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Edited Transcript of SNPS earnings conference call or presentation 22-May-19 9:00pm GMT

Q2 2019 Synopsys Inc Earnings Call

MOUNTAIN VIEW Jun 4, 2019 (Thomson StreetEvents) -- Edited Transcript of Synopsys Inc earnings conference call or presentation Wednesday, May 22, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Aart J. de Geus

Synopsys, Inc. - Co-Founder, Chairman & Co-CEO

* Lisa Ewbank

Synopsys, Inc. - VP of IR

* Trac Pham

Synopsys, Inc. - CFO

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Conference Call Participants

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* Gary Wade Mobley

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* Jason Vincent Celino

KeyBanc Capital Markets Inc., Research Division - Associate

* Jay Vleeschhouwer

Griffin Securities, Inc., Research Division - MD of Software Research

* Mitchell Toshiro Steves

RBC Capital Markets, LLC, Research Division - Analyst

* Richard Frank Valera

Needham & Company, LLC, Research Division - Senior Analyst

* Sterling Auty

JP Morgan Chase & Co, Research Division - Senior Analyst

* Thomas Robert Diffely

D.A. Davidson & Co., Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Synopsys earnings conference call for the second quarter of fiscal year 2019. (Operator Instructions) Today's call will last 1 hour. 5 minutes prior to the end of the call, we will announce the amount of time remaining in the conference.

At this time, as a reminder, today's call is being recorded. At this time, I would like to turn the conference over to Lisa Ewbank, Vice President of Investor Relations. Please go ahead.

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Lisa Ewbank, Synopsys, Inc. - VP of IR [2]

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Thanks, Anna. Good afternoon, everyone. Hosting the call today are Aart de Geus, Chairman and Co-CEO of Synopsys; and Trac Pham, Chief Financial Officer.

Before we begin, I'd like to remind everyone that during the course of this conference call, Synopsys will discuss forecasts, targets and other forward-looking statements regarding the company and its financial results. While these statements represent our best current judgment about future results and performance as of today, our actual results and performance are subject to many risks and uncertainties that could cause actual results to differ materially from what we expect. In addition to any risks that we highlight during this call, important factors that may affect our future results are described in our most recent SEC reports and today's earnings press release.

In addition, we will refer to non-GAAP financial measures during the discussion. Reconciliations to their most directly comparable GAAP financial measures and supplemental financial information can be found in the earnings press release, 8-K and financial supplement that we released earlier today.

Also included in the financial supplement is detailed information around our long-term financial objective, the transition to ASC 606 this year and operating segment results. All of these items plus the most recent investor presentation are available on our website at synopsys.com. In addition, the prepared remarks will be posted on the site at the conclusion of the call.

With that, I'll turn the call over to Aart de Geus.

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Aart J. de Geus, Synopsys, Inc. - Co-Founder, Chairman & Co-CEO [3]

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Good afternoon. I'm happy to report excellent second quarter results. Revenue was a record $836 million with strength across both operating segments. In Semiconductor & System Design, software revenue growth was particularly strong, moderated somewhat by a tough hardware comparison versus a record second quarter 2018. Software Integrity revenue tracked right to plan with greater-than-20% growth and is expected to be profitable for the year.

Non-GAAP EPS was $1.16, and we repurchased 100 million of our stock, bringing the total so far this year to 129 million. While the U.S. export restrictions that were announced last week do have an impact, we are raising our non-GAAP earnings guidance in the top end of our revenue range to reflect the strength of our business. Trac will provide some additional color on this topic and discuss the financials in more detail.

Whereas geopolitical tension has escalated, the overall customer environment for us is quite solid. The hunger for advanced technology, design tools, IP and security solutions is strong, creating a robust market opportunity.

The growing impact of AI, 5G, the Internet of Things and big data is profound and is driving substantial investment in new compute and machine learning architectures. Virtually all vertical markets are engaging with AI and the potential economic impact is forecast to be in the trillions of dollars. In addition to long-time semiconductor vendors, very large system companies and cloud providers are investing competitively, opening further opportunities for us.

The push for AI solutions, along with the growing security issues associated with a highly interconnected world, benefits our entire Silicon-to-Software product portfolio.

Synopsys is ideally positioned to solve these very complex challenges: Our EDA design and verification solutions are front and center in creating brand-new AI-optimized engines; our IP is broadly used in the most advanced silicon technologies ever built; our Prototyping tools run and test software on new subsystems long before silicon is available; and our software security and quality solutions are essential to minimize vulnerability to threats.

In that context, let me provide some highlights from the quarter beginning with EDA. The underlying driver of EDA growth is design complexity along 3 vectors: one, advanced processes moving to smaller, denser technology nodes such as 7, 5, and most recently, 3-nanometer; two, optimizing designs in more established nodes for cost reduction, but also speed and low power; and three, massive software content that is becoming integrated as part of chip design. And overall, the system challenge is to make sure the chip and the software work well together.

In design, customers rely on Synopsys for virtually all of their 12-nanometer and below designs. The key reasons are state-of-the-art tools and also our unmatched collaboration and support. This quarter, we continued our long-standing foundry enablement with TSMC, who certified both our digital and custom design platforms for its 5-nanometer FinFET process.

TSMC also certified our Fusion Design Platform for their innovative System-on-Integrated-Chip, or SOIC chip-stacking technology, delivering design solutions for true 3D design -- device integration. Samsung used our complete design solution to develop the very first test chip for its brand-new gate-all-around process.

In digital design, a rapidly growing highlight is the success of our new Fusion Compiler product, which we launched in November. It's a revolutionary combination of the main pillars of design, all of which are cornerstones for Synopsys: synthesis, place-and-route and signoff into a single solution on a single data model.

Fusion Compiler is doing really well from both technical and business perspectives. A rapidly growing set of customers is reporting excellent results, including significantly shorter design times, a high level of predictability and better timing, area and power results. Adopted by 19 different logos across 8 different processes nodes and used for about 250 active and by now completed designs, the trajectory is impressive.

One such customer is Renesas, who deployed Fusion Compiler across its high-value automotive portfolio. Renesas cited consistently superior power, performance and full-flow productivity on its production design. The versatility and potential of the Fusion Design Platform is living up to its promise which includes continuously adding of new Fusion Technology capability to broaden its impact. This quarter, for example, we launched a fully integrated test flow, containing next-generation capabilities for automotive tests and functional safety. Stay tuned as we deliver further enhancements over the next 12 months.

Now turning to verification, where we continue to see outstanding results and a strong outlook for the year. Thanks to many years of great technology advances and excellent customer support, we are the market leader. Verification is a huge bottleneck for chip and systems design. Customers tell us that they can't get enough verification, as design complexity is getting more difficult and more time-consuming by the day.

Synopsys is fortunate to have the fastest software and hardware solution and demand is high for our Verification Continuing Platform. Q2's strength in verification software was driven in part by accelerating demand from influential systems companies who are reinventing how to design and verify their next-generation products.

Our decade-long leadership is an important indicator of our impact. 12 of the top 15 semiconductor companies in the world use our franchise VCS simulator as their primary verification solution.

Demand for our hardware-based verification is also high and increasingly broad-based. The ability to validate chips together with the software and the need for early software development are paramount. Our new ZeBu 4 emulator, launched late last year, is doing very well, with early demand exceeding expectations and outpacing that of previous solutions.

Adoption of our HAPS FPGA-based prototyping solution, which targets early software development was again robust in the quarter. As a result of our differentiation, we are the market leader in both emulation and prototyping.

Now to IP, which had another very strong quarter and is poised for an excellent year of double-digit growth. As the #2 vendor in the world and the market leader in interface, analog, embedded memory and foundry-specific IP, we provide the industry's broadest set of building blocks to address today's most complex design requirements for AI, automotive, Internet of Things, cloud computing and more.

The quarter featured a number of important milestones at advanced nodes. We announced that we have achieved more than 250 IP wins on TSMC's 7-nanometer FinFET process across a broad range of applications. In addition, we signed a multiyear agreement with a marquee global customer for 5-nanometer IP. Meanwhile, our portfolio continues to expand. Further building on our strength in automotive, we announced a collaboration with Global Foundries to develop the industry's first automotive-grade IP for their 22-nanometer FDX process. We announced a complete solution for one of the hottest markets around, narrowband IoT, enabling the next wave of connected devices. And we taped out 2 key IP titles for cloud computing and AI application, including 112-gig SerDes, an ultra-high-speed connection for hyperscale data centers.

With the rising complexity and time-to-market challenges inherent in delivering today's electronic systems, Synopsys fills a critical and growing need for sophisticated low-risk IP. Which brings me to our Software Integrity Group, which has now reached the 10% of Synopsys' revenue milestone and is scaling nicely. As software security issues continue to increase in both number and severity, testing during the development process becomes a necessity. This is true not only for electronics but for anyone who develops software in financial services, medical, automotive, industrial and beyond.

The progress our team has made in building this business over the past 5 years is striking. While we acquired compelling technologies and added substantial organic investment, we also focused our deep knowledge towards building a compelling software security and quality platform.

In March, we announced our new Polaris Software Integrity platform. It brings products and services together into an integrated, user-friendly, cloud-based solution that makes deployment and scalability easier. While we will continue to deliver enhancements to the platform over the next 12 to 18 months, the initial release is already showing great promise. We are engaged with customers across all regions and early reaction has been very positive. This included a Fortune 500 insurance company who placed a multiyear, multi-million-dollar order for Coverity delivered on Polaris. The power of our portfolio, the broadest in the industry, is evidenced in the growing number of high-value contracts in companies adopting multiple products.

Industry recognition of our solution also continues to grow. Last month, for the first (sic) [third] year in a row, Synopsys was named a leader in Gartner's Magic Quadrant for Application Security Testing. In fact, we were placed at the highest level. We're also, again, recognized as a leader in the Forrester Wave for Software Composition Analysis for open source software. Important rankings, such as these, substantiate our leadership for customers who were investing significantly in choosing their preferred partners.

To summarize, we delivered another very strong quarter and are raising the top end of revenue and non-GAAP EPS guidance for the year. We're making step-by-step progress in expanding our ops margin, our new EDA products in the early stages of a multiyear adoption cycle are experiencing rapid and substantial adoption. Demand for IP portfolio is high, and we expect to deliver another year of low double-digit growth. And our software security and quality business is scaling well, reaching about 10% of total revenues and expected to reach profitability for the full year.

Finally, I want to say thank you to the global Synopsys team for its continued hard work and commitment to helping our customers meet their important and always urgent objectives.

Let me now turn the call over to Trac.

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Trac Pham, Synopsys, Inc. - CFO [4]

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Thanks, Aart. Good afternoon, everyone. We continue to execute well, delivering good top and bottom line growth and non-GAAP operating margin of 25%. Operationally, we are on track for another outstanding year with an outlook that reflects high-single-digit revenue growth on an apples-to-apples ASC 605 basis, substantial operating margin improvement and double-digit non-GAAP EPS growth.

Last week's government action to restrict trade with one of our customers and its affiliates does have an impact on the business because we are currently unable to ship products, deliver software updates or provide support. As a result, we are not able to book new business and recognition of currently contracted revenue is on hold. However, due to the strength of the first half, we're still able to raise our non-GAAP EPS guidance and the top end of our revenue range. I'll provide more details in a moment.

Now to our Q2 numbers. All comparisons are year-over-year unless otherwise stated and all results are reported under ASC Topic 606. For a summary of these results as well as equivalent financial metrics under ASC 605, please refer to our financial supplement.

We generated consolidated total revenue of $836 million or 8% growth and saw broad-based strength across both segments. Semiconductor & System Design revenue was $753 million, up 6% or high single digits, excluding hardware, which had a record second quarter last year. For Software Integrity, revenue was $83 million, an increase of 23% as that business continues to capitalize on market dynamics and gain share in this high-growth market.

Continuing down the income statement. Consolidated total GAAP costs and expenses were $721 million. Total non-GAAP costs and expenses were $626 million resulting in a non-GAAP operating margin of approximately 25%. At the segment level, Semiconductor & System Design delivered an adjusted operating margin of 26.8%, with Software Integrity at 10.1%, reflecting both underlying strength and quarterly variability of revenue and expenses. Note that certain operating expenses, such as stock-based compensation, amortization of intangibles and other expenses that are managed at the consolidated level, have not been allocated to our segments.

We continue to expect Software Integrity to be profitable for the full year with the goal of reaching at least our consolidated corporate margin over the long term. These operating results, in turn, drove GAAP earnings per share of $0.77 and non-GAAP earnings per share of $1.16.

Turning to cash. Operating cash flow was $353 million, driven by strong collections in the quarter. We ended the quarter with a cash balance of $631 million and total debt of $292 million.

Before moving to guidance, let me provide some additional color around the impact of last week's government action. As I mentioned, we are not able to book new business with this customer and its affiliates and revenue recognition for current contracts is on hold until either the contract expires or the restriction is lifted. Because the duration of the ban is unclear, we've expanded our ranges to account for an array of potential impacts.

We believe that we will eventually be able to recognize the revenue depending on the timing of the alternate resolution of the government action. Our targets, based on ASC 606 for the fiscal year 2019 are: revenue of $3.29 billion to $3.35 billion; total GAAP costs and expenses between $2.798 billion and $2.853 billion; total non-GAAP costs and expenses between $2.505 billion and $2.525 billion, resulting in a non-GAAP operating margin at the midpoint of just over 24%. Other income and expenses, between minus $12 million and minus $8 million; a non-GAAP normalized tax rate of 16%; outstanding shares between 153 million and 156 million; GAAP earnings of $2.85 to $3.27 per share; non-GAAP earnings of $4.24 to $4.40 per share, an increase at the midpoint of $0.08 over our prior guidance.

Cash flow from operations of $670 million to $700 million, which reflects additional uncertainty due to the trade restrictions and some restructuring costs as we reallocate resources for future growth; and capital expenditures of approximately $270 million. We continue to expect CapEx to drop by roughly half in 2020.

Now to the targets for the third quarter. Revenue between $810 million and $850 million; total GAAP costs and expenses between $700 million and $746 million; total non-GAAP costs and expenses between $620 million and $640 million; other income and expenses between minus $4 million and minus $2 million; a non-GAAP normalized tax rate of 16%, outstanding shares between 153 million and 156 million; GAAP earnings of $0.60 to $0.83 per share; and non-GAAP earnings of $1.07 to $1.12 per share.

I'll conclude by reiterating our long-term financial objectives. Annual double-digit non-GAAP earnings growth, driven by revenue growth in high single digits, reflecting mid- to high single digits for EDA, low double digits for IP and Software Integrity growth in the 20% range. And operating margin expansion to the high 20s by 2021 and in the 30% range longer term. Our execution in the first half reflects our commitment to driving near-term results that will put us on a path to achieving our longer-term operating objectives.

Our capital allocation strategy enables us to meet these dual objectives while returning substantial value to shareholders. We maintain a balance of internal and external investments for growth and a robust share repurchase program. And with that, I'll turn it over to the operator for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Rich Valera with Needham & Company.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [2]

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Aart, aside from the ban which has some specific implications, would you say there's any other change in the outlook or the demand from your customers relative to a quarter ago?

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Aart J. de Geus, Synopsys, Inc. - Co-Founder, Chairman & Co-CEO [3]

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Actually, I would say no. I don't think that there's material other change. There was some worry about 3 months ago that seems to have settled it. I think the market is just readjusting itself among the companies who is doing better than others. But the end demand, I think reminds -- remains just as strong as it were before.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [4]

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Got it. And then Trac, just a clarification on the guidance for the rev rec with Huawei. So can we assume that the low end of your revenue range that there is no rev rec assumed for Huawei for the balance of the year? Is that correct?

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Trac Pham, Synopsys, Inc. - CFO [5]

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That's correct, Rich. We tried to widen the range to capture the possibility of their restrictions remaining in effect and then the higher end of the range which reflects the execution in the first half, which has been very strong and possibly that gets lifted in some reasonable amount of time.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [6]

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Right. So is it fair to say that the low end would have been going up had not you had this change with respect to Huawei?

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Trac Pham, Synopsys, Inc. - CFO [7]

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That's correct.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [8]

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Got it. And then with respect to the hardware business which obviously had a tough comp in Q2, but generally I think has kind of a tough comp for all of next year. I think when you came into this year, you were thinking that, that would be flattish. I don't know if you gave a specific guidance, but my sense was you were sort of thinking about that being flattish. Any change in thoughts on the hardware business now that we're a couple of quarters into the year?

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Trac Pham, Synopsys, Inc. - CFO [9]

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No, I think -- fundamentally, I think we have predicted it reasonably well. And while we didn't use those words, your words are not all that far away from where we are. And so we do see good demands and broader demands, so that is excellent. So in the long term, I think that will just settle back. Last year was just particularly strong and actually overall, so far this year is good in general. I think you characterized it correctly.

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Operator [10]

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Our next question comes from Tom Diffely with D.A. Davidson.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [11]

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Following up on Rich's question on Huawei. Were there application engineers on location that had been removed at this point?

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Aart J. de Geus, Synopsys, Inc. - Co-Founder, Chairman & Co-CEO [12]

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Well, I don't think we want to go into the intricacies or all the individual action. But with all of our customers, we have essentially constantly applications, engineers helping them. And right now, we're just follow exactly the rules set by the government and they include not giving specific support.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [13]

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Okay. And then just one more question on that. Was it a combination of both traditional EDA tools as well as IP? Was one more significant than the other?

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Aart J. de Geus, Synopsys, Inc. - Co-Founder, Chairman & Co-CEO [14]

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Yes. While we wouldn't break it into individual pieces, large companies typically are participants in all of our portfolio. So that's -- so it would include tools and IP.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [15]

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Okay. As I said, at some point, there were some of the strong growth you've seen in IP comes from a lot of the Chinese customers as they're fairly new to this space. Okay. So I guess moving on, do you see any other impacts from the trade war, the tariffs on your business? And if you do, is there a difference between delivering EDA traditionally versus over the cloud?

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Aart J. de Geus, Synopsys, Inc. - Co-Founder, Chairman & Co-CEO [16]

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No. We don't see any changes, and I think it's too early to see any changes in the market. Obviously, there will be some readjustments of how different suppliers act. I'm talking about semiconductor companies. But I think it's really much too early to speculate as even the last few days there have been changes.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [17]

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Okay. And then Trac, when I look at your full year view, obviously, you've got the dampening effect of Huawei, but was there any other puts and takes that created the spread? Or was it really just that one particular event?

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Trac Pham, Synopsys, Inc. - CFO [18]

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It was really that isolated issue because when you look at the first half results, you're seeing very good growth in the top line. Margin improving very well against last year, and you can see in our guidance in Q2 it was very constructive. And so the widening of the guidance range really reflects the trade restrictions that went into effect last week.

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Operator [19]

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Our next question comes from Mitch Steves with RBC Capital Markets.

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Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [20]

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Can you hear me?

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Aart J. de Geus, Synopsys, Inc. - Co-Founder, Chairman & Co-CEO [21]

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Yes, we can.

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Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [22]

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Okay. I apologize, I'm on the road. So I only have two questions. The first one is pretty high level. So obviously, the U.S. and China are kind of having higher tensions here. Maybe I'm thinking about this too much, but is there a chance that essentially the Chinese vendors you guys are selling to outside of Huawei would want to push the client going into the higher-end node now? Now that there's potential for it to get banned, wouldn't it make sense they would try -- I guess try to invest into higher tech? Or do you have any thoughts on that?

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Aart J. de Geus, Synopsys, Inc. - Co-Founder, Chairman & Co-CEO [23]

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Well, I think that all companies that are indeed in the same arena are continually racing forward to try to provide products with the high-end nodes and the most sophisticated technology. I don't think that goes away under any economic scenario. And so this is one of the reasons why we think that overall our business outlook is very solid or strong because the demand given the applications that are being developed, requires strong investments on the part of our customers in advanced technologies. And so different companies will get there in different ways. But the race is definitely on.

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Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [24]

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Got it. And I didn't exactly want to get to let Trac take the limelight for this one. So if I look at the Software Integrity, is this now 10% margins already? That seems pretty substantial on a Q-over-Q basis. Can you maybe help us understand how that's going to ramp? Because I think that's going 50% sequential growth in terms of a margin perspective is pretty high. So how do we model that going forward in the next couple of years?

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Trac Pham, Synopsys, Inc. - CFO [25]

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Yes. Let me start with this. Let's focus on this year. We're showing very good -- a good trend on Software Integrity and that's heading into the right direction after roughly 5 years of investment in that area. The profitability or the OM for that business is going to be noisy from quarter-to-quarter. Keep in mind, it's a nascent market that's growing and the profile of that business will vary from quarter-to-quarter in terms of revenue growth, but still very strong. And we'll continue to invest in this area, so you'll see us talking to revenue growth and investments. For this year though, we are certainly on track for profitability for the business, but I would just be cautious about extrapolating too quickly on the Q1 results heading to Q2. But we definitely will be profitable. Longer term, given the dynamics and the nature of that business, we do expect it to be at least at the corporate average in terms of OM.

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Operator [26]

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Our next question comes from Sterling Auty with JPMorgan.

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Sterling Auty, JP Morgan Chase & Co, Research Division - Senior Analyst [27]

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I apologize, I don't know if it's the static or I didn't quite catch the following 2 questions around the China situation. The first one is, is it all revenue related to all products currently with that customer that's put on hold? Is there anything else that potentially could come out of the revenue line over the coming quarters? And I've got one follow-up.

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Trac Pham, Synopsys, Inc. - CFO [28]

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Okay. So the revenue guidance includes all revenues for all products related to that one customer.

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Sterling Auty, JP Morgan Chase & Co, Research Division - Senior Analyst [29]

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Okay. And all support and maintenance...?

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Trac Pham, Synopsys, Inc. - CFO [30]

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So there's no revenue at all coming for that customer in the income statement.

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Sterling Auty, JP Morgan Chase & Co, Research Division - Senior Analyst [31]

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All right. Perfect. And then the other one is I didn't catch -- what about cash flow, in terms of cash collections and payments?

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Trac Pham, Synopsys, Inc. - CFO [32]

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Yes. So our cash flow guidance of $670 million to $700 million does reflect a couple of new items. One is an impact of cash collection for that customer, and probably it's just a reflection of the fact that we are unable to provide additional support for them. So the prudent outlook is to assume that the collections will be delayed. The other part is a restructuring that we took in Q2, a minor restructuring we took in Q2.

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Sterling Auty, JP Morgan Chase & Co, Research Division - Senior Analyst [33]

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I think that's very fair. That last element, FX impact on top and bottom line in the quarter and the outlook?

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Trac Pham, Synopsys, Inc. - CFO [34]

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Generally, immaterial to our results. Keep in mind the 1 currency that's not denominated in USD is the yen and that is hedged at the beginning of the year. So the top and bottom line is pretty much dampened by FX.

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Operator [35]

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And our next question comes from Gary Mobley with Wells Fargo Securities.

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Gary Wade Mobley, Wells Fargo Securities, LLC, Research Division - Senior Analyst [36]

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A follow-up question on the operating margin for the Software Integrity business. You mentioned the long-term target of being at corporate average, presumably high 20%. What revenue level has to be achieved to get to that target?

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Trac Pham, Synopsys, Inc. - CFO [37]

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Really, the model that we describe for Software Integrity is roughly in that 20%-plus growth. And if we continue on that path, the growth will be there and then over the last few years, not only have we invested in the product portfolio and our go-to-market infrastructure, but we have also spent time building out the organizational infrastructure, the back office, whether it's the systems or the processes to scale it up. So you'll continue to see improvements in operating margin through a combination of revenue growth in that 20% range and operating leverage as that business scales.

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Gary Wade Mobley, Wells Fargo Securities, LLC, Research Division - Senior Analyst [38]

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Okay. Trac, you mentioned a minor restructuring in the second quarter, but I think the charge was the highest charge you've had in at least a few years. So could you shed some more light on what the restructuring was and perhaps what the headcount in prior groups might be impacted?

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Trac Pham, Synopsys, Inc. - CFO [39]

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Yes, it's really -- Gary, it's very much fine-tuning. We've committed to driving operating margin expansion with a focus on hitting the high 20s by 2021. We'll continue to invest in the business, that's the important part, across all areas. And as we tweak and tune it, we'll try to -- our focus is making sure that we're emphasizing the business areas. That is going to deliver the best combination of top line and -- top line growth and margin expansion. As of Q2, it's just a function of that.

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Gary Wade Mobley, Wells Fargo Securities, LLC, Research Division - Senior Analyst [40]

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Okay. Last question, I'll ask it quickly. Hopefully, it's a quick answer. But do you have handy the mix between merchant, chip vendors and system OEMs and captively developed integrated circuits?

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Aart J. de Geus, Synopsys, Inc. - Co-Founder, Chairman & Co-CEO [41]

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Sorry, I don't follow that question.

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Gary Wade Mobley, Wells Fargo Securities, LLC, Research Division - Senior Analyst [42]

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Well, what's your sales mix between merchant-integrated circuit companies and system OEMs?

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Aart J. de Geus, Synopsys, Inc. - Co-Founder, Chairman & Co-CEO [43]

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That ratio has never changed all that much. It was always sort of in the 40-ish percentage for the system houses. But in all fairness, those definitions are becoming much fuzzier because a number of system companies, that in the past didn't do any chip design, have now started to invest in chip themes. And I think we mentioned some of those as being some of the mixed cloud providers for example, or some of the very large companies in the world. And at the same time, the other people that are dedicated to chip design are spending more money because it's more challenging. So fundamentally for us, the picture is changing, but it's not evolving away from those numbers.

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Operator [44]

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(Operator Instructions) And our next question comes from Jay Vleeschhouwer with Griffin Securities.

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Jay Vleeschhouwer, Griffin Securities, Inc., Research Division - MD of Software Research [45]

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Trac, just a quick clarification. You did not mention in your prepared remarks an updated backlog number as you did in Q1 if you can provide that. Second, for Aart, with respect to the restructuring, that ties into a couple of questions that we had meant to ask you anyway and that is back in September at an investor meeting in New York, and again, at the analyst meeting a couple of months ago, you referred to improving your internal processes that related to the company's profitability and Trac referred to efficiencies but you didn't really go into much detail as to what you're doing or you're changing your cost structure here, but in one other operational and ongoing ways are you, in fact, going to improve those processes and efficiencies that you alluded to? And also, it looks now, just a quick spot check this afternoon, once the restructuring news came out, that your current job openings are the lowest in 1.5 years. And it looks like most of the pullback in openings is in the U.S. And you still have a fair number of openings in China. So maybe just talk about all of those issues together in terms of processes, cost structure and hiring.

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Trac Pham, Synopsys, Inc. - CFO [46]

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So let me start with your first question, Jay. The backlog was around $4.3 billion, pretty consistent with where it was at the end of Q1. Overall, the business, as you can see in the outlook, the business has been pretty healthy and run rate growth was actually up in Q2 again. I'll make a few comments on the fine-tuning of our business and Aart can provide more color, but it ranges across the board. For example, it goes from systems implementation. Over a couple of years ago, we upgraded our ERP system to get prepared for 606 transition as well as the evolution of the business into different portfolios. Having that platform then allowed us to go in and spend time last year and continuing into this year, looking at our infrastructure and the processes around the Software Integrity business and allowing us to scale. Some of that benefit you're seeing, certainly in the profitability improvements in the first half. But really you're looking at our business processes and then these systems that are supporting that business, the CRM system that supports that business, which is very different than what we were traditionally used to. It's much higher volume, lower dollar in absolute terms relative to the EDA and IP business. Those are 2 examples of the sort of things that we're looking at. But you can see in some ways, they're big, heavy lifts in terms of creating the infrastructure, but they are the appropriate things that you'd want to do in terms of scaling the business from where we are today, $3 billion, to the next level of ambition.

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Aart J. de Geus, Synopsys, Inc. - Co-Founder, Chairman & Co-CEO [47]

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Yes, so maybe I can comment a little bit going back to, I forget exactly if it's 2 or 3 quarters ago when we communicated to you that we had essentially executed on a multiyear investment push with a number of acquisitions, specifically creating the Software Integrity Group, but also a number of pushes on the tool side and involving our IP portfolio. And so we are continuing on all these investments because I think we invested in the right direction and things are looking quite good there. At the same time, as we communicated to you that we were putting additional emphasis on improving the ops margin after this round of investment, we are not only looking at all the infrastructure tasks and all the processes, as Trac mentioned, but literally, going through every business and looking at which products have higher potential, which areas in the world or areas with customers need additional emphasis or can be slightly reduced. And even what verticals are of interest. And we've done very well, for example, in the automotive side, but there may be other sides we could consider. And so it is actually a long list of a lot of fine-tuning, but the fine-tuning does have an impact. As to the openings, I do think that we have a very large number of openings at this point in time. They do change from time to time also because business units revisit where the needs are, how these have evolved, which positions have been filled, what are we looking for. And they also move a little bit from geography to geography as a function of the situation. So I wouldn't say there's anything abnormal in that, but I think we are very serious and well organized to keep pushing on the ops margin. And if you have watched the results in the last few quarters, you should at least get an inkling that we're heading in the right direction.

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Operator [48]

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Our next question comes from Jason Celino with KeyBanc Pacific Crest.

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Jason Vincent Celino, KeyBanc Capital Markets Inc., Research Division - Associate [49]

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Staying on the margin topic, even your semi and systems operating margins increased by 30 bps quarter-over-quarter. How should we think about linearity of those margins? I appreciate your coming from the variability of the other segments, but how should we look at the core margin?

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Trac Pham, Synopsys, Inc. - CFO [50]

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If you look at it on a multiyear basis, you should see a steady progression from where we were last year to where we want to be in 2021, which is the high 20s. You'll see a steady progression towards that. On a quarter-to-quarter basis, it can be very highly variable and very lumpy given the mix of the business that we shipped that particular quarter or the contracts that are in play at a quarter. But overall, you'll just see that trend on an upward trajectory.

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Jason Vincent Celino, KeyBanc Capital Markets Inc., Research Division - Associate [51]

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Okay. And then relative to the new ZeBu 4 product, you said you're getting some good feedback from customers. Can you maybe provide some more color around that?

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Aart J. de Geus, Synopsys, Inc. - Co-Founder, Chairman & Co-CEO [52]

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Sure. One of the key capabilities of the ZeBu 4 is: a, that it is faster; and b, that it can do much larger capacity. And the fact that you can really scale your capacity as required by the needs of the customer. Lastly, the cost for computation is the lowest on the market, and so that makes for an attractive solution. It's actually a solution that has also found some really hairy problems to solve such as can you start running software on hardware that you don't have yet? In other words, can you virtualize your designs? Can you implement them in an emulator before you actually have the silicon? And that is turning out to be a very challenging problem but one that we are well equipped for. So we're very encouraged with where this is going, and if nothing else, we've also seen in the last few quarters that we are broadening the number of customers that are intrigued or that actually have started to use this.

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Operator [53]

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And our next question comes from Gal Munda from Berenberg Capital Market.

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Unidentified Analyst, [54]

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This is actually [Francois] on for Gal. I just wanted to revisit the China contract that you said was on hold. We were just wondering how long do you think that would be on hold. And then as a follow-up, you mentioned how system companies are driving software verification. Are these customers purchasing hardware as well? Or is that not necessary for the complexity of their designs?

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Trac Pham, Synopsys, Inc. - CFO [55]

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Our guidance is focused on FY '19. So the range, particularly on the lower end reflects the possibility that the restrictions are, in effect, for the rest of the year. In the event that it does change, then you would expect it to be on the higher end of our revenue and earnings guidance.

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Aart J. de Geus, Synopsys, Inc. - Co-Founder, Chairman & Co-CEO [56]

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Regarding your question on Prototyping, most customers, if not all, really use both. Meaning that if -- let me say it differently. The people that use hardware, invariably, also use the software because that's typically how they got to know us in the first place. For smaller problems, you try to get as far along as you can on the software. And once the speed is woefully inadequate and the complexity has grown, that's where people start using the hardware to get much faster results. And we have multiple variations on that theme, by the way. So the other comment I would make is that it's one thing to do very, very fast simulations. It's another thing to actually diagnose what happens when something goes wrong. And so that's where the debugging is extremely important. And we have a very, very powerful set of software debugging capabilities that work with both our software simulator and with the emulators.

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Unidentified Analyst, [57]

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Okay, great. And what's the length of that -- those kinds of contract?

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Trac Pham, Synopsys, Inc. - CFO [58]

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Our duration in general is typically 3 years. It runs around 3 years.

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Unidentified Analyst, [59]

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Okay. And then I just have one more on your Polaris platform. Is that platform completely built in? And if not, what's left to be integrated? And what is the roadmap for completion? And how should we think about that for the benefit to your margins?

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Aart J. de Geus, Synopsys, Inc. - Co-Founder, Chairman & Co-CEO [60]

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Okay. Let me take one step back and say what is the platform all about. Well, the platform is all about to let software developers use really a multiplicity of tools that can detect a variety of quality and security issues as you develop the code. And so you have to realize that it's a little bit more than a year ago that we actually acquired one of the bigger pieces of our products. And so the objective for this year, and it turned out it was early in the spring this year, was to have the first version of the Polaris platform that aims at bringing all of our products together, including, by the way, some services through that platform also. What we have today that some customers have already purchased is the platform with the first set of tools and Coverity was the first set of tools that is on there. As we now progress through the next 12 to 18 months, more and more of our tools will become available. The last comment about this is that why is this particularly relevant for the larger companies? Because if you are the CISO or the Head of IT in a large company, you have a lot of challenges around security. And of course, for each challenge, there are 10 different companies that have some miracle cure and while we do not participate in many of these remedial situations, what we intend to provide is the best development environment that can constantly diagnose and early indicate issues so that the development is better in the first place. And for that, the ITs -- Heads of ITs or CISOs would rather have one trusted broader partner as long as, "the stuff works together." And that's so easily said and so difficult to do. And this is why we are so excited about Polaris platform because we are making things work together really well. And of course, we have 25 years of lessons learned from EDA on how to do that and now we're applying all of these lessons to the Software Integrity space.

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Operator [61]

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And there are no further questions in queue at this time. I will turn it back over to the host for any closing remarks.

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Aart J. de Geus, Synopsys, Inc. - Co-Founder, Chairman & Co-CEO [62]

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Sure. Let me start by apologizing on the static. While we don't hear any of that, you've been loud and clear to us. I hope that the messaging at least came across. And if nothing else, we understand that there's quite a bit of noise in the market. And most of those things, there's no control we can have over that situation. But in general, our business has been strong in the first 2 quarters of the year. It's looking good for Q3. And so we are continuing unperturbed on our trajectory, and we appreciate all the interest that you have in this earnings release. Have a good afternoon.

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Operator [63]

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And ladies and gentlemen, that does conclude our conference for today. Thank you for your participation, and you may now disconnect.