Good afternoon. My name is Brianna and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence Fourth Quarter and Fiscal Year 2023 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. Thank you. I will now turn the call over to Richard Gu, Vice President of Investor Relations for Cadence. Please go ahead, sir.

Thank you, operator. I'd like to welcome everyone to our fourth quarter of 2023 earnings conference call. I'm joined today by Anirudh Devgan, President and Chief Executive Officer, and John Wall, Senior Vice President and Chief Financial Officer. The webcast of this call and a copy of today's prepared remarks will be available on our website, cadence.com. Today's discussion will contain forward-looking statements, including our outlook on future business and operating results. Due to risks and uncertainties, actual results may differ materially from those projected or implied in today's discussion. For information on factors that could cause actual results to differ, please refer to our SEC filings, including our most recent Forms 10-K and 10-Q, CFO commentary, and today's earnings release. All forward-looking statements during this call are based on estimates and information available to us as of today, and we disclaim any obligation to update them. In addition, we will present certain non-GAAP measures which should not be considered in isolation from or as a substitute for GAAP results. Reconciliation of GAAP to non-GAAP measures are included in today's earnings release. For the Q&A session today, we would ask that you observe a limit of one question and one follow-up. Now, I'll turn the call over to Anirudh.

Thank you, Richard. Good afternoon, everyone, and thank you for joining us today. I'm pleased to report that Cadence delivered an outstanding Q4, wrapping up a record 2023, achieving 15% revenue growth, 42% non-GAAP operating margin, and over 20% non-GAAP EPS growth for the year. We exited 2023 with a record backlog of $6 billion, as customers increasingly committed to our chip-to-system integrated design and analysis platforms. We expect our innovative solutions to continue driving broad-based business momentum in 2024. John will provide more details in a moment. Secular trends of digital transformation, hyperscale computing, and autonomous driving, all bolstered by an AI super-cycle, continue to fuel strong broad-based design activity. We continue to successfully execute our Intelligent System Design strategy, which triples our TAM opportunity while greatly expanding our portfolio. Our innovative engine delivered several significant products including most recently, the revolutionary Millennium M1 platform, the industry's first accelerated multi-physics supercomputing platform. The platform tightly integrates our Fidelity CFD software with high-performance GPUs and combines AI, HPC, and digital twin technology to deliver an unprecedented 20x energy efficiency and up to 100x design impact. We were honored to have customers including Honda, Boeing, and GE as speakers at our launch event. We substantially grew our footprint with market shaping customers and furthered our relationships with key ecosystem partners. We advanced our partnership with Intel Foundry through a strategic multi-year agreement on providing design software and leading IP at multiple Intel advanced nodes, thereby advancing Intel's IDM 2.0 strategy and accelerating mutual customer success. Cadence is at the forefront of the AI revolution, closely partnering with marquee companies on their trailblazing AI designs for training and inference from cloud to the edge. NVIDIA and Cadence have collaborated closely over several years, and in Q4, we deepened our partnership through a meaningful expansion of our hardware solutions and EDA software. Earlier in the quarter, we announced our work on Cadence.ai with NVIDIA's Nemo Retriever, and now we're thrilled to deepen our partnership and extend it to the new Millennium MultiPhysics Supercomputer and SaaS solution, which is co-optimized with NVIDIA's Accelerated Computing and AI platform. As the exclusive EDA partner of Arm Total Design, Cadence and Arm are closely collaborating to accelerate the development of custom SoCs based on the Neoverse Compute Subsystem. Over the year, we've continued building out our generative Cadence.ai portfolio, the industry's broadest AI offerings spanning chip to board to system, and delivering exceptional optimization and productivity benefits. Earlier in Q2, we introduced Virtuoso Studio and Allegro X AI, bringing AI to custom/analog and PCB designs. In Q4, we added Voltus InsightAI for automatically addressing voltage drop violations. We also pioneered bringing LLM capabilities to chip design, successfully helping Renesas accelerate functional specification to final design. The accelerating momentum of our Cadence.ai portfolio has led to an almost tenfold increase in the number of customers adopting our GenAI solutions in 2023, as customers embrace the technology to develop optimized products much more efficiently. Now, let's talk about some of the product highlights for Q4 and 2023. Rising system complexity and challenges stemming from the growing hyperconvergence of the electrical, mechanical, and physical worlds are driving the need for a seamless platform solution across design, packaging, simulation, and analysis. We made this a core tenet of our Intelligent System Design growth strategy six years ago, and our System Design and Analysis business continued its strong momentum, delivering 18% year-over-year growth in Q4 and 22% growth for the year. PCB and advanced packaging are linchpin technologies that sit at the crucial intersection of mechanical and electrical domains and Cadence's rich heritage in these areas remains a key strategic differentiator, especially in the emerging chiplet era. We continue advancing these technologies with Allegro X AI providing greater than 10x acceleration in PCB design, and endorsed by Schneider Electric and Kioxia at its launch. Our multi-physics analysis portfolio couples our expertise in physics-based modeling with AI-driven optimization and is delivering superior results to customers across multiple vertical segments, especially aerospace and defense and automotive. Recently, we launched Celsius Studio, the industry's first complete AI thermal design and analysis solution for electronic systems, delivering up to a 10x performance benefit over legacy systems, with endorsements by Samsung and BAE Systems. Wistron, a leading technical services provider, used Optimality's AI-driven optimization technology and Clarity for fast, accurate electromigration in-design analysis, improving design reliability while realizing a 2x improvement in turnaround time. Our digital IC business finished another strong year with 22% revenue growth in Q4, as our solutions continued gaining share at market shaping customers, especially at the most advanced nodes. Our digital software is proliferating in all top 20 semiconductor companies, and our digital full flow was adopted by 34 additional customers during the year. We are very pleased with the accelerating momentum of our flagship Cadence Cerebrus GenAI solution, whose transformative PPA and productivity benefits have led to its deployment in all our top 10 digital customers and used in well over 300 tapeouts. In Q4, Cadence Cerebrus run rate more than quadrupled at several market shaping customers and it also drove significant digital full flow expansions at two top-tier semi customers. Our Integrity 3D-IC platform is the industry's only unified 3D-IC design and analysis platform and ties our best-in-class SoC and package design technologies with system-level planning and analysis. In Q4, GUC successfully used Integrity to tapeout a complex 3D stacked die design with a wafer-on-wafer structure on an advanced FinFET node. Next, I will talk about our Functional Verification business, which had another remarkable year, delivering 11% year-over-year revenue growth in Q4 and 22% growth for the full year. Escalating system and software bring-up challenges, along with the pressing need for first-pass silicon success, continued driving strong demand for our Functional Verification solutions. Our best-in-class dynamic duo of Palladium Z2 and Protium X2 platforms delivered another record year with strong momentum across AI, hyperscale, auto, and mobile. Virtually all of the top hyperscalers are Palladium customers, and the majority of them are also Dynamic Duo customers. Last month, we announced a new set of Palladium Z2 applications that included the industry's first four-state emulation and mixed-signal modeling capabilities, that will significantly accelerate SoC verification. Marquee customers including NVIDIA and Samsung supported the announcement. Our hardware family added 26 new and over 110 repeat customers during the year, with the top three deals being with a global marquee systems company, the leading AI systems company, and a leading communications services company. Demand for the Duo greatly exceeded our expectations with more than two-thirds of the orders in the year including both platforms. Our Custom IC Virtuoso and Spectre franchise solutions tackle the most complex challenges in analog, mixed-signal, RF design, and circuit simulation, and are increasingly crucial for our customers. Building on our market leadership, our Custom IC revenue grew 16% year-over-year in Q4. Customer interest in our recently announced Virtuoso Studio is strong, with over 2,000 downloads so far, and adoption of our newer Spectre platform products continues to ramp. Virtuoso had a major win with a top global memory company, which replaced its internal tools with our technology. Our IP business drove a strong finish to the year, growing 36% year-over-year in Q4. We continued to sharpen our star IP strategy with targeted acquisitions such as Rambus PHY IP and Invecas to capture market opportunities offered by AI and heterogeneous integration. Customer interest in the Rambus PHY assets, especially HBM and GDDR IP, has been extremely positive, which have already been instrumental in closing some strategic deals. Our Invecas acquisition is also highly synergistic to the strategy, adding a skilled engineering team with expertise in delivering custom solutions across design, product engineering, advanced packaging, and embedded software. In closing, we are pleased with our outstanding performance in 2023 and are excited by the business momentum and market opportunities in 2024. Now, I will turn it over to John to provide more details on the Q4 results and our 2024 outlook.

Thanks, Anirudh, and good afternoon, everyone. I am pleased to report that Cadence delivered a strong Q4 and 2023, driven by growth across all of our businesses. Robust design activity and customer demand, coupled with our strong execution, helped us to achieve revenue growth of 15% and EPS growth of over 20% for the year. Fourth quarter bookings were strong, and I am pleased that we achieved record backlog and record current remaining performance obligation levels, finishing the year with approximately $6.0 billion in backlog and approximately $3.2 billion in cRPO. Here are some of the financial highlights from the fourth quarter and the year, starting with the P&L. Total revenue was $1.069 billion for the quarter and $4.090 billion for the year. GAAP operating margin was 31.5% for the quarter and 30.6% for the year. Non-GAAP operating margin was 42.9% for the quarter and 42.0% for the year. GAAP EPS was $1.19 for the quarter and $3.82 for the year. Non-GAAP EPS was $1.38 for the quarter and $5.15 for the year. Next, turning to the balance sheet and cash flow, our cash balance was $1.008 billion at year-end, while the principal value of debt outstanding was $650 million. Operating cash flow in the fourth quarter was $272 million and $1.35 billion for the full year. DSOs were 43 days. We used $700 million to repurchase Cadence shares during the year. Before I provide our outlook for Q1 and 2024, I'd like to share some assumptions that are embedded in our outlook. In 2023, our up-front revenue mix increased to approximately 16%, largely due to strong hardware demand. In 2024, we expect another record hardware revenue year and strong IP growth. As a result, at the midpoint, our outlook assumes that our up-front revenue mix for the year will increase to approximately 17.5%. In Q1 2023, our up-front revenue mix was approximately 20%, largely due to our effort to improve hardware delivery lead times at the start of last year. In Q1 2024, at the midpoint, our outlook assumes an up-front revenue mix of approximately 14%. Our non-GAAP EPS outlook is based on a tax rate of 16.5%. Finally, our outlook for Q1 and 2024 is based on our usual assumption that export control regulations in place today remain substantially similar for the remainder of the year. In our outlook for 2024, we expect: revenue in the range of $4.55 billion to $4.61 billion; GAAP operating margin in the range of 32% to 33%; non-GAAP operating margin in the range of 42% to 43%; GAAP EPS in the range of $4.08 to $4.18; non-GAAP EPS in the range of $5.87 to $5.97; operating cash flow in the range of $1.35 billion to $1.45 billion; and we expect to use approximately 50% of our free cash flow to repurchase Cadence shares in 2024. For Q1, we expect: revenue in the range of $990 million to $1.01 billion; GAAP operating margin in the range of 24.5% to 25.5%; non-GAAP operating margin in the range of 36.5% to 37.5%; GAAP EPS in the range of $0.74 to $0.78; and non-GAAP EPS in the range of $1.10 to $1.14. As usual, we've published a CFO Commentary document on our Investor Relations website, which includes our outlook for additional items, as well as further analysis and GAAP to non-GAAP reconciliations. In conclusion, I am pleased that for 2023 we achieved revenue growth of 15% and EPS growth of over 20%; we achieved a seventh consecutive year of over 50% incremental non-GAAP operating margins, resulting in non-GAAP operating margin of 42%; and we finished the year with record backlog and cRPO, setting ourselves up for a great 2024. 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.

Your first question comes from Jason Celino with KeyBanc Capital Markets. Please go ahead.

Hey, guys. Happy Monday. So, maybe my first question on the backlog strengths, really impressive, especially given the hard year-over-year comp. John or Anirudh, what drove the strength here? It sounds like it's hardware related, or maybe it's broad-based. Anything helpful?

Jason, yes, it was very broad-based, broad-based across geographies and broad-based across all of the businesses. On the hardware front, you might recall this time last year, we finished with over six months of backlog for hardware. We addressed those lead times at the start of the year and now we're down to a more normal eight weeks of hardware backlog. When you compare the backlog at the end of '23 against the end of '22, I think it reflects strong bookings, broad-based bookings across all geographies, across all businesses, but on the hardware side, slightly less hardware or maybe less hardware certainly in backlog at the end of '23 versus the end of '22.

Okay. And then, when we think about 2024 as a whole, is it a big renewal year, or I guess how does 2024 look compared to other years, particularly '23 when you think about renewal timing and things like that? Thanks.

Yeah, great question, Jason. Last year was heavily weighted towards the second half of renewals. We don't expect it to be that heavily weighted in the second half this year. Looking at software renewals and when they come due, if you look at the annual value, it's probably weighted 40% first half to 60% second half.

Your next question comes from Charles Shi with Needham. Please go ahead.

Hi, good afternoon. I guess top of the mind of many investors, can you guys provide any thoughts on the Synopsys and Ansys merger or whatever you call it? Especially now, Cadence probably needs to execute that Intelligent System Design strategy more in an organic way than inorganic way. Any thoughts would be great. Thanks.

Yeah. Hi, Charles. This is Anirudh. As you know, we have been executing on our Intelligent System Design strategy for six years now. We started this in 2018 and we know for a while that there will be this convergence of electrical and mechanical domains. This convergence of system and semi companies, semi companies becoming system companies and system companies doing silicon, as you all know. Now we have commented that about 45% of our business is coming from system companies. But we have been executing on this from 2018 and focusing on our core business, which is EDA, expanding into SD&A, which is what we call System Design and Analysis, and AI over the last five, six years. If you look at our results on SD&A, even in 2023, our business revenue is up 22% in SD&A. It has been up more than 20% for the last several years, whereas that market is not really growing at that rate. So, we are gaining a lot of share in SD&A. This is primarily due to our products and customer response. Customers have really embraced our strategy and embraced our product differentiation. We first started with Finite Element with Clarity, and that is benchmarking very well, winning a lot of shares and a lot of customers. Recently, you must have seen our new product in CFD. CFD is a big market. There are two big simulation areas in SD&A: one is finite element, which we are already ahead in, and the other is CFD. With Millennium, this is like one of the most revolutionary products in CFD in the last 30 years. I can tell you more about Millennium later. The third thing in our SDA strategy is we are the only company that has a very strong position in packaging and PCB, which is critical for chiplets and 3D-IC. Overall, I feel very confident in terms of our market position. The strategy we have implemented for six years is showing a lot of growth and momentum going forward.

Thanks, Anirudh. Maybe a follow-up. I do want to dig a little bit into your digital IC design and the signoff revenue. You reported last quarter, I think it's exceeding $300 million. It has been bumping along $250 million since I think early part of 2022, but then it does seem to show some really good strength since the second half '23. You talked about the sheer gains, and I do understand this is the part where you have the most overlap with your direct competitors Synopsys. I'm just really curious, how sustainable is the strength you saw in Q4? And is there any color you can provide us on what's driving the revenue upside for that business in the fourth quarter? How should people think about the sustainability of that? Thanks.

Yeah, hi, Charles. That's a good question on digital. There are multiple reasons driving that, but I would say the main reason is the AI super-cycle. There's a lot more design activity. You will notice some of our key partners increasing the cadence of their major product development. In AI, we participate in several ways. One is just the buildout of the AI infrastructure, which is, of course, our great partnership with NVIDIA and all the other hyperscalers. Then, also, our AI-enabled products like Cerebrus and Optimality and our overall AI portfolio. As I mentioned in my prepared remarks, Cerebrus, which is the flagship product for digital implementation using AI has seen our business go up 4x. There's much more design activity, especially at the most advanced node. AI products provide acceleration on top of that. The other thing I had mentioned before is that as people use Cerebrus, which is the overall AI product in digital implementation, it also has a push-through of the full flow, not just place and route, but also synthesis and signoff. So, what I'm very pleased to see is that AI products like Cerebrus are doing well, but they're also pulling through synthesis. Our position has improved dramatically in synthesis in the last year and also a lot of signoff engagement. Overall, I'm pretty pleased with the technology progress, the AI progress, and also engagement with some big customers that traditionally were not using Cadence. Now, like we mentioned, all top 20 customers are using Cadence solutions in digital. We'll see how it progresses, but I think it's good progress on digital and I expect that to continue.

And Charles, I would just add to that, in Q4, we saw some very good cash collections from customers that were lower credit-worthy customers that we didn't think we would collect from. So, it wasn't in our forecast. We had some upside from that.

Thanks.

Your next question comes from Vivek Arya with Bank of America Securities. Please go ahead.

Thanks for taking my question. I actually had a question on growth. Just kind of first on the segment side, IP growth has been more modest than the entire company growth. So, I was hoping you could give us some color on that. But then, Anirudh, my bigger question is that when I look at the overall sales growth for Cadence, 19% in '22, then 15% last year, and now 12% is what you're guiding to for this year. I mean, these are impressive growth rates versus the semiconductor industry. Still, it shows a deceleration for the last few years, which is very different than the acceleration that we see for a lot of other semiconductor companies that are exposed to the AI and generative AI theme. So, what is the right way to interpret this deceleration in your sales? Should we be expecting acceleration back at some point as some of these AI initiatives get bigger? Or what is the right way to interpret and compare your growth rate versus the acceleration of growth in a number of the AI names?

Yeah, Vivek, good question. First on the IP part, like in '23, I think the first three quarters we had, the growth was much more challenged. It's primarily in comparison to the previous year, but also some of the macro uncertainties. As you can see in Q4, we had very strong growth in IP, more than 30% growth in IP. The whole AI super-cycle is driving much more disaggregation. The 3D-IC is concentrated at HPC and AI application, which requires more IP like UCIe or SerDes IP, and then HPM and memory IP. That's why we acquired assets of the five assets of Rambus. Our own portfolio in UCIe and DDR is doing pretty well. We did several acquisitions to improve our talent in IP. Because of AI, our own actions, that IP should do much better in 2024. That's our current modeling. '23 had some unusual challenges, but going forward, the IP business should improve. We've focused on profitability over the last few years in our IP business. I'm pleased to say that the profitability levels we are now happy with. Now, I think we can focus more on growth and expanding our portfolio. You may have also seen that there's all this other activity at most advanced nodes and more foundries. We are pleased with our partnership with Intel, Intel Foundry that we just announced today, and also all the other major foundries, and we are glad to do much more with the IFS. That should also help our IP business going forward.

And Vivek, I'd just like to add, you asked about how to look at the revenue growth. We tend to look over a three-year CAGR because most of our customers are in three-year baseline contracts on the software side. If you look at, since 2017, our three-year CAGR has been accelerating and continues to accelerate. In 2022, we hit 15%. We actually exceeded 15% on a three-year CAGR basis. For last year, we're very, very pleased that we were over 15% again. At the midpoint of the guide for '24, the three-year CAGR is about 15.3%. So, that would be three consecutive years of over 15% revenue growth on a three-year CAGR basis. From time to time, you can get some lumpiness in things like hardware timing or IP timing, and that can distort individual quarters or individual years. But we think looking over a three-year CAGR basis is probably the best way to look at it. That's how we look at it ourselves.

Got it. And for my follow-up, maybe John, one or two clarifications. What's the assumption for China contribution in '24? And then, the incremental EBIT, I think from the guidance, seems like it's below 50%, right? It's still impressive, but it is below what we have been used to the last few years. If you could clarify that, that would be very helpful also. Thank you.

Yeah, sure. Great questions again, Vivek. On the incremental margin front, we typically don't start the year in the initial guide with over 50%. We tend to start lower than that and we build towards greater than 50% with growth through the year. As you know, we always like to under-promise and over-deliver. If you look at our incremental margin over the last few years, it was slightly lower in 2023 compared to previous years. That's because on the organic side, we had incremental margins north of 55%, but we did some acquisitions. Typically, when you have an acquisition, it can be dilutive in the early year or two, and that's a bit of a headwind for incremental margins. In relation to China, glad you asked me about that. China, the last four years, contributed 15% of our 2020 revenue, then followed that with 13% in '21, 15% in '22, and 17% in '23. Last year, I think China benefited from that large hardware backlog that we had. There was an outsized portion of that backlog for the China region. It was a boon year for China. I wouldn't expect to repeat that this year. Our guide would expect China to be flat or slightly down. We've de-risked China into the 14% to 15% range for this year, consistent with the previous three years.

Okay. Thanks very much.

Your next question comes from Gary Mobley with Wells Fargo Securities. Please go ahead.

Hey, guys. Thanks for taking my question. Let me apologize in advance for the background noise. I wanted to ask about the disconnect between record levels of cRPO and what is assumed in your revenue outlook and as well your higher outlook for up-front revenue. Why the assumption that less of that cRPO translates into revenue in fiscal year '24, especially considering the higher mix of up-front?

Thanks for the questions, Gary. Regarding cRPO and its connection to this year’s revenue, last year we had more than six months of hardware backlog in cRPO at the end of 2022. A significant part of our hardware revenue this year came from that backlog. We increased our production capacity and have now returned to normal delivery lead times of around eight weeks for hardware, which is crucial for our customers. Customers prefer to buy hardware knowing they will receive it within a reasonable timeframe. Generally, hardware revenue aligns more closely with production capacity than with the backlog versus new business each year. By resolving hardware lead times, the revenue profile this year looks different compared to last year. In the first quarter of 2023, we had a substantial amount of hardware coming from backlog. For 2024, we anticipate another record year for hardware revenue, and our business plans to increase hardware production each quarter to meet the demand. However, this year, hardware revenue is expected to grow quarter-over-quarter, while last year's first quarter was our strongest hardware quarter.

Just to be clear, John, cRPO does not include hardware backlogs that RPO does?

cRPO would include hardware. Even with over six months of hardware delivery lead time, the revenue is expected within a year. So even though it's in your backlog, it's also reflected in your cRPO. Therefore, last year's cRPO contained a significantly larger amount of hardware compared to this year's cRPO, particularly regarding product revenue.

All right. I want to circle back, Anirudh, on a metric you gave in your prepared remarks, that is a quadrupling of the Cerebrus run rate at several market shaping customers. So, should we take that to mean the annual contract value for those who took Cerebrus at market shaping customers quadrupled? Or maybe if you can clarify this, I've been missing that?

Cerebrus is performing exceptionally well and is now utilized by all of our top 10 customers. In general, AI engagement has surged by tenfold over the past year. The Cerebrus business has a growth pattern where customers start with limited use and then expand their adoption significantly, which we are pleased to see. We believe there is still potential for further growth. Historically, we have indicated that we anticipate it will take about two contract cycles, roughly six years, and we are currently two years into that timeline. This is a positive aspect of our model, as we aim for steady growth moving forward. Other products, which were introduced after Cerebrus, such as Verisium, Allegro X AI, Virtuoso Studio, and Optimality, are also making good progress. Overall, regarding AI, I am quite satisfied because we have previously discussed three major avenues for benefiting from AI. The first phase involves developing infrastructure, exemplified by our notable partnerships with NVIDIA where we have been collaborating on AI product development for many years. Our long-standing relationship with them has positioned Palladium strongly amid other AI advancements. The second phase pertains to our own products. It began with Cerebrus in the digital space, but we now also have five significant co-pilot platforms across our businesses that are transitioning from initial to broader deployments. The third phase includes the introduction of new products that we foresee will create market opportunities, particularly in life sciences and bio-simulation, which will become more prominent in the coming years. These three phases of AI activity are crucial for our success, and I am confident in our positioning and the results we are achieving.

Thanks for the detail.

Your next question comes from Jay Vleeschhouwer with Griffin Securities. Please go ahead.

Thank you. Good afternoon. Anirudh, you noted the large number of new products you've introduced just in the last year, Virtuoso Studio, Optimality, Allegro X, and so forth, and then of course Millennium just a couple of weeks ago. Could you talk about how you're thinking about the contribution of those incrementally, collectively this year as part of your guidance and perhaps even rank the ones that you think might be most incremental to your revenue growth this year over and above the pre-existing products, such as Innovus and the signoff products? Then, my follow-up.

Yeah, hi, Jay, good question. We are a very innovative company and we have done that for years now, investing one of the highest percentages of R&D into R&D. It's good to have all of these new products in multiple areas. Of course, the three big areas are EDA, SDA, and AI. But we don't try to rank our children. We want all of them to do well. It's also difficult to predict how it will play out because these are all for the long run. There is a lot of momentum with the AI products. There's a lot of momentum with 3D-IC and chiplet. Millennium is a huge innovation in CFD in the last 30 years. I talked about the three-layer cake, which includes AI orchestration, physical simulation, and accelerated compute. We haven't discussed much Millennium when we made the acquisition about two years ago from Stanford Cascade, which is very high fidelity and accurate to CFD. We had that at the heart of it and then AI on top with accelerated computing. It completely changes the game in CFD. For the first time, we can simulate entire cars and planes in a few hours. It’s emulation for systems that has never been possible before. The potential with Millennium is significant because it’s a new product. We're offering both cloud and on-prem. Most of the customers are currently choosing the cloud version. That's great, as it's more ratable. So, I think it's good to have multiple engines contributing to the growth. We focus on margin at the same time. We are well positioned going forward, but it's difficult to predict which will do better than the others, and we don't guide on a product basis as of now.

All right. So that's a good segue to my follow-up. And since you mentioned Dassault, Cadence is quite visible here at the conference today. When you think about your ISD strategy generally and perhaps CFD specifically, can you talk about the resources and investments you're having to make to effectuate that strategy beyond or over and above the core EDA strategy? What do you know now about those markets that you might not have known three, four, five years ago when you were much earlier in developing the strategy?

Yeah, Jay, that's a good question. Our SDA business is about 12% of revenue in 2023. It's already at a good pace and it has enough scale now to apply significant R&D to that space, as well as the simulation space. We know the simulation space pretty well and we have a lot of high R&D synergy from our EDA R&D to SD&A R&D. I'm happy with how much R&D we have invested and will continue to invest there. It is also very profitable. Our model is not just revenue growth, but also profitability. I felt we would be more profitable when we started six years ago because simulation is more profitable in EDA. That's what is playing out in SDA. It's pretty profitable. Simulation has always prioritized accuracy, performance, and capacity. The market is always looking for new simulators. That's how it has played out in electromagnetic. I'm much more confident with the massive disruption with Millennium. With Dassault, we have mentioned before, that we are computational software companies. That means what we will not do. We won't get involved in things in the system space, which are not as computational. PLM and mechanical CAD platforms fall under that. Dassault is the clear leader. They are great in those areas. It’s a perfect partnership for Cadence, as we focus on computational software and EDA and SDA, packaging and PCB. We're glad to see that expansion that was announced today.

Your next question comes from Harlan Sur with JPMorgan. Please go ahead.

Hi, good afternoon. Thanks for taking my question. Back to your IP business, it was up 4 percentage points, 5 percentage points last year. I know that it was a relatively tough comp relative to 2022, but I would have thought that the growth in IP would have been closer to your overall growth, just given that higher chip design complexity does motivate your customers to license more IP to drive efficiencies in their chip design cycle time. Was there some customer push-offs of IP into this year, just maybe given timing of customer programs, or was there another dynamic at play? Relative to your outlook for 12% total growth this year, how do you think your IP business does this year?

Yeah, good question. The shape of the IP revenue last year was a little atypical. There were a couple of reasons for that. In 2023 we had very, very strong Q4, but the first three quarters were not strong at all. The overall year is in single digits, like you mentioned, but it had a very strong Q4. There were some tough comparisons from '22 to '23 in IP, especially in the beginning of the year. As I mentioned, of course, the macro environment has been tough, but it is improving now. In 2024, I'm cautiously optimistic about IP. Our portfolio is broader and the whole AI super-cycle, our new engagements with IFS and other companies will likely create opportunities for better performance. So overall, I'm optimistic about '24. John, you want to comment?

Of course. Harlan, as you know, we always focus on profitable and scalable revenue growth, and the IP revenue contributes largely to our up-front revenue percentage. For 2023, our up-front revenue percentage increased from 15% to 16%. That was on the back of a strong record hardware year. IP revenue growth was low compared to prior years. This year, we're expecting the 16% to go to 17.5%. We expect both to contribute significantly to improvements in up-front revenue this year.

We expect the IP growth to be higher than Cadence average this year. We'll see how it plays out.

Your next question comes from Joe Vruwink with Baird. Please go ahead.

Great. Thanks for squeezing me in. Just to follow up on some of the earlier questions. I think of your growth as being tied to the R&D budgets at your customers, not the revenue at your customers. Certainly, R&D budgets tend to move around more steadily. Anirudh, you mentioned earlier a lot of your revenue is ratable. Changes can take some time to work through the model. I wanted to ask, because I think 2024 has the potential to see a pretty big inflection in R&D spending within the semi-customer base. A, are you maybe seeing that? Is it included in your outlook starting the year? B, if it does end up moving higher and influencing renewals and purchasing decisions, does that manifest in a bigger way, probably more in 2025 than it really would in 2024?

Yeah, Joe, that's a very good observation. The mood seems to be changing a little bit. '23 was a tough environment, but we grew very well. There was a change in Q4 in the overall macro sentiment. There may indeed be more investment in '24 and '25. We based our outlook and John can comment more on the backlog we see rather than guessing what will happen in '24 and '25. If there is an improvement in R&D, that's good for our business. There is a lot of design activity, and I see our position improving in EDA and IP this year, continuing with SDA and AI.

Certainly, everyone seems to be more optimistic this time this year compared to last year. This time last year, everyone was asking me when the recession would happen. There seems to be strong design activity, even with China. We're still seeing strong design activity in China. I de-risked the guidance for that because the large outperformance in China last year was attributed to that hardware backlog. Now that we’re back to normal lead times, it’s prudent to assume China revenue drops back to prior levels of 14% to 15%. That's embedded in the guidance. We always prefer to de-risk the guidance for concerns, while focusing on long-term business with customers.

Absolutely. AI contributes to hardware strength, given our strong position. AI is more HPC and chiplet based. It helps our IP business, as well as hardware. Let’s see how it progresses with the IP being strong this year, along with hardware and Millennium.

I will now turn it back to Anirudh Devgan for closing remarks.

Thank you all for joining us this afternoon. It is an exciting time for Cadence as we enter 2024 with product leadership and strong business momentum. Our continued execution of the Intelligent System Design strategy, customer-first mindset, and our high-performance inclusive culture are driving accelerating growth as we grow our core EDA business while expanding our portfolio. Fortune and Great Place to Work named Cadence as one of the World's Best Workplaces in 2023, ranking it Number 9. On behalf of our employees and our Board of Directors, we thank our customers, partners, and investors for their continued trust and confidence in Cadence.

Thank you for participating in today's Cadence fourth quarter and fiscal year 2023 earnings conference call. This concludes today's call. You may now disconnect.