Ladies and gentlemen, welcome to the Synopsys Earnings Conference Call for the Second Quarter Fiscal Year 2024. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] Today's call will last one hour. As a reminder, today's call is being recorded. At this time, I would like to turn the conference over to Trey Campbell, Senior Vice President, Investor Relations. Please go ahead.

Thanks, Sarah. Good afternoon, everyone. With us today are Sassine Ghazi, President and CEO of Synopsys; and Shelagh Glaser, CFO. 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 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 might 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 certain 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, financial supplement and 8-K that we released earlier today. All of these items, plus the most recent investor presentation are available on our website at www.synopsys.com. In addition, the prepared remarks will be posted on our website at the conclusion of the call. With that, I'll turn the call over to Sassine.

Thanks, Trey. Good afternoon. In Q2, we continued our strong execution and momentum. Semiconductor and systems companies continue to invest in Synopsys Solutions to maximize their R&D capabilities and productivity. Revenue was up 15% year-over-year and at the high end of our guided range. Non-GAAP operating margin was 37.3%, up approximately 3 points year-over-year. And non-GAAP EPS was up 26% year-over-year and above guidance. Given our momentum and continued confidence in our business, we are again raising our full year revenue and non-GAAP EPS guidance. Shelagh will discuss the financials in more detail. First, I'll give some context for our confidence and share some business highlights from the quarter. First, we are in an era of pervasive intelligence, fueled by the rise of artificial intelligence, silicon proliferation and software defined systems. These trends are driving systemic complexity for technology R&D, which in turn drives unprecedented opportunity for Synopsys. Our silicon customers are racing to design and manufacture complex, purpose built silicon. And our customer set is expanding as systems companies are also either designing their own chips or defining and optimizing their system performance at the silicon level. In March, many of our semiconductor and systems customers attended SNUG, our yearly Synopsys user Group Conference in Silicon Valley. Thousands of passionate design engineers shared best practices and learned about the innovations we're driving. And we were honored to have a dozen key customers, including NVIDIA, Intel, AMD, AWS, Tesla and others contribute their perspective regarding the mission critical role Synopsys plays in their innovation. As a leading silicon to systems design solutions company, Synopsys opportunity has never been greater. Today, we have best-in-class EDA tools and the broadest portfolio of silicon IP. Our planned acquisition of Ansys will expand our TAM and further our mission of empowering technology innovators everywhere.…

Thank you, Sassine. We continued our strong momentum in Q2 with revenue at the high end of our guided range, non-GAAP operating margin of 37.3% and non-GAAP earnings above the high end of our guidance. Our Q2 results are driven by our relentless focus on execution, leading technology that is mission critical to our customers and a resilient and stable business model with $7.9 billion in non-cancellable backlog. We remain confident in our business and after raising guidance at our Investor Day in March, we are again raising our full year targets for revenue and non-GAAP EPS. As Sassine noted, we entered into an agreement to sell our software integrity business. Unless otherwise noted, our software integrity business has been presented as a discontinued operation and our consolidated financial statements for all periods presented. I'll now review our second quarter results, which are presented on a continuing operations basis. All comparisons are year-over-year unless otherwise stated. We generated total revenue of $1.45 billion, up 15%. Total GAAP costs and expenses were $1.12 billion, total non-GAAP costs and expenses were $911.7 million, resulting in non-GAAP operating margin of 37.3%. GAAP earnings per share were $1.92 and non-GAAP earnings per share were $3. Now on to our segments. Design Automation segment revenue was $1.05 billion, up 14%, driven by strength in EDA software and hardware. Design Automation's adjusted operating margin was 39.6%. Design IP segment revenue was $399.8 million, up 19%, driven by broad based strength. Design IP adjusted operating margin was 31.2%. Operating cash flow, including discontinued operations was $477 million for the quarter and free cash flow, including discontinued operations was $438 million. We ended the quarter with cash and short-term investments of $1.66 billion. Now to guidance presented on a continuing operations basis. For fiscal year 2024, the full…

Thank you. [Operator Instructions] Your first question comes from the line of Joseph Vruwink with Baird. Your line is open.

Hi, great. Hi, everyone. I wanted to start, it sounds like the analog and verification AI products are really gaining a nice foothold at customers. So there's probably a bit more of a baseline financial experience. Is it possible to say just what the uplift around ACV tends to be with these customers adopting the newer AI products? I think the 20% uplift upon renewal figure you provided last year was more driven by DSO.ai. I'm just wondering how the newer AI products are maybe starting to change and factor into the model.

Yes, very good question. So it's true. The 20% uplift is based on the DSO.ai incremental booking and revenue we're able to capture and the baseline increase for Fusion Compiler. On ASO.ai and VSO.ai, we're still in early stages, it's very difficult at this stage to give you what will the average be. So give us some time before we're able to capture more data points. But the one thing that we can confirm is as customers are using that technology in production, we're able to monetize it through the same approach and uplift to get access for the technology and an uplift based on the consumption -- the baseline consumption.

Okay, that's great. And then -- yeah, good to hear about the update on Ansys. Maybe anything you can say in terms of financial performance of Ansys and just how you two are working together and kind of your expectations for the balance of the year as you approach joint customers and kind of think about the financial performance of the Ansys business.

So two points on the Ansys performance. One, as you know, we're operating as two separate companies. So my suggestion here is to refer you back to what they're communicating, which is their continued commitment for double digit ACV and revenue growth for their FY 2024. And the other point is, during our diligence process, we had a close insight in terms of the shape of the year where it's tilted more for a second half performance compared to the first half in terms of the shape. So really that's the most we can say at this stage. But if you have any questions, refer back to the Ansys commentary.

Okay. Thank you very much.

Thank you.

Your next question comes from the line of Jason Celino with KeyBanc. Your line is open.

Hey, great. Thanks for taking my questions. This quarter was a little unique and that we got basically an update 60 days ago at SNUG in the Analyst Day. Nice to see the quarter come at the high end and raising the guide again. But curious like -- again, I don't see Synopsys as being like a very back end loaded company, but curious what exactly drove the strength and the upside just from that short period ago.

So continued momentum in the core business. I mean, what we're seeing is the ongoing demand for faster compute energy efficient compute either by semiconductor companies or by hyperscalers is increasing the demand for the latest, greatest EDA technology as well as the demand for our IP portfolio. So with that, we are in a fortunate position with our customers and our portfolio that's driving that growth. And I know just 60 days ago, we updated to take the software integrity as a discontinued operation. But as we went through the quarter and we're looking at the rest of the year, it gave us confidence to raise the midpoint to 15%, which is roughly another $30 million raise for the year.

Thank you.

Yes. And the other thing I would add is, I think as said in his prepared remarks, we outperformed on hardware this quarter. So it was another nice quarter of execution by the hardware team.

Okay. Perfect. And then maybe just a quick one for Shelagh. I think you said backlog of 7.9. Is that an AppSec backlog number?

Absolutely, Jason. So thanks for the question. It's AppSec because of course, that's moved into discontinued operations. And just to give you some relevant comps that will come out later in this week as you get the quarterly filing. Q1 2024 on that same basis was 7.7% and then Q2 2023 on that same basis was 6.8%. So that versus what I just shared are Q2 actual 7.9%.

Okay. Excellent. Thank you.

Thank you.

Your next question comes from the line of Charles Shi with Needham. Your line is open.

Hey, good afternoon. Congrats on the solid results for the quarter. I have a question about the IP business. It seems like it takes a little bit of a pause in April quarter, but your full year guidance seems to suggest maybe IP will have slightly higher run rate from the fiscal second quarter level into the third and into the fourth. I recall like 90 days ago, you were talking about maybe IP is going to be a little bit first half weighted. Is that still the shape you're expecting? And if I may, is it more concentrated in Q4 because your Q3 guidance and the full year guidance kind of implies another very strong sequential growth into the year and wonder if it's IP driven. Thanks.

Well, as you noted, IP tends to be lumpy for us. And so you saw us have about 53% IP growth in Q1. So Q1 -- Q2 is a bit muted from that, although we're still up 19% year-over-year and we anticipate another strong year for IP. And the lumpiness is really about the timeline in which the customers need to ingest IP into their design. And so as you noted, that will continue through the year and we expect continued growth throughout Q3 and Q4 with a strong Q4.

Thanks. May I ask again that the China revenue, you guys were expecting contribution to be lower in fiscal 2024 compared with 2023, but the dollar wise still going to be a record -- I mean, it's still going to grow on a year-on-year basis. Is that still the case?

Yes. As you recall, Charles, we communicated early in the year that we're a little bit cautious on China as we see macro and challenges in the economy in China and some impact of the restrictions. We had a good first half. We are anticipating growth in China. But overall, we're taking a balanced approach for the overall macro.

Thanks.

Thanks, Charles.

You're welcome.

Your next question comes from the line of Josh Tilton with Wolfe Research. Your line is open.

Hey, guys, can you hear me?

Yes.

I really appreciate the color on kind of tracking these displacements that you called out. I think you mentioned the 20 -- I don't remember if that was this quarter or year-to-date, but could you maybe just give us a little bit more color on what's driving those, where they're coming from and kind of how we should expect those displacements to trend for the rest of the year?

Sure. Our customers are expecting analog design workflows and environment methodology, et cetera, to be more modernized. Think of it feeling more like digital. And this is a great opportunity for Synopsys and we introduced couple of things. One is the AI for analog, which is ASO.ai. Our customers are using it primarily for migration from a node-to-node or in some cases foundry-to-foundry. And the other aspect of the analog competitive wins that we've had is the full flow. When you look at the complete design environment, simulation, et cetera and offering a modern competitive platform for our customers. And we're actually very excited about the momentum that ASO.ai is driving and the overall the workflow that we're putting together for our customer?

Maybe just a follow-up to that. I know you mentioned that you and Ansys are running in separate businesses at the moment, but are you already seeing any changes in purchasing behavior? And what I mean by that, are there any customers you can identify that maybe weren't as strong buyers or starting to go more all in or maybe weren't customers at all, but are now starting to buy Synopsys because of the future they see between you and Ansys that will exist in the combined business?

Yeah. remember, Josh, we've had a partnership since 2017. So the customers that we engage -- we Synopsys engage with in our core business, we already have that established go-to-market and established technology connections between the products that are relevant for that grouping of customers. So I won't say there is anything different in terms of customer behavior at this stage. Think of it as a continuation of what we started in 2017.

Super helpful. Congrats on a great quarter, guys.

Thank you.

Your next question comes from the line of Gary Mobley with Wells Fargo Securities. Your line is open.

Hi, everyone. Thanks for taking my question. I wanted to ask about the regulatory approval process for the Ansys acquisition and I guess what's developed most recently was China SAMR approval. I presume that you always expected to file a China SAMR given the close timeframe of first half next year. Maybe if you could just speak to your confidence in that approval process and any concessions you might be willing to make to get that across the finish line?

Sure. So Gary, few things. One, from a regulatory process point of view, we had a really a thorough roadmap on different jurisdiction filing and processes that we needed to -- with China, the first step we took was to communicate that our transaction is below the merger notification threshold. And that was confirmed last week in the letter, which is actually a positive confirmation. At the same time, it was communicated that they will desire to review the transaction, which at this stage, we're reviewing the notice, we're evaluating the potential next steps. And as we communicated to every jurisdiction, it's important to work collaboratively, try to understand what are any customer competitive, et cetera concerns that we need to take into account. And we're just following that process at this stage.

Okay. Thank you. As my follow-up, you mentioned in your prepared remarks about a customer win with an Asian memory designer. And if I'm not mistaken, memory as a subgroup of the semiconductor industry hasn't historically leaned heavily on commercial EDA. Maybe if you can just give us how that -- some insight into how that might be changing and then in particular, how HBM memory for data center might be factoring into some of the needs for your tools?

Yes. There are a couple of parts of the portfolio actually that they are incredible sweet spot for memory design. As you know, memory design is more a custom structured custom design where we have our leadership position in fast spice simulation, where you take a memory design and you try to bring in acceleration in our fast spice simulation. And there over the last number of years actually, the memory market has been a sweet spot for growth for us in that space. We even introduced GPU acceleration for that fast spice simulation that the memory customers were the leaders and early adopters of that technology in order to deal with the complexity as these memories, especially the HBM3 and all flavors of new memory design, it drove nice opportunity for us to continue on expanding those engagements. So it's true, while memory companies were more a custom type of design flows. Over the last number of years, they've been leaning quite heavily to adopt latest technology to deal with that complexity.

That's good color. Thank you.

You're welcome.

Your next question comes from the line of Lee Simpson with Morgan Stanley. Your line is open.

Great. Thanks so much. I just wanted to ask an IP question. And really just in relation to a new node being stood up at TSMC. So I think as many of us know, the end to capacity is being stood up probably around mid 2025. And I was just trying to get an understanding of when you thought that would impact on your business, particularly from the foundational IP perspective and maybe more broadly, as last caller was asking around about how might pull in things like HBM and so forth as well? Thanks.

Yes. So when a new node comes online, we engage in the point one and in some cases like foundation IP, even we engage before the point one PDK. And the reason we engage that early is in order to deliver what's called the node entitlement to get a sense of what's the power, the performance, the area of that node. And that's a very deep in the trenches collaboration with in this case TSMC, but it applies to Samsung, Intel, many other foundries. So the first is with our foundation IP. Then shortly after it's followed by the interface IP, where we are a number of the test chip shuttles that they have for internal validation of their process technology. And those come way before the customers buying the IP from us. So by the time the customer is ready to at a the 0.5 PDK. And in some cases, as you know, they wait for 0.9 PDK, et cetera, that's when they start pulling the IP from us. So the engagement starts, in some cases a year, a year plus before we see a customer ready to pull the IP.

Great. That's really clear. Maybe just a quick follow-up. I noted it's quite a lot of color around Fusion and the AI-based optimization doing quite well over the last quarter, at least some good call out wins at 2 nanometers and I think also with a flagship mobile chip at Samsung. I guess where I'm really going with this is, I think the way that Fusion could work with Redhawk going forward and some of the build around that you've got as a stack around Fusion, which looks quite interesting. Is it too much to make the leap to say that interoperability in EDA might become a thing in the past and that there'll be no interest to make this the various stages of design flow interoperable with other people's offerings? Thanks.

Not at all. Interoperability is so essential for the workflows, so essential. And as far as I can go back and remember in EDA, you have customers that they're using mixed flows, mixed environments. It's very well alive and thriving in terms of customers using this mixed environment for many reasons. Many times the customer wants to introduce their special sauce inside the flow and they want to have these handshakes in an industry standard interoperable ways. And we've been doing it with Ansys. We've been doing it with our competitors, et cetera and I don't see anything changing there. The one thing that you hear when we talk about Fusion is there is absolutely value when you integrate deeper than the technology into your platform, the value of it to our customer is a predictable outcome where the step one is correlated with step 2, correlated with step 3, et cetera. But that as well can be achieved through an Interoperable mix environment. So I absolutely see that will continuing and you absolutely need an ecosystem in order to deal with the complexity of the future. It cannot be in my mind, a one platform that is sufficient to close the gap of complexity.

Great response. Thank you very much.

Thank you, Lee.

Your next question comes from the line of Jay Vleeschhouwer with Griffin Securities. Your line is open.

Thank you. Good evening. Starting with NAI question, you noted some adoption of some of your branded products as seen, but perhaps a two part question. Number one, what are you seeing in terms of the relative adoption of AI, your branded AI by semi versus systems customers? And over time, would you be indifferent to the economics of supporting those two classes of customers with AI? In other words, with your ACV, your margin structure, et cetera, be indifferent to that mix with respect to AI adoption? And are you also beginning to see any signs of customers taking two or more solutions at this point of AI branded products? And then my follow-up.

Actually, it's an interesting question regarding the mix. The advantage I want to say of a system company is typically they're starting from scratch, meaning they don't have the legacy CAD teams, the legacy workflows, et cetera. So the adoption of new technology is typically faster. That's what we observe. So when we introduce new technology, the rate of adoption is faster. But now as I look back, for example, at the DSO.ai or even the new technology, ASO.ai, VSO.ai, we have a mix of adoption, the classic semis and hyperscalers as well. And the second part of your question, if I understood it correctly, are we seeing customers that they're using two or more of the AI technology? The answer is yes, absolutely. What is different, Jay, now compared to 2020 when we introduced DSO.ai, AI was such a foreign new concept for even Synopsys engineers supporting it in the field and the customer adopting it. They were trying to prove can I trust it? How do I use it? What's the compute requirement to use it? Now it's a completely different discussion. Our customers' executives are pushing their teams to leverage any AI productivity booster that they can get and it's absolutely giving an acceleration of adoption compared to what we witnessed in 2020.

Okay. Now you noted the strength of hardware. This is a follow-up. And hardware of course, for you and your peers has been a substantial growth category for a decade. The latest data shows that including your numbers, it's well over $1.2 billion of total revenue for the category. The question is, where do you still see pockets of underutilization or under automation, vis-a-vis EDA hardware. I mean, do you foresee this, including yourselves growing to be, for example, a $2 billion category, the way IP has grown into a $2 billion category.

So if you step back and ask why do customers use hardware, there are really two use cases. One, there is the whole verification acceleration. Can I get the verification done faster? And two, software bring up. I don't think we will debate the fact that they're going to be more software content, customers are going to have to bring up as much as possible the software before the silicon is ready. And for both use cases, but we're -- I want to say biased that the software bring up use case is going to have a bigger opportunity of adoption for the reasons I just described. And as you know, we are more suited with our solution to a software bring up use case given the architecture of our hardware system. And those are the areas that I don't believe there will be any slowdown or direct change in direction when it comes to the hardware assisted verification use cases.

Okay. Thank you, Sassine.

Thank you, jay.

Your next question comes from the line of Gianmarco Conti with Deutsche Bank. Your line is open.

Hi, Sassine and Shelagh. Thanks for taking my questions and congrats on another great quarter. So perhaps the first one would be around AI. In your prepared remarks, you spoke about a leading American GP designer and deploying DSO. And could you perhaps talk a little bit more about the penetration rates and any relevant KPIs here? And are you starting to see more material revenue generation from the broader XFO that the AI suite? And how much is it currently included in the backlog? I'll ask a follow-up after. Thank you.

Okay. Yes, for DSO.ai, what we communicated actually during Investor Day that if you look at the TAM for the DSO.ai, use cases that you can take advantage of that technology. We're still in early stages. We are in roughly 20% of the TAM from a adoption point of view for DSO.ai. So there's plenty of opportunity to continue on expanding. And within that 20%, we are roughly at the 15%-ish in terms of adoption. And the reason for that, not because customers are pushing back or they're not seeing value, and there's a rhythm of adoption where you have to finish the tape out, go into the next project and broader that deployment across more -- we call them blocks, meaning partitions of the design. So that's DSO.ai. VSO.ai, we anticipate the adoption to be faster and the ramp to be faster than DSO.ai because what it does, it looks at your verification cycles and it improves the coverage by not having to go back and run and verify something you already verified in the previous run. So it's smarter approach to improve coverage while reducing the time and the need to just waste more verification cycles. And what the customer, the way they're looking at it is a TCO reduction because it impacts their hardware utilization where they're running that software on in order to get a higher coverage and speed up. As I mentioned on ASO.ai, it's all about modernization of the workflow. And in the early use cases we're seeing is a node migration. So to automate, accelerate, the customer feel of moving from node A to node B, where do they stand in terms of power performance area, and it's not only a digital thing you need because you need the whole SoC to go through this entitlement exercise.

Understood. And I have a second one follow-up for perhaps, Shelagh. I noticed your R&D expenses grew well above revenue in the quarter. And could you perhaps talk about where are you directing most of the investments? Are you pouring more into the whole AI development or is more budget being allocated to the setup of what would be the product integration development post-acquisition? Any color would be great. Thank you.

Sure. So our main focus on our investment is obviously investing in both design automation and design IP. So we're -- I think as we talked about at Investor Day in the IP Group, we're building out IP blocks for the leading edge technology where the standards are moving much more rapidly, especially driven by the kind of the insatiable needs of AI. So we're building out the standards in a more rapid fashion. And so that's a significant part of our R&D. And then in the EDA the Design Automation group and the EDA in particular, we're investing in building out all our Synopsys study, AI capabilities and continuing to further those because even the ones that we've already launched, we're driving improvements in those. Those aren't just static investments.

Thank you.

Your next question comes from the line of Clarke Jeffries with Piper Sandler. Your line is open.

Hello. Thank you for taking the question. First is for Shelagh. I wanted to clarify 2 percentage point of operating margin expansion is within continuing operations, not based off of the removal of SIG and how you think about that number for ongoing operating margin expansion for the core business going forward? And then one follow-up.

Correct. It's within the continuing operations and thanks for the clarification. I know there's a lot of moving parts here with the move of SIG to discontinued operations. And the way we're thinking about it is, as you know, we are scaling the business, how do we drive better leverage across the R&D and then how do we drive better leverage across the core infrastructure of the company. And our long-term expectation that we shared in Investor Day and when we did Ansys is that our expectation is that we're going to drive operating margin to the mid 40s. So we see continued expansion and it's very much a part of how we're thinking about the growth of the company. And as Sassine talked a lot about the AI that we're infusing in our customers. And if you will, we're eating at our own restaurant. We're infusing AI into everything we do inside the company to drive more modern ways of doing things so that allows us to drive more innovation?

Perfect. And then just how should we think about net proceeds for the SIG sale and what to consider there absent of timing? I know there was a payable payment in cash. Just any way to think about net proceeds as the deal closes? Thank you.

Certainly. So what we talked about with SIG is it's up to $2.1 billion in consideration. And the way that breaks out is in three distinct parts. So we'll have $1.5 billion payment at close of the SIG transaction. And as we had noted, we expect that this transaction will close in the second half of 2024. So that would happen in this year. And then over the subsequent five quarters, starting in Q1, our first fiscal quarter of 2025, there is a cumulative $125 million payment. So you can think about the cash that we'll get is 1.625. So think about that. And then the balance, the 475 is payable upon agreed to specified rate of return that the sponsors would achieve and then we would participate in that -- that upside through a potential liquidity transaction.

Perfect. Thank you very much.

Thanks for the question.

Your next question comes from the line of Blair Abernethy with Rosenblatt Securities. Your line is open.

Thank you. And nice quarter, guys. Sassine, I just wanted to come back on the analog side of things. And it seems like you've had a good performance here. Are you seeing a shift in momentum in that part of the business for Synopsys? And where do you see sort of the lowest hanging fruit or the best opportunities for you in analog?

So from a customer base point of view, there are the core analog companies that are truly trying to improve their productivity, improve the way they approach design and what we are hearing from that cohort of customers is how can we digitize our analog workflows to be more efficient, more productive, take advantage of the latest technology, et cetera. So that's a grouping of customers. And for that grouping of customers is very exciting because we're engaging them based on new technology and a new approach, if you think about it for designing their chips. Then there is the other grouping of customers where, as you know, customers always encourage and enjoy to see a competitive strong player to have alternatives to have for many other -- for many motivations. And that's part of it as well. So where we see a competitive displacement and engagement in that space as well. So think of it as two buckets that we're seeing the momentum that we have.

Great. Thank you very much.

Thank you.

And did you have a follow-up? Did you have follow-up, Blair or is that it?

No, I'm good. Thank you.

All right. Thank you.

There are no further questions at this time.

Let's go ahead and close out the call. Thanks, Sarah.

Thank you.

Thank you.

This concludes today's conference call. We thank you for joining. You may now disconnect your lines.