Cadence Design Systems Inc

NASDAQ:CDNS

Earnings Call Transcript 2020-Q2

[Operator]

Good afternoon. My name is Mike and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence Second Quarter 2020 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. [Operator instructions] Thank you. I will now turn the call over to Alan Lindstrom, Senior Group Director of Investor Relations for Cadence. Please go ahead.

[Alan Lindstrom, Senior Group Director, Investor Relations]

Thank you, Mike. And I would like to welcome everyone to our second quarter 2020 earnings conference call. I am joined today by Lip-Bu Tan, Chief Executive Officer 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 June 12, 2020. A copy of today’s prepared remarks will also be available on our website at the conclusion of today’s call.

Please note that the discussion today will contain forward-looking statements and that actual results may differ materially from those expectations. For information on 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, including the company’s future filings and the cautionary comments regarding forward-looking statements in the earnings press release we issued today.

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 certain results using non-GAAP financial measures. Investors and potential investors are encouraged to review the reconciliation of non-GAAP financial measures with their most direct comparable GAAP financial results. The reconciliations are available at the Investor Relations section of cadence.com.

Copies of today’s press release dated July 20, 2020 for the quarter ended June 27, 2020, related financial tables and the CFO commentary are also available on our website. Note that Cadence is continuing to adhere to social distancing practices and therefore we are conducting today’s earnings call from our respective remote locations. Apologies in advance if there are any glitches or handoffs that take a little longer than usual.

And now, I will turn the call over to Lip-Bu.

[Lip-Bu Tan, Chief Executive Officer]

Good afternoon, everyone and thank you for joining us today. I am very pleased to report that in an environment of continued uncertainty, we achieved excellent financial results for the second quarter of 2020. We exceeded our financial outlook on all key metrics, as the team successfully navigated through challenges posed by the pandemic. In view of continuing, strong broad-based demand for our innovative solutions, combined with a robust design environment, we are raising our financial outlook for the year. John will provide more details on our Q3 and annual financial outlook shortly.

We are all going through unprecedented times and I hope that you and your families are staying safe and healthy. In this environment, our top priority continues to be ensuring the safety and well-being of our employees, customers and communities. Our employee base has adapted well to working from home, which appears to be the new normal, at least for the foreseeable future. Our R&D and customer deliverables are tracking well, and our sales and application engineering teams continue to engage effectively with our customers. We are increasing our investment in infrastructure and collaboration platforms in order to maintain high level of employee productivity. Fueled by the generational drivers such as 5G, AI and hyperscale computing, the data-centric revolution is accelerating semiconductor demand and design activity. As a result, we are seeing widespread demand for our EDA software, IP and hardware solutions and our Intelligent System Design strategy has us very well-positioned to benefit from these trends.

Now, let us look at some of our Design Excellence highlights for the quarter. We have deepened our partnership with Renesas to accelerate their innovation, through a wide-ranging expansion of our EDA and hardware solutions. Our new digital full flow with the innovative iSpatial technology continued its momentum with 10 new full flow wins during the quarter. We expanded our partnership with Micron through a broader proliferation of our EDA solutions, including the deployment of our digital full flow for the development of their next generation products. Cadence collaborated with TSMC and Microsoft, to ensure customers to accelerate designs, timing signoff, using Cadence signoff solutions in TSMC technology on Microsoft Azure. Our Cadence Verification Suite delivers the best verification throughput and had several wins across mobile, networking and medical verticals. We deepened our relationship with a leading medical technology company as they expanded usage of our Verification Suite, digital and custom analog solutions. Our Xcelium simulator has been steadily proliferating, with multiple migrations from competitive simulators underway.

We had another outstanding hardware quarter, with the compelling value proposition of the integrated Z1 and X1 combinations being increasingly attractive to customers. The Palladium Z1 emulator with its unique custom chip-based architecture, continued to win new customers and significantly expand capacity at existing key customers. Our Protium X1 prototyping platform has ramped strongly based on the differentiated ability to provide very fast bring-up time and high performance. The growth of analog, mixed signal and RF designs is driving the need for high performance and accurate circuit simulations. Our massively [parallel] [ph] Spectre X circuit simulator continued proliferating at multiple customers like Skyworks and won several competitive displacements, including at a market shaping hyperscaler.

Q2 was an especially strong quarter for our IP business as it again delivered double-digit revenue growth. Our refined strategy of focusing on Star IP at the most advanced nodes continues to pay-off. Robust demand continues for high-speed SerDes and DDR IP and Tensilica had particular strength in Hi-Fi True Wireless stereo and vision applications, as well as strong royalties. Our System Innovation segment executed very well, delivering double-digit revenue growth. Several market shaping customers across multiple verticals have successfully used our 2.5D and 3D IC advanced packaging solutions on production designs. Integration of AWR and Integrand is progressing well with the teams working on developing a comprehensive high-frequency RF platform. Business momentum was strong and AWR added 6 new customers in Q2. The new System Analysis tools continue to gain momentum, with over 125 engagements underway, multiple new wins and expansions at several existing customers. New Clarity customers included a market-shaping hyperscaler and new Celsius customers included ASUSTeK.

Now, I would like to take a moment and talk about inequality and racial intolerance. These significant societal issues have led to heartbreaking events over the past few months are very close to my heart. At Cadence, embracing diversity and fostering inclusion are key tenets of our culture. We believe that by being open to different views and perspectives, we learn from one another and together we become stronger as one team. We have several related initiatives underway, including training, pay equity, community donations, recruiting and career advancement support, among others. We are committed to treating each other with respect and dignity and are proud to take stand against racism, prejudice, intolerance and violence.

Now, I will turn it over to John.

[John Wall]

Thanks, Lip-Bu and good afternoon, everyone. I am pleased with our results for Q2 and updated outlook for fiscal 2020. For Q2, we exceeded all of our key financial metrics for the quarter. Back in April, we were expecting that some Q2 revenue might shift to Q3 in part due to the pandemic related challenges that we thought would delay a number of our Q2 IP deliveries and hardware installations into July and Q3. On reflection, business was stronger than we expected and our team adapted well to the delivery challenges presented by the COVID-19 pandemic. Ultimately, those anticipated delivery challenges did not have the impact to our Q2 results that we originally feared.

As with last quarter, our recurring revenue model gives us strong visibility into revenue for the remainder of fiscal 2020. Based on our experience in Q2, we are much less concerned about our ability to substantially overcome any hardware and IP delivery challenges caused by the pandemic, and we have factored that experience into our estimate of how much of our second half revenue we expect to record in Q3 and Q4. I will share more on the assumptions embedded in our outlook in a moment, but first let’s go through the key results for the second quarter starting with the P&L. Total revenue was $638 million. Non-GAAP operating margin was approximately 35%. GAAP EPS was $0.47 and non-GAAP EPS was $0.66.

Next, turning to the balance sheet and cash flow. Our cash balance was approximately $1.2 billion, while the principal value of debt outstanding was $700 million. Operating cash flow for Q2 was $345 million. DSOs were 45 days. And during Q2, we repurchased $75 million of Cadence shares.

Before I provide our updated outlook for fiscal 2020 and what we expect for Q3, I would like to take a moment to share the assumptions embedded in our outlook. Our outlook continues to assume that the export limitations that exist today for certain customers remain in place for all of 2020. Our outlook also assumes that the COVID-19 pandemic will remain a challenge for the remainder of the year. As a result, we have taken steps to prepare our workforce to work from home for longer and we are anticipating that a number of our smaller customers will experience liquidity challenges that will likely result in some of those customers being unable to meet their contractual payment commitments. We have taken the precaution of pausing revenue recognition on bookings from customers, where we believe there is significant uncertainty surrounding our ability to collect payments. The financial impact of non-payment on those accounts has already been factored into our outlook for the remainder of the year.

And with that, our updated outlook for fiscal 2020 is as follows: revenue in the range of $2.585 billion to $2.615 billion, non-GAAP operating margin of approximately 33%, GAAP EPS in the range of $1.84 to $1.90, non-GAAP EPS in the range of $2.50 to $2.56 and we expect operating cash flow to be in the range of $810 to $840 million and we expect to use approximately 50% of our free cash flow to repurchase Cadence shares in 2020.

And here is how much of our annual outlook that we currently expect to record in Q3: revenue in the range of $630 million to $650 million; non-GAAP operating margin of approximately 32%; GAAP EPS in the range of $0.49 to $0.51; non-GAAP EPS in the range of $0.59 to $0.61; and we expect to repurchase $75 million of Cadence shares. You will find guidance for additional items as well as further analysis in the CFO commentary available on our website.

In summary, Cadence delivered another quarter of strong revenue growth and expanding profitability and we are pleased to raise our outlook for the year. Before the pandemic, Cadence operated from around 50 sites across the globe. We are now effectively operating from a distributed network of more than 8,000 homes. We are blessed to have many strong leaders, located across the world and I am very impressed and thankful for how our employees are not only rising to the challenge, but positively thriving as they remain intensely focused on delivering successful outcomes for our customers and partners. Finally, I would like to close by thanking our customers, partners, and our hardworking employees for all that they do. And I would like to remind them all that their health and safety continues to be our first priority.

And with that, operator, we will now take questions.

[Operator]

[Operator Instructions] Your first question comes from Ruben Roy from Benchmark.

[Ruben Roy, Benchmark]

Hi, thank you for taking my questions and congrats for continuing to perform so well in such challenging times. John, I want to start and just kind of drill into the commentary on this more customers and the liquidity challenges that you are talking about, are these ongoing conversations you are having with customers, have you seen some of this in the numbers that you have reported and guided to for Q3 or is this more sort of anecdotal thinking as you think about the guidance for the full year? Thank you.

[John Wall]

Thanks, Ruben. Good question. But yes, I mean, as we said, business was stronger than expected, particularly in hardware and IP. And last quarter, we were concerned that compliance with some containment measures around the globe would impact everyone’s day-to-day operations. And we expected those measures to impact us in three ways. We thought if our customers’ offices remain closed that would impact us on the – on our ability to install hardware. On the IP side, access to our own IP labs would impact and we were fearful that, that would impact our ability to complete delivery in our IP. And then the other thing we were concerned about was that if the shelter-in-place restrictions were prolonged we were concerned that the pandemic would disrupt the normal business and operations of many of our smaller customers and that would impact their liquidity. And ultimately, we were preparing for collections challenges on those accounts in the event that some of those customers were unable to pay us for what they purchased. On reflection, as I said in the script, on reflection with Q2 behind us business was stronger than expected. Our team adapted well to the delivery challenges. The issue though on collections from smaller customers remains that the potential collections impact is a concern. We received a number of requests from customers to delay their payments to us. We have chosen to continue to provide services to those customers and some will eventually get back on track and pay us, but many, despite theirs and our best efforts may not be able to get back on track and we will likely fail to collect on a number of accounts. And our best estimate of that is we have basically reserved for about $17 million worth of bookings. Right now as of the end of Q2 to put that in context, over the 3-year period from 2017 to 2019, we didn’t collect on $36 million worth of orders. So we pause revenue now on $17 million worth of bookings. So we are covered for twice the experience we had over the previous 3 years.

[Ruben Roy, Benchmark]

Very helpful detail, John. I guess just for a quick follow-up, I was looking at the core IC design tool performance in the June quarter and down a little bit sequentially on the digital side, up a little bit on the custom IC side, it would seem that maybe that’s where you are seeing some of the near term issues. Is that the way to read into what is going on with those line items?

[John Wall]

Yes, absolutely, the impact on collections with particularly smaller customers is more heavily slanted towards our software business. So we paused revenue on a number of contracts where we think collections are challenging but and that impacts the software business more than it would say hardware or IP in many cases on the hardware side, because we get revenue upfront, we expect payment upfront. So you don’t have as much credit exposure there. On the IP side, much of our IP revenue is coming from royalties. And royalties are typically with customers, like with our top 100 customers, which are very good credits customers, they have strong balance sheets but this is really isolated to that group of customers that are outside our top 100. And it’s the kind of the smaller customers.

[Ruben Roy, Benchmark]

Got it, okay. That’s very helpful. Thanks.

[Operator]

Your next question comes from Tom Diffely from D.A. Davidson. Your line is open.

[Tom Diffely, D.A. Davidson]

Yes, good afternoon. I guess first John just following up on the last question, is there a geographic bend to the small customers that you are worried about?

[John Wall]

Sorry, can you repeat that? Tom? I didn’t quite get that.

[Tom Diffely, D.A. Davidson]

Sorry. Yes. Is there a geographic bend towards the customers that you were concerned about, the smaller customers or is it broad based across the world?

[John Wall]

No particularly. I mean, if there’s any particular demographic that’s been hit, it is smaller customers; it is right across the globe, but very much in smaller customers, and probably mostly in software over IP or hardware.

[Tom Diffely, D.A. Davidson]

Okay, sounds like your business is fairly strong across the board. But I was wondering if you are seeing any kind of bifurcation between your consumer-driven customers and the high performance compute customers that you seemingly are much stronger today?

[John Wall]

I think on the certainly on the royalty side, that I think royalties for the first half are like 25% higher and they were, like for the first half of 2019. I think it is hard to break it down in terms of where their strength in different parts of the business I think it is kind of across board we have seen strength across the board, the challenge in the credit side are quite random in the, in this - in the smaller pool of customers.

[Tom Diffely, D.A. Davidson]

Okay, it sounds like a lot of customers are a lot of players out there have seen strength in high performance compute offsetting some weakness in consumer. But from what you say it sounds like you have continuing to see strength across the board so is kind of a new?

[John Wall]

Yes. Well our royalty revenue is related to the consumer electronics market mainly, but and we are seeing strength there like I say 25% up I mean, I think the royalties were around $21 million for the first half of the year compared to just under $17 million for the first half last year. IP was strong. On the design IP front our refined strategy of focusing on Star IP at the most advanced nodes continues to pay off. Demand for high-speed SerDes and DDR IP continue to be strong with deployments at leading mobile networking hyper scale and storage customers. And then on the Tensilica side, the highlights there were our customizable, scalable DSP IP, including the deployments in true wireless stereo and vision applications helped along with strong royalties to have a very strong performance for Q2 revenue and IP.

[Lip-Bu Tan, Chief Executive Officer]

And then add on, this is Lip-Bu. I think clearly, beside – it's kind of a block base but I think your question on the data center cloud, hyper scale, we see very strong demand because of the infrastructure of when people work from home. There is a lot of scaling so we see also very strong in that area, too.

[Tom Diffely, D.A. Davidson]

Okay. Thank you, Lip-Bu.

[Operator]

Your next question comes from John Pitzer from Credit Suisse.

[John Pitzer, Credit Suisse]

Yes, good afternoon guys. Thanks for letting me ask the questions. John, maybe different sides of the same coin, but why don’t you just help me understand as you look into the September quarter, what’s driving op margins down sequentially? I would have thought that perhaps in the current environment, there were some costs that you might have to incur around COVID mitigation actions that actually might dissipate as we go into the back half of the year. And I guess similarly, over the last several years, the operating cash flow has been more front-end loaded first half weighted than second half, which is relative to your guide feels like second half is only about 30% of the operating cash flow. I am wondering what might be driving that maybe it’s the same thing, maybe it’s different?

[John Wall]

Yes, John, the – yes, good question that in terms of on the op margin profile there is a couple of things in that question. So, let me unpack it a little bit that in terms of the op margin profile, the expectation that we had and when we gave guidance for Q2 was we thought that some revenue might shift from Q2 into Q3. Our experience was an actual fact that there was a net shift the other way. We thought that maybe I mean if you look at our Q2 guidance, we went out with the midpoint of 590 having followed Q1, which was 618, which typically you would expect Cadence to be pretty much, I mean, 618, you would expect 618, 620 or something for Q2. So, we were expecting about $30 million to push from Q2 into Q3. As it happened about $10 million has moved, maybe just less than $10 million has moved from Q2 into Q3, there is about $10 million of deliveries that we couldn’t get done in the quarter that will now revenue in Q3, but we had approximately $20 million that came the other direction. And that was customers that you know as things lifted in June we had customers in new bookings in the second quarter that wanted to accelerate the installation on what they have purchased. And of course, as our guys had time when they were trying to – when they had some customers that they couldn’t deliver to, they just kept on going down through the list. I mean, typically at Cadence, you probably have, maybe two-thirds of your orders or bookings in any one quarter would fall into the, like the last month of each quarter. So, it’s unusual for such a high amount to get delivered in the quarter, but like I say, we – our experience in Q2 was there is probably some shift of revenue from Q3 into Q2, net-net, maybe about $10 million -- $10 million to $15 million from Q3 to Q2.

On the expense side, in contrast to that, we – because of the uncertainty in Q2, we held up some of the offers on hiring that until late in the quarter. Once we got comfortable that you know what, we are good for revenue in the quarter and that it looked like customers were very resilient, our team was very resilient in terms of overcoming the challenges then we released the offer letters and hiring accelerated into the end of the quarter has continued at the start of this quarter. So, that’s probably meant there is some expenses shifted from Q2 to Q3 and some revenue shifted from Q3 to Q2 and you end up then with like a 35% operating margin in Q2 compared to our guidance of 30% and then Q3 is at 32%. Also, you mentioned operating cash flow, I think that if you recall I mean, last quarter, I mean, I hesitate to say it, but last quarter, we were mentioning this, we had deliberately closed some strategic business early in the year. And what you are seeing is we got paid for that business. So, you have probably seen an uptick in cash and an uptick in deferred revenue. I wouldn’t be surprised if my expectation right now would be deferred revenue will burn off from this level through the end of the year, because we deliberately aim to get paid early.

[John Pitzer, Credit Suisse]

That’s helpful. And then as my follow-up, it’s nice to see that China, as a percent of revenue has remained fairly stable over the last several quarters at kind of low double-digits. That doesn’t prevent us from still worrying about the concern that perhaps there is some buy forward going on in China just given U.S. China relations and how critical you are to the overall semiconductor supply chain in China. Wondering if you could just handicap what you are seeing in China today? Is there a risk that there is pull forward and then how do you try to manage through some of the ebbs and flows of the tensions between the governments of the U.S. and China?

[Lip-Bu Tan, Chief Executive Officer]

Yes, good question. So, I think overall our China business has remained quite good. And then the Q1 Q2, as John mentioned, I think clearly the hardware and IP, which are more upfront revenue and that help. And I think overall, I think we are providing that to an IP globally to our customers and meanwhile we comply with the U.S. regulations. And it’s very fluid and very – we are closely monitoring it, but so far I think all the uncertainty and we already built into our estimates. So, I think overall, we are confident I think we continue, I think 12% I think quarter-to-quarter sometime it varies, but I think overall, is a strong business in Asia and China for us.

[John Pitzer, Credit Suisse]

Perfect. Thanks, guys. Congratulations on the strong results.

[Lip-Bu Tan, Chief Executive Officer]

Thank you.

[John Wall]

Thanks.

[Operator]

Your next question comes from Mitch Steves from RBC Capital Markets.

[Mitch Steves, RBC Capital Markets]

Hey, guys. Thanks for taking my questions. So the first one I kind of want to drill on just kind of the geographic movements here, it looks like the U.S. is up pretty significantly. So, I know you guys are concerned about kind of the – what I assume are the smaller players not being able to make payments and kind of rolling off some money for you guys there. But is there any chance or maybe I am thinking about this incorrectly, any chance that basically the larger players end up investing more, because what we picked up is that a lot of these larger companies are actually pushing forward on the tech front with chip design. So when does that actually offset and actually be a benefit to you guys, if the larger customers end up spending more in EDA tools, while the smaller ones kind of get pushed off to the side?

[Lip-Bu Tan, Chief Executive Officer]

Yes. I think that – Mitch, good question. I think that geographically, I think overall, I think all the across the board was we see strong design activity, we don’t see any slowdown. I think this silicon Renesas in the industry with all the generational drivers like AI, 5G, hyperscale and this – we move into this kind of a data-centric big data that is really driving a lot of silicon development and the design. And to answer your question in terms of the big guy, the monthly crowded market-shaping customers, I think you kind of you can read from my transcript that you know clearly are highlighting all this full flow and all this proliferation with market shaping and those are the leader in the industry. We pay a lot of attention and this is a golden opportunity to double, triple down in R&D for the next generation products. So when this cycle recovers, there will be much stronger leaders. And so answer your question, the design activity doesn’t slow down, actually, those big guy are really, really driving the R&D. And we are delighted to be the trusted partner to work with them.

[John Wall]

Yes. And Mitch, this is John Wall here. I mean, just the fact that we raised the year despite the fact that we had some – we have some collection challenges that the smaller customer base illustrates that larger customers are investing more in R&D.

[Mitch Steves, RBC Capital Markets]

Got it. Understood. And then just kind of switching gears if you hear much about 3D Clarity, it’s been sort of maybe two quarters or so, so you guys are talking more about COVID and core EDA, can you maybe provide an update on what is going on with the 3D Clarity products or the customer wins, backlog interest anything like that, I realized that the environment is a little bit strange, but I think it will be interesting to hear what’s happening with the 3D Clarity product front?

[John Wall]

Yes, happy to share with you, I think currently, we have a very strong – this is a good market for us. This is 10 markets about $700 million, clearly our product as we mentioned earlier, customers see up to 10x performance and then continue providing the accuracy. This time we highlight market-shaping hyperscale to go with us. And then we have over 125 engagements in this together with Celsius. And so I think a lot of momentum, a lot of multiple new wins and more important expansion of the – at the existing customers. So I think overall, we are very excited about the product we have and we continue to really drive the differentiation and engaging with the leading customer that can see the value.

[Mitch Steves, RBC Capital Markets]

Okay, great. Just one really small one, should bookings continue to go up this year or are they going to be flattish kind of a 37?

[Lip-Bu Tan, Chief Executive Officer]

Sorry, your question again.

[Mitch Steves, RBC Capital Markets]

Just really, really small on the backlog you guys have provided now on a quarterly basis, should we expect that to be more stable or go up because they realized last year is up 20%. This year, it’s pretty stable 37 for a couple quarters and just trying to understand what we should expect from your backlog?

[Lip-Bu Tan, Chief Executive Officer]

John, you want to highlight that?

[John Wall]

Yes. Mitch, I mean, we don’t guide bookings. But given that we closed some business early in the year deliberately killed some business early in the year and pulled out some business from later in the year. I am not surprised that our RPOs have kind of – were flat from Q1 to Q2. But I wouldn’t expect a dramatic change between now and the end of the year.

[Mitch Steves, RBC Capital Markets]

Okay, perfect. Thank you very much.

[John Wall]

Thank you.

[Operator]

Your next question comes from Gary Mobley from Wells Fargo.

[Gary Mobley, Wells Fargo]

Hey, guys. Thanks for the question. Congrats on a strong quarter. I wanted to start out by digging a little bit deeper into the China conversation. And so I know we have this new Mill Arrow rule as part of the newest export restrictions. And I know you guys have been working hard to try to answer some of the topics on it and perhaps don’t have 100% clarity as we see here today, but maybe if you can give us an update, as you see it today, how it impacts maybe your fourth quarter or even looking at fiscal year ‘21 and beyond?

[Lip-Bu Tan, Chief Executive Officer]

Just asking about this new direct product rule from the military and use the arrow?

[Gary Mobley, Wells Fargo]

That's right.

[Lip-Bu Tan, Chief Executive Officer]

Okay. So I think overall our outlook included all the estimate on the impact on the trade restriction clearly, we are monitoring very carefully, we are complying to all the requirements and make sure that our customer not commit to us is not turning to the military use. And so, it's a lot of more work and we are working there now towards that and comply is the number one priority for us and delay and support the customer is equally important, but I think we have made sure that we are complying to all the requirements.

[Gary Mobley, Wells Fargo]

Okay.

[John Wall]

Okay. And Gary, any metal impact of the military in use, or the direct product rules is already included in our guidance.

[Gary Mobley, Wells Fargo]

Okay, but it's not mistaken it doesn't go into effect until September so not really much of an impact so much in fiscal year ‘20 right.

[John Wall]

Again, like I said we have reviewed potential impact on our business and included everything we know today into our guidance outcome for the remainder of the year.

[Gary Mobley, Wells Fargo]

Okay, as my follow up, I wanted to shift gears and talk about, sort of setups for fiscal year ‘21. I realize you are not going to give any sort of preliminary revenue guidance for the year. But if I'm not mistaken, the extra week and some acquisitions may be contributing to roughly what 200 basis points of revenue growth this year. And so, we get on the flipside of this year, should we think about an equal amount of perhaps a headwind looking into next year?

[John Wall]

Yes, I think with the acquisitions are pretty small. It’s the 53-week definitely needs to be a consideration when you think about next year, Gary, but I mean, when I think last quarter, I said that I expect revenue impact for that extra week to be about $40 million. Right now. I would say it's probably closer to like $43 million, but again on the expense side, the, I would guess on a non GAAP basis, maybe about 33 it's, it's we will get a full impact of full week of expense. But on the revenue side, it'll be that recording revenue, part of our business that we get the extra revenue for. So I think the impact of that 53 week, my own modeling when I do it, I kind of assumed $43 million for revenue about $33 million for expense. And naturally you have to adjust for that if you are comparing a 53-week year to a 52-week year, but like you say, we are not guiding 2021.

[Gary Mobley, Wells Fargo]

Got it. Alright. Thank you guys.

[Operator]

Your next question comes from Rich Valera from Needham.

[Rich Valera, Needham]

Thank you. Let me add my congratulations to the Cadence team for another strong quarter in tough conditions. So John, just wanted to follow up on the questions around the strength in the quarter, which I understand I guess was driven by less than feared dislocation in the hardware and IP businesses. Is that also what accounted for the increase in your overall annual guide or are there some other product areas that contributed to the increase in the full year guide?

[John Wall]

Yes. I think, we were very pleased with, with how our IP business is doing. I think it's mainly the functional verification business, that product category. I think that's probably the one that's increased the most, really strong hardware quarter, outstanding hardware quarter. I mean, the compelling it's a compelling value proposition with the integration of Z1 and X1 as a combination that's increasingly attractive to customers, the Z1 emulator with its differentiated custom chip based architecture and we were continuing to win new customers and significantly expand capacity at existing key customers. And then with Protium X1, the prototyping platform there has ramped up strongly and it has got a unique ability to provide very fast bring uptime and high performance that the cross selling between Z1 and X1 and vice versa, was very, very resilient and apparent in Q2

And it's continuing I mean the early weeks of July, we are already seeing that strength continue. But now, when I gave a range of $20 million again for Q3 on revenue and that was partly because we did see a shift from Q3 to Q2 for revenue slight shift, net shift and that was maybe on the hardware side, we saw that customers looking for earlier delivery. I am not sure how much of the pandemic is driving that behavior and customers are thinking that get the hardware in now, but Q3 is strong again. And again, we have included that in the guidance.

[Rich Valera, Needham]

That’s very helpful. Thank you. And for my follow-up, just wanted to ask another one on the system analysis products, you have been giving kind of a quarterly wins number, I think it was 30 plus last quarter and you seem to maybe have pivoted towards an engagement number. Is there an equivalent engagement number from Q1 that we could use to compare to sort of how that’s expanded over the last quarter and will you at some point maybe revert to giving out wins as opposed to engagements?

[Lip-Bu Tan, Chief Executive Officer]

Yes. I think this is a very strong product offering for us. The two products have been well received on the Clarity and Celsius. We highlight about a win that we have and then most of them were over 125 in much stronger platform, we can even do more with them. And so both companies that you alluded to are very good companies, great companies and so far I think the consolidations, each one are unique and in our own way and then but we now try to be the trusted partner to work with them and then to continue to grow and then drive better solutions for them to have a bigger footprint for them accessible.

[Rich Valera, Needham]

Understood. And then I have quick follow-up. One of the presentations today from Cadence at the virtual DAC was on cloud deployments and the increasing demand for cloud deployments, I just curious here when we see some other software businesses that have either are transitioning from on-premise to the cloud or have multiple offerings or multiple deployments of on-premise and cloud deployment. There is a pretty significant uplift in terms of revenue from customers that have cloud deployments versus on-premise. So, John or Lip-Bu, I was just curious, do you see similar uplift in revenue associated with cloud deployments relative to on-premise?

[Lip-Bu Tan, Chief Executive Officer]

I can start first and then John can fill in more. Clearly, the cloud solution for EDA to the customers, are very important. We want to provide their flexibility from the different range of use model either as a customer manage or Cadence manage and then you are using the cloud for the software and even include the hardware platform and also that we provide them the compelling productivity and scalability benefits. And at the end of the day, we really want to try to productivity and performance. And then if you have unlimited server, by theory, you should really drive the performance better and also more cost effective for the customer. And so we want to create that flexibility for them to do that. And we are delighted we highlight the key point of collaboration with TSMC and Microsoft to have this cloud for the signoff tool, campus in Qantas and then using our cloud bus that gives them the flexibility and they can optimize the throughput and the cost. And I think that is the way to go. I think we are going to be very cautiously moving towards the cloud. So I think the new product like the System Analysis tool, we develop as a cloud native and so it will be much easier and people – customer can see the benefit using the cloud. And then for all EDA tools we kind of tool by tool try to moving into optimizing the cloud. And staking so far we are making great progress. And we highlight that over under 25 customers adopted our cloud solution. So that is increasing we are delighted at.

[Rich Valera, Needham]

Great. Thank you.

[Operator]

Your next question comes from Jason Celino from KeyBanc.

[Jason Celino, KeyBanc]

Hi everyone. Thanks for fitting me in. Just one for me, most of the reference customers that you have announced your clarity has been semiconductor and companies and other electronics ecosystem companies, but today you kind of talked about a new hyper scalar win when was this hyper scale customer, already a customer and they expanded and then also, if you think about with some of the expansions are they adding, the Celsius product or the expanding has to do with their comments?

[Lip-Bu Tan, Chief Executive Officer]

A quick question. So I think enough clearly this is a new product for us, Clarity. And so any other new product new customer, we highlight are new to us in the way that they are. Now we don’t have that business before. So the hyperscale market-shaping, hyperscale for the parity and the Asus Tech for the output Celsius and then we are delighted we have 125 engagements, multiple new wins, I think most important, our customers see the benefit and using our performance, up to 10 times better than incumbents. And I think the most important thing to highlight is not the not expansions at the existing customers and that is a very validation of who is really good they would use it and then they like it, they buy more. And that is the good validation of a good product.

[John Wall]

Jason, for Clarity, specifically, I think in relation to your question, but one of our new customers for Clarity, this quarter included a market shaping hyper scalar we didn’t have that. It’s not a new hyper scalar for us, but, but new for Clarity for us.

[Jason Celino, KeyBanc]

Okay. And then, one quick follow up with this hyper scale customer using it to some supplement their simulation processes or more of like a adopting it for kind of all their needs on the electromagnetic side?

[Lip-Bu Tan, Chief Executive Officer]

Yes, I think that wants to know, again, is a existing customer, but I think it’s just continue to expand amount of product usage.

[Jason Celino, KeyBanc]

Okay, great. Thanks. Appreciate the time.

[John Wall]

Thank you.

[Lip-Bu Tan, Chief Executive Officer]

Thanks.

[Operator]

Our final question comes from Adam Gonzalez from Bank of America.

[Adam Gonzalez, Bank of America]

Hi, guys. Congrats on the solid results and thanks for squeezing me in just a minor clarification question. But on the collection issue that you are experiencing with some of your smaller customers, is this concentrated customers that have a particular end market or application exposure or is it more broad-based?

[John Wall]

It’s more broad-based, Adam. Yes, I mean, it’s broad-based not just across the customer base, but across the globe. But the thing that’s consistent is that it’s typically smaller, smaller value orders and smaller value customers. And what we are trying to do there is that we continue to provide services to those customers, even though in some cases, I don’t think we will get paid. But what we have done is we paused revenue on about $70 million of bookings. And it’s likely that we won’t get paid so there won’t be a P&L impact because we are not taking the revenue. But and we will continue to help those customers for as long as we can, but and hopefully that, but we won’t lose good companies as part of this pandemic.

[Adam Gonzalez, Bank of America]

Got it. That’s helpful. Thank you. And then my second question and apologies if this is asked before the connection cut off for in the middle of the call. But the implied second half revenue guidance, the split between Q3 and Q4 seems to be heavily favored towards Q4. Is that really just the extra week in the fiscal year that’s driving that?

[John Wall]

Yes, the extra week is a big part of that. I know also, of course, I mean, I’m trying to estimate learning from learning from Q2, what we expect to fall or what would we expect to record in Q3 versus Q4. That’s why we have a slightly wider range for Q3, we went with 630 to 650. If we see an experience similar to Q2 where there was a shift of some revenue from Q3 into Q2, if we see that again, there may be a shift from Q4 into Q3, which means we will be up at the higher end of that range. But I’m not there’s I don’t have any doubt about the remainder of the year really, it’s just what falls into Q3 versus Q4. It’s our best guess right now based on the experience of Q2.

[Adam Gonzalez, Bank of America]

Got it. Helpful. Thanks so much.

[Lip-Bu Tan, Chief Executive Officer]

Okay.

[Operator]

I will now turn the call back to Lip-Bu Tan for closing remarks.

[Lip-Bu Tan, Chief Executive Officer]

Thank you all for joining us this afternoon. Our Intelligent System Design strategy is playing out very nicely as we benefit from new opportunities in Design Excellence, System Innovation and Pervasive Intelligence and an expanded total addressable market. I am very impressed and proud of the dedication and commitment shown by our employees to continue innovating and delighting our customers, especially during these uncertain times. We are all in this together and I am convinced that we will collectively come out of this unfortunate situation stronger as a company, as a community. And lastly, on behalf of all our employees and our Board of Directors, we want to give our heartfelt thanks to the extremely brave and courageous healthcare workers and others on the frontlines. And they continue to work tirelessly to fight this pandemic. Thank you all for joining us this afternoon.

[Operator]

Thank you for participating in today’s Cadence second quarter 2020 earnings conference call. This concludes today’s call. You may now disconnect.