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

Thanks, everyone, for joining us here at JPMorgan's 50th TMC Conference this morning. My name is Noah Herman, I'm a software research analyst here at JPMorgan. We're really thankful to be hosting Synopsys, Sassine Ghazi, President and COO of Synopsys. Thank you so much for joining us here today. We really appreciate it. Can you just take a few minutes to introduce yourself and the company and the customers you serve at Synopsys?

Sure. My name is Sassine Ghazi. I've been with Synopsys for about 24 years. I serve different functions in the company. Started as an engineer, was in sales for about 14 years, then general management of the EDA business unit, then the last couple of years as the President and COO. As far as Synopsys, we are really in 3 major businesses: EDA, IP and Software Security business.

Great. And touching on EDA a bit. I think a lot of people would want to know why is EDA growing faster than it was maybe 5 or so years ago. What's really driving that growth?

Sure. I'll contribute the growth to really 3 factors. One is the strength in our portfolio. Number two is our operational execution focus that we put in place roughly about 5 years ago. And three, the market. The market in the semiconductor and chip demand is driving the growth in EDA in particular.

Great. And I think last quarter, recently raised your fiscal year 2022 guidance again by $225 million. What are the drivers for that? And what gives you the confidence to achieve those targets?

Yes. We're having a great FY '22. And again, it's driven by portfolio strength. If you look at our portfolio in EDA, there are multiple dimensions of EDA. And in each dimension, we are leading in terms of technology and market share, which is driving revenue growth. Our operational execution, we put a big focus on simplifying our go-to-market, our customer engagements, which is moving the needle in terms of our contract growth and revenue. And I'll contribute the third one to really the market. The market has been strong, not only in semi but as well in the high demand for software security and safety, which is part of the portfolio that we made an investment around the 2015 time frame.

Great. Before I continue on, just to remind everyone, if you have any questions. I'll bring the audience into the discussion. So maybe a little bit halfway through our meeting, if you have a question, just raise your hand, someone with the microphone would come over and help you ask a question. Yes, so touching back on to the guidance itself, if you want to drill down a little bit further. How much would you say is contributed to the market dynamics themselves or the simplified go-to-market strategy? Can you kind of help us decipher how much contribution should be attributed to these elements?

We're definitely growing above the market. If you think of the EDA market and you compare us to the rest of the market, which is the competition, they are around 13% to 14% as a company. We are at 20% growth. And if you look at the $5 billion that we raised to, about 65% of it is EDA, which is growing double digits. IP, which is roughly about 25% of the company, is growing in the mid-teens. And you have the Software Security business, which is roughly at this point, 10% of the company growing in the 15% to 20%.

Got it. And...

So the portfolio itself is driving the growth significantly above the market.

Right. And that's sort of in line with your long-term revenue targets double-digit growth in EDA, mid-teens growth for IP. And so you think that's durable for a few years, those long-term targets?

Yes. That's what we communicated in December, and we're still confident that this is the range, the long-term range that we're targeting and we can deliver to.

Great. And touching on the IP business a little bit. Are you seeing any impact from the ARM noise and what's going on there? How are those discussions with customers changing, if at all?

Not really because the -- if you look at our IP portfolio, I'll say about 70% of it does not really compete whatsoever with the ARM's offering, is what we call interconnect IP. So ARM is more a CPU processor. IP, our portfolio is any connectivity that is required inside the chip or between chips, is our IP portfolio, which is very unique to Synopsys. And in the rest of the portfolio where we have overlap. We serve different market segments. For example, in our own processor offering, we target automotive very aggressively or embedded processing, which is different than what ARM offers. So long answer to your question, not necessarily, we're not seeing an impact in terms of what's going on at the ARM.

And it seems also too on that Fusion Compiler, that's really gaining traction. What were some of the barriers to adoption early on that customers you think are now getting over?

Yes. What happened was around 2017 time frame, we made a significant investment to truly change the way customers design digital chips. And anytime you're doing something disruptive, it takes a while for the customer to see the value and why do they need to change. Then when they saw the benefit in terms of productivity and results, they jumped on it. So right now, actually, it's not an issue anymore. It's -- we have a great momentum, and significant part of the installed base has already moved to the Fusion design platform.

Got it. And how is that tied into maybe the simplified go-to-market strategy with Fusion Compiler?

It has absolutely an impact because historically, when you design a chip, you have multiple phases in the design process. And with the complexity of Moore's Law, the complexity of designing the most advanced chips, you really needed to simplify it. And we were in a unique position that we had a strength throughout the design of a chip that we were in the position to create that disruption. And it's absolutely driving a big part of our market share gain in digital design.

Got it. And I think -- can you talk about some of the drivers for the record backlog? What's driving this increase? Is it structurally higher or a few large onetime deals that you're seeing?

Both. But the key driver really is -- and I'm sorry to be repetitive, the -- we're able to drive growth in our agreement, run rate growth in our renewals due to the strength in technology. So in our customer engagements, it's very competitive. What I mean by that is, at the end of the day, they need to use whatever technology gets them the most competitive chip, the most competitive design. And with the strength in the portfolio and the offering, we're able to take share and drive revenue and run rate growth, which is contributing to the $7.2 billion, $7.3 billion in backlog.

Great. And just following up on those contract renewals, what are the pricing renegotiations looking like? Are you typically repricing higher or lower? Are you pegging it to CPI? Just any thoughts on that.

So in our world, each negotiation, especially with the large customers, is so customized. They are unique negotiations, meaning what kind of access do they get, the duration of the agreement, the discounts, et cetera. And of course, if you are coming with a strong position and the position meaning is how much are they using of your software. And our software is fairly sticky, meaning, if they're using it, they cannot just stop using it in the middle of designing a chip or typically the next generation, they do prefer to use the same flows, methodology they put in place. Given the strength that we have built and the big investment in innovation and new technology, that puts us in a position to be more confident in our negotiation with the customers, which is demanding higher pricing and run rate increase in our negotiations.

And is competition at all having any impact on pricing? Or what are you really seeing within the competitive landscape?

Sure. Yes. Because typically, when you're losing share, you try to reduce pricing to hold it, you try to provide incentives for customers to stay with you. Some customers do. Other customers that they really need to meet the schedule, get the chip to a level that is competitive. They need to use the best technology to get it there. Let's say, if you're delivering to the next phone or to the next HPC chip, you cannot say it's okay, I'll deal with more power because I'm sticking to an older technology or a less competitive technology. You need to use the latest technology in order to meet the requirements of the design, which gives us a price increase advantage in the process.

Got it. Great. I think a big topic. Well, it is a big topic or some of the recent macro risks going on in the world today, obviously, Russia-Ukraine, inflation, some of the lockdowns in Shanghai and China. How is that impacting your business? And, yes, just from your perspective, what are you seeing?

Yes. From pure revenue standpoint, the impact of Russia-Ukraine had a very little impact on Synopsys. In China and the lockdown, we have significant customer base and employee base in China. It did have some impact, but it was not material to do anything different for the fiscal year or the next quarter or 3. Yes.

And on the topic of China, what is your outlook on the regulatory and maybe the just the customer activity in the region?

I want to say we get used to it because for the last 3 years, almost every other quarter, some new customers get added to the entity list. And we factor it into our projections as well. So we adapted to the new world and the new environment.

And staying on some of the macro risks, are you seeing any shortages in hardware? Or in the hardware business, any supply chain shortages or impacts there?

Yes, there was some. And again, we factored it in. I want to say early when the -- about 1.5 years ago or so, we had to look at our forecast for hardware and which inventory we have access to and it's already in-house, which part of the inventory that we needed to secure for multiyear. And we did all of that a number of months ago. So whatever you see in terms of our forecast, it's already taken into account that we can secure the parts needed in order to deliver to it.

Got it. And with the guidance that also sort of embeds your expectations for inflation, for wages. What are you kind of seeing there? And do you think -- is it more so you'll see that impact in the first half of the year, the second half of the year? How do you think about operating margins?

We do take it into account, of course, because Synopsys is roughly about 17,000, 18,000 employees. And big part of our delivery to customers is really people-based. Like when you think of our EDA business, our Software Security business, IP, et cetera, with the exception of hardware, we have a dependency on an actual bill of material beside people. And the last year, 1.5 years, the competitive landscape around talent and the increase in wages has been a challenge, not only for Synopsys, for everybody in the high-tech world. We dealt with it fairly well. Actually, our attrition rate is much lower than the average in the industry. And we are taking it into account from an operational profitability and ops margin standpoint. For this year, FY '22, given the growth that we are able to achieve, which is a 20% year-over-year, we're going to cross $5 billion in revenue in FY '22 after we crossed $4 billion in '21. And we're able to pass part of that revenue growth to EPS. So we are growing the operating margin by 250 basis points. So that tells you that there is enough flexibility, I want to say, in the revenue growth we're able to achieve and how much do we pass to the [ OM ].

I think we'll take a pause here to see if anyone has any questions. You just -- I think someone will come over to the mic.

I had a couple of questions related to your competition with Cadence. In their Q1 numbers, they talked about a big marquee digital win. Can you speak to whether that's one of your customers that come at your expense? Was that greenfield? Can you just talk about the mix of your business versus theirs and that customer?

Sure. Without going into details about the specific customers, if it's a big marquee customer, I can assure you, it's a Synopsys customer as well. There is no big marquee semiconductor that's not a Synopsys customer. This specific one, Synopsys has established a primary relationship with about 15 years ago. And we -- I can assure you, we continue on growing our both market share and revenue with that specific customer. So there is no loss whatsoever in our usage share or revenue with that specific customer.

Okay. And then the other question is the 2 of you have kind of different strategies around IP. They seem to treat it as kind of an add-on and do recognize that it's lower margin, whereas you seem a lot more focused on it. What's your -- what's the reason for your much higher focus on IP at the expense of the profitability dynamic?

That's an excellent question. IP is hard, hard work because the moment you deliver what an IP is, you're delivering an actual part of a chip to the customer. So as they're developing a chip, part of that delivery is dependent on Synopsys. So if you screw it up, you're screwing up a chip for a customer, which is a huge risk. We started the IP business about 25-plus years ago. And it's been a significant focus, commitment, investment for Synopsys. So we became the trusted low-risk partner to many of our customers as we deliver these IP components. As competition trying to come in, not only Cadence, many other companies, it's not simple to build that credibility and confidence that you're going to be able to deliver that IP on time and with high quality, so you're not risking a customer chip and a commitment. So long answer to your question is it's a long-term investment we made with know-how and credibility in delivering to these chips. The strategy our competition took and the number of other companies is they try to do the same, but the ability to do it, especially on the advanced technology, is just not simple. In terms of profitability, we're able to actually manage that business with a nice level of profitability that puts Synopsys overall to where we are. So it's not a business. I don't want you to assume it's a business that is operating at a very low profitability level that's dragging the company.

And actually, just one more on China. With EDA being pretty hard to copy or replicate, a lack of success there, it would be -- if the geopolitical situation escalated, it would really not be hard for the U.S. to simply decide no more selling EDA software in China, at which point 15% of your business would go away. How do you think about that or handicap that risk?

Our portfolio in China is, as you can imagine, not only EDA, we have a strength in the EDA and IP and Software Security. Of course, if the U.S. decides that we cannot sell any part of our portfolio, it will have an impact. But that will apply to the rest of the industry as well. So as I said that if you're being specific on EDA in particular, the percentage that we have in terms of distribution, it's fairly strong across the portfolio in China, not necessarily EDA, as the main part of the portfolio that's contributing to the 15%.

Yes. A question on this share that we're seeing with your major customers designing chips in-house. How do you envision that over the next 5 years? And could you see that list growing, not only being the big platform guys, but maybe second-tier customers such as auto OEMs or maybe some of the networking guys? And what does that mean for Synopsys' opportunity?

Yes. So it's an excellent, beautiful opportunity for Synopsys when we see companies that they did not design chips before and they're starting to design a chip. So what we're seeing right now, and actually, if I can go back a little bit in time. The mobile started this disruption early on in the early 2005 when they started, let's say, Apple developing their own chips, where Apple was just a pure system company. Then they started investing to develop their own chips. And right now, Apple is a significant customer of Synopsys because they're designing one of the most advanced mobile chips. Then you look at the last 6, 7 years with hyperscale compute, the differentiation they're trying to drive, the HP -- the hyperscalers, is not only at the software level, they're trying to optimize their software workload with a specific hardware underneath it. And if they're able to get those chips from a general-purpose chip that is able to optimize with the software, then they will not develop their own chips. But the optimization opportunity between their software application demands them to develop that hardware underneath. And that's, again, a beautiful opportunity for us because the discussion with those customers start with IP, with the architecture of the chip, which is the IP building blocks. And from there, start driving the EDA business. So given the position we have in IP, it's giving us an advantage with those customers. Now you see every hyperscalers is developing their own chips. Now the other market that they started, I want to say, about 2-ish years ago is automotive, not only the OEMs, but the Tier 1, because they have the architecture knowledge of the system, of the actual car, and what type of requirements they need for the hardware or the chip to drive a user experience at the OEM level. And again, for us, those are new customers, new demand for our IP, EDA and the Software Security and Safety. Given our position in Software Security and Safety, if you're an OEM, you do care that the car does not get hacked, that from a functional safety perspective, that you're validating your software and hardware together. And that's where our position in software security and IP and EDA is opening up nice growth for Synopsys.

Any other questions? Okay. I'll just continue on. If you do have, just raise your hand. So you recently announced cloud-based EDA. What is the value proposition there?

Yes. That's actually a very -- it's a great opportunity. What I mean by that is the following. For a chip design, the constant challenge is do you have enough compute to design and validate your chip? And I'm talking about many hundreds of thousands of cores that you may require at some point in time to just verify that before you send the chip to manufacturing that is going to work. So what we have done with our SaaS cloud offering, is we provide the flexibility for our customers to come to Synopsys, Synopsys will manage access to the software needed -- the EDA software needed. And in partnership with Azure, we will provide a configurable machines for the specific EDA workloads because the EDA workload is very different than many other workloads. It requires different memory, different CPU or a GPU compute for speed and efficiency. And that is very unique in our industry. So this is truly a disruptive offering to accelerate the chip design by having more compute available. And affordable, given it's a new business model for us. Customers will end up paying based on the use of both the compute and the software that they are using.

And with that, are you also partnering with AWS and GCP?

Yes. Yes, good question. What I just described the SaaS business model, we needed to partner at this point with one cloud supplier in order to configure the compute to the EDA workload. We have another cloud offering, what we call bring your own cloud, BYOC, where many mid- to large-sized customers, they already have their own relationships with AWS, with Google, with Microsoft. And there what we do is we are providing a different business model, where the customers can bring their own cloud provider and we adapt our business model so they can pay per use on cloud.

Got it. I wanted to touch a little bit on the WhiteHat acquisition. What does it really bring to your software integrity business? And any details on the potential revenue and EPS accretion with that acquisition?

Yes. So we've already invested quite heavily, actually, in the application software security testing. What WhiteHat does it bring a dynamic aspect to it. What we mean by that is they offer a SaaS-based continuous application security testing for customers. So say you're a customer and you have [ Xline ] of software code that you're using. Software is not static, so you want a continuous checking of your software to ensure that it is not vulnerable for security hacks. So what WhiteHat brings is that aspect of validation. So we already had it with Black Duck. With WhiteHat, it's an expansion of -- it's called DAST, which is dynamic application security testing portfolio, which today we are the leader there. And maybe one point to add to it. With the security concerns from many governments, they are requiring many companies to make sure that they do some sort of a software supply chain that checks on ensuring that if you have a third-party source code in your software, that you're checking for the security and the quality of the software. And today, with Black Duck and WhiteHat, we are truly the de facto standard for providing these checks. So that's why we expanded it into that M&A.

Are the systems companies cannibalizing work that would have been done by Intel, AMD and NVIDIA?

Yes. Maybe that's similar to the question that was asked earlier. I don't think at this point it's cannibalizing the opportunity for the semi guys; however, it's an inflection point. Meaning, if you're just delivering a general-purpose chip, it's not cutting it anymore for certain applications, in particular, hyperscalers, another wave will be automotive. So the semi guys are looking for ways to deliver more than a chip. And what's more than a chip is how do you deliver a chip with a flexibility as you integrate it into the system that the application software can be customized for the chip that you're delivering. So there's a lot of work that is happening with the chip guys that you mentioned in order not to become just a general purpose IC or a chip and not to be cannibalized in the process.

Take another pause here for -- yes, yes.

First, Trac announced his intention to retire some time? Maybe could you update like how the search for the new CFO going? Secondly, just general on the industry side, like we are seeing manufacturing kind of reaching its limits on 3-nanometer side. Are you seeing your customers using any new kind of technology for like further shrinks?

Yes. So on Trac, we're still searching, nothing to report at this point, will inform you as soon as we have a candidate identified and a time line. On this 3-nanometer, excellent question. Yes, not only because it's getting more complex to continue on shrinking the transistors, it's the cost and the time that it takes to move to the next process technology or manufacturing technology. So what customers are starting to do and starting -- started actually about 3-plus years ago is to use multiple dies in a package. So we call it 3D IC, which you bring multiple chiplets or smaller chips into a single package. And each one of those chiplets can be on different technology. Some of it can be on 3-nanometer, another part of it can be on 16-nanometer. So it provides the flexibility and not be too dependent on the entire chip being on the most advanced technology.

Two shorts, if I might. Just was wondering on the M&A strategy, what the areas of focus are in terms of the new categories, adjacencies, what's of interest to you? And separately, just on the design side, on the EDA side, improving the performance of chips or somebody just talked about the limits of shrink, but people often talk about material, packaging, new architectures. So just how are you exposed also to those kind of variables? Does it mean that EDA intensity goes up from here because you have to work on many more dimensions versus just to purely shrink, where people were focused on in the past? So M&A and just EDA intensity as we move into advanced nodes.

Yes. Very good question. On M&A, we believe we have right now with the portfolio of EDA, IP and Software Security, plenty of room to continue on investing our cash in places where we believe we need to accelerate our portfolio. And the reality is in the EDA world, there are very little M&A opportunities and IP is slightly more, and Software Security is furthermore. On the EDA complexity, you're very -- on point, the complexity and the hunger for innovation in order to continue the rhythm of advancing the technology delivery is where we spend tons of energy with our customers to see what are the big trends happening and how do we invest in R&D innovation there. So we put a big effort in AI, which is a huge lever in driving further performance power into the chip, but in an efficient manner, 3D IC is one. Photonics, as you look ahead, it's another element to drive speed and connectivity between chips inside the package. It's a wave that we believe in around 2025 time frame, you're going to see more adoption of that technology. So there are multiple other aspects given the Moore's Law has slowed down and became more expensive to be able to just continue on that rhythm, as the only way to get to the performance or the power requirement of a chip.

The intensity goes up?

The intensity absolutely is going up, absolutely is going up. But again, there are multiple levers, as I call them, in order to be able to support that increase in intensity. And AI is one, the 3D IC, the health of a chip as your -- what we call silicon life cycle management, multiple investments where we've started and we continue on making in order to deliver to that.

I think we're just actually out of time, but I just want to thank you again, Sassine, for joining us today. We really appreciate it. Thank you.

Thank you. Thank you.