Cadence Design Systems Inc (CDNS) — Q1 2016 Earnings Call Transcript

Thank you, Shannon, and welcome everyone to our first quarter 2016 earnings conference call. With me today are Lip-Bu Tan, President and CEO; and Geoff Ribar, Senior Vice President and CFO. The webcast of this call can be accessed through our website, cadence.com and will be archived through June 17th, 2016. A copy of today's prepared remarks will also be available on our website at the conclusion of today's call. Before I start, I want to call your attention to our CFO commentary which was included in our 8-K filing today and is available on our Investor Relations' website at cadence.com. The CFO commentary should be referenced in conjunction with both today's conference call remarks and the earnings press release issued today. Next, please note that today's discussion will contain forward-looking statements and that our actual results may differ materially from those expectations. For information on the factors that could cause a difference in our results, please refer to our filings with the Securities and Exchange Commission. These include Cadence's most recent reports on Form 10-K and Form 10-Q including the company's future filings and the cautionary statements regarding forward-looking statements in the earnings press release issued today. In addition to the financial results prepared in accordance with Generally Accepted Accounting Principles, or GAAP, we will also present certain non-GAAP financial measures today. Cadence management believes that in addition to using GAAP results in evaluating our business, it can also be useful to measure results using certain non-GAAP financial measures. Investors and potential investors are encouraged to review the reconciliation of non-GAAP financial measures with their most direct comparable GAAP financial results, which can be found in the quarterly earnings section of the Investor Relations portion of our website. Additionally, a copy of today's press release, dated April 25th, 2016, for the quarter ended April 2nd, 2016, and related financial tables can also be found in the Investor Relations portion of our website. Now, I'll turn the call over to Lip-Bu.

Good afternoon, everyone, and thank you for joining us today. Cadence delivered good operating results for Q1. Revenue was $448 million, up 9% year-over-year. Non-GAAP operating margin was 26%. Non-GAAP EPS was $0.28 and operating cash flow was $83 million. Looking at the environment, conditions have not changed significantly since last quarter. Semiconductor business conditions remain challenging and we are mindful of the ongoing consolidation in our semiconductor customer base. While we do not expect a material impact on our business in 2016, consolidation could pose a challenge to industry growth over the next few years. I will begin our Q1 business highlights with system design and verification. In February, I asked Anirudh Devgan, who has led the resurgence of our Digital & Signoff business to expand his responsibilities to include leadership of our system and verification group. Anirudh will bring innovative ideas and drive to our next-generation verification solutions. Cadence offers a holistic verification suite of connected solutions that are based on strong core engines and optimized for total verification throughput. Rapidly growing complexity and time-to-market requirements make emulation more critical than ever for customers designing chips and systems for mobile, cloud, automotive, and other verticals. Palladium Z1 sales ramped nicely as customers embrace its advanced enterprise-class capabilities, while demand for Palladium XP remains strong. As a result, Cadence achieved its best quarter ever for hardware revenue. While our primary innovation focus continues to be organic development, we will also consider strategic acquisitions that will bring outstanding technology and talent. Recently, we announced that we've entered into a definitive agreement to acquire Rocketick Technologies. Rocketick brings pioneering technology and a talented team that will significantly increase the performance of our Incisive enterprise simulator using parallel computing on standard multi-core servers. In the custom, analog, mixed-signal design world, Virtuoso has been the de facto industry standard for the past two decades, used on the vast majority of designs with thousands of tape-outs. At our CDNLive Silicon Valley user conference earlier this month, we announced the next-generation Virtuoso platform including the Virtuoso Analog Design Environment Suite and the Virtuoso Layout Suite. The new Virtuoso offers designers an average 10X improvement in performance and capacity across the platform. The platform includes new technologies to address the requirements of automotive safety, medical devices, and IoT applications. IP is an important component of our System Design Enablement strategy, and I am very pleased to announce that Pieter Vorenkamp has joined Cadence as Senior Vice President and General Manager of our IP Group. Pieter comes to Cadence after 18 successful years with Broadcom, where he held roles of increasing responsibility, most recently as Senior Vice President of Operations Engineering. Pieter’s rich experience will enable us to deliver high-quality, differentiated products, as he drives the refinement of our IP strategy to focus on sustained and scalable growth. This quarter, I would like to highlight our Tensilica DSP cores, which are a very strategic component of our IP business. In Q1, we had a key design win for 5G baseband DSPs with a leading mobile handset company. And Spreadtrum licensed our Tensilica HiFi Audio/Voice DSP because of its ultra-low power capabilities. Now moving on to digital and signoff. The success and momentum we've gained with our new flow has continued with strong adoption of the full flow in Q1, especially with customers in mobile, consumer, automotive, and IoT segments. In Q1, a leading mobile chip company adopted our digital and signoff flow for its most demanding 10-nanometer projects. The Innovus implementation system added more than 15 new customers in Q1, while our Genus RTL synthesis solution added more than 25 new customers. TSMC certified our digital and signoff tools for 7-nanometer design and 10-nanometer production, and Samsung Foundry certified our tools for its 14LPP process. Finally, we also announced today that Geoff Ribar has decided to retire from Cadence in March 2017. Geoff has been a great partner to me and the company over the past five and a half years. As an integral member of my leadership team, he has made long-lasting contributions to the company. During Geoff’s tenure, we have consistently met or exceeded our financial objectives, improved both our operating margin and cash flow, strengthened the balance sheet, and optimized our return on capital. Geoff has done an outstanding job of executing on the strategy and management philosophy that my board and I have built in place, and he has built a strong finance team. We have initiated a comprehensive search to identify our next CFO, and Geoff is working with me in the search process. Once the new CFO is appointed, Geoff will work collaboratively on the transfer of responsibilities and will remain actively involved with us through his retirement date. While Geoff’s retirement is bittersweet, we all congratulate him on a successful career as a CFO and wish him well in the next chapter of his professional life. In summary, Cadence once again delivered good results in a challenging environment. Our portfolio of solutions across chip, package, board, systems, software, and IP, guided by our System Design Enablement strategy, best positions us to drive new business in verticals including automotive, aerospace, medical, and across IoT applications. Strong, broad-based demand for the new Palladium Z1 contributed to our best hardware revenue quarter ever; the innovative new Virtuoso platform strengthens and solidifies our position in custom, analog, and mixed-signal design; and our digital and sign-off solutions are proliferating with current customers and gaining new customers. Now, I will turn the call over to Geoff to review the financial results and provide our outlook.

Thanks, Lip-Bu, and good afternoon, everyone. It has been an honor for me to serve as CFO of Cadence for the past five and a half years. I'm extremely grateful for the support of my colleagues and our talented extended team. I will work with Lip-Bu in the search process, and I am fully committed to ensuring a smooth transition and look forward to maintaining our strong momentum throughout the transition process. I'm confident that our strong CEO, executive team, and finance team will continue to successfully execute strategic initiatives and drive shareholder value, just as we have over these past five and a half years. Now moving onto our results, please note that the CFO Commentary that we posted on the investor section of our company website should be referenced in conjunction with both my remarks and the earnings press release issued today. As Lip-Bu discussed, Q1 was a good quarter in what remains a challenging environment. Innovative new products and strong execution continue to distinguish us in the market. Total revenue was $448 million, up 9% year-over-year. Non-GAAP operating margin was 26%, compared to 23% for Q1 2015. Timing of revenue and expenses contributed to a higher-than-expected margin for Q1. We are maintaining our revenue and margin outlook for the year. GAAP net income per share was $0.17. Non-GAAP net income per share was $0.28, up $0.22 over the year ago quarter. Operating cash flow was $83 million. Cash and short-term investments were $907 million, compared to $711 million at the end of Q4 2015. Recall that in January, we entered a three-year $300 million term loan and drew $50 million on a revolving credit agreement. At quarter end, we had $700 million of debt outstanding. Approximately 45% of cash and short-term investments were in the U.S. at quarter end. DSOs were 32 days, down from 35 days in Q4. We repurchased 11.6 million shares of stock for $240 million, which represents a little less than 4% of shares outstanding. Before turning to our outlook, let me call your attention to the following items. As Lip-Bu mentioned, we believe Rocketick will help accelerate our innovation in functional verification to address the increasing challenges of system design complexity. This acquisition is expected to close in Q2 and is not expected to have a material impact on our 2016 financials. We have not disclosed the terms of the transaction. We undertook a restructuring during Q1 as part of our ongoing efforts to optimize resource allocation and operate the business efficiently and effectively. The restructuring charge was $14 million. Now let’s turn to our outlook. There are no changes to our fiscal 2016 outlook for bookings, revenue, operating margin, non-GAAP EPS, or cash flow. We continue to expect bookings in the range of $2 billion to $2.1 billion, which equates to 8% growth at the midpoint. Revenue in the range of $1.79 billion to $1.84 billion should be a 7% growth at the midpoint. Non-GAAP operating margin of approximately 26%, GAAP EPS in the range of $0.71 to $0.81, non-GAAP EPS of $1.15 to $1.25, and operating cash flow in the range of $380 million to $420 million. For Q2, we expect revenue to be in the range of $445 million to $455 million, non-GAAP operating margin of approximately 25%, GAAP EPS in the range of $0.17 to $0.19, and non-GAAP EPS in the range of $0.27 to $0.29. Approximately 90% of revenue is expected to come from beginning backlog. You'll find guidance for additional items in the CFO commentary.

Yes, hi thanks for taking my question. I had a couple of them. First and foremost, can you just talk a little bit about the tool you're getting from your customers given that there are some near-term demand and longer-term consolidation; just kind of curious what your point is what you're hearing from your customers in terms of what they are telling you regarding purchases?

Okay, so let me start. First of all I think as I mentioned, semiconductor business conditions remain challenging, little or no growth expected for 2016 according to various analyst reports. But clearly, we are positioned in terms of long-term growth opportunity, in terms of the mobile IoT vision, machine learning, and automotive-related areas, so those will be driving some advanced growth in system and IP. So, in answer to your question, clearly, we don't see much change, but actually we see a lot more design opportunity in terms of proliferating our tools and solutions in various vertical markets. Regarding consolidation, clearly last year was a big consolidation year with more than 100 billion in major deals like Avago-Broadcom, Intel-Altera, and many others, so we are mindful of the ongoing consolidation in our semiconductor customer base. But meanwhile, we see, as I mentioned earlier, opportunities in proliferating our new solutions. The long-term impact of consolidation is very hard to predict, but we don't expect any material changes to our business, and I think in the longer run, this consolidation may pose a challenge to industry growth over the next few years.

Got it. That's very helpful. And in terms of R&D, there's a question I've asked in the past, kind of curious about any updated thoughts regarding the five video customers getting more cognizant of their cost and complexity. So along that is there an opportunity for you guys to be efficient with your R&D or do you think mid 30% is going to be the predictable mix of R&D for the intermediate future?

Yeah. So, let me try to answer your question if I hear correctly. The complexity and time to market pressure are increasing tremendously, especially in the advanced nodes like 14, 16, 10, and 7, and the mass cost is pretty high, so first-time pass is critical. We see tremendous growth into our emulation, and also growth in terms of the full flow in the digital and custom mixed-signal segments. Our relationship with the foundry partners becomes very critical, and we mentioned we have a very deep partnership with TSMC, Samsung, and many others. I think these relationships, along with our ARM IP ecosystem, are critical for success. We will continue to drive R&D efficiency and, as Geoff mentioned, about the restructuring to drive more efficiency; we are doubling down in these areas along with support from some key customers. We want to ensure that the designs based on our tools are successful in implementing the most advanced nodes.

I have two quick housekeeping questions. First, during the last earnings call, Geoff mentioned that most of your operational expenses are front-loaded, which means they slow down a bit in the second half. Is that still the case? Secondly, what is the remaining amount for the buyback?

So, I'll answer the second question first. We have $720 million left on the buyback for the remaining part of this year. As far as OpEx, yeah, in the first half of the year, you tend to have less vacation and more social security tax, those things roll off in the latter half of the year. We continue to invest in key R&D people and key technical salespeople, so that will counteract the other trend.

So, OpEx should be similar in the second half versus first half?

Yes, approximately similar. Because we have more shutdowns and less social security tax impact, but more talented engineers and talented salespeople.

Got it. Thank you very much, guys.

Hi everyone, thanks for taking my question. So if I'm not mistaken, Cadence has a policy of raising prices to try to implement a price increase every two years or so. I'm curious if that is an across-the-board price increase for all products or whether or not that's staggered across the various product lines, and could you remind us of when we may be hitting that biannual price increase?

So, our fundamental purpose, of course, is to deliver great innovative products to our customers, and when we do that we can capture value from our customers. We do focus on the quality of our deals and pricing, but the key thing is when we deliver value, we'll get paid for it.

Okay. You mentioned that hardware sales are at record levels and are related to emulation. I'm curious how those hardware sales are impacting your gross margin and operating margin for that matter, and how it may create some lumpiness in the bookings backlog figures that you guys are striving for in 2016.

Well, our emulation like our hardware business is certainly lumpy, like our IP business will be lumpy. What we've said is since we introduced and released the Z1, we expect revenue to increase in our hardware business and margins to go up with the new product. I think we're happy with that, and you saw we had a record hardware quarter. So, we're doing quite well so far.

Okay. Any notable change between EDA and system design enablement? Is it still roughly a 55/45 mix respectively?

Our system side is about 40% of our business; 60% is in the traditional semiconductor.

Okay, great. Thank you, guys.

Thank you.

Thank you. With regards to the restructuring, Geoff, is that more of a business-as-usual reallocation of resources, pruning in areas that are less strategic and adding in more strategic areas?

Yes, it was planned as part of our guidance, and certainly, we're trying to optimize our resource allocation between different parts of the business. So, yes.

Got it. And then I'm guessing you kind of said what you want to say on emulation, but I'll try anyway. You talked about very strong demand for XP boxes in the quarter which helped drive this record quarter. Can you help us understand why folks would buy an XP when a Z1 is out there? Maybe other than the obvious which is they can't get Z1 yet because you can't make them as fast as people would like them?

So let me start first and then Geoff can fill in. Clearly, we want to highlight that the XP platform still continues to remain strong, and the Z1 is the best launch for us and is enterprise-class with extra throughput and scalability that customers love; we ship as we build and have been very well received, and we are delighted with that. The combination of both makes the quarter the best quarter ever; and Geoff, you can expand more.

Obviously, I think both product lines were very strong, and there are different purposes for each product and different customer needs, so people are going to buy what they need, and we are happy to sell them what they want.

Got it. It sounds like you've brought on a new Head of IP, which is great. Can you share more details about the direction of that business? From what you've mentioned, it seems you anticipate slower growth this year compared to previous years, which you indicated was around a mid-teens rate. Could you discuss your expectations for growth after the restructuring is complete and as you align some of the portfolio towards more sustainable and profitable businesses?

Yes, Rich, I'm happy to highlight here. So clearly we are excited that Pieter Vorenkamp joined us with his rich experience and high qualifications to deliver high-quality, differentiating products as we refine our IP strategy and focus on sustainable and scalable models going forward. In terms of growth, Pieter Vorenkamp, as I mentioned at the last job he had at Broadcom, was Senior VP of Operations Engineering, and he was in charge of not just design but also global manufacturing and technology, which includes all of the hardware programs. He is a strong innovator and holds more than a hundred issued and patent-pending applications in the U.S. We are excited for him. As we grow the business over 10% of revenue right now, it's about time to refine our IP strategy for the next phase of growth. We previously mentioned moderate growth in 2015, and that is already built into our guidance. Longer-term, we expect IP revenue to grow above the corporate average, and that is our expectation regarding growth.

Thanks for taking my questions.

Thank you. Good evening. Lip-Bu, Geoff, I'd like to start with a couple of product segment questions. First, when you think about your IC implementation business, what percentage of incremental bookings in that business are coming from upgrading your own base versus adoption in competing or incumbent product environments? Perhaps for new products; a mix of both, but how do you think about that divide?

Jay, these are good questions, and let me address one at a time. First of all, in the digital and signoff area, as you know, we revolutionized that whole digital flow with some of the new tools. I think you mentioned a couple of them and Innovus for implementation, place-and-route synthesis for Genus, and we also have Tempus for signoff, Voltas for power, Quantus for timing, and Joules for power analysis. Overall, we have been very good last year, and now we are seeing strong adoption and growth in Q1, especially in mobile, consumer, automotive, and IoT-related areas. In Q1, we mentioned that a leading mobile chip company has adopted our full flow digital signoff for their most demanding 10-nanometer projects with volume. We had 15 new customers adopting Innovus in Q1, and many of those are competitors that we have won over. Genus added 25 new customers, and Tempus added 15. Voltas added four, Quantus added six, and Joules added three. We continue to proliferate nicely and have deep partnerships with the ecosystem, including TSMC, Samsung, and ARM, which are critical for success in most of the advanced nodes like 10 and 7-nanometer. I mentioned earlier that today, Toshiba adopted our Innovus implementation for production of mobile memory controllers, achieving a 16% area reduction and 25% power savings; those are very remarkable metrics in real-case scenarios because of a much better product and solution.

And in the numbers a little bit, the digital revenue was up substantially quarter-over-quarter and year-over-year, and some of that was a benefit from a completed contract in Q1, but generally our digital business has been quite strong. The system interconnect business has been, I would take, nothing more than a pause. We sometimes have fluctuations in revenue accounting due to MEAs or payable contracts, so we view it as nothing more than a pause.

And regarding the PCB-related area, Q1 was an overall solid quarter with several sizeable renewals from both system and semiconductor companies, and we continue to expand our collaboration with TSMC on the integrated design flow that pertains to integrated fan-out and IC packaging technology. We have driven the foundry-proven IC packaging, analysis solutions, and security for power signal integrity, which is for system-level analysis. Our 2016 technology portfolio improved the product creation time and ends up with a PCB design analysis methodology for multi-gigabit interfaces like USB 3.1.

With respect to your earlier comments on restructuring and your margin expectations for the year, let me ask you this: we've noticed just from checking your website, an unusually large increase in job openings that you're posting, probably the largest we've counted in several years, including a particularly large increase in R&D and virtually none for sales. To what extent is that increase in R&D positions reflective of compensating for attrition versus real organic investment or capacity additions in R&D?

I think it shows a lot of confidence that we have these positions. We do tend to concentrate on hiring in technical positions in R&D and technical sales, and you'll generally see most of those as being in that area. The restructuring is, of course, focused on efficiency and effectiveness in ensuring we're using resources where we need to. As you're well aware, we are in a great place to work; we're very highly ranked and it's a good time for us to attract talented people.

Lastly, Geoff, could you comment on the increase in services revenue in the quarter? Was that largely related to IP engagements, and is there anything to extrapolate from that?

No, we recognized revenue on a completed contract in Q1, which drove the services revenue up uniquely in Q1.

Thank you.

Thanks for taking my question. The first question on the emulation side: one of your peers, Mentor, mentioned that they think you guys had a very good quarter in emulation, but they were seeing evaluation times looking to stretch from three months to seven to nine months, along with some pricing pressure in the market. How would you reconcile that?

We don't want to comment on our competitors. I think thus far we have been very focused on our business. As I mentioned earlier, especially in the most advanced nodes, the complexity and time-to-market in emulation is a must-have, and clearly our XP platform and Z1 have been doing really well. Customers are placing orders and there are many repeat orders. So overall, we see a tremendous opportunity for us because time to market is critical for semiconductor companies and system companies, and our Z1 sales have ramped nicely.

Keep in mind, we introduced a product in late Q4 and discussed this being the fastest ramp for an emulation platform we've had. I think those two things clearly show what we believe the cycle time to be.

Thanks. Then Geoff, on the operating margins side, Q1 Op margins are better year-over-year and Q1 is typically the lowest revenue quarter, so likely margins go up from here, but in your 2016 Op margin guidance, they are slightly lower year-over-year. Are you just being conservative?

I think the Q1 outperformance was largely related to the timing of revenue and expenses between quarters, but we are expecting to hire, as Jay asked in his question, in both R&D and technical sales. This will increase spending in the later part of the year, and we’re quite comfortable maintaining our revenue and operating guidance for the year.

Thanks. Last one, Intel announced typically a 10-11% workforce reduction. Do you see an impact from that?

Yes, I think first of all clearly, Intel is a great company, and I have a lot of respect for them, but we won't comment on any specifics about that company.

I meant any impact on EDA spend due to the reduction of headcount.

We just don't comment on individual companies, but they are a great company, as Lip Bu said.

Okay, thank you so much.

Thanks, hi guys. I want to start with the comment about the hardware revenue record in the quarter. How did that perform relative to your expectations? In other words, did you factor in that record revenue in your guidance? And how did the margins stack up versus what you were expecting, especially in the new Z1 platform?

When we give guidance, we always include everything we know at the time. It’s hard for us to comment specifically on that. When we introduced the Z1 and started talking about it, we expected to see higher revenue this year and higher margins as a result of the transition to the Z1 platform. Of course, we know hardware is a lumpy revenue piece for us, along with IP.

If I can add a little more, clearly we have an outstanding team and they are driving the business, so far we are very comfortable to meet the customer demand.

Relative to the IP business, I'm curious, I understand lumpiness, but what's impacting the growth rate in terms of seasonality for this year?

It's really the change in our focus; as we said on the last call, we're focusing on sustained scalable growth and concentrating on delivering that. More than anything else, that's driving our business. We expect more modest growth this year than last year. In the long term, we expect IP growth to be above the corporate average.

Last question. If you look at the OpEx, I guess the OpEx dropped in the first quarter for sales and marketing; it’s more than I think historically, at least for the last few years, and the OpEx drop in R&D was actually less. Didn’t know if that was indicative of what you guys did as hiring in the quarter or if there's something else going on.

Yes, we're not going to comment on the details of our restructuring or the number of positions impacted. Obviously, we focused on effectiveness and efficiency with the restructuring, and that has some impact on spending in the quarter.

To add some color on that, clearly as Geoff mentioned earlier, we are doubling down on R&D and Field Support Engineering, because of a couple of big customers that are proliferating, and we are working with them to support them successfully in the most advanced nodes, so it’s more to provide technical support and continue the innovation for the flow that we are focusing on.

Great. Thank you, guys.

Yes, good afternoon. I was curious, are you at what you would consider full production right now for the emulation business, or are you still in the process of ramping the new tool?

We are in production and meeting customer demand.

Okay, sometimes cycles take a while to get to full levels. Alright, and then Geoff, when you look at your commentary, it looked like the GAAP margin was down a little bit. What was the driver of the GAAP margin decreasing but the non-GAAP staying constant?

We expect a higher tax rate this year than we did last year on a GAAP basis.

Okay, but cash tax rate stays the same?

It should stay the same, maybe slightly up.

Okay. And is that just the location of where you are getting your revenue?

I think every government in the world needs more money.

Alright. When you look at your full-year guidance, I'm curious how much of the buyback was in that. Were you assuming buyback through the year, or just buyback through the quarter? How much I guess…

We are guiding through the buyback as authorized through the Board for the year.

Okay, alright that's it. Thank you.

Hi, guys. Thanks for taking the question. First of all, on the emulation products, Z1, would you expect a natural sort of initial uptake of products as the products launched, and then pause to digest those, or would it be a steady ramp?

So the business is going to be lumpy, obviously, for emulation. Customers are going to buy the product when they need it based on their designs, so they weren't waiting; they were buying what they needed, and they are going to continue buying what they need.

Okay, that answers my question. The other question is around the system customers versus semis. Would you expect that mixed shift over the next several quarters or years? More importantly for system customers, are they more likely to take bundles of your products versus semi-customers given that they're getting into the semi business themselves?

Suji, I assume you're talking about the broad product rather than emulation, right?

Correct, exactly.

I think clearly we are excited about the whole system design enablement and this exactly addresses not just silicon players, but those moving to systems and service providers. We are embarking aggressively on this, and it’s very exciting because we have not just the tools, we also have IP, and we have packaging and systems design and analysis, which can be compelling to work with them in automotive sectors like ADAS, function safety, crowd infrastructure, and hyper-scale infrastructure for machine learning. We have seen success with the Tensilica and our tools in IoT applications. We also had an announcement with Silicon Labs on ultra-low power mixed signals. The opportunities are great, and we are excited about the prospects in medical, aviation, automotive, crowd, and IoT-related areas; I believe the system-level will grow significantly.

Okay, thanks again, guys.

Thank you.

In closing, I'm proud that for the second year in a row, Fortune Magazine has recognized Cadence and our hardworking employees by including Cadence in a list of the hundred Best Companies to Work For. I would like to thank all our shareholders, customers & partners, Board of Directors, and employees for their continued support. Thank you all for joining us this afternoon.