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

All right. Welcome, everyone, to the afternoon session here on the 49th Annual JPMorgan Technology, Media and Communications Conference. My name is Jackson Ader. I'm a software research analyst here at JPMorgan. I'm very pleased to have Trac Pham from Synopsys present with us this afternoon. Trac will get into introductions and a little overview of the business in just a second. I just want to remind everybody in the audience, if you have any questions, just hit that button in the video portal, and I'll be sure to answer anything that comes in the queue. But yes, without further ado, Trac, thanks for being here.

Jackson, it's great to see you again. I'm glad we could join you guys for the conference this year, and really happy this time they've worked out that way.

Yes. Yes, it's great. So we're just coming off of your April quarter results. Do you just want to start maybe with some highlights from the quarter? And then we'll do an overview of the business before we get into the fireside chat.

Yes. Overall, I mean, it was a great quarter, fantastic Q2. And it really capped off a good start to the year for the first half, first half in terms of delivering really strong growth, margin expansion and really solid earnings growth compared to last year. Given how the first half played out and our confidence in the year, we raised the outlook for the full year revenues by $35 million, increased the lower end of our margin guidance and then upped our EPS expectations for the year as well, as well as increasing our cash flow guidance. So overall, business is great and just the momentum continues to be really strong for the business.

That's great. So we'll come back to kind of the results here. But just so that we get a lay of the land, the core EDA, IP, Software Integrity, can you just give us a little bit of a brief background on those major businesses that Synopsys is in?

Great. High level, we service 2 customer segments. One is the semiconductor market, which we're traditionally well known for. And that is supported by the EDA, software, hardware business as well as IP. Software Integrity is roughly 10% of our business, and we've been in this space for about 7 years. And it services the software developers market, really essentially selling tools and consulting services to help them increase the security and quality of their code. Now it's a pretty diverse range of products. But ultimately, the thesis here is that our belief that, over the long term, there's a convergence of more applications being out there requiring optimization and hardware. And so we like to refer it to as the software and silicon opportunity. So increasingly, you're going to see a pervasiveness of software, and they're running on a secure hardware. And so the idea is to secure the various elements of that and capture the growth on both segments. Okay?

Okay. Great. Oh, sure, go ahead.

No, please.

So just speaking of core EDA, and whether it's the software piece or hardware with emulation and prototyping, about how big is this portion of your business? And then we'll get into some more detail.

So high level, the EDA portion of the business is about 70% of overall revenues; IP is roughly, call it, 20%; and the Software Integrity, over the course of 7 years, we've grown it to be about 10% of total revenues.

How did that core market -- either EDA and IP, how did that hold up during the pandemic?

You know, remarkably well. Not -- I would say that not only did it hold up, but we actually saw an increase in momentum in both those businesses. We didn't see a change in the -- we were concerned about a change, a negative turn for the business. But the design schedules and our customers continue to, really, be really aggressive with their design schedules, and we didn't see any slowdown in their activities. And so the challenge for us throughout last year was really finding a way to continue to support our customers and support their needs with a very unusual -- under unusual circumstances. But fortunately, we -- our team adapted really well in terms of working from home and was able to connect to our customers, either with video or phones, and got them through their schedules. And so we came out of last year seeing really good momentum, and that's continued through the first half of this year.

And just so that we're clear, I mean, design cycles for semiconductors are so long. When we hear about manufacturing hiccups or the next node actually coming to tape out, I mean, these are months and often years in the making. And so one thing that I'm always curious about is, well, in a world where some technology needed to be -- and digital transformation needed to be accelerated. I mean in terms of the actual design of the chips, how -- I mean, how much faster can people run, right, from what they were doing in 2019? And how did that accelerate in 2020?

They definitely are trying to run faster, right? Because they're seeing a burst in end use of demand and various applications for that. You're seeing growth in verticals. You're seeing growth in different market segments. And so the challenge, from a customer perspective, hasn't changed at all. And as I said, it's accelerated, either because they're solving new problems, they're solving new challenges. The complexity of chip design hasn't slowed down, and you're seeing new market entrants to designing chips. So historically, we're servicing largely semiconductor companies. But over the last several years, you're seeing an increase in the hyperscalers increasing the number of designs. And that's created not only a market opportunity for us, but a competitive situation relative to the traditional semi companies that then end up having to up their game.

And these system companies that you often refer to, about how much of your core EDA actually comes from these system companies relative to traditional semiconductor?

For both the EDA and IP business, it's about 40% of the business. It's relatively -- been relatively stable, maybe improving marginally over time, and largely because of the shift in that mix of systems companies. Yes, traditionally, we would have seen more telecommunications companies, more networking companies in that system space. But we're seeing more, obviously, household names like Amazon, Google, Facebook designing their own chips for their own hardware devices.

And what about the -- I know you guys have talked a lot about the automotive industry over the last number of years. Is the automotive industry also following these hyperscalers and designing chips specific for specific use cases? Or are they adopting more IP? What's the difference, really, in terms of some of these end verticals that are outside of semiconductors?

All of the above, which is interesting, because we -- if you were to rewind back a number of years, the way that we would be interacting with the automotive vertical was maybe further removed, right? They're increasingly -- we're connecting to them, in some cases, very directly, either through the Software Integrity space because of the increased software content in cars and the need to secure that software for security and safety reasons, or the fact that there's increase in chip content. And as they're trying to navigate the complexity of the increase in chip content in software, they are often looking for a partner that is familiar with that space and, in some ways, serve as a guide to make all the various pieces connect. Because we're connecting to the Tier 1 service providers, in some cases, they're connecting to the OEMs themselves, and we're bringing our domain expertise there, both on software and the chip side. And it's hard for them because they don't have that sort of domain expertise and the ability to integrate all these various technologies that they're putting in their cars. And so we find that, that opportunity has opened up the chance for us, in some cases, to deal directly with the OEMs or often going to the OEMs with a Tier 1 partner. And so it's just giving us a tighter connection to the -- that market and increasing our visibility position in that space.

Is the automotive market probably -- is that the most successful end vertical in terms of selling everything core EDA, IP and Software Integrity as you look out into your customer base?

I'd say it's a very -- yes, it's a great example, in which we're able to sell the full suite of products, and given the ways that we connect with -- the various ways that we can connect in with the customers and their problems.

Okay. Now I want to be mindful that we're speaking to the Chief Financial Officer here, and I don't want to get terribly technical. But there are a couple of areas that Synopsys has really invested in over the last couple of years, and the one that I want to speak about first is Fusion Compiler. So can you just tell us why is Fusion Compiler such a game changer in terms of the way that the design flow works from front end to back end? And then also -- well, let's just start there and then I'll follow up after that.

Let me describe it in straightforward terms because I think, as you've highlighted, I'm not a technologist. But if you imagine there are different tools for different elements of design, right, and if you think about placing routes, synthesis and the various elements of that. When -- and you look at our position in those spaces, we have a market-leading products in those various categories of technology required to design a chip. So we've always had a platform. So you can come to us to get everything that you need to design a chip from beginning to end, right? But now imagine that when you're designing a chip and the time to market pressure increases and the complexity, let's say, a specific problem, whether it's a power consumption problem, or how to maximize the area of the chip, you're going to find that there is -- you're creating some judgment in each of these elements of design to account for what you expect it to achieve from a design and what it will actually achieve when you get that chip. You're always making judgment in each of those categories of design. And when you make judgments, right, you're going to increase the variability from what you expect to what you get. And so if you take -- if we are effectively driving that design with market-leading products, and we still have judgment that increases that variability, and we're the best at it. The way to reduce that variability is to reduce the judgment in each of those segments and processes, right? And how do you reduce judgment in each of those areas? Is it rather than doing a handoff of 1 product to the next? You're building a common -- you're integrating the software at each of those places so the handoff from A to B to C is more seamless, and you're transitioning it on a same data platform. And so by doing that, what Fusion Compiler does is it integrates market-leading products into essentially 1 common product that reduces the variability. So what you design and what you're expecting to design versus what you will get in the final outcome, there is much less variability in that. And so now, when you talk to our competitors who will say, "Well, I can do that, too." They could do that, too. Well, one, they don't have market-leading products, and we've been working at this for multiple years now. So it's not as if we're coming out in terms of creating a platform. These are much more tighter integrated products from a technology perspective. And as a result, you're seeing results that far exceeds what the customer is expecting from an outcome perspective.

I remember, one time, in a conversation with Aart, he said this was basically a once-in-a-kind-of-decade, call it, investment. Is that part of the driver as to, now, as we look out over the next few years? And you're really looking to expand margins and, certainly, part of that is in your semiconductor and systems business. Is feasting on the previous investments from Fusion Compiler part of why you're able to expand margins over the next couple of years?

I would abstract the comment on Fusion Compiler to freely apply to the business, the broad business, right? Over the last few years, we've improved margins from 2019 to now. We're going to increase margins by over 5 points, right? And that is a function of the massive investments that we made up until 2018, whether it's Fusion Compiler or new hardware products or broadening the titles and IP or just building out the Software Integrity Platform. There are massive investments across the board, right? And so it didn't stop after 2018. And what happens is we continue to invest, but those huge investments that we made allowed us to accelerate revenue growth, and therefore, actually are in a healthier position to both drive revenue growth while expanding margins, which allows us to further fund investments. And so we're -- what you're seeing today definitely is a function of the investments we've made. But we're on a path -- the optimism really is a function of the fact that business -- the business is so strong and so healthy that there's a strong confidence in our ability to continue to invest while still delivering on margin improvements over the next several years.

Okay. Great. We've got a couple of questions coming in from the audience, but I just want to hit on one thing before we go there. You mentioned hardware, just announced a hardware refresh. What are some of the highlights you can give us? And then what do you tend to see with a brand-new hardware refresh? What do you tend to see, either competitively, or maybe in the numbers financially as the new hardware starts to head out into the market?

Well, at a high level, the products that we've introduced really broadens the breadth of the new use cases that we can support, right? So we -- the range of products from high-level emulation down to FPGA prototyping and everywhere in between, the combination of the investments that we've made in new hardware as well as new software for emulation and prototyping really allows us to, in a more granular way, create hardware that is specific to particular use cases, where the functionality is really -- where the capability is really a function of a mix of different software on different hardware. It doesn't increase our COGS or inventory position or doesn't increase the types of software that we have to develop, but just the ability to mix and match in a much more granular way allows us to extract more value from different applications. And so that's exciting. We're seeing use cases that, over the last few years, even though we were the market leader in hardware, we're seeing new use cases and customers apply in very specific applications that is very encouraging in terms of not only growth, but value, our ability to get appropriate pricing, therefore, margins on that. Secondly, when we see these transitions, we're in a different position. So we don't typically see a discontinuity in our business because we can use a market-available FPGAs. Our hardware products are running on FPGAs, the commercially available FPGAs. And so we don't have this 18-month cycle where we're transitioning on an internally developed chip. And therefore, there isn't that risk in terms of managing that transition. And so for us, over the last 10-plus years, are really that -- to transition from one generation to next has been typically pretty smooth execution-wise. And right now, just with the capabilities that we're offering, we're excited about the growth prospects for that business.

Great. All right. A couple of quick ones from the audience. So can you touch on pricing structure of your -- of the software first? And then a question about switching costs. But first, on the pricing structure of the software.

We try to price -- we definitely try to extract value for the new products. And we are -- they are excluded from the traditional license. So a customer typically signs a 3-year subscription model for a certain set of products and -- over that period of time. And we keep new products out of that. And so when we do introduce new products, the expectations of the customer, if they want access to that, they'll have to pay more. Now that's a push and pull. There's always a tension because the customer is spending a lot of money, and there is a constant negotiation in terms of trying to us extract value and them keeping their costs low. But over the years, we've done a pretty good job in terms of extracting value. And as I've said at the beginning, the complexity of chip design hasn't slowed down. And if anything, it's continued to increase. And so our efforts in making these investments is with an eye towards pricing it to get the extra value. The second part of the question, in terms of -- I'm sorry, Jackson, I forgot the second part of that.

Yes. Just quickly, just to clarify, when we're talking about pricing structure as well, this is on a per seat basis or a per engine -- number of products per seat, correct, in terms of the structure of how you're actually pricing the tools?

It will vary. But typically, keep in mind that the way that we sell it, it is really a broad portfolio of products. We do itemize seats and price per seat. But in the end, the customer is buying it as a full flow. And so that's where I get into ensuring that the contract value explicitly excludes new product introductions or new releases is going to be key for us to extract value from those new products.

Got you. So the second part of the question is really about the dynamics around switching costs. And how difficult is it for someone to switch from Synopsys to Cadence, Cadence to Synopsys, Mentor, what have you? And also, are there -- you've just mentioned full flow. Are you seeing more full flow adoption rather than going with the best individual product for each area of the design?

A couple of comments to make. One is that the switching costs can be difficult, but not something that's not -- they can't overcome. And the fact that, historically, this industry is -- it enables that the customers to move from 1 vendor to another. And it's created an environment where the customer doesn't want to give up that flexibility, right? And so that's the market that we're selling into. Frankly, they're spending a lot of money on this. And it's such a critical element of their design. They definitely do not want to be locked into 1 vendor. And so it's a risk mitigation and also an economic discussion. The -- so it's possible. Typically, what you will see is that the -- in any customer, they will have multiple vendors. And when we talk about full flow, typically, they'll run a project -- they'll run projects with 1 vendor and sometimes they'll match it. But you'll normally get better results running with 1 vendor when they switch. They don't switch en masse as a company. They may switch at a project level. And so that's why, from our perspective and from the industry perspective, coming out with new products and highlighting the value that it will provide is key to increasing user adoption and usage, which then, ultimately, will, over time, drive revenue growth.

And then another follow-up from the audience. How would you characterize the Synopsys competitive advantage? And I know that this is likely referring to your EDA tools, but as specific as commentary would be helpful.

At a high level -- I think let's focus on the semi market. At a high level, the fact that we have the largest EDA business and the second largest IP business to ARM and the broadest, tightest of IP -- semi IP, that really lends itself to increasing our competitive position, right? So in any negotiation, the fact that we can fill, provide that breadth of products on software and hardware and IP just allows us to negotiate much more effectively. And what we've also seen over the number of years is, historically, we would lead with EDA, and IP would be pulled through in these negotiations. But over time, given how, as I said, the complexity of chip design and the challenges that are facing both -- our customers are facing both on a technology perspective but also an economic perspective, we're finding increasingly the conversation is led with IP and, in some cases, it will pull EDA through it because they can buy essentially everything they would need from an IP perspective. So in a case where you're dealing with a hyperscaler that has a lot of -- they have the resources, but they don't have the time and they want to get them -- they either don't have -- they have the financial resources, may not have the technical capabilities and don't want to use the time, and they want to accelerate their time to market, the conversation often is led with IP. And so from that perspective, a high level, it provides us with a unique competitive advantage. With regards to the EDA tools itself, it's -- frankly, it's very -- candidly, it's very hard from an investment perspective to weigh how the 2 companies and the multiple companies talk about their products. I would just say that, in the end, we're incredibly bullish about the portfolio that we have. We have made significant investments in all areas of the EDA portfolio. And you're hearing us be very vocal about those products and how they're gaining traction with customers and the -- in usage -- the increase in usage. And ultimately, it's going to translate the revenue. But so far, over the last 18 months plus, you've seen very good momentum with revenue growth. And so it's not just us being vocal about the new products, but it's actually reflected in the results. And further, there is a strong confidence in the momentum of that business and how that's going to translate into the future growth, and our ability to continue to drive strong growth and margin improvements. So I think it's both what we're seeing from a technology perspective, what we're sharing in terms of what the customers are getting, but at the end of the day, it's reflected in the financial results.

How are you guys thinking about China as a market, both as a semiconductor manufacturer? Are there local Chinese design houses that you will have to compete against? What do you think that market looks like over the next few years?

It has, for close to 20 years now, it's been a great market for us. And despite the trade restrictions that have been in effect for the last couple of years, it continues to be a very healthy market for us. And our -- and as challenging as the trade restrictions are -- and I'll just to remind everyone, our guidance does reflect that the trade restrictions remain in effect for the rest of the fiscal year. Despite that, we've continued to do really well. And we're seeing really broad strength across multiple levels. Where we're seeing in terms of the new customers that are adopting our products, new customers that we're engaging with, we're seeing strength across all areas of the business, EDAs, the software, the hardware, the IP. The -- and its large, established customers, we're seeing it in foundries, the [ salon ] shops and tiny little startups. And so it's a really healthy market for us. And we will continue to manage the headwinds from the trade restrictions, but overall, it's a really healthy market for us. From a competitive perspective, there certainly are a huge investment in terms of the government funding, the creation of the semi vertical there. And so we're seeing startups that are delivering very pointed -- point tools or specific capabilities, but really none that have the breadth or even remotely close to the breadth of capabilities that we have on the software side, nor anything remotely close to what we have on the IP side. And certainly, if we continue to make the investments that we make broadly, I think we're going to be -- I feel confident that we'll continue to do well.

Can we just switch gears quickly to Software Integrity? I think you -- the company still feels confident in getting back to double-digit growth here at -- by the end of the year. But that implies we're going to have to do some work here sequentially to get back to double digits year-over-year in the Software Integrity business. What gives you the confidence that you can -- that, that can happen?

We feel really good, and that confidence is really a function of us hitting our numbers, right? And what we described at the beginning of the year was, it's going to take time for the changes to take effect, right? And given that it's a time-based model with typically a 2-year duration, that, if we execute the way -- execute to our plan and we deliver the growth rates that we're planning on, where -- because for the full year, we do expect bookings to grow in the 15% to 20% range. It's going to take time for that activity to translate to revenue. And our expectation is that if we deliver on the plan, that by Q4, we're going to exit the year with growth rates in the double-digit range. Now with -- we have a new management team in place, and this would be the GM's third quarter. He's brought in some additional talent to support him, and they've been very aggressive with regards to the changes that they're making. And we're seeing that play out in us hitting our bookings targets and our -- not only the bookings target, but the key business metrics that would deliver on that growth. And so far, with 3 quarters behind them or with 2 quarters behind them in this year, we're not only are we hitting those numbers, we're overachieving on that. And so that certainly positions us well for the commitments that we made. We're definitely feeling very bullish about that space. But for those who are familiar with us, we're managing this over a multiyear horizon. So we tend to be very somber and not get too excited over short-term results, right? Because we're focused on not only this quarter, not only the year, but we're making sure that we're setting the right path for the next several years. And so, so far, we're hitting the numbers on a quarterly basis. We're on track for the full year. And we're really optimistic about the market opportunity and our ability to execute against that. Because frankly, right now, it's not a market issue. It would be a different concern, but the market is healthy. There's a huge potential, and it's really on us to figure out how to execute to capture that value.

Got you. Okay, that's -- yes, that's good to hear. You don't often hear a company say, "Hey, this is on us." Not -- it's almost always a market issue, not a company issue.

Yes.

Okay. So just speaking about both the long term and the short term, so you've put out some kind of 3-year midterm, mid-type targets getting to the Rule of 45 on a margin plus revenue growth basis. Where should we expect maybe those metrics to end as we exit fiscal '21?

Well, the guidance that we just communicated last week on our earnings call was for revenue growth of 10% to 11% and margins of 29.5% to 30% for the year. So we're well on track and, in fact, ahead of what we had communicated to investors several years ago. And when we exited FY '18 with margins in that 22% range, we felt really -- despite the fact that there is a lot of concern from investors about where March is, where we felt very optimistic about our ability to drive really good growth and margin expansion. And relative to the commitments that we made at the beginning or early 2019, we are definitely ahead of those plans. And so we've delivered on what we said we were going to deliver on. And we feel very bullish about our ability to continue to accelerate revenue growth and drive margins up over the next few years.

Now then the growth rates through the year looked a little wonky, right? It grew a ton in the first half, second half looks odd, right? I mean it looks like you're going to end the year basically flat year-over-year. Can you just give us kind of what are the dynamics? What happened in the second half of 2020 that makes things look a little off?

It may look unusual, but I actually love this profile. It's a very linear profile, right? When you look at -- when you step back and you look at 2021, it's a pretty linear profile, which is fantastic. And the comparison, they look unusual really because you're comparing it to a year prior that was incredibly back-end loaded, right, that the mix between the first half and the second half was very much skewed to the second half and very much skewed to Q4. And for those who aren't familiar with it, last year, we had a major -- a large hardware customer that delayed their deliveries to Q4 of last year. We had visibility to it. We felt very confident about it, but it was -- it was sitting in very late in the year. And then you combine that with an expectation of hardware -- of IP signature -- revenue signature that was also skewed to the back half, also skewed to Q4. When you look at the comparisons this year, first half versus second half, it looks really unusual. But overall, I'm really pleased with the mix this year. The fact that we can have this -- lock in the certainty that we've had through half of the year, the fact that we built backlog in the first half and really gained good visibility in the second half in order to raise it, this is really a fantastic profile. And the comparison is really more a function of the reference point than this year.

Right. Right. All right. Great. Trac, we are out of time. This is fantastic. Really appreciate you doing this. And thanks to the audience for all the questions that came in. That was good feedback. So Trac, thanks again.

Thanks very much. Great to see you again. Take care.

All right.

Bye.