolver from October 14, 2016 to May 19, 2020. The amended and restated Credit Agreement also replaced a financial covenant requiring us to maintain a minimum specified level of cash with a covenant requiring a minimum interest coverage ratio. Subject to obtaining additional commitments from lenders, the principal amount of the loans provided under the amended and restated Credit Agreement may be increased by us by up to an additional $150.0 million through May 2019. The amended and restated Credit Agreement contains financial covenants requiring us to operate within a maximum leverage ratio and a minimum interest coverage ratio, as well as other non-financial covenants. As of October 31, 2016, we were in compliance with all financial covenants.

As of October 31, 2016, we had no outstanding balance under the Term Loan and a $205.0 million outstanding balance under the Revolver, which are considered short-term liabilities. As of October 31, 2015, we had a $45.0 million outstanding balance under the Term Loan and a $160.0 million outstanding balance under the Revolver, all of which are considered short-term liabilities. Borrowings bear interest at a floating rate based on a margin over our choice of market observable base rates as defined in the amended and restated Credit Agreement. As of October 31, 2016, 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 our leverage ratio on the daily amount of the revolving commitment.

The Credit Agreement was amended and restated on November 28, 2016. See Note 5 of Notes to Consolidated Financial Statements for details.

Contractual Obligations

The following table summarizes our contractual obligations as of October 31, 2016:

Total

Fiscal 2017

Fiscal 2018/ Fiscal 2019

Fiscal 2020/ Fiscal 2021

Thereafter

Other

(in thousands)

Lease Obligations:

Operating Leases(1)

385,493

52,373

97,444

64,636

171,040

Purchase Obligations(2)

144,879

143,554

1,232

Revolver(3)

205,000

Other Long-Term Obligations(4)

2,440

675

1,350

415

Long term accrued income taxes(5)

39,562

Total

777,374

401,602

100,026

65,144

171,040

39,562

(1)

See Note 7 of Notes to Consolidated Financial Statements.

(2)

Purchase obligations represent an estimate of all open purchase orders and contractual obligations in the ordinary course of business for which we have not received the goods or services as of October 31, 2016.

Although open purchase orders are considered enforceable and legally binding, the terms generally allow us the option to cancel, reschedule and adjust our requirements based on our business needs prior to the delivery of goods or performance of services.

(3)

This commitment relates to the principal balance of the Revolver as discussed in Other Commitments above.

(4)

These other obligations include fees associated with our Revolver.

(5)

Long-term accrued income taxes represent uncertain tax benefits as of October 31, 2016. Currently, a reasonably reliable estimate of timing of payments in individual years beyond fiscal 2016 cannot be made due to uncertainties in timing of the commencement and settlement of potential tax audits.

The expected timing of payments of the obligations discussed above is estimated based on current information. Timing of payment and actual amounts paid may be different depending on the time of receipt of goods or services or changes to agreed-upon amounts for some obligations.

Off-Balance Sheet Arrangements

As of October 31, 2016, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.