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

All right. Well, welcome to the afternoon sessions of the 23rd Annual Needham Growth Conference. I'm Rich Valera. I cover technical software for Needham & Company, and it's my pleasure for this next session to have a fireside chat with the CFO of Synopsys, Trac Pham. And to kick things off. First of all, welcome Trac. Thank you very much for joining us. Happy New Year.

Thanks, Rich. Just glad to be joining you guys for the conference.

So maybe to kick things off and kind of level set the audience. You had a pretty remarkable fiscal '20, which you have completed since you're a little bit of an off fiscal year. You exceeded on all your key metrics and upped your initial guidance, grew your backlog. You sort of wouldn't have known there was a pandemic raging in the world behind you. So maybe to start off, just talk about what were some of the key drivers, maybe both from a macro perspective and from a company perspective that helped you deliver those results despite the challenging macro backdrop?

That's a good start. Rich, it was a very strong year for us. And you're right, it was amazing considering the context that we are operating in. I would say that the drivers of that success is a combination of the fact that the end-user demand, right? The continued demand for more compute, for more connectivity, for more electronics in devices, I think, certainly drives that. And as a result, our customers' investments and our customers' design activity continue to stay very healthy throughout the year. We didn't really see a slowdown in demand from the end user or demand from our customers. And notwithstanding a few moments as companies and society was adjusting, for the most part, things continue to keep pace. Internally, what was remarkable, and I don't want to take for granted how hard it was for us to execute to this, but the company was able to shift very quickly from the beginning of the year and back in March to adapting to working from home and maintaining an environment where we can continue to support our customers and execute on our plan. It was remarkably hard, but it just shows the resiliency of not only the business model, but the resiliency of our employee base.

That makes sense. Maybe just to drill down one more level there. You talked sort of about the macro drivers that were helping you out. How about from the product side, you've got sort of a number of product cycles, which -- a lot of which have manifested as a result of several years of R&D, but maybe take us through some of the big product categories where you've had some significant product cycles? And how those were sort of shaping up through over the course of the year?

Certainly, the -- to your point, we've been making investments in the portfolio across the door for a number of years now. And so this isn't necessarily an unusual blip, but we'll continue to see very strong innovation and new product launches in -- not only for the last few years, but we'll continue to see that over the next few years. The areas where we got a really good traction was on the digital design side. You saw strong growth in EDA and a large proportion of that was not only on the digital side, but also on the analog side as well. The reaction for Fusion Compiler, which is a new product that we launched probably 18 months ago continues to be remarkably strong. We talked about benchmark wins on our earnings calls. And then we've talked about the momentum of bookings and the reaction to that has been remarkable. And so we'll continue to see -- seem as that rolls it out and as the usage share on that continues to increase, I expect us to see that flow to the financials even further. So that's one example, whether it's in design or verification, software/hardware and even despite the challenges that we've had in software integrity, we've continued to get really good customer reaction across the board and that's a function of the investments that we continue to make through different cycles.

And maybe just a follow-up on one product area that you mentioned early on in that comment, analog Custom Compiler, that was -- having followed you guys for well over a decade. I know that's an area you've been sort of banging your head against the wall for a lack of a better term for a very long time. And it seems like in the last 12, 18 months, you started to get some meaningful traction. Can you talk about that? And say, is that sort of starting to move the needle for you guys? I mean you're a big company, but is that starting to become a meaningful kind of new-ish business for you?

Yes. I can certainly laugh at that comment, Rich, because it's mostly true. I mean we've struggled to gain traction on that. But I'm excited about the technology that we've introduced. And this has been on the mark for several years now. We're seeing similar to Fusion Compiler, the reaction from our customer base in terms of the innovation that we've developed and launched in Custom Compiler. And the results our customers are getting with this product, we're really seeing good traction on that. Now granted, we're coming from a smaller base and it's a very -- the competition is incredibly strong in the market. But I'd love the momentum that we're seeing in this space, and I think it bodes it well for us continue to gain share and see positive results on the financials.

Got it. So I wanted to pivot a little bit towards software integrity. And I have to say if there's one business that you could say maybe didn't go quite as well as you would have hoped, it might be software integrity in fiscal '20, where it seems like you had some COVID headwinds but also maybe sort of scaling and sort of growth issues as you guys transition that to a larger organization. I mean you did roll out a platform, which was great, and you can maybe talk about the benefits of that. But I wanted -- can you talk us through some of the challenges you saw there? Some of the things you've done to rectify them, including hiring a new GM, Jason Schmitt? And just talk us through sort of what happened there? What you've done to address it and how you're thinking about software integrity as we head into this New Year?

Okay. Well, let me give some context for as a few of us who might not be familiar with it. My software integrity is roughly 10% of our overall revenues. So it's a growing business. It's a business that we're very excited about. And I think we have a long runway to grow and increased profitability here, but it's still 10% of the business. We've been in the space for -- in 2020, it was 6 years in this effort. And so from my perspective and our ability to grow this from really 0 to about 10% of the business and reach profitability, I think, is a pretty remarkable achievement. It highlights the -- not only the demand for this product and the fact that we really are -- there is really a there and there. And that there's a strong interest in security and over the years that we've been building this out, that certainly has proven itself. But also it reflects our execution in this space that's very new for us. Now 6 years into it, and I think it's quite normal that business -- as the business evolves, there's a natural maturity -- a natural maturing of it. And so I'm not quite surprised that we would see a need to evolve the business to scale further. And some of the challenges that you've highlighted, both from COVID, the -- except we sell a lot to enterprise customers. And during the first half of the year, and for the most part of the year, things really slowed down as customers were really trying to focus on securing their financials. And so despite the importance of this, it wasn't -- they really need to focus on managing the business and staying focused on their financials and their health. Now that said, we needed to bring in a new GM. And the good thing with that process is that when he came in, he did his assessment of the business. And he had an opinion before joining, obviously, but his view, before he joined and as he's doing his assessment, it was is the vision intact? Is the strategy on point? Is there a strong demand for this business? Is the technology strong? And when he assessed that, he really came to a conclusion and validated the reasons why he joined us is that this is a -- we're on a point with this strategy, we're on point with the fact that we're onto something that is incredibly valuable to customers and we're on point with regards to how we're implementing that -- executing on that technology road map. Now the challenge is really on the execution side. So strategy is intact, the vision's intact, the issue has really been mostly on execution. And so his immediate focus was making sure we fix the execution and given the slowdown in bookings and revenue momentum, spend a lot of his energy addressing the go-to-market strategy and how we focus on that. And so we made a bunch of changes in the Q4 versus -- not just good Q4 and made changes as we headed into this New Year. And I feel good about the path that we're on. This year to me, FY '21, is going to be a transitioned year. And so given that things have slowed down over a period of time, it'll take time for it to ramp up as well. But we do expect that bookings for the year, we actually feature in our plan, it should be in that 15% to 20% range, which would then imply that over time, we should get back into the model of revenue growth of 15% to 20%. Now I'll take time given the time-based model for software integrity for that bookings momentum to show up in revenues. And -- but on that point, while we won't be seeing that kind of growth for the full year, I do expect us to exit the year in Q4 with growth in that range. So I'm very optimistic. I feel good about the changes that we're making. And it certainly feels like we were -- we're at a good point to scale up this business, and we've got a leadership team with a GM, a new GM, and a leadership team that's really well positioned to make that -- to make those changes that get us to back on path.

Got it. That's helpful. And just from a macro standpoint, it seems like if anything, in the 5 years or so, you've been in this business, that software security has become more of a front and center issue. And even, obviously, some very recent hack -- very major and recent hack. I'm just curious, what are your thoughts there? I mean it seems that this is the growing awareness. There should be some sort of positive secular drivers, I think, in your favor. And just curious on your thoughts there and if you're starting to maybe see some of that even if not exactly showing in the financials yet?

Absolutely, Richard. This has been -- I would say that, that's been the trend of the last 2, 3 years or maybe even longer than that.

Sure.

We entered this in early 2014. The question was why Synopsys? Why are you doing this? And then the other side of the questions were, I don't get it. Why would you tackle security in the software development cycle? And today, so much of that is taken for granted that they understand that as the amount of code that exists and they see the pervasiveness of software code in all elements of a life, right? Whether at work or at home or in transit in our cars, there's so much software content in the devices that connect to our lives that the people clearly recognize that the software code and the quality of the software code is really a risk point in many regards. And so -- and on top of that, we've seen, unfortunately, we've seen a lot of security threats come through on the software side. And so the strategic premise that we had going into building out this business really has not only held but been much more visible to our customers and investors in general. So I feel really good about the -- this strategy that we laid out and the execution that we've made so far. And I'm extremely confident in our ability to grow this business to the level of ambitions that we have set up for it.

Got it. Thank you for that, Trac. And I'd like to pivot to your IP business, your semiconductor IP business as it were, a really strong year for that business, up about 20% year-over-year, which is pretty well above the -- it's always had a healthy historical growth rate sort of double digits, but I think this was an unusually good year kind of solidifying yourself as a solid #2 semiconductor IP vendor behind ARM. But what would you -- if you had to talk about a few things that you'd attribute the strength of in 2020 in that business, what would they be? Can you just give us sort of your thoughts there?

Well, it's just -- in short and I would say that it's a combination of a very healthy market and just an amazing execution. That team has been executing incredibly well over the last several years in order to drive growth in that business. And I feel like when the opportunity accelerated in FY '20, the team was maybe executing at its best over multiple years. And so they were able to capture the market opportunity when it presented itself. Why is the market healthy? Well, the underlying trend towards outsourcing continues, right? And the outdoor sourcing trend is a very strong tailwind for that business. Further, when you look at how chips are being designed today, you're seeing new entrants, right? So China. China design shops get a lot of press, but you also hear from hyperscalers. You're hearing about new end markets, whether it's automotive or AI. There's just an incredible demand and new customers that are trying to service that demand. And the beauty of IP is that if you're open to not doing everything in house, we can really provide you a broad set of capabilities to complement what you're doing. And so for a hyperscaler who is really not biased towards doing everything themselves, but they're really focused on getting to market as quickly as possible and targeting their resources, even though it's vast, they do want to target their resources on areas where they can provide the greatest differentiation and the greatest amount of value add, IP is something that fits really well in that portfolio. And so you take that sort of use case for the hyperscale as you apply to the vast numbers of design shops in China or in Asia or anywhere else, that's really been a strong catalyst for us. And then as I said, the team has executed remarkably well against that demand, which is really hard, given that it tends to be a little bit more resource intensive.

That makes sense. So question on the margins of that business. Historically, you've acknowledged it doesn't have margins at the same level of sort of your core corporate software margins, but that it has potential to sort of move up over time Can you give us any sense of maybe the trajectory of those margins as that business is scaled and how we should think about the potential margin upside in that business over time?

It scaled up much like the rest of the business has, which for us to drive margins to 28% last year... 9% to 29% to 30% and then talk about a real 45%, everyone has a good tribute across different groups. And so the IP business is really scale. I would say a large part of that is supported by very strong growth. It's a lot easier to drive margin when you're getting the kind of growth that we're seeing in that business. They're helping themselves certainly by driving very strong growth. Two, that leader has really been focused on optimizing its cost structure, I would say over a decade. So he's built out large teams outside the U.S. and really strong technical areas, but areas that are lower cost in the U.S. And so he's distributed as his footprint in a way to leverage strong technical capabilities in areas that we are able to build and create critical mass, and so its cost structure also helps. As far as execution, the other area that helps them is really disciplined on management of the business they're selecting. So there's two elements for that. They're very selective about thinking about what emerging opportunities they want to engage in, right? Because in some ways, it is both a challenge and a great opportunity because you take the right leading customer and you're partnering with them to do new development. In one way, we're getting help with them to invest in new technology. You have to pick the right -- we have to make the right bets, then you can then take that technology to the broader market. So that's one area where they've been very disciplined about making sure they are focusing their business that can be taken to a broad market but also very disciplined about their pricing. And so across the board, just really strong execution and giving you a couple of examples how they're able to do that. We'll continue to lean on them more to drive that kind of behavior to accelerate margins.

Got it. And since it's pretty topical, and I'm sure investors are wondering. I just wondered if you had any thoughts on the proposed ARM NVIDIA transaction. I mean, clearly, there's some pretty big regulatory hurdles and approvals to get that deal through. But do you think that has any impact on you guys? I mean you guys obviously have partnered with ARM over the years and I suspect that would continue, whoever owns them. But any thoughts at all on that transaction potential implications for Synopsys?

Yes. Just some brief comments, really because NVIDIA, their public commentary has described the thesis as making the investment in order to continue support of that ecosystem, right? It makes a little sense. You're not going to buy -- make that sort of acquisition without supporting the ecosystem and growing the ecosystem. And against that context, which I believe is how they're going to create value, it's certainly good for us because ARM and NVIDIA are both very strong, very good customer for us. And ARM is also a strong partner for us. And so in -- under the thesis that the NVIDIA will continue to invest and build out the ecosystem. I think it serves us well because that means that there's going to be more opportunities, more innovation and more designs around ARM -- the ARM processes. So that's -- I think that anything that drives design will only be good for us.

Sure. That makes sense. Appreciate the thoughts on that. So another popular investor topic when we talk about EDA is China and China growth. And we can kind of do the math on your business and it was -- you had an exceptional year on a lot of accounts in one place was growth in China, which by our estimates grew something probably approaching 30-ish-percent for you guys. So can you just talk about that? I mean it was just -- and to sort of level set the audience, right? You guys had some headwinds there from entity list restrictions that hit Huawei going back to around the second quarter of last year as well as restrictions on a number of other Chinese companies and entities over the course of the year, yet still showed that remarkable growth. So can you talk about sort of what do you think is driving that? And then, I guess, from an investor perspective, the concern is around sort of the sustainability of strength in China? So?

So there's a lot there.

Yes. Yes.

So let me start with that. Our success in China is with the broad-based, which is both encouraging and also highlight of the risk mitigation, right? Is that -- the success was not driven by any one customer or one product category even when you decompose our growth rates. And by the way, your numbers on point with regards to growth. It was very strong growth and to the level you described. But when you decompose that revenue and that growth, it really was broad-based from a customer perspective, and it was really strong across all the product categories. And it was in line, maybe the growth accelerated in recently in this past year that the growth and the success, the broad-based growth of success was very much in line with what we've seen over several years. Now the additional color I provide is just to get context. Remember, we -- you go -- you have to go back to May of '19, right, when the entity list restrictions were in effect. And so we've been working under this -- those conditions since May of '19. If you recall, when we came out with earnings, the Q2 results, given guidance for Q3, we widened our guidance for not only the quarter, but the year, given the uncertainty. And the beauty of our model, right, is that it gives us time. This time-based business model gives us time to react to those sort of events, lure the weekend before earnings. We had the change in the numbers given the issues that came up. And so given the business model, we were able to adapt and redirect whatever our efforts. We're previously focused on the companies that are on the entity to us to broaden our customer base. That's always a focus, but when you have a customer that consumes a lot of cycles or consumes a lot of energy, that's a reality. You have to focus on them. And when the entity list went in effect, we really redeployed those resources to other areas. And so not only were we able to meet the guidance that we are provided, but we actually were able to offset the very significant headwinds that we saw in FY '19. Now heading into '20 is the same issue because the entity list continued to stay in effect. It was more of the same. It's pretty -- it's boring, but it's really the most accurate answer. The team on the ground and the team -- the development teams continue to support as many customers as we can. And so the outcome for the last year was very broad-based strength. There's -- there continues to be developing new developments with regard to China on a regular basis. And so what I would say is that we don't take the growth for granted. I think we executed really well. So I feel extremely confident in our ability to navigate that. But that said, we're very cautious in making sure that we're staying on top of the issues. But so far, we've been able to manage very well despite the restrictions.

And just to maybe put a final point on that. I mean some of the latest actions revolved around actual manufacturing, in particular, SMIC, who presumably, it's not a big consumer of EDA tools. And that's kind of what we stress to investors. I mean they manufacture and they may have some tools of yours they use, but they're not big designers, right? So I'm just curious if you could comment specifically on some of the restrictions around the manufacturing side. And clearly, you've dealt with them, but just your thoughts on that.

Yes. There's been some new developments, I think, late mid-to-late December. I mean new companies have been added to the -- where we've seen more restrictions and certainly, we -- our initial assessment of that is that the -- it's sort of a immature impact on our numbers. And we should be -- and given the diversification of our customer base and our business, we should be able to navigate that well.

Okay. Fair enough. So I wanted to pivot to more financial-oriented questions here. Now you've alluded in some of your prior responses to the fact that you've been driving very consistently towards higher margins across the company for a number of years. And I guess that sort of culminated in you guys graduating, if you will, from targeting the Rule of 40 to now targeting a Rule of 45, which is quite impressive. So kudos on that. But can you maybe lay out more specifically some of the things you've been doing to continue to drive margin expansion and how you're balancing investing for growth versus margin expansion as you drive towards this new Rule of 45 target?

Yes. To some, it might be a little surprising given that we still have a year left on the 3-year strategy. Obviously, we feel very good and confident about the year ahead. Now that doesn't make it easy, but if we're sure we have the pieces that will get us to that goal. And the reason why we feel confident about talking -- taking the ambition of over the next several years is -- I think it starts with the initial comments that we started this conversation around that, the investments that we've made in our business, whether it's in EDA or IP or hardware or software integrity. We can -- despite the fact that we've been able to drive margins up over the last few years and we're guiding again to margin improvements, we've made really substantial investments in the business and across the entire portfolio. And those investments have been very targeted and that we're seeing a very strong reaction from our customer base to those investments and those new product launches. And so there's a high level of confidence in our ability to continue to not only grow but potentially accelerate growth in some areas, right? And so it starts with a very strong covenants in our ability to sustain healthy growth over time. That's a great precursor and a great prerequisite to sustainable profitability improvements. Secondly, gaining the confidence and also seeing how we can execute on the margin expansions by prioritizing investments by looking for opportunities to scale out the business and really making those changes over the last few years, Rich, also increases our confidence in terms of executing on the expense side a bit. So the beauty of this is that this business is very -- this opportunity is incredibly sustainable. And that we're not looking at to drive margin improvements or the increasing to the Rule of 45 by cutting expenses, we feel that by sustaining very good growth and also being thoughtful about our investments and continue to invest in the business, we should be able to drive both good revenue growth and margin improvements in a way that will leave us even stronger in the next few years.

That makes a lot of sense. With that, I'm pretty much out of questions. And so I think we're going to wrap things up, but that was a great conversation. Really appreciate the time, Trac. Hope you have a good rest of your conference with your one-on-ones, and we'll chat again soon.

Thanks, Rich. I appreciate the chance to catch up with you. It's been nice to actually spend more time with you to talk about the business.

Absolutely. Thanks, take care.

Bye.