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

Welcome back to this morning session. I'm Vivek Arya. I lead the U.S. semiconductor and semi-cap equipment research team and absolutely delighted to have Shelagh Glaser, CFO of Synopsys, joining us this morning. We'll go through a list of my questions, but please feel free to raise your hand if you would like to bring any other point in between. Very warm welcome, Shelagh, I really appreciate you joining us. And I guess 6 months on the new job, shine -- still the new office smell, just shiny new thing. So give us a sense of how it has gone so far, what's been the positives and things that can be improved on from your perspective?

Sure. I mean, it's been a whirlwind. I knew this company. I worked at Intel for 29 years, then did SaaS and then came to this company. So it's kind of like the mix of those 2 things, because we're in service of silicon engineers, but we sell them software. So the pace has been incredible. The pace of innovation in the industry is extremely exciting. The number of chip designs, the number of different flavors of chip designs is super exciting. And I think the world now understands chips more than they used to before the pandemic. So it's been a really exciting time. The company is on a great growth trajectory. We just finished our Q2 earnings. We beat the high end of our revenue range. We beat the end of our EPS range. We raised our revenue guide for the year, so we're 14% to 15%. And we raised our profitability guide, a 150 basis points year-over-year and our EPS 21% to 22%. So we see a lot of opportunity in the market and our role is to help our customers tame all this complexity that's coming at them and allow them to be able to serve up the chips to their customers. It's a great business. We have a big subscription part of the business. We have $7.3 billion in noncancelable backlog. So very robust, very durable business model. So it's an exciting part to play in a great industry, and it's a great company to be on the team with.

Excellent. One thing Shelagh that I find very interesting about the EDA space is how it has consistently accelerated the growth, right? What used to be 7%, 8% growth went to 10%, 11% growth. And as you just mentioned, now you're putting up 14%, 15% growth. Even though the semiconductor industry growth rates have kind of been in that 5% to 7% range. So what has helped Synopsys and the EDA industry consistently accelerate growth rates over time?

Sure. So we're indexed to the R&D investment, which I think even though there's a lot of perturbation on finished goods demand supply, that R&D does not change dramatically because it takes 3 to 5 years to build a chip. So the role that we're playing as we're innovating on our EDA tools and our IP, we have an enormous IP library, about 7,500 titles on 340 process nodes is how do we help our customers simplify the work that they have to do. They're getting bigger and bigger requirements, but they're not necessarily having more people to do it. As you said, their budgets are not expanding by probably their requirements. And so that's where we step in. And over time, how do we help them automate some of their work? I'm sure we're going to talk about AI here. So we've got exciting things to talk about there. But how do we sort of become a multiplier for them? And as we become a multiplier for them, we actually share and have a bigger and bigger role in the R&D spend because we're helping them do more work. So we think there's more that we can do and there's more opportunity. And as we do that, then we share a bigger part of the pie.

Got it. Do you think these kind of growth rates are sustainable? Or what needs to happen for these growth rates to be sustainable. That -- or is this just a temporary one-off and the sustainable growth rate is lower than this?

Well, the underlying pinnings of demand are not going to change. I think now everything is digital. Every company is software company and underlying software is silicon. And so the trend on silicon, I think, is at a new pace because that silicon needs to be really purpose-built for a power performance envelope. So gone are the days where it's just one piece of silicon and everybody go figure out your workloads. Now the workload is deciding what the silicon is. So that trend is not changing. And then in terms of the requirements for the teams to go off and solve these big hard problems they need to solve, that trend is not changing, and we're the tools that help them be able to tame this complexity. And so our commitment is for continued double-digit growth. We think that, that is certainly possible over the horizon. Again, as that underlying demand and that need for more and more compute, and specialized compute continues.

Got it. You mentioned those 2 magic words of A and I. So let's dig into that. So give us a sense for how is AI helping you both from a revenue capture and growth perspective and then also in terms of optimizing, right, your tools, your DSO.ai right tool, a number of design type almost doubled sequentially. So what's -- what is the value proposition of that? Why are you suddenly seeing that acceleration of that tool?

Sure. So we pioneered AI and design automation. So we started it in 2017. We had some experiments we showed in 2018, and we were able to commercially show it with a commercial tape out in 2021. And we started in the front end of a design. And our first tool is DSO.ai. that's design space optimization. That's a consequential part of designing a chip, deciding how that chip is going to be configured because that affects a lot of steps down the line. It affects what the power of the chip is, what the performance of the chip is and what the area is. So that's a very consequential workflow. People don't have enough people to throw at that problem and don't have enough time to optimize it. So what our tool does, the way we monetize it, is you buy our underlying subscription and then you buy the DSO.ai tool per project. So that's a part of the subscription. And what we're finding with customers is as they're running multiple iterations to optimize the design, they actually use more of the underlying tools because the thing that they want to do is they want to come with what is the optimal optimization for this design, and they only have a certain amount of time to do that work. And so if they have more tools from us, they can run more iterations. And so what we also announced in our software users group at the end of March is that we're launching TSO.ai. That's the test and VSO.ai. So we're building AI tools out across the entire design flow. And we -- each 1 of those is a per project and it's driving, first of all, customers to want to use our tools because the data is only from our tool. Our customers' data is very precious. We can't be sharing that anywhere. So it's very important that we handle that with care. So you need our underlying tool for the tool to run on top. And we think over time, this has enormous benefits. We're really focused on making sure that we're driving broad adoption so we can have the successful use cases, and we'll experiment over time with additional monetization.

So as you mentioned that even though I guess we are all kind of waking up to this growth spurt in AI, right? You guys have been engaged with it for a number of years. So as you take a look back, is there a way to quantify how much AI has given the company in terms of the incremental, like what growth rates have been like 11% or 12% instead of 15%, like is there a way to quantify how much AI has helped in accelerating the growth?.

Well, certainly, it's one of the reasons that we're growing faster than, as you said, the underlying R&D spend is growing. So it's a contributor to that. And we think about our pricing as we're adding more value to the customer. And as a part of adding more value, we're collecting a portion of that value. So it's certainly been a contributor.

Got it. Any other quantification Shelagh, which is on -- is there like a certain attach rate map on DSO.ai or VSO.ai or TSO.ai right? Anything that helps us better understand where you are in the process of upselling that incremental tool on top of the baseline and where that can go over time?

Yes. And so we've been really excited at the rapid adoption rate. It obviously started in like POCs because the design flow is so important. You can't be putting something in there. And we announced in Q1 that we had 100 commercial tape-outs using DSO.ai. We announced in Q2 that we've got 200 million commercial tape-outs, Obviously, that's still a fraction of the tape-outs. But you can see we're getting really rapid uptake. Our Fusion Compiler, which is kind of our #1 seller we think this adoption rate may be even faster than that, and that was one of our fastest adoption rate. So we've been really excited with how much the customers are clamoring for this. And the reason they're clamoring for it is a lot of the things that we've been talking about, more complexity, more chip designs, not necessarily more skilled people to be able to do those chip design. So this helps become a multiplier for their team. So we've seen really rapid adoption. And as we see that more adoption, collecting customer successes and what were their outcomes as part of what we're really focused on. So we can continue to drive even more benefit to the customer.

Got it. So you have not given a number, but if I throw out a number like mid-single-digit percent kind of attach rate, would that be somewhere...

I think we're still even in early innings, but we see ahead of us. Really, most of our customers are going to want to adopt this. We don't see sort of a barrier to adoption. It's more when does it make sense for a customer to infuse it into their design.

Got it. One other thing that we have seen that's interesting is that we have the hyperscalers who have their internal design teams, right, bringing some of their IP to bear and then we have -- we just had the team from Marvell yesterday, we had the team from Broadcom helping them. So do both of them buy -- so not them specifically, but do like both the system companies trying to do internal designs and the semiconductor companies buy these tools or just one of them buys a tool. Like do you get a magnification as more systems and semiconductor companies engage in this?

So for us, it's an and. So if we think about their traditional semiconductor companies, there's new entrants hyperscalers. Automotive is also a new entrant. So more people designing more chips, that's really our surface area.

Got it. Okay. Now if you look at just the growth in AI, do you think -- because if I look at it, just the most kind of downstream. The spending pie is not growing the same level. So it's something else not being done because AI is taking up so much of that CapEx on that oxygen right? Do you see that push and pull in your business also?

What we see right now is the time to design a chip hasn't improved a lot. It's probably gotten longer but the impatience with people getting chips out is high. And what we see is people don't have enough resources to be able to get things done. So what we're filling in the gap is -- and they don't have enough seasoned resources. And by the way, I should have mentioned that the results customers are getting on the DSO.ai is better than the people we're getting and it's fewer people and less trained people. So the gap that we're sort of filling in is that gap in terms of resourcing that customers have in terms of, you're right, ultimately, does the pie grow for everything? Or does some portion of the pie get shared differently. And at this point, we think we can play a bigger role in whatever size pie, it turns out to be.

Got it. And while AI, right, just the design starts on AI are going on, you're also benefiting from just the progress on the process road map, right, going towards 5 nanometers, 3 nanometers gate all around. So give us a sense for what that means for Synopsys. Let's say there was no AI, right? And all we had was just this increasing complexity. -- on the process side, what does that mean incrementally as you go from 1 more...

Sure. So I think Moore's Law as we knew it in the olden days, has changed. It used to be you got the benefit almost automatic. I know people worked really hard, but almost automatically going to the new process. And that's not exactly what's happening now. So we see the race is still on with people building big factories, new -- the new litho. People wanting to continue that. We also see that people want to get into what they're calling multi-chip solution so that maybe not all the die is moving forward, maybe only portions of it, but they want the chip to actually act like all the parts are right next to each other. So we see both the race and technology is helpful for us, but then the solutions that people are starting to bring to market are also beneficial to us to try to tame that complexity. Art calls it systemic, our founder, who is our CEO, calls it systemic complexity, because it was hard enough to design things on one chip. But now you're going to have to design it on multiple chips because maybe 1 or 2 of the chips stays a node back, but you want the multichip to behave as if it's all one instantiation. So no delay in communication across. And we see that as an opportunity to choose. So as people try to solve some of the barriers running into Moore's Law, some of the innovations they're coming up with is also a growth vector to us. So continuing the race, but trying some new approaches to mitigate some of those challenges that are on standard more slot-rated.

Got it. So you brought up this interesting topic of multi-die silicon. The traditional design is just making larger and larger sized dies, right, that obviously increases. Multi-die is supposed to reduce complexity, right? So how is reducing complexity a positive for Synopsys?

Well, it changes the complexity because now all of a sudden, yes, when you have one die, one group of people is probably building that, monolithic die. So you've got sort of 1 set of parameters that were operating to, all of a sudden, when you change it and maybe a chips coming from 1 vendor and the chips coming from vendor A, vendor B and then you're putting your chip on top of it, you change where the complexity was. Now all of a sudden, you have to be worried. Is that chip good? Where did that IP come from on the chip? And we haven't talked about our IP business, but we obviously have an incredible IP business, 7,500 titles on 340 process nodes. I mean, we're the land of standard IP versus ARM as CPU IP. So we sort of do everything but that. You want to make sure all those things are working well, and then you want to make sure that, that communicate. So the complexity at the monolith die hasn't changed, but now the complexity in managing all those interactions across multiple parties, that changed pretty considerably.

Right. I'm glad you brought up the IP side. I mean, next to ARM, you guys, I believe, are the second largest IP. But it's a very different strategy than your main competitor, right, who has a much smaller IP business. So talk to us why Synopsys decided to have a much larger IP business? And what are kind of the pros and cons of having a much larger IP business?

Sure. So ARM does CPUs, and we do all the standard interfaces or memory and it's incredibly strategic for us because it puts us in people's designs. We are now side by side. You can think of the IP as sort of LEGO blocks that they would integrate next to the blocks that they'll create. So they'll create some differentiated block, and then they'll take standards from us. And it puts us literally right inside the design team. So you can think about us being kind of hand in glove with the customer. So it creates a much tighter alignment. And then over time, and certainly, we talked about some of the newer players, they didn't even build the standard IP block teams because they know that they can pull them from us. They know they're battle tested. They know that if you want to ramp on a new process node, we have that ready for you. And for the traditional companies, I think it's an opportunity for us over time as they have more and more on their plate, how do we play a bigger role. And it's a profitable business. We think of that business, think of it almost as building an IP factory. You're constantly building IP blocks. Standards always evolve. You always need to move to the next node and then customers pull the IP based on when their design is. So we kind of manage it over a 12-month period, and we think that can grow in the mid-teens. And the profitability of that is slightly below our corporate profitability. And it gives us a much stickier relationship with the customer because we're literally right inside their chip building.

Got it. So IP, you think actually can grow faster than EDA business?

I think, well, IP is -- those are the building blocks across everything. So the race is on for all our businesses to grow because we want the company to grow at double digits. But opportunity across all of our businesses.

And to clarify, the majority of your IP is still subscription based?

Well, we can sell IP in multiple different ways, but we sell like a flexible spending account, we call it an FSA, and that's got a specific term to it. So the customer will pull the IP based on when they're in the stage of their design flow wherein they need to pull the black button down and integrate it, but they -- what they've signed up with us is for a specific amount of dollars over a specific amount of time.

I see. So it's not as kind of cyclical, right? It's not as exposed to units?

Well, there are some where would they just buy an IP block, so buy it out of the shelf. But increasingly, we have customers buying in the FSA because they know they're going to be building a chip and so they know that over time, they're going to need the IP blocks.

Makes sense. And then the third part of your business, the Software Integrity business. That's a business I find toughest to understand because it doesn't do much with semiconductors. So give us a sense for what is the kind of the strategic rationale for having that as part of the company? And what are the synergies between your EDA -- that business with EDA and the IP part.

Sure. So the customer for our core businesses, our design automation, our Design IP is the silicon design engineer. So that's who we're in service of or a manufacturing engineer, manufacturing test or verification engineer. And then the Software Integrity, really, that's in service of like the DevOps, the software folks in the team. And if you think about chips, software and hardware, and the discipline around software is different than the discipline around developing a hardware chip. So as we started on the journey, we wanted to build a comprehensive set of tools for those customers, and it was all about security. And increasingly, it's about security and software -- security and safety and software because there are so many places where software is playing a major role. So our core customers buy it. But we can also sell that to financial services, transportation companies, way beyond. And really, as we start to work with like auto manufacturers, they're certainly worried about from silicon all the way to software, because what's going to -- when a car is out on the road, how is it going to behave, how we're going to do the updates, how we're going to know that safe and secure. And so as we think about Smart Everything, we think all of those things do end up coming together at a solution and what we're in service of is making sure that application security testing, making sure that all that code is good and that there's no kind of bad code inside of there. And so we've got the broadest platform in the industry. We're the largest player in that part of the industry. We announced that on a trailing 12 months, we're [ 500 million. ] So that's kind of our run rate now in that business. And we see that we can continue to scale that area. It's a very fragmented part of the market. We think, especially in a constrained environment that consolidation play is even more important to people. And over time, it becomes increasingly important as a lot of the capability to get delivered in software and people need to make sure that it's safe, smart and secure.

Do you ever see it being accretive to corporate EBIT margins?

So our focus is on growing that. We've -- our target is 15% to 20%. This year, we mentioned it will be at the lower end of the range, just a lot of the headwinds you're seeing in enterprise hardware, elongated deal cycles, we're seeing all that. But our focus is on driving profitability. And we think over time, we can drive the profitability significantly and drive it towards the corporate average.

Now one other macro type of risk that investors are concerned about is just the threat of restrictions, right, when we look at U.S.-China relationship. How much of an early warning system does Synopsys have? So when the last set of restrictions came about, was the company informed about them well in advance and you could take corrective steps. So how should we handicap, like if you were in our seat, how would you handicap that risk? Because it's a 14%, 15% customer.

Yes, China is 15% of our business across our different segments. And we've incorporated all the entity list is inside our guidance. So everything that's known as fully incorporated -- and I don't believe we get any more warning than anybody else gets, I don't believe that there's an early warning system. I mean when the government makes a decision, then we certainly adhere with it. That said, the need for technology in China is still there. And so operating inside the confines and the restrictions, we still think that there's enormous opportunity for us, both on IP, EDA and then also in our software integrity. So we know that there's lots of uncertainty at play in China. We know that they want to become independent, and so they will endeavor to do so. But we view that as any competition. They're viewed -- our job is to continue to offer value so that we're the choice of the customer. So I guess what I would say is I don't have a crystal ball. I don't know exactly what's going to happen there. But we still view in these current conditions that it can be a vibrant market for us.

Got it. Just a few kind of near-term questions. So when I look at the second half expectations, right, it's for like 10% to 12% half-on-half growth. So how are you feeling about that? How is your confidence, visibility as you look into the second half of the year?

Sure. So this year is a more normal year for us. Last year was a bit abnormal and the second half and the first half were more evenly balanced -- and what we can see, and it goes back to some of the conversation we have. In IP, we know we can see what's going on with customers because we're working so closely with them. So I think I mentioned in the conference call, we see strength in the back half, but we see strength across our businesses in the second half. So I think we feel good about what's going on in the business and feel good about what's going on in our end customers markets.

Got it. And since the majority of your business, right, 80-plus percent, right, is kind of recurring. So it's hard to change revenues, right? Which is kind of both good, right, because it protects us from the downside risk also. But if there is any upside in the second half, what could be the potential source of that? Is it just hardware or?

Well, I mean, obviously, the focus is making sure that we're playing a bigger and bigger role in our customer success. And so for us, we've got the ratable business, as you said, the subscription business for our EDA tools. And then we've got IP, which is, as I said, increasingly, we're selling it in FSAs, but that's always kind of period revenue and then we've got hardware, which is period revenue.

Got it. Second thing on operating margins. I think you have laid an objective of expanding it at least 100 basis points. Historically, you have managed to expand it a lot more than that. So what's different about this year that you can't -- or is there a scenario in which you can actually be in line with the historical margin expansion?

So this year, we had started with a greater than 100 basis points. We raised it to 150 obviously. Our long-term goal is greater than 100 basis points. So we're committed to that. And our focus is on profitability, driving that across the business. So thinking about how as we continue to scale the business, we drive greater and greater leverage.

Got it. And then free cash flow margins are very strong. And just given the predictability right in your business, why not consider paying a dividend?

So one of the things that our priorities for our cash are is first to invest in our business. That's our clear priority. And we obviously invest considerably in R&D, everything we're just talking about, all the innovation required as a significant R&D investment. We do quite a bit of tuck-in acquisitions and we are able to bring capabilities in. We -- in terms of cash back to the shareholders, we're really focused on this phase in terms of doing that through buybacks.

Got it. And then the last one, which right many investors, right? So investors have a choice, right, in terms of investing, right, between the 2, right, the top 2 EDA companies, from your perspective, why should they consider right Synopsys instead of your competitor?

Well, so first of all, I'd say the space is a great space. So the old days of silicon stad only old [indiscernible] companies do silicon. Now everybody does silicon. Silicon is heart of everything. And software companies, what does software run on? It runs on silicon. So the space is absolutely vibrant, and I see none of that changing. And so if you're interested in this space, you could be interesting in either one of them. I would always choose us. I think that would surprise 0 people in this room that I would always choose us. And for me, there's a couple of considerations. First of all, I saw the power of this company as their top customer. And that's obviously disclosed in our annual report with our top customers. The difference that it makes in terms of the capabilities that we're able to achieve as a -- when I was a customer was profound. And then we are the leader in design automation. If you're going to go on a leading node, you come through us. And you come through us on our design automation tools, you come through us on our IP, because you want battle-tested IP, because what do you really want to do? You want the chip to work. And when you want the chip to work, the stakes are really high. So you want to make sure you've got a partner you can choose. We pioneered AI before -- just as you said, even before anybody was talking about any of this, the company innovated because we could see that we needed to do something to help our customers tame this complexity. The complexity was getting way beyond what any one person or any one team can actually deal with, and that's doing nothing but accelerating. So we've got already DSO.ai, VSO.ai, TSO.ai, we are calling it synopsys.ai. We're going to have it across our tool flow. That data requires you to have our underlying tools. So we think it's an opportunity for us to further expand. And then our IP library is unmatched, absolutely unmatched. We have the IP that can help you if you're in a lagging node, if you're in a leading node, help make sure that your chip is going to tape out, going to be a great success. And then we're investing on the software side because a lot of the value is coming over time from a chip integrated with software. And so we want to play a role in helping team the difficulties that people have there and making sure that their code is safe and secure. So we see opportunity everywhere, and we are set to continue to evolve, maintain our leadership position and serve a bigger and bigger role in our customers' success.

Excellent. Thank you so much, Shelagh. Really appreciate it.

Thank you, Vivek.