Cadence Design Systems Q3 2023 Earnings Call Transcript

Participants

Corporate Executives

• Richard Gu, Vice President of Investor Relations
• Anirudh Devgan, President & Chief Executive Officer
• John Wall, Chief Financial Officer

Analysts

• Charles Shi, Needham & Company LLC
• Gianmarco Conti, Deutsche Bank Aktiengesellschaft
• Harlan Sur, JP Morgan Cazenove
• Gary Mobley, Wells Fargo & Company
• Jay Vleeschhouwer, Griffin Securities
• Jason Celino, KeyBanc Capital Markets
• Vivek Arya, Bank of America Co.
• Ruben Roy, Stifel Nicolaus
• Joshua Tilton, Wolfe Research
• Joe Vruwink, Robert W. Baird
• Andrew DeGasperi, Berenberg Bank

Presentation

[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.

[Richard Gu, Vice President of Investor Relations at Cadence Design Systems]

Thank you, operator. I would like to welcome everyone to our third quarter of 2023 earnings conference call. I'm joined today by Anirudh Devgan, President and Chief Executive Officer; and John Wall, Senior Vice President and Chief Financial Officer. The webcast of this call and a copy of today's prepared remarks will be available on our website, cadence.com. Today's discussion will contain forward-looking statements, including our outlook on future business and operating results.

Due to risks and uncertainties, actual results may differ materially from those projected or implied in today's discussion. For information on factors that could cause actual results to differ, please refer to our SEC filings, including our most recent forms, 10-K and 10-Q, CFO commentary, and today's earnings release. All forward-looking statements during this call are based on estimates and information available to us as of today, and we disclaim any obligation to update them. In addition, we will present certain non-GAAP measures, which should not be considered in isolation from, or as a substitute for, GAAP results. Reconciliations of GAAP to non-GAAP measures are included in today's earnings release. For the Q&A session today, we'd ask that you observe a limit of one question and one follow-up. Now, I'll turn the call over to Anirudh.

[Anirudh Devgan, President & Chief Executive Officer at Cadence Design Systems]

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 hyper-convergence between electrical and mechanical domain, systems and semis, and hardware and software, is driving the need for tightly integrated core design and analysis solutions. Additionally, trends such as growing number of 3D-IC and chiplet design, 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 is 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 still 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 are pleased to announce that Broadcom has accelerated the adoption of Cadence Cerebrus across multiple business units, achieving impressive quality of results. In Q3, we pioneerd leveraging GenAI's LLM capability, 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 pass, thereby boosting their quality and efficiency. We also renewed and deepened collaboration with some large semi and system 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 accelerate, we continued our momentum by enhancing our core EDA and systems footprint with several customers, including a 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 industries 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 it's deployment at all of our top 10 digital customers and in about 300 tape-outs to date. Imagination technologies use 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.

Evergrowing system design complexity, coupled with the need for first-time right[phonetic] 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 capability. Our hardware business had a record Q3 with close to half of the hardware orders, including both platforms. Highlights for the quarter include a major dynamic duo expansion with a top AI and automotive chip supplier, and a significant deal with the 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 are pleased with the reception of our AI-driven Virtuoso Studio solution as several marquee customers adopted for their M2 and M3 designs, and it has close to 1,000 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 5 IP asset.

[Operator]

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 booking quarter, with strong AI and chiplet design activity, especially in the mobile, automotive, and hyperscaler verticals. In addition, we launched our Tensilica, NEO and PHY IP[phonetic] [indecipherable] 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 on cloud and targeting small and medium businesses. Our Fidelity CFD platform continued its strong momentum with customers in automotive, aerospace, and defense and industry verticals. In summary, I'm pleased with our team's continued innovation and execution.

We are well-positioned to benefit from the tremendous opportunities ahead. As we help customers design the 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 loss of innocent lives is truly heartbreaking and a matter of global concern. The well-being of our employees and their families in the region is of utmost importance to us. And we 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.

[John Wall, Chief Financial Officer at Cadence Design Systems]

Thanks, Anirudh, and good afternoon, everyone. I'm pleased to report that Cadence delivered another strong quarter of top and bottom-line results in Q3. All businesses contributed to revenue growth, and we completed more hardware installations in Q3 than we originally assumed. Here are some of the financial highlights from the third quarter starting with the P&L. Total revenue was $1.023 billion. GAAP operating margin was 28.6% and non-GAAP operating margin was 41.1%. GAAP EPS was $0.93, and non-GAAP EPS was $1.26. Next, turning to the balance sheet and cash flow. Cash balance at quarter end was $962 million, while the principal value of debt outstanding was $650 million.

Operating cash flow was $396 million, and we used $125 million to repurchase Cadence shares in Q3. Before I provide our updated outlook. I'd like to highlight that our outlook contains the usual assumption but export control regulations that exist today remain substantially similar for the remainder of the year. Our updated outlook for fiscal 2023 is revenue in the range of $4.06 billion to $4.1 billion. GAAP operating margin in the range of 30.5% to 31%. Non-GAAP operating margin in the range of 41.5% to 42%. GAAP EPS in the range of $3.48 to $3.54.

Non-GAAP EPS in the range of $5.07 to $5.13, operating cash flow in the range of $1.3 million to $1.4 billion, and we expect to use at least 50% of our annual free cash flow to repurchase Cadence shares. As a result for Q4, we expect revenue in the range of $1.039 billion to $1.079 billion. GAAP operating margin of approximately 31%, non-GAAP operating margin of approximately 42%. GAAP EPS in the range of $0.85 to $0.91. Non-GAAP EPS in the range of $1.30 to $1.36, and we expect to use approximately $125 million of cash to repurchase Cadence shares. As usual, we have published a CFO commentary document on our Investor Relations website, which includes our outlook for additional items, as well as, further analysis and GAAP to non-GAAP reconciliations.

In summary, we are on-track to deliver a strong 2023, I am pleased with our team's continued execution of our Intelligent System Design strategy. With our updated outlook for 2023 at the midpoint, we now expect revenue growth of approximately 15%. Non-GAAP operating margin of approximately 41.75%, a seventh consecutive year of greater than 50% incremental operating margin. Non-GAAP EPS of $5.10, a sixth consecutive year of high-teen or better non-GAAP EPS growth. As always, I'd like to close by thanking our customers, partners, and our employees for their continued support. And with that operator, we will now take questions.

Questions and Answers

[Operator]

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

[Charles Shi, Analyst at Needham & Company LLC]

Hey, good afternoon. Thanks for -- for taking my question. I want to ask you a little bit about the backlog. It looks likes the backlog compared with last quarter was up. I mean, the September quarter kind of implies a very good book -- bookings for September quarter. Just want to ask, do you see the backlog will continue to grow into the year end, and because you -- you talked about the second half bookings strength. I want to -- I want to see where it goes from here. Thank you.

[John Wall, Chief Financial Officer at Cadence Design Systems]

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

[Charles Shi, Analyst at Needham & Company LLC]

Thanks. Maybe I want to ask one quick follow-up, you kind of raised your full year revenue outlook, a little bit less than you did for Q3 in terms of the revenue, kind of implies that the -- your full year outlook you provided one quarter ago was largely accurate, but it seems to be some timing shift for the revenue. I mean, pulling in from Q4 to Q3, was that related to your comment about hardware installation, the timing of that? Thank you.

[John Wall, Chief Financial Officer at Cadence Design Systems]

That -- that's right, Charles. You now, in -- in hindsight now, I was a little 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 guides, we assumed that -- that those installations would fall into Q4. In actual fact, we completed those hardware installations and the -- the -- the second half looks stronger than we thought at this time last quarter. But, you know, even with all of those hardware, we -- we kind of beat our expectations in Q3, and Q4 is higher than -- than we thought.

[Charles Shi, Analyst at Needham & Company LLC]

Thank you.

[Operator]

Thank you. The next now is Gianmarco Conti at Deutsche Bank.

[Gianmarco Conti, Analyst at Deutsche Bank Aktiengesellschaft]

Yeah, hi. Thank you for taking my questions. I guess my first one would be, when do you expect to be giving more AI KPIs, and wheather on concept value at Play Store catch rising rates? And wish to share any color you can provide us on how can we quantify the AI tailwinds in -- in your numbers and whether we are going to see this coming through in -- in bookings in sometime. Thank you.

[Anirudh Devgan, President & Chief Executive Officer at Cadence Design Systems]

Yeah, hi. This is Anirudh. Let me take that. So, you know, like we mentioned in the prepared remarks, we are seeing lot of activity in AI. And that, they -- you know, have multiple customer and multiple verticals. So, whether it's the -- the -- the system company designing their own chips, or, of course, the semiconductor companies designing it. What we mentioned this time, for example, Broadcom which helps, you know, 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, you know, NVIDIA and Tesla.

And then on top of that, it's also applying AI to our own products, and then we have this extra generative AI products on top of our base products, that also drives revenue. So, the first part which is, you know, build-out of the AI infrastructure, whether it's with, you know, 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, you now, 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, you know, what part of our -- what the customers are using it for, but AI is a significant portion of, you know, design activity and the build-out that's going to happen for years.

Now there is a second part of our business in which we are selling AI products ourselves, you know, like, you know, 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 -- 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 I also say there is another part of AI which is the build-out of infrastructure, which is more difficult to predict.

[John Wall, Chief Financial Officer at Cadence Design Systems]

And Gian, I would just add to that, this, you know, when -- when Anirudh calls out that the -- the revenue from those products is almost tripled in the space of 12 months, we're not reclassifying any revenue, this is direct revenue attributable to those five products that we have in our JedAI platform.

[Gianmarco Conti, Analyst at Deutsche Bank Aktiengesellschaft]

Right. That's -- that's really good. Thank you. I just have a -- a follow-up, perhaps talking a little bit on China, if you could comment on whether there is any impact from the -- you know, the Entity List and -- and the new -- the new rules come into place. And also if you have 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, you know, whether EDA tools are being used in China for -- for mature versus advanced nodes, any color that on -- on -- on this, it would be great. Thank you.

[Anirudh Devgan, President & Chief Executive Officer at Cadence Design Systems]

Yeah, that's a good question, because there were lot of, you know, recent reports on some of the changes in regulation. So, for us, you know, there's not that much difference. Most of the regulations were targeted at some chip companies or manufacturing companies. As we -- as you know, we are in the design process. So, those regulations, the latest round doesn't have a, you know, big effect on -- on Cadence business. Now there are some companies added to the Entity List, you now, so we monitor that carefully. But since we are so diversified geographically and, you know, in terms of customers, you know, that's not a significant impact either. And all our guidance that we -- we just gave includes the impact of all these regulations that were announced recently. And of course, we -- we carefully follow all US regulations. But the latest change is not -- they are not that material to our business.

[Gianmarco Conti, Analyst at Deutsche Bank Aktiengesellschaft]

Got it. Thank you.

[Operator]

Thank you. We'll go next now to Harlan Sur at JP Morgan.

[Harlan Sur, Analyst at JP Morgan Cazenove]

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

[Anirudh Devgan, President & Chief Executive Officer at Cadence Design Systems]

Yeah, Harlan, that's a good question. You know, like we mentioned last time, we still see a lot of strong design activity. And I would say compared to like three months ago, I would say the activity is similar. Like you mentioned some segments are, are going through tough times and then some segments like accelerated computing AI have lot of growth. But overall, as you know these products that our customers are designing takes several years to develop, and we are part of the R&D cycle. So what we see the customers still investing in R&D for building our products for the future, and we are glad to partner with them. So -- and so I think, I would say the largely the environment is similar than it was like few months ago.

[John Wall, Chief Financial Officer at Cadence Design Systems]

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's the value of finished goods in our inventory was less than $10 million at the end-of the, end of the quarter in Q3. So the demand is very strong still, and we're just producing the hardware as quickly as we can. But we're expecting a very strong Q4 as well for our IP Group. I mean they are 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.

[Harlan Sur, Analyst at JP Morgan Cazenove]

Yeah, no. I appreciate the comments there. You know one of your large AI SoC customers recently laid out their future roadmaps right in. Given the complexity of all these next-generation AI computer workloads, right there actually accelerating their chip roadmap so new GPU chips, every year versus every two years, which was there prior Cadence and then on top of that, they're starting to segment their product lines, right. So not only accelerating roadmaps with more chips per product family, I've got to believe that other competitors in this space and doing exactly the same thing are you guys seeing this step-up[phonetic] in Design activity, obviously much higher productivity is required. So how is this all being sort of reflected in the business momentum and your visibility.

[Anirudh Devgan, President & Chief Executive Officer at Cadence Design Systems]

Good point. I mean, like you said earlier, the macro-environment is challenging, especially some of the segments are weaker, some are stronger. But, you know, design activity is very strong and especially. I would say in, in two verticals, 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 datacenter 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. You know, these two segments will grow significantly the whole AI driven datacenters 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 if we are using AI internally to be more productive ourselves.

So definitely for these two big, big verticals and this is a multi-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 datacenter and AI space and also now in the, in the automotive space. So that activity is strong, and I expect that to continue, yeah.

[Harlan Sur, Analyst at JP Morgan Cazenove]

Yeah. Well, thank you.

[Operator]

Thank you. Moving next now to Gary Mobley at Wells Fargo.

[Gary Mobley, Analyst at Wells Fargo & Company]

Hey guys, thanks for taking my question. John your upfront license revenue year-to-date has averaged around 17%. I think typically it is 15%. Given where you're at in the verification hardware product cycles Z2 and X2 in the conversion of the backlog there. How do you see that upfront revenue trending, looking next year and related to that, how would you see the influence and overall growth next year?

[John Wall, Chief Financial Officer at Cadence Design Systems]

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 to the end of Q3 is at 16% now, but I take your point is probably closer to 17% for the first three quarters. But what 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%. I mean, we're assuming essentially about a 13% growth rate on a recurring, recurring revenue line for the year. But that's consistent with like over a three-year CAGR basis, it's about 13% as well. Of course, we're not guiding next year.

[Gary Mobley, Analyst at Wells Fargo & Company]

Understood, understood. All right. I suspect that we're not going to get anymore AI metrics out of you, Anirudh, but maybe if you can just give us a sense of where we're at in the commercialization of the five different AI tools. Have those started working their way in baseline license renewals or are they still on a per design basis, and maybe you can give us a sense of -- of where you expect them to cut into, you know, baseline licensing activity.

[Anirudh Devgan, President & Chief Executive Officer at Cadence Design Systems]

Yeah, Gary, that's a good point. So, we are -- we are watching that carefully, of course. And as you know, like these JedAI and these five major platforms are -- are new products that our customers, you know, should engage with us on and they run on top of our existing kind of leading platforms. So, you know, it depends on the customer. I -- 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, right. I mean, this is what happened in -- in digital or, you know, 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 -- to fully deploy these products and what we have said in the past is, as typically, you know, at least in my experience with -- with digital, you know, like about seven, eight years ago, it took like two contract cycles for them to fully deploy.

Okay, so that's -- so that's still three, four years to go. We are probably like two, three years into it and still three, four years to go, which -- which is a good thing in my mind, because, you know, this is a natural progress of -- of -- of deployment. Now, it depends on the customer, you know, some customers are adopting them in -- in a much bigger way, you know, especially, like in the previous discussion, you know, the -- the new kind of AI designs or hyperscalers, you know, 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, you know, try it on few designs or -- or few groups. But we have seen some pretty broad kind of deployments. And that helps -- that helps our overall engagement with that particular customer.

So -- so that's what I would like -- like to say, Gary, that, I think is 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, you know, like 8% to 10% power improvement from Cerebrus, and we have mentioned several of these in the past also, I mean that's a -- that's a huge improvement. You know, sometimes that's equivalent or roughly equivalent to a node migration.

You know, 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, you know, roughly, you know, two-third of that from better AI tools. So the value is there and, you know, 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.

[Gary Mobley, Analyst at Wells Fargo & Company]

Thank you, both.

[Operator]

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

[Jay Vleeschhouwer, Analyst at Griffin Securities]

Alright. Thank you. Good evening. So, my first question, I'd like to ask a -- a variant of the EDA market environment question. So, on the one hand, what are you seeing in terms of unscheduled new business, that is to say, intra contract, new or expansion business that could be construed positively? On the other hand, how concerned are you about the evident deceleration of semi R&D growth? It's still reasonably good, better than four or five years ago, but somewhat slower than it's been. A lot of that can be attributable to Intel. But still, how are you thinking about those two different dynamics? And then, I'll ask the follow-up.

[Anirudh Devgan, President & Chief Executive Officer at Cadence Design Systems]

Yeah. Hi Jay. A good question. I mean, we are just watching it carefully. You know, like you said -- like we said earlier, I mean, design activity is still strong, but of course the the macro environment is challenging. You know, it's like natural -- even though the customers realize that, you know, they need to invest in R&D for the future, if, you know, the revenue is impacted because of macro situations, you know, that -- that decision has become a lot more prudent, you know. But, this is just natural, you know, business process. But in general, you know, still the -- 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, you know, 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, you know, going forward.

[John Wall, Chief Financial Officer at Cadence Design Systems]

Jay, as you know, a lot of our customers come back and purchase add-ons during the course of their baseline contracts and with the teams releasing significantly new business, new products from the different R&D groups, customers have an intend to come back and keep purchasing, so they don't -- they don't wait when we launched AI tool, they don't wait for the baseline renewal to come up or to expire to purchase them, they'll purchase add-ons and they will purchase a few licenses and then hopefully proliferate more on the -- on the contract renewal. And as you know, we have a lot of contracts that come up for renewal in Q4.

[Jay Vleeschhouwer, Analyst at Griffin Securities]

Understood. We'll follow-up. I'll ask about some interesting Cadence management comments. At last month's Cadence live event in Boston. So there was an interesting comment about the role of AI as "de-risk" in schedules so in addition to the design exploration use-case and what's interesting, there was 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 about risk mitigation moves up earlier in the process. Do you think that there will be a spending share shift within the totality of [indecipherable] spend perhaps some from the back-end more towards the front-end where you play with a lot of fewer tools.

[John Wall, Chief Financial Officer at Cadence Design Systems]

Yeah, Jay. I would say that. It should lead to more design activity. We are able to reduce risk in the design process. I mean, as you know, this is the history of EDA, history of automation, even for the last 20 or 30 years. You know, I remember in the old days in the 90's, we would take like five years and 500 engineers to design some big chip. And now that takes six to 12 months and maybe 50 engineers. So that's like 100 times more efficient than--than 25 years ago, and I think AI can as you know, provide the next-generation, next level improvement in productivity and risk mitigation. I mean, part of it is also a risk mitigation. So then, I think it should lead to more design activity especially by the system company.

Now the shift of front-end to back-end. I mean I think back is still complicated process and so, I think even though some of the things can be pulled upfront using AI or using hardware platforms. As building the back-end design process requires a lot of work so, I would expect that affects all of them. And then the other thing we're trying to do on the front-end. As you may have noticed is, is really incorporate LLM's like our partnership with Renesas, because the front-end process has been less formal in the backend process, especially once we have RTL.

Then we go to [indecipherable] go to GDS is a very formal process, very structured process. But the front-end of the process, especially verification and specification has been less formalized. And I think AI and LLM can help formalize that which definitely, like you said can minimize the risk, but I think activity should still be strong in both front-end and back-end. And our goal anyway is to make the design easier. So more customers and more people can do them.

[Jay Vleeschhouwer, Analyst at Griffin Securities]

Yeah, thank you.

[Operator]

Thank you. The next now to Jason Celino of KeyBanc Capital Markets.

[Jason Celino, Analyst at KeyBanc Capital Markets]

Great, thanks for taking my question. Maybe first for John. Yeah, on the Q4 guide about apologies for asking this again but folks might -- might be wondering [indecipherable]. I guess why aren't we seeing more upside to the guide for fourth quarter. Is this more in my view some conservatism or what why we be overlooking in terms of the setup.

[John Wall, Chief Financial Officer at Cadence Design Systems]

Oh, yeah, Jason, the -- as you know that your -- your question probably emanates from the fact that, you know, we beat by $23 million in -- in Q3 and raised by $10 million. But that was -- that was mainly due to a prudent guide for -- for Q3 with respect to certain hardware installations. I think overall, we've -- we've taken the -- the quarter up by our -- the -- the -- the year up by $10 million at the mid-point. But I think there is -- because it's -- it's expected to be a strong bookings quarter and -- and a particularly strong quarter for our IP Silicon Solutions group that I mean, they're -- they're having -- they're gonna have an -- an -- an excellent Q4, but -- but we're expecting that all year. I think if there is -- if there is upside, they'll probably come from that group.

[Jason Celino, Analyst at KeyBanc Capital Markets]

Okay. No, that's fair. And then just my quick follow-up on -- on backlog. You know, I know you've got some weird comps because of the hardware stuff. But when might we -- 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.

[John Wall, Chief Financial Officer at Cadence Design Systems]

Yeah. I think just to give you a bit of color on that. I think if you recall at the end of last year, our backlog included about 28 weeks of lead time on hardware. I think we're down to an eight to 10 week range now on lead time for, for hardware. So of course, you know, we beaten some backlog as a result of that. But I think we talked those essentially in the middle of the year, we expect in the second half to be stronger for contract renewals. Because the number of contracts expired in the, in the second half. In Q3, you saw backlog starting to pick back up again, we'd expect it to pick back up again in, in Q4 because we have a strong bookings quarter, we're expecting a strong bookings quarter.

The one, I look for really is the the annual -- see RPO is the one I track, because I'm looking at the annual value and I think when you compare the annual value at the end of this year with the annual value backlog at the end of last year. The thing to remember is the fact that's, there'll be so much less hardware in it, I would expect. Because we have the production capacity now to deliver on the hardware.

[Jason Celino, Analyst at KeyBanc Capital Markets]

Okay, perfect. Now, that's super helpful. Thank you.

[Operator]

We will go next now to Vivek Arya at Bank of America.

[Vivek Arya, Analyst at Bank of America]

Thanks for taking my question. I appreciate it's early for' 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?

[Anirudh Devgan, President & Chief Executive Officer at Cadence Design Systems]

Yeah. Hi Vivek Like, like before you know, we -- you know in Q3, we don't comment on the next year. We are diligent, we want to make sure we finish out the year. See what Q4 looks like, and then we'll be glad to share our assessment in our next -- in the full year in February earnings call. And that's what we have done in the past, and that has worked out well, right so.

[Vivek Arya, Analyst at Bank of America]

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 as a category over, or under growth EDA and does that influence your growth prospects. So both what kind of near and longer-term question on the IP business.

[John Wall, Chief Financial Officer at Cadence Design Systems]

Let me take the first part of that, and then I'll hand it over to Anirudh for the second part. I think in relation to the IP business, like I say, we were expecting a strong Q4 for that group. I mean if you look at the guide we've given for the year, essentially we're regarding to 14% to 15% revenue growth for the -- for the -- for the year, which means Q4; however, Q4 is going to grow kind of between 15% and 20%. Now largely that's due to the strength of our IP business in Q4. Do you want to talk about the longer-term?

[Anirudh Devgan, President & Chief Executive Officer at Cadence Design Systems]

Yeah. Hi Vivek. I mean, as you know already more customers are outsourcing, you know, their IP needs. And we have always participated in that and we always said we want to participate in that 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 stronger, as 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 five assets of Rambus, you know, which is the HBM and GDDR based IP. So I feel now that our IP portfolio is, is in the right areas. And also the use of this in automotive and hyperscaler and AI, IP's -- and most of these markets are evolving into -- 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.

[John Wall, Chief Financial Officer at Cadence Design Systems]

Just to clarify the contribution from acquisitions, is likely to be immaterial for this year. So, so the strong Q4 that we expect is really from organic business.

[Vivek Arya, Analyst at Bank of America]

Thank you.

[Operator]

Thank you. The next now to Ruben Roy at Stifel.

[Ruben Roy, Analyst at Stifel Nicolaus]

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 incorporate generative AI 11[phonetic] to 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 or two years. It sounds like this business 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 and along with that, just the final part is -- would you consider this a leading-edge design that Renesas is working on or, were if you could talk a little bit about the type of design that be great. Thank you.

[Anirudh Devgan, President & Chief Executive Officer at Cadence Design Systems]

Yes, absolutely. So I mean, we are very pleased with the collaboration with Renesas. And I think they have a whole initiative if you follow them, or if you look AI for the design process, and we are glad to be a very close partner with Renesas. As we are with other companies, right. So we just wanted to highlight Renesas this time and the collaboration is broad-based. I think they are using almost all of our AI tools, whether it's Cerebrus for digital, or verification Verisium and other two. And also we are doing some new collaboration with them on LLM, like we mentioned. And you know, the LLM collaboration is fairly broad-based. It can be applied to any kind of design. Especially, Renesas has a range of design, all the way from advanced node to mainstream nodes.

And the other, you know, you may now all already, but the key thing one benefit of AI is that, there is a -- of course, the quality of results can be better productivity can be better. But there are other benefits, which are also true for large kind of global companies like Renesas. And the tool that I would like to highlight, which came to the forefront with our partnership with Renesas. One is, all these large companies have geographically diverse teams, right. It's not that the team is only in one location, typically they're in multiple locations. So the good thing with AI is that -- and we can -- we can do, you know, a lot of cases design better than a human can do. But also it depends on the starting point, right. So if you have a geography diverse team, not all teams are, are super expert.

So if the AI tool is same or better than your best team. Then the -- the reason to deploy is that wherever, just by the nature of human productivity, there is a variation across the organization. The results can be even greater, and your teams which are -- were historically not performing as well, as you would like. And the other thing is also true in terms of experience, and this will happen I believe in AI in other industries as well, was definitely happening in chip design. You know, So if you had three years experience doing chip design, versus 20 years experience in chip design. Okay, with AI that gap is narrowing. So, so -- you know, it less experienced engineers can be almost as productive as more experienced engineers.

So apart from like productivity and, and quality of results benefit, it has this other kind of, almost workforce management benefit for large organization like Renesas because they've organization in, in multiple locations and also a wide experience range from you know, young engineers to experienced engineers. And this we are seeing in other companies as well. And I think what is also interesting is that the companies that adopt these AI tools first and faster will benefit more versus their peers. So we are seeing that the fast-moving company, and Renesas is definitely one of them and then we talked about, of course, a Broadcom. We talked about NVIDIA, we talked about Tesla and there's so many other kind of great large multinational companies we have the privilege of working with. So, there are more than one, there's a whole workforce development benefit of AI which is actually quite profound.

[Ruben Roy, Analyst at Stifel Nicolaus]

That's very helpful. Thanks for all that detail, Anirudh. I guess just a quick follow-up. I mean, it -- it sounds, you know, 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, you know, sort of the way you've seen EDA growth. Would you -- can you comment on that, you know, as you think about whether [indecipherable] or adding, you know, add-ons as John talked about, you know, over the next 12, 18, 24 months, would you say this would be incremental to sort of that, you know, mid-teens growth that the EDA tools have been growing at, you know, over the -- over the last three years or so?

[John Wall, Chief Financial Officer at Cadence Design Systems]

I would comment on that. That's just, I think our style of Cadence is to be patient with our customers and we'll go at the pace that they're ready. As Anirudh said earlier in the -- in the call that, you know, we -- we expect to proliferate our AI tools across our entire customer base over about two contract cycles and -- and some are adopting more rapidly and embracing the AI tools. Some are, you know, they're adopting the AI tools and add-ons, but they might be, you know, shaving back their configuration somewhere else, that -- that tends to be a false economy because they'll -- they'll just come back and purchase more add-ons later. So to get the full effect, it probably takes a couple of contract cycles, but we're very, very pleased with the start we've made.

[Ruben Roy, Analyst at Stifel Nicolaus]

Very helpful. Thank you, John.

[Operator]

Thank you. The next to Joshua Tilton, Wolfe Research.

[Joshua Tilton, Analyst at Wolfe Research]

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

[John Wall, Chief Financial Officer at Cadence Design Systems]

Clear.

[Joshua Tilton, Analyst at Wolfe Research]

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.

[John Wall, Chief Financial Officer at Cadence Design Systems]

That's a great question. That pipeline is very strong. I mean the hardware demand just continues to -- to amaze me that it's just tremendous. Those products are that verification group is just performing at a really high-level and such a consistent fashion through probably eight quarters now, but. So it's a very pleased with our. You might have noticed that we kept the same range on the guide from last Q3 from Q3 the same--same [indecipherable], because we thought, there's probably a broader kind of array of potential outcomes, with the amount of business that we expect to sign in Q4, we're expecting a strong bookings quarter in Q4 and there is a strong pipeline for hardware, but like I said, in relation to the AI question. But we're very patient with our customers. We will go at their pace and naturally, if something slips from Q4 to Q1, it goes from this year, next year our vice-versa. You can have stuff that customers are planning to buy in Q1 out in Q4 as well. But, but I think we've accounted for that in the guide everything we know is in our guidance.

[Joshua Tilton, Analyst at Wolfe Research]

Super helpful. And then just a follow-up, obviously on AI [indecipherable] touch it. But as that business of yours triples. Are you seeing the, the driver 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.

[John Wall, Chief Financial Officer at Cadence Design Systems]

Yes, absolutely, that's a very good point. Because the AI tools, our AI tools will run on the -- on the full flow by nature, whether that's digital implementation or it is on verification and of course, we believe we have best and great tools anyway on the base. I think you have to have the full flow, the basic engines to be best-in class and then add AI on-top of them which is best-in class. But it is, it is helping the underlying tools. So when our customers are doing more AI tools. It also and also, as you know, we have commented in the past that the AI tools by nature used lot of underlying tools. So when Cerebrus runs for example, which is a AI tool for digital implementation, which is one of the most difficult task in chip design. So it will typically the customers will use them on like one run a Cerebrus we'll typically run on 10, 20 machines, okay.

And each of them could be like 32 CPUs or 16 CPUs. So they are using lot of compute and also they using lot of underlying licenses. So it could be like you know 10 incentives of [indecipherable] which Cerebrus is running. So and then it is also Synthesis place and route and sign-off. Like in case of digital and then in logic simulation formula verification hardware, in case of verification and same thing with analog, it's not just Virtuoso but [indecipherable] so it's definitely a full flow is enabled but also, typically, the requires more instances because we're doing AI-based design or AI-based intelligent surge of the design process. So it will require multiple runs typically instead of one or two runs, it may require 100 or 200 run. But the user were doing that manually.

In a sequential manner and we can do that automatically anymore parallel that, definitely helps. But it's still worth it because you get much better PPA. And it's like using more compute and more software and more automation in place of more human effort and we can do it faster and embedded PPA now.

[Joshua Tilton, Analyst at Wolfe Research]

Super helpful. Thanks guys.

[Operator]

Up next now to Joe Vruwink at Baird.

[Joe Vruwink, Analyst at Robert W. Baird]

Great. Hi, everyone. Sorry to [indecipherable] backlog questions by the as a person going to if we rewind two years ago and look at 3Q into 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 due and why 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 change in composition of hardware and software. Just given what Cadence has been able to do on production capacity and ramping their. 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.

[John Wall, Chief Financial Officer at Cadence Design Systems]

Hi Joe. Great questions there. But, Yeah. I guess the way you profile last year's growth a large portion of that growth would have been of course the hardware, we weren't able to service at the time. And the reason I called out the lead times was end of last year. That's backlog and current year or the next 12 month backlog, if you like contained about 26, 28 weeks of lead-time for hardware. That's down to about eight to 10 weeks now, so, I guess to answer the second part of your question there. But when you get to the end of this year. Because we ramped-up on the hardware production. You'll need less to be in backlog for the, there'll be less need for revenue to come out of backlog for next year's revenue, then there was for this year.

That's, like I said, we've kept the production levels at the same level, all year. So every quarter we ratcheted up in Q1. And we've maintained that production levels to try and reduce, but those lead times because we think we're more competitive with customers. I mean, I was impressed this time last year people were awaiting over six months for our hardware solutions. And split, but we'd be silly to assume that that would continue as important to get the lead times down to eight to 10 weeks. I think that's more normal kind of more normal level to get to, but, very-very pleased with the progress we've made so-far this year and again I mean, we're not really talking about next year, but we've got a very busy Q4 ahead of us.

[Joe Vruwink, Analyst at Robert W. Baird]

Yeah, great, thanks, John. I can just squeeze one more in. I think we're about to lap the OpenEye acquisition. I just wanted to see how that generally has tracked relative to your original expectations and maybe just get an update about how Cadence's thinking about the opportunity from molecular sciences group and the role you can play in life sciences looking-forward.

[Anirudh Devgan, President & Chief Executive Officer at Cadence Design Systems]

Absolutely, we are super-excited about that. We are super-excited about molecular design and the future. It's almost like that EDA was maybe 20 years ago. Before I talk specifically about molecular design. I want to tell you in terms of our product strategy and how that is in logistics and similar too. So I see lot of activity in our main products, which I would describe as like a three layers -- in three layers, so the middle layer is actually the software products that we have which are like, either you are doing like EDA design or they are doing system simulation or they're doing finite element, or computational fluid dynamics, or molecular simulations. So that's the middle layer of the cake.

And below that, is this new emergence of, of computational hardware which is special purpose hardware like -- like we had in the past. We had special purpose hardware with Palladium, which is our custom chip. But now we use FPGA's for, for Protium. We have of course, X86 based Intel and AMD, CPU's. And then recently, a lot of activity on GPU's, especially with NVIDIA GPU's and accelerated computing. So that's the bottom layer of the cake. And then, the top layer of the three layer cake is AI orchestration.

AI can provide this new level of automation, and productivity and doing what was typically done by humans. It can be done with AI, like we talked about Cerebrus or Verisium. So this three layer cake is central to our product strategy. So the Middle is simulation, which is physics-based biology-based. The top is, is AI orchestration. The bottom is computational hardware. And then this can be verticalized across multiple verticals, whether it's EDA and chip design, whether it's package design with Allegro X AI, whether it is Clarity and Optimality, whether it's CFD with the Fidelity. And more importantly, like you asked with, with biosimulation.

So the reason we acquired OpenEye is that gives that critical middle layer of physics-based biological simulation, which are very, very few companies that can do that. But then we can add to it AI-based drug discovery and computational hardware with GPU's. So, as you may know the OpenEye has Orion cloud-based platform. It already runs on GPUs giving significant speed[phonetic] up for biosimulation, and then recently, and we'll talk more about in the future. We expanded our collaboration with one major top five pharmaceutical company, to do traditional and AI based drug discovery on top of OpenEye and Orion Platform and so I think this thing in the future if you go forward, and I mentioned last time also the application of AI, also I think is going to go into three steps.

So first application of AI is going to be, in building out the infrastructure. Like we talked about, of course, the great companies like NVIDIA and Tesla and now Broadcom, so the build of infrastructure and then there are so many other hyperscaler companies as you know, they are all building out AI infrastructure. So that's the first phase of AI adoption, the second phase of AI adoption is applying AI to our own products like Cerebrus and JedAI and Verisium we talked about that today also. And that's going pretty well and we talked about the progress in the last one year. And that, I think will still take several years to go.

And then the third phase of AI adoption is AI applied to areas that were not automated in the past, okay. So I think that that may take longer, maybe five years plus, but that has to be driven to digital biology and lifesciences. I mean there is a huge application of AI and to do that properly, we need that three layer cake and we need AI on top we need biosimilars and with OpenEye bring, and then computational hardware with our leading compute platform. So I'm very opportunity -- optimistic about the future and it will take some time and that has not happened in a quarter or two quarters, but it's right to invest for the future and it is synergistic with the other parts of, you know, lot of the bio simulation is similar to what we're doing, circuit simulation or CFD and things like that. So, but overall, I would like to say is still in the early innings with biology and biosimulation and OpenEye. But it is a good start and we are investing it for the future in a controlled way, of course. We are always financially disciplined, but I think the potential is there in the future for it to emerge as one of the big areas.

[Joe Vruwink, Analyst at Robert W. Baird]

That's great, thanks very much Anirudh.

[Operator]

Thank you. Our final question comes from Andrew DeGasperi at Berenberg.

[Andrew DeGasperi, Analyst at Berenberg Bank]

Thanks for fitting me in. Just had two quick ones. I know most of them were answered so far in 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 a non-GAAP basis. Just wondering maybe if you could lay out what the puts and takes there, is it revenue mix? Is the recent acquisitions that you've made that might have sort of crystallize that number. And [indecipherable] answer the second time. But like in terms of investments that you're making for next year, as the pace of hiring going to change at all based on what you're seeing right now.

[John Wall, Chief Financial Officer at Cadence Design Systems]

Great questions, Andrew. Yeah, in relation to the margin the recent acquisitions are more dilutive to this year. So we're picking-up more expense, we're picking very, very little revenue, we're picking-up expense immediately. And that kind of narrowed the range on the margin outcomes first -- are at the midpoint of 41.75%, I think it works out to be about $5.10 on non-GAAP EPS. In relation -- what was the second part of the question. Sorry, I have forgotten the second part of the question.

[Andrew DeGasperi, Analyst at Berenberg Bank]

Yeah, it's just on the -- in terms of hiring[phonetic]. Just in terms of how you're thinking about it so far.

[John Wall, Chief Financial Officer at Cadence Design Systems]

Yes. I mean, it's great. We continue to attract top talent to Cadence, you may notice though in our 10-Q we did some restructuring in August, we initiated a restructuring plan to better align our resources with our business strategy and we incurred about $12 million of costs comprised of severance payments and termination benefits relation -- in relation to headcount reductions. But that -- I would kind of categorize that as a bit of housekeeping in preparation for next year.

[Andrew DeGasperi, Analyst at Berenberg Bank]

Understood. Thank you.

[Operator]

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

[Anirudh Devgan, President & Chief Executive Officer at Cadence Design Systems]

Thank you all for joining us this afternoon. Our 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 Americas 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]

[Operator Closing Remarks]