Q3 2022 Cadence Design Systems Inc Earnings Call
Our most recent forms 10-K, and 10-Q 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.
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.
Conciliation of GAAP to non-GAAP measures are included in today's earnings release.
Today's earnings release for the third quarter of fiscal 2022 related financial tables, and CFO commentary are also available on our website.
For the Q&A session today, I would ask that you observe a limit of one question and one follow up you.
You may re queue, if you would like to ask additional questions and time permits.
Now I'll turn the call over to Henri.
Thank you Richard Good afternoon, everyone and thank you for joining us today.
I am pleased to report that cadence delivered excellent results for Q3.
Driven by our technology leadership strong execution.
Diversified customer base and resilient business model.
We beat our Q3 guidance on all key metrics.
Raising our financial outlook for the year, yet again.
The 19% year over year revenue growth.
40% operating margin.
John will provide more details on our Q3 results and updated outlook for the year.
Notwithstanding the prevailing macroeconomic uncertainties.
Our pieces about generational drivers such as five G Hyperscale computing and.
In AI ml driving robust design activity over the long term remains intact.
These secular trends are accelerating the digital transformation.
Several end markets.
While the growing hyper convergence across multiple domains mechanical and electrical.
Hardware and software.
And systems and semi is driving the strong need for continued innovation and compute.
<unk> and storage.
Customers are investing heavily to differentiate their next generation platform with.
With system companies increasingly developing purpose build silicon.
And semiconductor companies benefiting from expanding silicon content.
Our comprehensive offerings comprised of leading end to end <unk> solutions.
IP.
Hardware and expanding systems portfolio.
Uniquely position us to support our customers.
While providing us with ample growth opportunities.
Yes.
In an environment of increasing design complexity.
Tighter time to market requirements.
And growing shortage of talent.
Sophisticated AI ml solutions can greatly held to democratize chip and system development.
While dramatically increasing productivity and quality of results.
Yes.
Customers deploying our game changing AI driven cadence cerebral.
And ophthalmology solutions are realizing amazing results.
And in Q3, we augmented our portfolio with the transformative <unk> AI verification platform.
And the Jedi data platform.
Verification continues to be the critical path and system time to market.
Consuming the vast majority of resources.
With <unk> being the largest component.
Whereas in provides a generational shift in verification.
Moving from our legacy single run single engine approach to algorithms that leverage big data and AI to optimize multiple runs across multiple engines.
Leading to a tenex boost and debug productivity.
Several customers, including Samsung and SD micro electronics.
Observed impressive results with various Liam for automatically triage ing and route causing Budd.
<unk> is our revolutionary AI, driven big data analytics platform that.
That is foundational to unifying our AI innovations.
Across cadence cerebral optimality and very soon.
Jedi operates on what's the amount of data.
Including all types of design.
Verification analysis and methodology information to facilitate smaller design optimization.
So it facilitates smarter design optimization and enhance productivity.
In Q3, we significantly expanded our footprint with market shaping customers as they increasingly embraced our optimized platform offerings.
We deepened our partnership with <unk> systems.
Across our core EDA and systems portfolio.
Including proliferation of our digital full flow and analog products and.
And abroad expansion of our PCB and multi physics system analysis solutions.
Additionally, in Q3, we strengthened our collaboration with Teradyne.
Which included a broad proliferation of our core EDA software.
Across digital analog and verification.
As well as a significant expansion of our PCB and system analysis business.
Demand for our core EDA software remained strong and broad based.
Our digital business had another strong quarter.
With 22% year over year growth driven by key competitive wins and continued proliferation and market shaping customers.
13, new customers adopted our digital full flow in Q3.
It's been just over a year since we launch cadence cerebral and it's fast becoming a lynchpin technology for customers.
As they derive incredible productivity and PPA results on a wide variety of their most advanced Soc design.
Several leading customers have major multi design multi project production deployments underway and are reporting up to 30% improvement in quality of results and 30 ex productivity improvements.
Additionally, we see accelerated growth in our front end sign of offerings.
In part due to the cadence city Bruce pull through effect.
Yes.
We launched the service closer solution, which dramatically accelerates complete design closure.
By using an innovative hierarchical architecture and if.
Fully automated environment, but concurrent full chip optimization and sign up using.
Using <unk>.
<unk> observed six X faster chip level sign off closure.
Versus current methodologies.
And Max linear.
Experienced overnight full chip sign of closure.
While realizing up two 5% of untapped power savings.
Our custom IC business.
News to define the analog market that this bold vision market, leading technology and comprehensive portfolio.
In Q3.
It grew 12% year over year.
Even by best in class virtuoso platform and by strong growth in our Spectre simulation solutions.
Now moving onto functional verification.
In Q3, our business grew 31% year over year.
Led by hardware and <unk>.
Our palladium zone, two and proteomics to hardware platforms, providing industry, leading system verification and software bring that capability.
Added three new customers and had 20 repeat orders, including from high end mobile AI and Hyperscale customers.
Our IP business led by our Star IP offerings at the most advanced nodes continue to benefit from ongoing IP outsourcing trend and from customers, increasing embracing IP reuse for.
For risk reduction and faster time to market.
During Q3, we signed our largest contract ever.
With a marquee U S semiconductor company.
And had a major expansion at a leading U S <unk> company.
Then silica extended leadership and the true wireless stereo market.
While proliferating its functional safety and infotainment solutions with automotive companies.
We also had multiple design IP wins across our leading pcie DDR and die to die portfolio.
Our system design and analysis business is a key tenant of our growth strategy.
To leverage our competition of software expertise and expand our Tam by.
Growing in near Adjacencies.
This business continued its strong momentum.
Delivering 29% year over year growth.
As we increase our footprint in several verticals, including aerospace and defense and high Tech electronics.
Our broad systems portfolio, providing tightly integrated platform solutions across the design simulation and analysis.
Is resonating strongly with customers as they increasingly choose a broader set of our solutions across these domains.
In Q3, we broadened our collaboration with Emerson.
A global industrial technology and software leader as the significantly expanded their use of our system solutions.
Notably, our PCB AWS and system analysis technology.
Fidelity Cfd software.
That was announced earlier this year.
Is ramping nicely and facilitating customers in verticals such as aerospace.
Marine and turbo machinery to do design optimization.
Leading to efficiency improvement and meaningful reduction in emissions and energy consumption.
And the addition of future facilities digital twin based thermal and power optimization technology.
We will further help datacenter customers to reduce their carbon footprint.
Lastly, we completed the acquisition of open ice scientific.
<unk> in the computational molecular design space.
We're very excited to bring our system level simulation.
And AI ml expertise to the life sciences market to help improve the speed and accuracy of Biosimilars <unk>, thereby enhancing the efficiency and success rate.
Drug discovery process.
Integration of both our future facilities and opened nine acquisitions is progressing well.
In closing.
Q3 was an outstanding quarter as.
As we advanced our intelligence system design strategy and continue to closely collaborate with our customers on their next generation designs.
We are managing our business with the intense focus on innovation and operational excellence.
To drive both revenue growth and margin expansion.
And are very well positioned to capitalize on the massive opportunities ahead.
Ahead of us.
Now I will turn it over to Jon to provide more details on the Q2 results and our updated 2022 outlook.
Thanks, <unk> and good afternoon, everyone.
I am pleased to report that we completed the acquisitions of open ice scientific and future facilities.
In the third quarter of 2022.
Cadence exceeded all key financial and operational metrics for the quarter.
Here are some of the financial highlights from the third quarter.
Total revenue was $903 million.
GAAP operating margin was 29% and non-GAAP operating margin was 39%.
GAAP EPS was <unk> 68.
And non-GAAP EPS was $1 <unk>.
Operating cash flow was $317 million.
We used $150 million of cash to repurchase cadence shares and.
And at the end of the quarter, our cash balance totaled $1 billion, while the principal value of our debt outstanding was $800 million.
Before I provide our updated outlook for the remainder of fiscal 2022, I'd like to take a moment to share certain key assumptions embedded in our outlook.
We expect the impact of the recent changes to U S trade restrictions on our business to be limited and manageable.
The impact is included in our outlook.
Our outlook also assumes that the export limitations that exist today remain substantially similar for the rest of the year.
Embedding these assumptions into our outlook for fiscal 2022, we now expect revenue in the range of 3532.
The 355 $2 billion.
GAAP operating margin in the range of 29, 7% to 37%.
non-GAAP operating margin in the range of $39, 7% to 47%.
GAAP EPS in the range of $2 71.
To $2 75.
non-GAAP EPS in the range of $4 20.
To $4 24.
Operating cash flow of approximately one two to $1 billion to $6 billion.
And we expect to use approximately 1.05 billion of our free cash flow to repurchase cadence shares in 2022.
For Q4, we expect revenue in the range of 872 $890 million.
GAAP operating margin of approximately 24%.
non-GAAP operating margin of approximately 35%.
GAAP EPS in the range of 50 to 54.
non-GAAP EPS in the range of 89% to 93.
And we expect to use approximately $300 million of cash to repurchase cadence shares in Q4.
Our CFO commentary, which is available on our website includes our outlook for additional items as well as further analysis and GAAP to non-GAAP reconciliations.
In summary, I'm pleased with our progress across all lines of business this year.
At the midpoint of our outlook, our Q3 revenue CAGR continues to increase and I would like to thank our cadence team for their exceptional execution and financial discipline at the midpoint of our outlook, we expect our annual non-GAAP operating margin to exceed 40% for the first time, which is especially pleasing.
As always I'd like to thank our customers partners and our employees for their continued support.
And with that operator, we will now take questions.
At this time I would like to remind everyone.
In order to ask a question. Please press Star then the number one on your telephone keypad now.
We will pause for a moment to compile the question and answer roster.
Your first question comes from Jason <unk> from Keybanc capital markets.
Great. Thanks.
My question.
Danny.
Yes, Jason.
Okay perfect perfect pardon me straight to the point here, but China is on everybody's mind.
50% growth in the quarter and.
To some extent there was an easy comp.
<unk> revenue when we've seen.
<unk> and <unk>.
And experience.
So I guess, where do you see the strength and then how would you describe the linearity of that strength was it all throughout the quarter or was it Brian I applauded our backup on Im curious.
Paul.
Oh, that's a great question, Jason and thanks for the opportunity to clarify in Q2, you saw 13% of our revenue Q2 came from.
From China and that jumped to 17% in Q3.
Most of the increase the vast majority of that increase was a result of hardware sales in the quarter hardware revenue that was recognized from deliveries into China during Q3.
So that's that uptake in China revenue is all from upfront revenue sources.
Okay, perfect and then I did notice that backlog with kind of sequentially.
Dallas merge in the quarter.
Much of that was due to the inclusion of some of these new restrictions.
Thanks.
Yes, another great question, Jason that last quarter I think it was $2 75 in terms of our current <unk> and that's down to two seven now.
Partly as a result of all of that hardware deliveries into China.
Also includes the this quarter we've included the impact of the.
The new U S export regulations.
On backlog in total I think it went from five 6% to five five.
The current <unk> there was.
That was slightly down more.
And we had an increase in IP, we signed our largest IP contract ever and that's in the noncancelable commitments portion of our backlog.
Okay, great I'll get back in queue. Thanks, John .
Thanks, Jason.
Your next question comes from the line of Charles C.
From Needham and company.
Hi, good afternoon.
And our job really just wanted to go back to the China question, maybe not immediate Q4 or fiscal 'twenty two about the track and look a little bit of a hat.
Sure.
Among your like a kind of like mid teens of the total revenue coming from China.
I know yourself as kind of to various kinds of customers.
In fact multinationals.
Large semiconductor companies domestic you've got AI startups, Chinese Stefan companies, but across a wide spectrum of different kind of customers in China.
What kind of customer sales to the customer could be the most impacted by the export control and.
While can you kind of quantify to us.
How much of the percentage of your revenue is going to be impacted.
Because of the latest round of export controls and I have a follow up to that.
Hi, Charles this is Jon.
Yes.
Good point, there, we did call out that the.
The impact is limited we believe the impact is limited and manageable.
Thats not just for Q4, but for the foreseeable future going forward.
Any thoughts on <unk>.
Any specific type of customers that you may see the greater impact.
China.
In your China market.
Okay.
Yes, Hi, Charles this is an era so overall.
<unk> is a diversified customer base and we have a lot of design activity in China.
No.
Thinking about cadence as we participate in all kinds of designs I admit that analog or digital on memory in different market segments.
So overall I feel that that will be intact.
I think there is some effect on local like China foundries and the latest regulations.
As you probably know, but overall our business is very diversified not just in China, but other geos. So.
And therefore, we feel the impact is limited and manageable.
What Jon said not just for the remaining of the year, but also going forward okay.
Thank you.
Mhm.
Your next question comes from the line, Gary Mobley from Wells Fargo.
Hey, guys. Thanks for taking my question.
I wanted to.
Talk about perhaps the indirect impact from the China export restrictions and as well the general semiconductor market backdrop and the challenges. This may present for companies like cadence.
So.
You have.
Some of your large customers, who can ship product to China because of various export restrictions, which can't ship $400 million worth of product.
These export restrictions so to what extent long term might the R&D budgets of those types of companies be impacted and related to that the chip design activity as they can no longer sell to various and large end markets like China.
And then related to the overall market backdrop are you seen any change in customer behavior with respect to the time it takes.
Ticket sign off on any large license deals.
Yes.
Hi, guys. Good good point, especially the indirect effect and also overall macro economic uncertainties.
And we are carefully.
And are monitoring the situation on both of these trends.
We are more on the.
No design side than on the on the well.
Volume of shipments.
So on the macroeconomic trends of course, there is a lot of news in the press and we are carefully monitoring it but right now.
We see robust design activity and as you know we participate in all the.
Market verticals, so even if some verticals may.
Maybe weaker.
On the shipment side, they will still do design, but then some verticals are still good on the shipment side as well so with this combination of us being on the design side, and then us being very diversified across multiple verticals right now we still see very robust.
Design activity and Thats reflected.
And the results that we're reporting today and our outlook for the rest of the year now on the indirect effect on China. That's to be observed also but again, we are pretty diversified and then.
Yes, there is always some effect on some of our customers, but again, we are pretty diversified and then so we right now feel that that's manageable, but we will carefully monitor that going forward.
Alright, thanks, thanks for that color.
So I wanted to switch topics to your Jedi based AI and machine learning tools, including three business some of the others you recently announced.
I know you are in the early days.
Price discovery and introducing those products to market what has been the feedback as it relates to quote unquote price discovery and and and related to that how deeply you maybe seeing penetration in some of your early days customers there.
Okay.
Yes, that's a great point.
We're super excited about this new AI based solution.
Because like I mentioned earlier this is a great opportunity for.
Core EDA to add more value to our customers because if you look at historically EDA.
Has always been like.
It has done that we have done lot of great productivity improvements for our customers, but it has always been like a single run environment right you run at all one time.
And then the multiple runs have been managed by the customers typically when you do the design youre not running our tools one time youre running a multiple time.
So with this data analytics and AI, we can really offer solutions in this multi around environment and so AI is a key part of that but in our multiline environment. You also have to manage the data.
Because AI tools run on top of that all the data that is generated.
And we are very proud of this new Jedi platform and new data analytics platform to capture all kinds of data in the design process.
And that unifies our solutions across the space and then we had three like big apps on top of <unk> on top of this data analytics. So one you already know that cadence here Bruce.
Which was launched last year optima.
Optimality, which is on the system space using some of the similar technology the city Bliss, but applied to system simulation.
And now we're ECM and verification.
By the way verification as you know is one of the most.
Yeah.
Time consuming parts of the design flow and also the one that generates the most data logic simulation hardware verification generates the most amount of data in DDA. So thats why it was it was critical to have Jedi.
Unify all these things, but also get ready for more data Lake and verification.
And the adoption has been actually.
<unk> good.
All the big customers, they engage UC and very soon we have endorsement from.
Several big customers, Doug with cerebral as last time.
So at this point all the major customers really do want to deploy the solution and and like I mentioned in the script not just for one or two designs, we are seeing broader and broader adoption.
And we are we are very happy with the progress so far.
Thanks, Ken.
Okay.
Your next question comes from.
The shower from Griffin Securities.
Thank you good evening.
Auto Road for you first when you look back the last one or two years.
How would you rank the contribution to your bookings growth and or share gain in what we define as core EBITDA from the various products that go under your us.
Nomenclature I assume.
This has been part of that given its size, but when you look at some of the various other sign off and other tools that you've introduced under the that nomenclature.
Again, how would you rank the.
New momentum our incremental contribution.
From those and perhaps even look out ahead over the next one to three years in that respect.
Secondly for you John .
What has been your experience to date in terms of the predictability of your IP business. This is not a China specific question, but feel free to talk about China.
Specifically in terms of the increase.
Increasingly material upfront components that we've seen for IP Rev Rec.
As well as for your services engagements related to IP. Thank you.
Yes, Hi, Jay.
That's a good question.
And actually I'm very pleased with our strengths our portfolio in core EDA and as you know we have been doing.
Increasingly well over the last couple of years.
And I can say that guidance core EDA portfolio is strongest it has ever been.
We wanted to apply our expertise in computational software to new areas like system analysis and system design and analysis.
But it's super critical to maintain the leadership in the core because core always comes first and then we take those expertise and apply it to.
Two new areas like system. So we are always focused on the core first.
Core parts are let's say three big areas that I had in core EDA.
Digital analog and verification at a high level and I feel that we have a very strong portfolio now in terms of contributions of growth.
Era in analog we are always strong and I think there were some areas to improve inspector simulation, which have been fixed over the last two years.
So I think analog is more steady and you can see even this quarter. It grew a healthy 12%.
But a lot of the growth has come from digital.
It just <unk>, which is place and route but also now the synthesis and sign off and Citigroup.
So I would say no.
Digital.
Is growing very well also in terms of take.
Strengthening the position in the market.
And then im, especially pleased with verification now verification that is systemic growth drivers that is helping hardware.
But I think that some of it is the strength of our portfolio and some of it is hardware becomes.
More critical to the design portfolio.
But it didn't verification I actually also pleased with various yet our logic simulator I think thats doing really well.
And then this year and over the last couple of years and that completes our overall verification platform. Because we are now strong and hardware palladium and protium.
And then Jasper we have always been the leading solution and formal verification and with the strength of <unk>. It completes our verification platform.
I would say the growth in core EDA is driven by digital.
Number one verification close second and then maintaining and strengthening our position in analog.
And in relation to your IP question, and particularly the predictability of.
IP revenue.
Our focus remains on profitable growth through differentiated star IP, that's highly reusable and easier to scale and have been very pleased with the discipline from the management team that run that business for us and their ability to target more profitable and sustainable revenue growth Thats, what we asked for we always ask them to run IP.
It's our family business sign us up to two business that you'd want to do if this was your family business not not just a public company.
And of course with the with IP in amongst that profitable sustainable regular recurring revenue. There is also some upfront components to IP that can have more variability.
Naturally we are.
We're cautious on that going forward.
We'll have to look at the macroeconomic environment on the impact of that for next year, but we see a lot of upfront revenue this year in our in our numbers.
I think upfront revenue for 2022 is on track to be almost 50% growth year over year.
That sets up some pretty tough comps for next year. So we'll look at that carefully and almost that's coming on the hardware side, but when I look at all of the business all the businesses across cadence. They are all on track to go by.
Low teens or more growth this year.
Like I said very very pleased with the predictability of VIP business, particularly because they focused on profitable and sustainable revenue growth for us.
Okay.
Thank you both.
Thanks.
Your next question comes from Vivek Arya from Bank of America.
Yeah.
Thanks for taking my question I wanted to ask the China question in a different way.
How much of your 17% of sales to China were to customers that were involved and would eventually be involved in sub 14 nanometer logic design leading edge.
And our DRAM I guess, it's just not intuitive that leading edge design is not possible without you towards China, just got restricted from doing leading edge. Yet you are not seeing the restriction in any way, it's just not intuitive to me at all.
Hi, Vivek I mean, we've taken the necessary steps to be in full compliance with the new export regulations.
Our guidance includes the full impact.
But we haven't broken out how much of our China revenue is sub 14 nanometer.
But we do believe that the impact to the company is limited and manageable.
But is that in near term.
John in that is it because you are.
More involved in analog is it because you are in towards tier contracts or is it because you think that there is other revenue sources outside of China that can help you kind of offset that.
Great.
But we also feel it's limited and manageable going forward.
<unk>.
Again, I mean, we are.
We're applying these rules.
These new U S export restrictions, we've applied them that we've included the impact in our guides, we believe it's limited.
And I would say like I say manageable from an R&D perspective.
We have to look at some resources and maybe redeploy some of those resources.
Okay and for my follow up.
Im curious what happens if semiconductor sales go down 10% to 15% next year, what happens to the budget for EDA, but even if you don't decline is it possible that the growth rate.
Slows down from the mid teens or I guess asked in a different way under what scenario what cadence of growth rates slow down next year.
Okay.
Yes, Hi. This is <unk> first of all I think <unk> already I just wanted to remind you that.
We believe our business is more resilient.
And but of course, we are not immune to.
Macroeconomic situation right. So it will depend on.
At a high level it will depend on.
And if there's a recession how severe the recession is the mild recession or is it like a very very severe recession.
So it's a very very severe as the recession then of course nobody is immune to it.
But in general from our kind of business I think there are three factors that makes it more resilient so.
One as you know we are.
Essential part of the.
Design process.
So we are not tied directly to <unk>.
Volume of shipment modes to design activity and then design activities there both in the semi companies and of course the system companies.
And we're also expanding our portfolio into the system. So I think first part is we are more essential.
And tied to R&D second part as you know we are very ratable most of our revenues.
And third part is we are very diversified.
In multiple geographies and verticals, so that gives us more resiliency than other companies in this environment, but of course like I said, we're not immune to it, especially if there is a very severe.
And a correction and so we are carefully monitoring that and I think when we talk to you next time in January we will have more information on the macro situation and can provide more color for next year.
The macro will really impact upfront more I mean, we are very resilient robust stream of recurring revenue.
I think thats, what Jay was getting at is there any question about the predictability of VIP business I feel very confident in the IP business, because we've been focused on profitable and sustainable revenue growth there, but we've had a really strong hardware revenue year. This year.
And I don't know myself, if there is if there's a severe downturn.
Downturn and macroeconomic conditions.
It's in one of the first things that you look at in terms of do you need to purchase hardware and capital equipment and things like that and that could impact us on the upfront side.
Thank you.
Your next question comes from Harlan sur with JP Morgan.
Hi, good afternoon, Thanks for taking my question.
A follow up to the last question. So you know your functional verification portfolio, which includes hardware emulation and prototyping right. That's up 25% for the first nine months of this year.
Very strong growth, but if I think about a weaker semi industry next year and think about where the risks could be you talked about some of the upfront portion of your revenues and I think about hardware emulation and prototyping platforms, but then on the flip side, we continue to hear that design verification and early software development.
<unk> very significant bottlenecks in these next generation digital associate chip design, so actually very critical to your customers. Overall design process do you guys agree with that and given your pipeline visibility backlog do you see your hardware emulation and prototyping pipeline at least as Youre looking at it now remaining wells.
These strong into next year.
That's up from a backlog perspective.
We probably have six months of hardware revenue in backlog.
But any kind of <unk>.
Increased issues on the macroeconomic front will will probably slow down hardware purchasing going forwards.
We'll need another few months to assess what the climates like there, but hardware is really a pipeline business you get about three or six months kind of visibility into what that pipeline looks like.
So again I think on the hardware side, it's been it's been a phenomenal year.
Functional verification group has had a tremendous year this year.
We'll be lapping some tough comps next year.
But we need to we need a few more months to assess.
Before we can guide anything to next year.
But in general <unk> is correct I mean hardware almost become indispensable to the design of.
Chimps and electronic systems, so without these emulation and prototyping platforms is almost impossible to design that and as the chips get bigger.
If you go to newer nodes the chips.
In terms of they get bigger in terms of.
Number of gates site. So the next not always has more gains than the previous node, even if the chip side or the same as you know so as the chip number of gates get larger it requires more and more verification and emulation. So overall I think there is a systemic.
Kind of support.
How much emulation and verification needs to be done.
So it just depends on how.
That overall.
Baseline growth required gets affected by any large macroeconomic ships, but in general. These hardware platforms are almost indispensable now as you do design in almost all our big customers.
Relying on them.
From a business perspective, and we're building out our cloud infrastructure to be able to provide that hardware in the cloud that changes.
Spend for emulation capacity from being capital spend to expand spending from a revenue standpoint, though.
Emulation capacity Thats used in the cloud we would have to recognize that revenue ratably, but we do have a business solution. If there is cutbacks on capex spending.
Well. Thank you I appreciate that and maybe just a longer term question, because we're having more and more about this but on.
And the move to 800 gig and higher optical stays in the data center. This is driving a pretty strong focus on large integrated silicon photonics based solutions either optical module based on co package electrical optical.
Intel Marvell Broadcom and video Cisco all of some of your big customers are all working on FIFO solutions. I know you guys have a pretty strong portfolio here you got.
But she also photonics I think he's got some of your advanced packaging and module design solutions thermal and power modeling.
Since then as well and you guys also have pretty strong partnerships with some of the manufacturing guys. How do you guys see this market opportunity unfolding for the team over the next few years.
Yes, that's a great point I mean photonics is vague and then you also touched on package level integration.
These things again play to the we are in a good position there based on the strength of cadence.
Lot of these things are done and virtuoso platform, which is the flagship platform.
And then also Allegro, which is again flagship platform for advanced packaging.
And then over the last four years, we have built all these <unk>.
Analysis tools like clarity and Celsius for electromagnetics, and thermo, which are critical for photonics and CD Ics. So we have a pretty broad solution and.
And thats. The other exciting part is there are multiple vectors of growth that are possible with cadence and this is definitely a very exciting area. As you know so well. So we are we are working with all the big.
Cause of our position and virtuoso and Allegro and the new analysis tools.
We are working in this very important market.
Great. Thank you.
Hum.
Your next question comes from Gal Munda with Wolfe Research.
Hi, Thank you for taking my questions.
Maybe the first one John for you when I think about the guide heading into Q4.
Especially around.
The opex whats implied to get to that level of profitability.
Is there anything accelerate that anything that we need to kind of factor in terms of the hiring.
On cost side or do you think.
Yeah.
I think.
Incremental margin that's implied is kind of low thirties to get you to that number.
Is it more conservative how would you kind of assess that part of the guide.
Yeah sure good question, Gail, but on the operating expense side of course. It includes a full quarter now of expense for openness scientific and future facilities plus incremental heart.
Hiring that we did during Q3 and intend to do again in Q4 could you get the full bow wave effect of any hiring in Q3, you have a full quarter of that expense in Q4.
Also on the bookings front.
But we've had seen substantial increase in bookings compared to our forecast. This year. That's our sales have been very very good and so there'll be increased commission costs embedded into that.
Q4 guide as well.
Okay. That's helpful as a follow up.
Yes.
Obviously hardware has done really well this year, but if you think about back when you introduced at Q4. The guide for the year and then this is the third race in a row.
What.
Look back nine months.
Thing that surprised you most.
Was it the hardware itself how strong it's been this year.
Or has it been anything out that's allowed you to keep raising the guide on the top line throughout the year.
Okay.
Very very pleased with the performance of all of the businesses like you say every single one of our businesses are performing exceptionally well.
Performing businesses.
Showing teen growth.
Year over year.
Absolutely tremendous now what I wasn't expecting with upfront revenue to grow by almost 50% over 2021, I don't think any of us would ever predicted that.
But youre seeing a lot of that upfront revenue coming through from from hardware.
It's the popularity of our emulation systems.
It's just been off the charts.
Long may it continue but it's.
It was very hard to determine how long that will continue for we do have substantial backlog.
Already in a long lead time, and we're making those systems as fast as we possibly can I think if you look at the inventory.
Less than $10 million of finished goods there.
The vast majority of that is already out on demonstration with customers, but so there's a there's a triage situation that goes on every system that comes off the production line.
There is a plan for getting that out to a customer as quickly as possible.
That's very helpful. Thank you so much.
Okay.
Your next question comes from Jonny Conti from Deutsche Bank Securities.
Hi, everyone and thank you.
And congratulations on delivering another great quarter.
Now given the strong performance that you've had and some of the kind of assets.
<unk> I'm, sorry, but could you perhaps give some color on how your customers are reacting to budgetary decisions regarding spend in this category given the current economic climate are you seeing customers sticking a similar to that with EBITDA consumption.
Or is this bucket of software spend more volatile attachment.
And I would imagine companies, particularly for this bucket of more defensive JP speaking.
I'll ask a follow up offline. Thank you.
Yeah, Hi, this is Donald.
Good question.
The real like like I mentioned, we are pleased with the adoption of these AI based solution.
Because I think it can grow.
<unk> more automation than what <unk>.
Tools have done in the past and to some extent there also deflationary.
Have opportunity I think for the entire industry.
To move more of the world.
From people to.
Two automation for people to tools and this is possible because we have a jedi and then.
<unk> lot of the lower level that which were very mundane can be automated and the designer can focus on more value added higher higher test and that's a team of our AI.
AI based solution as they move the mundane were exited.
The designer focus on higher value will help in terms of.
You need the same resources can you do tend to do more work.
And that team is very popular and made all the Ceos over the last three to six months and Thats, even popular in a tough environment because there is need for more automation and it's even more. So this is actually very timely the launch of AI based solutions launches city, Bruce because the productivity of the organization goes up.
And also productivity of that talent, because a lot of companies.
Big issues, they have large teams, which are deployed across multiple countries our location.
And the question always is are you getting enough value from from all the locations and.
Something like Zebra is our AI based solution naturally uplifts that talent of your whole organization. Because these algorithms are the same whether they run in one part of the world or the other.
So I think these AI based solution. This is very timely and appropriate in this kind of stuff.
Tough environment.
And I think we have a very good platform with Jedi and then we have three major.
Solutions on top of it and we will do more I mean, you will see more from US next year in this area. So we are very pleased with the progress and I think it's very timely to the situation. We are in the macro situations.
Thanks.
Just could you shed some color on whether there's been any changes to the backlog great pipeline conversion.
<unk> itself cycles, given what's happening in software.
Are your expectations unchanged to that reported in Q2, but it's true for half of the backlog is expected to slow in.
In the next 12 months, maybe any commentary here on sort of the economic impacts for next it will be fantastic I'm just trying to understand if there's any material changes to your backlog and pipeline conversion in how you were looking at it.
That two three months ago.
Yeah, I think that would be.
Great. Thanks.
Okay Fairpoint Johnny that.
When I look at the current <unk>.
Despite the fact that it's slightly down from Q2 to Q3, but slightly down including the impact of the latest U S. Exports restrictions put also including the fact that we shipped more hardware into China in Q3.
I feel very very confident in the current <unk> in the IPO and I'm very very pleased with the growth that we've seen there but typically.
You've just started covering us, but typically what we tend to see is about 55% of what we have in.
In backlog turns up in revenue in the next 12 months, but.
And generally Q4 is the goods kind of add on quarter for us for growing that current or appeal, but.
I feel very piece in terms of where we are annual values about $2 7 billion now off of a backlog total backlog of $5 five annual value to 75 five represents time.
$2 seven as the annual value there.
And I would anticipate that that should grow through to the end of the year and set us up well for next year for our recurring revenue that the upfront revenue is a lot more difficult to.
To predict because it tends to be more lumpy.
Right that's right yeah, it's interesting to see how much you guys.
Yes.
Yes.
I'll jump back in the queue.
Thanks.
Your next question comes from Joe the week from Baird and company.
Great.
I wanted to go back to that topic, and specifically asked about the record award.
If I look at your diet.
<unk> access arrangements it looks like that value went from $171 million $434 million.
Is that primarily reflecting this award and then is there anything unusual or is this a normal term life, so kind of reading between the lines.
Thanks, Scott Bob.
Kind of quite visible in backlog.
Should see that kind of hitting revenue next year.
Yes, Joe.
That record contract and IP is.
Included in our noncancelable commitments in our number in our backlog.
We're delighted with the with the performance of the IP team and how well they're doing whats interesting what I always find this kind of not intuitive when you. When you look at cadences results is that sometimes in the biggest bookings quarters, you may not have a great increase in.
And your current appeal for that particular business our find win.
When you have big renewals coming around we tend to play defense on on the renewal and then leave room for add on opportunities later, but.
<unk>.
So often you can have a big bookings quarter may not generate a huge amount of growth in current OPO and then in contrast, you might have lower bookings quarters, where theres a lot of add on opportunities get booked in those quarters and that can increase your current or pure and drive growth for the company.
But in this particular case, it's a record contract so.
Youre trying.
Trying to pay more defense on something like that so you haven't seen a huge uptick in and current appeal for IP this quarter, but I think that will come later.
Okay. Okay that is helpful and then.
Yes, I appreciate youre not guiding to next year, but there has been some conversation just around how good upfront deliveries.
This year I mean, obviously that creates a tough comp I wanted to take the other component and just focus on recurring revenue and John I think in the past.
Kind of framed recurring revenue and a three year CAGR basis.
Last quarter. The number was I think 12% to 13% and then you mentioned, how you thought that rate of growth was sustainable going forward yes.
Or later, some things have changed but given the visibility you have in hand today any difference that you had comments on kind of 12 13 or some other Reits on a kind of a three year CAGR basis as it pertains to recurring revenue.
Great question, Joe I think I would characterize.
My opinion on our recurring revenue I'm more confident now.
Post the now that we know what the U S export restrictions or I think I'm more confident in our recurring revenue going forward now than I was this time last quarter I think the challenge on from the macro.
Macroeconomic standpoint is.
How the what the macro climate does to our Upfronts business for next year I mean, that's the toughest one to predict that's why we need we need an extra few months just to figure out what that means for next year.
Okay, great. Thank you very much.
Your next question comes from Blair Abernathy from Rosenblatt Securities.
Hi, nice quarter, guys and thanks for sliding me in the questions here.
Just wanted to talk a little bit about the cadence on cloud.
Particular.
The Palladium cloud can you just walk us through sort of how you're looking at this cloud based emulation.
How as a customer coming to you.
Having to make a make a decision between on Prem hardware solutions.
Palladium cloud, just just walk us through that a little bit and maybe.
How are you thinking about or how you're approaching pricing.
Yeah, Hi, Blair. This scenario. Thanks for asking this question that's a very important point so in general.
We really like these cloud offerings.
Especially for hardware.
Even if you think about in the regular cloud right with the <unk>.
<unk> cloud by the Big cloud vendors.
What theyre doing is theyre amortizing hardware.
Across multiple customers and moving from a more from a capex to Opex model. So the cloud model has been successful in hardware first right and then you build all kinds of software solutions on top.
This is the same hope for a palladium business.
We would we would want more and more customers to go to a cloud offering.
That also makes the hardware business more and more ratable and also gives a lot of flexibility to our customers because.
One of the issues that palladium and rhodium being even more.
Popular than they are now is that sometimes the smaller companies are not able to deploy as much as the some of the big companies because theres the upfront cost to get like a full palladium rack, whereas if you have them on the cloud. It gives access to a lot of small companies also to use hardware emulation as theyre doing more and more complicated designs.
And then the second reason of course, it makes it more and more ratable. So we prefer.
We encourage all of our customers.
To move to the cloud and we have build infrastructure.
In data centers together with some big datacenter partners to have this capacity in the cloud. So now it depends on customer choice right now if the customer wants to buy more for in house use then of course, we support that.
But I think I feel customers are becoming more and more flexible in terms of.
Whether they want to deploy on prem or on the cloud I mean, the hardware that they buy from us.
And like what John was saying earlier and this kind of tough environment.
Wanted to reduce capex and use more opex than palladium cloud does that opportunity okay.
I mean this is something we have been building for several years and we'll see how it goes but in general we want to encourage our customers to move to the hardware cloud on.
On the on cloud, which is on the software piece I think like we talked about in the last earnings call.
That's also great for startups and also far system companies.
That won't have big IP Department.
Department and and data centers, so we really feel that on cloud.
We started first with system products from cadence is suitable for because system.
That could be like 50000, 70000 customers in that space.
And then some of them are our big of course and have their own data centers, but a lot of them are not as big and they prefer this kind of cloud and it also helps us go to.
To the long tail and a much more.
Smarter way and we want to innovate not just on the product side, but go to market side, so, especially innovating on the system side the long tail on cloud is great.
And palladium and protium cloud or even good for the EDA big customers because it gives us more add the ability and flexibility in choices on how they buy hardware. So overall I think these are two very strategic areas for us and we want to encourage all our.
Our customers to use more and more of these cloud offerings.
That's great. Thanks for the Colorado River.
Okay. Thank.
Thank you.
Our final question comes from Ruben Roy from Stifel Nicholas.
Hi, Thanks.
Yes.
About every question there was.
But I wanted to maybe drill into the new customers on the digital design flow or can you, maybe just talk a little bit about what type of customers youre, saying its a competitive displacement of traditional semiconductor companies or non traditional a combination of both and then I guess attached to that are you seeing a higher attach rate.
And either semiconductor company store systems companies for for hardware. These days as you as you sign up these new deals on digital design.
Yeah, Hi, Robyn great points.
In general in terms of the digital business I think it's both new customers and existing customers.
And taking share.
In general I think what's great about <unk>.
Like I mentioned earlier it does more automation.
Of mundane task is almost like adding automatic driving versus manual driving right. You don't have to control all the knobs and all the <unk>. The tool does it for you, but it also unifies the platform we've been talking about unified synthesis placement and sign off from I don't know 2014 O 2000 <unk>.
<unk>.
I think sorry risk naturally unifies the whole platform because it can work across the whole.
Synthesis place and route and sign off.
Like I mentioned in my comments, there is a pull through or sentences in Sino along with placement route through Citigroup.
And we are seeing that so we're pleased with the progress we are making in synthesis and sign off along with.
Places out implementation.
And then.
It does help.
In terms of.
Full floor. So this drives like.
Full flow wins right not displacing load. So I think in 2022, we have more than 40, new full full wins, so that's helping our digital business and you see this quarter we had.
Good growth in digital just like we had last quarter.
Now on the hardware side, I mean that the attach rate is there and the large kind of semi companies, but also theres a lot of hardware being used as system companies design semiconductors.
By nature as you know system companies have more software right. That's why there are system company. So when you are have software you're naturally need these hardware platform for four software bring up so I think we are very pleased to see.
The growth of hardware not assistant the traditional large semi but also in the large system companies.
And then we try to do these new offerings like I talked about cloud to help lower barrier to entry for smaller companies that have their system or semi for hardware.
Overall I think we are pleased with the progress of both digital and hardware and we just carefully monitor it going forward.
Thanks for all that detail on or it I'll leave it there for now thanks.
I will now turn it back to Andy.
David <unk> for closing remarks.
Thank you everyone for joining us this afternoon.
We are excited about our business momentum and the tremendous market opportunities ahead of us.
We are proud of the innovative and inclusive culture, we have built that cadence.
And we are grateful for the recognitions, we have received over the years.
Including most recently being named as one of the world's best workplaces for seven time by Fortune and great place to work.
We're also honored to be included in the investor's business daily.
100, best ESG companies.
For 2022.
Fourth year in a row that we have achieved this recognition.
On behalf of our employees and our board of directors, we thank our customers.
Customers partners and investors.
For your continued trust and confidence in cadence.
We look forward to speaking with you again on our Q4 2022 earnings call.
Thank you and have a great evening.
Thank you for participating in today's cadence third quarter 2022 earnings Conference call. This concludes today's call you may now disconnect.
[music].