新思科技 (SNPS) 2014 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to Synopsys' earning conference call for the first quarter of FY14.

(Operator Instructions)

As a reminder, today's conference is being recorded.

I'd now like to turn the conference over to Lisa Ewbank, Vice President of Investor Relations.

Please go ahead.

Thank you very much.

Good afternoon, everyone.

With us on the call today are Aart de Geus, Chairman and Co-CEO of Synopsys; and Brian Beattie, Chief Financial Officer.

Today's conference call will include commentary regarding our Q1 fiscal 2014 results, and also the definitive agreement to acquire Coverity, both of which we announced this afternoon.

Before we begin, I would 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, our expectations about the timing and likelihood of closing the acquisition, and about the potential benefits of a combination.

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 this call, important factors that may affect our future results are described in our most recent annual report on Form 10-K, today's earnings press release and our press release announcing the definitive agreement to acquire Coverity.

All financial information to be discussed on this conference call, the reconciliation of the non-GAAP financial measures to their most directly comparable GAAP financial measures.

And supplemental financial information can be found in the 8-K, the earnings press release and the financial supplement that we released today.

All of these items are currently available on our website at www.synopsys.com.

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

Good afternoon, and thank you for joining us.

I am happy to report that we began fiscal 2014 with a strong Q1.

We met or meet every target we communicated last quarter.

We made excellent progress preparing for a number of important product announcements over the next couple of months.

And half an hour ago, we announced Synopsys' entry into the software quality testing and security tools market through the acquisition of Coverity.

Before introducing you to this major move, let me first summarize our results.

We delivered revenue of $479 million and non-GAAP earnings per share of $0.59.

For the year, we're tuning guidance on the revenue side, raising operating margin and reiterating our non-GAAP earnings per share targets.

Our guidance excludes any impact of the Coverity acquisition.

Looking at the semiconductor landscape around us, there is remarkably little change in our customers' cautious behavior.

While there are clearly a number of companies that are new doing noticeably better than others, on average, the various confidence metrics continue to show uncertainty, while technology advances continue unabated.

These economic and technical challenges drive companies to be cautious in their spending, demanding in their needs, and in some cases, to consolidate their businesses with others for efficiency and market position.

While none of these pressures are new, the length of this period of uncertainty is notable in the light of the continued intense drive for state-of-the-art design to meet unforgiving market windows.

Fortunately for Synopsys, the technical and time-to-market pressures make great EDA and IP solutions absolutely essential for success.

In Q1 we were the beneficiary of this trend, with one of the top global fabless companies increasing its spending with us through a substantial broadening of products and options.

Which brings me to some highlights, starting with core EDA.

From a technology perspective, our leadership in advanced designs, including FinFET transistors, is evident.

As we have often reported, we track the first 450 to 500 designs of each emerging process node.

This quarter we see 2022 nanometer designs increasing somewhat, and a definite acceleration of activities at 14/16 nanometer, driven by the quest for substantial performance, low power and area benefit.

Our design platform is relied on for nearly 9% of the 2022 nanometer and below project.

This is not by accident, as our TCAD CD simulation of process and transistor devices is used well-ahead of these technologies becoming available to the design community.

This early modeling information, an increasingly comprehensive collection of IP ranging from logic libraries to memory blocks to advanced interfaces, and a complete set of digital and analog mixed-signal design tools make Synopsys the solution of choice for FinFET design.

Indeed, through our customers we see how FinFET-based chips will impact a growing number of products entering the market in late 2014, and significantly, in 2015.

This rapid advance in chip complexity brings enormous challenges to designers, but also to the core design tools.

Please stay tuned this quarter for Synopsys to launch a major new capability in design tools.

The outcome of many years of work, we have demonstrated excellent results with early partners.

And I am looking forward to discussing the impact later in the quarter.

Moving to verification, we see an even bigger need for solution breadth and productivity increases.

Be it in simulation, emulation, prototyping, verification IP or debugging, the complexity challenge is growing faster than Moore's Law.

With approximately 70% of advanced digital designs counting on Synopsys tools, and virtually all of the top semiconductor companies relying on our analog circuit simulation, we are driving a very promising solution.

Over the last 12 months, we've made excellent progress towards building our next-generation verification platform, based on both organic development and acquired technology.

This quarter we intend to roll out our long-term verification vision, introduce two major new products, and to deliver a unique set of productivity improvements resulting from our massive integration investment.

Now to IP and systems, where demand is strong.

In Q1, we launched a number of new products, including an ultra low-power non-volatile memory for Internet of things applications.

And the multi-protocol 12-gig series for the data center market.

In the ultra high-definition TV space, Realtek, Synopsys, and UMC announced first-pass silicon success of an award-winning chip utilizing Synopsys IP tools and professional services.

Meanwhile, our customers continue to adopt our USB solutions, which are now shipping in many millions of chips.

For example, Microsoft uses our USB 3.0 IP in the Xbox One Game console.

In an industry first, we also demonstrated the next-generation USB 3.1 controller at CES in Las Vegas.

It delivers end-to-end transfers of 10 gigabits per second.

This is twice the data rate of USB 3.0.

Our customers will be designing the new USB standard into products over the next year.

And as contributors to the development of the spec, we already have IP ready to go at these early stages.

As mentioned earlier, our FinFET footprint is rapidly widening, with releases of key FinFET optimized IP titles at several foundry processes.

As we grow in IP, customers are signing up for larger and more wide-ranging agreements, and several that include some technologies still in development.

Because of this, as well as the timing of orders in 2014, we are seeing a slightly different profile than planned of how and when IP bookings translate to revenue.

This results in a small amount of 2014 revenue now being scheduled in 2015.

And while our annual bookings plan remains unchanged, we're tuning our 2014 revenue outlook slightly down.

Consequently, we will drive ops margins slightly higher, and maintain non-GAAP EPS guidance.

For a multi-year perspective, we continue to see IP and systems as a low double-digit growth space.

On the systems side of this business, our SPG-based and virtual prototyping products did particularly well during the quarter.

While rewarding, this is not a surprise, as many of our customers are significantly increasing their focus on the simultaneous development and verification of hardware and software.

Which naturally brings me to the very important announcement we made today: Synopsys is entering the emerging software quality test and security market.

While this market is directly adjacent to our present position, it simultaneously extends to customers that Synopsys had no interaction with in the past.

Today we announced that we have signed a definitive agreement to acquire Coverity, the leading provider of software quality testing and security tools.

The $375 million transaction, which is approximately $350 million net of their cash, will be funded with a combination of US cash and debt.

Subject to HSR regulatory review and other customary conditions, we expect to close the transaction in our fiscal Q2.

Coverity fits well with the Synopsys high-tech customer offset DNA.

Its 300 employees have built a solid business, with 2013 revenue of approximately $75 million and a recurring revenue model, and an average growth rate of 20% per year.

The acquisition is important for two reasons.

First, it's a natural adjacency and expansion of our total addressable market within our existing customers that are seeing growing amounts of software embedded in their products.

And an ever-increasing number of engineers dedicated to that task.

Second, the market for software quality extends well beyond the semiconductor industry to all software developers and all industries, thus opening a long-term growth opportunity beyond our existing customer base in a fast growing market we don't address today.

Let me quantify the opportunity.

IDC today places Coverity as the number one in the software quality analysis and measurement market segments, currently at approximately $500 million, with estimated 2017 market revenue of nearly $1 billion.

We believe the increasingly complex development and deployment environments, including mobile, cloud and embedded, could drive did the CAGR to 20% or more in the next few years.

As we've discussed previously, today's electronics are differentiated by a combination of chip design and, increasingly, software.

Semiconductor companies today typically hire more software than hardware engineers.

And the importance of software goes well beyond the semiconductor space.

With more than 6 million professional software developers in the world writing at least 60 million lines of code every day, productivity, quality and the security tools serve a rapidly growing market.

Traditional techniques for testing code, many of which have not changed for decades, are no longer sufficient.

In that regard, Coverity is a leader in a new age of the software development tools.

The company spun out of a Stanford research project 10 years ago, pioneered a disruptive technology that find defects by inspecting the code itself rather than running the code and waiting for a box to appear.

This allows developers to fix quality or security defects early in the process.

Since early fixes are relatively cheap compared to discovering defects in final quality assurance, or even worse, shipping defective software, the economic benefit of this technology spans costs, quality and end-products and time-to-market.

Coverity has built an impressive customer base.

Large global companies, such as Adobe, SAP, Samsung Electronics, Citrix, Deso Systems, Panasonic, Raytheon, Expedia, and Compaq use Coverity today.

Its customer base of more than 1,000 includes 9 of the top 10 software companies, 8 of the top 10 global brands, 6 of the top 10 semiconductor companies, and 7 of the top 10 aerospace and defense companies.

As a matter of fact, Synopsys itself has been a Coverity customer for almost a decade.

And for the past several years, we have mandated that Coverity be run on all of our software.

Bringing the two companies together has the potential to create incremental revenue opportunities in a couple of ways.

One, through increased sales to current Synopsys semiconductor and system customers.

While these customer logos overlap, Coverity tools are sold to different buyers and different budgets.

Two, using Synopsys' broader reach and brands to increase penetration in industry new it to Synopsys, and where Coverity has only begun to serve: application software, financial services, banking and trading platforms, government services and basically any industry using software to power their operations.

In addition, we see a pathway to expanding even further into this space and building a substantial presence over the years, similar to what we did first with EDA, then IP.

Coverity it will be managed by John Chilton, one of our most senior executives, who is well-known to many of our investors.

And who built our IP organization from the early stages.

We will integrate Coverity carefully into Synopsys, taking advantage of opportunities to leverage Synopsys' reach, while utilizing the already-successful practices and perspective of the Coverity team.

In summary, we delivered strong results in Q1.

During Q2 and through the next 12 months, we'll be launching compelling new technology in both core design and verification.

And we're excited to embark on a new journey as we completed the acquisition of Coverity.

I'll now turn the call over to Brian Beattie.

Well, thank you, Aart, and good afternoon, everyone.

In my comments today I will summarize our financial results for the quarter, provide you with our guidance for Q2 and the full year of 2014, and provide some financial details of the Coverity transaction.

In my discussions, all of my comparisons will be year over year unless I specify otherwise.

Now, as Aart highlighted, in the quarter we continued to execute well, meeting or exceeding all of the quarterly financial targets that we provided in December.

In addition, business levels were strong.

We repurchased $55 million worth of Synopsys stock, and our balance sheet remains healthy.

Total revenue increased slightly to $479 million, well within our target range.

About 90% of Q1 revenue came from beginning-of-quarter backlog.

And one customer accounted for just over 11% of first-quarter revenue.

The weighted-average duration of our renewable customer license commitments for the quarter was about 2.6 years.

We continue to expect average duration for FY14 to be approximately 3 years.

Now turning to expenses, Q1 total GAAP cost and expenses were $419 million, which included $28 million of amortization of intangible assets, and $18 million of stock-based compensation.

Q1 total non-GAAP costs and expenses were $370 million, down 6% sequentially, and slightly below our target range, driven primarily by timing of quarterly expenses, including some delay of hiring, along with overall cost control.

Non-GAAP operating margin was 23% for the quarter.

For all of FY14, we currently expect non-GAAP operating margin to increase over FY13 levels by about 100 basis points.

We continue to focus on operational efficiency.

And this year we will adjust our planned expense level slightly to achieve our targeted FY14 non-GAAP earnings.

Turning now to earnings, GAAP earnings per share were $0.43.

Non-GAAP earnings per share were $0.59, which was above our target range.

So now looking at our cash flow, as expected, there was a Q1 net operating cash outflow of $74 million, due primarily to the timing of our prior-year annual incentive compensation payments.

We continue to target operating cash flow of $425 million to $450 million in FY14.

We repaid $7.5 million of our outstanding term loan, leaving a remaining balance of $98 million.

During the quarter, we purchased about 1.4 million shares of Synopsys stock for $55 million.

And we have approximately $445 million remaining on our current share repurchase authorization.

As a result, we ended the quarter with cash and cash equivalents of $893 million, with 32% onshore and 68% offshore.

DSO was 47 days, and we ended Q1 with approximately 8,690 employees, with about one-third in lower-cost geographies.

Now, turning to the Coverity acquisition.

As Aart mentioned, we anticipate funding the acquisition with a combination of US cash and debt, the specifics of which will be determined over the next several weeks leading up to the close.

Coverity generated approximately $75 million of revenue in 2013, is roughly breakeven on a non-GAAP basis, and is slightly cash flow positive.

While we will not update our specific guidance until after we close the transaction, at this point, we would expect its revenue contribution to be approximately $20 million to $25 million in 2014, and increase substantially in 2015 as we work through the deferred revenue haircut.

Our aspiration is to grow revenue in this space to more than $100 million over the next two years.

Now, due primarily to the impact of purchase accounting and the associated deferred revenue haircut, we expect the acquisition to be approximately $0.10 dilutive on a non-GAAP basis in FY14, reach breakeven in the second half of 2015 and be accretive in 2016.

Without the impact of the deferred revenue haircut, we would expect that the acquisition would be accretive in 2014 and beyond.

So now let's address our second-quarter and FY14 guidance.

Now, none of this guidance includes the impact of the agreement we announced today to purchase Coverity.

After the acquisition closes, which we expect to occur in our second quarter, we intend to provide updated guidance.

So for the second quarter of FY14 our targets are revenue: between $505 million and $515 million.

Recall that there is increased variability in quarterly revenue, driven by factors such as sales volatility and emulation and prototyping hardware, which generates up-front revenue, timing of IP-consulting projects and royalties, and certain contracts where revenue is recognized when customer installment payments are due.

We continue to expect a revenue model that's approximately 90% time-based: total GAAP costs and expenses between $422 million and $444 million, which includes approximately $19 million of stock-based compensation expense; total non-GAAP cost and expenses between $377 million and $387 million; other income and expense: between zero and $1 million; and non-GAAP tax rate of approximately 24%.

Outstanding shares between 155 million and 159 million; GAAP earnings of $0.33 to $0.41 per share; and non-GAAP earnings of $0.60 to $0.62 per share.

Now, our fiscal 2014 outlook, again, excluding the impact of Coverity: revenue of $2.03 million to $2.065 billion, which reflects the timing and profile of IP revenue that Aart mentioned; other income and expense: between $8 million and $11 million; a non-GAAP tax rate of approximately 24%; outstanding shares between 155 million and 159 million; GAAP earnings-per-share of $1.72 to $1.83, which includes the impact of approximately $77 million in stock-based compensation expense.

We are reiterating non-GAAP earnings per share of $2.55 to $2.60.

Capital expenditures of approximately $130 million.

And we continue to target cash flow from operations of $425 million to $450 million.

And finally, to assist in your modeling, second-half revenue is expected to be a bit higher than our first-half revenue, with Q4 higher than both Q2 and Q3, which were similar.

And at this point, we expect total non-GAAP expenses to be skewed slightly towards the second half of the year.

So in summary, we have achieved another quarter of solid financial performance and execution.

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

(Operator Instructions)

Rich Valera, Needham & Company.

Congratulations on the transaction.

Thank you Rich.

First just wanted to clarify in terms of the expectations for Coverity, ex any deferred rev rec.

So you had a $75 million baseline, it sounds like, in 2013.

So ex deferred revenue effects, you would have expected that revenue to be about 20% higher in 2014?

Is that an accurate statement?

No.

We are not giving what the estimate -- we're just saying, based on not having the deferred revenue haircut and looking back at what 2013 looked like, it would be accretive if we didn't have to do a pretty significant typical deferred revenue haircut.

The key there, Rich, is that there is about $75 million of deferred revenue that we will anticipate acquiring when the deal is approved.

And again, just very typical deferred revenue haircut.

We think it would be close to about 80% of that would be lost in the accounting treatment.

So we just wanted to highlight that if we didn't do that, we would be actually in breakeven immediately for 2014.

Great.

And you mentioned it was a recurring revenue model.

Is this a SaaS-like model?

Or is it more the typical subscription that you currently do with your customers?

It's more the typical subscription license model.

Got you.

Very similar to ours as well.

Got you.

And just trying to think about how you are thinking about this from a synergy perspective, Aart.

As you mentioned, a lot of overlap in customers from the high-level corporate standpoint, but clearly very different groups.

And I would think you would need different people calling on them.

So I'm just wondering, do you envision sales synergies here?

Or do you really view this as a somewhat separate operation that lets you get more wallet share within some of your big customers, as well as other customers outside of your traditional domain?

That is an excellent question, because we are very much looking at this as a -- the first thing we have to do is really learn well how they did it.

Obviously we have experience dealing with these large customers.

We have a lot of experience doing very large transactions.

But we also know that sometimes it's very good to be able to sell a different budget to different people under a different premise.

And so we will be quite careful before we integrate too forcefully.

Because Coverity clearly did a number of things very well as they grew their an initial market presence.

But there is benefit of being able to go to these large companies and already have a strong brand.

Then the second comment, and why I am personally so ecstatic about this is that, on one hand it's absolutely adjacent.

And I can say that many ways, because you have seen us invest the last number of years in tools that all are heading towards this hardware-software interaction.

And of course, we know very well that our customers in the semiconductor market are embedding more and more software on chips that themselves are multi-processing little miracles of silicon.

And so right there, there is a degree of complexity that is entering the software world, that used to be very well-known in hardware for many years.

But now is really starting to play there.

At the same time, beyond this adjacency, software is of course a broad term.

And in many of the end-applications -- be it financial systems, to take just one example -- you can see that the complexity and security is becoming a very real issue.

And so being able to apply A, the newer techniques that Coverity has pioneered.

But B, potentially over time to bring some of the techniques that EDA has pioneered, I think is very promising.

But it's going to be a world of forward discovery.

So we want to be careful to not over-emphasize the future.

But I think in the short term, this is just a fabulous extension for Synopsys.

Great, that's helpful color, Aart.

And then just wanted to follow up on your trimming of your revenue guidance for the -- it sounds like pushed-out IP revenue.

First wanted to clarify that the revenue from your non-IP business is unchanged.

That's what I would infer from your comments.

And then just hoping you would give more color on why your customers are pushing out these projects, and how it this changed relative to your original expectations.

Yes.

So fundamentally, on the core tools, the picture has not changed.

And whereas it's always very difficult to exactly predict what one will do four quarters from now, in general, I don't think that we would say anything fundamental has changed.

On the IP -- and actually some of the other projects that tend to be much more turn-oriented.

Meaning you do a transaction and you will turn some of that transaction to revenue within 12 months.

About a quarter of the Synopsys business falls into that category -- just by definition, always a little bit more noise on how to predict that transition.

In that context, the IP deals have become more complex and are relying on a broader set of products, some of which gets delivered when the customer wants them.

And the very fact that they predict that they will want something this year or next year is a function of where they are going.

And some of it is predicated on when the development is finished.

And the positive in that is, a number of customers are really relying quite heavily for us on all the FinFET technologies.

And those have their own timeline.

And so as we did our own modeling -- which we do on a continual basis -- looking forward with all these, it became clear that tuning the revenue a little bit was the right thing to do.

At the same time, as we have said many times, we focus on earnings per share.

And so in aggregate, we manage the Company for that commitment.

Okay, that's helpful color.

Thank you, Aart.

You're welcome.

Krish Sankar, Bank of America Merrill Lynch.

Brian, I just want to clarify one thing.

Did you say the goal for Coverity is to grow to over $200 million?

Or was it $100 million in two years?

It was $100 million over the next two years, Krish.

Got it, all right.

And then one other question I want to find out was, it seems like if you use your onshore cash post this transaction, you'll be left with almost no onshore cash.

So is it fair to assume that the buybacks are going to cease at this point?

No.

Let me help you clarify.

First of all, we are looking at funding that's both with our onshore US cash, as well as debt.

And the exact balance of that is something we are working through as the deal closes.

And we will let you know what that ultimate breakdown is in the next -- within the next quarter as we close this transaction.

And so again, that is access and using our line of credit, which we've had in place for over a year.

And that is totally available for these type of transactions.

And then on the question of a buyback, it really comes up to be the same position we've had.

We've said from the use of cash that M&A is our number one priority.

And that stays consistent, and that's in line with this announcement we've made today.

And secondly, as far as buybacks and that, that's another option that we will continue to evaluate.

Continue to look at the best uses of our cash relative to M&A, relative to other buybacks, relative to paying off a little bit of our debt.

And we balance all those things all together.

So that's where we balance.

And I'll give you the details over the next quarter of how much it of this will be using US cash and how much will be using our line of credit to help fund it.

Got it, that's very helpful.

And then a final question from my end.

On the emulation business, the EVE business, what kind of goals do have for this year?

Do you expect the revenues from the business to increase, double?

Any kind of color on that would be helpful.

Well, we never disclose individual products.

But clearly we see this as an opportunity to grow our business and our Company overall.

Most importantly, we are also seeing it as a key ingredient in our verification strategy.

And all of the technical effort right now is focused on the integration of that product line with all the other technologies that we have.

Stay tuned.

There will be more information coming out about that specifically in the not-too-distant future.

And it's clearly a field that continues to evolve very rapidly.

Got it.

Thanks, Aart.

Thanks, Brian.

You're welcome.

Tom Diffely, D.A. Davidson.

First, a question.

When you talked about how you were trimming the revenues a little bit but raising the margin, what are the dynamics behind the margin going up higher than you initially had them?

Well, that is called management.

(laughter) The fact is that we, to the best of our abilities, set a plan for the year.

And then during the year we continually re-adjust it.

And of course, at any point in time, there are many variables that play in.

Sometimes suddenly you can have fluctuations in currency exchange, for example.

And we've seen plenty of that in the last few years.

You can see that some product lines move faster than others.

In other words, there is variability.

The reason we have always communicated to you as the first variable to be the earnings per share -- specifically the non-GAAP earnings per share -- is that is our way to say: we will do our best to re-balance if any of these variables, for whatever reason, changes.

And so in this case, we made sure that we are focusing on driving the ops margin by controlling the expenses or looking at the growth of our population, for example.

We are a growing Company, so there's many things we can do there.

But it is a proactive act of management.

And it is good to see that as a team, we can align behind that very quickly as it is indicated.

Okay.

So it's not simply that if you have a lower IP levels and IP's lower margin, that helps your margin overall?

No.

I wouldn't go at it from that angle.

At any point in time, any of our businesses -- we always like to do more business.

So don't worry about your variable levels of profitability of any of our products.

In general, as long as the product is positive, it's a good thing for the Company.

Now, having said that, when we look at variances or rebalancing of the products -- ever slightly so -- we still look at the aggregate expenses for the Company.

And it's not at all a bad thing from time to time to focus on that.

Because one can always find things in the drawer that one hadn't thought one was spending money on.

And so that is exactly what we've been doing.

And that's why we are able to, at this point in time, guide for the same earnings per share guidance that we had at the beginning of the year.

Okay, all right.

And then looking at Coverity, and maybe I missed this earlier.

But on a longer-term basis, do you see Coverity as still standalone products separate from EDA?

Or do you integrate that technology into your EDA tools?

Yes and yes, I guess is probably the best answer.

Because at this point in time, there is no question that with some of our existing customers, there's technology that will be of interest coming in from Coverity.

At the same time, it's only my hope is that many of the deep algorithms that we have pioneered in the hardware world for many years will also be of high value to Coverity's products that apply to a much broader set of potential customers.

And so the reason we are cautious on stating too strongly how we want to integrate is because we are facing a very interesting new market for us, a growth market that we want to learn as much as possible from the Coverity team.

And then of course, hopefully bring some of the experiences that Synopsys has had over the years to the benefit of accelerating the penetration in that market.

Okay.

And Aart, one more question on IP.

When you look at it on a broad basis, are you starting to see more overlap with companies like Cadence or other IP venders?

Or is it still really the internal production that you're trying to displace?

Oh, it's far and away the internal that is the biggest opportunity space for us.

This is a growing market.

And as I think I mentioned in the preamble, that we see the growth rate on multi-year basis really not having changed for us.

There's a lot of opportunity still with customers that have probably barely outsourced 50% of the building blocks that are easily outsourceable.

So there's space to do things there.

And the other thing is that with the increasing complexity of these blocks, I think we're going to see more customers that actually -- if they wanted to -- can no longer do them themselves.

And so that in itself, over time, will provide a good opportunity for us.

Okay.

When customers are cautious like they are right now with spending, does that make it easier or harder to sell IP?

Are they looking to decrease their cost structure?

Or is it they just don't want to spend any money?

That's an interesting question, because in general, you would always say: well, when customers are not cautious, they spend more money.

But it's hard to point to the years where customers are not, to some degree, cautious.

And IP outsourcing is particularly interesting.

Because more often than not, actually customers come at this from economic perspective rather than a technical perspective.

Because outsourcing IP 10 years ago was absolutely taboo.

Today is actually a great way to accelerate the product development with state-of-the-art blocks that otherwise would be difficult to do for them, and would not necessarily be differentiated.

In other words, they would have to spend their most competent engineering time on it without necessarily getting differentiation.

So we've seen in the various downturns that each one of those brings about a rethinking on the side of the customer as to what they should do and what they should not do.

And the very fact that we have a very strong, I think, track record of quality and also support of the customer, has served us well when people want to explore outsourcing and have come to Synopsys.

Okay.

And then last question for Brian.

The tax rate of 24%.

Do you still view that as your long-term tax rate?

Or does that change in the years to come?

Well, it is, yes.

We're still in that 24% range.

I'd just remind everybody, as all of us CFOs look at projecting tax rates for 2014 and beyond, we have not factored in the R&D tax credit into any of our assumptions.

Okay, great.

Thank you.

You're welcome.

Thank you, Tom.

Sterling Auty, JPMorgan.

It's [Sackett] here for Sterling.

Aart, you touched on this on a prior question, but just wanted to dig a bit deeper.

In your prepared remarks, you talked about how customers remain relatively cautious, despite a lot of technological advancement.

What you think is driving that disconnect?

It feels like it's been a few quarters now -- more than a few quarters.

But what are some of your updated thoughts there?

Well, I think you have to start with the big picture.

Which is, of course, in the last four or five years, global GDP has languished.

Semiconductors has done significantly better than that, but semiconductors are not growing enormously fast.

However, the technology demands are growing enormously fast.

And so in many ways, customers are, for starters, between this squeeze of: how do I get the money and how do I pay for all the new good stuff?

Secondly, there are some markets where there's just been an increase in concentration, all the way to some markets that tend to be sort of winner takes all, in terms of behavior.

And so there, another dynamic is in play, which is how do our customers create critical mass?

And that often results in either acquisitions within a product line or outright company mergers for mass and for size.

And so all of these changes are relatively difficult to execute well.

I think that is why if you look at some of the -- what's it called?

Confidence indexes that look at semiconductor execs and ask them: so how confident are you?

It is quite remarkable how these things oscillate between 48% and 52%.

And 50% is the -- to me, is between happy and unhappy.

So that is life in the fast semiconductor lane right now.

And so it's not a surprise that customers are cautious.

Maybe cautious is not even the right word.

They are just managing within the budgets that they have.

Now, having said that, I think we have -- Synopsys certainly out-executed in terms of growth over quite a number of these years.

And we expect to continue to do that.

But it's hard work, and that's our job.

And then on the IP -- push-out of IP revenue, is it fair to say that most of that is customer-driven?

Meaning, they are pushing out their own product introductions, which in turn, trickles down to you?

Somewhat.

I think there is certainly a number of cases where what you said is absolutely correct.

There are a number of cases where they do larger VPAs, where either the take-up of the IP or the availability on our part of the IP is impacted by both their timeline and our timeline.

And so those are sometimes very difficult to predict.

They are good signs, because they are signs of customers trusting us with their future.

But sometimes just a little bit more difficult to predict.

And as you certainly can see from my earlier comments about the stress levels of technology, for our customers that move to FinFET, is a pretty big decision.

We see the large guys have all gone to that and are investing.

The next segment of customers is just now moving into that domain.

And then on Coverity, it sounds like they're selling to a bunch of different verticals.

But can you disclose about how much they generate from the semi-vertical, even if just a range?

Let me not do that, partially because until this is closed, I should not really speak about that company beyond what is a reasonably public knowledge.

What is -- what I can say certainly is that more than half of their customers today are in the semiconductor segment that we know well.

And that's of course where we initially encountered them.

But it is a quite interesting that at least a quarter to a third are pretty far away from where Synopsys resides.

But you can immediately see how important quality in software is.

Just take the financial services or banking services.

But we're also talking about people doing oil research or aeronautics research.

There's a lot of software being developed.

And I think the interesting insight here, I hope, that plays out going forward is, for a number of decades the level of quality for hardware had to be extremely high.

Because an error forced people to redo their chip.

And that right there is often a multi-million dollar decision.

Whereas an error in software could often be fixed by a patch.

While that is true if your software is not to complicated, when the software becomes very intertwined with many other things, it's only have truly systemic complexity, which we know well on the hardware side.

And that is why my hope is that over time, a number of the techniques that Synopsys has pioneered will also apply to the broader software world.

Got it.

Thanks for taking my questions.

You are most welcome.

Jay Vleeschhouwer, Griffin Securities.

Aart, a couple of questions to start, on Coverity.

Could you talk a bit about how the dynamics of that business differ from what you are used to in EDA?

For instance, with over 1,000 customers, they would seem to have an average amount of spend per customer of maybe $0.75 million or so, considerably below what you are used to in EDA.

Assuming that number isn't scalable per customer, would be fair to say that much of the growth would be depending on new customer acquisition vis a vis Coverity?

Also, if you think about Coverity in a larger context of systems design -- not just at the software quality level, but more broadly -- does it then also become important for Synopsys to have a strong position in custom IC?

And a couple follow-ups.

Sure.

So first off, it's interesting that the numbers that you cite is -- when we started Synopsys, we would have loved to have numbers like that.

And it took quite a while to build up the site's transactions and relationships that we have with our customers today.

It took many years.

And of course, the sales approaches evolved quite a bit in what for us has like 25 to 27 years or so.

Having said that though, I think you're still pointing your finger at an interesting set of questions, which is there will be a number of customers that initially are brand-new customers that are new to using tools around software.

And they will gradually penetrate that market.

There are some customers that very quickly will realize if the software works well and has impact, how can they move to larger volumes?

How they can they broaden the utilization?

Or how can they even do what we at Synopsys did, which ultimately mandates the software utilization?

Now, I don't think that there is much correlation between this and what we do in the custom world.

Except for one area that I think is interesting in the long-term, which is the intersection between digital and custom is clearly visible in the Internet of things.

The Internet of things is full of -- quote, things -- that have some software embedded.

And so when you look at that in aggregate, this is precisely what I always refer to as systemic complexity -- a very multi-set of things.

I think for right now, this is all looking far forward.

The way we should look at Coverity today is new [TAM] that is existing today on the very focused area of quality and testing and security of software.

And just focusing on that alone will be our first challenge.

The reason I emphasize some of these other things is just because I see a natural adjacency for both our technology and our market position.

Okay.

A couple more for you, Aart, regarding the bigger picture of the market.

You mentioned that you are seeing some improved penetration or consolidation of some accounts.

With your largest customer, you clearly have the large majority of their customer spend.

The question is, are you seeing a trend where you are now or have become the majority of a greater number of customer spend?

Is that a trend at all?

And then -- go on, sorry.

In general, our objective obviously is to grow with our customers and to grow into customers where we are not well-represented.

Ultimately, the EDA industry is relatively stable.

But within that, Synopsys, I think, has done well.

For those customers that are really impacted by our tools -- and it tends to come from the most advanced side of the spectrum.

Meaning, all the people do a very large volume, very high complexity, low-power designs.

That's our natural home.

And so the fact that our tools are increasingly performance and increasingly performing very well together, I think is one of the reasons that a number of customers have broadened their footprint with us.

But you have to earn that every day.

And it's a field of continual change.

So we'll keep pushing on that, and this is only opportunity for us.

And lastly, a geographic question.

For you, in terms of the whole industry, Asia Pac has been by far the fastest growing market over the last number of years -- and it in fact, decade.

Not just on the tool side, but increasingly on the IP side.

If you do a 10-year CAGR analysis, it looks like Asia Pac for you has been a mid-teens growth business.

And all other regions, low to mid single-digits.

The question is, do you see any risks that could potentially decelerate or disrupt the kind of above-average growth that you've seen in Asia Pac for these last many years?

And conversely, are you seeing any sense of it bottoming in Japan?

Outside of currency affects, are you seeing any signs that the long, slow erosion in that market -- as far as EDA is concerned -- is beginning to bottom out?

Well, let me start with the top of the question.

Of course, the growth of one region comes at the expense of another, within the profile of the overall growth of the semiconductor industry.

And so if you grow higher than the industry, than some other region must by definition grow lower.

And you are absolutely correct that Asia Pacific, initially coming from almost nowhere, has grown to become a very important market.

It is also a market that has invested in technology and invested in this cooling of technology as IE engineers substantially.

So that reason alone makes it an interesting place.

If you add to that the fact that some of those economies -- specifically, China -- has the potential to grow its own indigenous customer base substantially, certainly one would believe that, that can continue for a while.

If you look at Japan, I do think that there are a number of positive while very difficult changes.

And you can see it in companies that are restructuring, that are refocusing.

And of coarse at the national level, there's been a high degree of emphasis on stimulating the economy and utilized currency as one of the mechanisms to do so.

I think the feedback tends to be a little up and down from one quarter to another.

And you have to only read newspapers to see that.

But I'm still a believer that in aggregate, the structural changes that industry is going through are necessary.

They are painful.

They will take some time.

But over time, Japan high-tech -- if I put it under that umbrella -- will emerge as stronger.

All right.

Sorry.

Could I squeeze one in for Brian on the IP business?

In Q1, would it be fair to say that there was a close correlation between the $10 million or so drop in IP revenues from Q4, and the $10 million drop or so in your services revenue from Q4?

I'd say that as far as one of the changes for our IP business as we saw in Q1, that the services part is down.

And that just again reflects timing of the bookings of when those transactions came in, the breath of the larger contracts in effect coming through as well.

So you're right.

It is IP.

It is related to the services line, which is different.

And again, remember this is contract by contract, account by account.

And it varies from quarter to quarter.

We've anticipated some reduction in terms of the IP business going from Q4 to Q1, as we let everybody know last year.

And then as we look ahead to our guidance for Q2, again it looks as a stronger business, based on the projections that we have at this point for Q2.

Thanks very much.

You're welcome.

And no one else is queuing up with a question.

So at this point in time, let me thank you again for joining us for this call.

Hopefully you took away from it that Synopsys is in good shape as a Company, and has just made a very interesting move to broaden our longer-term opportunity space.

As usual, Brian and I will be available for your comments and questions after the call.

Thank you very much.

Have a good afternoon.

And ladies and gentlemen, that does conclude your conference for today.

Thank you for your participation and for using AT&T teleconference.

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