Cadence Design Systems, Inc. (CDNS) Q1 2013 Earnings Report, Transcript and Summary

Good afternoon. My name is Madison, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence Design Systems First Quarter 2013 Earnings Conference Call. [Operator Instructions] I will now turn the call over to Alan Lindstrom, Group Director of Investor Relations for Cadence Design Systems. Please go ahead.

Thank you, Madison, and welcome to our earnings conference call for the first quarter of fiscal year 2013. The webcast of this call can be accessed through our website, cadence.com, and will be archived for 2 weeks. With us today are Lip-Bu Tan, President and CEO; and Geoff Ribar, Senior Vice President and CFO. Please note that today's discussion will contain certain forward-looking statements and that our actual results may differ materially from those expectations. For information on those factors that could cause the 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 comments 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 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. A copy of today's press release dated April 24, 2013, for the quarter ended March 30, 2013, 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. Cadence delivered strong results in Q1. Total revenue was $354 million. Non-GAAP operating margin was 24%, and operating cash flow was $75 million. The environment is challenging, with macro uncertainty and softness in semiconductors. Despite that, many of our customers continue to innovate and invest in new design activities. They are looking to Cadence to collaborate more closely with them and their ecosystems to help build great products that drive their success. Today, I will highlight our progress in IP, advanced node design and verification. Expanding our IP business is strategic focus for Cadence. Recently, we took several important steps. The acquisition of Tensilica significantly expand the scope of our IP business by adding configurable dataplane processing units. Tensilica has an attractive loyalty model and serves fast-growing end markets via by mobile wireless, network infrastructure, audio infotainment and home applications. In February, we announced our intent to acquire Cosmic Circuits, which will add significant silicon-proven analog and mixed signal IP to our portfolio. This includes IP for USB, MIPI, audio and Wi-Fi standards. We expect that transaction to close soon. Last month, we acquired a talented team of approximately 25 analog IP designers that are specialized in development of SerDes blocks for high-speed interfaces. Last year, we shifted significant numbers of highly skilled analog designers from our service business into R&D to develop commercial IP and accelerate delivery on our IP roadmap. Many of these designers have more than a decade of experience developing high-speed interfaces such as SerDes. Along with high-quality IP and impressive customer list, each of these acquisitions adds very talented and experienced developers to the growing IP R&D team at Cadence. When all these acquisitions close, we will have over 600 engineers in our SoC Realization group.…

Thanks, Lip-Bu, and good afternoon, everyone. I will review the results for the first quarter, present our outlook for Q2 and update the outlook for 2013, including our recently closed acquisition of Tensilica. Cadence continued to do strong operating results in Q1, outperforming guidance in all key metrics. Total revenue was $354 million compared to $346 million for Q4 and $316 million for the year-ago quarter. Year-over-year growth was 12%. Product and maintenance revenue was $328 million, and services revenue was $26 million. The revenue mix for the geographies was 44% for the Americas, 22% for EMEA, 19% for Asia and 15% for Japan. Total costs and expenses on a non-GAAP basis for Q1 were $270 million compared to $265 million for Q4 and $250 million for the year-ago quarter. Headcount. Q1 headcount was 5,312 compared to 5,189 for Q4. The increase was primarily due to hiring in R&D and technical field positions. Non-GAAP operating margin for Q1 was 24% compared to 23% for Q4 and 21% for the year-ago quarter. For Q1, we recorded GAAP net income per share of $0.27. This included a $0.12 benefit for the reversal of a tax reserve, which is no longer required. Non-GAAP net income per share was $0.21 compared to $0.20 for Q4 and $0.17 for the year-ago quarter. Operating cash flow for Q1 was $75 million compared to $96 million for Q4 and $61 million for the year-ago quarter. Total DSOs for Q1 were 20 days compared to 27 days for Q4 and 25 days for the year-ago quarter. In Q1, revenue collection and the timing of billings all contributed to lower DSOs. We are revising our DSO target to approximately 30 days to reflect further improvements in our operations. Capital expenditures for Q1 were approximately $7 million. Cash and short-term…

[Operator Instructions] And your first question comes from the line of Krish Sankar with BoA ML.

This is Thomas Yeh calling in for Krish Sankar. First off, given your focus on growing the IP business, I just wanted to get your perspective on the status of the third-party outsourced IP landscape in general. Within the segments that you now serve, what is your view on the current penetration of outsourced versus in-house and what you expect it to be going forward?

Yes, this is Lip-Bu, Tom. Thomas, first of all, let me answer a couple of your questions. So first of all, regarding the trend of outsourcing, yes, it's happening. A lot of customer we talk to they try to outsource the standards-space IP that is not as essential for them as their core IP or core digital products. And so they prefer to outsource that. If it's a qualified silicon-proven IP with good quality, they will prefer to do that. And that's something that we try to do. So it's a strategic focus for us. As you know, we are very strong in our VIP business. In the first quarter, we have 2 orders over $10 million, very strong. Now we are building up our design IP with the internal organic growth and also our Denali acquisitions in the memory modeling IP. And now, we add on the Tensilica, the data -- configurable dataplane processing units, and it's very important. The program provides very important features on that. And clearly, very strong in the mobile side, the LTE and all the video, audio-related area. And then now, we also add on the analog mixed signal IP and the high-speed connectivity IP from Cosmic Circuits. And then also the talent pool that we pull in for the SerDes, for high-speed SerdDes, those are very, very important for our customer. So I think we have a very strong design IP portfolio. After all this acquisition, we have over 600 engineers in that IP design capability. So I think it's very important for us. In terms of penetration, I think we just started with this design IP. A lot are engaged with our customer, and our customer is very pleased with our portfolio, especially the Tensilica acquisition, they are very excited about.

Great. And with your repeat orders that you mentioned on Palladium XP, are your expectations for emulation revenue to still be lower compared to last year? Is that still the case?

Yes. So let me answer that first. First of all, I think that clearly, we have a very strong demand from Palladium XP in 2012. We expect to be down, and we guided down in 2013 because of the uncertainty in the environment. But meanwhile, we are remaining to do well. We have good orders coming through. And so all in all, we have a lot of repeat orders. And as I mentioned, about Qualcomm, we mentioned about 1 customer that ordered 35 systems over the 18-month period, so clearly, there's strong demand. In complex chip design and time-to-market pressure, we are the premium products.

And your next question comes from the line of Jay Vleeschhouwer with Griffin Securities.

Geoff, a couple of questions first for you regarding guidance. Of the $55 million increase in the bookings range for this year, how much of that is due to Tensilica? Secondly, can you talk about what you're assuming regarding the license mix for Tensilica in terms of the upfront versus ratable? And then thirdly, in terms of the overall revenue outlook for the year, the range went up by about $25 million to $35 million, Tensilica will be $27 million of that and then you beat Q1, at least versus the midpoint, by about $7 million. So is there some other part of the business that organically, where you are perhaps a little bit less positive about to make all that math work? Going back to the previous question there, are you perhaps looking for somewhat less hardware business than you might have before? Then a follow-up.

Okay. So Jay, approximately $40 million of the bookings increase was related to Tensilica. That's approximate of course. We're 2 days into the acquisition. And how we're going to treat the ratability versus upfront nature of the Tensilica business, licenses are going to clearly be considered ratable and are very similar to the ratable business we have. And just a definitional basis, we're going to call royalties ratable also. Again, the things that we'll -- we would call upfront would be then generally hardware upfront and perpetual licenses. As far as the overall guidance, clearly, we'd adjusted guidance based on our Q1 operating performance. It's very clear to us that the environment remains uncertain and challenging, both in the macroeconomic conditions and in the semiconductor conditions. We're quite comfortable with the guidance, and we clearly take that into account when we gave the guidance. As we said and Lip-Bu said just a minute ago on Palladium, right, we guided Palladium down for the year. We haven't changed our overall view on Palladium from where we started.

Okay, okay. Just a follow-up on that and just another product question. In Q4, our understanding is that your Palladium backlog increased. Could you say how your backlog looks now for Palladium XP versus Q4?

So Jay, we're not going to give -- we don't give detail of our product segments on backlog or bookings or even on revenue. So -- but it's in line with our guidance.

All right. Lastly, for Lip-Bu, on the last call, you mentioned that the vast majority of your customers, as you put it, had moved to Virtuoso 6.1. And in 2012, your custom IC segment did pretty well in terms of revenue growth. It looks like it was up maybe 20% or so. How are you thinking about custom IC growth this year, the drivers to what is typically your largest business for this year? And perhaps as well, if you could talk about expectations for the system interconnect business.

Sure. So let me try to explain -- answer your question. So regarding the Virtuoso 6.1, the proliferation is very good. We are very happy with that. And clearly, that we note, we continue to drive differentiation into the advanced nodes and -- so that our tool can be -- work well at the advanced node, so 20-nanometer and below. We are all qualified, and we'll continue to drive that. And then secondly, because of our strength in the Virtuoso, a lot of our customers right now, they are also looking at the whole -- our digital flow and help enhance our digital flow and qualify that. And because they're looking for integrated mixed-signal solutions, that's enough to be a very big benefit for us. So I think we'll continue driving the leadership in the Virtuoso, continue to drive future performance on that in the advanced node. And then that also apply helping us on the digital side because we are substantially improved in our digital development, especially in the advanced nodes, and that all tie in. Most of the design right now is SoC. It's clearly mixed-signal. It open up tremendous doors for us. And your second question, I think, the system side. Clearly, while we continue to drive the whole system verification side and also reaching out to the PCB, if you recall, we acquired Sigrity, that is very well-received by customer because when they're designing a product, they want to really know the power envelope, the signal integrity analysis before. So it really helped complete our PCB offering as a total solution.

And your next question comes from the line of Sterling Auty with JP Morgan. Sterling P. Auty - JP Morgan Chase & Co, Research Division: Sorry, I've been jumping between calls. But Geoff, can you just reiterate what is the bookings guide for the full year? I heard Jay's comment about $55 million, but what was the actual range?

Yes, so we said approximately $1.5 billion is the number. But the bookings range is $1.48 billion to $1.53 billion. Sterling P. Auty - JP Morgan Chase & Co, Research Division: Okay, great. And then Lip-Bu, I think you made a comment about just the challenging semiconductor environment. From a 100,000-foot view, I think a lot of us are watching, just wondering if there's going to come a point where we start to see OpEx cuts as they start to defend margins, which would impact EDA spending. Any sense where their -- the heads are at in terms of spend at this point?

Yes, good question. So I think as you hear on the earnings calls, it's a mix in terms of the challenging environment for macro and also semiconductor. Clearly, PC is challenging, and some portion of the automotive is challenging. And so I think it's a mixed bag. But the good news is in terms of design activities, we don't see any slowdown. And so we are not related as much into the manufacturing CapEx area. We tend to be more in the -- our business tends to be more related to the engineering headcount. So far, we don't see a lot of changes, only a few. All the while, I think this is -- as you know, the last portion that you want to cut is the engineering talent doing design of new products. So, so far, as I mentioned before, we haven't seen any changes in the design activity. And in fact, on the contrary, because of advanced node, because of complexity of the design, our engagement with customers substantially increased in terms of they need us a lot more in terms of closer collaboration actually in the complex SoC, the IP block, the digital, the mixed signal, the analog and the power and that integrity -- signal integrity, order with packaging. And so frankly speaking, the engagement with the customer is substantially increased.

And your next question comes from the line of Gus Richard with Piper.

In terms of process technology, it looks like most people are going to ship -- skip 20 and go directly to either 16- or 14-nanometer FinFETs. What impact is that having on design starts? What impact is that having on your need to spend on R&D? How is it sort of hitting your business model?

Yes, Gus, it's a good question. So clearly, we have some customers who engage with us a lot. Some of the key customer in the 20-nanometer, but there are also some customer decides to go from 28, it's going to be a long node, and then jump into 16 and 14 based on FinFET. And so I think it's a combination of both, so I think we will continue our digital custom analog and the various tools that we are all fully qualified, the final tool, all qualified at 20 nanometer, so we're ready to support the customer. If they decide to continue doing the 20. And then clearly, the advantage from 28 to 20 will really depend on the application. Some of the customers still want to do that at 20. We will definitely support that. But meanwhile, there are also some customer who decide to skip and go way down to 16 and 14. And we are ready and we are supporting them. That's why we emphasize a lot about the FinFET and 3D-IC so that we can really support them in very complex design in those advanced nodes.

And has that required you to pull in any the R&D spend in order to support customers with FinFET?

I'm sorry, can you repeat again? I can't hear too well.

Sure. Is that -- has the sort of move to FinFETs required pull in of R&D spending on your part in order to facilitate the transition?

No. I think the answer is no. And clearly, FinFET is a very challenging technology, on the top of patterning and the various key area. And clearly, we are executing towards our plan.

Okay. And then the last one for me is just on the pricing environment. Are you guys able to pass through pricing for this year [ph], is that planned?

Yes, so I think pricing environment is still very competitive. But as I mentioned earlier, now the chip getting very complex and a lot of our customer are looking to us for deeper collaborations, not just for the complex chip design and also for the process node and the migrations. And also I think the 2, IP and foundry, really had to work much closer together, and we are delighted. We are ready for that and also multiple foundries relationship that we have to support. So this is a very exciting time, and I think our customer are looking to us to have a much deeper collaboration, and we welcome that. And that's how we're going to learn, how we're going to provide the solution. And I think the quality execution will be key to provide them the IP, the tool, the support that they need for the time [ph] paths for the time-to-market opportunity.

And your next question comes from the line of Rich Valera with Needham & Company. Richard Valera - Needham & Company, LLC, Research Division: Geoff, I think the math is pretty simple, but I just wanted to clarify. You increased your bookings guidance by $55 million, $40 million of that from Tensilica. So net, about $15 million increase to your sort of organic bookings target. Is that correct?

Yes, Rich, you're very good at math. Richard Valera - Needham & Company, LLC, Research Division: Yes. It's not complicated, but thank you for the compliment. So yes, there's a lot of discussion, obviously, about the environment. And was looking at your word very carefully and how you described the environment a quarter ago and how you describe it this quarter, and they seem pretty similar. I think a quarter ago, you described the environment, Lip-Bu, as challenging with macro uncertainty and softness in semis. And this quarter, I think you talked about it sort of being soft and uncertain. I just wanted to clarify that the environment is challenging but essentially the same as it was a quarter ago. Would that be a fair statement?

That is correct. And so clearly, it's the same environment, where a couple of area have some softness, and some of the area are very exciting and nice growing. But I think fundamentally, it's not much impact to us in terms of the customers feel very committed to innovate. And new design activity, we didn't see any slowdown. I think more important right now because of complexity and our collaboration actually increased, our R&D support even increased, the customer really need and look up to us for collaborations. And I think it's our job to provide the best-quality proven IP to support them, and then that will be good to the whole industry to grow. Richard Valera - Needham & Company, LLC, Research Division: That's helpful. And I'm going to beat the emulation dead horse a little bit here. But you guys talk about your product being kind of the gold standard. But clearly, your biggest competitor in that market has been growing their business quite a bit faster than yours and claiming some functional superiority to Palladium with their latest box, leading -- some of them suggest that your box is kind of dated and needs a refresh to sort of be really competitive. First of all sort of what's your response to that? And is there anything you'd be willing to say about the life cycle of a Palladium box and when we might expect any kind of refresh or update there?

Sure. So I think, as I mentioned earlier, the Palladium continued to be strong demand, and we have a lot of repeat orders. And we continue to grow and in terms of overall market in term of capacity that we provide. Are we stand still, doing nothing? No. We are double, triple down in terms of investment, in terms of R&D. And so we'll continue to drive success and continue to drive -- clearly, the customer needs and requirement will continue to increase the complexity of the chip and the time-to-market and clearly, it's going to continue to drive the growth. And insofar, we have been heavily engaging with the customer. And some customer will use the multiple vendors, suppliers, but we continue to drive the performance, continue to drive the support, continue to drive the performance scalability, and we continue to invest

I think, Rich, we match up really pretty well with our top -- the top semiconductor customers match up really well with our customer base. And based on overall size of the market that Edac [ph] talks about of $350 million, we believe we're still in a very good position. Richard Valera - Needham & Company, LLC, Research Division: Appreciate that color. And one final one, Geoff, is there anything you're willing to say about the size of Cosmic, either from an employee standpoint or revenue standpoint?

We will talk about that, Rich, more when we actually close the deal and probably with our Q2 earnings call. We like to wait until we close before we give much more color on that one.

Your next question comes from the line of Mahesh Sanganeria with RBC Capital Markets.

This is actually Shunmugam [ph] sitting in for Mahesh. A couple of questions here. So about the Tensilica acquisition, I understand that you mentioned the $57 million standalone revenue for this year. And it was about 30% of growth. And then the past 2 years, the company has been growing at about 35% range. What's do you invision once Tensilica -- after the acquisition -- well, you now already closed the acquisition, what's your view on the median- to longer-term growth rate for the company?

Yes, so it's a little bit early for us to give a longer-term growth rate for the business. But clearly, we think that there are synergies with the our IP business and with their IP business and synergies also with our tool business that we think can lead to strong growth going forward. We'll talk more about, obviously, the future growth in Tensilica when we get to 2014 guidance. But again, we think strong synergies with our IP portfolio and strong synergies with our tool.

Sure. And then you also mentioned that Tensilica acquisition will start becoming accretive in 2014. I'm just wondering, because of the 16 revenue -- the $16 million of merger accounting, it's dilutive this year. Should that go away? Would it be accretive to EPS for this year?

So we can't give you the numbers, but as merger accounting works, right, this is impacting revenue, it's not impacting expenses. That $16 million would largely drop to the bottom line, if we didn't have deferred revenue.

[Operator Instructions] And there are no further questions at this time. I would now like to turn the call back over to Lip-Bu Tan.

In closing, Cadence continues to deliver great technology to our customers, and our business results reflect this. Our IP business is developing critical mass, and we expect it to be a strong contributor to our future growth and profitability. While the macro environment remain uncertain, Cadence has made great progress over the past several years in terms of technology, customer relationships, strategic alliance and financial performance. I believe Cadence is well positioned to continue to execute on all these fronts. Thank you, everyone, for joining us this afternoon. We look forward to speaking with you soon.

Thank you for participating in today's Cadence Design Systems First Quarter 2013 Earnings Conference Call. You may now disconnect.