Synopsys: Looking to Stay Ahead of Industry Trends after Solid Q3

Key Points

• Synopsys' earnings release showed solid performance in the last quarter.
• Synopsys operates in a concentrated market, which provides the firm advantages.
• Earnings call questions around two other industry giants had interesting and encouraging answers.

Synopsys  NASDAQ: SNPS is a firm in the semiconductor industry that provides key software to chip designers. So far this year, the company has underperformed its industry with a total return of 10%. In contrast, the Invesco PHLX Semiconductor ETF NASDAQ: SOXQ has returned over 26%. It tracks the PHLX Semiconductor Index.

Let's dive into Synopsys' business and market presence. Next, we'll examine the company’s fiscal Q3 2024 earnings report from Aug. 21. I'll also shed light on key insights from the firm's earnings call.

Synopsys’ Software Is a Small but Mighty Part of the Chip Industry

Synopsys is a leading supplier of electronic design automation (EDA) software, along with competitors Cadence Design Systems NASDAQ: CDNS and Siemens OTCMKTS: SMAWF. Together, these firms control 75% to 80% of the EDA software market share. The company also provides IP cores.

The company has three segments: Design Automation (EDA), Design IP (IP cores), and Software Integrity. In fiscal 2023, EDA made up 63% of revenues, Design IP made up 26%, and Software Integrity made up 9%. This distribution has remained almost exactly the same since fiscal 2021.

The firm is selling its Software Integrity business. It now reports the segment under "discontinued operations."

Looking at the firm’s place in the semiconductor industry, EDA software and IP cores make up a relatively small percentage of the overall value added at around 2% to 3%. However, even though the percentage of value that EDA software adds is small compared to other players, the products themselves are essential to the advancement of the semiconductor industry.

It is more or less impossible for design firms like NVIDIA NASDAQ: NVDA to create advanced chips without EDA software. To help design firms continually make more advanced chips, EDA companies are well known for spending a huge percentage of their revenues on research and development (R&D). In 2023, R&D spending was equal to 33% of total revenues. On the other hand, the number was 14% for NVIDIA.

The EDA market is concentrated, with three players controlling almost all of it. This gives Synopsys a big advantage. This lack of competition allows the firm to have some of the highest margins in the global technology sector. According to Koyfin, the company’s operating margin is higher than 91% of these firms.

Synopsys Delivers Strong Performance in Fiscal Q3 Earnings

Synopsys beat estimates on both earnings and revenue and raised full-year guidance above expectations. Adjusted EPS was $3.43, a surprise of 4% and an increase of 27% from the prior year's quarter. Sales came in $10 million above expectations at $1.53 billion, an increase of 13%.

Synopsys raised its full-year adjusted EPS guidance to a midpoint of $13.10, 1% higher than analysts surveyed by Capital IQ expected. The results caused shares to jump over 3% in after-hours trading, but early trading on Aug. 22 wiped out those gains.

Encouraging Earnings Call Answers Provide a Positive Outlook

One question hovering over Synopsys was how the recent poor performance of Intel NASDAQ: INTC would affect the company. Intel is a large Synopsys customer and announced it is laying off 15% of its workforce. This could cause demand for Synopsys’s products to decline as Intel scales back its operations.

Yet, one analyst on the earnings call posed a question with the opposite tone. They believed that these layoffs would mean Intel might have to outsource more of its EDA and Design IP capabilities to firms like Synopsys, which could bolster the firm's sales.

However, CEO Sassine Ghazi says Intel’s transition to using more external software and IP is not new. In short, Ghazi said he doesn’t see any short- or mid-term impact on the company’s revenues, positive or negative, based on the Intel layoffs.

It was also good to hear Ghazi’s response to a question about Advanced Micro Devices NASDAQ: AMD recent acquisition of ZT Systems. AMD wants to move to a “systems approach” in its data center offerings to better compete with NVIDIA.

Data centers are extremely important in the industry right now. In its last earnings release, NVIDIA grew its data center revenue by 427%, and analysts expect the firm to bring in $100 billion in data center revenue in fiscal 2025.

Ghazi said these systems' offerings are “exactly the solution and the partnership we are working with our customers on." This strong response is encouraging. It provides confidence that Synopsys is staying ahead of semiconductor industry trends.