Synopsys, Inc. — Q1 FY2018 Form 10-Q
Reporting period: Quarter ended January 31, 2018. Synopsys’ fiscal first quarter included 14 weeks, versus 13 weeks in the prior-year quarter; management estimates the extra week contributed approximately $46 million of revenue and $34 million of expenses. Fiscal 2018 is a 53-week year. Synopsys provides EDA software, semiconductor IP, hardware, and software security and quality products and services.
Financial performance
| Metric | Q1 FY2018 | Q1 FY2017 | Change |
|---|---|---|---|
| Revenue | $769.4 million | $652.8 million | +18% |
| Gross margin | $588.3 million; 76.5% | $497.0 million; 76.1% | Margin +0.4 percentage points |
| Operating income | $107.7 million; 14.0% margin | $96.9 million; 14.8% margin | +11%; margin down 0.8 points |
| Income before taxes | $120.1 million | $108.4 million | +11% |
| Income tax provision | $123.8 million | $21.8 million | Increased $102.0 million |
| Net income (loss) | $(3.7) million; $(0.02) per diluted share | $86.6 million; $0.56 per diluted share | Turned to a loss |
| Operating cash flow | $(59.4) million | $46.9 million | Down $106.3 million |
Revenue growth reflected higher time-based subscription license revenue from prior-period bookings, the additional fiscal week, and increased hardware, maintenance, and services revenue. Time-based products revenue was $570.9 million, upfront products revenue $91.6 million, and maintenance and service revenue $106.9 million. Time-based revenue represented 88% of total revenue.
Costs and operating expenses totaled $661.7 million, up 19%, largely due to higher headcount, including acquisitions, and the additional week. Research and development increased 24% to $264.4 million. The reported effective tax rate was 103.1%, principally because the Tax Act generated a provisional $119 million tax charge, including $46 million from deferred-tax remeasurement and $71 million of transition tax, plus $2 million of state tax. Tax accounting estimates remain provisional.
Balance sheet, liquidity, and capital allocation
- Cash and cash equivalents were $605.9 million at January 31, down from $1,048.4 million at October 31, 2017. Approximately $459.5 million was held in foreign subsidiaries.
- Working capital was negative $618.1 million, compared with positive $68.5 million at fiscal year-end, primarily reflecting lower cash and higher short-term borrowings.
- Debt totaled approximately $572 million: $430 million drawn on the revolving facility and $142.1 million net outstanding on the term loan. The revolver is part of a $650 million facility; the company reported compliance with its financial covenants. Borrowings carry floating rates.
- Investing cash outflow was $625.0 million, including $608.3 million of net cash paid for acquisitions and intangible assets. Financing provided $230.4 million, including credit-facility proceeds and share repurchases.
- Synopsys repurchased $180 million of stock during the quarter. $200 million remained authorized for repurchases at January 31. Management said cash, operating cash generation, and available revolver capacity should meet routine needs for at least the next 12 months.
Material changes, outlook, and risks
- Acquisitions: The company completed two acquisitions for aggregate cash consideration of $595.9 million, net of acquired cash and investments. The principal transaction was Black Duck Software, acquired for total consideration of $565.1 million; preliminary purchase accounting included $396.9 million of goodwill and $178 million of identifiable intangible assets.
- Tax Act: The unusual tax charge drove the swing from prior-year profit to a quarterly loss despite higher operating income. Synopsys had not yet completed its analysis of several provisions and said estimates could change; accounting was expected to be finalized no later than Q1 FY2019.
- Outlook: No specific quarterly or annual revenue or earnings guidance is provided in the supplied filing text. Management described the business outlook as solid and expected time-based revenue to remain at least 90% of revenue excluding hardware. It anticipated higher professional-services revenue from acquisitions, but said the effect on total revenue was not expected to be material.
- Revenue recognition: Synopsys expected adoption of Topic 606 in fiscal 2019 using the modified retrospective method. It anticipated no material change for TSL contracts, but was still assessing certain term and IP license arrangements; a small portion of year-end backlog could be adjusted to retained earnings.
- Contingencies: In Mentor Graphics patent litigation, Synopsys had accrued $39 million as the probable loss. Proceedings continued, and the company warned that an unfavorable outcome could exceed the recorded amount and materially affect results. Separately, its Hungarian subsidiary paid a tax assessment of approximately $47 million plus more than $18 million in interest and penalties while challenging it in court; the potential tax-benefit impact was also described.
- Other risks: The filing highlights dependence on semiconductor and electronics markets and a relatively small number of large customers, acquisition integration and execution, competitive and technology risks, cybersecurity, foreign exchange, tax uncertainty, and hardware supply and margin variability. Revenue timing can also fluctuate because most subscription revenue is recognized over contract terms averaging about three years.
Important facts for investors to verify
- Assess revenue and expense growth on a comparable-week basis; the quarter contained one extra week.
- Track the final Tax Act accounting, including the transition-tax liability and any revisions to provisional estimates.
- Monitor operating cash conversion, working capital, revolver borrowings, floating-rate interest costs, and cash repatriation or location.
- Review Black Duck integration, acquisition-related costs, and the final purchase-price allocation.
- Follow the Mentor litigation and Hungarian tax appeal for developments that could change recorded or potential exposures.
- Check subsequent filings for quantified guidance and the financial effects of Topic 606 adoption, neither of which is fully quantified here.