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

It's Jason Celino, and I'm the vertical software analyst with KeyBanc. With me today is Shelagh Glaser, the CFO of Synopsys.

Maybe if we start Shelagh, I know this is the first conference with us and you joined Synopsys a couple of months ago. Maybe you can just start with your background and then specifically, what drove you to Synopsys.

Well, Jason, nice to meet you. Nice to be here with everybody. So I've been at Synopsys since December. So it's been a whirlwind. Prior to that, I was with a company called Zendesk, SaaS CRM company. That company was sold to a PE firm. And then prior to that, I was at Intel for 29 years, and at Intel, I was CFO of 2 of the largest businesses. So the PC business and the data-centric business. And what drew me to Synopsys was really that is the integration of software and semiconductors. And Synopsys is really in the center of this move to smart everything. So as you think about increasingly, people are building silicon from the workload down. Our tools and our capabilities are becoming more and more important, not just the semiconductor companies, but increasingly to systems companies. So it's an extremely vital company. We've got product offerings that help accelerate the development of silicon and help improve security of software. So I think as we think about everything becoming smart, we're really at the center of helping our customers be successful.

Excellent. And then I almost forgot to read the safe harbor statement. But today's discussion may contain forward-looking statements related to Synopsys current outlook, expectations and beliefs, which are subject to certain risks and uncertainties that could cause actual results to differ. Please refer to the company's most recent SEC filings for a discussion of risk factors that materially affect these statements. So with the intros out of the way, maybe I'll start with my first real question, we have been covering Synopsys and the EDAs for nearly 10 years. When we first started covering Synopsys core of the growth profile of the company was solidly in the single digits. Last year, Synopsys reported almost 20% growth this year, projections are for 14% or 15%, which is impressive given the tough comp. But I guess what gives you confidence that the best times for EDA and Synopsys are still ahead.

Yes. we had an incredible strong 2022, 21% growth and then 14% to 15% growth this year. What gives us confidence is a couple of things as we have a business that has a big component of ratable revenue. I've got $6.9 billion in noncancellable backlog. So that gives me good insight. We work very closely with our customers on their design start. so we're deep in our customers and we have a strong understanding of what their roadmap is and therefore, how we are going to support them in our roadmap and their roadmap and I think the changing growth rate is really driven by that focus on Smart Everything. So if you think about the advent of Hyperscalers, they're building purpose-built silicon, they know what the workload is. They're building purpose-built silicon, automakers increasingly are starting to think about purpose-built silicon. So the more people that are thinking about driving smart everything, the more that we have a stronger customer base. And we -- the business is 3 segments: design automation, design IP and software integrity. And really, they all work in concert as people are deciding to build a chip. They're using our design automation tools, oftentimes, especially for new entrants in the market. They just want to pull from our IP library. That's a LEGO block. That's a pre-validated IP block that I could quickly put into their chip. And then increasingly with software, security safety is becoming more important. So I think it's really the kind of immutable fact that everything is becoming smart. We offer tools and capabilities to allow our customers to speed up their product delivery.

Okay. Excellent. And then when we think about Synopsys and the EDA subsector as a whole, it's really outperformed over the last couple of years. And this is despite the macro and despite the cycle in semis. So for investors that aren't familiar with Synopsys, what separates the company from the cyclical components of its semiconductor customers, and then perhaps what separates it from cyclicality of other software companies?

Sure. So we are very indexed to R&D investment. So while we're seeing a lot of perturbation because there was a disconnect between supply and demand, and we are seeing that come into balance with our customers, we're seeing some pressure on revenue and inventories. R&D is largely intact. That's because these are very long-term projects. Designing a chip can take anywhere between 3 to 5 years. So that's a long-term endeavor because I think that we've all learned in this market is you need to come out of a difficult economic environment stronger. And so you can't take your foot off the gas of r&D investment, you can't take your foot off the gas of innovation. So that strength is really where we're indexed and we don't see as much change in that. In fact, we don't see very much change in design starts at all. You're also seeing a big infusion of CapEx into the industry, again, as there is some interest in making sure that they're secure supply. We certainly saw that we were under supply during the COVID environment. And one of the things that we do is we help those factories be filled, both between our design automation tools and our IP block that are LEGO blocks that they can pull from that helps those factories be full. And once you put CapEx in the ground, the thing you want is you want that factory to be full, you don't want it sitting around idle. So I think we help them build those, and we're very indexed to that R&D side, which is a little bit different than what you're seeing in the top line of some of those companies. What separates us from other software companies, I would say, is the tools that we offer are critical for design engineers to do their jobs. It's very hard to design silicon. That's a really complex endeavor, and it's a high stakes endeavor for a company. We help give those designers and those engineers tools for them to be able to handle that complexity and to be able to deliver their products on time and allow them to optimize for power performance and area, all of which are very important for their business model.

Okay. Perfect. And you kind of answered it a little bit, but I know some of these Hyperscalers have been incremental buyers of EDA and IP over the last couple of years. Some of them have announced cost rationalization, some layoffs. Do you think that's going to impact their budgets for EDA?

I think for Hyperscalers, their business model is really built on making sure that they've got the capacity for their customers and that they've got the cost structure behind the capacity and the performance behind capacity. So the reason they're building their own chips is they understand the workload of their customers so well, and they know how to tune a chip exactly for some of those workloads. So I think for them, it's not only how they help cost-reduce their offerings to customers, but also how they differentiate in performance for their customers. So I see that being a very robust and successful endeavor for them, and I would expect them to continue. And again, think about these as being a 3- to 5-year investments. It's really about the R&D today is really something that will yield something in the future. So I see strong commitment to that.

Okay. Perfect. And then if we kind of change subjects a little bit and just think about the most earnings in kind of the year. I think Q1, very solid in line quarter, you reiterated the guidance. Maybe can you just talk about the shape of the year and why it might be a little more second half loaded?

Sure. We had a really strong start to the year, and our expectation for this year is fairly normal linearity. So if you look back through our history, we're often very back-end loaded. And again, the timing of our revenue has to do with design starts of our customers and then timing on some at wins and renewals. So it's a fairly normal, a little bit more back half weighted than first half weighted.

Okay. And then when we think about hardware, that's one of line items that's more upfront. Can you just speak to the demand trends? Are the demand trends still really strong for emulation, et cetera?

So we had shared that last year was a record for hardware. We expect this year to be a record year for hardware. It tend to be lumpy because our customers order based on their design projects. So they'll often buy significant equipment before they get into of heart of design. And the reason they buy this hardware is because they want to make sure that they can -- before they even have the chip built, they want to check the software. And sometimes they want to check the chip that isn't even built to make sure that, that is going to tape out and not have bugs. So it's a really good investment for them because if you take out a chip that has bugs, not only do you waste the mask and wafer cost, you waste the time. So investing in the hardware is an upfront investment for them, but it pays significant dividends because it speeds up their development cycle. It speeds up their ability to find issues early in the development cycle, fix them and be able to have a clean tape-out.

Perfect. And then if we think about some of the new revenue classification breakouts that you provided recently, that was kind of the big news from the quarter. I guess, why decide to break out the IP revenues now?

So over the course of the last several years, we've been business and evolving how we manage the business and made some changes in terms of our executive staff and the segment reporting that we shared, sharing design automation, design IP and continuing our software integrity really matches with how we manage the company and how we drive the company. And we think about, in Design Automation is about 65% of our revenue. So that's our lion's share of our business. Our Design IP is about 25% and Software Integrity is about 10%. And as we think about the Design Automation and the Design IP, those are both very big businesses that we've grown over the past several years. They have different behaviors because the product line is different, the way customers purchase them is different. The margin structure is slightly different on them. So we want to actually make that very transparent to our investors. And we feel that because we've started in this process of changing how we manage the company over the last several years, this is the right time for us to be able to share this more broadly with our investors. So we're excited to be able to share that. I think the feedback has been positive because obviously, for all of us, it helps each of us do our job better, the more transparency we have with how the business is being run. And we're really pleased with the success of all 3 businesses. We have leadership in all 3 businesses. And so we want to be able to share that and share the margin structure and the growth structure of those businesses more clearly with the investors.

Okay. Maybe if we kind of tackle it by each segment. If we start with IP, those were -- the margins there were a lot higher than I think what a lot of investors had expected. Can you just walk us through the expectations for margin improvement over the long term for that segment?

So what we shared in the call was that Design IP over time will be slightly than the corporate average. And you can think of Design IP as almost us having a factory of engineers who build IP blocks, and they build IP blocks for -- we have standard IP blocks that literally every computer probably in this room has some of the standard IP blocks on, and each process node requires new IP blocks and then those standards change over time. So USB changes over time, PCIe changes over time. And then in terms of our development, we have a very regular road map of updating those IPs and building out those IPs for new processes. There's a bit of lumpiness in it because it depends on when our customers pull those IPs down from their allotment with if you they buy a bucket of IP from us. And then as they move throughout their design cycle, they pull that IP down. So in terms of the timing of revenue that can be a bit lumpy, but in terms of our development, that's an ongoing development because we want to make sure that we've always got the right standard, ready at the right time for our customers. So over time, that will tend to be a little bit lower margin than the overall corporate average.

Okay. And then several years ago, one of your competitors made the decision to forego certain IP projects to maintain a level of profitability for that business for them. How should investors think about Synopsys balancing IP growth opportunities with that margin improvement?

Well, I would start with the high level. We are very committed to improving margin. Our guidance for the year is greater than 100 basis points in margin improvement, and that's our guidance over the long term, too. We intend to focus on driving operating margin improvement. And we really view these as very complementary businesses. The design automation is a tool to help the engineers do their really complicated work better. It allows them to have tools to speed up their work. And then the IP blocks that are standard, allow them just to focus on their own differentiated IP. So for most companies, their differentiated IP is usually a Processor block. It could be a GPU block, it could an AI block. And those standards are things that are already tested that they can just pull down from the library. So it allows their R&D to be more efficient. So we view these as working really closely together. And overall, we're committed to driving operating improvement every year.

Okay. So there's kind of a lot of optionality in kind of the margin improvement. So when we think about the design automation side, if we kind of look at what has been achieved already, I mean, for Q1, it was 39%. That was 250 basis points over the same period 2022 for any software business has a lot. I guess, what was the main driver of that? And then specifically, could we see these design automation margins go to, I don't know, 45% or something?

So our focus in design automation is to deliver both the software tools for customers and the hardware that we've talked about. Over time, that margin will be higher than our corporate average. And as we more and more capability to the company. That will be an area of margin growth for us. But we'll see some pertubation through the quarters, again, depending on when our renewals are and when our expansions are. And what I would say is design automation, one of the really exciting things that we're doing in there is our DSO.ai platform, and that's really allowing our customers speed up their design process faster. So we think that's also a growth area for us in the future.

Okay. I do want to touch on the AI pieces, but maybe before we get there, if we talk about software integrity a little bit. This business -- how is it positioned in a typical macro like this?

So our Software Integrity business is absolute -- application security testing capability. We have the broadest portfolio. We're on path to be about $500 million at some point this year. So we're the largest player in that market. We've got multiple products. We allow customers just to be able to buy from 1 supplier or so platform consolidation. We are, and we have said in both earnings and our Q1 earnings experiencing the same type of elongated deal cycles, more approval loops than we had in the past. I think that's pretty common. Most folks selling into enterprise are seeing that. We're still committed to 15% to 20% growth in that business over time, and we're still committed to driving operating margin improvement over time.

So with the SIG business, I think last year, you kind of described like 15% industry growth for software security testing. In Synopsys it is targeting to grow a little bit faster. I guess what gives you confidence that you can grow slightly faster than the market in spite of some fast-growing private companies who are pure plays in this space.

So our real competitive differentiation is the fact that we offer multiple tools to customers. So we become a one shop for them. One of the things we hear from customers, it's very difficult for them to manage multiple vendors in this space. And then also it's difficult for them in terms of making sure that they are not leaving gaps in any of the application testing. So we think we offer superior economics for them with a consolidated platform. And then also in terms of their use case.

Okay. And before we go to the AI topic, are there any questions from the audience? I thought I'd open it up.

Yes, I want to ask to go back to the IP business. I think that growth at -- the growth profile is over 20% in the past 2 years is not really good growth. And I think we're targeting mid-teens growth in long term. Can you just talk about maybe the drivers that are in the near term and long term? And do you see the potential of hosting 20% growth in the future?

So we have had strong growth there. Our long-term goal is mid-teens. And what's happening is all of the standards evolve. So USB, PCIe, every standard evolves over time. It never stands still. So you are constantly innovating on those. And you've got some customers on the old, some customers on the new and then move to process tech -- new process technologies. We've got multiple technologies being used throughout the industry right now. So those are more different IP blocks. And then there's a real push towards multi-die. So there's interconnect capabilities that we're building out there because you want all those stack dies to act as if they're on the same piece of silicon, you don't want any delay between those chips. So we're innovating in that area. So I think IP over time is a great growth driver for us. The other, I would call it, economic changes. The new entrants into the business chose to put their engineers on the highest differentiated IP blocks. And so they never actually really stood up teams to be able to do that. I think the more traditional companies had teams for that over time, I think that's opportunity for us to win business too because again, as they concentrate on their highest value add, this is something that they can just pull from our libraries, know that it works and increase the success of their product development.

Okay. Great. And sorry.

What is that the market is captive at this point at which customers can use on the design work themselves or [indiscernible]?

Would say it's a mix in terms of opportunity, even inside customers where they've got a standing team, they still may for certain projects pull IP blocks for us. I think over time, as people are faced with the kind of requirements on their own business, it will make sense for them to start to move some of these more systematically to us.

Perfect. And when we think about generative AI, it's been a hot topic, but Synopsys has really been at the forefront of this. And one of your solutions, DSO.ai. How should we think of that in terms of opportunity? And when we think about customer spend or customer focus, how incremental is it today versus what it could be?

Sure. So we have a product design on Solution Automation, and it really looks like the whole development, like set of tools and helps offer solutions that a human may be able to do given enough time, but we all know nobody has enough time and really helps us optimize. And so what we're hearing back from our customers is, first of all, we started about 2.5 years ago in proof of concepts with customers, which is just having them in kind of a sandbox, check this. Very quickly, customers started to ask us to put it into their mainline product development, which is unusual because the stakes are really high to move something from a POC and domain line development. We announced at our earnings greater than 100 in production chips are using that. That's phenomenal within -- basically 2 years that it would be infused in commercial tape-outs because, again, stakes are really high there. What customers are reporting is they're able to get better power optimization, then they would be able to do just doing it themselves. They're able to get better performance optimization and then area, which is cost. And so they're seeing really great results. The way that we're monetizing it at this point is it's not a part of the tool set. It's a project by project. And this is an area that we're still evolving how we think about it over time. But obviously, we're adding tremendous value because the proof, the objective proof is that customers are into their designs really quickly. So we think there's really more that we can do here to help make our customer development, be even more robust. And we think over time, this is a great differentiator for us.

Okay. And if it's my understanding, it's mainly for placement route right now, but maybe you're testing it in some other areas.

Yes, we're infusing it across our capabilities. So I think we've already put it in into some broader capabilities and think about this as something that will infuse across our tools.

Okay. And I think there's just a couple of minutes left. I think we can close out with everyone's favorite topic, China. Certainly, there's the geopolitical tensions and there's been some restrictions announced. I guess what is the medium-term outlook on China as a whole?

So China, I think, is an important business for all of us in technology. For us, it's about 15% of our business. We're obviously fully in compliance with any of the restrictions and we see China as a continued strong opportunity. There's lots of innovation. We've got strong customers who are helping drive the Smart Everything that we see in this part of the world. They're driving the Smart Everything there, too. So we still see it as a good positive opportunity for us. And we know there's a lot of tension and complexity there and that we'll just continue to navigate. So great opportunity for us. We've got a strong team there, and we're very committed to it.

Okay. And then given the opportunity is so big and given China's ambitions to develop their own semiconductor ecosystem. Are there any domestic Chinese competitors that we should be worried about? Or I guess, what gives you confidence that Synopsys can keep finding them up?

Well, I think we've got 36 years of doing this. So we've got a lot of innovation that we've built. We've got a lot of expertise that we've built. It's very deep because we've been the key lead that top customers have gone to. And that learning cycle is really hard to pick up. And so certainly, there's other people in the market and in the China market, and we just look at it as competition. So we just have to move faster.

Perfect. Perfect. And with that, maybe 1 last question from [indiscernible] from Portland. Favorite restaurant, do you have one?

Oh my gosh, like that is the hardest question you asked me. I was just saying, I went to a new restaurant there, Janken. It's -- if you get to Portland, please go, it's got a cherry blossom tree on the inside. So I would implore you to go if you're in Portland.

Great. Thank you, Shelagh, and I hope everyone likes the comments.