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

Good morning. I'd like to welcome everyone to the third day of the 24th Annual Credit Suisse Technology Conference. It's my distinct pleasure this morning to introduce Lip-Bu Tan, the Chief Executive Officer of Cadence Design Systems. We've got about 30 minutes to go through a fireside chat. As is typical in this virtual setting, if you do have a question, please e-mail it to me directly and I'll try to work it into my prepared questions. But with that, Lip-Bu, I first want to thank you. I know -- now I'm not on the West Coast as well, so I know it's early your time. Appreciate you getting up and having a cup of coffee with us this morning. I'm sure that most of the people listening to this virtual presentation know Cadence well, but there's always a desire at these conferences to try to bring new investors in.

And as a result, I always think it's helpful as my first question in these fireside chats to make it a little bit open-ended and kind of give you the opportunity to position the company, talk about your core IP, the market drivers and kind of what your overarching strategy is and value proposition is to Wall Street.

Sounds good. Thank you so much for inviting me. And so first of all, before I begin, I need to mention about the safe harbor statement. Today's discussion will contain forward-looking statement that will make use of certain non-GAAP financial measures. Please see our most recent 10-K, 10-Q and website for the discussion of risk factors and use of our non-GAAP financial measures. So with that, let me start. Cadence Design is electronic design automation software and also IP that we enable customer from system to silicon to provide design their core products and then from other way from digital, custom and design mixed-signal all the way to verification. We have entire verification suite. And then we also kind of providing the packaging that become more and more important in 3D, 2.5D packaging on the semiconductor system packaging that you know what you're designing and that envelope of the power and the signal integrity is all come together. And so that's kind of our business and also providing all the key IP model industry standard, connectivity IP, memory IP and so that -- and also compute IP like Tensilica to provide customer to build their core products. And then our vision is basically, besides providing the, I call it, the design excellence, we want to provide the best and tool for our customer to design their core products. And then secondly, we are expanding into, I call it, the intelligent system design called SD and the ISD, basically moved toward system analysis and provide more system-level solution to our customer and also the embedded security. And then further moved up into the pervasive intelligence that's providing the AI/machine learning to various verticals that we pursue from defense, aerospace to automotive to mobile to the hyperscale cloud opportunity. So that's kind of a quick background of the Cadence Design.

That's very helpful. I want to spend a few minutes kind of unpacking the EDA industry overall and some of the drivers. And clearly, there are some market demand drivers that you touched upon. There's also some complexity drivers around Moore's Law and the EDA space. And we've all seen the inverted pyramid of electronics. And I would argue that at the APEX of that pyramid, holding everything up is the EDA industry. I'm wondering if you could talk a little bit about some of the complexity drivers that are driving growth? And how we should think about growth versus historic trend? Because you've always been tied to your customers' R&D budgets, but it does seem like there's a strong argument that the EDA growth is poised to accelerate as Moore's Law is becoming more difficult and we're moving into some exotic techniques around chiplets and tile. But I'd love to get kind of your perspective on that.

Wonderful question. So first of all, let me highlight, there's a couple of big drivers for our industry. First of all, it's this, I call it 5 generation waves and they all come together. That's very exciting for me. So 5G, you have AI/machine learning, autonomous driving, the superscale, hyperscale data center cloud and then also this whole industrial IoT, the industrial transformation for the big industrial group. And all this is really driving the semiconductor at the heart of it. And so we see a lot of design activity and you can really point out and it's really that we're playing a very critical role to helping some of these customer to do the transformation. And then the other part is also, I kind of pay a lot of attention to it, is we are moving into, I call it, the data-centric era, it's all about data and then who control the data, own the data is very important. And so from the data generating to transmission, to store and to really processing it and so it is a huge opportunity. And then just give you a few data. One, only the last 2 years generating 20 -- 90% of the order data generating, and this is exponential increase. And then secondly, 80% of the data is unstructured data, the video, the audio. And so those are humongous. And then thirdly, only less than 2% of data are being analyzed and utilized. So that is a huge opportunity and it's really driving a lot of service provider, system player and then really try to drive more optimization for their solution and then the service they try to provide. And that increase a lot of development activity and getting very complex. As you know, the -- all the system level, and that's why we decided to go into system analysis and system securities become critical. And then the other part, even the silicon itself, we moved down to the 7-nanometer, right now working on 5-nanometer in productions and you saw some of the announcement. Customer mentioned about the 5-nanometer in productions, and now we are working on 5-nanometer -- 3-nanometer and 2 nanometer. And there's a lot of complexity in terms of power, the signal, the performance and that's where we play a very critical role. We are heavy heavily engaged with customer in 3-nanometer, and we already started in 2-nanometer. So the complexity increased a lot. Then the other part we mentioned on Moore's Law and clearly, there's a slowdown on Moore's Law, but you know all the good engineers, they know how to work around and design around and so you can see that parallelism and also some of the exciting thing to me is rather than the general purpose CPU or GPU, now you see the domain-specific processor and that basically optimize for specific application you try to drive. And that's why you see a lot of AI/machine learning coming up, big time to doing that. And so I think that, to me, is really exciting. And then the other part is modern Moore, and that become -- I mentioned earlier, the packaging, we have a complete packaging end-to-end that we provide and the 2.5D, 3D and it's become the -- some of the technology integration for automotive and hyperscale and then combining all our tool together to help solve the problem for some of our customers.

Lip-Bu, do you believe that all those dynamics set the foundation for the core EDA industry to see accelerated growth?

Absolutely. And that's why I've been on the -- as the CEO of Cadence Design for 12 years, and the demand and the challenges on the design is increasing tremendously. And that's why almost all our tools from digital to custom and verification, we apply AI/machine learning, massive parallelism and then now we try to do cloud-native so that we can really perform even better and flexibility for our customer and using the cloud with some of our key partners and the cloud provider to provide that kind of speed and scalability. And to give you one example, in some of the simulation, it may take days, we can do it in hours using the unlimited server that you provided by the hyperscale guy, and you don't have to buy for your data center. And that's a huge benefit. And that's why we are excited in the cloud offering. We have more than 150 customers and then we have the largest orders in last quarter, and we are very excited about those opportunities. So I think long story short, we try to do everything, meet the customer, delight the customer and then we have a very trusted relationship with our customer, work on the next-generation product. And then one thing that I'm very proud of is Cadence, they have a culture of innovations. And last 3 years, we have 20 -- more than 20 design products that is organically developed other than through acquisition. And so I think that is something that we continue to drive improvement. And almost all our tools completely rewritten and make sure that we meet the customer requirement and the challenges they face.

Lip-Bu, I want to spend the back half of the fireside, talking about some of the company-specific drivers. But just staying a little bit on this theme of accelerated industry growth, I'd be curious to get your perspective on a few things. Number one, M&A has been a big driver in the semiconductor industry overall. I think since the financial crisis, by our math, there's been 250 mergers and acquisitions in the core semi-space. I'm kind of curious, clearly, going forward, the pace of M&A needs to slow because there are just less targets out there. Was M&A a headwind to revenue growth in the EDA space? And now that it's probably poised to slow, does it become a day factual tailwind in your mind?

Yes. John, it's a good question. And the last 8 years, I have been observing a lot of acquisition merger, it's a trend and then some of the big companies, they need to increase their platform, they have to acquisition to do that or they move some strategic direction to get expand their TAM. And so that I think is unavoidable. It will happen. Good news is so far, we have a great management team. We're proactively engaging with the company going to be acquired or acquiring company before they even announce. And so in a way that we really work closely and knock on wood, so far, all these M&A acquisition last few years, we continue to grow, continue to increase our footprint. And in some way, acquisition, usually, they try to drive that expense down in terms of operation or sales, consolidation. But the last thing they want to cut is the engineering. And so -- and even when they cut engineering, you disappear from this company then showed up in next company. And so it just continues to grow. And then the other part I'm excited because of this 5 generation waves and it's so much design activity. And the other part is, as you know, I'm also the venture capitalist, I've been funding a lot of start-up company. And that becomes an important customer for us and continue to grow, and we know what they really design. And so I think this innovation is continue, and it's like a pendulum and you swing one way and then you do many acquisition and then sometimes the big company is very slow in innovation. So there are some new start-ups come out and addressing some of these major waves. And we are delighted to support them like, for example, in the AI/machine learning. There's so many start-up company and then they all use -- many of them use my EDA tool and the hardware emulation to do their core high-performance AI machine to process the company.

That's a great segue into the second half of my question, which was really to talk about the fact that while on the one hand, you have consolidation of your core customers, on the other hand, you're seeing an acceleration of what I like to call the noncore customers. There's a saying that software is eating the world. I'd like to add to that silicon has at least a seat at the table, because you're seeing hyperscale companies investing more in their silicon efforts. You're seeing a vibrant start-up community, not only around technology trends like AI but around new sovereign entrants like China. I'm wondering if you could talk about this group of sort of not -- what I like to call noncore customers, quite frankly, we're seeing auto companies wanting to do more silicon design as they think about autonomous driving 4 or 5 years from now, how big is that bucket of sort of new nontraditional customers today? And how large could it get for you over time?

Yes. I think this is a very good question. And in fact, a lot of our killer apps and the service provider, we share with them and a lot of your killer apps. And if you cannot have the silicon to optimize it, and like, for example, your cell phone, sometimes I have to cancel some of the app because my battery run out in the middle of the day and I have to charge my battery. So power becomes a big issue. And so I think clearly, we are excited about the non-semiconductor customer and it's growing very rapidly. I think you'll highlight the hyperscale and I think if you saw the Andy Jassy keynote speech at the Amazon, he talking about the silicon is so important in the Graviton tool and then training them and then also in Habana. And then those I kind of mentioned that they are treating the silicon becomes important to optimize for their service providing that they want to provide and then whether they are general purpose CPU and GPU, they're still going to use -- work with them, but there are some applications they want to be -- really drive cost and price and performance for their own solutions. So we are really excited on some of these hyperscales, they are quietly building up the silicon team and they also have the need in terms of system modeling, system simulation, and that's why we embark into the system analysis that's a very important growing engine for us because they decide using our tool for design, they also want to know the system-level, the envelope, the power, the performance, and that's exciting to me. And then same thing with automotive. Now we highlight automotive, working with us on the most advanced nodes and we are excited about it, and we also highlighted in the last earnings call, one big hyperscale guy working with us on 3 nanometer, really drive the differentiation, drive the performance they are looking for. And then the other part that we are excited is the mil/aero, aerospace. And then they're also starting to look at the opportunity how to use our tool to optimize some of the design. And then the other part is very exciting for me is that industrial automations and transformation is happening. And so we are excited to work with them in terms of optimizing and so that they can provide the solution to collect the data, analyze the data to really drive the efficiency of their system.

Well, you've been doing this long enough to know that Wall Street is not really happy unless we're worrying about something. And I think one of the things that is concerning to some investors about Cadence is just the emerging strength in China and how we should think about China as a growth engine against the backdrop of sort of the U.S.-China regulatory trade tensions. If you look specifically to your last reported quarter, you saw a big jump in growth in China. There's always a concern that the Chinese are worried about future bands and are buying ahead. How do you think about China as a long-term growth engine for the company, especially against the backdrop of all the regulatory concerns and trade tensions?

Yes. Good questions. And clearly, Asia-Pacific is a fast-growing area for us. And the region is very vibrant. And it's not just China, Taiwan, Korea and even Japan, in some of the system design are increasing. So we are delighted to be part of and -- the solutions. And we basically treat all the customers the same in terms of driving -- providing the best tool and IP to them globally. And specifically on China, I should know, China government is really driving the semiconductor ecosystem. They pull a lot of money to support a lot of start-ups and then clearly, their STAR market is like our NASDAQ equivalent and so many semiconductor going public with a lot -- a very big market cap so that they can really do a lot of innovation. And so I think we're providing global opportunity to our customers. And as long as, meanwhile, we comply to the U.S. Government Regulation on the trade and so if they are Entity List, and we have to tell them candidly we cannot provide them the solutions. But there's a lot of other companies that are not on the Entity List and they are doing very well from the hyperscale, from the system company and a lot of semiconductor, mixed-signal company are growing very, very fast. And so that's why you see good growth for us and especially the last 2 quarters, the hardware and IP more upfront, and so we kind of highlight that revenue grow but overall, I think I'll answer your question, China is very determined to build a semiconductor. And it's the biggest market for semiconductor company, a lot of our U.S. customers also have a huge portion of China business. So we benefit from the China entity, the company that are doing start-up and have innovation. And we also have a lot of U.S. companies and a big chunk of their revenue percentage-wise has come from China, and they're growing very nicely so we support them. So overall, I don't think it's a risk actually, like in Chinese say [ wait and see ], it's a risk and opportunity, depending on how you look at it, people who look at it as a risk, but for me, it's opportunity and to add to grow.

Well, to follow up on that, Washington and Clarity are not 2 words that you typically associate together. But I'm kind of curious, do you think that the incoming Biden administration will provide more stability, clarity just sort of the regulatory backdrop and trade tension backdrop or how are you thinking about that?

Well, I think it is not to me to comment. And I think, clearly, in January, there will be normal. But at least, I know that the President Biden elect and is more predictable. And so hopefully, nothing will be more good for the industry. And so I think it's difficult to predict, but I'm not a politician, but I think all indications, I think we are very hopeful, and hopefully, will be more predictable that we can be managing.

I want you to change gear now to more some bottoms-up questions about Cadence specifically. And there's really 2 areas I want to address that you've touched upon previously in this conversation, but it's really what you have you done to improve kind of your core position in the EDA market? And then also what steps you've taken to kind of grow into new TAMs like the IP side of the business? On the first part, the EDA -- core EDA, you've always had a strong tradition and history of being a very powerful player in mixed-signal analog, maybe a little bit less so in digital. But it seems like over the last several years, you've made some really good strides on the digital side of the market. And I'm wondering if you could help us understand what's been driving that? And maybe talk about some of the new product offerings. You talked about Palladium cloud, but maybe just Palladium in general and Protium as well?

Wonderful. Thank you for bringing it back to Cadence. So a couple of things. One, clearly, we are excited about our offering. And as you correctly point out and then the mixed-signal and analog is our strength historically. And then when I came onboard, I decided to treat on the digital implementations because it's the biggest TAM. And so we rewrote the -- all the digital flow from place and route, synthesis and the timing signal -- sign off and tool. And so we've introduced a lot of new products, as I mentioned earlier, double down, triple down on the innovation using parallelism and AI/machine learning, we can drive 12% to 15% improvement in terms of our performance. And we work closely with the most leading customer. They are most demanding customer to drive the most advanced nodes. And I mentioned earlier that 5 nanometer, 3 nanometer, we're already engaging and now starting with 2 nanometer now. And so I think the two, clearly, from the customer point of view, they want to see at least 25% improvement before they're shifting to you. So we have been very successful in the digital implementation because we improved substantially, improved better than the competitors and in the most advanced nodes. And so that ends up place and route in our Innovus and more than 80% of the customer is already shipping with us. And [ synthesis ] is a new tool that will come out. And then we also applied the high special improvement to integrate even better performance. So clearly, we're starting to see a lot of leading customers starting to ship to us. And then I think more important right now, if you look at our earnings call, we highlight a lot about full flow. That meant that you completely the whole digital full flow using us and we highlight by a few big important company, customers are shifting to us. And then the other part is that I mentioned earlier after the design is critical is the verifications. So we have an entire verification suite. And then Jasper is for the formal verification is the industry standard and more than 80% of the customer going with us, and we are excited about that. And then with the Xcelium, there's a simulation tool. And clearly, we are doing a lot of improvement, which has introduced the Xcelium ML using AI/machine learning and that will show a significant improvement to our customer and they love it. And so they're starting to use it. And then finally, we also have in our Pegasus and then the packaging side in terms of signal integrity and then the tape-out and that's critical tool, stay tuned, we're going to have a lot of certification from our customer, and then we can be deployed by the customer in the year to come. So I think all in all, I think we are excited. And then the other part is that you mentioned earlier, the hardware innovation. And then the Z1 is doing extremely well and especially the advanced nodes. And now we have the X1, there's a prototyping for software regressions and then very successful in the last 2 quarters, stay tuned. We continue to do well. And our next-generation development is on track, and we are very happy with the progress we are making.

And Lip-Bu, you mentioned earlier -- you mentioned earlier...

Sorry, that's last...

I'm sorry, go ahead, please.

Yes. So the last question, I think, is the -- with this intelligent system design, and then we move into system analysis, and we are very excited with the product we announced, Celsius and Clarity. They clearly see the -- drive a lot of computation, the performance improvement and we're excited. And we also just announced the 3D transient, and it's very well received by our customer. So stay tuned. I mean that could be potentially our next 10% revenue growth for us. And then the system analysis, a lot of demand, a lot of requests from our customers. And so we are very that opportunity.

You mentioned earlier about your efforts in cloud. I'm kind of curious -- and you have very strong recent quarter on the cloud side of the business. To what extent is this giving you access to new customers versus allowing you to engage with existing customers in a different way? And if it's the latter, is the economics between sort of on-prem and cloud design all that different?

Yes. Good question. And it's something that we are very excited, and we are pursuing aggressively. It's the cloud offering to our customer. So we have customer managed and also Cadence managed offering in the cloud, and we are very delighted in our ecosystem partner and like ARM and TSMC and really embrace that. And then make it easier for us to provide that solution to the customer. And not just delivering the solution to them, but it's important to also developing the cloud native. So some of the new products that we just highlight, it's easy when you do the new product and you can do design the cloud native so that you can really provide a solution to the customer. And then the other part, as I mentioned earlier, the fundamental of driving the cloud solution is to drive flexibility, scalability and performance to our customers. And it's very important for them to see the benefit of moving to the cloud, and it's very secure. And then secondly, you can really scale other than you have to keep adding on to your server at your data center and you can leverage on somebody else solution equipment that is unlimited, and then you can just pay as you go. And that, I think, is really exciting. And we are -- highlighted that last quarter, we have 150 customers and it's growing and we also signed the largest orders for that. And so stay tuned, and it's something that is still in the early inning and then -- but I think we're going to execute -- continue to drive the solution to our customers.

I'm going to oversimplify this next question, but I'm kind of curious from a pure technology perspective, is it easier for a company with a core legacy in mixed-signal analog to move into the digital space? Or is it easier for someone with a core competency in digital to move in to mixed-signal and analog? And as you answer the question, I'd be curious to get your perspective on the design intensity of chiplets. As the digital world starts to disaggregate die and really start to kind of optimize core blocks of IP, does that naturally open up more business opportunity? And is it a more design-intensive process than a chiplet?

Yes. I think the digital and mix signal are quite different and a different approach. And I have to say that the mixed-signal a little bit, I call it like the black magic, and it comes with experience. And you have to tweak it. And then it's not like the digital 0 and 1 binary. And so the complexity and the time it take to really master the analog, mixed-signal is much harder. And also very challenging, really driving the Moore's Law and so you really use some of the techniques that I mentioned earlier in terms of the parallelism and AI/machine learning to really drive some of this performance. And I think they both are challenging from one to go to the other. And then even the mixed-signal is not just digital, analog we put together will work. And there's a lot of challenging in terms of the mixed-signal and you have to prepare the interference and then all the integration that is complexity increased a lot. So I think that's something we spend a lot of time to work on that. And clearly, when we moved out the geometry and to 3-nanometer, in the analog space, we are driving the gating, the 5, 3 nanometer and then in some way, we try to meet the customer requests to meet the requirement for their design, for their application, they try to drive, for example, in the 5G area, that has become more and more complex. And that's why we acquired AWR and Integrand and so that we can really provide for RF microwave design on the antenna and all this in the front-end module, it's very complex for the 5G and we want to provide a solution to meet our customer. And we're delighted -- last quarter we highlighted 15 new customer orders, and that is exciting to me that the integration worked well. And the team gel together, and we are really excited for them to come to Cadence family. And so I think all in all, I think the complexity is just -- we are really critical player to provide a solution to our customers.

Lip-Bu, we're coming near to the end of our time for this session, but I wanted to round off the conversation with one last question just on the IP business. I know it's only about 15% of revenue, but it's been a good growth engine. I'm wondering if you could talk a little bit about kind of the prospects for that business going forward, both organically and kind of inorganically, are there M&A targets out there that you see that could be helpful in growing that business over time?

Yes. It's a good question. When I came onboard to Cadence 12 years ago, I decided IP is very important. The building block for a lot of our customers to build and then usually you really need to be -- the quality has to be good because it related to the productions. And so we are delighted. This is an important business for us and then this outsourcing trend is really happening because keeping the IP is getting very challenging in terms of multiple versions, that PCIe Gen 4, Gen 6. And so I think it's important, good business for us. And we have 2 of the IP business, and we are really focused on the STAR IPs. And so really, it's important to the customer. So one is clearly is the connectivity like the SerDes, the PCIe Gen 4, Gen 5, and those are very important. And memory IP is very important to our customer. And so those are being one bucket that we're really excited, and we doubled down on that, it's a very nice growth business. And then the other part is the Tensilica, this is the compute area of the IP and then we are really strong in the audio and then now video and the video surveillance and also right now in the AI/machine learning, and we are quietly building it up. And so I think this fast growing for us. I think you can see the last 2 quarters. And then -- and we love that from 0, we get to 10%, now beyond 10%. And it become -- we're driving the performance in terms of operating margin and some of the measurement we try to drive just like our EDA. And so I think stay tuned, I think this is exciting growth engine for us.

Perfect. With that, we've ended our time here, but I really want to thank Lip-Bu and everyone who joined us in this virtual setting. And I want to pass along our well wishes that you, your immediate family and the larger Cadence family stays safe and healthy during what's been a very trying 2020. I think we're all looking forward to January 1 and turning the calendar to 2021 and getting a vaccine widely distributed, but really appreciate the time this morning. This was a great conversation.

Thank you, John. Everybody enjoyed that. Have a good day.