Synopsys, Inc. — Q3 FY2022 Form 10-Q
Reporting period: Fiscal quarter ended July 31, 2022; nine-month year-to-date period ended the same date. Amounts below are in U.S. dollars. Unless noted, comparisons are with the corresponding fiscal 2021 period.
Business context
Synopsys provides electronic design automation (EDA), semiconductor intellectual property (IP), systems design and validation products, and software security and quality tools. Its reportable segments are Semiconductor & System Design and Software Integrity. Software license revenue is substantially recognized over contract terms, so current-period revenue often reflects prior-period selling activity.
Key financial metrics
| Metric | Q3 FY2022 | Q3 FY2021 | Nine months FY2022 | Nine months FY2021 |
|---|---|---|---|---|
| Revenue | $1,247.8 million | $1,057.1 million | $3,797.3 million | $3,051.8 million |
| Gross margin | 78.3% | 80.6% | 79.4% | 79.5% |
| Operating income | $233.9 million | $201.9 million | $944.7 million | $544.5 million |
| Operating margin | 18.8% | 19.1% | 24.9% | 17.8% |
| Net income attributable to Synopsys | $222.6 million | $198.6 million | $831.1 million | $556.1 million |
| Diluted EPS | $1.43 | $1.27 | $5.31 | $3.54 |
| Cash from operating activities | Not separately presented for the quarter | Not separately presented for the quarter | $1,345.4 million | $1,122.1 million |
Q3 revenue increased 18%, operating income 16%, and diluted EPS 13%. Year-to-date revenue increased 24%, operating income 74%, and diluted EPS 50%. Q3 gross and operating margins were lower year over year; year-to-date operating margin improved substantially.
- Revenue mix, Q3: Time-based products $754.3 million (+13%); upfront products $268.6 million (+32%); maintenance and service $224.9 million (+19%). Upfront products rose to 22% of revenue from 19%.
- Segments, Q3: Semiconductor & System Design revenue was $1,129.4 million (+18%) with a 34% adjusted operating margin, unchanged year over year. Software Integrity revenue was $118.3 million (+21%) with a 10% adjusted operating margin, versus 9%.
- Liquidity and debt, July 31: Cash, cash equivalents and short-term investments totaled $1,531.2 million, compared with $1,580.8 million at October 31, 2021. Debt was $22.0 million, all under a China facility; there were no borrowings under the $650 million revolving facility. The company reported compliance with its credit covenants.
- Cash deployment, nine months: Investing activities used $531.3 million, including $416.3 million net cash paid for acquisitions and $102.9 million for property and equipment. Financing activities used $825.2 million, including $717.3 million for treasury-stock purchases and $76.8 million for debt repayment.
- Contract visibility: Deferred revenue was $1,920.6 million, up from $1,653.9 million at October 31, 2021. Contracted unsatisfied or partially unsatisfied performance obligations were approximately $7.1 billion, including $998.1 million of non-cancellable customer FSA commitments. Excluding FSA commitments, approximately 42% was expected to be recognized over the next 12 months.
Material changes and notable items
- Management attributed revenue growth to continued organic growth across product groups and geographies. Semiconductor & System Design revenue grew 18% in Q3; Software Integrity grew 21%.
- Upfront revenue growth reflected higher IP and hardware sales. Management cautioned that the timing of IP sales, hardware shipments and customer FSA drawdowns can cause revenue variability; hardware generally has lower gross margins than software.
- Q3 total cost of revenue and operating expenses rose 19%, with management citing higher employee-related costs, largely associated with headcount growth and acquisitions. Stock-based compensation expense increased to $127.6 million from $85.2 million in Q3.
- Year-to-date other income (expense) shifted to a $41.3 million expense from $61.9 million income, primarily due to losses on executive deferred compensation plan assets ($50.0 million expense versus $62.7 million gains). This volatility materially affected the comparison of pretax income.
- Synopsys acquired WhiteHat Security in June 2022 for $330.1 million cash consideration. The preliminary allocation included $247.7 million of goodwill and $97.5 million of intangible assets. The company also acquired other businesses during the year, including a 75% interest in OpenLight; its redeemable non-controlling interest was valued at $43.5 million at quarter-end.
- The company repurchased $752.3 million of shares during the first nine months under its program; $242.7 million remained authorized at July 31. The remaining $40 million settlement under the May 2022 accelerated repurchase agreement occurred in August.
Outlook, risks and contingencies
- The filing provides no clear quantified revenue or earnings guidance for the next quarter or full year. Management said existing liquidity and funding sources should be sufficient for cash requirements and the capital return program over the next 12 months and beyond, while noting that future cash needs depend on growth, R&D, acquisitions and repurchases.
- Management reported no material operating impact to date from COVID-19, inflation, or the global semiconductor shortage, but identified continued uncertainty. Risks include economic weakness, customer spending changes, supply-chain constraints, rising costs and interest rates, and volatility in upfront product demand.
- International operations expose the company to foreign-exchange movements, export restrictions and geopolitical developments. Synopsys suspended business operations in Russia in Q2; it said Russia and Belarus were not a material portion of its business, but restrictions prevent certain exports and support there.
- The Hungarian Tax Authority assessed approximately $25 million of withholding taxes plus $11 million of interest and penalties against a Synopsys subsidiary. The assessment was paid as required by Hungarian law; litigation remained ongoing, with another hearing scheduled for September 22, 2022. The filing does not provide a clear estimate of the ultimate outcome.
- The Inflation Reduction Act, enacted August 16, 2022, includes a 15% minimum tax effective for Synopsys in FY2024 and a 1% excise tax on covered stock repurchases after December 31, 2022. The company was assessing the effects and preliminarily did not expect a material impact from the repurchase tax. The CHIPS and Science Act was also enacted; Synopsys was evaluating potential opportunities.
- Other stated risks include competition and customer concentration; cybersecurity and intellectual-property threats; acquisition integration; tax uncertainty; and routine litigation. Management said disclosure controls were effective and there were no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the strong growth in upfront IP and hardware revenue is sustainable, and how product mix affects gross margins and quarterly variability.
- How much of the $7.1 billion performance-obligation balance converts to revenue, including the timing and customer drawdown of FSA commitments.
- Whether acquisition-related costs, acquired goodwill and intangible assets, and OpenLight’s redeemable minority interest evolve as expected.
- The impact of deferred compensation asset volatility, stock-based compensation and share repurchases on reported earnings, cash flow and per-share results.
- The eventual outcome and financial effect of the Hungarian tax dispute, and any material effects from new U.S. tax legislation.
- Any subsequent changes in demand, supply constraints, export controls, cybersecurity exposure, liquidity needs or the company’s outlook; this filing does not include quantified forward guidance.