Cadence Design Systems, Inc. (CDNS) Earnings Call Transcript & Summary

All right. Great. Good morning, everyone. Thanks for joining us today for the 48th Annual JPMorgan Technology, Media and Communications Conference. Very happy to have Lip-Bu Tan, CEO of Cadence here with us today. So just -- we'll let Lip-Bu give us a quick introduction of himself and the company. I'll go through some Q&A, but I do want to just right off the top, encourage people. [Operator Instructions] But without any further ado, Lip-Bu, thanks again for joining us. Could you just maybe give us a quick introduction of cadence and the markets you serve?

Happy to do that, Jackson. First of all, let me mention the safe harbor statement before -- today's discussion will contain forward-looking statements. And we'll make use of certain non-GAAP financial measures. And please see our most recent 10-K, 10-Q and website for the discussion of risk factors and the use of non-GAAP financial measures. Let me start with the overview of -- very brief overview of Cadence Design. We're a technical software, largely in the EDA space, electronic design automation space, that we provide software tools, IPs, hardware verification platform and service to semiconductor and system companies. And we're executing towards the intelligent system design that consists of design excellence at EDA and IP system innovation that is on the system analysis and also embedded security space. And then, of course, the last one is pervasive intelligence that is on the AI serving vertical markets. And our business is very -- a lot of recent resiliency that is a very broad, diversified customer base, and we have $3.7 billion backlog, and then it's a ratable business model. And so we announced a few weeks ago excellent Q1 financials. And then we also reaffirm our guidance of 10% revenue growth for the year. And then we basically serve very broad vertical markets, mobile, consumer, cloud, data center, automotive, mil/aero and also up and coming industrial and medical space. And we have a culture of innovation. Last 3 years, we have more than 20 innovation organically developed. Last year, we had 7 altogether in 2019. And then we are very focused on being the trusted partner to data customers. So we engage very early and then understanding what they need and providing the tool, solution, IP to help them design their coolest products they're designing. So that's kind of a quick overview of the business.

That's great. Can we just maybe speak to trends in your major end markets? So both semiconductors and how EDA fits into -- you mentioned systems companies. A lot of people say, well, what's a systems company outside of semiconductors? So what are the major trends of those 2 major markets?

Yes. So a couple of things that getting me very excited. We see 5 major trend happening. One is the AI machine learning. This is all about data, and then how do you use the data to drive the productivity and to drive the efficiency and then find new business model, new business, and that's exciting for me. And then the hyperscale and most of the people -- most of the things moving to the cloud or the edge. And that is very exciting for me. There's a lot of silicon development to address that requirement. And of course, the automotive -- autonomous driving. And also, the whole digital transformation for the industrial IoT. And right now, we are moving to what I call it, the domain-specific processing development. It's not just computing. It's all how do you drive different application and optimize for that. And then the other big piece is basically is the digital transformation I just mentioned. Industrial group, they have a lot of data. How do you transform that using industrial IoT? There's going to be a lot of semiconductor component into it. So all in all, we're pursuing this, I call it, the intelligent system design, not just the silicon, you go all the way up to the system analysis, providing the best solution to drive some of this application in the new data era.

Now how does the EDA industry and then specifically Cadence, what role does your strategy actually play in helping your customers capitalize on the trends that you just laid out?

Yes. So we are very well positioned to provide that solution to them. And first of all, we provide the semiconductor design tool and IP to make that work. And then secondly, we also have the PCB board system analysis, the packaging side of the business and the layout of the whole system. And then the next thing, we have to gradually have a few new suite of products coming up and -- on the system analysis, so they can help them to do some of this requirement. And like, for example, 5G, that's another big area. We have the RF capability. We bought AWR, an integrant that provide the RF and integrate with our Virtuoso and our packaging solution that can provide a very integrated, high-frequency RF solution for the 5G deployment.

Yes. Can we just quickly follow up on that, on the system analysis? This is -- some of these are more -- are 3D solvers and maybe outside of the core, what we would consider EDA or semiconductor design. Why do you feel that this makes sense as an adjacency for Cadence to get into? And do you have any early successes that you want to share or maybe early findings that you've come across thus far?

Happy to share that. And clearly, our customer facing a very challenging system complexity, time to market pressures. And then also, currently, the solution that is not driving the requirement they need in terms of capacity limitation. And then some of these legacy solutions that are not able to meet the requirement, and we decided our strong computation software capability and experience can play a role here. And so we announced 2 new products that in Clarity 3D Solver that is addressing the electromagnetic field simulations and also Celsius, the thermal -- electrothermal solution that we provide to the customer. And clearly, we showed more than 10 -- up to 10x performance differentiation. And it's a very big TAM market. It's about $5 billion. These 2 products providing $700 million opportunity for us, and we are delighted. And besides, we're showing the performance. Last quarter, we have 20 customers and just finished at Q1, we have 30 paying customer, and we're delighted, and there's many evaluation going on. And then we have customers like Micron, STMicro, Realtek, Ambarella, Renesas, ROHM, Enflame and many others. So we are excited that we are providing better performance, stronger scalable capability without compromising the accuracy that customer like.

Okay. Great. So we'll hop back maybe to core EDA and then -- and circle back to some of those new segments maybe a little bit later. But in core EDA, the digital design flow, Cadence has made some significant inroads into digital design, I think, when most people think the EDA industry, Cadence has been synonymous with strength in analog design. But where have you felt like Cadence has really made the most significant inroads into digital design? What is it about Cadence's tools in digital that you see stacking up well against the main competition?

Yes. Digital implementation is the largest segment of EDA. And few years ago, I think, when I took over as a CEO, I decided, digital is something that we want to be the leader. And we put a lot of effort in terms of re-architecture, redesign, tool by tool, from place and route synthesis and our timing sign-off. And so one by one, we really using machine learning, deep learning and also new architecture to really drive the differentiations. And then recently, I think last -- end of Q1, we announced the iSpatial that integrating the placement and the synthesis tool to make it a lot more efficient. And we definitely show a tremendous improvement in terms of 3x faster and 20% better PPA, and that is really, really important for the customer. And then so far, I think we are -- right now, we have all the right tool in places. So right now, we are pushing the full flow, and we are very delighted. We have Samsung, MediaTek and Gaus. And then the last quarter Q1, we highlight 1 major Asian hyperscale company using our full flow to tape out their infant chip with a very good performance. And now they decided in 5 and 7 nanometer using our full flow. We have a very large the automotive semiconductor company. They decided to do our full flow for to become their primary EDA to do that. So I think overall, we see tremendous progress very well received. 19 out of 20 semiconductor company engaging with us on the full flow digital, so we are very excited. Especially, we also move into the most advanced node. We are on the 7 nanometer, 5 nanometer, and now we are starting working on 3 nanometer. So I think we're clearly supporting the customer to do the best we can to drive the performance, PPA run time, and make them better in the efficiency on their design.

And is this the full flow buying behaviors, is this a departure from maybe what you have seen in the market before? I realize that it's taken some time for Cadence to simply build out the full flow. But do you see maybe differences in buying behavior from some of the larger companies that maybe will go best-of-breed tools and maybe some of the smaller design houses will go full flow? Just any comments you have on difference in buying behavior.

Yes. In terms of this adoption rate, I think that's what you're asking. Different companies have different approach. But clearly, they like to see at least 25% better performance. Otherwise, the shifting cost is very high. So first of all, they want to show when the test, whether the tool really providing that kind of performance. And then secondly, when they're starting to see the performance, they give you a few projects to really show that you can really get the result, what they want and what you claim. And then after that, they're starting to say, okay, maybe I have 1 product line, and now to go through and see what you can really deliver. So they have their various stage, like the bronze, silver, gold and then workhorse. So until you become the workhorse, then they're starting to deploy massively. And then maybe starting with 1 product group, let's assume this, like CPU first, then SOC, then overall, the GPU, that's a more difficult one because of the power requirement. Then other than that, they can massively deploy and count on you to be the primary EDA for the full flow. And so when you move down the geometry to 7, 5 and 3, it's harder and harder to do point tool selections because then, you need to have a very big team in-house to do the integration. So they decided to pick one as a primary, so that you can really drive the performance, drive the schedule that you want to have. Then if you need to have 1 or 2 point tool to complement that. And -- but otherwise, I think when you move down to 5, 3, every time you do a re-spin, it cost you a lot of money, tens of millions. And so with that, they usually like to choose one they can trust. And that's why we keep emphasizing that can become a CEO, we want to be the trusted partner. They can call on us. We're going to work really hard to make sure that they're successful.

Why is the integration between the tools more difficult at the smaller geometries than previously?

Yes. You can get a lot of challenges because in our different tool how to integrate because they may not be -- interoperability is an issue. And then -- and also some of the solution, you need to bring them together. That takes a lot of effort to do that. So it's much better to pick 1 primary, and then if any particular tool, they are not as good or there are some better one, they can augment that. And -- but you want to have 1 that you can count on, especially if you have a very tight schedule, and you just can't take the chance of something is not working or there are some corner cases that you didn't address, and that's a very big problem to delay the schedule and also increase the cost. And you also lose the market leadership because you don't have that first-mover advantage that you can have much higher margin.

Right. Okay. That makes sense. The next area I want to talk about is hardware. So both emulators, prototyping, this has increasingly become a large portion of the EDA industry. You talked about Cadence having a very ratable software model, but there is some lumpiness with hardware. It's becoming a bigger part of the mix. So what are some of the innovations that the EDA industry has made in terms of hardware that has allowed more use cases and hardware to become more of the mix over the last few years?

Yes. So I think the hardware is part of the verifications, and verification becomes the bottleneck in terms of design to manufacturing to really go to market. And so this is a really bottleneck, and we see that as tremendous opportunity for us. And then we are pushing, as you recall, we have 4 product group and basically, hardware, Palladium and then prototyping Protium, and then we also have Jasper for function verification and also Xcelium for simulations. So I think that complete suite that we have called verification suite, and we've done very well, and it's very well received. And then all 4 product group are the best-in-class in each one of them. And then we're able to make it integrate together. And then talk specifically about hardware and then the hardware innovation on Z1. We continue to have a very strong momentum. And last quarter, we have 4 new customers, logos, and then we have 9 major expansions, and we quietly launched the Protium last year. Protium is an FPGA based, and that is very good for software regressions and also earlier software development, and that's also very well received. We have 6 new customers and then 6 repeat customer last quarter. And so I think this strong momentum on the Palladium and Z1 and then the Protium X1, the one of the main reason customer like is we have the same common front-end compiler, so that you don't have to shift from the other, so that you can use the same software and then very much scale the capacity from prototyping regression all the way to the whole emulation, and I think that had been so well received. And then we see particular strength in the hyperscale data center area. They really like that. And also, we highlight a couple of major market shipping customer. They are the leader in the industry. They see the benefit and then can help faster, tape-out the chip and then can go to the market faster, knowing that all this verification of the design have been done, checked, and then we can -- they can able to go for production, and that is a significant value for them.

Is the -- common front-end platform, is that a something that's specific to Cadence in terms of a competitive differentiation between the other 2 major hardware competitors?

Yes, that's correct. And then we're basically able to do it very integrate way, so that you can do prototyping or software development using the Protium X1. And then when you want to go into the big, massive emulation, and you can just use the Z1 and very automatically and then so much easier for production, so I think people love it. And of course, the performance is very strong, very good.

Okay. Actually, that's a nice segue to a question that we got from the audience. So the question is, if we look 3 years out, how do you see the competitive landscape shaping up relative to maybe what you see today? I think a lot of people you see Synopsys. And people will just frankly assume that this is just a 2-horse race, and that's not necessarily the case. So -- but if we look out into the future, how do you think the competitive landscape is going to be different than maybe it is today?

Yes, so I think to tie in to our, we call it, the ISD, intelligent system design, strategy that we have. And EDA and IP is roughly about $10 billion, $12 billion TAM. We're starting to move up into the, I call it, the system innovation with system analysis and in better security, and that is increasing the TAM from $10 million to $30 billion. And in the EDA and IP front, clearly, we have a lot of respect for our competitor. They've done very well, and we continue to really drive innovation. I think that over the years, you can see that we have so much innovation coming up. The tool is much better. So in the way customer can count on us for the future, a tool that we can drive, continue to drive the performance efficiency productivity for them. And then meanwhile, we also embark into the system analysis space, and that is a $5 billion TAM market for us. And then we have earlier entry of the 2 products. Stay tuned, we have more products coming up, and that's what we can really use our computational software to really drive a difference. And then meanwhile, the core EDA is doing very well. I think as I mentioned, last year, we did 9% revenue growth. This year, we reaffirmed -- even in this COVID-19 pandemic, and we still reaffirm the 10% revenue growth for this year, and we continue to drive success on that. And we don't take our competitor lightly. We're laser focused to drive what we can do to help our -- the most important is to delight the customers.

The reiteration of guidance in this environment was certainly impressive and surprised us, I think, to the positive. So how has COVID-19 impacted the company in terms of your internal operations? How has it impacted your customers? And why is it that you think that EDA has been able to hold up so nicely when in other industrial -- in the other industrial software complex, we've actually seen a little bit more weakness maybe than Cadence is expecting?

Yes. So I think again, I'm very blessed with the resiliency of our business. As I mentioned earlier, we have $3.7 billion backlog, nicely increased from the year before. And then the other part is a very broad, diversified customer base we have. And then we have a very good team. I used to be a basketball player. I always believe the championship win by the team, and that's how we work as 1 team. And first of all, the #1 priority for me is the safety and well-being of our employees, customer and community. And then right now, majority of our employee right now working from home, I'm very, very impressed with how smooth the business is going. Our team is very adopted to the new working environment. And then clearly, our IT are doing a fabulous job, and we have tight communication, very frequent communication. And I also learned that in this period, customer is more welcome to talk to you because they've come from home. So they're happy to talk to you, and we kind of take that opportunity to work closely and learn from them. And our sales and application engineer work very well in this environment with engaging with the customer. And so far, we don't see any delay or cancel of design activity. And so meanwhile, I think we see all these big drivers. We are so well positioned on 5G, RF, AI machine learning, hyperscale. We are engaging deeply with them and the industrial group for the IoT. So I think overall, even though the challenging environment, I think we -- knock on wood, we have been holding up very well and winning company, customer of ours, they double down on investment in R&D and accelerating their innovation. And they count us as a trusted partner, so they go deep with us. So I think overall, we are happy with that. And that's why we can -- after careful accessing the situation, we look at our business backlog. And then the only challenge for us is the hardware installation at the customer side. Sometimes the customer is not ready to open up for us to install the hardware. And then the IP, clearly, in the Q2, we see that the lab excess -- the lab is critical in terms of some of the design IP. But besides that, I think it's not -- we are not losing anything, but it's just some like a delay on Q2 to Q3. And -- but we are very confident with that. So I think overall, we are very comfortable with 10% growth. We are on track on that, daily, weekly monitoring the situation with the customers.

Have you actually seen any increased demand in maybe cloud deployments? Or you have offerings where a lot of your software tools or even hardware tools can be accessed through the cloud? Have we seen any material tick-up in those type of deployments?

Absolutely. I think as you can tell, right now, people work from home, the cloud infrastructure need to scale to support. We are delighted. We are partnered with multiple of the hyperscale cloud guys, and they are deploying massively. They request more, and some of them are quietly building their silicon capabilities. And we are delighted to be their partner and then support them in the tool, the design, and we start very early. So when they are just starting on the silicon development, we treat them, I treat them like they are big customer, and so they really appreciate the support, the commitment we have for them, and they continue to count on us to expand and scale that. So that is a fast-growing area for us.

Another question from the audience, just quickly. Yes. So if we could just switch gears to geography. So China is about 10% of your business. There has been some changes to the Department of Commerce, came out with interpretations on new Chinese export rules. How do you expect this to affect Cadence?

Good question. So I think APAC is a strong growth region for us, and we've done well in China. This is a growing opportunity for us. And in -- China, as you can tell, is very committed to growing their semiconductor ecosystem, and then we support global customers include China. And then meanwhile, we also make sure that we comply with the U.S. government export restriction. It's a very fluid and changing, and we're monitoring closely. And meanwhile, I think we -- this quarter-to-quarter, sometimes they are up and down in terms of percentage of the revenue. But overall, I think we are strong in the IP and also the hardware in China. And so I think so far, we are doing fine. And then meanwhile, there's a lot of exciting start-up and innovation in China. As you know, China have this star market, many of the companies going public. They have a lot of funding to buy tools and IP from Cadence and Synopsys. So I think so far, we continue to monitoring very closely, and we do everything we can to comply the U.S. government law and then we're monitoring closely. Meanwhile, we support our customer globally, include China.

Okay. So just on, I guess, the fresh new rules. It's just too early to tell for the impact of the business.

Yes, too early to tell. We'll make sure that we're monitoring closely, but until they become implementing as a law, then, of course, we comply to it.

Right. Okay. Could we -- you've mentioned IP a couple of times. This has been a growing -- similar to hardware, this has been a growing part of the EDA industry. How -- what does your IP portfolio look like relative to maybe some of the other competitors in the market? And then also, could you just revisit what is the underlying trend that is pushing IP to become more important for new designs in this day and age?

Yes. I think IP is a good business, and IP outsourcing trend continue. As you can tell, the IP is very challenging to maintain, different generation IP and different protocol. So I think it's getting more and more difficult for company -- semiconductor company to maintain their IP. So as long as industrial standard, and I think the key thing for IP is the quality. So if you can deliver industrial standard, clear IP that are good silicon proven, customer will prefer to outsource. So I think so far, that outsourcing continue. If you recall, a couple of years ago, we're growing very fast. Finally, I put the stop and then reassess the IP. We wanted to make sure that we are growing the IP as a comparable operating margin as EDA in the long run. And so we decided to really fine-tune the IP strategy focus on the star IP. When I say star IP, is something that you can really trust for loyalty or have a better margin. And then it's critical -- mission-critical for the customer. And then secondly, some of these are one-off or just holding. We decided not to do that. And then the other part is focused on the advanced node. It is 2 latest nodes. Somebody already have the IP. There's no value for us to provide in terms of good margin. So we want to really move into the 7-, 5-, 3-nanometer IP that the customer anticipate to use. I'll give you an example like star IP, it's like Tensilica. It has been very good for us in terms of audio, variance and mobile. We can see that -- we can charge loyalty for that. It's a great momentum for us, a great model for us tied with the operating margin. And then the other part is like the SerDes, a high-speed SerDes, 56 112-gig SerDes on the most advanced node. That's why we bought new semi for that. That is a must-have for the data center and infrastructure play. So I think those are really good IP for us, and we are excited about some of this IP we have. And then, of course, the design IP. We mentioned about the DDR memory, PCI Gen 4, Gen 5, Gen 6. And then those are critical IP, of course, some of the data center infrastructure play, and we have a very strong footprint. We continue to drive differentiation. So I think overall, as you can tell, last quarter is double-digit revenue growth. Last year, the whole year, 16% growth. So it's a double-digit revenue growth for us. We like that. So we continue to drive the IP, providing the IP to the customers.

IP has also been an M&A target, right? Where -- how do you balance the buy versus bill equation for IP?

Yes. So I think the IP, the M&A is very similar to what the Cadence M&A. First of all, you have to fit to our strategy, the IST strategy. And then secondly, we really want to have differentiating technology and also the talent, the engineering talent, managerial talent, and they have a road map going forward. So when we're acquiring that, we want to make sure that we hold ourselves accountable to really drive the business. So I think IP, there are some pocket of IP that I call it star IP that we want to have, and they are really good in terms of customer like them, and we can support them and continue to expand. Those are the kind of the criteria for us.

Okay. Just a couple of minutes left, so I want to hit some strategic questions. Any thoughts on -- as you continue this kind of systems analysis and moving into solvers, any thoughts on maybe inorganic M&A activity in the systems analysis rather than what you've done, which is mostly organic R&D?

Yes. So I think we do both, and we're proactively looking at the right and are back to that strategy, in fact speeding the strategy, great talent, great product with strong customer support, we definitely will proactively acquire. We are very actively looking at it. This environment is great time for talents and great time for M&A, if we find the right one. And then meanwhile, always, it's good to know what you want to buy, and that's why we're creating our own internal organic growth development. So we have 2 new products. Stay tuned, we have more coming up. We are investing and based on the customer feedback. And then if we can pick -- find the right one that available, tie into the good return and with the criteria, then we'll do the acquisition.

Okay. Well, Lip-Bu, we are just about out of time. So I really appreciate your joining us this morning. Thank you, everybody, for your questions, and thanks for joining us. Take care, and enjoy the rest of your day. Thanks, Lip-Bu.

Goodbye.

Take care.