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

Okay. Good morning, and good afternoon, everyone. Thanks for joining us. My name is Adam Gonzalez, and I cover the U.S. semiconductor and electronic design automation sectors on Vivek Arya's team here at Bank of America Securities. Today, I'm really excited to have Lip-Bu Tan, the CEO of Cadence Design, join us. We'll get started with a little bit of an introduction before diving into some Q&A. We'd also like to keep this session as interactive as possible. So if you do have any questions, please submit them to me in the web portal, and I'd be glad to ask them if time permits.

So with that, let's get started. Lip-Bu, thanks for joining us. Just to start out, can you give us a quick introduction of Cadence, its unique business model, the markets it serves, and its role in the semiconductor, broader tech and electronics ecosystem?

Yes. First of all, thank you, Adam, for inviting me to speak here. And before I start, let me just do the safe harbor. Before I begin, I want to mention that safe harbor statement. Today's discussion will contain forward-looking statements and will make use of certain non-GAAP financial measures. So please refer to our most recent 10-K, 10-Q and website for a discussion of risk factors and our use of non-GAAP financial measures. So let me get started with a brief introduction of Cadence. We are a technical software company, largely in the electronic design automations space. We provide software tools for designing and IP and also hardware verification platform service to semiconductor and electronic system company in the whole. And of the -- we're pursuing intelligent system design strategy. And basically, the foundation is intelligence, is the -- clearly the design excellence, and that is our core EDA and IP business. And on top of that, we have the system innovation that I will talk a little bit more on the system analysis space that is addressing a $5 billion TAM market opportunity. And with our new acquisition of AWR and Integrand will provide a very high-frequency RF design. And also, we have the embedded software expertise in the safety and security with the investment in Green Hills Software, and that's what we are addressing. And then the third layer is the pervasive intelligence that's providing the AI algorithm know-how to our core business and also specific verticals. And so far, I think, we have finished the Q1 earnings call and with the excellent financial results. And we also reaffirmed our guidance of 10% revenue growth for the year, and we are serving the broad sector of industry for mobile, consumer, cloud, data center, mil/aero, automotive and industrial, medical-related areas. And we have -- we take pride on the culture of innovation. And so last 3 years, we have organically developed and introduced more than 20 significant products. The culture of innovation really provide us the product leadership so that we can be trusted partner to our key customers. One thing good about our business, we have a very broad, diversified customer base. We have more than $3.7 billion backlog at the end of Q1. And also with a very highly ratable business model and that provide that resiliency of the business that we can really affirming our 10% revenue growth rate, 85% to 90% is recurring revenue model. And all in all, I think we are excited about the opportunity and able to address this intelligent system design from $10 billion to $30 billion TAM market for the next 5 years. We continue to drive the efficiency. Our operating margin we are guiding is 32% to 33% and so this is kind of a very quick summary of our business.

Great. That was a really great overview. For my next question, I really wanted to start more in the longer term. And I wanted to discuss really the top 5 technology trends that you think will drive growth for Cadence over the next 5 years. And how these trends might differ at all between your traditional semiconductor customer base and your electronic system customer base? And then, as part of that, can you walk us through what impact, if any, COVID-19 has had on your business thus far? How that might have changed since you reported Q1 results? And how we should think about some of the near and longer-term disruptions, both positive and negative moving forward?

Good question. So I think that some of this technology trend that we like. Clearly, these are just few. 5G, of course, everybody know, is starting to deploying. That's a very exciting opportunity for us, particularly in the RF front. And then the hyperscale computing, I mentioned earlier, this is a very exciting opportunity for us in terms of people work from home or remote locations. The scalability of the hyperscale computing and the CapEx increase in that area is very exciting for us. And machine learning, deep learning are ranging from small start-up to a big company is -- basically, we're moving into a data era and then how do you store the data, how do you organize the data, how do you use the data for analytics would really drive some of the performance improvements and that is very exciting for us. And the other part, of course, the automotive and autonomous driving, industrial, digital transformation of the Industry 4.0, those are all great opportunities for us. And then if you go below that, there's a lot of sea change in terms of the general-purpose CPU and GPU. Now they have this, I call it, the domain-specific computing and also system companies starting to build their own silicon to drive differentiation, so they have more control of the whole process. And also a suite of new start-up companies in the quantum computing, AI, machine learning, deep learning. And then I mentioned earlier that this digital transformation for some of the big industry group. So those are great opportunities for us, and we are pursuing. That's why we kind of described this intelligent system design, not just at silicon level. We also drive the whole system packaging, the layout and then how to really drive this whole data era opportunity to support them. In terms of COVID-19, clearly, it's very challenging for all of us. And -- but I think, so far, we're doing fine. And in the Q1, we result -- we have excellent results. And also, we give the guidance of the whole year. We're reaffirming our guidance of 10% revenue. And our top priority right now is to ensure the safety and the well-being of our employees, customers and the whole community. And vast majority of our global employee base is working from home. Our transition so far had been doing very smoothly. The business continuity have been doing fine with -- thanks to our infrastructure, collaborative platform, high communication that the company culture has and that maintained to continue the high level of productivity, specifically in the R&D innovation and also delight the customer with the support. And our sales and application engineers adopt very well with the new model of working and able to engage with customers very actively in business, training and customer support. And overall, I think, we are excited, even with this very challenging environment. We'll continue to innovate on that. And I mentioned earlier, we have very diversified customers, and we have the strong backlog, ratable model. And then so far, I think, we're holding well, except the Q2, we kind of point to all of you that hardware installation at the customers' sites and then IP able to access to the labs have some impact. But overall, I think, we are doing quite well. And that's why after careful testament of the situation, we feel comfortable with reaffirming our guidance.

Got it. Yes. And I'll get back to that reaffirmed guidance in a minute, but I just wanted to talk briefly and get a little background on your core EDA business, which really accounts to the lion's share of your business today. That market is largely dominated by you and Synopsys, and it's really consolidated meaningfully over the last decade or 2. Can you walk us through how you are positioned competitively there versus the other big vendor? And how your product portfolio, strategy and customer exposure has really evolved since you took over as CEO 10-plus years ago?

Yes. So I think -- thank you for the questions. And I've been the CEO more than 10 years now, 11.5 years. And we've changed the culture, changed the way we do business. And so one of the big focus for me is to be the technology leader. And we do a lot of investment into rewriting all our tools and really driving the platform so that we can be now really leading edge in the most advanced nodes. And in fact, right now, we are working on 7-, 5-, 3-nanometer and exporting 2-nanometer, so I think we are taking the leadership on the advanced nodes. And then secondly, clearly, on the product by product, we are driving the differentiation and completely rewrite some of the tool, using massive parallelism, using AI, machine learning or using cloud infrastructure, cloud enablement, cloud native way to drive the software. And so let me just touch on a few. First is the digital implementation flow. That is very important. It's the largest EDA segment. And we completely re-architecture, as I mentioned earlier, in the digital and signoff tools from Innovus, Genus, Tempus, a whole suite of names. And we like to have the really best-of-class in each of the engines. And after that, we want to really drive that integration to drive the performance. I'll give you one example, iSpatial technology was announced in Q1, basically able to really unify the whole placement and the physical optimization engine and then using the AI machine learning capability to drive more than 3x faster throughput and 20% more improvement in PPA, and that's where the customer really cares. And we are delighted to highlight a couple of key customers endorsed us: MediaTek, Samsung. And in Q1, we highlight a hyperscale guy in Asia, large hyperscale guy using our full digital flow to tape out the machine learning inference chip and are now deploying a full flow at 7- and 5-nanometer. And then same thing with the marquee Asian electronic system company, completely using the digital full flow tapeout on the 5-nanometer, low-power process and then beating their own power targets. And we are delighted that market-shaping semiconductors, specialized in automotive consumer-related areas, chose us as the primary EDA digital signoff. And so again, digital flows. And again, it's just from time to time, every quarter, we will let you know what other market-shaping customers adopting our flows on the digital front. And then on the custom/analog side, we clearly are the leader in that. But we are pushing the envelope even further. We've moved into the most advanced solutions on the complex analog RF mixed-signal areas. Virtuoso and custom clearly is the market leader and the gold standard. We add more sophistication in capacity and the most advanced nodes. And then in terms of simulation side, where Spectre X circuit simulators are getting a lot of momentum, very delighted to see the customers see a benefit of our massive parallel architecture and then increase capacity so far, I think, without compromising any of the accuracy and entirely integrating with our Xcelium. And then, of course, I mentioned earlier, the AWR, Integrand acquisitions that will provide us full features RF platform across chip packaging for module ICs. And clearly, it's very successful. Customer really delighted. So I think that, so far, has been good for us. And of course, our hardware emulation. Now we have this whole verification suite that includes the engine like Xcelium, Jasper, Palladium Power emulation and Protium FPGA platform that integrate together providing that verification suite and so far have been delight the customers. They really like that and have been very strong. Our Z1, last quarter, we have 4 new customers, 9 major expansions; Protium, we have 6 new customers, 6 repeat customers' orders. And clearly, the benefit of Z1 and X1 with the front-end compiler -- common complier, really -- customers really like that and especially, the hyperscale guys and then some of the market-shaping customers. So overall, I think, we have a good platform and then, of course, the IP is another good area. They have more than double-digit growth. We can talk about that more as you go.

Great. Yes, you actually highlighted a lot of great points, and I'll try to flesh those out as we progress through this call. But I wanted to just go back to the 10% full year outlook that you guys reiterated after Q1. And I think for some of the people who are perhaps newer to Cadence out there, that might be a little bit surprising. Maybe you can just cover how is it that you're able to have such strong visibility, especially in the current environment, when you think about your exposure to the semiconductor industry, which most people think could be tracking down mid-single digits this year. Can you just touch upon really briefly how you can have such a strong up year in that context?

Thank you. And this, again, reflects our business model. And as I mentioned earlier, normally, we sign with a customer and our contract is like 2.5-year, 3-year contract. And then anything new organically developed or acquired, we have -- we call it the add-on contract. And then after 2.5 years, 3 years, the renew of the contract will be the baseline plus all the add-ons will be the new baseline. So our business model is really ratable. And then 80%, 90% of our business is that kind of recurring business. And so it gives us a very clear visibility in the quarter ahead of us. And so far, I have to say that my team, and I'm a basketball player, I like to have a team that work well together. We really integrate the team. We really enjoy working together. And we set goals that we can really drive some of this innovation and be the trusted customer to the -- partner to our customers. And so far, knock on wood, we're really excited about the design activity, no slowdown we see, especially some of the area I mentioned earlier in the hyperscale related. And then in the -- I mentioned about this whole data era that is happening right now. And it's all about data. And then how do you drive machine learning, deep learning, to store the data, to organize the data and utilize the data. And those are massive change. And we are excited we are in the middle of it to help our customers to fulfill that. So I think, overall, we feel good about the visibility we have for the year. And we've raised the focus on the, we call it, add-on business. That we make sure that there, we can see the future next year, the growth and that we can continue to surprise.

Great. And then just circling back to -- you discussed some of the improvements you made in your full-flow digital product portfolio and as well as your -- some of the improvements you made on the custom/analog side as well. Can you help us understand what factors into the customer decision-making process when they're deciding to go with one vendor or another? How important is full flow integration? Is that changing? What are really the switching costs involved for customers, the barriers to entry for competitors? And why the market really evolves where Cadence was the king in custom/analog and Synopsys until recently was more dominant in digital design?

Yes, good question. So I think the shifting cost for customer is very high unless they see 25%, 50% better improvement, otherwise, they will stick to the old flows. And usually, when you have a new tool, initially, the customer would like to benchmark and then see how you -- what you claim and what you deliver is the same excitement. And the moment they're starting to see that your -- couple of projects for you to try and then if you show the performance, they say that, wow, this is good. Then they will starting to deploy you into some specific product group or, for example, if you have a very broad diversified customer, they may start trying you with CPU; then the SoC and then the system on chip; and then later on, the GPU; then across the whole company. Then they select you to be the platform of choice. And so that is kind of the process we're going through. So the, clearly, last couple of years have been very focused on putting resources into the innovative products, rewrite some of the tools, as I mentioned earlier, architecturally using massive parallelism, using AI, machine learning and then to really drive the differentiation. And then not just show 25%, 50% multiple; 3x, 10x better improvement so that you get the attention of the customer. They're willing to try our product. And after that, one step at the time. Each engine, either the place and route or synthesis tool, they're going to be benchmark you and see whether your performance is as good as you claimed. And after that, I think, it's very important to full flow. The main reason driving the full flow and because when you move out the geometry, from 14 to 7, 5 to 3, you really need to be -- really depend on the trusted partner to really drive the performance with your R&D team. And so with that -- that's why we emphasize, we want to be the trusted partner. They can count on us. We become the workhorse for them. They design using our tools. They have a very high confidence, you will be able to fabricate either at TSMC and Samsung or Intel successfully or GLOBALFOUNDRIES. So those kind of our responsibility to make sure that they are really solidly proven and silicon proven so that they can -- all the corner cases have been corrected. And so that they can count on us as a tool for production. But that's why we are very excited right now. All the tools are the best-of-class. So that we can integrate, pushing for the whole full flow. And we are delighted, as I mentioned earlier, MediaTek, Samsung endorsed that. And we have a couple of key customers are shifting to us, and we're delight with that. So I think, as I mentioned earlier, digital is a big platform, the largest EDA platform. In the past, we are not the leading position. And now we clearly become the leader in technology. And now it's just proliferating across the board, and hopefully, we'll be a market leader. And then custom/analog, clearly, is our franchise. And so we continue to drive success. But we're not just content with being the leader. Right now, we drive more and more performance with most advanced nodes so that we can really drive success for the customer.

Got it. And then shifting gears to the hardware piece of your business, which has really become a bigger piece of the EDA pie over the last several years. And that's really the emulators and the prototyping systems that are out there. I get a lot of questions from investors on this. So can you just provide some context to the audience as to what these hardware systems actually do? How they are used by customers in the design process? And why has the need for them become greater in recent years? And then finally, what are some of the key differences between emulation and prototyping? And how are you positioned relative to the main competition out there?

Very good questions. So I think, clearly, the semiconductor and system design complexity increased substantially and then the high cost of failure. So I think whatever the complex design they designed, they need to verify and that's why I think the hardware emulation and prototyping become critical. Functional verification is a fast-growing challenge for the customer because it's their bottleneck. Before they really stand for the production and then get to the marketplace, they want to make sure that everything they design is being verified and then proved that it's working because the mask cost and the production is very expensive, especially the advanced nodes. So it's almost a must-have. If you are below 65-, 40-nanometer, this is definitely the must-have even though it's expensive, but people -- it's a critical mission that they need to have to check that before they go for production. And as I mentioned earlier, we are pushing for the whole suite, verification suite, and that is the Xcelium, Jasper, Palladium and Protium. So let me talk about Protium and then the Palladium. This is the hardware and prototyping machine. So the hardware Palladium, we call it Z1, is the best in the market in terms of performance. And the customer love it. And then the moment you're starting to buy one, you're going to buy more, because if you have a lot of design, this is a must-have. And then this is the massive supercomputing that you're able to verify whatever you design, and you have confidence to go for production because some of these advanced nodes tapeout and the mask cost is 10 million and beyond. And so it's critical to test all this before you go for productions. So in the past, we have just Z1. And we don't have that prototyping for earlier software development and hardware regression. So finally, we decided to come out this X1, and this is the prototyping for software development and the small-scale regressions. And one thing that's unique for us because of common front-end compilers, so when you do whatever you do on the prototyping and X1, very easy for you to move to Z1 of massive production-scale verification. So I think this is something that really the hyperscale guys and market-shaping leaders in the semiconductor customers, they love it. And that's why we mentioned not just early customer adoption is that the real big business opportunity for us is the repeat orders and expansion. But because they love it so much, after you buy 1, you want to buy 10, you want to buy 20. And we had a couple of customers in the, we call it the 10 billion clubs and 10 billion gates, massive deployment on the hardware emulation, and we are delighted to serve them and to -- for their verification.

Great. And then on the intellectual property side, semiconductor IP, that's been a really nice business for Cadence, and it's been growing at a solid double-digit pace over the last, I'd say, 3 or 4 years. But your strategy is a little bit different relative to the top 2 in the market, which is ARM and Synopsys. So can you just give us an overview of what some of the major IP blocks and end markets that the company has chosen to focus on? Can you speak to some of the industry trends that have really been driving a shift to more outsourced IP usage?

Yes. They're good questions. So I think just like EDA, in the old days, 30 years ago, you have IBM, some of the big companies, they have EDA in-house. But because now this is getting more and more difficult to continue to be in the front end of the development. And so they become outsourcing out, and that's why you have Synopsys, you have Cadence, you have Mentor to create the business for the EDA outsourcing. Same apply into the IP. For big company, unless it's critical -- mission critical in their own core IP, they need to have -- they keep it inside. Otherwise, they will outsource the IP because all these different versions, system protocols and like PCIe Gen 1, Gen 2, Gen 3, Gen 4, Gen 5, every generation is very complex to maintain. And so unless you have a very good silicon and quality, and as an industrial standard, they prefer to outsource. And that's why you see that Synopsys, Cadence, we're coming up very strong. And that -- so I think that outsourcing trend continues. And then the other part, we are differentiating with other of our competitor, we will focus on the -- few years ago, we decided to refine the IP strategy and we focused on star IP. That meant that really the customer critical IP they need. And so some of this foundation IP, we leave it to someone else to have it but we really focus on the star IP. And then secondly, we are very focused on the advanced nodes. There's no point to do 90-nanometer IP because that is already a commodity, low margin. We're really focused on the leading edge IP. So in the 7-nanometer, 5-nanometer, 3-nanometer, that's where we are focused on. And then the other part is we're also focused on the customer. We really targeted customers. We really focused on hyperscale, cloud infrastructure, connectivity IP, interface IP and those are very extremely important in the memory IP, PCIe Gen 4, Gen 5 and then the nusemi acquisition in the 112 gig SerDes, those are must-have in some of these systems, switching systems, networking systems and hyperscale guys. And we also bought Tensilica, and that is a very strong IP that's able to provide leadership in the audio, vision and in some of this deep neural network core for AI. And so far, I think, that strategy have worked out well. Last year, we have 16% year-to-year growth. Q1 also double-digit growth for us. So I think overall, I think, we're really focused on that, and that has been the great business. We are very targeted. We're looking for those kind of star IPs supporting the leading customers. And that's kind of our strategy.

Great. As we get close to the end of our session, I want to make sure I touch on system analysis. And that's really been at the core of Cadence Intelligent Systems Design strategy. First, I know you spoke about this earlier in our talk, but can you outline the market opportunity here? I know you speak about a bridge from getting Cadence's TAM from $10 billion to $30 billion. Can you talk about some of the early product launches with your Clarity and Celsius solvers? What's the competitive landscape here? And how do your -- how have your product has been received by customers? If we were to flash forward 5 years from now, how can Cadence growth in this area really transform its customer and business mix versus where it is today?

Yes. Very good questions. And something that we very thoughtfully think through before we embark on this system analysis space. And we went through a very long soul-searching, what are we really good at? And we are really good at computational software, and that's what is our core competent of the EDA. And also, it's something that we hear from the customer, and they want us to be there. And because this is fully integrated to the whole system solution they're looking for, it's a great opportunity for us in the system analysis. It's about $5 billion end market opportunity. And then we just touch on the tool solution that we just announced last year. One is Clarity 3D Solver, and that is electromagnetic field simulations. And then the other is Celsius. Towards the end of the year, we announced Thermal Solvers. That is electrothermal co-simulation solution. And these 2 solutions roughly got the TAM market, roughly, about $700 million opportunity. And we're able to show using our proven massive parallelism architecture and also cloud native, we can drive 10x better performance than the incumbent. And that, a lot of customers get very excited about and are able to use some of these tools to integrate with some of our Virtuoso and Allegro design and provide a tighter integration and customers love it. And last quarter, we have over 30 customers so far. We may name a few: Micron, STMicro, Kioxia, Realtek, Ambarella, Renesas, ROHM, Enflame and more coming. And we've got really strong support from the customers and they love that performance. They love that integration to our solutions, the Virtuoso. And so far, so good. And we are excited, and now we'd really like to see the growth and address the TAM market opportunity for us.

That's really great and exciting to hear. And earlier in your overview, you also talked about RF and 5G, and I think this kind of touches on the 2 acquisitions -- 2 most recent acquisitions the company has made in AWR and Integrand, which really only contributing modestly to the top line this year, but really have the potential to enhance your exposure to the RF and 5G markets moving forward. Can you discuss the rationale here and how these acquisition integrations are progressing?

Wonderful. And I think clearly, the RF, the integration and the solution is critical for the 5G and also aerospace, defense and automotive segment. This is a very thoughtful acquisition we make. AWR provided high-frequency RF millimeter wave solution for module and systems, and the Integrand is providing the leading RF solution for analysis and abstractions. And these 2 tie in very well with our Virtual and Allegro platforms and provide a fully integrated, comprehensive platform for the RF millimeter wave for chip, package, board systems. And we received very strong customer delight on this solution for them. And also, we form a very strategic alliance with National Instruments. They're able to do the design, test flow, enable the customer to improve the quality. So overall, we are very excited and then stay tuned. And then for the years to come, you can see the results.

Great. One last question I think before we hit the time. This has really been a topic that's top of mind with investors in U.S.-China trade and the export restrictions and whatnot. And I know Cadence overall has only really been modestly impacted by the Entity List restrictions since they were first unveiled in middle of last year. But there have been a whole host of new restrictions announced over the last month or so that really have the potential to impact your business moving forward. I know China is a pretty important growth market for EDA overall, and it's about 10% of your business currently. Can you just provide us an update as to where you stand currently on the trade front? Synopsys seemed to indicate that there wasn't much of an impact to their business. But just wondering where you stand.

Yes. I think we're monitoring very closely. It's a very complex and fluid situation. And clearly, we are a U.S. company. We continue to comply with all the export control regulations. And meanwhile, we try to do everything we can to serve our customers globally. And meanwhile, we have to comply with the rules. And we're monitoring closely. And so far, our Asia Pacific now is a strong growth area for us. We've done well in China and then depend on different quarters, somewhere around 10-plus percent or around that range. Clearly, China is building up their own semiconductor ecosystem. And we support our global customer, include China. And then meanwhile, we observe carefully with the U.S. regulations.

Great. And with that, I think, we're out of time. Lip-Bu, really wanted to thank you for joining us. And for the investors out there, if you have any follow-up questions, please feel free to reach out to me directly. Thanks, everybody.

Thank you.