Cadence Design Systems, Inc. ($CDNS)

Okay. Thanks, everyone, for joining us back after lunch. We're going to keep this lively so that nobody goes into the proverbial as we call in the U.S., the food coma and make sure that we can really get some good insights here from Cadence. So before I get into talking to Richard Gu, who is the VP of IR at Cadence, I'd like to read the disclaimer that today's discussion will contain forward-looking statements, including Cadence's outlook on future business and operating results. Due to risks and uncertainties, actual results may differ materially from those projected or implied in today's discussion. Everyone understand that? Good.

Richard, thanks for being with us. We appreciate you -- we always appreciate you coming back and you are in such great demand for the meetings today. Let's start by -- if you wouldn't mind giving us a quick overview of Cadence and what you think differences -- differentiates Cadence today from just a few years ago. I used to remember it as Cadence design. That shows how far back I go.

Thank you, Bob. Great to be here, and good afternoon, everyone. So Cadence, we've been around about 30 years, and the company was founded by engineers, for engineers, okay? And we play a very pivotal and foundational role in the entire semiconductor ecosystem, which is one of the most critical, most dynamic in the world. And our technology portfolio consisting of IP, EDA and system design analysis are really essential for our customers to design the most advanced chips and electronic systems from anywhere from the AI accelerators to smartphones to autonomous driving vehicles to aerospace systems. So it's fair to say any electronic system in the world has always has a component of cadence technology in it. The company has grown by leaps and bounds over the years, and we've always been a great compounder. And this year, the revenue has accelerated to 17% year-over-year growth. And our non-GAAP op margin is going to push and reach 44%. So in a Rule of 40, if you will, we're talking about exceeding the Rule of 60 this year, which is going to be a company record. I think from -- if you -- on your second part of the question, Bob, comparing us now versus a couple of years ago, I think a couple of things have changed, okay? One thing is worth pointing out is obviously, AI is a big inflection points, right? And we, as a company, under the leadership of our CEO, Anirudh Devgan's Intelligent System Design strategy. We are thinking about AI from really two major vectors, and we have a massive AI beneficiary. One is design for AI because our technology -- we're one of the few companies where our technology is embedded and used and it's so essential to design all these AI chips, okay, NVIDIA, Broadcom and everybody, all hyperscalers. And we also talked about the AI for design. So we apply AI, the reinforcement learning, the agentic AI to our own product set to make it better. You probably heard about [ Jason ] talking about the -- our agentic AI product ChipStack, providing over 40X kind of productivity improvement for his engineering team during the most recent Computex in Taiwan. I think that's a strong validation to our product road map and our pole position really when you think about the agentic AI in our industry, okay? So I think that's one thing. The second thing is the overall environment and the customers' environment in our operating kind of environment is getting a lot better and improved, okay? Not only does the 10, 15-ish top AI companies are going gangbusters, kind of really lock up in this dead heat to one of each other in the AI race. But also, if you look at the broader set of traditional semiconductor companies like the analog designs and mixed-signal companies, they are getting stronger, and they have a big role to play in the data center with power and everything. And they're also going up cycle. So these are great things for us. It bodes well for our business. The last point I want to mention is competitively, we're very strong, okay? We're the strongest ever in our company history. So we feel very good about where the business is right now.

Yes. You don't sound too dissimilar to what we talk about in our business, which is AI in the business and AI in the product. And so differentiating between those 2 and how we use them. We can get into more of that later on. But can you further highlight some of the kind of secular trends that you think are driving this long-term growth? And tell us about maybe some of your top customers and your partners that you use in the semiconductor ecosystem that are working with you on this?

Sure. Yes. Our business, if you look at our top, say, 60, 70 customers, which is maybe a majority of our revenue, 60%, 70% of our revenue, they're the [ hoosives ] of the world, okay? And we also work very closely with all the major foundries in the world, TSMC. I mean we have made a great announcement to collaborate with Intel on its 14A journey yesterday. So it's a big step forward. And we collaborate with Samsung and everybody in ARM also, okay? So really just very strong, sticky kind of ecosystem. And when it comes to the secular trend driving our business, I would probably break it down into, say, volume and pricing, okay? So volume -- from a volume standpoint, there are a lot of designs to be had, right? All these major companies they are competing to capitalize on this big AI megatrend and try to take advantage of that fantastic opportunity could be a lifetime opportunity for all of us. So there are lots of designs to be had. Not only do all these semi companies are launching a variety of advanced silicon and chips and systems. But also if you look at the hyperscalers and the systems companies, they are entering into the space very strong and their demand is very robust. They're designing their own ASICs, right? We kind of use the analogy of the 4-story staircase. So as companies, they go about the custom silicon, they'll move from the merchandise silicon to ASICs using a third-party vendor to go after that journey. And as they mature, they go do some sort of what we call hybrid COT, it's customer-owned tooling. And then towards the end, they could do like COT, okay? So as they go down the stairs, what it means for us is it's not only more designs, but also the EDA and IP content will grow steadily,okay? So it's a great business opportunity for all of us. And I think the last thing I want to mention is all these -- I mean, pricing is an important component of our business, right? And over the years, the industry has consolidated to really two major players, okay? And we are very disciplined in terms of the pricing conversations. I want to make sure we can capture that value. So overall, the company and the business is well set up to capitalize on the next wave of growth.

So we touched on AI earlier. AI disrupting Cadence? Are your customers going to use less of your tools because the agents are going to do more of the work and they're not going to need Cadence as much as they need today?

That's a good question. I think the beta was few years, a couple of quarters ago. But we -- our CEO, Anirudh, likes to use the analogy, which is I think is at in terms of our business is like a 3-layered cake, okay? It's not like we have a Cadence bakery or anything. Our core business is the middle layer which is the principled software, be it EDA, IP or system design analysis or hardware business, okay? When you think about it, it's really grounded in the immutable kind of ground truths, be it physics or mathematics, right? So the relationship with the customers is very deep. It's super embedded. We are completely vested and committed to their journey. The conversation is R&D to R&D multiple times a day. So the business is irreplaceable in the middle layer, okay? But we are continuing to innovate on that, too. And when you think about the upper layer in terms of agentic AI, we're launching a slew of super agents. The example I gave just now on the CHIPS Act with NVIDIA is one of the many products we're launching, okay? We have like 3 or 4 super agents launched in the past couple of months, and the opportunity is massive, okay? So the opportunities for us is not only as a new TAM expansion, right? So we can monetize and capture that with great pricing, and we can actually shifting more dollars from the labor budget in the R&D bucket to more automation and tools. Because one of the key things you have to realize and keep in mind for is there is this big mismatch between the design demand from our customers and the engineering supply, okay? TSMC have been talking about this 48 to 50x kind of transistor growth in the next 5 years, okay? If you think about complexity of those designs, in terms of the volume and it's -- in terms of the workload volume, it's going gangbusters, okay? It is absolutely impossible for any of these companies to keep up by throwing bodies of the province, okay? So with our products with automation, AI, agentic AI, we have the opportunity to help bend that engineering hiring curve to help them meet their ultimate goal and objectives in the design process. So I think there are massive opportunities. We're seeing really early signs, very encouraging. The business -- the core business is doing great, okay? So I think we can be patient in terms of monetizing the top layer, making sure we can capture the full value. But the opportunity is very, very exciting for us.

So I guess I want you to remember a few things, right? You got to step down the stairs, 4 stories. You got the cake, the 3-layer cake. So there's going to be a quiz later. So got to remember all this, right? So I'm glad you jump right into my next question, which is really, it seems like you're benefiting on the other side of AI in terms of your -- these new Agentic AI tools. And so will there be monetization and revenue impact? And how should this group think about the potential timing of that?

Sure. It's a great question. So we -- in terms of monetization for this agentic AI products, one of the great things is, is a new category, right? And it's a TAM expansion. By pivoting more R&D dollars from labor to automation and AI. So it has a lot of promise. And we are thinking about a business model where we want to make sure it's a combination of subscription plus consumption, okay? Think of it as a rental car, car rental, okay? The base subscription model is we obviously, we price these AI, call it, the virtual engineers, okay? And the value is commensurate to what a physical human engineer can do. So it's definitely not priced like an LLM token, okay? It's worth tens of thousands of thousands of dollars, okay? And if you drive in those car rental example, if you -- on a daily rate, you have a difference embedded 100 miles. -- okay? But if you drive more, like if you drive 500 miles, incremental 400 miles will come with, say, 4 tokens, each is worth like 100 miles per se, okay? So this is how we are thinking about it. Another key point of monetization, we definitely should not lose sight for, and we're very excited about is, as you think about these virtual engineers, right, is agentic AI agents, a big difference with the human beings, they don't rest, right? They can't work 24/7, okay? So they can help explore the design space a lot more far away than a human engineer could do. So what it means is they're going to call a lot of the baseline underlying tools, which is the middle layer of the cake, I was referring to and talking about. So I think the monetization opportunity is enormous. It could come from all these different factors, and the natural question is where is the limit, right? I think we obviously -- we're still exploring, experimenting, but the early signs are very, very encouraging. [ Jason ] actually mentioned on stage with Anirudh during our cadence live back in April. He mentioned he was willing to spend 50% of the human engineers cost on the tokens, okay? So what it means for us is it's 1/3 of the R&D budget, which is about 3 -- call it, 33%. Just as a reference point, right now, EDA is only 11%, 12% of the R&D budget. So the headroom is massive. So I think, obviously, we have -- the most important thing for us is want to make sure the products are strong, right? And then we're providing values to our customers. And that's how we can share and ultimately capture value accordingly. Okay.

Good. So let's shift gears a second, go into your IP business. You touched on that earlier. Seems to be growing well and well ahead of the market for the third year in a row. What's driving this?

Yes. The IP has historically with, I think, we deliberately underinvesting IP. Because I think Anirudh wanted to make sure EDA is solid and is world-class. I think we are at this point, right? We have the most comprehensive and strongest EDA platform in the world, okay? So -- and a couple of things have changed in IP, too. When you think about IP, I think AI definitely is a game changer. With AI, I mean, these are really disaggregated architecture, right? Because a lot of the AI chips is not just one SoC. It's multiple chips all connected together in a chiplet or 3D-IC kind of fashion, okay? So what it comes with it, what it means for us is there are lots of high-value, high-growth IP, especially those connectivity IP, like the UCIe, PCIe, the SerDes and also storage to the memory, right, HBM, the DDRs of the world. And so our strategy is we want to focus on the, we call it star IP, the high-value, high-growth IP, which we are, okay? And I think a second important thing we did right is Hard hired this phenomenal leader from Intel, Boyd Phelps a couple of years ago. And he surrounded him with fantastic engineering leaders, okay? So I think we're always a product-first company. As long as we have the right people in place, the product is getting better because ultimately, people's buying decisions for IP is based on the value of those and the PPA benefit, okay? And competitively, we're very strong in terms of the PPA kind of benchmarking. So IP is gaining ground. And now it's all very much exposed to the AI megatrend. And the third growth driver for IP is there is definitely -- you're seeing a foundry ecosystem expansion, right? TSMC is phenomenal. but you're seeing a lot of the other foundries too, right? I think the Intel conversation and the announcement we had on 14A is a clear example, right? And then in Japan, they're building Rapidus, which is new foundry. Elon is talking about Terafab, all these things. So I think as the foundry diversify further, there's more demand and more opportunities because not only do we have to help them set it up, to enable the foundries and make sure the EDA tools can work seamlessly with them, just like the Intel situation. But also as they capture the end customers will have more revenue streams on that front. So IP, I mean this is the third year in a row. We are growing way above the market, okay, above like 20%, 23% this year. So we foresee the IP will continue to have very strong growth and continue to gain share in the market.

So let's talk about competition for a minute. How does Cadence view your competition? EDA has predominantly been a duopoly between you and Synopsys. Can you talk about how you differentiate yourself?

Sure. So I think we are under Anirudh's leadership, I think one of the main thing is we are a product R&D-centric company, okay? And if you get a product right, ultimately, you're going to win, okay? The strongest product always wins in the market. So I think that's the most important point to take away from. And I think at this point, we feel very, very comfortable in terms of our competitive situation. We are gaining share across the board. I think EDA, EDA, we have the strongest platform. Analog is our market. digital, we are very strong, and we are gaining on -- with the Intel announcement and everything. Samsung, we're collaborating with Samsung SF2, okay? And when it comes to verification with our own ASICs, our Palladium platform is the gold standard in that market because we use our own ASIC, okay? So this is a clear differentiator. So we feel very good about core EDA is growing double digit strongly. And we touched on IP already, okay, IP where we're gaining, and we are much more focused and much more profitable also. SD&A for system design analysis, we chose to focus on the two bookends of the market because not all SD&A is all tied or exposed to the AI megatrend, okay? So there are two bookends. One is closer to the silicon is the packaging and the 3D-IC and the chiplet, okay, which we have a strong footing because our Allegro is the market leader. And then on the physical AI front, closer to physical AI and robotics and autonomous driving and drones, we have built a strong business and platform with the most recent Hexagon acquisition, which really brought us the two key platforms. One is called Adams and another is called Nastran, these are the leading software simulators for multi-body robotics. And then when you combine that with the pre and post capabilities from Beta, CAE, which acquired a couple of years ago, I think we're full flow for physical AI. And when you think about the physical AI, it's a phenomenal opportunity for us because not only do we innovate on that core server kind of realm, but also what it means for us is there's a lot of great silicon too, underneath that, okay? Because the physical AI, what it means naturally, it will be mixed signal, low power, and that's really our core strength when it comes to analog and mixed signals. So I think competitively, we feel very strong where profitability is great. We're talking about the Rule of 60. And I think continue to focus on our own execution and satisfy and delight our customers.

Yes. I want to talk more about the Rule of 60 in a second, but certainly in the right space now as we hear more about, obviously, drones with this little conflict going on in the Middle East. And then robotics and some of the robotics companies that we've seen, some of us have seen and all you have to do is go to Asia these days, and there's plenty of them being built. And I know that more and more in the U.S., robotics is going to be a big focus in the future. So it would seem like you're very well positioned there.

Yes, because I mean these are massive markets, right? I mean when you think about the AI, again, another 3, okay? We like 3x3 kind of model because for us, the infrastructure AI build-out is massive, right? It's happening right now and here, right? It's got so many more -- so much more growth to be had in there with all these investments and opportunities. But the next wave is emerging, too, right? The physical AI is real. And they started with the autonomous driving. We live in the Bay Area and then you're seeing Waymo everywhere. I mean this is phenomenal. It's like when you think about the that the combination of the silicon plus the world models plus the physical cars, I mean, they've done a great job in there. So I mean, plus these are multitrillion-dollar opportunities. So massive, massive opportunities. We're very excited about this.

Yes. We hear more and more about -- you talked about data centers, but the data center build-outs and using robots to build the data centers. And it becomes kind of virtuous and the opportunity that exists.

Well, that's a great point. I think, again, like when we think about the physical AI, it's actually in the cars, right? These are data center on wheels in a way, right? A lot of the data, which they collected has to be trained in the data centers, right? So it's a reinforcing kind of mechanism with the data center build-out in the physical AI world. So I completely agree, there's a flywheel.

Yes, because the more places that you put a Waymo, the more data that needs to be -- you can't have data from the Bay Area in Indianapolis that doesn't really work or Knoxville, Tennessee or whatever -- I mean, you need to have local data in order to really to make it function in those jurisdictions. So it will be more and more important for those -- to have more and more of these data centers and how they're going to be constructed and be constructed quickly using your tools.

Absolutely.

So you've touched on it a couple of times, you talked about the Rule of 60. So Cadence has been one of the few companies out there delivering on the Rule of 60. How should we think about the long-term revenue growth and operating margins under that scenario?

So we are a financially disciplined and fiscally responsible company, okay. We don't go out and guide multiyears, okay? We look out 1 year at a time. And it's also very, very important for us to make sure we are growing in a very profitable way, okay? So I think there is a trifactor of our operating philosophies. We strive to deliver and drive growth. And it's accelerating, right? Clearly, you're seeing like 17% as it stands right now for the year. And also, we wanted to continue to drive 50% -- north of 50% incremental margin, okay? In our core business, organic business is actually close to 60 okay? And on top of that, we wanted to continue to spend and give back use like more than 50% of the free cash flow for share repurchases. So I think those were quite well for us for years, and we don't have any intention to deviate from that philosophy. So we certainly feel very good about the long-term trajectory of the business because it feels like all the long-term drivers, if you will, tailwinds, it all stays intact if you look at a very long horizon in ARC in that way. Yes.

It. So one of the things you mentioned earlier was your acquisition of Hexagon, D&E which I believe fits into your system design and analysis business. How does that increase the TAM? And what was the strategic rationale behind that acquisition?

Sure. So Hexagon is really is a fantastic technology, and it's a carve-out for us. What's valuable for us is, I mean, again, like I mentioned, they got two great platforms. One is called Adams, okay? It's a multi-body simulation tool and another is called Nastran, okay? So when you think about the physical AI challenges, part of that is just the simulation is not accurate enough, okay? So these tools could be kind of interposed or inserted in the simulation loop to make it work, okay, to make the simulation lot faster and more accurate, okay? So that is a great kind of set of tools we are acquiring. And then like I said also, -- by combining that with the beta CAE's technology, we have a physical AI simulation full flow, okay? So with that, I think we are well poised to capture some of the opportunities as it emerges. I think in the -- so in the autonomous driving segment, robotics is coming up very strong, right? So I think certainly, I think these are great business. Integration has gone quite well. So we closed the deal about a quarter ago. And then our team is just heads down, focused on making sure we'll continue to capture the upside and the opportunities.

So you think of that TAM, how do you think about that TAM?

Yes. So the -- I mean, if you think about the EDA TAM in the -- I mean we've talked about the convergence between silicon and systems, okay? So it's fair to say that the simulation and SD&A TAM is as big as the silicon side of the equation. So it could double the TAM over time. And then not to mention, now AI is another lack of growth. So I remember years ago, the TAM is, I call it, $10 billion, $15 billion. Now it's much higher now. So it's a great opportunity for us to continue to prosecute, I say, yes.

Sure. So we'll have time for some questions in a minute or 2, if any of you have them. So I just want to preview that for you. Are there any areas of the portfolio, Richard, do you think we could benefit from more M&A, more focus on that? And what's the philosophy? You talked about how you return cash through share repurchases, but how does the philosophy look between M&A and share repurchase?

Sure. So our philosophy has always been organic is the first order of business, okay? We always invest first and foremost, in our own R&D capacities and capabilities. This is a very R&D-intensive business. And organically, we have to say organic is delicious, okay? So that's has the greatest highest return for our shareholders. So that's our core focus area. And we don't do major transformative deals, and we don't have any EBITDA to do that, okay? We will supplement the core organic business with some tuck-in acquisitions opportunistically if the right asset is in the market with a good price or a good talent out there. But we don't feel any need to do any major deals, okay? And I think the third order, obviously, is the share buybacks. So -- but I think we feel at this point, the portfolio is fairly complete and comprehensive and the market is growing very nicely. So I think we wanted to make sure we have the best product in place to support the growth and the innovation agenda for our customers.

So focusing inward rather than outward.

Focus on organic. First and foremost, I'd say..

Do we have questions? Yes, sir?

Thank you very much for all today for your attendance. This session is now concluded. You may now leave the webinar. Thank you.