Earnings Call Transcript - CDNS Q3 2023

Operator, Operator

Good afternoon. My name is Bo, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence Third Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' prepared 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.

Richard Gu, Vice President of Investor Relations

Thank you, operator. I would like to welcome everyone to our third quarter of 2023 earnings conference call. I'm joined today by Anirudh Devgan, President and Chief Executive Officer; and John Wall, Senior Vice President and Chief Financial Officer. The webcast of this call and a copy of today's prepared remarks will be available on our website at 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. Reconciliations of GAAP to non-GAAP measures are included in today's earnings release. For the Q&A session today, we'd ask that you observe a limit of one question and one follow-up. Now, I will turn the call over to Anirudh.

Anirudh Devgan, President and CEO

Thank you, Richard. Good afternoon, everyone, and thank you for joining us today. I'm pleased to report that Cadence delivered strong results for the third quarter of 2023. We exceeded our Q3 guidance on all key metrics and are raising our outlook for 2023. John will provide more details on our financials shortly. Notwithstanding the macro uncertainties, design activity remains strong, driven by transformative generational trends such as AI, hyperscale computing, 5G and autonomous driving. Growing hyperconvergence between electrical and mechanical domains, systems and semis, and hardware and software, is driving the need for tightly integrated co-design and analysis solutions. Additionally, trends such as a growing number of 3D-IC and chiplet designs, and system companies building custom silicon, are accelerating. In this rapidly evolving design landscape, the relevance of AI-driven design automation cannot be overstated, as it's enabling customers to accelerate their pace of innovation while enabling them to meet their targets more efficiently. Over the past few years, we focused initially on incorporating powerful AI algorithms in our core engines, and then built our Generative AI solutions on top of our software platforms. We are seeing growing momentum for our comprehensive JedAI Generative AI platform, with an increasing number of customers adopting these solutions, achieving exceptional quality of results and productivity gains. While still in the early stages, sales of our GenAI solutions have nearly tripled in the last year. Our solutions are enabling marquee AI infrastructure platform companies to deliver their next-generation compute, networking, and memory products. Last quarter, we had referenced our successes with NVIDIA and Tesla. And this quarter, we're pleased to announce that Broadcom has accelerated the adoption of Cadence Cerebrus across multiple business units, achieving impressive quality of results. In Q3, we pioneered leveraging GenAI's LLM capabilities to chip design, successfully collaborating with Renesas on accelerating functional specification to final design. This is a key step in demonstrating the potential of LLMs to automate the translation of natural language specifications to final chip design and verification tasks, thereby boosting their quality and efficiency. We also renewed and deepened collaborations with some large semi and systems customers in the 5G, AI, hyperscale and connectivity areas. For instance, we strengthened our long-standing partnership with a global marquee systems company through a significant expansion of our EDA software, hardware, design IP and system solutions. As the digital transformation in aerospace and defense accelerates, we continued our momentum by enhancing our core EDA and systems footprint with several customers, including at two market-shaping companies. Now let me share some of the business highlights starting with Digital IC. With 11 new wins, our digital full flow delivering industry leading quality of results at the most advanced nodes, continued proliferating with market-shaping customers. We are very pleased with the accelerating momentum of our flagship Cadence Cerebrus GenAI solution, whose transformative results have led to its deployment at all of our top 10 digital customers and in about 300 tapeouts to date. Imagination Technologies used Cadence Cerebrus and our digital full flow on its latest 5-nanometer GPU design in the cloud, to achieve a 20% reduction in leakage power. Next, I will talk about our Functional Verification business, which had another strong quarter with 18% year-over-year revenue growth. Ever-growing system design complexity coupled with the need for first-time-right silicon, continued to drive strong demand for our Palladium Z2 and Protium X2 hardware platforms that provide industry-leading system verification and software bring-up capabilities. Our hardware business had a record Q3 with close to half of the hardware orders including both platforms. Highlights for the quarter included a major dynamic duo expansion with a top AI and automotive chip supplier, and a significant deal with a market-shaping datacenter chip company. Our flagship Custom IC business continued to pave the way in analog innovation, delivering 15% year-over-year revenue growth. We're pleased with the reception to our AI-driven Virtuoso Studio solution as several marquee customers adopt it for their N2 and N3 designs, and it has close to a thousand downloads since its launch six months ago. And Nisshinbo Micro Devices utilized the Virtuoso Studio Custom IC design platform to gain a 30% reduction in turnaround time for routing analog blocks. In Q3, we continued investing in our IP business and closed the acquisition of the Rambus PHY IP assets. Customer reception has been overwhelmingly positive to the addition of their HBM and GDDR IP to our Star Design IP portfolio. Design IP had a record bookings quarter with strong AI and chiplet design activity, especially in the mobile, automotive and hyperscaler verticals. In addition, we launched our Tensilica Neo NPU IP and NeuroWeave software tools to accelerate on-device and edge AI performance. Our System Design and Analysis business that is driving our expansion beyond EDA continued to deliver strong growth, increasing revenue by 20% year-over-year. On the PCB front, Allegro X AI has several successful engagements with market-shaping customers underway, and we announced OrCAD X, our next-generation AI-driven PCB Design solution, enabled by Cadence OnCloud, and targeting small and medium businesses. Our Fidelity CFD platform continued its strong momentum with customers in automotive, aerospace and defense and industrial verticals. In summary, I'm pleased with our team's continued innovation and execution. We're well positioned to benefit from the tremendous opportunities ahead, as we help customers design their differentiated products with improved quality of results, productivity and shorter time to market. I did want to take a moment to comment on the unfolding conflict in the Middle East. The ongoing violence and the loss of innocent lives is truly heartbreaking and a matter of global concern. The wellbeing of our employees and their families in the region is of utmost importance to us, and we'll continue doing everything we can to support them. Our thoughts are with everyone who has family, friends and loved ones there and we are helping out by providing humanitarian aid through the Cadence Giving Foundation. John will now go through the Q3 results and present our Q4 and updated 2023 outlook.

John Wall, Senior Vice President and CFO

Thanks, Anirudh, and good afternoon, everyone. I am pleased to report that Cadence delivered another strong quarter of top- and bottom-line results in Q3. All businesses contributed to revenue growth, and we completed more hardware installations in Q3 than we originally assumed. Here are some of the financial highlights from the third quarter, starting with the P&L. Total revenue was $1.023 billion. GAAP operating margin was 28.6%, and non-GAAP operating margin was 41.1%. GAAP EPS was $0.93, and non-GAAP EPS was $1.26. Next, turning to the balance sheet and cash flow. Cash balance at quarter-end was $962 million, while the principal value of debt outstanding was $650 million. Operating cash flow was $396 million. And we used $125 million to repurchase Cadence shares in Q3. Before I provide our updated outlook, I'd like to highlight that our outlook contains the usual assumption that export control regulations existing today remain substantially similar for the remainder of the year. Our updated outlook for fiscal 2023 is revenue in the range of $4.06 billion to $4.1 billion. GAAP operating margin in the range of 30.5% to 31%. Non-GAAP operating margin in the range of 41.5% to 42%. GAAP EPS in the range of $3.48 to $3.54. Non-GAAP EPS in the range of $5.07 to $5.13. Operating cash flow in the range of $1.3 billion to $1.4 billion, and we expect to use at least 50% of our annual free cash flow to repurchase Cadence shares. As a result, for Q4, we expect revenue in the range of $1.039 billion to $1.079 billion. GAAP operating margin of approximately 31%. Non-GAAP operating margin of approximately 42%. GAAP EPS in the range of $0.85 to $0.91. Non-GAAP EPS in the range of $1.30 to $1.36, and we expect to use approximately $125 million of cash to repurchase Cadence shares. As usual, we've published a CFO Commentary document on our Investor Relations website, which includes our outlook for additional items, as well as further analysis and GAAP to Non-GAAP reconciliations. In summary, we are on track to deliver a strong 2023. I am pleased with our team's continued execution of our Intelligent System Design strategy. With our updated outlook for 2023, at the midpoint, we now expect: revenue growth of approximately 15%; non-GAAP operating margin of approximately 41.75%, a seventh consecutive year of greater than 50% incremental operating margin; and non-GAAP EPS of $5.10, a sixth consecutive year of high-teen or better non-GAAP EPS growth. As always, I'd like to close by thanking our customers, partners, and our employees for their continued support. And with that, operator, we will now take questions.

Operator, Operator

Thank you. And your first question comes from Charles Shi at Needham.

Charles Shi, Analyst

Hey, good afternoon. Thanks for taking my question. I want to ask you a little bit about the backlog. It looks like your backlog compared with last quarter was up. I mean, the September quarter kind of implies very good bookings for September quarter. Just want to ask, do you see the backlog will continue to grow into the year-end? Because you talked about the second half booking strength. I want to see where it goes from here. Thank you.

John Wall, Senior Vice President and CFO

Yeah, Charles, thanks for the question, and thanks for remembering what we said last quarter. Yeah, we expect a very strong second half for bookings, and Q4 is exceptionally strong. But — so, our expectations for bookings are very, very strong in Q4.

Charles Shi, Analyst

Thanks. Maybe I want to ask a quick follow-up. You raised your full year revenue outlook a little bit less than you beat the Q3 in terms of revenue. It kind of implies that your full year outlook you provided one quarter ago was largely accurate, but there seems to be some timing shift for the revenue, I mean, pulling in from Q4 to Q3. Was that related to your comment about hardware installation, the timing of that? Thank you.

John Wall, Senior Vice President and CFO

That's right, Charles. In hindsight now, I was a little too prudent in the Q3 guide with respect to hardware installations that were scheduled in China around the end of September. If you recall in our guide, we assumed that those installations would fall into Q4. In actual fact, we completed those hardware installations, and the second half looks stronger than we thought this time last quarter. But even with all of those hardware, we kind of beat our expectations in Q3 and Q4 is higher than we thought.

Operator, Operator

Thank you. We go next now to Gianmarco Conti at Deutsche Bank.

Gianmarco Conti, Analyst

Yeah. Hi, thank you for taking my questions. I guess my first one would be, when do you expect to be giving out more AI KPIs, whether on contract value uplift or penetration rates, or just, like, any color you can provide us on how can we quantify the AI tailwind in your numbers, and whether we are going to see this coming through in bookings sometime? Thank you.

Anirudh Devgan, President and CEO

Yeah. Hi, it's Anirudh. Let me take that. So, like we mentioned in the prepared remarks, we are seeing a lot of activity in AI. And that's from multiple customers and multiple verticals. So, whether it's the system company designing their own chips, or, of course, the semiconductor companies designing it, or we mentioned this time, for example, Broadcom, which helps other companies design it. So, we are participating in the AI design process in all three ways. And last time we talked about NVIDIA and Tesla. And then, on top of that, it's also applying AI to our own products. We have these extra generative AI products on top of our base products that also drive revenue. So, the first part, which is build out of the AI infrastructure, whether it's with large semi companies like NVIDIA, or large system companies like Tesla, or companies like Broadcom, that’s a big part of our business. We don't break that out specifically because it's sometimes difficult to figure out exactly what part of the customers' business is AI or not, and we don't want to be in that kind of to try to guess what part of our customers are using it for. But AI is a significant portion of design activity and the buildout that's going to happen for years. Now there's a second part of our business in which we are selling AI products ourselves, like Cerebrus and Verisium and our JedAI platform, which has five main products. In that segment, if our own software products and IP products are AI-enabled, we did comment that even though it's early in the process, our revenue from our own AI products has almost tripled from a year ago. So, we are very pleased with that progress. I just want to highlight that, and also say there's another part of AI, which is the buildout of infrastructure, which is more difficult to predict.

John Wall, Senior Vice President and CFO

And Gian, I would just add to that when Anirudh calls out that the revenue from those products has almost tripled in the space of 12 months, we're not reclassifying any revenue. This is direct revenue attributable to those five products that we have in our JedAI platform.

Gianmarco Conti, Analyst

Thank you. I have a follow-up regarding China. Can you share any insights on the impact of the entity list and the new regulations? Additionally, do you have any visibility into whether Chinese customers are focusing on designing at more mature or advanced nodes? There seems to be ongoing discussion about tracking the usage of EDA tools in China for different node types. Any information on this would be appreciated. Thank you.

Anirudh Devgan, President and CEO

Yes, that's a good question because there were a lot of recent reports on some of the changes in regulation. For us, there's not that much difference. Most of the regulations were targeted at some chip companies or manufacturing companies. As you know, we are in the design process. So those regulations, the latest round doesn't have a big effect on Cadence's business. Now there are some companies added to the entity list, so we monitor that carefully. But since we are so diversified geographically and in terms of customers, that's not a significant impact either. And all our guidance that we just gave includes the impact of all these regulations that were announced recently. And of course, we carefully follow all U.S. regulations, but the latest change is not that material to our business.

Gianmarco Conti, Analyst

Okay, thank you.

Operator, Operator

Thank you. We'll go next now to Harlan Sur at JPMorgan.

Harlan Sur, Analyst

Good afternoon. Thanks for taking my question. Macro conditions in the semiconductor industry are still fairly muted, right? We're close to a cyclical bottom, but recovery seems more gradual than expected across many different end markets, right? Accelerated computing, AI are strong. Auto, industrial, enterprise service provider market is still relatively soft. So, across some metrics that you track, renewals, hardware buys, IP take rates, is the team seeing any signs of hesitation or pushouts across your different customers or different businesses?

Anirudh Devgan, President and CEO

Yeah, Harlan, that's a good question. Like we mentioned last time, we still see a lot of strong design activity. Compared to like three months ago, I would say the activity is similar. Like you mentioned, some segments are going through tough times, and then some segments like accelerated compute and AI have a lot of growth. But overall, as you know, these products that our customers are designing take several years to develop, and we are part of the R&D cycle. So, what we see is the customers still investing in R&D or building their products for the future, and we are glad to partner with them. So, I think I would say that largely, the environment is similar to what it was like three months ago.

John Wall, Senior Vice President and CFO

Yeah, absolutely. And on the hardware side, we're producing hardware as fast as we were all year. And you can see in our 10-Q that we filed today that the value of finished goods and our inventory was less than $10 million at the end of the quarter in Q3. So, the demand is really strong still, and we're just producing the hardware as quickly as we can. We're expecting a very strong Q4 as well for our IP group. I mean, they're delivering a number of silicon solutions to our customers in Q4. And I think that sets up a really strong quarter for that group, but we were expecting that all year.

Harlan Sur, Analyst

Yeah. No, I appreciate the comments there. One of your large AI SoC customers recently laid out their future road maps, right? And given the complexity of all these next-generation AI compute workloads, they're actually accelerating their chip road maps, so new GPU chip every year versus every two years, which was their prior cadence. And then on top of that, they're starting to segment their product lines, right? So, not only accelerating road maps but more chips per product family. I've got to believe that other competitors in this space are doing exactly the same thing. Are you guys seeing the step-up in design activity? Obviously, much higher productivity is required. So, how is this all being reflected in the business momentum and your visibility?

Anirudh Devgan, President and CEO

Yeah, good point. I mean, like you said earlier, the macro environment is challenging, especially, some of the segments are weaker, while some are stronger. But design activity is very strong. Especially, I would say, in two verticals for the future of the semi and the system business, and at least the two very, very strong verticals in terms of design activity, are data center and AI, and automotive, given the electrification and the massive transformation that's happening. So, if you look at the next three to four years, these two segments will grow significantly: the whole AI-driven data centers and automotive. Because they are growing so—first of all, the cadence of those end customer products is increasing, and they need to be more and more efficient given the design activity and complexity increasing. So, there is more design activity and also use of AI to accelerate and be more productive. We are fortunate to work with leading companies in these sectors. So, I expect that to continue.

Harlan Sur, Analyst

Yeah. Well, thank you.

Operator, Operator

Thank you. We go next now to Gary Mobley at Wells Fargo.

Gary Mobley, Analyst

Hey, guys, thanks for taking my question. John, your upfront license revenue year-to-date has averaged around 17%. I think typically, it's 15%. Given where you're at in the verification hardware product cycles, Z2 and X2 and the conversion of the backlog there, how do you see that upfront revenue trending looking into next year? And related to that, how would you see the influence on overall growth next year?

John Wall, Senior Vice President and CFO

Yeah, great question, Gary. I mean, we're always watching that carefully. As you know, last year, the upfront piece ticked up to 15%. This year, I think in the 10-Q, if you look over a rolling four-quarter basis till the end of Q3, it's at 16% now, but I think your point is closer to 17% for the first three quarters. That's a reflection of the strength of hardware. On the ratable and recurring part of the business, although that's 84% of the trailing 12-month revenue, if you look at our guide, we're assuming essentially about a 13% growth rate on a current revenue line for the year, but that's consistent with like over a three-year CAGR basis is about 13% as well. Of course, we're not guiding next year.

Gary Mobley, Analyst

Understood. All right. I suspect that we're not going to get any more AI metrics out of you, Anirudh, but maybe if you can just give us a sense of where we're at in the commercialization of the five different AI tools? Have those started working their way into the baseline license renewals? Or are they still on a per design basis that maybe gives us a sense of where you expect them to cut into baseline licensing activity?

Anirudh Devgan, President and CEO

Yeah, Gary, that's a good point. We are watching that carefully, of course. As you know, these JedAI and these five major platforms or new products that our customers should engage with us on run on top of our existing leading platforms. It depends on the customers. I would still say we are still in the early stages of the adoption of these AI products because, as you know, any of these new software tools take years to fully deploy. This typically happens in digital or with major platform releases. Even though we are like two years into it, I think it will still take some time to fully deploy these products. What we have said in the past is typically, at least in my experience with digital like about seven, eight years ago, it took like two contract cycles for them to fully deploy. So, that’s still three to four years to go. Now, it depends on the customer. Some customers are adopting them in a much bigger way, especially with the new AI design or hyperscalers, and there is an improved cadence of design activity. So, just as a general statement, while we're seeing broader engagement, the deployment might differ among customers. We have seen some remarkable results.

John Wall, Senior Vice President and CFO

Just to clarify, the contribution from acquisitions is likely to be immaterial for this year. So, the strong Q4 that we're expecting is really from organic business.

Gary Mobley, Analyst

Thank you, both.

Operator, Operator

Thank you. We go next now to Jay Vleeschhouwer at Griffin Securities.

Jay Vleeschhouwer, Analyst

Thank you. Good evening. For my first question, I'd like to ask a variant of the EDA market environment question. On the one hand, what are you seeing in terms of unscheduled new business, that is to say, intra-contract new or expansion business that could be construed positively? On the other hand, how concerned are you about the evident deceleration of semi R&D growth? It's still reasonably good, better than four or five years ago, but so much lower than it's been. A lot of that can be attributable to Intel. But still, how are you thinking about those two different dynamics? And then I'll ask a follow-up.

Anirudh Devgan, President and CEO

Yeah, hi, Jay. Good question. I mean, we are watching it carefully. Like you said, design activity is still strong. But of course, the macro environment is challenging. Even though the customers realize they need to invest in R&D for the future, if the revenue is impacted because of macro situations, those decisions become a lot more prudent. So, this is just a natural business process. In general, the large customers in the big segments are still investing in R&D, and design activity is still strong. We had a good Q3 in terms of bookings, as we mentioned. So, we'll see what happens in Q4, and that will also give us a better idea going forward.

John Wall, Senior Vice President and CFO

Jay, as you know, a lot of our customers come back and purchase add-ons during the course of their baseline contracts and with the teams releasing significantly new business — new products from the different R&D groups — customers have an intent to come back and keep purchasing. So, they don't wait for the baseline renewal to come up or to expire to purchase them, they'll purchase add-ons and a few licenses, and hopefully proliferate more on the contract renewal. We have a lot of contracts that come up for renewal in Q4.

Jay Vleeschhouwer, Analyst

Understood. For a follow-up, I'll ask about some interesting Cadence management comments at last month's Cadence Live event up in Boston. There was an interesting comment about the role of AI as 'derisking schedules' in addition to the design exploration use case. What’s interesting is that historically, schedule risk or completion risk has to do more towards the back end of the process, for example, physical verification. To the extent that more of that risk mitigation moves up earlier in the process, do you think that there will be a spending share shift within the totality of EDA spend, perhaps some from the back end, more towards the front end where you play with a lot of your tools?

Anirudh Devgan, President and CEO

Hey, Jay, I would say that it should lead to more design activity if we are able to reduce risk in the design process. As you know, this is the history of EDA, even for the last 20 to 30 years. I remember in the old days in the '90s, it would take like five years and 500 engineers to design some big chip. Now that takes six to 12 months and, with fewer engineers, we are seeing significant improvements. AI can provide the next level of improvement in productivity and risk mitigation. Part of it is also risk mitigation. So, I think this can lead to more design activity, especially for the system company. The back-end design process still requires a lot of work, so I think it will affect both front-end and back-end. Our goal is to make the design easier, so more customers can take on these challenges.

Jay Vleeschhouwer, Analyst

Thank you, Anirudh.

Operator, Operator

Thank you. We go next now to Jason Celino at KeyBanc Capital Markets.

Jason Celino, Analyst

Great. Thanks for taking my question. Maybe first for John, on the Q4 guide. Apologies for asking this again, but folks might be wondering tomorrow why aren't we seeing more upside to the guide for the fourth quarter? Because where might be some conservatism or what way will you be overlooking in terms of the setup?

John Wall, Senior Vice President and CFO

Yeah, Jason, as you know, your question probably emanates from the fact that we beat by $23 million in Q3 and raised by $10 million, but that was mainly due to a prudent guide for Q3 with respect to certain hardware installations. I think overall, we've taken the quarter up, or the year up by $10 million at the midpoint. Because it's expected to be a strong bookings quarter and a particularly strong quarter for our IP Silicon Solutions group, I think if there's upside, it'll probably come from that group.

Jason Celino, Analyst

Okay. No, that's fair. And then just my quick follow-up on backlog. I know you've got some weird comps because of the hardware stuff. But when might we see year-over-year growth again? Or I guess if we stripped out the hardware-related backlog, I don't know if there's any way to share what type of growth you might be seeing?

John Wall, Senior Vice President and CFO

Yeah. I think just to give you a bit of color on that, I think if you recall, at the end of last year, our backlog included about 28 weeks of lead time on hardware. I think we're down to an eight to 10 week range now on the lead time for hardware. So, of course, we've eaten some backlog as a result of that. But I think we troughed out essentially in the middle of the year. We're expecting the second half to be stronger for contract renewals, because the number of contracts expired in the second half. In Q3, you saw backlog starting to tick back up again. We'd expect it to tick back up again in Q4 because we have a strong bookings quarter, or we're expecting a strong bookings quarter. The one I'd look for is the annual value of backlog at the end of this year, with the annual value of backlog at the end of last year. The thing to remember is the fact that there’ll be less hardware in it, I would expect because we have the production capacity to deliver.

Jason Celino, Analyst

Okay. Perfect. No, it's super helpful. Thank you.

Operator, Operator

We go next now to Vivek Arya at Bank of America.

Vivek Arya, Analyst

Thanks for taking my question. I appreciate it's early for a '24 outlook, but Anirudh, I was hoping that you could give us some color given that your model is 85% recurring. Conceptually, what is the likelihood Cadence can maintain this kind of mid-teens growth rate? And what would make '24 different or similar to '23 from a growth perspective?

Anirudh Devgan, President and CEO

Hi, Vivek. As in Q3, we don't provide insights on the upcoming year. We are focused on completing this year and evaluating what Q4 looks like, after which we will be happy to share our assessment during the February earnings call. This approach has served us well in the past.

Vivek Arya, Analyst

Okay. On the IP side, I think John, you mentioned that you're expecting a strong quarter for IP in Q4. I was wondering how much would your two recent acquisitions contribute to that? And just longer term, do you think IP has a category over or undergrows the EDA? And does that influence your growth prospects? Both kind of near- and longer-term question on the IP business.

John Wall, Senior Vice President and CFO

Let me take the first part of that, and then I'll hand it over to Anirudh for the second part. I think in relation to the IP business, we're expecting a strong Q4 for that group. If you look at the guide we've given for the year, we're essentially guiding to 14% to 15% revenue growth for the year, with Q4 over Q4 growing between 15% and 20%. That's due to the strength of our IP business in Q4.

Anirudh Devgan, President and CEO

More customers are outsourcing their IP needs, and we have consistently engaged in that space. Our aim is to build a highly profitable IP portfolio. The profitability of our IP business has seen improvement over the past few years, and we are generally pleased with it. We are exploring other areas for growth while maintaining profitability. Notably, the emerging areas of chiplet-based design and 3D-IC are becoming significant, especially for AI and hyperscaler applications. This is why we acquired the PHY assets from Rambus, which include HBM and GDDR based IP. I believe our IP portfolio is now aligned with the right sectors. The automotive and hyperscaler markets, along with AI IP, are increasingly adopting chiplet-based and 3D-IC designs, which introduce new IPs like UCIe. Consequently, we are increasing our investment in our IP business, as you have seen, and we anticipate a strong Q4, followed by assessment for 2024.

John Wall, Senior Vice President and CFO

Just to clarify, the contribution from acquisitions is likely to be immaterial for this year. So, the strong Q4 that we're expecting is really from organic business.

Vivek Arya, Analyst

Thank you.

Operator, Operator

Thank you. We go next now to Ruben Roy at Stifel.

Ruben Roy, Analyst

Thank you. Anirudh, I wanted to ask if you could talk a little bit more in detail about the collaboration with Renesas and kind of incorporating Generative AI LLM into chip design. I think you mentioned some expectations for quality improvement, efficiency improvement. I would think that longer term, you'd be thinking about productivity improvement as well. Are those milestones that you're expecting to have answers about within the next year or two? It sounds like this is sort of a longer-term collaboration and testing going on today. Just wondering about your thinking about timeframe in terms of incorporating some of these types of tools into chip design. Along with that, just the final part is, would you consider this a leading-edge design that Renesas is working on? Or if you could talk a little about the type of design, that'd be great. Thank you.

Anirudh Devgan, President and CEO

Yes, absolutely. We are very pleased with the collaboration with Renesas. They have a whole initiative regarding AI for their design process, and we are glad to be a close partner with Renesas as we are with other companies. I think they are using almost all of our AI tools, including Cerebrus for digital or Verification, Verisium and other tools. We are also doing new collaboration with them on LLM. It can be applied to any, especially, given Renesas has a range of design from advanced node to mainstream nodes. One significant benefit of AI is that the quality of the results can improve productivity. But there are other benefits, particularly for companies like Renesas. Large companies often have geographically diverse teams. If the AI tool is the same or better than your best team, you get improvements across locations. Moreover, less experienced engineers can function almost as effectively as more experienced ones, leading to broad-based productivity improvements. Companies that adopt these AI tools faster often outperform their peers, and Renesas is a prime example of that.

Ruben Roy, Analyst

That's very helpful. Thanks for all that detail, Anirudh. I guess just a quick follow-up. I mean, it sounds from what you're saying, this should be incremental. I mean, EDA has grown nicely. If you look at the core EDA growth over the last several years, you guys like to call out the three-year CAGR. From what's going on here, we should assume that this would be incremental on sort of the way you've seen EDA growth. Can you comment on that as you think about whether it's software renewals or adding add-ons, as John talked about, over the next 12, 18, 24 months, would you say this would be incremental to the mid-teens growth that EDA tools have been growing at over the last three years or so?

John Wall, Senior Vice President and CFO

Well, I would comment on that. I think our style at Cadence is to be patient with our customers, and we'll go at the pace that they're ready. As Anirudh said earlier in the call, we expect to proliferate our AI tools across our entire customer base over about two contract cycles. Some are adopting more rapidly and embracing the AI tools. Some are adopting the AI tools in add-ons, but they might be shaving back their configuration somewhere else. That tends to be a false economy, because they’ll just come back and purchase more add-ons later. It typically takes a couple of contract cycles, but we're very pleased with the start we've made.

Ruben Roy, Analyst

It's very helpful. Thank you, John.

Operator, Operator

Thank you. We go next now to Josh Tilton at Wolfe Research.

Josh Tilton, Analyst

Hey, guys, thanks for squeezing me in. Can you hear me?

Anirudh Devgan, President and CEO

Clear.

Josh Tilton, Analyst

Great. My first question is just how does the Q4 hardware pipeline look compared to kind of some of the strength that you saw in the first three quarters of the year? And given that you mentioned that the macro is still challenging, is there any extra conservatism in the Q4 guide to account for the potential for maybe some hardware to slip into next year?

John Wall, Senior Vice President and CFO

Yeah, that's a great question. The pipeline is very strong. The hardware demand just continues to amaze me. Those products are — that verification group is just performing at a really, really high level and in such a consistent fashion through probably eight quarters now. But — so very pleased with that. You might've noticed that we kept the same range on the guide from last Q3 — from Q3 the same range, because we thought there was probably a broader kind of a range of potential outcomes with the amount of business that we expect to sign in Q4. We're expecting a strong booking quarter in Q4, and there is a strong pipeline for hardware. If something slips from Q4 to Q1, it goes from this year to next year or vice versa, you could have stuff that customers are planning to buy in Q1 happening in Q4 as well. We've accounted for that in the guidance. Everything we know is in our guidance.

Josh Tilton, Analyst

Super helpful. And then, just a follow-up. Obviously, on AI, I can't not touch it. But as that business of yours triples, are you seeing the drive or the want to adopt these AI tools cause more of your users to make full flow decisions when maybe this has been more of a best of breed market historically?

Anirudh Devgan, President and CEO

Yes, absolutely. That's a very good point. Because the AI tools, our AI tools run on the full flow by nature, whether that's digital implementation or it is on verification. And of course, we believe we have best on breed tools anyway on the base. It’s like you have to have the full flow, the basic engines to be best in class, and then add AI on top of them, which is best in class. But it is helping the underlying tools. When our customers are doing more AI tools, it also requires a lot of underlying tools. A run of Cerebrus typically runs on 10 to 20 machines. And those machines could be like 32 CPUs or 16 CPUs. So, customers are using a lot of compute, a lot of underlying licenses, and the use of AI to be more productive.

Josh Tilton, Analyst

Super helpful. Thank you, guys.

Operator, Operator

We go next now to Joe Vruwink at Baird.

Joe Vruwink, Analyst

Great. Hi, everyone. Sorry to belabor the backlog questions, but I suppose I'm going to. If we rewind two years ago and look at 3Q and the 4Q of 2021, current RPO then went up by nearly $400 million sequentially. Is that how you would start to frame just renewal values that are coming to and what you could potentially look to build on? And then, second part of my backlog question, and it gets back to Jason's question on just the changing composition of hardware and software. Given what Cadence has been able to do on production capacity and ramping there, does that change the relationship in terms of what needs to be sitting in backlog at year-end in order to support some sort of next 12 month revenue expectation?

John Wall, Senior Vice President and CFO

Hi, Joe, great questions there. I guess the way you profile last year's growth, a large portion of that growth would have been, of course, the hardware we weren't able to service at the time. The reason I called out the lead times was, end of last year, that backlog and current year or next 12-month backlog contained about 26 to 28 weeks of lead time for hardware. That sounds about eight to 10 weeks now. So, to answer your second question, when you get to the end of this year, because we've ramped up the hardware production, you'll need less in backlog for next year's revenue than there was for this year. We maintained the production levels at the same level all year. So, every quarter, we ratchet it up in Q1, and we’ve maintained that production level to try to reduce those lead times. I think we’ve done well to get it down to a more competitive level.

Joe Vruwink, Analyst

Great. Thanks, John. If I can squeeze one more in, I think we're about to lap the OpenEye acquisition. I just wanted to see how that generally is tracked relative to your original expectations? And maybe just get an update about how Cadence is thinking about the opportunity from the Molecular Sciences group and the role you can play in life sciences looking forward?

Anirudh Devgan, President and CEO

Absolutely. We are excited about molecular design and the future. It's almost like where EDA was maybe 20 years ago. Regarding product strategy, we see a lot of activity across multiple verticals. So, the middle layer is actual software products, whether in EDA design, system simulation, or computational fluid dynamics or molecular simulation. This can be vertically applied using computational hardware and AI orchestration. We see a synergy from our recent acquisition of OpenEye; it gives a critical middle layer of physics-based biological simulation. This can lead to substantial growth in life sciences and the ability to apply AI more broadly. You’re right that it takes time and will be a controlled investment, but we see significant potential in this area.

Joe Vruwink, Analyst

That's great. Thanks very much, Anirudh.

Operator, Operator

Thank you. And our final question comes from Andrew DeGasperi at Berenberg.

Andrew DeGasperi, Analyst

Thanks for fitting me in. Just had two quick ones. I know most of them were answered so far on this call. But first on the margin, maybe could you lay out, John, in terms of the guidance for the year, I know you took down slightly the top end of the range for the operating margin on a non-GAAP basis. Just wondering maybe if you could lay out what the puts and takes are there? Is it revenue mix? Is it the recent acquisitions that you made that might have crystallized that number? And without having to answer the second time, but in terms of investments that you're making for next year, is the pace of all the hiring going to change at all based on what you're seeing right now?

John Wall, Senior Vice President and CFO

Great questions, Andrew. In relation to the margin, the recent acquisitions are more dilutive to this year. We're picking up more expense — we're picking very, very little revenue. We're incurring expenses immediately, which narrowed the range on the margin outcomes for us to 41.75%. I think it works out to about $5.10 on non-GAAP EPS. In relation — what was the second part again?

Andrew DeGasperi, Analyst

No worries. It's just on the terms of hiring, just in terms of how you're thinking about it so far.

John Wall, Senior Vice President and CFO

Yeah, it's great we continue to attract top talent to Cadence. You may notice, in our 10-Q, we did some restructuring plan to better align our resources with our business strategy, incurring about $12 million of costs composed of severance payments and termination benefits in relation to the headcount reductions. I would categorize that as a bit of housekeeping and preparation for next year.

Operator, Operator

Thank you. I'm now going to turn it back over to Anirudh Devgan for closing remarks.

Anirudh Devgan, President and CEO

Thank you all for joining us this afternoon. A strong execution of the intelligent system design strategy and customer-first mindset continue to drive growth as we expand our portfolio with new innovative AI-driven solutions. We are proud of our inclusive culture and focus on enabling sustainable innovation and honored to recently be named to Newsweek's America's Greenest Companies 2024 list. On behalf of our Board of Directors, we thank our customers, partners, and investors for their continued trust and confidence in Cadence. Thank you.

Operator, Operator

Thank you for participating in today's Cadence third quarter 2023 earnings conference call. This does conclude today's call. You may now disconnect.