Ladies and gentlemen, thank you for standing by and welcome to the Synopsys earnings conference call for the third quarter of fiscal year 2017. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. Instructions will be given at that time. If you should require assistance at any time during the call, please press star followed by zero. 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, Ernie. Good afternoon. 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 and performance are subject to many risks and uncertainties that could cause actual results to differ materially from what we expect. In addition to any risks that we highlight during the call, important factors that may affect our future results are described in our most recent SEC reports and today's earnings press release. We will also refer to non-GAAP financial measures.
Reconciliations to their most directly comparable GAAP financial measures and supplemental financial information can be found in the 8-K, earnings press release, and financial supplement 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 the call over to Aart de Geus.
Good afternoon. I'm happy to announce that Synopsys completed another outstanding quarter. Last October, we entered fiscal 2017 with expectations for solid revenue, earnings, and cash flow. As a result of excellent execution and robust customer demand, we're on track to substantially exceed those expectations for the year. For Q3, we posted revenue of $695 million, with good growth across all product groups, most notably hardware and IP. Non-GAAP earnings per share were $0.92, and we generated $280 million in operating cash flow. We completed our third share buyback of 2017 for a total of $300 million so far this year. Lastly, we're raising our revenue and non-GAAP earnings per share guidance for the year. Trac will discuss the financials in more detail.
As we look at the dynamics of the three customer groups we serve, semiconductors, systems companies, and software developers, I would characterize the environment as exciting, visionary, and intensely competitive. The age of smart everything, some call it digital intelligence, is here. Following the decades driven by computation and mobility, we view smart everything as the third major wave of electronics impact. In verticals such as automotive, medical devices, virtual reality, and industrial applications, big data and machine learning are quickly becoming familiar terms, and early results are promising. This is good news for the semi industry, as these techniques require more and more compute power, cloud storage, and networking infrastructure to support massive data, complex software, and to add one more challenge, the imperative of security. Synopsys is uniquely placed at this vital intersection of hardware and software.
Through our IP and design platform, we enable faster, lower power, and denser silicon chips. Through our verification and software integrity offerings, we make possible the verification of hardware/software systems and the optimization of software for security and quality. From a business perspective, we've successfully grown and broadened Synopsys by building the leading position in EDA, a highly successful IP business group, and by branching out into the large adjacent TAM of software security and quality. In this context, let me provide some highlights for the quarter. Companies continue to prioritize aggressive adoption of advanced silicon while relying heavily on Synopsys. The evolution and use of FinFET technology continues to progress rapidly, with total designs reaching well over 500. From 16, 14, 12, 10 down to seven nanometer, Synopsys is involved in 95% of designs through our design platform.
For designs below 20 nanometer, our VCS verification is the primary simulator used in nearly 90% of chips, and we're very pleased with the growth of our emulation and prototyping solutions. In IP, we continue to deliver the largest catalog of IP titles, now rapidly becoming available down to seven nanometer through close collaboration with the leading silicon providers. Enabling the astounding next generation of five, three, and two nanometer technology nodes, our TCAD lets our customer partners create upfront process and transistor modeling while giving us early access and insight towards readying our design tools for new nodes. In this rapidly advancing and highly competitive semiconductor market, our design platform drove solid business in Q3. From synthesis to place and route to sign off to physical verification, we're engaged in the world's most critical designs.
In Q3, we announced qualification for Samsung's eight and seven nanometer LPP low power processes, as well as GlobalFoundries' seven nanometer FinFET node. At the Design Automation Conference, HiSilicon, Renesas, Samsung, and Qualcomm presented details of their successes on very demanding digital circuits ranging from 14 to seven nanometer. In custom design, ST, TDK, Micron, and Panasonic highlighted the significant benefits they've realized with Custom Compiler, while TSMC showcased their certification collaboration with us around their seven nanometer technology. Some comments now on verification, where we again delivered excellent growth. Our verification continuum platform, essentially the fusion of best-in-class software and hardware products into an integrated, differentiated solution, is ideally placed at the intersection of semiconductors and systems customers. Semiconductor customers want to verify that their chips implement the functionality dictated by the systems houses' software requirements.
Meanwhile, the systems companies want to debug and optimize their software to run on the most advanced chips being designed by their semiconductor suppliers. These companies share common pressure points in time to market demands and growing complexity. Synopsys verification solution provides the bridge between the two. Over the past 3 quarters, technical advances have delivered substantial growth in formal verification IP, and our newest VCS generation, which is rapidly proliferating its new fine-grained parallel simulation. Hardware verification products had a record Q3 and are delivering another excellent year. For example, in emulation, ZeBu was selected by Konica Minolta as their standard hardware platform for verification and early software bring up of their multifunction printer designs. In FPGA prototyping, MediaTek standardized on our HAPS-80 for their next generation SoCs, motivated by its scalability and performance.
Moving to IP, where we continue to generate strong results, including excellent growth in the quarter. In Q3, we further expanded our market leading interface portfolio by introducing complete solutions for the CCIX and HBM2 standards. In addition, our IP continues its rapid adoption into the most advanced process technologies, including 7 and 10 nanometer processes. We see strong demand for our embedded vision processor and announced a new generation that quadruples the performance of our neural network engine. Interest is coming from ADAS, video surveillance, and general AI applications. We also continue to expand our IP ecosystem with a partnership with Morpho to optimize their machine learning scene recognition technology for our embedded vision processor. Now to software integrity, where we focus on security and quality testing tools, as well as services for software developers in many industries.
While our traditional system customers are a prime growth opportunity for us, given increasing embedded software complexity and an acute need for security, the number of companies who develop and rely on software as a critical component of their business is much larger than in EDA and IP. The compounding challenges of exponentially increasing software complexity and the growing risks and costs of defects associated with data safety, security, and privacy affect companies across the board. This need is clearly visible in verticals such as medical devices, financial institutions, automotive, aerospace, and industrials. At Synopsys, we're focused on the software development process and are making excellent progress. In Q3, we announced key updates to our software integrity platform, including expanded language and industry standards coverage.
We're pleased with the Q1 acquisition of Cigital, which adds high-value security consulting, enabling earlier, more strategic discussions at the CIO and CSO levels of our customers. The recognition of Synopsys in Gartner's Magic Quadrant, combined with Cigital's consulting practice, is generating new interest, new business, and growing brand recognition. At the popular Black Hat security industry conference in July, which drew more than 15,000 attendees, the number of inquiries by current and potential customers quadrupled over last year to more than 2,000. From a financial perspective, we're also executing well, and while still in the early stages of scaling this part of the business, we've reached critical mass and are enthusiastic about its potential. Earlier, I mentioned the opportunities in the vertical spaces for software security and quality. Many companies are impacted by security worries while simultaneously racing towards the promise of smart everything.
Automotive is a prime high visibility example of this is a vertical market that touches almost everything that Synopsys does, ranging from TCAD to optical, to FinFET design, to IP, to verification, to hardware, software prototyping, all the way to code security and quality. Automotive stands out because of its sophisticated supply chain from OEMs to tier 1 and tier 2 suppliers, also because of its complex standards aimed at guaranteeing safety.
Our influence and business here is evolving in many ways, including increasing verification growth at leading car companies, new capabilities in analog simulation tools for reliability of automotive chips, competitive wins in automotive lighting software. A growing number of business wins for our 16 and seven nanometer IP that is qualified for the most stringent automotive safety and reliability standards, all the way to active leadership with the Society of Automotive Engineers cybersecurity task force focused on setting new standards for software security. In summary, we delivered another excellent quarter in our raising revenue and non-GAAP earnings guidance for the year. Our strategy increasingly demonstrates the value of our rationale as the investments we've made over the years are paying off. Near term, our strong products and customer relationships in EDA and IP are leading to very good revenue and EPS growth.
Longer term, our expansion into the new software security and quality TAM is showing great promise. Let me now turn the call over to Trac.
Thanks, Aart. Good afternoon, everyone. Over the first three quarters of 2017, we've executed very well across the board, driving strong financial performance and reinforcing the confidence we have in our future. In Q3, we delivered double-digit revenue and non-GAAP earnings growth and generated significant operating cash flow. In addition, we repurchased $100 million of stock and continue to invest strategically to drive long-term growth and profitability. As we enter the final quarter of the year, we are confident in our outlook and are raising revenue and non-GAAP earnings guidance. As I talk through specific results and targets, all comparisons will be year-over-year unless I specify otherwise. Total revenue increased 13% to $695 million, driven by solid performance across all product groups, led by hardware and IP. About 90% of revenue came from beginning of quarter backlog, and one customer accounted for more than 10% of revenue.
Largely because of record hardware sales, upfront revenue was greater than 10% of the total. Investors should expect continued variability in revenue due to the growth of our hardware products and their upfront revenue recognition. Excluding hardware, our revenue model remains at approximately 90% time base. The weighted average license duration was approximately 2.5 years, and we expect the 2017 average to be somewhat less than three years. Total GAAP costs and expenses were $590 million, and total non-GAAP costs and expenses were $521 million, within our target range. Non-GAAP operating margin was 25% for the quarter. For the year, we expect solid organic margin expansion over 2016, moderated by the impact of the Cigital and Codiscope acquisitions. GAAP earnings per share were $0.75, and non-GAAP earnings per share were $0.92. We generated $280 million of operating cash flow, driven by strong collections and business levels.
We ended the quarter with cash equivalents, and short-term investments of $1.3 billion and total debt of $436 million. We have repurchased $300 million of stock so far this year and have $500 million remaining on our current authorization. Now, to the fourth quarter and fiscal 2017 guidance. As we indicated in May, due primarily to timing of hardware revenue and seasonally higher expenses, we expect Q4 to be the lightest quarter of the year. Q4 targets are: revenue between $642 million and $657 million, total GAAP costs and expenses between $586 million and $602 million, total non-GAAP costs and expenses between $535 million and $545 million, other income between negative $1 million and $1 million, a non-GAAP normalized tax rate of 19%, outstanding shares between 153 million and 156 million, GAAP earnings of $0.26-$0.33 per share, and non-GAAP earnings of $0.55-$0.58 per share.
For 2017, we are raising our revenue target range to $2.67 billion-$2.685 billion, a growth rate of 10%-11%, other income between $4 million and $6 million, a non-GAAP normalized tax rate of 19%, outstanding shares between 153 million and 156 million, GAAP earnings of $1.92-$1.99 per share. We are also raising the midpoint of our non-GAAP earnings target range by $0.03 to $3.29-$3.32 per share, a growth rate of 9%-10%, capital expenditures of approximately $90 million, and cash flow from operations of $580 million-$600 million. Finally, we are still preparing our 2018 budget and would suggest that it is premature to change your 2018 estimates until we provide detailed guidance in late November. Having said that, we believe the current 2018 consensus non-GAAP EPS estimates look reasonable. This is consistent with our long-term objective of driving high single-digit non-GAAP EPS growth.
In summary, we are executing very well on our goal to maximize long-term shareholder value. We substantially increased our 2017 targets compared to initial expectations, reflecting good growth across the board with particular strength in hardware. We continue to prudently invest in our next wave of growth, Software Integrity, while simultaneously driving ongoing EDA and IP growth and profitability. Lastly, in the first three quarters of the fiscal year, we have returned $300 million of capital to shareholders through our stock buyback program. With that, I will turn it over to the operator for questions.
Thank you. Ladies and gentlemen, if you wish to ask a question, please press star then one on your touch-tone phone. You'll hear a tone indicating that you have been placed in queue. You may remove yourself from the queue at any time by pressing the pound key. If you're using a speakerphone, please pick up the handset before pressing the numbers. Once again, any questions, please press star one at this time. Our first question will come from the line of Gary Mobley with Benchmark Company. Please go ahead. Your line is open.
Hi, guys. Thanks for taking my question. A question about the Software Integrity Group. Can you give us some color on where the revenue stands? I know you've been talking about how it's been about 5% of the total revenue mix, and I'm sure that's plus or minus 100 basis points or so. Could you give us a sense of where we're at on a run rate for the full year?
Hi, Gary. This is Chuck. We're pretty pleased with how we're doing with the Software Integrity business this year. Let me remind you of some of the commentary we provided at the beginning of the year. Last year, we ended the year for Software Integrity at about $100 million, and our goal was to get that business to break even this year and grow at about 20%. When we completed the Cigital and Codiscope acquisitions, we mentioned that it was roughly half of the existing Software Integrity business. To date, when we look at the results, we're certainly tracking to the plans that we had laid out, and profitability is trending pretty much to plan. As we look forward on the Cigital and Codiscope acquisition, our goal is to get that to break even probably in the second half of next year.
Okay, about $170 million in revenue this year, or at least annualized.
In that range, yep.
Got you. Okay. I did notice your U.S.-based cash is at a record low in terms of the percentage of the overall cash, and just wondering if that presents a problem with respect to your capital allocation plans.
No, I certainly don't feel that way. For the quarter, we did end with a cash balance that's lower than it's been over the last few quarters, but cash flow continues to be very healthy in general, as we mentioned in the Q3 results, and our forecast for the year still shows very healthy cash flows. From a debt perspective, we have about $280 million outstanding on the line of credit with a capacity to go to $650 million. We feel like we've got a lot of flexibility in terms of managing our capital allocation similar to prior quarters. I think just to reiterate, the way that we've used our U.S. cash this quarter was a combination of the buybacks, which typically comes out of U.S. cash, and then the geo mix was a little bit different than it was in prior quarters.
Last question. If memory serves me correct, you haven't really done a whole lot of M&A in the last couple of quarters, and I'm just wondering if that's reflective of potential targets expecting too much, or if it's anything indicative of how you want to use your cash.
Well, remember that in Q1, we acquired Cigital, and so that was a very important acquisition. If you were to look at our history over many years, or should I say many decades, you would see that there is quite a degree of randomness when things get acquired and closed for the very simple reason that, while we may have very solid strategic plans on what we do, we have very little control over when things become available or are for sale, and even the closing process has many imponderables. Having said that, though, we have not changed our fundamental strategy, which is we invest strongly in our own R&D because that is a very good way to continue innovation and typically provides very good return on investment.
At the same time, we don't hesitate to bring in forces from outside, be it for technology reasons or for market position reasons. In the case of the SIG business, we have been quite successful so far, and I dare to say it's probably not over yet.
Okay. Appreciate the comments. Thanks, everyone.
You're welcome.
Thank you. Let's go to the line of Rich Valera with Needham & Company. Please go ahead.
Thank you. A big picture question for you. There's been a lot of discussion about the potential incremental spending by systems and particularly Web 2.0 companies that are developing their own hardware, these companies that didn't exist, say, 10, 15 years ago. You also have companies like Apple that have taken a lot of semiconductor design inside, so they're designing a lot more, at the same time, they've kind of depleted their supply chain. I just want to get your sense of how incremental you see the new system companies, particularly Web 2.0 companies, to the overall EDA spending pie, if you will.
Well, for starters, I think they're very interesting because, of course, that is the center of gravity of where the action is in turning electronics into the next wave of massive impact on the world. These are the companies that do two things at the same time. They have algorithms that are really quite revolutionarily new and practical in the AI space, at the same time, they continually explore, would there be benefits to have hardware that is more specialized, dedicated, or optimized for exactly that?
I think the jury is very much out in terms of how many of those companies and which ones would go how far. I know I gave you a lot of questions here, how far into doing their own design. What is absolutely clear is that in many situations, they do the top end of design as it is relevant to verify that their software will be able to run very well on it. Of course, we are privileged to be very often in the middle of that story via the very rapid prototyping and emulation. We're also increasingly in that story by virtue of being close to everything that needs to now be secure. We have a lot of interactions with companies that in the past we either had only marginal interaction with, but now are really the drivers for the future.
Some of those people also rely on semiconductor companies to be their partner. We get to see a little bit more of the value chain. I mentioned automotive as a good example of that.
Got it. I guess relatedly, you've had a pretty fantastic run in hardware, and it sounds like it's sort of dual pronged there on both the emulation and the FPGA prototyping side. I know you're always loathe to make predictions here, but just want to get a sense of how you view that business on maybe sort of a medium-term basis in terms of the growth outlook, and would you distinguish between emulation and the FPGA prototyping in terms of potential growth rates, if you'd give any color on that? Thanks.
Well, the way to respond is not the dual prong, it's more a triple or quadruple because when you look at the verification platform, other techniques such as the software simulation, the debugging, and static techniques, they all play together with the emulation and the FPGA. That platform is becoming more and more solid. That's relevant because even if you have super-fast emulation, if you find an issue and you cannot track down what it is, your debugging becomes the bottleneck of success. Having said that, there's a reason why we have been cautioning you about drawing a straight line on the whole hardware side of our business because it's very lumpy. It comes in fairly large increments, and those increments are not always predictable.
Even if in the long term, we are actually a strong believer that there is continued good growth in that area, we certainly continue to invest well in that, the technologies are very promising. Well, lastly, you mentioned, we don't really make that much of a difference between the FPGA boards and the emulator. They're really two sides of the same spectrum, which is essentially use hardware to massively accelerate some software function, both are doing quite well.
Fair enough. Just one final one for me, I think this is for Trac. Trac, when you talked about your model this time, you basically said you see it as 90% ratable going forward, excluding hardware, and I'm not sure, I think that's the first time you've used that language, excluding hardware. Obviously, hardware's been part of the mix for quite a while here. Is that new language, and do we think this is because hardware is likely to be a bigger percentage of the mix on an ongoing basis than it has been historically?
Hi, Rich. It really wasn't meant to be a deliberate change in the messaging. We just want to highlight that it was an extremely strong quarter. The results are really solid. It was driven largely by hardware, much like the year has been, and we just want to highlight that if there's any concerns about the rest of the business, have we changed the business model and the rest of the business? We haven't. I think we said that early in the year as well, so it's a pretty consistent message.
Got it. Okay. Thanks very much, gentlemen.
You're welcome.
You're welcome.
Thank you. We'll follow up, Tom Diffely with D.A. Davidson. Please go ahead.
Yeah, good afternoon. I'd like to follow up on Rich's questions on the system customers. Do you think that the growth over the last few years was stronger, greater than you expect the growth to be over the next few years? I mean, have we kind of gone past the peak growth of that new market?
I think for that part of the market the changes are all ahead of us in terms of the impact on literally virtually every product in the world. We're coining the term smart everything because that's really what we mean, meaning that there are so many areas, from services to hard products to infrastructure and so on, that all will benefit from this emerging wave of artificial intelligence very much rooted in the combination of big data and machine learning. I think we're just touching the tip of the iceberg in terms of its impact. That doesn't mean that instantaneously every system company in the world is going to say, "Well, I'm going to become a chip designer." Not at all.
It does mean that there's a whole new wave of demand for semiconductor, and I would say in general, electronics technology to accelerate the very algorithms that finally are starting to yield some interesting and positive results. We've seen this in the past. Once computation became interesting for a broader set of people, immediately everybody became hungry for much more and faster computation. The same is going to happen here. What is slightly different maybe than the wave of computation where computation was fairly segregated from software, meaning the software people just were designing on a very general platform. I think this time around, the platform is going to be adapted much more to the software. That's why these intersections between system houses, semiconductors, and ourselves are very interesting.
We purposely try to position the company at this intersection of hardware, software because we see big long-term opportunities there.
Okay. It sounds like that the way you expect the market to roll out over the next several years is a lot more, but perhaps smaller system customers that are more additive versus cannibalizing the semi guys.
Oh, I think there's zero cannibalization. I mean, the makeup of the semiconductor industry has obviously changed substantially in the last five, six years. You may remember the dialogues we had, was it a maturation and a slowdown of the industry, or was it the opposite, which is a rejuvenation? Those words often go hand in hand, and that's why change is always painful. I think a lot of the semiconductor industry is orienting itself very much to be in sync with the emerging system companies that will take advantage first of these techniques. A good example that's so visible to many is the automotive industry, where people that had nothing to do with much of the sophisticated intersection of hardware, software are now deeply involved in changing their field by using partners to get there.
I'm not worried that semiconductors are going to be jeopardized. No, they are an ingredient, and of course, they will have to negotiate hard for pricing as they always have because the race is on again.
Okay. When you see a higher number of smaller customers augmenting the business going forward, does that change the operating model at all as far as, especially the SG&A or R&D line?
Well, the reason for the higher number of smaller customers comes actually from a different angle, which is as we entered the software quality and security space, as we've said in very broad terms, fundamentally, any company that significantly relies on software has challenges from a complexity and security point of view, and therefore will start to look for solutions. Now, some of those companies are not very large, and very often, the early engagements with these companies are on the basis of rather small purchase orders. That brings an interesting challenge for Synopsys because we have the opposite in the areas where we have grown our business for many decades.
We are walking this balance of working with large companies and gradually increasing the purchase orders while trying to keep the door as effectively open to anybody who wants to talk to us about these problems, because they may well turn out to be large customers in just a few years. That brings with it a significant increase in the number of logos of companies, many of which I've never heard the name of. Interesting perspective.
Hey, Tom, this is Chuck. Let me just add to that. From a business model or operating model perspective, the Software Integrity Group definitely does open up a much broader customer set to us, and they have a different buying pattern, certainly a different scale than what we're accustomed to. As we think about scaling not only the Software Integrity Group, but Synopsys to grow profitably, we're very conscious of making sure that the infrastructure that we build around that business, both from a system, from a process perspective and how we deal with that, is effective to scale in an environment where we're dealing with many more customers at a lower price point. We're conscious of that as we build our long-term model.
Next we go to the line of Krish Sankar with Bank of America Merrill Lynch. Please go ahead.
Yeah. Hi. Thanks for taking my question. A couple of them. Aart, number 1, on the IP business, you said it's still pretty strong. Is there a way you can quantify either what you think the growth rate for your IP business or for the industry is today?
Well, we have stated for our business that it's in the low double digits, and it's doing very well in that regard. It's also doing very well because we see many customers that continue to commit more of their needs to us. That bodes well because it takes a long time to build good trust with customers because there's very little tolerance for IP errors, as you would imagine. Simultaneously, the IP blocks themselves are subject to continuous evolution. Not only do the standards evolve, so the version 1, version 2, version 3 of standards, these are just numbers. But number 3 is a lot more complex than number 2, which is a lot more complex than number 1. Simultaneously and in parallel to that, they also constantly migrate to the next silicon technology. That's a compounding effect of complexity.
Against that backdrop, we continue to broaden our portfolio both with the existing titles into the next version, with new standards and with support of the most advanced technology nodes. All of this bodes well for continual strong business. We feel that we are actually in a very good position, and we complement extremely well the leader in the industry, which would be Arm, around its core offering. We're, I think, in a very solid position.
Got it. That's very helpful. On the hardware side, actually specifically on emulation, are you guys, if I may use the term, are you guys competing with Cadence and Mentor on the traditional emulation, or are you really gaining more traction on the software wrapping side?
Well, in this space everybody is competing a little bit on everything, but it is also certainly true that we all have our respective strengths. I think it is a very promising part of the industry, and as far as I can tell, everybody is doing reasonably well. Having said that, there's no question that we have selected what we think is the sweet spot, which is this intersection of hardware, software, and most importantly, the ability to help software people bring up their software on the hardware that doesn't exist, so to speak, by using emulation or FPGA-based prototyping as a way to model that very hardware. It is only in fairly recent years that the technology capabilities in emulation and prototyping became sufficiently fast to do that in a meaningful way.
The fact that we can bring up, for example, a complete Android operating system on one of the most advanced apps processors on an emulator in less than half an hour gives you a sense that, hey, if you can do that, you can run some other software too. That is why I think that door has been opened and now people are moving towards using it more and more. From that perspective, certainly our specialty would be that, and I think we're well-positioned.
Got it. I just like two final questions for Trac. One is, can you say how much is auto as a percentage of total sales for you guys?
We haven't talked about that specifically, Krish, but it's certainly increasing over time. It's across all of our product groups.
If I may add something. One of the reasons we're a little cautious with those numbers is because they're actually difficult to define. The reason is that a number of the very big automotive-related suppliers related to our field are, of course, the semiconductor folks that are partially specialized. Those companies invariably do many other things as well. It is also spread in the other parts of our business. We increasingly do IP for automotive. When I say IP for automotive, we really mean something different than the regular IP, because automotive has, at the minimum, two very challenging set of standards. One is everything that has to be certified for safety, and we really mean the safety of the part in the context of utilization. The other thing is the automotive temperature ranges and voltage ranges can be very different.
These are additional challenges, and the very fact that we manage those and that we have a rapidly growing automotive IP portfolio is a good sign because it takes a long time to invest in those and make it work.
All right, good. Just the last question for Trac. Your op margin has been in the 23%-24% range for a while, and I understand hardware could be dilutive on the gross margin level. Just if you want to look forward and where the margins could expand to, would the best opportunity come from being more efficient on the R&D side or more on the SG&A side?
Let me step back and say that we are still committed to grow operating margins to mid-20s. When you look at our results and you peel back the results for 2017, we're actually growing margins in a very healthy way from 2016 to 2017 when you exclude the dilution from the Cigital and Codiscope acquisitions. Looking forward, as we try to determine where we can actually expand margins, I think it's going to come across a whole variety of things. At the highest level, how do we manage the business from the existing EDA IP business versus scaling up the Software Integrity Group business? You raise specifically from a functional perspective, do we see opportunities in both in R&D versus SG&A? I think it's going to come through a combination of both those areas.
I would just continue to reiterate that on the EDA side, it's a very technical, very complex space that I think long term, while we try to drive margins, we'll likely keep the R&D spend as % of revenue in that 30% range. If you look at the results for this year, it's closer to 30% than it's been north of that over the last couple of years.
Thank you. Let's go to the line of Farhan Ahmad with Credit Suisse. Please go ahead.
Thanks for taking my question. Trac, my first question for you is just in terms of how you go from about $0.56, $0.57 in EPS in October quarter to more like a $0.90 per quarter EPS range over the next year, which is kind of the expectation the street has for fiscal 2018. What's causing so much variability in the hardware or your overall business now that you can go from pretty much the best quarter that you have had to the worst quarter in terms of the earnings that you have had over the last four years?
That's pretty straightforward answer. It's hardware, both on the emulation and HAPS side. As you've described, it's been a very strong hardware revenue year. Year to date, we've had increasingly strong growth in hardware. The profile of it is just, that's the profile for Q4. It's going down quarter to quarter based on what the customer deliverables are. I would just reiterate that typically we do manage this business on an annual basis over the long term. Quarter to quarter, things would change in the past because of IP, and now increasingly as we are more successful with hardware and it becomes a bigger part of our business, you'll see more variability. We're not particularly concerned about Q4 because that's a profile of the revenue that we see.
We feel comfortable enough with the overall business that we can at least guide FY 2018 to where the consensus numbers are right now. Just remind you that as you look at the 2017 numbers and the guidance for 2017, we actually have taken up the revenue guidance for the full year again.
Got it. Just in terms of hardware, because historically the market share in hardware has tended to move around quite a bit between the different suppliers, I'm just trying to understand what gives you the confidence that your hardware portion comes back or remains strong in the next year?
Well, I think the term is remain strong because, as Trac said, we're managing everything on a yearly basis. The fluctuations in the quarter is a phenomenon that we signaled to you at least 4 or 5 quarters ago, saying, "Hey, this is going to increase because that's just the nature of that business." What we also are very clearly signaling to you is that the problem of being able to run software before you have the chips is growing in importance. That is great news for us. We're in the right place with these technologies. Of course, we have to stay competitive, and we have to continue to invest in the next generations and all of those things, but that's nothing new for Synopsys. We've lived for 30 years on the edge of driving Moore's Law from our side.
We will continue to exhibit the behaviors that hopefully accomplish that going forward. I think the fact is that with the noisiness of the hardware on the P&L from quarter to quarter, the way we look at it is on a yearly basis or a trailing 12-month type basis. All the indicators we have right now is that we're in a very solid position. Never say that you won't make mistakes, but right now, if anything, you should take a fairly positive note away from this earnings release.
Got it. Just in terms of your headcount, it has gone up somewhat this quarter. Can you talk about some of the areas that you're investing more now?
Sure. Obviously, we are careful of how we invest, and that too comes a little bit in waves as a function of how we manage the year. Typically, all of our BUs are careful before they invest, before they get their budget for the year. Having said that, we continue to invest in the areas where we see great opportunity. We have actually, I think, a reasonably well-disciplined internal process where we watch the profitability of each of the businesses. The ones that are much below the average of the company have clear instructions on how to gradually move up. We also have sometimes clear instructions to invest because we think that there is an opportunity to grow. SIG, the Software Integrity Group, is definitely in that category. That too can come in lumps by virtue of acquisitions.
I think we're pretty much investing in every area of the company at this point in time. The software part would certainly be a prime example of that.
Farhan, this is Trac. Let me add to that comment. I think for a fact, we are growing and profitable across the business line. In Software Integrity Group, we're still in investment mode. Across the businesses, we are growing and have very good profitability, we continue to invest across the various groups. The hiring, you might see it pick up from Q3 to Q4 or Q2 to Q3. It's pretty much per the plan. It's not unusual. If you remember what we described in our Q1, Q2 earnings call, we were a little bit behind in hiring before we saw visibility to the improvements in revenue. The pickup in the second half is really per the plan.
Investor line of Sterling Auty, please go ahead. Your line is open.
Thanks. Hi, guys. Wonder if you could give some additional color in where you saw the strength in particular in the IP business that you mentioned and what the margin profile on that strength actually looked like.
the word strength almost invariably brings also a better margin profile because when your business grows well, that is because it's partially repetitive on things that you did before, or it is in areas that are of particular interest to customers and more advanced. We mentioned a little bit automotive before. I think we're doing quite well in automotive. Across the board, the interfaces are doing very well. The embedded vision is interesting because this is an area that is seeing very rapid technology evolution on our part. We had an early product on the market late last year. A number of people have done some interesting things with it and immediately came back with a slew of requests, and we're fulfilling those. That's as much a fun area as it is a good area for us.
lastly, we're also doing quite well in everything that touches the actual physics of semiconductors because moving things to the advanced nodes is actually a very sophisticated set of tasks, and we are becoming better and better at that.
how would you characterize the competitive dynamics? Because it seems like a number of players, yourself, Cadence, et cetera, have been putting up good results in IP. Have you found that similar to hardware that you've kind of spread out in terms of where the focus is?
we have been, I think, fairly disciplined in making sure that we invest in IP areas where one has actually a good chance of getting a return on investment. It's very easy to jump on every piece of IP that moves, so to speak, because the customer really wants it. if they are the only one or if they are customers that may have grand ambitions, but in our assumption a chance of actually not making it to significant chips, we become more careful. in general, we look to have clear proof that there is a life cycle to the IP that we invest in. we have now the benefit of many years of experience. That's just the positive word for having made mistakes and learned from them.
That learning is paying off, and as customers have seen us learn, and as they have learned with us, it has built a certain degree of trust because success is so often achieved by, in the last minutes together, overcoming some issues, and that is only the case in IP. That's why I'm thinking of it as an extremely solid, high-quality business that's very sophisticated, but that has a very good chance of continuing to grow at a good rate.
Thank you. Next, we go to Jay Vleeschhouwer with Griffin Securities. Please go ahead.
Thank you. Good evening. Aart, let me start with you with a couple of technology questions around Core EDA. With respect to ICC, in terms of its adoption, at the DAC two years ago, Synopsys quoted you're having, I think, 33 customers at the time, at DAC last year, more than 90, and now as of DAC two months ago, more than 150 customers. The question there is, do you think that the expansion of logos in terms of ICC adoption has largely run its course, and so now you've become relatively more dependent on expansion per logo, or do you think there's still good logo expansion opportunity?
Second Core EDA question, thinking back also to DAC two months ago in your joint presentation with TSMC and Arm, there was a lot of discussion, of course, around seven nanometer and some of the implications for Core EDA tools. In that respect, how do you think seven nanometer or anything under 10 might impact synthesis specifically? I imagine that's still a more than $200 million business for you, probably generating some good margin and cash flow, and is there some upside opportunity owing to the technical requirements of advanced submicron for that product line?
Let's start with the ICC logo expansion. The expansion will continue, but the reality in our field is by the time you are at logo number 150, those are typically dramatically smaller in their expenditures than certainly the top five or 10 or 20 or 50. The expansion then typically tends to continue more in breadth with the existing companies. They gradually move over from the previous version, ICC1 to ICC2. Regarding the intersection of our tools with TSMC and Arm as one of the key cores that is so relevant to many of our joint customers, and that intersection with us all on the theme of 7 nanometer, I think there's no question that 7 nanometer and for similar technologies from other vendors, they have a different number for it. Think of it as the most advanced production manufacturing technology.
It is growing rapidly. If we look at the curves of FinFET in general, while there was probably a discontinuity between planar technology, which is 28 nanometer, and everything underneath that, which became FinFET, at this point in time, we sort of see the same curves of adoption and growth, except, of course, that the chips are again, dramatically more complex. The complexity is both in terms of the gate count, but also in the literal physical or interconnect demand for the synthesis, place and route verification, and timing tools, and so on. I hesitate to say it like that, it's sort of technology business as usual. Please stay on the exponential, keep driving it like crazy, the chips will continue to come out successfully.
A lot of work has gone into that, for TSMC, 7 nanometer is sort of their flagship. They have pushed very hard. They have multiple versions of 7 nanometer, and all of this is continually aligned with them on a technology basis and continually exercised with Arm on their blocks. Our joint job is to deliver best possible chips while reducing the risks and then the work that it takes. I would say so far so good, actually. I think it's doing quite well.
Right. I appreciate that. Actually, I was asking for a specific comment as it relates to synthesis, let me move on to my next question, having to do with hardware. Inferring from your results and your comments, it would seem that Synopsys will have been the largest by revenue and emulation for the quarter and for the trailing 12 months, which you've not been before, that's what the data now suggests. My question is, since this ramp-up in emulation began about 2 years ago for you now to this new, much higher level, has ZeBu been consistently larger, either on a quarterly or trailing 12 basis than HAPS, or have there been periods where prototyping was in fact larger than emulation?
As you well know, we never disclose the very specifics of individual products. Maybe, answering the gestalt of your question, there's no question that the hardware solution, and we really think of it as a combination of ZeBu and HAPS, has done extremely well for Synopsys. By the way, I think that the overall industry has done well, so this is not a negative on our competitors. For Synopsys, we came from a few years of having zero position there into a very strong position, and I think it is very much on the strength of the technology, but also on the focus at the right place with the customers. I do expect this area to continue to be strong.
You've heard the caveats before of lumpiness and all that, but fundamentally, the theory of understanding design and the importance of software would certainly say this area will continue to be very important for people getting system products to the market. Yeah, we're gratified that the team has executed very well and that we have a number of very advanced customers that are really seeing the benefit of shortening the time to market of the combination of hardware and software, and therefore, we expect them to continue to want to accelerate that benefit.
We are at four minutes to the top of the hour. We will go to Monika Goyal with KeyBanc Capital Markets. Please go ahead.
Hi, thanks for taking my question. First, if I look at upfront revenue year to date, it's almost growing more than 50% year to date. Is it most of it coming from emulation or something else adding to that too?
Monika, it's a combination of hardware, which is a combination of emulation and HAPS.
Got it. Aart, a lot of companies used to do EDA development in-house. Given the increasing complexity of EDA tools and design complexity, do you see more EDA development moving to EDA companies? How do you think the increasing silicon content in autos, artificial intelligence, machine learning, self-driving cars, everything, how does that change the TAM for EDA tools?
Okay. Well, the move of internal EDA to commercial EDA, i.e., to EDA companies, started to accelerate massively in the 1980s. I would say that by the 2000s, it was a rare occurrence that people would develop their own EDA tools. There are a few companies that still rely somewhat on their internals because the internal EDA is specialized for the type of machines they build, and the well-known example that stands out is IBM for their super big machines. Aside of that, I'd be hard-pressed to point at anybody. The exception to that may be that in some areas, people may develop some specialized tool that actually adds something to what our tools are doing.
They may have a special analysis that they put in our timer or in our place and route system or so, in order to get better results for something that they want to be quiet about and are doing. Your question on the machine learning is very pertinent because, just like we are preaching that the impact of digital intelligence will have importance everywhere, well, we are part of everywhere. We have quite a number of projects ourselves in that area. There's a lot of opportunity to rethink about problems. I also want to caution that when you have big excitement waves, there can be a little bit of a bubble phenomenon, where suddenly everybody thinks that they know what to do, and one can easily over-invest in that as well.
We have been fortunate to be quite engaged in this field with both a number of customers and internally. I think we have a good balance in it. It will have impact on EDA tools, and we certainly are in the camp of having an enormous amount of data, and we will try to use that wisely.
Thank you. Our final question will come from Mitch Steves with RBC Capital Markets. Please go ahead.
Hey, guys. Thanks for taking my question. I just have one for Aart, one for Trac. Just from a high-level perspective, when I think about people using more tools to kind of design chips, are you seeing more of the demand because people are creating new chips or because people are trying to fit more transistors onto the chips themselves?
I was going to say years, but I really meant to say decades. It's been the latter, which is, it's the complexity of the chips, not the number of chips that has driven our business. Up until 2000s or so, the number of chips was growing, and after that, it actually came down to about half and has been, as far as I can tell, somewhat stable since then. It's complexity that's driving it.
Got it. Second one for Trac, just really quick. I know you've just talked about how FY18 seems like you guys can do that based on consensus numbers. Given the fact that hardware is becoming a larger % of the business, should we anticipate hearing kind of a long-term growth rate for that business, given that you've given it to us for kind of the software piece, the EDA mid-singles, et cetera?
No, we typically don't break out product categories. I think to remind you, the emulation business hardware rolls up into core EDA, and that's part of our guidance in terms of the growth rate for that area is in the low to mid-single digits.
Right. Despite the hardware increase, you still think you can hit that target?
Long term, yes.
Got it. Thank you.
Well, I think we have arrived at the end of our allocated hour. Thank you for your interest and excellent questions. Hopefully, you took away from the earnings release that we delivered good results and feel very solid about the year. We were cautious to not give yet guidance for 2018. We're not ready for that. You did get a sense that we support the consensus as it stands. We'll be available after the earnings call, and thank you again for your interest.
Thank you. Ladies and gentlemen, that does conclude our conference for today. Thanks again for your participation and for using AT&T TeleConference Services. You may now disconnect.