Synopsys, Inc. (SNPS) Earnings Call Transcript & Summary

Okay. Good morning, and good afternoon, everyone. Thanks for joining us today. My name is Adam Gonzalez, and I cover the U.S. semiconductor and electronic design automation sectors on Vivek Arya's team here at Bank of America Securities. And today, we're really excited to have Trac Pham, CFO of Synopsys, join us. We'll start with a little bit of an introduction before we dive into some Q&A. But we'd also like to keep this session as interactive as possible. So if you do have any questions, please feel free to submit them to me in the Veracast portal, and I'd be glad to ask them as time permits. So with that, let's get started. Trac, can you just really briefly just give us a quick introduction of Synopsys, its history, the unique business model, the markets you serve, and just really help us give us some context for the role that Synopsys plays in the broader semis, tech and electronics ecosystem?

Okay, great. Well, first, Adam, really great -- it's great to join you for this call. It's nice to have some sense of us working back to normal. Before I start, let me just make some comments. We're going to talk about -- provide commentary that contains forward-looking statements and I'll use and refer to some non-GAAP measures. So for our audience, please refer to our recent 10-K, 10-Q and website for discussions of risk factors and our use of non-GAAP financial measures. So as for the introduction, Adam, you know us well with -- for our audience, let me start by describing Synopsys. We are a technical software company with, really, 2 main segments. One, the semiconductor and system design segment, which includes our EDA software tools and semiconductor IP blocks. These are basically tools and IP that semiconductors and systems companies can use to design chips. And this represents about 90% of overall revenues. Our second segment is the Software Integrity business, which includes a software security testing tools and consulting services. And this is an emerging opportunity for us that we've been investing in and developing over the last 6 years. And right now, it is approximately 10% of our overall revenues. And this is a TAM expansion opportunity for the company. This year, we are on track to generate about 3.2 -- $3.625 billion in revenues, with margins roughly in the 27%, which is an improvement over last year. The combination of revenue growth and margin expansion is going to drive about mid-teens non-GAAP EPS growth and over $800 billion in operating cash flow. We've got a great stable growing business. That's about 90% recurring revenues. And we've got about $4.7 billion in noncancelable backlog. Our business model and the essential nature of our products, really provides a great stability throughout different cycles. So during down cycles, we weather it pretty well and then up cycles, we participate on the upside. We reported Q2 earnings roughly 2 weeks ago, really an outstanding quarter, record orders, revenue, non-GAAP earnings and cash flow. And based on the strength of the business through the first half of the year, we reaffirmed our annual revenue guidance and margin guidance as well as raising our EPS and operating cash flow numbers. I think we've -- we reported really strong results -- executed really strong results under -- in absolute terms. But I think considering the context that we're operating in with half the quarter, with most of the employees working from home and operating under a very difficult conditions, it was really an extraordinary effort from the company to post really strong results. Right now, we're benefiting from a very strong market. Despite the economic circumstances, our semi, systems and hyperscaler customers continue to really keep pace with their chip design, and we're not seeing a slowdown in demand for our products. And that, combined with the fact that we have been investing actively in the business over the last 5 to 6 years across the entire portfolio. It's really a nice convergence of strong demand and new product introductions over the year. So we feel really good about where we are and how we're positioned to continue to grow and drive margin expansion over the next few years. So with that, that's a brief background on Synopsys.

Great. And you touched on this a little bit just now, but I just wanted to cover this a little bit more, given that it's top of mind. When we talk about COVID-19, it seems to be disrupting the market overall, but you guys seem to be weathering the storm, at least in the near term, better than others. You talked about no disruption to your customer design activity. But if we were to think about some of the longer-term disruptions, both positive and negative, moving forward, how do you see that playing out relative to Synopsys' growth drivers?

Well I'll start with how we've managed through it recently. We touched on it a little bit, but when we transitioned to working from home back in mid-March, it was definitely a major switch for us. And I think the vast majority of employees were working from home and through a combination of really strong focus and a tremendous amount of effort, we tried to get back to a normal level of productivity as possible. And historically as a company, we've done a really good job, managing a very global company that's highly distributed. So we're familiar with that. And I think that this situation really just play to our strength in some ways, but also it just required the employees to increase their focus. So that effort over the near-term really allowed us to transition very quickly and get back to a healthy state. The second part is just, again, I touched on the idea that our products and services are essential to chip design. And given that that is -- that certainly helps us in terms of managing a very stable business. As I think about how we will -- could perform going forward. I think if you look at the past as referenced, whether it's the crisis through '08, '09 with the global financial crisis, our business holds up pretty well because of the financial model. It's a 3-year subscription model, the essential nature of what we provide. And the fact that through different cycles, our customers will continue to invest in chip design even if they're under stress from a revenue perspective because our customers, obviously, know that to experience -- if they don't continue to invest during those down cycles, it's really hard for them to participate on the upside. And so while I don't take it for granted that the opportunity will continue to be healthy. I do know that when you look at history, our semi and systems companies know that they have to continue to invest to continue to be relevant and succeed over the long term. So that's a good backdrop for us. And so that's something that we certainly look forward to continue to manage effectively.

Great. That's helpful. And then I just want to dive into the business segment, starting with your core EDA business, which you said is 90% of sales right now. Just focusing on that market. It's really dominated by you and your peer, Cadence, and the market's really consolidated pretty meaningfully over the last decade or 2. Can you walk us through how you are positioned competitively versus the other big vendor? And how your product portfolio strategy or customer exposure has evolved over time?

Well I'd start with the fact that we do provide a complete solution in the end flow. So a customer can come to us and purchase all the tools that they need to design chips. So I think that's a very strong position to be in. Secondly, the -- we are the largest EDA vendor -- large EDA vendor. And from a product perspective, I think we've got strength across all the platforms, whether we're talking about software or hardware, whether it's digital design or analog and design versus verification. I think we have strong leadership positions in many parts of the -- many segments of the market. And why I particularly feel good and optimistic about our outlook and our ability to continue to drive very solid growth and improved profitability is the fact that we've continued to invest in that portfolio over the last 5-plus years. We've been doing well, but it's the outcome of what we're seeing today and then over the last couple of years is a function of the heavy investment that we've made and the fact that we're going through a cycle of new product launches right now in an environment where despite the economic challenges, our customers continue to want and need to new products and new advanced capabilities. And so that combination of end-market demand plus -- customer demand plus a set of new products across the board, really, certainly, positions us well.

Great. That's helpful. There's been a lot of talk in the semiconductor industry about decelerating Moore's Law. And I think, there's a perception out there that EDA growth is kind of closely tied to the Cadence of Moore's Law. So in that context, can you talk about some of the puts and takes there, I mean, what opportunities there are in electronic design, even if Moore's Law is slowing somewhat?

That's interesting. Let me start by highlighting that our outlook for growth in EDA, we actually increased our outlook for growth over a multiyear period. We see it as a mid- to high single-digit growth business for us. And if you go back a few years, our expectation for that market was a little bit lower. And so in fact, despite that concern, we have actually upped our growth prospects for that line of business. And the reason why is that the -- despite the slowdown in Moore's Law, that historically has been the proxy for complexity in the past. And what we're seeing is that there are different elements or dimensions of complexity. And we don't see the pace of complexity -- or we don't see the complexity and the challenge of designing chips slowing down. If anything, the pace is either keeping -- the complexity is keeping pace or increasing relative to history.

Great. And for Synopsys, your core competency has really been in digital design. Can you talk about how your product line stacks up versus Cadence? And then on the custom side as well, you've done a lot of good investments there in the last few years, and I think you're a bit stronger on the verification side. Can you just help us understand how you're making progress on that side of the market? And how -- specifically on the custom and analog side, how the go-to-market or customer approach might be different versus in core digital design?

I think you've characterized it fairly at the highest level. I think what we say is that we have an incredible position on digital design and verification. And historically, Cadence has been much stronger on the analog side. What I like about our position right now is that we're coming from a place of strength. And with the investments we've made in the analog business and the competitiveness of the products that we're launching, that the incredible reaction that we've got from our customers so far with the new custom compiler products, it's really a good indication about the outlook for the future. So when you look at where -- the pockets where we are historically strong and where we're introducing new products on the analog side and the fact that we've got a rich portfolio of both software and hardware tools, really positions us well relative to the competition. Now that said, the environment is healthy, so that certainly helps both us and Cadence. The fact that our customers continue to keep their pace of design pretty steady and the fact that they continue to invest heavily into their new chip design and the fact that there are new customers, like the hyperscalers who are investing in developing their own hardware, all those things are positive for the market. And the fact that we're both driving for new innovation and our focus on margin improvement, I think it just highlights how healthy the overall market is. Now that said, I love the position that we're in, given the scale of the business, the breadth of the portfolio and where we are with regards to new product introductions. We're well positioned to capture our share of growth, if not more.

Great. I think that's a nice segue into a question I received from the audience. And I think they would like to ask about your new DSO.ai product and what kind of productivity improvements you're seeing there with customers?

Well, DSO.ai plus all the various products that we've introduced recently, the reason why you hear us talking more about those products, the digital products on our calls over the last several quarters, is mostly because of the fact that the reactions from our customers has been so strong and overwhelmingly positive, whether it's that product or some of the other new digital tools, the fact that we've won -- consistently won our benchmarks and the fact that our customers are coming back with substantial improvement in terms of their results, whether that's area, whether it's timing or other characteristics, the reactions from the customers have been so strong and overwhelmingly positive because of what they're getting. And that's a good sign. That's a good sign of the investments and the targeted efforts we've made in our products.

Great. And you touched on hardware a bit before. I want to dig a little deeper there. First, can you -- I know hardware has become a bigger piece of the EDA pie over time, and EDA overall is probably about a $10 billion market; $6 billion, tools; and $4 billion, IP. Can you give -- help us -- give us some context for how big the hardware market is now and provide some context to the audience as to what exactly these systems do, how they're used by customers in the design process? Why has the need for them to become greater in recent years? And what are some of the key differences between emulators and prototyping systems and how you're positioned there?

Let me start by -- we don't describe specifically the size of the hardware business. But increasingly, it's a larger part of the overall revenues. And we've been investing heavily in hardware. And I think over the course of the last 7, 8 years, we've come from a very small position in hardware to a point where last year, we reported record results in hardware. Despite our pretty public -- our public comments about our largest hardware customer pushing out their requirements to this year, we still were able to deliver record results in hardware. And that really just shows the breadth of our customer base. And whether it's geographically diversified or just a variety of different use cases. I think we've been able to grow that hardware business to a very diverse set of customers. And there are different use cases for Emulation and HAPS FPGA prototyping. Emulation, the reason why that's been successful, and the reason why it continues to be successful, it's just the -- it starts with the scale of the code base for chip design these days. And as that gets larger, it gets increasingly more difficult and challenging to run simulations and verification on software. And in effect, the Emulation hardware box allows our customers to simulate their designs much quicker. And one other very unique use case, a very -- a use case that's particularly strong for us is the ability for a software to bring up. And what that does is that allows our customers to begin software development in parallel and earlier in the chip design process. So instead of having to wait for an actual chip to come back, they can actually pull in their software development cycle early into that process and use the Emulation box to simulate the hardware in order for them to start doing software development. And what's -- why that's so compelling, despite the fact that Emulation is a bigger-scale investment for our customers, the fact that they're able to put it in by weeks or months at a time has a pretty significant economic value when you think about the volumes that you might see in a mobile customer, right? So if they can pull in their timing of software development and then go-to-market one month or a quarter earlier, that has significant economic benefits for them. So we've seen a really good traction on Emulation due to that use case. And then on FPGA HAPS prototyping product, it's really a hardware box that mimics an FPGA. And so again, our customers are able to use that box to simulate an FPGA and really help their -- help improve the quality of their design and also to speed up the timing of design. And so far the reactions, given the growth in that business and given the diversification of that customers, this just shows that the value that we're bringing is pretty broad-based.

Great. That was a very nice overview. Just a few more questions on the EDA side before we shift into Software Integrity. But on IP, that business has been growing very nicely for you. And you're really the #2 in that market behind ARM, although your portfolios aren't really comparable. What's the strategy here? What major IP blocks and end markets is the company focused on? And can you speak to some of the industry trends that have really been driving a shift to more outsourced IP usage?

Okay. So you did mention that we're #2 behind ARM. And as you described, there really is 2 different models, right? And when you look at our portfolio, it is the broadest set of IP titles available in the market. And the reason we've been able to be successful is the -- is both a combination of our execution but also just the end market demand. Increasingly, it's what we do -- historically, it started out as just outsourcing some IP blocks that our customers didn't want to do. And we were -- we certainly started from that position. But over time, by broadening that capability, we were able to engage with customers more and more. And then more that we engage with them and the more we delivered the products on time, on schedule, at the price that we agreed to, they just increased their confidence in us, and as a result, they were able to -- willing to outsource more. And it creates a virtuous cycle in that business and a flywheel in that business because the more IP blocks that we're building, the more that we're able to invest in new development. And now we've reached a point where we're doing blocks that are, in some ways, so complex that our customers either can't do it or aren't willing to take that risk or -- and therefore, are much more confident in our ability to deliver on a very complex design. And the -- what's driving that from their side is that complexity and that challenge. But also, when you think about the end-market demand continues to be very healthy because what drives the growth in that space is changes in standards. So if we've got blocks for standard IP. So it's USB, HDMI or other interfaces, as the standards change, that naturally is a driver for growth. And once we build that out, it's a broad market sell. So that's a very positive thing. And that's an area where customers can't really differentiate. And so for the most part, we are leaders in the digital interface to just new use cases. You're seeing IP blocks for automotive, for example, or AI or IP blocks with security built in, those different use cases are driving demand. There are new customers. The hyperscalers, as I mentioned earlier, are developing their own chip design. And so -- and the hyperscalers are unique customers in that they don't have that inherent need to design everything themselves. They want to focus on the areas where they're going to differentiate or specialize. They want to build out massive -- a massive team of chip designers. They want to be very selective about what they're focusing on. And they're going to buy some EDA. They're going to be open to IP blocks that are -- that allows them to get to market faster and allows them to differentiate, and they're going to use our consulting services to help them with that design. And so that's another driver of growth. And when you look at all those kind of layers of incremental growth opportunities, it's -- that trend has not changed. And if anything, we're seeing an acceleration in that. And so our outlook for IP continues to be very healthy, and we certainly view it as a sustainable, low double-digit growth business for us for the next several years. And the main challenge for us is continue to staff and scale and grow that business in order to sustainably and scalably support our customers' demand, because the demand is very healthy.

Got it. That's helpful. Last question on EDA. A question I often get on it is really on your pricing model. Can you walk us through the various pricing models that Synopsys uses for each of its businesses, particularly in core EDA. And how is pricing really a function of designer seats, IC production from a unit perspective or just general tool and design complexity?

I think generically speaking, those factor in, like the number of seats that they're going to use and the mix of the products that they want and the types of products that they want. Certainly, those things factor in. But generically speaking, for the most part, we sell into to a customer's budget that they have a certain amount of budget that they have to spend on chip design. Outside of people, EDA spend is one of the larger pieces -- larger blocks of spending. And they invest a large amount of dollars in this space and so they want to maximize that dollar. So -- and so while we factor those elements in there, largely, it's a budget sell. And our challenge is how do we consider all those factors, but also then aggregate it in a way where we're able to drive run rate growth on this business. Because this is -- this business is -- we'll consistently renew these contracts after 3 years. And so we book a deal, our expectation is we want to run this business as an annuity over time, and we expect to renew it when it comes due. And so the job is at each renewal, how do we think about the engagement in such a way where we factor all those variables to drive run rate growth. And so it's not enough just to describe us hitting the bookings number and us being disciplined about pricing because that's one element of it. But all of those things come together, they have to ultimately translate into run rate growth. And so when I talk about the record bookings quarter for us in Q2, it was really remarkable in absolute terms. It was by far the largest bookings quarter we've ever had. But what was more important or equally important was the fact that we drove those bookings with solid run rate growth, which translates to very good visibility and growth for the business. And as a result, we were able to guide to the full year, reaffirm our guidance for the full year. And so it's really a number of different factors that come into pricing. And it's not as straightforward as just looking at seats or price per product. And it is -- each contract really is unique in its own right. From an IP perspective, we do -- there's a variety of different pricing but for the most part, we do have standard contracts that run multi-year and over time, but it really depends on what the customer requirements are based on their design process.

Great. That's helpful. Shifting gears to Software Integrity. This business has scaled nicely for you, although near term, it's probably a little bit more impacted by the weaker macro environment. You've really outlined getting into that $500 million to $1 billion sales range as the next target to look out for. First, can you talk about the strategic rationale for getting into that business? I know Synopsys leads there right now, but it is a relatively fragmented market. And then with a lot of enterprise spending decisions kind of on pause in the near term, can you walk us through how we can get confidence around the sort of the low double-digit growth target that you've laid out for this year specifically?

Well, the strategic thesis for this back 6 years ago when we launched this, was to build a new TAM for the company. And when we -- when you go back to where we were 6 years ago, we were doing very well with the company. We are growing, profitable, generating very healthy cash flow. And the question that we received then was, why would you want to look for new TAM, you're doing really well in your markets? But that's exactly when you should be looking for new opportunities to drive growth because we weren't looking out just 3 to 5 years ahead of us, but we're trying to figure out how we can keep this business growing over the long term, next 5, 10, 15 years. And so we were actively looking for a TAM expansion opportunity. And typically, when companies do that, the challenge is you either stay too close -- you find some of this too close to where you are and therefore, it doesn't create a big enough opportunity long term or you go too far, and there's really no connection to the business that you have at hand. And what was unique about the Software Integrity business is that it provided a nice bridge to the future in that the -- in the near term, the business that we initially acquired to build out the Software Integrity business, it's -- it is -- it provides a set of tools to test for security and quality. It's security and quality testing on your software code base. We've been using these tools for, I want to say, about 15 years before we actually acquired the company. And half their business was to our existing customer base, the semiconductor and systems companies. Because they saw the value of ensuring that the code base was bug-free and secure because they're spending, I'll say, 18 months on chip design. What you don't want to do is get to the end, do a keyway and find out there's a bug in your chip, and therefore, you've got to restart it. And so they'll run the keyway on their code base throughout that process to ensure that the issue was not going to be on the software. And so in effect, by buying a business and building a business from a platform where half the business was -- half the customers with -- was in our existing customers, we were able to really derisk that acquisition and that expansion opportunity. Now when I say the bridge of the future, well, we've derisked half of it because we can secure half of the business and half that revenue. The bridge of the future is on the other side, which is the enterprise customers. Because long term, if we can expand the enterprise customers and expand that market opportunity is going to create and open up a whole new market for Synopsys. And that's what -- really what's played out is that with a mix that's been 50-50 when we initially started, now it's much more heavily weighted towards the enterprise customers. And longer term, increasingly, if we're successful and we expect to be successful, that enterprise customer base is really what's going to provide that long-term growth and profit opportunity for the Software Integrity business. And I forget the second part of your question, but that was the strategic rationale. Well -- sorry, you did ask about COVID and that business being one area that is affected by the macro environment. You're right, the -- if there was one area in the Synopsys results that was impacted by COVID and the broader macro environment certainly was the software integrity space. But yes, to be fair, the macro environment, I think, exacerbated an internal transition too. Because we had built this business to be about 10% of overall Synopsys. But as you highlighted, our ambitions are much greater than that. Certainly, we see this as, certainly, on a path to reaching $500 billion. But we do believe this is a $1 billion-plus opportunity for us over the next several years. And back in the fall of last year, we were already rethinking about how do we retool our go-to-market strategy, how we think about the necessary changes in order to scale this business up, as it's -- as it matures, to ensure that we really have the capabilities to grow to $1 billion. And we were in the process of retooling our -- and investing in our go-to-market resources and capabilities in the midst of what's happening now. So I think those 2 things combined really presents a challenge that we're working through. Now that said, why do we feel confident that we can't get back to the growth rates that we've communicated. First of all, it starts with the product. The breadth of the capabilities that we provide. So let's start off with the fact that we have both product tools and consulting services. That's unique. And on the product side, we have the broadest set of capabilities on the products, whether you want to test open-source software or proprietary software, you want to test it in a static state or while it's running, whether you want to test a web interface, a software or something else. We just have a broad variety of tools that can be brought to bear on a -- on their security and quality testing requirements. And on top of that, we are in the midst of integrating those capabilities into a cloud-native platform. And so the combination of that really positions us well from a technology and product perspective. And the -- this is not just us describing it, but also if you look at Gartner -- Gartner's Magic Quadrant report, if you look at where we were last year, we were certainly up into the right the farthest spot in that graph, and there's a clustering of kind of the other competitors. And when you look at the report that just recently came out, we've moved up further into the right. So there's an external validation of our vision for the products and the capabilities. And so we're excited about that. And I like the bet of us, on us and our execution because so far, over the last 6 years, we've built out a really strong product and consulting capability. And it's just a matter of us making the necessary tweaks to get us to the next level.

Got it. I'd love to continue the conversation, but I think we're out of time right now. I want to thank you again for joining us. Apologies, anyone in the audience if I didn't get a chance to ask your question. Feel free to e-mail me, and I'd be happy to follow-up. Thanks, Trac. Thanks to the Synopsys team. Bye for now.

Thanks, Adam. Take care.