Cadence Design Systems Inc

NASDAQ:CDNS

Earnings Call Analysis

Strong Q2 Performance and Elevated Guidance for Cadence

Cadence delivered robust results in Q2 2024 with total revenue at $1.061 billion and a GAAP operating margin of 27.7%. This performance, underpinned by high demand for their AI-driven solutions, enabled them to surpass all key metrics and update their revenue guidance to over 13% year-over-year growth. They have a significant backlog of approximately $6 billion, buoyed by strategic partnerships and a strong IP business. Cadence projects 2024 revenue to reach between $4.6 billion and $4.66 billion, with a GAAP EPS range of $3.82 to $4.02. Their strategic positioning in AI, automotive, and system design sectors continues to drive their market leadership.

Strong Financial Performance and Future Outlook

Cadence delivered impressive financial results for the second quarter of 2024, surpassing expectations across key metrics. The total revenue was $1.061 billion, with GAAP operating margins at 27.7%, and non-GAAP operating margins reaching 40.1%. GAAP EPS was $0.84, while non-GAAP EPS stood at a robust $1.28. Looking forward, the company has updated its 2024 revenue guidance to a range of $4.6 billion to $4.66 billion, expecting over 13% year-over-year growth. The non-GAAP operating margin is projected between 41.7% and 43.3%, with an EPS range of $5.77 to $5.97 .

Strategic Acquisitions and Expansions

Cadence expanded its multiphysics platform in Q2 by completing the acquisition of Beta CAE. This acquisition is expected to contribute approximately $40 million in revenue for 2024, despite causing a short-term dilution of $0.12 on non-GAAP EPS. Beta CAE strengthens Cadence’s position in key verticals such as automotive, complementing the firm’s offerings with structural analysis capabilities. Additionally, Cadence continued its collaborations with major foundries like Samsung and TSMC, optimizing tools for advanced node processing and emerging technologies like 3D-IC .

Boost from AI and Advanced Technologies

AI and other technological advancements are major growth drivers for Cadence. The Cadence.AI portfolio has seen orders more than triple over the last year, reflecting strong market demand. Cadence's solutions, which enable AI infrastructure build-outs, are critical for the semi and system industries. Notably, NVIDIA has broadly deployed Palladium Z1 for its next-generation AI product roadmap, and another marque hyperscaler has significantly expanded its partnership with Cadence through the adoption of the company’s EDA, SDA, and hardware portfolios .

Financial Health and Share Repurchase Plans

Cadence's financial health is strong, with a cash balance of $1.059 billion at the end of Q2 and a principal debt of $1.350 billion. The operating cash flow for the quarter was $156 million. The company plans to use approximately 50% of its annual free cash flow to repurchase shares, which underscores management’s confidence in Cadence's financial stability and growth prospects .

Guidance for Third Quarter 2024

For the third quarter of 2024, Cadence expects revenue between $1.165 billion to $1.195 billion. The GAAP operating margin is projected to be in the range of $27.7% to 29.3%, while the non-GAAP operating margin is anticipated to be between 40.7% and 42.3%. The GAAP EPS is forecasted to be within $0.83 to $0.93, and non-GAAP EPS is expected to be between $1.39 and $1.49 .

Earnings Call Transcript 2024-Q2

[Operator]

Good afternoon. My name is Briana, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence Second Quarter 2024 Earnings Conference Call. [Operator Instructions] I will now turn the call over to Richard Gu, Vice President of Investor Relations for Cadence. Please go ahead.

[Richard Gu, executive]

Thank you, operator. I'd like to welcome everyone to our Second Quarter of 2024 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. Due to risks and uncertainties, actual results may differ materially from those projected or implied in today's discussion. For information on factors that could cause actual results to differ, please refer to our SEC filings, including our most recent Forms 10-K and 10-Q, CFO commentary and today's earnings release. All forward-looking statements during this call are based on estimates and information available to us as of today, and we disclaim any obligation to update them.

In addition, we'll present certain non-GAAP measures, which should not be considered in isolation from or as a substitute for GAAP results. Reconciliation of GAAP to non-GAAP measures are included in today's earnings release.

[Operator Instructions] Now I'll turn the call over to Anirudh.

[Anirudh Devgan, executive]

Thank you, Richard. Good afternoon, everyone, and thank you for joining us today. Cadence delivered strong financial results for the second quarter of 2024, with broad-based momentum across our product portfolio. Bookings were stronger than expected, leading to a healthy backlog and underscoring the robust demand for our innovative technologies.

We exceeded our outlook on all key metrics and are updating our revenue guidance for the year to over 13% year-over-year growth. John will provide more details on both our Q2 results and updated outlook for the year.

Generational trends such as hyperscale computing, 5G and autonomous driving, all underpinned by the AI super cycle are driving strong design activity across multiple verticals, particularly in data center and automotive. Along with increasing chip complexity and system companies building their own silicon, these trends are creating tremendous tailwinds for our differentiated solutions.

We are steadfastly executing to our intelligent system design strategy, extending our leadership in core EDA, while steadily expanding our footprint in the new system design and analysis area. Customers are ramping up their R&D spend in AI-driven automation. Our Cadence.AI portfolio offering unparalleled quality of results and productivity benefits continues to gain momentum with orders more than tripling over the last year. Our solutions are enabling the massive AI infrastructure build-out across the semi and system space. Additionally, we continue embedding AI in our EDA and digital biology solutions.

In Q2, our long-term development partner, NVIDIA broadly deployed Palladium ZI to deliver to its next-generation AI product road map, further solidifying Cadence's leadership in the industry. A marquee hyperscaler meaningfully expanded its partnership with Cadence in Q2 through a board proliferation of our Cadence.AI EDA, SDA and hardware portfolio.

The growing foundry ecosystem is driving increased design activity and creating significant opportunities for our industry-leading products. And in Q2, we expanded our collaboration with several leading foundry partners. We announced that Cadence.AI digital and analog tools were optimized for Samsung's advanced node SFII gate all around process, driving enhanced quality of results and accelerating node migration.

We extended our long-standing collaboration with TSMC through a very comprehensive and innovative technology advancement, ranging from 3D-IC to design IP and photonics and providing optimized digital and analog full flows for TSMC's latest and 2 process technologies. Our integrity 3D-IC platform is the industry's leading unified design, analysis and sign-up platform for multi-chiplet architectures. Integrity has been certified for all of TSMC's latest 3D fabric offerings and now has enabled several new features like hierarchical 3D-IC design.

We also announced that Integrity has been enabled for all of Samsung Foundry's multi-die integration offerings, accelerating the design and assembly of stacked chiplets. Additionally, we released a complete Intel foundry EMIB advanced packaging reference flow that is optimized to work seamlessly with Intel 18A technology. We are also collaborating with multiple foundries to optimize our industry-leading IP cores for AI, HPC, mobile and automotive applications for their advanced process technology so as to ensure seamless integration into customer designs.

We saw strong momentum in our IP business, but they're delivering 25% year-over-year growth in Q2. I as we executed to our profitable and scalable growth strategy. AI use cases, HPC and heterogeneous integration were the primary drivers fueling the demand for our HBM PCIe GDDR 112 gig SerDes and UCIE products.

We expanded our system IP portfolio with the addition of Cadence [indiscernible] Network-on-a-Chip solution. that manages high-speed communications effectively with minimum latency, enabling customers to achieve their PPA targets faster and with lower risk. Emulation and prototyping have become mission-critical elements of chip design and software [indiscernible] flows. Following the launch of our market-leading Z3 and X3 platforms, there is robust demand for these best-in-class systems, particularly by AI, hyperscale and automotive companies, and we continue to ramp up our production capacity accordingly.

Verisium, our AI-driven verification platform, continued seeing rapid customer adoption with several market-shaping customers, including Qualcomm successfully using Verisium SIMAI for coverage maximization and achieving up to a 20x reduction in verification workload time. Our system design and analysis business continued its strong momentum in Q2, delivering 20% year-over-year revenue growth.

As chiplet-based architectures gain traction, our industry-leading Integrity 3D-IC platform had increased adoption and expansion from large deployments at 5G, hyperscale, memory and consumer customers.

Our AI-enabled Allegro X design platform is being rapidly adopted and driving competitive displacement as multiple aerospace and defense, hyperscalers and EV customers take advantage of the platform's productivity and next-generation capabilities. Allegro X's in-design analysis capabilities are also driving a pull-through of our multi-physics analysis solutions.

In Q2, a leading EV auto company forged a strategic partnership with Cadence, making a significant investment across the breadth of our multiphysics portfolio.

With the close of beta CA in Q2, we now offer a comprehensive multiphysics platform covering electromagnets, electrothermal CFD and Structural Analysis Solutions. Our digital IC and custom businesses delivered another solid quarter. Proliferation of our digital full flow at the most advanced nodes continued with close to 40 full flow wins over the last 12 months, especially at hyperscalers.

With over 400 tape-outs, customers are increasingly relying on Cadence [ Celebros ], the leading AI tool in the industry, as it continues to deliver amazing PPA and productivity benefits. For example, Cadence [indiscernible] has been delivering up to a 10% PPA gain for a global marquee systems company and is now deployed as part of the default flow for their latest designs at the most advanced nodes.

Samsung Foundry leveraged Cadence [indiscernible] in both DTC and implementation to achieve more than a 10% leakage power reduction on their SFII gate all around platform. Socionext utilized [indiscernible] closure and temper sign-off to reduce timing closure time by 73% and doubled productivity while reducing memory cost by 90%.

Our AI-driven Virtuoso Studio is the leading automated solution for analog and RF designs. And its new AI features allow much more efficient migration from 1 process node to another. Virtuoso Studio added 35 new logos in Q2, led by top hyperscalers, aerospace and defense and automotive customers.

In summary, I'm pleased with our Q2 results and the continuing momentum of our business. The AI-driven automation era offers massive opportunities and the co-optimization of our comprehensive EDA and SDA portfolio, with accelerated computing and AI orchestration, uniquely positions us to provide disruptive solutions to multiple markets.

Now I will turn it over to John to provide more details on the Q2 results and our updated 2024 outlook.

[John Wall, executive]

Thanks, Anirudh, and good afternoon, everyone. I'm pleased to report that Cadence delivered strong results for the second quarter of 2024, finishing the first half with backlog of approximately $6 billion. Also, we expanded our multiphysics platform in Q2 by completing the acquisition of beta CAE. Here are some of the financial highlights from the second quarter, starting with the P&L.

Total revenue was $1.061 billion. GAAP operating margin was 27.7%, and non-GAAP operating margin was 40.1%. And GAAP EPS was $0.84, with non-GAAP EPS $1.28.

Next, turning to the balance sheet and cash flow. Cash balance at quarter end was $1.059 billion, while the principal value of debt outstanding was $1.350 billion. Operating cash flow was $156 million. DSOs were 49 days, and we used $125 million to repurchase Cadence shares in Q2.

Before I provide our updated outlook, I'd like to share some assumptions that are embedded. Our updated outlook includes beta CAE. And it contains the usual assumption that export control regulations that exist today remain substantially similar for the remainder of the year. Our updated outlook for 2024 is revenue in the range of $4.6 billion to $4.66 billion. GAAP operating margin in the range of 29.7% to 31.3%. Non-GAAP operating margin in the range of 41.7% to 43.3%. GAAP EPS in the range of $3.82 to $4.02. Non-GAAP EPS in the range of $5.77 to $5.97. Operating cash flow in the range of $1 billion to $1.2 billion, and we expect to use approximately 50% of our annual free cash flow to repurchase Cadence shares.

With that in mind, for Q3, we expect revenue in the range of $1.165 billion to $1.195 billion, GAAP operating margin in the range of $27.7 million to 29.3%, non-GAAP operating margin in the range of 40.7% to 42.3%, GAAP EPS in the range of $0.83 to $0.93 and non-GAAP EPS in the range of $1.39 to $1.49.

And 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 Q2 results. We exceeded our outlook on all key financial metrics. A good finish for the first half and ongoing demand for our solutions sets us up for strong growth in the second half of 2024. As always, I'd like to close by thanking our customers, partners and our employees for their continued support. And with that, operator, we will now take questions.

[Operator]

[Operator Instructions] Your first question comes from Charles Shi with Needham & Company.

[Yu Shi, analyst]

Anirudh and John, maybe the first question, I do want to ask a fairly big question -- a big picture one. So you did pick up your outlook for the year, but some of that really comes from beta CAE, but the broader question is the semiconductor -- global semiconductor sales is on track to grow a lot faster, let's say, compared with you and your peers' synopsis and -- but this seems to me kind of like a reversal of the trend of the last 3 years when you actually did [indiscernible] semiconductors. But with so much AI being a big driver for semiconductors, would you wonder whether it's either through pricing or to some other measures, Cadence can actually gain a little bit bigger piece of the pie from overall semiconductors, especially from AI? I don't know if you could provide some thoughts today. I'm not necessarily asking how to change the trend in terms of the value capture, but any thoughts would be great.

[Anirudh Devgan, executive]

Yes. Charles, thanks for the question. I mean, first of all, I'd like to say that overall, we are pleased with how we are performing. If you step back -- because you asked a longer-term question, right? If you step back, we will deliver, we expect, more than 13% revenue growth and about 42.5% operating margin. So I think that's a best-in-class combination of both revenue growth and operating margin. And then if you look at our CAGR over the last 3 years, which is one of our kind of favorite metrics, that's also performing pretty well in terms of growth and margin expansion.

And you mentioned semi cycle, I mean it's encouraging to see that there is going to be growth this year, which it was not there last year. But as you well know, Charles, we are tied to the R&D spend more than the revenue of our customers. And of course, if the revenue goes up, they're more likely to spend on R&D. But in general, our customers, both system and semi companies continue to spend on R&D and these are long-term projects. So we'll see how that goes as the semiconductor revenue improves, but this is not an instantaneous effect on R&D spend.

There's always some lag sometimes. And so we really -- but we are encouraged to see the improvement in semi spending overall in the semiconductor revenue. So I would like to say, and you can see in our backlog also, we've maintained a pretty healthy backlog. So overall, I think things are performing well, and this AI is broadening out. I mean you know this well. AI is broadening out beyond data center, which we are glad to have great partnerships to automotive, to more edge consumer devices like phones and PCs. So overall, I feel pretty good about the industry and of course, our position in it as the essential provider of design software.

[Yu Shi, analyst]

Got it. And maybe a quick follow-up on China. It looks like China revenue is still pretty light in the second quarter. So I recall you were thinking maybe China contribution is probably going to be slightly less than the mid-teens or less than 15%. But even if -- let me assume the China revenue gets to like a 14%-ish, it still implies a little bit of a second half reacceleration of China revenue growth. Is that still the case? Or do you think maybe compared with the 3 months ago, China actually make up a little bit weaker as you previously thought?

[John Wall, executive]

Thanks for the question, Charles. And that's -- I mean, regional revenue is notoriously hard to predict. I will say that at the midpoint of our current revenue guide, we only need China to get to 13% of overall revenue to be able to hit that midpoint. I mean when you look at performance in Q2 and the first half, we had a very strong bookings first half, very pleased with customers' response to our new hardware systems. The IP and SD&A businesses continue to grow strongly. Core businesses continue to scale really well, and we're focused on profitable revenue growth. I know, in your first question, you indicated that we hadn't raised the outlook, but we did raise non-GAAP EPS by $0.06.

We're very pleased with the improvement in profitability. And when you look at the current guide, we're actually on track for 50% incremental margin, excluding the impact of beta CE. Beta CE is in our guide. But it's in our guide that what we previously communicated in the press release, is $40 million of revenue. and about $0.12 dilution to non-GAAP EPS, there is an impact to Opcash as a result of beta CE as well. But overall, very, very pleased. We thought it was prudent to to assume lower China revenue for this year at the midpoint of our guide, but that's it. We only need 13% to get to the midpoint of guidance.

[Operator]

Our next question comes from John Marco Conti with Deutsche Bank.

[John Marco Conti, analyst]

Yes. So on my first one, could you talk a little bit about the implied Q4 ramp up to 29% growth at the midpoint of guidance? And what is giving you the confidence in reaching the target? Is it mostly hardware visibility coming through? Or are there an unusually higher number of Q4 renewals that you're waiting for? Any color here would be great.

[John Wall, executive]

Yes, Marco. I mean, there's no real change from what we said last quarter. I mean it's effectively the shape of the revenue curve for the year. We're expecting upfront revenue a lot more AP revenue in the second half is just the timing of shipments really that's up for revenue typically comes from IP hardware and to a lesser extent some software on the SG&A side. With the hardware, it takes time to build the systems. We have higher revenue in Q4 versus Q3 as a result. But also from IP, there's IP is -- we recognize revenue and IP based on the timing of deliveries. We're confident in that guide. It's just the shape of Q3 and Q4 is what we have in the guide now.

[John Marco Conti, analyst]

Okay. Great. So my follow-up would be on [indiscernible]. If you could talk a little bit about how much visibility you have actually in H2? Are you booking and delivering in the same quarter, hence, why we're not seeing a major uplift in backlog growth? Or is it -- is there a different amount to it? I'm trying to understand if you're booking, manufacturing and delivering all in the same quarter for hardware essentially.

[John Wall, executive]

Thanks for the question. Yes, in some cases, on the newer systems, there is a time line, a lead time to building the systems. We have more bookings than our ability to actually fulfill those those bookings. But we do have some inventory of the older systems. We're able to deliver those in the quarter. Yes, so I mean there's always a mix. We did have a challenge in the past with getting inventory and building the inventory as fast as we could for the demand. I think we've dealt with a lot of that. You'll also see in the OpCash guide, there's -- we're planning to purchase a significant amount of raw materials for building inventory in Q3. That's the biggest portion of the change in OpCash guide.

[Anirudh Devgan, executive]

Also just to add on the overall hardware cycle, as you remember, we launched new systems in April, just a couple of months ago, a few months ago now, and the response to them has been phenomenal. Actually, we -- these Palladium -- especially both Palladium and protium but these systems can design ships, like I mentioned last time, with capacity of 1 trillion transistors, and the current biggest chip is like 200 billion transistors, most of them are 100 billion or less. So we are 5 to 10x higher capacity than what is needed. So that should suit the industry well for next several years.

And I'm also what pretty pleased about is that we delivered production deployments of our new systems to some very major customers. So we highlighted NVIDIA, a development partner with a significant deployment of Z3, also one of the leading mobile system, mobile companies in the world and one of the leading hyperscalers. So it's across multiple markets that we delivered our latest systems, which are performing exceedingly well. So that sets up very well for the future and also competitively. And we have a significant lead given the nature of our systems. It's a combination of Protium is based on SPGA, and then Palladium is based on our own chip and advanced TSMC process. And Cadence is the only solution that does that and provides a unique value.

So overall, I think hardware business is performing well. And as you know, these are multiyear upgrade cycles. So this is not all in '24. So we'll see how things go in '25 and '26, yes.

[Operator]

Our next question comes from Vivek Arya with Bank of America Securities.

[Vivek Arya, analyst]

So on an absolute basis, in fiscal '24, organic sales growth rate is robust. But in terms of revisions, it has stalled, right, essentially no real movement since what you suggested at the start of the year. So I'm curious, Anirudh,how has the year transpired versus what you thought? And how do you think about bookings and backlog trends into the second half? Should we expect that backlog stays around the $6 billion? Will it start to pick up? Just I'm trying to understand that should we be thinking about sales accelerating from here? Or this being kind of the sustainable growth rate for the company?

[Anirudh Devgan, executive]

Vivek, good question. So in general, what I would like to say is like we mentioned last 2 times, the shape of the curve this year is unique to Cadence given multiple factors. This is not what we expected last 2 years. So this time, it's more back-end loaded for the reasons we mentioned before. So the guide is a little different, and we are also, given that shape of the curve, more prudent in our guide like we were in Q2, and then we'd rather overachieved and deliver that and give the team flexibility to do the right business for the long term.

So I think that's the difference this year versus last few years is, given the shape of the curve, we have more prudence in our revenue guide, like John mentioned, and John can comment on the backlog expectations.

[John Wall, executive]

Yes. I mean we don't guide bookings, but we were very pleased with the strong bookings in the first half. And I get the question, Vivek. I mean, essentially, we're seeing strong demand for our hardware systems. We're seeing strength across all our businesses. And I guess your question is that when you add in beta CE, you're not really taking the revenue guide up. I think, essentially, I mean, if your question is, what would we like to see improve? I think it's the China revenue percentage. It was 12% in Q1, 12% in Q2. It improved in Q2 over Q1, and we think it will continue to improve through the year. But right now, our guide only assume -- only needs to get to 13% China to hit the midpoint of that guidance.

[Vivek Arya, analyst]

And for my follow-up, you mentioned beta CAE quite a drag to EPS. I think you mentioned $0.12 dilution and almost, I think, what is like a $300 million hit to operating cash flows. Can you describe that acquisition a little more? And when does it start to become accretive to your financials?

[John Wall, executive]

Yes, Vivek. On the $300 million drop in operating cash, just to clarify that, that about 40% of that $300 million drop is due to M&A. I mean, in things like beta CAE, some of the purchase price, the geography of where the operating -- or where the cash impact goes, it slows -- some of that payment flows through OpCash. A bigger portion of the impact on operating cash is our plan to purchase a lot of inventory raw materials for the hardware demand that we're seeing. We're prepurchasing a lot of inventory. So you'll see our inventory spike in Q3 with all of the raw materials we're purchasing.

we want to make sure that we have all the raw materials necessary to ramp up the build-out of our hardware systems.

And then in relation to beta CAE, this -- I mean it's very recent acquisition, the -- it's no different to what we have in the press release. On the press release, we said we were expecting $40 million of revenue at the midpoint. That's embedded now in the guide. We're expecting $0.12 dilution on non-GAAP EPS, that's also in the guide now. And we expect it to be -- I mean, operationally, it will be accretive next year, but there is some interest cost associated with this. But we think it will be accretive next year.

[Anirudh Devgan, executive]

Also a couple of things to clarify. So one thing, this purchase of inventory for the hardware systems, I mean that will be used over multiple years. It's not just for '24. So I think it's a onetime investment that pays for several years, and that's a prudent decision to make to get the right kind of parts for the future? And then on beta, it completes our system analysis portfolio to add structural analysis, and it also strengthens our position in automotive.

Of course, data center is a big vertical with all the AI super cycles, but I think one of the other exciting verticals is automotive with all this electrification and also AI getting added in the self-driving or driver assistance. So we see a lot of design activity in automotive. Also, automotive is also moving through chiplets and 3D-IC. So I think automotive has all the 3 tenets of our IST strategy. It has silicon content that is increasing and more and more system design, of course, is needed for the design of automotive and AI for all the data and computational software. So for that reason, beta CAE completes our portfolio in automotive and positions us well in the future.

And this is not just with the semiconductor companies doing automotive, but also the system companies now, OEMs doing more and more chip design and doing more of our system solutions. And I also want to highlight and congratulate McClaren. There was a big news this weekend, McLaren got 1 and 2 in Hungarian F1, and we have been working with them for the last few months and years, and it's good to see them do well as we deploy. So I think the automotive solution that we are driving is a combination of silicon system and then AI, and we are seeing the results of that through organic and inorganic expansion.

[Operator]

Our next question comes from Joshua Tilton with Wolfe Research.

[Joshua Tilton, analyst]

Guys, can you hear me?

[John Wall, executive]

Loud and clear, Josh.

[Joshua Tilton, analyst]

Great. The first 1 is just kind of more of a clarification. I know there's been a lot of questions around the mix in upfront versus recurring. I guess what I'm just trying to understand is, and I could be wrong with my math here, but it feels like it was -- the upfront component was still a little light in 2Q, and now we're a little bit more second half weighted, more 4Q weighted because you need time to develop inventory. Am I thinking about that the right way?

[John Wall, executive]

That's fair, Josh. I would do the [indiscernible] on you in terms of bookings were stronger than we expected in Q2, and we got some uplift in recurring revenue, took a bit of pressure off on the upfront side that -- and we are -- I mean, we're taking orders. We've got strong demand for the hardware and we're building those harbor systems as quickly as we can, particularly the newer hardware orders.

IP is doing really well and system design and analysis are doing really well. And what we've reflected in the guide is our expectation of how much of that revenue will fall in Q3 and Q4. We took the opportunity, we really derisked the guide for the year by reducing our expectations for China. Upfront, we still expect to be in a range of 80% to 85%. But I think we might get slightly more recurring revenue as a result of the strong bookings in the first half.

[Joshua Tilton, analyst]

That makes super clear. And then I guess just my follow-up to that is, I guess it's another visibility question, but how much of what's baked into the guy from an upfront perspective do you feel like you have like good inventory levels to meet that guidance? Or does the guidance that you put out today still require you to build and develop inventory between now and shipping those boxes?

[John Wall, executive]

Yes. But it's -- we definitely need to build a and you'll see the impact on our inventory in Q3 with the amount of raw materials we're purchasing. But as Anirudh says, that's a onetime thing that we're doing to try and get raw materials and to build those systems as quickly as we can. But the -- a lot of the upfront revenue in the second half comes from the strength in our IP business, and we have those orders in backlog, and it's just a case of executing against those.

We also have some SD&A, or system design and analysis upfront revenue that's scheduled to occur in Q3 and Q4. Again, most of that is from orders in the system. On the hardware side, that's -- it's kind of mid- to high single digits is what we were expecting the SPG group to deliver to be able to hit the midpoint of that guidance.

[Joshua Tilton, analyst]

Super, super helpful. And then just a quick follow-up is, really awesome to see the recurring revenue growing sequentially this quarter. Is there any way you can maybe help us on what the expected recurring versus upfront mix is supposed to be in 3Q?

[John Wall, executive]

I don't have that to hand, but let me come back to that. We'll see if I can dig it out here.

[Operator]

Our next question comes from Ruben Roy with Stifel.

[Ruben Roy, analyst]

John, just a very quick question and then I guess a follow-up, and then I'll ask a real question. But on the inventory purchases, is am I right in assuming that that's mostly for the Z3, X3?And has anything changed in terms of when you're thinking about general availability of those hardware products?

[John Wall, executive]

Yes, that's correct. But the vast majority of the purchases are to get raw materials to help build those new systems.

[Ruben Roy, analyst]

And then in terms of the timing of it?

[Anirudh Devgan, executive]

Yes. Just to clarify, I mean, also, I mean, we have 2 systems, right? So Palladium we design ourselves, and we manufacture the chip and [indiscernible] [indiscernible]. We also design ourselves, but the silicon itself is primarily from AMD with Xilinx, FPGAs. So a lot of this purchase is for for X3 and the FPGAs, and that should serve us for multiple years.

On Z3, like we said, we're already shipping them, and they're already deployed in production this quarter. So I think Z3 is slightly different than X3 in terms of the mix of the silicon content just to clarify that.

[Ruben Roy, analyst]

Okay. I apologize. I thought they were going to sort of certain customers not generally available. And the real question, just around some of your top customers have been accelerating the rhythm of bringing sort of their very complex chips to market NVIDIA and AMD certainly have accelerated their road maps to sort of a 1-year rhythm. Are you seeing any changes in sort of the way your business is impacted or affected kind of by the acceleration of their product road maps yet?

[Anirudh Devgan, executive]

Yes, I would like to -- I think we're seeing more and more design activity, like you said, the rhythm or the cadence of the products and also different kind of chips. It's not just the big data center chips, but even within them, there is more and more customization. Of course, the hyperscale is doing their own silicon. And then now we talked about our partnership with, for example, Qualcomm and they are doing consumer or edge laptop AI devices. So the amount of AI is also spreading to other verticals, not just obviously the big one on data center. And data center design is accelerating. And I think when we look at it, we still see that the data center part of AI still should accelerate, at least the visibility we have for the next couple of years. So we'll see how that goes.

And then the other thing is automotive, now automotive takes normally a little longer, but they're already seeing design activity and the deployment may be a few years down maybe after data center. And then consumer and PC is already starting with phones and laptops. So overall, we do see accelerating deployment of AI into the whole semiconductor ecosystem. And we are very proud of our position in it, whether it's 3D-IC, whether it is data center chips, whether it's our own AI products, we are winning almost all kind of engagements on all -- on our kind of Cadence.AI portfolio. So overall, we do see more and more design and deployment of AI infrastructure and our own AI product.

[John Wall, executive]

And if I could just come back to Josh's question -- sorry, if I could just come back to Josh's question on the revenue mix for Q3 that for recurring revenue, we expect, sorry, 80% to 85% of revenue to be recurring for the year and Q3 includes the middle of that range and then the balance is Q4. So you can do the math and work out what the upfront piece is.

[Operator]

Our next question comes from Jay Vleeschhouwer with Griffin Securities.

[Jay Vleeschhouwer, analyst]

On a rod question about the evolution of the product portfolio for EDA generally and perhaps for SG&A specifically. What I'd like to ask about is how you're thinking about packaging the products. Over the last year, you've introduced a couple of products with the term studio in the name. And I'm wondering if you're thinking about more and more bundling or packaging of that kind via that nomenclature for the EDA products? And then specifically for SD&A, now that you do have multiple codes, how are you thinking about packaging or integrating across the various simulation codes that you've assembled now in acquisition? Then I'll ask my follow-up.

[Anirudh Devgan, executive]

Jay, good question. So I mean, as you know, in EDA, when we go to lower nodes, there is more integrated solutions, which are required, where it's digital or analog or verification. And that is further accelerated by use of AI, so, like [indiscernible] for example, in digital, will integrate not just place and route, but also synthesis and sign-off. So I think that trend is definitely there. And same thing with Verisium, our leading AI product for verification also integrated the 4 major verification platforms we have. So it is more and more a platform-driven approach. And we can do that now with SD&A now that we have a complete portfolio. And we mentioned like a leading EV company, like OEM, one of the leading, the most advanced EV companies deployed our entire portfolio. So as we have a bigger portfolio in SD&A, it does let us do what we have always done in EDA, focus on solutions, not just on individual products and integrated solutions with our own kind of native integration, whether it's analog, digital verification and now with SD&A.

[Jay Vleeschhouwer, analyst]

As a follow-up, I know it's still quite early in the propagation of AI and ML by you and your peers to the customers, but are you beginning to see any commonality or convergence towards a relatively small number of use cases that customers are mostly employing the tools for? And then relatedly, are you also seeing AI/ML adoption having any meaningful effect on your services revenue?

[Anirudh Devgan, executive]

Yes, Jay. So what I would like to say is that the number of use cases I see is increasing at this point. I mean, of course, one of the biggest use case that we started with was digital implementation since it is so kind of heavy kind of design process. So automating the digital implementation process was a huge benefit. And we talked even this quarter, [indiscernible] being deployed at one of the leading system companies for the default flow also used by Samsung. Also you see verification being used by Qualcomm. So I think what is happening in that [indiscernible] or the implementation use case, 2 things. One is that it is going not just for design, but also for DTCO, design, technology co-optimization. And also for higher level in the design process like floor planning and 3D-IC exploration. So it's all not just for implementation of the design, but also for architecture and exploration.

And the other thing is like there's more workflow automation. As customers get used to [indiscernible], they are using it not just towards the end of the design process, they're using it right from the beginning throughout the design process. So it allows us to do more workflow automation and [indiscernible] has also evolved to allow much more of an entire workflow rather than a specific implementation use case.

And then same thing is happening in terms of more and more use cases, for example, packaging. Allegro X is doing pretty well. And recently, one of the leading customers in 3D-IC used its capability to automate, for example, routing, for automating placement, which was not there before in PCB and package design. So overall, I do think it's a maturing of the workflows. And then with these LLMs and Gen AI, we have kind of several workflows for taking spec to RTL, and we highlighted some of them last quarter.

So I actually do see finally that in the -- we are always kind of building out the AI infrastructure. These big companies designing chips, but I do see now there is a turning point in deployment of AI for the design process with the initial workflow being [indiscernible] and digital implementation now to expanding to LLM based spec, expanding to DPCO, expanding to 3D-IC, of course, expanding to analog, packaging, verification, and we do have the most comprehensive AI portfolio in terms of all 5 major kind of product lines. So actually, it's a pretty encouraging view compared to a year ago.

[Operator]

Our next question comes from Harlan Sur with JPMorgan.

[Harlan Sur, analyst]

Is the bookings profile for the full year still expected to be 40% first half, 60% second half? Because if it is, then that would imply book-to-bill greater than 1 for the full year, total backlog up about 9% this year to about $6.5 billion. But I guess how much of that backlog is due to the beta CAE acquisition? What I'm just trying to figure out is ex-beta CAE, if core Cadence orders and backlog are expected to be up this year, which would continue the strong sort of 6- to 7-year trend of increasing orders and backlog for the team.

[John Wall, executive]

Yes, Harlan, again, like I said, it's -- we're not guiding bookings, but we were very, very pleased with the strong first half for bookings the beta CAE contribution to backlog is very, very small, it's immaterial. Because basically their revenue is upfront. So that's the upfront piece of the business rather than the recurring revenue. But we're very pleased. I mean you can typically expect us to always be driving for a book-to-bill of greater than 1, but we don't guide bookings so...

[Harlan Sur, analyst]

Okay. Perfect. And there's a pretty interesting dynamic with your memory customers, right? They're big customers of your custom product family, Virtuoso, but they are moving more and more to advanced digital design, right? The [indiscernible] control logic chip, for example, is moving to leading edge technologies and advanced chip design. Similarly with some of your NAND customers, they're moving towards more of this sort of bonded CMOS periphery to array. The periphery chip, again, is also moving towards advanced digital design as well. So are you starting to see more adoption of your advanced digital implementation and verification products by your memory customers? And then does the leadership in memory via virtual also sort of give you an advantage as they bring on more advanced logic design capabilities?

[Anirudh Devgan, executive]

Yes, Harlan, that's a great observation. And we are fortunate to have very deep and long standard partnership with all the major memory companies. At least there are 3 big ones and then maybe 2 at the next level. But overall, we are -- given our strength like you mentioned, in Virtuoso, which is the platform for choice for all memory implementation, and yes, there is a lot more digital and implementation design happening at memory companies, primarily driven by HBM and other trends. And actually, also, there is some kind of -- I mean they were always doing digital, but it's a lot more now, and there is a trend of even integrating TSMC's technologies with kind of memory. And given our strong partnership with TSMC, that also helps us with the memory companies.

And as you know, they are also doing a lot more 3D-IC, all the 3 big memory companies. And these memory layers are going from -- they're actually 1 of the most advanced 3D-IC with the memory layers going from 8 to 12. And that also plays to our strengths. And even in my prepared remarks, I mentioned, for example, our partnership with Samsung and 3D-IC, and then so is true with the other kind of 2 major players in memory.

So we are pleased in our position in memory and the emerging trends of HBM and 3D-IC integration, and we'll see how that progresses. But I think memory is often overlooked. And I don't need to tell you, but just in general, memory is often overlooked in the big AI super cycle. It's not the big chips, logic chips, but memories play a very essential role, and we are very well positioned, both with the leaders like NVIDIA on the logic side and then we highlighted Samsung and the other big memory players in general.

[Operator]

Our next question comes from Jason Celino with KeyBanc Capital Markets.

[Jason Celino, analyst]

[indiscernible] have some questions so far on the hardware timing. But I think, John, on prior calls, you've said that the hardware delivery times typically are like 8 to 10 weeks. That's what it is for like a normal cycle. But are you saying the lead times for the Z3, X3 are longer than this because the demand is much better than what you're seeing?

[John Wall, executive]

Demand is strong. Demand is strong. What I was trying to point out was that we do have inventory of the older systems that we can deliver right away. The newer systems we're having to build them as quickly as we can because the orders are coming in faster than we can build them. So the lead times is a bit of a moving target in that respect. We are planning to purchase a lot of raw materials and build as quickly as we can in Q3. So you'll see a significant uptick in our inventory balance at the end of Q3.

[Jason Celino, analyst]

Okay. No, that's helpful. And then just a clarification. I think you were saying like the FDA group to hit your guide needed to do like mid- to high single-digit growth. I'm not familiar with SDG. Is that the functional verification kind of guide for the year? And then, if you're parsing out, like does that imply what do we need to see on IP since that's the other upfront component to hit the guide?

[John Wall, executive]

Yes, that's fair. That's -- yes, IP is having a really, really strong year as is system design and analysis. They'll be our 2 fastest growers for the year. And then again, there's some upfront revenue from them. It's more weighted towards Q4 versus Q3. So we have the the shape of the curve is really driving our guide. And I would categorize it as prudent. and Anirudh, would you add anything?

[Anirudh Devgan, executive]

No, that's right, John. And sorry for the acronym, SPG is a system verification group. So when we say SPG, that means verification. So I think that's what John was implying. Verification should grow, but right now, we are not assuming massive growth in verification for this year, but it should grow compared to last year.

And then like you mentioned some of the upfront revenue is also IP. If you remember, we highlighted in Q1 new partnership with Intel. And they are -- we are deploying our IP portfolio for the Intel process. So it takes time to do that and deliver to that, and some of it is in Q3 and Q4. And also this time, we talked about our expansion partnership with Intel on -- both on EMIP, their packaging and 3D-IC platform and 18A, just to clarify the...

[Jason Celino, analyst]

Our next question comes from Lee Simpson with Morgan Stanley.

[Lee Simpson, analyst]

Great. Well done on a good quarter. Just wanted to get some clarification. I don't know if I heard correctly, but I think I heard you say that a mobile OEM had taken the Z3 platform. And if that's the case, do you have a sense for what the emulation work might be? Would it be for chips on device? Or would it be for chips both on device and perhaps in, let's say, a network situation?

[Anirudh Devgan, executive]

Well, good question. We don't comment on individual customers or specific customer use cases. But in general, these hardware systems, as you know, are used both for chip design and for system software bring-up, so both use cases are there, and we are the leading platform given Palladium and Protium. And this is true for all -- even in the AI use case -- even in the data center AI use case, a lot of it is for software development. Actually, Palladium is a platform for choice to even our AI chip customers to give a model to their customers. Because even before they have a chip, they can give a Palladium model see how it performs. So it's both for chip design and also for system design and system software. And that's true for multiple major verticals, data center, mobile, automotive, these things.

[Mark Edelstone, analyst]

Yes. Just on those multiple verticals, if we look at the incidence of 3D-ICs coming through, I get the sense that, that's starting to hit the tape now in automotive. You have mentioned EV companies as a collaboration of late. But you have mentioned a number of chipmakers also. I wonder if it's possible at this point, or even if it's relevant, could you just maybe talk about the split between the customers? Are we talking system customers, i.e., OEMs and Tier 1s in the majority right now, or is it still major semis chipmakers for the automotive work?

[Anirudh Devgan, executive]

So, great question. So first, yes, like you correctly pointed out, I think the 3D-IC is a lot more prevalent in automotive than, let's say, 6 to 12 months ago. And of course, the original genesis is HPC and data center AI, but now all these chiplets and 3D-IC platforms are moving to automotive. And I think over time, we'll move to other verticals like consumer. They already moved to laptop, for example, the several of the laptop chips are 3D-IC. But I think that will be the progression. It will gradually go to all verticals, but definitely active in automotive. Because as you know, with the chiplet architecture, the customer doesn't have to redesign all the chips. And also, they can use some standard ships and have some specifics, which are more value-added for them. And that's particularly true in automotive as each OEM wants to differentiate versus the other OEM.

So this trend is not just for semi companies, to your question, it's also there in OEMs. And I think actually more -- I do think that the 3D-IC trend makes even more sense for end OEMs because then they're able to customize and differentiate versus the other. So we are seeing that, and we are seeing that in other geographies as well because, as you know, China is critically strong in EVs and then U.S. and then Japan, there's a lot of activity. So overall, I think automotive, there is more activity on 3D-IC, including both semi and OEMs, yes.

[Operator]

Our next question comes from Clarke Jeffries with Piper Sandler.

[Clarke Jeffries, analyst]

My first question is, Anirudh, how do you expect the delivery of these third-generation systems to translate to additional software consumption in the recurring revenue portfolio? These products are happening with verification acceleration software bring up, but how do you see that additional consumption panning out after the delivery of a new ZRX system? And then I have one follow-up.

[Anirudh Devgan, executive]

Yes. Great question. I mean like what John was saying, when we say SVG, System Verification Group, so hardware is part of that group. Even though hardware is a significant business, we organized it as part of verification. And one of the big reasons for that is, apart from -- in verification, apart from the hardware systems, we have a lot of other verification products, which are doing pretty well like Jasper for formal verification, XLEM for logic [indiscernible]. And the customer is looking for a integrated solution on verification.

To the earlier question that Jay had about what is happening in SDA. In EDA, you always have believed for the last several years that it's going to be integrated solution in verification. So the stronger our hardware products get, we do expect it should help our software verification products, things like [indiscernible] and Jasper and Verisium. Because a lot of -- some of the hardware capacity is also used for what is called SIM XL, simulation acceleration in which they use Palladium to accelerate logic simulation. So there is a natural tie-in between verification software products and verification hardware products.

Now exactly how it pans out, we just have to see. But the strength in hardware should help us in our overall portfolio's strength.

[Clarke Jeffries, analyst]

Perfect. And then 1 follow-up for John. I think just to kind of finally put a cap on the whole discussion around timing. I guess then, is it fair to say that, that sort of $600-odd million of upfront revenue in the second half, maybe a majority of that is coming from IP and SD&A and not necessarily the Gen 3 systems and that maybe the interpretation is that there's going to be more of a demand curve in the beginning of '25 rather than this $600 million being strongly driven by third gen plan in and Protium. Is that a fair takeaway?

[John Wall, executive]

No, I think that is, Clark. Yes, that's exactly right. I mean, we always knew that it would take time to build the hardware system, so we originally included that in our guide in the first place.

[Operator]

Our final question comes from Joe Vruwink with Baird.

[Joseph Vruwink, analyst]

Great. I did want to follow up to stay with verification and just this raw material investment. So the thing I'm trying to reconcile is I would imagine you entered this year expecting the new platform, strong demand, meeting the scale production, and therefore, invest in inventory. So I guess I'm wondering what changed in the quarter that warranted this updated assumption for cash flow and raw material purchase? And really at the heart of the question, did something change about your hardware demand expectation, not necessarily for 2024, but maybe out into 2025?

And we just happen to be getting that news now because of the need to update your cash from ops forecast associated with the inventory input?

[John Wall, executive]

Yes, it's a great question, Joe. I mean the leaders of that business, I spent plenty of time with them this last quarter because they were monitoring what the demand was like for the new systems. Demand is quite strong. And then the key thing to a here is it's a onetime multiyear purchase of inventory raw materials. They feel very, very confident in the longevity of these systems and the longevity of that demand, and they wanted to prepurchase multi years of inventory in Q3. Now that was new to us, if you like, so we thought that onetime thing we wanted to include at all now in Q3 and not impact -- that doesn't impact next -- I mean it will be favorable for next year's operating cash.

[Joseph Vruwink, analyst]

Okay. Great. Then lastly, you mentioned at the start, orders for Cadence.AI tripled year-over-year. I don't think that's possible without also without also getting a lift in the base business, both across EDA and SD&A. I guess on an ACV run rate basis, what has the AI lineup meant for Cadence overall? And does this create a step-up in value where, as you start pulling these contracts from backlog in coming quarters, it will become more noticeable in revenue, and we'll kind of see the AI contribution more than we have to this point?

[Anirudh Devgan, executive]

Yes, good question. I mean, AI is adding -- like I was mentioning before, I mean, it almost becomes like table stakes now. So all our new contracts include our Cadence.AI portfolio as customers get more and more kind of used to using them. And once you start using the AI portfolio, it's difficult to go back to not using them. So without getting into like what happens exactly to future revenues and bookings, we are always cautious about that. But in general, there is uptick with more customers deploying AI. And whenever we have new contracts, we are including them as it makes sense in them.

[Operator]

I will now turn the call back to Anirudh Devgan for closing remarks.

[Anirudh Devgan, executive]

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 innovative road map 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]

Thank you for participating in today's Cadence Second Quarter 2024 Earnings Conference Call. This concludes today's call. You may now disconnect.