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

Amazing. Welcome back, everyone, to DB's 20th Annual Tech Conference. My name is John-Marc Conti, and I'm heading the Hardware Equity Research division here. Today, we have the pleasure of having Richard Gu, Head of Investor Relations at Cadence. So before we start, a quick safe harbor. 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. So Richard, never got that out of the way. Let's frame the time for the room. EDA for the past 30 years has been growing a few percentage points faster than R&D spending. And then suddenly -- well, not so suddenly, I guess, in the past 3 to 5 years, we've had a lot of companies start to do custom ASICs and custom designs from hyperscalers to large system companies. So I guess what has structurally changed with H Design chips? And what role does Cadence have within it today?

Thank you for having me, Johnny. So first off, I want to take a step back and just introduce Cadence real quick for the ones newer to our stories. So Cadence is a pivotal foundational player in the semi ecosystem. We provide the semiconductor design tools to all the chip companies, semi companies and systems companies, okay? So -- and it's indispensable kind of role that we play in there. If you look at the -- what happened in the past, I'd say, 10, 15 years, there are 2 major trends, Johnny, to your question, that's shaping the industry, okay? One is the convergence and the merge between semi and the systems, okay? Because all these semi companies are becoming like systems companies and vice versa, be it hyperscalers or autonomous driving vehicle companies or even frontier and other model companies that design their own ASIC chips now, okay, which is a great thing to see. Because what it means for us is not only the aperture has expanded dramatically in terms of the new entrants and the new customers and design starts, which is always a great tailwind for our business, but it also means increasing compounding complexity for those designs. So if you put together these 2 dimensions, it's a fantastic tailwind for the company for the next, I'd say, 10, 15 years, unabated, okay, first. So -- but the second trend, I'd say, is the AI obviously is a turbocharger for the entire semi ecosystem. And Cadence is a structural winner throughout this entire process. Not only are we supporting and supplying the EDA, IP, hardware systems and system simulation software to all the key players to design their AI accelerators. But also we're applying AI to our own tools to make sure our customers can reap the benefits of the massive boost in productivities and they can design better chips too. So I think with those 2 together, we're seeing a very strong tailwind for the business. Our most recent Q2 results is a reflection of that, right? You see clearly all the semi companies and systems companies are doubling down in terms of innovation road maps and R&D spend continue to grow, which is a great leading indicator for our business. And in the meantime, I'd say our business is accelerating. We're growing this year at a clip of 19% with 44.25% of kind of non-GAAP op margin. So when we talk about the Rule of 40, this is -- we're going to surpass Rule of 60 this year. So it's a great business, and the Cadence is well positioned to tap into a long-term growth.

Yes. So clearly, it's showing. Maybe we'll just unpack a little bit of that AI development of Argenti. You acquired CHIPStack last November. Within 3 months, you shipped the CHIPStack AI Super Agent, which is the industry's first Agentic workflow for front-end design verification. So for those in the room that have not tracked EDA closely, what does it actually mean for an AI agent to design and verify a part of the chip? And what parts of the chip design process can tackle into the nextogentic race?

Great question. So we're very excited about CHipStack and also the other 3 super agents we launched Rapifire over the past couple of months, which literally straddles the entire spectrum of the chip design in the back end also, including VerStack, which is the analog design kind of full flow orchestrator and also InnnoStack, which runs the digital flow and Atack, which runs the packaging, okay? So now with those super agents, what we can help our customer achieve accomplish is the dramatic improvement in productivity. when we think about the design challenges for our customers, everybody is faced with a big mismatch in terms of what they try to accomplish in their innovation road map and the supply side of the equation in terms of how many designers they can have, okay? And the workload is increasing unabatedly for the next 5, 6 years to the tune of even 30, 40x. So it's absolutely impossible for any company to hire that many engineers. Hence, the automation, EDA, AI needs to do a heavy lifting and bridge the gap. So that's a massive opportunity. What it means is these super agents, they all like will be endowed and trained with a certain human designer skill, be it front-end design -- take CHIPS Act as an example, right? So it will be doing the RTL code generation, translating the design spec to the machine code and also create test benches. And what it does is they also invoke and call a lot of the underlying EDA tools, including simulation, verification, which is a constant kind of iteration and looping process. So what it does is it's going to free up the human designers to a higher level and it allows them to do a lot more designs to be a lot more productive. Even Jensen talked about during the COPUTxt about 2 months ago, the CHIPS Act, they are seeing 4x productivity benefit. So the opportunity is massive. I think importantly, Johnny, to keep in mind is also the -- when it comes to the R&D spend in the design realm, right, the EDA spend right now in terms of wallet share, it's still like low teens, call it, 10%, 11%. So the massive 90% of the spend is still in human designers. So we definitely see this irrevocable trend in terms of that wallet share will continue to shift more and more towards tools and automation, which bodes well for our business in the long term.

Yes. So clear -- there's some clear productivity advantages here, right? So maybe speaking a little bit about that. If, say, you have 10x productivity, -- how does Cadence capture -- commercially, how do you capture a fair share of that value? And how do we think about what Generative AI does to a business model that has historically been built around the mix of seats and project-based R&D? Like could the agent stack open the door to those companies that don't have a team of chip designers like hyperscalers, but still wish to do custom designs?

Great question. So the -- from a monetization standpoint, the way we're going to monetize the super agents is through 3 vectors, okay? So first off, those agents, they are human designer segrogation, okay? So we're tapping into the greenfield, okay? This is a complete greenfield for us. What we're going to do is we're going to create -- we're creating separate price books for these 4 super agents. And in terms of the pricing, it's all going to be commensurate to what a human designer skills could be. So it will be worth tens of thousands of dollars. And once the customer exceeds or surpass the prescribed workload within that super agent, obviously, we want to charge them additional consumption in terms of tokens and extra usage. And another great avenue, the third avenue for the monetization is the calling and invoking of the underlying tools, okay? And you can imagine these agents, they're not humans, right? They don't need like AR, like you and me. So they'll be able to kind of explore in a much thorough and bigger fashion than a human designer could possibly do. So what it means is it's going to be a lot more base to usage, which has come through in our typical traditional EDA model, EDA monetization model. To the second point of your question on the -- what does it do for newer entrants. I think it definitely -- it levels the playing field, right? Because now with a smaller team, you could do amazing things, right, by leveraging these tools, as long as you have a clear mind in terms of what kind of chip you're going to have, what kind of system you're going to have and then you can leverage the tools, I think there are different business models existing in place already. Anre talked about the 4-story beauty, like going from merchandise to ASIC to hybrid COT to COT. That typically is going good on that path. I think the more companies -- more customers get straddled around that 4-story building, the better opportunity will be for Cadence.

That makes sense. So okay, the bottleneck in AI systems has been moved from the transistor to the system, data movement, memory bandwidth, packaging and thermals, right? So your fastest-growing segment in recent quarters have been FDA, which is the simulation piece and IP rather than the classic EDA. So I guess my question is, is it fair to say that Cadence's growth is now tied to system complexity rather than chip unit growth? And what does it mean for how investors should size the market?

Sure. So the business is actually -- we're seeing broad-based strength, right? If you look at the most recent quarter, we grew -- the revenue is growing like 24%, okay? And the core EDA is growing 18% to 19% and SD&A growing at about like 35% -- north of 35%, IP growing north of 40%, okay? So these are fantastic numbers to see. So I mean, using the analogy of chariot, pulled by multiple like 3 or 4 horses. I'd say all the horses are already at top speed, which is great to see. The CADA is always a great linchpin in terms of like 70% of our business is in CADA, right? It's great to have that kind of growth. I think in general, I think if you look at the -- our business is -- workload is important. So the driver of the revenue, workload is always important, okay? And one unique aspect for our business is our workload is not static, okay? It is growing exponentially. If you think about the complexity of the chip design, the most complex chip these days is, call it, Blackwell orub,'s like 10 billion transistors. But it's -- we fully expect that to grow. It's going to grow to like $1 trillion in a matter of 5 to 6 years, okay? If you weave into complexity, it's about 30, 40x kind of workload increase in the foreseeable future. So that will be the ultimate driver for our business. And it will be coming through in both the workload growth and the pricing opportunities, which is still an opportunity for us to flex further. I think AgenticI just give us so much more in terms of growth levers. But the business is so well positioned that we have multiple irons in the fire. And it's kind of a 4, 5 cylinder engine. Mile engines are running well.

It's almost like it's like additive, right? Like any layer that you're able to capture onto that Agentic layer, it's kind of like net new for you guys, right?

Absolutely. The middle layer, I mean we use the analogy of 3-layer cake, right? -- middle layer for the core principal software, hardware, IP, these are unassailable, okay? -- irreplaceable unassailable. So AI is a great overlay on top of that. It's going to orchestrate and help customers reap massive productivity benefit. But what it does is not only gives us the opportunity to tap into that greenfield opportunity, but also it's going to drive a lot of tool usage in the middle layer. Now we can optimize that with data and the chips and the systems. So I think it's a beautiful 3-layered kind of stack that we're going to continue to leverage and grow.

One can kind of also put the comparison with how Cerebrus was pulling from the back end, the multiple licenses of Innovus, right? It's almost like same parallelism when you think about how a new product can pull legacy tools that are required, that's like the engine behind -- so sounds like a great opportunity.

Yes. I think that's -- it's definitely a kind of parallel. Cerebvers -- I mean, you're familiar with that. One copy of Cerebus can drive 10 copies of the full flow digital standpoint. So there's lots of pull-through. I think Agentica is not a big opportunity for us to drive an abstract even further up.

That's fair. Okay. So maybe we should unwrap some of the IP developments. You recently displayed wins in the IP business with Ceres, LPDBR6, PCIe, UCIe. For the investors in the room, how should they think about the IP developments, the key areas of the portfolio where you're seeing substantial market demand? And how do you juggle basically a higher IP mix but also wanting to keep a pretty steady margin progression, right? Because IP is not as strong as EDA margins.

So IP for us is a great business, right? It's certainly situated and positioned in a place where we're seeing like great secular trend and growth trend drivers. But for IP, for us, it's always a balance, right, a balancing act. It's a conversation between the revenue growth and the margin kind of accretion also, okay? So we -- early on, we devised an IP strategy that we're not going to be everything for everyone, okay? We chose very deliberately to focus on the advanced nodes IP designs, IP titles, HBM, UCI, PCI, all these connectivity kind of important IP. That is very much exposed to the AI super kind of cycle, okay? So that is bearing fruits. You have certainly seen IPs growing at a very fast clip, okay? We're gaining share in the market. We're going to be at a $1 billion clip by the end of the year, so at scale and growing at much faster than market, which is great to see, right? And also, I'd say the foundry ecosystem is helpful, right? Now it's not just TSMC, Intel, it's Samsung, it's Rapidus. So we're working with them all, okay? So that gives us a great opportunity to continue to tap into that growth engine. But in the meantime, we don't want to be everything to everyone. We want to make sure like if -- I think if done right and managed right, we have the opportunity to strike that goldilocks in terms of tapping into that high IP growth, but not sacrificing the overarching company margin, okay? -- because the margin growth and the EPS growth is always a North Star for us. So I think $1 billion is a great place to be. And we'll continue to work with the customers and make sure that they're delighted with our products. And the products is getting a lot better, too. I think now we're in a good place that we can really grow well in general, but at the same time, continue to maintain and have and achieving that 50% incremental margin in general for the company.

Yes. So maybe just following on that question on the IP. I'm curious about what your thoughts on -- obviously, we've seen OpenAI coming out with Palapinho and the whole debate about whether you can possibly expedite substantially the tape-out process and the design process of the chips. So I guess my question here is on the IP side, could you see a future into which pockets of the IP portfolio get a little bit more commoditized. And so you have a bit more of a software layer allowing customers to just churn out faster and better IP. And so maybe the -- I guess, that will be reflected into the TAM of the IP market thoughts.

Yes. So the IP is a great business, but EDA is -- I mean IP is a good business, but EDA is a great business. Because for IP, there's -- the conversation is always the build versus buy. I think the market is so conducive now. It's almost like all the -- I mean, on every customer's mind, the main objective is they want to win the race, right? They want to go to market a lot faster with a great product that can go to production, okay? Hence, I think IP is going very well. But EDA is a fantastic business because EDA can only buy, you cannot build, okay? So that's why I think IP will give us good growth if we do it right, I do feel like IP, ultimately, you have to make sure you have the product excellence, right? Because the measurement of successful IP is you have to deliver the PPA benefit to the customers. As long as you can do that, I think you can continue to have great growth. But over time, that's why, like I said, we need all the horses, all the engines to run well for the business, and EDA is a great business. We should never lose sight and take eyes off fat. I think overall, we're managing the business in totality as a portfolio. I think IP has a lot of growth to be had in the coming years, given what I talked about the AI super trend K and I talked about the sort of the foundry ecosystem build-out. And also with Intel, we're doing a lot more, right? 14A, I think you probably noted that we signed a meaningful kind of deal with Intel to help them design their 14A on the foundry side. So it's not just for IP, but also it helps with our EDA tools also and Gen AI products. So I think ultimately, I think we're -- and the company is just firing on all cylinders. We're sitting in a great place.

So it's safe to say that maybe because EDA is a greater business, perhaps that portion is a bit more shielded by any developments of in-housing software to basically replicate the motions of EDA, right? Because as we know, some of the biggest challenges in chip design is verification, right? And it's a problem with which today still requires enormous amounts of efforts to really reduce all the errors prior to tapeout. So would it be still fair to say that visibility in the next 2 to 3 years as far as EDA comes is still like a safe software business and sort of shielded from the fast way?

Good question. So I think the EDA is unassailable. The position of EDA is unassailable and impreractable. The reason being that EDA is all deterministic, right? It's a physics-based kind of -- it has to be physically accurate, okay? You don't want to take any chances with any of the probabilistic stuff in there at all, okay? So I think EDA is a great place to be. We can see that the reliance from our customers on EDA to help them deliver against their innovation road map is going to become a lot more acute and then a lot more pronounced in the coming years. Just given all what we try to do and given the shortages on the labor side. I think it's a fantastic opportunity and tailwind for our business in the long term. said. And I think also -- Johnny, I think I want to highlight from an innovation standpoint, we want to innovate on all 3 layers, right? Core EDA, unassetable position, AgenticAI, if we can do things right by embedding that and co-optimize that with the core tools and then you build it on top of that proprietary good data, data set, data moat and then great systems to build on top of that. I think it's a fantastic 3-layer cake supporting the long-term growth of the story. That's very fair.

Okay. So maybe we'll shift a little bit on the geography side. China used to be a big point of contention, right, in the past. Now we're seeing healthy growth again as a mix of competitive displacements and lcentpolitics helping capture back some of that lost growth. Knowing what you know and given how much China is pouring into the development of new fabs to startups challenging incumbent architectures, what is your view on how will China fit into Cadence's growth equation, say, 3 years from now? Like is it a constant race towards wanting better emulators or perhaps IP is taking more off? Just walk us through the motions there.

China is a good market, I'd say. But I think if you look at our business, the rest of the world is growing very nicely, too, okay? So it's fairly balanced. I'd say the broad-based strength is not -- does not just apply to the product set portfolio, but also apply for all the geos and regions. I think we're also pretty confident that China is going to grow at least at the company average this year, okay? Because if you look at the dynamics in the China market, it actually mirrors a lot of what's happening in the U.S., right? They have great LLM model companies. They have good hyperscalers, a lot of EV kind of autonomous driving vehicle companies. We work with a lot of those. I think the strength is across the board. And not only do we sell a lot of emulation system to the Chinese market, but EDA is a big part of that, too. So I think it's a reflection of the excellence for the product set and the tight relationship with the customers. So we do feel like China, I think the strength in Q2 really is a reflection of a lot of the bookings and add-on deals we had for the past couple of quarters. So it just come through. But I think it's a good market. We'll keep a close eye on it. And -- but I think overall, the company is growing in a very balanced fashion.

What about competition locally? Like we used to have a debate maybe like 3, 4 years ago about the Univistas Imperion of the world. How has that shaped up recently? And firstly. And then secondly, I guess, with your closest competitor, how are market share shifts happening in what product segments? Like are you seeing that those bookings push more on the hardware side? Or I'm just curious to see the market share dynamics happening in the region.

Sure. Just by sheer growth rate, you can tell we're gaining share in the market. So -- and I think the -- it's part of that is just -- is really driven by the product excellence across the board, right? But I think from a local competition standpoint, it's not our concern at this point because I think a lot of the local competition, they're still a lot smaller. They have some point tools, a lot more -- just not up to our standard, and they don't have full flow. And a very important consideration is also they don't have the foundry ecosystem or certification from TSMC -- so it's not -- I think we'll keep an eye on those, but it's not a near-term or medium-term threat for us, okay? I think versus our peer company, we feel very confident. I think our growth rate speaks volume in terms of our market position in China. Again, it's not just emulation systems, it's EDA tools. IP, we still have a lot of room to grow in there, too. So I think overall, it's a great business. And we keep an eye on China. But again, like overall, all the geos are doing well. Yes. That's fair.