新思科技 (SNPS) 2014 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Synopsys earnings conference call for the second quarter of FY14.

(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 like to turn the conference over to Lisa Ewbank, Vice President of Investor Relations.

Please go ahead.

Thank you, Rich.

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.

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 this call, important factors that may affect our future results are described in our most recent quarterly report on Form 10-Q and today's earnings press release.

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.

You can also easily access information on your mobile device with our new IR app available for Android and iOS devices from Google Play and iTunes.

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

Good afternoon, and thank you for joining us.

Our fiscal second-quarter results were very strong and solidify our expectations for the full year.

In summary, business was robust in all key areas.

After many years of investments in innovation, we launched several important new products, including a game-changer in digital design, and we closed the acquisition of Coverity, bringing us into the emerging market of software quality, test, and security.

Highlighting our financial results, we delivered revenue of $518 million, non-GAAP earnings per share of $0.65, and $112 million in operating cash flow.

For the year, we're now including the impacts of Coverity in our guidance.

Based on the combination of solid organic business and the impact of purchase accounting on Coverity, we expect 2014 revenue of $2.05 billion to $2.075 billion and non-GAAP earnings per share of $2.45 to $2.50.

We're also raising our operating cash flow guidance to a range of $450 million to $475 million, primarily reflecting strong collections in the organic business.

As we look at the customer landscape, we see continued focus on balancing the drive for better, faster, differentiated products with continued caution around cost.

If there's any change in our customer's mindset, it is the mounting pressure to develop and utilize more and more advanced technologies.

In addition, companies are relying more on complex software to differentiate their products and their customers are becoming less and less tolerant of software with quality and security defects.

Synopsys is uniquely positioned to be the partner of choice for companies facing these challenges.

With our technical expertise, spanning all the way from deep silicon to the hardware-software intersection, to software, we now appeal to nearly all companies that utilize technology to drive their business.

Our added emphasis on software not only extends our business opportunity along a path that our existing customers are taking, but also engages a broad set of new companies across the industry spectrum.

Synopsys is one of the deepest high-tech companies in the world and we deliver some of the most sophisticated software ever built.

With Coverity, we've entered a market segment that now needs and will benefit from the same level of technical depth.

This changes our outlook considerably as it is opening our broadest customer base ever.

Let me provide some highlights from the quarter, beginning with leadership in core EDA, which was marked by some product introductions that can be rated among the most important in a decade.

The first of those, IC Compiler II, is the game-changing successor to IC Compiler, today's industry-leading place-and-route solution.

Several years ago, we tasked our team to drive an order of magnitude leap in productivity by developing a complete new architecture and algorithms while, in parallel, continuing advances in our existing IC Compiler flagship product.

The team has succeeded well beyond my expectations.

IC Compiler II is truly transformative and features a measurable 10X faster throughput.

10X, not 10%, is an astounding accomplishment.

Introduced at our March users group meeting, key partners such as Imagination, LSI, Panasonic, and [SD] told attendees about their early use and independently confirmed the magnitude of the results.

While IC Compiler II will officially ship as full system in July, it has already contributed to production designs at early partners and we have received confirmation of several successful tape-outs.

Needless to say, there is significant interest and demand, which we are managing carefully to ensure seamless adoption and success for early customers.

The timing of this breakthrough coincides perfectly with our technology push into advanced FinFET, supporting all the capabilities needed for absolute state-of-the-art design of very complex devices.

Incidentally, the breakthrough algorithmic advances also benefit hard driving designs at well-established nodes, such as 28-, 40- and 65-nanometer, for example, where 10X throughput improvements are economically just as meaningful.

We're also making excellent progress in our custom digital, co-design and won two engagements over the incumbent for our custom FinFET solution.

Moving to verification, we announced a major step in our road map towards redefining this market segment and giving customers a next-generation end-to-end solution that does not exist today.

Specifically, in March, we introduced Verification Compiler, which features complete access to all verification technology needed in a single product, including industry-leading simulation and debug.

In addition, verification compiler includes brand-new static and formal technologies that are 3X to 5X times faster than anything on the market.

On top of that, key verification IP significantly completes and accelerates the verification of crucial IP structures.

All of this is tightly integrated to deliver 3X productivity improvements for customers' increasingly complex circuits.

The result of the massive development and integration project, fed by both organically developed and acquired technology, Verification Compiler is a great first step on a multi-year road map to revolutionize verification.

On the hardware side, we introduced our next-generation emulator, Zebu Server-3.

It's the industry's fastest system, with the highest capacity available today.

Customers such as AMD and Freescale have already adopted our new solution, citing benefits in shortening verification time and meeting accelerated software developments and validation schedules.

Our verification vision and the innovations recently introduced are triggering partnerships with key customers and one world leader already made a major commitment for long-term collaboration with us this quarter.

Now to IP, where demand is strong, evidenced by record orders in the quarter.

As the leader in interface, memory, analog, and physical IP and the number two IP player overall, Synopsys continues to benefit from our customers' move to outsourcing more and more complex IP.

Driving our success are unmatched product quality, breadth that enables design teams to centralize a substantial portion of their purchases with us, and almost 2,000 engineers on the leading edge of technology development.

Even the few customers who have resolutely held on to internal development are re-examining their strategy and are increasingly selecting Synopsys as their partner.

One of the few major semiconductor companies who had not previously purchased our IP, bought a number of interface blocks this quarter as a first step towards a broader outsourcing effort.

In Q2, we announced two major new IP titles, a new USB 2.0 and 3.0 PHY that reduces area by 50% over the previous generation, and the industry's first LPDDR4 memory controller.

A couple of years ago, we began offering the next level of IP, complete subsystems.

They include elements such as interface blocks, low-power processors, memories, and software, all optimized for a particular application.

One example is our Sensor Subsystem, which is gaining good traction in the Internet of Things space.

Our FPGA-based and virtual prototyping products also continue to do very well.

We just announced a multi-year Center of Excellence collaboration with Freescale to speed development of automotive electronic systems software.

In driving the future in prototyping, we collaborated with industry leaders to publish a seminal book on advanced software developments with virtual prototypes.

The title says it all -- Better Software Faster.

Using real-life case studies from our mobile, consumer, industrial, and automotive partners, the book offers practical guidelines for accelerating project schedules.

We've already had well over 1,000 downloads in just a few weeks.

Better software, faster is precisely the mission of our new business group.

After just two months, the acquisition of Coverity is showing great promise.

As a refresher, Coverity products are central in the software creation lifecycle.

Our tools automatically test source code for software defects that can lead to product crashes, unexpected behavior, security breaches, or catastrophic system failures.

In contrast to traditionally running the code and waiting for bugs to appear, our tools find defects by sophisticated formal inspection of the code itself.

About one-half of Coverity's business is with our current customers, although addressing different users and different budgets.

The rest extends well beyond, catering to independent software vendors, e-commerce, and industries as wide ranging as energy, industrial, and financial services.

The strategic Coverity acquisition does significantly expand our TAM and customer base.

Within the broad automated software quality space, which analysts size at approximately $2.5 billion, Coverity is the leader in the sub-segment called software quality analysis and measurement.

IDC sizes this segment at approximately $500 million, with estimated 2017 market revenue of nearly $1 billion.

Our goal is to build a substantial presence in this space over the years, similar to what we did first with EDA, then IP.

To that end, last week we announced a small acquisition, Kalistick, that expands our reach beyond software developers to quality assurance, while bringing a number of cloud capabilities to Coverity.

Results to date have been very encouraging.

Orders were slightly better than expected in Coverity's first six weeks as part of Synopsys.

The team is running on all cylinders, already driving increased lead generation and closing a number of growth renewal opportunities.

Our objective is to determine the right level of integration by the end of the Synopsys fiscal year, to maximize our brand and channel leverage, while optimizing for the specific needs of this exciting market.

Due to the purchase accounting impact on deferred revenue, we expect Coverity to contribute $20 million to $25 million in revenue and be approximately $0.10 to $0.13 dilutive to non-GAAP EPS this year.

Without the purchase accounting impact, Coverity would already be accretive this year.

We reiterate that we expect it to reach breakeven in the second half of 2015 and be accretive in 2016 and beyond.

In summary, Q2 was a strong quarter, with some extraordinarily high-impact new product introductions in the core of our business, strong business and demand for sophisticated IP, and a great entry into the software quality, test, and security market, with excellent execution of the on-boarding of Coverity.

While having made big strides in further differentiating our core business, we're also well on our way to diversifying the Company into new TAM areas and feel that we're executing well on the growth strategy we'd communicated to you a number of years ago.

Let me now turn the call over to Brian Beattie.

Thank you, Aart and good afternoon, everyone.

In my comments today, I will summarize our financial results for the quarter and provide you with guidance for Q3 and the full year of 2014.

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

Synopsys delivered a very strong quarter, highlighted by strong business levels, and considerable cash flow generation.

Additionally, we continued our stock repurchase program and completed the Coverity acquisition and two smaller tuck-in deals.

Total revenue was $518 million, above our target range.

As expected, revenue from the Coverity product sales were very modest, reflecting the standard purchase accounting haircut that was applied to deferred revenue during the first six weeks as part of Synopsys, and I'll say more about this later.

About 90% of Q2 revenue came from beginning-of-quarter backlog and we had one 10% customer.

The weighted average duration of our renewable customer license commitments for the quarters was about 2.8 years.

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

Turning to expenses now.

Q2 total GAAP costs and expenses were $454 million, which included $32 million of amortization of intangible assets and $19 million of stock-based compensation.

Q2 total non-GAAP costs and expenses were $393 million, slightly above our Q2 guidance, due to the Coverity acquisition.

Non-GAAP operating margin was 24% for the quarter, and 23.4% for the first half of FY14.

Turning now to earnings, GAAP earnings per share were $0.40; non-GAAP earnings per share were $0.65, exceeding our target range, even with the $0.02 dilution from Coverity.

Our non-GAAP tax rate was 19% for the quarter, below our target, due primarily to a more favorable geographic mix than forecasted.

As a result, we think that a non-GAAP tax rate of approximately 21% is a reasonable estimate for FY14.

Now, turning to our cash flow, during the quarter, we generated $112 million in cash from operations and are raising our operating cash flow target for the year to $450 million to $475 million.

We ended the quarter with total debt of $290 million, which includes $200 million from our revolver due to the Coverity acquisition.

We also repaid $7.5 million of our outstanding term loan, leaving a remaining balance of $90 million.

During the quarter, we purchased 628,000 shares of Synopsys stock for $25 million.

During the first half of the fiscal year, we spent $80 million, repurchasing approximately 2.1 million shares, and have $420 million remaining on our current share repurchase authorization.

We ended the quarter with cash and cash equivalents of $822 million, with 18% on-shore and 82% off-shore.

DSO was 57 days, reflecting strong business levels and the timing of invoices.

We ended Q2 with approximately 9,100 employees, with over one-third in lower cost geographies, and approximately 325 of the additional employees were from our Q2 acquisitions.

Now, a couple of additional words about Coverity product sales.

For reporting purposes, you'll notice we've adjusted our financial supplement to reflect the inclusion of Coverity products in an updated product group we call IP and Software Solutions.

While we're not breaking out the Coverity product sales, we are on track for the expected $20 million to $25 million of revenue in FY14 as we work through the deferred revenue haircut.

Without the impact of the deferred revenue haircut, FY14 contribution from Coverity would have been approximately $24 million higher and they would have been accretive on a non-GAAP basis in 2014.

At closing, Coverity had $69 million of deferred revenue, of which 69%, or $47 million, will not be recognized due to standard purchase accounting.

The majority of the haircut occurs in the first two years, with a small amount extending beyond that, so as a result, we continue to expect that Coverity will reach breakeven on a non-GAAP basis in the second half of 2015.

At a Corporate level, we continue to manage the Company with a multi-year goal of high single-digit non-GAAP EPS growth.

Contributing to that is core EDA revenue growth, generally in the low to mid-single-digits; IP and Software Solutions revenue growth, generally in the low double-digits; operating margins solidly in the mid-20%s; exploration of value and TAM-expanding M&A; and optimizing use of our strong cash flow through a balance of M&A, stock buybacks, and debt reduction.

Now let's address our third quarter and FY14 guidance, which excludes the impact of any future acquisitions.

For the third quarter of FY14, our targets are revenue between $515 million and $525 million; total GAAP costs and expenses between $450.5 million and $471 million, which includes approximately $20 million of stock-based compensation expense; total non-GAAP costs and expenses between $400 million and $410 million; other income and expense between $1 million and a negative $1 million on a non-GAAP tax rate of approximately 20%; outstanding shares between 155 million and 159 million; GAAP earnings of $0.30 to $0.38 per share; and non-GAAP earnings of $0.60 to $0.62 per share.

Now, our FY14 outlook: revenue between $2.05 billion and $2.075 billion; other income and expense between $10 million and $12 million; a non-GAAP tax rate of approximately 21%; outstanding shares between 155 million and 159 million; GAAP earnings per share of $1.55 to $1.68, which includes the impact of approximately $79 million in stock-based compensation expense; non-GAAP earnings per share of $2.45 to $2.50, reflecting the expected $0.10 to $0.13 dilution from Coverity, partially offset by our Q2 over-achievement.

We're trimming capital expenditures to approximately $115 million, and we're now targeting cash flow from operations of $450 million to $475 million.

So in summary, we're pleased with our very good second-quarter financial performance and continued execution.

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

(Operator Instructions)

And we'll begin with the line of Rich Valera with Needham & Company.

First a question on ICC II, was hoping to get some sense of the potential financial impact from this.

I'm wondering if, first, you could say if it's a maintenance upgrade or if you'll get incremental revenue when customers upgrade to it.

And then how do you expect it to roll out to your customer base?

It sounds like general release in July, but how would we expect this to roll out to your entire customer base, with timing and how that might affect bookings and revenue as we look out over the next couple years?

Sure, Rich.

First, this is not a maintenance upgrade; this is a new product.

The only refinement on that statement is that we have a number of customers that can have access to new technology, provided that they buy off the price list at that point in time, and so they can replace existing products with the new product, which will bring new revenue opportunities for us, but also brings fabulous leverage for the customer because it is truly dramatically better.

So from that perspective, it is a product that's priced higher but also valued much higher than what we have, which is arguably already the best on the market.

Having said that, the adoption rate, I expect to be quite fast, because when have you that level of productivity improvement, and of course we have tried to design it so that the changeover issues are very minimal, you can very quickly move to the new product, people that are under constant pressure to get better design sooner are immediately intrigued by it, and that's why we have already a lot of demand.

Nonetheless, we will pay a high degree of attention to make sure that the early customers do very well, get good results, and are very well supported, and we do that with all new products and actually all new releases to make sure that feather them in, but the interest is certainly super high right now.

Great and then question on EVE.

You've been fairly quiet about eve since you bought it a bit ago and now you've done a lot of work integrating into Verification Compiler and you've got ZeBu 3 out.

Just wondering, one, it doesn't -- wouldn't expect that there's been a lot of growth there, just due to the lack of commentary, that could be mistaken so I'd be happy to get your thoughts on that, but two, do you see that product as maybe reinvigorated and having a better medium-term growth outlook than it's maybe had in the past year-plus?

Excellent question.

There's two aspects to EVE.

One is the absolute capabilities of the product itself, and of course, there are multiple generations of this product.

And two, the degree of integration in our offering.

What we just announced this quarter was really the next generation of the product, so a product that is substantially faster again for substantially higher capacity.

The integration has many, many ramifications.

We actually did not say all that much about it and we have made excellent progress there, but we have still more work to do.

I would say, stay tuned on what will be coming there, because there are a lot of capabilities that will be leveraged by a much better degree of integration.

Fair enough.

And Brian, a question for you on the revenue guidance.

At the risk of splitting hairs here, if you look at the mid-point of your old and new revenue guidance for the year, you're up $15 million.

You guided for $20 million to $25 million from Coverity, so that would imply down $5 million to $10 million in the base business.

Is that accurate math?

Am I -- is this rounding?

Just wanted to get your take on that?

I look on it, Rich, as just a narrowing of the range, given, again, we've had good momentum through the first six months; we feel very comfortable in our outlook now with only six months left to go.

We see a fact that our run rate is up and it's really effectively narrowing of the range and, again, the Coverity piece is performing exactly as we expected, even slightly ahead in the first six weeks.

Great and just wanted to understand, you gave some nice color on Coverity, with and without deferred, and that color suggested it roughly a 50% deferred haircut in their seven-month contribution this year, which seems quite high.

Is there anything unusual about their business model and how do you view that level of deferred haircut relative to a typical acquisition of that type of business?

We see actually, based on all the valuational work that we did and our third parties did, a 69% haircut on the overall deferred revenues that we acquired at the beginning of the Company.

As you know, just the accounting rules are that you do get to keep the cost of generating that revenue going forward, plus a reasonable margin, and in a way, the good news is that the cost of ongoing is not that significant and therefore, the haircut, at 69%, is typically a little bit higher than what we would see.

We also saw the deferred revenues being a little bit higher relative to the annual run rates than companies we've acquired in the past have had.

So those two factors combine to a slightly higher deferred revenue haircut than what we've seen in the past.

Great.

That's helpful color.

Thank you.

Thank you.

Thank you.

We'll now go to the line of Krish Shankar with Bank of America Merrill Lynch.

I actually had a few of them.

Aart, the IC Compiler II definitely seems very interesting and exciting for you guys.

Just trying to figure out, you guys don't break out your current IC Compiler product, which is part of your core EDA revenue, but do you think the IC Compiler II could be a $100 million revenue product next year?

As you said yourself, we don't break out the individual products, but there's no question that IC Compiler will fairly rapidly be added on top of IC Compiler or replace a number of IC Compilers that are in utilization today, because it has really the ability to do the same amount of work in literally a fraction of the time.

And it's interesting, by the way, to see how different customers use that capability very differently.

Some say, well, now I can go to market faster, but there are also quite a number that say now because of that, I can actually do more optimizations and ring out some more area or some more speed and, thus, make my product either lower cost, lower silicon cost, or higher performance, thus higher differentiation.

So it's always intriguing to see how, when one provides something that is truly radically better, the ways in which it gets used is not always predictable.

The reason I'm sharing this is because we have already very good evidence of the very good results from multiple customers and so I expect it to be phased in to utilization very rapidly.

From an economic point of view, this is all part of our usual three-year ratable model and we expect and hope that this will utilize up a little faster the contracts that we have in place with customers and that's always an opportunity to grow our business.

Got it.

Okay.

That's very helpful.

I just had a couple of more questions.

On the last earnings call, you guys -- pre-Coverity -- you guys took down your full-year revenue a little bit because your FinFET customers were seeing some push-outs in their schedules.

I'm curious what the status is now.

Do you think they have been working through their issues or do you think that it's still going to be a while before you start seeing those revenues flow in for you?

No, actually, we see a lot of business around FinFET, and partially because we are not just working with customers, we're also part of putting in place the very ecosystem that's necessary in order to do advanced FinFET design.

What I mean with that are all the IP tools and IP that is necessary around that and a number of the tools that are looking at the yields optimization.

And so you're absolutely right that a number of the providers of FinFET technology did a number of adjustments to their schedules, but also to the competitiveness of their products, and so the race is absolutely on among the people providing the silicon and what we can see is that there are typically two groups.

There's the group that is already moving massively to FinFET because they have either the super high volume or the technology needs of very large transistor counts and low power.

Then there's the group that is saying, well, I'm going to wait at 28-nanometer, which is exactly behaving as we had predicted already a year ago, and is going to be a big node.

And then there are a number of people that even use older technologies but really squeeze them for economic benefit.

And so it's advanced design at every node at this point in time, but our tools have had big impact on all of these nodes because productivity enhancements lay everywhere.

So from that perspective, we see a lot of intense investments and a number of people essentially jockeying for being in the lead position from a technology point of view, and this year, we'll see a lot of designs.

Got it.

Got it.

Very helpful.

Then the final question is that obviously you guys do a lot of M&A -- it's a question I asked in the past in terms of capital allocation, and you're doing minimal buybacks every quarter.

Is that still the plan or is there a plan to get more aggressive on the buybacks or maybe consider a dividend down the road?

We've been very clear for many years that the priority relative to our capital structure has been on new TAM creation or value and earnings generation through M&A.

And we have put the balance sheet to work; in particular, if we look at our past quarter with Coverity, we did spend a total of about $368 million in our second quarter and also did a small buyback.

So again, our priorities are, in that order of M&A first, buyback second, and our debt repayment, and that's how we plan to continue to deploy and just continue to look at all the options in front of us from quarter to quarter.

Got it.

Thanks, guys.

You're welcome.

Thank you.

We'll now go to the line of Sterling Auty with JPMorgan.

Please go ahead.

In your prepared remarks, you talked about the pressure that the customers have in terms of the technology side, but still being balanced with being cost conscious.

What I want to see is -- or what I'd like to hear is -- in summary, do you feel that your customers' buying behavior or buying position is in a healthier position today than where it was, let's say, at the end of last year?

Yes, if you look at the charts that look at semiconductor growth rates, at a variety of confidence meters, they all look a little bit better than last year.

I'm maybe cautious just because I've seen so many of these for many years, and so when we say they look a little bit better, that means that, A, people are right now forecasting the second half of the year a little bit higher growth in semiconductors, and B, the confidence index is up by 3% or 4%.

3% or 4% when you're below 50% or above 50% is all the difference between seeing good weather or bad weather, and from that perspective, people do feel a little bit better, but they are just as experienced as I am in terms of many years and so they remain careful because these are all big decisions.

Sure.

Switching over to IC Compiler II, how is the pricing of that compared to IC Compiler on an apples-to-apples basis?

Well, the IC Compiler II is priced higher and there is a variety of prices because there is a variety of configuration of the system, including different configuration for different compute-type situations, and we don't disclose all the details of that.

But obviously, we do it in such a fashion that the value that the customer gets is many times higher than the increase in pricing, so that at the end of the day, hopefully both the customer and ourselves are happy campers in this equation, and that they feel very compelled to move to this new technology because it will have good impact on them.

But this is clearly a case where there's no question that there is massively more value.

This is not an incremental 1.3 or 1.4 times better, which by the way, we deliver at least every year, so we've always been on a fast treadmill.

This is really an order of magnitude and that just changes the whole equation of utilization going forward.

What portion of the IC Compiler installed base is not on a contract where they could trade into it by just buying -- or paying the price differential?

In other words, what portion of the IC Compiler installed base, if they do decide to move, would end up paying the full price?

I actually don't know the answer to that.

My guess would be not all that many, but in general, that has never been an impediment for people to move or start spending more money if there's more value.

So the ability to upgrade from IC Compiler I is often there in the contract, but the ability to upgrade from other products is rarely there.

On Coverity, can you remind us what the contract structures there were?

I'm specifically wondering how quickly the deferred revenue that you've written off may come back into the income statement as you go through contract renewals?

The first comment would be -- and this was part of the earlier question of why is the haircut bigger than what one normally sees on companies -- this was a company that was very aggressively trying to use the revenue as soon as possible in order to be able to invest in high growth.

This is a great opportunity space.

And we will continue to try to do that.

At the same time, we have a very disciplined, typically three-year contract horizon.

We're in the process of learning what is actually the optimal contract configuration for Coverity users.

They are in a different space.

Software people do behave differently and one of the reasons we are cautious before we make a lot of changes to their business is because we want to first learn what they have done to do it so well, and then if there are improvements or if there are things that we can apply that we have learned in our ability to scale is -- we should certainly apply those because this is a business that is eminently scalable.

Last question.

Will you maintain or expand the Coverity sales force, because it sounds like it's a different touch point even within your existing customers that sell that product line?

Well, we will certainly retain all the salespeople.

We have some very, very good people there.

How we structure it is precisely part of the decision process between now and the end of our fiscal year, because that's a natural point to decide to what extent we integrate or not, and there may be a sophisticated path in the middle to take advantage of some of the practices that they have been particularly good at, and take advantage of some of the brand position and the Company position that Synopsys has on a worldwide basis that is much more comprehensive.

So maybe it's a long answer to say we don't know the answer to your question yet because we are in the process of rapidly learning.

Understood.

Thank you.

We'll now go to the line of Tom Diffely with D.A. Davidson.

Please go ahead.

First a model question for Brian.

When you look at the EPS upside in the quarter, despite the slight negative impact of Coverity, was the upside primarily driven by taxes or was there another component in there that was quite beneficial?

Our revenues came in very strong in our quarter, towards the higher end of what we had anticipated.

So that helped us out as well.

The spending, again, as we've been managing towards that EPS number for this year, even with a little bit of that headwind we talked about back in Q1, we're still committed to making that earnings per share that we had addressed earlier, so we've been watching our expenses very closely.

Then the third point is, as you mentioned, our tax rate and the geographic mix, which does take into account the impact of our acquisitions and where they're located, has provided a favorable geographical mix of our pre-tax income, and of course, we have to catch up in our second quarter on a year-to-date basis to make that entry as well.

So all that contributed to a very attractive tax rate for us and we see that in terms of very attractive tax rate for the entire 2014.

So overall, that's how we contributed.

We had a great start to the year to get us on track and you can see that confidence in the full-year guidance.

Okay.

And then when you look at your cash level, you mentioned that it was 18% on-shore.

Is there a minimum level of cash you'd like to have on-shore when considering potential acquisitions or share repurchasing?

Yes, there is, Tom.

We actually used that this past quarter.

So we have about $120 million of tax in the US and that is a healthy amount, based on any of our commitments that we have elsewhere.

That's $120 million -- is our good minimum US on-shore tax rate and for the purposes of the acquisition, again, very specific purpose, we borrowed a very low cost interest rate of about 1.3%, and we're able to use that to leverage up the capabilities in the Company.

Again, our discipline is traditionally to pay that off over some period of time, probably by the end of the year, and again, we'll see our US balance growing up a little bit.

Okay.

Are you seeing that--

You meant cash rate, right, Brian?

Cash rate, not tax rate?

Yes.

$120 million tax rate, you meant cash rate.

In the cash, yes.

Cash dollars, yes.

We're a team here.

Okay.

And Aart, are you seeing the potential for more off-shore type acquisitions out there or most of what you look at -- is it US-based?

No, we look at many things all the time, and as you can imagine, we don't communicate much about that ahead of time, but if you take just not that long ago, we did two major acquisitions offshore, one was SpringSoft, the other was EVE.

And so the reality of worldwide taxation is such that we do distinguish between the different locations of the cash and we have to take that into account when we plan forward.

Okay, but you see plenty of other candidates out there that are on an offshore basis?

One never sees plenty.

One looks at plenty and one actually -- look at many, buy few.

Yes.

We did three deals overall in Q2 and one significant one was US-based but the other two were in Europe.

So again, we continue to see opportunities for investing outside the country as well.

Okay.

Great.

And then when you look at the IP part of the business, have you seen an increase in competition in that space since guys like Cadence have gotten a little more aggressive?

Any time there's more competition, one sees it immediately, and we consider that just part of a market that is actually growing very well.

And so in that context, Synopsys continues to do well and last quarter was a very good example of that.

But the competition just drives the state-of-the-art forward faster, and that is part of why we're an extraordinary industry.

Okay, and it sounds like there's some pretty strong growth in the next couple of years as the industry moves towards more of an outsourced model.

Beyond that, do you see the actual IP market itself growing or is it mainly just the outsourcing portion of it that's the growth driver?

That's an excellent question, because obviously, initially, it is outsourcing and we, Synopsys, have already seen multiple different waves from outsourcing stuff that anybody could design, to outsourcing things that are reasonably difficult to design and where it really becomes a build versus buy decision for the customer to now outsourcing blocks that are extremely complex to build, and then on top of that, are extremely complex to build on the most advanced silicon technologies.

So in that sense, some of the Synopsys intellectual property is highly differentiated already today.

That in itself is half of the answer because, as people outsource more things, they also now increasingly get access to building blocks that previously they would not have been able to build themselves.

That changes a bit the very nature of design, especially in light that many of these building blocks themselves are almost mini computers and therefore they come with embedded software and the opportunity for the customer to differentiate themselves more and more with the layers of software on top of that.

That all sounds maybe a little complex, but complexity is precisely what feeds certainly Synopsys' business, and so the IP is a great contributor towards the next decade of very sophisticated chip design.

Okay.

That's very helpful.

Thank you.

You're welcome.

We'll now go to the line of Monika Garg with Pacific Crest.

Please go ahead.

The first question is on the IC Compiler II.

With the IC Compiler II, you have been -- nicely, you've been able to drive higher value for Synopsys with this new version of the tool.

So do you think as you release the new version of their other tools in the simulation market, prototyping in other segments, that you could also drive higher value than previous generation of those tools?

That has been our life-long objective, of course, as a Company.

In many ways if you look back for just a second, it's fair to say that Synopsys is certainly one of the reasons Moore's law has prospered so well on the design side.

We have continued to support it.

Going forward, we absolutely see at least another decade of continuation of complexity, and that involves doing exactly what we just did with some of these tools, which is dramatic new improvements in light of sophisticated new technology challenges coming our way.

And so just to clarify also an answer from earlier, many of our customers, when they buy into one of our advanced tools, such as IC Compiler, they really buy into Synopsys, and the assurance that they will be able to stay up-to-date.

And in many cases, they do contracts that allow them to get the next version of the tool, and of course, if there's a change in price for the next version of the tool, they will have to pay for that difference.

But it makes it for a smooth outlook and a high degree of assurance to have low risk transitions and get the best technology at any point in time.

This applies not only to the implementation flow, it absolutely applies also to the verification flow, and with Verification Compiler, this is another example of fairly radical new improvements, while at the same time putting together multiple capabilities that originally were partially available only in isolation.

So individual products.

And from a value point of view, this is a very high value, because if you use a simulator and you want to very quickly debug something, simulate again, maybe verify some of the aspects by using the verification IP, this is all available in one product that, granted would be more expensive than just a simulator, but from a value per price ratio is enormously attractive for the customer.

So fundamentally our job is to -- pardon the expression -- techonomically -- both the technical and the economics -- match Moore's law every day of the week and so far we've done that.

Thanks.

The other question I have is on the EVE.

Is it the hardware upgrade or is it software upgrade.

Then could you talk about what you think is the installed base of EVE?

Do you think those people now, since you have a new generation of the tool, will upgrade that?

And maybe--?

Sorry.

Go ahead.

Sure.

The EVE ZeBu Server-3 is a complete new hardware machine.

With the hardware comes an enormous amount of software because this is a very complex device that essentially maps the design that one wants to simulate on the internal hardware structure of that machine.

And so the upgrades are both hardware and software, but this is truly a new machine.

A number of people, essentially, when they add machines, they decide which generation one they want to add and mostly people will gravitate fairly quickly to the most advanced machines because there too the value per price invariably is the best ratio.

So we see an opportunity to sell more, and actually, you heard from my preamble that we have already a number of customers that are moving in that direction.

Maybe could you take a stab at where do you think your market share in emulation can be?

It has lagged the other two guys in the market?

We never disclose installed base or market shares.

At this point in time, we're clearly the number three in the market, so that's another way of saying there's a lot of opportunity.

Okay.

We'll now go to the line of Jay Vleeschhouwer with Griffin Securities.

Please go ahead.

Thanks.

Good afternoon.

Aart, a geography question for you first.

Would it be fair to say that the very substantial sequential and year-over-year increase in your Asia-Pac revenues were highly correlated to the increase you saw in your IP and Software Solutions business?

And if that was the case, do you think that the disproportionate growth or consumption of IP in Asia-Pac can continue?

Also, in that part of the world, you may recall that a quarter ago we talked about the possibility that Japan might be bottoming for EDA, though perhaps not ready to inflect higher, but in the quarter you saw further decline in the Japan business.

Was that currency, further structure weakness, or what's your thinking now about some possible bottoming for EDA in that part of the world?

Sure.

Let me take them in reverse order.

Japan, actually, it is not a decline of our business.

The numbers that you see here are currency-related.

There's no question that Japan is going through the -- hopefully the end of their two lost decades because there's an enormous amount of change happening in the country in general and specifically in the high-tech and semiconductor market.

You see a number of consolidations.

You see a number of things changing.

Synopsys has done particularly well there and we expect that to continue and we certainly hope that the technical talent that's in Japan will find now a renewal phase given that their sophistication is actually quite high and connecting more to the world market is really the opportunity there.

Talking about Asia-Pac, there are many elements there because Asia-Pac, of course, on one hand is a number of countries that have been highly technical for many years, specifically Taiwan and Korea, and at the same time, you have China becoming larger and larger in terms of its role of utilization, but also in development of chips and absorption of chips domestically.

And so that country, of course, has come later to the high-tech market and what we invariably see when new countries come to any field is that they almost immediately start on whatever the latest design methodology is.

So there the question was not so much outsourcing of designs one used to do, it's just outsourcing period, meaning you start right away with building blocks that are commercially available and one grows from there.

And so the opportunity space is very good for us there as we expect that market will continue to grow and its on methodologies that Synopsys has a lot to offer in.

And so A-P will be continue to be a strong market.

Can you still hear us?

Okay.

And then our last set of questions then will come from the line of Mahesh Sanganeria with RBC Capital Markets.

Brian, a question on the offshore cash.

What is your plan for that?

My question, more specifically, what do you expect the tax law changes to -- what are you expecting in terms of tax law changes over next couple of years and how does your strategy with the offshore cash change with that?

Well, as we were saying earlier, in terms of M&A opportunities and growth outside of the United States, we believe our cash that is outside this country will remain there permanently.

We have a 100% permanent reinvestment position on the tax side and that is just where we will keep that offshore and we can borrow domestically at a lower cost than what we have.

But it's also to point out, there's not a significant amount of cash offshore -- we're talking $600 million, $700 million -- and we would expect that to continue there under the current tax regime.

And then one question for Aart, in terms of your assumption for the core EDA growth of 3% to 5%.

Where is there -- what are your assumptions on that growth, are you assuming the number of seats increasing or the content increasing?

Can you elaborate on that one?

And maybe also talk about why can't we get a higher growth rate considering the rising complexity and consolidated supplier base.

I would think that you should be able to get better growth rate than what you're forecasting for core EDA?

Okay.

Let me go backwards on that, on the growth rate, first.

It's always a little bit difficult to predict exactly where this ends up, but clearly, we are, for the core of that business, inside of the semiconductor industry and so the semiconductor industry now three, four years in a row has had a growth raid of rate of 2% to 3%.

In that sense, we are getting a bigger share of that value chain than our semiconductor customers at times.

That is the heart of where some of these challenges are.

It's not a question of can we offer more value and make more difference.

Over time, there's certainly an opportunity for EDA to continue to grow at a higher rate than semiconductors.

If we look at where the value goes, the number of design seats will grow gradually, partially because in Asia-Pac, for the earlier question, there will be more and more designers coming on board.

But mostly the value goes into a higher degree of absorption of multiple copies of the same tools for the same engineer, and that's mostly limited by the cost of the hardware to run it on and so that's the balance of the equation.

I would add one more thing for us, which is new, and in the next few quarters, we'll gradually communicate more to you as we learn more, is the fact that for the first time in our existence, or certainly in our recent existence, we have a dramatically broader potential customer base, meaning people we've never talked to.

And that is because, as we enter, or as we now have entered with a leadership position in the quality test and security verification of software, we are talking to many companies that do software that is not visibly linked to semiconductors because they're really running things on computers.

You can argue computers are semiconductors, but the fact is, most of those people do extremely complex projects with all the challenges of errors and bugs and maintenance and whatnot and they are now needing increasingly the same level of quality that semiconductors have needed already 20 years ago.

And so from that perspective, our outlook is going to be positively enhanced by the fact that first time we can talk to customers that we have never met in the first place.

That's both a lot of learning, but also opportunity.

Okay.

Thank you very much.

You're most welcome, Mahesh.

Thank you.

Please continue.

We're at the top of the hour, which is our cut-off point.

Thank you so much for attending our earnings release.

I hope that you took away that we had strong results with a lot of exciting moving parts, specifically great, great advances on the technology side and a broadening of the total TAM that Synopsys is looking at.

Those are certainly exciting developments looking at our future and we hope to have your support going forward.

Thank you very much.

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