SYNOPSYS INC quarterly report, Q3 FY2012

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Synopsys, Inc. — Q3 FY2012 Form 10-Q

Reporting period: Fiscal third quarter presented as ended July 31, 2012; the company states the fiscal quarter actually ended August 4, 2012. Comparisons are with the prior-year quarter and nine-month period. Fiscal 2012 is a 53-week year; its extra week contributed approximately $26 million of revenue and $16 million of expenses in the first nine months. Unless noted, figures below are in U.S. dollars.

Business context and reporting period

Synopsys sells electronic design automation (EDA) software, hardware, intellectual property, and related services used to design chips and electronic systems. It reports one operating segment. Management describes a recurring-revenue model: more than 90% of revenue is generally recurring, and typically more than 90% of quarterly revenue is committed entering the quarter. The Magma Design Automation acquisition closed in February 2012.

Financial performance

  • Q3 revenue: $443.7 million, up 15% from $386.8 million. Time-based license revenue was $362.8 million (+13%), upfront license revenue $25.4 million (+34%), and maintenance and services $55.5 million (+22%). Growth reflected overall business expansion and acquisitions, including Magma.
  • Q3 profitability: Gross profit was $344.0 million, or 77.5% of revenue, versus 78.1% a year earlier. Operating income was $63.4 million (14.3% margin), versus $58.2 million (15.0%). Net income was $75.7 million, up 45%, and diluted EPS was $0.50 versus $0.35. The improvement in net income reflected higher revenue and a Q3 tax benefit from tax settlements.
  • Nine-month results: Revenue was $1.302 billion, up 14%; gross profit was $1.012 billion (77.7% margin); operating income was $150.5 million (11.6% margin), down from $156.5 million; net income was $153.3 million, down from $181.4 million. Diluted EPS was $1.03 versus $1.20. The extra fiscal week and acquisition contributions benefited revenue, while expenses rose and the prior-year period had greater tax benefits.
  • Costs and investment: Q3 operating expenses were $280.6 million, up 15%. R&D increased 18% to $144.0 million, sales and marketing rose 10% to $100.0 million, and G&A rose 17% to $31.8 million. Acquisition-related amortization and employee costs were important contributors to expense growth.
  • Cash flow: Nine-month operating cash flow was $383.1 million versus $367.3 million. Investing used $471.0 million, principally reflecting $584.4 million of cash paid for acquisitions and intangible assets, partly offset by investment proceeds. Financing provided $204.7 million, including credit-facility proceeds and stock issuance; the company also repaid debt and repurchased $40.0 million of shares.
  • Liquidity and debt: Cash and cash equivalents were $963.8 million at July 31, versus combined cash, equivalents, and short-term investments of $1.004 billion at October 31, 2011; the short-term investment portfolio had been liquidated. Working capital declined to $155.5 million from $327.8 million. Debt was $142.5 million, including $30.0 million current and $112.5 million long-term; there were no revolver borrowings, and the company reported compliance with covenants. The term loan bears a variable rate; the reported average rate was 1.375%.
  • Balance sheet: Total assets were $3.869 billion, including goodwill of $1.639 billion and net intangibles of $350.9 million, both substantially increased by acquisitions. Deferred revenue was $856.1 million, current and long-term combined.

Material changes versus prior comparable periods

  • Q3 revenue grew $56.9 million; time-based licenses remained the dominant source, at 82% of revenue. Maintenance revenue was nearly flat in the quarter, while professional services and other revenue increased.
  • Q3 operating income grew more slowly than revenue, and operating margin declined by about 0.7 percentage points. For the nine months, operating income and net income fell despite revenue growth.
  • Acquisitions materially changed the balance sheet and cash deployment. Magma consideration was approximately $550.2 million; the company also completed other fiscal 2012 acquisitions with $78.5 million of preliminary purchase consideration.
  • Tax results were unusually favorable in Q3: the effective tax rate was negative 23.9%, compared with 6.9% in Q3 FY2011, primarily due to IRS and Taiwan tax settlements. The nine-month effective rate was 3.2%, versus a 9.6% benefit in the prior-year period.
  • Cash and equivalents rose from the prior-year-end cash balance, but total cash plus short-term investments declined 4% from October 2011, reflecting acquisition spending and the liquidation of investments. The company had no debt at October 31, 2011.

Outlook, commentary, risks, and unusual items

  • Management characterized the outlook as strong, citing recurring revenue, customer relationships, expense discipline, demand for mobile devices, and expanded products from acquisitions. The filing provides no clear numerical revenue or earnings guidance.
  • Management said cash, cash equivalents, and operating cash generation should meet routine business needs for at least the next 12 months. Approximately $750.7 million of cash was held in foreign subsidiaries and considered indefinitely reinvested; repatriation could require additional U.S. taxes.
  • On August 3, 2012, Synopsys announced a tender offer and planned merger for SpringSoft, subject to approvals and tender conditions. Expected consideration was approximately $406 million, or $305 million net of acquired cash; Synopsys guaranteed the subsidiary’s obligations and expected to use cash held outside the United States.
  • Risks highlighted include semiconductor and electronics demand, customer R&D spending and payment defaults, industry competition, acquisition integration and expected synergies, international operations and foreign exchange, tax uncertainty, intellectual-property claims, product defects, cybersecurity, and business disruption. One customer represented 10.8% of Q3 revenue.
  • Contingencies include routine legal matters, a proposed settlement of Magma-related shareholder suits subject to court approval, and a patent infringement suit by Dynetix involving Synopsys’ VCS products; Synopsys has asserted counterclaims. The filing does not quantify a probable material loss for these matters.
  • Gross unrecognized tax benefits were $119 million, excluding interest and penalties; approximately $74 million would reduce the effective tax rate if recognized. Management estimated possible reductions of $0–$44 million over the next 12 months, with timing and outcomes uncertain.
  • Q3 net income included the benefit of tax settlements. Nine-month acquisition-related costs were $32.7 million for Magma and $3.5 million for other acquisitions. These and acquisition-driven intangible amortization affect comparisons.

Most important facts for investors to verify

  • Whether recurring license commitments, renewals, and deferred revenue support the stated outlook; also monitor customer concentration and customer payment behavior.
  • How much revenue and profit growth is organic versus acquired, and whether Magma integration produces the expected growth and cost synergies.
  • The effect of acquisition amortization, acquisition-related costs, and the 53-week fiscal year on reported margins and comparisons.
  • Cash availability by geography, potential tax costs of repatriation, term-loan repayment and variable-rate exposure, and funding of the proposed SpringSoft acquisition.
  • Resolution of tax audits and unrecognized tax positions, the SpringSoft tender and merger conditions, and the status and potential financial effects of the disclosed lawsuits.