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

Maybe first as an intro for people in audience and on the webcast, you may not know Synopsys' story. Do you want to give us the 2-minute elevator description and a little bit about yourself?

Great. Jason, it's good to see you. I know we talked just a few weeks ago. So it is awesome to see you in person and attend the conference. For those of you who are not familiar with Synopsys, we are a software company. This year, we're on track to do about close to $5 billion of revenues, growing in the double digits. And we have really 3 lines of business: One, that's a semiconductor software focus. It's EDA tools that companies -- chip companies use to design chips. We have an IP business, which is basically preconfigured software, building blocks for chip design. And then our emerging business is the Software Integrity business, which is roughly 10% of the overall company and a software focused on finding security vulnerability in the software development process.

Perfect. Perfect. And this is in person. So if anyone wants to ask a question, you can try to weave those in if there are any.

But maybe first, this double-digit growth framework that you gave last year, I think it's double-digit EDA growth, mid-teens IP growth, 15% to 20% SIG growth. Nice uptick over previous years. Can you just go into what's driving this confidence and the strength?

I'd start with saying that we're in a sweet spot right now. We're in a sweet spot in that the markets that we're serving, both the semiconductor market as well as the software development markets, are extremely healthy. And on top of that, the investments that we've made over the last few years really positions us well from a technology portfolio perspective, and we're executing well. So the combination of a healthy market plus execution, really good execution is putting us in a great spot. Now we're a deep technology company. On the -- we're a deep technology company on both the semiconductor side as well as the software development side. And the development cycle typically is multiple, several years in the making. And so the product position that we have today is a function of the investments we made over the last few years. And given the progress that we've made in terms of accelerating growth and improving profitability, that's actually given us even more flexibility to make the investments. And so I do see that the markets will continue to be healthy, but more importantly, the fact that we are able to continue to invest in the product portfolio really gives us high confidence that we can sustain the recent performance as well as looking outward, raising the profile of growth and profitability.

Okay. Perfect. And when we speak to investors, things that everyone is incrementally focused on is your incremental buyers. So you've, over the last couple of years, seen new deep-pocketed hyperscalers. We've seen a lot of these chip start-ups and, I think, over the last, call it, a year or 2 with the pandemic. It's been kind of automotive. Can you maybe speak to why -- particularly with these 3 types of customers, why they're new? And what gives you confidence that this is -- these are sustainable purchasers and customers here?

The premise of the question -- excuse me, the context that you set up for the question really is the answer. The reason why we have raised our long-term growth profile, growth expectations for the business in total as well as the different product groups is just that -- is that we're seeing strong demand from existing customers, right? So the existing customers that we have, we are seeing very good growth in the business that we're booking. We're seeing longer-term commitment. We're seeing bigger commitments from those customers. Secondly, there is a better cross-selling opportunity. So we're getting more share of wallet from the existing sales, but we're also doing a lot of cross-selling with those existing customers. And then you layer on top of that, we've got new customers that you've highlighted, new verticals like automotive, financial services, and the expansion of the hyperscalers and the investments that they're making with regards to chip design. So there are so many different layers of new growth opportunities.

Do these new customers purchase different subsegments of your portfolio more than others? Or I guess how would you describe it?

The hyperscalers in particular or just in general?

Maybe we'll take 2 perspectives. Obviously, the hyperscalers are very large, very deep pocketed. And then what -- and then let's take a look at it from the start-up automotive angle.

Yes. It's good that you bring those two up because they're really great case studies for why we've done well and why we're optimistic and confident to raise the growth outlook. So look at the hyperscalers. They have deep pockets. They want to get the market faster with their own chip design because they want to integrate their applications on processors that are going to optimize what they're trying to do on software. But they don't have teams of designers, hundreds or thousands of designers that they -- legacy designers. And so even though they have deep pockets, they're going to be very targeted at how they make those investments. And what's the best way to differentiate their technology and what's the fastest way to get to market? And their circumstance is really well suited to what we have available, right? Clearly, we have the largest EDA software business that with the full suite of tools that you can come to us and buy everything you need to design chips. But we actually have the largest IP and the broadest IP portfolio. Now ARM is the large semiconductor IP company in the market, but they're really processed on a particular processes. They're specifically focused on processes. We have the full range of titles that you would need to design a chip, whether that's processors, memory blocks, interfaces or any other components. And so if you are a hyperscaler with deep pockets and you can spend money any way you want, you want to focus to get differentiation and time to market, we are well suited for that, right? Because they're buying both EDA tools and they're not beholden to supporting -- designing things in-house because they have designers that they need to support. So they're really open to buying large amounts of IP from us. And so we're doing exceptionally well with hyperscalers. And on top of that, they're looking to -- another reason why we're successful there is that in addition to the EDA tools and the IP, we have a really significant services business. And so they're looking to us to be a partner to help make it work. And so -- sometimes they do want a turnkey solution that's starting with IP and services. And sometimes they want to pick the various pieces, but they're also interested in having someone integrated with services. And so our portfolio is really well suited. Automotive is another area where I think it's a great case study for why our portfolio and why our capabilities is well suited because a lot of the automotive companies, they have a traditional supply chain, right? And a lot of these vendors are not coming from the semiconductor space. So they don't know how to integrate the different pieces, the different subsystems and how to orchestrate between the chips and the subsystems and the various vendors. And we've done that in the semiconductor industry. We are a trusted vendor that is able to be the hub that brings the fabs together, that brings the designers together, that brings the multiple pieces together in an integrated outcome. And so if you are an automotive company or a vendor in that space, you want to turn to a partner who knows how to bring these pieces together. And so again, similar to what we're doing with the hyperscalers, the pieces that we have -- not only the portfolio and the pieces that we can bring together but our experience working with the fabs and working with the chip suppliers in this new space really positions us well as a trusted partner for them.

Okay. Interesting. I'd be remiss if I didn't ask you at least a couple of financial questions. So maybe one with just the -- because you just reported Q1. When we look at it in terms of revenues, Q1 was the biggest Q1 in terms of revenues we've ever seen -- at least while I covered it, right? And let alone it being in Q1. And then Q2, a similar level. And without maybe -- I'd be curious on the visibility to trends, right? So have you seen any periods in the past where one half was stronger than the other because it's all dependent on your customers' time of taking down IP hardware. So curious if we could talk about that a little bit.

Sure. Just for the audience's benefit, we reported Q1 last month. And it was a record quarter across almost all dimensions, top line growth, margins, EPS growth. Some of it is a function of the profiling, right, because last year's Q1 versus this -- some of it was just -- this year is a little bit more front-end loaded. But you strip that apart, whether you look at it from the product line growth, you look at geographic growth, the trend for the quarter is continuing to be very, very strong. So very good growth, good margin improvement, good EPS growth. The -- to your question about what the trend is, with the 606 revenue change in 2019, we're going to see more volatility in the quarterly numbers, right, because with IP in particular, revenue now and so being taken over time is going to be a little bit more lumpier because when our customers actually pull down from our website, the IP title that they need, we're going to recognize revenue at that point. But that said, the trend -- long-term trend for IP consumption continues to be really healthy, and I don't see that slowing down. Hardware is increasingly a bigger part of our business. And that's going to be lumpy depending on the customer shipment. But overall, hardware demand continues to be healthy. So overall, when I look at the business, you strip away the quarterly profile first half, second half profile, when we look at the annual profile, when you look at our business over a decade period, we've weathered the global recession. We've weathered the massive amount of consolidation in the industry -- the semiconductor industry in 2015. It was tough entering the pandemic 2 years ago. When you look at the results and you zoom out and you didn't know anything about what is happening in the world, it's been just a remarkable trend in terms of growth, in terms of margin improvement, in terms of cash flow improvement. And a lot of that has to do with the fact that it's our business model. Our business model is close to 90% time base. Even if you factor in the lumpiness of revenue, these contracts that we have on the EDA software and IP business is largely time-based. So the fact that 90% of our business is time-based gives us a lot of predictability. And so even with the noise within the quarter or even a big event like China 2 years ago with the Entity List, we have time to manage through these transitions. And so if you didn't know anything about what's happened in the world, you would have thought that it was all very smooth. And so with that model in place, we're able to really look at the business over a longer-term horizon and really make commitments with regards to investments, make commitment with regards to how we run the business. And we're -- while it's important for us to deliver on the quarter and the full year, we are looking out over multiple horizons, the quarter this year as well as over the next few years. And so you're going to see a lot of predictability over a multiyear period. And given that predictability, Jason, it says a lot that we're raising the long-term outlook for the company, right? Because the investments that we've made a few years ago gives us the results that we're seeing today. We're executing really well. But the investments that we're making and our read of where we think the market is going and what we can do within that market gives us the confidence to raise the growth outlook for the company and the margin outlook for the company back in December. And when we guide -- when we talk about raising the long-term model, this is a multiyear expectation.

Okay. Perfect. And then maybe -- you mentioned margins. So on the margin side, obviously, you're seeing top line strength, which enables you to drive leverage. But Synopsys has this larger IP portfolio. Can you walk us through how the IP portfolio may or may not -- could that be -- like how does that come into play relative to other software companies that may not have that IP kind of mix?

Right. Let me put it into context. This year, we're on track to do roughly $4.8 billion in revenues at the midpoint of guidance, about 32% operating margins and then EPS growth in the mid-teens. Of that $4.8 billion of revenue, 10% is roughly the Software Integrity business. That's our emerging growth business of 15% to 20% growth long term. Margins are right now around the 10% range and improving over time. IP, the business that Jason is referring to, roughly 20%-ish of the overall revenues, growing in the mid-teens, very profitable. It's more a very profitable business. It's a little bit more resource intensive. It's not a royalty business like ARM, but it's still very profitable, right? And then the remaining business is EDA software, which is a double-digit growth, very profitable. It's a software business. So since it's a software business, so very profitable. To your question, IP against that context, I think it starts with the fact that it's growing in the mid-teens. That's clear. That's going to help. And I don't see the dynamics of IP demand slowing down because the pressures on our customers to get to market faster with more capabilities and from a technology perspective, consume less power and fitting it into a smaller footprint. I don't see the pressures on our customers slowing down. So I think the underlying demand for -- the underlying pressures from a technology perspective and the underlying pressures from an economic perspective is really going to be a tailwind for our IP business. So it starts with really good growth. And I think that we still have room to improve margins on IP for -- the fact that we're -- we have a lot of room to think about how we increase productivity, efficiency. But also as we scale up that business, there's opportunities to rethink business models around that. There are different ways to package IP. I'll give you one example. With the increase in numbers of IP and the titles and pieces of IP that our customers are buying from us, one business model is we're reconfiguring that. Rather than sending them 10 pieces for them to integrate, we're finding that there's a trend with certain titles that are being configured by them. And so rather than them having 10 pieces of IP blocks that they have to test and verify and integrate into their chip design, well, we're going to sell that as a subsystem right? And that integration piece allows us to price it in a certain way that's maybe more favorable. Well, not maybe, it's more favorable. And so now instead of having 10 pieces, they have 1 piece of IP that they can test and integrate into their design. So there's different opportunities for us to really to -- for us to think about how we can expand margins on IP and it's beyond just pricing and it's beyond just being more efficient. There's -- I feel very optimistic about the options available to us given the scale of that business.

Okay. Interesting. No, that's very helpful. And maybe for this last topic. I wanted to talk about China but actually on the competition side. So this is an area that admittedly it's not my wheelhouse. But we've seen some Chinese EDA companies make some noise in recent years, where they raised north of $100 million in capital. Obviously, China is a very strong sector for you. China, in general, has broad ambitions to grow their domestic business. So it would make a very natural sense for them to at least develop maybe some of their own EDA tools. So I guess any color? Or how do you think about the competition from maybe Chinese EDA start-ups?

Okay. I'll answer your question, but I think it's important to provide context right? For those of you who are not familiar, we do have a very healthy business in China. We've been in China for over 20 years. 2 years ago, in May of 2019 -- or we're approaching 3 years. Well, the Entity List restrictions went to effect. And at that time, we were literally the weekend before we were going to announce earnings, the Entity List went into effect. And we had to rethink the outlook for the year because we couldn't ship to some -- we couldn't ship products. We couldn't recognize revenue and we couldn't service our customers. And so there was a pretty significant impact on our business at that point in terms of how we sized it. And we actually had to widen the guidance range if you recall, at that time.

In hindsight, it wasn't that big of an impact.

In hindsight, it turned out to be okay, but here's the important part. Despite that -- those restrictions, our business in China has grown north of 20% over the last couple of years, and we've continued to do really well across all areas of the business, EDA software, IP and Software Integrity, because what do we do? We -- again, right, we had a time-based model that allows us to think about this business strategically. And so we expanded our customer base. We were able to sell across the broad range of products. And so we've been able to grow this north of 20%, and that's kind of a conservative statement. So against that backdrop, why are we able to do well? Because our Chinese customers are no different than the customers that we see in the rest of the world. They want the best products because they want to compete not only in China, but they want to compete globally. And so the way that they're going to win is to have the best tools, to have the best products and the capabilities to deliver on their technology. And so we've been successful for that reason. So when I look at the competition in China -- don't get me wrong, we do take the competition very seriously. We take any global competitors, and we take the Chinese competitors very seriously But on a $4.8 billion revenue base, we're spending 30% of revenues on R&D, right? Wherever they're coming from, we've got 35 years of experience doing this. And we're spending a ton of money developing products, and we're winning. So the momentum and the investments we're making, I feel like we can't control what they're doing, but we're doing what we can control, which I think is a really good hand. We're spending a ton of money on investments to continue to innovate and differentiate and make sure that our customers are successful. And whether it's Chinese competitors or global competitors over the last few years, we continue to do really well. And as I said, we raised the growth outlook. So it gives you a sense of our confidence competing going forward.

Okay. I think -- I guess it would make sense that if we were to hear rumblings, it wouldn't just come out of left field. It -- you could see it coming or something like that.

Yes. We are worried and we're focused on making sure that we win, but we raised our outlook in December in terms of growth. So we feel like we can manage what's coming at us, particularly with what we have available to us.

Okay. Excellent. And with that, we're -- we'll take -- we got -- I guess we got time for one question, Bill.

Okay. When you look at your largest EDA competitor and -- what I'd like to understand is where do you think your best opportunities are to gain share for the EDA markets? And where are the areas where you feel like you have opportunities maybe to either expand the product portfolio or move into other maybe end markets that weren't penetrated, where you...

Yes. So the question is, where does Synopsys feel that they can gain share in the EDA market?

Yes. So short answer is, I don't think it is whether or not we see the opportunity, we are executing to that. We are winning. So we have the largest EDA business. And you look at the growth rates over the last couple of years, we are winning. We are winning because of the technology that we've got, whether it's AI, integrated design, DSO.ai or whether it's our Fusion pilot platform or whether it's SLM, Silicon Lifecycle Management software. We are winning. And we have raised the growth outlook for our EDA business multiple times now. So this is a reality. It's not a hypothetical, it's not an opportunity. We are doing it. And we wouldn't feel so confident about raising the outlook for this business despite that competition, unless we felt like we have been doing it, and we can actually accelerate it.

Excellent. And now we're actually out of time, but I would like to thank Trac very much for joining us today and hope everything go well.

Thanks for your time. Great to be here.