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

Yes, that's exactly right, Tom. Certainly, to the first and probably second order too. What matters to EDA is design activity and chip designs. And whether someone uses their own fabs or a third-party foundry, that -- I mean you -- the physical design of a chip has to be tuned to whatever process it's going to be made on. But unless there's some sort of change in design activity, it shouldn't matter much to EDA.

Okay. Great. And then just one more question. In general, when you look at the semiconductor market. Historically, you guys have done very well on the logic chips and memory because they're a little simple architecture, hasn't been a big driver. But over the last, call it, 5-plus years, the speeds of memory have gone up so much that they almost have a true logic interface front end to them. I'm just curious, how important is memory to your business going forward? And how much growth are you seeing from just the memory markets versus where they were in the days of old?

Yes, I don't have a specific number for growth, but you're again exactly right. Memories have gotten more complicated. And as memories have gotten more complicated, I think we've certainly seen the larger ones climb up the customer list. Again, not as big as spenders as logic companies, but certainly more than they used to be.

Okay. Great. So let's shift over now and look at some of the long-term growth drivers for your industry. Obviously, core EDA is the bulk of your business. Over the last 10 years, it used to be a low to mid-single-digit base linked to R&D budgets for the semiconductor guys. But over the last 7, 10 years, it jumped up to a 6%, 7% growth rate CAGR. And I'm curious, obviously, what do you think the biggest factors were for that almost doubling of the market growth? And do you think over the next 5 years, say, it can stay at the higher levels? Or is there going to be a reversion back to the mean?

Yes. So we do -- Tom, we do believe that the EDA industry can grow faster than the overall economy. We also believe that our intelligent system design strategy will help us to provide more capabilities and value to our customers while also expanding our current TAM of about $10 billion to over $30 billion over the next 5 years. Now having said that, due to various other uncertain factors, including changes to the global economic environment, semiconductor industry consolidation or other industry consolidation, we are not comfortable putting out a long-term growth projection, a specific long-term growth projection. Now when you look at our results last year, Cadence revenue grew 9%. And for 2020, we are projecting midpoint growth of approximately 11%. And we are also expecting that all of our product technologies will be growing in the high single digits to double digits this year. So again, I think if you look at the overall drivers that exist out there. Right now, we are seeing the confluence of about 4 to 5 key drivers that I believe will continue to stay the course for the next so many years, which will obviously then result in very high design activity and that benefits companies like Cadence and Synopsys and other players in the EDA industry, right? So to the extent that design activity continues to stay strong, we believe that we will continue to see more growth opportunities. And again, we are not going to be putting out a long-term target, but we will continue to focus on executing in a very disciplined and balanced approach that we believe will be in the best interest of our shareholders.

Okay. And maybe I missed it, did you say that you think the core EDA market could double from $10 billion to $20 billion over the next 5 years?

No, our TAM. Our TAM is -- today, we are about -- if you look at our current TAM, we are about $10 billion. And given the growth that we expect to see in core EDA, which includes hardware and IP as well as our expansion into the systems and analysis space, we expect that TAM to grow to about $30 billion over the next 5 years.

Okay. Yes. No, IP has been a very nice segment of the market over the last 7, 10 years, and it's growing in a nice double-digit clip. And projections are part continue to grow 10% to 15% over the next 5 years. Is your exposure in the IP segment kind of at par, do you think, for the growth of the IP segment overall? I know you -- over a couple of years ago, you kind of fine-tuned your offerings in IP and this went on to a select group of it. I'm just curious, do you think that portion of your business can continue to grow in the 10% to 15% range? You're muted, Alan.

I'll take that one, Tom. Yes, we did -- Cadence got into the IP business in earnest about 10 years ago when we acquired a company called Denali, which had memory controller IP. And then in 2013, we bought Tensilica, which had a digital signal processor IP and have continued to grow the business from there. We fairly quickly grew it up to 10% of our revenue. And that -- and then a few years ago, we took a realignment and realigned the business to focus more on profitable growth and did that by a focusing of the business on advanced nodes, certain end markets and certain customers. But IP has -- is a continuing outsourcing opportunity, which is where you can get those above-average growth rates for an industry. But as we go back to that realignment of the strategy we had a few years ago, we're -- Cadence is focused on profitable growth for our IP business. So it's an optimization of revenue growth and profitability. And we do that by trying to focus on what we call STAR IPs, where we can offer differentiation. For instance, our Tensilica processor IP is very strong in audio applications and usage of it has been growing for both image processing, computer vision. And more recently, we're seeing it used for AI, machine learning applications, especially at the edge and Tensilica processors are very low power. Some other key areas of IP for us is ultra-high speed SerDes, which is, of course, a cloud or a data center play. PCI Express is strong for us. And then we remain strong in the original memory controllers and PHYs that got us started in all of this. So again, we're really not focused on matching or beating an industry growth rate, but finding that sweet spot of growth and profitability for ourselves.

Okay. That makes sense. So good summary on core EDA, good summary on IP. What about the systems business? That seems to be a little more of a black box to us on the outside. You talked about some of the new products serving some adjacent markets, and they look to be pretty, pretty large markets that are new to you. So how do you view the emerging systems business over the next 5 years? Is this something that is slowly steady grow over time? Or is this going to be one of those step function markets that will take a jump every time you enter a new piece?

Yes. Well, yes. So Cadence entered what we're calling system analysis, some people call it simulation market. You see the word solver. You used a lot in this context, too. So to begin with, just how to -- what you call the industry is confusing. But Cadence entered this initially in the third quarter of last year with our Clarity electromagnetic simulator and then followed it up a quarter later with the thermal simulator. So those are our first 2 products. And these are our focus beyond chip design and board design and next level or 2 up in systems, but they grew out of our core competency in what we call computational or mathematical software. The fact is that probably upwards of 40% of the core EDA business involves some form of simulation, whether it's the analog 5D simulators or the logic simulators. And so -- and -- so you're oftentimes solving very, very large matrices, the same thing you have to do with the more mainstream simulation products. So we're very good at that. And so we had to add some domain expertise in the thermal electromagnetic area. But what we brought to that was, again, building off of our ability to build computational software with a lot of capacity and a lot of speed brought simulators that were faster and higher capacity in the market. And so again, so what we want to do is build off of those core competencies into product areas that are important to our customers. Now this is software. Cadence has a ratable software model. So revenue growth is going to be a lagging indicator for us just because of that. But as of the end of last quarter, we had over 125 engagements going just for those first 2 products, and we continue to invest in this business, and we're serious about it.

All right. That's great. Now in the past, I think you've talked about how your products currently address about a $700 million market. But the broader market that could have similar appeal would be somewhere in the $5 billion to $10 billion range. Is that still kind of your view of the kind of -- big picture view of what the opportunity is out there for you over the next many years?

Yes, there is. Yes. We -- yet to be seen which of the subsegments will move forward in, probably be similar to what we've done so far, which is to, again, move up from our core competencies and what is most important to our largest customers. But again, didn't get into just to be a 2 product player.

Okay. That makes sense. And then moving over to the model. I know you don't have a future model. But just trying to look at a few of the aspects or pieces of it. When you look at continued revenue growth in your core businesses, and the incremental add from this new adjacent market. Is this a model that continues to ramp up with operating leverage? Or are there certain aspects of it where you have to go into an investment mode for a while that could provide margin dollars but hurt margin percentage? I just -- what are the kind of big picture views? If we make the assumptions on the revenue, what happens to the earnings model?

Yes. So the -- good question, Tom. So we are obviously focused on top line growth, but I think we are equally, if not more so focused on scalable and profitable growth. And at Cadence, we pay a lot of attention to effectiveness and driving operational efficiencies. We are extremely data-driven. We use metrics a lot to make ROI-based decisions, whether it relates to pricing, resource allocation or investments. And obviously, all of that has resulted in an uptick in our operating margins over the past several years. And over this time period, over 50% of our incremental revenue has flown through to our non-GAAP operating margin. And even as we look at expanding into these new areas, he was speaking about systems analysis, the margin profile of those opportunities are very important to us, right? So for us, we understand that with our core EDA business, it is a very complex business, it will require investment. But when we are looking at metrics, and we are ensuring that over time, these investments will result in over 50% of that incremental flow through to non-GAAP operating margin. I think that gives us kind of the -- how do I say that the baseline from which to kind of operate, right? Because even within Cadence, all of our senior members know that we are tracking to that. And the product line owners or the general managers have that as a goal that they need to kind of meet when they are requesting for funding. And so I do believe that focused approach, that data-driven approach, and not just focused on top line but also the scalable and profitable growth that we will continue to, like I said, provide a good return to our shareholders.

Okay. That's great. I appreciate that. Good color. So I guess runoff against the clock here. So final question, technology theme. Over the last 5 to 10 years, the emergence of the hardware business has been one of the really bright spots in EDA. And obviously, Cadence, leader in emulators, leading the charge. Just curious, what do you see as far as the future? Is this trend going to continue going forward? Was this just an initial build out? How do you view the hardware business on a go-forward basis? Dramatic pause?

I'm off of -- no, no. I had to find the mute button again. So yes, thanks for the last question. I'll make it quick. But hardware is part of what we would call our verification suite, which includes the logic simulator, our formal verification tool. And then these days, 2 hardware products, both the Palladium Z1 emulator as well as the Protium X1 prototyping system. And as chips get more complex, verification continues to be the biggest problem to manage for the customers. And that -- it's increasing software content of chips too. Customers have to -- even semiconductor companies employ a lot of software engineers these days. And both the hardware emulators and the prototypers have a very important role to play in that co-development of software, too. So it's not just chip complexity itself in terms of verifying that you got the circuits right, but it's also verifying that the software you've written is working with the chip. So we think that verification overall, well, which hardware is part of is certainly going to be one of the more important areas going forward.

Great. Well, with that, I think it's a good thought to leave it. Once again, I thank both Sandhya and Alan for joining us today. It's always nice to hear about Cadence. It's been a remarkable run over the past decade, and I'm hoping that the next 5 years are just as exciting. But with that, we'll end the chat today. And just like to let our -- Mike, let us know that we can log out now.

Thanks, Tom.

Thanks, Tom.