Cadence Design Systems Inc
NASDAQ:CDNS
Earnings Call Analysis
Q3-2023 Analysis
Cadence Design Systems Inc
Moving into the fourth quarter, Cadence anticipates a robust revenue range between $1.039 billion and $1.079 billion, with a GAAP operating margin of approximately 31% and a non-GAAP operating margin of around 42%. Earnings per share (EPS) are estimated to be between $0.85 and $0.91 on a GAAP basis and between $1.30 and $1.36 on a non-GAAP basis. In line with its capital allocation strategy, the company plans to use about $125 million of its cash to buy back shares. Looking at the full year 2023, Cadence sets the bar high, projecting a revenue growth of approximately 15%, a non-GAAP operating margin of around 41.75% which marks the seventh year of over 50% incremental operating margin, and a non-GAAP EPS of $5.10, representing a sixth consecutive year of high-teen growth. This positive outlook underscores the successful execution of the company's Intelligent System Design strategy.
Management's forecast for the second half of the fiscal year signals exceptionally strong bookings. Q4, in particular, is projected to be remarkably robust, building upon what was already anticipated as a strong period. This projection accentuates the company's successful sales strategies and growing demand for its offerings.
Reflecting on the third quarter, management concedes that their initial guidance may have been conservative, particularly in regard to hardware installations in China which were completed earlier than expected. The advancements in Q3 led to a domino effect with a better-than-anticipated performance in the quarter, setting up an even stronger outlook for Q4.
The revenue generated from AI-based products has seen a significant leap, almost tripling over the past year. This impressive growth reflects the company's innovation and successful expansion within the high-potential AI field.
Despite recent regulatory changes affecting chip companies and manufacturers, Cadence, which operates in the design space, confirms that these alterations have not materially impacted its business. This reassures investors of the company's resilience and capability to navigate complex regulatory environments without significant disruptions.
Cadence reports that despite varying market conditions across different industry segments, the level of design activity remains strong, mirroring the position three months ago. Particularly noteworthy is the robust design activity in areas like accelerated computing and AI. The company highlights its integral role in the R&D cycle, with ongoing commitment from customers to invest in new product development. This steady investment indicates confidence in Cadence's continued partnership and long-term growth potential.
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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. [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.
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 in 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. [Operator Instructions] Now I'll turn the call over to Anirudh.
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 conversions 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's enabling customers to accelerate their pace of innovation while enabling them to meet their targets more efficiently. Over the past few years, we focused initially on incorporating powerful AI algorithms in our core engines and then build our Generative AI solutions on top of our software platforms. We are seeing growing momentum for our comprehensive JedAI Generative AI platform with an increasing number of customers adopting these solutions and achieving exceptional quality of results and productivity gains. While still in the early stages, sales of our Gen AI 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 pioneered leveraging Gen AI's LLM capabilities to chip design, successfully collaborating with Renaissance on accelerating function specification to final design. This is a key step in demonstrating the potential of LLMs to automate the translation of natural language specification to final chip design and verification tasks, 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 accelerates, we continued our momentum by enhancing our core EDA and systems footprint with several customers, including at 2 market-shaping companies. Now let me share some of the business highlights, starting with digital IC. With 11 new wins, our digital full flow delivering industry's 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 Gen AI solution, whose transformative results have led to its 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 a first-time right silicon, continued to drive strong demand for our Palladium Z2 and Protium X2 hardware platforms that provide industry-leading system verification and software bring-up 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 data center 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 N2 and N3 design. And it has close to 1,000 downloads since its launch 6 months ago. And [ Neshimbo ] micro devices utilize 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 assets. Customer reception has been overwhelmingly positive to the addition of their HBM and GDDR IP to our STAR Design IP portfolio. Design IP had a record booking quarter with strong AI and chiplet design activity, especially in the mobile, automotive and hyperscaler verticals. In addition, we launched our Tensilica Neo NPU IP and Neurovive 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 XAI has several successful engagements with market-shaping customers underway, and we announced Arcade 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 their differentiated products with improved quality of results, productivity and shorter time to market. I did want to take a moment to comment on the unfolding conflict in the Middle East. The ongoing violence and loss of innocent life is truly hard breaking 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.
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 that 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 billion 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've 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 and non-GAAP EPS of $5.10, a sixth consecutive year of high teens 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.
[Operator Instructions] And your first question comes from Charles Shi at Needham.
I want to ask you a little bit about the backlog, it looks like the backlog compared with last quarter was up. I mean the September quarter kind of implies -- very good bookings for September quarter. I just want to ask do you see the backlog will continue to grow into the year-end and because you talked about the second half booking strength. I want to see where it goes from here.
Yes, Charles. Thanks for the question. And thanks for remembering what we said last quarter, yes, we expect a very strong second half for bookings and Q4 is exceptionally strong. But -- so our expectations for bookings is very, very strong Q4.
Maybe I want to ask one quick follow-up. You kind of raised your full year revenue outlook a little bit less than you beat the Q3 in terms of revenue kind of implies that your full year outlook, you provided one quarter ago was largely accurate, but there seems to be some timing shift for the revenue, I mean, pulling in from Q4, Q3, was that related to your comment about how installation -- the timing of that.
That's right, Charles. In hindsight now, I was a little too prudent in the Q3 guide with respect to hardware installations that we're scheduled in China around the end of September. If you recall in our guide, we assumed that those installations would fall into Q4. In actual fact, we completed those hardware installations. And the second half looks stronger than we thought this time last quarter. But even with all of those hardware, we kind of beat our expectations in Q3 and Q4 is higher than we thought. .
The next now is Gianmarco Conti at Deutsche Bank.
I guess my first one would be, when do you expect to be giving out more AI KPIs, whether on contract value uplift or penetration rates just any color you can provide us some how can we quantify the AI tailwind in your numbers and whether we are going to see this coming through in bookings in sometime.
It's Anirudh. Let me take that. So like we mentioned in the prepared remarks, we are seeing a lot of activity in AI, and that's a multiple customer and multiple verticals. So whether it's the system company designing their own chips or of course, the semiconductor companies designing it or we mentioned this time, for example, Broadcom, which helps other companies design it. So we are participating in the AI kind of design process in all 3 ways. And last time we talked about NVIDIA and Tesla. And then on top of that, it's also applying AI to our own products. And then we have these extra generative AI products on top of our base products that also drives revenue. So the first part, which is build out of the AI infrastructure whether it's with, of course, large semi companies like NVIDIA or like large system companies like Tesla or companies like Broadcom, I mean that's a big part of our business. We don't break that out specifically because sometimes difficult to figure out exactly what part of customers' business is AI or not, and we don't want to be in that kind of to try to guess what part of our what the customers are using for. But AI is a significant portion of design activity and the build-out that's going to happen for years, okay? Now there is a second part of our business in which we are selling AI products ourselves, like [ you know ], like [ Serebrus ] and Verisium, our JedAI platform, which has 5 main products. So in that segment, if our own software products and IP products are AI-enabled. So in that, we did comment that even though it's early in the process, our revenue from our own AI products has almost tripled from a year ago. So we are very pleased with that progress. So I just wanted to highlight that. And also say there's another part of AI, which is the build out of infrastructure, which is more difficult to predict.
And Gianmarco, I would just add to that, that when Anirudh called out that the revenue from those products has almost tripled in the space of 12 months, we're not reclassifying any revenue. This is direct revenue attributable to those 5 products that we have in our JedAI platform.
Right. That's really good. I just have a follow-up, perhaps talking a little bit on China. If you could comment on whether there is any impact from the entity list and the new rules come into place? And also, if you had any visibility into Chinese customers into trying to understand whether you actually know whether they're designing at more mature versus advanced nodes. I feel like there's been a lot of conversation around whether there is a way to track whether EDA tools are being used in China for mature versus advanced nodes. Any color on that -- on this, it would be great.
Yes, that's a good question because there were a lot of recent reports on some of the changes in regulation. So for us, there's not that much difference. Most of the regulations were targeted some chip companies or manufacturing companies. As you know, we are in the design process. So those regulations, the latest round doesn't have a big effect on Cadence business. Now there are some companies added to the entity list. So we monitor that carefully. But since we are so diversified geographically and in terms of customers, that's not a significant impact either. And all our guidance that we just gave includes the impact of all these regulations that were announced recently. And of course, we carefully follow all U.S. regulation. But the latest change is not that material to our business.
We go next now to Harlan Sur at JPMorgan.
Macro conditions in the semiconductor industry are still fairly muted, we're close to a cyclical bottom, but recovery seems more gradual than expected across many different end markets, right? Accelerated computing in AI are strong, auto, industrial, enterprise service provider market is still relatively soft. So across some metrics that you track, renewals, hardware buy, IP take rates, is the team seeing any signs of hesitation or pushouts across your different customers or different businesses?
Yes, Harlan, that's a good question. Like we mentioned last time, we still see a lot of strong design activity. And I would say compared to like 3 months ago, I would say the activity is similar. Like you mentioned, some segments are going through tough times and then some segments like accelerated compute and AI have a lot of growth. But overall, as you know, these products that our customers are designing take several years to develop and we are part of the R&D cycle. So what we see is the customers still investing in R&D or building our products for the future, and we are glad to partner with them. So I think I would say that largely, the environment is similar than it was like a few months ago. Yes.
Yes, absolutely. And on the hardware side, we're producing hardware as fast as we were all year. And you can see in our 10-Q that we filed today that the value of finished goods and our inventory was less than [ 10 million ] at the end of the quarter in Q3. So the demand is really strong still and we're just producing the hardware as quickly as we can. We're expecting a very strong Q4 as well for our IP group. I mean they're delivering a number of silicon solutions to our customers in Q4. And I think that sets up a really strong quarter for that group, but we were expecting that all year.
Yes. No, I appreciate the comments there. One of your large AI SoC customer has recently laid out their future road maps, right? And given the complexity of all these next-generation AI compute workloads right, they're actually accelerating their chip road maps, so new GPU chip every year versus every 2 years, which was their prior cadence? And then on top of that, they're starting to segment their product lines, right? So not only accelerating road maps but more chips per product family. I've got to believe that other competitors in this space are doing exactly the same thing. Are you guys seeing the step-up 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?
Yes, good point. I mean like you said earlier, the macro environment is challenging, especially some of the segments are weaker, some are stronger. But design activity is very strong. And especially, I would say, in 2 verticals for the future, for the future of the semi and the system business. And at least the 2 very, very strong verticals in terms of design activity, is data center and AI and then automotive, given the electrification and the massive transformation that's happening. So if you look at even -- you know this anyway, Harlan, if you look at for the next 3, 4 years, these 2 segments will grow significantly, the whole AI-driven data centers and automotive and because they are growing so -- first of all, the cadence of those end customer products is increasing. And also, they need to be more and more efficient given the design activity and complexity is going up. So there is more design activity and also use of AI to accelerate and be more productive. And even we are using AI internally to be more productive ourselves. So definitely for these 2 big, big verticals, and this is a multiyear trend. This is not a -- and you mentioned some of our large customers, we are very fortunate to work with. We always say we want to win with the winners, and we always focus on the leading companies in the data center and AI space and also now in the automotive space. So that activity is strong, and I expect that to continue.
We go next now to Gary Mobley at Wells Fargo.
John, your upfront license revenue year-to-date has averaged around 17%. I think typically, it's 15%. Given where you're at in the verification hardware product cycles, Z2 and X2 and the conversion of the backlog there, how do you see that upfront revenue trending, looking into next year? And related to that, how would you see the influence on overall growth next year?
Yes. 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 4-quarter basis, the end of Q3, it's at 16% now, but I think your point is probably closer to 17% for the first 3 quarters. But I think that's a reflection of the strength of hardware on the ratable and recurring part of the business. although that's 84% of the trailing 12-month revenue, if you look at our guide at [ 40, 80 ], I mean, we're assuming essentially about a 13% growth rate on a current revenue line. For the year, but that's consistent with like over a 3-year CAGR basis is about 13% as well. Of course, we're not guiding next year.
Understood. Understood. All right. I suspect that we're not going to get any more AI metrics out of you in a route, but maybe if you can just give us a sense of where we're at in the commercialization of the 5 different AI tools. Have to working their way in the baseline license renewals? Or are they still on a per design basis and maybe it gives us a sense of where you expect them to cut into baseline licensing activity?
Yes, Gary, that's a good point. So we are watching that carefully, of course. And as you know, like these JedAI and these 5 major platforms or new products that our customers should engage with us on and they run on top of our existing kind of leading platforms. So it depends on the customers. I would still say we are still in the early stages of the adoption of these AI products because, as you know, any of these new software tools take years to fully deploy it, right? I mean this sort of happened in digital or in any major kind of platform releases we do. So even though we are like 2 years into it, I think it will still take some time to fully deploy these products. And what we have said in the past is typically at least in my experience with digital like about 7, 8 years ago, it took like 2 contract cycles for them to fully deploy, okay? So that's still 3, 4 years to go. You're probably like 2, 3 years into it and still 3, 4 years to go which is a good thing in my mind because this is natural progress of deployment. Now it depends on the customer. Some customers are adopting them in a much bigger way, especially -- like in the previous discussion, the new kind of AI design hyperscalers, there is like an improved cadence of design activity. So they are adopting them maybe a little faster than some of the other verticals. So it just depends on -- some are still on like tried on few designs or a few groups. But we have seen some pretty broad kind of deployment, and that helps our overall engagement with that particular customer. So that's what I would like to say, Gary, that I think it's still early, but what good thing, I think we mentioned in the prepared remarks that all top customers are now fully engaged and some of the results are truly remarkable. Actually, I was talking to 1 major customer recently, and they are getting like 8% to 10% power improvement from Cerebrus, okay? And we have mentioned several of these in the past also. I mean that's a huge improvement. Sometimes that's equivalent or roughly equivalent to a node migration. Typically, you go from one node to another, you may get like 10% to 15% PPA improvement, and you're getting close to that or roughly 2/3 of that from better AI tools. So the value is there. And that's what we are focused on, make sure the products really provide value and then work with the customers in the pace of deployment that they want to see because it's a natural process to try some and then deploy. But some of them are doing it much faster, like I mentioned.
We go next now to Jay Vleeschhouwer at Griffin Securities.
For my first question, I'd like to ask 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 4 or 5 years ago, but so much lower than it's been. A lot of that can be attributable to Intel. But still, how are you thinking about those 2 different dynamics. And then I'll ask a follow-up.
Yes, Jay, good question. I mean, we are watching it carefully. Like you said, like we said earlier, I mean, design activity is still strong. But of course, the macro environment is challenging. It's like natural -- even though the customers realize that they need to invest in R&D for the future if the revenue is impacted because of macro situations, that decisions become a lot more prudent. But -- so this is just natural business process -- but in general, still the large customers in the big segment, they're all investing in R&D, design activity is still strong. And then we just have to see -- we had a good Q3 in terms of bookings, like we mentioned. So we'll see what happens in Q4 and that will also give us a better idea going forward.
Jay, 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 that customers have an intent to come back and keep purchasing. So they don't wait when we launch AI tools. They don't wait for the baseline renewal to come up or to expire to purchase them, they'll purchase add-ons and they'll purchase a few licenses and then hopefully proliferate more on the contract renewal. And as you know, we have a lot of contracts that come up for renewal in Q4.
Understood. For a follow-up, I'll ask about some interesting Cadence management comments at last month's Cadence Live event up in Boston. So there was an interesting comment about the role of AI as derisking schedules, in addition to the design exploration use case, and what's interesting there is historically schedule risk or completion risk has to do more towards the back end of the process, for example, physical verification. So to the extent that more of that risk mitigation moves up earlier in the process, do you think that there will be a spending share shift within the totality of EDA spend, perhaps some from the back end more towards the front end where you play with a lot of your tools.
Jay, I would say that it should lead to more design activity if 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, 30 years. I remember in the old days in the '90s, we would take like 5 years and 500 engineers to design some big chip. And now that takes 6 to 12 months and maybe engineers. So that's like 100 times more efficient than 25 years ago. And I think AI can, as you know, provide the next generation, next level of improvement in productivity and risk mitigation. I mean, part of it is also 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 end is still a complicated process. And so I think even though some of the things can be pulled upfront using AI or using hardware platforms. I still think the back-end design process requires a lot of work. So I would expect it affects all of them. And then the other thing we are trying to do on the front, as you may have noticed, is really incorporate LLMs like our partnership with Renesas because a lot of the front-end process has been less formal. The back-end process, especially once we have then we go to gates, we go to GDS. It's 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.
We'll go next now to Jason Celino at KeyBanc Capital Markets.
Maybe first for John. on the Q4 guide about apologies for asking this again, but the folks might be wondering tomorrow, I guess, why aren't we seeing more upside to the guide for fourth quarter. Where might be some conservatism? Or what will you be overlooking in terms of the setup.
Yes, Jason, the -- as you know, your question probably emanates from the fact that we beat by $23 million in Q3 and raised by $10 million, but that was mainly due to a prudent guide for with respect to certain hardware installations. I think overall, we've taken the quarter up the year up by $10 million at the midpoint. But I think there's -- because it's expected to be a strong bookings quarter and a particularly strong quarter for our IP Silicon Solutions group that -- I mean they're having they're going to have an excellent Q4, but we're expecting that all year. I think if there's upside, it will probably come from that group.
Okay. Okay. No, that's fair. And then just my quick follow-up on backlog. I know you've got some weird comps because of the hardware stuff. But might we see like year-over-year growth again? Or I guess, if we stripped out the hardware-related backlog, I don't know if there's any way to share what type of growth you might be seeing?
Yes. 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 8- to 10-week range now on lead time for hardware. So of course, we've eaten some backlog as a result of that. But I think we troughed out essentially in the middle of the year. We're expecting the second half to be stronger for contract renewals because the number of contracts expired in the second half. In Q3, you saw backlog starting to pick back up again, we'd expect it to tick back up again in Q4 because we have a strong bookings quarter or we're expecting a strong bookings quarter. The one I'd look for really is the annual -- the kind of CRPO 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 there'll be so much less hardware in it, I would expect because we have the production capacity now to deliver on the hardware.
I'll go next now to Vivek Arya at Bank of America.
I appreciate it's early for a '24 outlook, but I was hoping that you could give us some color given that your model is 85% [ record ]. 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?
Yes. Vivek, like before 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 February earnings call. And that's what we have done in the past, and that has worked out well, right? So.
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 2 recent acquisitions contribute to that? And just longer term, do you think IP as a category over or undergrow the EDA? And does that influence your growth prospects? So what kind of near and longer-term question on the IP business.
Okay. But 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're expecting a strong Q4 for that group I mean if you look at the guide we've given for the year, essentially, we're guiding to 14% to 15% revenue growth for the year, which means Q4 over 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?
I mean, as you know already, more customers are outsourcing their IP needs. And we have always participated in that, and we have always said, we want to participate in that in kind of Star IP portfolio so that it's more and more profitable. And the profitability of our IP business has improved over the last few years. And so I think we are overall happy with the profitability of the IP business. So now we're trying to see, okay, what other areas can it grow and maintain profitability. And I think the areas that are emerging, which are strong are this whole chiplet-based design and 3D-IC and which are used for a lot of AI and hyperscaler applications. And that's also the reason we bought the 5 assets of Rambus, which is the HBM and GDDR-based IP. So I feel now that our IP portfolio is in the right areas and also the use of this in automotive and hyperscaler and AI IP. And most of these markets are evolving into chiplet-based and 3D IC-based designs, which also have certain new IPs like UCI 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.
Just to clarify, the contribution from acquisitions is likely to be immaterial for this year. So the strong Q4 that we're expecting is really from organic business.
We go next now to Ruben Roy at Stifel.
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 ] 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, 2 years. It sounds like this is sort of a longer-term collaboration and sort of testing going on today. Just wondering sort of what you're thinking about time frame 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 if you could talk a little bit about the type of design that would be great.
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 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're using almost all of our AI tools. whether it's Cerebrus for digital or verification, Verisium and other 2. And also, we are doing some new collaboration with them on LLM, like we mentioned. And the LLM collaboration is fairly broad-based. It can be applied to any kind of design. Renesas has a range of design all the way from advanced node to mainstream nodes. And the other mall already, but the key thing is, one benefit of AI is that there is -- 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 pennies. And the [ tools ] 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 are in multiple locations. So the good thing with AI is that -- and we can do in 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 geographically diverse team, not all teams are super experts. So if the AI tool is same or better than your best team, then the reason to deploy it is that wherever -- just by the nature of human productivity, there's a variation across the organization. The results can be even greater in your teams, which 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, but definitely happening in chip design. So if you have 3 years experience doing chip design versus 20 years experience in chip design, okay, with AI, that gap is narrowing. So less experienced engineers can be almost as productive as more experienced engineers. So apart from like productivity and quality of results benefit, it has this other kind of almost workforce management benefit for a large organization like Renesas because they have organization in multiple locations and also a wide experience range from young engineers to experienced engineers. And this we are seeing in other companies as well. And I think the -- what is also interesting is that the companies that adopt these AI tools first and faster will benefit more with their peers. So we are seeing that the fast-moving companies and Renesas is definitely one of them. And then we talked about, of course, 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 them. So there are more than one. There is a whole workforce development benefit of AI, which are actually quite profound.
That's very helpful. I guess just a quick follow-up. I mean, it sounds from what you're saying this should be incremental. I mean, EDA has grown nicely. If you look at the core EDA growth over the last several years, you guys like to call out the 3-year CAGR. But from what's going on here, we should assume that this would be incremental on sort of the way you've seen EDA growth. Would you -- can you comment on that as you think about whether it's software renewals or adding add-ons, as John talked about, over the next 12, 18, 24 months, would you say this would be incremental to sort of that mid-teens growth at the EDA tools have been growing at over the last 3 years or so?
Well, 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 call that we expect to proliferate our AI tools across our entire customer base over about 2 contract cycles. And some are adopting more rapidly and embracing the tools. Some are -- they're adopting the AI tools and add-ons, but they might be shaving back their configuration somewhere else. That tends to be a fourth economy because 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.
We'll go next now to Josh Tilton at Wolfe Research.
Can you hear me?
Clear.
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 3 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?
Yes, it's a great question. But pipeline is very strong. I mean the hardware demand just continues to amaze me that it's just tremendous. Those products -- that verification group is just performing at a really real high level and in such a consistent fashion through probably 8 quarters now. But -- so very pleased with that. You might have noticed that we kept the same range on the guide from last Q3 or from Q3 the same rate because we thought there's probably a broader kind of an 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 that we're very patient with our customers. We'll go at their pace. And naturally, if something slips from Q4 to Q1, it goes from this year to next year or vice versa, you can have stuff that customers are planning to buy in Q1 happen in Q4 as well. But I think we've accounted for that in the guide. Everything we know is in our guidance.
Super helpful. And then just a follow-up, obviously, on AI, I can't not touch it. But as that business of yours triples, are you seeing the drive or the want to adopt these AI tools cause more of your users to make full flow decisions and maybe this has been more of a best-of-breed market historically?
Yes, absolutely. That's a very good point. because the AI tools, our AI tools will run on the full flow by nature, whether that's digital implementation or it is on and verification. And of course, we believe we have best on breed tools anyway on the base. it's like 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 helping the underlying tools. So when our customers are doing more AI tools. And also, as you know, we have commented in the past that the AI tools by nature used a lot of underlying tools. So when Cerebrus runs, for example, which is our 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 of 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 a lot of compute. And also, they're using a lot of underlying licenses. So it could be like 10 instances of Innovus, which [ Serebras ] is running.
So -- and then it is also synthesis, place and route and signoff like in case of digital, as and then logic simulation, formal verification, hardware in case of verification and same thing with analog. It's not just Virtuoso, but it's Spector. So it's definitely a full flow enable, but also typically requires more instances because we're doing AI-based design or AI-based intelligent search of the design process, so it will require multiple runs. Typically, instead of 1 or 2 runs, it may require 100 or 200 runs. But the user we're doing that manually in a sequential -- and we can do that automatically in a more parallel manner. It definitely helps. But it's still worth it because you get much better PPA and it's like using more compute and more software, more automation interest of more human effort. And we can do it faster and a better PPA.
We go next now to Joseph Vruwink at Baird.
Great. Sorry to belabor the backlog questions, but I suppose I'm going to if we rewind 2 years ago and look at 3Q and the 4Q of 2021, current RPO then went up by, I think, nearly $400 million sequentially. Is that maybe how you would start to frame just renewal values that are coming due and what you could potentially look to build on? And then second part of my backlog question. And it gets back to Jason's question on just the change in composition of hardware and software, just given what Cadence has been able to do on production capacity and ramping there, does that change the relationship in terms of what needs to be sitting in backlog at year-end in order to support some sort of next 12-month revenue expectation?
Joe, great questions there. But yes, I guess the way you profiled 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 backlog and current year or the next 12 months backlog, if you like, contained about 26 to 28 weeks of lead time for hardware, that sounds about 8 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've 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 than there was for this year, that -- and like I said, we've kept the production levels at the same level all year. So every quarter, we ratchet it up in Q1, and we've maintained that production level to try and reduce that those lead times because we think we're more competitive with customers. I mean I was impressed this time last year, people were waiting over 6 months for our hardware solutions. But would be silly to assume that, that would continue as important to get the lead times down to 8 to 10 weeks. And I think that's kind of a more normal level to get to. But yes, very pleased with the progress we've made so far this year. And again, we're not really talking about next year, but we've got a very busy Q4 ahead of us.
Great. Thanks, John. I can 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 is thinking about the opportunity from the Molecular Sciences Group and the role you can play in life sciences looking forward?
Absolutely. We are super excited about that. We are super excited about molecular design and the future. It's almost like where EDA was maybe 20 years ago. And before I talk specifically about molecular design, I want to tell you in terms of our product strategy and how that is synergistic and similar to. So I see a lot of activity in our main products, which I would describe as like 3 layers. So the middle layer is actual software products that we have, which are either you're doing like EDA design are they doing system simulation or are they doing finite element, computational flow dynamics or molecular simulation. So that's the middle layer of the cake. And below that, is this new emergence of computational hardware, which is special purpose hardware. Like we had in the past, we had special piece of hardware with Palladium, which is our custom chip. But now we use FPGAs for Protium. We have, of course, x86-based Intel and AMD CPUs. And then recently, a lot of activity on GPUs, especially with NVIDIA GPUs and accelerated computing. So that's the bottom layer of the cake. And then the top layer of that 3-layer cake is AI orchestration. AI can provide this new level of automation and productivity and doing what was typically done by humans, can be done with AI, like we talked about [ Serebrsor ] or Verisium. So this 3-layer cake is central to our product strategy. So the middle is simulation, which is physics-based biology-based. The top is AI orchestration. The bottom is competitional hardware. And then this can be verticalized across multiple verticals, whether it's EDA and ship design, whether it's package design with Allegro X AI, whether it is clarity and optimality, whether it's CFD with Fidelity and more importantly, like you asked with biosimulation. So the reason we acquired OpenEye is that gives that critical middle layer of physics-based biological simulation, which are the very few companies that can do that. But then we can add to it AI-based drug dry and computational hardware with GPUs. So as you may know, the OpenEye has an Orion cloud-based platform, it already runs on giving significant speed up for biosimulation. And then recently -- and we'll talk more about it in the future. We expanded our collaboration with 1 major top 5 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, as mentioned in the last time also, the application of AI also, I think, is going to go into 3 steps. So first application of AI is going to be in building out the infrastructure. like we talked about, of course, great companies like NVIDIA and Tesla and now Broadcom. So the build of infrastructure and there's so many other hyperscale 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 Celebros and JedAI and Verisium talked about that today also. And that's going pretty well, and we talked about the progress in the last 1 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 may take longer, maybe 5 years plus, but that has to be driven to digital biology and life sciences. I mean there's a huge application of AI. And to do that properly, we need that 3-layer cake, and we need AI on top. We need biosimulation with OpenEye [ bring ] and then computational hardware with our leading compute platform. So I'm very optimistic about the future. Now it will take some time. This is not happens in a quarter or -- but it's right to invest for the future, and it is synergistic with the other parts of a lot of the biosimulation is similar to what we do in 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's 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. Yes.
And our final question comes from Andrew DeGasperi at Berenberg.
Just have 2 quick ones. I know most of them were answered so far on this call. But First on the margin, maybe could you lay out john, on -- in terms of the guidance for the year? I know you put 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 are there? Is it revenue mix? Is it the recent acquisitions that you made that might have sort of crystallized that number? And without having to answer the second time, but like in terms of investments that you're making for next year, is the pace of, call it, hiring going to change at all based on what you're seeing right now?
Great questions, Andrew. The -- yes, in relation to the margin, the recent acquisitions are more dilutive to this year. So we're picking up more expense. We can very, very little revenue. We're picking up expense immediately and that kind of narrowed the range on the margin outcomes for us. But -- or 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've forgotten the second part of the question.
No, no worries. Just on the -- in terms of hiring, just in terms of how you're thinking about it so far.
Yes. I mean that's -- 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 in relation to head count reductions. But that -- I would kind of categorize that as a bit of housekeeping in preparation for next year.
Thank you. I will now turn it back over to Anirudh Devgan for closing remarks.
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's America's Greenest Companies 2024 list. On behalf of our Board of Directors, we thank our customers, partners and investors for their continued trust and confidence in cadence. Thank you.
Thank you for participating in today's Cadence Third quarter 2023 Earnings Conference Call. This does conclude today's call. You may now disconnect. Thank you for participating today.