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

Okay. Welcome, everybody. Today, we have Cadence Design. We have John Wall, SVP and CFO; along with Nimish Modi, SVP, Marketing & Business Development. So I think a lot of people are familiar with the story. It's been a very interesting story for the last decade or so. But before we jump into Q&A, I'd like to give a chance for them to just provide a quick overview of the business. So I'll turn it over to Nimish.

Thanks, Mitch. Hello, everyone. Before I begin, let me -- I need to mention the safe harbor statement. Today's discussion will contain forward-looking statements and will make use of certain non-GAAP financial measures. Please see our most recent 10-K, 10-Q and website for a discussion of risk factors and our use of non-GAAP financial measures. So in terms of a high-level overview of Cadence, we are a technical software company, largely in the EDA space. And we provide software tools, intellectual property, hardware verification platforms and services to semi and electronic system companies. This will provide all of these companies to develop their chips, their packages, their PCB boards and systems. Our strategy is the intelligent system design strategy, which has our EDA and IP portfolio as the foundation and it leverages our computational software expertise. And we are looking at tripling our TAM by going into newer market opportunities over the next 5 years. From a customer perspective, we've got a wide variety of customers across multiple verticals, including cloud, data center, mobile, mil/aero, automotive and increasingly in industrial and medical as well around the corner. We've got a very innovative culture, focused very much on innovation. About 40% of our revenue comes -- of our revenue is in R&D. And over the past 3 years, we have developed and introduced more than 20 organic products. We are very customer focused. We partner very closely with them at very early stages of the design cycle so that we can understand their needs, and our customers, in turn, actually help define and guide a road map. And then lastly, I would say that in our last earnings call, we reported excellent financial results for Q3, raised the guidance for the year. And this will be the third year in a row that we'll be driving to the Rule of 40, which is basically revenue growth plus op margin greater than 40%. So that's like a high-level overview of the company.

Okay. I don't even recall the last time because it didn't put up as being raised. So it's been quite a long time. So very consistent results for you guys. Now before I turn on my questions, FYI for anybody listening, you can type in your questions into the system we have, and I'll try to put them in as we get them. But just you're talking about the product side, we'll start there. I think that's probably a good spot. Digital has been a very topical point for the last 3 or 4 years. Can you maybe talk about the traction you guys are getting there? How to think about it? What the market opportunity is? And how Cadence is trying to enter that subsector?

Yes. So digital is the largest segment in EDA. It continues to be a great opportunity for us. So here, the segment is largely driven by the relentless kind of advancement of Moore's Law to lower and lower process geometries. So as we have mentioned in the past, we've rearchitected our digital and sign-up portfolio a few years ago and the focus there being on providing best-in-class quality of results, which is power, performance and area. And we've had some really very good strong momentum over here, especially with what we call the market-shaping customers. These are customers who are shaping the market in their own domains, very demanding. And over time, we've gotten to a point where we are now in 19 of the top 20 semiconductor companies and we are steadily proliferating with them. So we -- driven by the customers, we continue adding -- innovating, adding new capabilities and techniques to improve our PPA, the power, performance and area I talked about. As an example, earlier this year, we introduced the new Cadence digital full flow with iSpatial technology, unified placement and physical optimization, so 3x faster throughput and improved power performance here up to 20%. So that's on the engine story. I think it's very important to have the right engines in place, best-in-class engines. But if you look at it over and beyond that, from a customer perspective, they are looking at adopting a more -- the full flow, if you will, across, for example, synthesis-based route sign-off because it enables them the tighter flow optimization and the integration and the engine sharing there gives better results and faster conversions. So as we talk about proliferation of our point tools, we are also seeing proliferation of our full flow as well. We had talked about -- last year about 50 -- more than 50 full flow wins, and we've got more than 20 through for Q3 of this year. And we have talked about customers and the top-tier customers such as MediaTek, Broadcom, the Marquee U.S. semiconductor company. And in our Q3 call, we called out that we had significantly deepened our partnership with the global market customer across EDA software and hardware, but that included them accelerating the proliferation of our digital full flow across the design thing. So this is very exciting for us. So overall, I think we are really excited about the momentum we have in this space, the very strong activity at the most advanced nodes, and we are pleased with the progress we've made to date and taking advantage of the growth in this segment in terms of the segment share gains we've made. But we still believe that a large part of the opportunity still lies ahead of us, and we are very well positioned to take advantage of that.

And so to kind of build off that, maybe we should talk about the different type of growth rates you got in the other subsegments. So let's go digital, analog and mixed signal, you guys have done a very good job there. You have been market leader for a long time. And then functional verification. So do you think there's going to be any disparate growth rates there or how sure about those 3 kind of major buckets?

Yes, Mitch. So I think the way to think about this is what's driving the industry growth, the trends there. And we've stated that we look at these, what we call, generational drivers, be it 5G, be it AI/ML, be it data analytics, hyperscale computing, every one of these are very long-term drivers. I mean, there are different phases of maturity of their life cycle. But the unifying theme over here is, every one of them is driving a lot of design activity. And we believe it's going to continue providing a very good tailwind to EDA from that perspective. So we talked about digital earlier, and that's one of Moore -- predicated largely by Moore's Law, but there's also very strong activity on the More than Moore front as well. So all these market trends I talked about will drive the need for more and more More than Moore components such as RF, MEMS, power management, sensors, 5G is going to need antennas and filters, and complex imaging is going to be -- sensing is going to be needed for mobile stuff and the like. All of this is in the analog/mixed-signal CAM. So -- and growing more and more sophisticated capabilities are being required over here. Just kind of -- we are seeing steady growth over there, and that's going to continue accelerating. Now talking -- you mentioned verification. Verification is the largest challenge our customers are facing. And no surprise. You're growing -- this is something which is growing by the day. More and more heterogeneous functionality is being integrated together. Software content is increasing. And so there's an exponential increase in complexity and -- as well as in the cost of failure. The thing over here is that there's no one engine or one solution that's going to solve this problem. I mean, you need a whole plethora of complementary capabilities. And that's when we look at verification. Our platform, which is comprised of best-in-class engines from simulation to formal analysis, emulation, prototyping, I mean, these are all tightly integrated together. So you focus on verification throughput and so that's that. But all this is at the chip level, you've got to look at this, it's about the overall system, right? I mean, other technologies, such as advanced packaging, PCB, system simulation, I mean they're becoming very important as well. So when you put all of this together, I mean, we look at the trends, we look at what they're driving, what the needs are from a customer base perspective and that's how we came up with our strategy, the intelligent system design strategy. So the goal is to provide this very broad level of system capabilities and value to our customers. I mentioned the tripling of our TAM. We think we can go from a $10 billion current TAM to about $30 billion over the next 5 years. Now these -- we manage our business for the long-term. We look at the long-term trends and our strategy is for the long-term. And so in the short-term, you're going to look at this and say, yes, there are going to be puts and takes on different aspects of these different components of the design flow, or verification flow based upon global economic conditions, industry consolidation, cycles in the semiconductor business. But over the long-term, we feel confident. Thesis is going to hold. And from Cadence perspective, we are not providing longer term guidance beyond this year. But you can look at the last 3 years, and you can see that revenue has grown. And John has talked about the guidance, and he'll talk about it more, close to a double-digit rate over the past 3 years.

Perfect. And then just one extra one. I mean, you guys have started entering a 3D Clarity product, right, that recently came out. I try to ask about it like every other conference call or so, it's because I feel like you guys have the best-in-class product there, 10x better than your competitors. But I mean, is there anything you can do to just kind of help us understand how that should ramp? I mean, should there be a time when suddenly it's generating $50 million or $100 million for you? I mean, I'm just trying to understand how that should ramp for you guys going forward? Any sort of key logos or customers you've won over the last year or so?

Right. So again, you look at what's driving this vector, right? And what was our thought process for going into the segment, right? So I think it's just similar kind of themes here, system complexity increasing, time-to-market pressure increasing and so all of this is driving the need for much, much more engineering simulation at the system level. And the market itself, system analysis market, roughly $6 billion, give or take, TAM opportunity, growing in double digits. So great opportunity here. When we looked at this, what we thought is like we can address some of the significant performance and capacity kind of limitations of legacy solutions which are out there because the need is outstripping what's available, and I think that we felt that there was a great opportunity over here. And then we are leveraging. Again, this is where the core competency aspect becomes really relevant. Our core competency in EDA is in computational software and system analysis is also computational software. So we're really greatly leveraging that core competency to apply the learnings in the core space, in the EDA space within the rearchitecture solvers and the like to a new application domain. And as you said, I think the customer reception on this has been great. I mean, in the end, what do customers really care about, right? We lead with innovation. They are looking for solutions, which are materially going to improve some key care about that they have. In this case, with Clarity and Celsius, given the massively parallel architecture and the algorithms we have, we are delivering up to 10x faster performance without compromising the accuracy, and that's beautiful. So -- and then on top of that, we -- back to the platform story, right? This is not just about point tools for themselves. Over time, the integration with the other design platforms in Virtuoso, Allegro and Oracle is coming to fruition. So now you talked about what's the uptick over there. I think in the last call, we talked about this as well that the excitement that we have is not just in winning the new logos, but what we are seeing is customers are beginning to give repeat orders, right? So they benchmark their stuff. They get a few copies. They like what they see. And they come back for more. The customer profile is also broadening, right, including which -- with AI, hyperscale system customers. So it's broadening out from that perspective, which is great. And then we're seeing customers are also purchasing both the products there. So again, very early days, but our thinking on this is you win the mind share, market share follows, right? Now the revenue recognition model on this is a ratable basis. So I mean, it's a long journey there, right? You do the benchmarking, you do the adoption, you do proliferation, then bookings come and then revenue is recognized over the duration of the contract, and in many ways, that's a lagging indicator, right? So many of the upcoming -- or sorry, the upfront kind of indicators that we track with design sockets and all that stuff is really interesting and exciting. And the one other thing, which I would like to say is that while we talk about system analysis as a very exciting opportunity, we think customers can benefit through this overall platform story, which comprehend analysis, but also design and simulation as well, right? So when we talk about our system design and analysis portfolio, which is beside system analysis and PCB and packaging, we also have systems products there from AWR and brand acquisitions. And as we said in the call, the integration is really going very smoothly, and the business is tracking ahead of our internal expectations. So very excited by the progress over there, much more to come.

Yes. Maybe just add one, just to clarify, maybe this would be more for John, he's the numbers guy, but I guess what I'm trying to drive at, is there going to be any time like the next couple of years, where you're going to say, look, we did $100 million or $50 million of revenue because it feels like it's just kind of be put within the buckets of the overall business? So is there anything like that you could give us in terms of what you think that it's going to, I don't know what the right phrase is, a substantial portion of revenue or material enough to call out on a call?

Yes. I would say when it gets to about 10% of our business, we'll probably call it out, but we're trying to grow through stealth right now. And we're deliberately structuring the contracts of its recurring revenue growth. But -- and it's recurring revenue that's -- our focus right now is we're learning in that space. We've got great products. We've got 3 real channels for -- that we're driving on the sales side. We have our normal EDA channel, if you like, in terms of where we've got significant touch with those bigger customers in that space, then you have the channel partner programs and then we're building out our e-commerce model as well. But -- and probably follow a similar trajectory as we've seen on the digital over the last 7 or 8 years on the digital business where you're going to win winners and then kind of proliferate through there and then cascade out to the broader customer base.

Okay. Perfect. I got one for the Q&A here. Just to clarify the verification side you mentioned earlier, that's probably one of the most difficult things that the customers are having issues with? Can you maybe unpack that a bit? And under -- help us understand why verification is so critical right now? What's happening that's causing that to be a stick point for customers?

Sorry, can you repeat that?

Right, so within the lines of what I said, when you look at just the complexity of design and you look at all the different components of what goes into a chip, the heterogeneous integration, many disparate functions coming together, integrated together, be it on a monolithic chip or in a system in a modular manner, it's just the complexity requires, I mean, just opens up many more permutations and combinations of boundary conditions and the like, and all of that's got to just work. And the cost of failure, which have been very high, especially at the most advanced geographies, I mean, think about the cost of a respin. This is not just the mass cost and the like. It's also the time to market. You're losing several months when you're doing a respin there. You might even miss in some phase of market window completely. So with that onus there, and verification is something which is never done. I mean, it's not like you're converging on timing or you're converging on some other metric over here. You can just get to a high enough level of confidence from a coverage perspective, but with all these different elements that I talked about, it just -- it's a very, very complicated and exponentially growing challenge for the customers. And so this is why you just can't get -- cannot get enough of verification and you -- and there's no one engine with all of this. So you got to bring a whole suite of different products, which are complementary in nature, together to get to that level of confidence on the verification side.

Yes, that's wonderful. I have a simple guy to really make it at the point simple. It's kind of like FPGAs, GPUs, CPUs, all the stuff are kind of working closer and closer together, that just makes the room for error smaller and smaller. You have to get them all to connect very quickly, right? That's kind of like the quick summary. Maybe I just flip this over again to John, really quick. I feel like we need to flag this. So you've had a strange year, to say the least. I mean, probably benefiting a bit from COVID on the OpEx side. You had an extra week, arguably, some people believe you had some pulling in China. I think that, that was a pretty significant quarter in Q3. Can you talk to -- talk about the financial model, at least, for the year and how we should think about it for next year since next year will be a 52-week year instead about 53-week year?

Yes. Sure, Mitch. Yes, great question. And I read your note after the earnings call, I thought it was -- I think you were right on in terms of hitting all the key points. But I think you called out the fact that China revenue was kind of 96% up year-over-year, which -- I'd love to see that as being repeatable, but it's a challenge that -- I mean, in terms of unpacking our guidance, that we guided to a midpoint of, what was it, $2.653 billion. We raised the year by $53 million, and we called out specifically that $40 million of that came from that spike in China revenue that we saw in Q3. And that was predominantly on the hardware side, a little bit of IP, but mainly on the hardware side. And the hardware, as you know, is lumpy and its upfront revenue when you deliver. But if I break down the $2.653 billion into 3 components, it's -- $45 million of that is coming because we have an extra week in 2020, and that extra week falls into Q4. But -- and then we had a large jump in that China revenue, that $40 million that we talked about, $40 million to $53 million increase. And then excluding those 2 things, the balance of the guide comes in at about $ 2.568 billion. But when we give you guidance for 2021, we'll do that in our February call. We'll need to wait until January to see -- end of January by the time we'll have a clear view in the pipeline in terms of what happens with that $40 million. I mean, the way I describe it is that there are some things that we definitely know. And we know that next year is going to be a 52-week year. So the $45 million doesn't follow through -- the $45 million for that extra week in Q4, doesn't follow through into next year. There are things that we don't know yet, and we have to wait until January to find out, and that's about $40 million. I mean that $40 million, if it's a pull forward, it will come on next year. But if it's a one-off, maybe it benefits 2020 but doesn't follow through next year. And then if it's a new level, then it would fall through next year. And there's any range of those outcomes are possible, but we won't no for sure until we see the -- until we see what the pipeline looks like in January. That's why I wanted to call out that specific item in the earnings call because we just don't know. But then on the underlying business, I mean, there's like $2.568 million (sic) [$2.658 billion] of revenue coming from the rest of the businesses. All of the businesses are performing well, either high single digits or double-digit revenue growth this year. I mean, we'll be lapping some tough comps as a result next year. But what I wanted to point out there is if you look at the 3-year CAGR across the business since -- from 2016 forward, and we called it out in the CFO commentary, you picked that up from our website. But we're seeing accelerating revenue growth on a 3-year CAGR basis. And that takes out a lot of the noise in terms of what's happening in individual quarters or individual years. And you're right, 2020 is a strange year. I mean, it's been a strange year for everybody, but we've got like an extra week. We've got some pandemic impacts, and we've got that China spike in revenue. And like I say, we don't know if that follows through in the next year or not.