Cadence Design Systems, Inc. (NASDAQ:CDNS) Q4 2022 Earnings Call Transcript

Cadence Design Systems, Inc. (NASDAQ:CDNS) Q4 2022 Earnings Call Transcript February 13, 2023

Operator: Good afternoon. My name is Julianne, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence Fourth Quarter and Fiscal Year 2022 Earnings Conference Call. Thank you. I will now turn the call over to Richard Gu, Vice President of Investor Relations for Cadence. Please go ahead.

Richard Gu: Thank you, operator. I would like to welcome everyone to our fourth quarter of fiscal year 2022 earnings conference call. I am joined today by Anirudh Devgan, President and Chief Executive Officer and John Wall, Senior Vice President and Chief Financial Officer. The webcast of this call and a copy of today’s prepared remarks will be available on our website cadence.com. Today’s discussion will contain forward-looking statements, including our 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. For information on factors that could cause actual results to differ, please refer to our SEC filings, including our most recent Forms 10-K and 10-Q and today’s earnings release.

All forward-looking statements during this call are based on estimates and information available to us as of today and we disclaim any obligation to update them. In addition, we will present certain non-GAAP measures, which should not be considered in isolation from or as a substitute for GAAP results. Reconciliations of GAAP to non-GAAP measures are included in today’s earnings release. Today’s earnings release for the fourth quarter of fiscal 2022, related financial tables and CFO commentary are also available on our website. Now, I will turn the call over to Anirudh.

Anirudh Devgan: Thank you, Richard. Good afternoon, everyone and thank you for joining us today. I am pleased to report that Cadence delivered record results for 2022 as we exceeded our guidance yet again, achieving 19% revenue growth and over 40% non-GAAP operating margin. Cadence’s innovative solutions are essential and especially relevant in the current environment, enabling customers to achieve their increasingly challenging design goals. Secular megatrends such as 5G, hyperscale computing and AI/ML that are driving sustained long-term semiconductor and system growth remain unchanged. Amid ongoing macroeconomic uncertainty, companies continue making significant investment in their next-generation products, resulting in robust design activity.

We expect our pioneering solutions to continue fueling broad-based business momentum in 2023, driving strong revenue growth and profitability. John will provide more details in a moment. Our Intelligent System Design strategy greatly broadens our total available market and leading end-to-end EDA IP, hardware and expanding system analysis portfolio uniquely position us to capture a wide range of market opportunities. During the year, we introduced 9 significant innovative products across all of our business groups and we expect these to be key drivers of our future growth. The age of AI is upon us and Cadence provides several groundbreaking computational software-driven generative AI technologies at both the chip and system level unified by JedAI, our differentiated big data analytics platform.

Our customers are seeing dramatic results, with these solutions delivering highly optimized designs and unprecedented efficiency gains. Additionally, by automating repetitive tasks and producing new ideas, our generative AI frees up engineers to focus on more advanced high-value activities, opening up more opportunities for innovation. During the year, we also materially expanded our core EDA, IP and system solutions footprint and market-shaping customers. In Q2, we extended our collaboration with AMD to a far-reaching commitment to our innovative core EDA hardware, design IP and system software solutions. In Q3, we deepened our partnership with BAE Systems across our core EDA and systems portfolio, including proliferation of our digital full flow and analog products and a broad expansion of our PCB and multi-physics system analysis solutions.

And in Q4, we have broadened our relationship with a global leader in memory and storage solutions through an extensive proliferation of our custom, digital and system solutions. We also expanded our strategic partnership with a global leader in networking and telecommunication through their renewed commitment to our core EDA, IP and system solutions. In addition, we further our partnership with leading foundry, IP and cloud service providers and won six Open Innovation Platform Partner of the Year awards from TSMC. Now, let’s talk about some of the product highlights for both Q4 and 2022. Our digital IC business finished another strong year, with 17% revenue growth. Deployment of our digital full-flow delivering industry-leading quality of results at the most advanced nodes continue to accelerate, with nearly 50 additional customers adopting it during the year.

Our digital software is now deployed in all top 20 semiconductor companies. We are pleased with the accelerating growth of our front-end Genus and Joules Tools and signoff products such as Tempus and Qantas, complementing the board proliferation of Innovus. Our transformative Cadence Cerebrus AI-driven solution continued to deliver impressive PPA and productivity gains across a wide range of designs, resulting in broader adoption and accelerating proliferation. Among others, it is now deployed at 10 of the top 20 semiconductor companies, including 7 of the top 10 semis and at several major hyperscalers. In Q4, GUC successfully delivered an advanced HPC design and a CPU design using our digital full flow and Cadence Cerebrus on TSMC N5 process technology, delivering 8% reduced power and a 9% area improvement while significantly improving engineering productivity.

In 2022, several market-shaping customers, including Intel, NVIDIA, Broadcom, Samsung and Renesas shared their remarkable successes with Cadence Cerebrus at our CadenceLIVE user conferences. Escalating system and software bring-up complexities, combined with relentless first-pass silicon requirements, continued to drive strong demand for our essential Functional Verification solutions. Our Verification business grew 28% year-over-year, fueled by secular trend for hardware, which had another record year. Our dynamic duo of Palladium Z2 and Protium X2 platforms, providing best-in-class system verification and software bring-up solutions, saw accelerated growth and strong momentum across mobile, hyperscale, HPC and increasingly, auto EV segment.

Our hardware family added 30 new customers and over 160 repeat orders during the year. Due to the compelling value offered by common front-end compiler, demand for the pair greatly exceeded our expectations, with more than two-third of the orders in the year, including both platforms. Our new Cadence Verisium AI Verification Platform enables dramatic improvements in debug productivity. And in early production usage at several market-shaping customers, Verisium delivered up to a 30x improvement in efficient root cause analysis. Our custom IC Virtuoso and Spectre franchise solutions tackled the toughest challenges in analog, mixed signal, RF design and circuit simulation. And as electrification and digital transformation trends gain momentum, they are becoming increasingly crucial to our customers.

Building on our market leadership, our custom IC revenue grew 13% year-over-year in 2022, with Virtuoso growth spurred by demand in advanced nodes, heterogeneous integration and the emerging silicon photonics segment. We added 200 new Virtuoso logos and more than 150 logos for Spectre, with Spectre FX making strong headway in FastSPICE memory applications. Increasing usage of preconfigured IP blocks to reduce risk and time to market, coupled with our star IP portfolio, led to a strong year for our IP business, which grew 12% year-over-year in 2022. Demand was particularly strong in HPC, 5G and automotive segments, with our silicon proven, high-performance PCIe Gen 5, LPDDR5 and Ethernet interfaces helping secure key wins in advanced node designs.

Our Tensilica DSP portfolio continued expanding its footprint in smart speakers and True Wireless Stereo headsets, imaging and machine learning applications. Rising system complexity and challenges stemming from the growing hyperconvergence of the electrical, mechanical and physical worlds are driving the strong need for a seamless platform solution across design, packaging, simulation and analysis. Our System Design and Analysis business that is expanding our TAM beyond EDA continued its strong momentum, delivering 27% year-over-year growth. Industry interest in advanced packaging solutions notably spiked in 2022, with customers embracing our revolutionary Integrity 3D-IC solution, the industry’s only comprehensive platform providing tightly integrated system planning, implementation and analysis technologies.

Our multi-physics portfolio comprising of leading electromagnetic, electrothermal, signal and power integrity and CFD solutions continued ramping strongly across multiple end-markets. Our in-design analysis solutions had several significant wins with HPC and hyperscaler customers, while our CFD Fidelity platform proliferated with market shaping aerospace and defense customers. During the year, Fidelity CFD’s software meshing capabilities were chosen by Toyota Motor Europe to be their standard workflow for CFD preprocessing. And in numerous customer engagements, Optimality Explorer, the industry’s first AI-driven multidisciplinary system analysis and optimization solution has demonstrated up to a 10x efficiency improvement in design space exploration, leading to faster time to results.

Lastly, in keeping with our transition plan, Lip-Bu Tan has notified the Cadence Board that he will not seek reelection at our upcoming 2023 Annual Stockholders’ Meeting in May. He will continue to serve as an advisor to me. We will return to an independent chair structure with ML Krakauer becoming our next Board Chair following that meeting. The rest of the Board and I look forward to working closely with ML in her new role. In closing, we are pleased with our strong execution in 2022 and are thrilled by the business momentum and market opportunities ahead of us in 2023. Now, I will turn it over to John to provide more details on the Q4 results and our 2023 outlook.

John Wall: Thanks, Anirudh and good afternoon, everyone. I am pleased to report that we exceeded all of our key financial and operating metrics for the fourth quarter and 2022. Robust customer design activity and demand for our strong technology portfolio continued to drive growth across all of our businesses. Cadence had an excellent 2022 and we began 2023 with a lot of confidence and strong momentum on the back of the stability and resilience you would expect from a predominantly recurring revenue model. Here are some of the financial highlights from the fourth quarter and the year, starting with the P&L. Total revenue was $900 million for the quarter and $3.562 billion for the year. GAAP operating margin was 23.5% for the quarter and 30.1% for the year.

Non-GAAP operating margin was 35.6% for the quarter and 40.3% for the year. GAAP EPS was $0.88 for the quarter and $3.09 for the year and non-GAAP EPS was $0.96 for the quarter and $4.27 for the year. Next, turning to the balance sheet and cash flow. Our cash balance was $882 million at year end, while the principal value of debt outstanding was $750 million. Operating cash flow in the fourth quarter was $264 million and $1.24 billion for the full year. DSOs were 49 days and we repurchased $1.05 billion worth of Cadence shares during the year. Before I provide our outlook for Q1 and 2023, I’d like to share a few comments. Our most recent fiscal year ended on December 31, 2022. This fiscal year will also end on December 31 as we have now moved our fiscal year to a calendar year.

Approximately 15% of our annual revenue for fiscal 2022 was upfront with 85% recurring. At the midpoint of our 2023 revenue outlook, we are expecting a similar revenue mix for the year. And our outlook for 2023 assumes export control regulations remain substantially similar for the remainder of the year. In our outlook for 2023, we expect revenue in the range of $4 billion to $4.06 billion, GAAP operating margin of 30.5% to 32%, non-GAAP operating margin of 40.5% to 42%, GAAP EPS in the range of $3.24 to $3.34, non-GAAP EPS in the range of $4.90 to $5, operating cash flow in the range of $1.3 billion to $1.4 billion. And we expect to use approximately 50% of our free cash flow to repurchase Cadence shares in 2023. For Q1, we expect revenue in the range of $1 billion to $1.02 billion, GAAP operating margin in the range of 31% to 32%, non-GAAP operating margin of 41% to 42%, GAAP EPS in the range of $0.84 to $0.88, and non-GAAP EPS in the range of $1.23 to $1.27.

And as usual, we published the CFO commentary document on our Investor Relations website, which includes our outlook for additional items as well as further analysis and GAAP to non-GAAP reconciliations. In conclusion, I am pleased that we achieved double-digit revenue growth across all of our businesses, increased 3-year revenue CAGR into the mid-teens. And I am especially pleased that we continue to expand annual operating margins. As always, I’d like to thank our customers, partners and our employees for their continued support. And with that, operator, we will now take questions.

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Q&A Session

Operator: Our first question comes from Charles Shi from Needham & Company. Please go ahead. Your line is open.

Charles Shi: Hi, thank you for taking my questions. Maybe the first one is kind of like a two-part question. Maybe this is to John. John, your fiscal year and Q1 guidance seem to imply a relatively flat revenue profile through the year. And I am sure you heard €“ it will appear there seems to be seeing a slightly upward trending profile through their fiscal year. Although I know the fiscal year, yours and theirs end slightly different months. Is the difference just a matter of more conservatism on your side or is it a matter of different end market mix or product mix? Maybe let me ask the second part. I think they are kind of related. I will ask all at once. I think one quarter ago, you were cautious, your hardware sales into fiscal €˜23 because 2022 like you just said, it’s a record year for the hardware sales.

So what is your assumption in the full year guidance for fiscal €˜23 on your hardware revenue profile in the year? Is it flat? Or is it that €“ are you assuming there is some recovery in the second half of the year? Thank you.

John Wall: Hi, Charles. Thanks for the questions, those excellent questions. The €“ yes, we’re expecting another strong start to the year as we continue to see strength in our hardware business. You did pick up some caution ahead I think the last quarter because hardware was proving not to be discretionary at all for our customers, and hardware demand was outpacing our ability to produce the hardware. And that was the case for the entirety of last year. We were not able to keep up with demand. Demand is really, really strong as we head into the new year for 2023. But we’ve increased our production capacity and we feel more confident in our ability to meet that demand for 2023. And as you can see from the outlook, we’re expecting that last year, the 85-15 split in recurring revenue to upfront revenue mix, we expect that to continue.

Now the second half of the year is harder to predict for hardware, so typically, I wait until the middle of the year. And if we see continued strength into the second half of the year, we can increase the second half later. And then I think that impacts the quarterly profile because you started your question with why the year felt a little bit flat. And that’s because we expect to deliver a lot of hardware in the first half of the year. And in the second half of the year, we’ve kind of de risked the second half of the year for hardware. If we see continued demand at this pace, we will have to take the second half up.

Charles Shi: Thank you. That’s excellent. Maybe my second question, maybe this is for Anirudh. I think some investors are worried about hyperscaler spending on EDA, I mean, both on a near-term and a long-term sense. I mean, in the near-term, I mean, obviously, the layoff in tech, well, some people think it could reduce the chip design projects and lost jobs for design engineers. And in the long-term, I mean, there is a smaller portion of the investors are kind of worried about the sustainability of the hyperscale spending strength, although I think chatter around AI recently seems to suggest that, that strength is probably not going to €“ going down but probably going to accelerate. So can you share your observation or any insights, the real demand coming from hyperscaler side? And what’s your thought €“ what’s your current outlook going into like a 2, 3-year horizon? Thank you.