Cadence Design Systems, Inc.

Good afternoon. My name is Jamaria, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence second quarter 2021 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. Thank you. I will now turn the call over to Alan Lindstrom, Senior Group Director of Investor Relations for Cadence. Please go ahead.

Thank you, Jamyra. I would like to welcome everyone to our second quarter 2021 earnings conference call. I am joined today by Lip Bhutan, Chief Executive Officer, Anirudh Devgn, 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 September 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 uncertainties, actual 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. And by the way, our second quarter 10-Q was filed about 4.15 Eastern time today, so it's out there. 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 this time, and cadence disclaims any obligation to update any forward-looking statements except as required by law. In addition to financial results prepared in accordance with generally accepted accounting principles, or GAAP, we will also present certain non-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 financial results, GAAP financial results, in today's earnings press release. Copies of today's press release dated July 26, 2021, for the quarter ended July 3, 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 Lipu.

Good afternoon, everyone, and thank you for joining us today. Cadence delivered outstanding financial results for the second quarter as broad-based customer demand for our innovative solutions grew stronger than expected revenue growth, profitability, and cash flow. We are significantly raising our financial outlook for the year, highlighted by a $40 million increase in revenue guidance or 10% year-over-year revenue growth. John will provide the details in a moment for both our Q2 results and the updated outlook for the year. Before I get into more details about the quarter, I would like to talk about CEO transition news that we announced earlier this afternoon. We announced Anirudh Deskan, our president, would take over as CEO on December 15, 2021, and our transition to the role of executive chairman at that time. It has been a privilege to serve as the CEO of Cadence for the past 12 plus years. Over that period, I'm very pleased that we instilled a sustainable culture center on leapfrog innovation and customer delight, forged very close partnership with our customers and partners, and built an extremely talented Cadence team of over 9,000 employees. Kaden is now firmly established not just as a top end-to-end EDA provider of choice, but a company that is well on its way in expanding beyond EDA by executing our exciting ISD strategy that tripled our TAM to $30 billion. The Board and I are very excited that Anirudh will become CEO in December. and we cannot think of anyone more uniquely qualified to lead Cadence to even higher heights. He's a proven leader with bold strategic vision, a relentless focus on innovation and execution, and passion for driving customer success. Over the past four years since he became president, Anirudh and I have jointly led the company And the Board and I think this is the right time to execute the next phase of our succession plan and hand over the baton to him. You can expect to see a lot of continuity going forward as we view this transition as more of a formalization of our current responsibilities. As Executive Chairman, I will focus more on new market opportunities, key strategic initiatives, and deepening our relationship with customers and partners and on maximizing shareholder value. And now let me move on to the business highlights. Generation trends such as 5G, hyperscaler, and autonomous vehicles underpin AI, machine learning, and data analytics are accelerating the digital transformation across multiple industries. with semiconductors at its foundation, these trends are driving strong design activity across a growing spectrum of semi and system companies. And we are very well positioned for this to be a sustainable long-term growth driver for us. Delighting customers and accelerating growth require a relentless commitment to innovation. With the launch of the four new products, we have now introduced eight significant innovative products so far this year across all the business groups and will contribute to future growth. We continue to expand our business with market-shaping customers. And our differentiated solution led to a broad-based expansion of our partnership with Samsung, including proliferation of our digital full-flow. It was an outstanding quarter for our digital and sign-off business, with revenue growing 16% year-over-year. Our digital full-flow delivering industry-leading quality of results at the most advanced note, adding 13 new customers that included key competitive displacements by expanding significantly at several market shipping customers. Noteworthy among them were a large US data infrastructure company, further expansion of a marquee US aerospace and defense firm, a major Asia-Pacific hyperscaler, and an exciting AI startup. We have been steadily incorporating cutting-edge AI ML technology into our solutions. And we significantly advance that with last week's introduction of new Cerebus Intelligent Chip Explorer. Cerebus' unique reinforcement learning model increased effectiveness with each use and enables to 20% TPA improvement, and 10x productivity gain. Syribus was endorsed by Samsung and Renesys. And several customers have realized meaningful benefits across multiple process nodes and applications. It was also a great quarter for our verification business with 23% year-over-year revenue growth. Our verification suite comprising of best-in-class engines and delivering the best verification throughput saw continual strong customer adoption and expansion at several leading customers. Circular demand for our hardware continue unabated, leading to best Q2 ever for our Palladium and Protium platforms. There is a robust customer interest in the new Z2 and X2 systems, with sales ramping nicely. Our sales of Z1 and X1 remain strong. Our hardware family had 15 new orders and over 65 repeat orders in the quarter, with the three largest transactions being with hyperscalers, and included our largest 2TM transaction to date, which was for Neo X2. Strong momentum continued for our system design and analysis segment, with 20% year-over-year revenue growth. We expanded our system footprint with multiple verticals, including aerospace and defense, 5G wireless and communications. Growing system complexity for high-frequency applications is driving the needs for an integrated platform solution across system design, simulation, and analysis. As we continue building our system portfolio, we are pleased to see earlier indication of customer increasingly choosing a broader set of our solution across these domains. For instance, in Q2, a large US data infrastructure company make a significant commitment to our PCB, IC packaging, RF, and system analysis solutions. We introduced our next generation PCB and IC packaging design platform, Allegro X, that provides a unified engineering platform incorporating innovative machine learning techniques and delivering up to four-time improvement in overall design team productivity. AWR and Integra have a record quarter, and the integration of our recent Numeca and Pointwise acquisitions is progressing well. We have added several hundred system customers as we enhance our go-to-market and channel organization to help accelerate our business. Next, I want to make a few macro level comments. We continue to monitor the ongoing semiconductor supply chain situation. As I reported last quarter, so far we are not seeing any slowdown in design activity across our customer base. Unfortunately, the COVID-19 pandemic continues to evolve in our unpredictable manner. in an unpredictable manner, with overall progress being threatened by new variants. As always, the health and safety of our employees, customers, and partners is paramount, and we will continue doing what is in their best interest while working closely with local regulatory agencies. Now I will turn it over to Anurag to say a few words.

Thank you, Libbu. I'm very honored and humbled to be appointed the next CEO of Caton. And I'm deeply grateful to the board and Libbu for their confidence in me. I'm also very thankful to Libbu for his mentorship and guidance over the years, and I'm excited to continuing partnering with him in our new roles. Generational industry drivers and rapidly unfolding digital transformation across several industries presents an enormous opportunity for Cadence. And I strongly believe we couldn't be better positioned to seize this opportunity. Our intelligent system design strategy lays out a very exciting growth path as we enhance our portfolio to serve a growing set of customers. Our highly innovative solutions have led to a very strong foundation in core EDN IP and to our early successes in the system and AI ML segments of our strategy as we expand into large, fast-growing adjacencies. I enthusiastically look forward to working with our talented team to accelerate our growth strategy while relentlessly driving to deliver strong business results and delight our customers with breakthrough innovation, execution, and unparalleled support. I also look forward to furthering our collaborations with customers and ecosystem partners and deepening the engagements with you, our valued shareholders. Thank you. And I will now hand it over to John to go over the financial highlights.

Thanks, Anirudh, and congratulations to you and Litboo in your new roles. This is a great day for Cadence. Good afternoon, everyone. I'm pleased to report that we exceeded all of our key financial metrics for the quarter with broad-based demand for our innovative solutions driving stronger than expected revenue growth, profitability, and cash flow. As a result, we are raising our financial outlook for the year across all key metrics. Before getting into the numbers, I'd like to say a particular thank you to our India team As we all know, India was particularly hard hit by the pandemic in Q2, and we are deeply grateful to our India leaders for going above and beyond the call of duty to put people first. We commend them for their heroic work in helping the local relief efforts, and it's reassuring to see the situation in India improve over the past few weeks. Now let's go through the key results for the second quarter, beginning with the P&L. Total revenue was $728 million. Non-GAAP operating margin was 39.5%. GAAP EPS was 56 cents. And non-GAAP EPS was 86 cents. Next, turning to the balance sheet and cash flow, At quarter end, cash totaled $847 million, while the principal value of debt outstanding was $350 million. Operating cash flow for Q2 was $380 million. DSOs were 49 days, and during Q2, we repurchased $220 million of cadence shares. Before I provide our updated outlook for fiscal 2021, I'd like to take a moment to share the assumptions embedded in our outlook. We continue to expect that our new Mecca and Pointwise acquisitions will be slightly dilutive this year before becoming accretive next year. Our hiring plans in the first half were delayed by the COVID situation in India, but our outlook currently assumes we catch up on much of that delayed hiring activity in the second half. Our outlook for the second half includes the cost of salary and promotion increases for the broad employee base. Those salary increases and promotions were generally affected from July 1st. And finally, our outlook assumes there will be no changes to the export limitations that exist today. Embedding these assumptions into our outlook for fiscal We expect revenue in the range of $2.925 to $2.965 billion. Non-GAAP operating margin in the range of 36 to 36.75%. GAAP EPS in the range of $2.15 to $2.21. Non-GAAP EPS in the range of $3.14 to $3.20. Operating cash flow in the range of $925 to $975 million. And we expect to use at least 50% of our free cash flow to repurchase key shares in 2021. For Q3 2021, we expect revenue in the range of $730 to $750 million. Non-GAAP operating margin of approximately 34%. GAAP EPS in the range of $0.48 to $0.50, and non-GAAP EPS in the range of $0.74 to $0.76. 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 conclusion, Cadence delivered another quarter of strong revenue growth and expanding profitability, and we're pleased to raise our outlook for the year. I would like to close by thanking our customers, partners, and our hardworking employees for all that they do, and I'd like to remind them all that their health and safety continues to be our first priority. And with that, operator, we'll now take questions.

At this time, I would like to remind everyone who wants to ask a question to please press star then the number one on your telephone keypad now. Please limit your questions to one question and one follow-up question. Again, please limit your questions to one question and one follow-up question. We will pause for a moment to compile the Q&A roster. Your first question comes from Jay Fleschauer with Griffin Securities.

Thank you. Good evening. Anu, let me start with you and then my follow-up for Vipul. With regard to last week's product announcement of Cerebris, the application of AI and ML to EDA, it would seem fair to say that that's perhaps the most significant methodological advance in EDA since the days of synthesis placing route 20 years or so ago. The question I have for you is Cerebrus extensible to your non-digital businesses, such as custom and PCB, and your new computational software ambitions? And similarly, to the extent that there's a growing design trend towards specialty or domain-specific designs, does Cerebrus have to be tuned to an increasingly specialty chip market. And then for Lipu, the follow-up is, in your keynote last month at Cadence 5, you listed all your market opportunities, such as 5G, IoT, and so forth. Interestingly, you referred to hyperscaler market as, quote, the most exciting. Could you explain why you said that? And was that just circumstance for the Q2, or was that an ongoing view of the world?

Jay, let me start. Thanks for the question. And, you know, we are really truly excited about Cerebrus. I believe Cerebrus is a, you know, fundamental breakthrough using reinforcement learning to basically drive our digital full flow. So, I mean, Gen as you know, with Tempest can give great quality of results, but the designers still, you know, run them and, you know, based on their intuition, run them again and, you know, do the design that way. And Cerebrus can do that, you know, much more in a much more mathematical way to, you know, explore the design options and parameters. And, you know, we announced that last week, as you said, and, you know, some of the results or some of the endorsement, for example, Samsung said they got 8% power improvement, and this could be done in days versus months. And Renesas said that they got 10% improvement in frequencies. So these are definitely very promising results. I mean, it's still early. We are continuing to work with more and more customers. But so far, we are happy with how well Cerebrus is performing. And these are based on fundamental kind of new optimization methods. And one thing I would like to remind you is that we have a lot of expertise in computational software, and a lot of it can be applied to AI. So, you know, it's still early days, and I think these can be definitely applied to other areas. So, for example, we also announced Allegro X a couple of months ago, and that also has new machine learning technology to try and more automate, you know, place and route for PCBs. So I think it's still early days, but we are very pleased by what Cerebrus can do and the application of AIM and in general to EDA and to simulation and system design.

Yeah, Jay, the second question that you have in terms of my keynote on the, we are very excited about this high generation waves that drive a lot of silicon design and activity. And I call it the Silicon Renaissance because I think clearly this five generation are driving a lot of innovation. And one particular one I call out is the hyperscalers. But because, as you know, the data is explosive. And then the hyperscalers, they are really trying to scale their infrastructure in terms of networks, storage. And the workloads have changed. and move towards more in the domain-specific, application-specific application. So there's a lot of different processes required. And that drives a lot of innovation, a lot of design activity. And that fits in very well with our Cadence ISD intelligence system design strategy, that besides the silicon, besides the IP, you move up into the system innovation that ties in very well to Anurut mentioned about this whole system modeling, system analysis, and RF packaging. And all this is going to be a lot of new requirements. And that's why we are very well positioned to capture this opportunity. And it's a double-digit growth opportunity for us.

Your next question is with Gary Mobley with Wells Fargo Securities.

Hey, everybody. Thanks for taking my question. Let me start off by congratulating Labu and Anirudh for all that you've accomplished in your careers at Cadence as a team and as well your next roles. Mike, I want to start with a multi-part question on the backlog metric. It was nice to see the improvement, and I think you were expecting an improvement from where it ended in the first quarter. Might we see some further improvement for the balance of the year in that backlog metric? And to what extent was that backlog metric helped or hurt by, you know, average license terms or, in other words, a duration-adjusted backlog metric? And to what extent has it been, you know, held back by some of your decision back in late 2019, early 2020 to renew some key accounts prior to expirations?

Yeah, Gary, I can take that one. Taking the last part of your question first, I don't think our decision to renew some business early back at the start of 2020 has an impact because typically our customers are on three-year renewal cycles for their base contract. In relation to RPOs, I think that's what you're referring to. RPOs bounce back a little bit. As you recall, Q1 was a light renewals quarter for software. Q2 was a heavier renewals quarter for software. But the annual value of those contracts in Q2 jumped, and that allowed us to raise our guidance for revenue for the year. So all lines of business were performing really well. And I think I said on the last call that We thought that the decline in RPOs in Q1 was a temporary phenomenon that we expected to climb back and improve throughout the year.

Okay. And my second question relates to China. John, I think you mentioned last earnings call that you would expect sort of a normalized level for China-related revenue, about 12% of this year's revenue, which would imply really a low double-digit percent year-over-year decline in your China business revenue. But it trended well in the second quarter. So my question to you is, are you still a little bit cautious with respect to your China revenue this year? Or is that 14% China mix in the second quarter perhaps indicative of where you might land for the full year?

Yeah, I think it's the latter, Gary. I think, you know, we saw a very solid second quarter and an uptick in China business. I was cautious in the first quarter because last year we benefited from higher than average upfront revenue mix in the second half in China. And that contributed to, I mean, close to 70 percent growth last year, which is a really tough comp to lap. So I was being careful with the guide. But now, you know, having seen the strength in Q2, I think one of the sales guys told me that Q2 was the best Q4 we've ever had. And they were really impressed with the strength of bookings that were coming through. But I think we feel much more confident in the region. And there's broad-based strength across all the bookings activity in Q2. So, yeah, I think that the year is probably going to be more like Q2 than Q1.

Thanks for the color.

No worries.

Your next question is with Gal Munda from Barenburg.

Hi. Thank you for taking my questions. So the first one is just kind of touch a little bit on this trend that you've seen on the digital side specifically. You mentioned 30 new customers. You mentioned some competitive displacements. I guess I want to kind of, if you zoom out a little bit and think about what's really driving the growth there, between the competitive displacement and just a very, very healthy design activity in terms of the market. Could you help us understand that?

Hi, this is Anil. I'll take that question. I think your question is regarding the digital and sign-up group growth. Yes, we are very pleased with the digital group performing well. Like Libu mentioned, it grew about 16% from last q2 and i believe you know faster than market and there is a lot of design activity which continues to to you know accelerate especially at the advanced node you know where we do particularly well so we see a lot of design activity at you know increasing at n5 and n3 and you know some early you know work with foundries at n2 so i think the the whole trend of people moving to more advanced nodes is continuing at a strong pace. And I think that helps us in our digital business. And also we are getting more full flow adoption, you know, not just placing route. The full flow means synthesis, placing route, sign off. So customers are more and more comfortable running our entire flow. And that's, again, a trend that we have worked on for a while to give a full integrated flow to our digital customers. And then there are other trends, you know, like 3D IC becoming more prevalent, you know, of course, mixed signal. We are always strong in mixed signal. So overall, we are confident in our digital position. And then on top of that, we can have cerebrals to perform, you know, to give even better results than, you know, just using a regular digital flow. So I think the summary is that the design activity is strong, and we are glad to work with our customers for these designs.

Gotcha. That's very helpful. And then maybe as a follow-up, I don't know, maybe for you, even John, maybe, when I think about kind of the way Q2 came in extremely strong, it enabled you to kind of go, you know, above and beyond the beat in order to kind of raise the guidance for the year. What gives you that confidence is the fact that, you know, we were able to do that at Q1 because of the fact that, you know, there was still a lot of hardware issues have come from last year and stuff, and now you're kind of another three months in and seeing more of it? Or what's behind kind of the thinking to be a little bit more keen to reflect the outperformance in the quarter and beyond in the guidance?

That's a great question, Gal. But, yeah, I can take that. Essentially, the annual value of the contracts that we booked in Q2, in a lot of cases, were significantly higher than the contracts that were expiring. And that gave us great confidence. That, along with, I guess, the visibility into the second half that we have now, that becomes clearer and clearer as you get closer to the start of the second half. But that helps us a lot. I would advise anyone not to look at any one quarter, but maybe focus on the year's numbers. because, you know, the quarter since the pandemic started, the quarters can be distorted. I mean, digital was great, you know, growth this quarter over last Q2 2020. But I would like to remind you that in Q2 2020, we did back out some revenue for expected bad debt. And some of that we later recovered in Q4. So some of the quarters have been a bit distorted. So I've been trying to focus on the year. And when we look at the year, But the annual value of contracts has increased considerably and enough for us to raise the guidance by $40 million at the midpoint for revenue.

That's very clear. Thank you. Thanks.

Your next question is with Jackson Ader from JP Morgan.

Thank you. Can we just touch on the subpoena that was disclosed in the 10-Q? You know, just from reading the language, it sounds like you received it in February. And so I'm just curious, why was it something that was disclosed in this quarter and not in the previous queue? And is that, you know, what kind of risk or whether it's operationally or, you know, any kind of penalties does this really imply?

Yes, that was really just a bit of housework, really, I guess, in terms of the nature of the subpoena became more clear to us during the last quarter, and we wanted to make sure that investors were aware of it. We don't think it's hugely significant, but we wanted to document it in the queue in the interest of full transparency. Okay, fair enough.

And then on the hardware side, out of those, was it 15 new orders and 65 repeat orders of V2, I'm sorry, of hardware orders, how many of those were Z1 X1 versus V2 X2, if we had that breakdown?

Yeah, I think I will let Anuradh answer the question, and I will chip in V2 answers.

Yeah, thanks. That's a good question. So, I mean, we are pretty pleased with the performance of Z2 and X2, palladium and protium, and more and more of our business is transitioning to the new systems, which is Z2 and X2. And we still have, you know, Z1 and X1 still perform well, so we are continuing to sell them depending on the customer situation. But more and more, we are selling the new systems, which are performing well, and And I think John mentioned last time we expect about six months of overlap with the two systems. So it will be a few months into that. So I think that trend will continue, but more of it is the new systems and should be, you know, I would expect by the end of the year, most of it will be the new systems.

Yeah, we're very happy with the X2 and Z2 ramp, and we're building inventory as fast as we can to meet demand. Great.

Okay. Thank you.

Our next question will come from Joe Vrewink with Beard.

Great. Hi, everyone. And first of all, best wishes and congrats to Lipu and Anirudh. You know, just I wouldn't expect, I suppose, much change in the strategy. I think Lipu mentioned continuity. That certainly seems to be the case. But I'll still ask the question, just given the leadership changes, if Maybe you do see an opportunity in particular areas of the business to accelerate what growth has been. Certainly, the product announcement last week on AI-driven design seems to be a big trend, not just for Cadence, but the industry. Are there things like that where, over the next few years, you would expect these to be much bigger contributors and ultimately help accelerate the growth profile of the company?

Yeah, thank you, Joe. And I think I would like to say that Cadence is in a very strong position, right, as you guys see. And I worked closely with Libu over the last four years ever since I became president of the company. And, you know, so there is a lot of continuity going forward. And we are very confident in our intelligent system design strategy. You know, I'm a big believer that – Computational software is our core strength. EDA has done that for decades. And this is the right time to not only do well in our core business of EDA and IPE, but also expand it to other adjacencies, one of them being system design and analysis. And as you know, we have a big effort in that. And then the second one being AI and machine learning, which are also inherently computational. So I think EDA and IP have been a good business. You know, we think it will continue to be a good business, but added with system design and analysis and AI and machine learning, you know, it provides other adjacencies we can grow into. So we are truly excited. I think we are in a great position and we look going forward, look at all the, we work very hard to accelerate all these trends and accelerate the growth and opportunities that we see and take cadence to new heights.

That's great. And then just to follow up on the anticipated margin cadence in the back half, it looks like the outlook implies maybe 34 to 35%. Is that purely a reflection of hiring accelerating? Is there any T&E that might be working back into the budget? Or maybe what's the best way to say just relative first half, second half margins?

Yeah, Joe, I think the first thing to note there is we completed our annual salary review and promotion cycle during Q2, and that's part of the story. But there are also some one-time things that kind of distort the margin picture in the second half. As part of our succession planning efforts... We did a voluntary early severance program at the same time as the promotion round. And there will be some temporary overlap in expense in the second half as the impending retirees transition to their roles, to their replacements. So we kind of double up on expense for six months there. And that's a temporary phenomenon. There's also the purchase accounting treatment of the acquisitions we had in the first half with New Mecca and Pointwise. They cause our second half margins to be lower than they would otherwise be. And, yeah, we're planning to do a lot of hiring in the second half, and I've embedded that into the guidance. But my team and I will review all of that and make sure it's absolutely necessary. So there could be some upside to that margin outlook following our review. As I mentioned earlier, the quarterly... Quarantine numbers can be a little bit distorted during the pandemic. It's better to look at the annual view. And I think when I look at the annual guide, 36 to 36.75%, that's closer to the margin levels at which the business is currently performing.

That's helpful. Thank you. No worries.

Your next question is with Jason Salino from KeyBank Capital Markets.

Great. Thanks for taking my questions. Lipu and Arun, congrats on the well-deserved promotions. Maybe for my first question, you know, ACV being bigger, it might be indicative of, you know, the customer budget and spend. But, John, when we think about the guidance raise, are you able to provide any more segment color on where we've seen the uptick? It sounds like from a geo perspective, China particularly last quarter, but what else can you add?

Yeah, it was pretty broad based. I would say China, sorry, Asia and then China within Asia was a part of that. And then, of course, North America, I thought they were probably the stronger performing regions. But it was pretty broad-based strength across all lines of business. I think the kind of recurring revenue profile we have right now and what we've projected in the guide for the second half of the year is our typical average profile. I think it sets us up really well for growth for next year.

Okay, great. And then maybe diving down in that a little bit, No IP growing mid single digits in the quarter. Not entirely a surprise given the call outs from from last call. But how are you feeling about the IP for the remainder of the year today versus maybe three months ago?

Well, I'll let Anirudh talk to the IP business. I think it's performing really well. But, I mean, when I look at the numbers, it's kind of similar to China. Last year, IP grew 25%, so there have been some really, really tough comps. And we did highlight last quarter that we thought, you know, that Q2 and Q3 might be a little bit light because of those comps. But Q4, we thought we would power back in Q4 and set ourselves up for growth. for next year, and it's, you know, with another quarter under our belt, I'm more confident that that's what the outlook looks like. Anirudh, do you want to say anything about the IT business generally?

Yeah, thanks, John. That's a good summary, and Jason, that's true. One thing I would just like to add is that, you know, overall we are pretty happy with the IP business. Like John mentioned, there is some seasonality to it, which is a lumpy business. And also, the IP purchases are more based on projects. So there's just a little bit of lumpiness. But overall, the trends are strong. The whole outsourcing trend for IP continues, as you would expect. And, you know, there is more and more design activity, more foundry activity. So we are pleased with where we are in the IP business and make sure we have the right kind of star IP to serve the customers. Excellent. Thank you.

Our next question is with Pradeep Ramani from UBS. Yes.

Hi, thanks for taking my question. Congrats to Honeybird and Lipo. John, I think you mentioned that your APD in Q2 was higher. What is driving that? I mean, our customers... buying up the stack, or is it a function of renewal by different customers? What is driving that higher ACV? And in terms of sustainability, how do you feel that it's sustainable going forward and just beyond, you know, cheaper?

Sure. Yeah, great question. But yeah, what we saw, I guess, was, I mean, design activity was very strong and the volume of licenses that were purchased were higher than the previous contracts, expiring contracts. Also, pricing had improved a little bit. And generally, I mean, when I look at – like if I look at the business at a very high level, Tom, I like to look at the three-year CAGRs, and I put them in the second page of the CFO commentary. And over the last few years, we've seen consistently accelerating revenue growth year over year when you look at the three-year CAGRs, and we're on track again for that for this year to improve on last year. So generally, I think with all of our accounts, we keep providing – you know, greater value to our customers. They're buying more products. It's a virtuous cycle, so to speak. I think a few years ago, we often talked about, you know, we released 20 significant new products in the previous three years. We've launched eight new products in the last six months. But I think the pace of innovation and the release of new significant products at Cadence has accelerated, and that's helped us improve our ACV across a very, very broad base across our customers.

Okay. And for my follow-up on the verification side, you mentioned there was some V2 and V1, but in terms of just thinking about it, about where we are in the penetration cycle for V2, would you say that we're very early days, but you still had significant contribution from V2 and Q2? Or was the contribution from Z2 slash X2 sort of pretty negligible on Q2?

Oh, no, I think it's a significant contribution. I don't know whether, if you don't mind me using an Olympic-style analogy, it's a bit like a relay race in terms of handing over the baton. I think Q2 and Q3, these middle quarters of the year, are where you see that transition where we're selling X1 and Z1 alongside X2 and Z2. I think by the end of the year, by the time we get to Q4, we'll be off and sprinting with... with the newer systems, and we'll have very little of the older systems left to sell.

Thank you. Our final question comes from John McPeak with Rosenblatt Securities.

Thanks for squeezing me in, guys. Can you hear me okay? Yes. Yeah, I can hear you. Oh, great. Hey, guys. Congratulations, Litboo and Anaru. It's been quite a run, Litboo. Amazing. I guess you'll be on some more calls, but I just wanted to mention that. So the first question I had is about, you know, the high-level trends in the semiconductor industry. You know, they're getting more competitive than they've ever been. I mean, you're seeing some shareships. You're seeing some historically significant companies, you know, seeing major rethinks about their strategy. And I'm wondering if that potentially is freeing up budget, uh, in those companies to try new things that they historically may not have done with, uh, you know, the prior, uh, management regimes that were in place. Um, cause it seems like it could be kind of significant, uh, for cadence. That's, that's my first one. Then I have a follow up.

Yeah, I think, uh, let me answer that, John. Thank you so much. And, uh, so clearly we see this, uh, industry change in the five generation wave and a lot of data being generated and less than 2% of data being analyzed. So I think there's a humongous opportunity in terms of the hyperscaler and all the autonomous driving, industrial automation for the industrial group and autonomous driving. That is another part. So I think those five areas are going to be driving a lot of new applications and new solutions needed. So a lot of innovation needed. And so in some way, our ISD strategy is really playing very well from the silicon all the way to the system and how to provide some of this solution, especially in the workload has changed a lot. And so not just the CPU computing, And it's a lot of new domain-specific application driving the solution. And that creates a lot of new design. So that's why we don't see any slowdown in design. In the contrary, actually, we see a lot of increase in design activity. And that gave me a lot of hope going forward.

Right. And then I guess specifically, it seems like when you get to three and under, Um, potentially we're going to gate all around and, um, I'm curious as to what that might do for, uh, place and route and, and your digital strategy there. I think you've made some announcements at three, uh, some tape outs already. Maybe you guys could talk about that a little bit.

Yes, John, let me, let me take that. So, you know, we have quite a bit of activity at three nanometer, as you could imagine, a lot of customers are. already designing a lot at 3 nanometer. And also we are happy to work with the major foundries. So we do have solutions which are being optimized for gate all around, and we are happy with the progress there. And like I said earlier, we're also starting work on N2. So I think this is good for the industry. 3 should be a very, very strong node. and also, you know, N2 after that, or the 2-nanometer node after that. And one key thing is that 3-nanometer, what we noticed is that it's good news for EDA and cadence. You know, the role of tools and methodologies becomes even more critical than, let's say, 7 or 5 nanometers, because there is a little bit of, you know, slowing of pure performance scaling from Moore's law. I mean, Moore's law is still giving a lot of Area scaling or number of transistors keep going up, but the performance you get from each transistor is not as much as before. So then there is more demand for cadence tools and EDA solutions and IP solutions to deliver that performance. So I think the role of EDA will become more and more critical at lower nodes. and then combined with other advances like cerebrus and machine learning. So overall, we are pretty pleased with our position at these advanced nodes, and I think it is overall good news for the industry.

Thank you. I mean, it would just seem like there's a shortage of engineers, and you guys are the ones making them more productive. So thank you. Yes, thanks.

I would now like to turn the call back over to Lit Bhutan for closing remarks at this time.

In closing, thank you all for joining us this afternoon. I'm very excited about the growing market opportunities and the business momentum so far in 2021. 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 expand the total addressable market. And lastly, on behalf of our employees and our board of directors, we thank all our customers and partners for their continued trust and confidence during these unprecedented times. Have a wonderful day.

Thank you for participating in today's Cadence Second Quarter 2021 Earnings Conference Call. This concludes today's call.