Cadence Design Systems Q3 2021 Earnings Call Transcript

There are 15 speakers on the call.

Operator

Good afternoon. My name is Jaimarya, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence Third Quarter 2021 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.

Operator

Thank you. I will now turn the call over to Alan Lindstrom, Senior Group Director of Investor Relations for Cadence. Please go ahead.

Speaker 1

Thank you, Jaimai Ria. I would like to welcome everyone to our Q3 2021 earnings conference call. I'm joined today by Lip Bu Tan, Chief Executive Officer Anurag Devgan, President and John Wall, Senior Vice President and Chief Financial Officer. The webcast of this call is available through our website, cadence.com, and will be archived through December 17, 2021. A copy of today's prepared remarks will also be available on our website at the conclusion of the call today.

Speaker 1

Please note that the discussion today will contain forward looking statements. Forward looking statements include, but are not limited to statements about our business outlook, product development, business strategy and plans, Industry and regulatory trends, market size opportunities and positioning due to known and unknown risks and actual uncertainties, Results may differ materially from those projected or implied in today's discussion. For information on factors that could cause a difference in our results, Please refer to our filings with the Securities and Exchange Commission. These include Cadence's most recent reports on Form 10 ks and Form 10 Q and the cautionary comments regarding forward looking statements in today's earnings press release. You should not rely on Forward looking statements as predictions of future events.

Speaker 1

All such statements are based on estimates and information available to us at this time And Cadence disclaims any obligation to update any forward looking statements except as required by law. In addition to financial results prepared in accordance with Generally Accepted Accounting Principles or GAAP, we will also present certain non financial or non GAAP financial measures today. Cadence Management believes that in addition to using GAAP results in evaluating our business, It can also be useful to review results using certain non GAAP financial measures. These non GAAP financial measures These non GAAP financial measures are not based on any standardized methodology prescribed by GAAP and may not be comparable to similarly titled Measures from Other Companies. Investors and potential investors are encouraged to review the reconciliation of non GAAP financial measures with their most direct comparable GAAP financial results in today's earnings press release.

Speaker 1

Copies of today's earnings press release dated October 25, 2021, for the quarter ended October 2, 2021, related financial tables And the CFO commentary are also available on our website. For the Q and A session today, we would ask that you observe a limit of one question and one follow-up. You may re queue if you would like to ask additional questions and time permits. Now I'll turn the call over to Lip Bu.

Speaker 2

Good afternoon, everyone, and thank you for joining us today. Cadence delivered strong financial results

Speaker 3

For the

Speaker 2

Q3, driven by accelerating customer demand for our innovative solutions and continued strong execution by the team. Driven by the broad based strength of our business, We are raising our financial outlook for the 3rd time this year and are expecting about 11% revenue growth and 37% non GAAP operating margin for 2021. John will provide the details in a moment for both our Q3 results and the updated outlook for the year. The data driven era is being fueled by generation trends by 5 gs, hyperscale computing, Autonomous driving and industrial IoT that are accelerating the digital transformation of several industries. This requires continued innovation in key areas such as compute, connectivity, Storage and data analysis, which is in turn driving circular semiconductor growth and design activity across by range of end markets.

Speaker 2

Before I ask Anurudu to go through the business and product highlights for the quarter, I would like to remind you that I will be transitioning With the role of Executive Chairman on December 15 with Anna Rud becoming our President and CEO at that time. It has truly been an honor leading Cadence for the past 13 years. I'm very proud of the team's accomplishments and grateful for the confidence and trust that our customers And shareholders have placed in us. Cadence is extremely well positioned and as I And the turn over to Anurud. I can think of no other better We lead the company through next phase of growth and are eagerly looking forward to him taking Cadence to new heights.

Speaker 2

While I will remain engaged with shareholders, this will be my last earnings call. Thank you very much for your continued support. And I will now turn the call over to Anurush.

Speaker 4

Thank you, Libbu. Our intelligent system design strategy leverages our strong computational software expertise As we expand beyond EDA into new markets and we are uniquely positioned to capture the exciting opportunity

Speaker 3

that Lip Bu talked about.

Speaker 4

As we execute to our strategy, we are especially pleased to see Our EDA, IP and System Solutions be increasingly adopted by growing number of system companies. For instance, Tesla utilized a broad set of Cadence EDA software solutions and hardware platforms to enable the successful delivery of their innovative Dojo system. Delighting customers and accelerating growth requires a relentless commitment to innovation. This quarter, we launched The Integrity 3DIC platform, Tensilica AI platform, Midas Safety platform and the Helium virtual and hybrid studio. We have now introduced 13 Significant innovative products this year across all of our business groups and these will be key drivers of our future growth.

Speaker 4

Let me share some of the business highlights starting with digital and sign on, which had another strong quarter With 18% year over year revenue growth, our digital full flow delivering industry's leading quality of Results at the most advanced nodes continue to proliferate with market shaping customers And was adopted by 13 new customers. We are very pleased with the growing momentum of our transformative Cadence Cerebras solution that incorporates unique reinforcement learning, AIML technology To deliver significant PPA, power performance in area and productivity gains. In addition to Samsung and Renasant's endorsement at the time of launch, several market shaping customers have added Cadence Cerebras To their production flows and are realizing great benefits. As an example, The global mobile semiconductor company use Cadence Cerebras on their manually tuned CPU design To reduce total power by almost 10% and improve timing by over 25% Automatically in only 8 days. Additionally, Cadence Eribus enabled a marquee mobile system company To reduce the power consumption of the 4 nanometer design by over 25% and get over 10x improvement in productivity.

Speaker 4

We continued growing our business with hyperscaler customers, including a broad expansion of our EDS software with a marquee hyperscaler that included a significant commitment to our digital products. Next, I will talk about our verification business, which had a Strong quarter with 13% year over year revenue growth. Growing system design complexity And need to get first time right silicon continues to drive strong demand for our verification suite, which provides a comprehensive solution across IP, SoC and system verification, hardware software regression and early software development. This momentum is especially noticeable in our hardware business, where customers are deploying a significant additional capacity as they reap the performance, quality and productivity benefits of our industry leading hardware platform. Accelerating adoption of our new dynamic duo, The Palladium Z2 and Proteum X2 led by hyperscaler and global marquee customers Drove the majority of hardware orders in this quarter.

Speaker 4

In verification software, Accellium ML, our machine learning optimized logic simulator, delivered up to 5x faster regression was adopted by marquee customers in North America and Asia. We launched the Helium Virtual and Hybrid Studio, A new platform that accelerates the creation of hybrid and virtual prototypes of complex systems, Enabling early software bring up. Helium was endorsed by NVIDIA and several other engagements with leading customers are underway. We also announced the Midas Safety platform, which is part of the comprehensive Cadence Safety solution featuring integrated digital and analog safety flows and engines for faster certification of safety critical automotive design. Moving on to system design and analysis.

Speaker 4

I'm particularly pleased that this segment, which is driving our market expansion beyond EDA, Continues to deliver strong double digit growth, increasing revenue by 17% year over year As we grow our footprint in several verticals, including aerospace and defense and 5 gs communication. With 5 gs and AIML applications pushing silicon vertical limits and transistor scaling slowing down, There is an accelerated move to disaggregate SoC into a heterogeneous set of discrete dies that can be integrated together with sophisticated packaging technology. Leveraging over 2 decades of pioneering packaging expertise, We are very excited to have launched Integrity 3DIC, the industry's first And only comprehensive platform that ties together our best in class system planning, implementation And thermal timing and power analysis technology along with a multi technology database all in a unified cockpit. This 3rd generation 3 d IC solution enables Designer to achieve system driven PPA With reduced design complexity and faster time to market. And we are engaged with several leading semi and system houses, Foundries and Packaging Companies.

Speaker 4

Our organically developed system analysis products continued to make good headway. With clarity, our electromagnetic 3 d simulator displacing the incumbent solution and becoming plan of record at a marquee hyperscaler. And Celsius, our electrothermal 3 d simulator was deployed at a global Marquee system customer. Our recently acquired CFD solutions Also delivered strong results, winning new business with several automotive and aerospace and defense customers. And now before I turn it over to John, I want to say a few words about the upcoming CEO transition on December 15.

Speaker 4

On behalf of the Cael's Board and our employees, I want to thank Lip Bu for his outstanding leadership and his numerous illustrious accomplishments over the past 13 years that have made a lasting impact on our industry and on our cadence. With his laser focus on creating a highly innovative and results based culture, he drove a cultural transformation at Cadence that was rooted in customer and shareholder success, leading to trusted partnership with leading customers and delivering shareholder return of over 3,500%. I'm especially grateful to Libbu for his mentorship and guidance and look forward to continuing our partnership As along with our talented team, we relentlessly drive to deliver strong business results and delight our customer and shareholders. Now I will turn it over to John to go through the Q3 results and present our Q4 and updated 2021 outlook.

Speaker 5

Thank you, Anurud, and thank you, Lip Bu. They say values are like fingerprints, nobody's are the same, but you leave them all over everything you do. Your impact on Cadence has been significant and will last for many, many years It's been a truly remarkable run over the past 13 years and I feel blessed to have had the chance to work so closely with you. I've also heard it said that legacy is not something you do for yourself, but it's something you leave for the benefit of the next generation. And on behalf of all Cadence Stakeholders, I'd like to thank you both for conducting such a smooth CEO transition.

Speaker 5

We haven't missed a beat. Focused execution by the entire Cadence team combined with broad based strength across our product portfolio and customer base drove another strong quarter We exceeded our expectations for all key financial metrics and we are raising our financial outlook for the year. Now let's go through the key results for the Q3, beginning with the P and L. Total revenue was $751,000,000 Non GAAP operating margin was 35.7 percent. GAAP EPS was $0.63 and non GAAP EPS was 0.80 dollars For the balance sheet and cash flow, cash totaled $1,014,000,000 at quarter end, while the principal value of debt outstanding was $350,000,000 Operating cash flow was $296,000,000 DSOs were 40 days and we repurchased $110,000,000 of Cadence shares during the quarter.

Speaker 5

Next, let's turn to our updated outlook. Our outlook continues to assume that there will be no changes to the export limitations that exist today. For fiscal 2021, we now expect revenue in the range of $2,960,000,000 to 2.98 $1,000,000,000 non GAAP operating margin of approximately 37%, GAAP EPS in the range of $2.36 to 2.40 Non GAAP EPS in the range of $3.24 to 3.28 and operating cash flow in the range of $975,000,000 to $1,025,000,000 For the Q4, we expect revenue in the range of $745,000,000 to $765,000,000 Non GAAP operating margin of approximately 35 percent. GAAP EPS in the range of $0.49 to $0.53 Non GAAP EPS in the range of $0.76 to 0 point We expect to repurchase $110,000,000 of Cadence stock in Q4. Our CFO commentary, which is available on our website, In closing, I am pleased that revenue growth continues to accelerate with our 3 year revenue CAGR now approximately 11.5% at the midpoint of guidance.

Speaker 5

We are expecting approximately $1,000,000,000 of operating cash flow for 2021 at the midpoint and we are on track to deliver over 50% incremental operating margin As always, I want to thank our customers, partners and of course our employees for their continued support. And with that operator, we'll now take questions.

Operator

Your first question will come from the line of Joe Vruwink with Baird. Please proceed with your question.

Speaker 6

Great. Hi, everyone. And let me just start by extending my best to Lip Bu. Maybe I'll begin with the next generation hardware with simulation and prototyping. I'm wondering Was component availability at all a factor in either meeting demand in the quarter or does component availability Factor in at all to the forward outlook, either in a good way catching up on maybe things that slipped this quarter or considering maybe Yes, some demand getting extended into next year.

Speaker 5

Hi, Joe. This is John. Thanks for the question. Yes, we're delighted with the demand for our hardware verification systems And we're building the systems as quick as we can to meet that demand. Yes, we're very, very pleased with the customer reaction.

Speaker 5

I'd like to say building the systems as quickly as we can. I would say it's fair to say that demand is outstripping supply right now, but we're building as fast as we can. You can see it in the inventory, the inventory is slightly up.

Speaker 6

Okay. That's helpful. And then maybe more of a product Sure, strategy question. When thinking about 3 d ICs and the co design that needs to happen between package and chips being Zack, is it as simple when you think about the opportunity for Cadence, as simple as customers adopting the new Integrity platform? Or is it maybe broader than that and this trend across the industry actually happens to impact and benefit Multiple areas of the Cadence product portfolio?

Speaker 4

Yes, that's a great question. Let me take that, Suneel. We believe that 3 d IC is the future, right? So the road to the future goes through 3 d IC for Multiple reasons, which you know, I mean, putting multiple chips on a package, ability to mix technology, ability to do bigger and bigger systems. And I do believe that Cadence is uniquely positioned for that and it affects multiple technologies.

Speaker 4

Now some of it is because of our history. So we have had a leading platform in packaging for a while with Allegro And a leading platform in analog with Virtuoso for a while. And then over the last 5 years, we have done Very well in digital. And then if you remember over the last 2, 3 years, we have done a lot of investment in system analysis, Like clarity and Celsius are also critical for 3DIC, given that thermal is a big challenge when you put these things together. So I believe Cadence is uniquely positioned and with integrity we put this all together.

Speaker 4

And it's not just integrity draws into the other parts of Cadence, like I mentioned. And then as a comparison, when as we work with customers and leading foundries to do something similar in other products, It's not even one company can you need 3 or 4 companies to do the same thing, whereas if you come to Cadence, we have a comprehensive solution Across multiple segments. So I think as 3DIC takes more momentum going forward, I believe we are well positioned.

Speaker 6

That's great. Thank you very much.

Operator

Your next question will come from the line of Jason Celino from KeyBanc, please proceed with your question.

Speaker 6

Great. Thanks for taking my question. And Lip Bu, it's been an absolute pleasure. Glad to have you on for one more earnings call. So my question, with the supply chain shortages, we've seen several different automakers like Hyundai and Volkswagen Announced intention to design some of

Speaker 3

their own

Speaker 6

semiconductors, but we know that these design cycles are quite long and It's a multiyear investment. So how do we think about this as maybe an incremental dollar opportunity versus just Market shift from customers taking some of those workloads in house.

Speaker 2

Yes. Jason, first of all, thank you so much for the kind words. In terms of the global supply change, we're monitoring the Semiconductor Global Supply changed very carefully. So far, we don't see any slowdown in our design activity Across our customer base. And then as you know, our product is very much focused on the R and D engineering, designing their chip system.

Speaker 2

And so and this is a multiyear approach. And I mentioned earlier the generations drivers I have been really driving a lot of increase in the design activity. And then answer your question in terms of automotive lifecycle, Yes, absolutely correct. It's a multiple year increment. And then lately because of more and more electronics in the automotive, So we see a lot of design activity like auto numbers driving and I think Anurul mentioned about the Tesla It's about driving the AI chip and using our broad based Cadence tool.

Speaker 2

That's one good example And many more coming. And so I think clearly, we're excited about the automotive platform that will create opportunity in the multi years to come.

Speaker 6

Okay. And then, good thanks for that. That was helpful. And maybe my quick follow-up is, I think the automotive customers have been maybe the more vocal, but are you seeing these type of trends In other industries as well, in terms of

Speaker 7

the with that. Thank you.

Speaker 2

Yes. I think it's a very interesting challenging opportunity time in this whole supply chain. Clearly, And for the automotive industry, it's starting to become a very realize that the whole visibility to the supply chain And become very important for them. And so in different automotive companies, they experience different challenges in the supply chain. And we are here to help them in terms of the design, automation and the whole system level, complexity of design and then time to market.

Speaker 2

And then so we try to be available and be helpful to them as a design partner and then and also support them Throughout this period. So I think you're going to see more and more opportunity in the automotive. It's a big platform for us.

Speaker 6

Great. Thank you.

Operator

Your next question comes from the line of Jackson Ader from JPMorgan. Please proceed with your question.

Speaker 7

Great. Good evening, guys. Thanks for taking my questions. And I'll just quickly echo all the kind words that have already been said about Chiwipu. Yes.

Speaker 7

Congratulations and looking forward to continuing the relationship. So Anurag, you mentioned that In the last few years, digital tools have been driving a lot of growth. And I think you also mentioned that a hyperscaler This past quarter significantly increased their digital footprint. So I'm just curious, what tools Or at least what parts of the digital design flow just from a high level of synthesis, plates and routes, what have you are actually driving The increased uptick maybe in the last 12 months to 18 months in digital.

Speaker 4

Yes. Thanks, Jackson, for the question. So I think as you know, like at lower nodes, we have always believed that the integration of The whole digital full flow is critical. So that synthesis place and route and sign off. So what we are pleased to see, especially in the last, let's say, 12 months is Wider deployment of our digital full flow.

Speaker 4

So we went back like few years ago, the engagement would start with Innovus and That was the leading kind of product that we would do well in. But now I think overall market has accepted our full flow And we see more and more signs of that. So that includes Synthesis and Signoff along with Innovus. And that is becoming more the norm than anything else. So to answer your question, not only Innovus does well, but now since this is in cyanon, which is Janus and Tempus and Voltage, we are pretty happy with the proliferation.

Speaker 4

And I think that's the trend here to stay.

Speaker 7

All right. Awesome. Thank you. And then Quick follow-up. John, can we just get a what is going on with backlog and And the implied bookings, it's really swung around a bunch, this year.

Speaker 7

Just curious if there were any duration impacts or What we should be reading into in terms

Speaker 4

of the implied bookings number this quarter?

Speaker 5

Yes, Jackson, thanks for the question. I wouldn't read too much into it. Again, it's like the Timing of contract renewals, we had a similar phenomenon in Q1. We would expect to end the year with a higher backlog in RPO than we started the year. And that's reflected as well if you have a look at the margin guidance for Q4.

Speaker 5

Margin guidance for Q4 is slightly down on what we achieved in Q3 Because of the impact of some hiring and an expectation for higher sales commission costs in Q4 because we expect a lot of bookings to come through in Q4.

Speaker 7

All right. Awesome. Thank you. No worries.

Operator

Your next question comes from the line of Pradeep Ramani from UBS. Please

Speaker 8

Hi. Thank you for taking my question. I just wanted to get Some more insight on the verification fees. It seems like the verification for September was Flattish to down a little bit versus June, and yet hardware seems to be doing well. So are we to sort of interpret that it's more on the software side that You're seeing maybe a little less growth than what might have been anticipated or are you being constrained on the hardware side?

Speaker 8

And I just want to get a sense about ramp on the hardware side as well.

Speaker 5

Hi, Pradeep. This is John. But we're absolutely delighted with the customer reaction Our new hardware systems that's and we're building and installing inventory as fast as we can to meet their demand. But I mean, I'd remind you that Cadence is part of the design cycle. But so I mean it hasn't really impacted us too much with our customers that and then in relation to your comments on growth, We raised guidance for the year.

Speaker 5

We're very happy with growth. We're seeing accelerating growth. When you look at the 3 year CAGRs and I've called them out on the CFO commentary, it's rounding up to 12% now. It's approximately 11.5%. And that seems to continue to increase year after year.

Speaker 5

And that's reflecting strong demand across all lines of business.

Speaker 8

Okay. And for my follow-up on the digital ITPs, I mean, it has been very strong. Are you seeing increasing competitor displacements? Or is it Market being strong. Can you speak to maybe qualitatively on how you're sort of viewing digital IP going forward as well?

Speaker 4

Well, it continues to do well like you saw. And I think it's a combination of things. I mean the market is definitely growing because of all this design activity as you can see in these multiple domains. So the market is growing and we believe that we are also taking market share. So I would say it's a combination of both these things driving our digital growth.

Speaker 3

Thank you.

Operator

Your next question will come from the line of Jay Shahriar with Griffith Securities. Please proceed with your question.

Speaker 9

Thank you. Good evening. Anurud, both of my questions are for you. But first, On a personal note, Lip Bu, it's been a pleasure working with you for the last 13 years and certainly look forward to continuing the Dialogue with Anurud. So first question, Anurud, at the Cadence Live Europe Conference a week or so ago, Cadence said in one of your presentations that Allegro had recently undergone a major overhaul, which You certainly saw with Allegro X.

Speaker 9

The question is what's next in terms of anything you might be working on for an additional Major overhaul, we do see this periodically in EDA. For example, synopsis a few years ago We ramped up its internal investments in Synthesis and they launched their new version of DC. And I'm wondering Based on what seemed to be your internal investment patterns, if you're undergoing a rejuvenation or reinvesting cycle for your synthesis or what else you might be able to talk about in terms of any major overhauls. Secondly, with regard to the Ingredients you need to succeed with the computational software strategy. There was an interesting announcement 2 weeks ago of a relationship between Synopsys and Dassault.

Speaker 9

And I'm wondering if you see you're having to partner more For both technical and channel expansion reasons to succeed in computational software.

Speaker 4

Yes, Jay, both great questions. I think in terms of new kind of you said new products or revamp of existing products. So we are continuously looking at that all

Speaker 2

the time. We want to

Speaker 4

make sure all our products are doing well. As you can see this year, we have launched 13 new products. Several of them are improvements or existing products like Allegro X or So I think this is a continuous process. As you know, we have a very high investment in R and D compared to our peers. So we are constantly looking at that and you will see more things come out of course as we go forward.

Speaker 4

On the second one, we are confident in our computational software strategy that's delivering good results. I think we have a lot of organic ability to innovate, which We demonstrated with clarity and sales here. And at the same time, we are definitely looking at new partnerships that make sense. Like you said, both on the product size and on the go to market side. So I think we will talk about them When they're ready, but Cadence always has a culture of partnering.

Speaker 4

We partner, for example, with MATLAB. That was a great partnership at the system level. We partnered with National Instruments when we bought AWF from them. We have partnership with Greenhill. So we are always looking for win win partnerships and that continues to be the case going forward.

Speaker 9

Yes. All right. Thanks, Oliver.

Speaker 10

Thank you.

Operator

Your next question will come from the line of Gal Munda from Berenberg. Please proceed with your question.

Speaker 3

Yes. Hi. Thanks for taking my questions. Just this first one in terms of the strong margin outperformance again and then kind of thinking about The rest of the year, maybe John to you. You mentioned that

Speaker 4

a little bit got to

Speaker 3

do with the timing, a little bit got to do with investment. But if we're thinking about Kind of sustainability of the margin performance. How much is it kind of inability or Maybe not being able to hire and invest as much as you'd like right now versus, just the top line really driving

Speaker 5

Yes. Great question, Gal. And We're back on track with hiring. I think our hiring performance has been really good and we're delighted to be recognized on so many of these top 100 Places to work around the world. That's certainly helping us with our hiring activity.

Speaker 5

Yes, on the margin side, it's really outperformance The revenue side on like right across all our lines of business, we thought IP would have a soft middle to the year And it would recover toward the end of the year, started recovering a bit earlier, but they had a strong finish to Q3 and we're expecting good things for them in Q4. On the hardware side, again demand customer reaction has been tremendous and demand is really strong there. And on the software side, all lines of business are performing really, really well. And like you say, if you look over a contract cycle over a 3 year CAGR basis that we're continuing to see accelerated revenue growth. So on the operating leverage side, We're delighted with the operating margin performance.

Speaker 5

2nd half of the year includes some double up on expenses we did in early retirement program. But I think the overall business is pretty much I mean, if you take out the one time things, we're operating pretty much at The guide we've given for the year was about 37%.

Speaker 4

Got you. And then as a follow-up just on the top line again. We mentioned you touched a little bit on

Speaker 3

the supply chain issues in the semis. And when you move kind of through the year, you said It's incrementally affecting the business. On the royalties, now we're talking about the hardware demand being stronger than kind of the ability to supply. Is there a way to kind of quantify that from your perspective in order to kind of understand the magnitude of the impact, this kind of demand Is that, but we're kind of limited by the supply side?

Speaker 5

Yes. It's a very, very small impact to us. Like I said, the majority of our revenue Comes from part of the design cycle. Your chip capacity constraints that you're referring to has really impacted production side of the cycle. And that's where it touches us in terms of royalty revenue.

Speaker 5

I think last year royalty revenue for Cadence was around $50,000,000 That this year will be slightly lower than $50,000,000 but we would expect that to recover again next year. Yes, so the impact is pretty small. And the same then on the hardware side, we're happy with our supply chain and You see inventory growing a little bit. We talked a couple of years ago about moving from just in time to just in case in terms of our inventory management. So We carry a lot of inventory.

Speaker 5

So I think we're well protected, certainly for the next few quarters on the supply chain side. But yes, we're very happy with where we're positioned right now.

Speaker 3

Right. And just to clarify on the royalties, nothing has changed over the last couple of quarters once you've kind of said that the impact is being Slightly down from last year, that's kind of consistent to what you said?

Speaker 5

That's right. That's right. I mean, there's our IP business is a mix of licensing and royalty business. Any capacity constraints from last year could feed into unit production this year and broad fees are slightly down, but It's very, very small in terms of the impact to Cadence on our overall numbers.

Speaker 4

Okay. Thank you so much.

Operator

Your next question will come from the line of Gary Mobley from Wells Fargo Securities. Please proceed with your question.

Speaker 11

Hey, guys. For different reasons, let me extend my congratulations for the next chapter for Anirud and Lip Bu. I wanted to start off by asking about the X2Z2 products and the Step function increase in processing power that these new tools facilitate. And the way I understand it, it allows customers to not only bring up hardware, but Also in parallel bring up software. And so my question is, can you give us a sense of the magnitude of how this increases The potential dollar opportunity with each customer engagement or how it improves your sort of available market with this New software bring up capability.

Speaker 11

Thank you. And a follow-up.

Speaker 4

Yes, Gary, that's a good that's a great question. And You're absolutely right. I mean the reason for doing also Protium X2 with having the same front end as Palladium is to Expand our reach to more and more software bring up. And if you this quarter when we launched helium, That's for the same reason. So not only we can run RTL, but with Helium, we can run hybrid models, higher level models with RTL.

Speaker 4

All this is for software bring up. And historically, I think Cadence has done well in RTL bring up with palladium, but not as well. The market is growing more in the software bring up and now we are doing pretty well with palladium with the combination of palladium and protium and helium for software So I think in terms of the market, of course, difficult to quantify. But at the high level, I think the market The opportunity is maybe 1.5x to 2x larger once you combine the software and the hardware bring up together. Of course, it takes Several years to fully realize all this, but I think the market opportunity for Cadence with protium, palladium and helium is much expanded Because of the software being developed.

Speaker 11

I appreciate that Anurud. And perhaps this is for John, but I want to ask about Navigating the China export restrictions and maybe if you can give us a sense of whether it's any more difficult or any easier to obtain Licenses to serve service those customers based in China and then maybe give us a sense of what the various puts and takes are there for China revenue growth or lack thereof as we sit here in the second half of fiscal year 'twenty one?

Speaker 5

Yes, Gary, yes, good question. Yes, when I look at China revenue, I think it's probably easier to look at China over a 2 year period because last year With the pandemic impact in the 53rd week impacting Q4, I think if you look at where we're on track for 2021, it's probably 30% CAGR in In terms of growth in China since 2019, we're working our way through all the export controls and everything that we and all the compliance Required and we have and we will continue to comply with all export control regulations. But the situation is fluid and we have to continuously Monstress that our outlook assumes everything that exists today remains in place today. We haven't predicted any changes that of course if there are changes we would have to take another look at our outlook. But essentially for the sake of guidance, we just assume that all export limitations that exist today certain customers who remain in place for the remainder of the year.

Speaker 5

And then for 2022, we'll update you all in 2022 when we give you our year end results in February.

Speaker 4

Thanks, John.

Speaker 5

Thanks.

Operator

Your next question will come from the line of Tom Diffely from D. A. Davidson. Please proceed with your question.

Speaker 12

Yes. Good afternoon and thanks for taking my question. So a little bit, Bill, I guess I've only been around for the last 12 years, but since then the stock has gone from $6 to 1.67 So, obviously, very impressive, but I look forward to inevitably taking it to 4000 over the next 12, 13 years. So, I guess a question on the supply chain from maybe a little different angle. What are you seeing in terms of capacity at the foundries?

Speaker 12

And just curious if you're taking steps to diversify foundry activity from either geographic or company specific reasons?

Speaker 4

Well, let me yes, that's a good question. I think we like Lip Bu and John mentioned, we are more on the design side. So we are trying to make sure that we can serve all our customers as they continue to do all these designs. And in that process, we work with all the foundries, all the major foundries, of course, in U. S.

Speaker 4

And Asia and Different parts of the world. So we have a pretty healthy relationship with all the major ones and we are encouraged to see more investment in the U. S. So with our overall position, Tom, we are pretty active with all the major foundries and we hope to continue that.

Speaker 12

I was wondering more on just the manufacturing of your chips that you design and build and put in your palladiums and what have you.

Speaker 5

Okay. Got it. Yes.

Speaker 4

So I think the current set of palladium chips, I mean, the palladium has is a big system, so it has a lot of chips that goes into it. Some of them we buy and some of them we make ourselves. So the ones we make ourselves are made by TSMC, which is One of the leading foundries and we continue to work with them and we are designing new systems, the next generation of V2 and all. And we always look at all the foundries, but overall we are very happy with our foundry partners for the Palladium Z2 system.

Speaker 12

Okay, great. And then curious, are you seeing an impact from COVID in any of the kind of Many regions that you participate in around the world from just more of a manpower point of view.

Speaker 4

I think it's fair to say that the impact was more like a few months ago. I mean, you still have impact and We are still mostly, of course, working from home in several parts of the world. And we are slowly opening some offices. But in terms of we had a big impact in India a few months ago. I think that has thankfully Improved.

Speaker 4

And so it's become more of the norm now and we just continue to work through it. So no new things, I think in the last 3 months. Great. Our return to work was delayed a little bit because of Delta. So we hope to take that up early next year.

Speaker 4

But on that, we are working through all the COVID issues. Great.

Speaker 12

Okay. Thank you, Anurag.

Speaker 4

Thank you, John.

Operator

Your next question will come from the line of John Pitzer with Credit Suisse. Please proceed with your question.

Speaker 13

Yes. Good afternoon, guys. Thanks for letting me ask the question. And I'll add my thanks and congratulations to Lip Bu. My first question, John and Andrew, is really on that 3 year CAGR acceleration.

Speaker 13

And John, I know we've got to wait another 90 days Before you give us a full outlook for calendar year 2022, but it's impressive that you guys have seen this acceleration over the last 2 years in the midst That's sort of a global pandemic. And if you look at Street consensus numbers for next year, they've got growth that goes back That high single digits and yet you talked earlier about demand outstripping supply. Just wondering if you think these double digit CAGRs are Sort of here to stay. And if so, to what extent is this sort of the fruits of your labor in some of your SAM expansion efforts versus some of the dynamics of the core business?

Speaker 5

John, that's a great question. But, yes, I think the nature of Our revenue model is such that I wouldn't expect any dramatic changes in our 3 year revenue CAGRs because 85% to 90% of the revenue is recurring in nature. So I mean, when we calculate 3 year CAGR by the end of 2022, we'll be including 2020 2021 in that. So you're not going to You shouldn't really have a dramatic change. And I think if you have a look at the CFO commentary, you'll see the kind of step function that we've seen over the last few years.

Speaker 5

It's been slowly accelerating, but it's pleasing to see that it continues to accelerate and that we're just up over 11.5% now, so running up to 12% this year. So, yes, very pleased with the way the business is going. Again, we will refrain on talking anymore about 2022 until We need another 90 days just to get through Q4 for that. But yes, very, very pleased with the way it's going. And because of the recurring revenue Nature, up so much of our business, I wouldn't expect the 3 year CAGR to change pretty much.

Speaker 13

That's helpful. And then I'd love to get your thoughts. Clearly, the U. S. And Europe have, I guess, rediscovered How strategically important the semiconductor business is and you're seeing sort of this push to regionalization of supply, But it's not just about manufacturing.

Speaker 13

I think that world governments are going to incentivize sort of IP domestically as well. And so I'm kind of curious if you guys have kind of thought through or could help And so I'm kind of curious if you guys have kind of thought through or could help us think through what you think the impact to your business will be from things like the Chips Act and similar legislation that's trying to make its way through the EU right now.

Speaker 4

Yes, that's a great point. And we are eagerly awaiting all the details. But if As you know, in the chipset, there is funding for manufacturing, but there's also funding for R and D. And then as you said, it's not just The hardware or the manufacturing movement, it's also the IP and the software that enables all these things. So I think we are optimistic about all this investment in different parts of the world.

Speaker 4

But I think the details, as you know, still have to be Sort it out. But overall, we have a strong portfolio in multiple geographies. As there is more investment in U. S. And Europe, I think that is systemically positive.

Speaker 5

Yes, John, that's a great indication of All the design activity that's going on, I mean, we're seeing strong secular demand across all these generational drivers. We have a great strategy, great portfolio and solid execution that's and everything you mentioned kind of just indicates more design activity globally and that's good for Cadence.

Speaker 13

Perfect. Thanks guys.

Operator

Your next question will come from the line of Charles Hsieh from Needham and Company. Please proceed with your question.

Speaker 14

Hi, good afternoon. Thank you for taking my question. So I want to go back to your prepared remarks. You mentioned about Integrity 3DIC See being the industry's 1st and only comprehensive platform for 3 d IC, but A few days ago, your competitor put out the press release. They said their product is a complete end to end solution.

Speaker 14

I just wonder how do I reconcile the 2 different comments around these 2 competing products? And in addition, your competitor Synopsys, They announced a strategic collaboration with TSMC, yet folks obviously did not see a similar press release coming from you guys right ahead of TSMC opening the innovation platform forum, which will start tomorrow. So kind of wonder what How you're positioning and what's the progress of Integrity 3 d versus your computing platform? Thank you.

Speaker 4

Yes, thank you. That's a good question. So in terms of integrity, like I said in my remarks, I think we are pretty confident of our position. And a lot of the 3 d IC thing is Not one thing, it's a combination of lot of things. So for example, some 3 d IC systems are more package based, Some of our more package technology based, some of them are more interposer based, which is a more digital technology.

Speaker 4

But all in all, Cadence It is the most unique platform. We have leadership in packaging with Allegro, with analog and virtual, so The digital Innovas and all the analysis tools with Claroty and Celsius and they're all integrated and best of class solutions, Okay. So we are pretty confident of our position and the response we are getting. And to your question with TSMC, TSMC is a great partner of Cadence And we are working with them on variety of things, including Integrity, 3DIC. And actually to give you example, one of the leading Mobile customers did a 3DIC solution with us and TSMC and one of the key things there was the thermal profile And they use Celsius to do silicon validation that Celsius is accurate for 3DIC temperature simulation.

Speaker 4

So I think CDIC is going to be big and it requires multiple products and multiple implementation flows and we are pretty confident in our position.

Speaker 14

Thank you, Anirud. And maybe a second question, not sure if this has been asked before, since I Recently just started following you guys. I want to ask a question about Intel, but the Intel IBM 2.0 strategy, I know you probably don't want to be too customer specific, but that turnaround effort by Intel is too material to ignore in my opinion. Any thoughts on how Cadence can do to support Intel's grand turnaround efforts over the coming years? And if you don't want to comment Cadence specific, maybe give us some color at the industry level.

Speaker 14

Thank you.

Speaker 4

Yes. Thank you for the question. I think Intel, we are glad to do more with Intel. Actually, they have the Intel Foundry announcement and Also some new programs like RAMSI with the government. And I'll just quote what is already public By Randhir, who is Head of Intel Foundry, he said, along with our customers and ecosystem partners, including IBM, Cadence and Opsys And others, we will bolster the domestic semiconductor supply chain.

Speaker 4

So this is official comment from Intel and I think We let them speak for their strategy, but we are glad to do more with

Speaker 3

Intel. Thank you.

Speaker 12

Thank you.

Operator

Our final question will come from the line of Vivek Arya from Bank of America. Please proceed with your question.

Speaker 10

Thanks for taking my question and congrats and best wishes to Lip Bu and Anirudh from my side as well. For my first one, on your Numecca and Point wise acquisition and just kind of the general expansion into system analysis and CFT. Could you give us a sense, How big is it today? How big can it be over the next 1, 2 years? And importantly, when does that Start becoming accretive, right to the 11.5% kind of growth model that you have.

Speaker 3

Yes, we're very pleased with

Speaker 5

the M and A Integration for Nubeqa endpoint wise, they're not hugely significant from a revenue standpoint right now. We would expect them to be accretive next year.

Speaker 10

Got it. And then maybe as a follow-up, I think John you mentioned some higher costs in Q4. Are they one off costs or do they become kind of the baseline as we start thinking about OpEx for next year?

Speaker 5

Yes, great question. I mean, so slightly I expect slightly higher cost in Q4 versus Q3, partly Q2, we did a bit of catch up in hiring in Q3. And of course, anyone we hired in the second half of Q3 will have a full quarter of their expense in Q4, Where you didn't have a full quarter of expense in Q3, so slight uptick for that. And then secondly, I expect a little bit more on Commission costs because we expect bookings to be stronger in Q4 because I would anticipate that we will finish the year with a stronger Or PO than we started the year. So expecting a good bookings quarter in Q4, which will add a little bit of commissions expense.

Speaker 5

And then also we have Slightly higher G and E investment to be forecast.

Speaker 10

That continues into Q1? I know you're not giving Q1 But all else be equal, does that become kind of the baseline for going into Q1?

Speaker 5

Yes. I feel very good about the continuing operating leverage. I don't think there's any near term ceiling on operating leverage. I mean, you'll see that we're up to 37% now, but it's the 5th year in a row that we've delivered more than 50% incremental margins. So every dollar revenue growth from 2017 until now, we're dropping through more than $0.50 of that Revenue growth through to operating income.

Speaker 5

So as long as we're delivering incremental margins of over 50%, that's Your operating leverage will should continue to rise. Got it.

Speaker 4

Thanks very much.

Speaker 7

Thanks.

Operator

And that concludes our question and answer session. I would now like to turn it back over to Lupe Tan for closing remarks.

Speaker 2

Thank you all for joining us this afternoon. It is an exciting time for Cadence with growing market opportunities And strong business momentum. Our intelligent system design strategy is playing out very nicely As we benefit from new opportunities in design excellence, system innovation and pervasive intelligence and an expanded total addressable month. We are proud of the innovative and inclusive culture that we built At Cadence, we are grateful for the recognitions that we received over the years, including most recently being named The Newsweek list of most loved workplaces for mid-twenty 21. And lastly, on behalf of Our employees and our Board of Directors, we thank our customers and partners for their continued trust and confidence during these unprecedented times.

Operator

Thank you for

Earnings Conference Call
Cadence Design Systems Q3 2021
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