Synopsys Inc
NASDAQ:SNPS
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Synopsys Inc
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Ladies and gentlemen, thank you for standing by and welcome to the Synopsys Earnings Conference Call for the Second Quarter Fiscal Year 2018. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] Today’s call will last 1 hour. 5 minutes prior to the end of the call, we will announce the amount of time remaining in the conference. 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, Laurie. 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 would 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, 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 8-K, earnings press release and financial supplement that we released earlier today. All of these items, plus the most recent investor presentations, are available on our website at synopsys.com. In addition, the prepared remarks will be posted on the site at the conclusion of the call.
With that, I will turn the call over to Aart de Geus.
Good afternoon. I am happy to report that our second quarter results were excellent. We delivered double-digit revenue and non-GAAP earnings per share growth. Revenue came in at $777 million, with strength across all product groups and non-GAAP EPS was $1.08. We repurchased $35 million of our stock, bringing the total so far this year to $235 million and we are raising our revenue and non-GAAP earnings guidance for the year. Trac will discuss the financials in more detail.
The landscape around us continues to thrive, with semiconductor growth pegged at 10% plus for 2018. We see new chip and systems companies entering the market, as big data and AI are driving new compute and chip architectures optimized for machine learning. Substantial investments are being made as the AI digital intelligence push is increasingly evident in verticals such as automotive, medical, industrial and growing networks of connected IoT devices.
The automotive vertical is particularly interesting, as AI-enabled autonomous driving has the potential to revolutionize the very notion of car ownership, while simultaneously requiring massive amounts of electronics and software in cars. These deep transformations rattle the well-established safety practices in one of the most sophisticated supply chains ever built and software security is rapidly becoming paramount to shipping modern vehicles. Synopsys is ideally positioned in these evolutions. The three customer groups we serve semiconductors, systems companies and software developers are all investing significantly in very advanced chips, massively complex systems and large amounts of software. Consequently, it’s imperative that they increase their efforts to test for or better preemptively avoid security vulnerabilities.
Over our entire history, Synopsys has invested in the most advanced technologies, paired with unmatched global customer support and has been privileged to team up with customers who have changed the world. This is happening again now. Our EDA design solutions are helping design brand new AI engines. Our IP is broadly used in the most advanced silicon technologies ever built. Our verification and emulation tools help bring up and test software on prototypes long before silicon is available. And our software security and quality tools assist in making that very software less vulnerable to threats.
This quarter, all of our product groups did well. EDA revenue growth continues to outpace the competition and we’ve begun to rollout breakthrough digital design capabilities through our new Fusion Technology. IP continues its double-digit growth, driven by our broad portfolio that is already on pace to enable the 5-nanometer IP needed in the near future. And lastly, our software security and quality group, which has reached economic critical mass and is executing very well with the integration of Black Duck, continues to deliver excellent organic growth.
Let me provide some highlights from the quarter, beginning with EDA. In Q2, our EDA revenue was strong across the board. Synopsys is the essential partner for the most advanced designs. Customers rely on us for more than 95% of their FinFET designs. Our track record at 7-nanometer is unrivaled, with nearly all of the 120 plus designs we are tracking impacted by our digital tools. At 5-nanometer, our deep collaborations with customers and ecosystem partners are resulting in early successes. Here too, customers are relying on Synopsys digital for nearly all designs. Our expertise and influence reach down to 3-nanometer and 2-nanometer, where we are already involved in preparing for still more advanced technology nodes. Foundry support and ecosystem partnerships are critical to enabling joint customers. During Q2, TSMC certified our full digital and custom flows for their 7-nanometer FinFET Plus and emerging 5-nanometer processes. Together with ARM, we announced a multiyear extension of our long-tenured collaboration, spanning all Synopsys tools, to best enable advanced ARM-based SoCs.
In digital design, we saw revenue growth accelerate over the last two quarters. In 2Q, we announced our new Fusion Technology, which represents a completely new level of integration of our market-leading products in synthesis, place and route, and signoff. A systematic sharing of algorithms, code and data representations across multiple tasks opens the door to previously unachievable levels of performance and quality of results by redefining conventional product boundaries. An example of the power of our Fusion solution is from Samsung Electronics, which experienced 10% better quality of results and significant reductions in turnaround time. They joined ST, Toshiba, and our product partner, Ansys to share the benefits of Fusion Technology with fellow customers at our Silicon Valley user conference. Our digital design vision and roadmap are already driving expanding customer relationships, including a key long-term agreement with a very high-profile global systems company. We delivered strong growth in custom as well and launched an enhanced custom design platform, with 2x faster simulation for FinFET and automotive designs.
In verification, we continue to see outstanding results and a strong outlook for the year. Demand is high for our Verification Continuum Platform, built upon the fastest engines in the industry and our number one position in both software and hardware-based verification. Q2 was a record quarter for hardware. Customer adoption of ZeBu emulation was broad-based, with substantial growth in existing accounts and a competitive win at a top 10 semiconductor company, driven by ZeBu’s significant speed advantage. Cambricon, a global leader in intelligent processors, adopted our FPGA prototyping solution for its AI processor product. HAPS-80 delivers the performance, capacity and scalability needed to enable Cambricon to accelerate software development and system validation.
Now to IP, which had another strong quarter and is poised for an excellent year, our strength is driven by multiple customers, regions and application segments. For example, several key agreements were for mobile chips focused on next-generation processes. We saw excellent success in cloud computing. A number of important deals were with automotive companies, for interface IP and our new safety-certified ARC embedded vision processor. And overall, business is strong worldwide, notably in China, where many companies look to third-party IP to maximally speed up their time to market. In order to ensure that the latest IP titles are available from Synopsys in the customers’ desired manufacturing processes, ecosystem partnership and intense bleeding-edge investments are critical.
During the quarter, we announced collaboration with TSMC to deliver key memory IP and logic libraries for TSMC’s 22-nanometer ultra-low power processes. We are also collaborating with Samsung Foundry to develop DesignWare IP for its 8-nanometer FinFET process, particularly benefiting low-power, high-performance applications. To address the growing needs in data-intensive applications such as machine learning, cloud computing and networking, we continued our investments in high-speed SerDes IP with the acquisition of Silicon and Beyond. At this point, it is worthwhile to note that we continue to make excellent progress in the automotive vertical as well. One of the requirements to participate in this market is product certification for a number of safety standards. We offer the broadest portfolio of IP that is certified for safety and reliability, ranging from embedded vision processors to embedded memories to the industry’s widest selection of interface IP.
In EDA, our design portfolio achieved the industry’s most comprehensive ISO 26262 certification by exida, the leading automotive functional safety certification company. Certification spans our custom, analog/mixed signal, digital implementation, signoff and library development flows and of course, automotive safety also implies software security, which brings me to our Software Integrity Group, which serves a third customer base, software developers across many industries including, but also well beyond, semiconductors and systems. We provide products and services that help developers build security into the software development lifecycle and across the entire cyber supply chain.
Software Integrity is a key differentiator for Synopsys and has substantially expanded our TAMs. In recent quarters, we have reached critical mass with significant growth both organically and through acquisitions. Our Software Integrity platform is making good progress. We are step by step combining key technologies and will continue to rollout incremental advances over the next 12 months and beyond. We are excited about the very positive impact that our broad solution will have on our customers’ efforts. The addition of Black Duck provides another compelling set of products addressing the ever-expanding open source content in today’s software. While still early, the integration is proceeding very well. The combined team is energized, the roadmap planning is on track, we are benefiting from the brand recognition of Black Duck, and we are beginning to see some cross-selling benefits.
Finally, for the second year in a row, Synopsys was named a Leader in Gartner’s Magic Quadrant for application security testing. The Magic Quadrant is an important indicator for customers, who often use it to narrow their list of potential vendors. We have seen a definite increase in our customer interest since first being recognized last year. To summarize, the company is hitting on all cylinders. We had a very strong quarter. We are raising revenue and non-GAAP EPS guidance for the year. We are making excellent progress with our leading products in design and verification and our investments in IP and software have broadened our market reach, TAM and company outlook.
Let me now turn the call over to Trac.
Thanks, Aart. Good afternoon, everyone. In delivering another excellent quarter, we achieved record revenue with strong growth across all geographies and product groups. We delivered double-digit non-GAAP earnings growth and we returned cash to shareholders by repurchasing $235 million of stock in the first half of 2018. Based on the strength of first half results and better visibility to an increasingly favorable second half, we are raising our 2018 revenue and non-GAAP EPS guidance.
Now to the numbers, as I talk through the results and targets, all comparisons will be year-over-year unless I specify otherwise. Total revenue increased 14% to $777 million, reflecting strength across our product portfolio. The weighted average license duration was approximately 2.6 years and we expect the annual average to be about 3 years. Total GAAP costs and expenses were $650 million. Total non-GAAP costs and expenses were $587 million, resulting in an operating margin of 24.5%. GAAP earnings per share were $0.67. Non-GAAP earnings per share were $1.08, a 23% increase over the prior year. We are in the process of preparing our 2019 plan and will not have more definitive guidance for next year’s tax rate until after Q4. Based on what we know at this point, we currently expect our non-GAAP rate to be below our previous 19%, but higher than our 2018 rate of 13%. Operating cash flow was $63 million for the quarter, including a one-time tax payment totaling $33 million related to our 2017 repatriation of offshore cash. We ended the quarter with cash and cash equivalents of $571 million, 23% of which is onshore and total debt of $524 million.
We are committed to investing in the business to drive sustainable growth and managing our balance sheet to increase long-term shareholder value. In Q2, in addition to completing our previous $200 million ASR, we also repurchased $35 million of stock in the open market. On a trailing-12-month basis, we have returned more than 100% of our free cash flow to shareholders through buybacks. We have $490 million available on our current repurchase authorization. Black Duck, which we acquired in Q1, has been a very successful addition to our Software Integrity Group. It’s on track to meet our 2018 target of $55 million to $60 million in revenue, which reflects a purchase accounting deferred revenue haircut of about $20 million. Consistent with previous guidance, we project Black Duck to be approximately $0.12 dilutive to 2018 non-GAAP EPS and to reach breakeven in the second half of 2019. In addition, we closed two small acquisitions in the quarter that will enhance our photonic design and high-speed SerDes IP solutions.
Finally before moving on to guidance, a reminder regarding the transition from Accounting Standard Topic 605 to Topic 606, which will go into effect for us in fiscal 2019 beginning in November, because of the new rules, we do expect a loss of backlog at the time of transition. However, based on our current estimates, we expect the impact on revenue to be immaterial. The precise impact will be affected by future bookings and business transactions through the rest of the year and we will provide more definitive commentary with our fiscal 2019 guidance.
Now to the third quarter and fiscal 2018 guidance, for Q3, the targets are revenue between $760 and $785 million; total GAAP costs and expenses between $669 million and $685 million; total non-GAAP costs and expenses between $605 million and $615 million; other income and expenses between minus $3 million and minus $1 million; a non-GAAP normalized tax rate of 13%; outstanding shares between $153 million and $156 million; GAAP earnings of $0.65 to $0.75 per share; and non-GAAP earnings of $0.89 to $0.93 per share.
For 2018, the targets are revenue of $3.07 billion to $3.1 billion; other income and expenses between minus $6 million and minus $2 million; a non-GAAP normalized tax rate of 13%; outstanding shares between $153 million and $156 million; GAAP earnings of $1.66 to $1.76 per share; non-GAAP earnings of $3.76 to $3.83 per share; capital expenditures of about $110 million; and cash flow from operations of $500 million to $550 million. As we look to the remainder of fiscal 2018, you will note that our guidance implies higher revenue in Q3 than in Q4. This reflects the inherent variability associated with hardware and IP and is based on our best visibility at this point. Earnings will also be higher in the third quarter reflecting seasonally higher operating expenses in Q4.
To summarize, we delivered our strongest revenue quarter-t-date and we are on track for a record revenue and earnings year. We continued to complement our investments in our core businesses with incremental spending in our newer higher growth products to support sustainable long-term growth. Finally, we have achieved these results while maintaining our commitment to a balance of organic investment, M&A and the return of capital to deliver strong results for our shareholders.
Let me now turn it over to the operator for questions.
[Operator Instructions] And our first question from the line of Gary Mobley with Benchmark. Please go ahead.
Good afternoon, everyone. Thanks for taking my questions. Let’s just verify few things more so than anything. Your implied fiscal year ‘18 EPS guidance assumes I believe 500 basis point sequential dip in operating margin and operating margin of the year is somewhere in the neighborhood of 22% on a non-GAAP basis. And you did in fact show 600 basis point sequential dip in operating margin in the fourth quarter of last year and as you described it’s a function of seasonally weak revenue and continued increases in OpEx, so should that be the way we normally model the way your fiscal year unfolds a large sequential dip in operating margin just given the away seasonality trends?
Hi, Gary, this is Trac. For this year that’s the case. It happens to be similar to last year, but I would call that as a normal trend over time. It really depends on the quality profile of our business and so you will see variable comp or commissions accruals vary from quarter-to-quarter. As we said for this year given the revenue profile and our hiring trends and then what is an expected true-up for a variable comp in Q4, it just happens to be our lowest EPS quarter.
You mentioned that Black Duck is roughly $0.12 dilutive in the current fiscal year and just doing some calculations, it looks like it’s like 200 basis points operating margin dilutive and I am assuming there is some dilution contribution from the other two acquisitions, Silicon and Beyond and Phoenix and whatnot. Can you verify that’s approximately the amount? Can you verify that maybe operating margin in 2018 will be on par with what was in the prior year if not for the acquisition dilution?
Your calculation on the operating margin impact of Black Duck is in the right neighborhood. In addition to that, we have also made some investments in IP and EDA this year given the opportunities that we are seeing in the market. With regards to the operating margin changes from year-to-year excluding the impact of Black Duck, it would have been up marginally or marginally flattish year-over-year. We do expect to drive operating margins to the mid 20s as we stated in the past. And as although we are in the midst of planning FY ‘19 right now, we do plan on driving it up next year.
Last question, is the Software Integrity Group still on pace for roughly $260 million revenue this year?
You are in the right range.
Alright, that’s it for me. Thank you.
Our next question is from Rich Valera with Needham & Company. Please go ahead.
Thank you. Impressive increase in your annual revenue number there, $150 million, is there any other color you could give on kind of where that’s coming from I mean, is it predominantly hardware or is it a mixture of all the products? And then just sort of looking at the incremental flow-through of that to the bottom line, it looks like it’s kind of that about half of the implied corporate operating margin. So wondering what’s going on there is there some incremental dilution from the acquisitions or are you doing maybe some incremental reinvestment from some of the upside you expect to see on the top line? Thank you.
From a growth perspective, there are three things. First, it was broad across the board all businesses did very well and then I would say standing out beyond that was the IP and the hardware both did very well. It’s a little lumpy as these things occur, but at the same time I would say overall, these are healthy businesses. In terms of the ongoing management of the profitability, this has been absolutely been a year where we have made investments, we see opportunities. Black Duck of course has its own investment via M&A. And so I want to just state exactly what Trac was saying we did this on purpose knowing that we have great opportunities to grow well. And looking forward to ‘19 without giving specifics, we will pay more attention to the ops margin moving it up again.
That makes perfect sense. And then just the service and maintenance revenue line this quarter, Trac, was this pretty strong as that, was there a meaningful contribution from Black Duck in there or is that – can we kind of expect that line to stay at those levels going forward or is there any other color you could give on that? Thanks.
Yes. So the consulting services business for Software Integrity is actually doing very well. However, the quarter-on-quarter increase was largely driven by the IP business, particularly the percentage completion revenues.
Got it. That’s helpful. Thanks very much, gentlemen.
You’re welcome.
And we go next to Farhan Ahmad with Credit Suisse. Please go ahead.
Hi, this is Darren on for Farhan. My first question we kind of gone on this already a little bit, but when we look at sort of your guidance for 2018 last quarter, you basically had implied second half ‘18 of down 10% year-over-year and now we are getting par about 10% up year-over-year. Could you give us some color again on what’s changed your outlook and maybe you provide some idea of linearity across your business segments?
Yes. The starting point is that overall the businesses are doing well, so that gives us very nice baseline for the year. But what really changed this quarter was based on the strength of the business that we booked in the first half and the visibility that provided to stronger IP and hardware revenues, that’s why we are increasing the second half, but it will remain very – as those businesses grow both IP and hardware we will see more variability in the business. And what we are provided right now is our best visibility of that.
Got it. And then also sort of on the margin question again if I keep the gross margins and then sort of the SG&A flat and I see that R&D is probably where you could probably get more expenses, is it right to think that the R&D should go up in the second half, maybe up 17%, 18% when you look at half over half or should I be looking at expenses coming somewhere else in terms of diluting the margins as a seasonality?
I can’t – I haven’t looked at the year-over-year increase. I can’t quote the 72% increase that you are driving, but we should see a combination of expense increases in R&D as well as the sales and marketing line as we ramp up both hiring those areas as well as the sales and marketing line, it’s going to be a variable comp or commissions increase.
Understood. And then final question on the Black Duck and software security platform, it’s doing really well. I am curious a little bit about sort of the cross-selling aspects going forward? And then also do you see possible customers coming outside of the semiconductors in terms of just being interested in the Software Integrity platform overall? Thank you.
Well, let me start with the end. Absolutely, we are seeing growth in the customer base that we knew existed, but didn’t touch in the past. And so remember when we started in this direction with acquisition Coverity, at that point in time, it was roughly 50-50 balance between semiconductor systems on one hand and software development in areas that were certainly not in our purview. That balance has continued to shift to become broader and broader as we touch very different segments be it from oil reserves to health to financial sector as industrial you name it. And fundamentally, the problem of security vulnerabilities is really anywhere in software. And so from that perspective, we do feel that we have tapped in a broader TAM. The fact that the different acquisitions I think were well chosen because they are so nicely adjacent and supportive of each other, I think you are starting now to prove itself true. And in the middle of that, Cigital added a service component that also allowed us to engage at high-leveling companies that were frankly looking themselves as to what they should be doing and by being able to provide multiple aspects of the solution, we are more attractive, we are low risk and we have sort of the steadiness of a large company that’s going to be there for the long run. So I think it’s fair to say that there is many open questions for the future, but that all-in-all we are very happy with how this is developing.
Got it. Thank you for your time.
You’re welcome.
We have a question from Sterling Auty with JPMorgan. Please go ahead.
Yes, thanks. Hi, guys. Couple of quick questions. First, given that you mentioned Black Duck couple of times, can you just give us what was the organic growth rate in the quarter?
I am sorry, the organic business versus Black Duck?
For the company and for the whole, so what was total organic revenue growth?
Sterling, we don’t break that out.
Okay. Usually, I think about hardware as having upfront revenue recognition, so you talked about the strength in both hardware and IP helping the revenue in the second half, why is the hardware bookings in the first half spilling over? Was there an increase in lead times?
No, typically hardware, sometimes you can ship if you have inventory ready to go or if you are expecting certain orders and they indeed came in at the right time. The challenge with hardware is that it is lumpy in terms of size and it is somewhat unpredictable in terms of timing and then the shipping is on top of that a function of availability and of desire of the customer frankly too. So, all of these things is a grab bag of things that are all not quite predictable. I want to just come back to the previous question, because I think it wasn’t quite clear we understood the question. We certainly don’t want to leave the impression that the organic growth rates of the integrity business was – Software Integrity business was not very good, it was actually very good, just that we don’t break it out anymore between M&A and the res. What we have said in the past and it continues to be so is that we expect the profile of acquisitions to gradually become profitable in about an 18 to 36 month timeframe. And so that’s the other financial aspect to this and the overall growth rate of that business we have in the 20% pointish neighborhood.
Got it. And then one last one kind of following on question I think Rich asked, so based on the strength in hardware and IP and how that’s impacting the second half business. How should we think about the different revenue line items, because one of the things that we have had I think more challenges in terms of forecasting, I think the total revenue estimates have been good, you have come in and beat, but our mix of time-based license versus maintenance services etcetera, I think has been more difficult to kind of pin down and I think that’s created some noise. So any help that you can give in terms of clarity to help us on those line items would be great?
Yes, I will in general, it won’t be precise for some of the nuances of it, but in general, hardware will typically show up in upfront line. And then on the IP business two-thirds of it is going to be time-based with the third being more upfront and then time-based you will see it in the time-based line as well as the consulting and maintenance – with the services and maintenance line.
Maybe the comment I would add to that, you must have heard at least in the last six or seven earnings releases that we used the term lumpy, more difficult to predict in terms of to that effect. None of these terms are negative in regard to the business, but they do highlight a little bit to why we go into a year with a certain degree of caution in terms of how we predicted, because in general, we like to be able to deliver what we guide towards. At the same time, if you look at the evolution of Synopsys over now quite a number of years and you just look at the revenue line, you see that it’s fairly consistently going in the right direction even from quarter-to-quarter it may not be perfect or maybe little bumpy overall I think the company is in good shape.
Understood. Thank you.
You are welcome.
We go next to Jay Vleeschhouwer with Griffin Securities. Your line is open.
Thanks and good evening. Aart, let me start with hardware, in 2017 and now for the trailing 12 months it would appear that Synopsis is total hardware business based on our calculations, we are about half of the combined EDA big 3 hardware when we look at emulation and prototyping together in fact by quite a good margin on a trailing 12 basis. So when Mentor said that they were number one in emulation for Q4 that does seem to have been the case. My twofold question on that is first, what are you seeing in terms of the breadth of the hardware business which is basically a concentration question? And secondly, are you seeing more and more customers taking or with same customers taking both emulation and prototyping? So, that’s first part of the question. Thanks.
Okay. So, everything about hardware, I think the first comment is we are doing very well in this area and there is a reason for it. The reason is that the area of focus that we have zoomed in on is the intersection of hardware and software, specifically the notion of can you bring up the software, can you run the software in other words on hardware that doesn’t exist yet and therefore you use a prototype such as an emulator or FPGA board or we have some other forms of that as well. And the answer is that is a growing need because both the complexity of the hardware and delivery times and the software that’s running on the chips is demanding an earlier exercising of software and that is where we do very well. Our own sense is that yes, we have grown our market share and that we are in the lead, but Mentor does not disclose its number. So, I don’t know if they are doing something great and good for them if they do. In terms of the breadth of the product line, we have talked for quite a while about the fact that we have a verification continuum. So, the hardware pieces, emulation, HAPS boards are actually working very well in conjunction with our software tools, the simulator, the debuggers and so on. And yes, a number of customers tend to use multiple pieces and assemble them, because each one of these solutions have different characteristics, some are really good for running large amounts of software that are really good for directly interacting with real life situations, for example, the HAPS boards would be that. And in that sense, we are a very complete solution and we do see both growth in depth and in breadth and in repeat business.
Second question has to do with the next generation chips that you talked about in your prepared remarks for AI and so forth. Can you talk about any meaningful differences in terms of the consumption of your core EDA software in terms of mix and/or numbers of licenses for the next generation of chips? When you think about synthesis, power, timing, you name it versus what the leads would have been 5, 10, 15 years ago for the then-hot generations of chips, any fundamental differences in any of those kind of dimensions?
Actually, not really and this is one of the reasons we have articulated for a while that we believe there is whole wave of new opportunities is actually great for semiconductors, because the minute you can get some AI algorithm to run and do something useful, the next minute you think boy, it’s so slow, can I just make it faster? And so these chips will in no time drift forward to the most advanced Silicon Technologies. And by the way also too in a number of cases to the largest chips to be built, I mean, these are truly quite exceptional. Now, I want to quickly also say that of the many AI companies that are doing chips, they span a broad spectrum from super advanced to how quickly can we get something on the market for IoT that is using more established technologies that are narrower in their capabilities. And so I don’t think it’s actually all that different than the ways that we have seen in the past be in the computation age or in the mobility age or the networking. And there is no question that the foundries are very much focused on making sure that they continue to deliver increased transit accounts in smaller dimensions.
Lastly if I may, your press release refers to Synopsis hitting on all cylinders, which is I guess confirmation that you really are an automotive company now. When you think about the various pieces of the portfolio, can you rank the relative impact on each from automotive, in other words, you think the largest relative impact might be on, let’s say, IP or SIG or core EDA, how would you think about that?
Well, actually I can say that there are four areas that are touching it quite substantially. The design tools touch it, because the chips have to ultimately be certified on ISO 26262 and a number of those chips have some very sophisticated timing and power demands. The verification most definitely touches it and will touch it more as prototyping in the cars is going to be absolutely necessary, because the complexity is growing so fast that unless they prototype much more and that could be virtual prototyping to be really fast, they will not be able to ship the cars. The preferred areas, IP, because in these new systems, there is a lot also interface IP, there is a number of embedded processors, those two aside of having to be certified are things that people just don’t design themselves anymore, they put them in the chips. And last but not least coming from above is our Software Integrity Group, where the notion of security had a rude awakening a couple of years ago when the Jeep was hacked. And instantaneously, many decades of diligence around safety were put into question as people realized that they have sort of forgotten by the software. So in that sense they are all moving forward. Lastly, to your well-pointed clip that we are working on all cylinders, I would like to say we are working on electrification of ourselves here and so hopefully it won’t just combustion engine, but will be autonomously running the company.
Thanks, Aart.
And we will go next to Monica Garg with KeyBanc. Please go ahead.
Hi, thanks for taking my question. Aart, specifically in your comment, you kind of talk about AI application that’s kind of one example of growth, maybe talk about what kind of used cases you are seeing in the market and how much revenue we could see from these applications going forward?
Yes. I don’t think that we can be very precise on the revenue partially because we wouldn’t disclose it partially also because there are many companies that do many things and so it’s a little bit subjective, but there is no question that there is a lot of effort in a lot of chips and also that there are quite a number of companies that 3 years or 5 years ago did not exist. And that is certainly a good sign and maybe over time, some overheating of that as all of these things tend to be above all, but at the same time, I think this is going be a long bubble, because the minute a company sees that they are not in the right direction, they will get absorbed by somebody else and the investments will continue. And so if you look at the used cases, there are quite a number of companies that are going sort of in the generic AI direction essentially trying to provide capabilities that could be used in the cloud, typically a full learning, some are very visible and so you certainly would know about an NVIDIA that has done extremely well in that, but there are many others on the way. And then there is a large number of companies that are looking at the type of things that you could put on in the edge. So it’s not the learning, but the interpreting of the learned behaviors or learned characteristics and they range from all kinds of facial recognition, voice recognition, pattern recognition of course for autonomous driving and so on, but also analysis of vibration patterns to see if machines are going to brake, identification of cracks inside of pipes. I think there is going to be a lot of very interesting creativity here and I believe that as fast as this is moving we are still very much in the beginning of this major phase.
Alright, thanks. And then I have operating margin question if I look back Synopsis like 10 years numbers like in 2008, revenue was somewhere $1.3 billion, $1.4 billion and operating margins was like 23%, now fast forward 10 years, revenue has increased more than 150% to $3.1 billion, what you are guiding, but kind of margins similar to slightly lower. I guess the question is when we are seeing some significant and great growth in revenue, why we are not seeing more leverage in the margins?
That’s a very good question. And so we have always said that if we needed to do it we would push growth above ops margin, but I certainly set the price with the fact that it’s time for us to put more emphasis on the ops margin going forward. I would highlight something else though. We have been a company that has attempted and I think being successful now twice in broadening our TAM for the long-term and the first of those was in the early 2000s building the IP business, which is not a substantial part of our portfolio. And then 4 years or so ago, we decided that we would invest in what we see as a continuity from hardware into the software world and invested in the Software Integrity business throughout a number of acquisitions and also quite a bit of organic investment. And I would say that in 2018 we can say I think that has been successful. And so we are very grateful for that, because that gives us some of the opportunity to touch many, many customers that before we never have had any interaction with. It gives a different level of stability to the company in the long-term when you look at potential ups and downs in markets over many, many years. And in that sense I think it has brought an outlook to Synopsis that is more in the many years space than in the next year outlook. So in that context, your point raises the right issue, which is can we now improve the incremental improvements towards the profitability, but I would like to highlight that we are actually very happy as to where the company is now based on those investments.
Thank you so much, Aart.
You are most welcome.
[Operator Instructions] We will go next to Mitch Steves with RBC Capital Markets. Please go ahead.
Hey, guys. Thanks for your question. A few kind of small ones. I guess, I will start with the easy ones first. So just with the two quick acquisitions you guys did, is it fair to assume that didn’t contribute much to the July quarter guide meaning that it’s somewhere under 1% to the revenue line?
Yes, Mitch, this is Trac. They were immaterial to the results.
Okay, perfect. And the second one I realize that people are going to poke around a bit on the operating margin line, but am I doing this math correctly that essentially the core business is growing faster, because if I add $0.12 to your FY ‘18 guide, it looks like EPS is outpacing revenue growth, which implies that the core business is essentially expanding operating margins. Is that correct?
There is a few things in the results. If you break it out, clearly you have highlighted the Black Duck dilution. We do have the benefit of the tax rate which we knew some of that benefit to invest back in the business and we have mentioned earlier that we have seen pretty good opportunity in the IP as well as in the EDA space. And so those things are some of the drivers of the operating margins, but overall you separate all those things out, we are holding margins relatively flat year-over-year versus ‘17.
Okay, perfect. And then the last one just in terms of the chip complexity in the security side, so we are seeing more and more news about people essentially finding hardware hacks and things of that in the chips. So where exactly are you guys seeing the cross-selling? I mean is it basically the cloud vendors like Facebook or something like that or who exactly is a cross-selling opportunity for the Software Integrity plus the core EDA tools?
Well, so we are talking two different cross-selling opportunities. The first one is actually within the Software Integrity space where the quality tools, mostly coming from Coverity, and the security tools, Cigital, Black Duck and a few other acquisitions, they are starting to cross-sell quite nicely and it’s becoming increasingly a very coherent domain. And you may have heard in the preamble that we will also continue to invest in gradually building a platform where all of these tools work better and better together. The cross-selling from the software security to the hardware security is a little bit less direct, it is much more brand positioning and understanding of the topic. And there we do have a number of opportunities to focus more mostly through the IP business. In creating security within that, we have encryption tools, we have capabilities to build route of trust. And I think it will – that area will gradually grow, because yes, hackers have figured out that hardware could be vulnerable too and a lot of companies understand this and now are investing and improving their solutions. And I think that will continue for many years.
Okay, perfect. One last small one, just on the IP business, that was running below corporate average, is there any sort of kind of revenue run-rate you get to where the IP piece of the business would be essentially in line with the operating margins?
Yes, we don’t disclose the specifics. Structurally, it is certainly a bit more difficult in the IP, because IP is sort of a better cost between products and service business. There is certain amount of customization. There is a number of things that we do early on for certain customers and their statement of works and that describes a little bit how that works. But having said that, there is also no doubt that over the years we have gradually grown the ops margin nicely and actually certainly last quarter IP had a very high level of orders, actually the whole quarters was very strong from an order perspective and we see the steady state of our run-rate growing against.
Okay, perfect. Thanks so much.
You are welcome.
And I will turn it back to our speakers for closing remarks.
Well, I think at this point in time hopefully you’ve taken away that we had a strong quarter. The run-rate is up. The business is looking quite solid for the second half of this year. And you got a sense of where we are looking at in terms of results for ‘18 and also the beginning of a sense of how we are thinking about ‘19 although it will hold back on further comments until we get a little bit closer. Thank you very much for your attention and your support. And as usual we will be available for the Q&A afterwards.
Ladies and gentlemen, this will conclude our teleconference for today. Thank you for your attendance on today’s conference and for using AT&T Executive Teleconference Services. You may disconnect at this time.