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

Okay. Great, everyone. Thank you for joining us today. I'm Joe Vruwink from the vertical software team here at Baird. And our next presentation comes from Synopsys. Synopsys is the leader in EDA software used in chip and electronic system design. Very pleased to have with us today, Trac Pham, he is CFO of Synopsys. I think what we're going to do is I'll turn it over to Trac, and he has an introduction and overview of Synopsys, and then we can handle a fireside chat format. So thanks again for joining.

Joe, it's good to see you again. Glad we can connect. As you know, we reported earnings a few weeks ago. And so far, we got off to a great start to the full year. First half, really strong growth, margin improvements and EPS growth. And based on how we performed in the first half, in particular, in Q2, with the visibility that we had, the deals that we closed, we were able to not only reaffirm the guidance for the year. But actually, in fact, raise the outlook for the full year in terms of our guidance for revenue, margins and EPS. So it's shaping up to be another strong year for us on the heels of what was a record year in 2020. So glad that we're -- we have a chance to spend a few minutes with you to share the story and describe the path that we're on.

Great. I did want to mention upfront. If anyone in the audience has a question, you can use the prompt and the webcast, and those will actually get sent to me, and I'll filter that into the conversation. I think the area I wanted to start, so I went back and read my notes from this conference a year ago. And at the time, we were talking about all these great secular trends. I'm sure we'll talk about them again. But the Synopsys EDA segment at the time, had just posted 4% revenue growth. And it begged the question, well, why isn't this stronger? You fast forward a year, and the business over the last year has grown at a low mid double-digit pace. So quite a bit has changed. Can you just maybe walk through some of the things that have helped drive that acceleration in demand that the EDA segment of Synopsys has seen?

I'll start by saying that the backdrop for us is very positive, right? Even going into the pandemic last year in the early parts of last year, the backdrop in terms of demand and the pace of design was actually very positive. And we felt very bullish about the year going into 2020, and it was reflected in the guidance. Now what we saw through the pandemic throughout last year was just the -- not only did the design activity remain intact, but in some cases, that really accelerated. And so we saw a stronger uptick in design activity and, therefore, demand in our product portfolio, both on the EDA and IP side. Part of the comparison in the early parts of last year was, keep in mind, it was an unusual profile. This is -- last year, the way it had laid out that was based on the profile that we saw for hardware and IP was very back-end at the year. And EDA includes the hardware products, at least emulation products. And so the comparisons were muted because of the quarterly profile for revenues. At the same time, for this year, it's -- the comparisons are all also skewed because it's relative to a relatively slow start to 2020. But overall, I'd just reiterate that the reason why you're hearing so much optimism and confidence in our business is the combination of the design activity, the customer base doing really well. The customer base continues to have a high degree of -- the pace of design continues to be very strong. And you match that up with the products that we have in the pipeline and that we have introduced. We're just -- it's a great combination of a strong market and really strong product portfolio position.

So you mentioned it several times, pace of design. So development activity, R&D this is the key thing. And I'll ask the question because there's been no shortage of headlines over the past year, whether it's chip shortages impacting end demand, whether it's big customers deciding to get into the foundry business and in bigger ways, maybe third-party foundries getting bigger, so on and so forth. And the question always comes up, well, what do these individual things ultimately mean for Synopsys? I'll just pose that question to you.

It really doesn't have an impact on the demand for our products. And because we're talking a supply chain issue, right? And it may limit the supply of what consumers going to end up purchasing and may affect the pricing of it because of the supply-demand dynamics. But what we're seeing today, right, in terms of what our customers are focusing on is what they expect to launch 18 months to 2 years from now. And therefore, they're not going to let whatever factor in the short-term effect of what their trajectory is because that's really going to be determined by what they're developing now and what they introduce 18 to 20 months to 2 years from now. And so because of that, despite the supply chain issues, we continue to see them be very focused on their design cycle, their design road map. Now you do have to assess whether or not the end-user demand will remain robust over the next several years. And I think as you think about the various applications, whether that's on a consumer basis or on an enterprise basis, right? That I don't see. The pace of people purchasing more electronic devices, I don't see it slowing down in terms of the content of chips that are going to devices that we touch every day and software content that goes into everyday consumer devices. And I don't see that changing on the enterprise side either. And so the -- ultimately, the end-user demand, once we work our way through this supply chain hiccup, and in some cases, people believe it may last several years, I think the underlying consumer demand and end-user demand, both on the enterprise and the consumer side, will continue to be very healthy. And so you work your way backwards, and I think that's what our customers are really looking at. They're assessing that despite the near-term hiccups or however long that last, that demand will continue to be very robust over the next few years. And so they definitely do not want to miss that opportunity by changing their schedules at this point.

Okay. Okay. I wanted to shift gears a bit and just talk about some of the individual product categories. So Synopsys has been the leader in digital chip design for decades at this point. And today, you have the Fusion Design Platform. And within that, even more granular pieces that we can touch on. But maybe I'll just pose it to you. When you think about Synopsys in digital design with future growth being driven off of all the activity that was happening in '18, '19, '20 to ready the Fusion platform for kind of the next wave of innovation. What are some of the key highlights, the things you would point to, to say that the company is maintaining its leadership in this category?

Well, I would circle back to your comment, right, at the beginning of this question, which is that we have been the leader in digital design. And we don't take that for granted, right? So despite the success that we've had over many decades, we've continued to innovate and invest heavily in our capabilities there. And what we brought to market with Fusion Compiler is unmatched in the marketplace because what we've done is taken market-leading products in synthesis and place and route and signoff, and we've integrated on a common platform to further increase the capabilities by being able to seamlessly move from the beginning of the process to the end of that process through these different product categories in a way that you can't match because, one, it's based on market leading products. And it's taking those products after multiple years of development to really streamline the integration on a common platform. You just -- you can't duplicate that. And so we're incredibly excited about the fact that in a market that is very healthy, where the momentum is positive, we're 1.5 years into seeing that gain, strong traction from a customer usage perspective, which is a great leading indicator of where this is going to go from a revenue perspective. So it's all turning well. And I think the early signs of this being used in production and the results that our customers are getting are building well for the increase in usage, and therefore, ultimately, it will be reflected in the improvements in revenue. And the great thing is that we're in the early stages of this. And so we'll see this impact further in over time.

Another question I tend to get is just how Synopsys thinks about the sequencing of innovation across something that is leading edge, 3-nanometer. But I think also in the last year, there's an appreciation that innovation is not done at 14 nanometer. A lot of pain points in the industry are 28-nanometer right now, I mean, there's opportunities across the full spectrum. You brought up full flow products. Is that something that a customer would deploy at the leading edge of innovation. And then there would be different products that typically are trying to squeeze out advanced productivity or whatever it might be at some of the older nodes.

We have a well-deserved reputation for being a leader at the leading edge from a technology perspective. What's often underappreciated by investors is the fact that we are able to capitalize on that leading edge capabilities and show to our customers who are still at the established nodes, how those leading-edge products can actually enhance their productivity and their time to market. So we're seeing success with innovation that can be applied across the full spectrum of design and across the full spectrum of customers. And that's why when we think about the success of -- the early success that we're seeing with Fusion Compiler, it really broads -- bodes well for the broad opportunity for growth across our entire portfolio -- across our entire customer base and different applications.

Okay. Okay. So that was a good coverage of digital design. You brought up earlier that within the scope of the entire EDA business, there's also verification and verification as Synopsys describes it or actually calls the product set, it's a continuum. So maybe we can just spend a little bit of time because on the hardware end of things, not just Synopsys, but your peers in the space have all introduced recently their newest generation of products. Hardware is a very important consideration, but there's an incredible amount of complexity when it comes to verification. In fact, I think even a typical design engineer in the industry at this point is spending almost 50% of their time doing verification work. So maybe we can just speak to how Synopsys addresses both hardware and software, both sides of the challenges verification presents.

The competitive advantage on verification is really unique. And that -- when we talk about the Verification Continuum, it's really the platform of both software and hardware products to the verified chip design. And we have a leadership position in the verification software side. And over the years, we have built a leadership position on the hardware side as well. And so you're coming into this verification portfolio from a leadership position across the hardware and software spectrum. And in addition to that, what we've done with this Verification Continuum, I'll describe in layman's term, which is best for me, is that we're able to allow our customers to do verification and simulations in a seamless way. So whether they're doing designs that are suited to do simulations on software or as they move to larger designs that require hardware simulation and emulation. In the process, the methodologies that flows that they can apply, from their perspective, feels very seamless, right? So it's not as if you're applying a process A, if you're doing simulation in software, you have to take a different approach with HAPS Prototyping, FPGA prototyping to emulation, the fact that we engineered it in a platform that allows them to really seamlessly move and do their verification in a variety of ways in a variety of use cases really further differentiates the product offering.

Okay. Okay. I'll maybe come back around to the IP business, but related to software bring up and debug and I think that maybe is a segue more into perhaps application security and what you're trying to tackle in that side of your business. Now this is potentially a growth accelerator for Synopsys, something that's capable of growing faster than what has been the core EDA profile in the past. Great set of technology that's been built out organically, but also via acquisition over time, there was another acquisition announced today. Maybe you can just by way of introduction, explain the rationale for why this needs to be apart and complement what Synopsys is doing in the semiconductor business. And then I have a few follow-up questions.

Certainly. Just for the audience benefit, you're referring to the Software Integrity business which is...

Yes. Yes.

Roughly 10% of overall revenues and is a business line that we really launched 7 years ago with kind of base -- a core acquisition in that space that we've complement over time with a number of acquisitions as well as organic investments. And over the 7 years, we built it up to scale that's roughly 10% of revenues. And what we -- while it's still a very nascent market, highly fragmented market, we have distinguished ourselves by assembling a very unique asset, which is this very broad set of software tools to test and to help software developers increase the quality and security of their code base. We complement that with a very robust security consulting business, which is unique. That combination of breadth on the product side, combined with consulting is unmatched in the industry. Now that business, the strategic rationale for that, there's a number of things. One is that there was a strategic belief that increasingly, there would be a greater integration between hardware and software, right? And you look at companies like Apple, Samsung, where you've got software -- their software stack running on their own hardware that creates this, I think, a more unique customer experience. And you see that thesis play out with the hyperscalers now designing more of their hardware to run their applications. So there was a belief in the tighter convergence between hardware and software. That's part of the thesis. The second part of the thesis was that we believe that over time, the amount of software would continue to increase exponentially. And the challenge of building a code base that would be secure and high-quality would be more challenging. Lastly, when we think about the business at the time when we launch software integrity, Synopsys is doing remarkably above. We're growing, profitable and executing really well on the IP and EDA business, the semi business. But we are looking ahead to the next decade, right? And thinking about what area would create a new TAM? And a challenge whenever a company looks for new TAM, it's always difficult to find that sweet spot, right? Because you want to stay close and leverage your capabilities in some capacity, whether it's technology or customers or execution capabilities. But you don't want to stay too close. Otherwise, you're not going to serve -- expand the market in that. Simultaneously, if you go too far you risk, I think, diluting the investment and risk the operating leverage that going to have in terms of building that business out. And for many years, we're looking for that sweet spot and didn't find that until we came across Software Integrity. We felt that the idea of creating a standardized methodology and having a set of tools to improve the approach for building security and quality into the software development cycle. It's not unlike where we were 35, 40 years ago with EDA, where if you -- depending on which customer you go to, which semiconductor company you go to, they would have their own unique tool to design chips, and they would have their own methodology. So those elements of the thesis and the strategic drivers were really what drove us to get into the space. And what was unique when we acquired this platform was half of the business of the company that we originally acquired was in the embedded space because the chip companies understood that the value of testing for quality and security early on, the process because they didn't want to get to 18 months, 2 years down the line to tape out their chip only to find out that it was -- that they couldn't because of a software bug or a security issue, right? So half of the business was in the embedded space. And so we basically were able to secure and grow that half while really only putting the other half the enterprise at risk. And so over time, if we're successful, which we have been that we would use that base on the embedded side as a way to leverage our knowledge and gain the experience to further build on the enterprise side. Today, that's a much larger mix of the business and will increasingly grow as a larger proportion of the business.

And then just to round out the product discussions, intellectual property. Do you think it has been a very consistent double-digit growth business for Synopsys, it's been a consistent double-digit growth category for the broader EDA space? We got a question from the audience of whether this is just structurally a faster-growing market. And if you believe the answer is yes, there's a lot of things which would plausibly be behind the question poses, you have system companies and more system companies that are trying to get products to market faster, that could be 1 driver, but I don't know what are your views on just IP being a sustainable kind of double-digit growth product set?

Absolutely. And that's our model. We do believe this is a consistent double-digit growth business for us over many years. And so that's been the belief and that continues to be the belief. And the momentum of that business continues to reinforce that model. And there are a number of factors that are driving growth and contribute to growth. And often, you'll -- some of them will be on one side of the ledger versus another, whether it's a tailwind or a headwind but there's a long list of drivers for growth. One is the outsourcing trend within the customer -- the semi customer base. That pace of outsourcing will continue and that's a source of growth. Changes in standards, whether that's interface standards or other standards. That's an area where our customers don't want to spend money on because there's no differentiation. New customers, right? And you mentioned hyperscalers, but new customers could be driven by verticals. In automotive, the need from the OEMs, the need from their subsystems providers. And even the chip companies are providing to the -- those end markets are -- that's the source of growth. New customers could also be Chinese customers. And the fact that, obviously, the investment that, that country is making to build out their industrial capabilities is just spawning hundreds and hundreds of new design shops that are looking to get the market faster and they have characteristics of hyperscalers and that they have a lot of funding, a lot of resources and capabilities but they're going to be very strategic about how they get the market faster and where they're going to differentiate. And their willingness to outsource more development by buying IP building blocks is going to be very different. So there's a host of things that are driving that. And we're barely -- the other thing I'd highlight is we're barely touching on security, right? Because what you see within the automotive place because it's very visible is the element of functional safety. I mean when you're dealing with -- it's one thing if your phone dies, you reboot it. It's another, there's a chip component that goes in the car. And the chips that go into car are going to have to meet regulatory requirements. And they're going to have to endure -- the life cycle is much longer, and the stress environment is much greater, higher heat temperatures, cold weather, extreme conditions. And so the need for more secure chips, the need for durable chips and therefore, the need for a secure and durable IP that goes into those chips really is then contributes to growth. And so go back 3 years, go back X number of years and as we look forward, the momentum that we see in the side is what we continue to see today and what we expect to see over the next few years. And so not all the things will lend on the positive side of the ledger. But so far, there's enough levers that we see we can pull that will allow us to grow that business in the double-digit range.

Do you have a sense if you weighted your IP portfolio by where the exposure is, and obviously, leader in interface, very strong in CPU, foundation, wireless is small, but fast-growing and so on and so forth, if you weighted the concentration and then applied what has been outsourced versus what is still in-house, do you kind of have a sense of the -- I don't know what you would call it the Synopsys-weighted outsourcing shares. So in other words, how much has come your way in your categories versus still could come your way?

That's a great question. And I don't think I'm going to do justice in this form, but I think if I tackle it really kind of a 50,000 foot level, right? It goes back to interfaces where they're standards. That's -- the penetration is really high, obviously, right? Because there's no differentiation. On the processor side, that's relatively a small business for us, but it's a great product, growing fast, but relatively small in the scheme of things. And so I think that as you see more -- more edge devices that need more intelligence or even lower, smaller processors and I think that's an opportunity for outsourcing. And then broadly, the other element of the chip design, I think it is going to be a function of how the technology evolves and the costs -- the make versus buy decision that our customers are making. In some cases, it's technology-first decision, meaning it's too risky to do it and/or it's an economic decision that that's not where they want to place their bets. But it's -- increasingly, we're seeing opportunities for outsourcing. That is not just economically driven, but really a belief in our ability to deliver high quality, very complex designs on schedule, on budget, per expectations. And what that does is that given the breadth of our portfolio and long history of execution and delivery, it's a virtuous cycle because you outsource 1 or 2. You see it works, you're going to be much more comfortable outsourcing more of those blocks out to Synopsys. And it's easy for us to describe. It's easy for me to describe. Outsourcing, it's a positive trend, but it's really -- it's a different conversation when you're the head of R&D or you're head of that project. And if the chip doesn't fail, if the chip isn't delivered on schedule or on budget, it doesn't really matter whose fault it is, right? And so the fact that we can -- we have such a breadth of capabilities combined with the history of execution really creates a virtuous cycle in terms of repeat business going forward.

Maybe last question. Last year ended up being the seminal year in terms of the margin inflection improvement Synopsys have been talking about for a number of years that came through. And now the company has been talking more about changing a framework and managing the business to a different rule of methodology. Can you preview your long-term operating margin, I'm just kidding. But that analysis is in the work. So stay tuned everyone. But maybe can you just -- what are some of the things where, as you think going forward, this is what investors should be mindful of in driving margin expansion from here?

Joe, it's a great question, and I'll answer it this way. More important than what the actual numbers are going to be in terms of how we expect it to -- where growth and margins are going to go. It's just the message that we feel very confident in the business that we see a very robust market that we're selling into, a very healthy market. And we feel that we've got a fantastic portfolio that will serve that demand very well. And the combination of all the pluses and minuses, how we assess it, we think that the combination is very, very positive for the future and such that it's sufficiently strong enough that we feel that we should be able to continue to drive good growth and margin expansion on what is record results for us last year. And what if we deliver on our guidance, is going to be a record result for this year. So it's building more success on what has been the exceptional several years. So more than what the specific numbers are, it's really just the confidence and the optimism of where we can take this business. I think there's a lot of room for us to continue to deliver a lot of value to our customers. And as a result, we believe we're going to deliver a lot of value to investors.

Okay. That's great. We can leave it there. I'm afraid we're out of time, but Trac, thank you very much for joining today. Thank you, everyone, for listening in, and I hope everyone has a great rest of the conference.

My pleasure. Thanks, Joe. Take care everyone.