Ladies and gentlemen, thank you for standing by, and welcome to the Synopsys Earnings Conference Call for the Second Quarter of Fiscal Year 2021. Today's call will last 1 hour. 5 minutes prior to the end of the call, we will announce the amount of time remaining in the conference. As a reminder, today's call is being recorded. At this time, I'd like to turn the conference over to Lisa Ewbank, Vice President, Investor Relations. Please go ahead.

Thank you, Sean. Good afternoon, everyone. With us today are Aart de Geus, Chairman and Co-CEO of Synopsys; and Trac Pham, Chief Financial Officer. Before we begin, I'd like to remind everyone that during the course of this conference call, Synopsys will discuss forecasts, targets and other forward-looking statements regarding the company and its financial results. While these statements represent our best current judgment about future results and performance as of today, our actual results are subject to many risks and uncertainties that could cause actual results to differ materially from what we expect. In addition to any risks that we highlight during the call, important factors that may affect our future results are described in our most recent SEC reports and today's earnings press release. In addition, we will refer to non-GAAP financial measures during the discussion. Reconciliations to their most directly comparable GAAP financial measures and supplemental financial information can be found in the earnings press release, financial supplement and 8-K that we released earlier today. All of these items plus the most recent investor presentation are available on our website at synopsys.com. In addition, the prepared remarks will be posted on the site at the conclusion of the call. With that, I'll turn it over to Aart de Geus.

Good afternoon. I'm happy to report outstanding second quarter results, exceeding all of our key guidance metrics. We delivered revenue of $1.024 billion with GAAP earnings per share of $1.24 and non-GAAP earnings of $1.70. Business was strong across all product groups and geographies. We continue to make good progress on our margin expansion goal and generated record operating cash flow of $526 million. As a result of our first half strength and growing confidence in our year, we are raising guidance for revenue, non-GAAP operating margin, earnings and cash flow. Trac will discuss the financials in more detail. Before commenting on highlights, let me say a few words about the dire situation in South Asia. While parts of the world are progressing well with vaccination, we are seeing an enormous challenge for the people of South Asia. Our top priority is the well-being of our employees, and we have taken many steps to support them and their families. Ranging from orchestrating oxygen concentrators to teaming up with vaccination clinics to ambulance services, food delivery and family health, our objective is to maximally mitigate the impact of COVID and make sure that every employee can call on Synopsys as a beacon of care and solidarity. Despite the pandemic challenges, we are thankful that from a business perspective, we continue to ship our products and support our customers with no material disruptions, and our business is doing well. Looking at the overall market, demand for semiconductors is very strong. While some of the near-term demand can be attributed to segments such as automotive catching up after a year of COVID slowing, there is an undeniable new wave of growth on the horizon as every vertical market demands machine learning chips to harvest their big data for their specific needs. In other words, the early technical successes of machine learning in the cloud are now moving to the edge, attracted by the economic promise of Smart Everything. The technology push has grown into a vertical economic pull. All segments are impacted, and the race is on to provide smart solutions in automotive, health, consumer, 5G and so on. This push/pull opens a whole new era for semiconductors and software, and with it, great opportunities for Synopsys. First, the foundational building blocks are complex chips, chips for data generation and sensors, for storage, for transport and for compute, all needing IP blocks, speed, low power and security. This is great for Synopsys. Second, not just chips, systems of chips. While the complexity of a system on a chip continues to grow, the leading edge is moving to systems of chips. By abutting them seamlessly and stacking them on top of each other, massive transistor counts open the door to brand-new functionality. This growing systemic complexity is great for Synopsys. Third, chips differentiated by vertical market. Each vertical has its own needs. Automotive has safety requirements. Mobile requires extreme low power. Aerospace and industrial want built in life cycle diagnostics. High-powered new entrants such as hyperscalers and AI design their own chips for super performance. And everybody, whether it be medical and health markets, financial sector, communications or infrastructure, everybody needs much better security. All of these are disciplines that we have invested in for years. Great for Synopsys. And lastly, software and silicon are tightly linked and must be tuned for each other: software to be written to consume less power in the chips; chips to be optimized for a huge amount of sensor data; software to be debugged on prototypes of chips that have not been built yet to speed time to market; chips to be optimized for blindingly fast computation; and always, software and chips must be secured together. These are all technologies we are leading in. Great for Synopsys. So we're perfectly placed, and our mission is to capitalize on the Smart Everything ambitions of our semiconductor partners and vertical customers by delivering 1,000x system performance in this decade. In that context, let me share some highlights, beginning with EDA, which delivered another strong quarter both in design and verification. In digital design, proliferation and competitive displacement by our Fusion Design Platform again drove strong growth. In particular, strong momentum for Fusion Compiler. For example, ARM is leveraging Fusion Compiler on its next-generation Neoverse V1 and N2 infrastructure cores. Fusion Compiler was also selected for advanced mobile designs at Samsung driven by superior throughput and performance per watt results. Our momentum in the most advanced 3-nanometer node is also evident with 5 new test chip tape-outs at processor, graphics and mobile technology leaders as well as next wave 3-nanometer adopters. We see strong innovation and market disruption with our Custom Design Platform as well. In Q2, we announced our PrimeSim Continuum platform for analog, mixed signal simulation. With the industry's brand-new graphics processor base acceleration, it cuts time to results by 10x. Endorsed by Samsung Electronics, NVIDIA and Kioxia, PrimeSim delivers significant productivity gains at companies such as Nanya Technology, where it is deployed on DRAM design. In addition, we again secured multiple full-flow displacements in the quarter, including another large analog design company in Japan. In verification software, we have strong growth with our Verification Continuum Platform driven by adoption momentum with hyperscalers. Our hardware verification solutions drove excellent results as well, including 14 new logos and more than 50 repeat orders in Q2. Fueling our ongoing strong growth is continuous innovation, including new turbocharged application-specific emulation systems, 2 of which went to market in the quarter. The ZeBu Empower emulation system lets customers perform power analysis earlier in the design cycle, dramatically reducing power-related risks. Also, just last week, we launched ZeBu EP1, the industry's first ultrafast 10-megahertz emulation system. It targets high-performance compute for 5G, GPU, AI and automotive, handling designs up to 2 billion gates. We also shipped the latest generation of prototyping HAPS-100. With the fastest performance and unmatched enterprise scalability, it accelerates software development, system validation and verification. Customers like NVIDIA and Furiosa are already relying on HAPS-100 for their most demanding projects. Now to IP, which again achieved excellent revenue growth driven by technical leadership and strong market dynamics. In Q2, we extended our advantage in the high-performance compute market. We acquired MorethanIP and its 400-gig, 800-gig Ethernet controllers. Combined with our existing 112-gig Ethernet PHY, we now offer a full Ethernet solution for high-performance data center applications. Advancing our lead in next-generation PCI Express interfaces, we delivered the industry's first complete PCI Express 6.0 IP solution. Needed for huge bandwidth demand, we see strong market traction with leading customers. And in addition to the EDA adoption I referenced earlier, we announced a strategic collaboration with ARM to closely align product road maps and enhance our interface IP solutions with specific features for the ARM Neoverse platform. Our interface and foundation IP are also gaining broad industry adoption on the advanced 5-nanometer FinFET process driven by vertical segments such as high-performance compute, automotive and AI. More than 20 leading semiconductor companies use our 5-nanometer IP with multiple first-pass silicon successes, attesting to the robustness and reliability of our portfolio. Lastly, to address the above-mentioned safety and security requirements for automotive, we launched a new DesignWare Hardware Secure Module and ARC Safety and Security Processor IP solutions with integrated functional safety features. Let me now turn to 2 exciting and disruptive technologies we recently introduced. First is DSO.ai, our award-winning AI-powered design system that hits right at the foundation of the new growth era, very complex chips. DSO.ai autonomously searches the vast design space for optimal solutions in terms of chip performance, power and area. It does this using very sophisticated machine learning. This not only substantially accelerates the schedule of human design teams, but it enables them to push the technology envelope towards better solutions. The improvements and results over the last 2 quarters have been extraordinary. One example is a very large influential U.S. company who reported what I like to call a productivity world record. On a leading-edge chip, a single engineer using DSO.ai was able to achieve in weeks what typically takes an entire team months to complete. Another global leader recently highlighted unprecedented 3x designer productivity and meeting timing specs weeks ahead of schedule. Results like these are driving notable adoptions. For example, Renesas now uses DSO.ai for its advanced automotive chip design environment. The other innovation push is our Silicon Life Cycle Management Platform, or SLM for short. This end-to-end solution monitors, analyzes and optimizes chips as they are designed, manufactured, tested and deployed in the field. SLM leverages our long-standing unique expertise to give customers visibility into performance, reliability, safety and security issues for the chip's entire lifespan. We're actively engaged with multiple customers at 5- and 3-nanometer that seek to use SLM to optimize their design flow with data collected during testing. The vertical market pull by hyperscalers, for example, is a strong driver of important adoptions. In Q2, 10 new customers adopted a variety of SLM capabilities. Several of them, having adopted one element of our portfolio, are already broadening to other aspects of our platform. Stay tuned as we continue to roll out new capabilities. Now to Software Integrity, which had another very solid quarter towards meeting its financial 2021 goal and accelerating growth. Revenue was ahead of plan in every region, reflecting strong order momentum. We're seeing good results from the changes we've made in our go-to-market strategy and execution. In Q2, we added 100 new logos, and retention exceeded our targets. The services business was particularly strong and is driving comprehensive service plus products engagements. A great example is an important multimillion-dollar new business win with a large transportation company who replaced incumbent products with Synopsys for the end-to-end value we provide. We also launched our channel partner program to expand our reach into geographies and verticals not currently touched through direct sales. The benefits are apparent. For example, we closed a multimillion-dollar new adoption in South America, where we didn't have any selling capability 6 months ago. On the technology front, we delivered a significant enhancement to our Polaris platform, Intelligent Orchestration. It's a set of processes within Polaris that run parallel to our customers' DevOps pipelines. Intelligent Orchestration communicates and automates security testing in synchronization with each company's specific protocol and is built for easier and efficient integration into their development pipeline. The opportunity in this space is vast, and we're encouraged by the steady progress the team is making. In summary, we delivered an outstanding Q2 and are raising our outlook for fiscal 2021. Our markets are strong, reflecting extensive customer investments in critical chip and system designs with an increasing need for safety and security. As we look beyond this year's $4 billion revenue milestone, we see a new era at the intersection of silicon and software that will deliver Smart Everything to all vertical market segments. We see technology challenges that demand cooperation and teamwork around many complex disciplines, disciplines we are strong in. And we see Synopsys in the midst of this vision as a well-equipped catalyst to our customers and partners' success. Finally, I want to recognize the efforts of our global team who over the past 1.5 years have adopted and succeeded despite upheaval and uncertainty. Thank you all for your solidarity and hard work.

Thanks, Aart. Good afternoon, everyone. As we report another outstanding quarter, let me echo Aart's thanks to our team not only for their dedication but also for their unwavering focus on innovation to fuel the exciting opportunities we have ahead. We are in a great position as we set our sights on the next level financial ambitions. On top of a solid foundation of nearly 90% recurring revenue, a diverse and growing customer base and market and technology leadership, our track record of excellent execution continued in Q2. We are increasingly confident in our outlook and are raising our revenue, non-GAAP earnings, non-GAAP operating margin and cash flow guidance for the year. Now to our second quarter results. All comparisons are year-over-year unless otherwise stated. We generated total revenue of $1.024 billion, up 19% and above our target range, driven by broad-based strength across product groups and geographies. Semiconductor & System Design segment revenue was $930 million, with strong growth in both EDA, software and hardware and IP. Software Integrity segment revenue was $94 million. The positive order momentum we saw in the quarter shows that the adjustments we've made in the business are taking hold. We are on track to meet our 2021 expectations of 15% to 20% orders growth and to exit the year with double-digit revenue growth in the fourth quarter. We're on a good path to accelerate revenue growth back to the 15% to 20% range long term. Moving on to expenses. Total GAAP costs and expenses were $830 million. Total non-GAAP costs and expenses were $707 million, resulting in a non-GAAP operating margin of 31%. We are on track to again deliver operating margin expansion for the year and are raising the bottom end of our guidance range. Adjusted operating margin for the Semiconductor & System Design segment was 33%, and Software Integrity margin was 9%. Finally, GAAP earnings per share were $1.24, and non-GAAP earnings per share were $1.70, well above our target range. Turning to cash. We generated a record $526 million in operating cash flow. We completed $145 million of stock buybacks, bringing the total for the year to $398 million. And we ended the quarter with a cash balance of $1.46 billion and total debt of $116 million. Now to guidance. For fiscal 2021, revenue of $4.035 billion to $4.085 billion, an increase of $35 million, representing double-digit growth; total GAAP costs and expenses between $3.241 billion and $3.286 billion; total non-GAAP costs and expenses between $2.835 billion and $2.865 billion; a non-GAAP operating margin of 29.5% to 30%; other income and expenses between minus $5 million and minus $9 million; non-GAAP normalized tax rate of 16%; GAAP earnings of $4.55 to $4.72 per share; non-GAAP earnings of $6.38 to $6.45 per share, representing mid-teens growth; cash flow from operations of $1.25 billion to $1.3 billion; and capital expenditures of approximately $100 million. Targets for the third quarter are: revenue between $1.03 billion and $1.06 billion; total GAAP costs and expenses between $807 million and $825 million; total non-GAAP costs and expenses between $707 million and $717 million; GAAP earnings of $1.30 to $1.41 per share; and non-GAAP earnings of $1.75 to $1.80 per share. Our track record is reflective of how we intend to manage the business to exceed the Rule of 40. Based on a vibrant market opportunity, our strong portfolio and our excellent execution, we see an opportunity to accelerate revenue growth and expand non-GAAP operating margin beyond 30%. Our long-term financial objective is to manage to Rule of 45 over the next several years, and we will provide additional details once our long-term planning process is complete. In conclusion, we delivered strong revenue and non-GAAP earnings growth and record operating cash flow. Our strength is broad-based across product groups and geographies, and we are raising our guidance for the year. At the same time, we continue to develop and deliver transformative innovations that enable our customers' endeavors and position us well for many years to come. With that, I'll turn it over to the operator for questions.

Our first question is from Jackson Ader from JPMorgan.

Great. Aart, first one is for you. You talked about the chip differentiation by vertical as a nice tailwind for the company. I'm just curious, how do we scale the benefits of those differentiations with the fact that there's more increased IP usage from some of these newer entrants? And so I'm just curious, with differentiation seeming to lead to more custom design, what does that mean for those IP blocks that get designed once and used by many?

Okay. Well, there's 2 ways to look at this, from the perspective of the vertical or from the perspective of the pure semiconductor companies. From the vertical, the first thing that people need to choose is, will they design their own chips, yes or no. And if you take the example of the hyperscalers, some, not all, but some of the automotive companies, the hyperscalers clearly are doing more and more of their own chip design. And automotive are either sort of dabbling in it or looking at some of their suppliers, the Tier 1s. In all cases, they are doing more chip design. And so that is good news for us. And absolutely, you're right that a lot of that design is done by substantial IP reuse, and you saw that our IP business is strong. Now if you sit on the other side of the fence as a semiconductor provider, you look at these customers as each of them as opportunities to take sort of a core architecture and then say, 'Well, how do I take my architecture and do different derivatives that are particularly good for different submarkets and essentially reuse some IP or add some that is just necessary for that vertical?' And so I think there's no doubt that, therefore, we will see more chips of different types and more design. In all cases, consumption of IP will continue to grow.

Okay. That's helpful. Trac, quick follow-up. The cash flow performance is impressive, much better than we anticipated. Was there anything that was accelerated, such as deals or collections?

No, not at all, actually. The profile is good because the business is pretty healthy, and we're generating obviously very strong operating margins. The other part to keep in mind is Q2 over the last couple of years will be normally our biggest collections quarter given the profile of renewals and where we end up invoicing at the end of Q1. But it was a combination of both. It's definitely a very healthy business right now.

Next then, we're going to go to the line of Tom Diffely from D.A. Davidson.

Trac, first one is for you. When you look at your increased guidance, which was a pretty substantial increase, is this more a factor of passage of time with comfort in your backlog? Or did you actually see an acceleration of business trends during the quarter?

Tom, regarding your question, there are several factors to consider. First, we have completed half of the year, and the visibility we have from the business we've booked definitely improves our outlook. As Aart mentioned, the overall markets are strong, and we are performing well in that environment. The increase in our backlog indicates whether the business is healthy. This quarter, our backlog grew due to the planned renewals. Overall, the business we secured demonstrated very good run rate growth, which gives us a strong outlook and confidence for the year.

Okay. Great. And then, Aart, just a broad question for you. When you enter into a market like we have today where there's chip shortages, what are the impacts of those shortages on design activity, either positive or negative?

Actually, very little impact. There are some people that do take existing chips and decide that they're going to do modification so that they can get more capacity with another vendor. People really hate to do that because it's a lot of work and no direct benefit, except that if you can ship to a customer, that's great. But it takes some time. And so I don't think that, that is going to be a particularly strong driver. But the shortages should not be just interpreted, I think, as a reaction to a market that has been partially asleep during the COVID time and now is obviously catching up. And automotive is the best example because the mistake that was made there is they stopped ordering. And in the past, they were very powerful, and everybody jumped when they needed something. Now there was just no capacity left. And the reason there's no capacity left is that all the capacity is used by huge demand periods. And that's why I'm trying to differentiate a little bit with the temporary demand that comes out of sort of just this historical 1.5-year wave versus, I think, something that is much more profound, which is a whole new era of semiconductors impacting verticals. And I expect that to continue. And by the way, you can see how many, many places, including countries have decided to substantially increase the capacity. Those increases will take a couple of years to actually have an impact. But they do illustrate the direction that our field is taking.

Great. And just a quick clarification. Did you say you had virtually no impact in India with your...

Well, we're dealing, like everybody else, with a humanitarian situation that is very demanding. We've been able already for a while to rebalance the activities of our employees in such a fashion that to date, we have 0 material impact or delays in shipping anything or supporting anything. But I expect that for a number of months, India will still be, from a humanitarian point of view, a point of focus where we'll give a lot of support to our team.

Next, we're going to go to the line of Joe Vruwink from Baird.

Great. I maybe wanted to start. New technologies like DSO.ai, SLM, these have been getting called out more regularly over recent quarters. Is there a way to characterize or maybe compare to products in your past and the consequence of these new technologies? Is this just the natural evolution of Synopsys? Or is there something different? And perhaps it's specifically about AI adoption in the industry, but is there something different about these technologies where the ramifications later on could be more consequential?

That's an interesting question. Let me begin with SLM, which is fascinating due to its life cycle aspect. If you consider a chip used in a phone versus one in a car, it's clear which has the longer life cycle. In the case of the car, safety plays a crucial role. This allows us to integrate sensors and diagnostic systems into the chip that can utilize AI for self-diagnosis, alerting users to potential issues. This creates significant value. A more immediate example is found in cloud centers, where users want to ensure processors are functioning at maximum capacity and anticipate any failures for timely replacements—essentially practicing preventive maintenance. SLM is intriguing because we engage with these chips even from the early stages of transistor development, using very detailed physics while also having substantial interactions with major companies in those specific sectors. Now, regarding DSO.ai, it represents breakthrough technology. Comparing it to our past work from over 30 years ago is challenging, but in the early days of Synthesis, we automated complex human tasks, allowing for circuit creation that surpassed human capabilities in speed and size overnight. Now, we are working on entire chip components, managing extensive designs with numerous constraints. We can reduce tasks that previously took months down to just a few weeks with fewer people, yielding even better results over recent quarters. This is reminiscent of our earlier advancements but, 30 years later, it involves exponentially greater complexity. It aligns perfectly with a moment in the semiconductor industry where there is a demand for more chips across various sectors. We sometimes find ourselves at the forefront of using AI to design AI chips, which is an exciting development that has already had a noticeable economic impact on users, even as we are just beginning this journey.

Okay. That's really interesting color. Second question, is there anything about the sequencing by quarter of this particular fiscal year that maybe is a bit different than you originally expected? I'm thinking about things like it was another very strong quarter in China. You occasionally hear about maybe pulling forward some future business. And then the way the margin guidance appears to sequence this year, it looks like perhaps 4Q has a bit more incremental cost. Maybe that's just hiring related. So I suppose is there anything that is maybe different timing-wise or just the sequencing of your quarters?

Joe, this is Trac. Overall, the profiling of the quarters is very close to what we had planned. I’m really pleased with the profile this year, especially considering how back-end loaded last year was. Most of the revenue you mentioned is pretty linear this year. Regarding the margin profile, that mainly relates to hiring throughout the year. We’re satisfied with how it’s progressing compared to our initial plan for the year.

Next, we're going to go to the line of Gary Mobley from Wells Fargo Securities.

Congratulations on a strong first half of the fiscal year. I noticed that China showed significant growth again, and I wanted to get your personal perspective, Aart, on the changing geopolitical dynamics between the U.S. and China. It seems these dynamics are now more affected by the widespread semiconductor supply shortage and the renewed emphasis on bringing chip production back to the U.S. I understand that your focus isn't primarily on expanding chip production, but many of the proposed measures and bills aim to enhance R&D investments as well. I'm curious if you are starting to see any impact from this in your licensing activities or what might be on the horizon for your company.

When a market is strong, it generally benefits everyone. It's encouraging that even politicians are aware of what chips are and may have seen them. Nations are looking to invest more because they recognize the strategic importance of being at the forefront of the next wave of Smart Everything and AI. While there may be tensions between countries regarding their actions, the competitive race is underway, and current shortages are highlighted by these tensions. What's particularly fascinating is the growing recognition that the future of innovative products is deeply connected to big data and AI, leading to smarter outcomes. It's noteworthy that electronics are now considered part of a country’s infrastructure. All of this is positive, as I believe it possesses significant potential to advance various industries. Therefore, it makes sense that interest has increased. Currently, the desire to invest more in R&D and manufacturing capacity bodes well for the semiconductor sector.

Appreciate that, Aart. Trac, you mentioned that backlog was up sequentially. I know you haven't filed your Q yet, but specifically, what were the remaining performance obligations for the end of the quarter? And related to that, would you expect revenue growth and backlog to trend sort of in line with each other? Or would you expect over time to generate a larger percentage of revenue from turns business like Emulation or whatnot?

We've made a change in the turns mix largely at the beginning of FY '19 due to the 606 transition. For the most part, the business has remained relatively stable, and that percentage may vary from quarter to quarter depending on hardware IP deliveries. However, I believe we are in a good stable position currently. The backlog has increased, and we plan to file our Q next week, so you will be able to see the actual amount. We expect to disclose that it's approximately $4.8 billion or slightly more than that.

Next, we're going to go to the line of Gal Munda from Berenberg.

When I evaluate your performance in the first half, it really contrasts with last year, which was heavily back-end loaded. It's great to see that recovery. Additionally, looking at the Q3 guidance, which appears quite robust, I'm wondering if, considering the visibility you now have for the remainder of the year, particularly for Q3, it would be reasonable to view the guidance as conservative, especially if some of the hardware orders come through. Or do you believe it accurately reflects what you're experiencing?

Yes. It's a good question. The profile we laid out, the quarterly profile we laid out for Q3 and Q4 is largely a reflection of the revenue recognition profile of IP and hardware. We actually had very good visibility in the second half, and that's why we raised the guidance for the full year. At this point, keep in mind, given the new revenue rules, you're going to see some variability from quarter-to-quarter depending on when hardware IP is delivered. But there's nothing unusual in the profile in the second half other than that. And actually, the business is really doing very well.

Next, we're going to go to the line of Jay Vleeschhouwer from Griffin Securities.

Aart, let me ask you 2 related questions regarding the evolution of EDA and your markets. Tonight, you referred to a new era of EDA. We've heard similar remarks from you and others in the industry for some time now or silicon renaissance and so forth. The question is how that affects your business profile specifically with respect to services. That is to say as you move into this new era, does this tend to increase the kind of services and AE support that you necessarily have to provide to encompass or support this new era? And if so, what could be the margin implications of having to provide that incrementally higher degree of support? Relatedly with respect to the next generation of chips, the domain-specific chips that you talked about now for actually 2 or 3 years, what does that mean during the design process in terms of license consumption? If we think about your model as now prospectively a kind of consumption model, as is often the case in simulation, do you think that the consumption or utilization intensity per design, per run, however you want to think about it, necessarily goes up?

Your question highlights the concept of systemic complexity, which refers to the increasing complexity and size of chips with more transistors. This trend is expected to continue for some time. What makes systemic complexity intriguing is the involvement of multiple players. Companies across various verticals are keen on understanding how these chips function because they develop their own software. Conversely, chip manufacturers are eager to know what software specific car manufacturers wish to run, which necessitates quick processing speeds and perhaps modifications to chip architecture. Our role has expanded as we find ourselves at the intersection of these developments. A few years back, we encapsulated this vision under the phrase "silicon to software," indicating a continuum that transfers the power of chips to end users who are primarily focused on achieving intelligent outcomes rather than the chips themselves. As we enter this area, it's not merely an increase in support but the emergence of new service opportunities. Many new entrants may lack expertise in these domains but understand their own potential within the market. Helping them connect presents an ongoing opportunity for our growth, and we are confident in our ability to manage this while ensuring profitability through our tools. Addressing the second part of your question concerning domain specificity, an example is the automotive sector. A while back, the automotive industry began exploring the concept of autonomous driving or, initially, defensive driving. Chip manufacturers recognized the potential long-term opportunities here, yet automotive companies face strict safety regulations that have evolved over time, some of which are straightforward while others have grown quite complex. For companies like Synopsys, this translates into significant efforts on both the IP and tool sides to incorporate Functional Safety, known as FuSa, which is partly mandated and partly developed in response to increasing complexity. This has opened up substantial opportunities for us, as we have invested heavily in Functional Safety over the past 5 to 6 years. This considerable effort has allowed us to stand out in the marketplace. I see our position as a catalyst connecting diverse factions, and I anticipate an increase in the number of verticals that will rapidly engage in this competitive landscape.

Next, we're going to go to the line of John Pitzer from Credit Suisse.

Congratulations on the solid results. Trac, this question was asked earlier, but I want to approach it differently. Despite the positive performance and the guidance increase, the full year forecast hints at a softer outlook for the last quarter. In relation to that forecast, you seem to be indicating a significant slowdown, particularly in EPS. Is this simply a matter of typical caution, or are you genuinely suggesting that there are underlying factors making Q4 less robust this year compared to previous years?

No, not at all. We don't see any slowdown in the business. In fact, it's quite the opposite. We feel very positive about the momentum we're experiencing. This is also reflected in our full-year guidance. We've consistently noted that the quarter-on-quarter performance can fluctuate based on revenue patterns. From a revenue standpoint, I'm really pleased with how consistent it has been this year and that we managed to secure nearly half of our business in the first half. This results in a strong profile with great visibility. We are increasing hiring in the second half, which will raise our expense levels. However, as we expand our workforce, we're carefully considering the trajectory and its implications for our ability to enhance our margins over time. We are very aware of that. But there is nothing out of the ordinary in our profile, and I wouldn't describe it as a slowdown. It's important to remember that last year was particularly back-end loaded, which will affect year-over-year comparisons, especially in the second half.

That's helpful. And then, Aart, I want to go back to an earlier question about sort of the regionalization or domestication of semiconductor production. It's a clear benefit to the equipment ecosystem. But I'm trying to get a better understanding of what it means to the EDA ecosystem. As existing foundries kind of move from region to region, is there sort of redundant or duplicative spend on the EDA, kind of question number one? And question number two, there's one big guy out there that's trying to reemerge as a foundry business from just an IDM. How does the EDA spend conceptually trend as they try to do that?

Good question. So we touched manufacturing a little bit because we have a number of tools that are designed specifically under the topic of silicon engineering to help optimize circuitry and chips for manufacturing efficiency and yield. But you're absolutely right that most of the investments on sheer capacity don't touch us so much, except if people want to enter the business such as be in a foundry or go after specific segments of the market that they didn't go before. There, certainly our tools matter a great deal to help them get there. In general though, when volume increases, with it, also the number of designs increases. And so the advances in sheer silicon technology and the number of designs are actually very positive at this point in time. And the fact that more people want to be in the manufacturing means that more people are also into the investment of R&D around the field. So at this point in time, it's all positive.

Aart, I have one more question. One unique aspect of the current semiconductor cycle is the tightness in trailing capacity. Are you noticing any signs that design activity at the trailing edge is increasing as customers leverage this tightness to consider moving to smaller node widths at a faster pace than usual? Additionally, how do you view the total addressable market for the trailing edge market in the coming years?

Well, it's an excellent question because some of the trailing edge manufacturing equipment has already gone up in terms of pricing as people try to get capacity wherever they can. But the other comment would be different foundries are sort of also focusing on different type nodes. Some focus mostly on the most advanced nodes. Other would be sort of in the middle field. And then the truly older trailing edge nodes, they're typically limited by the amount of capacity at 200-millimeter wafers. What is interesting in the nodes that are maybe not the leading, leading edge but, let's say, 3, 4 years behind that, there, the application of the newer tools that we have actually has a lot of impact on those, too, because newer tools for older nodes still means a lot better design out of these older nodes. And so it actually gives them a bit of a second life from an efficiency point of view. And as you said, if people can do really well with nodes that have been well honed where the yield is high, the cost equation is very attractive. And we see, for example, one of our most advanced tools, Fusion Compiler, going back to older nodes with some of our customers with great delight.

Next, we're going to go to the line of Jason Celino from KeyBanc Capital Markets.

Great. Aart, Trac, it seems like a pretty good demand environment for Emulation and Prototyping just across the board. But in the past, we've seen some customers gravitate towards the latest and greatest products here. One, is that still the case? And then two, if that is still the case, how does the new improvements to the ZeBu EP1 compare to some of the other announcements in the market?

You're welcome. So clearly, Emulation and Prototyping is increasing in value and importance in some parts of the tasks and especially for us in the task that has to do at this intersection of hardware and software. And there's no question whatsoever that, that is an area that will continue to grow. And we had mentioned in earlier conversation specialties for certain verticals. It's interesting that these are capabilities, Prototyping, that are of high interest in the automotive space, for example, because they start working on the software many, many years before a car is even fully conceived. And so being able to accelerate all of that is of high importance. Now underneath that, there is invariably always the same demand, which is make it faster, make it faster. And that is what Emulation and Prototyping is all about. But it's also give it a larger capacity. And it's also are there certain tasks that you would like to accelerate such as the question of, 'Well, if I write my software this way, how much power is it going to consume versus if I write it differently, will I be able to do better?' Well, those are specialty questions that we now are increasingly answering using Emulation and Prototyping.

Next, we're going to go to the line of Vivek Arya from Bank of America Securities.

I had two questions as well. The first one is about the growth in the business. Aart, you mentioned some improvement in engagement verticals like autos. However, when I review your full year growth outlook of around 10%, it aligns with the growth you achieved in the previous fiscal year. My question is more conceptual. Why isn't your sales growth accelerating when semiconductor designs are becoming more complex? Additionally, if I look at the implied Q4 sales, they appear to be flat year-on-year. Even if I disregard the quarter-to-quarter fluctuations, the full year sales growth seems to match last year. Why is there no acceleration in your sales growth?

The acceleration typically follows the fulfillment of orders over a multi-year revenue recognition period. Additionally, we recently raised our end-of-year guidance with a strong belief that we are on the right track. We'll need to see where we ultimately end up, but it’s clear that we aim to move beyond single-digit growth to higher levels. We haven't adjusted our guidance yet, but we will do so as we approach next year. The key takeaway is that we believe we have a significant opportunity for substantial growth ahead.

Vivek, I want to emphasize that it's important to be cautious about analyzing Q4. Last year, Q4 was exceptionally high due to the timing of hardware and IP releases. Therefore, comparing this year's Q4 to that one isn't a reliable measure of our business's momentum.

I'm curious about your level of exposure to AI start-ups. Do you anticipate any consolidation or decline in the number of these start-ups? In earlier calls, Aart, you mentioned that systems companies are engaging in considerable AI work, particularly among hyperscalers. Additionally, we see large incumbents like NVIDIA. Can the industry sustain so many smaller players targeting this market, especially given the high costs associated with the semiconductor sector? Essentially, what is your exposure to the activities of these AI start-ups, and do you foresee any rationalization occurring?

We are broadly exposed to many AI companies, and it's true that many of them are creating their own versions of the best AI chips. On one hand, this might lead to consolidation over time. On the other hand, it reflects typical behavior seen in promising, early stages of product or technology development. Several successful AI companies have already been acquired by larger firms, and two years later, we see new teams tackling similar innovations. We are currently in a highly active phase of invention and market exploration. Over time, AI technologies will likely become more specialized for specific industries. While consolidation will occur eventually, the number of designers is certainly not decreasing during this period. We have performed quite well through these kinds of phases filled with activity.

And then our final question is going to come from the line of Pradeep Ramani from UBS.

I have a couple of questions. First, regarding China, should we think of it as contributing approximately 12% to 13% of your revenue in the second half? Or do you anticipate any slowdown during that period? The comparisons might be getting tougher, but I'd like some clarification on how investors can view China. I have a follow-up question after that.

China continues to perform very well for us. While we report China as a separate country, we do not provide guidance or comments on the outlook for individual countries.

For my follow-up, regarding the Rule of 45, it looks like this year you'll be very close to 40. Your semiconductor margins this quarter were 33%. How should we view the sustainability of margins in semiconductors, not only for the second half of the year but also in the longer term within the context of the Rule of 45 framework?

Okay. Let me try to explain it this way. Overall, we do see an opportunity to improve margins across the entire business. Really for us to drive to Rule of 45, it really is going to require everyone to contribute. And keep in mind that the semi business does represent 90% of the overall mix. And so that's going to contribute. But I would circle back to the fact that it starts with growth. The reason why we do feel good about our ability to drive margins up in all areas of the business is that we're seeing really strong growth in the business. And that's going to help us effectively get more operating leverage and therefore drive margins up.

If I can add to that, we have focused our objective on the Rule of 40, and we are close to achieving it. We even mentioned the Rule of 45, which is our next target. I believe we are disciplined in ensuring that, as Trac mentioned, we focus on growth while also increasing our operating margin, and these two goals support each other. From this earnings release, you should understand that we are on track with our plans and are executing everything we've communicated over the past few years.

I assume that this means that the meeting is over. In any case, thank you so much for participating today. And we hope that you and your family stay safe as hopefully the world is moving to rapid vaccination. Be well.