Cadence Design Systems, Inc.
Q2 2011 Earnings Call Transcript

Published: 29 Jul 2011

[Operator:]

Good afternoon. My name is Kristen, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence Design Systems Second Quarter 2011 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Alan Lindstrom, Director of Investor Relations for Cadence Design Systems. Please go ahead.

[Alan Lindstrom:]

Thank you, operator, and welcome to our earnings conference call for the second quarter of fiscal year 2011. The webcast of this call can be accessed through our website www.cadence.com and will be archived for 2 weeks. With us today are Lip-Bu Tan, President and CEO of Cadence, and Senior Vice President and CFO, Geoff Ribar. 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 Form 10-K for the period ended January 1, 2011, our 10-Q for the period ended April 2, 2011, the company's future filings with the Securities and Exchange Commission and the cautionary statements regarding forward-looking statements in the earnings press release issued today. In addition to financial results prepared in accordance with generally accepted accounting principles, or GAAP, we will also use certain non-GAAP financial measures today. Cadence's 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. A copy of today's press release dated July 28, 2011, for the quarter ended July 2, 2011, and related financial tables can also be found in the Investor Relations portion of our website at www.cadence.com. Now I'll turn the call over to Lip-Bu.

[Lip-Bu Tan:]

Good afternoon, everyone, and thank you for joining us. I'm pleased to report that our strong momentum in Q1 continued into Q2. For the second quarter, revenue totaled $283 million, non-GAAP operating margin was 17%, and we generated $69 million of operating cash flow. Demand for both our software and hardware products was strong, driving increased run rates on renewals. For example, 2 of the world's top 10 semiconductor companies significantly increased their usage of our digital products. Both of these transactions consist primarily of new business, and together, will provide more than $10 million of incremental annualized revenue. And now let me turn to the second quarter by highlighting each of the 3 businesses

[Geoff Ribar:]

Thank you, Lip-Bu and good afternoon, everyone. Cadence posted strong financial results for Q2 and that we have good momentum going into Q3. I will review results for the second quarter and then present our outlook for Q3 and update you on 2011. Total revenue for the second quarter was $283 million compared to $227 million for Q2 of 2010. Product revenue was $158 million, maintenance revenue was $96 million and services revenue was $29 million. The revenue mix for the geographies was

[Operator:]

[Operator Instructions] Your first question is from Paul Thomas with Bank of America Merrill Lynch.

[Paul Thomas:]

Obviously, the numbers speak for themselves, but I guess if you contrast what you guys are seeing with the larger semi industry, it looks like there's more uncertainty on the customers' side versus you guys, now versus 6 months ago. Your run rates are increasing, but I just wanted to get your commentary on when you speak with customers, is there any sense of caution, more caution now than there was 3 months or 6 months ago, or is there a sense right now that the focus is really on getting the next generation of products ready, and they're really looking through any uncertainty in the second half of the year here?

[Lip-Bu Tan:]

Yes, Paul this is Lip-Bu. Let me try to answer your questions. First of all, I think we all know that the macro environment [indiscernible] and unclearly, the second half a little bit soften. And then somewhat the result from the semiconductor company that are announcing the results have been mixed. But overall, I think from the feedback from our customer that design activity still remains strong. And engagement, the new model of engagement we have with the customer starting to bear fruit and that really engaged strategically with us on the next challenging product they have. Clearly, we see smartphone, tablets, server, area of strengths. PC, networking and some of the industrial and selective part of the automotive has been weakened. But overall, I think it's a very healthy, we see in terms of the design activity and our engagement with our customer continue to be strong. And then we look at some of our ecosystem partners like Foundry and now clearly, the Q3, a little bit correction, but they all indicate good pickup in Q4. So overall, I think the semiconductor trend we see is about 5%, 7% growth, but answer your question on the design side remain very strong.

[Paul Thomas:]

Maybe just one more on emulation. I know no Geoff, you talked about hardware sales being down half over half. I guess when you look at 2009 to 2010, the EDAC data says 15% growth for emulation, and Q1 started off more like a 30% pace. Do you still think you'll be ahead of that 2009, 2010 15% growth rate this year? Or I guess any color you can give there would be helpful.

[Lip-Bu Tan:]

Paul, this is Lip-Bu. Let me just touch on the high level and then Geoff can tell you more in detail. So overall, as you know, the Palladium XP, our verification platform is very, very needed and is essential for any complex chip design anything below 40-nanometer and time-to-market in terms of improvement finding the box earlier is a must-have and we are starting to see companies I mentioned, Marvell in the past, Broadcom, in the earlier earnings call. So there's a suite of company like NVIDIA have been a great partner for us. So anything complex-intensive design is a must-have. We continue to see strength in that. And Geoff?

[Geoff Ribar:]

Yes. It's obviously a secular trend. Emulation is becoming more and more important, and we think we are doing very well in it. The reason the second half is down for us has to do with the manufacturing bubble that was created on initial orders for Palladium XP. We've now worked through that manufacturing bubble. Having said that, we don't guide specifically on hardware revenue and numbers, but we are of course, going to see growth year-over-year.

[Operator:]

Your next question is from Sterling Auty with JPMorgan.

[Sterling Auty:]

I want to follow on with the commentary on the first set of questions. Given the mixed results that we've had in the semiconductor area, what's your sense in your conversations with them? How long would it have to go in terms of this kind of current sluggishness that they're in before some of the design trends and activities start to get reined in? Do you still feel like we've got at least a couple quarters through the back half of the year before we have to worry, or maybe I should put it this way, that there's runway in hope we get an uplift, so it carries them into 2012?

[Lip-Bu Tan:]

I think first of all, it's very hard to generalize a way to answer your question, and I mentioned earlier, I think some of the customer we have engaged specifically in the smartphone, tablet and server has been very strong. And they are heavily engaging with us. And then some of the low MPC and networking, I think is – I see it as temporary. Some of the infrastructure delay, but I think one or two quarter, semi will be coming a back -- and there's no slowing down that the design for the next-generation design. So overall, I'm optimistic and from the design activity point of view, we do not see any slowdown.

[Sterling Auty:]

And then follow-up would be, since you've got the pattern on Palladium, second half versus the first half, what are the areas that you think will continue to power through? And you made a lot of commentary about the IP side of things, as well as the digital side. I didn't hear as much commentary on this call about the analog platform, so what should we be looking for in terms of what you think is going to be the strength in the back half of the year?

[Lip-Bu Tan:]

Okay, so a couple of things. First of all, I think in this quarter, across our product line had been strong, and I think we'll continue the strength going forward for the second half. In terms of the growth area, first of all, let me touch on the digital side. Clearly, we mentioned about 2 of the top 10 semiconductor companies engaging with and now using us, have a nice incremental replacement for competitors. And then clearly with the 2 acquisitions we make, Azuro and Altos make us very competitive, especially in the advanced nodes for optimizing power performance in the area. So I think we continue to see strength in terms of the digital solution that we provide. In terms of the IP area, and I think I mentioned that the Denali continue to -- doing very, and especially in the memory modeling and then some of the critical storage management, and we announced wide I/O and DDR4. We have a very strong reception from the customer and we have been very focused on highly differentiating we call it interface or connectivity IP. And we are going to continue doing that, and we see strength on that. And then in terms of the analog side, and I think we continue to see the proliferations from our customers, and we don't see any meaningful competitors' position then. So I think we'll continue to do very well and then in the longer run, I think the EDA360 is really our vision and our strategy. We are laser-focused on that whole SoC realization and the System Realization and we have a lot of good traction there. In time I mentioned about the System Development Suite that we announced. We have received a lot of very positive customer feedback like ARM, NVIDIA, Western Digital and continue to expand the list. So clearly, the application-driven is a fast-growing sector. And then we continue to drive deal quality improvement, and so I think we'll continue to be optimistic, cautious/optimistic about the progress we are making.

[Geoff Ribar:]

And I think just a couple of pieces, Sterling, of tactical, to back some of that up. The 2 top 10 semiconductors companies in the world will had over $10 million of annualized run rate. So that's obviously material to us. I think also the duration of our backlog has come down as the duration of our bookings have come down. And I think that's increased the quality of our backlog, increased the confidence in our future guidance.

[Operator:]

Your next question is from Rich Valera with Needham & Company.

[Richard Valera:]

Kind of a follow-up on that. If you take the midpoints of your third quarter and full-year guidance, it would imply a revenue level in the fourth quarter of about $10 million higher than the second quarter, yet one would expect probably a significantly lower level of emulation business in that fourth quarter. So just wondering how we should think about the sustainability of that fourth quarter revenue run rate as you exit this year. It seems like it won't have any sort of unusually high level of emulation in it, so maybe we could sort of use that as a starting point as we think about next year in terms of implied sort of software run rate. Just want to know if you could comment on that.

[Geoff Ribar:]

You're correct. Emulation is going to be down in the second half of the year, and we're making that up largely in software, right, and maintenance component to our business. We expect the Emulation business to be a good business next year, and we expect Q4 to be approximately where you just worked out. Having said that, we’re really not guiding 2012 yet.

[Richard Valera:]

Okay, fair enough. And also on emulation historically, emulation has been the most economically sensitive of the EDA products out there. I know you just had a great quarter from a revenue standpoint. Any signs at all of customers being more cautious with emulation purchases or outlook there?

[Lip-Bu Tan:]

Yes, so I think Rich, first of all, I think you’re talking about the pattern I think Geoff mentioned to you, in terms of the customer engagement we have, we continue to see a lot of strength and a lot of engagement because time-to-market is so critical. Somewhat a complex design and some of the customer tell me that they really need it. It's a lifesaver and they would like to buy more of that. So I think we continue to see strength and with the industry development moving down below 40-nanometer and with the best of class and it's a must-have.

[Geoff Ribar:]

I think on the other side, it also helps the productivity of our customers, right, and the amount of engineers and resources they need to use to get the design out the door.

[Richard Valera:]

So was it your feeling that maybe emulation is going to be more resilient this cycle, presuming where we may be heading into some sort of ebb in the cycle here than it was historically?

[Lip-Bu Tan:]

Yes, so I think if you look closely into our Development Suite, it's really built around a whole emulations. And that's why you have the whole virtual co-design hardware and software and also the Rapid Prototyping, and that is a very good growth engine for us in terms of what we discuss with the customer, time-to-market, time for integrations and that are really critical for them especially in the SoC. And so I think it's not just looking at just pure hardware. We should look at the whole other software to drive productivity and time to integration, time-to-market and that is very critical to win in this marketplace.

[Richard Valera:]

And then just one final one, a bookkeeping one. I missed your updated bookings guidance, Geoff, if you could just give me that again please?

[Geoff Ribar:]

Sure, it's $1.115 billion to $1.145 billion.

[Operator:]

Your next question is coming from Tom Diffely with D.A. Davidson.

[Thomas Diffely:]

It sounds like you're seeing some strength across-the-board. I was curious though, at this point, are you seeing your big customers get even stronger? Is there a widening of the GAAP between your big and small customers?

[Lip-Bu Tan:]

Absolutely. And that's why 2 years ago, I really focused on the top 40 customers. And clearly, for a start-up company, [indiscernible] are not backing as many and then secondly, some of – even the public company, if they don't have -- able to create a platform, it's become harder and harder to be a stand-alone company. So I think a couple of key platform company and I call it a winning company. We'll just have to continue increasing and we are making great progress, we mentioned about 2 of the top 20 in this quarter and then continue we’re going to make progress, and I think it's critical for our health of the company.

[Thomas Diffely:]

So this trend continues, does that have a negative impact on margins?

[Lip-Bu Tan:]

No. We continue to drive the deal quality, and we continue to provide that shorter duration so that we are aligned with the design cycle with the customer. And so that we continue to drive value to provide to our customer, and we want to be there so that a trusted partner that they can count on us to provide the solution they need to time-to-market and then to win in the marketplace.

[Thomas Diffely:]

Okay. And then looking at margins in the second half of the year, if the emulation of the hardware component goes down, is that a boon for margins, at least in the near-term?

[Geoff Ribar:]

Yes, obviously hardware margins are lower than software margins, but we also have some offsetting trends. We're going to have some increases related to higher commissions, related to higher bookings. So -- and we'll also have some incremental expenses related to the 2 acquisitions that we've done.

[Thomas Diffely:]

Okay. And Geoff, if you could also just dig in a little deeper on the notes and derivatives and what the structured mechanics are for that, that would -- what kind of scenarios do you see potentially happening over the next year or 2?

[Geoff Ribar:]

So as you know, Tom, we moved the notes to current, the 2015s because we're traded over the essentially over the trigger price, if you want to look at it. We expect the note hedges to move in tandem. We expect the notes to be current as long as the share prices stays over that price. We don't expect the notes to be converted. They’re trading at a materially higher price in the market than conversion, materially higher price, so we don't expect the notes to be converted at all.

[Thomas Diffely:]

And what kind of stock price would you need before you thought it would be a possibility or likelihood?

[Geoff Ribar:]

I don't think it's even the price of our stock that would allow the notes to be converted. They get a nice interest payment on it and until it becomes closer to 2015, it's really not an issue.

[Operator:]

[Operator Instructions] Your next question is from the line of Jay Vleeschhouwer of Griffin Securities.

[Jay Vleeschhouwer:]

A couple of detailed questions first about the second quarter and then a couple of longer-term questions. So Geoff, first, when we look at your sequential change and cost of product, the increase there was about the same as the increase from Q4 to Q1. Was that predominantly driven by the cost of product for the hardware? And if so, does that mean that the hardware revenues increased by about as much sequentially in Q2 as they did in Q1?

[Geoff Ribar:]

So the cost of product is largely hardware and the second question can't really answer because we don't give specific on revenue for hardware.

[Jay Vleeschhouwer:]

Okay. Was there anything unusual or nonrecurring in the maintenance number? It's usually not quite that strong in the second quarter, at least not compared to the first quarter. So is that just a function of how you apportion bookings, or was there something else going on in terms of one-time payments or something of that kind?

[Geoff Ribar:]

Yes, Cadence used to have a history where in Q1 and Q3 maintenance would go up and then Q2 and Q4 maintenance would go down related to Japan. That's no longer the trend anymore. We're gradually getting away from that trend and getting more reasonable over a period of time. So don't expect to see that cyclical pattern going forward. Did that answer your question, Jay?

[Jay Vleeschhouwer:]

Well, not entirely. Is there something stemming from the way you apportion a fixed percentage of bookings each year?

[Geoff Ribar:]

No, it's just that the swings that used to be caused by Japan aren't as relevant anymore. So there's no really other material changes as to how our, how we manage our maintenance.

[Jay Vleeschhouwer:]

Going for the longer-term, how are you thinking about the progression of bookings over the next number of years? For this year, you're looking for about $150 million to $200 million increase over last year but let's, for the moment, strip out the bookings for services and maintenance and just look at product bookings. You'll still be pretty considerably below your '05 through '07 levels of bookings just for product. And the question is, do you think you're going to need perhaps another couple of years to get back to where you were, adjusting for duration and that's one of the questions.

[Geoff Ribar:]

So Jay, what we've said consistently about bookings and this applies to total bookings, right? We tend to look at total bookings, is that we expect '11 to be better than '10 and '12 to be better than '11, and this is related to the model change and also our normal renewal cycles. We haven't gotten much more specific beyond that. We've said that Q4 2012 will be essentially when we're fully converted on our model change and 2013 will be the first year where we're fully in our new model. And really can't comment on 2005 to 2007 or what's going to take to go forward. We're guiding that far out yet.

[Jay Vleeschhouwer:]

Sure. Question about duration. You're tending towards the low end of the range that you've given before of 2.5% to 2.9%. I guess the question is 2.5% necessarily a floor? Are they're already practical limitations to customers going even shorter than that, particularly your larger customers?

[Lip-Bu Tan:]

So I think Jay, let me answer that question. So first of all, we try to be aligned with the customer in the design cycle. And we're the ones who give them too much and that give them too little that are nervous. I think it's kind of case-by-case with the customer. And then more important also, we want to have it a little bit shorter so that we can really introduce new technology, new product or new solution that we can provide to them and so that's kind of our strategy.

[Jay Vleeschhouwer:]

Okay, and then lastly, could you talk about how you see the progression of R&D spending for the balance of the year? It was kind of sideways in the second quarter. And related to that as well, what kind of investments do you think you need to make in services, in support of your overall IP strategy?

[Lip-Bu Tan:]

Let me answer that and then Geoff can add on to that. So first of all, I think we feel comfortable with our R&D spending and we continue to drive our efficiency and also very focused and targeted in terms of the digital mixed-signal flow, IP and SoC and also the system level. And we drive some of the road map in terms of how to provide the best solution to the customer and that we also did acquisition

[Geoff Ribar:]

And specifically, from Q1 to Q2 on engineering spending it was relatively flat. Obviously, social security and FICO kind of rolled off as people made it over those limits. And second of all, there's was little bit more vacation taken. We expect those numbers to increase though in the second half of the year for the reason Lip-Bu gave.

[Operator:]

There are currently no further questions. I'd like to turn the call back to Mr. Lip-Bu Tan for closing remarks.

[Lip-Bu Tan:]

So in closing, Q2 was a great quarter for Cadence, and we have momentum going into the second half. We are introducing exciting new products like System Development Suite that expand our market. We are winning new business at important accounts on strength of our technology. We are making acquisition that matter to our customers. And our key operation metrics are all improving. Thank you everyone for calling in this afternoon. And we are looking forward to speaking with you soon and thank you again for joining us.

[Operator:]

Thank you for participating in today's Cadence Design Systems Second Quarter 2011 Earnings Conference Call. You may now disconnect.