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

Hi, everyone. Good afternoon. Thank you for joining us today at the 2022 Needham Growth conference. My name is Charles Shi. I'm the covering analyst of the EDA industry at the Needham. It is my pleasure to host this fireside chat with the Synopsys. Joining me today from the company is Trac Pham, Chief Financial Officer of Synopsys. On behalf of Needham, Trac, really want to thank you for spending time with us today. Before we start Trac, I want to give you the opportunity to make a few opening remarks. Maybe if you want to recap the fiscal '21 results and the fiscal '22 guidance, so to level set the discussion today.

Great. Thank you. Charles, it's good to see you again. We appreciate the chance to join you at the conference. It's always a great event to start the year at Needham and then kick off the New Year with conversations with investors. I'm looking forward to catching up with you again.

Yes, yes. Same here. Same here. Yes. So sorry, sorry for the technical difficulty earlier. Trac, I really want -- and so let's maybe just turning to the questions. So do you have any other opening comments?

So just some comments. I think for those who have quite familiar with Synopsys or did -- weren't able to listen to the earnings call in December. We did report a very strong FY '21 top line growth of 14% versus the prior year. And then in addition to that strong growth, we also expanded operating margins by 250 basis points versus the prior year. The results were strong across the board, geographically across different customer base and across all of our product sets. We grew double digits in all areas. And it's been a nice journey over the last several years as we continue to grow the business and expand operating margins. What was also significant in December was we gave an update on our long-term financial model where we raised the outlook for the growth of our business to double digits overall. And that was going to come through a combination of double-digit growth in EDA, mid-teens in IP and then driving growth in the software integrity business of 15% to 20%. And with an improved growth outlook for the business, which were very thought about, we also committed to increasing operating margins by at least 100 basis points annually going forward. So the combination of a really strong healthy growth with margin expansion should deliver very solid mid-teens EPS growth for the future. So with that, I'm happy to take questions about the business.

Okay, okay. Thanks, Trac. Once again, for the folks on the webcast, really -- our apologies for the technical issues earlier. Yes, thank you, Trac. I really want to start my first question with the growth -- starting from the growth rate of the EDA. We probably don't really need to go all the way back to the 2000s to really discuss the historical trend. But really just only looking at the past 10 years to today. It seems to me that the EDA industry growth has been accelerating. I recently learned from one of our direct competitors Siemens EDA, who said that the EDA industry in the past, the growth was mainly driven by new design tools being added to the design flow. And in the past, existing tool sales did not really grow as fast. Yet, in recent years, it seems like -- they show data that every tool category has been growing significantly year-over-year. Obviously, this is a view of your competitors. Do you agree or disagree with that? And what's really driving the industry growth and your own growth in EDA?

Well, I would say that you're right. To start with the fact that it is a healthy environment right now. Our customer base is doing well. The supply chain issues and the pandemic in the last year, the challenges associated with that certainly has affected the industry and the overall economy. But the customer base is actually doing very well in spite of that. More importantly, though, our results is really a function of the execution that we've had over the last several years. The focus on innovating new products and delivering new technologies and new product capabilities. Over the last couple of years, we have brought a long list of new products to market, and we continue to announce new products. We continue to bring new products to the market and discuss this as well. But overall, the execution has been extraordinary. And the strength of our portfolio today is as strong as it's ever been. And so we're executing well and bringing a really strong portfolio to an environment that is very healthy. So the combination of it to is really what's driving the results -- our recent results. And what is the catalyst for the confidence in us raising our outlook for the next few years.

So -- thanks, Trac. So I think the other phenomenon that's in the EDA industry is that the system companies, meaning the companies whose end products are not really the chips, right, but maybe some other stuff like smartphones that those end market devices [ are ] really entering the semiconductor space and doing new designs by themselves. So there is -- it seems to me there's a diversification of the EDA customer base. But we often hear the semiconductor industry is consolidating, which means maybe to some people that the customer base for EDA were maybe shrinking over the longer term, maybe it has been expanding in recent years. So the question, I mean, or the skepticism among some folks at least is that the strong growth in the past couple of years, I mean, driven by system companies coming in, maybe it's just an exception outlier rather than really the new normal. Can you give us a sense of what your view is on that?

You're absolutely right that the systems companies are contributing to growth, but I would broaden it that the reason why the overall market itself is that there's just more chip design activity in general, right? And there are more companies and potential customers designing chips. And so we're seeing a very healthy environment for both the traditional semiconductor companies. And not just the normal large established companies. We're seeing more new entrants and the funding levels for new chip companies, I think it's been very healthy over the last few years. And so in that environment, the number of customers and the activity has been very high. And frankly, China, China has contributed to that as well as well as new end user applications and new opportunities like automotive, A&D, the AI applications, ML applications. And so that's driving increased design activity. You're also seeing more system studies do that. But as I said, it's just -- and the systems companies are just another new set of entrants that I highlighted. Historically, the systems companies have been around 40% of our overall revenue. And the growth in that space has been pretty steady and the momentum continues. I don't see that slowing down. And to date, right now, that number is approaching 45%. So I don't see this as a blip in trend or a trend that's likely to reverse itself in the near term.

Yes. So maybe let's really go back to the -- in terms of the new tools. And you mentioned about the strong execution of the company and your portfolio is that it has been very strong, performing very well. So you introduced a number of tools very recently. I mean, including things like DSO.ai, like 3DIC Compiler, like a silicon life cycle management -- time management, sorry. Are those tools -- are the kind of opportunity for you to really negotiate a bigger dollar contract with your customers, raise your prices or are those like premium features that kind of help you only like preserve the market share you already have? I mean I'll let you know where this question really comes from. I came from the semi cap equipment industry and knew that not all the new tools, new features really get paid, but a lot of time those are differentiators just help you to defend your market share, right, the TAM growth drivers. So are you able to really meaningfully monetize these new products, new tools you release and get paid?

And the short answer, Charles, is definitely, we do see this as an opportunity to monetize those investments and as an opportunity for long-term growth. Let me characterize how we expect it to help the overall growth. In some ways, they can help establish and validate our technical strength, and therefore, lead to stronger renewals in terms of run rate growth with our existing customers, right? When you highlight some of these new products. Our customers are trying them out. They're using them. They're testing it out, and they're seeing remarkable results. And so that gives them the confidence to sign in some cases, bigger and longer-term deals as we described in December. These commitments with some of our large customers reflect their confidence in the technology position that we're in and where we're headed. It also helps us in terms of increasing our revenues so that while the numbers are small right now, and it's mostly really an early stage of usage, eventually, that usage and the results that they're seeing in their early trials, the -- that eventually will translate to revenue gain. And so we'll see specific revenues coming from those opportunities, while right now, it's very small. We expect it to grow. It also is an opportunity for growth and that it's going to pull through more demand on other products. As an example, I'll highlight DSO.ai. Intuitively sometimes you would think that a product that can generate that kind of level of productivity, a lot of productivity, given how familiar with design is unseen in history. A lot of people think, well, that's going to mean less demand for your products. In fact, essentially the reverse because you increase the productivity of the engineers. That means they have time to do more [ fix ]. They have more time to take on more work, accelerate their work, accelerate the timeline or even maintaining the timeline, but actually pack more capabilities and results into that schedule. And so we're seeing more demand for the other products and yet pull-through. And so there are multiple touch points in which these new technical capabilities are contributing to both near-term and longer-term growth.

Got it. Got it. So I think I want to maybe ask you another question. I mean relatively a comment among investors. Obviously, if we compare you and your closest competitor Cadence, let's say, there seems to be some valuation gap here. But one can argue that, I mean, that valuation gap should close at some point. But those who argue against that, this seems to point to the operating margin difference here between you and your competitor. I'm not going to ask you about the valuation, but I really going to ask you about margin. So structurally speaking you have a little bit of different of a product mix, right? We haven't really touched upon which is the IP side. I think I'll ask you later on, on this topic. But structurally, you have a different product mix and IP seems to have a slightly lower operating margin than EDA. So kind of can you remind us from a CFO perspective, why that has been the case? And more importantly, if we want to be optimistic and forward-looking, how strong is the operating leverage in IP side of business? Is that able to really catch-up the margin of the EDA over the longer term? Any chance that the margin difference between the 2 lines can be closed?

Okay. Philosophically, let's start at the 50,000-foot-level philosophically. We see a tremendous opportunity to grow this business over the long term. We made some significant investments in the business to really raise -- to take advantage of that opportunity. And you've seen that in the results that we've posted over the last couple of years and in the guidance that we've given for this year as well as the long-term model. So the growth opportunities for this business, I think, is tremendous. That said, if we focus on driving the growth that we're capable of and the opportunity we see ahead of us, and we continue to deliver on the margin expansion that we've committed to, which is at least 100 basis points a year. I do see that the valuation would take care of itself, right? So I think the valuation will be an outcome of really strong execution. With regards to your question specifically regarding the margin difference between IP and EDA, the reality is software margins are in general, going to be much higher. And IP -- semi IP, our semi IP business is directionally lower than that, given that it's a little bit more resource-intensive. That says, the margins are very strong, and we will continue to drive the margins up in that business. And the thing that I will highlight on the IP business or why is such a compelling value-creating opportunities is that, you look at the growth in that segment, that business line over the last couple of years has been very strong. Can you combine that with the operating leverage of margin expansion, the profit growth in that business is extraordinary, right? So even if it's directionally lower than EDA, the product [ or ] the revenue growth and the margin expansion is creating tremendous profit growth. And so I think over time, we'll continue to see very good value creation in the IP business, even if on a reported basis, the margins are directionally lower.

Maybe it's a good time to really let me -- allow me to double click a little bit on the IP side of the business. We know enough about EDA and touch upon a little bit on the margin profile. So when we look at the Synopsys, right, the IP is truly like a founding franchise for your company, right? The design where, along with the design compiler arguably probably the longest oldest brand names in the EDA IP industry for a few decades. But at the same time, I did notice that outside the arm Synopsys and maybe, let's say, the Cadence and Imagination into the mix. Really, like no other company, obviously, based on 2020 numbers, has reached anything over like $100 million, the glass ceiling for a lot of the smaller IP companies. But you kind of reported like about over like $1 billion IP revenue, right, [ in ] '21 really coming up from around $900 million in fiscal '20. I mean it's just like within a year, you grew like more than $100 million. So how is this happening? I mean, in terms of the big IP companies growing even bigger and no sign of a slowdown here. And one could argue, well, maybe there's a synergistic component between EDA and IP. I know a lot of the pure-play IT companies, they will disagree about that, but I really love to hear your thoughts on what's really driving the IP business despite your large scale.

I guess, there's 2 things that needed to come in mind. One is, when you look at the breadth of IP titles that we have IP products that we have, it doesn't match, right? When you think about any [ little bit ] -- various capabilities with the [indiscernible] you compare to Synopsys and buy that capability through an IP building block. So internally, we've been very deliberate about building out a very broad set of capabilities. From an outside-in perspective, what's driving the IP demand is just the breadth. One, is the challenge that our customers are facing, not just the traditional semi companies, but the systems companies. Well, the challenges that they're facing with regards to their schedules and the complexity design. And over the course of 20 years, we have built up a reputation of delivering on-time, on-budget, on-respect to what they need. And so in an environment where they're trying to get the market faster or they're trying to maximize their returns or their spend going to a vendor that has the breadth of products that we have in the history of delivering like we do, isn't easier to sell that way. right? And we work really hard to make it easier for them to consider that by make versus buy decision and increasingly more customers are leaning towards buying IP rather than building it in-house.

Got it. So maybe one last piece of your business. We're talking about EDA. We're talking about IP, but let's talk about software integrity. So now you're looking for the growth of the SIG business to return to the 15% to 20%. What gives you the confidence that this kind of growth at this rate is sustainable? And on top of that, obviously, SIG remains like a smaller part of your business, and so far, it is margin dilutive. But structurally, once it gets to a certain scale, could -- the SIG really reached the corporate margin level and the stock being dilutive for the overall business?

Let me work backwards to start with the later part of your question because it's an easy one. Yes, for sure, structurally there's no reason why software integrity can't -- to have margins are approaching the corporate average. And in fact, structurally, there's no reason why it can't have margins are higher than the corporate average. And so it's a matter of just getting to scale. We've done a really good job growing that business to that roughly $400-plus million level. And we do see an opportunity for us to drive growth in that 15% to 20% longer term, while also expanding margins. So the leverage in terms of profit growth for that business is going to be very strong over the next several years. And beyond that, this is a bet on the next -- not only the next 5 years would have been on the next decade plus because of the opportunity ahead of us. With regards to why we feel confident about that growth prospects. Charles, it really comes down to the way we executed last year in '21. We entered the year with a new leader for that business because it -- we were 7 years into this investment, and we had a very strong position from a product perspective. We had some growing pains on scaling of this business. But we felt were really confident and had strong condition about where we were positioned relative to the competition. And we had strong condition about what the long-term opportunity is in this space. And so we looked at FY '21 as a reestablishment of a strong foundation to grow and scale to the next level. And we brought in -- so we brought in a new leader to the business, who really was focused on getting the product portfolio right, getting the go-to-market motion right. And methodically, throughout last year, there's been a very strong focus on the go-to-market execution. And by the end of the year, we overachieved across all metrics for that business. If you recall, when we entered FY '21, we were very open with investors that we were reestablishing this foundation and getting that business back on track. And we felt that it would take some time for the new bookings momentum to translate to revenues, and we originally committed to exiting FY '21, i.e., Q4 a double-digit revenue growth rate. As it turns out, we saw really good execution consistently throughout the year. And as the momentum built throughout each quarter, we were able to actually deliver on double digits for the full year and not just exiting year. And we did this while keeping margins relatively flat at 10% year-over-year. And so it highly [ skew ] the strong discipline that we have, the strong culture of execution of this -- of that business. And we were making the necessary changes on the go-to-market side to really feel comfortable that we could drive bookings growth that can set us up for a 15% to 20% growth. And candidly, the execution piece is really the focus because the portfolio, we've got the strongest portfolio, the broadest portfolio, and a unique position in terms of both having strong products and then a consulting services. And so when we look at the position that we're in, it was just a matter of getting the execution right. And by the end of the year, the momentum that we saw really gave us confidence so we could drive for sustainable 15% to 20% over the next several years.

Before I move to really to the next set of questions, I want to remind the folks on the webcast, if you joined us through the Needham portal, there's a place for you to enter your questions. Given how we are progressing through the fireside chat, I believe we may be able to have time to let you ask 1 or 2 questions directly to Trac. So take the opportunity. And let me know, I will ask on your behalf, and I will not announce your name in case you're worried about that, you want to stay anonymous. So next Trac. I want to move on to some of the near-term dynamics here. I really want to ask you about your partnership with ANSYS. So you and your closest competitor Cadence seems to have a slightly different strategy in terms of how you want to execute through DIC, for example. Synopsys chose to partner with ANSYS. So 2 of you are both are very well-established players in the EDA industry. Really came together and now offer your customers a complete suite of 3DIC solutions here. So your competitor, the Cadence seems to want to do things on their own, right? So clearly, there's -- there are different approaches here. So obviously, each strategy has its own pros and cons. But from your perspective, what do you think is an advantage of Synopsys/ANSYS alliance here over what Cadence is trying to do?

Well, our approach reflects our belief that we're going to focus on the things that we're both best at, right, that we -- our relationship with ANSYS is intended to maximize our particular strengths and leverage both our particular strengths, right? They are clearly a world-class leader in systems analysis, right? That's -- I would say that's in question and they're coming from a position of strength. And for us, we're coming into this with clearly the market share and technology leadership on the design and sign-offs capabilities. And so hard to be the combination where you're bringing the best-in-class capabilities of those particular areas, right, of design sign-off and systems analysis to the packaging opportunity. And so for us, our -- like I said, the strategy really reflects where we think we can get the most leverage based on our strengths and our unique strengths, combined with ANSYS' unique strengths.

So now let's really come to some of the near-term questions. So one of the metrics really jumped out to me on your fiscal fourth quarter results was the massive backlog, right? Like the $6.9 billion. Obviously, backlog is pretty lumpy quarter-to-quarter and -- but I think I did -- I mean, before you announced your results, I did forecast maybe your backlog should be around something like $5.4 billion. I mean that's based on your typical backlog coverage ratio historically. So you beat me by a mile. Congratulations on that. But on the other hand, though, that massive backlog number seems to suggest, and I believe you have said it on the call, that your average contract duration is now a little bit longer than what you typically was. Typically, it was about 2.5, 3 years in the past, if I really remember correctly. So is there any in terms of change of your customer behavior, so they want to sign up longer-term, bigger dollar contract with you now? Or for one thing, I did learn from the -- I did learn that the customers, typically, they do not want to be tied down to one specific EDA/IP supplier for too long because they want to keep their options open. So I know you probably don't want to get into those customer-specific details. But can you offer some thoughts here maybe in generic terms, what's happening here in that $6.9 billion number?

Yes. It's definitely a big number, and it's -- let's talk about objectively what it means, $6.9 billion of backlog, great visibility. But it offers great visibility to future. It is a source of knowing that we have stability and confidence to whether whatever may come up, right? So I talk often about the business model and our ability to have a runway to deal with any short-term or near-term issues and $6.9 billion objectively, it just gives us a lot of confidence in terms of the path going forward. Now the more qualitative important elements of the $6.9 billion is this. The -- it reflects just incredible execution on bookings last year and the orders that we booked. Broadly speaking, our customer base hasn't changed the way they want to approach buying these tools. There isn't a change in what we're selling in terms of business model, and there isn't a fundamental change in terms of how our customers are approaching it. That said, the reason why we did deliver over $6.9 billion in backlog is really twofold. One is that we saw a very good run rate growth in the business that we renewed last year. That's one. Secondly, probably more impactful is that there were a handful of large customers, large significant customers who signed up for longer-term contracts and bought a largest set of the portfolio, and they drove very good growth in the portfolio. And so they went wider, they went bigger, and they went longer. And while that's good as they go back to -- having a $6.9 billion backlog is great. What it showed us and what it indicates is the validation of the technology that we're offering and the strength of the technology and the confidence that our -- these large customers have not only in the products that we delivered but also their belief in the roadmap and the technology progress that we're going to make going forward and their willingness to sign on to these longer-term agreements. Because we believe that deeper collaboration and deeper partnership with us would benefit them and allow them to gain a competitive advantage and have the ability to differentiate in a very highly -- in a highly competitive environment. So as good as the $6.9 billion is, what I feel better about is the signaling of what those large deals in those large agreements meant to us in terms of the future path that we're on from a portfolio and from a technology perspective.

So maybe we have a little bit of time but let me really get to the last question. It's going to -- it's about capital allocation. So I'm new to be -- follow the EDA companies like Synopsys, but one thing that really jumped out to me is how strong the balance sheet is and how much cash -- the ability to generate cash for -- I mean, Synopsys capability is really phenomenal. So can you kind of remind us your capital allocation policy here? And specifically on M&As, what are the things you look at? Any criteria in general for MAs?

Is short, what I'm going to -- all the details in short, it really has to -- it has to fit our strategy, right? We are doing well as a company. We're executing well as a company. So we are able to be very thoughtful about the acquisitions that we're making, right? We're not doing it because we have a gap in the portfolio. We're not doing it because we can't make numbers, or we can't -- we're not coming into from a firm position or weakness. And so clearly, it has to get into the longer-term strategy. If you think about whether or not you want to make or buy, it has to make sense to buy this company strategically. And strategically, I mean, does it bring -- is this synergistic from a technology perspective? Is this synergistic from a go-to-market perspective? Is this synergistic from an operating leverage perspective. That said, a lot of time people get caught up in the strategy of it. They take -- they justify a stretch for us. For sure, it's a hurdle. You get across -- if it does make sense strategically, then it doesn't make sense to continue the conversation. But if it does makes sense strategically, you also have to be very disciplined about it. And the way we have always approached M&A in the past is that we do model, just like everyone else does, but we are very critical about what the first 12 to 18 months are in terms of execution metrics. And our ability to extract value on this really depends on our belief in the model upfront and is in our threshold. But where we really measure is within the first 12 to 18 months. Are we executing against that plan? And if there are issues within that plan, are we adjusting appropriately to make sure that we're getting value out of this? That's been the recipe over the years when we've acquired towards the M&A both tuck-ins as well as large M&A, and that will continue to be a model going forward. And so M&A will clearly be part of strategy going forward because it's been a part of the strategy in the past. And one thing I feel really good about is the capability that we have within the company in terms of that only being able to identify targets, but more importantly, integrating those targets to extract the value that we've -- that were identified.

Just a reminder to folks -- okay, we got a question. We got 3 minutes left, but it's a good to like really get this question answered. So the question is really about your contracts. Do the larger or longer contracts, kind of like meaning that you're stabilizing your pricing, or the customers are able -- I mean, to really gain more concessions from you? I mean are you able to like hope [ you line ] -- customers really sign longer contract with you? Or do you have to give away something, say, like give more concessions when they sign longer contracts with you?

Short answer is no. I mean we show -- we feel very confident about what we're bringing to market. We've made significant investments to deliver on those products. But we want to make sure that we extract the appropriate value for that. For us, there's no reason for us to sign longer-term deals for the sake of just locking them in because there's no value in that, right? But if there's an opportunity to sign longer-term deals because the customer values it and we're able to extract value, then we'll certainly do that, but there's no compelling reason for us to sign longer-term for the sake of just having the longer-term deals.

Got it. Got it. We have -- we are about to end our session but maybe Trac any closing comments and you would like to -- let's take the last 1 minute if you have any.

The outlook for the business, not only for this year but for the next few years is incredibly compelling. We see an opportunity to accelerate growth and maintain growth at this higher double-digit level. And we will continue to drive margin expansion as we grow at the faster rate. And I think that you'll see very strong results on the bottom line as a function of that. And so we're very optimistic, very confident in the outlook, and glad we had a chance to share the story with you and the investors today. Thank you.

Thank you, Trac, and that ends our session and really want to thank you for joining us today. And I look forward to the earnings call, which will come up probably like in a month or 2. And thanks, everyone on the webcast, and thank you for joining us at the Needham Growth Conference. Hope everybody enjoy the rest of the conference, and have a good night.

Thanks, Charles. Take care, everyone.

Thank you.