Ladies and gentlemen, thank you for standing by, and welcome to the Synopsys Earnings Conference Call for the Second Quarter of Fiscal Year 2020. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, instructions will be given at that time. [Operator Instructions] Today's call will last one hour. 5 minutes prior to the end of the call, we will announce the amount of time remaining in the conference. 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.

Thank you, Greg, and 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 the 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, 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 Synopsys.com. In addition, the prepared remarks will be posted on the site at the conclusion of the call. Finally, we are all participating from different locations today, please forgive any delays, technology glitches or awkward handoffs in the Q&A session as we navigate this new virtual dynamic. With that, I'll turn the call over to Aart de Geus.

Good afternoon. I'm happy to report outstanding second quarter results with record orders, revenue, non-GAAP earnings per share and operating cash flow. We substantially exceeded all of our key guidance metrics. Revenue was $861 million with GAAP earnings per share of $0.71 and non-GAAP earnings of $1.22. Orders were substantially greater than our internal plan, driven primarily by digital design software, and we continued to make good progress on our margin expansion goals. As a result of our first half strength and the resilience of our business, we are reaffirming our revenue and non-GAAP margin guidance for the year. While raising our non-GAAP earnings and cash flow targets, Trac will discuss the financials in more detail. Before providing quarterly highlights, let me comment on the market landscape, which is, of course, dominated by the COVID-19 pandemic and its substantial recessionary pressure on the global economy. While in a matter of weeks, many companies around the world have adapted to widespread work from home, the semiconductor sector has stayed busy as electronic system and system design continues unabated. Driven by the sudden need for bandwidth and compute for home, be it for work, schooling or entertainment, advanced chip design is not slowing down. We've seen this continuous design activity in previous downturns. Regardless of where a company or industry is and its business cycle, continuous investment in new technologies, be they AI and machine learning, 5G, IoT, automotive or cloud end markets, is the best way to be ready when the economy turns up again. Synopsys is at the core of this enablement. Combining that with our time-based business model, a high-level of recurring revenue and a non-cancelable backlog of $4.8 billion, Synopsys is well-positioned to withstand the uncertainties of today's macro environment. With that context, let me provide some highlights…

Thanks, Aart. Good afternoon, everyone. Our record results are especially noteworthy, in light of the considerable challenges faced by ourselves and our customers over the past few months. Given our history of strong execution, sometimes it's easy to forget how much hard work goes into delivering results like these. So I'd like to add my thanks to our employees for their dedication under these difficult circumstances. Complementing our excellent execution in the first half is our very solid business foundation, technology leadership, a diverse customer base and nearly 90% recurring revenue. These elements position us well for periods of high demand as well as during times the greatest stress. This rare combination gives us the confidence to reaffirm our annual revenue and non-GAAP margin guidance, and to increase our non-GAAP earnings and operating cash flow targets. Now to our second quarter results. All comparisons are year-over-year unless otherwise stated. Orders substantially exceeded our plan, driven in large part by EDA, particularly, digital design. Ending backlog was $4.7 billion. We generated total revenue of $861.3 million above our target range, driven by broad strength and some revenue that moved in from Q3. Semiconductor & System Design segment revenue was $773 million. This strong growth in EDA software moderated by tough hardware comparison over a strong Q2 of last year. Excluding hardware, EDA software results remain within our long-term target range of mid to high single-digits. A quick note on hardware, while COVID-19 has presented some minor HAPS-related supply chain challenges, due to shelter-in-place mandates, we're managing through them well. Our contract manufacturing partners are gradually increasing capacity and because our products are considered essential, they are top priorities. Software Integrity segment revenue was $88.3 million, 10% of total. Moving on to expenses. Total GAAP cost and expenses were $735 million which…

Thank you so much. Before we begin the Q&A session, I would like to ask everyone to please limit yourself to two questions to allow us to accommodate all participants. If you have additional questions, please re-enter the queue, and we'll take as many as time permits. [Operator Instructions] And our first question comes from the line of Rich Valera with Needham & Company. Please go ahead. Your line is open.

Thank you, and congrats to the team on delivering very solid results in a challenging environment. First, just on the order commentary, I think you said you saw a stronger than expected orders primarily in core EDA. I was wondering if you could give any color on sort of what drove that strength. And if you thought it was maybe timing related, or if you think that was sort of a net increase in demand, relative to your original plan?

Well, I think there are multiple things are played in all at the same time. Obviously, in a time like this, we all pay a lot of attention to execution, and so, we will give some credit to just working hard at it. But I think the other thing that happened is that a number of the new products that we introduced last year, and some that we announced just recently are very attractive and benchmark extremely well. And so the hunger for more sophisticated products continues because during the same timeframe, what we're seeing is that a number of the advanced customers are moving now from 7-nanometer to 5-nanometer. And so that have both implications on the IP that they're using and on the strength of tools that they want. And so the demand, I think was absolutely there and it was for us to make sure that we find a way to get at it.

And just one more on the SIG business, one, could you say what the bookings were there? I know they were pretty good last quarter, despite the relatively modest revenue growth. And two, any progress on getting a business unit - a new business unit head there? Thanks.

So we normally don't disclose the bookings for any subpart of the Company. We did communicate that they were lower this quarter than expected and therefore that has some ramifications going forward. It's not completely a surprise because a lot of the interactions early on in the COVID time were very impacted by people essentially hustling for shelter from home. On the recruiting, we have started a search and - so we expect that in the next six months, this will be fulfilled and now we're looking at candidates.

Next, we turn to the line of Tom Diffely with D.A. Davidson. Please go ahead.

Maybe first a question on the hardware business. At this point, is that completely outsourced? Or do you still do or do you do a final assembly and test in house? And just curious if COVID was a bigger issue for your suppliers or for your own internal assembly in test?

It's an excellent question. So we do a little bit of all of that. We outsource obviously, as much as we possibly can. There - depending on what the status is of the hardware, we assemble some of it ourselves. And, as you would expect, when you have a global disruption of all the markets initially, you have to watch out where all the parts are coming from, who is doing the assembly, et cetera. And the issues that we looked at initially were HAPS related. I'm quite impressed by how quickly our team was on top of that. And after that, the fact that this is essential equipment benefited us as the assembly people we work with gave us a high priority. And so, I think the problem is mostly resolved at this point in time.

Okay, that's great to hear. And then Trac, when I look at the midpoint of guidance for I guess, the third and the implied for the fourth quarter, pretty strong revenue growth, not a lot of model leverage off that revenue growth. So I'm curious is that, because it's more hardware centric? Is it conservatism? Or is there something else going on?

It is a little bit of the hardware mix. You got COGS ramping up with expenses as well. And the profile is that, it does have some additional expenses in terms of hiring, but I do expect that you'll see an improvement in operating margins from Q3 to Q4.

Next return to the line of Joe Vruwink with Baird. Please go ahead.

And apologies, if this came up, I joined a little bit late, but just current events question. I'm wondering if the recent proposals around new export restrictions have either impacted Synopsys anyway or maybe since the April quarter close cause some of your customers maybe to reconsider certain spending decisions? Or just any impacts from, you know, the past couple of weeks and some of the news that's been coming out?

Well, the bottom line of the answer is no. The recent announcements were one or two weeks old, and while very fairly complicated, we're able to get a good sense of it. And our conclusion is, it does not affect us beyond what is already prohibited in the entity. We have also not had any follow-on of customers that we're worried in any form. So I think, that interpretation has been fairly universal.

Okay, great. And then on Software Integrity, I guess, the qualitative commentary, just in terms of some of the buy-in to Polaris, and the fact that you're getting competitive displacements for Polaris at this points, that strikes me as pretty positive. So, I guess my question is, did it surprise you to have platform traction in a more difficult environment created by COVID? And does that give you maybe some optimism and thinking about bookings for the back half of your year?

You know, we live with optimism and actually, this is a good example of it, because the whole point of a platform is to get the benefit of multiple tools that work well together. And by the way, for the buyer, it has another benefit, and especially for larger companies, they are trying to maintain an environment that is not overly complex with tools from many, many different vendors. And so being able to bring multiple capabilities together in a structured fashion, that over time will gain more and more value because things work well together is actually precisely the direction that we are counting on. And the fact that the number of customers have actually bought Synopsys precisely for that reason is extremely encouraging.

And next, we turn to line of Mitch Steves with RBC Capital Markets. Please go ahead.

Yes. I want to focus a bit here on the operating margin here. So the implied number, it looks like you guys are going to get to the kind of the high 20s exiting the year. So I really have two parts to my question. The first one is just that, is that correct, you're going to kind of exit at 29%? And then secondly, does that imply that '21 should actually be better than your high 20s target? Because now, you guys kind of get work from home dynamic, you don't have as much T&A expense. It's something we've heard that a lot of companies, particularly software coverage able to do. So is there any way you guys are going to be able to squeeze extra basis points out of the OpEx line going forward?

Let me work backwards on your question, Mitch. You're right, we are - we will be exiting in the high 20s for the year, but keep in mind that it's largely a profile of the revenue ramp. And we remain committed to our long-term goals of driving margin expansion. But at this point, it's too early to talk about FY '21. We'll come on that later in the year. As far as savings from COVID, certainly, we're seeing some element of that flow through - that benefits flow through to the results. But you know, the result are largely driven by us executing the plan that we set out to - for the year which is continue to focus on our spending, be more diligent about where we're investing and driving a plan that's going to deliver good margin growth this year and over time.

And just one small one, if I could. I couldn't ask multiple questions there. So just - was there any revenue impact you guys could quantify in terms of what the hardware shipments would have been if you had any push outs in terms of sales because I'm curious why the full-year guide didn't go about? How do you think that you'd be able to get a lease above - towards the high-end, I guess, the revenue guide? So was there any sort of push out or anything related to COVID in the quarter?

No. And really, COVID had a really small effect on the results or immaterial effect on the financial results. As we mentioned, we had a - some initial challenges with the supply chain. When the shelter-in-place, mandates went into effect, but we were able to overcome that and execute on the numbers for the quarter. And good execution in Q2, the results were strong its own, but we did see some revenues move in from Q3 to Q2. At this point, we're providing our best view of the outlook for hardware and it really reflects a profile of it growing in Q4. And so far, we feel confident in our ability to execute to that - that's why we're reaffirming guidance.

And next, we turn to line of Jackson Ader with JPMorgan. Please go ahead.

Thanks for taking my questions, guys. The first one to Aart is a follow-up, actually on some of the trade restrictions. You addressed, I think the Entity List and Huawei, I guess tighter restrictions, having already been factored in. But what about the military end-user or military end-use case I guess, control actions that were put out at the end of April? Do you expect any impact from that?

No, we don't. So fundamentally, the guidance that we have given you encompasses all of our interpretation of all of the various actions that have been taken over the last year and a half. And I think we feel very solid in that interpretation at this point in time.

Okay, all right, great. Thank you and then follow-up for Trac.

You're welcome.

Yes. Just quickly on cash flow. So are customers - are there any customers either in Software Integrity or in the semiconductor business, that are looking for maybe some payment flexibility? I saw the provisions for doubtful accounts went up, but just curious where the strength in cash flow is expected to come from?

Yes. For the most part, we haven't seen any meaningful impact of that or customers coming back and renegotiate in terms. And so far, that's been very positive. We're prepared to - we're prepared for that kind of potential, but so far we haven't seen much of an impact. On the strength in the cash flow outlook is really confidence in the P&L and what we're guiding to. It's pretty solid growth for the year, as well as good margin improvement. And that's going to eventually translate to cash as a reflection of both strong collections and more effective disbursements are lower disbursements.

And next, we turn to the line of Gary Mobley with Wells Fargo Securities. Please go ahead.

The 7% sequential increase in backlog is commendable. And reading between the lines, I see that your average license duration is spiked quite significantly. And so does that speak to I guess the concentration of the record orders with perhaps one customer renewal? Or is there some more diverse overall bookings trends there?

It is the second. It's not the single customer at all if it's multiple customers. I think in general, there are often variations in lengths of contracts. At this point in time, it is encouraging that the contracts have not become shorter as in times of economic stress, people could be worried about it. That appears to not be the case at all. And as said from use and approach to design, we see no difference. If nothing else there, a number of companies that are really accelerating as they hope to have good opportunities in next year with new products. So the technology advances are on track and the business I think reflects that directly.

Okay.

Gary, I would also add that the - it's nice to have the back - that large backlog in an environment like this, in general, but particularly, in environment we grew it like this. But the Q2 bookings was not only a record in absolute numbers, but we also saw a very good run rate growth in the quarter. So, I'm pleased with that combination.

Okay. And as my follow-up question. With the shelter-in-place, I guess largely still intact there in the Bay Area, and perhaps affecting access to your facilities and access to labs in whatnot. Is that a hindrance to completion of some IP deliverables? Is that perhaps an explanation why the fourth quarter may be still back-end loaded?

While initially there were a number of questions of how to best get access to labs, how to manage that, can we manage it. I think there too, we were able to find practical solutions pretty quickly. And I'm actually a very positively surprised that how well the IP group is executing as we continue to send chips to manufacturing, as we can - as we continue to deliver new cores. And so I think the distribution of revenue is more a function of the uptake from the customer than anything else.

And next, we turn to line of Adam Gonzalez with Bank of America. Please go ahead.

And first on the Software Integrity business, I'm just wondering if you could elaborate on some of the delay in business decisions that alluded to on - in the prepared remarks? And then what gives you the confidence in the low-double-digit growth target that you imply the business would grow this year? And then secondly, how have your sales efforts be impacted by the shelter-in-place orders, and say have your spending plans changed at all versus what they were last quarter? Thanks.

Yes. Let me go backward on that. As the working at home started to become - acted on with many of our customers, it did slow the interaction somewhat. We also saw some slowdown in our ability to hire people as quickly as we had planned. And those are the type of things that then tend to impact the orders' rates that one gets in. And so one can still - they always point I think that we could do better on the circumstances, but all-in-all, the reception through the types of capabilities that we have and the need have not diminished at all. As a matter of fact, you can see how a wave of concern has gone through many of our customers as they established work from home and immediately the security of many of those installations were somewhat in question. Now we ourselves barely touched that but that is not the field that we're in. But the secondary ramification of that is that people will look again harder at what to do in the software to protect from future security breaches. So from that perspective, I think the business opportunity is just as healthy as it was before. The circumstances will evolve and I think our execution can improve, and that's what we're focusing on.

And then my follow-up, just generally speaking, do you see any read across EDA industry more broadly from the duplication of SMEs and tech supply chain seem to be progressing toward? Just asking, following up on TSMC's decision to build a fab in Arizona. Thanks.

I'm sorry, I couldn't hear the first. You said something across, but I'm not sure what the something was. Do we see what?

Do you see any read across the EDA industry broadly from the duplication of supply chain efforts with US and China? Thanks.

That is an interesting question, because whenever supply chain starts to duplicate efforts, they actually become less efficient, which is actually not a bad thing for the people supplying to them in turn. And so I don't think that we see an enormous amount of effort in that yet. But clearly, there are sort of fairly big macro discussions on different countries wanting to have a high degree of independence of other countries, all the way to manufacturing of semiconductors, as you saw for the recent announcements of TSMC. And so I think that we're going to see a fairly dynamic evolution over the next year. And given that we're connected to all of those people very well, and suddenly intend for us to participate in whatever they're going to build and whatever they need to construct in a fashion that is good for our business.

And next, we turn to the line of Jay Vleeschhouwer with Griffin Securities. Please go ahead.

And Aart, needless to say the comments about record orders was quite important and same about record backlog. If I'm not mistaken, the last quarterly record for bookings was seven years ago. The question is - yes. The question is how will this momentum in EDA influence your direction or allocation of internal resources? Normally when we see that kind of strength in EDA, again driven by demand and new product adoption, we would see for instance, significant ramping up of the AE capacity as a coincidental or leading indicator for that kind of strength in EDA. So perhaps you could talk about that kind of internal investment you're thinking of incrementally for EDA. And conversely, what you might be doing differently in terms of SIG investments as you go through this slower period of growth? And maybe Trac can comment a little bit more elaborately on the restructuring intend. And then my second question is back on EDA. You in the last year on a couple of conversations we've had, spoke about two big trends driving the EDA industry, one was moving from the general to the specific or specialty chips as you call them, and that the next big thing in EDA was as you described it prototyping, broadly speaking at different levels of abstraction. I'm sure you remember those comments. Is there any way to parse how either or both of those is directly having a business impact incrementally versus let's say older forms of design or older methods.

Okay. I will try to answer that in less than half an hour. Let me start with the very good results from an order perspective. And frankly, I didn't know that seven years ago at that time we were more covered by single large customers making an impact. This was much broader. Nonetheless, when we entered the global pandemic crisis, it became instantaneously clear that there were more questions than answers on what this would do to the market, to the behavior of the customers and so on. And it was also instantaneously clear to Synopsys that as well as all hands on deck to make sure that we maintain strong relationships with the customers, first from a support point of view to make sure that they do well. And secondly, from the perspective of continuing to bring in the business, in order for us to be able to fund however long the downturn maybe. We executed on that clearly well. And as mentioned, I think one of the very early questions today, I think partially it is because we focus extremely well, but also because we had a good time with new products and new necessities from a design point of view, such as the new nodes, the advanced technologies, the increase of IP reuse, et cetera. And so we will continue to manage the way we've always done, which is we committed to you a - to - obviously, optimize the growth rate, but also to work towards the DevOps margin improvement and this helps in the right direction. But this also ties to your next question, which is what are the key trends behind this from a technology point of view. And what I must have called many years ago, specialty chips, now we would call AI…

And in addition to that - to your question regarding the restructuring. We are committed and we remain on a path to driving margins up over time. In addition to that, we'll continue to invest in the business, because all of the segments that we're in, we're seeing good growth opportunities. The restructuring is really a reflection of fine-tuning the investments and making sure that we're placing happier bets in the areas where we think we can get the best combination of growth and profitability.

And next, we turn to the line of Jason Celino with KeyBanc. Please go ahead.

And first question, maybe Trac, can you maybe go into the comments on the pull forward of some revenues from Q3, just more on the EDA side or the hardware side?

Mostly on the EDA side, what we saw in EDA, particularly, in Q2 was just a few shorter contracts because there FSAs and so we saw that benefit and that's why you might see a little bit higher on the time base relative to the upfronts. But overall, the profile for the year, there is significant growth and strength across the board.

Great. And then my follow-up, the SIG margins did increase 300 basis points, probably the highest SIG margins you've reported since breaking that segment out. How much of this was from the restructuring, maybe the slower hiring? And then would you look to prioritize managing profitability for this segment while the growth profile is a little more challenged?

It's a little bit of all those things that you described. You're right, the margins did come up to around 13%. We mentioned at the beginning of the year that we were going to try to invest further in that business to invest for growth. And I think we're still committed to that plan and the profile from margins will vary from quarter-to-quarter depending on the ramp-up in expenses. I wouldn't extrapolate that up to the full-year or as a new plant will continue to balance investing the business well, making sure it fits into the overall Company's growth.

And next, we turn to the line of Krish Sankar with Cowen & Company. Please go ahead. And Mr. Sankar, you may have put your phone on mute.

Maybe we can go to the next and come back to the gentlemen.

And next, we turn to the line of John Pitzer with Credit Suisse. Please go ahead.

Aart, a quick question, just going back to China. I appreciate all the color you gave on the recent Huawei licensing news from last week and the military use. But I'm just kind of curious just given how critical EDA is to the software - to the semiconductor ecosystem and China's desire to kind of build that system out, you guys become a really important sort of pawn on the geopolitical sort of chessboard. And so I'm kind of curious you break out Asia-Pacific revenue, but you don't break out China revenue, specifically. Can you help us kind of just ballpark that? And I guess as you look inside of China, what percent of the customers are you supporting in China today that if for some reason you couldn't, that demand would probably get soaked up somewhere else, i.e. Huawei can ship into phones, but maybe MediaTek and Qualcomm can. And so what percent of the Chinese customers do you think or maybe a lot of start-ups that if you're not shipping to them that demand probably doesn't go elsewhere?

Well, this is a very difficult and hypothetical question because there's so many geopolitical forces de facto in play at the same time. I can tell you that so far, a number of companies have picked up very quickly where others could not develop themselves. And I expect that to continue because after all - and globally speaking, it's a very open market and people jump in when there is an opportunity one way or another. And so really - since the Entity List came about which was May last year, we obviously have learned how to live without, and really have not felt much change. Growth continues well in China. Actually, growth continues overall in the world, but China particularly, and there are many companies that are jumping in both there as well as in other parts of the globe.

And then maybe for a follow-up, just back to SIG. I'm just kind of making sure I understand this. Is the growth sort of slowdown here a function of your inability to actually bring on new headcount and drive channel growth there? Or is it actual customer activity? And I guess I'm asking the question - I'm just trying to get a better sense of why the confidence that once we get through this COVID phenomenon, growth will re-accelerate there? What metrics are you looking at to support that view?

Sure. Well, I think the most objective answer has to be that it's a combination of the two, meaning that, yes, we did see a slowdown as a number of customers just have been sidetracked into their own survival challenges in different ways, and that tends to slow down this type of investment, at the same time, and you saw a little bit of that in or commenting that our hiring was slower than planned. That is our own execution. That is in question. So bottom line is, we will need to put - continue to put effort in bringing this part of Synopsys into a very good profile. And we're doing exactly that. Now what gives confidence is that the problem is not shrinking at all and the solution that we have is getting better and better. Now you say, well that in itself, doesn't give you money. But, yeah, you're right, we have to work for that. But the problem will continue to grow and it will continue to grow because so many electronic systems are much more intertwined than they were before. And that will continue to happen in the present pathway that electronics is on. Therefore, there will be needed more assurances that the sub pieces have built in security in a variety of ways. That's certainly is massively the case on software, but as a side note, it will also increasingly be the case on the hardware side. So there is nothing that has changed in our opinion of this being a good market, a technically challenging, therefore particularly good market for us. And the combination of the overall situation and perhaps our own execution gave us - led us to this point. But let's not underestimate, this is actually a very good business for Synopsys. It is now growing a bit slower than we wanted this year. But it is well on track to have a good future.

And speakers, we have no further questions in queue.

Well, in that case, let me first thank you to attend. My assumption is that, if not all of you, most of you attend from home, so we hope that your home situations, family situations are also safe and sound. And all the more do we appreciate hearing your voice and having your support on a quarterly basis through these earnings releases. Please take care of yourself and be well. Bye-bye.

And ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T conferencing service. You may now disconnect.