Business context and reporting period
Synopsys provides electronic design automation software, semiconductor intellectual property, hardware, and software quality and security products and services. This Form 10-Q covers fiscal Q2 and the six months ended April 30, 2017; comparisons are with the corresponding 2016 periods. The company reports as one operating segment.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $680.1 million | $605.0 million | $1,332.9 million | $1,173.6 million |
| Gross margin | $518.0 million; 76.2% | $473.4 million; 78.2% | $1,015.1 million; 76.1% | $912.5 million; 77.8% |
| Operating income | $53.6 million; 7.9% | $86.8 million; 14.3% | $150.5 million; 11.3% | $157.9 million; 13.5% |
| Net income | $53.3 million | $69.4 million | $139.9 million | $129.4 million |
| Diluted EPS | $0.34 | $0.45 | $0.90 | $0.84 |
- Q2 revenue rose 12%; six-month revenue rose 14%. Q2 revenue comprised time-based products of $501.1 million, upfront products of $83.5 million, and maintenance and service of $95.5 million.
- Q2 net income fell 23% year over year, while six-month net income increased 8%. Q2 effective tax rate was 14.1%, versus 28.6% a year earlier; the six-month rates were 17.9% and 19.9%, respectively.
- For the six months, operating cash flow was $169.9 million, down from $187.3 million. Investing cash use was $218.5 million, including $187.6 million for acquisitions and intangible assets; financing provided $66.8 million. Cash and cash equivalents ended at $991.3 million.
- Cash, cash equivalents, and short-term investments totaled $1.132 billion. Total debt was approximately $418 million ($270 million revolver and $147.7 million term loan, net of debt issuance costs); the company had net cash of about $714 million on that basis.
- Working capital was $88.7 million, compared with $2.0 million at October 31, 2016. Deferred revenue was $1.034 billion, including current and long-term balances.
Material changes versus prior period
- Q2 operating income declined $33.2 million despite higher revenue. Management attributed the increase in costs and expenses to litigation accruals, higher headcount and acquisition costs, higher hardware and consulting costs, and variable compensation.
- General and administrative expense doubled to $83.4 million, primarily reflecting a $38 million litigation-related accrual. Restructuring expense rose to $12.9 million in Q2 and $25.0 million for six months; total charges under the 2017 plans were estimated at $32–$34 million.
- Upfront product revenue increased 43% in Q2, largely due to hardware sales; maintenance and service revenue increased 53%, mainly from IP consulting projects and acquisitions. Time-based product revenue increased 3%.
- Six-month acquisition and intangible-asset cash outlays increased substantially from the prior-year period. Acquisitions completed in the first half had aggregate consideration of $188.1 million, net of cash acquired.
Outlook, risks, contingencies, and unusual items
- Management described the business outlook as solid, citing technology, customer relationships, the time-based revenue model, expense management, and acquisitions. It gave no specific numeric earnings or revenue guidance in the supplied filing text. Management said time-based revenue was 88% of Q2 revenue and expected it to remain at least 90% of revenue excluding hardware.
- Synopsys recorded a $39 million probable loss accrual for Mentor Graphics patent litigation after an appellate court affirmed an earlier verdict of approximately $36 million. Further proceedings remain pending; the company is appealing and states that losses beyond recorded amounts are possible.
- The Hungarian tax authority proposed approximately $46 million in tax assessments for fiscal 2011–2013, with about $19 million of potential interest and penalties. Synopsys disputes the assessments and intends to contest them. The company estimated a possible $0–$31 million decrease in unrecognized tax benefits over the coming 12 months, subject to uncertain audit outcomes.
- Approximately 89% of cash, cash equivalents, and short-term investments were held by foreign subsidiaries; repatriation may trigger U.S. taxes. Management said available liquidity, operating cash flow, and revolver capacity should meet routine requirements for at least 12 months.
- Key disclosed risks include semiconductor-industry demand and customer consolidation, dependence on a small number of large customers (one customer exceeded 10% of revenue), hardware-related margin and supply risks, acquisitions, cybersecurity, foreign exchange, and tax uncertainty.
- The company expected to adopt the new revenue standard in fiscal 2019 using the modified retrospective method. It anticipated no significant timing change for Technology Subscription License contracts, but was still evaluating possible effects on certain term and IP licenses and contract acquisition costs.
Important facts for investors to verify
- Track whether revenue growth—especially hardware and IP consulting—translates into improved operating income and margins.
- Monitor Mentor litigation developments and whether additional damages or other losses arise beyond the $39 million accrual.
- Check the status and potential financial effect of the Hungarian tax dispute and other tax examinations.
- Assess debt, variable-rate borrowing costs, foreign-held cash accessibility, and cash generation against acquisitions and share repurchases.
- Review restructuring costs against the $32–$34 million estimate and assess the impact of the new revenue standard when implementation details become available.