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Synopsys Q3 2023 Earnings Call Transcript


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Participants

Corporate Executives

  • Trey Campbell
    Senior Vice President, Investor Relations
  • Aart de Geus
    Chair and Chief Executive Officer
  • Sassine Ghazi
    President and Chief Operating Officer
  • Shelagh Glaser
    Chief Financial Officer

Analysts

Presentation

Operator

Ladies and gentlemen, welcome to the Synopsys Earnings Conference Call for the Third Quarter of Fiscal Year 2023. 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. And 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, sir.

Trey Campbell
Senior Vice President, Investor Relations at Synopsys

Thanks, Lisa. Good afternoon, everyone. With us today are Aart de Geus, Chair and CEO of Synopsys; Sassine Ghazi, President and COO; 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 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 Aart.

Aart de Geus
Chair and Chief Executive Officer at Synopsys

Good afternoon. We delivered outstanding results in the third quarter, exceeding the midpoint of all our guidance targets while reaching another quarterly revenue record. Revenue of $1.487 billion was in the high-end of our guidance is with non-GAAP operating margin at 35.3%. GAAP earnings per share were $2.17, while non-GAAP earnings per share was above our target range at $2.88. We generated $560 million of operating cash flow and ended Q3 with a backlog of $7.1 billion.

By now, you have all seen our other news. So before I address our segment results and outlook, let me warmly welcome to Sassine Ghazi to the call. Today, we announced that the Synopsys Board has named Sassine as Synopsys' President and CEO starting January 2024, and that I will take the role of Executive Chair of Synopsys Board at the same time.

I'm absolutely thrilled with this transition into the CEO role for Sassine. Sassine is uniquely qualified. He is a proven operational leader, a technology innovator and a trusted partner to our customers and ecosystem friends. But he's so much more than that. He embodies our values and culture and inspires our Company, including me, with his results focused leadership. Sassine, welcome to your first of many Synopsys earning calls.

Sassine Ghazi
President and Chief Operating Officer at Synopsys

Thanks, Aart. I'm incredibly honored, humbled and profoundly grateful to the Board and you Aart, for placing your unwavering trust in me. You built Synopsys from a disruptive startup into one of the world's essential semiconductor ecosystem companies. I'm so proud to have been a part of that journey for the last 25 years working with you, our leadership team and the many colleagues across the organization.

I'm determined to build upon our strong foundation, drive innovation and propel Synopsys to even greater heights of success. I look forward to engaging with all of you moving forward and to the continuing partnership with Aart.

Aart de Geus
Chair and Chief Executive Officer at Synopsys

Thanks, Sassine. You have my full support. Now let's turn to what we're seeing in the market. Technology industry trends are playing to our strengths. The AI-driven, Smart Everything era is putting positive pressure on the semiconductor industry to deliver more.

Despite economic challenges, semiconductor design starts and R&D investments continue unabated. Our relentless innovation drive has made Synopsys a catalyst for our customers' success in this new growth era for semiconductors. In fact, the market is playing out much as we expected when we planned the year, and we are executing accordingly.

Based on continued strong design activity, our high confidence -- and high confidence in our business, we are raising our full-year revenue guidance range to between $5.81 billion and $5.84 billion. We are increasing our year-over-year non-GAAP ops margin improvement expectation to 200 basis points. This is approximately 0.5 point up versus prior guidance. We are raising our full-year non-GAAP EPS range to between $11.04 and $11.09. Shelagh will give you -- will discuss the financials in more detail.

Prior to giving color on our segment results, let me update you on our AI progress. By now, I hope that we all understand that AI can, and does, and has further potential to unlock massive new productivity gains. So, while we continue to embed AI in everything we do, not surprisingly, one consistent question most of you are asking is how we'll monetize our AI leadership. Let me address that question head-on through the techonomic lens of product differentiation and business model framework, including some early proof points.

For AI monetization, we see three distinct value streams: first, through our design participation in the explosive growth in demand for AI chips; second, by pervasively embedding our pioneering AI across our full EDA stack, which we call Synopsys.ai; and third, through AI-driven efficiency transformations, as we optimize and automate our own internal workflows.

Let's start with AI chips. Use cases for AI are proliferating rapidly, as are the number of companies designing AI chips. Novel architectures are multiplying, stimulated by vertical markets all wanting solutions optimized for their specific applications. Third parties estimate that today's $20 billion to $30 billion market for AI chips will exceed $100 billion by 2030. In this new era of Smart Everything, these chips in turn drive growth in surrounding semiconductors for storage, connectivity, sensing, AtoD and DtoA converters, power management, etc.

Growth predictions for the entire semi market to pass $1 trillion by 2030 are thus quite credible. We are uniquely positioned to benefit. In the semi ecosystem, Synopsys is the leading EDA provider to AI chip designers; designers requiring unmatched capabilities in design tools, particularly at the most advanced process nodes. They also need our leading interface IP portfolio, as AI chips are banking on enormous amounts of data driving new, faster and lower power interconnect protocols. Synopsys excels at this.

In summary, AI chips are a core value stream for Synopsys, already accounting, on a trailing 12-month basis, for well over $0.5 billion. We see this growth continuing throughout the decade.

Let's move to our second value stream, Synopsys.ai. This is where, starting in 2017, Synopsys, incidentally, led by Sassine, pioneered AI-driven chip design, and we have relentlessly advanced the state-of-the-art ever since. Using our AI to automate entire design sub-flows, our customers report schedule reductions from months to weeks, while simultaneously also achieving better results in terms of speed, power and area of the chips.

In February, we reported that our customers had passed 100 commercial tape-outs using our AI. Today, the tally crossed 270, as adoption continues rapidly. Nine out of 10 of the top semiconductor vendors are using Synopsys.ai in production and the 10th one is already testing our solution. What makes this doubly relevant is that the worldwide semi industry has a significant resource shortage. Third parties estimate a design engineering gap of between 15% to 30% by 2030.

Even the multiplicity of national CHIPS Act recognizes this, and AI in design automation will be critical to help bridge the gap. That's where the industry's first AI-driven full EDA suite, Synopsys.ai, comes in.

Initially launched in 2020 for design optimization, we have since added AI-driven test and verification flows now in commercial adoption. Usage is expanding rapidly as customers are seeing stunning results. In the last quarter, our customers have demonstrated up to 10x faster turnaround time and double-digit improvements in verification coverage. Customers are also reporting more than 20% silicon test cost reduction.

Recently, we engaged Synopsys.ai for analog and custom design. One of our top customers used our AI-optimized Custom Compiler to achieve a 6% performance improvement over manually crafted custom circuits. Further completing our Synopsys.ai stack, more AI-driven manufacturing flow extensions are coming soon. But back to the economics.

Synopsys.ai revenue is just starting to ramp, but early proof points give us high confidence in its long-term growth prospects. We've moved from project-based experimentations to customers now adding Synopsys.ai subscriptions. Synopsys.ai has driven more than 20% value increases in several recent digital implementation renewals, often leveraging significant growth for the underlying core tools used by Synopsys.ai. This quarter, we saw multiple full-flow displacements to Synopsys.ai driven by up to 10x productivity differentiation versus the competition, which brings me to generative AI.

Over our history, key disruptive technologies have catalyzed innovation opportunities for Synopsys to deliver leaps in productivity. Gen AI is such a technology. Anchored in 35-plus years of experience in developing model-based solutions, now with an unparalleled data asset portfolio, we intend to harness gen AI capabilities into Synopsys.ai. We see this delivering further advances in design assistance, design exploration, and design generation.

On the design flow spectrum from optionality to optimality, in other words, moving from many options in early architectures, to highly-tuned, error-free tape-outs, gen AI techniques will augment the exploration, accelerate design choices, and automate some design generation. This will further broaden the intelligence dimensions in Synopsys.ai. These new capabilities represent additional customer value, opening multiple new monetization opportunities. We will elaborate more on our roadmap in the coming quarters, which brings me to our third monetization value stream, operational efficiency transformations.

Gen AI isn't just an opportunity for our customers. We, ourselves, fully intend to eat at our own AI restaurant, so to speak. We see significant operational efficiency and automation potential in processes across the company, so that our employees can focus on higher ROI tasks. Our experimentation is in full swing and we are rapidly learning the strengths and challenges [Phonetic] of these new approaches.

Overall, fast progress on our AI journey and it is great to have Sassine on the call for Q&A as he is very focused on our AI business strategy and monetization.

Let me now give some color on our segments of Design Automation at roughly 65% of our business, Design IP at about 25%, and Software Integrity at around 10%.

Starting with Design Automation, we saw strong revenue momentum and the segment delivered its first $1 billion quarter. Fusion Compiler momentum continues to grow with increased customer share and Synopsys-enabled customers taping out first to a number of leading manufacturing nodes, including TSMC N2 and N5A, Samsung SF3 and Intel 18A. Fusion leadership at advanced nodes has also translated into key HPC core wins at both semiconductor and hyperscale companies.

Transitioning to multi-die chip design, our 3DIC Compiler platform continued momentum across verticals, achieving deployment on the industry's first advanced 3D-stacked heterogeneous design for smartphones. We also expanded our multi-die ecosystem enablement, including qualification for leading foundries' latest multi-die flows, and support for key 3D design standards. Of note, we deepened our collaboration with Samsung Foundry to accelerate multi-die system design for advanced processes.

Let's move to verification, where the need for acceleration is paramount. In Q3, we won a Zebu hardware-assisted verification engagement with a RISC-V AI chip provider, and saw HAPS deployments for prototyping AI chips at a large hyperscaler and a large HPC company.

Synopsys Cloud continues to deliver substantial differentiation and time-to-market gains for our customers. Our SaaS solution, which accounts for 70% of our cloud users, continues to gain strong adoption with multiple AI chip start-ups leading new SaaS deployments.

Now turning to Design IP, which is roughly 25% of our revenue. We had an excellent quarter working closely with some of our partners to enable the most advanced process nodes in the design ecosystem. Just this week, Synopsys and Intel announced a very significant expansion of our long-standing strategic partnership in EDA and IP, to speed the design and manufacturing of advanced SoCs and multi-die systems for Intel processes. This comprehensive agreement enables Intel's internal IDM 2.0 teams and their external foundry customers to accelerate chip and system designs with a powerful portfolio of essential IP developed by Synopsys for Intel 3 and 18A processes.

Synopsys IP is now key to ramping and filling multi-billion dollar wafer fabs as the advanced node IP supplier of choice for customers and the manufacturing ecosystem. Further supporting this, in Q3, we also announced the industry's broadest portfolio of silicon-proven IP for TSMC's N3E process as well as an extensive portfolio of IP for all of Samsung Foundry's advanced process technologies.

In automotive, autonomous driving ADAS systems continue to drive strong demand for our IP. This quarter we exceeded 30 design wins in 5 nanometer and won our first 3 nanometer design at a marquee automotive OEM. All in all, we have won IP sockets on more than 100 ADAS chips.

Third, the Software Integrity segment, which represents 10% of our revenue. Against a continued challenging macro environment for enterprise software, the business delivered solid results. The imperative for security and quality in software has always been critical, and with the rise in gen AI generated code, big new risks are emerging. Racing forward, we continue to develop innovative new solutions like our AI code analysis API offering on our Polaris SaaS platform.

AI code analysis API enables developers to automatically submit code snippets from code assistants such as GitHub Copilot and ChatGPT to receive instant feedback on whether the code may originate from risky open-source projects.

In summary, we had outstanding Q3 financial results and operational execution and are confident in a strong close to the year. We are raising our guidance for full-year revenue and year-over-year ops margin, as well as non-GAAP earnings per share expectations.

We have a resilient business model, and our customers continue to prioritize investments in the chips and systems that position them for future growth. We continue to invest in technology leadership, multi-die design solutions, state-of-the-art IP, and the leading-edge AI-driven EDA suite to help catalyze this decade of smart, secure and safe products. And last, but certainly not least, I am just delighted to welcome Sassine as our next CEO. I would like to thank our employees and our partners for their passion and commitment.

With that, I'll turn it over to Shelagh.

Shelagh Glaser
Chief Financial Officer at Synopsys

Thank you, Aart, and congratulations, Sassine. I look forward to continuing to partner with you as you transition to CEO and scale the Company to the next level of growth.

On to results. Q3 was another outstanding quarter, with record revenue and earnings. EPS was above the high end of our range. We continue to execute well, which is a testament to our execution and leadership position across our segments, robust chip and system design activity by our customers, who continue to invest through semiconductor cycles, and with $7.1 billion in non-cancellable backlog, the stability and resilience of our time-based business model. With our continued confidence in the business, we are raising our full-year targets for revenue, non-GAAP operating margin improvement and EPS.

I'll now review our third quarter results. All comparisons are year-over-year, unless otherwise stated. We generated total revenue of $1.49 billion. Total GAAP costs and expenses were $1.19 billion. Total non-GAAP costs and expenses were $963 million, resulting in a non-GAAP operating margin of 35.3%. GAAP earnings per share were $2.17, and non-GAAP earnings per share were $2.88.

Now, on to our segments. Design Automation segment revenue was $1 billion, up 23%, driven by broad-based strength. Design Automation adjusted operating margin was 41.4%.

Design IP segment revenue was $350 million, up 12%. Adjusted operating margin was 24.7%.

Software Integrity revenue was $133 million, up 12%, and adjusted operating margin was 16.9%. Due to continued macro impact on this segment, we now expect Software Integrity revenue growth in 2023 to be below our long-term guidance of 15% to 20%.

Turning to cash. We generated $560 million in operating cash flow and used $300 million of our cash for stock buybacks. Our balance sheet is very strong. We ended the quarter with cash and short-term investments of $1.8 billion, and total debt of $18 million.

Now to guidance. As we have previously communicated, we had expected a strong second half. We are again raising our full-year outlook for revenue, non-GAAP operating margin improvement, and earnings.

For fiscal year 2023, the full-year targets are: revenue of $5.81 billion to $5.84 billion; total GAAP costs and expenses between $4.544 billion and $4.564 billion; total non-GAAP costs and expenses between $3.78 billion and $3.79 billion, resulting in non-GAAP operating margin improvement of 200 basis points; non-GAAP tax rate of 16%; GAAP earnings of $7.85 per share to $7.96 per share; non-GAAP earnings of $11.04 per share to $11.09 per share; cash flow from operations of approximately $1.65 billion.

Now to targets for the fourth quarter: revenue between $1.567 billion and $1.597 billion; total GAAP costs and expenses between $1.184 billion and $1.204 billion; total non-GAAP costs and expenses between $1.005 billion and $1.015 billion; GAAP earnings of $2.17 per share to $2.28 per share; and non-GAAP earnings of $3.01 per share to $3.06 per share. Consistent with prior years, we will provide additional comments and guidance for 2024 when we report next quarter.

In conclusion, we delivered record quarterly revenue and earnings. Based on our outstanding results year-to-date and strong outlook, we are again raising our targets for the full year. We continue to see strong momentum in the business, reflecting our leadership position across our segments, robust design activity by our customers who continue to invest through semiconductor cycles, and the stability and resiliency of our time-based business model.

With that, I'll turn it over to the operator for questions.

Questions and Answers

Operator

Thank you. [Operator Instructions] We'll take our first question from Jason Celino with KeyBanc Capital Markets.

Jason Celino
Analyst at KeyBanc Capital Markets

Great. Thanks for taking my question. I -- frankly, I don't know where to begin. Aart, what a run, and Sassine, well deserved. And maybe, Sassine, sorry to put you on the spot here, but can you just frame your vision around AI and how closely you've been working with the AI strategy?

Sassine Ghazi
President and Chief Operating Officer at Synopsys

Sure. First, thank you, Jason. And as Aart mentioned, actually the AI journey for Synopsys started around 2017. I was the General Manager of our EDA business at the time. And no one in our industry was talking about AI at -- in 2017 for EDA applications. Around the 2020 timeframe, we actually had customers using it in early production stages. And now as you saw the number, many, many tape-outs.

At the time we started with the design space as the early stage of high-impact using AI, and as you have seen us talk about the last couple of quarters with Synopsys.ai, where we're expanding the impact into test, verification, analog custom, manufacturing, etc. And Aart mentioned in his remarks that we have customers at this point buying our AI solution as part of their subscription license. And when a customer does that, they already see the value and the impact, and they are willing to pay for it and that's the stage we're in at this point.

Jason Celino
Analyst at KeyBanc Capital Markets

Okay. No, that's great. And then my brief follow-up. I think it was mentioned that in some renewals, you're seeing a 20% increase because of AI. Is this mainly driven from the tools themselves? Or is this more related to the upsell of the core because of the compute? Thanks.

Sassine Ghazi
President and Chief Operating Officer at Synopsys

I'm sorry, the 20% increase in what? I missed the first part of the question.

Jason Celino
Analyst at KeyBanc Capital Markets

I think Aart mentioned that in some renewals, you were seeing 20% increases in value. I was just curious on the drivers of that or maybe I misheard.

Sassine Ghazi
President and Chief Operating Officer at Synopsys

We are seeing absolutely two factors. One, there is a pull through of the technology that our AI system uses, like Fusion Compiler, PrimeTime, etc., etc. And the customer is adding money -- new money in the agreement based on the AI system that we are selling them. So it's not only in upsell and the pull through of the license, its incremental value that the customers are adding to their renewal with Synopsys.

Jason Celino
Analyst at KeyBanc Capital Markets

Okay. Great. Thank you very much.

Sassine Ghazi
President and Chief Operating Officer at Synopsys

Thank you, Jason.

Operator

We'll take our next question from Gary Mobley with Wells Fargo.

Gary Mobley
Analyst at Wells Fargo Securities

Good afternoon, everybody, and thank you for taking my questions. And congrats to both Aart and Sassine on the transition. And...

Sassine Ghazi
President and Chief Operating Officer at Synopsys

Thank you.

Gary Mobley
Analyst at Wells Fargo Securities

I want to pick up where the last discussion point left off. I wanted to maybe probe in into maybe how many renewals have come up since you went from on a per design subscription for AI tools to enrolling into baseline license renewals? I just want to get a sense of how many of these license renewals are now including AI.

Sassine Ghazi
President and Chief Operating Officer at Synopsys

As you know, an average EDA contract is about three years. So 2020, when we started with customers, and we have number of those customers included it in their renewals. So we're already in that first stage with number of customers including it in their three-year contract.

Gary Mobley
Analyst at Wells Fargo Securities

Okay. Thank you for that, Sassine. I wanted to change topics and move to the different trends in the operating margin for the different business segments. I know that you called out in the past quarter-to-quarter volatility in the op margins for the IP business that we now have a trend with the -- trend downward for the past two quarters. Maybe if you can speak to that, specific to the IP business?

And then conversely, you're showing nice gains in the Software Integrity business with seemingly not much revenue ramps. So maybe you can speak to the undercurrents there and as it relates to opex controls in the Software Integrity side?

Shelagh Glaser
Chief Financial Officer at Synopsys

Sure. So, I think it is -- this is the change that Aart and Sassine drove in the organization. So that's why we've got this more comprehensive segment reporting and you're able to see what is going on in our three large segments. So if I talk about Design IP, specifically, we really think about that business on a long term. And as Aart talked in his prepared remarks, we're building out an IP portfolio for each new node, for each different boundary, for each different customers. So think of us as constantly investing in IP. And when we're signing contracts with customers, we're signing an agreement for a specific amount of dollars with the specific term.

And when the customers pull down the IP is based on when their design is needing to integrate that IP into the design. So over time, we expect that IP op margin is slightly below our corporate margin. And what you're seeing is what we've always called lumpy, you're able to see what lumpy looks like now with our new segment reporting. So the expectation hasn't changed.

And as we're looking out, we're seeing customers deep into their designs and we understand the timing of when the IP would be pulled down. So we feel strongly about that business, plus it's an incredible strategic asset for us to be so deeply involved and engaged in our customers' design. So we've got strong view of -- a positive view on that op margin.

For Software Integrity, we've talked about we've been focused on improving the margins in that business as we scale the business, and you're seeing some of the pull through for that in the Q3 timeframe.

Gary Mobley
Analyst at Wells Fargo Securities

Thanks, Shelagh.

Shelagh Glaser
Chief Financial Officer at Synopsys

Thank you.

Operator

We'll take our next question from Joshua Tilton with Wolfe.

Joshua Tilton
Analyst at Wolfe Research

Hey, guys. Thanks for taking my questions. First, Aart, I guess -- not I guess, but you'll definitely be missed, and congrats, Sassine, on the new role.

Aart de Geus
Chair and Chief Executive Officer at Synopsys

Not like I'm completely disappearing, right? Just to be clear.

Joshua Tilton
Analyst at Wolfe Research

No, your voice on these earnings calls, it will definitely...

Aart de Geus
Chair and Chief Executive Officer at Synopsys

Yeah.

Joshua Tilton
Analyst at Wolfe Research

I guess my first question is just, it seems like as of January, we're going have a bit of a new regime in place. Maybe what are some of the things you can either do differently or just some levers that you feel that you could pull to maybe drive some meaningful margin expansion in the model come next year?

Sassine Ghazi
President and Chief Operating Officer at Synopsys

Joshua, I've been part of this Company for 25 years. And the last three years, it's really been the start of what we call like momentum journey, and we'll continue that pace of the journey moving forward. What Aart and I -- when I was appointed to COO and then later President, we really set out three vectors as priority for the Company. The first one is focused on the growth ambition. The second one is scaling and how do we scale efficiently as a company. Three, technology leadership and innovation.

And if you look at the results, they are really amazing. Over that period of time, we were able to grow revenue 17% CAGR, 700 basis point in non-GAAP operating margin and 26% CAGR EPS. And doing all of this while pioneering industry-first technologies like the AI solutions that we're talking about, plus the 3DIC from a multi-die, both IP and design tools, etc., etc.

So as we look ahead, January 1st as you commented, it's just a continuity of that pace. At the time where the market, the semiconductor chip activity is so exciting driven by the AI demand that requires more compute either data center, cloud or edge, as well as everything going smart, smart everything in the car, in home and the industry, etc. So it's really continuing that pace of momentum we created on all three vectors.

Shelagh Glaser
Chief Financial Officer at Synopsys

And I would add that we're committed to both short- and long-term operating margin improvements. That's what you're seeing the improvement in the second half of the year. And we, of course, will guide '24 next quarter, but our long-term guide is at least 100 basis points improvement. So we're very committed to that.

Joshua Tilton
Analyst at Wolfe Research

Super helpful. And I think just a quick follow-up of that talk track. When you guys started buying up all these STIG assets, I think the bullish take was we have this portion of the business that's growing a lot faster than core EDA and we could see this nice mix shift effect as STIG becomes a bigger piece of the total pie. But I guess, how do we think about when as -- from an investor perspective, we should kind of expect STIG growth to be back above the corporate average? Maybe help us out with a little color there.

Sassine Ghazi
President and Chief Operating Officer at Synopsys

The thesis behind STIG remains very strong, which is software quality and security. And actually right now, you can argue, and the future is as strong or stronger with AI generated code and the need for any developer to ensure that it's secure software that are using in their product.

What's happened over the last 12 months or so, it's not unique to Synopsys, is you're seeing it in the industry, especially at the software enterprise industry, is a slowdown and that headwind is really what you're seeing right now. And as Shelagh mentioned, even though we're not speaking about long-term projection and guidance for any part of the business, but we are -- last quarter, if you recall, we said we'll be at the lower end of 16% [Phonetic] to 20% and now it will be slightly below that number. But it's not due to the portfolio or the execution, it's truly the headwinds we're facing in the market.

Joshua Tilton
Analyst at Wolfe Research

Makes sense. Thanks, guys.

Sassine Ghazi
President and Chief Operating Officer at Synopsys

Thank you.

Aart de Geus
Chair and Chief Executive Officer at Synopsys

Thank you.

Operator

We'll take our next question from Joe Vruwink with Baird.

Joe Vruwink
Analyst at Baird Equity Research

Great, and big congrats to Sassine and Aart. I maybe wanted to start just, Aart, in your opening comments that resources of monetizing AI -- AI chips and that market opportunity, so that's more market growth for customers. Your AI products, that's wallet share for Synopsys. And then how you can employ AI internally, I would take that as meaning higher margins. I guess when you just add all of those things together, can you maybe comment on how it could start to influence your long-term financial framework because a lot of these things were certainly early days or not as present back in 2021, that's when the framework was first debuted?

Aart de Geus
Chair and Chief Executive Officer at Synopsys

Well, you have our basic financial outlook because we have communicated that we're focusing on, number one, growth and continued gradual improvement of ops margin. And in many ways, this is against the backdrop that is fantastically exciting because there's going to be a wave of end users and I mean, with that, systems companies that all want to have AI, that all want to have chips that are way faster, way lower power, way more data.

With other words, the entire industry around us will be unhappy with semiconductors because they want more. And there is nothing better than that, because that is what in the early days drove the whole Moore's Law at super-high growth. And we have a similar feel going on right now. And you may say, well, but is the technology not limited? Well, no, it's not.

What has changed is that, the architecture is all changing and that's the ability to bring chips immensely close together, including stacking them vertically, is now suddenly opening up. Still difficult, still expensive, but that's what FinFETs where before too and then suddenly, out of nowhere there were over 10 generations of it. And I think this is exactly the space that we've entered.

And so, that's another way of saying design is going to become more complex, more engineers are needed, and given that the world supply of engineers is somewhat limited, more automation is the only answer to solve this. Again, not any different than in the 1980s, 90s, 2000s, and we all feel this drive because the notion of smart everything has shown itself as relevant.

Now, a little portion of that is, well, how smart are we on the inside. And there is a lot that we can learn. And obviously, anything that we can automate or accelerate in our processes directly goes to the bottom line. And at that point of time, Sassine's job is to figure out how much of that money to the bottom line goes directly back into AI research, right? So that circle is very active.

Joe Vruwink
Analyst at Baird Equity Research

Okay. That's all great. I wanted to go back and Jason asked about the renewal anecdote. I think that's a pretty interesting one. I guess my question is the 20%, is that pretty typical or emblematic of what place and route has been seeing so far? And maybe if it is, how do you see renewals evolving as customers get more experience, more proof points on things like tests, your new AI verification, analog, kind of the full Synopsys.ai suite? What could that mean for a typical renewal?

Sassine Ghazi
President and Chief Operating Officer at Synopsys

Yeah. In the early stages of AI, what the customers were struggling with were two things: one, I may not have enough compute; and two, I may not have enough licenses -- EDA licenses. On the compute side, there are multiple ways that can be addressed, but most of our customers figured it out, given the value that they were able to see. On the EDA side, the reason we started with project base [Phonetic], we were really trying to figure out with the customers, what's the combination of number of licenses needed for an AI job because AI, it's pulling far more licenses of the technology that is under the hood compared to an engineering -- individual engineer effort.

So after we learned from that experimentation, let's call it, around 2020, and customers wanting to scale it up, we started providing it as part of the subscription license in order to enable broader and easier adoption for the customer. And with that came monetization to Synopsys. As I said, incremental monetization on two sides; more selling of the licenses, plus selling the AI technology as well.

We have now actually many. It's still early stages though. When I say many in terms of renewals, remember those are three-year cycles of renewals and 2020 was just around the corner in terms of renewal cycle. But we have many customers that they have gone through renewing their subscription license with Synopsys and added more technology that's pulling and the AI life.

Joe Vruwink
Analyst at Baird Equity Research

Great. Thank you, all.

Sassine Ghazi
President and Chief Operating Officer at Synopsys

Thank you, Joe.

Operator

We'll take our next question from Vivek Arya with Bank of America Securities.

Vivek Arya
Analyst at Bank of America Securities

Thank you and best wishes to both Aart and Sassine on your new roles.

Sassine Ghazi
President and Chief Operating Officer at Synopsys

Thank you.

Aart de Geus
Chair and Chief Executive Officer at Synopsys

Thank you, Vivek.

Vivek Arya
Analyst at Bank of America Securities

Welcome. So I had a near and a longer-term question. So, on the near-term Design IP, when I look year-to-date, if the model is right, your sales are basically flattish so far this year. I think maybe up 1%. So I'm curious why is that well below your long-term growth expectations? And then when can we see this business get towards your target, which I think is to grow at kind of in the mid-teens annual basis?

Shelagh Glaser
Chief Financial Officer at Synopsys

So it is a lumpy business. As I've described before, the contracts we signed with the customers, we have term and a dollar amount, and then the timing of those pull downs is really based on customer design. So we're confident in our long-term growth in that business because of that contracts we have signed with customers. But Vivek, it is lumpy because it's really dependent. We're delivering IP all the time, constantly refreshing and delivering new IP blocks, and then it's really the pull downs are based on the customer design schedule. And we see robust chip activity and we expect customers' pull downs over near-term horizon.

Vivek Arya
Analyst at Bank of America Securities

Got it. And for my follow-up, I'm trying to think of what is the right way to think about your sales growth for the next two to three years. Can it stay mid-teens? Will it decelerate right to low-double digit? Will it accelerate? Because AI is growing, but that's only 10% of your sales, is that really enough to help Synopsys continue to grow at this mid-teens pace? Because when I look at a lot of the other parts of semis, right, whether it's consumer or parts of industrial, a traditional datacenter, they have really slowed down. So I'm curious, is just AI enough to help Synopsys continue to grow its sales at kind of this mid-teens pace over the next two to three years? Thank you.

Aart de Geus
Chair and Chief Executive Officer at Synopsys

Just one comment, Vivek. You're asking, of course, the question that you should ask at the end of Q4, right? That's when we give guidance for the coming year. At the same time, overall, as we mentioned, we are in a market that we perceive as strong for us. We don't see any big changes. From year to year, of course, there is variability, but too early to really talk about that. But fundamentally, what we said in the preamble is that fundamentally, we have a degree of momentum that feel -- that shows us that we are in a very strong business at a good time. And so I wouldn't think that there are any major changes. At the same time, again, we are declining too far out guidance here.

Vivek Arya
Analyst at Bank of America Securities

Right. Without giving guidance, Aart, I guess what I'm curious about is your insight on the growth in the business excluding AI, because you gave a $0.5 billion number over the last month...

Aart de Geus
Chair and Chief Executive Officer at Synopsys

Yeah. Yeah. Okay. Yeah. Good point. Sorry, I didn't catch that. Yeah. Outside of AI, the business is just strong across the board. We talked earlier about IP. These agreements that we made over the last quarter are very powerful for a long period of time, and they establish us as a provider that is one of necessity for foundries to be successful.

Remember, for a foundry to be successful with a new node, it takes fundamentally four things. One, you have to have, of course, the technology. That's their job. Secondly, you need to have the capacity. Third, the EDA tools which turns out we are always on time. And fourth, you need the collection of IP ready to go, because otherwise the end users can't do design.

And the fact that we have strong agreements to provide us to the leading foundries in the world is fantastic, and that gives us a degree of stability, but also potential further growth that is very, very good.

Vivek Arya
Analyst at Bank of America Securities

Thank you.

Operator

We'll take our next question from Ruben Roy with Stifel.

Ruben Roy
Analyst at Stifel Nicolaus

Thank you, and my congrats as well to Aart and Sassine. And Aart, I hope we get to see you playing the guitar more going forward from here.

Aart de Geus
Chair and Chief Executive Officer at Synopsys

I like to see you at the gig.

Ruben Roy
Analyst at Stifel Nicolaus

You'll see me there, definitely. Sassine, I wanted to ask on AI as well around the sort of how you're viewing the pervasiveness of AI. Aart talked about the $100 billion market potentially in AI chips by the end of the decade and 10% of a $1 trillion semiconductor market. Early days, but do you think for now that AI-embedded tools are slated better for a certain portion of semiconductor design market?

Clearly, generative AI as a design helper mechanism can be pervasive across the entire gamut of semiconductor, I would think. But for now is that the right way to think about it? Is this kind of large designs with very complicated place and route? Or do you think it will be more pervasive than that?

Sassine Ghazi
President and Chief Operating Officer at Synopsys

It will be more pervasive than that, but it will definitely be in the stages of the design. So if you think of the design as three stages, there is the front end of the design, then there is the implementation/optimization of the design, and the sign-off where we started with DSO.ai in the physical implementation. Because of this space of optimization is so large, it was such a perfect opportunity for an AI system to look at that large space of optimization and find the right parameters to tune and then give you the most optimized physical implementation.

But as we expand into test, for example, and reducing the test pattern or verification, improving your coverage, analog mixed signal, it's a whole other place where there is plenty of opportunity to innovate in that domain. And you go into manufacturing, they are all time and can leverage AI for both productivity as well as the quality of the results that you get.

Now, Aart mentioned as well in his script three stages of design assistance, design exploration and design generation. Those -- I want to say some of those are ambitious, meaning this is where we can see the technology heading in the next one, two years at various level of R&D in some cases, and customer discussions of where do they see the high impact as well as where do we see the technology available today from AI models, etc., etc.

And you can open up the door to how do you protect your IP, the customer IP, how does the system learn. So the opportunity is definitely in early stages in terms of impact of AI overall on the chip design.

Ruben Roy
Analyst at Stifel Nicolaus

Very helpful.

Aart de Geus
Chair and Chief Executive Officer at Synopsys

If I may add something because I love what Sassine just has said in terms of these opportunities, it is important to understand that what we have done is we started actually with the single hardest problem, which is all the stuff that sits before tape-out. Tape-out is when the design is done and it gets sent to manufacturing. Well, the one thing you don't want to happen is any errors in that. And so as you add more and more and more detail, you're coming to this notion of the absolute necessity to be as close as you can to zero errors.

And that's why Sassine mentioned, not only the design, but also the verification steps, the sign-off steps. And we have integrated all of those under our AI. And I think it's going to take a long time before many of the other techniques get close to that. But we are going to, of course, put those around. So, it broadens our opportunity space, as Sassine has said, but the core of our pioneering was really we can do it and get correct chips out. Now that is challenging.

Ruben Roy
Analyst at Stifel Nicolaus

Yeah. That's a very interesting discussion. Thanks for all the detail, guys. If I could ask what I hope is a quick follow up. Some of your semiconductor customers have started to show their own accelerated compute platforms as platforms for EDA tools and in those demonstrations, more efficient than current standard server farms running EDA. What's your feeling on that? Do you view that, obviously early days, but as additional accelerant to EDA use or semiconductor design activity out there as the overall productivity could get faster as we cut some of these new systems in place for your tools?

Sassine Ghazi
President and Chief Operating Officer at Synopsys

You're right, it's the right observation. Think of it as another tool that you can use to accelerate a workload. We were primarily CPU, then we introduced some GPU acceleration in a number of simulation functions and verification, and some other method. So, yeah, Ruben, you can think of it that way.

Ruben Roy
Analyst at Stifel Nicolaus

Got it. Thank you very much.

Sassine Ghazi
President and Chief Operating Officer at Synopsys

Thank you.

Operator

[Operator Instructions] We'll take our next question from Jay Vleeschhouwer with Griffin Securities.

Jay Vleeschhouwer
Analyst at Griffin Securities

Thank you. Aart, first, I've always enjoyed our more than 100 quarters of dialog and Sassine, I'm sure you'll look forward to another 100 quarters of multipart questions on the conference call. But for the two of you, let me ask a product roadmap question, and it does relate to AI.

As you may recall from your last analyst meeting back in 2019, an answer to a question at the time -- sorry, an answer to a question at the time about what you thought the longevity or useful life of your new data architecture or a new platform might be, having just introduced Fusion on top of it and DC NXT, for example, on top of it, you answered about a decade. And I know that was an approximation. But the question is, do you think that AI, as you embed it in your own products, extends that useful life of that architecture that you introduced a few years ago? Or might it on the other hand, require you to accelerate a rebuilding of the architecture as you completed a number of years ago?

Sassine Ghazi
President and Chief Operating Officer at Synopsys

Jay, excellent question, and I remember that discussion as well. When we introduced MDM at the time, if you remember, for our digital platform data model, it was around the 2015 time frame. So when you look at the decade, it's right around the corner. We continue -- and that's what's really the primary foundation to build Fusion, where you bring PrimeTime, Fusion Compilers, StarRC, etc., the whole digital platform on one unified data model that is helping us accelerate our innovation pace and rhythm because tools are connected and we're able to move much faster in delivering a new technology, new products.

And as you can imagine, the team is constantly looking, is there a more efficient new data model that we can build on? And you mentioned the 2019 Investor Day, maybe I spilled the beans. We will have -- hopefully, in the first half of '24, it will be great timing to talk about how we see the future given all the very exciting areas of technology innovation and the market around us.

Jay Vleeschhouwer
Analyst at Griffin Securities

What do you mean, there is an Investor Day?

Sassine Ghazi
President and Chief Operating Officer at Synopsys

What did I say, Investor Day?

Jay Vleeschhouwer
Analyst at Griffin Securities

You didn't say an Investor Day at that time. That's what you meant, right?

Sassine Ghazi
President and Chief Operating Officer at Synopsys

Okay. Investor Day, sorry, I was too excited.

Operator

And we'll take our next question from Charles Shi with Needham.

Charles Shi
Analyst at Needham & Company LLC

Hi. Thank you for squeezing me in. And congrats to Aart. It's really been my great pleasure and honor actually to work with the luminary of the EDA and semiconductor industry as you are. And also congrats, Sassine...

Aart de Geus
Chair and Chief Executive Officer at Synopsys

I'm blushing.

Charles Shi
Analyst at Needham & Company LLC

Yeah. Thanks. And congrats to Sassine as well. Looking forward to working with you in the future. Maybe my question, I wanted to ask again on the IP revenue. It seems like, so far this year, it's been tracking to like single-digit growth this year. It doesn't sound too right because your long-term guidance is kind of like in the mid-teens. Unless are you expecting we get a big bump in Q4? Or are we going to be tracking below that long-term guidance? But maybe next year, we should expect a somewhat above the long-term guidance kind of growth? That will be my first question. Thank you.

Shelagh Glaser
Chief Financial Officer at Synopsys

Yeah. Thanks for the question. Yeah, we do anticipate a very strong Q4. So our model that we have, we think is well intact, and that's a long-term model. And so when you look to the quarter-on-quarter variability, we don't as much manage it in the 90-day increment. We're managing it at the full year and 12-month increments, and we do expect a strong Q4 in IP.

Operator

We'll take our next question from Gianmarco Conti with Deutsche Bank.

Gianmarco P. Conti
Analyst at Deutsche Bank Aktiengesellschaft

Yeah. Hi, Aart, Sassine, Shelagh. Thanks for taking the questions and congrats on another strong quarter and to Sassine. So perhaps starting with SIG, could you explain whether the new go-to-market strategy is bearing some fruits? I actually, I know you've mentioned this before, but maybe you can go a little bit more detail into what exactly happened this quarter with regards to the marginal slowdown. Is this simply part of the macro demand that you have previously described? Is there something else in the mix? And conversely, what is driving the higher margin for this division right now? Thank you.

Sassine Ghazi
President and Chief Operating Officer at Synopsys

Yeah. We set out two priorities for SIG about 1.5 years, two years ago. One is building out our Polaris platform, which is an integrated SaaS, which is the static and dynamic software composition analysis and it's a cloud-native, cloud-ready system. So from a go-to-market point of view, we're still in a transition phase our -- transitioning our customers to Polaris while we're selling Coverity, Black Duck, etc., all the other point products that they can be primarily used on-prem. So that's from a technology platform point of view.

From a go-to-market standpoint, actually, we've done a fairly good job in putting the right investments, how much do we do direct, how much do we do through distribution. And we're still on that journey of evolving our go-to-market. Where we're seeing difficulties right now is the negotiation with the customers, given the headwind, they're ending up being a shorter renewals and taking longer to close. So that's really the more -- the impact we're seeing, not from a value, market share, etc., etc., standpoint. It's just the budget is tighter, in particular, for our enterprise customers.

Shelagh Glaser
Chief Financial Officer at Synopsys

And just a comment on operating margin. We're committed to improving operating margin. We had set out to do that this year to improve year-over-year, and we feel well on path to that. And obviously, the strong results in Q3 give us confidence [Phonetic] on the full year.

Trey Campbell
Senior Vice President, Investor Relations at Synopsys

Operator, we'll take one more question.

Operator

And we'll take our final question from Blair Abernethy with Rosenblatt.

Blair Abernethy
Analyst at Rosenblatt Securities

Thanks very much and let me offer my congratulations on the transition as well, gentlemen. Just on the IP business, I'm wondering if you can give us a sense of where you're seeing the biggest opportunity over the next, say, three years to five years? Is it 3D multi-die interconnects? Is it AI chip Design IP? And just sort of where are you -- how are you thinking about your investments in this segment?

Aart de Geus
Chair and Chief Executive Officer at Synopsys

On questionnaires, one would feel I'm all of the above, meaning that the continuation of technology development is still very fast, even for individual chips. And therefore, with those come new speeds, new bandwidth and constant new demand. You're absolutely right to throw in the 3D aspects because one of my perspectives on that, it is precisely the fact that 3D has improved dramatically in terms of the connectivity, both in number of pin counts and the speed on the pins and the decrease of energy to switch a pin that actually opens that domain for a decade of success.

Now the fact that AI is in the midst of that is -- what's a little bit different about AI processes, it's just the bandwidth and the enormous amount of data that needs to constantly, in many cases, dynamically be treated while the car is driving, so to speak. And so all of these things are wonderful for our field because that says, well, do a lot better. And while the world better, of course, has many variations, we all know that means that there's more design happening, more new chips, more differentiation among the end customers, among themselves. And so these are positive words in our field for sure.

Blair Abernethy
Analyst at Rosenblatt Securities

Thank you so much for the call. Look forward to talking with you over the coming days.

Aart de Geus
Chair and Chief Executive Officer at Synopsys

With that, I guess we close the call. Thank you for your attention. For those of you that will connect with us later on today, we're ready to talk to you. And again, have a good rest of the day.

Trey Campbell
Senior Vice President, Investor Relations at Synopsys

Thank you.

Operator

[Operator Closing Remarks]

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