Earnings Call Transcript - CDNS Q2 2025

Operator, Operator

Ladies and gentlemen, good afternoon. My name is Abby, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Cadence Second Quarter 2025 Earnings Conference Call. Thank you. And I will now turn the call over to Richard Gu, Vice President of Investor Relations for Cadence. Please go ahead.

Richard Gu, Vice President of Investor Relations

Thank you, operator. I'd like to welcome everyone to our second quarter of 2025 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 as well as the impact of our DOJ and BIS settlements. 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, all financial measures discussed on this call are non-GAAP unless otherwise specified. The non-GAAP measures 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, I would ask that you observe a limit of one question only. If time permits, you can requeue with additional questions. Now I'll turn the call over to Anirudh.

Anirudh Devgan, President and Chief Executive Officer

Thank you, Richard. Good afternoon, everyone, and thank you for joining us today. Cadence delivered exceptional financial results for the second quarter of 2025, exceeding our Q2 revenue and EPS guidance driven by ongoing broad-based strength across our AI-driven product portfolio. Bookings were stronger than expected, highlighting the strategic relevance of our AI-driven portfolio and the depth of our customer relationships. Demand for our technologies continues to grow, driven by customers embracing our products at scale, and we are raising our financial outlook for the year to 13% revenue growth and 16% EPS growth for 2025. John will provide more details on both our Q2 results and the updated outlook. We continue executing to our intelligent system design strategy initiated in 2018, which remains a clear differentiator in a rapidly evolving landscape. Our early investments delivering to our vision of unified EDA, IP, 3D-IC, PCB and system analysis are paying off. These capabilities are enabling us to lead through the accelerating waves of the AI super cycle from AI infrastructure build-out to physical AI in autonomous systems to the emerging frontier of sciences AI. Customer R&D investments remain robust, particularly as AI drives exponential design complexity, such as in advanced node design and complex system architectures. And this is translating into broad-based demand across our portfolio. Embedding Agentic AI into our design platforms across core EDA, system design and system simulation workflows enables the evolution from traditional tool-based flows to autonomous goal-driven agents. Our Cadence AI portfolio powered by multiple autonomous silicon agents and built on our unified JedAI platform, with NVIDIA accelerated compute is delivering optimized designs and massive efficiency gains for our customers. At CadenceLIVE 2025, we introduced the new Millennium M2000 AI supercomputer featuring NVIDIA Blackwell, delivering AI accelerated simulation at unprecedented speed and scale across engineering and science workloads. This tightly co-optimized hardware/software full system stack delivers up to 80x higher performance and up to 20x lower power versus traditional CPU-based systems. Multiple customers provided endorsements, including Ascendance, MediaTek and Treeline Biosciences. In Q2, we furthered our long-standing partnership with ADI through a broad proliferation of our core EDA software, including AI-driven Cadence Cerebrus and Verisium solutions as well as system software across PCB, advanced packaging, and system analysis. Also in Q2, we deepened our partnership with SK Hynix through a broad expansion of our EDA software, system software and design IP solutions. A major semiconductor company meaningfully expanded its relationship with Cadence in Q2 through a broad proliferation of our EDA, IP and SDA portfolio. We continued the strong momentum in our IP business, delivering more than 25% year-over-year growth in Q2, driven by product strength and a broadening silicon solutions portfolio. AI and HPC use cases spearheaded the strong demand for our IP offerings with advanced technologies such as HBM4 and 224-gig SerDes, notching key wins for scale-up and scale-out in the AI infrastructure space. We built on our strategic collaboration with emerging advanced foundry as they awarded us a large deal in Q2 for our leading HBM4 solution. We introduced the industry's first LPDDR6 memory IP offering up to 50% higher performance to meet the growing memory and capacity needs of AI LLMs and Agentic AI workloads. At CadenceLIVE 2025, we launched the Cadence Tensilica NeuroEdge 130 AI Co-Processor to accelerate physical AI applications. In Q2, a market-shaping wireless technology company selected Tensilica HiFi 5s as the standardized audio solution for its music and voice platforms. Our core EDA revenue grew 16% year-over-year in Q2. Further proliferation of our digital full flow at the most advanced nodes continued, and more than 50% of advanced nodes designs using our implementation solutions are now using Cadence Cerebrus. In Q2, we launched Cadence Cerebrus AI Studio, the industry's first Agentic AI, multi-block and multiuser SoC design platform. This technology delivering up to 20% PPA improvement while accelerating chip delivery time by 5x to 10x was endorsed by Samsung and STMicroelectronics at launch. Renesas successfully used our Pegasus physical verification solution to sign off an advanced node SoC after it demonstrated a significant throughput advantage. Our industry-leading Palladium Z3 and Protium X3 platforms accelerated their momentum, delivering outstanding results with Q2 being the best revenue quarter ever for our hardware systems. Demand for hardware was strong and broad-based, driven by AI, HPC and automotive customers. Our verification software suite that includes Verisium, Xcelium and Jasper and leverages big data and AI to optimize verification workloads saw continued expansion with 27 new logos in Q2. Building upon 30 years of industry leadership, we launched the Virtuoso Studio 25.1 release, offering broad support for RF, photonics, mixed signal and advanced heterogeneous designs. Our leading Spectre X circuit simulator closed several deals with strong growth, while our FastSPICE circuit FX platform has now been adopted by the top 3 memory companies. Our system design and analysis business delivered another standout quarter with 35% year-over-year revenue growth. On the packaging front, there was strong customer uptake of our 3D-IC technology, and top foundries and semi customers embraced our AI-driven advanced substrate router, which provides tremendous productivity benefits. Our AI-driven Allegro X PCB design platform saw continued proliferation as multiple aerospace and defense, hyperscale and EV customers took advantage of the platform's meaningful productivity and next-generation capabilities. Our Clarity and Celsius solvers saw significant expansion at a major hyperscaler, and Clarity secured a key win at a marquee AI company, while our reality data center digital twin drove strong growth at a top hyperscaler. Finally, I'm pleased to share that we have entered into a settlement with the U.S. Department of Justice and the U.S. Department of Commerce's Bureau of Industry and Security that resolved the previously disclosed investigations into certain transactions with customers in China that occurred between 2015 and 2021. The settlement represents a mutually acceptable path forward for all parties, and we believe it is in the best interest of our customers, partners, and shareholders. I want to emphasize that Cadence is deeply committed to the highest standards of compliance, and we have significantly enhanced our compliance processes over the last few years and continue to implement improvement measures to proactively address evolving trade restrictions. We remain focused on delivering for our customers and shareholders and executing the clear strategy we have laid out to drive innovation and enhanced value creation. In summary, I'm delighted with our Q2 results and the continued momentum across our broad and innovative portfolio. The AI-driven era presents tremendous opportunity, and the co-optimization of our comprehensive EDA and SDA portfolio with accelerated computing and Gen AI uniquely positions us to deliver breakthrough solutions across a wide range of markets. Now I will turn it over to John to provide more details on the Q2 results and our updated 2025 outlook.

John M. Wall, Senior Vice President and Chief Financial Officer

Thanks, Anirudh, and good afternoon, everyone. I'm pleased to report that Cadence delivered excellent results for the second quarter of 2025 with broad-based momentum across all of our businesses. Strength in other regions more than offset the impact of the export restrictions on China outlined in the BIS letter dated May 23, which was later rescinded. Robust design activity and customer demand, coupled with our strong execution, drove 20% revenue growth and 29% non-GAAP EPS growth year-over-year for Q2. Here are some of the financial highlights from the second quarter, starting with the P&L. Total revenue was $1.275 billion. GAAP operating margin was 19%, and non-GAAP operating margin was 42.8%, and GAAP EPS was $0.59 with non-GAAP EPS $1.65. Next, turning to the balance sheet and cash flow. Cash balance at quarter-end was $2.823 billion, while the principal value of debt outstanding was $2.5 billion. Operating cash flow was $378 million. DSOs were 51 days, and we used $175 million to repurchase Cadence shares. Before I provide our updated outlook, I'd like to share what's embedded. As Anirudh mentioned, I'm pleased that we've reached a settlement with the DOJ and BIS, resolving previously disclosed investigations into certain China sales from 2015 to 2021, totaling approximately $45 million over the 6-year period. As part of the agreements, we will make a payment of approximately $141 million in our third fiscal quarter. Please see our Form 8-K, which includes additional details regarding the terms of the agreements. On July 4, 2025, the One Big Beautiful Bill Act was enacted in the United States. This act includes the restoration of favorable tax treatment for certain business provisions, including the immediate expensing of United States research and development expenditures. We expect it to decrease Cadence's United States federal tax payments for the remainder of fiscal 2025 by approximately $140 million. Our updated outlook includes the timing of the settlement penalty, the cash tax benefit of the OBBBA and the usual assumption that export control regulations that exist today remain substantially similar for the remainder of the year. Our updated outlook for 2025 is revenue in the range of $5.21 billion to $5.27 billion, GAAP operating margin in the range of 28.5% to 29.5%; non-GAAP operating margin in the range of 43.5% to 44.5% GAAP EPS in the range of $3.97 to $4.07. Non-GAAP EPS in the range of $6.85 to $6.95. Operating cash flow in the range of $1.65 billion to $1.75 billion, and we expect to use at least 50% of our annual free cash flow to repurchase Cadence shares. With that in mind, for Q3, we expect revenue in the range of $1.305 billion to $1.335 billion, GAAP operating margin in the range of 32% to 33% non-GAAP operating margin in the range of 45% to 46% GAAP EPS in the range of $1.14 to $1.20 and non-GAAP EPS in the range of $1.75 to $1.81. As usual, we 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'm pleased with our strong first half results and the robust pipeline for the second half of the year. At the midpoint, we now expect revenue growth of 13% and non-GAAP operating margin of 44% for the year. 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

As a courtesy to all participants, we ask that you limit yourself to one question. Our first question comes from Joseph Vruwink with Baird.

Joseph D. Vruwink, Analyst

I wanted to ask a question on physical AI. It seems like over the past quarter or so, many of your key development partners have had more to say around what they're doing with edge devices or even small language models maybe as a means to enabling physical AI. Is this factoring into the bookings strength you've seen recently? And is it maybe leading to more spend or different spend with Cadence just in terms of the tools that this is going to need versus what the initial build-out of AI infrastructure has meant?

Anirudh Devgan, President and Chief Executive Officer

Yes, Joe, it's a great question. And first of all, I'm very pleased by our results and our performance and the demand for our products, which is broad-based. Also, I believe there is overall optimism in the benefits of AI in our customers, both from what they can do with their own products and also how they can use AI internally. Therefore, they are investing more in their innovation and given the critical nature of our products, investing more in Cadence. Now it has several aspects to it. I have been a big fan of physical AI for a long time because one unique advantage we have in Cadence is the privilege to work with all the top companies in the world. Of course, AI infrastructure is huge, but physical AI has the potential of being even bigger, then followed by sciences AI. That's why we have laid out this 3-phase evolution of AI. If you look in the marketplace, autonomous cars or robots and drones are becoming much more public. Our advantage is that even though these things might come out later, customers start investing in R&D before they come out in public. Physical AI will play a very key role for our products because the silicon required for physical AI is fundamentally different than data center silicon. The simulation and design are also different, and the AI models themselves are different. Even if the inference for an autonomous car runs on the car, the actual AI model is trained on the data center. Physical AI is creating new opportunities for us, and it is emphasizing the importance of AI infrastructure in the data centers. We are benefiting from this movement as we are working with all the major AI data center players as they design chips and systems. The impact is observed on both the data center side and the edge side. Overall, the customer environment feels significantly better than it was six months ago.

Operator, Operator

And our next question comes from the line of Gianmarco Conti with Deutsche Bank.

Gianmarco Paolo Conti, Analyst

Firstly, congrats on another amazing quarter. Simply, what led to Cadence's increase in the growth outlook, even though you could not recognize one month of China revenue? I guess the curiosity is whether there was a single stack of renewals across EDA or was this across all fronts? And maybe you can give us more comment on backlog and the development throughout the year.

John M. Wall, Senior Vice President and Chief Financial Officer

Yes, Gianmarco, great question. It's been an interesting quarter. China accounted for 9% of our revenue in Q2, down from 11% in Q1. However, we've seen strong demand across all geographies, and strength in other regions more than offset any near-term softness related to China during Q2. We've stressed before how well diversified our customer base is. We're seeing significant growth in bookings from AI, HPC and system design workloads globally. We're very pleased with the way backlog ended up at the end of Q2, which was stronger than we expected going into the quarter despite all the restrictions. And yes, we are very pleased with our positioning halfway through the year.

Anirudh Devgan, President and Chief Executive Officer

No, John, that's right. Overall, the demand is broad-based, as reflected in all the results of our three main lines of business. Hardware is performing phenomenally well. We had a record quarter in terms of revenue, and we have a clear lead in hardware. Additionally, we are essential to all the major AI chips being designed using Palladium and our EDA software. All these agentic AI tools like Cerebrus AI Studio are performing phenomenally well, along with Verisium and Allegro X. The software and hardware business is excelling in core EDA. The IP business also had a great quarter due to the AI infrastructure build-out, and at least four major companies are working with advanced node foundries now, including TSMC and Samsung. If you look at all the three main areas, I feel we are strongly positioned and the market itself seems to be improving with the AI super cycle.

Operator, Operator

And our next question comes from the line of Vivek Arya with Bank of America.

Vivek Arya, Analyst

Just a near and a longer-term China impact question. On the near term, how much of a headwind was China in Q2? I know, John, you mentioned they went from 11% to 9%, but what was kind of the expectation? Then if we zoom out for all of 2025, I think in the past you had said China sales were expected to be flat year-on-year. Is that still the right approach because that would still imply quite a bit of a lift in the back half? And then Anirudh, if we look longer term, what is the right China exposure for Cadence? Does it naturally just come down over time? Or will it probably stay at this 9%, 10%, 11% kind of range over the longer term?

John M. Wall, Senior Vice President and Chief Financial Officer

Yes, Vivek, I'll start because I understand your question. I view our outlook for China to be optimistic but prudent. Our guidance reflects what we believe to be a prudent and well-calibrated view of the second half of the year. The export control environment is dynamic. While we've incorporated the current regulatory framework into our assumptions, we always add some prudence to account for potential variability, whether geopolitical or operational. But we're very pleased with how China is performing. In the last quarter, we anticipated it would remain flat, but it's hard to see how China won't increase a little bit over last year, while we've been prudent with our guidance.

Anirudh Devgan, President and Chief Executive Officer

Long term, I think China will continue to invest in chip design and system design, just like all geographies. The percentage of revenue may be similar or might decrease a little, not because China won't do well, but because the rest of the world is performing phenomenally well. The significant investments are being observed in the U.S. and regions such as Japan and Korea. We witnessed this in Q2 as well, where there was significant investment. Although it's difficult to predict exactly what China will do moving forward, it is good to see that it is performing positively, while the rest of the world is doing even better.

Operator, Operator

And our next question comes from the line of Harlan Sur with JPMorgan.

Harlan L. Sur, Analyst

Great job on the quarterly execution. If I look at many of the AI xPU, ASIC, and merchant chip design programs that are in development right now, many of them are looking to transition from 2.5D to 3.5D advanced packaging architectures, which includes chip stacking. Many of these programs are going to start taping out in the second half of this year. In some cases, your customers are integrating up to 10 chips in a single package. Wondering how much is this contributing to the bookings and revenue strength as more of your customers are adopting your Integrity 3D-IC or your Allegro X advanced packaging platforms to tackle these challenges of 3.5D packaging? How much is advanced packaging roughly contributing to your overall revenues?

Anirudh Devgan, President and Chief Executive Officer

Yes, Harlan, that's a great question and a great observation. The whole industry, especially in HPC and AI, is moving to chiplet-based architectures. It's not just limited to data centers; other markets are also moving towards new packaging architecture. Cadence is uniquely positioned. Our Allegro platform is the choice for package design, and 3D-IC is another way of discussing package design. At the same time, we have Virtuoso for analog, Innovus for digital, and all the system analysis tools like Clarity and Voltus. Our Integrity platform had been designed with TSMC, which has done a great job in 3D-IC flow, and we've been working closely with TSMC for several years. We are working with other foundries like Rapidus and Samsung to develop new 3D-IC flows that are critical for the foundries. While we don't explicitly call out Allegro in our SDA business, it forms a significant part of that business and pulls in other products such as analysis tools and base tools like Virtuoso and Innovus. It is the platform of choice for all major companies as they implement new 3D-IC technologies. This is only at the beginning; even TSMC's roadmap indicates this will increase. We are pushing on both dimensions: maintaining alignment with the latest technologies and expanding into 3D-IC and heterogeneous integration.

Operator, Operator

And our next question comes from the line of Lee Simpson with Morgan Stanley.

Lee John Simpson, Analyst

Well done on another great quarter. I think it falls to me to maybe ask about the Agentic systems. I know this is the second quarter you're mentioning it. Development appears to be moving ahead, and I'm assuming you're seeing some early sales, likely in pilot line development. But I'm trying to put this into perspective. Do we need a new business model or a different go-to-market strategy to realize the full value here? More generally, how will you monetize the added value that an Agentic system will bring to customers? Any thoughts around that and potentially timing as well because it looks like this still relies on early-stage reasoning models.

Anirudh Devgan, President and Chief Executive Officer

Yes, Lee, that's a good question. As you know, we package them separately from our base tools. Our base tools are exceptional. However, we have these Agentic workflows on top of our base tools, and customers are enthusiastically embracing both. A couple of great examples include Cerebrus. By itself, over 50% of designs are already using Cerebrus, which we can label as classical AI. However, with Cerebrus AI Studio, it represents an entire workflow. This means that instead of just conducting block implementation, it also handles floor planning and timing closure. What a designer could previously accomplish on 3 million to 5 million instances of design, now they can manage 30 million to 50 million instances. The product has been adopted by major players like Samsung and ST. On the other side, we are also focused on LLMs generating code for RTL. These areas are both promising. We engage with customers on the traditional toolset versus the Agentic AI flow, and our history in EDA positions us well to deliver measurable value. The workload is continually increasing. Our goal is to align with customers to provide more automation. Our focus is on measuring productivity improvements which will lead to increased adoption.

Operator, Operator

And our next question comes from the line of Jim Schneider with Goldman Sachs.

James Edward Schneider, Analyst

I was wondering if you could talk a little more about the core EDA results, which were very strong in the quarter with significant growth. Can you cite some of the drivers behind that strength, be it new customers, pricing benefits from Cerebrus, or anything else that might be one-time in nature? Additionally, can you provide a sense of how you expect core EDA revenue to trend in the back half of this year?

Anirudh Devgan, President and Chief Executive Officer

Core EDA is performing phenomenally well. Just to remind everyone, we have the broadest portfolio in core EDA. We lead in digital, particularly in the TSMC ecosystem, while Virtuoso is the de facto standard in analog mixed signal. Our verification software tools and platforms like Palladium and Protium also contribute greatly. Cadence has the most comprehensive EDA portfolio available. With the ongoing adoption of AI, we see strength in both our core product portfolio and AI-driven agents. Some of the key customer wins include SK Hynix, which is doing exceptionally well with AI and HBM, as well as our long-term partner ADI. The hardware strength was broad-based, with advancements seen in both IP and systems, which are outside of EDA. Although there could be variations from individual quarters, I believe that EDA is doing well, and I expect growth moving forward.

John M. Wall, Senior Vice President and Chief Financial Officer

Yes. Jim, we're experiencing proliferation at marquee customers, and the second half appears particularly strong for both software and hardware in core EDA.

Operator, Operator

And our next question comes from the line of Jason Celino with KeyBanc Capital Markets.

Jason Vincent Celino, Analyst

John, if I think I heard you correctly, you mentioned that China would be up a little bit this year compared to flat previously. Given this is on top of the observations of the China restrictions that were temporary, this seems significant. If you could indulge us a bit, what do you think China growth could have been if those restrictions never happened?

John M. Wall, Senior Vice President and Chief Financial Officer

Yes, Jason, great question. It's challenging to determine what revenue would have been in a situation without those restrictions. I find comfort in knowing that the restrictions came and went. The strong performance across all businesses and geographies suggests it is hard to maintain a flat outlook for China. Given the current trends, it's difficult to see how China won't increase a little bit over last year, but we've remained cautious and thoughtful in our expectations.

Operator, Operator

And our next question comes from the line of Gary Mobley with Loop Capital.

Gary Wade Mobley, Analyst

John, when we entered the year, your expectation was for a strong renewal period in the second half. Clearly, your bookings in the first half have exceeded expectations, potentially by several hundred million dollars. My questions are two-fold: Could you confirm that the June quarter-ending backlog excludes China? Additionally, with the first half's strength, what does that indicate about the potential for second-half bookings and exiting the year with record levels of backlog?

John M. Wall, Senior Vice President and Chief Financial Officer

Yes, Gary, great question. To confirm, we had to exclude a number of China bookings from our backlog at the end of Q2 to reserve for those. Thus, the closing backlog at the end of Q2 reflects a lower level than it would have been had those restrictions been lifted before June 30. Regarding the year outlook, I am confident we will end the year with a higher backlog than we started with. I am optimistic that we'll see a book-to-bill ratio greater than 1, especially as the renewal cycle remains strong in Q3 and Q4. I expect to see bookings in Q3 and Q4 exceed our revenue for those quarters, leading to a record level of backlog by year-end.

Operator, Operator

And our next question comes from the line of Jay Vleeschhouwer with Griffin Securities.

Jay Vleeschhouwer, Analyst

Anirudh, you spoke earlier regarding Agentic AI and I'd like to ask about its broader implications and requirements. This year, orchestration has been significantly discussed in software, including EDA. If we consider that what you're providing with Agentic AI is fundamentally a type of simulation, what does that necessitate in terms of new processes, data management and traceability from a simulation perspective? Beyond the introduction of these agents and aids, how are you considering the broader capabilities that need to be provided to customers, especially regarding their workflows?

Anirudh Devgan, President and Chief Executive Officer

Yes, Jay, that's a great point. We aim to create more automated workflows, as I mentioned with Cerebrus AI Studio. It’s not just a point function; it handles multiple tasks together with reasoning. This requires a robust data structure or database to track all actions taken. I'm delighted with the customer response to JedAI, our joint enterprise data and AI platform. It features data storage for capturing multiple tools and flows, akin to how a human would operate. JedAI's flexibility allows some customers to opt for on-prem solutions due to data sensitivity, while others may prefer a cloud-based system. This unique positioning allows us to seamlessly integrate our platform into existing workflows, providing substantial value through automation to customers.

Operator, Operator

And our next question comes from the line of Joe Quatrochi with Wells Fargo.

Joseph Michael Quatrochi, Analyst

Just to follow up on the question regarding the China impact, could you clarify what RPO would have been without the restrictions? Also, for the entire year guide increase, is this solely attributable to the upside in China or do other regions contribute as well?

John M. Wall, Senior Vice President and Chief Financial Officer

Yes, Joe, to address the second question first: the increase is due to strong performance across all geographies. The guidance we've provided reflects this comprehensive performance. The revenue impact of the pause in China bookings has been accounted for, and our RPO figures will reflect these adjustments. Overall, I expect we will exit the year with a higher backlog and a book-to-bill ratio above 1, driven mainly by strength from across all regions and a high level of renewal activity in Q3 and Q4.

Operator, Operator

And our next question comes from the line of Charles Shi with Needham.

Yu Shi, Analyst

This is probably for John. I understand that you reported recurring revenue as a percentage in Q2 was 78%, probably a multi-year low. What is your full-year expectation for that and a normalized long-term level? As a related question, I believe your hardware is primarily manufactured in the U.S., implying no direct tariff impact. Did you observe any customer behavior-driven pull-ins in Q2 and possibly also in Q3?

John M. Wall, Senior Vice President and Chief Financial Officer

Yes, Charles, great questions. Demand for hardware continues to be impressive. We produce systems in North America for our local market and abroad for international demand, so our tariff exposure remains limited. Overall, the strength in hardware combined with paused revenue in China led to the recurring revenue percentage dipping to 78% for this quarter. Typically, we aim for about an 80% recurring and 20% upfront split, and I expect this ratio will stabilize around 80-20 moving forward, as we are seeing strong growth across our software. We are delighted with the ongoing adoption from our customers.

Operator, Operator

And our next question comes from the line of Ruben Roy with Stifel.

Ruben Roy, Analyst

Anirudh, I'd like to revisit the IP segment. Traditionally, IP has shown some volatility in performance. However, recently, you've reported significant strength with an increase of 30% last year, 40% last quarter, and another 25% this quarter. You mentioned a broadening portfolio, but it seems much of this success is tied to AI and HPC. What is your longer-term perspective on IP growth? Is it sustainable at potentially higher rates than historically?

Anirudh Devgan, President and Chief Executive Officer

Yes, that's a great question. Overall, I have become much more optimistic about IP than I was two to three years ago. Several factors contribute to this outlook. We are investing more in IP now because we feel our EDA position is strong. Previously, we didn't invest as much, but the emergence of chiplet-based architectures has create more opportunities for IP. The growth in advanced node foundries, with at least four major ones now, also provides increased IP opportunities. Our portfolio has improved through valuable M&A, such as acquiring HBM4 from Rambus. I believe we have crossed a critical mass for IP to become a robust business for us. You're witnessing it this year. While one year doesn't establish a trend, I believe IP can grow faster than Cadence's average in the long term, even though it may hold slightly lower margins than EDA. We aim for our rule of 40, as we're continuously investing here, especially with the rise of AI-driven IPs.

Operator, Operator

And our next question comes from the line of Clarke Jeffries with Piper Sandler.

William Clarke Jeffries, Analyst

Could you clarify on the tax benefits? I heard $140 million for the remainder of the year. Is that for two quarters, indicating the annualized benefit might be close to double that? From a philosophy perspective, does this change around R&D expensing change your willingness for incremental investments, or is it a near-term windfall without change to appetite?

John M. Wall, Senior Vice President and Chief Financial Officer

Clarke, that is correct. We expect the cash tax impact of approximately $140 million before the end of this year, which will be reflected in Q4. However, it doesn't alter our non-GAAP effective tax rate, which will continue to be at 16.5% this year. Our strategy regarding R&D investment remains unchanged. We continue to love investing in R&D; we do it quite well, and the change in tax consequences won't influence our growth strategy.

Operator, Operator

And our next question comes from Joshua Tilton with Wolfe Research.

Joshua Alexander Tilton, Analyst

Congrats on a great quarter and a nice raise to the full-year outlook. Most of my questions have been answered already. So, maybe more of a medium-term thought question. When you look at the guide for the full year, it still implies that the recurring revenue side of the business will see muted growth. I know some of this is due to revenue pauses in China. What’s the long-term trajectory look like for recurring revenue growth? How confident are you in total growth durability as possibly you roll off the hardware cycle or start to see slower growth on the upfront side?

John M. Wall, Senior Vice President and Chief Financial Officer

Great question. Over the last few years, we have witnessed a drift towards a lower level of recurring revenue, with a higher level of upfront revenue. This shift is primarily due to faster growth rates in IP and hardware compared to our average. Currently trending at an 80% recurring and 20% upfront split, this ratio has been stable, and I believe it will continue for a while as we see strong growth in core EDA. So the observed shift in recurring revenue reflects nuances in how our customers consume our technology and how we provide our solutions, and we remain optimistic about our overall growth potential.

Operator, Operator

And our next question comes from Nay Soe Naing with Berenberg.

Nay Soe Naing, Analyst

Congrats on the quarter and the full-year guide raise. I wanted to ask about Agentic AI. Could you share your thoughts on what the toughest adoption barriers might be? From my standpoint, the ROI for Agentic AI products should not be a sticking point, so I wonder if it might be operational challenges or some human element where there is concern about job security as the technology is adopted?

Anirudh Devgan, President and Chief Executive Officer

Yes, very insightful question. I want to emphasize that engineering software or EDA has already been significantly automated over the years, long before AI came into play. Our customers have grown accustomed to automation, and we have seen productivity improve tremendously. Looking ahead, our customer's workloads are increasing exponentially due to Moore's Law and 3D-IC demand. This discrepancy in their staffing won't accommodate expected workload growth, so customers are turning to AI and automation. Given the productivity demands, our customers are keen to invest in R&D but do not wish to increase headcounts by 30-fold. Thus, we expect to see customer adoption driven by the need for better productivity solutions. This will help bridge the gap, as we focus on delivering considerable productivity gained with AI-driven agents. Meeting these productivity expectations will be our primary test, and if we can deliver on those metrics, customers will be inclined to adopt.

Operator, Operator

And our last question comes from the line of Blair Abernethy with Rosenblatt.

Blair Harold Abernethy, Analyst

Great quarter. Anirudh, I want to ask again about system design analysis, including traditional simulation and multiphysics simulation. You're significantly outpacing the market, even accounting for extra months from Data CAE, yielding mid- to high 20% organic growth. What drives that organic growth? Is Millennium contributing? Looking ahead, how sustainable do you think that growth trend will be in comparison to the overall 10% growth market?

Anirudh Devgan, President and Chief Executive Officer

Yes, great question. The growth is driven by several factors. Firstly, the strengths in Allegro and 3D-IC design are key factors. Disruption is occurring very close to chips and in data center simulation, which is aligned with our strategic initiatives in Cadence Reality, focusing on full data center simulation, as well as Allegro and 3D-IC design. This targeted focus allows us to outpace the rest of the system market, where growth is projected to be slower. Furthermore, BETA is assisting in channel expansion, which is a channel challenge we faced in the system space. Moreover, Millennium is an exciting area that is still in the early stages, with a lot of demand and a significant pipeline, contributing to our momentum. However, we should be cautious as these expectations unfold and keep our sights on sustainable growth in systems. Thank you all for joining us this afternoon. It's an exciting time for Cadence with strong business momentum and growing opportunities with semiconductor and system customers. With a world-class employee base, we continue delivering to our innovation roadmap and working hard to delight our customers and partners. On behalf of our Board of Directors, we thank our customers, partners, and investors for their continued trust and confidence in Cadence.

Operator, Operator

And ladies and gentlemen, thank you for participating in today's Cadence Second Quarter 2025 Earnings Conference Call. This concludes today's call, and you may now disconnect.