Synopsys, Inc. — Q3 FY2017 Form 10-Q
Reporting period: Fiscal quarter ended July 31, 2017 (the company states the quarter ended July 29; dates are presented using the closest calendar month-end). Comparisons are with the corresponding 2016 period. Synopsys supplies electronic design automation software, semiconductor IP, hardware, and software quality and security products and services.
Financial performance
| Metric | Q3 FY2017 | Q3 FY2016 | Nine months FY2017 | Nine months FY2016 |
|---|---|---|---|---|
| Revenue | $695.4M | $615.2M | $2,028.2M | $1,788.8M |
| Gross margin | $525.8M; 75.6% | $475.5M; 77.3% | $1,540.9M; 76.0% | $1,388.1M; 77.6% |
| Operating income | $105.4M; 15.2% | $76.7M; 12.5% | $255.9M; 12.6% | $234.6M; 13.1% |
| Net income | $116.8M | $64.7M | $256.6M | $194.1M |
| Diluted EPS | $0.75 | $0.42 | $1.66 | $1.26 |
| Operating cash flow | — | $449.7M | $439.0M |
Quarterly revenue increased 13% and operating income rose 37%. Growth reflected higher hardware sales, IP consulting projects and time-based license revenue, with a smaller contribution from acquisitions. Revenue mix shifted: time-based products grew 5% to $503.5M; upfront products rose 50% to $100.3M; maintenance and services increased 33% to $91.6M, including a 39% rise in professional services and other revenue. Management reported 86% of Q3 revenue was time-based.
Quarterly gross margin declined about 1.7 percentage points, reflecting higher hardware and consulting-related costs and personnel costs, partly offset by lower intangible amortization. Nine-month operating expenses included $31.0M of restructuring charges and $39.0M of accrued patent-litigation loss contingency; G&A expense also rose substantially. Q3 net income benefited from a $4.0M income-tax benefit, producing a negative 3.5% effective tax rate; the nine-month effective rate was 9.4%, versus 21.3% a year earlier. Excess tax benefits from stock-based compensation contributed to the lower tax rate.
Cash, debt and liquidity
At July 31, 2017, cash and cash equivalents were $1,155.0M and short-term investments $147.5M, together $1,302.5M, up $185.2M from October 31, 2016. Current assets were $1,894.6M and current liabilities $1,764.4M, leaving working capital of $130.2M. Net receivables were $411.3M; DSO was 54 days, down from 63 days at fiscal year-end.
Debt was approximately $435.8M: $290.0M drawn on the revolving facility and $145.8M net carrying value under the term loan. The $650M revolver matures in November 2021; borrowings had floating rates of LIBOR +1.000% on the revolver and LIBOR +1.125% on the term loan. The company reported compliance with financial covenants. Cash, cash equivalents and short-term investments exceeded debt by approximately $866.7M. However, about 92% of worldwide cash, cash equivalents and short-term investments was held by foreign subsidiaries; repatriation may trigger U.S. tax.
Nine-month investing cash outflow was $245.0M, including $187.6M for acquisitions and intangible assets and $50.2M for property and equipment. Financing cash outflow was $25.9M, including $300.0M in treasury-stock purchases, offset in part by credit-facility proceeds. The company repurchased $300.0M of shares in the nine-month period and stated that $500.0M remained available under its repurchase program at July 31.
Outlook, commentary and material risks
- Management characterized the outlook as solid, citing technology, customer relationships, the time-based revenue model, expense management and acquisitions. No specific quantitative revenue or earnings guidance is provided in this filing.
- Management said time-based revenue should continue to represent at least 90% of revenue excluding hardware. The company notes that revenue recognition typically trails sales activity because most subscriptions are recognized over contract terms averaging about three years; upfront hardware and license revenue can make results more variable.
- Revenue grew 13% in both the quarter and nine-month period, while nine-month operating margin declined year over year. Management attributed higher costs to headcount, acquisitions, hardware shipments and IP consulting activity; lower amortization partly offset increases.
- Mentor Graphics patent litigation: The Federal Circuit affirmed a jury verdict and approximately $36M damages award on one patent. Synopsys recorded a $39.0M probable-loss accrual for the nine months. Further proceedings, including claims involving other patents and supplemental damages, remained pending; the company warned that losses could exceed recorded amounts.
- Hungarian tax assessment: The Hungarian Tax Authority assessed approximately $47M in tax plus more than $18M in interest and penalties for fiscal 2011–2013. Synopsys contested the assessment in court and stated it believes the assessment lacks merit. The company also disclosed a possible $18M reduction in later-period tax benefits if the authority’s treatment were applied to subsequent years.
- Other risks include semiconductor-industry cycles and customer consolidation, dependence on a relatively small number of large customers (one customer exceeded 10% of revenue), competitive pressure, acquisition integration, hardware margin and supply risks, foreign-exchange exposure, cybersecurity, and uncertain tax outcomes.
- Revenue standard Topic 606 was expected to apply beginning in fiscal 2019. The company anticipated no significant change for technology subscription licenses, but was still assessing effects on certain term and IP licenses and expected to capitalize qualifying contract-acquisition costs such as commissions.
Most important facts for investors to verify
- Whether revenue growth and higher upfront hardware and consulting sales are sustainable, and how the mix affects margins and quarterly variability.
- Whether the Q3 tax benefit and low nine-month effective tax rate are repeatable; review the effects of stock-compensation tax benefits and tax settlements.
- The outcome and potential additional exposure from Mentor litigation, including whether the $39.0M accrual remains adequate.
- The status, potential cost and indirect tax consequences of the Hungarian assessment and appeal.
- Foreign cash accessibility, floating-rate debt and revolver usage, covenant compliance, and the pace of acquisitions and share repurchases.
- Final acquisition purchase-price allocations and the eventual effects of Topic 606 on licenses and contract costs.