Earnings Call Transcript - CDNS Q3 2021

Operator, Operator

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

Alan Lindstrom, Senior Group Director, Investor Relations

Thank you, Jumeirah. I would like to welcome everyone to our third quarter 2021 earnings conference call. I am joined today by Lip-Bu Tan, Chief Executive Officer; Anirudh 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. 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 those 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-K and Form 10-Q, and the cautionary comments regarding forward-looking statements in today’s earnings press release. You should not rely on our forward-looking statements as predictions of future events. All such statements are based on estimates and information available at the 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 should not be considered in isolation from or as a substitute for GAAP results. 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. Copies of today’s 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&A session today, we would ask that you observe a limit of one question and one follow-up and you may re-queue if you would like to ask additional questions and time permits. Now, I will turn the call over to Lip-Bu.

Lip-Bu Tan, Chief Executive Officer

Good afternoon, everyone, and thank you for joining us today. Cadence delivered strong financial results for the third quarter, driven by accelerating customer demand for our innovative solutions and continued solid execution by the team. Driven by the broad-based strength of our business, we are raising our financial outlook for the third 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 generational trends like 5G, 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 in turn is driving secular semiconductor growth and design activity across a wide range of end markets. Before I ask Anirudh to go through the business and product highlights for the quarter, I would like to remind you that I will be transitioning to the role of Executive Chairman on December 15, with Anirudh becoming our President and CEO at that time. It has truly been an honor leading Cadence for the past thirteen 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 hand the baton over to Anirudh, I can think of no one better to lead the company through its next phase of growth and I eagerly look forward to him taking Cadence to new heights. 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 Anirudh.

Anirudh Devgan, President

Thank you, Lip-Bu. Our Intelligent System Design strategy leverages our strong computational software expertise as we expand beyond EDA into new markets, and we’re uniquely positioned to capture the exciting opportunities that Lip-Bu talked about. As we execute to our strategy, we are especially pleased to see our EDA, IP and systems solutions being increasingly adopted by a growing number of systems 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 3D-IC 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. Let me share some of the business highlights starting with Digital and Signoff, which had another strong quarter with 18% year-over-year revenue growth. Our digital full flow, delivering industry-leading quality of results at the most advanced nodes, continued 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 Cerebrus solution, that incorporates unique reinforcement learning AI/ML technology, to deliver significant PPA — power, performance and area — and productivity gains. In addition to the Samsung and Renesas endorsements at the time of launch, several market-shaping customers have added Cadence Cerebrus to their production flows and are realizing great benefits. As an example, a global mobile semiconductor company used Cadence Cerebrus on their manually tuned CPU design to reduce total power by almost 10% and improve timing by over 25% automatically in only eight days. Additionally, Cadence Cerebrus enabled a marquee mobile systems company to reduce the power consumption of their 4 nanometer design by over 25% and get over 10X improvement in productivity. We continued growing our business with hyperscaler customers, including a broad expansion of our EDA 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 the 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 regressions, and early software development. This momentum is especially noticeable in our hardware business, where customers are deploying significant additional capacity as they reap the performance, quality and productivity benefits of our industry-leading hardware platforms. Accelerating adoption of our new Dynamic Duo, the Palladium Z2 and Protium X2, led by hyperscaler and global marquee customers, drove the majority of hardware orders in this quarter. In Verification software, Xcelium-ML, our machine learning optimized logic simulator delivering up to 5X faster regressions, 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 virtual and hybrid 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 designs. Moving onto System Design & Analysis, I am particularly pleased that this segment which is driving our market expansion beyond EDA, continued to deliver strong double-digit growth, increasing revenue by 17% year-over-year, as we grew our footprint in several verticals including aerospace and defense and 5G communications. With 5G and AI/ML applications pushing silicon vertical limits, and transistor scaling slowing down, there’s an accelerated move to disaggregate SoCs into a heterogeneous set of discrete die that can be integrated together with sophisticated packaging technology. Leveraging over two decades of pioneering packaging expertise, we’re very excited to have launched Integrity 3D-IC, the industry’s first and only comprehensive platform that ties together our best-in-class system planning, implementation and thermal, timing and power analysis technologies, along with a multi-technology database, all in a unified cockpit. This third-generation 3D-IC solution enables designers to achieve system-driven PPA with reduced design complexity and faster time to market, and we’re engaged with several leading semi and system houses, foundries, and packaging companies. Our organically developed system analysis products continued to make good headway, with Clarity, our electromagnetic 3D simulator, displacing the incumbent solution and becoming plan-of-record at a marquee hyperscaler. And Celsius, our electro-thermal 3D simulator, was deployed at a global marquee systems 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 wanted to say a few words about the upcoming CEO transition on December 15. On behalf of the Cadence Board and our employees, I want to thank Lip-Bu for his outstanding leadership and his numerous illustrious accomplishments over the past thirteen years, that have made a lasting impact on our industry and on 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 partnerships with market-shaping customers and delivering shareholder return of over 3500%. I am especially grateful to Lip-Bu for his mentorship and guidance and look forward to continuing our partnership in our new roles, as along with our talented team, we relentlessly drive to deliver strong business results and delight our customers and shareholders. Now, I will turn it over to John to go through the Q3 results and present our Q4 and updated 2021 outlook.

John Wall, Senior Vice President and Chief Financial Officer

Thank you, Anirudh 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 to come. 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. 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 of top and bottom line results. 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 third quarter, beginning with the P&L. Total revenue was $751 million. Non-GAAP operating margin was 35.7%. GAAP EPS was $0.63, and non-GAAP EPS was $0.80. For the balance sheet and cash flow, cash totaled $1.014 billion at quarter-end, while the principal value of debt outstanding was $350 million. Operating cash flow was $296 million. DSOs were 40 days, and we repurchased $110 million of Cadence shares during the quarter. 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 billion to $2.980 billion. 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 million to $1.025 billion. For the fourth quarter, we expect revenue in the range of $745 to $765 million, non-GAAP operating margin of approximately 35%, GAAP EPS in the range of $0.49 to $0.53, non-GAAP EPS in the range of $0.76 to $0.80, and we expect to repurchase $110 million of Cadence stock 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 closing, I am pleased that revenue growth continues to accelerate with our three-year revenue CAGR now approximately 11.5% at the midpoint of guidance. We are expecting approximately $1 billion of operating cash flow for 2021 at the midpoint, and we are on track to deliver over 50% incremental operating margin for the year. 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, Operator

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

Joe Vruwink, Analyst, Baird

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 prototype thing. 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 demand getting extended into next year?

John Wall, Senior Vice President and Chief Financial Officer

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 quickly as we can to meet that demand. We're very, very pleased with the customer reaction and like building the systems as quickly as we can. I'd say it's fair to say that demand is outstripping supply right now, but we're building as fast as we can and you can see it in the inventory number; inventory is slightly up.

Joe Vruwink, Analyst, Baird

Okay. That's helpful. And then maybe more of a product or strategy question. When you announced 3D-IC and the co-design that needs to happen between package and chips being stacked. 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 kind of said multiple areas of the Cadence product portfolio.

Anirudh Devgan, President

Yeah. That's a great question. Let me take that. This is Anirudh. So, we believe that 3D-IC is the future. The road to the future goes through 3D-IC for multiple reasons, including putting multiple chips on a package, mixed technologies and the ability to build bigger and bigger systems. I do believe that Cadence is uniquely positioned for that and it affects multiple technologies. Now some of it is because of our history. 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 five years, we have done very well in digital. Over the last two to three years, we have invested a lot in system analysis. Clarity and Celsius are also critical for 3D-IC, given that thermal is a big challenge when you put these things together. So, I believe Cadence is uniquely positioned. With Integrity, we put this all together. And it’s not just Integrity; it ties into the other parts of Cadence, as I mentioned. When we work with customers and leading foundries, it's often the case that you need three or four companies to do the same thing, whereas if you come to Cadence, we have a comprehensive solution across multiple segments. So I think as 3D-IC takes more momentum going forward, I believe we are well-positioned.

Joe Vruwink, Analyst, Baird

That's great. Thank you very much.

Operator, Operator

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

Jason Celino, Analyst, KeyBanc

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 to my question, with the supply chain shortages, we've seen several different automakers, like Honda and Volkswagen announce intentions to design some of their own semiconductors, but we know that these design cycles are quite long and it's a multi-year 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?

Lip-Bu Tan, Chief Executive Officer

Yeah, Jason, first of all, thank you so much for the kind words. I have been monitoring the global supply chain very carefully. So far we don't see any slowdown in our design activity across our customer base. Our products are very much focused on R&D engineering and designing the chip system. This is a multi-year approach. I mentioned earlier, the generational drivers have been really driving a lot of increase in design activity. In terms of automotive buy cycles, yes, you are absolutely correct it’s a multi-year investment and lately, because of more and more electronics in the automotive, we see a lot of design activity like autonomous driving. I think Anirudh mentioned the Tesla autonomous driving AI chips using our broad-based Cadence tool — that's one good example and many more are coming. So I think clearly we're excited about the automotive platform that will create opportunity in the multi-years to come.

Jason Celino, Analyst, KeyBanc

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

Lip-Bu Tan, Chief Executive Officer

Yeah. I think it's a very interesting and challenging time in the whole supply chain. Clearly in our part, the automotive industry is starting to become very realized that they do not have whole visibility to the supply chain and that has become very important for them. Different automotive companies experienced different challenges in the supply chain, and we are here to help them in terms of design automation and system-level complexity and time to market. We try to be available and helpful to them as a design partner and support them throughout this period. So, I think you are going to see more and more opportunity and the automotive is a big platform for us.

Jason Celino, Analyst, KeyBanc

Great. Thank you.

Operator, Operator

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

Jackson Ader, Analyst, JP Morgan

Great. Good evening, guys. Thanks for taking my questions. I’ll quickly echo all the kind words that have already been said about Lip-Bu. Congratulations and looking forward to continuing the relationship. So Anirudh, 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. I'm just curious, what tools or at least what parts of the digital design flow — from a high level of synthesis to place and route — what have you are actually driving the increased uptick maybe in the last 12 to 18 months in digital?

Anirudh Devgan, President

Thanks Jackson for the question. So I think at lower nodes, we always believed that integration of the whole digital full flow is critical. That said, this includes place and route and signoff. What we are pleased to see, especially in the last 12 months, is wider deployment of our digital tool flows. A few years ago the engagement would start with Innovus, which was our leading product. Now the market has accepted our full flow and we see more deployment across the stack. So that includes synthesis and signoff along with Innovus and that is becoming more the norm than anything else. To answer your question: not only Innovus, but also synthesis and signoff — Genus, Tempus and Quantus — are proliferating, and we are pretty happy with that trend.

Jackson Ader, Analyst, JP Morgan

All right. Awesome. Thank you. And then quick follow-up John, can we just get — what is going on with backlog and the implied bookings? It's really swung around a bunch this year; just curious if there were integration impacts or what you would be reading into in terms of the implied bookings number this quarter?

John Wall, Senior Vice President and Chief Financial Officer

Yes Jackson, thanks for the question. I wouldn't read too much into it. It's largely timing of contract renewals. We had a similar phenomenon in Q1. We would expect to end the year with a higher backlog and RPO than we started the year, and that's reflected as well. If you look at the margin guidance for Q4, margin is slightly down from 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.

Jackson Ader, Analyst, JP Morgan

All right. Awesome. Thank you.

Operator, Operator

Your next question will come from the line of Pradeep Ramani from UBS. Please proceed with your question.

Pradeep Ramani, Analyst, UBS

Hi. Thank you for taking my question. I just wanted to get some more insight on the Verification team. It seems like Verification was flattish to down a little bit versus June, and yet hardware seems to be doing well. So I read this to interpret that it's more on the software side that you see maybe the letdown versus what might have been anticipated, or are you being constrained on the hardware side? I just want to get a sense of ramp on the hardware side as well.

John Wall, Senior Vice President and Chief Financial Officer

Hi, Pradeep. This is John. We're absolutely delighted with the customer reaction to our new hardware systems. We're building and installing inventory as fast as we can to meet demand. Cadence is part of the design cycle, so manufacturing constraints haven't really impacted us too much with our customers. In relation to your comments on growth, we raised guidance for the year and we're seeing accelerating growth. If you look at the three-year CAGR, which I've called out in the CFO commentary, it's around 11.5% and continues to increase year-over-year. That's reflecting strong demand across all lines of business.

Pradeep Ramani, Analyst, UBS

Okay. And my follow-up on the digital IPs. They have been very strong. Are you seeing increasing competitor displacements, or is it more of the market being strong? Can you speak qualitatively on how you're using digital IP going forward as well?

Anirudh Devgan, President

It continues to do well, and I think it's a combination of things. The market is definitely growing because of digital connectivity across multiple domains. We also believe that we are taking market share. So it's a combination of a growing market and Cadence gaining share that is driving our digital growth.

Pradeep Ramani, Analyst, UBS

Thank you.

Operator, Operator

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

Jay Vleeschhouwer, Analyst, Griffin Securities

Thank you. Good evening. Anirudh, 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. Certainly look forward to continuing the dialogue with Anirudh. First question Anirudh, at the Cadence event in Europe a week or so ago, Cadence said Allegro had recently undergone a major overhaul, which we certainly saw with Allegro X. 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, Synopsys a few years ago significantly ramped up its internal investments in synthesis and launched a new version of DC. Based on your internal investment patterns, are you undergoing a rejuvenation or reinvestment cycle for your synthesis or what else might you comment on in terms of major overhauls? Secondly, regarding the ingredients you need to succeed with the computational software strategy, there was an announcement of a relationship between a competitor and Dassault. I'm wondering if you see you’re having to partner more for both technical and channel expansion reasons to succeed in computational software.

Anirudh Devgan, President

Both great questions. In terms of new products or revamps of existing products, we are continuously looking at improvements across our portfolio. You'll see this as an ongoing process — this year alone we launched 13 new products; several are improvements of existing products like Allegro X or Sigrity X. We maintain a high investment in R&D compared to peers, so we are constantly innovating and you’ll see more things come out as we go forward. On the second point, we are confident in our computational software strategy — it's delivering good results. We have strong organic innovation demonstrated with Clarity and Celsius. At the same time, we are open to partnerships that make sense on both the product and go-to-market side. We will discuss them when they're ready, but Cadence has a culture of partnering. For example, we partner with MATLAB, National Instruments, AWS, Green Hills, and others. We will continue to look for win-win partnerships going forward.

Jay Vleeschhouwer, Analyst, Griffin Securities

Got it. Thanks Anirudh.

Operator, Operator

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

Gal Munda, Analyst, Berenberg

Hi, thanks for taking my questions. First, in terms of the strong margin outperformance again, thinking about the rest of the year — John, you mentioned hiring and investments — how much of the margin performance sustainability is due to inability to hire and invest as much as you'd like versus top-line driving additional scale? If that makes sense.

John Wall, Senior Vice President and Chief Financial Officer

Great question Gal. We're back on track with hiring and our hiring performance has been good — recognition as a top workplace helps. On margin, it's really outperformance on the revenue side across all lines of business. We expected IP to have a soft middle to the year and recover toward the end; they recovered earlier and had a strong finish to Q3. Hardware demand is strong and software lines are performing well. Over a contract cycle on a three-year CAGR basis, we continue to see accelerated revenue growth. On operating leverage, we're delighted with the performance. The second half of the year included some one-time items like an early retirement program, but if you take out one-time things, we're operating near the guide given for the year, which is about 37%.

Gal Munda, Analyst, Berenberg

Gotcha. And as a follow-up on the top line, you touched on supply chain issues. You said royalties slightly down from last year. Is there a way to quantify how much demand is being limited by supply, versus demand being simply higher than supply?

John Wall, Senior Vice President and Chief Financial Officer

There's a very small impact to us. The majority of our revenue comes from the design side. The chip capacity constraints impact production, which affects royalty revenue. Last year royalty revenue for Cadence was around $50 million; this year it's slightly lower than $50 million, but we'd expect that to recover next year. So the impact is very small. On the hardware side, we're happy with our supply chain and inventory is growing a little bit. We moved from just-in-time to just-in-case inventory management, so we carry more inventory and feel well protected for the next few quarters.

Gal Munda, Analyst, Berenberg

Right. Just to clarify, the royalties being slightly down from last year is consistent with what you said earlier?

John Wall, Senior Vice President and Chief Financial Officer

That's right. Our IP business is a mix of licensing and royalty business, and chip capacity constraints from last year can feed into unit production this year and royalties are slightly down, but it's a very small impact on our overall numbers.

Gal Munda, Analyst, Berenberg

Thank you so much.

Operator, Operator

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

Gary Mobley, Analyst, Wells Fargo Securities

Hey, guys. Congrats on the leadership transition. I wanted to ask about the X2 and Z2 products and the step-function increase in processing power they facilitate. My understanding is they allow customers to bring up hardware and in parallel bring up software. Can you give a sense of the magnitude of how this increases the potential dollar opportunity with each customer engagement or how it improves your available market with this software bring-up capability? Thank you and a follow-up.

Anirudh Devgan, President

Yes Gary, that's a great question. You're absolutely right — Protium X2 along with Palladium Z2 expands our reach into software bring-up by having a consistent front end. This quarter we also launched Helium for similar reasons. With these platforms, you can run RTL and hybrid models, enabling early software bring-up. Historically, Cadence did very well in RTL with Palladium, but the market is growing more in software bring-up. Now with the combination of Palladium, Protium and Helium, we're addressing a much larger opportunity. It's difficult to quantify precisely, but at a high level the market opportunity can be roughly 1.5X to 2X larger once you combine software and hardware bring-up together. It will take several years to fully realize, but these products meaningfully expand Cadence's opportunity.

Gary Mobley, Analyst, Wells Fargo Securities

I appreciate that Anirudh. Perhaps this is for John: navigating China export restrictions — can you give a sense of whether it is harder or easier to obtain licenses to serve customers in China, and what the puts and takes are for China revenue growth as we sit here in the second half of fiscal 2021?

John Wall, Senior Vice President and Chief Financial Officer

Gary, good question. When I look at China revenue, it's easier to look over a two-year period because last year had pandemic impacts. On track for 2021, it's roughly a 30% CAGR in China since 2019. We're working through export controls and comply with all export control regulations. The situation is fluid and we continuously monitor it. Our outlook assumes the current export limitations remain in place. If there are changes, we'd reassess our outlook. We'll provide more detail for 2022 when we give year-end results in February.

Gary Mobley, Analyst, Wells Fargo Securities

Thanks, John.

Operator, Operator

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

Tom Diffely, Analyst, D.A. Davidson

Yes. Good afternoon and thanks for taking my question. Lip-Bu, I've been around the last 12 years; the stock has gone from $6 to $167 — impressive — I look forward to seeing it go to $4,000 over the next 12 to 13 years. A question on the supply chain from a different angle: what are you seeing in terms of capacity at the foundries? Are you taking steps to diversify foundry activity from either geographic or company-specific reasons?

Anirudh Devgan, President

That's a good question. We are more on the design side, serving customers as they continue to design. We work with all major foundries in the U.S. and Asia and have healthy relationships with them. We are encouraged to see more investment in the U.S. Overall, we are active with all major foundries and hope to continue that.

Tom Diffely, Analyst, D.A. Davidson

I was wondering more about the manufacturing of the chips that you design and build and put in your Palladium systems — what are you seeing there?

Anirudh Devgan, President

Got it. The current set of Palladium systems includes many chips; some we buy and some we make ourselves. The ones we make are manufactured by TSMC, one of the leading foundries, and we continue to work with them. We are designing new systems, including the next generation Z2, and we look at all foundries, but overall we are very happy with our foundry partners for the Palladium Z2 system.

Tom Diffely, Analyst, D.A. Davidson

Okay. Great. And are you seeing an impact from COVID in any of the regions you operate in from a manpower point of view?

Anirudh Devgan, President

It's fair to say the impact was greater a few months ago. We still have impacts and many employees work from home in several parts of the world. We're slowly opening some offices. India had a big impact a few months ago, which has thankfully improved. We're working through it. Our return to work was delayed a bit because of the Delta variant. We hope to ramp that up early next year, but other than that, no new major developments in the last three months.

Tom Diffely, Analyst, D.A. Davidson

Great, thank you Anirudh.

Operator, Operator

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

John Pitzer, Analyst, Credit Suisse

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 Anirudh, is really on that three-year CAGR acceleration. 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 two years in the midst of a global pandemic. Street consensus for next year has growth back to high single digits. You talked earlier about demand outstripping supply. Do you think these double-digit CAGRs are here to stay? To what extent is this the fruits of your SAM expansion efforts versus dynamics of the core business?

John Wall, Senior Vice President and Chief Financial Officer

Great question. Given our revenue model — 85% to 90% recurring — I wouldn't expect dramatic changes in our three-year CAGR. When we calculate three-year CAGRs by the end of 2022, we'll include 2020 and 2021. You shouldn't expect dramatic swings. That said, we've seen a step-up over the last few years and it's pleasing to see continued acceleration; we're now around 11.5%. We will refrain from discussing 2022 until after Q4, but we're very pleased with how the business is performing, and because of the recurring nature of our revenue, the three-year CAGR tends to be stable.

John Pitzer, Analyst, Credit Suisse

That's helpful. Anirudh, relatedly, there's increased government interest in regionalizing semiconductor supply and incentivizing domestic IP and R&D. How do you think acts like the U.S. chips act or similar EU legislation could impact Cadence?

Anirudh Devgan, President

Good point. We're eagerly awaiting details. The chips acts include funding for manufacturing and also R&D, and it's not just hardware; IP and software are critical to enable these themes. We're optimistic about investments in different parts of the world. As there is more investment in the U.S. and Europe, it's systematically positive for Cadence. We have a strong portfolio across multiple geographies, so increased design investment globally is positive for us.

John Pitzer, Analyst, Credit Suisse

Perfect. Thanks, guys.

Operator, Operator

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

Charles Shi, Analyst, Needham & Company

Hi. Good afternoon. Thank you for taking my question. You mentioned Integrity 3D-IC being the industry's first and only comprehensive platform for 3D-IC, but a competitor recently called their product a complete end-to-end solution. How should we reconcile the two different claims around competing products? Also, your competitor announced a strategic collaboration with TSMC. We didn't see a similar press release from Cadence ahead of TSMC's innovation platform forum. Can you comment on Integrity 3D versus competing platforms and your positioning/progress?

Anirudh Devgan, President

Thank you. In terms of Integrity, we are confident in our position. 3D-IC is not one single thing; it is a combination of many technologies. Some 3D-IC systems are more package-based, some are more digital technology-based. Cadence brings a unique combination: leadership in packaging with Allegro, analog with Virtuoso, digital with Innovus, and analysis tools with Clarity and Celsius, all integrated and best of class. We're confident in our position and the response we've received. Regarding TSMC, they are a great partner of Cadence. We work with them on a variety of things, including Integrity 3D-IC. For example, one leading mobile customer executed a 3D-IC project with us and TSMC, using Celsius for silicon thermal validation. 3D-IC is growing and requires multiple products and flows; we are confident in where we stand.

Charles Shi, Analyst, Needham & Company

Thank you, Anirudh. Second question — not sure if this has been asked — about Intel's foundry and IDM strategy. Any thoughts on how Cadence can support Intel’s turnaround efforts over the coming years? If you don't want to be customer-specific, maybe comment at an industry level?

Anirudh Devgan, President

We're glad to do more with Intel. They announced foundry initiatives and programs, and publicly Randhir, Head of Intel Foundry, has said that along with customers and ecosystem partners, including Cadence, Synopsys and others, they will bolster the domestic semiconductor supply chain. That is an official position from Intel, and we are glad to participate and support as appropriate.

Charles Shi, Analyst, Needham & Company

Thank you.

Operator, Operator

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

Vivek Arya, Analyst, Bank of America

Thanks for taking my question, and congrats and best wishes to Lip-Bu and Anirudh. First, on your NUMECA and Pointwise acquisitions and the expansion into System Analysis and CFD, could you give a sense how big that is today, how big it can be over the next one to two years, and when that starts becoming accretive to the 11.5% growth model?

John Wall, Senior Vice President and Chief Financial Officer

We are very pleased with the M&A integration for NUMECA and Pointwise. They are not hugely significant from a revenue standpoint right now, but we would expect them to be accretive next year.

Vivek Arya, Analyst, Bank of America

Got it. And a follow-up: John, you mentioned some higher costs in Q4; are these one-off costs or do they become baseline for OpEx going into next year?

John Wall, Senior Vice President and Chief Financial Officer

Great question. I expect slightly higher costs in Q4 versus Q3 partly due to catch-up in hiring in Q3. Anyone hired in the second half of Q3 will have a full quarter of expense in Q4 where you didn’t have a full quarter of expense in Q3. Secondly, I expect a little more in commission costs because we expect bookings to be stronger in Q4; finishing the year with a stronger RPO than we started will add commission expense. We also have slightly higher T&E impact than forecasted. That said, I feel very good about continuing operating leverage. We have delivered more than 50% incremental margins for five years in a row. As long as we deliver incremental margins of over 50%, operating leverage should continue to rise.

Vivek Arya, Analyst, Bank of America

Got it. Thanks very much.

Operator, Operator

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

Lip-Bu Tan, Chief Executive Officer

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 market. We are proud of the innovative and inclusive culture that we have built at Cadence and are grateful for the recognitions we’ve received over the years, including most recently being named as One of the World’s Best Workplaces for the sixth time by Fortune and Great Place to Work, as well as being named to Newsweek’s List of Most Loved Workplaces for 2021. 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, Operator

Thank you for participating in today's Cadence third quarter 2021 earnings conference call. This concludes today's call. You may now disconnect.