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SNPS > SEC Filings for SNPS > Form 10-Q on 26-Aug-2014All Recent SEC Filings

Show all filings for SYNOPSYS INC

Form 10-Q for SYNOPSYS INC


26-Aug-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q, includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act) and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act), which are subject to the "safe harbor" created by those sections. Any statements herein that are not statements of historical fact may be deemed to be forward-looking statements. For example, words such as "may," "will," "could," "would," "should," "anticipate," "expect," "intend," "believe," "estimate," "project" or "continue," and the negatives of such terms are intended to identify forward-looking statements. Without limiting the foregoing, forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements concerning expected growth in the semiconductor industry, our business outlook, the ability of our prior acquisitions (including our acquisition of Coverity, Inc.) to drive revenue growth, the sufficiency of our cash and cash equivalents and cash generated from operations, and our future liquidity requirements, and other statements that involve certain known and unknown risks, uncertainties and other factors that could cause our actual results, time frames or achievements to differ materially from those expressed or implied in our forward-looking statements. Such risks and uncertainties include, among others, those identified below in Part II, Item 1A. Risk Factors of this Form 10-Q. The information included herein represents our estimates and assumptions as of the date of this filing. Unless required by law, we undertake no obligation to update publicly any forward-looking statements, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future. All subsequent written or oral forward-looking statements attributable to Synopsys or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. Readers are urged to carefully review and consider the various disclosures made in this report and in other documents we file from time to time with the Securities and Exchange Commission (SEC) that attempt to advise interested parties of the risks and factors that may affect our business. The following summary of our financial condition and results of operations should be read together with our unaudited condensed consolidated financial statements and the related notes thereto contained in Part I, Item 1 of this report and with our audited consolidated financial statements and the related notes thereto contained in our Annual Report on Form 10-K for the fiscal year ended October 31, 2013, as filed with the SEC on December 20, 2013. Overview
Business Summary
Synopsys is a global leader in providing software, intellectual property and services used to design integrated circuits and electronic systems. We supply the electronic design automation (EDA) software that engineers use to design, create prototypes for and test integrated circuits, also known as chips. We also offer intellectual property (IP) products, which are pre-designed circuits that engineers use as components of larger chip designs rather than designing those circuits themselves. We provide software and hardware used to develop the systems that incorporate chips and the software that runs on them. To complement these product offerings, we provide technical services to support our solutions and we help our customers develop chips and electronic systems. We are also a leading provider of software tools that developers use to improve the quality and time-to-market of software code in a wide variety of industries, including electronics, financial services, energy, and industrials.
Our EDA and IP customers are generally semiconductor and electronics systems companies. Our solutions help them overcome the challenge of developing increasingly advanced electronics products while reducing their design and manufacturing costs. While our products are an important part of our customers' development process, our customers' research and development budget and spending decisions may be affected by their business outlook and their willingness to invest in new and increasingly complex chip designs.
Despite global economic uncertainty, we have maintained profitability and positive cash flow on an annual basis in recent years. We achieved these results not only because of our solid execution, leading technology and strong customer relationships, but also because of our time-based revenue business model. Under this model, a substantial majority of our customers pay for their licenses over time and we typically recognize this revenue over the life of the contract, which averages approximately three years. Time-based revenue, which consists of time-based license, maintenance and service revenue, generally represents approximately 90% of our total revenue. The revenue we recognize in a particular period generally results from selling efforts in prior periods rather than the current period. Due to our business model, decreases as well as increases in customer spending do not immediately affect our revenues in a significant way.


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As we continue to expand our product portfolio and our total addressable market, for instance in IP products, we may experience increased variability in our revenue, though we expect time-based revenue to continue to generally represent approximately 90% of our total revenue. Overall, our business outlook remains solid based on our leading technology, customer relationships, business model, diligent expense management, and acquisition strategy. We believe that these factors will help us continue to successfully execute our strategies.

Acquisition of Coverity
On March 24, 2014, we acquired Coverity, Inc. (Coverity) the leading provider of software quality, testing and security tools. We believe this acquisition has enabled us to enter into a new, growing market dedicated to helping companies deliver better software faster, by finding software code defects as the code is being developed rather than at the end of the process. Coverity's customer base includes Synopsys' semiconductor and systems customers, albeit different users and budgets, and extends well beyond to software developers such as independent software vendors and companies engaged in e-commerce. We believe the Coverity acquisition has expanded our total addressable market. However, due to the fair value adjustment of acquired deferred revenue and amortization of intangible assets, the acquisition will have a negative effect on net income in the short term. We report revenue from our Coverity software quality, testing and security tools in our IP and Software Solutions group, which we previously referred to as IP and System-Level Solutions.
Financial Performance Summary for the Three Months Ended July 31, 2014 (Compared to the Three Months Ended July 31, 2013)
Net income of $65.7 million for the quarter was 26% higher compared to the same period in fiscal 2013 due to our overall growth and acquisitions, which increased our revenue by 8%, while our expenses increased by 6%.

We repaid our senior unsecured revolving credit facility balance of $200.0 million.

Our cash flow from operations increased by 24% primarily due to higher cash collections.

We continued to derive more than 90% of our revenue from time-based revenue.

New Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, "Revenue from Contracts with Customers (Topic 606)," which supersedes nearly all existing revenue recognition guidance under U.S. generally accepted accounting principles (GAAP). The new guidance will be effective for fiscal 2018, including interim periods within that reporting period, using one of two prescribed retrospective methods. No early adoption is permitted. We are currently in the process of evaluating the impact of the adoption of ASU 2014-09 on our consolidated financial statements and related disclosures.
Critical Accounting Policies and Estimates Our discussion and analysis of our financial results under the heading "Results of Operations" below are based on our unaudited condensed consolidated financial statements, which we have prepared in accordance with GAAP. In preparing these financial statements, we make assumptions, judgments and estimates that can affect the reported amounts of assets, liabilities, revenues and expenses and net income. On an on-going basis, we evaluate our estimates based on historical experience and various other assumptions we believe are reasonable under the circumstances. Our actual results may differ from these estimates. The accounting policies that most frequently require us to make assumptions, judgments and estimates, and therefore are critical to understanding our results of operations, are:
Revenue recognition;

Valuation of stock compensation;

Valuation of intangible assets; and

Income taxes.

Our critical accounting policies and estimates are discussed in Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the fiscal year ended October 31, 2013, filed with the SEC on December 20, 2013.


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Results of Operations
Revenue Background
We generate our revenue from the sale of software licenses, maintenance and professional services and, to a small extent, hardware products. With respect to software licenses, we utilize three license types:
Technology Subscription Licenses (TSLs). TSLs are time-based licenses for a finite term, and generally provide the customer limited rights to receive, or to exchange certain quantities of licensed software for, unspecified future technology. We bundle and do not charge separately for post-contract customer support (maintenance) for the term of the license.

Term licenses. Term licenses are also for a finite term, but do not provide the customer any rights to receive, or to exchange licensed software for, unspecified future technology. Customers purchase maintenance separately for the first year and may renew annually for the balance of the term. The annual maintenance fee is typically calculated as a percentage of the net license fee.

Perpetual licenses. Perpetual licenses continue as long as the customer renews maintenance plus an additional 20 years. Perpetual licenses do not provide the customer any rights to receive, or to exchange licensed software for, unspecified future technology. Customers purchase maintenance separately for the first year and may renew annually.

For the three software license types, we recognize revenue as follows:
TSLs. We typically recognize revenue from TSL fees (which include bundled maintenance) ratably over the term of the license period, or as customer installments become due and payable, whichever is later. Revenue attributable to TSLs is reported as "time-based license revenue" in the unaudited condensed consolidated statements of operations.

Term licenses. We recognize revenue from term licenses in full upon shipment of the software if payment terms require the customer to pay at least 75% of the license fee and 100% of the maintenance fee within one year from shipment and all other revenue recognition criteria are met. Revenue attributable to these term licenses is reported as "upfront license revenue" in the unaudited condensed consolidated statements of operations. For term licenses in which less than 75% of the license fee and 100% of the maintenance fee is payable within one year from shipment, we recognize revenue as customer payments become due and payable. Such revenue is reported as "time-based license revenue" in the unaudited condensed consolidated statements of operations.

Perpetual licenses. We recognize revenue from perpetual licenses in full upon shipment of the software if payment terms require the customer to pay at least 75% of the license fee and 100% of the maintenance fee within one year from shipment and all other revenue recognition criteria are met. Revenue attributable to these perpetual licenses is reported as "upfront license revenue" in the unaudited condensed consolidated statements of operations. For perpetual licenses in which less than 75% of the license fee and 100% of the maintenance fee is payable within one year from shipment, we recognize revenue as customer installments become due and payable. Such revenue is reported as "time-based license revenue" in the unaudited condensed consolidated statements of operations.

We recognize revenue from orders we receive for software licenses, services and hardware products at varying times. In most instances, we recognize revenue on a TSL software license order over the license term and on a term or perpetual software license order in the quarter in which the license is delivered. The weighted average license term of the TSLs and term licenses we entered into for the three months ended July 31, 2014 and 2013 was 3.1 and 2.9 years, respectively. Revenue on contracts requiring significant modification or development is accounted for using the percentage of completion method over the period of the development. Revenue on hardware product orders is generally recognized in full at the time the product is shipped. Contingent revenue is recognized if and when the applicable event occurs.
Revenue on maintenance orders is recognized ratably over the maintenance period (normally one year). Revenue on professional services orders is generally recognized after services are performed and accepted by the customer. Our revenue in any period is equal to the sum of our time-based license, upfront license, maintenance and professional services for the period. We derive time-based license revenue largely from TSL orders received and delivered in prior quarters and to a smaller extent due to contracts in which revenue is recognized as customer installments become due and payable and from contingent revenue arrangements. We derive upfront license revenue directly from term and perpetual license and hardware product orders mostly booked and shipped during


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the period. We derive maintenance revenue largely from maintenance orders received in prior periods since our maintenance orders generally yield revenue ratably over a term of one year. We also derive professional services revenue primarily from orders received in prior quarters, since we recognize revenue from professional services as those services are delivered and accepted or on percentage of completion for arrangements requiring significant modification of our software, and not when they are booked. Our license revenue is sensitive to the mix of TSLs and perpetual or term licenses delivered during a reporting period. A TSL order typically yields lower current quarter revenue but contributes to revenue in future periods. For example, a $120,000 order for a three-year TSL delivered on the last day of a quarter typically generates no revenue in that quarter, but $10,000 in each of the twelve succeeding quarters. Conversely, a $120,000 order for perpetual and term licenses with greater than 75% of the license fee due within one year from shipment typically generates $120,000 in revenue in the quarter the product is delivered, but no future revenue. Additionally, revenue in a particular quarter may also be impacted by perpetual and term licenses in which less than 75% of the license fees and 100% of the maintenance fees are payable within one year from shipment as the related revenue will be recognized as revenue in the period when customer payments become due and payable.
Our customer arrangements are complex, involving hundreds of products and various license rights, and our customers bargain with us over many aspects of these arrangements. For example, they often demand a broader portfolio of solutions, support and services and seek more favorable terms such as expanded license usage, future purchase rights and other unique rights at an overall lower total cost. No single factor typically drives our customers' buying decisions, and we compete on all fronts to serve customers in a highly competitive EDA market. Customers generally negotiate the total value of the arrangement rather than just unit pricing or volumes.

Total Revenue
                          July 31,
                      2014         2013       $ Change     % Change
                                 (dollars in millions)
Three months ended $   521.8    $   482.9    $     38.9       8 %
Nine months ended  $ 1,518.5    $ 1,457.3    $     61.2       4 %

Our revenues are subject to fluctuations, primarily due to customer requirements, including payment terms and the timing and value of contract renewals. For example, we experience variability in our quarterly revenue due to factors such as the timing of renewals of maintenance contracts, timing of IP consulting projects and royalties, and certain contracts where revenue is recognized when customer installment payments are due, as well as volatility in hardware sales.
The increase in total revenue for the three months ended July 31, 2014 compared to the same period in fiscal 2013 was due to our overall growth and increases in time-based license revenue, including contributions of revenue from acquired companies, and professional services and other revenue, which were partially offset by a decrease in our upfront license revenue.
The increase in total revenue for the nine months ended July 31, 2014 compared to the same period in fiscal 2013 was due to our overall growth and increases in time-based license revenue, including contributions of revenue from acquired companies, and upfront license revenue, which were partially offset by a decrease in our professional services and other revenue.

Time-Based License Revenue
                                    July 31,
                               2014          2013        $ Change      % Change
                                           (dollars in millions)
Three months ended          $   431.2     $   387.1     $     44.1        11 %
Percentage of total revenue        83 %          80 %
Nine months ended           $ 1,255.5     $ 1,186.5     $     69.0         6 %
Percentage of total revenue        83 %          81 %

The increase in time-based license revenue for the three and nine months ended July 31, 2014 compared to the same periods in fiscal 2013 was primarily attributable to an increase in TSL license revenue due to our overall growth, including contributions of revenue from acquired companies.


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Upfront License Revenue
                                  July 31,
                              2014        2013      $ Change      % Change
                                         (dollars in millions)
Three months ended          $  31.6     $ 40.0     $    (8.4 )     (21 )%
Percentage of total revenue       6 %        8 %
Nine months ended           $ 101.9     $ 95.5     $     6.4         7  %
Percentage of total revenue       7 %        7 %

Changes in upfront license revenue are generally attributable to normal fluctuations in customer requirements, which can drive the amount of upfront orders and revenue in any particular period.
The decrease in upfront license revenue for the three months ended July 31, 2014 compared to the same period in fiscal 2013 was primarily attributable to a decrease in the sale of hardware products, which was partially offset by an increase in the sale of perpetual licenses to IP and Software Solutions products.
The increase in upfront license revenue for the nine months ended July 31, 2014 compared to the same period in fiscal 2013 was primarily attributable to an increase in the sale of perpetual licenses to IP and Software Solutions products, which was partially offset by a decrease in the sale of hardware products.

Maintenance and Service Revenue

                                              July 31,
                                          2014        2013       $ Change    % Change
                                                    (dollars in millions)
Three months ended
Maintenance revenue                     $  18.0     $  19.1     $   (1.1 )     (6 )%
Professional services and other revenue    41.0        36.8          4.2       11  %
Total maintenance and service revenue   $  59.0     $  55.9     $    3.1        6  %
Percentage of total revenue                  11 %        12 %
Nine months ended
Maintenance revenue                     $  56.1     $  59.9     $   (3.8 )     (6 )%
Professional services and other revenue   105.0       115.4        (10.4 )     (9 )%
Total maintenance and service revenue   $ 161.1     $ 175.3     $  (14.2 )     (8 )%
Percentage of total revenue                  11 %        12 %

Changes in maintenance revenue are generally attributable to timing and type of contracts that bundle maintenance.
The changes in professional services and other revenue for the three and nine months ended July 31, 2014 compared to the same periods in fiscal 2013 was primarily due to the timing of IP customization projects that are accounted for using the percentage of completion method.


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Cost of Revenue
                                              July 31,
                                          2014        2013       $ Change     % Change
                                                     (dollars in millions)
Three months ended
Cost of license revenue                 $  68.5     $  69.9     $    (1.4 )     (2 )%
Cost of maintenance and service revenue    20.7        19.2           1.5        8  %
Amortization of intangible assets          26.3        26.5          (0.2 )     (1 )%
Total                                   $ 115.5     $ 115.6     $    (0.1 )      -  %
Percentage of total revenue                  22 %        24 %
Nine months ended
Cost of license revenue                 $ 198.7     $ 195.9     $     2.8        1  %
Cost of maintenance and service revenue    62.1        59.1           3.0        5  %
Amortization of intangible assets          74.7        79.4          (4.7 )     (6 )%
Total                                   $ 335.5     $ 334.4     $     1.1        -  %
Percentage of total revenue                  22 %        23 %

We divide cost of revenue into three categories: cost of license revenue, cost of maintenance and service revenue, and amortization of intangible assets. We segregate expenses directly associated with consulting and training services from cost of license revenue associated with internal functions providing license delivery and post-customer contract support services. We then allocate these group costs between cost of license revenue and cost of maintenance and service revenue based on license and maintenance and service revenue reported. Cost of license revenue. Cost of license revenue includes costs related to products sold and software licensed, allocated operating costs related to product support and distribution costs, royalties paid to third party vendors, and the amortization of capitalized research and development costs associated with software products that have reached technological feasibility.
Cost of maintenance and service revenue. Cost of maintenance and service revenue includes operating costs related to maintaining the infrastructure necessary to operate our services and training organization, and costs associated with the delivery of our consulting services, such as hotline and on-site support, production services and documentation of maintenance updates.
Amortization of intangible assets. Amortization of intangible assets, which is recorded to cost of revenue and operating expenses, includes the amortization of certain contract rights and the amortization of core/developed technology, trademarks, trade names, customer relationships, and covenants not to compete related to acquisitions.
Cost of revenue for the three months ended July 31, 2014 compared to the same period in fiscal 2013 was flat due to increases in (a) personnel-related costs of $5.9 million driven by higher headcount and (b) consultant and contractor costs of $1.5 million, being offset by lower product costs of $7.5 million, primarily due to lower hardware sales and purchase accounting adjustments that were recorded in fiscal 2013.
Cost of revenue for the nine months ended July 31, 2014 compared to the same period in fiscal 2013 remained relatively flat, primarily due to increases in
(a) personnel-related costs of $8.4 million driven by higher headcount and (b) $4.0 million in consultant and contractor costs, being offset by lower product costs of $6.6 million, primarily due to lower hardware sales, and purchase accounting adjustments that were recorded in fiscal 2013, and a decrease in amortization of intangible assets due to certain intangible assets being fully amortized.


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Operating Expenses
Research and Development

                                  July 31,
                              2014        2013       $ Change      % Change
                                         (dollars in millions)
Three months ended          $ 182.8     $ 166.7     $     16.1        10 %
Percentage of total revenue      35 %        35 %
Nine months ended           $ 528.4     $ 494.1     $     34.3         7 %
Percentage of total revenue      35 %        34 %

The increase in research and development expenses in the three months ended July 31, 2014 compared to the same period in fiscal 2013 was primarily due to an increase of $12.8 million in personnel-related costs primarily as a result of headcount increases, including those from acquisitions, and functionally allocated expenses that were higher by $3.6 million.
The increase in research and development expenses for the nine months ended July 31, 2014 compared to the same period in fiscal 2013 was primarily due to an increase of $22.4 million in personnel-related costs primarily as a result of headcount increases, including those from acquisitions, functionally allocated expenses that were higher by $8.9 million, and a $3.4 million increase in consultant and contractor costs.

Sales and Marketing

                                  July 31,
                              2014        2013       $ Change     % Change
                                         (dollars in millions)
Three months ended          $ 112.3     $ 105.4     $      6.9       7 %
Percentage of total revenue      22 %        22 %
Nine months ended           $ 332.8     $ 311.1     $     21.7       7 %
Percentage of total revenue      22 %        21 %

The increase in sales and marketing expenses in the three months ended July 31, 2014 compared to the same period in fiscal 2013 was primarily due to an increase of $6.5 million in personnel-related costs as a result of headcount increases, including those from acquisitions. . . .

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