Bull Of The Day: Cadence Design Systems (CDNS)

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I last wrote about Cadence Design Systems (CDNS) in early August after another stellar quarterly report put the stock back in the upper tiers of the Zacks Rank for positive earnings estimate revisions (EER).

As the current bear market ravages technology and semiconductor companies like NVIDIA (NVDA) , it's time for an update on this $50 billion provider of Electronic Design Automation (EDA) and System Design Enablement (SDE) software tools for semiconductor manufacturers.

Cadence calls their unique brand and strategy of platform capabilities for chip makers Intelligent System Design.

In fact, NVIDIA is a Cadence customer precisely because Jensen Huang and his teams of engineers are highly focused on simulating all facets of their chip design and testing.

Through its Intelligent System Design strategy, the company offers software, hardware, and reusable IC (integrated circuit) design blocks to electronic systems and semiconductor customers.

Cadence's core EDA software and services enable engineers to develop different types of ICs. Its design IPs are directly integrated into the ICs.

Here's what I wrote in May when I was recommending CDNS shares near $130 and they rallied above $190 by mid-August before the current market rout...

 

Nexus of Software and Industrial Design

The software to design semiconductors has become ever more important for at least 3 reasons...

First, transistor architecture has slipped to sub-microscopic levels under 10 nanometers, smaller than the coronavirus.

Second, the proliferation of applications in autos, mobile, home, factory, and datacenter are accelerating demand and custom solutions for OEMs.

Third, the engineering, testing and simulation of these ultra-miniature designs are critical before they are shipped to a chip foundry, or "fab."

(end of notes from May)

 

Beat & Raise Quarter

On July 25, Cadence delivered Q2 non-GAAP earnings of $1.08 per share, up from $0.86 a year earlier, topping the Zacks Consensus Estimate by 11.3% and increasing 26% year over year.

Revenue for the June quarter totaled $857.5 million, up from $728.3 million a year earlier. Revenues surpassed the Zacks Consensus Estimate by 2.45% and increased 18% on a year-over-year basis.

The top line benefited from continued strength across all segments driven by higher demand for its products. CDNS ended the quarter with a backlog of $5.6 billion.

Driven by strong second-quarter results, the company raised its outlook for 2022. Revenues for the full year are now projected in the range of $3.47-$3.51 billion compared with the earlier guidance of $3.395-$3.435 billion. The Zacks Consensus Estimate for 2022 revenues is currently pegged at $3.4 billion, which indicates year-over-year growth of 13.8%.

The company anticipates Q3 earnings per share of $0.94 to $0.98 on revenue of $860 million to $880 million. Consensus estimates are for normalized EPS of $0.90 and revenue of $832.3 million.

For the full year, EPS is expected to be in the range of $4.06 to $4.12 against prior consensus estimates of $3.92 per share.

 

Acquisition of OpenEye Scientific Software

Cadence also announced it has struck a deal to buy privately held computational molecular design company OpenEye Scientific Software for about $500 million in cash.

OpenEye's services are used by pharmaceutical and biotechnology companies for drug discovery. The transaction is expected to contribute "immaterial revenue" in 2022 and about $40 million in fiscal 2023, Cadence said.

This deal was especially exciting to me for two reasons:

1) As the portfolio manager for Zacks Healthcare Innovators, I am very interested in companies creating technology platform expertise in the exciting new eras of genomics and protein folding.

2) This move reinforces the company mission as being foundationally about software for any sector, not just the semiconductor verticals it already serves. It's only natural that this platform expertise in simulation would move into Biosimulation where billions of combinations of proteins must be navigated.

The acquisition is aimed at accelerating Cadence's Intelligent System Design strategy and expand its total addressable market. The company wants to expand its reach in the molecular modeling and simulation market as pharmaceutical and biotechnology companies leverage computational software solutions for drug discovery.

And here is the update after closing the deal on September 1st...

 

Cadence Design completes acquisition of OpenEye Scientific

CDNS announced that it has completed the acquisition of OpenEye Scientific Software. The addition of OpenEye's technologies and team accelerates the Cadence Intelligent System Design strategy by extending Cadence's computational software core competency to molecular modeling and simulation that is targeted to life sciences.

From the company press release on 9/1...

"The acquisition will allow pharmaceutical and biotechnology companies to benefit from more robust drug discovery solutions that combine OpenEye's innovative molecular modeling and simulation software solutions for drug discovery with Cadence's algorithmic and solver expertise, efficient large data management infrastructure, and leading AI/ML and cloud solutions."

 

Performance Details

In the second quarter, Product & Maintenance revenues (93.6% of total revenues) of $802.3 million were up 16.6% year over year. Services revenues (6.4%) of $55.2 million increased 36.7% from the year-ago quarter’s figure.

Geographically, the Americas, China, Other Asia, Europe, Middle East and Africa (EMEA) and Japan contributed 45%, 13%, 18%, 18% and 6%, respectively, to total revenues in the quarter under review.

Product wise, Custom IC Design & Simulation, Digital IC Design & Signoff, Functional Verification, IP and Systems Design & Analysis contributed 23%, 27%, 24%, 14% and 12% to total revenues, respectively.

The company’s digital and signoff business delivered 14% year-over-year growth in revenues. Digital Full Flow saw robust traction with 25 new customer wins in the first half of the year. The company’s Cadence Cerebrus solution witnessed accelerating momentum and was deployed by several customers like Intel, NVIDIA, Broadcom, Samsung and Renesas.

Palladium and Protium (especially Z2 and X2) platforms witnessed continued momentum with many deal wins. The company noted that it won 10 new clients and 50 repeat orders in the second quarter, which included more than two-third for both platforms. Mostly deal wins came from clients in the hyperscale, AI/ML and server customers.

In the quarter under review, the company launched 15 Verification IP solutions that enable customers across industrial, automotive, hyperscale data center and mobile domains to develop system-on-chip.

Cadence’s System Design & Analysis Business segment reported 29% year-over-year growth.

In the quarter under review, total non-GAAP costs and expenses increased 12% year over year to $493.9 million.

Non-GAAP gross margin contracted 120 basis points (bps) to 90.6%, but the non-GAAP operating margin was up 300 bps on a year-over-year basis to 42.4% in the quarter under review.

 

Balance Sheet & Cash Flow

As of Jul 2, 2022, the company had cash and cash equivalents of approximately $1.03 billion compared with $1.135 billion as of Apr 2, 2022.

The company’s long-term debt came in at $348 million as of Jul 2, 2022, compared with $347.8 million as of Apr 2, 2022.

The company generated an operating cash flow of $661.1 million in the reported quarter compared with the prior quarter’s figure of $588.8 million. Free cash flow in the quarter under review was $301 million compared with $319 million reported in the previous quarter.

The company repurchased shares worth approximately $320 million in the second quarter.

 

2022 Outlook Raised

In addition to the revenue and EPS guidance mentioned earlier, Cadence provided these forward-looking details about its performance...

For 2022, the non-GAAP operating margin is forecast in the range of 39.25-40.25% against the range of 38.5-40% guided previously.

For 2022, operating cash flow is projected to be $1.2 billion. Management expects to utilize the free cash flow generated to repurchase shares worth approximately $900 million.

Non-GAAP operating margin is forecast between 37% and 38% for the third quarter. The company expects to repurchase shares for at least $150 million in the next quarter.

 

Analyst Reaction

KeyBanc analyst Jason Celino reiterated his Overweight rating and $215 PT in August citing these drivers of growth and profitability...

Increasing silicon content in autos, autonomous driving, IoT, AI/ML designs, and increasing chip design complexity provide multiyear growth tailwinds.
EDA tailwinds + internal process improvements driving further efficiency + continued execution = pathway to high-30% OM over the next two to three years.
Expansion to system analysis provides incremental growth opportunities

Needham analyst Charles Shi raised the firm's price target on Cadence Design to $200 from $193 and keeps a Buy rating on the shares. The analyst cites the company's "beat and raise" Q2 while noting that the stock may have recently come off the bottom. Shi adds that he is "encouraged" by Cadence Design's print and also believes that the best time for bottom fishing of semiconductor stocks may arrive sooner than many investors think.

I agree with Shi. And investors may get one more shot and buying chips cheaper after the NVDA warning.


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Kevin Cook is a Senior Stock Strategist for Zacks Investment Research where he runs the TAZR Trader and more

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