Synopsys' (SNPS) CEO Aart de Geus on Q1 2016 Results - Earnings Call Transcript

| About: Synopsys, Inc. (SNPS)

Synopsys, Inc. (NASDAQ:SNPS)

Q1 2016 Earnings Conference Call

February 17, 2016 05.00 PM ET

Executives

Lisa Ewbank – Vice President-Investor Relations

Aart de Geus – Chairman and co-Chief Executive Officer

Trac Pham – Chief Financial Officer

Analysts

Krish Sankar – Bank of America Merrill Lynch

Andrew Masuda – D.A. Davidson

Darren Jue – JPMorgan

Jay Vleeschhouwer – Griffin Securities

Monika Garg – Pacific Crest

Gary Mobley – Benchmark

Srini Sundar – Summit Research

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Synopsys Earnings Conference Call for the First Quarter of Fiscal Year 2016. 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 one hour. Five 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 now like to turn the conference over to Lisa Ewbank, Vice President of Investor Relations. Please go ahead.

Lisa Ewbank

Thanks very much. Good afternoon, everyone. With us today are Aart de Geus, Chairman and Co-CEO of Synopsys; and Trac Pham, Chief Financial Officer. Before we begin, I'd like to remind everyone that during the course of this conference call, Synopsys will discuss forecasts and targets, and will make other forward-looking statements regarding the company and its financial results.

While these statements represent our best current judgment about future results and performance as of today, our actual results and performance are subject to many risks and uncertainties that could cause actual results to differ materially from what we expect. In addition to any risks that we highlight during the call, important factors that may affect our future results are described in our most recent SEC report and today's earnings press release.

The reconciliation of the non-GAAP financial measures discussed to their most directly comparable GAAP financial measures and supplemental financial information can be found in the 8-K, earnings press release, and financial supplements 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 this site at the conclusion of the call.

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

Aart de Geus

Good afternoon and thank you for joining us. Q1 was a very good start to the year. We delivered revenue of $569 million and non-GAAP earnings per share of $0.68. We entered into a $200 million accelerated share buyback program and are well on-track to meeting our revenue, EPS, and operating cash flow objectives for the year.

Trac will discuss these in more detail shortly. As most of you know well, Synopsys serves the broad Electronics industry all the way from Silicon to Software. Over the past five years this market has seen, and is seeing, dramatic changes as continued advances bring daunting complexity challenges, but also a fabulous wave of impact and business

opportunities.

Most notably, demand is expanding for mobile and cloud infrastructure to support the enormous potential of big data, which is accelerated by a wave of Internet of Things data generation. Internet of things, or IoT for short, itself is rapidly morphing into the next generation of smart everything meaning digitally intelligent devices using functions such as vision, learning, and reasoning, as we’re already seeing in assisted and autonomous driving.

The increase in complexity of these sophisticated hardware/software systems challenges the entire value chain. Whereas the race is on again along the traditional metrics of performance, power and cost, it’s also subject to growing concerns on how to deal effectively with systemic security issues.

Synopsys is uniquely focused on enabling our customers across three market segments:

Semiconductor companies, who design chips and increasingly embed software in them;

Systems companies, who develop products that incorporate chips while adding their own differentiating software; and Software developers across many industry segments, who focus on handling the increasing complexity and security of their code.

For Synopsys, “complexity” is in our DNA and we’re well equipped to enable the next generation of opportunities. Many years of investments have made us the market and technology leader in EDA; the second largest IP company in the world; and the emerging front-runner in addressing the critical new software quality and security space.

We’re consciously building our Silicon to Software market position with an objective to grow shareholder value through strong operating cash flow generation, solid revenue growth and expanding annual non-GAAP operating margins through a balanced capital allocation strategy featuring stock buybacks to maintain or shrink share count. And acquisitions to expand our SAM and TAM and through the most predictable recurring, time-based revenue model in the industry, supported by a large multi-year backlog.

Our objective thus remains to drive long-term revenue and earnings growth, while continually evolving the position of Synopsys towards the sweet spot of today’s and tomorrow’s electronics. Let me make a couple comments on the present landscape. In Semiconductors, the environment is essentially unchanged since we spoke in December.

While consolidations are a bit of a headwind for the EDA industry, as customers rationalize their combined businesses over time, Synopsys is faring quite well in these situations.

The mission critical nature and completeness of our solutions mitigate risks and our Q1 results are very encouraging. In Systems, our strong position and focus on the intersection of hardware and software have been particularly positive, and we’re seeing growth for Synopsys. For software developers, our rapidly evolving platform of quality and security solutions is getting attention, and we see increased calls to action, most notably from the security perspective.

Now to some highlights from the quarter, beginning with EDA. In Q1 we signed a significant agreement with Globalfoundries for design, verification and manufacturing tools. Synopsys is supporting their recently acquired IBM ASIC business by providing access to a full Synopsys flow, including IC Compiler II place and route and IC Validator physical verification.

In addition, a cornerstone memory supplier increased its business with us by more than 25% per year, with particular strength in analog simulation and manufacturing. Meanwhile, our next-generation physical design system, IC Compiler II, continues its rapid deployment as customers see excellent results. The solution is production proven, with nearly 150 production designs supporting 19 different silicon process nodes.

Demand is quite high as IC Compiler II continues the fastest ramp of the Synopsys product ever, with opportunity for further growth. Some visible successes include: November’s qualification of IC Compiler II by Samsung Foundry for its 10nm production work. A collaboration with Globalfoundries on the industry’s first 22nm FD-SOI process and reference flow that includes Synopsys synthesis, IC Compiler II, and signoff.

As the clear leader in advanced design tools, we are witnessing increased adoption of 16, 14, 10 and even 7nm FinFET technology. Of the 286 active FinFET designs currently being tracked, Synopsys is relied on for 95% of those chips. 100% of the 10nm and 7nm tape-outs completed thus far utilized Synopsys design tools.

Notable also is Samsung already providing 10nm qualified Synopsys physical verification run-sets. IC Validator, which works particularly well with IC Compiler II and on FinFET technologies, is seeing an increase in customer utilizing its full signoff status. We also experienced strong growth and business alignment this quarter with multiple silicon manufacturing partners in both lithography and TCAD at very advanced nodes.

Now to verification, an area where we’ve seen excellent growth as our vision is now being realized. A number of years ago, we recognized that existing verification approaches were woefully inadequate to deal with the upcoming complexity growth in hardware, and the systemic challenges of hardware and software.

We had a vision, anchored around our market-and technology leading VCS simulation, to

deliver a complete platform of interacting verification techniques which we called the Verification Continuum. This vision and its subsequent execution were right-on, and today we’re seeing excellent technical results, as well as business and market share growth.

A great example in Q1 was a major enterprise-level partnership and expanded commitment to Synopsys by one of the top mobile semiconductor companies, to drive state-of-the-art technology collaboration and broadened adoption of our solution. Both the hardware and software elements of our Verification Continuum did well this quarter.

Our emulation system, ZeBu, saw excellent growth and continues to demonstrate performance and cost advantages. In prototyping, we shipped a large number of our next-generation HAPS FPGA based systems. On the software side, our virtual prototyping solution is having solid success, particularly in the auto industry. As evidenced by a large Q1 agreement with a leading U.S. OEM, our automotive strategy is bearing fruit as the industry is massively increasing its investments towards opportunities such as Advanced Driver Assistance Systems.

We expect the verification business to do well this year. Now to our IP products, where a solid results quarter accompanied continued expansion of our already broad portfolio. Our distinct leadership in interface IP continues. This quarter we were first to market with the new USB Type C, which supports the connector that functions with either side up or down.

In Q1, we also announced our Data Fusion Subsystem for IoT devices. The many sensors on cell phones, tablets, and the like need to take data in and process it effectively. This first-of-its-kind integrated subsystem bringing together the processors, peripherals, memories, libraries and drivers necessary makes it easier, quicker, and lower risk for customers to build this functionality into their chips.

We also continue to innovate in our security IP portfolio. This quarter, we announced an enhanced security package, featuring data encryption, address scrambling, and data integrity checks aimed at providing protection from system attacks and IP theft. The theme of security naturally brings me to our Software Integrity business group. This new TAM, higher growth area is our most recent investment and holds great promise, as testing for defects and security vulnerabilities is now a necessity in virtually every market segment, ranging from automotive, to health, to energy, to financial markets.

Our objective is to provide both developers and users of software with tools to automatically check for quality and security issues, as the software is being developed or

used in larger systems. The size of this tools market is approximately $2.4 billion, highly fragmented, and growing about 20% per year.

Driven by a universe of 20 million plus software developers and a cost of failure that has gone up dramatically, particularly when human safety is at stake, this market is evolving rapidly. Last week you may have seen the President’s budget proposal, in which he asked for a 35%, $5 billion increase in the U.S. cyber security budget. Another good example is automotive, where, following some widely published hacking incidents, focused on software security and safety has become intense.

As we attract some world class experts, integrate technologies from the four software security companies acquired in last eight months, and closely collaborate with the automotive industry to help drive standardization efforts addressing cyber security, we’re garnering attention and building a strong brand in the new emerging area of software sign-off.

I hope you see from my comments that our Silicon to Software push is both well anchored and visionary. Last quarter we delivered excellent progress in virtually every area of our business. In summary Q1 was a very good start to the year, and we’re well

on-track towards meeting our annual financial targets

Our core business is solid with areas of promising growth; we continue to invest towards broadening our TAM; and our Silicon to Software vision aligns well with where the customer base is going, and opens up brand new markets.

Let me now turn the call over to Trac.

Trac Pham

Thanks, Aart. Good afternoon everyone. Q1 was an excellent start to the year. Building on the momentum from 2015, we continued to execute very well in a challenging environment.

Q1 business levels were strong. We met or exceeded all quarterly financial targets. And we returned $200 million to shareholders through our stock buyback program. With our strong Q1 performance, we remain confident in our ability to achieve 2016 revenue, earnings and cash flow objectives.

Now to the numbers: As I talk through Q1 results and 2016 targets, all comparisons will be year-over-year unless I specify otherwise. Total revenue was $569 million, with growth across all product platforms. Over 90% of revenue came from beginning of quarter backlog, and one customer accounted for more than 10% of revenue. The duration of new renewable customer license commitments averaged approximately 3.7 years, which reflects a couple of large, longer-term agreements. Duration will vary depending on customer requirements and we expect the full year 2016 to average approximately three years.

Total GAAP costs and expenses were $497 million. Total non-GAAP costs and expenses were $440 million, slightly below our target range, due largely to the timing of expenses which included some delayed hiring. Q1 non-GAAP operating margin was 22.5%, and for the year, we expect margin to increase over 2015. We will continue to drive global operational efficiency in order to expand non-GAAP operating margin to a solid mid-20s range.

GAAP earnings per share were $0.39, and non-GAAP earnings per share were $0.68, above our target range. Similar to prior years, Q1 had a net operating cash outflow. The $35 million outflow was due largely to the timing of 2015 annual incentive compensation payments. We expect this strong operating cash flow for 2016, with a target of at least $500 million.

We ended the quarter with cash, cash equivalents and short-term investments of $706 million, with 16% onshore – and total debt of $228 million. In 2016, we plan to increase buybacks to slightly reduce share count. In Q1, we initiated a $200 million ASR, which we’ll complete in Q2. There is $300 million remaining on our share repurchase authorization.

In addition, we closed a couple of small acquisitions in the software security space, adding key technology to support our strategy and drive long-term growth. DSO was 57 days, within our target range, but up from Q1 last year due to strong business levels. We ended Q1 with 10,290 employees, with more than one-third in lower-cost geographies. The increase in headcount was due to planned hiring and acquisitions.

Now to second quarter and fiscal 2016 guidance, which excludes the impact of any future acquisitions. For Q2, the targets are: revenue between $595 million and $610 million, as we communicated in December, we expect more variability and quarterly revenue due to the timing of our hardware and consulting business.

Total GAAP costs and expenses between $503 million and $522 million; total non-GAAP costs and expenses between $450 million and $460 million; other income between $0 million and $2 million. A non-GAAP normalized tax rate of 19%. Outstanding shares between 153 million and 156 million, GAAP earnings of $0.38 to $0.47 per share, and Non-GAAP earnings of $0.78 to $0.81 per share.

For 2016, revenue of $2.35 billion to $2.39 billion, other income between $0 million and $4 million, and a non-GAAP normalized tax rate of 19%. Outstanding shares between 153 million and 156 million, a reduction of 2 million shares versus our prior guidance range.

GAAP earnings of $1.64 to $1.79 per share, non-GAAP earnings of $2.93 to $3.00 per share, capital expenditures of approximately $80 million, and cash flow from operations of at least $500 million.

In summary, our priorities remain centered on managing the business to maximize long-term shareholder value; our predictable business model and strong cash profile provide a very solid financial foundation for this year and beyond and with our strong Q1 performance, we remain confident in our ability to achieve 2016 revenue, earnings and cash flow objectives.

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

Question-and-Answer Session

Operator

[Operator Instructions] And first, we will go to the line of Krish Sankar with Bank of America Merrill Lynch.

Krish Sankar

Hi thanks for taking my question I actually joined a little late. The first question was Aart the Globalfoundries customers you mentioned, is it a new win or is it an existing customer what kind of margin profile do you expect for that business?

Aart de Geus

Krish if you don’t mind we never call into about specifics about a customer. But Globalfoundries be it through the Globalfoundries side or the IBM side were customers before and I can only say that we are very pleased with the results and the support from Globalfoundries. It has worked very well.

Krish Sankar

Got you, no worries. The second question I had was you know obviously you guys spoke about it last earnings call there have been a lot of chatter around impact about semi M&A on R&D? Kind of curious, have you actually started seeing any impact or what are your customers telegraphing to you either those that just finished the acquisition or those that are in the process of getting acquired?

Aart de Geus

So Krish, sorry you missed a little bit at the beginning. I tried to explain that we have really three customer categories the semiconductor ones the system houses and the software companies. When we are talking about consolidation in the semiconductor industry we are mostly talking about literally semiconductor companies, people that design chips, maybe embedding a lot of software, but nonetheless, are centered there.

And of course a number of the consolidations that occurred or that got started in the last 18 months have meanwhile progressed and closed in some cases, and we are engaged with all of these companies. As I mentioned in the preamble, we are very encouraged by the results that we have gotten, that we are faring quite well with this.

And I think one of the reasons is that as companies look for becoming more efficient, they also often rethink which suppliers they want to work with and how they want to work with them. And given both our vision from hardware towards software and our ability to deliver a very broad I think well-honed set of platforms, we are not only a leader in helping them differentiate themselves in technology, but also far and away the lowest risk. And so we have fared well with this.

Krish Sankar

Thanks, Aart. And just a final question either for you or Trac, you guys have done a great job in execution and, talking about a mid-20s operating margin profile. I'm kind of curious, is this a business that can be a 30% operating margin business, driven by any kind of like levers you can pull on the OpEx side? Or is this a business where Op margin expansion is just purely a function of drop-through from the top line?

Trac Pham

Well, Krish, I would emphasize we're focused on driving high single-digit EPS growth sustainably. I think reality is getting to a 30% ops margin. You can do it for a short-term, but not sustainably over time. The nature of our business is pretty technical. Long-term, though, to drive high single-digit EPS growth sustainably, it's really going to come through a combination of driving top line growth and margin expansion. And the benefit we have in terms of trying to grow margins, we'll really be looking at how we balance the portfolio between core EDA, IP, and software integrity.

And also as we look across our functional grids, whether that's R&D sales and marketing and G&A. I think typically you’ve referred to the 30 – folks will look at R&D spend, but from our side, we'll increase margins either from driving that top line or balancing our resources.

Krish Sankar

Okay. Thanks, Trac. Thanks, Aart.

Operator

And next we’ll go to the line of Tom Diffely with D.A. Davidson.

Andrew Masuda

Yes, it's Andrew Masuda asking a question on behalf of Tom. First one for Aart, just on the IP business, could you maybe update us on the percentage of IP that is outsourced today and, where do you see it going over the next year or two?

Aart de Geus

Well. First, it’s actually a difficult question to answer, because the definition of IP that's outsourcable has grown dramatically in the last few years.

For those that have followed us for many years, you recall that at some point in time we were proud to provide an adder and simple things like that. Today we are absolutely driving the state of the art of building blocks in terms of both complexity and some of the advanced [indiscernible] USBs and other interfaces are not only very complex on their own. They are also extremely complex as you put them into brand-new silicon technology, such as 10-nanometer or fin set.

We ourselves think that at best, 50% or so has been outsourced. I just want to give the honest caveat that it’s a little bit hard to estimate. But as a little side note the evolution in the market that we see both through some of the consolidations, but also through this move towards providing much more differentiation through the combination of hardware and software, makes a number of customers focus on the higher levels of abstraction. Meaning more and more of the software, and therefore an increased tendency to delegate or to outsource the hardware IP and we are in a certainly a very good position to benefit from that.

Andrew Masuda

Great. Thank you. And then next question is for Trac. Could you maybe just talk about your expectations on the linearity for operating cash flow as we move throughout the year?

Trac Pham

Operating cash flow. Let me describe the P&L and maybe that can help you. You probably expect that the second half revenues will be a little higher than the first half. Same thing with expenses, with EPS ramping up weighted towards second half. Lisa later on can probably give you more details in the after calls.

Andrew Masuda

Great. Thank you.

Trac Pham

You’re welcome.

Operator

And next we’ll go to the line of Sterling Auty with JPMorgan.

Darren Jue

Hi. It’s Darren is here on for Sterling. Thanks for taking the question. Just wondering about those large deals that drove the contract duration higher. Was there any sort of unusual level of discounting that had to be extended to get those customers to sign the long-term deals? Or was it sort of their desire to sign the longer term deals?

Aart de Geus

Well, the reason customers sign long-term deals is maybe financial, but in most cases it’s really because one is looking at a collaborative partnership that has the potential to create additional differentiating value for the customer. And over the years from time-to-time we have done very engaging – build very engaging relationships that have demonstrated that working closely together cannot only impact the way our tools are used presently, but also hone it for the specific situation that the customer has. And so although of course when you do a multi-year deal, you always make sure that it is balanced for both parties. You also make sure that one creates something that is beyond what would be just a customer supplier relationship.

Trac Pham

Darren this is Trac. I would stress that not only were the deals large, but they were quality deals. We did see run rate grow in Q1.

Darren Jue

Okay. And maybe just one other question for you, Trac. At least based on our model, looked like most of the upside in the quarter in terms of EPS actually came from the gross margin line. I was wondering if you could just talk about what drove that.

Trac Pham

Yes, the overachieve on EPS is really expense story. We were light on expenses. Typically we started the year behind in hiring and this year was probably more, more in common with that. We'll be catching – we'll try to catch up on our hiring for the rest of the year. If you look at our head count, it was pretty flattish versus the end of the year. That's where the upside came from.

Darren Jue

Okay. All right, thanks.

Operator

And next we’ll go to the line of Jay Vleeschhouwer with Griffin Securities.

Jay Vleeschhouwer

Yes, thank you. And couple of questions, Aart, about how your business is evolving and the end market and start with the most popular question, of course, having to do with consolidation. So it sounds as though so far it hasn't had an adverse effect on you in terms of post merger, budgeting versus premerger budgeting. The longer-term question is for you. Do you think that the concentration of your customer base, the top 10 or 20 will be up, down or sideways over time, at least in the core business? Do you think the top 10 to 20 will continue to account for half or more of your revenues, even taking into account some post merger cutting among some of your large customers? And couple other questions.

Aart de Geus

Well, by definition, when you have consolidation, that means that some customers are becoming larger, assuming that you continue the business relationship, which we have. And so I think that is not a new phenomenon and that will continue. At the same time, I've always been a believer that in times of consolidation, you can't look at it as a maturation of a market, or you can look at it as the beginning of a next phase. And the reason we're emphasizing and we're investing along the lines of working with both semiconductor systems and software developers is precisely, because we see an evolution in the market that we will continue to emphasize this increased role of the intersection between software and hardware.

And so we are well positioned for that. Obviously, on the hardware side, we go as deep as anybody down into the silicon. On the software side, we have put down new gamuts in the software sign-off, software integrity space.

And then in the middle, we have a large business that deals with the intersection of those two, be it in verification or even some in the IP side. So I think we're well balanced and I tried to express that by saying we're trying to sort of follow the sweet spot of the industry. And in that context, of course, the players do change over time. But I think we're – we have solid roots down and I think good opportunities looking up.

Jay Vleeschhouwer

With respect to the IP business, you said yourself that in the early days, the technology was, that you offered was fairly primitive compared to what you do now. But it's always been the case that IP has been a fairly fragmented business. In other words, lots of different categories, which historically had made it hard to scale as far as margins were concerned. You've done better over the years now with margins, but my question is, particularly now in having to meet the needs of the new IoT markets, your new automotive strategy, et cetera. Could you foresee that the portfolio for IP becomes even more fragmented again and if it is so, how might that affect your cost structure or the margin profile going forward in IP?

Aart de Geus

Well, I think it's a good question, although I must say we never use the word fragmented about our own position because we see it as broad. Meaning that having more products available, more IP titles is actually a good thing, given that it is relatively costly to build up the channel that is capable of both selling and supporting this. Secondly, given that it's important to build good relationships with the customers and if the trust the IP1 delivers, they are more likely to come back for other things. And so in that context, I hope that we will continue to actually broaden the portfolio.

But I also would say that we are deepening the portfolio because maybe to be more to the point, the difference between a USB 1, a USB 2, a USB 3 and now a 3.1 and a USBC are quite remarkable just in terms of the capabilities that go into that part. And then on top of that, you layer the evolution on the silicon side from I forgot when we started this, probably by 65-nanometer or so, and then down to 40, 28, 16, 14, 10, and now 7. That is a substantial evolution in terms of the complexity of what we deliver. And so all the more is a trust relationship, an execution relationship with customers essential. So if we can broaden it even more, that is good. But we also partner very well with some other key providers and our objective is to make sure that our customers are successful with this way of doing design. So far, I think it's proven to be true.

Jay Vleeschhouwer

One more for you, if I may, on strategy and then wrap up with Trac on Q1. So you've become quite enthused now about the automotive opportunity and the question there is how you see yourself positioned for that. In other words, do you think your play is largely at the IP and software integrity level, or do you think you can and should move up the supply chain into the automotive systems suppliers themselves, or even up into the OEM level that car companies themselves, as Mentor has done, for example, in some cases.

Lastly for Trac, for Q1, would it be fair to say that the substantial sequential increase in your IP business was correlated to the unusually large sequential increase in the Asia-Pac business? And then on the other hand, was your decline from Q4 North America largely correlated to a sequential decline in emulation? Thanks.

Aart de Geus

So let me start with your automotive question. The first reason why, of course, automotive is in so many discussions is because somewhat surprisingly so, almost overnight it has turned into the poster child of what digital intelligence can do. And this, I say surprisingly so, because automotive in the past has been a relatively slow adopter of silicon technology for many good reasons, because safety was absolutely paramount. And so it demanded a lot of very specific long-term design. I think this is changing radically, meaning that suddenly automotive is now on the clock tick of Silicon Valley, so to speak, of software combined with most advanced silicon. And therefore, many of the capabilities and tools and IP that we provide is front and center.

Now, to your specific question of our position in automotive, we have a remarkably complete set of capabilities that is well vested in a number of automotive-specific techniques, such as making sure that the chips are designed with proveable safety and verifiability in mind. So in that context, we I think are very well positioned and very engaged at by the way, all the levels that you mentioned. So semiconductor companies, Tier 1s, even some automotive companies specifically. I don’t want to go overboard with the enthusiasm here either. It’s an industry that doesn’t ship as many cars as their cell phones. So the numbers are somewhat moderated by that. But it is an industry that suddenly has caught the bug of how do they differentiate themselves in this new space and I think the race is very much on.

Trac Pham

So Jay, this is Trac. Your question regarding the geographic growth and the product growth, I wouldn’t read into any correlation between other geographic growth and product growth. We see both emulation and IP as growth areas for us long-term and that's pretty broad-based. We're not expecting that necessarily comes from any one geography. It would be broad-based growth.

Jay Vleeschhouwer

Right, but I was asking specifically if that was the case, however, in Q4 to Q1.

Trac Pham

In emulation, that would be partly the case, whether it's quarter on quarter, yes.

Jay Vleeschhouwer

Okay. Thanks very much.

Aart de Geus

You're welcome.

Operator

[Operator Instructions] And next we'll go to the line of Monika Garg with Pacific Crest.

Monika Garg

Hi, thanks for taking my question. I – First I have a follow-up on the questions he asked earlier. If you look at your closest feared Cadence they posted north of 26 points operating margin last year and we could see them going to at least 27 points in one or two years. Since you are still talking about mid-25% margins, my question is to understand it's not 30% of margin business, but could Synopsys be between 25 to 30 points.

Aart de Geus

Monika, we have said for a while that where we are heading is toward the mid-20s. So these numbers are all in that space. At the same time, one of the things that we decided to do a couple of years ago is to invest specifically in a new emerging area. And we did that with the belief and understanding that a lot of functionality would move into software, that the software was quickly going to reach the issue of complexity and then security issues that would become enormous, and we continued to invest in that. Of course such an area initially is not particularly profitable. But it has potential.

Secondly, we have seen that the investments that we've made recently through some of the acquisitions initially bring about a small hair cut and those are the small differences that would make up or explain what you were mentioning. Be it as it may, our objective is very clear. Our objective has always been how do we deliver shareholder value over the long-term with a fairly consistent pattern so the intent is not to surprise anybody, but at the same time, to also not be hesitant to put our chips down if we see some opportunity. And that is exactly what we are continuing to do. You have noticed that in the last couple of years we have not been hesitant to also utilize our balance sheet towards buybacks, as we found them to be appropriate and have done so again this quarter. So the balance of those things is how we're managing the company.

Monika Garg

Got it. Aart and then as a follow-up, how big do you think emulation market can become? And how are you thinking about growth of your emulation business this year?

Aart de Geus

Well, you know, the emulation business is difficult to characterize because they are multiple players with multiple sort of cycles of product and there is some degree of – I wouldn't say seasonality as just things go up and down from one quarter to another because it's somewhat lumpy. Lumpy was the word I was looking for. Having said that, the reason that we are bullish around emulation is actually a broader one, which is that we are strong advocates and we think we strongly deliver around a vision of a verification continuum that allows to use emulation in the context of many other tools as appropriate for the task at hand.

And without going too technically deep here, the reason this is important is because we are dealing with a space that goes all the way from verifying strictly some hardware to verifying some chips with embedded software all the way to people wanting to bring up entire operating systems and some application software on hardware that has not yet been built. And so in that context, the, the collection of technologies assembled in a platform that we have is truly quite amazing compared to where we were just five or six years ago. And we have seen that the take-up in system companies that are now hitting this intersection has been particularly positive and that was visible in some of the Q1 growth.

Monika Garg

Got it. The last one for Trac, Trac, at the midpoint you beat Q1 by almost $0.06 EPS and why not raise the yearly EPS guidance?

Trac Pham

Well, as mentioned, the overachievement was mostly on light expenses and, you know, most of that's timing, still early in the year. We are definitely focused on the full year, full-year EPS targets. At this point, we feel pretty good about the guidance.

Monika Garg

Got it. Thank you, so much.

Trac Pham

Thank you.

Operator

And next we'll go to the line of Gary Mobley with Benchmark.

Gary Mobley

Hi. Guys. Thanks for taking my question. Most of my questions have been asked and answered, but I did just have one question about the M&A environment. Given the equity Capital Markets turbulence and maybe some economic softness, more broad, has it become a buyer's market for cash-rich companies like you in what has been sort of a consolidation strategy?

And in other words, are you seeing more companies being shopped to you that are perhaps a good strategic fit, are companies potential acquisition targets more amenable to price terms and considering the answer to that, do you feel the best use of cash might be to decelerate M&A pace or stay on the same cash return strategy or like some dividends and share buybacks?

Aart de Geus

Okay, well, Gary, you probably know that we never respond to specific M&A questions. But in general terms, if you watch Synopsys, we have found a balance between using repurchase mechanisms and M&A as the two ways to leverage our balance sheet. When we look at M&A, invariably it's driven by two things. Either a mechanism to increase the strength of our SAM, meaning purchase companies that have either technology or market position that we think we can do better with or that strengthens our position, or just as importantly, maybe even more important is opportunities to create new TAM for us. And so in that sense, the last 18 months have been interesting because we've done a number of acquisitions, starting with a company in the software quality space.

And the reason that one was important is because that is the fundamental platform to analyze software. And then just in the last I think eight months or nine months or so, we've acquired four security companies that can all pretty swiftly be integrated into the overall software analysis platform. And so these are all good examples of how we utilize our cash on an ongoing basis.

Now, are there waves of these? Yes, they are. Sometimes they are driven by the state of the market. But in general, I would tell you that many of these things are often on the radar scope for many years and the moment has to just be right to be able to acquire something both from a seller point of view and a buyer point of view. And there's quite a bit of dating that goes around before marriage. So in that sense, we're always busy.

Gary Mobley

Understood. Appreciate the response. Thank you.

Operator

And next we’ll go to line of Srini Sundar with Summit Research.

Srini Sundar

Hi guys, thanks for taking my call. First question is on the mid-20% operating margin that others have also explored. My question is what do you propose will be the timing and how exactly will you achieve it? Meaning will it come from the gross margin line or R&D or a G&A? So if you could…

Aart de Geus

Sure. Well, in general, as Trac alluded to, at the end of the day, revenue growth is the single-best recipe to grow margins, and in that sense, we are heading there. And as mentioned, based on some of the past acquisitions and recent investments, we see that the haircuts will gradually fade away and our continued growth and diligent expense management will get us there. So to me the issue is not can we get there or not. Yes, we will. And we have been committed to that for quite a while.

Srini Sundar

Okay. And my next question is if you go down in the dimensions of the nodes, the number of products that the foundries, that the foundries will design will be reduced. So, for the industry as a whole right now, semiconductors form the bulk of the revenues. So maybe by 2020, what kind of revenue percentage will come from the difference, do you think?

Aart de Geus

Well, in general, I would observe two things. The most advanced nodes by definition are always the ones that get adopted by the people that have both the skills to use them, but most importantly, have the business opportunity to leverage differentiation of faster, much more dense, lower power chips. Initially, that is invariably a small number, as the foundries themselves hone these processes to gradually grow the yields, meaning bring down the cost per chip. The most advanced design companies spend most money because they have an economic return on that differentiation.

If you look back at only three years or four years, the belief was that FinFET would be the reality for only three or four companies. Well, that is most definitely not the case. We are seeing actually a rapid increase now, as the proof points of solid FinFET technology are there by a broader set of companies. And interestingly enough, a set of companies that one would never have thought about in the past, the automotive companies, are suddenly interested here as well, as they want to introduce digital intelligence in their products. So I think the push will continue, which is not to say that it gets easier or much cheaper, but the value of differentiation is quite high and we will continue to work with those most advanced customers.

But as said, we also work equally much with the system houses that integrate these chips and each would have an understanding of the insides of the chip and the software that runs on it. So it's actually a fairly broad field of companies that we touch that are deeply involved with FinFET.

Srini Sundar

Just one last question, your service revenues for Q1 seem to be the lowest among the last nine quarters. Any particular reason for that?

Aart de Geus

The services line? It's right in the range, Srini, so when you look at the services line, it's a relatively flat at 61 versus the last quarter. And the nature of that business, that's where a lot of our IP consulting business does flow through. So it can move around quarter-to-quarter depending on the revenue signature and the project schedules.

Srini Sundar

Okay. Thank you very much for taking my questions. Thanks.

Aart de Geus

You’re welcome.

Operator

And there is no one left in queue to ask a question. I would like to turn it back to the speakers for any closing remarks.

Aart de Geus

Well, again, thank you very much for attending our earnings release. I think the first quarter was particularly positive as a start to the year and I think many of the issues that were alluded to last year actually quite mitigated. And so we have a strong outlook going forward. Thank you again for your time and we'll be available after the call for the analysts.

Operator

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

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