Semiconductor design software provider Cadence Design Systems (NASDAQ:CDNS) reported results in line with analysts' expectations in Q2 FY2023, with revenue up 13.9% year on year to $976.6 million. However, next quarter's revenue guidance of $1 billion was less impressive, coming in 1.55% below analysts' estimates. Cadence made a GAAP profit of $221.1 million, improving from its profit of $186.9 million in the same quarter last year.
Cadence (CDNS) Q2 FY2023 Highlights:
- Revenue: $976.6 million vs analyst estimates of $977.2 million (small miss)
- EPS (non-GAAP): $1.22 vs analyst estimates of $1.19 (2.28% beat)
- Revenue guidance for Q3 2023 is $1 billion at the midpoint, below analyst estimates of $1.02 billion
- The company reconfirmed revenue guidance for the full year of $4.07 billion at the midpoint
- Free cash flow of $393.8 million, up 63.6% from the previous quarter
- Gross Margin (GAAP): 90.1%, in line with the same quarter last year
With the name chosen to reflect the idea of a repeating pattern or rhythm in electronic design, Cadence Design Systems (NASDAQ:CDNS) offers a software-as-a-service platform for semiconductor engineering and design.
Known as an electronic design automation (EDA) software platform, Cadence helps engineers design semiconductors and test them through simulation. The company's flagship product is the Cadence Encounter digital implementation system, which provides a complete set of tools such as logic synthesis, placement and routing, and timing optimization. Logic synthesis converts electronic designs into detailed digital circuit implementations. Placement and timing tools determine the physical locations of components to meet design constraints. Timing optimization ensures the digital circuit meets the required performance metrics.
As chips become smaller and more densely packed with transistors, it becomes harder to design and optimize them. Cadence's tools address these challenges by automating many of the design and optimization tasks, which lets engineers to focus on higher-level decisions. Simulation capabilities means testing can be done before final production to identify and correct defects or inefficiencies, which saves time/resources and improves time to market.
Cadence principally generates revenue by selling software seat licenses, usually based on number of users in a customer’s organization. In addition, the company generates a smaller portion of revenue from consulting and support services to ensure that customers succeed with the company’s software suite.
The demand for rich, interactive 2D, 3D, VR and AR experiences is growing, and while the ubiquitous metaverse might still be more of a buzzword than a real thing, what is real is the demand for the tools to create these experiences, whether they are games, 3D tours or interactive movies.
Competitors in engineering and design software include Ansys (NASDAQ:ANSS), Synopsys (NASDAQ:SNPS), and Siemens EDA (subsidiary of XTRA:SIE).Sales Growth
As you can see below, Cadence's revenue growth has been over the last two years, growing from $728.3 million in Q2 FY2021 to $976.6 million this quarter.
This quarter, Cadence's quarterly revenue was once again up 13.9% year on year. However, the company's revenue actually decreased by $45.1 million in Q2 compared to the $121.8 million increase in Q1 2023. Regardless, we aren't too concerned because Cadence's sales seem to follow a seasonal pattern and management is guiding for revenue to rebound in the coming quarter.
Next quarter's guidance suggests that Cadence is expecting revenue to grow 10.8% year on year to $1 billion, slowing down from the 20.2% year-on-year increase it recorded in the same quarter last year. Ahead of the earnings results announcement, the analysts covering the company were expecting sales to grow 11.6% over the next 12 months.
Profitability
What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. Cadence's gross profit margin, an important metric measuring how much money there's left after paying for servers, licenses, technical support, and other necessary running expenses, was 90.1% in Q2.
That means that for every $1 in revenue the company had $0.90 left to spend on developing new products, sales and marketing, and general administrative overhead. Significantly up from the last quarter, Cadence's excellent gross margin allows it to fund large investments in product and sales during periods of rapid growth and achieve profitability when reaching maturity.
Cash Is King
If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills. Cadence's free cash flow came in at $393.8 million in Q2, up 31.1% year on year.
Cadence has generated $1.13 billion in free cash flow over the last 12 months, an eye-popping 29.8% of revenue. This robust FCF margin stems from its asset-lite business model, scale advantages, and strong competitive positioning, giving it the option to return capital to shareholders or reinvest in its business while maintaining a healthy cash balance.
Key Takeaways from Cadence's Q2 Results
Sporting a market capitalization of $66.2 billion, more than $873.9 million in cash on hand, and positive free cash flow over the last 12 months, we believe that Cadence is attractively positioned to invest in growth.
It was great to see Cadence generate strong free cash flow that beat Wall Street analysts' expectations and also improve its gross margin this quarter. Those really stood out as positives in these results. On the other hand, its underwhelming revenue and non-GAAP EPS guidance for next quarter was disappointing. Overall, the results could have been better. The company is down 4.6% on the results and currently trades at $230 per share.
Is Now The Time?
Cadence may have had a bad quarter, but investors should also consider its valuation and business qualities, when assessing the investment opportunity. Although Cadence is not a bad business, it probably wouldn't be one of our picks. Its revenue growth has been weak, and analysts expect growth rates to deteriorate from there. And while its impressive gross margins are indicative of excellent business economics, unfortunately customer acquisition is less efficient than many comparable companies.
Cadence's price to sales ratio based on the next twelve months of 15.5x indicates that the market is definitely optimistic about its growth prospects. We don't really see a big opportunity in the stock at the moment, but in the end beauty is in the eye of the beholder. And if you like the company, it seems that Cadence doesn't trade at a completely unreasonable price point.
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