Cadence Design Systems Q4 2022 Earnings Call Transcript

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Provided by Quartr
February 13, 2023

Key Takeaways

  • Cadence delivered record 2022 results with 19% revenue growth to $3.56 B, over 40% non-GAAP operating margin, and 2023 guidance of $4.00–4.061 B revenue and 40.5–42% non-GAAP margin.
  • Free cash flow remained strong with Q4 operating cash flow of $264 M, $882 M cash on hand, $1.05 B in share repurchases during 2022, and a commitment to use ~50% of 2023 free cash flow for buybacks.
  • Cadence introduced nine major innovations in 2022—most notably Cerebras AI‐driven chip implementation, Verisium AI verification and Optimality Explorer—delivering up to 30× debug and 10× system optimization gains.
  • Broad-based segment growth was driven by secular trends—digital IC revenue +17%, verification +28%, custom IC +13%, IP +12% and system design & analysis +27%—as customers invest in 5G, AI/ML and heterogeneous integration.
  • Cadence expanded strategic partnerships with AMD, BAE Systems, global memory/storage leaders and TSMC (sixth OIP Partner of the Year), and announced Board Chair transition from Lip-Bu Tan to ML Krakauer.
AI Generated. May Contain Errors.
Earnings Conference Call
Cadence Design Systems Q4 2022
00:00 / 00:00

There are 13 speakers on the call.

Operator

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 4th Quarter and Fiscal Year 2022 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. Call.

Operator

After the speakers' remarks, there will be a question and answer session. Thank you. I will now turn the call over to Richard Gu, Vice President of Investor Relations for Cadence. Please go ahead.

Speaker 1

Quarter. Thank you, operator. I would

Speaker 2

like to welcome everyone to our Q4 of fiscal year 2022 earnings conference call. Conference call. I'm joined today by Anurag Devdan, President and Chief Executive Officer and John Wall, Senior Vice President and Chief Financial Officer. Quarter. The webcast of this call and a copy of today's prepared remarks will be available on our website, cadence.com.

Speaker 2

Call. This discussion will contain forward looking statements, including our outlook on future business and operating results. Quarter. Due to risks and uncertainties, actual results may differ materially from those projected or implied in today's discussion. Quarter.

Speaker 2

For information on factors that could cause actual results to differ, please refer to our SEC filings, quarter, including our most recent Forms 10 ks and 10 Q and today's earnings release. All forward looking statements during this call are based on estimates and quarter. We disclaim any obligation to update them. In addition, quarter. We will present certain non GAAP measures, which should not be considered in isolation from or as a substitute for GAAP results.

Speaker 2

Quarter. Reconciliations of GAAP to non GAAP measures are included in today's earnings release. Quarter. Today's earnings release for the Q4 of fiscal 2022 related financial tables and CFO commentary are also available on our website. For the Q and A session today, we would ask that you observe a limit of 1 question and one follow-up.

Speaker 2

Quarter. Now I'll turn the

Speaker 3

call over to Anurud. Quarter. Thank you, Richard. Good afternoon, everyone, and thank you for joining us today. I'm pleased to report that Cadence delivered record results for 2022 quarter as we exceeded our guidance yet again, achieving 19% revenue growth and over 40% non GAAP operating margin.

Speaker 3

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 5 gs, hyperscale computing and AIML 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.

Speaker 3

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 opportunity. Quarter. During the year, we introduced 9 significant innovative products across all of our business groups, quarter. And we expect these to be key drivers of our future growth. Quarter.

Speaker 3

The age of AI is upon us and Cadence provides several groundbreaking computational software driven generative AI technologies quarter at both the chip and system level, unified by JEDI, our differentiated big data analytics platform. Quarter. Our customers are seeing dramatic results with these solutions delivering highly optimized design an unprecedented efficiency gain. 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. Quarter.

Speaker 3

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.

Speaker 4

Quarter. In

Speaker 3

Q3, we deepened our partnership with BAE Systems. Across our core EDA and Systems portfolio, quarter, 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 broadened our relationship with a global leader in memory and storage solutions through extensive proliferation of our custom, digital and system solutions. We also expanded our strategic partnership with a global leader in networking and telecommunications 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 6th Open Innovation Platform Partner of the Year Awards from TSMC.

Speaker 3

Now let's talk about some of the product highlights for both Q4 and 2022. Quarter. 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. Quarter.

Speaker 3

Our digital software is now deployed in all top 20 semiconductor companies. We are pleased with the accelerating growth of our front end Janus and JUULS tools and Cyno products such as Tempus and Qantas, complementing the broad proliferation of Innovus. Our transformative Cadence Cerebras 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, quarter, including 7 of the top 10 semis and at several major hyperscalers. In Q4, GOC successfully delivered an advanced HPC design and a CPU design quarter.

Speaker 3

Using our digital full flow and Cadence Cerebras on TSMC N5 process technology, delivering 8% reduced power and a 9% area improvement, while significantly improving engineering productivity. Quarter. In 2022, several market shaping customers including Intel, NVIDIA, Broadcom, Samsung and Renesys shared their remarkable successes with Cadence Cerebras at our Cadence Live user conferences. Escalating system and software bring up complexities combined with relentless first pass silicon requirements Continue to drive strong demand for our essential functional verification solutions. Quarter.

Speaker 3

Our verification business grew 28% year over year, fueled by secular trend quarter, which had another record year. Our dynamic duo of Palladium Z2 and Protium X2 platforms quarter. 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 quarter. Due to the compelling value offered by common front end compiler, quarter.

Speaker 3

Demand for the payer greatly exceeded our expectations with more than 2 third of the orders in the year, including both platforms. Quarter. Our new Cadence Vericium AI verification platform enables dramatic improvements in debug productivity quarter. And in early production usage at several market shipping customers, Vericium delivered up to a 30x improvement and Efficient Root Cause Analysis. Our custom IC Virtuoso and Spectre franchise solutions tackle the toughest challenges in analog, fixed signal, RF design and circuit simulation.

Speaker 3

Quarter. 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. Quarter.

Speaker 3

We added 200 new Virtuoso logo and more than 150 logos per Spectre. With SpectorFX making strong headway in fast paced memory applications. Increasing usage of pre configured 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, 5 gs 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 and Smart Speakers and True Wireless Stereo Headsets, Imaging and Machine Learning Applications.

Speaker 3

Quarter. Rising system complexity and challenges stemming from the growing hyper convergence of the electrical, mechanical and physical worlds are driving the strong need for a seamless platform solution across design, packaging, simulation and analysis. Quarter. 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.

Speaker 3

With customers embracing our revolutionary Integrity 3DIC 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. Quarter. Our in design analysis solutions had several significant wins with HPC and hyperscaler customers, quarter. While our CFD Fidelity platform proliferated with market shaping aerospace and defense customers.

Speaker 3

Quarter. During the year, Fidelity CFD software meshing capabilities were chosen by Toyota Motor Europe to be the standard workflow for CFD preprocessing. And in numerous customer engagements, Optimality Explorer, the industry's 1st 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, Libhut 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.

Speaker 3

We will return to an independent chair structure With M. L. 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. Quarter.

Speaker 3

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.

Speaker 5

Thanks, Anurud, and good afternoon, everyone. Quarter. I'm pleased to report that we exceeded all of our key financial and operating metrics for the Q4 2022. Robust customer design activity and demand for our strong technology portfolio continue to drive growth across all of our businesses. Quarter.

Speaker 5

Cadence had an excellent 2022 and we began 2023 with a lot of confidence and strong momentum on the back of the stability and resilience you'd expect from a predominantly recurring revenue model. Here are some of the financial highlights from the Q4 the year, quarter starting with the P and L. Total revenue was $900,000,000 for the quarter and $3,562,000,000 for the year. Quarter. GAAP operating margin was 23.5% for the quarter and 30.1% for the year.

Speaker 5

Non GAAP operating margin was 35.6% for the quarter 40.3% for the year. Quarter. GAAP EPS was $0.88 for the quarter $3.09 for the year and non GAAP EPS was $0.96 for the quarter and $4.27 for the year. Next turning to the balance sheet and cash flow. Our cash balance was $882,000,000 at year end, quarter, while the principal value of debt outstanding was $750,000,000 Operating cash flow in the 4th quarter was $264,000,000 $1,240,000,000 for the full year.

Speaker 5

DSOs were 49 days quarter. And we repurchased $1,050,000,000 worth of Cadence shares during the year. Quarter. Before I provide our outlook for Q1 and 2023, I'd like to share a few comments. Our most recent fiscal year quarter ended on December 31, 2022.

Speaker 5

This fiscal year will also end on December 31st, quarter as we have now moved our fiscal year to a calendar year. Approximately 15% of our annual revenue for fiscal 2022 was upfront with 85% recurring. At the midpoint of our 2023 revenue outlook, we're expecting a similar revenue mix for the year. Quarter and our outlook for 2023 assumes export control regulations remain substantially similar for the remainder of the year. In our outlook for 2023, we expect revenue in the range of $4,000,000,000 to 4.06 $1,000,000,000 GAAP operating margin of 30.5% to 32%, non GAAP operating margin of 40.5% to 42%.

Speaker 5

Quarter GAAP EPS in the range of $3.24 to $3.34 quarter non GAAP EPS in the range of $4.90 to $5 operating cash flow in the range of $1,300,000,000 to $1,400,000,000 quarter and we expect to use approximately 50% of our free cash flow to repurchase Cadence shares in 2023. For Q1, we expect revenue in the range of $1,000,000,000 to $1,020,000,000 GAAP operating margin in the range of 31% to 32%, non GAAP operating margin of 41% to 42%, quarter GAAP EPS in the range of $0.84 to $0.88 and non GAAP EPS in the range of $1.23 to $1.27 And as usual, we published the CFO commentary document on our Investor Relations website, quarter, which includes our outlook for additional items as well as further analysis and GAAP to non GAAP reconciliations. In conclusion, I'm pleased that we achieved double digit revenue growth across all of our businesses. Increased 3 year revenue CAGR into the mid teens, and I'm especially pleased that we continue to expand annual operating margins. As always, I'd like to thank our customers, partners and our employees for their continued support.

Speaker 5

And with that operator, we'll now take questions.

Operator

Call. At this time, I would like to remind everyone who wants to ask a question, please press star then the number one on your telephone keypad. We'll pause for just a moment to compile the Q and A roster. Our first question comes from Charles Hsieh from Needham and Company. Please go ahead.

Operator

Your line is open.

Speaker 6

Call. Hi. Thank you for taking my questions. Maybe the first one, it's kind of like a 2 part question. Maybe this is to John.

Speaker 6

John, your fiscal year and Q1 guidance seem to imply a relatively flat revenue profile through the year. And I'm sure you heard your peer, they seems to be seeing a slightly upward lending profile through their fiscal year, although I know the fiscal year, yours and theirs end slightly different month. Is the difference just a matter of more conservatism on your side? Or is it a matter of a different end market mix or product mix? Maybe let me ask the second part.

Speaker 6

I think they are kind of related. I'll ask all at once. I think 1 quarter ago, you were cautious, your hardware sales into fiscal 'twenty three because 2022, Like you just said, it's a record year for the hardware sales. So what is your assumption in the full year guidance for fiscal 2023 On your hardware revenue profile for the year, is it flat or is it that are you assuming there is some recovery in the second half of the year? Thank you.

Speaker 5

Hi, Charles. Thanks for the questions. That's excellent questions. 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 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.

Speaker 5

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. Quarter. Now, the second half of the year is harder to predict for hardware.

Speaker 5

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 That's 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. In the second half of the year, we've kind of derisked the second half of the year for hardware.

Speaker 5

If we see continued demand at this pace, we'll have to take the second half up.

Speaker 6

Thank you. That's excellent. Maybe my second question, maybe this is for Anirudh. I think some investors are Worried about hyperscaler spending on EDA, I mean, both on near term and long term since I mean, in the near term, I mean, obviously, the layoff intact, quarter. Well, some people think it could mean reduce the chip design projects and lost the jobs for design engineers.

Speaker 6

And in the long term, I mean, There's a smaller portion of the investors that kind of worry about the sustainability of the hyperscaler spending strength, although I I think chat is around AI recently seems to suggest that that strength is probably not going to go going down, but probably going to Accelerate that. So can you share your observation or any insights that your demand coming from hyperscaler side? And what's your thought? Quarter. What's your current outlook going into like a 2, 3 year horizon?

Speaker 6

Thank you.

Speaker 3

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.

Speaker 3

That includes hyperscaler and other kind of system companies. And I'm very cautiously optimistic that This trend has continued for a long time, okay, because I think some of these trends are irreversible. Of system companies doing silicon design. They're already having a lot of success. If you look at whether they're social media companies or phone companies or datacenter companies or car companies, they have multiple design projects in different stages of development.

Speaker 3

And overall, we see strong design activity on the system side and on the semi side. Now there's always some reports here and there. This is not a straight line, right? Quarters. Some customers may do less, but overall like there will be more and more designs done by system companies.

Speaker 3

And as you know, the other part of our interaction with system companies is also expanding our portfolio to include system design and analysis product, our SDA segment. So we are working with system companies not just on the silicon side, But on the system side, whether it's 3 d IC or thermal simulation or CFD, and you can see that part of our business is also growing very quarter. So last year, we reported about 27% growth in the system business, which is beyond our traditional EDA Business. So overall, I'm 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 and analysis.

Speaker 6

Thank you, Anirui. Thank you, John.

Speaker 4

Quarter.

Operator

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

Speaker 1

Quarter. Great. Thanks and good quarter. When I look at the guidance, 12% to 14% growth to start the year, best growth guidance I've seen and even best last year's On a much tougher comp. John, any change to philosophy in terms of how you that guidance.

Speaker 5

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 quarter. We're approaching this year very similarly.

Speaker 5

We just finished with really, really strong momentum to the year. And the guide is the guide. I mean, there's so much of it coming out of backlog. We feel very confident in the year. Okay.

Speaker 1

And then I think you mentioned on the hardware side, you increased capacity. How hard is it to toggle that up and down? I'm just trying to understand what this means in terms of confidence level and pipeline. Thanks.

Speaker 5

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.

Speaker 5

We didn't keep up with demand. So we've ramped up production capacity again for 2023 and we feel very confident 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.

Speaker 4

Quarter. Excellent. Thank you.

Operator

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

Speaker 7

Hey, guys. Thanks for taking my question. I want to ask about JetAI and all the related machine learning and AI enabled tools. We've been getting a lot of questions from investors in terms of how to think about how that becomes accretive to your growth rate and how it becomes accretive to your average deal size. Maybe if you can just share with us where you're at in this price discovery phase and how you plan to, I guess, mass market price it.

Speaker 7

And

Speaker 4

If I'm

Speaker 7

not mistaken, this will all be included in digital IC, which according to the finish to the year was dilutive to your overall revenue growth. How should we read into that? Is AI machine learning simply just not impacting that light on them yet?

Speaker 3

Yes. Hi, Gary. Great question. So first of all, I'm very optimistic about AI. And we always have talked about applying AI for optimization.

Speaker 3

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 right now, some of these chips have 100,000,000,000 transistors, right, on 1 inch by 1 inch. And if you look at by 2,030, They will have 1,000,000,000,000 transistors. Okay. So just in terms of size, it will be 10x more.

Speaker 3

And then these the chips are more complicated, 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.

Speaker 3

And of course, we have done other ways to do automation in our industry. Quarter. 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 parallelism, running things on more CPUs, using cloud. But going forward, one of the biggest ways to improve productivity is using AI.

Speaker 3

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 task and mundane task 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 JEDI data analytics because data is critical too, as you know, To data analytics and AI platform and then we have multiple applications on top of it, okay. So, Cerebras is a key one quarter for implementation. We also launched few months ago Verisium for verification, which is another very difficult and all consuming problem for our customers.

Speaker 3

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 automation that the chip industry has seen, but we are getting dramatic improvements with the optimality as well. So taking together, I believe that we have the most comprehensive AI portfolio and we have always focused AI on optimization, which of course now call generative AI. And we have been working on it for 5 years.

Speaker 3

I think the products introduced were about 2 years ago. And even for Cerebras, I mentioned in my prepared remarks, several leading companies like Intel, NVIDIA, Samsung, Renesas, they all talked about the results they're seeing. We have more than 160 designs That we are tracking on Cerebras. 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.

Speaker 3

And that is driving the growth that you're seeing in our business and the outlook. Quarter.

Speaker 7

Thank you for that, Anarud. And a quick follow-up for John. Backlog up again, Nice job on that, up 32% in the year, next 12 month backlog up 26% on the year. Was there a large deal or renewal that came into the fray in the 4th quarter? Or maybe you could just speak in terms of diversity of that growth?

Speaker 5

Quarter. 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 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 is 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.

Speaker 4

Thanks, John. Quarter.

Operator

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

Speaker 8

Got it. Thank you. Anurudh, a wise man once said that silicon companies are becoming increasingly like systems companies and systems companies are becoming increasingly like semiconductor companies. You alluded earlier to some of the additional opportunities that systems companies represent for you, for example, in CFD and so forth. In what other ways Would you say that these two classes of customers do still remain different or different enough for you, even though they are becoming more like and in ways that perhaps influence your either your RAD or your go to market.

Speaker 8

And then the second question is, if you could talk about where your R and D priorities go from here. The last number of years, you and for that matter Synopsys have significantly ramped up, for example, your Synthesis, Verification, AI you mentioned, of course. And from here, how are you thinking about the R and D priorities in areas like custom and CFD and of course in AI.

Speaker 3

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 a reversible trend, okay, this is irreversible.

Speaker 3

And for us, we invest heavily in R and D, as you know. I mean, about 35% of our revenue is invested in R and D. That's one of the highest percentages of any S and 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 and D.

Speaker 3

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 It's best in class. And then on top of that, there are certain thematic things that we are investing in. And then the 3 that I want to highlight, Which is which I think will be thematic for years to come.

Speaker 3

One is, of course, AI. AI will have A big effect on, like I mentioned, the design work, and that's true for both semi and system companies. 2nd is 3 d IC, the emergence of chiplets and heterogeneous integration and Cadence is the best position to take advantage of this. And then the 3rd 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.

Speaker 3

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.

Speaker 3

So overall, to answer your question, these are the 3 big themes. On top of the base, see the base is always important, the best in class of the basic algorithms, but AI, 3 d IC and systems

Operator

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

Speaker 9

Yes. Good afternoon. Thanks taking my question. So on hardware verification, you guys have sounds like very good visibility to the first half of the year. I know the team still has some concerns on maybe more discretionary type spending pullbacks here.

Speaker 9

But we've also talked about how these hardware platforms are becoming A need to have, right? Not a nice to have, but a need to have as it relates to these very complex digital SoC platforms. We're well into this semiconductor industry downturn. I would have assumed that you would have already seen some cancellations in orders or push outs in hardware shipments if customers were concerned. So Has the team seen any of this type of activity?

Speaker 9

I'm just trying to figure out what's driving the conservatism here on hardware?

Speaker 3

Well, thanks for the question. This is Anil. 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 platform to verify them.

Speaker 3

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 like Nice to have. You need to have them, okay.

Speaker 3

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 software bring up With Protium, we provide a unique so, so far, the demand is strong. And we had a record year quarter. Last year, these days we have I think we have the record year after that too. But we see continued growth in hardware.

Speaker 3

Quarter. And we are very pleased with our competitive position in hardware. We are very pleased with The demand is no longer nice to have, it's no longer discretionary. And also in multiple end markets. So what happened is like we talked about automotive, right.

Speaker 3

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.

Speaker 9

Perfect. And then my follow-up, the team has done a great job on integrating machine learning based method as a part of your customer's digital SoC designs and verification flows. Although different, but Nevertheless, still needing many iterations around many variables, is your custom cell and IP design and analog simulation and verification Seems like the team could take advantage of your ML frameworks and apply it to your custom and analog franchise. Is the team working on integrating ML into Virtuoso and other parts of the analog and custom portfolio?

Speaker 3

Oh, that's a very, very good point. So I mean, like I mentioned, we have more than 30 projects in all aspects of AI. You know, AI inherently is computational software, right? It's computer science plus math, which is what we are very good at. So you can assume that we are working throughout our design flow.

Speaker 3

And then we announced products in a more conservative way now. We want to make sure they're with several customers with different end markets and then we announced them. So last year the year before we talked about digital implementation. Last year, we talked about JEDI and verification. And I think this year, you will hear more from us in other parts of the business.

Speaker 3

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. Okay.

Speaker 9

Cycle. Thank you.

Speaker 3

Yes.

Operator

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

Speaker 10

Quarter. Great. Hi, everyone. I wanted to go back quickly to the current RPO topic. So 4th quarter It was very good, finished north of 25% growth.

Speaker 10

And then even if I appreciate that probably has some hardware on it, John, as you said, The trend growth is closer to a mid teens type number now. Can you just help reconcile That mid teens growth with the implied outlook for recurring revenue, I think it would be more like 12% or 14% growth. It does seem like Starting visibility to come from backlog is higher than usual. And so is there an implicit bookings assumption quarter. In 2023 that's factoring into this or those conservatism like it applies to hardware also maybe apply to software bookings game Sunshine of the Year.

Speaker 5

Great question, Joe. I mean, as Gary mentioned earlier, that he was asking about The number of customer, were 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 Anurud said earlier.

Speaker 5

They become an indispensable part of our customer spend on the R and D side, and people wanted to get their orders in before the end of

Speaker 8

the year. So we have

Speaker 5

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 you 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 2022 and we're guiding to mid teens for 2023.

Speaker 5

So I think you can take out some of the noise by looking over a 3 year kind of average period.

Speaker 10

Call. Okay. That's helpful. And then I guess I'll stay on the topic of AI, and obviously Cadence is already using a lot of reinforcement learning and design flow and verification. I guess any thoughts on quarter.

Speaker 10

The recent attention around large language models, you've started to see I think some tinkering with like RTL code generation or maybe within Certain aspects of verification. Does this maybe supplement what you're already doing or does it have the potential to bring about entirely new products?

Speaker 3

Yes, good point. I mean one thing to mention is we always look at all the kind of AI technologies. We have 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.

Speaker 3

And to give you 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. Typically, you see this improvement from Going from one node to the next, okay, spending 1,000,000,000 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.

Speaker 3

Quarter.

Speaker 10

Okay. Great. Thank you very much.

Speaker 5

Yes. Our

Operator

next question comes from Vivek Arya from Bank of America Securities. Please go ahead. Your line is open.

Speaker 11

Thanks for taking my question. Anil, when I look at the relative growth in your different segments, The system design and analysis seems to be the fastest growing segment, obviously, of 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?

Speaker 3

Yes. Hi, Vivek. I just want to point out first That all businesses are doing great. If you look at even our analog business, that's grew 13%. That was used to be a stable business few years ago, okay.

Speaker 3

Digital business, 17%, okay. These are very remarkable numbers, okay. Verification business, 28%, okay. So I mean just to put that in contrast to what was happening in EDA and chip design like 5 years ago to quarter. I mean, this is remarkable growth in our business and at the same time, very good profitability.

Speaker 3

We have more than 40% Operating margin. So I think we focus on growth and profitability. And to come to your question on systems, I mean that had a very strong year with 27% growth. And that's because our products are just better. And the customers 1, this integration like I mentioned, like Jay mentioned earlier, system companies and semi companies.

Speaker 3

So I think this is again a reversible trend. There is need for power analysis, thermal analysis. When you look at 3 d IC, one of the biggest thing I've mentioned before is thermal simulation. Cadence is in the best position to provide that. Electromagnetic simulations, our products will run like 10, 20 times faster and higher performance because of our computational software trend.

Speaker 3

So I don't see anything in the near term that will change that. I mean, this is going to continue, right? So we are pretty confident where we are. And as you know, we are expanding to other areas using the expertise, whether it's computational fluid dynamics or biosimulation. And I think this is another irreversible trend, the need of simulation.

Speaker 3

And the other thing that we are investing heavily in that space, which I mentioned in my prepared remarks is AI and optimization. That area still They could barely simulate things in that you could barely simulate a wing or a car properly, right? Forget about optimization. But with optimality, not only we can simulate, we can put that in the inner loop of a reinforcement based AI engine To give results automatically that that space has not seen. So I'm actually very optimistic about AI driven optimization in the system space, Because it's entirely new to that set of customers, along with like regular simulation performance and capacity improvement.

Speaker 3

Quarter. So I think we are still small part of the market, but growing rapidly. I think we crossed $400,000,000 in revenue in that important segment. Quarter. And I think there's a lot of room to grow there.

Speaker 11

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 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.

Speaker 5

That's a great question, Vivek. And thanks for pointing out incremental margins. As you know, we focus very carefully on those. Over the last, I mean, we're very pleased that I think 2022, I think, was the 6th year in a row we achieved over 50% incremental margins. And the range that we've achieved over that period of time, it ranged from 52%, I think to 58% incremental margin over the last 6 years.

Speaker 5

So very, very pleased with that. And we're starting this year with slightly less in the guide. I think it's 48.5% is what is implied in the guide, but that is the largest and strongest the largest initial guidance, the strongest start to any of the 7 years of the last 7 years. But so very, very pleased to be in this position starting off the year. And as you know, throughout the year, we tried to find profitable and sustainable revenue growth to improve that through the year and we've managed to achieve that 6 years running, feel confident about doing that for a 7th year.

Speaker 4

Quarter. Understood. Thank you very much.

Operator

Our next question comes from Blair Abernethy from Rosenblatt Securities. Please go ahead. Your line is open.

Speaker 1

Thanks very much and great quarter guys. Just wanted to See if there's anything to update on the future facilities acquisition. Last summer, you've 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?

Speaker 3

Yes, great point. Great point. I mean, I'm very excited about future facilities because I think that the way to differentiate in the system space is also through differentiated vertical offering. Because if you look at the simulation space, there are only few like of well known algorithms. There's finite element, there's CFD and now we are doing molecular simulation.

Speaker 3

But there are a lot of end markets, Okay. And the one way to even further differentiate CFD, one way we differentiate CFD is by our compute power, right, doing things bigger things and faster. But the other way to differentiate it is building a vertical kind of end market. And in CFD, one of the Biggest thing is this data centers and smart building. So with future facilities, not only the thermal simulation is good, the core CFD engines and we can with the rest of the CFD product, but they also have built like lot of models for like if you go into a building or a data center, they have models for all the components, whether they're AC vents or AC systems and racks and all that.

Speaker 3

So the customers can get very, very accurate digital twin for the data center. And that technology can be actually applied to any building, Not just the data center. Now we started with data center because that's a big market and as you know, they consume a lot of power. So right now, Data centers consume as much energy as like the whole airline industry, okay. So that's a lot of energy that they're consuming.

Speaker 3

And we have a lot of engagements that have picked up Since we because they are now in a bigger home with the whole Cadence reach. So we have a lot of engagements which are picked up with the hyperscalers and with Other companies, even in other industries, because a lot of companies have big data centers, whether they're internal or on the cloud. So you will see more of that from us and I'm pretty optimistic about that's why we made that acquisition of this verticalization of having these vertical solutions in the CFD space.

Speaker 1

That's great. Thank you.

Operator

Quarter. Our next question comes from Reuben Roy from Stifel Financial. Please go ahead. Your line is open.

Speaker 4

Quarter. Thank you. Anurud, 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 you about. But I guess one thing that stood out to me from your commentary was the 2 thirds of your, I think new orders In 2022, we're for both Palladium and Proteum. And that was interesting to me because it seems Like as we're moving to more SSD designs, more firmware and software on those designs that that sort of selling Palladium and Proteum together is likely to move up.

Speaker 4

So I guess just comment on that and how you're thinking about that as either TAM expansion or a revenue growth driver Kind of longer term behind hardware would be interesting. Thank you.

Speaker 3

Yes, absolutely. Great point. I mean, the thing with hardware, first of all, it's in a secular growth trend like we mentioned, but it's always good to have multiple products. And that's why the addition of Palladium and Protium that are complementary, but address different parts, which both of them are growing, is also provides more predictable growth quarter. So like we mentioned, even though we had a record year last year, we still see growth this year and in the future because of this product mix.

Speaker 3

Because software bring up, I don't need to tell you most of the designs now are software defined hardware design. Software is what is driving the requirements for the hardware design. So initially, they actually start with the software model and that is run on Protium to figure out what kind of architecture to do. And then once you do the chip design, then Palladium comes in and then at the end, Protium comes in again. So there is a lot of back and forth between software bring up and chip design.

Speaker 3

And therefore, having a common compiler It's a unique value that you can move it seamlessly between the two platforms. But I also believe that Just like our customers have different silicon platforms, we need to do that too. Okay. So Palladium, the reason it is well differentiated is we use our own Cadence silicon. We design it ourselves, build with 1 of our foundry partners, And that gives advantage in terms of compile time that is unmatched, right.

Speaker 3

But for software bring up, FPGA is good. So we use FPGA platforms And then we have built a differentiated offering with Protium. And same thing on like our regular verification systems like formal with Jasper and Xcelium Logic Simulation. We also offer multiple hardware platforms. Of course, X86, that has been traditional, We have also ported all our software platforms, especially in verification to ARM based systems because they can offer price performance.

Speaker 3

So not only we have multiple products with Palladium and Protium, we are always looking at the right hardware to run them on. So in case of palladium, it's a custom silicon. In case of, Protium, it's FPGA. And then in logic simulation and formal, we look at both X86 and ARM, so to give a full variety of options to our customers.

Speaker 4

Quarter. Thanks for all that detail Anurud. If I could just ask a quick follow-up for John. I don't think you were at on the pricing environment, John, and just Watching the backlog move up again and kind of all the megatrends that you're talking about, it's understandable that things are going well. But I'm just wondering, in light of the macro, etcetera.

Speaker 4

If how you're thinking about pricing as In the context of the guidance that you've given for 2023. Thank you.

Speaker 5

Thanks. Yes, I mean, We're very focused and disciplined on driving value for Cadence and for our customers. Like I said, on our hardware side, we don't believe that very much on the software side too that a lot of our customers spend with us is not really question. It's quite indispensable tools that they need from us. And everybody these days wants to focus on improving productivity and all the tools we provide help our customers to drive that.

Speaker 5

So I think we're in a sweet spot at the moment. So we're disciplined on pricing, But the pricing that we're extracting for our tools has come from the increased value that our customers are getting From the use of our tools.

Speaker 3

Makes sense. Thanks, John. Yes. One thing to add to what John said, I think you know this already, but one thing to emphasize, Typically, when people move from one node to another, right, so we are at 5 nanometer, a lot of the designs at 3, then 2, 1.4, 1. So we have 10 years of node migrations ahead of us.

Speaker 3

So anytime you go from one node to the next node, the number of transistors effectively doubles in the chip. So number of blocks effectively doubles and complexity doubles. So for the same chip being done, it has more things in it. So that Normally requires more use of our software. So that's one thing just to emphasize to our investors is that Whenever there's a no transition and this is happening in the past, but this is will continue to happen for next 10 years.

Speaker 3

So that also requires more hardware capacity, that requires more simulator, that requires more place and route runs to be done. And of course, with AI, we can make that even more productive. So And Moore's Law is not slowing down for at least 10 years, okay. And on top of that, you add 3 d IC, that adds another 10 years off. So we have a lot of sustained growth That the customers will build amazing products and they need more and more of our software and hardware to do that.

Speaker 4

Yes. Thanks, Sean Arun. I guess that's where I was going with the question. I mean, obviously, with Farabir going and running on top of Innovus and I'm just kind of trying Think about how it seems and you guys have talked about that the greater portion of R and D budgets from both semiconductor systems companies are going into kind of the suite of tools that you quarter. Anyway, thank you very much and congrats on a great deal.

Operator

Our final question will come from Andrew to Gaspery from Berenberg. Please go ahead. Your line is open.

Speaker 12

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 this? And what is the kind of timeline That it typically takes from when you introduce it to them to when they're kind of using it in terms of their day to day processes.

Speaker 3

Yes, that's a very good point. So I think there's something like Cerebras AI, Our use model is very similar to what they are doing right now, because we don't change any of the interfaces. And if they are used to running Innovus, then Cerebras will run on top of it, almost like a cockpit, But it will do those experiments that they are doing manually, they will do it in an automatic way. But the interfaces are similar, the commands they are used to running are similar. But instead of manually running and trying different things, Cerebras will do that automatically.

Speaker 3

So typically, we have seen that's why you have seen a lot of And an uptick to Cerebras and these AI based tools because they don't fundamentally require a new working model is just takes away some of the mundane tasks that the customers were doing. And similar things are true for optimality, similar things are true for Verisium. There is always some learning gap, but it is our customers are very smart Users anyway, right? They are designing all these complex chips. So this is nothing that they can't pick up in a pretty quickly.

Speaker 12

Quarter. That's helpful. And then, one question for John. In terms of the share repurchases, I think you bought $1,000,000,000 or so last year. This year, you're guiding for a bit below that.

Speaker 12

I was just wondering, what was the thinking behind that? Is it a function of investing the Q and A in terms of the different the 3 different themes you mentioned earlier or is it potentially for additional M and A that you're planning for the year?

Speaker 5

Yes. Andrew, our approach for capital allocation hasn't changed and share repurchases that's effectively for this year, again, we're expecting to use 50% of our free cash flow to repurchase shares. That's the way we started last year too. We have a number of repurchase programs. We have our baseline repurchase program.

Speaker 5

We had an accelerated share repurchase last year to offset dilution from the general stock refresh in the middle of the year because we do merit in the middle of the year. But also we have an opportunistic repurchase program that kicks in when certain price levels are met. And last year that kicked in Q1, Q2 and Q4. So we bought back shares when the prices were lower. We typically don't guide to that right now, but we assume Using at least 50% of free cash flow to repurchase shares this year.

Speaker 5

If our opportunistic repurchase program kicks in, we'll buy back more.

Speaker 1

Quarter. Great. Thank you.

Operator

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

Speaker 3

Thank you all for joining us this afternoon. It's an exciting time Cadence as we enter 2023 with strong business momentum and robust design activity offering tremendous market opportunities. Quarter. 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, quarter, 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.

Speaker 3

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

Quarter. Thank you for participating in today's Cadence 4th Quarter and Fiscal Year 2022 Earnings Conference Call. This concludes today's call. You may now disconnect.

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