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

Good morning. Welcome to the 2017 Annual Needham Growth Conference. My name is Charles Shi, I'm the semiconductor design software and IP analyst at Needham. With me here right now is Shelagh Glaser, Chief Financial Officer of Synopsys. Shelagh. Thank you for being with us today.

Charles, great to be with you.

Yes. Thank you. Before we start, allow me to read the safe harbor statement from Synopsys. 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 Synopsys' most recent SEC filings for a discussion of risk factors that may materially affect these statements. Now let's get started.

Shelagh, the past month has obviously been tough for Synopsys stock, but there seems to be some confusion around the fiscal 2025 guidance you issued at the fiscal fourth quarter conference call. On a continuing basis, let me just quickly recap some of the key metrics. You guys guided 10.1% to 11.1% top line growth for the upcoming fiscal year and as well as it's a more second half weighted, let's say, 45 to 55 profile, when we look at the revenue split between the first half and the second half. Do you mind if we start there? And I'll give you a chance to really recap and hopefully, clarify some of the misunderstandings around that guidance.

Certainly. Thanks for the question. So as we thought about guidance for 2025, it was really informed by 3 things. So first of all, what we're seeing in the marketplace, which I think probably everybody in this call listening is what we call a tale of 2 markets. We're seeing anybody in and around AI, really racing ahead the -- kind of the rhythm with which they're delivering products and the complexity that they're chasing is something we've never seen before. So you see those customers moving in a quite rapid clip. Really, the customer has not yet indexed to AI, trying to find AI use cases. We're not seeing them move at the same clip. So if can just think about our customer base tale of sort of 2 markets. The other piece that we talked about was China. And China continues to have a lot of headwinds as it pertains to both economic and then as it pertains to technology. And really, when we think about China, it's not just of restrictions that come out daily, but it's the cumulative impact of these restrictions. Originally, the restrictions were for a specific company, and now they're getting more field of use. So we see hesitation in the China market, so that's a headwind for us. And then lastly, we're just being balanced and pragmatic. We're about to ingest the largest acquisition in our company's history. And first half of '25, we're obviously spending considerable time getting ready for that successful close and that successful day one.

That's a great overview. And obviously, there are several things. We're going to touch upon later in the fireside chat. But I want to -- I want to follow up on the '25 outlook, starting some of the product segment details. We know Synopsys runs industry-leading profile portfolio in IP and hardware. Well, I don't mean that the rest of the business is not industry leading, but these are the 2 businesses that we have seen that have been lumpy in terms of how the revenue progresses through the year, and not quite easy for us I mean, as analysts, as investors, to really do a good forecast, but you guys seem to suggest within that fiscal '25 profile, a very strong pickup of IP and hardware potentially in the second fiscal half of the year. What gives you the confidence that the profile is going to play out as what you see today and why this -- you guys feel like it's just a timing difference in terms of revenue recognition, and it's not anything that investors should be concerned about? Well, quite frankly, right, Shelagh, as you know, like investors in general, a little bit worried about the hockey stick type of guidance, but mind if you put people's mind at ease, would provide a little bit more color around why we are seeing -- why you are seeing it is like that.

Absolutely. So when we think about our IP business and our hardware business, we are working shoulder to shoulder with our customers. So you can think about us as being almost a member of the design team. And so we're constant IP. We're the second largest IP supplier, as you talked about. We're constantly building IP titles, but the revenue recognition is when the customer ingests that into their product. And so our IP timing of revenue is really aligned to customer product schedules. And so that just happens to be this year more second half weighted. And you've seen us -- this is why we actually did the segmentation to be able to help articulate what lumpy means. I mean, in fact, you saw us Q1 of last year, IP was up 53%. So it isn't that all that work just got done in Q1, but it is that the customer ingested. And the reason we have such high confidence on this is we're shoulder to shoulder with the customer delivering to their design. And so that lumpiness isn't about our delivery. It's about when that customer is going to ingest that into their design, and so that is what gives us confidence. On the hardware side, similarly, as somebody is building a chip, they're deciding what kind of hardware configuration they want and then there's a specific time in the chip design cycle where they want to ingest that hardware. And so that's really how that becomes more back-end loaded. We did mention in hardware one headwind that we're running into that we're working with customers is same as you're hearing everybody talk about data center space and power availability. You can think about our ZeBu as very purpose built server racks for a specific workload. That's a challenge some of our customers have. So we're obviously working with them to build out what we call ZeBu Cloud. So customers can actually access our systems on our premise while they secure space and power on their side. So the reason we have confidence we're literally shoulder to shoulder with the design engineers to deliver the product, and so that's really what those schedules are.

Thanks, Shelagh. And maybe let me talk a little bit more about the China, right? I think -- you mentioned about China, you have a cautious view this year, but you have been cautious. I think this is for the second consecutive year, you have that cautious view on China. But what's your view on the impact from the export controls, well that was announced in early December. I think that was right in front of your earnings, right? You did provide some color, right, the HBM related restrictions, you do expect some impact. But just last night, yesterday to today, the news is that there seems to be more restrictions around the foundries outside of China, that will restrict their ability to supply to the Chinese customers. And basically that kind of means that some of the access to leading-edge manufacturing, but China is going to be further restricted. There will be all these kind of restrictions, like you said, it's cumulative, but how should investors think about what that means to your China business. Can you kind of walk us through in a more comprehensive way.

Yes. So I'm not going to reference what came out 24 hours ago because, obviously, all of that needs to be ingested by the industry. But I will talk about what we talked about in the call and really what we're seeing in China. So over the course of multiple years, more companies have been added to the entity list. The minute a company is added to the entity list, there's no further engagement. So that comes out of backlog. There's no further engagement with that customer. But what has increasingly been happening is technology restrictions and field of use restrictions. And so that narrows the capability and opportunity for customers that we're working with. And so what that has the effect of doing is either delaying a decision because the customers are trying to understand whether the chip will be able to be manufactured and taken to high volume or, in some cases, cancellation of the chip. Because they realize that once they make that chip, it's not going to be competitive because it won't be able be at the right performance indicator. So we're anticipating that environment continues where there's hesitation on customers or the customers may decide not to move forward with a particular design. What we talked about in HBM during our earnings call was it's not so much just that block. It's what that block is enabling. And so the need for HBM, obviously, is growing in the industry because as people have higher and higher compute workloads, you need that memory, that very high power memory to interface with it. And to the extent that a customer can't have that technology and makes them rethink about, well, what is going to be the performance of that chip. And so then they think about whether that chip is going to move forward or not. So that's what we talked about in earnings, but the environment we think is going to continue to have a lot of headwinds.

Got it. All right. Let -- I want to switch gears towards the longer-term picture. So one of the worries that the investors have is EDA growth deceleration. Of course, one should not expect a company to really set a new growth record every year. That's a little bit unrealistic. There will be ups and downs, but the long-term trend, we think it's still quite positive. But we also did see that the Synopsys growth rate on a continuing basis, right, has come down from, let's say, 20% plus in 2022 to, let's say, closer to 12% in 2025 if we really factor in the calendar differences between fiscal '25, '24, but 12% is what we see, right? So what do you say to those investors who may be worried about deceleration of EDA.

So what we see, and I'm going to start with the environment, and then I'll start with our role in that environment. So we see continued strength in design starts and R&D, which is really what our business is indexed to, and we play a mission-critical role. Nobody can create complex leading edge chips without the use of our tools. It's just impossible to do. And we think about ourselves as obtaining the complexity that our customers are facing. So we see no slowdown in design activity. We see no slowdown in kind of the urge for continued power and performance. And we've talked a lot about the move now from chips designed sort of workload down, so purpose-built chips, so more heterogeneous environment. So that's the demand environment we see. We talked about that at our investor meeting last year, we see no change in that. Short term, there's this tale of 2 markets. But obviously, even in that tale of 2 markets, the folks that aren't yet infusing AI are trying to figure out how to infuse AI. And so for us, we still are playing a mission-critical role with our customers. We see long-term growth of industry-leading double-digit growth. So there's really no change in our view of the long term.

Got it. So maybe switching gears more into the more the P&L side of the business, and Shelagh, I think since Sassine and you're part of the -- now part of the Sassine team, since you guys took over the leadership of Synopsis, I think you both have done a fantastic job improving the profit margin for Synopsys. Well, you just guided, let's say, 40% operating margin for fiscal '25, but going back just a couple of years, and I think the number was in low 30s, right? So you're now -- and now you're targeting mid-40s percent operating margin over the long term. Obviously, divesting software integrity business is one factor there. But when we look at IP, right, making 37% operating margin, in some quarters, even over 47%, something seems to have changed structurally for Synopsis, because I think you've told us, all right, that the IP is structurally -- you should expect a lower operating margin. But looking at all these IP margin numbers, it feels different. So mind if you walk us through what you have done and maybe more importantly, what you plan to do going forward to get to that mid-40s operating margin. And where is the confidence from to make -- to convince you that mid-40s is really achievable?

Yes. And we are very committed to that. And as you said, we've been demonstrating that commitment. So it starts with intentionality about portfolio, discipline on our portfolio. And as you mentioned, the significant disinvestment that we drove of our Software Integrity business as we really looked at deploying capital inside the company. The returns on both IP and our design automation business, are superior, and we've got this sort of once-in-a-generation opportunity that's really being borne by AI, and then we'll talk a little bit about Ansys too. So really making sure our dollars are in the right place in the company and making sure that we've got close loop expectations of type of return on those dollars. And then it also starts with making sure that we're building a modern work environment for our customers. If you think about what do we sell to our customers, we sell them tools to obtain complexity. We need to be doing that to ourselves. We need to be modernizing our own market environment. So we've got specific dedicated focus on really how do we continue to be best-in-class in a modern work environment for every engineer. We're mostly an engineering company. So how do we ensure that those folks have the latest greatest, and we're constantly creating engineering capacity, which is what we do for our customers. So how do we do that for us across our software engineers and then our hardware engineers and our IP engineers. So that's a dedicated focus for us inside the company on that. And then also, if you think about the core sort of engine of the business, we've got a dedicated focus on driving digital transformation. So you can think it up more being on the sales and the G&A side. So I think we're excited as we bring Ansys on to be able to bring their capability and then jointly between the two of us to drive margin in the mid-40s.

Yes, that's a very good segue to talk about Ansys and overall picture on M&A. And so Synopsys has made I mean quite a few announcements over the last, I would say, 1 or 2 months related to the regulatory approval of the Ansys acquisition -- there's a -- you guys talk about the U.S., the latest on the U.S. And obviously, we've seen press release on the U.K. and the EU review process, you've made progress. Mind if you recap to us a little bit because there's a lot there? And more importantly, what do those milestones mean, mind, if you kind of unpack a little bit for us towards the eventual closure of the Ansys acquisition?

Absolutely. Yes. So we're really pleased with the process, this is obviously a critical part. And so I'm going to make sure that again, I'm all right, the EC has approved our pro-competitive transaction in Phase 1. The U.K. CMA provisionally approved the transaction in Phase 1. And as we mentioned in our earnings call, we talked about having the HSR period had expired, we're working with the FTC for that finalization, and we're working through to make sure that all those various parties review the remedies that we've talked about. You've seen us announce the sale of our optical business to Keysight. You similarly saw Ansys announced the sale of the PowerArtist business -- PowerArtist business to Keysight. We also announced recently that China had accepted our filing, which means they're now in the review process. And so all of those milestones, just if I would summarize, give us the confidence that we will be able to close in first half of '25. And obviously, each jurisdiction has a slightly different set of meetings and requirements and things like that, but this is all very positive. This -- seeing the kind of the provisional Phase I and then the Phase I approval in the U.K. So we feel very positive. We're working very cooperatively with these agencies. And I think really what underpins it, Charles, is we've had enormous support from customers. in terms of their interest in having us be able to create this, if you will, combine design environment to help them really accelerate their product development, so been very positive.

Thanks, Shelagh. So it sounds to me, right -- I am no legal expert, but that sounds to me that the approval process with the U.S., U.K. or EC looks like it's more -- a more advanced -- at a more advanced stage at this point, but China looks like still relatively early. Do you have any thoughts on the China side, especially given that the China SAMR has -- well, the track record of approving the U.S. semiconductor deals in the past few years hasn't been really great. But what's your thought there?

So it's been strong engagement, and it's been a very cooperative process, and what we see is when you look at U.S. to U.S. transactions they largely have been approved because if you think about we're already subject to the U.S. restriction, so is Ansys, and so there's really no change in terms of how we can conduct business in China, and we're working cooperatively through the process, and we're seeing strong engagement for them. So again, it leads us to confidence of first half of '25.