Business context and reporting period
Synopsys, Inc. supplies electronic design automation software, semiconductor intellectual property, related services, and software quality, testing and security tools. This Form 10-Q covers the fiscal third quarter and first nine months of fiscal 2014, reported as ended July 31, 2014; the company notes the fiscal quarter actually ended August 2, 2014.
Key financial metrics
Amounts are in millions except per-share data and percentages. Comparisons are with the corresponding 2013 period.
| Metric | Three months | Nine months |
|---|---|---|
| Revenue | $521.8; +8% | $1,518.5; +4% |
| Gross margin | $406.3; 77.9% (prior 76.1%) | $1,183.0; 77.9% (prior 77.0%) |
| Operating income | $67.2; +22% | $191.2; -2% |
| Net income | $65.7; +26% | $196.7; +3% |
| Diluted EPS | $0.42 (prior $0.33) | $1.25 (prior $1.22) |
| Operating cash flow | Not separately provided | $378.0 (prior $305.4) |
| Cash and cash equivalents | $903.0 at July 31, down from $1,022.4 at October 31, 2013 | |
| Debt | $82.5 outstanding: $30.0 current and $52.5 long-term; no revolver balance | |
| Working capital | $87.5, down from $225.1 at October 31, 2013 |
Quarterly revenue comprised $431.2 time-based licenses (+11%), $31.6 upfront licenses (-21%), and $59.0 maintenance and service (+6%). Time-based license revenue was 83% of revenue. The nine-month effective tax rate was 6.4%, versus 11.9% in 2013; the quarterly rate was 7.2%, versus 10.1%.
Material changes versus prior period
- Quarterly revenue growth reflected higher time-based license revenue and professional services, including acquired-company contributions; lower upfront license revenue, mainly from reduced hardware sales, partly offset growth.
- Quarterly operating expenses rose 9% to $339.1, including higher R&D, sales and marketing, and administrative costs, largely related to personnel and acquisitions. Operating income nevertheless increased as revenue growth outpaced expense growth.
- For the nine months, maintenance and service revenue fell 8%, primarily due to lower professional services revenue and project timing; operating income declined despite revenue growth.
- Operating cash flow increased, primarily due to higher collections. Investing cash use rose to $430.1, including $373.5 for acquisitions and intangible assets. Financing cash use was $62.7; the company repaid the $200.0 revolver draw used partly to finance Coverity.
- Cash declined by $119.4, reflecting acquisitions, share repurchases, and capital spending, partly offset by operating cash generation. Receivables fell and DSO improved to 42 days from 46 at fiscal year-end.
Outlook, risks and unusual items
- Management characterized the business outlook as solid, citing technology, customer relationships, the time-based revenue model, expense management, and acquisitions. No quantified revenue or earnings guidance is provided.
- Management said time-based revenue generally represents about 90% of sales and cushions near-term effects of customer spending changes; it also noted expansion into IP and other markets may increase revenue variability.
- Coverity was acquired for $375.5 cash in March 2014. Its purchase-price allocation remained preliminary; acquired deferred revenue was written down from $68.5 gross to $21.3 fair value. Management expects acquisition-related deferred revenue and intangible amortization to weigh on near-term net income.
- A $6.4 gain from liquidation of an investment contributed to nine-month other income. Tax settlements and statute-of-limitations expirations reduced the effective tax rate; gross unrecognized tax benefits were $102.9, and potential decreases over the next 12 months were estimated at $0–$23.
- Cash held abroad was $793.7, or approximately 87.9% of worldwide cash; repatriation could incur additional U.S. taxes. The company stated cash, operating cash generation, and available credit should meet routine needs for at least 12 months.
- Key risks include semiconductor-industry demand and design activity, competition, customer concentration (one customer represented 10.5% of quarterly revenue), acquisition integration and realization of benefits, foreign-exchange and international risks, tax uncertainty, and litigation. Mentor Graphics patent litigation continued; rulings narrowed the Oregon action, with Mentor’s ’376 patent remaining at issue there and related patent-office appeals pending.
- ASU 2014-09, the new revenue recognition standard, is effective for fiscal 2018; the company was evaluating its impact. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether sustained time-based license growth offsets weakness or volatility in upfront licenses and services, and whether revenue remains near management’s indicated time-based mix.
- Coverity’s contribution to growth and its impact on margins, earnings, purchase accounting, and integration costs as the purchase allocation is finalized.
- Cash conversion and liquidity, including the large offshore cash balance, working-capital decline, future acquisition or repurchase spending, and compliance with credit-facility covenants.
- Whether the low effective tax rate is repeatable; monitor tax audits, uncertain tax positions, and potential cash tax or repatriation costs.
- Developments and potential financial consequences in the Mentor litigation and other disclosed intellectual-property matters.