Operator:

Good afternoon. My name is Brianna, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence Second Quarter 2024 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I will now turn the call over to Richard Gu, Vice President of Investor Relations for Cadence. Please go ahead.

Anirudh Devgan:

Thank you, Richard. Good afternoon, everyone, and thank you for joining us today. Cadence delivered strong financial results for the second quarter of 2024, with broad based momentum across our product portfolio. Bookings were stronger than expected, leading to a healthy backlog and underscoring the robust demand for our innovative technologies. We exceeded our outlook on all key metrics and are updating our revenue guidance for the year to over 13% year-over-year growth. John will provide more details on both our Q2 results and updated outlook for the year. Generational trends such as hyperscale computing, 5G and autonomous driving, all underpinned by the AI super cycle, are driving strong design activity across multiple verticals, particularly in data center and automotive. Along with increasing chip complexity and system companies building their own silicon, these trends are creating tremendous tailwinds for our differentiated solutions. We are steadfastly executing to our intelligent system design strategy, extending our leadership in core EDA, while steadily expanding our footprint in the new system design analysis area. Customers are ramping-up their R&D spend in AI driven automation. Our Cadence.AI portfolio offering unparalleled quality of results and productivity benefits continues to gain momentum with orders more than tripling over the last year. Our solutions are enabling the massive AI infrastructure build out across the semi and system space. Additionally, we continue embedding AI in our EDA, SDA and digital biology solutions. In Q2, our long-term development partner, NVIDIA, broadly deployed Palladium Z3 to deliver to its next generation AI product roadmap, further solidifying Cadence's leadership in the industry. A marquee hyperscaler meaningfully expanded its partnership with Cadence in Q2, through a broad proliferation of our Cadence.AI EDA, SDA and hardware portfolio. The growing foundry ecosystem is driving increased design activity and creating significant opportunities for our industry leading products. And in Q2, we expanded our collaboration with several leading foundry partners. We announced that Cadence.AI digital and analog tools were optimized for Samsung's advanced node SF2 gate all around process, driving enhanced quality of results and accelerating node migration. We extended our long standing collaboration with TSMC, through a very comprehensive and innovative technology advancement, ranging from 3D-IC to design IP and photonics and providing optimized digital and analog full flows for TSMC's latest N2 process technologies. Our integrity 3D-IC platform is the industry's leading unified design, analysis and sign-up platform for multi-chiplet architectures. Integrity has been certified for all of TSMC's latest 3D fabric offerings and now has enabled several new features like hierarchical 3D-IC design. We also announced that integrity has been enabled for all of Samsung foundry's multi-die integration offerings accelerating the designer assembly of stack chiplets. Additionally, we released a complete Intel Foundry EMIB advanced packaging reference flow that is optimized to work seamlessly with Intel 18A technology. We are also collaborating with multiple foundries to optimize our industry leading IP cores for AI, HPC, mobile and automotive applications for their advanced process technology, so as to ensure seamless integration into customer designs. We saw strong momentum in our IP business with a delivering 25% year-over-year growth in Q2. As we executed to our profitable and scalable growth strategy, AI use cases, HPC and heterogeneous integration were the primary drivers fueling the demand for our HBM, PCIe, DDDR, 112 gig SerDes and UCIe products. We expanded our system IP portfolio with the addition of Cadence Janus Network on a chip solution, that manages high speed communications effectively with minimum latency, enabling customers to achieve their PPA targets faster and with lower risk. Emulation and prototyping have become mission-critical elements of chip design and software bring of flows. Following the launch of our market leading Z3 and X3 platforms, there is robust demand for these best-in-class systems, particularly by AI, hyperscale and automotive companies and we continue to ramp-up our production capacity accordingly. Verisium, our AI-driven verification platform, continued seeing rapid customer adoption with several market shaping customers, including Qualcomm, successfully using Verisium Sim AI for coverage maximization and achieving up to a 20x reduction in verification workload time. Our system design and analysis business continued its strong momentum in Q2, delivering 20% year-over-year revenue growth. As chiplet based architectures gained traction, our industry-leading integrity 3D-IC platform had increased adoption and expansion from large deployments at 5G hyperscale, memory and consumer customers. Our AI enabled Allegro X design platform, which is being rapidly adopted and driving competitive displacement as multiple aerospace and defense hyperscalers and EV customers take advantage of the platform's productivity and next generation capabilities. Allegro X's in design analysis capabilities are also driving a pull through of our Multiphysics analysis solutions. In Q2, a leading EV auto company forged a strategic partnership with Cadence, making a significant investment across the breadth of our Multiphysics portfolio. With the close of BETA CAE in Q2, we now offer a comprehensive Multiphysics platform covering electromagnetics, electrothermal, CFD and structural analysis solutions. Our digital IC and custom businesses delivered another solid quarter. Proliferation of our digital full flow at the most advanced nodes continued with close to 40 full flow wins over the last 12 months, especially at hyperscalers. With over 400 tapeouts, customers are increasingly relying on Cadence Cerebrus, the leading AI tool in the industry as it continues to deliver amazing PPA and productivity benefits. For example, Cadence Cerebrus has been delivering up to a 10% PPA gain for a global marquee systems company and is now deployed as part of the default flow for their latest designs at the most advanced nodes. Samsung foundry leveraged Cadence Cerebrus in both DTCO and implementation to achieve more than a 10% leakage power reduction on their SF2 gate all around platform. Socionext utilized SerDes closure and temper sign-off to reduce timing closure time by 73% and doubled productivity while reducing memory cost by 90%. Our AI driven Virtuoso Studio is the leading automated solution for analog and RF designs. And its new AI features allow much more efficient migration from one process node to another. Virtuoso Studio added 35 new logos in Q2, led by top hyperscalers, aerospace and defense and automotive customers. In summary, I'm pleased with our Q2 results and the continuing momentum of our business. The AI driven automation era offers massive opportunities and the co-optimization of our comprehensive EDA and SDA portfolio with accelerated computing and AI orchestration uniquely positions us to provide disruptive solutions to multiple markets. Now I will turn it over to John to provide more details on the Q2 results and our updated 2024 outlook.

Operator:

Thank you. We will open the line for questions. [Operator Instructions] Your first question comes from Charles Shi with Needham & Company. Please go ahead.

Anirudh Devgan:

Yeah. Hi, Charles. Thanks for the question. I mean, first of all, I'd like to say that overall we are pleased with how we are performing. If you step back -- because you asked a longer term question, right, if you step-back, we will deliver we expect more than 13% revenue growth and about 42.5% operating margin. So, I think that's a best-in-class combination of both revenue growth and operating margin. And then if you look at our CAGR over last three years, which is one of our kind of favorite metrics, that's also performing pretty well in terms of growth and margin expansion. And you mentioned semi-cycle, I mean, it's encouraging to see that there is going to be growth this year, which it was not there last year. But as you all know, Charles, we are tied to the R&D spend more than the revenue of our customers. And, of course, if the revenue goes up, they're more likely to spend on R&D, but in general, the -- our customers, both system and semi-companies continue to spend on R&D and these are long-term projects. So, we'll see how that goes as the semiconductor revenue improves, but this is not instantaneous effect on R&D spend. There is always some lag sometimes. And so we will -- but we are encouraged to see the improvement in semi spending overall in a semiconductor revenue. So, I would like to say -- and you can see in our backlog also, we maintain a pretty healthy backlog. So, overall, I think things are performing well and this AI is broadening out. I mean, you know this well. AI is broadening out beyond datacenter, which we are glad to have great partnerships, two automotive, two more edge consumer devices like phones and PCs. So overall I feel pretty good about the industry and, of course, our position in it as the essential provider of design software.

John Wall:

Thanks for the question, Charles. And that's -- I mean, regional revenue is notoriously hard to predict. I will say that at the midpoint of our current revenue guide, we only need China to get to 13% of overall revenue to be able to hit that midpoint. I mean, when you look at performance in Q2 and the first half, we had a very strong bookings first half, very pleased with customers' response to our new hardware systems. The IP and SG&A businesses continue to grow strongly. Core businesses continue to scale really well and we're focused on profitable revenue growth. I know in your first question, you indicated that we hadn't raised the outlook, but we did raise non-GAAP EPS by $0.06. We're very pleased with the improvement in profitability. And when you look at the current guide, we're actually on track for 50% incremental margin excluding the impact of BETA CAE now. BETA CAE is in our guide, but it's in our guide at what we previously communicated in the press release is $40 million of revenue and about $0.12 dilution to non-GAAP EPS. There is an impact to OP cash as a result of BETA CAE as well. But overall, very, very pleased. We thought it was prudent to assume lower China revenue for this year at the midpoint of our guide puts the -- but that's it. We only need 13% to get to the midpoint of guidance.

Anirudh Devgan:

Thanks.

Gianmarco Conti:

Yeah. Hi, there. Thank you so much for taking my questions. And so on my first one, could you talk a little bit about the implied Q4 ramp-up to 29% growth at the midpoint of guidance? And what is giving you the confidence in reaching the target? Is it mostly hardware visibility coming through or are there an unusually higher number of Q4 renewals that you're waiting for? Any color here would be great. Thank you.

Gianmarco Conti:

Okay. Great. So my follow up would be on hardware. And if you could talk a little bit about how much visibility you have actually in H2? And are you booking and delivering in the same quarter, hence, while we're not seeing a major uplift in backlog growth or is it -- is there a different dynamic to it? I'm trying to understand if you're booking manufacturing and delivering all in the same quarter for hardware essentially? Thank you.

Anirudh Devgan:

Also just to add on overall -- yeah, hey, just to add on the overall hardware cycle, as you remember, we launched new systems in April, just couple of months ago, few months ago now. And the response to them has been phenomenal. Actually, we -- these palladium, especially both palladium and protium, but these systems can design chips like I mentioned last time with capacity of 1 trillion transistors and the current's biggest chip is like 200 billion transistors, most of them are 100 billion or less. So we are 5x to 10x higher capacity than what is needed. So that should suit the industry well for next several years. And I'm also what pretty pleased about is that we delivered production deployments of our new systems to some very major customers. So we highlighted the NVIDIA, our development partner with a significant deployment of Z3, also one of the leading mobile system -- mobile companies in the world and one of the leading hyperscalers. So it's across multiple markets that we delivered our latest systems, which are performing exceedingly well. So that sets up very well for the future and also competitively. And we have a significant lead given the nature of our systems. It's a combination of -- protium is based on FPGA and then palladium is based on our own chip at advanced TSMC process. And Cadence is the only solution that does that and provides a unique value. So overall, I think hardware business is performing well. And as you know, these are multi-year upgrade cycles. So this is not all-in in '24. So we'll see how things go in '25 and '26.

Operator:

Our next question comes from Vivek Arya with Bank of America Securities. Please go ahead.

Anirudh Devgan:

Yeah. Hi, Vivek. Good question. So in general, what I would like to say is, like we mentioned last two times, the shape of the curve this year is unique to Cadence, given multiple factors. This is not what we expected last two years. So this time it's more back end loaded for the reasons we mentioned before. So the guide is a little different and we are also given that shape of the curve more prudent in our guide like we were in Q2 and then we rather overachieve and deliver that and give the team flexibility to do the right business for the long term. So I think that's the difference this year versus last few years is given the shape of the curve, we have more prudence in our revenue guide like John mentioned and John can comment on the backlog expectations, yeah.

Vivek Arya:

Got it. And for my follow-up, you mentioned BETA CAE quite a drag to EPS. I think you mentioned $0.12 dilution. And almost, I think what is like a $300 million hit to operating cash flows. Can you describe that acquisition a little more? And when does it start to become accretive to your financials? Thank you.

Anirudh Devgan:

Also, a couple of things to clarify. So one thing, this purchase of inventory for the hardware systems. I mean, that will be used over multiple years. It's not just for '24. So I think it's a one-time investment that pays for several years and that's a prudent decision to make to get the right kind of parts for the future. And then on BETA, it completes our system analysis portfolio to add structural analysis and it also strengthens our position in automotive. Of course, data center is a big vertical with all the AI super cycles. But I think one of the other exciting verticals is automotive with all this electrification and also AI getting added in the self-driving or driver assistance. So we see a lot of design activity in automotive. Also, automotive is also moving through chiplets and 3D-IC. So I think automotive has all the three tenants of our IST strategy. It has silicon content that is increasing and more and more system design, of course, is needed for the design of automotive. And AI for all the data and computational software. So for that reason, BETA CAE is -- completes our portfolio in automotive and positions us well in the future. And this is not just with the semiconductor companies doing automotive, but also the system companies now. OEMs doing more and more chip design, doing more of our system solutions. And I also want to highlight and congratulate McLaren. There was a big news this weekend. McLaren got one and two in Hungarian F1 and we have been working with them for last few months and years and it's good to see them do well as we deploy. So I think the automotive solution that we are driving is a combination of silicon system and then AI and we are seeing the results of that through organic and inorganic expansion.

Operator:

Our next question comes from Joshua Tilton with Wolfe Research. Please go ahead.

John Wall:

Loud and clear, Josh.

John Wall:

That's fair, Josh. I would do the inverse on you in terms of bookings were stronger than we expected in Q2 and we got some uplift in recurring revenue. It took a bit of pressure off on the upfront side that -- and we are -- I mean, we're taking orders. We've got strong demand for the hardware and we're building those hardware systems as quickly as we can, particularly the newer hardware orders. IP is doing really well and system design and analysis is doing really well. And what we've reflected in the guide is our expectation of how much of that revenue will fall in Q3 and Q4. We took the opportunity, we really derisked the guide for the year by reducing our expectations for China. Upfront, we still expect to be in a range of 80% to 85%, but I think we might get slightly more recurring revenue as a result of the strong bookings in the first half.

John Wall:

Yes. But it's -- we definitely need to build hardware and you'll see the impact on our inventory in Q3 with the amount of raw materials we're purchasing. But as Anirudh says, that's a one-time thing that we're doing to try and get raw materials and to build those systems quickly as we can. But the -- a lot of the upfront revenue in the second half comes from the strength in our IP business and we have those orders in backlog and it's just a case of executing against those. We also have some SD&A, our system design analysis upfront revenue that's scheduled to occur in Q3 and Q4. Again, most of that is from orders in the system. On the hardware side, it's kind of mid to high-single digits is what we were expecting the SPG Group to deliver to be able to hit the midpoint of that guidance.

John Wall:

I don't have that to hand, but just let me come back to that. Let's see if I can dig it out here.

Operator:

Our next question comes from Ruben Roy with Stifel. Please go ahead.

John Wall:

Yes, that's correct. But the vast majority of the purchases are to -- to get raw materials to help build those new systems.

Anirudh Devgan:

Yeah. Just to clarify, I mean, also -- I mean, we have two systems, right? So, palladiums, we design ourselves and we manufacture the chip in TSMC and protium. We also design ourselves, but the silicon itself is primarily from AMD with Xilinx FPGAs. So, a lot of this purchase is for X3s and the FPGAs and that should serve us for multiple years. On Z3, like we said, we are already shipping them and they already deployed in production this quarter. So, I think Z3 is slightly different than X3 in terms of the mix of the silicon content, just to clarify that.

Anirudh Devgan:

Yes, I would like to -- I think we're seeing more and more design activity like you said the rhythm or the Cadence of the products. And also different kind of chips. It's not just that big data center chips, but even within them, there is more and more customization. Of course, the hyperscalers doing their own silicon. And then now we talked about our partnership with, for example, Qualcomm and they are doing a consumer or edge laptop AI devices. So, the amount of AI is also spreading to other verticals, not just obvious, the big one on data center and data center design is accelerating. And I think when we look at it, we still see that the data center part of AI still should accelerate, at least the visibility we have for next couple of years, so we'll see how that goes. And therefore -- and the other thing is automotive -- automotive takes normally a little longer, but we're already seeing design activity and the deployment may be few years down, maybe after data center. And then consumer and PCs already starting with phones and laptops. So, overall we do see accelerating deployment of AI through the whole semiconductor ecosystem. And we are very proud of our position in it, whether it's 3D-IC, whether it is data center chips, whether it's our own AI products, we are winning almost all kind of engagements on all -- on our kind of Cadence.AI portfolio. So, overall we do see more and more design and deployment of AI infrastructure and our own AI product.

Operator:

Our next question comes from Jay Vleeschhouwer with Griffin Securities. Please go ahead.

Anirudh Devgan:

Yeah. Hi, Jay. Good question. So, I mean, as you know, in EDA when we go to lower nodes, there is more integrated solutions which are required, whether it's digital or analog or verification. And that is further accelerated by use of AI. So, like Cerebrus, for example, in digital will integrate not just place and route, but also synthesis and sign-off. So, I think that trend is definitely there. And same thing with Verisium, our leading AI product for verification also integrates the four major verification platforms we have. So, it is more and more platform driven approach. And we can do that now with SD&A now that we have a complete portfolio. And we mentioned like a leading EV company like OEM, one of the leading -- the most advanced EV companies deployed our entire portfolio. So as we have a bigger portfolio in SD&A, it does let us do what we have always done in EDA, focus on solutions, not just on individual products and integrate solutions with our own kind of native integrations, whether it's analog, digital verification and now with SD&A.

Anirudh Devgan:

Yes, Jay. So what I would like to say is that the number of use cases I see is increasing at this point. I mean, of course, one of the biggest use case that we started with was digital implementation since it is so kind of heavy kind of design process. So automating the digital implementation process was huge benefit. And we talked even this quarter Cerebrus being deployed at one of the leading system companies for the default flow also used by Samsung. Also you see verification be used by Qualcomm. So I think what is happening in that Cerebrus or the implementation use case, two things. One is that it is going not just for design, but also for DTCO, design technology co-optimization and also for higher level in the design process like floor planning and 3D-IC exploration. So it's all not just for implementation of the design, but also for architecture and exploration. And the other thing is like there is more workflow automation. As customers get used to Cerebrus, they are using it not just towards the end of the design process, they're using it right from the beginning throughout the design process. So it allows us to do more workflow automation. And Cerebrus has also evolved to allow much more of an entire workflow rather than a specific implementation use case. And then same thing is happening in terms of more and more use cases, for example, packaging. Allegro X is doing pretty well. And recently one of the leading customers in 3D-IC used its capability to automate, for example, routing for automating placement, which was not there before in PCB and package design. So overall, I do think it's maturing of the workflows. And then with this LLMs and Gen AI, we have kind of several workflows for taking spec to RTL and we highlighted some of them last quarter. So I actually do see finally that in the -- we are always kind of building out the AI infrastructure, these big companies designing chips. But I do see now there is a turning point in deployment of AI for the design process with the initial workflow being Cerebrus and digital implementation now to expanding to LLM based art, spec -- expanding to DTCO, expanding to 3D-IC, of course, expanding to analog, packaging, verification. And we do have the most comprehensive AI portfolio in terms of all five major kind of product lines. So actually, it's a pretty encouraging view compared to a year ago.

Operator:

Our next question comes from Harlan Sur with J.P. Morgan. Please go ahead.

John Wall:

Yes, it's hard. And again, like I say, it's -- we're not guiding bookings, but we were very, very pleased with the strong first half for bookings. The BETA CAE contribution to backlog is very, very small. It's immaterial because BETA CAE, their revenue is upfront. So that's the upfront piece of the business rather than the recurring revenue. But yeah, we're very pleased. I mean, you can typically expect us to always be driving for a book-to-bill of greater than 1, but we don't guide. We don't guide bookings though.

Anirudh Devgan:

Yes, Harlan. That's a great observation and we are fortunate to have very deep and long standing partnership with all the major memory companies. At least there are three big ones and then maybe two the next level. But overall, we are -- given our strength, like you mentioned in Virtuoso, which is the platform for choice for all memory implementation. And yes, there is a lot more digital and implementation design happening at memory companies, primarily driven by HBM and other trends. And actually also there is some kind of -- I mean, they were always doing -- they were always doing digital, but it's lot more now. And there is trend of even integrating TSMC's technologies with kind of memory. And given our strong partnership with TSMC, that also helps us with the memory companies. And as you know, they are also doing a lot more 3D-IC, all the three big memory companies and these memory layers are going from -- they're actually one of the most advanced 3D-IC with the memory layers going from 8 to 12 and that also plays to our strengths. And even in my prepared remarks, I mentioned, for example, our partnership with Samsung and 3D-IC. And then so is true with the other kind of two major players in memory. So we are pleased in our position in memory and the emerging trends of HBM and 3D-IC integration and we'll see how that progresses. But I think memory is often overlooked in -- I don't need to tell you, but just in general, memory is often overlooked in the big AI super-cycle. It's not the big chips, logic chips, but memories play a very essential role and we are very well-positioned both with the leaders like NVIDIA on the logic side and then we highlighted Samsung and the other big memory players in general.

Operator:

Our next question comes from Jason Celino with KeyBanc Capital Markets. Please go ahead.

John Wall:

Demand is strong. Demand is strong. What I was trying to point out was that we do have inventory of the older systems that we can deliver right away. The newer systems we're having to build them as quickly as we can because the orders are coming in faster than we can build them. So the lead times is a bit of a moving target in that respect. We are planning to purchase a lot of raw materials and build as quickly as we can in Q3. So you'll see a significant uptick in our inventory balance at the end of Q3.

John Wall:

Yeah. That's fair. That's -- yeah, IP is having a really, really strong year as is system design analysis, that'll be our two fastest growers for the year. And then again, there's some upfront revenue from them. It's more weighted towards Q4 versus Q3. So, we have the shape of the curve is really driving our guide and I would clarify -- I would categorize it as prudent. Anirudh, would you add anything?

Jason Celino:

Very good stuff. And, yeah, thanks for the lingo acronym help, Anirudh. Very helpful.

Lee Simpson:

Great. Thanks for fitting me in and well done in a good quarter. Just wanted to get some clarification. I don't know if I heard correctly, but I think I heard you say that a mobile OEM had taken the Z3 platform. And if that's the case, do you have a sense for what the emulation work might be? Would it be for chips on device or would it be for chips both on device and perhaps in, let's say, a network situation? Thanks.

Lee Simpson:

Yeah. Thanks. Just on those multiple verticals, if we look at the incidence of 3D-ICs coming through, I get the sense that that's starting to hit the tape now in automotive. You have mentioned EV companies as a collaboration of late, but you have mentioned a number of chip makers also. I wonder if it's possible at this point or even if it's relevant to just maybe talk about the split between the customers? Are we talking system customers, i.e., OEMs and Tier-1s in the majority right now or is it still major semis, chip makers for the automotive work? Thanks.

Lee Simpson:

Great. Thanks, Anirudh. Great color.

Clarke Jeffries:

Hello. Thank you for taking the question. My first question is, Anirudh, how do you expect the delivery of these third generation systems to translate to additional software consumption in the recurring revenue portfolio? These products are happening with verification acceleration software bring up, but how do you see that additional consumption panning out after the delivery of a new ZRX system? And then I have one follow-up.

Clarke Jeffries:

Perfect. And then one follow-up for John. I think just to kind of finally put a cap on the whole discussion around timing. I guess, then is it fair to say that sort of $600 million odd of upfront revenue in the second half, maybe a majority of that is coming from IP and SG&A and not necessarily the Gen 3 systems and that maybe the interpretation is that there's going to be more of a demand curve in the beginning of '25 rather than this $600 million being strongly driven by third gen Palladium and Protium. Is that a fair takeaway?

Clarke Jeffries:

All right. Perfect. Thank you for taking the questions.

Joe Vruwink:

Great. Thanks for fitting me in. I did want to follow up to stay with verification and just this raw material investment. So, the thing I'm trying to reconcile is, I would imagine you entered this year expecting the new platform, strong demand, meeting the scale production and therefore invest in inventory. So, I guess, I'm wondering what changed in the quarter that warranted this updated assumption for cash flow and raw material purchase? And really at the heart of the question, did something change about your hardware demand expectation, not necessarily for 2024, but maybe out into 2025 and we just happen to be getting that news now because of the need to update your cash from OPs forecast associated with the inventory input?

Joe Vruwink:

Okay. Great. Then lastly, you mentioned at the start, orders for Cadence.AI tripled year-over-year. I don't think that's possible without also getting a lift in the base business, both across EDA and SD&A. I guess, on an ACV run rate basis, what has the AI lineup meant for Cadence overall? And does this create a step up in value where as you start pulling these contracts from backlog in coming quarters, it will become more noticeable in revenue and we'll kind of see the AI contribution more than we have to this point?

Joe Vruwink:

Okay. Thank you very much.

Anirudh Devgan:

Thank you all for joining us this afternoon. It's an exciting time for Cadence with strong business momentum and growing opportunities with semiconductor and system customers. With a world class employee base, we continue in delivering to our innovative roadmap and working hard to delight our customers and partners. On behalf of our Board of Directors, we thank our customers, partners and investors for their continued trust and confidence in Cadence.

Operator:

Good afternoon. My name is Regina and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence First Quarter 2024 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I will now turn the call over to Richard Gu, Vice President of Investor Relations for Cadence. Please go ahead.

Anirudh Devgan :

Thank you, Richard. Good afternoon, everyone. And thank you for joining us today. I'm pleased to report that Cadence had a strong start to the year delivering solid results for the first quarter of 2024. We came in at the upper end of our guidance range on all key financial metrics and are raising our financial outlook for the year. We exited Q1 with a better than expected record backlog of $6 billion, which sets us up nicely for the year and beyond. John will provide more details in a moment. Long-term trends of hyperscale computing, autonomous driving, and 5G, all turbocharged by AI super-cycle, are fueling strong broad-based design activity. We continue to execute our long-standing Intelligent system design strategy as we systematically build out our portfolio to deliver differentiated end-to-end solutions to our growing customer base. Technology leadership is foundational to Cadence and we are excited by the momentum of our product advancement over the last few years, and the promise of our newly unveiled products. Generative AI is reshaping the entire chip and system development process. And our Cadence.AI portfolio provides customers with the most comprehensive and impactful solutions for chip-to-systems intelligent design acceleration. Built upon AI-enhanced core design engines, our GenAI solution boosted by foundational LLM co-pilot are delivering unparalleled productivity, quality of results and time to market benefit for our customers. Last week at CadenceLIVE Silicon Valley, several customers including Intel, Broadcom, Qualcomm, Juniper, and Arm shared their remarkable successes with solutions in our Cadence.AI portfolio. Last week, we launched our third-generation dynamic duo, the Palladium Z3 emulation and Protium X3 prototyping platform to address the insatiable demand for higher performance and increased capacity hardware accelerated verification solutions. Building upon the successes of the industry leading Z2, X2 systems, this new platform set a new standard of excellence, delivering more than twice the capacity and 50% higher performance per rack than the previous generation. Palladium Z3 is powered by our next generation custom processor and was designed with Cadence AI tools and IP. The Z3 system is future proof with its massive 48 billion gate capacity, enabling emulation of the industry's largest design for the next several generations. The Z3 X3 systems have been deployed at select customers and were endorsed by Nvidia, Arm and AMD at launch. We also introduced the Cadence Reality Digital Twin Platform which virtualizes the entire data center and uses AI, high-performance computing, and physics-based simulation to significantly improve data center energy efficiency by up to 30%. Additionally, Cadence's cloud native molecular design platform Orion will be supercharged with Nvidia's BioNemo and Nvidia microservices for drug discovery to broaden therapeutic design capabilities and shorten time to trusted results. In Q1, we expanded our footprint at several top tier customers and furthered our relationship with key ecosystem partners. We deepened our partnership with IBM across our core EDA and systems portfolio, including a broad proliferation of our digital, analog and verification software and expansion of our 3D-IC packaging and system analysis solutions. We strengthened our collaboration with Global Foundry through a significant expansion of our EDA and system solutions that will enable GF to develop key digital analog RF/MM-Wave and silicon photonics design for aerospace and defense IoT and automotive end-markets. We announced a collaboration with Arm to develop a chiplet-based reference design and software development platform to accelerate software-defined vehicle innovation. We also further extended our strategic partnership with Dassault Systems, integrating our AI-driven PCB solution with Dassault's 3DEXPERIENCE Works portfolio, enabling up to a 5x reduction in design turnaround time for solid work customers. Now let's talk about our key highlights for Q1. Increasing system complexity and growing hyperconvergence between the electrical, mechanical, and physical domain is driving the need for tightly integrated co-design and analysis solutions. Our System Design and Analysis business delivered steady growth as our AI-driven design optimization platforms integrated with our physics-based analysis solution, continued delivering superior results across multiple end markets. Over the past six years, we have methodically built out our system analysis portfolio. And with the signing of the definitive agreement to acquire BETA CAE, are now extending it to structural analysis, thereby unlocking a multi-billion dollar TAM opportunity. BETA CAE is leading solutions have a particularly strong footprint in the automotive and aerospace verticals, including at customers such as Stellantis, General Motors, Renault, and Lockheed Martin. Our Millennium supercomputing platform, delivering phenomenal performance and scalability for high fidelity simulation is ramping up nicely. In Q1, a leading automaker expanded its production deployment of Millennium to multiple groups after a successful early access program in which it realized tremendous performance benefits. Allegro X continued its momentum and is now deployed at well over 300 customers. While Allegro X AI, the industry's first fully automated PCB design engine, is enabling customers to realize significant 4 times to 10 times productivity gain. Samsung used Celsius Studio to uncover early design and analysis insights to precise and rapid thermal simulation for 2.5D and 3D packages, attaining up to a 30% improvement in product development time. And a leading Asian mobile chip company use optimality intelligence system explorer AI technology and Clarity 3D Solver obtaining more than 20 times design productivity improvement. Ever-increasing complexities in the system verification and software bring-up continue to propel the demand of our functional verification products. With hardware accelerated verification, now a must have part of the customer design flow. On the heels of a record year, our hardware products continue to proliferate at existing customers, while also gaining some notable competitive wins, including at a leading networking company and at a major automotive semiconductor supplier. Demand for hardware was broad-based with the particular strengths seen at hyperscalers and over 85% of the orders during the quarter included both platforms. Our Verisium platform that leverages big data and AI to optimize verification workloads, boost coverage and accelerate root cause analysis of bugs saw accelerating customer adoption. At CadenceLIVE Silicon Valley, Qualcomm said that they used Verisium [Stem AI] (ph) to increase total design coverage automatically while getting up to a 20x reduction in verification workload runtime. Our Digital IC business had another solid quarter as our digital full flow continued to proliferate at the most advanced nodes. We had strong growth at hyperscalers, and over 50 customers have deployed our digital solutions on three nanometer and below design. Cadence Cerebrus, which leverages Gen.AI to intelligently optimize the digital full flow in a fully automatic manner now has been used in well over 350 tapeouts. Delivering best in class PPA and productivity benefits, it's fast becoming integral part of the design flow at marquee customers, as well as in DTCO flows for new process nodes at multiple foundries. In custom IC business, Virtuoso Studio, delivering AI-powered layout automation and optimization continued ramply, strongly, and 18 of the top 20 semi have migrated to this new release in its first year. Our IP business continued to benefit from market opportunities offered by AI and multi-chiplet based architecture. We are seeing strong momentum in interface IPs that are essential to AI use cases, especially HBM, DDR, UCIe, and PCIe at leading edge nodes. In Q1, we partnered with Intel Foundry to provide design software and leading IP solutions at multiple Intel-advanced nodes. Our TenSilica business reached a major milestone of 200 software partners in the Hi-Fi ecosystem, the de facto standard for automotive infotainment and home entertainment. And we extended our partnership with one of the top hyperscalers in its custom silicon SOC design with our Xtensa NX controller. In summary, I'm pleased with our Q1 results and the continuing momentum of our business. [Piling] (ph) chip and system design complexity and the tremendous potential of AI-driven automation, offer massive opportunities for our computational software to help customer realize these benefits. In addition to our strong business results, I'm proud of our high-performance inclusive culture and thrilled that Cadence was named by Fortune and Great Place to Work as one of the 2024's 100 best companies to work for, ranking number 9. Now I will turn it over to John to provide more details on the Q1 results and our updated 2024 outlook.

Operator:

[Operator Instructions] Your first question comes from the line of Joe Vruwink with Baird. Please go ahead.

John Wall:

That's a great question, Joe. And I think you've hit on the main point there that upfront revenue is driving a lot of the quarter-over-quarter trends this year. That -- when I look at last year, you recall that we had a large backlog of hardware orders and we dedicated 100% of the production, hardware production in Q1 to deliver that hardware in Q1 2023. As a result, in Q1 2023, 20% of our Q1 ‘23 revenue was from upfront revenue sources. That in contrast, Q1 this year, it's only 10% of the total revenue for this Q1 is coming from upfront revenue. But again, last year, and to reflect on where we thought we were this time last quarter, that we still expect that upfront revenue will probably be 15% to 20%. I mean, around the midpoint there is 17.5% in expectation for upfront revenue this year. And a midpoint of say 82.5% for recurring revenue. That's still the same as what we thought this time last quarter. That contrast with last year was I think 16% of our revenue was upfront last year. And to put dollar terms on it, last year $650 million of our revenue was upfront. This year, we're expecting roughly $800 million to be upfront. But the first half versus first half, last year, we had $350 million in the first half and $300 million in the second half because we had prioritized all those shipments in hardware and it skewed the numbers toward the first half last year. So $350 million and $300 million ending with the $650 million of upfront revenue last year. This year it looks more like $250 million and $550 million at the back end. But I know that's largely as a result of, we had a record backlog, our record bookings quarter in Q1. We've got a substantial backlog in IP that we're scaling up to deliver, a lot of that revenue falls into the second half. And also we launched these new hardware systems last week. Hardware revenue is expected to be more second half weighted now, because based on what we've heard, and I'll let Anirudh chime in here on the technical aspects of the new hardware systems, but we expect them to be so popular that a lot of demand will shift to those new hardware systems and we'll have to ramp up production to be able to deliver that demand. So it shifts some of the upfront revenue to the second half. So I think upfront revenue is really driving a lot of the skewed metrics. Anirudh, do you want to talk about Z3?

Joe Vruwink:

That's all very helpful, Thank you. Second question, I wanted to ask how -- some of the things you just spoke of, but also AI, start to change the frequency of customers engaging with you, how they approach renewals. So you just brought up how the [Harbor] (ph) platforms, the Velocity, there has improved from first generation to next six years. Now we're down to a three year new product cycle. When I listened to your customers last week talk about AI, they're not just generating ML models that can be reused, but then, of course, each run becomes better if you're incorporating prior feedback. So it would just seem like AI itself not only creates stickiness, but there would be an incentive to deploy it maybe more broadly than a customer traditionally would think about deploying new products. Does that mean the average run rates of a renewal ends up becoming much bigger and we'll start to see that flow in the backlog?

Joe Vruwink:

That's great. Thank you very much.

Charles Shi:

Thanks. Good afternoon. I just wanted to ask about the China revenue in Q1. It looks pretty light. I just wonder whether that's part of the reason that's weighing on your Q2. I understand you mentioned that you're going through that second-gen to third-gen hardware transition right now. Maybe that's another factor, but from your geographical standpoint, is what's the outlook for China for the rest of the year and specifically Q2. Thanks.

Charles Shi:

Thanks. I want to ask another question about the upcoming ramp of the third generation hardware. Where exactly is the nature of the demand? Is it the replacement demand, like your customers replacing your Z2 X2 with the Z3 X3, or you expect that lot more great deal of customers adopting Z3 X3 and more importantly I think you mentioned about 4 times to 5 times capacity increase they can design a larger -- much larger chips with a lot more transistors. How much of an ASP uplift you are expecting from the Z3 X3 versus Z2 X2?

Charles Shi:

Thanks.

Lee Simpson:

Great, thanks. And thanks very much for squeezing me on. Just wanted to go back to what you said last quarter, if I could. It did seem as though you were saying that there was an element of exclusivity around your partnership with Arm, your EDA partnership around Arm total design. I wondered how that was developing, if indeed you're collaborating to accelerate the development of custom SoCs using Neoverse. It looks as though it's pulled in quite a lot of work or continues to pull in quite a lot of work around functional verification. And I guess as we look at now third generation tool sets for Palladium and Protium, leaving aside some of the rack scale development that we're seeing out there, whether or not Arm’s total design, I guess development work is pulling in or is likely to pull in some of that second half business. That means not just hyperscalers, but perhaps in AI PCs and beyond. Thanks.

Lee Simpson:

Great, maybe just a quick follow up. You know, we've seen quite a bit of M&A activity from yourselves of late, you know, including the IP house acquisition of Invecas. You've had Rambus bought, you've now acquired BETA in the computer-aided emulation space for the car. There's been quite a lot of speculation in the market about the possibility of a transformative deal being done. I guess, given that we have you on the mic here, maybe if you get a sense from yourself, what would be the sort of thing that a business like Cadence could look for? Would you look for a high value and a contiguous vertical to what you've already addressed, let's say in automotive, or would it be something more waterfront, a business that spans several verticals, maybe being more relevant across the industrial software space? Could that be the sort of ambition that Cadence would have given the silicon to systems opportunities that are emerging? Thanks.

Lee Simpson:

That's great. Thank you.

Ruben Roy:

Thank you. Anirudh, I had a follow up on the Z3 X3 commentary that you had. And one of the things I was thinking about, especially as you talked about the InfiniBand low latency network across the multiple racks of Z3, you had mentioned that you're up to 85% attach rate of both systems with the Z2 X2. I would imagine that would continue to go up and if you can comment on if the new systems incorporate InfiniBand across Z3 and X3 and if so, do you expect that to be sort of a selling point for your customers that are designing these big chips, which in many cases these days have software development attached to the design process. Do you think that the attach rates continue to move higher for both systems?

Ruben Roy:

That's helpful. Thank you, Anirudh. And then a follow up for John. Anirudh mentioned HBM IP business, booked and shipping in second half. I was wondering if you can kind of give us a bigger picture update on how you're viewing IP in general in terms of bookings relative to sort of ramps of those IP sales. Is it sort of the entire segment sort of a second half? Should we think about the second half ramping at a heavier weight than first half or any update there would be helpful?

Anirudh Devgan:

Yeah, 1 thing, I want to highlight, I think you may have seen this, I just want to highlight our partnership with Intel and IFS. That was concluded in Q1. And so it's really good to see, you know, [Pat] (ph) and Intel investing more in the foundry business and also working more closely with us. So that's also a key contributor to IP, but like John said, we have to hire the people, do the -- we need to port our portfolio to the Intel process, okay? And that takes some time. So that's more will come towards the end of the year and next year. But we are pleased with that new partnership on IP.

Operator:

Your next question comes from the line of Jay Vleeschhouwer with Griffin Securities. Please go ahead.

John Wall:

Sure, thanks, Jay. Great question. I think what you're getting at there is what we would call add-ons. Typically, we have the very predictable software renewal business. And you'll see in the recurring revenue part of our business, I think we're at double digit revenue growth. But over the past few years, I think that's been at low teens. But we're seeing that a number of customers that have adopted AI tools are maybe not coming back and purchasing add-ons as frequently, but right now we're focused on proliferating those AI tools into accounts. I think there's an opportunity to increase pricing there, but maybe now is not the right time. I think we have such strong momentum on the upfront revenue business. We're preparing for scale into the second half there. But we'll have plenty of revenue growth in the second half of the year. We can continue to focus on proliferating our AI tools and technology into accounts. And pricing is something certainly we can focus on more intently in future years, but right now the focus is on proliferation. Anirudh, do you have anything to add to that?

Jay Vleeschhouwer:

Okay, Anirudh so [piggyback] (ph) to your conference last week, particularly the Gen AI track, it was interesting of course to hear the adoption presentations by Renesas, Intel and so forth. But what seemed to be taking place is a heavy focus on Cerebrus which makes sense, it is the one longest end-market. So perhaps you could talk about how you are thinking about the adoption curve for the other brands aside from Cerebrus? And are there any critical parts of the design flow that might not necessarily be amenable to AI enablement. We hear a lot about implementation, analog, verification but we don't hear a lot about AI as being applicable to synthesis, for example. So maybe talk about those areas where it makes a lot of sense and knows where perhaps it will remain more or less conventional technology.

Jay Vleeschhouwer:

Okay, very good. Thank you.

Gary Mobley:

Hi guys. Thanks so much for taking my questions. John, I appreciate the fact that China revenue in the first quarter was down against a tough year-ago comp on the hardware verification side as you work on backlog. And I assume that you still expect China to be dilutive to overall company growth in the fiscal year. Could you speak to whether or not you are starting to see US export controls begin to impact your ability to do business there, whether that be a function of restrictions around gate-all around or certain China customers added to the entity list.

Gary Mobley:

Okay. The follow up, I want to ask about bookings trends for the balance of the year. You obviously highlighted better than seasonal Q1 booking trends. How would you expect the bookings to play out for the balance of the year? And to what extent will Z3 and X3 factor into that for the balance of the year? Thank you.

Gary Mobley:

Okay. Thank you.

Jason Celino:

Hi, thanks for [heading] (ph) me. And Anirudh, congrats to your R&D team. [I] (ph) -- Impressed that they reduced the cycle there, all while designing that among [box] (ph), too, right? So -- maybe first, just how many of the -- for the Z3 and X3, does it become available in Q3? I guess when can customers start putting orders in for that?

John Wall:

Yeah, we try to derisk the guide -- with the assumption that there is going to be strong demand for the newer systems. But it will give us the opportunity to put some of the older systems into the cloud because we have a large underserved community that want to use our emulation capacity. But we haven't had a lot of capacity to share with them through our cloud offering. To the extent we do that, that will lead to ratable revenue though, because I think when it is used in the cloud, you get revenue over time, whereas when we deliver and they use it on-prem, we take revenue upfront.

Jason Celino:

Okay. Because that's kind of -- what I was going to ask next is I think last time in 2021, you had like a six month period where you are selling both. And I think, you were trying to clear inventory for the Z1 and X1. It doesn't sound like you will be trying to do that again. Because when I think, about this Q2 air pocket, is it a function of customers waiting for Z3 X3? Or is it a function of they might not want to buy the older version?

Jason Celino :

Okay, perfect. Thank you both.

Vivek Arya:

Thank you for taking my questions. I think you mentioned second half growth will be driven a lot more by hardware. Do you think you will see all the benefit of the hardware refresh within this year? Will it be done? Will it continue into 2025. I guess my bigger question really is that if I exclude the upfront benefit from last year and this year, your recurring business is expected to grow about 10%. And I'm curious, Anirudh, is that in-line with the kind of recurring revenue growth you are expecting or we should be expecting going forward, right along with periodic hardware refreshes -- or is that not the right way to interpret your core recurring part of your business?

John Wall:

Yes. And Vivek if I could -- I'd like to kind of take -- carry in some of Gary's question earlier that I don't think I addressed because he was asking about the bookings profile for the year. Q2 for software renewals, I think is our [latest] (ph) software renewals quarter for the year. But I think, we explained last quarter that we expect the weighting of bookings first half to second half to be about 40-60 this year. But the recurring revenue right now in the guide is about double digits -- above 10%. And in the past, it's been about 13%. Now we are not really anticipating a huge number of add-ons, but to grow that above 10%. To the extent that, that comes through, it will be upside to the guide. But what we try to do when we do the guide is de-risk for the risks that we can see.

John Wall:

Yes, Vivek, I think what you are referring to really is that, I mean, for what, seven years in a row now, we think we've been achieving over 50% incremental margins. It's a matter of pride here, we try to achieve that every year -- we'll certainly be trying to achieve that this year. I think we are in the high 40s. It's probably about 47% when you look at this guide right now. I think, one of the biggest challenges with something like that is you know, we do small tuck-in M&A, but I don't want to go over Lee Simpson – answer Anirudh gave to Lee Simpson, but organic is delicious here. At Cadence, we focus on innovation and growing with organically driven products and then with small tuck-in M&A. But to the extent that we do some larger M&A and of course, we have BETA CAE, which apparently is the gold standard in structural simulation. So that's a big acquisition for us. But -- now I think the size of that probably still qualifies as a small tuck-in. But when you do something like that -- that those M&A transactions typically are headwinds to that incremental margin calculation in the short-term, they will be beneficial in the long-term. But in the short-term, M&A can be -- dilutive pretty much in the first year and then becomes accretive later. When we look at our incremental margin that's a headwind. But we try to overcome that headwind because normally, all we do with these small tuck-in M&As So I haven't given up on 50% incremental margin for this year. It's a challenge, but we'll do our best to achieve this.

Operator:

Your final question will come from the line of Harlan Sur with JPMorgan. Please go ahead.

John Wall:

Yes, Harlan. That's a great question. And thanks for highlighting that -- because I had that on my list of things to say. I think there's something funny going on with the rounding on when you kind of apply the growth rates for SDA for Q1 over Q1, the actual growth rate is probably high single digits Q1-over-Q1. I know, that's lapping tough comps against Q1 '23. I think, if you look on a two year CAGR basis, I think it's up about 17% per annum on a two year CAGR basis for SDA. But we're expecting strong SD&A growth again this year, and it will be higher than the Cadence average. That's our expectation.

Anirudh Devgan:

Yeah Harlan, that's a very good observation. And the pace of AI innovation like is increasing and not just in the big semi companies, but of course, in these system companies. And I think several announcements did come out, right, including, I think now Meta is public that Meta is designing a lot of silicon for AI, and of course, Google, Microsoft, Amazon. So all the big, really hyperscaler companies, along with Nvidia, AMD, Qualcomm, all the other kind of Samsung had AI phone this year. So I mean, there is a lot of acceleration both on the semi side and on the system side. And we are involved with all the major players there, and we are glad to provide our solutions. And I do think -- and this is the other thesis we have talked about for years now, right, five years, seven years that the system companies will do silicon because of a lot of reasons for customization, for schedule and supply chain control for cost benefits, if there is enough scale. And I think, the workload of AI, like if you look at I think some of the big hyperscaler and social media companies, they are talking about using like 20,000, 24,000 GPUs to train these new models. I mean this is immense amount. And then the size of the model and the number of models increased, so that could go to a much, much higher number than right now that is required to train these models and of course, to do inference on these models. So I think, we are still in the early innings in terms of system companies developing their own chips and at the same time, working with the semi companies. So I expect that to grow and those that -- our business with those system companies doing silicon, I would like to say is growing faster than Cadence average. But the good thing is the semi guys are also doing a lot of business. So I don't know, if that 45% will -- because that's a combination of a lot of companies. But overall, the AI and hyperscalers, they are doing a lot more than so are the big semi company.

Operator:

I'll now turn it back over to Anirudh Devgan for closing remarks.

Operator:

Thank you for participating in today's Cadence first quarter 2024 earnings conference call. This concludes today's call, and you may now disconnect.

Operator:

Good afternoon. My name is Brianna 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 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I will now turn the call over to Richard Gu, Vice President of Investor Relations for Cadence. Please go ahead, sir.

Anirudh Devgan:

Thank you, Richard. Good afternoon, everyone, and thank you for joining us today. I'm pleased to report that Cadence delivered an outstanding Q4, wrapping up a record 2023, achieving 15% revenue growth, 42% non-GAAP operating margin, and over 20% non-GAAP EPS growth for the year. We exited 2023 with a record backlog of $6 billion, as customers increasingly committed to our chip-to-system integrated design and analysis platforms. We expect our innovative solutions to continue driving broad-based business momentum in 2024. John will provide more details in a moment. Secular trends of digital transformation, hyperscale computing and autonomous driving, all bolstered by an AI super-cycle, continue to fuel strong broad-based design activity. We continue successfully executing to our Intelligent System Design strategy, that triples our TAM opportunity while greatly expanding our portfolio. Our innovative engine delivered several significant products including most recently, the revolutionary Millennium M1 platform, the industry's first accelerated multi-physics supercomputing platform. The platform tightly integrates our Fidelity CFD software with high-performance GPUs and combines AI, HPC and digital twin technology to deliver an unprecedented 20x energy efficiency and up to 100x design impact. We were honored to have customers including Honda, Boeing and GE as speakers at our launch event. We substantially grew our footprint at market shaping customers and furthered our relationships with key ecosystem partners. We furthered our partnership with Intel Foundry through a strategic multi-year agreement on providing design software and leading IP at multiple Intel advanced nodes, thereby advancing Intel's IDM 2.0 strategy and accelerating mutual customer success. Cadence is at the forefront of the AI revolution, closely partnering with marquee companies on their trailblazing AI designs for training and inference from cloud to the edge. NVIDIA and Cadence have collaborated closely over several years, and in Q4, we deepened our partnership through a meaningful expansion of our hardware solutions and EDA software. Earlier in the quarter we announced our work on Cadence.ai with NVIDIA's Nemo Retriever, and now we're thrilled to deepen our partnership and extend it to the new Millennium MultiPhysics Supercomputer and SaaS solution which is co-optimized with NVIDIA's Accelerated Computing and AI platform. And as the exclusive EDA partner of Arm Total Design, Cadence and Arm are closely collaborating to accelerate the development of custom SoCs based on the Neoverse Compute Subsystem. Over the year, we've continued building out our generative Cadence.ai portfolio, the industry's broadest AI offerings spanning chip to board to system, and delivering exceptional optimization and productivity benefits. Earlier in Q2, we introduced Virtuoso Studio and Allegro X AI, bringing AI to custom/analog and PCB designs. And in Q4, we added Voltus InsightAI for automatically addressing voltage drop violations. We also pioneered bringing LLM capabilities to chip design, successfully helping Renesas accelerate functional specification to final design. Accelerating momentum of our Cadence.ai portfolio has led to an almost tenfold increase in the number of customers adopting our GenAI solutions in 2023, as customers embrace the technology to develop optimized products much more efficiently. Now, let's talk about some of the product highlights for Q4 and 2023. Rising system complexity and challenges stemming from the growing hyperconvergence of the electrical, mechanical and physical worlds, are driving the need for a seamless platform solution across design, packaging, simulation, and analysis. We made this a core tenet of our Intelligent System Design growth strategy six years ago, and our System Design and Analysis business continued its strong momentum, delivering 18% year-over-year growth in Q4 and 22% growth for the year. PCB and advanced packaging are linchpin technologies that sit at the crucial intersection of mechanical and electrical domains and Cadence's rich heritage in these areas remain a key strategic differentiator, especially in the emerging chiplet era. We continue advancing these technologies with Allegro X AI providing greater than 10x acceleration in PCB design, and endorsed by Schenider Electric and Kioxia at its launch. Our multi-physics analysis portfolio couples our expertise in physics-based modeling with AI-driven optimization and is delivering superior results to customers across multiple vertical segments, especially aerospace and defense, and automotive. Recently, we launched Celsius Studio, the industry's first complete AI thermal design and analysis solution for electronic systems, delivering up to a 10x performance benefit over legacy systems, with endorsements by Samsung and BAE Systems. And Wistron, a leading technical services provider used Optimality's AI-driven optimization technology and Clarity for fast, accurate electromigration in-design analysis, improving design reliability while realizing a 2x improvement in turnaround time. Our digital IC business finished another strong year with 22% revenue growth in Q4, as our solutions continued gaining share at market shaping customers, especially at the most advanced nodes. Our digital software is proliferating in all top 20 semiconductor companies and our digital full flow was adopted by 34 additional customers during the year. We are very pleased with the accelerating momentum of our flagship Cadence Cerebrus GenAI solution, whose transformative PPA and productivity benefits have led to its deployment in all our top 10 digital customers and used in well over 300 tapeouts. In Q4, Cadence Cerebrus run rate more than quadrupled at several market shaping customers and it also drove significant digital full flow expansions at two top tier semi customers Our Integrity 3D-IC platform is the industry's only unified 3D-IC design and analysis platform and ties our best-in-class SoC and package design technologies with system-level planning and analysis. In Q4, GUC successfully used Integrity to tapeout a complex 3D stacked die design with a wafer-on-wafer structure on an advanced FinFET node. Next, I will talk about our Functional Verification business, which had another remarkable year, delivering 11% year-over-year revenue growth in Q4 and 22% growth for the full year. Escalating system and software bring-up challenges, along with the pressing need for first-pass silicon success, continued driving strong demand for our Functional Verification solutions. Our best-in-class dynamic duo of Palladium Z2 and Protium X2 platforms delivered another record year, with strong momentum across AI, hyperscale, auto and mobile. Virtually all of the top hyperscalers are Palladium customers and the majority of them are also Dynamic Duo customers. Last month, we announced a new set of Palladium Z2 applications that included the industry's first four state emulation and mixed signal modeling capabilities, that will significantly accelerate SoC verification. Marquee customers including NVIDIA and Samsung supported the announcement. Our hardware family added 26 new and over 110 repeat customers during the year, with the top three deals being with a global marquee systems company, the leading AI systems company, and a leading communications services company. Demand for the Duo greatly exceeded our expectations with more than two-thirds of the orders in the year including both platforms. Our Custom IC Virtuoso and Spectre franchise solutions tackle the most complex challenges in analog, mixed signal, RF design and circuit simulation, and are increasingly crucial for our customers. Building on our market leadership, our Custom IC revenue grew 16% year-over-year in Q4. Customer interest in our recently announced Virtuoso Studio is strong with over 2,000 downloads so far and adoption of our newer Spectre platform products continues to ramp. Virtuoso had a major win with a top global memory company, which replaced its internal tools with our technology. Our IP business drove a strong finish to the year growing 36% year-over-year in Q4. We continued to sharpen our star IP strategy with targeted acquisitions such as Rambus PHY IP and Invecas to capture market opportunities offered by AI and heterogenous integration. Customer interest in the Rambus PHY assets, especially HBM and GDDR IP have been extremely positive which have already been instrumental in closing some strategic deals. Our Invecas acquisition is also highly synergistic to the strategy, adding a skilled engineering team with expertise in delivering custom solutions across design, product engineering, advanced packaging, and embedded software. In closing, we are pleased with our outstanding performance in 2023 and are excited by the business momentum and market opportunities in 2024. Now, I will turn it over to John to provide more details on the Q4 results and our 2024 outlook.

Operator:

[Operator Instructions] Your first question comes from Jason Celino with KeyBanc Capital Markets. Please go ahead.

John Wall:

Jason, yes, it was very broad-based, broad-based across geographies and broad-based across all of the businesses. Actually on the hardware front, you might recall this time last year, we finished with over six months of backlog for hardware. We addressed those lead times at the start of the year and now we're down to a more normal eight weeks of hardware backlog. So, when you compare the backlog at the end of '23 against the end of '22, I think it reflects strong bookings, broad-based bookings across all geographies, across all businesses, but on the hardware side, slightly less hardware or maybe less hardware certainly in backlog at the end of '23 versus the end of '22.

John Wall:

Yeah, great question, Jason. Last year was kind of very heavily weighted towards the second half of renewals. We don't expect it to be that heavily weighted in the second half this year. Looking at software renewals and when they come due, if you look at the annual value, it's probably weighted 40% first half to 60% second half.

Operator:

Your next question comes from Charles Shi with Needham. Please go ahead.

Anirudh Devgan:

Yeah. Hi, Charles. This is Anirudh. So, as you know, we have been executing on our Intelligent System Design strategy for six years now. We started this in 2018 and we know for a while that there will be this convergence of electrical and mechanical domains. This convergence of system and semi companies, semi companies becoming system companies and system companies doing silicon, as you all know. And now we have commented that about 45% of our business is coming from system companies. But this is not -- I mean, we have been executed on this from 2018 and focusing on, of course, our core business, which is EDA, expanding into SD&A, which is what we call System Design and Analysis, and of course AI over the last five, six years. And if you look at our results on SD&A, even in 2023, our business revenue is up 22% in SD&A. And it has been up more than 20% for last several years, whereas that market is not really growing at that rate. So, we are gaining a lot of share in SD&A. And this is primarily due to our products, right, and our customer response. So, the customers have really embraced our strategy and embraced our product differentiation. So, we first started with Finite Element with Clarity, and that is benchmarking very well, winning a lot of share, a lot of customers. And then, recently, you must have seen our new product in CFD. CFD is a big market. That's the -- there are two big simulation areas in SD&A

Anirudh Devgan:

Yeah, hi, Charles. That's a good question on digital. I mean, there are multiple reasons driving that, but I would say the main reason -- and we had good growth in Q4, as you saw in our digital business. But of course, the main reason that's driving that is the AI super-cycle. So, there's a lot more design activity. You will notice some of our key partners increasing the cadence of their major kind of product development. So, there's AI. In AI, we participate in several ways. One is just the buildout of the AI infrastructure, which is, of course, our great partnership with NVIDIA and all the other hyperscalers. And then, also, our AI-enabled products like Cerebrus and Optimality and overall AI portfolio. So, as I mentioned in my prepared remarks, Cerebrus, which is the flagship product for digital implementation using AI, our business went up 4x, right? So that's also providing a lot of growth in terms of -- so there's one, there's overall much more design activity, especially at the most advanced node, and then AI products provide acceleration on top of that. And then, the other thing that I had mentioned before, but as people use Cerebrus, which is the overall AI product in digital implementation, it also has a pull-through of the full flow, not just place and route, but also synthesis and signoff. So, what I'm very pleased to see is one AI products like Cerebrus are doing well, but they're also pulling through synthesis. Our position has improved dramatically in synthesis in the last one year and also a lot of signoff engagement. So overall, I'm pretty pleased with the technology progress, the AI progress. And also engagement with some big customers that traditionally were not using Cadence, and now, like we mentioned, all top 20 customers are using Cadence solutions in digital. So, we'll see how it progresses, but I think it's good progress on digital and I expect that to continue.

Charles Shi:

Thanks.

Vivek Arya:

Thanks for taking my question. I actually had a question on growth. Just kind of first on the segment side, IP growth has been more modest than the entire company growth. So, I was hoping if you could give us some color on that. But then, Anirudh, my bigger question is that, when I look at the overall sales growth for Cadence, right, so 19% in '22, then 15% last year, and now 12% is what you're guiding to for this year. I mean, these are impressive growth rates versus the semiconductor industry. But still it shows a deceleration, right, for the last few years, which is very different than the acceleration that we see for a lot of other semiconductor companies that are exposed to the AI and generative AI theme. So, what is the right way to interpret this deceleration in your sales? Like, should we be expecting acceleration back at some point as some of these AI initiatives get bigger? Or what is the right way to interpret and compare your growth rate versus the acceleration of growth in a number of the AI names?

John Wall:

And Vivek, I'd just like to add, I mean, you asked about how to look at the revenue growth. We tend to look over a three-year CAGR, because most of our customers are in three-year baseline contracts on the software side. And if you look at -- since 2017, our three-year CAGR has been accelerating and it continues to accelerate. In 2022, we hit 15%. We actually exceeded 15% on a three-year CAGR basis. For last year, we're very, very pleased that we were over 15% again. And then, at the midpoint of the guide for '24, the three-year CAGR is about 15.3%. So that would be three consecutive years of over 15% revenue growth on a three-year CAGR basis. Now, from time to time, you can get some lumpiness in things like hardware timing or IP timing, and that can distort individual quarters or individual years. But we do think looking over a three-year CAGR basis is probably the best way to look at it. That's how we look at it ourselves.

John Wall:

Yeah, sure. Great questions again, Vivek. On the incremental margin front, we typically don't start the year in the initial guide with over 50%. We tend to start lower than that and we build towards greater than 50% with growth through the year. As you know, we always like to under-promise and over-deliver. And if you look at our incremental margin over the last few years, it was slightly lower in 2023 compared to previous years. And that's because on the organic side, we had incremental margins north of 55%, but we did some acquisitions. And typically, when you have an acquisition, it can be dilutive in the early year or two, and that's a bit of a headwind for incremental margins. In relation to China, glad you asked me about that, China, the last four years for China, China has contributed 15% of our 2020 revenue, then followed that with 13% of '21, 15% in '22 and 17% in '23. Now, last year, I think China benefited from that large hardware backlog that we had. There was kind of an outsized portion of that backlog was for the China region. So, it was a boon year last year for China. I wouldn't expect to repeat that this year. In fact, our guide would expect China to be flat or slightly down. So, we've kind of de-risked China into the 14% to 15% range for this year, which would be consistent with the previous three years.

Operator:

Your next question comes from Gary Mobley with Wells Fargo Securities. Please go ahead.

John Wall:

Yeah, Gary, good questions. In terms of cRPO and the relationship between cRPO and this year's revenue, if you recall last year, we had over six months of hardware backlog in cRPO at the end of 2022. So, a large portion of our hardware revenue in '23 came out of backlog at the end of '22. We ramped up production capacity and we're back to more normal levels of about eight weeks lead time now for deliveries on hardware, which is really, really important for customers. Customers want to be able to purchase the hardware and feel like they're going to get delivery of that hardware within a year. So, typically, your revenue on hardware is more correlated to your production capacity than it is to what's coming out of backlog versus what's coming out of new business in the year. And as a result of addressing those hardware lead times, the revenue profile for this year takes a slightly different shape to 2023. In 2023, in Q1, we had a lot of hardware coming out of backlog. In 2024, we expect another record hardware revenue year and the business is planning to build more hardware each quarter throughout 2024 to meet that demand. But there's kind of more of -- I guess, hardware revenue is expected to grow quarter-over-quarter this year, whereas last year Q1 was our biggest hardware quarter.

John Wall:

cRPO would include hardware. I mean, even when you have over six months hardware delivery lead time, it would all be expected to revenue in a year. So that's -- although it's in your backlog, it's also all in your cRPO. So, cRPO last year would have had a lot more hardware in it than cRPO this year, certainly on the product revenue side.

Anirudh Devgan:

Yeah. Hi, Gary. So yeah, I think Cerebrus is doing very well. It's deployed at all the top 10 customers. And actually, even AI, in general, we mentioned number of customers engagements are up like 10x in the last 12 months. And so, Cerebrus, run rate -- as we have mentioned before, the Cerebrus business, first the customers will try some and then they will adopt more. So, I think what's good to see in Q4 is what people were -- what the customers were doing and then they have adopted that in a much bigger -- at a much bigger rate. So, we are happy to see that. I think there is still room to go in that. Like we have always mentioned that we think it will take two contract cycles and we are like -- that's six years and we are like two years into it or two or three years into it. But that's good in our model, right? We want consistent growth going forward, but yes, the uptake in Cerebrus is very promising. And then, the other products are -- came a little after Cerebrus, like Verisium or Allegro X AI or Virtuoso Studio or Optimality, and they're also seeing good progression. So, overall, in terms of AI, what I'm very happy about is, I mentioned this before also in the last call, we have three big ways to benefit from AI. And this is true for any kind of new technologies. There are a lot of comparisons to AI, but if you compare it to like the Internet, the first phase is the infrastructure development, okay? So -- and this are marquee partnership with NVIDIA, which we have had for more than a decade. And we talked about it today, we're developing AI products with them. Them developing their own chips. Palladium, we are a development partner with NVIDIA in Palladium for more than a decade. And that also puts Palladium in a very strong position with all the other kind of AI developments. So that's the first phase of AI benefit, which is more the infrastructure. And then, the second phase is like what you asked, which is our own products. And it started with Cerebrus in digital side, but now we have five major kind of co-pilot platforms in all the five businesses. And those are progressing pretty well moving from like initial deployments to more wider deployments. And that's the second phase of AI deployments in which AI will be adopted into existing products, like chip design and system design. And one thing I want to point out is there's a lot of talk of what is a good application for AI. I believe one of the best applications for AI is chip design. It's because over the last 30 years, we have done so much work in automatic chip design. We have a language like RTL. We have all kinds of optimization we have built in. So, the chip process is already very automated. So, it's an ideal thing to apply AI on top of it for chip and systems design, which is what we are seeing. And then, the third phase of AI is new products that will enable. And I have believed for several years, and that's why the investment in OpenAI -- the OpenEye. The biggest new market that AI will enable will be life sciences, okay, and biosimulation and bio life sciences. And I think you will see that years going forward. So, there are these three phases of our AI activity

Operator:

Your next question comes from Jay Vleeschhouwer with Griffin Securities. Please go ahead.

Anirudh Devgan:

Yeah, hi, Jay, good question. I mean, as you know, we are a very innovative company and we have done that for years now and we invest one of the highest percentages of R&D -- of revenue into R&D. And then, it's good to have all these new products in multiple areas. Of course, the three big areas being like EDA, SDA and AI. But we don't try to like rank our children. We want all of them to do well. And it's also difficult to predict how it will -- because these are all for the long run, right? So, there is, of course, a lot of momentum with the AI products. There's a lot of momentum with 3D-IC and chiplet, as you know. There's Millennium, I'm super excited about. I think this is the biggest innovation in CFD in the last 30 years. And I talked about the three-layer cake, right, which is AI orchestration at the top layer, the physical simulation physics-based modeling at the middle layer, and then accelerated computer at the bottom layer. And CFD needed to be disrupted in that context, right? So, we have it -- and we didn't talk about it much when we made the acquisition about two years ago, is this acquisition from Stanford Cascade, which is very, very high fidelity, very accurate to CFD. So, we had that at the heart of it, and then AI on top, and then accelerate compute at the bottom together with NVIDIA, and this completely changes the game in CFD. For the first time, we are able to simulate entire cars and planes in a few hours. It's almost emulation for systems that have never been possible before. So, there is a lot of potential in Millennium now, because Millennium is a new product. We are offering both cloud and on-prem. Palladium is mostly, as you know -- on our chip business, Palladium is mostly on-prem, but Millennium is both in CFD. And right now, most of the customers are choosing the cloud version, which is great, it's more ratable, okay? So then, Millennium. And then, you must have seen today, we have this great partnership with Dassault. Actually, I'm also pretty happy about that. Dassault is a leader in PLM and MCAD and overall partnership, we have broadening partnership with Dassault. And then, we talked about our IP business, how that can grow, and this new partnership with Intel and IFS, and hardware continues to do well. So, I think it's good to have multiple engine, contributing to the growth. And then, we always focus on margin at the same time. So, we are well positioned going forward, but it's difficult to predict which one will do better than the others, and we don't guide on a product basis anyway as of now.

Anirudh Devgan:

Yeah, Jay, that's a good question. I mean, one thing to point out, our SDA business is about -- in 2023, is about 12% of revenue. It's already at a good pace. And also, it has enough scale now to apply significant of R&D to that space. And also simulation space, right? We know simulation space pretty well. And there's a lot of high R&D synergy from our EDA R&D to SD&A R&D. So, I'm pretty happy with how much R&D we have invested and we'll continue to invest there. But at the same time, it is also very profitable, okay, which is -- which our model always, right, is not just revenue growth, but also profitability. And which we -- when you asked me what -- we thought it should be more profitable when we started six years ago because simulation is more profitable in EDA. So that's what is playing out in SDA. So, it is pretty profitable. And it has played out roughly to the extent I thought it would. Simulation always is accuracy first and then performance and capacity. And the market is always looking for new simulators, and that's how it has played out in electromagnetic. And then, in CFD now I'm much more confident with this disruption, this massive disruption with Millennium. And the key thing with Dassault, and we have mentioned this before, as we -- I'm very confident in SD&A. You can see in terms of product synergy, product differentiation, but we have always said that we are a computational software company. So that also means what we will not do, right? So typically things in the system space, which are not as computational are things like PLM, things like implementation MCAD, mechanical CAD platforms, and Dassault is the clear leader in those. They are great in PLM, they are great with SolidWorks, in CATIA, in the high end. So, it's a perfect partner for Cadence, as we focus on computational software and EDA and SDA, packaging and PCB to partner with Dassault, and we're glad to see that expansion that was announced today.

Operator:

Your next question comes from Harlan Sur with JPMorgan. Please go ahead.

Anirudh Devgan:

Yeah, good question. I think the shape of the IP revenue last year was a little atypical. I mean, I think the two reasons were in 2023 we had very, very strong Q4, but first three quarters were not strong at all. So overall year is in the single digits, like you mentioned, but a very strong Q4. So, I think there are a couple of reasons for that. One is that there were some tough compares from '22 to '23 in IP, especially in the beginning of the year. And then like I mentioned, of course, last couple of years, the macro environment has been tough, though it is improving now. And then, IP typically gets affected more than others, in terms of a tough macro semiconductor environment. So, as a combination of that, I think the first three quarters were more challenging. But Q4 and then going into this year, I'm pretty cautiously optimistic about IP. One, our portfolio is better, is broader, and then this whole AI super-cycle, like I mentioned, and then, new engagements we have like with IFS and other companies. So overall, I feel better about '24. John, you want to comment about the...

Anirudh Devgan:

And then, we expect the IP growth to be higher than Cadence average this year. We'll see how it plays out. Okay? Yeah.

Anirudh Devgan:

Absolutely. Even for 30 years, even when I was in grad school, I always believed that hardware acceleration is a massive opportunity for EDA and SDA in general. And you see that borne out in Palladium. So, we have always dreamed about hardware acceleration. And that's why this three-layer cake, hardware acceleration is the bottom layer. And of course, AI orchestration is the top layer. And a perfect example is Palladium. Now, in Palladium and hardware emulation, what happened is, if you look at overall function verification on the chip side first, it's more than a $2 billion business, okay, I think if you look at all the software. And hardware became roughly 50% of that. So, hardware-assisted verification became almost 50% of chip verification. Now, CFD is also a $2 billion business, okay, and it needed this hardware-based acceleration along with AI. So, I don't know whether it will play out the same way, but there's a potential of a big portion of CFD to go to hardware-based acceleration, okay? Now, it will take a few years, and we are clearly leading in that. And the other thing it does, hardware-based acceleration or emulation for CFD, is it will improve the market size of CFD as well. Like I was talking to one of these big aerospace companies and they said, current CFD, the current simulation is only done to 20% of the flight envelope, okay, which is unheard of in chip design, right? In chip design, we simulate 99-point-some percent of the use cases so that when the chip comes back it works. But if you look at the system domain, because the accuracy is not there, because the speed is not there, they're only covering 20% of the use cases and all of them only in software. So, the potential with Millennium is one that 20% goes to much closer to much higher than 50%, and then a big portion of that can go to hardware-assisted emulation and verification. And by the way, the same thing can repeat again, this three-layer cake can repeat again in bio, which is a few years out. But I think right now the opportunity is there in system simulation and CFD. So, I'm pretty optimistic, but it's a new use case for that market. And sometimes the new use cases can take some time to deploy. So, we always have to be cautious about that. But the response so far has been phenomenal. And because they were doing some of this themselves, the customers, but to have a combined solution with AI, software, and hardware. And you are exactly right. It mimics our success we have done on the chip side.

Operator:

Your next question comes from Gianmarco Conti with Deutsche Bank. Please go ahead.

John Wall:

Thanks, Gianni, for the question. Yeah, on the revenue side, we expect 2024 to take a slightly different shape to 2023. That's largely a function of the revenue mix by quarter. You'll recall last year, in 2023, we had 20% up-front revenue in Q1 when the year ended up at 16%. But this year for Q1, we're expecting 14% in Q1 when the year is expected to be 17.5%. So, clearly from that you expect that -- we'd expect that up-front revenue to increase quarter after quarter this year, whereas last year Q1 was really the high watermark for up-front revenue. And then, on the expense side, we've invested heavily. We have about 1,000 extra heads this year. And that's for continued innovation and we're launching new products all the time. But so that -- but that expense on some of the acquisitions is more front loaded for the year. And as a result, that's kind of feeding into lower margins for Q1 in comparison to the rest of the year. For Q2, Q3 and Q4, we'd expect margins to be similar or higher than last year. Yeah, I think that's -- those are probably the main things to get across.

John Wall:

Yeah, Gianni, let me take the second part first, and I'll come back to the cash question. So, last year we had over six months of lead times for -- hardware delivery lead times. So there was a lot of last year's hardware revenue came out of backlog. The 5% shift can pretty much all be allocated to less hardware coming out of backlog for this year. Now, hardware revenue for the year will probably be more a reflection like it has been the last few years of just how much hardware we're able to produce in the year. And we expect to increase hardware production each quarter for this year to meet the demand that we're expecting. Last year, the operating cash flow was kind of muted. It was less than, although we beat on all our metrics, we came in just under the midpoint of $1,350 million. I think it was $1,349 million for operating cash flow. But that included us investing, spending a lot to ramp up on purchase -- advanced purchase of raw materials to build that inventory that we believe we need for hardware this year. We intend to do that again in Q1. So, we've already included that in our operating cash guide. So, we're investing some of that operating cash to improve gross margins by pre-purchasing a bunch of raw materials that we believe we need for -- to keep up with the demand on the hardware side. The other thing I wanted to highlight is that the business' forecast for hardware is again for another record hardware revenue year and for hardware demand to continue to accelerate quarter after quarter this year. Normally, I wouldn't include some of their expected demand for the second half, but until I see that, it's a pipeline business. So, we look at lead times. We look at the pipeline kind of closer to the summer before taking up the second half of the year. So, the guide does not include the full forecast from the business. I like to hedge that back in the second half until we get to the summer. I'd prefer to see the pipeline come through and then, there is potential to take the second half higher when we see that pipeline.

Operator:

Your next question comes from Josh Tilton with Wolfe Research. Please go ahead.

John Wall:

Yeah, I think that's fair. That's fair. But I didn't include the full forecast. The guide would have been higher. Of course, we have strong IP as well this year. I mean, certainly compared to last year, IP didn't contribute a huge amount. I mean, it's been great business for us. But we're much more confident going into '24 of the IP contribution to 2024 revenue. But hardware is going to be strong. Again, I mean, by nature, we always like to kind of hold back on the second half guide for hardware until we see the pipeline around summertime. So I haven't included the full forecast from the business in the guide.

Anirudh Devgan:

Well, I don't think that will change the competitive landscape at all, is my assessment, in digital or even in SD&A. Because digital anyway, we are competing very effectively in the marketplace. And with this AI, it is pulling in a full -- digital full-flow position. I think your comment may be more tied to part of digital, which is like 3D-IC. But with 3D-IC, we've always talked about there are three big portions of 3D-IC. There is actual chip implementation tools, which is -- I mean, digital is much bigger than that, right? Digital, we have a very big business, which is growing at all the top 20 customers. But 3D-IC has these three components to it. One is the chip design tools. So, in chip design tools, we are the only company that has both analog and digital chip implementation, okay? And the second part in 3D-IC is package design. And Cadence is the leader in package design, and that thing is still the very strong differentiation, no matter what the M&A news is outside. And then, the third part is the simulation tools like thermal and electromagnetic, and there we are already doing pretty well. So, I'm very confident in our product positioning and competitive advantage, no matter what happens on the M&A side, because anyway, we are competing very effectively. And then, the other thing that is good about Cadence is we also form very strong partnership in the ecosystem. We talked about Dassault on the SD&A side. But the other one that I want to highlight, we have a lot of news today, but one of the things I want to highlight is our partnership with Arm. Arm is also expanding into what they call Total Design, going into more towards silicon, more towards custom solutions. And we are the exclusive partner with Arm as they go implement that. And that really also helps our digital business. And so, overall, I feel pretty confident in our digital position, including 3D-IC.

Operator:

Your next question comes from Ruben Roy with Stifel. Please go ahead.

Anirudh Devgan:

Yeah. I think AI is definitely helping us already. Like you mentioned about our AI tools by itself has gone up by 3x and then Cerebrus more -- higher than that, and then also AI itself is -- the infrastructure part of AI, like our partnership with NVIDIA and all the hyperscalers. So, overall, we are pretty pleased with that. But of course, we are mostly a ratable business. So, these things take like multiple years to bleed in. And I think that's fine. Our model always is to have strong revenue growth and margin growth. So, I think this thing will still take multiple years to come into our model, but I think that's a good thing. It provides multiple years of growth.

Ruben Roy:

Right. Okay, that's very helpful. Thanks, guys. And then just quickly, John, you talked a lot about the hardware, and I think it's pretty clear at this point. But just to make sure I understand, it sounds like lead times have normalized. Is that correct? And also, in terms of sort of the visibility you get from your customer base, that hasn't changed, right? Is that what you're saying in terms of how far out your customers are ordering it? I guess it would be just kind of a function of increased attach rates, which is giving you the confidence that you're going to have another big growth year in hardware. I just want to make sure I'm thinking about that correctly.

Ruben Roy:

Got it. Okay. Thank you.

Joe Vruwink:

Great. Thanks for squeezing me in. Just to follow up on some of the earlier questions. So, I think of your growth as being tied to the R&D budgets at your customers, not the revenue at your customers. And certainly R&D budgets, they tend to move around more steadily perhaps. And then, Anirudh, you mentioned earlier, a lot of your revenue is ratable at the same time. So basically, changes can take some time to work through the model. I just wanted to ask though, because I think 2024 has the potential to see a pretty big inflection in R&D spending within the semi-customer base. If you are maybe seeing that

John Wall:

Yeah. Certainly everyone's field seems to be more optimistic this time this year compared to this time last year. This time last year, everyone was asking me "When was the recession going to happen?" But this year, design activity seems to be strong. Even when we talk about China, we're still seeing strong design activity in China, but I de-risked the guide for that because part of the large outperformance in China last year in achieving 17% of our revenue was because of that hardware backlog. And now that we're back to more normal lead times, it's prudent to assume that China revenue drops back to prior levels of between kind of 14%, 15%. But so that's embedded in the guide. I thought the right thing -- I mean, we always -- the approach this time of the year is always try to de-risk the guide for the things that we think people might be concerned about, and then have the business focus on doing the best business with customers for the long term. But we always feel our Cadence employees do the best business when they're not chasing.

John Wall:

Yes, yeah, of course. And partly it's that, I mean, if you've seen over the last number of years, we've seen the up-front contribution to our revenue mix has been increasing and it went from 15% in '22 to 16% last year. And I think what you're referring to is that we expected to go to 17.5% this year. That's a virtue of an expectation that we're going to have another record hardware revenue year, that we expect stronger IP growth this year compared to last. We feel much more confident in contribution from IP growth. And of course, we're launching new products all the time. Now, in relation to things like Millennium, we expect a large part of Millennium sales to be cloud-based, but maybe not all of them will be cloud based. I think that's another tailwind potentially for up-front revenue for the year. But I've hedged back slightly what I expect in the second half, because I'd like to see the pipeline in the summer before we take that up even higher. But the forecast is higher than 17.5%. But I'm only comfortable with going out with a guide of 17.5% for up-front revenue for this year.

Anirudh Devgan:

And just to add, AI contributes to -- I mean, the AI design activity, as you know, contributes to hardware strength, given our strong position. And also, AI is more HPC and chiplet based, and it does help our IP business as well, and then, all the comments on Millennium. But let's see how it progresses. But yeah, I mean, the IP is also strong this year along with hardware and Millennium.

Operator:

I will now turn it back to Anirudh Devgan for closing remarks.

Operator:

Thank you for participating in today's Cadence fourth quarter and fiscal year 2023 earnings conference call. This concludes today's call. You may now disconnect.

Operator:

Good afternoon. My name is Bo, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence Third Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' prepared remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I will now turn the call over to Richard Gu, Vice President of Investor Relations for Cadence. Please go ahead, sir.

Anirudh Devgan:

Thank you, Richard. Good afternoon, everyone, and thank you for joining us today. I'm pleased to report that Cadence delivered strong results for the third quarter of 2023. We exceeded our Q3 guidance on all key metrics and are raising our outlook for 2023. John will provide more details on our financials shortly. Notwithstanding the macro uncertainties, design activity remains strong, driven by transformative generational trends such as AI, hyperscale computing, 5G and autonomous driving. Growing hyperconvergence between electrical and mechanical domains, systems and semis, and hardware and software, is driving the need for tightly integrated co-design and analysis solutions. Additionally, trends such as a growing number of 3D-IC and chiplet designs, and system companies building custom silicon, are accelerating. In this rapidly evolving design landscape, the relevance of AI-driven design automation cannot be overstated, as it's enabling customers to accelerate their pace of innovation, while enabling them to meet their targets more efficiently. Over the past few years, we focused initially on incorporating powerful AI algorithms in our core engines, and then built our Generative AI solutions on top of our software platforms. We are seeing growing momentum for our comprehensive JedAI Generative AI platform, with an increasing number of customers adopting these solutions, and achieving exceptional quality of results and productivity gains. While still in the early stages, sales of our GenAI solutions have nearly tripled in the last year. Our solutions are enabling marquee AI infrastructure platform companies to deliver their next-generation compute, networking, and memory products. Last quarter, we had referenced our successes with NVIDIA and Tesla. And this quarter, we're pleased to announce that Broadcom has accelerated the adoption of Cadence Cerebrus across multiple business units, achieving impressive quality of results. In Q3, we pioneered leveraging GenAI's LLM capabilities to chip design, successfully collaborating with Renesas on accelerating functional specification to final design. This is a key step in demonstrating the potential of LLMs to automate the translation of natural language specifications to final chip design and verification tasks, thereby boosting their quality and efficiency. We also renewed and deepened collaborations with some large semi and systems customers in the 5G, AI, hyperscale and connectivity areas. For instance, we strengthened our long-standing partnership with a global marquee systems company through a significant expansion of our EDA software, hardware, design IP and system solutions. As the digital transformation in aerospace and defense accelerates, we continued our momentum by enhancing our core EDA and systems footprint with several customers, including at two market shaping companies. Now let me share some of the business highlights starting with Digital IC. With 11 new wins, our digital full flow delivering industry leading quality of results at the most advanced nodes, continued proliferating with market shaping customers. We are very pleased with the accelerating momentum of our flagship Cadence Cerebrus GenAI solution, whose transformative results have led to its deployment at all of our top 10 digital customers and in about 300 tapeouts to date. Imagination Technologies used Cadence Cerebrus and our digital full flow on its latest 5 nanometer GPU design in the cloud, to achieve a 20% reduction in leakage power. Next, I will talk about our Functional Verification business, which had another strong quarter with 18% year-over-year revenue growth. Ever-growing system design complexity coupled with the need for first time right silicon, continued to drive strong demand for our Palladium Z2 and Protium X2 hardware platforms that provide industry-leading system verification and software bring-up capabilities. Our hardware business had a record Q3 with close to half of the hardware orders including both platforms. Highlights for the quarter included a major dynamic duo expansion with a top AI and automotive chip supplier, and a significant deal with a market shaping datacenter chip company. Our flagship Custom IC business continued to pave the way in analog innovation, delivering 15% year-over-year revenue growth. We're pleased with the reception to our AI-driven Virtuoso Studio solution as several marquee customers adopt it for their N2 and N3 designs, and it has close to a thousand downloads since its launch six months ago. And Nisshinbo Micro Devices utilized the Virtuoso Studio Custom IC design platform to gain a 30% reduction in turnaround time for routing analog blocks. In Q3, we continued investing in our IP business and closed the acquisition of the Rambus PHY IP assets. Customer reception has been overwhelmingly positive to the addition of their HBM and GDDR IP to our Star Design IP portfolio. Design IP had a record bookings quarter with strong AI and chiplet design activity, especially in the mobile, automotive and hyperscaler verticals. In addition, we launched our Tensilica Neo NPU IP and NeuroWeave software tools to accelerate on-device and edge AI performance. Our System Design and Analysis business that is driving our expansion beyond EDA continued to deliver strong growth, increasing revenue by 20% year-over-year. On the PCB front, Allegro X AI has several successful engagements with market-shaping customers underway, and we announced OrCAD X, our next-generation AI-driven PCB Design solution, enabled by Cadence OnCloud, and targeting small and medium businesses. Our Fidelity CFD platform continued its strong momentum with customers in automotive, aerospace and defense and industrial verticals. In summary, I'm pleased with our team's continued innovation and execution. We're well positioned to benefit from the tremendous opportunities ahead, as we help customers design their differentiated products with improved quality of results, productivity and shorter time to market. I did want to take a moment to comment on the unfolding conflict in the Middle East. The ongoing violence and the loss of innocent lives is truly heartbreaking and a matter of global concern. The wellbeing of our employees and their families in the region is of utmost importance to us and we'll continue doing everything we can to support them. Our thoughts are with everyone who has family, friends and loved ones there and we are helping out by providing humanitarian aid through the Cadence Giving Foundation. John will now go through the Q3 results and present our Q4 and updated 2023 outlook.

Operator:

Thank you. [Operator Instructions] And your first question comes from Charles Shi at Needham.

John Wall:

Yeah, Charles, thanks for the question, and thanks for remembering what we said last quarter. Yeah, we expect a very strong second half for bookings, and Q4 is exceptionally strong. But -- so, our expectations for bookings is very, very strong Q4.

John Wall:

That's right, Charles. In hindsight now, I was a little too prudent in the Q3 guide with respect to hardware installations that were scheduled in China around the end of September. If you recall in our guide, we assumed that those installations would fall into Q4. In actual fact, we completed those hardware installations, and the second half looks stronger than we thought this time last quarter. But even with all of those hardware, we kind of beat our expectations in Q3 and Q4 is higher than we thought.

Operator:

Thank you. We go next now to Gianmarco Conti at Deutsche Bank.

Anirudh Devgan:

Yeah. Hi, it's Anirudh. Let me take that. So, like we mentioned in the prepared remarks, we are seeing a lot of activity in AI. And that's multiple customer and multiple verticals. So, whether it's the system company designing their own chips, or, of course, the semiconductor companies designing it, or we mentioned this time, for example, Broadcom, which helps other companies design it. So, we are participating in the AI kind of design process in all three ways. And last time we talked about NVIDIA and Tesla. And then, on top of that, it's also applying AI to our own products. And then, we have these extra generative AI products on top of our base products that also drives revenue. So, the first part, which is build out of the AI infrastructure, whether it's with, of course, large semi companies like NVIDIA, or like large system companies like Tesla, or companies like Broadcom, I mean, that's a big part of our business. We don't break that out specifically because it's sometimes difficult to figure out exactly what part of customer's business is AI or not, and we don't want to be in that kind of to try to guess what part of our -- what the customers are using it for. But AI is a significant portion of design activity and the buildout that's going to happen for years. Now there's a second part of our business in which we are selling AI products ourselves, like Cerebrus and Verisium and our JedAI platform, which has five main products. So in that segment, if our own software products and IP products are AI enabled, so in that, we did comment that even though it's early in the process, our revenue from our own AI products has almost tripled from a year ago. So, we are very pleased with that progress. So, I just want to highlight that, and also say there's another part of AI, which is the buildout of infrastructure, which is more difficult to predict.

Gianmarco Conti:

Right. That's really good. Thank you. I just have a follow-up, perhaps talking a little bit on China. If you could comment on whether there is any impact from the entity list and the new rules come into place? And also, if you had any visibility into Chinese customers into trying to understand whether you actually know whether they're designing at more mature versus advanced nodes? I feel like there's been a lot of conversation around whether there is a way to track whether EDA tools are being used in China for mature versus advanced nodes. Any color on that -- on this, it would be great. Thank you.

Gianmarco Conti:

Okay, thank you.

Harlan Sur:

Good afternoon. Thanks for taking my question. Macro conditions in the semiconductor industry are still fairly muted, right? We're close to a cyclical bottom, but recovery seems more gradual than expected across many different end markets, right? Accelerated computing, AI are strong. Auto, industrial, enterprise service provider market is still relatively soft. So, across some metrics that you track, renewals, hardware buys, IP take rates, is the team seeing any signs of hesitation or pushouts across your different customers or different businesses?

John Wall:

Yeah, absolutely. And on the hardware side, we're producing hardware as fast as we were all year. And you can see in our 10-Q that we filed today that the value of finished goods and our inventory was less than $10 million at the end of the quarter in Q3. So, the demand is really strong still and we're just producing the hardware as quickly as we can. We're expecting a very strong Q4 as well for our IP group. I mean they're delivering a number of silicon solutions to our customers in Q4. And I think that sets up a really strong quarter for that group, but we were expecting that all year.

Anirudh Devgan:

Yeah, good point. I mean like you said earlier, the macro environment is challenging, especially some of the segments are weaker, some are stronger. But design activity is very strong. And especially, I would say, in two verticals for the future, for the future of the semi and the system business, and at least the two very, very strong verticals in terms of design activity, is data center and AI, and then automotive, given the electrification and the massive transformation that's happening. So, if you look at even -- you know this anyway, Harlan, if you look at for the next three, four years, these two segments will grow significantly, the whole AI-driven data centers and automotive. And because they are growing so -- first of all, the cadence of those end customer products is increasing. And also, they need to be more and more efficient given the design activity and complexity is going up. So, there is more design activity and also use of AI to accelerate and be more productive. And even we are using AI internally to be more productive ourselves. So, definitely for these two big, big verticals, and this is a multi-year trend. This is not a -- and you mentioned some of our large customers, we are very fortunate to work with. We always say we want to win with the winners, and we always focus on the leading companies in the data center and AI space and also now in the automotive space. So that activity is strong, and I expect that to continue.

Operator:

Thank you. We go next now to Gary Mobley at Wells Fargo.

John Wall:

Yeah, great question, Gary. I mean, we're always watching that carefully. As you know, last year, the upfront piece ticked up to 15%. This year, I think in the 10-Q, if you look over on a rolling four-quarter basis till the end of Q3, it's at 16% now, but I think your point is probably closer to 17% for the first three quarters. But I think that's a reflection of the strength of hardware. On the ratable and recurring part of the business, although that's 84% of the trailing 12-month revenue, if you look at our guide at [40, 80] (ph), I mean, we're assuming essentially about a 13% growth rate on a current revenue line for the year, but that's consistent with like over a three-year CAGR basis is about 13% as well. Of course, we're not guiding next year.

Anirudh Devgan:

Yeah, Gary, that's a good point. So, we are watching that carefully, of course. And as you know, like these JedAI and these five major platforms or new products that our customers should engage with us on and they run on top of our existing kind of leading platforms. So, it depends on the customers. I would still say we are still in the early stages of the adoption of these AI products because, as you know, any of these new software tools take years to fully deploy it, right? I mean, this sort of happened in digital or in any major kind of platform releases we do. So, even though we are like two years into it, I think it will still take some time to fully deploy these products. And what we have said in the past is typically at least in my experience with digital like about seven, eight years ago, it took like two contract cycles for them to fully deploy, okay? So that's still three, four years to go. You're probably like two, three years into it and still three, four years to go, which is a good thing in my mind because this is natural progress of deployment. Now, it depends on the customer. Some customers are adopting them in a much bigger way, especially -- like in the previous discussion, the new kind of AI design or hyperscalers, there is like an improved cadence of design activity. So they are adopting them maybe a little faster than some of the other verticals. So, it just depends on -- some are still on like tried on few designs or a few groups. But we have seen some pretty broad kind of deployment, and that helps our overall engagement with that particular customer. So that's what I would like to say, Gary, that I think it's still early, but what good thing, I think we mentioned in the prepared remarks that all top customers are now fully engaged and some of the results are truly remarkable. Actually, I was talking to one major customer recently, and they are getting like 8% to 10% power improvement from Cerebrus, okay? And we have mentioned several of these in the past also. I mean that's a huge improvement. Sometimes that's equivalent or roughly equivalent to a node migration. Typically, you go from one node to another, you may get like 10% to 15% PPA improvement, and you're getting close to that or roughly two-third of that from better AI tools. So the value is there. And that's what we are focused on, make sure the products really provide value and then work with the customers in the pace of deployment that they want to see because it's a natural process to try some and then deploy. But some of them are doing it much faster, like I mentioned.

Operator:

Thank you. We go next now to Jay Vleeschhouwer at Griffin Securities.

Anirudh Devgan:

Yeah, hi, Jay. Good question. I mean, we are watching it carefully. Like you said -- like we said earlier, I mean, design activity is still strong. But of course, the macro environment is challenging. It's like natural -- even though the customers realize that they need to invest in R&D for the future, if the revenue is impacted because of macro situations, that decisions become a lot more prudent. But -- so this is just natural business process. But in general, still the large customers in the big segment, they're all investing in R&D, design activity is still strong. And then we just have to see -- we had a good Q3 in terms of bookings, like we mentioned. So, we'll see what happens in Q4 and that will also give us a better idea going forward.

Jay Vleeschhouwer:

Understood. For a follow-up, I'll ask about some interesting Cadence management comments at last month's Cadence Live event up in Boston. So, there was an interesting comment about the role of AI as "derisking schedules" in addition to the design exploration use case. And what's interesting there is historically, schedule risk or completion risk has to do more towards the back end of the process, for example, physical verification. So, to the extent that more of that risk mitigation moves up earlier in the process, do you think that there will be a spending share shift within the totality of EDA spend, perhaps some from the back end, more towards the front end where you play with a lot of your tools?

Jay Vleeschhouwer:

Thank you, Anirudh.

Jason Celino:

Great. Thanks for taking my question. Maybe first for John, on the Q4 guide. Apologies for asking this again, but folks might be wondering tomorrow, I guess, why aren't we seeing more upside to the guide for fourth quarter? Because where might be some conservatism or what way will you be overlooking in terms of the setup?

Jason Celino:

Okay. No, that's fair. And then just my quick follow-up on backlog. I know you've got some weird comps because of the hardware stuff. But when might we see like year-over-year growth again? Or I guess if we stripped out the hardware-related backlog, I don't know if there's any way to share what type of growth you might be seeing?

Jason Celino:

Okay. Perfect. No, it's super helpful. Thank you.

Vivek Arya:

Thanks for taking my question. I appreciate it's early for a '24 outlook, but Anirudh, I was hoping that you could give us some color given that your model is 85% recurring. So just conceptually, what is the likelihood Cadence can maintain this kind of mid-teens growth rate? And what would make '24 different or similar to '23 from a growth perspective?

Vivek Arya:

Okay. On the IP side, I think John, you mentioned that you're expecting a strong quarter for IP in Q4. I was wondering how much would your two recent acquisitions contribute to that? And just longer term, do you think IP has a category over or undergrows the EDA? And does that influence your growth prospects? So both kind of near- and longer-term question on the IP business.

Anirudh Devgan:

Yeah, Vivek, I mean, as you know already, more customers are outsourcing their IP need, and we have always participated in that, and we have always said we want to participate in that in kind of a star IP portfolio so that it's more and more profitable. And the profitability of our IP business has improved over the last few years. And so, I think we are overall happy with the profitability of the IP business. So, now we're trying to see, okay, what other areas can it grow and maintain profitability? And I think the areas that are emerging, which are strong are this whole chiplet-based design and 3D-IC, and which are used for a lot of AI and hyperscaler applications. And that's also the reason we bought the PHY assets of Rambus, which is HBM and GDDR based IP. So, I feel now that our IP portfolio is in the right areas. And also the use of this automotive and hyperscaler and AI IP -- and most of these markets are evolving into chiplet-based and 3D-IC-based designs, which also has certain new IPs like UCIe and other things. So, as a result of that, we are investing more in our IP business as you saw, and then we expect a strong Q4, and then, we'll see what happens in '24.

Vivek Arya:

Thank you.

Ruben Roy:

Thank you. Anirudh, I wanted to ask if you could maybe talk a little bit more in detail about the collaboration with Renesas and kind of incorporating Generative AI, LLM into chip design. I think you mentioned some expectations for quality improvement, efficiency improvement. I would think that longer term, you'd be thinking about productivity improvement as well. Are those milestones that you're expecting to have answers about within the next year, two years? It sounds like this is sort of a longer-term collaboration and sort of testing going on today. Just wondering sort of what you're thinking about timeframe in terms of incorporating some of these types of tools into chip design. Along with that, just the final part is, would you consider this a leading-edge design that Renesas is working on? Or if you could talk a little about the type of design, that'd be great. Thank you.

Ruben Roy:

That's very helpful. Thanks for all that detail, Anirudh. I guess just a quick follow-up. I mean, it sounds from what you're saying, this should be incremental. I mean, EDA has grown nicely. If you look at the core EDA growth over the last several years, you guys like to call out the three-year CAGR, but from what's going on here, we should assume that this would be incremental on sort of the way you've seen EDA growth. Can you comment on that as you think about whether it's software renewals or adding add-ons, as John talked about, over the next 12, 18, 24 months, would you say this would be incremental to sort of that mid-teens growth that the EDA tools have been growing at over the last three years or so?

Ruben Roy:

It's very helpful. Thank you, John.

Josh Tilton:

Hey, guys, thanks for squeezing me in. Can you hear me?

Josh Tilton:

Great. My first question is just how does the 4Q hardware pipeline look compared to kind of some of the strength that you saw in the first three quarters of the year? And given that you mentioned that the macro is still challenging, is there any extra conservatism in the Q4 guide to account for the potential for maybe some hardware to slip into next year?

Josh Tilton:

Super helpful. And then, just a follow-up. Obviously, on AI, I can't not touch it. But as that business of yours triples, are you seeing the drive or the want to adopt these AI tools cause more of your users to make full flow decisions when maybe this has been more of a best of breed market historically?

Josh Tilton:

Super helpful. Thank you, guys.

Joe Vruwink:

Great. Hi, everyone. Sorry to belabor the backlog questions, but I suppose I'm going to. If we rewind two years ago and look at 3Q and the 4Q of 2021, current RPO then went up by, I think, nearly $400 million sequentially. Is that maybe how you would start to frame just renewal values that are coming to and what you could potentially look to build on? And then, second part of my backlog question, and it gets back to Jason's question on just the changing composition of hardware and software. Just given what Cadence has been able to do on production capacity and ramping there, does that change the relationship in terms of what needs to be sitting in backlog at year-end in order to support some sort of next 12 month revenue expectation?

Joe Vruwink:

Great. Thanks, John. If I can squeeze one more in, I think we're about to lap the OpenEye acquisition. I just wanted to see how that generally is tracked relative to your original expectations? And maybe just get an update about how Cadence is thinking about the opportunity from the Molecular Sciences group and the role you can play in life sciences looking forward?

Joe Vruwink:

That's great. Thanks very much, Anirudh.

Andrew DeGasperi:

Thanks for fitting me in. Just had two quick ones. I know most of them were answered so far on this call. But first on the margin, maybe could you lay out, John, in terms of the guidance for the year, I know you took down slightly the top end of the range for the operating margin on an on-GAAP basis. Just wondering maybe if you could lay out what the puts and takes are there? Is it revenue mix? Is it the recent acquisitions that you made that might have sort of crystallized that number? And without having to answer the second time, but like in terms of investments that you're making for next year, is the pace of all the hiring going to change at all based on what you're seeing right now?

Andrew DeGasperi:

No worries. It's just on the terms of hiring, just in terms of how you're thinking about it so far.

Andrew DeGasperi:

Understood. Thank you.

Anirudh Devgan:

Thank you all for joining us this afternoon. A strong execution of the intelligent system design strategy and customer-first mindset continue to drive growth as we expand our portfolio with new innovative AI-driven solutions. We are proud of our inclusive culture and focus on enabling sustainable innovation and honored to recently be named to Newsweek's America's Greenest Companies 2024 list. On behalf of our Board of Directors, we thank our customers, partners, and investors for their continued trust and confidence in Cadence. Thank you.

Operator:

Good afternoon. My name is Lisa, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence Second Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I will now turn the call over to Richard Gu, Vice President of Investor Relations for Cadence. Please go ahead.

Anirudh Devgan:

Thank you, Richard. Good afternoon, everyone, and thank you for joining us today. Cadence delivered excellent financial results for the second quarter of 2023 with strong ongoing customer demand for our innovative technology. We exceeded our guidance on all key metrics and are raising our financial outlook for the year yet again, resulting in 14% year-over-year revenue growth and 19% non-GAAP EPS growth. John will provide more details shortly on both our Q2 results and the updated outlook for the year. With its unparalleled promise, Generative AI is beginning to make a significant impact globally. Our dedicated focus on AI over the past several years combined with our computational software expertise and invaluable data that lies at the core of AI it uniquely positions us to deliver to this tremendous potential of this transformational knowledge. With escalating design complexity, increasing design starts and a growing talent shortage, AI-driven design automation is crucial in empowering customers to fully realize their innovation potential. Our customers are increasingly adopting our chip, package, board, system, Generative AI portfolio, as they're achieving exceptional quality of results and productivity benefits with these solutions. Customers are ramping up their R&D spend in AI-driven automation, opening up significant opportunities for Cadence. Our solutions are enabling marquee AI infrastructure platform companies to deliver their next generation-compute, networking and memory products. For instance, in his Computex keynote earlier this quarter, Jensen Huang of Nvidia noted that Nvidia is a big Cadence customer and commented on the expanding strategic partnership between Nvidia and Cadence to accelerate EDA, system analysis, AI and digital biology. Cadence has successfully collaborated with Tesla on the development of their game changing DOJO AI supercomputer. Tesla utilized a broad array of Cadence solutions across digital, custom analog, verification, 2.5D and 3D IC and system analysis for developing DOJO chips and solutions. We are very excited to extend our partnership to Tesla's next generation DOJO and FSD platforms. Our customers like Tesla are able to leverage the power of revolutionary Cadence Cerebrus Generative AI technology to optimize the quality of results of their groundbreaking AI chips and related solutions. And from a products perspective, we began by providing AI-driven solutions for core ED applications, then expanded our AI portfolio to include system design and analysis and plan to extend it to life sciences in the future. With AI as they're underpinning, other generational trends such as hyperscale computing, 5G, and autonomous driving, continue to spur robust design activity across semi and system companies, creating ample market opportunities for our differentiated technology portfolio. Now let's talk about our key highlights for Q2. In Q2, we deepened our long standing partnership with a marquee electronic system company through a broad ranging expansion of our core EDA, hardware, IP and systems portfolio. Ambulation and prototyping have become a must have part of the chip tape out and software bring-up flows and secular demand for our hardware platforms drove our verification business in Q2 to a 27% year-over-year revenue growth. Following a record 2022 and Q1 ‘23 are Palladium Z2 and Protium X2 hardware platforms delivered a record Q2 as market demand accelerated for these best-in-class solutions. With 14 new customers and 45 repeat customers, more than half the orders during the quarter included both platforms. Demand for our hardware solutions was broad based with particular strength seen in AI, hyperscale computing, and automotive segments. A global communication services leader successfully deployed the Z2 and X2 systems to significantly accelerate the development of their data center chips for internal use, including those designed for AI applications. Our hardware platform enable them to accelerate their verification workload and software bring-up, enabling first-pass silicon and software success. Verisium, our AI-driven verification platform that's built upon the ZI database and natively integrated with our verification engines is gaining traction at market shaping customers. For instance, a large mobile chip company is working with us on developing a new Verisium regression optimization app and a Japanese semi customer is actively deploying Verisium apps across his automotive SoC and already saw a 4 times improvement in the identification of erroneous source code check-ins. Our digital IC business had another solid quarter with 15% year-over-year revenue growth largely driven by proliferation of our digital full flow, especially at the most advanced node at market shaping customers. Our Cadence Cerebrus solution leverages breakthrough AI-driven technology to explore the entire design space and automatically optimize the digital full flow to deliver transformational results. Adoption and proliferation of Cadence Cerebrus accelerated. And with multiple new marquee wins, is now deployed at eight of our top 10 customers. A leading hyperscaler doubled their run rate through a major expansion that included our digital full flow and Cadence Cerebrus. Another market shaping hyperscaler successfully used our digital full flow and Cadence Cerebrus to achieve a 16% leakage power reduction on their latest custom silicon. And [Indiscernible] achieved 2 times to 3 times better productivity with a new Joules RTL design studio. Through analysis, efficiency and significantly reduce iterations between RTL and implementation. On IP, our scalable and profitable growth strategy continues benefiting from ongoing outsourcing trend, as well as the opportunities offered by expanding foundry ecosystem. Demand for our design IP was strong, led by our multiyear agreement with Samsung Foundry to expand the availability of our design IP portfolio for Samsung's advanced process technology. We signed a definitive agreement with Rambus to acquire their five IT asset along with the talented team. The addition of their leading HBM GDDR5 solutions, and SerDes IP enhances our established IP portfolio, providing complete subsystem solutions for demanding networking, hyperscaler, and AI application. Our system design and analysis business continued its strong momentum in Q2, delivering 23% year-over-year revenue growth. With Moore's Law slowing down, and chip complexity and cost increasing, companies are looking to multi-die, 3D IC, and chiplet-based architectures to achieve better performance and greater cost savings. In Q2, we expanded our collaboration with Samsung Foundry through the delivery of reference flows and package design kits based on our uniquely differentiated integrity 3D IC platform. The industry is only unified platform that includes system planning, packaging, and system level analysis in a single cockpit. Our multi-physics solutions boosted by our optimality Generative AI technology, leverage differentiated system simulation and optimization techniques to deliver superior results. Our CFD portfolio that includes recently acquired high fidelity simulation technology, one large renewal and add-on business with top Aerospace and Defense company. We were pleased with the new win and growing repeat orders for our multi-physics portfolio from customers across multiple end markets. In summary, I'm pleased with our Q2 results and the continuing momentum of our business. AI-driven automation in chip and system design offers massive opportunities for Cadence over the long-term. That seamlessly align with our computational software, core competence, and intelligent system design strategy. We continue to invest in our world-class EDA system design and analysis and AI capabilities to deliver cutting edge innovation to our customers and partners. Now I will turn it over to John to provide more details on the Q2 results and our updated 2023 outlook.

Operator:

Thank you. [Operator Instructions] Our first question comes from Jason Celino with KeyBanc Capital Markets.

Anirudh Devgan:

Yes. Hi, Jason. Good question. In general, we manage our business for the long-term, and we are pretty positive with the results. For the full-year, like you mentioned, it's more than 14% revenue growth and earnings are growing at 19%. And then our strategy of doing EDA plus STA plus AI with the computational software expertise. So I think overall, we're pretty pleased with how all the businesses are performing. And, you know, continue to drive in all fronts, working with customers and partners to deliver the right solutions.

Jason Celino:

Got it. And then my quick follow-up, the IP acquisition from Rambus. Is it included in guidance? And then maybe can you speak to strategic rationale? I guess what goes into the decision, build versus high as early as IP? Thanks.

Anirudh Devgan:

Yes. And it's a great opportunity for us to acquire a very good set of IPs and a talented team. And, you know, what is particularly good in this case is that it is a existing, you know, commercial operation. You know, sometimes we have opportunity to acquire teams from, you know, other semiconductor companies, but in this case, it was existing commercial operation with key IPs like, you know, HBM and GDDR. So we took that opportunity, and we glad to, you know, partner with Rambus here and it really helps, you know, IP for AI and 3D IC with HBM and GDDR IPs. So overall it’s good acquisition, and we continue to invest in all our businesses, you know, including IP. So…

Operator:

We'll take our next question from Charles Shi with Needham & Company.

John Wall:

Yes, Charles, great question. Yes, we'd expect a stronger second-half for bookings. As we said last quarter, the -- we had very few contracts expiring in the first-half of this year, and we have more contracts expiring in the second-half of 2023. So we'd expect bookings to be higher in the second-half, compared to the first. When we look at backlog, we filed our 10-Q by the way. So you'll see our backlog at the end of Q2 dropped from $5.4 billion to $5.3 billion and RPO at the end of Q2 dropped from $5 billion at the end of Q1 to $4.9 billion. But the current value of that RPO, the annual value, as you know, backlog and RPO is a combination of the annual value multiplied by the time essentially that you've contracted with customers. And our current RPO is up from last quarter, it was $2.7 billion last quarter. It's up to $2.8 billion this quarter. So we've improved the annual value, and that's typically what we focus on, making sure we're improving the annual value. But yes, we're very, very pleased with the bookings performance for Q2. It was slightly stronger than we had anticipated or expected. And second half, we think it will be better again.

John Wall:

Yes, yes, Q1 was definitely a low bookings quarter for us. Q2 was a lot stronger.

John Wall:

Yes, Charles, I think you're referring to the step-up from Q3 to Q4 in our guide. So we're guiding about $1 billion of revenue in Q3 with a balance of just over $1.70 billion in Q4. Now that's slightly exaggerated the Q3 to Q4 step-up. When we originally looked at the top-down forecast for the second-half, there was a lower step-up in revenue mainly due to software increases in annual value and in software bookings that we expect. But when we looked at the hardware and the timing of when hardware deliveries happen and there's so many that fall late in the quarter, we thought it was prudent to assume that those bookings, we should include them in our implied Q4 guidance, so to speak, rather than including it in Q3 because I’m not really sure about the timing of those.

John Wall:

Okay, thanks.

Unidentified Analyst:

Hi, this is [Indiscernible] on for Vivek. Just wanted to start out, if you could provide some insight on how you quantify benefits from AI? Just looking at the semiconductor landscape, there have been several AI-related design programs that started a few years ago. So would you say you've already seen the benefits in your financials? Or should we expect even more growth acceleration in the future? And if you could comment on the attach rate of your AI-enabled products to baseline contracts, that would be helpful? Thanks.

John Wall:

Yes. And to answer your revenue question, essentially, I mean, I think it's clear that it's showing up quickly in the hardware space. We feel on the software side, it will probably take a couple of contract cycles for that to flow through. We're seeing strength in pockets on the software side. But the software side, because it's recurring in revenue will take a while to play through. But you're definitely seeing the impact of AI in hardware -- strong hardware demand.

John Wall:

Yes, [Blake] (ph), yes, we look at that all the time in terms of our cash allocation policy. In Q2, we used $325 million on stock repurchases. $200 million of that was due to an accelerated share repurchase. Now the timing of that was to coincide with -- was times deliberately to coincide with our merit and promotion cycle. You might have noticed as well in our guide that expenses take a step-up and margins slightly down second-half, compared to first-half. That's because our pay rise and promotion cycle kicks in on July 1 at Cadence. And that's typically when we do our stock refresh for employees in the company. And because we granted a lot of stock at that time of the year, we -- in our stock repurchase approach, we want to make sure that we're offsetting the dilution first. And then ideally, we want to reduce that share count over time. We've talked about dividends with the Board from time-to-time, but we think it makes most sense to use our excess cash for stock repurchases. Our policy is essentially to use at least 50% of free cash flow to repurchase our shares. And that should more than offset dilution, see the share count continues to decline over time and give us enough to grow the business.

John Wall:

Always.

Jay Vleeschhouwer:

Thank you. Good evening. Business question first and a technology question as a follow-up. So Anirudh, as you know, for the last couple of years, we've often spoken about how semiconductor companies and systems customers can become increasingly alike. The question though is, in what important ways do they remain dissimilar in terms of sales cycles, conversion of RPO to revenue, services requirements, account profitability? Anything you care to mention that continues to distinguish those two classes of customers?

Jay Vleeschhouwer:

Okay. As the technology follow-up at DAC two weeks ago, there was a quite interesting presentation by Cadence at the conference related to AI and there was the use of a very interesting with regard to productivity or where productivity is going to come from in future for EDA. And that term used by Cadence was task abstraction. So a new kind of abstraction from the decades of extraction we've seen in EDA for the last many years. So how are you manifesting that new concept of abstraction in terms of product development, packaging, all those sorts of things going forward since that term seems to be very much a critical part of your thinking going forward for EDA productivity?

Jay Vleeschhouwer:

Okay. Thank you.

Ruben Roy:

Thank you. Anirudh, if I could start from where you left off there, I had a question similar to Jay's. But I was wondering, I think you mentioned that SerDes with AI was deployed at eight of your top 10 customers. I'm just wondering today, can you talk about how AI is being used? Is it mostly placed in route? Or are you seeing some of these other areas being implemented in leading-edge designs, whether it's packaging or even some of the floor planning, et cetera? How far along are we?

Ruben Roy:

Thanks very much, Anirudh for that. A quick follow-up for John. Just on operating margin. Down a little bit in Q3 with what sounds to me like hardware, kind of, strengthening towards the end of the quarter and obviously into Q4. How are you thinking about that? Or how should we think about operating margin and sort of the moving parts between Q3? You bumped it up a little bit for the full year. So if you can help us out on how you're thinking about operating margin in the context of hardware attach rates going up as you exit the year, that would be helpful?

Ruben Roy:

Got it. Makes sense. Thank you, John.

Operator:

We'll take our next question from Blair Abernethy with Rosenblatt Securities.

Anirudh Devgan:

Yes, I'll start first and then John can comment on the inventory. But overall, China, we are pleased to see continuing strong design activity in all kinds of end markets and also good strength for hardware business. So we've also had a good hardware business in China. And particularly in Q2, I would say there was a lot of strength from mobile vertical. A lot of companies, some big system companies designing their own chips, and also automotive, especially EV automotive in China was particularly strong. So I mean, China is a -- just like rest of the world is pretty diverse market, and we play in all aspects of it. But those two verticals were pretty strong in China. John, do you want to…

Blair Abernethy:

Okay. Great. And actually, just one more question on the hardware, if I can. So the Palladium Z2 and the Protium X2 have been out in the market now for a bit of time. When can we expect to see next-generation versions?

Blair Abernethy:

Great. Thanks very much, guys.

Joe Vruwink:

Hi, there. Let me dig in a bit of a leading question. So you're now talking about second half revenues growing 15%. Some multiyear CAGRs are closer to 15% to 16%. There's -- things on the horizon in that next couple of quarters not trailing, but longer as just in terms of how your customers are acting and also what Cadence is offering that would seem to be better than what you've experienced, both in terms of R&D intensity and your potential wallet share? So the question is, instead of this 15% rate of growth being the high end of what historical growth rates have been, do you think we're maybe seeing a resetting of the overall base case for growth rates and what might be available to the company going forward?

John Wall:

Yes, Joe and you'll see it in the -- we published our CFO commentary in the second page of the CFO commentary, you'll see we track three-year CAGRs. But we're really trying to grow the accounts through a complete contract cycle, and most of our customers do three-year baseline contracts to do add-ons throughout the year that coterminate with those baseline contracts. So we think the three-year CAGR is a good metric. And if you look at the revenue growth rate on a three-year CAGR basis, it's continuing to decline. Now it's certainly the pace of acceleration seems to have slowed down this last two years in the kind of mid-teen mark that -- but our focus is on driving revenue growth -- profitable revenue growth. But we're using -- we generate huge amounts of cash flow. And we aim to use more than 50% of that cash flow to buy back shares and reduce share count. So we're trying to drive that non-GAAP EPS higher and be disciplined with our stock-based compensation. You'll see our stock-based compensation has consistently been around 8% of revenue, and our non-GAAP EPS CAGR, it's been 20% or higher for the last five years. And with this 19% rate that we're on now at the midpoint of the guide, that has us on track for 22% EPS growth on a three-year CAGR basis for 2023. So our focus is really on bottom line. We care about EPS and growing EPS for investors and growing profitability, and revenue growth is a means to an end, I guess, in that respect. But we're very, very pleased that is continuing to increase.

Anirudh Devgan:

Yes, that's a good question. I would say that the adoption curves are, at this point, I would say they are similar. Especially Verisium, as I said, verification is a big area. Now they're easier in some sense that there is already a proof point that the customers have seen with Cerebrus. So they are confident in our ability to deliver overall AI solutions. And same thing with like Allegro X, Virtuoso Studio. So -- but also how it is in this business, right, the customers have to try the things and they tried on some design, then they do broad adoption. So that's always there in new areas as well, so like with Verisium and Allegro. So I would say, overall, it is similar and there's a lot of interest. I mean the amount of interest in other AI solutions apart from the original like Cerebrus is very high. But I would say the rate at this point is similar of adoption. And this is going to take some time, which is okay. It is a natural process of trying and deploying. Now some areas, it's faster like hardware because of the nature of the revenue recognition. But overall, the adoption is great and moving along

Operator:

We'll take our next question from Gary Mobley with Wells Fargo.

Anirudh Devgan:

Gary, so these all are new to products. So they're not in previous contracts. So all of these products have to be purchased, and they can be purchased with the renewal or outside of renewal, as you know, in add-on business, but they are not part of existing contracts with customers. And we have different business models in which we introduced these products just like our base product. And then as we talk to customers, some of them are in very wide deployment. I think I gave you example in the prepared remarks on one hyperscaler. We had a very, very wide deployment of some of these AI tools. Some are in the early stages. But these are all new products versus what was there in previous contracts.

Anirudh Devgan:

Yes. IP is an important segment of our business. It's like having five kids, right? We love all the five kids, all five lines of business. Now one of them is very young and growing like SD&A, growing 20% plus. So that's great, but that doesn't mean we don't take care of all the lines of business. So IP, this was a great opportunity to get a right team and IP, which is synergistic, useful for AI and 3D-IC. So I think, at the right time, we will make investments in all lines of our business. And we have done so like with Virtuoso, with digital. And so we want to make sure all lines of business are competitive here.

Operator:

We'll take our next question from Andrew DeGasperi with Berenberg Capital Markets.

John Wall:

Yes, sure. Thanks, Andrew. But in relation to IP, we've always been expecting more IP to be delivered in the second half compared to the first half. It's actually the opposite of 2022. I think we called that out on last quarter's call as well. So we're expecting a stronger second half for IP, and IP can be a bit lumpy at times because it's based on the timing of deliveries. On system design and analysis that we're very, very pleased with the strength of the growth there. Again, I mean all of our businesses are growing strongly. I think when I look at the second half, and the 15% that we expect our total revenue to grow compared to the second half of last year, I think all of our businesses are growing double digits in that outlook.

John Wall:

Well, I'm certainly -- I'm very confident in the second half guide. But I'm now confident also in the Q3 guide -- I was less confident when I saw all those hardware deliveries time for kind of the final week and the final few days of Q3, and I didn't want to take the risk of including those in the Q3 guide. But for the second half, I'm very confident in the second half. But -- and as we reduce the lead times on our hardware, we found that we're certainly seeing the demand for our hardware strengthen and we have strong demand across all lines of business. And as Anirudh would say, I mean design activity is very, very strong. So I guess to the extent that we can continue to reduce those lead times and deliver hardware earlier, that certainly a track to the higher end of the guidance range because with hardware, of course, you get revenue upfront. But on the software side, growth takes – revenue takes longer to kind of play through because of the recurring revenue profile.

Operator:

We'll take our next question from Harlan Sur with JPMorgan.

Harlan Sur:

I appreciate that. And then for Anirudh, all of the leading-edge chip companies are moving to this chiplet that die-based packaging architecture. The systems customers are adopting these very, very complex board designs, right? Here you guys benefit with Allegro, Integrity, Clarity, Celsius platforms. Can you just give us a rough sense of the revenue contribution from advanced packaging and board design, simulation, verification? Is it near 10% of revenues? And roughly how fast is this subsegment growing on a year-over-year basis?

Harlan Sur:

Thank you for the insight.

John Marco Conti:

Hi, Anirudh and John. Thanks for taking my questions. And so the first one is, I know you've touched on this a little bit. Could you share some more color on the usage of AI tools in system companies this quarter? Are any of the new wins related to AI tools for system customers? And how can we think about the acceleration of usage, not just leading nodes, but in the broader design space, even at more mature nodes? I think investors are thinking what next when you taking the current use cases in the next two, three years, where the cost trade-off might not be as imperative as to say in the GPU market? I imagine is this a function of better price recovery matched with higher adoption/proven use cases.

John Marco Conti:

Got it. Just a follow-up on hardware. Could you talk about the renewal cycle for hardware? When do you expect the customers to come back and buy newer generation of Protium or Palladium? and is it in line with the EDA cycle, i.e., 2.5 to three years?

John Wall:

Yes, there's a secular demand for hardware capacity or emulation capacity that's -- and it's a pipeline business. So unlike our software business where you know when the existing contract expires and you know the renewal opportunity comes up, typically, we see -- in the past, we used to see a hardware customer come back and purchase a new system, maybe 2.5, three years after the first system, but now they're purchasing new systems regularly because like I said, demand is really, really strong, and there's just a secular trend in that demand for growth in emulation capacity.

Operator:

Our final question comes from Joshua Tilton with Wolfe Research.

John Wall:

So Josh, just to correct that, the expectation for 15% growth in the second-half is comparing second-half versus second half or total revenue at Cadence, all our businesses. We expect all of our businesses to grow by double-digits in the second-half, compared to the second half last year. Some are stronger than others. In relation to hardware specifically, we've seen strong demand pretty consistently for a couple of years now. In Q1, we ramped up production capacity because lead times had gone over six months. We tried to address those, and it certainly helped with improved demand in the second quarter, and we're seeing more opportunities in the pipeline for the second-half. Now that gives us comfort to raise the guide for the second half of the year. But it is a pipeline business. Typically, people only put their opportunities into the pipeline about a quarter before they intend to purchase. In some cases, you might get visibility four to six months in, but it's a pipeline business. Right now, we have strong backlog for hardware, and that's spread into our decision to increase our guide for the second half, but there is potential for that for that demand to continue. And if we're going to keep production capacity at the levels we're at right now because we expect that demand to continue into the future.

Anirudh Devgan:

Yes, absolutely. That's a very good observation. I mean one trend that is driving full flow adoption is advanced nodes when you move from seven to five to three to two. So that -- because things get more complicated and this -- and we architected this years ago to be full flow. So that helps -- and secondly, that helps is AI orchestration or Cerebrus because it can give better results if the AI engine is able to optimize all aspects of the flow. So there is a natural tie-in to that, which is great for us. This is a fabulous thing and the same thing in other areas as well, like verification. But both these trends are accelerating the deployment of full flow, advanced nodes and AI.

Operator:

I will now turn the call back over to Anirudh Devgan for closing remarks.

Operator:

Thank you for participating in today's Cadence Second Quarter 2023 Earnings Conference Call. This concludes today's call, and you may now disconnect.

Operator:

Good afternoon. My name is Emma, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence First Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I will now turn the call over to Richard Gu, Vice President of Investor Relations for Cadence. Please go ahead.

Anirudh Devgan:

Thank you, Richard. Good afternoon, everyone, and thank you for joining us today. I'm pleased to report that Cadence delivered strong results for the first quarter of 2023, with ongoing robust demand for essential and innovative solutions driving solid double-digit growth. In view of the strong start to the year and the continuing momentum of our business, we are raising our financial outlook for the year. John will provide more details in a moment. Generative AI design tools are revolutionizing chip and system development by delivering unprecedented optimization and productivity benefits. Customers have already been benefiting from our ground-breaking generative AI solutions in the digital, verification and systems areas, and with the recent introductions of Virtuoso Studio and Allegro X AI, we now have an unmatched chip to package to board to systems generative AI portfolio. Leveraging 30 years of industry leadership, Virtuoso Studio accelerates heterogenous system design, and through AI-powered layout automation and optimization provides an average 3x productivity boost for designs in the notably complex analog domain. Several customers including MediaTek, Renesas, Analog Devices and TSMC provided testimonials for the launch. Allegro X AI technology utilizes the latest innovations in generative AI to accelerate PCB design with more than a 10x reduction in turnaround time, and at the recent launch, it was endorsed by Schneider Electric and Kioxia. All of these powerful engines are fueled by our unique, differentiated big data analytics JedAI platform that unifies massive amounts of design and verification data to carry forward learnings and insights to future designs. Our rapidly proliferative generative AI solutions are enabling customers to reap significant power, performance and area benefits through better optimized designs while greatly improving engineering productivity and accelerating design closure. Along with AI, other generational trends such as hyperscale computing, 5G and the digital transformation across multiple verticals continue to propel thriving design activity across semi and systems companies, creating rich market opportunities for our differentiated end-to-end EDA, IP and systems solutions. I am pleased with the momentum in our core EDA business as well as our continued expansion into systems area that provides us both revenue and margin opportunities. Now let's talk about our key highlights for Q1. In Q1, we deepened our collaboration with MediaTek, which includes a broad base of our digital, analog, verification and systems design and analysis solutions. We significantly expanded our collaboration with a marquee aerospace and defense systems company, that included the proliferation of our digital full flow, custom, verification products, as well as our RF and system analysis solutions. And Cadence expanded its collaboration with TSMC and Microsoft, as we leveraged our Pegasus Verification System and Cloudburst platform to accelerate giga-scale physical verification in the cloud. Ever increasing complexities in system verification and software bring-up continued to propel our verification business, to a 31% year-over-year revenue growth. Hardware-based verification has become a must-have part of the customers design flow. And on the heels of a record year, our Palladium Z2 and Protium X2 hardware platforms delivered a record Q1 as market demand remained strong for these best-in-class solutions. With 14 new customers and nearly 30 repeat customers, more than 50% of the orders during the quarter included both platforms. Demand for hardware was broad-based, with particular strength seen in the aerospace and defense and automotive segments. Our new Verisium platform leverages big data and AI to optimize verification workloads, boost coverage and accelerate root cause analysis of bugs. Customers are realizing significant efficiency gains, with Renesas seeing up to a 6x improvement in debug productivity, shortening the time to market for its R-Car designs. Our digital IC business had another solid quarter, with our digital full flow continuing to drive growth especially at the most advanced nodes at market shaping customers. Our innovative Cadence Cerebrus solution provides customers an AI-driven cockpit by applying generative AI to explore the entire design space and intelligently optimizing the digital full flow in a fully automated manner. Cadence Cerebrus now has well over 180 tapeouts. And at last week's CadenceLIVE event, several leading customers, including TI, Renesas, Broadcom, Canon and arm described the remarkable benefits they realized with Cadence Cerebrus. Our system design and analysis business, which is driving our expansion beyond EDA, continued its strong momentum in Q1, delivering 27% year-over-year revenue growth. Accelerating hyperconvergence between system and silicon domains requires seamlessly integrated chip implementation, system design and analysis solutions. Our Integrity 3D-IC platform exemplifies that by natively integrating all the required engines to provide a comprehensive multi-chiplet and advanced packaging flow. Additionally, the growing complexity of designs as well as accelerating of virtual prototype trends require sophisticated multi-physics solutions that not just provide higher capacity and performance, but also result in more optimized designs. Our system analysis portfolio couples our expertise in physics-based modeling with AI-driven optimization and are delivering superior results to customers across multiple end-markets. We are pleased with the new wins and growing repeat orders for our organic Clarity and Celsius products, as well as our CFD technologies. During Nvidia's GTC2023, Nvidia CEO Jensen Huang talked about our joint partnership, and the throughput and energy efficiency benefits offered by Cadence's CFD offerings running on Nvidia's accelerated computing platform. And last week, we announced a multi-year technology partnership with the San Francisco 49ers that's focused on sustainability and based on our Future Facilities digital twin technology. In summary, I'm pleased with our Q1 results. Exploding chip and system design complexity will drive a significant non-linear growth in the workload requirements, opening up a massive opportunity for computational software to help realize these innovative products by investing more of the R&D spend in automation. In addition to our strong business results, I am proud of our high-performance inclusive culture and thrilled that we have been selected yet again by Fortune and Great Place to Work as one of the 2023 100 Best Companies to Work For, for the ninth consecutive year. Now, I will turn it over to John to provide more details on the Q1 results and our updated 2023 outlook.

Operator:

[Operator Instructions] Your first question comes from the line of Gary Mobley with Wells Fargo. Your line is now open.

John Wall:

Yes, Gary, great question. And, yes, they're all related. We were very pleased to be able to ramp up the production of our hardware because we had such strong demand for hardware solutions in the functional verification business. We successfully ramped that up in Q1 and the subsequent upfront revenue benefited functional verification, it benefited China. I think China is up to 17% of our revenue for Q1, that's mainly hardware driven. And again, we wanted to reiterate the fact that last year we did -- our recurring revenue mix was 85% of our total revenue, 15% upfront. We still expect that to be the case for this year. But in Q1, because of the increased hardware deliveries, the mix was 80% recurring and 20% upfront for the quarter. We wouldn't expect that to repeat for the rest of the year.

John Wall:

Great question again, Gary. Yeah, we were very pleased with hardware bookings again in Q1. We didn't take up the second half of the year. I want to wait until the summer to have a look at the pipelines, because hardware is very much a pipeline business. However, we did take up the year by $20 million, and part of that is the beat in Q1, which was some hardware. But the rest of that was strength on the software side, probably predominantly in the system design analysis space. And we raised that for the year, and that's kind of recurring throughout the year. But we haven't taken up second half of the year for hardware. I'd like to wait until the middle of the year for that. We still expect -- I mean, we expect all the businesses to grow strongly this year.

Operator:

Your next question comes from the line of Jay Vleeschhouwer with Griffin Securities. Your line is now open.

John Wall:

Yeah, sure, Jay. The second half of this year is very heavily weighted for bookings for the total year. We're very light in the first half of the year for software renewals. The second half of the year, Q3 and Q4, are very strong for software renewals this year. Unlike last year, last year, I think the first half was we had a number of big software renewals in the first half, we don't have that this year. And when you look at the second half, of course, I mean any big renewal you have in Q3 -- at the end of last year, we had like nine months in cRPO for that and now it's only six months at the end of this quarter. So, it's really just a function of renewal timing and the fact that the first half of the year is light for renewal timing. I'd remind you as well this in terms of renewal timing, the Q1 and Q2 are the two quarters that's kind of -- are like three years after the breakout of the pandemic back in 2020. So, those were light for us anyway in terms of light renewals. So, the second half of the year, much more heavily weighted towards the second half of the year for software renewals, and you see that impact on the RPO and cRPO. To a lesser extent, there was some a drop off on hardware because we delivered so much hardware in Q1, but it's mainly the timing of renewals.

Anirudh Devgan:

Yeah, Jay, good question. So, I think first things I would like to say just to add on to what John was saying earlier, I mean, there could be some fluctuations in renewal timing. But the great thing about our business is we are not sensitive to that, right? I mean, it's mostly ratable business and -- but what I'm pleased to see is that both in system and semi companies that design activity is very strong, okay? Because a lot of these products are -- I mean, we are resilient to the overall kind of macro environment. So, resilient because our products are critical and essential. And then, we are mostly ratable business. And then, we are very diversified, as you know, both geographically and markets. Now in terms of AI, I mean, this is having -- of course, having a significant effect in terms of amount of automation we can provide and the increased automation we can provide. So, we are embedding that, as we mentioned in our CadenceLIVE Conference last year in all products. And it will be pervasive throughout the product line. So, I'm actually pretty pleased to see not only our base kind of JedAI platform, which is you need a data analytics platform to really do AI in intelligent comprehensive way. But also, there are five big platforms on top of JedAI, so from chip to package to board to system. So we always had Cerebrus, which is doing phenomenal with more than 180 tapeouts; Verisium for verification; now Studio, Virtuoso Studio for analog with layout migration and design centering using AI; and then, X AI for Allegro, PCB and packaging, and Optimality for system design and analysis. So, it's a very comprehensive portfolio. And amount of R&D investment just depends on different products. And sometimes we have it within the product, sometimes we have outside, but it will be pervasive through the product portfolio. And like I have mentioned before, our strength in computational software naturally allows our regular -- even regular R&D to do a lot of AI. We, of course, have AI specific R&D, but our regular R&D, given the rich history of EDA and competition software, we can embed that in our product. So, the real value is to really do it comprehensively and make a big difference in terms of productivity, in terms of automation, in terms of PPA benefits that we are delivering to the customers.

Operator:

Your next question comes from the line of Charles Shi with Needham & Company. Your line is now open.

John Wall:

Yeah. So, Charles, yes, just for clarification, all of our renewals will be -- already be backlog. But if there's, let's say, you have a renewal that's coming up in September, you would have had nine months of backlog left on that renewal at the end of Q4 last year. Now, you have six months left in backlog. And then, when you get to September, you'll have nothing left in backlog and then you have the renewal will come through.

John Wall:

So, the new ones will not be until we do them in the second half of the year.

John Wall:

So, that -- I just wanted to clarify that. Yes, the -- so the remainder of the existing bookings will be in backlog, but that will reduce until we get to the actual renewal date. And then, on the renewal date, we'll have a new booking come through.

John Wall:

And that will be additive to the back up.

John Wall:

Oh, thanks for the opportunity to clarify there, Charles. Certainly, I didn't see any weakness in bookings in Q1. Bookings in Q1 were stronger than we were actually expecting at the start of the quarter. What I was trying to convey was that we had very few software renewals that came up for renewal in Q1 and therefore bookings were expected to be light. The beauty of the recurring revenue model that we have is that the timing of those renewals is not especially important, but it's the annual value of those renewals. And that we continue to see growth in the annual value of those bookings, and we see growth across all of the businesses.

John Wall:

Thanks.

Harlan Sur:

Hi. Good afternoon, and nice job on the strong quarterly execution. We had a call last week with one of the largest ASIC semiconductor companies, a very large customer of yours, that they've got chip design programs with many of the cloud and hyperscalers. And they told us that they're seeing a pickup just over the last sort of 60 to 90 days, just the meaningful pickup in design activity and design project pull-ins on their accelerated compute and AI SoC programs from their hyperscale customers. I guess, it's not a surprise given the AI arms race amongst the cloud titans. But have you seen this recent pickup in customer design activity, program pull-ins reflected in your recent discussions on upcoming renewals and/or customer engagements?

Harlan Sur:

No, I appreciate that. And then, maybe just a follow-on to that question, many of your cloud and OEM customers that historically have worked with these large ASIC companies, we're also hearing that some of them may be trying to build extra distance, right, and pull together the capability to do the entire chip design themselves, right, what we call COT based models, which I would think would mean further expansion of their design teams beyond just front-end design, right, which again would be maybe more market opportunity for things like your Virtuoso franchise, and many of your back-end physical implementation of verification tools. Are you guys seeing this trend as well?

Harlan Sur:

Yeah, insightful. Thank you.

Jason Celino:

Hey, thanks, guys. Just two questions from me. Maybe my first one, John, you mentioned taking up the full year guidance based on some strength in system analysis. I'm curious, was this driven more from your existing business there, or was it from OpenEye? I guess, how is OpenEye doing relative to expectation?

Jason Celino:

Okay. And then, my second -- sorry, go ahead, Anirudh.

Jason Celino:

Oh, sorry, yes. And then, my second question on the guide, it looks like second quarter is going to decline sequentially by about 5%, consistent with what we saw last year too. So maybe just a quick refresher on what's driving the seasonality here?

Jason Celino:

Okay. Excellent...

Jason Celino:

Okay. Awesome. Thanks for the clarification.

Vivek Arya:

Thanks for taking my question. I had a near term and then kind of a bigger picture question. So near term, your IP sales have slowed down. I think, for three quarters now, I think they are actually down year-on-year. I'm curious on what's -- Anirudh, what's driving the slowdown? And do you expect IP to grow in line with the 14% sales growth for the entire company? What will help those sales reaccelerate in the back half?

John Wall:

And so, yes, and what I would add to that is that -- and you know what, IP revenue generally can be lumpy because some of it's upfront and it's based on the timing of deliveries. Now last year, our IP revenue, we had more deliveries that fell into the first half compared to the second half. This year, it's the other way around, we have more IP deliveries that fall into the second half compared to the first half. So, it kind of skewed the year-over-year numbers, but we're very, very pleased with the performance of the IP business. As Anirudh says, we're generally targeting increasingly profitable low-teen growth every year for our IP business, and we're on track for that.

Anirudh Devgan:

Yes, Vivek, what I would say qualify AI is another way of providing dramatic automation, that's -- and this history of our industry is to provide more and more automation. And I would say AI is like third wave of massive automation and productivity improvement. I mean, the first wave was moving up abstraction level going from transistor level to gate level to RTL level to C level. That's one wave that drove our industry, which is -- the second wave in the last 10 years is parallelism. Cadence has invested heavily in massive parallelism whether it's on-prem or on the cloud, and starting from 2013, we have a lot of paddle products. And then, now, the third wave of productivity and automation is using AI or what I always call AI for optimization now called reinforcement learning or generative AI. So, we have a history over the last 20, 30 years of doing this kind of -- and in all cases, it doesn't cannibalize. Actually, the activity increases and amount of software used and amount of optimization that happens, more and more designs are done with the available resource headcount. So I expect AI to do that. I mean, in general, the benefit is so huge that when you get these new capabilities, you use it to do much more efficient design. Okay. I'll give you an example, starting to -- some very senior people in our industry, and one comment has been that the Moore's Law has slowed in terms of actual improvements you're getting from one node to another node, when you went from 65 to 40-nanometer, you get X amount of improvement, and now when you go to 5 to 3, that used to be 20%, now is -- they went to 50%, now maybe it's like 10% improvement. And even our tools like Cerebrus or a lot of the other AI-based tools can provide easily 5% to 10% improvement in PPA. So you are getting improvement from better algorithms, which are similar to half or full node of a process technology improvement, okay? And that's just huge. The amount of improvement you can get from this third wave of automation using generative AI is huge. So -- and I think that's one metric that we have published a lot in terms of how much PPA and product improvements we are getting, and that's what we closely monitor with our customers. And I think -- and the other thing is to apply that across other things, not just digital implementation, to apply to package design, to board design, to simulation. And what I think it -- opportunity it gives us is, over time, we can get higher share of R&D invested in automation, because the complexity of these things is going up exponentially, so the headcount can't go up exponentially. So, the headcount, I expect, still will grow five, 10 years from now in terms of R&D spend in our customers, but we can get a bigger share of that R&D spend applied to automation.

Operator:

Your next question comes from the line of Gianmarco Conti with Deutsche Bank. Your line is now open.

Anirudh Devgan:

Absolutely. I think, we talked about chip, right, and how AI can help this third wave of automation. But the same thing can be applied at package and system levels. I do want to highlight that. We have talked for a few years on importance of merging system and semi and how system companies are doing semi and then we can also provide solutions for system design and analysis like thermal simulation, electromagnetic simulation, fluid dynamics. And traditionally, those areas were -- first of all, the simulation capabilities were -- could be improved, just the raw simulation speed. So, for example, Clarity for electromagnetic, we got order of magnitude improvement versus traditional methods, because applying our computational software expertise, we can do a lot more simulation. But on top of that, there are two other things that can jump to our system design and analysis, and you're seeing that even our growth that you're seeing. So, one thing is use of GPU acceleration. And we talked about this in my prepared remarks. And I think GPU acceleration is significant for system design and analysis there. And the other thing is applying AI on top of simulation. So, EDA has a long history of optimization, not just simulation. An AI for optimization of generative AI is really new for system design and analysis, because they are barely -- even the simulation capabilities were not keeping up, but they didn't really have that much optimization capability. So, the response we are getting from Allegro X AI and Optimality is huge, because not only simulation is possible for the first time, but the optimization of simulation. Because in general, if you're doing some thermal design or design of the data center, yes, you want to stimulate of a car, but you want to optimize, whether it's the shape of the wing or placement of the racks in the data centers. And all this is really now possible with generative AI. So, I think the impact on this SD&A will be profound apart from the impact on chip design. And we are the company that can combine those two things and apply AI to both of these areas.

Anirudh Devgan:

Yes. I mean, in general, we want to start with the strategy, and we feel we have a very, very strong strategy with intelligent system design, this combination of silicon system and data. And we are very pleased with our progress, and we continue to grow organically and perform well both in terms of revenue growth and margin. So that's our base strategy, base outlook. Now, we always evaluate M&A as it comes up and if it's a good return for our shareholders and good return in terms of R&D. But in general, we are pleased with our strategy and our organic execution.

Operator:

Your next question comes from the line of Blair Abernethy with Rosenblatt Securities. Your line is now open.

Anirudh Devgan:

Yes, absolutely. The growth rate is a combination of organic and inorganic, right, the acquisitions we made in the past. And in terms of go-to-market, we have -- of course, there is a lot of overlap with our current customers, too. And then, of course, some of the customers are new customers. So, we try to leverage both our existing channel, and then we also have set up a system kind of sales team that targeted new customers that we traditionally haven't talked to. But one thing to remember in SD&A, as this overlap of system and semi companies, lot of the leading companies in SD&A are companies that Cadence already has a very deep relationships. So -- and we are still selling to the engineering organizations and it's just -- so the good part is both the EDA and the SDA, our engineering software maybe different parts of the customers are engineering organization, but more and more coupled engineering organization with the combination of system and semi. And then, when we go to SD&A side, we always look at a three-pronged approach in terms of go-to-market. So, one is direct sales, like we do for our EDA business. And that -- we have great relationship with the top customers in the world, which are consuming both EDA and SDA. And then, I think in SD&A, there is a bigger portion of indirect or channel. So, we had a strong channel for our Allegro and OrCAD businesses, which is PCB and packaging, but we have expanded the channel to now include SD&A to bring our new channel partners throughout the world. And then, the third part of our go-to-market is using cloud and OnCloud, we announced last year. So go direct, especially for smaller customers who don't want to have in their own IT department and especially in the systems space, they are much more amenable to direct SaaS kind of cloud offering. So, overall, this is an ongoing progression. As you said now the business is getting to a good scale and especially in SD&A, we want this three-pronged approach of direct, indirect plus cloud. But one thing to remember is a lot of the top customers in SD&A are already existing EDA customers, and that really helps us as we go to go-to-market.

Operator:

Your next question comes from the line of Ruben Roy with Stifel. Your line is now open.

John Wall:

Yes, Ruben, I'm not really worried about that in the second half in terms of the renewals. The renewals are with really large very, very highly creditworthy customers. But we did see some softness in the lower creditworthy Tier of customers like start-ups in Q1. And we have already factored that into our guidance for the year -- for both Q2 and for the year. But generally, at the high end with the big renewals are with like the strongest creditworthy customers in the industry.

Anirudh Devgan:

I mean the good thing with the hardware is that, like we mentioned in the past, like it has become almost an essential part of the design process. So -- and it's almost -- it's virtually impossible to design these complex chips without use of the hardware platforms. So, I would say all the major customers, especially all the big major customers that drive most of our revenue are using hardware anyway. Now, there is -- so there's always room for refresh of that of the hardware they're using. And also, as the chips -- as they go to different nodes -- I mean we are like 5-nanometer going to 3, to 2, to 1.4, to 1, so there is at least 10 years of node refresh ahead of us. So, every time we go to a new node, the size of the chip increases, the number of gates that are on chip increases. So, you typically need more and more hardware. So, the capacity requirement for hardware increases. So that's why I think that for long term, hardware is going to be in a secular growth period. Not only is it critical, but you need more and more and that's going to last for at least for the next 10 years, if not more. And then sometimes, there's opportunities for some of the smaller customers to add hardware, and we look at that also, and we have a variety of business models to help the smaller customers. But at this point, most of our big customers are using hardware, but still there is growth because the chip size increases, or if they're using Palladium, they can use more Protium and vice versa.

Ruben Roy:

That's really helpful, John. Thanks. I guess, just really quick, I know I'm only allowed one follow-up. But just on that point, have lead times normalized, would you say, or is there more work to be done on the production side?

Ruben Roy:

That's great. Thanks, John.

Joe Vruwink:

Great. Thanks for squeezing me in. I wanted to take another crack at the topic of AI and adoption. So, when you think about -- maybe the best example is Cerebrus, within implementation efforts, if you think about the total block engineers as an account, what share of those engineers are typically using the product at this point? And in your mind, is that something as we enter the next round of renewals, it could get more widely deployed across the entire team?

Joe Vruwink:

Okay. That's great. And then, on the system design segment, can you -- I don't think I heard it, just an update on where you expect growth to be in 2023? And then, in reflecting on the development here and kind of the upside you're seeing in bookings, is it possible to pinpoint at something like -- you talked about the repeat orders on the organic solvers. You've obviously built a bigger CFD business. There's some new channel initiatives. Are any of these things more important than others in terms of driving the upside you've seen?

Joe Vruwink:

Thank you.

Andrew DeGasperi:

Thanks for fitting me in. I guess one question I had is, and I know you've talked a lot about AI on this call, but just wondering if you think this could potentially lead to more pronounced market share shifts in the future? I know historically, there's not been a lot of market share changes in EDA. But just wondering if we thought with the portfolio that you have relative and your investments that you made relative to your competitors, do you think that could change?

Andrew DeGasperi:

That's helpful. And then -- sorry, go ahead.

Andrew DeGasperi:

No, go ahead.

Andrew DeGasperi:

That's helpful. And then, maybe on just general trends this quarter. Just wondering in terms of the systems business, have you seen any change, particularly in the data center side in terms of demand, or is it being kind of consistent relative to the previous quarters?

Andrew DeGasperi:

Great. Thank you.

Arsenije Matovic:

Hi. This is Arsenije on for Josh. So, just a double click on the systems company strength. And I wanted to see if there was any kind of call-outs, in particular end markets, and how many dealerships the end markets have changed relative to last year, or any kind of outlook changing in terms of end market demand within those companies? Thanks, and then a quick follow-up.

Arsenije Matovic:

Got it. And then, if we could kind of think about some of the strength in hardware, how much of that is driven from refresh from existing large semi customers versus maybe new purchases from systems companies? If you kind of like quantify that from a high level would be helpful.

Arsenije Matovic:

Thank you.

Anirudh Devgan:

Thank you all for joining us this afternoon. It's an exciting time for Cadence with strong business momentum and growing opportunities in the semiconductor and systems industry. We are proud of the innovative and inclusive culture we have built at Cadence. And on behalf of our employees and our Board of Directors, we thank our customers, partners and investors for their continued trust and confidence in Cadence.

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. [Operator Instructions] Thank you. I will now turn the call over to Richard Gu, Vice President of Investor Relations for Cadence. Please go ahead.

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.

Operator:

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

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.

Anirudh Devgan:

Yes. Hi, Charles, thanks for the question. Our demand is broad-based, right, across both our semiconductor customers and our system customers. So as we mentioned before, right now, about 45% of our business is coming from system companies. That includes hyperscaler and other kind of system companies. And I’m very cautiously optimistic that this trend is continued for a long time, okay? Because I think some of these trends are a reversible of system companies doing silicon design. They are already having a lot of success. If you look at whether they are social media companies or phone companies or data center companies or car companies, they have multiple design projects in different stages of development. And overall, we see strong design activity on the systems side and on the semi side. Now there is always some reports here and there. This is not a straight line, right? Some customers may do more. Some customers may do less. But overall, like there will be more and more designs done by system companies. And as you know, the other part of our interaction with system companies is also expanding our portfolio to include System Design & Analysis products, our SDA segment. So we are working with system companies, not just on the silicon side but on the system side, whether it’s 3D-IC or thermal simulation or CFD. And you can see that part of our business is also growing very strongly. So last year, we reported about 27% growth in the system business, which is beyond our traditional EDA business. So overall, I am pretty pleased. And I think design activity remains very strong, driven by 3-nanometer and other things and the expansion of our portfolio to System Design & Analysis.

Operator:

Our next question comes from Jason Celino from KeyBanc Capital Markets. Please go ahead. Your line is open.

John Wall:

That’s a great question, Jason. No, we’ve approached guidance the same way we normally do. Last year, if you recall, we wanted to wait until we had increased visibility into the hardware pipeline, so we were a bit more conservative about the second half for hardware. We’re approaching this year very similarly, but we had – we just finished with really, really strong momentum through the year. And the guide, I mean, there is so much of it coming out of backlog, we feel very confident in the year.

John Wall:

Yes, Jason, it’s – we’ve got access to more production capacity now. We have added additional lines to build the hardware. For the last year, we couldn’t build it fast enough. We did ramp up production capacity, I think, 40% last year, but we sold more than that so we didn’t keep up with demand. So we ramped up production capacity again for 2023, and we feel very confident that we have access to the inventory and the components we need to meet that production demand. But also to the extent that we can produce extra systems, we have a number of underserved or unserved customers that want access to our hardware in the cloud. So any excess capacity we can generate or any excess production we can generate, we can put into the cloud for that offering.

Operator:

Our next question comes from Gary Mobley from Wells Fargo Securities. Please go ahead. Your line is open.

Anirudh Devgan:

Hi, Gary, great question. So first of all, I’m very optimistic about AI, and we always have talked about applying AI for optimization. I mean, in EDA or in chip design or system design, it’s more about automating the design process and producing better results. So even if you look at – the way I look at it, even if you get it right now, some of these chips have 100 billion transistors, right, on 1 inch by 1 inch. And if you look at by 2030, they will have 1 trillion transistors, okay? So just in terms of size, it will be 10x more. And then the chips are more complicated and then you add software on top of it. So the design complexity that our customers need to do will go up by at least 20, 30x in the next 5 to 7 years. So the only way to meet that is by more automation. That’s the history of our industry. And the best way to do more automation right now is using AI, okay? And of course, we have done other ways to do automation in our industry. We started by doing more higher level design, moving from transistor level to gate level. Over the last 5, 10 years, we have done a lot of massive virilism, running things on more CPUs, using cloud. But going forward, one of the biggest ways to improve productivity is using AI. And you see that across our product portfolio. And the real benefit is that a lot of the mundane tasks can be done by the repetitive tasks and mundane tasks can be done by AI, so the designer can move to more higher-value tasks, right? And so the way we approach it through is a very comprehensive – we build this JedAI data analytics because data is critical, too, as you know, to a data analytics and AI platform. And then we have multiple applications on top of it, okay? So Cerebrus is a key one for implementation. We also launched, a few months ago, Verisium for verification, which is another very difficult and all-consuming problem for our customers. And then we are not only focused on the chip side but also on the system side. So we have optimality, which is having great success on the system side. And typically, the system customers are not used to optimization or this level of automation that the chip industry has seen. But we are getting dramatic improvements with the optimality as well. So taken together, I believe that we have the most comprehensive AI portfolio. And we have always focused AI on optimization, which, of course, now called generative AI. And we have been working on it for 5 years. I think the products introduced were about 2 years ago. And even for Cerebrus, I mentioned in my prepared remarks, several leading companies like Intel, NVIDIA, Samsung, Renesas, they all talked about the results they are seeing. We have more than 160 designs that we are tracking on Cerebrus. And if you include Verisium and optimality, we have hundreds of designs being done by AI. And because I believe in the next few years, almost all designs will have some AI component. And that is driving the growth that you’re seeing in our business and the outlook.

John Wall:

Yes, Gary, great question. I mean, we had a really strong finish to the year. And as you know, I mean, contract timing typically impacts the cRPO in any one quarter. But if you look over a typical contract cycle, you’ll see that we’re particularly pleased with the 3-year CAGR on cRPO. It’s tracking to mid-teens growth now, and that’s very consistent to the mid-teens growth we achieved over the last 3 years to 2022 and the mid-teens growth that’s implied at the midpoint of our guidance for 2023.

Operator:

Our next question comes from Jay Vleeschhouwer from Griffin Securities. Please go ahead. Your line is open.

Anirudh Devgan:

Yes. Thanks, Jay. Very valid questions. And of course, great point that system companies are becoming semi companies and semi companies are becoming system companies. And like I said before, this is irreversible trend, okay? This is irreversible. And for us, we invest heavily in R&D, as you know. I mean, about 35% of our revenue is invested in R&D. That’s one of the highest percentages of any S&P 500 company. Just for your reference, you may know this already, we have 10,000 people in the company. 9,000 are engineers or computer scientists. Either they are in customer support roles or in R&D. And we always make sure that the core is good, okay, because the core has to be best-in-class. So whether that is synthesis, like you mentioned, place and route, circuit simulation, analog, verification, so that’s a given, making sure that the core is best in class. And then on top of that, there are certain thematic things that we are investing in. And then the three that I want to highlight, which is – which I think will be thematic for years to come. One is, of course, AI. AI will have a big effect on, like I mentioned, design work. And that’s true for both semi and system companies. Second is 3D-IC, the emergence of chiplets and heterogeneous integration, and Cadence is the best positioned to take advantage of this. And then the third area is this move to systems, system design and analysis and our engagement with system companies are similar, to a lot of extent, with semi companies. Everybody wants to do more with less now, so the benefits of AI and productivity and better results are there in both set of customers. But of course, our emerging portfolio and system design and analysis provides unique value to our system companies because we are no longer talking to the chip designers. We’re talking to the system designers, the architect, the coupling of the mechanical and the electrical designs uniquely positions us. This convergence is going to happen between system and semi, between electrical and mechanical. And there is no other company better positioned than Cadence to take advantage of this, okay? So overall, to answer your question, these are the three big themes on top of the base. See the base is always important, the best-in-class of the basic algorithms. But AI, 3D-IC and systems will be with us for years to come.

Operator:

Our next question comes from Harlan Sur from JPMorgan. Please go ahead. Your line is open.

Anirudh Devgan:

Well, thanks for the question. This is Anirudh. I think you said it. I think what we see is the hardware is no longer – I know it could be part of CapEx, but it’s no longer discretionary spend for our customers. I mean, any chips that are designed today, any complex chips, you have to use these hardware platforms to verify them. And if you don’t verify them properly, then you spend all this money, the chips comes back and it doesn’t work. I mean, that’s a big no-no, right? It delays the whole product and the expense. So hardware platforms, both Palladium and Protium are no longer nice-to-have. You need to have them, okay? And then we have also strengthened our portfolio by not just chip verification but software bring-up. Chip verification has been traditional sense of Palladium. And now with bring us with Protium, we provide a unique. So, so far, the demand is strong. And we had a record year last year. These days, we have – I think we had the record year, year after that, too. But we see continued growth in hardware. And we are very pleased where our competitive position in hardware. We are very pleased with the demand as – it’s no longer nice to have. It is no longer discretionary. And also in multiple end markets, so what happened is like we talked about automotive, right? So automotive also has much higher complexity chips now. So the other thing with hardware is it is also expanding to other end markets, whereas traditionally, the big chips used to do it like data center chips. But now even automotive chips are almost networking. Almost all kinds of chips will require the use of these hardware systems. And we are very well positioned to take advantage of that.

Anirudh Devgan:

That’s a very good point. So I mean, like I mentioned, we have more than 30 projects in all aspects of AI. AI inherently is computational software, right. It’s computer science plus math, which is what we’re very good at. So you can assume that we are working throughout our design flow. And then we announce products in a more conservative way now. We want to make sure they are working with several customers, with different end markets and then we announce them. So last year, the year before, we talked about digital implementation. Last year, we talked about JedAI and verification. And I think this year, you will hear more from us in other parts of the business. The analog custom business is ripe for more automation and packaging PCB. So please stay tuned. But you can be rest assured, we are applying AI wherever it is possible and it is possible to apply it everywhere.

Operator:

Our next question comes from Joe Vruwink from Baird. Please go ahead. Your line is open.

John Wall:

Great question, Joe. I mean as Gary mentioned earlier, that he was asking about the number of customers, was there any big customer, there wasn’t one big customer in Q4. We just had a very strong finish to the year. Very strong finish across all lines of business and particularly hardware was very strong as we closed out the year in terms of bookings. I think our hardware systems are just not discretionary spend. As Anirudh said earlier, they have become indispensable part of our customer spend on the R&D side, and people wanted to get their orders in before the end of the year. So, we have a lot of visibility into the next year. And as you know, cRPO, from a quarter-to-quarter basis, can be lumpy in nature. And I think like if you want to reconcile between where the growth in cRPO, say, for the last year is probably up closer to 20%. But if you look over 3 years, it’s mid-teens. And if you look over 3 years for our revenue CAGR, that’s mid-teens to ‘22, and we are guiding to mid-teens for ‘23. So, I think you can take out some of the noise by looking over a 3-year kind of average period.

Anirudh Devgan:

Yes. Good point. I mean one thing to mention is, we always look at all the kind of AI technologies. We have a pretty talented team. And like I mentioned, for us, the biggest application is simulation plus optimization, because you can generate much better results for the customers. So, we are using reinforcement learning and all kinds of other kind of ML techniques for a while now. And to give you an example, like some of the results we are seeing, the PPA can be improved by 10% to 15%, okay. That’s a lot of improvement. And typically, you see this improvement from – going from one node to the next, okay, spending billions of dollars, okay. You can get that from better kind of AI algorithms. Now, some of the language models, there could be other applications, especially with the interface of our tools for customer support. There could be applications. But the main customer-facing applications are when we give better results, better productivity, which we are already doing in multiple ways, as I mentioned, and we will continue to look at all possible ways to improve that.

Anirudh Devgan:

Yes.

Vivek Arya:

Thanks for taking my question. Anirudh, when I look at the relative growth in your different segments, the System Design and Analysis seems to be the fastest-growing segment, obviously, off a lower base over the last 5 years. What do you think has driven that outperformance? And as you get bigger in that market, does the competitive landscape change? Can you continue to outgrow the market, or just how do you think about that particular aspect of your growth drivers?

Vivek Arya:

Understood. And for my follow-up, John, not complaining at all, but when I look at the implied incremental EBIT margin for this year, it seems somewhat lower than the average incremental margins that you have managed to achieve over the last few years. Just wanted to make sure we are not missing anything from a cost perspective that could restrain incremental EBIT leverage this year.

Vivek Arya:

Understood. Thank you very much.

Blair Abernethy:

Thanks very much and great quarter, guys. Just wanted to see if there is anything to update on the Future Facilities acquisition last summer. You have had it for a couple of quarters now. How is that trending? And are you seeing opportunities to cross-sell your other simulation software into that space?

Blair Abernethy:

That’s great. Thank you.

Ruben Roy:

Thank you. Anirudh, you got a bunch of questions on hardware, and I think Carlin’s question hit on most of the things that I wanted to ask about. But I guess one thing that stood out to me from your commentary was that the two-thirds of your, I think new orders in ‘22 were for both Palladium and Protium. And that was interesting to me because it seems like as we are moving to more SSD designs, more firmware and software on those designs, that that sort of selling Palladium and Protium together is likely to move up. So, I guess if you could just comment on that and how you are thinking about that as either TAM expansion or a revenue growth driver kind of longer term behind hardware would be interesting. Thank you.

Ruben Roy:

Thanks for all that detail Anirudh. If I could just ask a quick follow-up for John, I don’t think you were asked on the pricing environment, John, and just watching the backlog move up again and kind of all the megatrends that you are talking about is understandable that things are going well. But I am just wondering, in light of the macro, etcetera, if – how you are thinking about pricing as in the context of the guidance that you have given for ‘23? Thank you.

Ruben Roy:

Makes sense. Thanks John.

Ruben Roy:

Yes. Thanks Anirudh. I guess that’s where I was going with the question. I mean obviously, with Cerberus going – running on top of Innovus. And I am just kind of trying to think about how – it seems, and you guys have talked about this, greater portion of R&D budgets from both semiconductor and systems companies just going into kind of the suite of tools that you offer. So, anyway, thank you very much, and congrats on a great quarter.

Andrew DeGasperi:

Thanks for taking my question. I guess first in terms of the analytics products that you mentioned, I was just wondering in terms of your customers, how steep of a learning curve is it for them to adopt us? And what is the kind of timeline that it typically takes from when you introduce it to them to when they are kind of using it in terms of their day-to-day processes?

Andrew DeGasperi:

Yes. That’s helpful. And then one question for John, in terms of the share repurchases, I think you bought 1 billion or so last year. This year, you are guiding for a bit below that. I was just wondering, what was the thinking behind that? Is it a function of investing in the R&D in terms of the different – the three different themes you mentioned earlier, or is it potentially for additional M&A that you are planning for the year?

Andrew DeGasperi:

Great. Thank you.

Anirudh Devgan:

Thank you all for joining us this afternoon. It’s an exciting time for Cadence as we enter 2023 with strong business momentum and robust design activity offering tremendous market opportunities. Our exceptional execution of the Intelligent System Design strategy, customer-first mindset and a high-performance and inclusive culture are driving accelerating growth as we grow our core EDA business while expanding our portfolio with new innovative solutions. Fostering sustainable innovation is a top priority, and we are thrilled to have been included in the newly released 2023 top-rated ESG Company List, ranking number 18 out of over 1,000 companies in the software and services group. And on behalf of our employees and our Board of Directors, we thank our customers, partners and investors for their continued trust and confidence in Cadence.

Operator:

Good afternoon. My name is Aby, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence Third Quarter 2022 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I will now turn the call over to Richard Gu, Vice President of Investor Relations for Cadence. Please go ahead.

Anirudh Devgan:

Thank you, Richard. Good afternoon everyone and thank you for joining us today. I’m pleased to report that Cadence delivered excellent results for Q3 driven by our technology leadership, strong execution, diversified customer base and resilient business model. We beat our Q3 guidance on all key metrics and are raising our financial outlook for the year yet again, to 19% year-over-year revenue growth and 40% operating margin. John will provide more details on our Q3 results and the updated outlook for the year. Notwithstanding the prevailing macroeconomic uncertainties, our thesis about generational drivers such as 5G, hyperscale computing and AI/ML driving robust design activity over the long term, remains intact. These secular trends are accelerating the digital transformation across several end markets, while the growing hyperconvergence across multiple domains, mechanical and electrical, hardware and software, and systems and semis is driving the strong need for continued innovation in compute, connectivity and storage. Customers are investing heavily to differentiate their next generation platforms, with system companies increasingly developing purpose-built silicon, and semiconductor companies benefiting from expanding silicon content. Our comprehensive offerings comprised of leading end-to-end EDA solutions, IP, hardware and expanding systems portfolio, uniquely position us to support our customers, while providing us with ample growth opportunities. In an environment of increasing design complexity, tighter time to market requirements and growing shortage of talent, sophisticated AI/ML solutions can greatly help to democratize chip and system development, while dramatically increasing productivity and quality of results. Customers deploying our game-changing AI-driven Cadence Cerebrus and Optimality solutions are realizing amazing results, and in Q3 we augmented our portfolio with the transformative Verisium AI verification platform, and the JedAI data platform. Verification continues to be the critical path in system time to market consuming the vast majority of resources, with debug being the largest component. Verisium provides a generational shift in verification, moving from a legacy single-run, single-engine approach, to algorithms that leverage big data and AI to optimize multiple runs across multiple engines, leading to a 10x boost in debug productivity. Several customers including Samsung and STMicroelectronics have observed impressive results with Verisium for automatically triaging and root causing bugs. JedAI is our revolutionary AI-driven, big data analytics platform, that is foundational to unifying our AI innovations across Cadence Cerebrus, Optimality and Verisium. JedAI operates on vast amounts of data, including all types of design, verification, analysis and methodology information, to facilitate smarter design optimization and enhanced productivity. In Q3, we significantly expanded our footprint with market shaping customers as they increasingly embraced our optimized platform offerings. 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 Multiphysics system analysis solutions. Additionally, in Q3 we strengthened our collaboration with Teradyne, which included a broad proliferation of our core EDA software across digital, analog and verification, as well as a significant expansion of our PCB and systems analysis business. Demand for our core EDA software remained strong and broad-based. Our digital business had another strong quarter, with 22% year-over-year growth, driven by key competitive wins and continued proliferation at market shaping customers. 13 new customers adopted our digital full flow in Q3. It’s been just over a year since we launched Cadence Cerebrus, and it’s fast becoming a linchpin technology for customers, as they derive incredible productivity and PPA results on a wide variety of their most advanced SoC designs. Several leading customers have major multi-design, multi-project production deployments underway and are reporting up to 30% improvement in quality of results and 30x productivity improvements. Additionally, we see accelerated growth in our front-end and signoff offerings, in part due to the Cadence Cerebrus pull-through effect. We launched the Certus Closure solution which dramatically accelerates complete design closure, by using an innovative hierarchical architecture, and a fully automated environment for concurrent full chip optimization and signoff. Using Certus, Renesas observed 6x faster chip-level signoff closure versus current methodologies, and Maxlinear experienced overnight full chip signoff closure, while realizing up to 5% of untapped power savings. Our Custom IC business continues to define the analog market with its bold vision, market leading technology and comprehensive portfolio. In Q3, it grew 12% year-over-year driven by our best-in-class Virtuoso platform and by strong growth in our Spectre simulation solutions. Now moving onto Functional Verification. In Q3, our business grew 31% year-over-year, led by hardware and Xcelium. Our Palladium Z2 and Protium X2 hardware platforms, providing industry leading system verification and software bring-up capabilities, added 3 new customers and had 20 repeat orders, including from high end mobile, AI and hyperscaler customers. Our IP business, led by our Star IP offerings at the most advanced nodes, continues to benefit from the ongoing IP outsourcing trend and from customers increasingly embracing IP reuse for risk reduction and faster time to market. During Q3 we signed our largest IP contract ever, with a marquee U.S. semiconductor company, and had a major expansion at a leading U.S. 5G company. Tensilica extended its leadership in the True Wireless Stereo market, while proliferating its functional safety and infotainment solutions with automotive companies. We also had multiple design IP wins across our leading PCIe, DDR and die-to-die portfolio. Our System Design & Analysis business is a key tenet of our growth strategy to leverage our computational software expertise and expand our TAM by growing in near adjacencies. This business continued its strong momentum, delivering 29% year-over-year growth, as we increased our footprint in several verticals including Aerospace & Defense and high-tech electronics. Our broad systems portfolio providing tightly integrated platform solutions across the design, simulation and analysis, is resonating strongly with customers as they increasingly choose a broader set of our solutions across these domains. In Q3, we broadened our collaboration with Emerson, a global industrial technology and software leader, as they significantly expanded their use of our Systems solutions, notably our PCB, AWR and systems analysis technologies. Fidelity CFD software, that was announced earlier this year, is ramping nicely and facilitating customers in verticals such as Aerospace, Marine and Turbomachinery to do design optimization, leading to efficiency improvements and meaningful reductions in emissions and energy consumption. And the addition of Future Facilities’ digital twin based thermal and power optimization technology, will further help data center customers to reduce their carbon footprint. Lastly, we completed the acquisition of OpenEye Scientific, a leader in the computational molecular design space. We are very excited to bring our system level simulation and AI/ML expertise to the life sciences market to help improve the speed and accuracy of biosimulations, thereby enhancing the efficiency and success rate of the drug discovery process. Integration of both our Future Facilities and OpenEye acquisitions is progressing well. In closing, Q3 was an outstanding quarter as we advanced our Intelligent System Design strategy and continued to closely collaborate with our customers on their next generation designs. We are managing our business with an intense focus on innovation and operational excellence to drive both revenue growth and margin expansion, and are very well positioned to capitalize on the massive opportunities ahead of us. Now, I will turn it over to John to provide more details on the Q3 results and our updated 2022 outlook.

Operator:

[Operator Instructions] Your first question comes from Jason Celino from KeyBanc Capital Markets.

John Wall:

Yes, Jason. Go on.

John Wall:

That’s a great question, Jason, and thanks for the opportunity to clarify. In Q2, you saw 13% of our revenue in Q2 came from China, and that jumped to 17% in Q3. Most of the increase -- the vast majority of that increase was a result of hardware sales in the quarter, hardware revenue that was recognized from deliveries into China during Q3. So, that uptick in China revenue is all from upfront revenue sources.

John Wall:

Yes, another great question, Jason. Last quarter, I think it was 2.75 in terms of our current RPO, and that’s down to 2.7 now. That’s partly as a result of that hardware delivery into China. It also includes the -- this quarter, we’ve included the impact of the new U.S. export regulations. On backlog, in total, I think it went from 5.6 to 5.5. The current -- or the RPO piece that was slightly down more and we had an increase in IP. We signed our largest IP contract ever, and that’s in the non-cancelable commitment portion of our backlog.

Charles Shi:

I really just want to go back to the China question, maybe not immediate Q4 or fiscal ‘22, but to try to look a little bit ahead. Among your kind of like mid-teens of the total revenue coming from China, I know you sell to China to various kinds of customers. You’ve got multinationals, you’ve got the large semiconductor companies, domestic, you’ve got AI startups, Chinese system companies. But across this wide spectrum of the different kind of customers in China, what kind of customer, the sales to the customer, could be the most impacted by the export control? And well, can you kind of quantify to us how much of the percentage of your revenue going to be impacted because of the latest round of export controls? And I have a follow-up to that.

Charles Shi:

Any thoughts on any specific type of customers that you may see the greater impact in China -- in your China market?

Operator:

Your next question comes from the line of Gary Mobley from Wells Fargo.

Anirudh Devgan:

Hi Gary. This is good point, especially the indirect effect and also overall macroeconomic uncertainties. And we are carefully monitoring the situation on both of these fronts. As you know, we are more on the design side than on the volume of shipments. So on the macroeconomic trends, of course, there’s a lot of news in the press, and we are carefully monitoring it. But right now, we see robust design activity. And as you know, we participate in all the market verticals. So even if some verticals may be weaker, on their shipment side, they will still do design. But then some verticals are still good on the shipment side as well. So with this combination of us being on the design side and then us being very diversified across multiple verticals, right now, we still see very robust design activity. And that’s reflected in the results that we are reporting today, right, and our outlook for rest of the year. Now on the indirect effect on China, that’s to be observed also. But again, we are pretty diversified. And then yes, there’s always some effect on some of our customers. But again, we are pretty diversified. And then -- so we, right now, feel that that’s manageable, but we will carefully monitor that going forward.

Anirudh Devgan:

That’s a great point. And we are super excited about this new AI-based solution. Because like I mentioned earlier, this is a great opportunity for EDA to add more value to our customers. Because if you look at historically, EDA has always been like -- has done -- we have done a lot of great productivity improvements for our customers, but it has always been like a single-run environment, right? You run our tool one time, and then the multiple runs have been managed by the customers. Typically, when you do the design, you’re not running our tools one time, you’re running it multiple times. So with these data analytics and AI, we can really offer solutions in this multi-run environment. And so AI is a key part of that. But in a multi-run environment, you also have to manage the data because AI tools run on top of all the data that is generated. And we are very proud of this new JedAI platform. It’s a new data analytics platform to capture all kinds of data in the design process. And that unifies our solutions across this space. And then we have 3, like, big apps on top of JedAI, on top of this data analytics. So one you already know, like Cadence Cerebrus, which was launched last year; Optimality, which is on the system space using some of the similar technologies as Cerebrus but applied to system simulation; and now Verisium in verification, which, by the way, verification, as you know, is one of the most time-consuming parts of the design flow and also the one that generates the most data. Logic simulation, hardware verification generates the most amount of data in EDA. So, that’s why it was critical to have JedAI to unify all these things, but also get ready for more data like in verification. And the adoption has been actually surprisingly good. And all the big customers are engaged. You see in Verisium, we have endorsement from several big customers. We talked about Cerebrus last time. So, at this point, all the major customers really do want to deploy these solutions. And like I mentioned in the script, not just for one or two designs, we are seeing broader and broader adoption, and we are very happy with the progress so far.

Jay Vleeschhouwer:

Anirudh, for you first, when you look back at the last one or two years, how would you rank the contribution to your bookings growth and/or share gain in what we define as core EDA from the various products that go under your us and nomenclature? I assume Innovus has been part of that given the size. But when you look at some of the various other sign-offs and other tools that you’ve introduced under that nomenclature, again, how would you rank the new momentum or incremental contribution from those and perhaps even look out ahead over the next one to two years in that respect? Secondly, for you, John, what has been your experience to date in terms of the predictability of your IP business? This is not a China-specific question but feel free to talk about China, specifically in terms of the increasingly material upfront component that we’ve seen for IP rev rec as well as for your services engagements related to IT. Thank you.

John Wall:

In relation to your IP question and particularly the predictability of IP revenue, our focus remains on profitable growth through differentiated Star IP that’s highly reusable and easier to scale. And I’ve been very pleased with the discipline from the management team that run that business for us and their ability to target more profitable and sustainable revenue growth. That’s what we ask for. We always ask them to run IP like it’s our family business, sign us up to business that you’d want to do if this was your family business, not just a public company. But -- and of course, with IP in amongst that profitable, sustainable, regular recurring revenue, there’s also some upfront components to IP that can have more variability. Naturally, we’re cautious on that going forward, but we’ll have to look at the macroeconomic environment on the impact of that for next year, but we see a lot of upfront revenue this year in our numbers. I think upfront revenue for 2022 is on track to be almost 50% growth year-over-year. That sets up some pretty tough comps for next year. So we’ll look at that carefully. Now most of that’s coming on the hardware side. But when I look at all of the business, all the businesses across Cadence, they’re all on track to go by low-teens or more growth this year. And like I said, very, very pleased with the predictability of the IP business, particularly because they focused on profitable and sustainable revenue growth for us.

Vivek Arya:

I wanted to ask the China question in a different way. How much of your 17% of sales to China were to customers that were involved in or would eventually be involved in sub 14-nanometer logic design or leading edge NAND or DRAM? I guess, it’s just not intuitive that leading-edge design is not possible without your tools. China just got restricted from doing leading edge, yet you’re not seeing the restriction in any ways. It’s just not intuitive to me at all.

Vivek Arya:

But is that a near-term view, John, in that? Is it because you are more involved in analog? Is it because you are in two- or three-year contracts, or is it because you think that there is other revenue sources outside of China that can help you kind of offset that deficit?

Vivek Arya:

Okay. And for my follow-up, I’m curious what happens if semiconductor sales go down 10% or 15% next year? What happens to the budget for EDA? Like even if you don’t decline, is it possible that the growth rate slows down from the mid-teens, or I guess asked in a different way, under what scenario would Cadence’s growth rate slow down next year?

John Wall:

Yes. And the macro will really impact upfront more. I mean, we have very resilient, robust stream of recurring revenue. I think that’s what Jay was getting at in his earlier question about the predictability of the IP business. I feel very confident in the IP business because we’ve been focused on profitable and sustainable revenue growth there, but we’ve had a really strong hardware revenue year this year. And I don’t know myself, if there’s a severe downturn in macroeconomic conditions, IT budgets are one of the first things that you look at in terms of do you need to purchase hardware and capital equipment and things like that. And that could impact us on the upfront side.

Harlan Sur:

Maybe as a follow-up to the last question. So your functional verification portfolio, which includes hardware simulation and prototyping, right, that’s up 25% through the first nine months of this year, very strong growth. But if I think about a weaker semi industry next year and think about where the risk would be, you talked about some of the upfront portion of your revenues, and I think about hardware emulation and prototyping platforms. But then on the flip side, we continue to hear that design verification and early software development continue to be very significant bottlenecks in these next-generation digital SoC chip design, so actually very critical to your customers’ overall design process. Do you guys agree with this? And given your pipeline visibility, backlog, do you see your hardware emulation and prototyping pipeline, at least as you’re looking at it now remaining relatively strong into next year?

Anirudh Devgan:

But in general, your thesis is correct. I mean hardware almost become indispensable to the design of chips and electronic systems. So without these emulation and prototyping platforms, it’s almost impossible to design that. And as the chips get bigger, as you go to near nodes, the chips, in terms of -- they get bigger in terms of number of gates, right, so the next node always has more gate than the previous node, even if the chip size is the same as you know. So, as the chip number of gates gets larger, it requires more and more verification and emulation. So overall, I think there is a systemic kind of support of how much emulation and verification needs to be done. So it just depends on how that overall baseline growth required gets affected by any large macroeconomic shift. But in general, these hardware platforms are almost indispensable now as you do design and almost all our big customers are relying on them. Yes.

Harlan Sur:

I appreciate that. And maybe just a longer-term question because we’re hearing more and more about this. But on the move to 800 gig and higher optical space in the data center, this is driving a pretty strong focus on more integrated silicon photonics-based solutions, either optical module based or co-package electrooptical. Intel, Marvell, Broadcom, NVIDIA, Cisco, all of some of your big customers are all working on for thoughtful solutions. I know you guys have a pretty strong portfolio here. You’ve got also Photonics, I think you’ve got some of your advanced packaging and module design solutions, thermal and power modeling solutions as well, and you guys also have pretty strong partnerships with some of the manufacturing guys. How do you guys see this market opportunity unfolding for the team over the next few years?

Operator:

Your next question comes from Gal Munda with Wolfe Research.

John Wall:

Yes. Sure. Good question, Gal. But on the operating expense side, of course, it includes a full quarter now of expense for OpenEye Scientific and Future Facilities, plus incremental hiring that we did during Q3 and intend to do again in Q4. But you get the full bow wave effect of any hiring in Q3, the full quarter of that expense in Q4. Also, on the bookings front, we’ve had seen substantial increase in bookings compared to our forecast this year, that sales have been very, very good. And so, there will be increased commission costs embedded into that Q4 guide as well.

John Wall:

I’ve been very, very pleased with the performance of all the businesses. Like I said, every single one of our businesses is performing exceptionally well. The lowest performing business is showing teen growth year-over-year. Absolutely tremendous. Now, what I wasn’t expecting was upfront revenue to grow by almost 50% over 2021. I don’t think any of us would ever have predicted that. But you’re seeing a lot of that upfront revenue coming through from hardware. It’s the popularity of our emulation systems has just been off the charts. And long may it continue, but it’s is very hard to determine how long that will continue for. We do have substantial backlog already and a long lead time, and we’re making those systems as fast as we possibly can. I think if you have a look at the inventory, we’ve less than $10 million of finished goods there. The vast majority of that is already out on demonstration with customers. But -- so there is a triage situation that goes on every system that comes off the production line. There’s a plan for getting that out to a customer as quickly as possible.

Johnny Conti:

Congratulation delivering another great quarter. Now, given the strong clear performance that you’ve had in system design analysis and JedAI and Cerebrus, could you perhaps give some color on how your customers are reacting to budgetary decisions regarding spend in this category given the current economic climate? Are you seeing customers stickiness similar to that EDA consumption, or is this bucket of software spend more volatile down there? I’d imagine companies, particularly for this bucket and more defensive, generally speaking. I’ll ask a follow-up after. Thank you.