Synopsys, Inc. — Q3 FY2015 Form 10-Q
Reporting period: Fiscal quarter ended July 31, 2015; nine-month comparison is for the periods ended July 31, 2015 and 2014. Synopsys provides electronic design automation (EDA) software, intellectual property, hardware, and related services. More than 90% of revenue is generally time-based, with recognition commonly spread over multiyear contracts.
Financial performance
Unless noted otherwise, amounts are in millions of dollars. Comparisons are with the same period of fiscal 2014.
| Metric | Q3 FY2015 | Q3 FY2014 | Nine months FY2015 | Nine months FY2014 |
|---|---|---|---|---|
| Revenue | $555.8 | $521.8 | $1,655.1 | $1,518.5 |
| Gross margin | $426.3; 76.7% | $406.3; 77.9% | $1,276.0; 77.1% | $1,183.0; 77.9% |
| Operating income | $61.5 | $67.2 | $208.9 | $191.2 |
| Operating margin | 11.1% | 12.9% | 12.6% | 12.6% |
| Net income | $55.4 | $65.7 | $176.2 | $196.7 |
| Diluted EPS | $0.35 | $0.42 | $1.12 | $1.25 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $342.7 | $378.0 |
- Q3 revenue grew 7%; management attributed growth to organic performance and prior-year acquisitions. Upfront license revenue increased 55% to $48.9 million, primarily reflecting higher hardware sales. Time-based license revenue rose 3% to $445.8 million; maintenance and service revenue rose 4% to $61.1 million.
- Q3 total cost of revenue and operating expenses increased 9% to $494.3 million, outpacing revenue growth. Management cited higher headcount and acquisition-related costs, as well as the timing of expenses. Net income declined 16% year over year.
- For the first nine months, revenue increased 9%, while net income fell 10%. The effective tax rate was 21.9%, versus 6.4% in the prior-year period; the filing attributes the difference chiefly to acquired-technology integration and prior-year tax settlements and benefits.
- At July 31, cash and cash equivalents were $986.4 million and short-term investments were $136.5 million, totaling $1,122.9 million. Working capital was $168.2 million, compared with $117.9 million at October 31, 2014. Deferred revenue totaled $1,003.3 million, including current and long-term amounts.
- Total debt was $212.5 million: $160.0 million drawn on the revolving facility and $52.5 million under the term loan. Nine-month cash used for investing was $333.7 million, including $137.2 million net purchases of short-term investments and $126.9 million for acquisitions and intangible assets; financing provided $13.4 million.
Material changes and notable items
- Revenue mix shifted modestly toward upfront licenses: these were 9% of Q3 revenue versus 6% a year earlier, while time-based licenses were 80% versus 83%.
- Q3 gross margin declined by about 1.2 percentage points year over year, and operating margin declined by about 1.8 points, reflecting faster expense growth than revenue.
- Operating cash flow for the first nine months declined $35.3 million year over year, which management primarily attributed to higher vendor payments and lower net income.
- The company completed several acquisitions for aggregate consideration of $120.8 million, net of acquired cash, funded with existing cash. Preliminary allocation included $92.2 million of goodwill and $37.1 million of identifiable intangible assets; estimates remained subject to finalization.
- During the nine-month period, Synopsys repurchased $180.0 million of shares under an accelerated repurchase agreement, purchasing approximately 4.0 million shares at an average $45.37 per share. About $200.3 million remained authorized for repurchases.
- A November 2014 restructuring program cost $15.1 million and was substantially completed, with no balance outstanding at July 31.
Outlook, risks, and contingencies
- Management described the business outlook as solid, citing technology leadership, customer relationships, the time-based revenue model, expense management, and acquisitions. It expects time-based revenue to remain approximately 90% of total revenue. The filing provides no specific numerical earnings or revenue guidance.
- Management said available cash, short-term investments, operating cash generation, and revolving credit availability should meet routine business needs for at least the next twelve months. Approximately $777 million of cash, cash equivalents, and short-term investments was held by foreign subsidiaries and considered indefinitely reinvested; repatriation could trigger additional U.S. taxes.
- The revolving credit facility was increased from $350 million to $500 million and extended to May 2020. Borrowings are floating-rate; the filing reports July 31 rates of LIBOR plus 1.000% on the revolver and LIBOR plus 1.125% on the term loan. The company must comply with leverage and interest-coverage covenants.
- In Mentor Graphics patent litigation, a jury assessed approximately $36 million in damages and the court enjoined certain sales activities involving features found to infringe. Synopsys released revised ZeBu software and appealed; Mentor also appealed. The filing does not state that the judgment was a recorded loss accrual.
- Tax exposures include $115.0 million of gross unrecognized tax benefits, exclusive of interest and penalties. The company said resolution of certain audits or statute expirations could reduce unrecognized tax benefits by $0–$23 million within twelve months, but timing and settlement amounts were uncertain. It recorded tax benefits from IRS and Taiwan settlements during the period.
- Key risks include semiconductor-market and customer spending weakness or consolidation; acquisition integration and execution; competition and product development; revenue timing and customer concentration; foreign currency exposure; tax outcomes; cybersecurity and product defects; and intellectual-property litigation. The company also noted uncertainty over the potential tax implications of a Tax Court opinion concerning stock-based compensation in intercompany cost-sharing arrangements.
Important facts for investors to verify
- Whether revenue growth and the increased upfront-license contribution persist, given the variability of hardware sales and contract timing.
- Whether operating expenses, especially research and development and acquisition-related costs, moderate enough to stabilize or improve margins and earnings.
- Cash conversion, debt levels, revolving-facility utilization, covenant headroom, and the availability and tax cost of foreign-held funds.
- Developments in the Mentor litigation, including appeals, injunction scope, and any resulting financial or operating effects.
- Final acquisition purchase-price allocations, integration outcomes, and any effect of tax audits or changes in tax guidance on the effective tax rate.