Synopsys, Inc. — Q2 FY2018 Form 10-Q
Reporting period: Fiscal quarter ended April 30, 2018; comparative quarter ended April 30, 2017. Six-month results include 27 weeks in FY2018 versus 26 weeks in FY2017. FY2018 is a 53-week year; management estimates the extra week added approximately $46 million of revenue and $34 million of expenses in the first quarter.
Business context
Synopsys supplies electronic design automation software, semiconductor intellectual property, hardware and related services, and software security and quality products. It operates as one reportable segment. The company says its time-based model—principally technology subscription licenses (TSLs)—makes most reported revenue dependent on contracts sold in prior periods; management expects time-based revenue to remain at least 90% of revenue excluding hardware.
Financial performance
| Metric | Q2 FY2018 | Q2 FY2017 | Six months FY2018 | Six months FY2017 |
|---|---|---|---|---|
| Revenue | $776.8M | $680.1M | $1,546.3M | $1,332.9M |
| Gross margin | $598.1M; 77.0% | $518.0M; 76.2% | $1,186.3M; 76.7% | $1,015.1M; 76.2% |
| Operating income | $127.0M; 16.3% margin | $53.6M; 7.9% margin | $234.7M | $150.5M |
| Net income | $102.5M | $53.3M | $98.8M | $139.9M |
| Diluted EPS | $0.67 | $0.34 | $0.64 | $0.90 |
| Cash from operations | Not separately reported for the quarter | $4.1M | $169.9M |
Q2 revenue increased 14%, primarily from higher TSL license revenue from prior-period bookings. Upfront products rose 20% to $100.0 million, while maintenance and service revenue rose 26% to $120.1 million. Operating income increased 137%; lower year-over-year general and administrative expense was partly due to the absence of a $38 million litigation loss contingency recorded in Q2 FY2017. Research and development expense increased 13%, primarily reflecting higher headcount, including acquisitions.
For the six-month comparison, revenue rose 16% and operating income rose 56%, but net income fell 29%. The principal factor was the FY2018 tax provision of $140.6 million, including a first-quarter provisional $119 million Tax Act charge; the six-month FY2017 tax provision was $30.5 million. Six-month diluted EPS declined to $0.64 from $0.90.
Cash, debt and liquidity
- Cash and cash equivalents were $570.8 million at April 30, 2018, down $477.6 million from October 31, 2017. Approximately $130.2 million was held in the U.S. and $440.6 million in foreign subsidiaries.
- Six-month operating cash flow was only $4.1 million, down from $169.9 million. Management attributed the decline mainly to higher receivables from billing timing and increased operating and tax payments. Investing cash use was $679.8 million, including $643.5 million of acquisition and intangible-asset payments.
- Debt was approximately $524.3 million: $385.0 million drawn on the revolving facility and $139.3 million under the term loan. The revolver has a $650 million commitment; borrowings carry floating rates. The company reported covenant compliance.
- Working capital was negative $511.7 million, compared with positive $68.5 million at October 31, 2017, primarily reflecting lower cash and higher short-term debt. Accounts receivable rose 26% to $568.4 million; DSO increased to 67 days from 59.
- Management believes cash, operating cash generation and available revolver capacity will meet routine needs for at least the next 12 months and foreseeable future. The board replenished the repurchase authorization to $500 million; $490 million remained available at quarter-end.
Material developments, outlook and risks
- Acquisitions: The company acquired Black Duck Software for approximately $565.1 million in December 2017, adding open-source software security and compliance offerings. Aggregate six-month acquisition consideration was approximately $631.1 million, net of acquired cash and investments. Preliminary purchase accounting included $396.3 million of Black Duck goodwill.
- Tax: FY2018’s blended statutory federal rate is 23.4%, with 21% applying from FY2019. Tax Act accounting remains provisional and may change as guidance and company information develop. The company intends to pay its transition tax over eight years.
- Legal contingency: Mentor patent litigation remains active. Synopsys had accrued $39 million as the probable loss at the filing date; further losses beyond recorded amounts are possible. A related U.S. Supreme Court petition was pending, and proceedings in Oregon continued.
- Tax dispute: Synopsys Hungary paid an assessment of approximately $47 million plus $18 million of interest and penalties while appealing it. The next court hearing was scheduled for July 2018.
- Restructuring: A business realignment is expected to generate $8–$10 million of severance and benefit charges; approximately $1.8 million had been incurred by April 30, 2018.
- Outlook: Management described the business outlook as solid, citing technology leadership, customer relationships, its business model, expense management and acquisitions. No numerical revenue or earnings guidance is provided in the filing text. Management expects professional services revenue to increase following acquisitions, but not materially affect total revenue.
- Key risks: Customer concentration and semiconductor-industry cycles; competitive and technology changes; acquisition integration; variable hardware sales and potentially lower hardware margins; cybersecurity and product defects; foreign exchange and international trade; tax uncertainty; and the outcome of litigation.
Important facts for investors to verify
- Whether operating cash flow rebounds from the unusually low six-month result and whether receivables, collections and DSO improve.
- How much of the six-month earnings decline reflects the one-time Tax Act charge, and whether provisional tax estimates or future tax rules change.
- The status and potential exposure in Mentor litigation relative to the $39 million accrual, and the outcome of the Hungary tax appeal.
- Whether Black Duck and other acquisitions deliver expected growth and integration benefits without materially increasing costs or debt.
- The company’s ongoing liquidity, revolver usage and floating-rate interest costs, alongside continued buybacks and other cash commitments.
- Customer concentration: one customer, including subsidiaries, accounted for more than 10% of revenue in both reported three- and six-month periods.