Cadence Design Systems Inc

NASDAQ:CDNS

Earnings Call Transcript 2020-Q4

[Operator]

Good afternoon. My name is Rob and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence Fourth Quarter 2020 Earnings Conference Call. [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, Rob. I would like to welcome everyone to our fourth quarter 2020 earnings conference call. I am joined today by Lip -Bu Tan, Chief Executive Officer; Anirudh Devgannd, President and John Wall, Senior Vice President and Chief Financial Officer. The webcast of this call is available through our website cadence.com and will be archived through Mach 19th, 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 actual results may differ materially from those expectations. For information on factors that could cause 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 results using certain 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 February 22, 2021 for the quarter and year ended January 2, 2021, related financial tables and the CFO commentary are also available on our website. Note that again today we are conducting the earnings call from our respective remote locations. For the Q&A session today we would like to ask you to observe a limit of one question and one follow up. You may requeue if you would like to additional questions and time permits.

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

[Lip Tan, Chief Executive Officer]

Good afternoon everyone and thank you for joining us today. In a year of unprecedented macro challenges, I’m pleased to report that Cadence achieved outstanding financial results for both the fourth quarter and 2020.

For the year, we achieved 15% revenue growth and 35% non-GAAP operating margin with strength across the Board and all segments growing by double-digits. In a moment, John will present more information for Q4 results and our 2021 outlook. The acceleration of digitization due to the pandemic, coupled with exciting generational trends like 5G, AI/ML, data analytics and hyperscale computing, continued to drive strong semiconductor demand.

Leading hyperscaler, mobile and AI companies continue to aggressively pursue Moore’s law, while 5G/wireless; industrial and automotive verticals are leading the charge on the More-than-Moore front. Our Intelligent System Design strategy triples our TAM and our broad compelling portfolio of chip, package, board and system design solutions, uniquely positions us to realize these exciting opportunities.

In 2020, we accelerated our momentum at marquee accounts, while expanding our systems portfolio through compelling acquisitions, enabling us to win new customers in our targeted vertical segments. Of particular note was the strength of our aerospace and defense business as the digital transformation in this vertical continues and we expanded and deepened our relationship with Northrop Grumman, which includes the use of our custom-analog and digital full flow.

Additionally, we are especially excited by the momentum we have with hyperscalers as they accelerate their chip and system design activity. Our engagements with the system customers have steadily deepened over the past few years and revenue from systems companies is now closer to 45% of our total revenue. It was a great year for our Cadence Cloud, which now has more than 175 customers. And we further strengthened our partnership with cloud infrastructure and foundry partners.

Now let us review Q4 highlights. Design Excellence is the foundational layer of our strategy and includes our Core EDA chip design platforms and IP portfolio. Our design -- our Digital & Signoff solutions offering superior quality of results and faster convergence, continued proliferating at market shaping customers. We are engaged in well over a 100 projects at 5-nanometer and below process technologies, and we are in earlier collaborations on the 2-nanometer node.

Deployment of our full flow accelerated as more than 45 customers adopted our Cadence digital full flow at the most advanced nodes during the year, including MediaTek, Samsung, Micron, NuVia and a global marquee customer. Based on the superior quality of results, a market shaping hyperscaler significantly increased their usage of our digital solutions. Earlier in the year, a market shaping automotive semiconductor customer committed to Cadence as its primary EDA vendor for digital design.

Customers are faced with mounting challenges in system verification and software bring-up and are benefiting from our verification full flow solutions that deliver industry-leading verification throughput. Momentum continued for Xcelium, our digital simulator with several competitive displacements underway as well as expansions and new customer wins. Our hardware family of Palladium for emulation and Protium for regressions and earlier software development had a strong quarter to finish our best ever year for hardware.

For the year, Palladium Z1 had 24 new customers and 34 expansions, while Protium had 13 new customers and 14 expansions. Demand was particularly strong at AI and hyperscaler customers. Ericsson renewed their commitment to Cadence verification hardware, including both Palladium and Protium. A unique differentiator of the Protium X1 is the common front-end compiler with the Palladium Z1 that enables significant faster bring-up and about 40% of our hardware business during the year included both Z1 and X1.

Our IP business had a strong year as our focused strategy and the compelling portfolio leveraged the ongoing IP outsourcing trend. We continued expanding the footprint of our leadership DDR and PCIe IP and had several design wins at the 5-nanometer and lower process nodes. High speed SerDes is a critical component of hyperscaler infrastructure and several customers have adopted our 112 gig SerDes IP, including Xsight Labs, who has also demonstrated working silicon. Tensilica had strong royalties and significant wins at key true wireless stereo and mobile application processor customers. Additionally, the automotive segment had strong --- have good momentum with wins in functional safety, radar and digital radio, including an ADAS win at a leading self-driving car company.

In System Innovation, we are very excited about our system design and analysis segment, which had a particularly strong year with greater than 25% revenue growth. Rising system complexity for advanced 5G, automotive and HPC applications is driving the need for a seamless platform solution across design, simulation and analysis. AWR and Integrand delivered strong, great results in 2020 and there is a strong customer interest in our integrated Virtuoso, Innovus, Allegro and AWR Microwave Office solutions with in-design analysis.

In System Analysis, we are executing to our strategy of building out our multi-physics portfolio, offering best-in-class solutions and delivering superior results compared to legacy industry solutions. Strong market adoption continued for our System Analysis products and we are particularly pleased with the growing number of repeat orders with customers including STMicroelectronics, Realtek, and a market shaping hyperscaler.

We tripled our System Analysis TAM by adding Computational Fluid Dynamics, CFD technology through the pending NUMECA acquisition, which will bring leading CFD technology and deep domain expertise of Dr. Charles Hirsch and his team to Cadence. NUMECA has over 450 customers, including NASA, Honda and Ford, across multiple verticals such as aerospace, automotive, industrial and marine.

For Pervasive Intelligence, we continued to incorporate machine-learning technology in various tools for improved PPA and faster convergence. Xcelium-ML had successful engagements with several market shaping customers, delivering up to a 5 times improvement in regression throughput. We also progressed on providing IP specifically tuned for AI/machine-learning applications, especially edge inferencing applications.

Cadence continues to invest in fostering innovation and advancing education through endowments at top universities. Building upon previous endowments at Stanford, the University of California at Berkeley and Carnegie Mellon University, we announced a $5 million endowment at MIT’s Schwarzman College of Computing to promote research in the fields of artificial intelligence, machine-learning and data analytics.

Now, I will turn it over to John to go over Q4 results and present our 2021 outlook.

[John Wall]

Thanks, Lip-Bu, and good afternoon, everyone. I’m pleased to report we exceeded all of our key operating metrics for the fourth quarter and fiscal year 2020. We achieved 50% on the Rule of 40 metric for the first time through a combination of 15% revenue growth and 35% non-GAAP operating margin.

Consistent execution against our strategy and double-digit growth across all product categories helped us achieve this landmark, but we also had the benefit of some tailwinds during a fiscal year, which included a 53rd week, a strong second half in China and the recovery of $26 million that we previously thought to be uncollectable.

The pandemic brought many challenges and I’m very proud of our Cadence team for their compassion and resilience in the face of adversity. Their focus on innovation and customer success resulted in continued acceleration of Cadence’s three-year revenue growth CAGR, which is now into double-digits.

Let’s go through the key results for the fourth quarter and the year, starting with the P&L. Total revenue was $760 million for the quarter and $2.683 billion for the year. Non-GAAP operating margin was approximately 37% for the quarter and approximately 35% for the year. GAAP EPS was $0.62 for the quarter and $2.11 for the year, and Non-GAAP EPS was $0.83 for the quarter and $2.80 for the year.

Next, turning to the balance sheet and cash flow. Our cash balance was $928 million at year-end, while the principal value of debt outstanding was $350 million. Operating cash flow in the fourth quarter was $136 million and $905 million for the full year. DSOs were 44 days, and we repurchased $380 million of Cadence shares during the year.

Before I provide commentary for Q1 and fiscal 2021, I’d like to take a moment to share the assumptions embedded in our outlook. We expect strong revenue growth for the first half, followed by more muted second half growth as we lap some tough second half comps. Our outlook further assumes the pandemic restrictions will gradually ease across the globe this year, resulting in higher T&E expense in 2021 compared to 2020. We’ve included the expected impact of the pending NUMECA acquisition in our 2021 outlook. And finally, as usual, our outlook assumes that the export limitations that exist today for certain customers will remain in place for all of 2021.

Embedding these assumptions into our outlook for fiscal 2021, we expect revenue in the range of $2.86 billion to $2.92 billion, non-GAAP operating margin of 34.5% to 36%, GAAP EPS in the range of $2.09 to $2.19, non-GAA1P EPS in the range of $2.95 to $3.05, operating cash flow in the range of $900 million to $950 million, and we expect to use approximately 50% of our free cash flow to repurchase Cadence shares in 2021.

For Q1 2021, we expect revenue in the range of $710 million to $730 million, non-GAAP operating margin of approximately 35%, GAAP EPS in the range of $0.55 to $0.59 and non-GAAP EPS in the range of $0.72 to $0.76, and we expect to repurchase $110 million of Cadence shares in Q1.

Our CFO commentary, which is available on our website, includes our outlook for additional items as well as further analysis and GAAP to non-GAAP reconciliations.

In conclusion, Cadence delivered another year of strong operating results achieving 50% on the Rule of 40 metric for the very first time. We remain focused on driving profitable revenue growth and at the midpoint of our outlook for fiscal 2021; I’m pleased that we are on track to grow our annual revenue by over $1 billion since 2016 with more than $0.50 of every dollar of revenue growth dropping through to non-GAAP operating margin over that period.

I would like to close by thanking our customers, partners and our hardworking employees for all that they do. And I’d like to remind them all that their health and safety continue to be our first priority.

And with that, operator, we’ll now take questions.

[Operator]

[Operator Instructions]

And your first question comes from a line of Gary Mobley from Wells Fargo Securities.

[GaryMobley]

Good afternoon, everybody. Thanks for taking my question. And let me extend those congratulations to a strong start to the fiscal year and a strong execution relative to your Rule 40 CD map by 10 percentage points. And that leads me to my question, John, could you help us level set what that 35% operating margin in 2020 may have been if you didn't have I guess the reversal of the bad debt reserve, or bad collectible reserve, the fact that you're weren't able to bring on employees at a fast enough rate? And then as well, the extra week how does that 35.25% operating margin guide this year 2021 compared to a level set fiscal year 2020.

[JohnWall]

Hey, thanks for the question. Gary, it's probably a multi part question that. But yes, I guess in terms of the collections, we had collections windfall of $26 million in the second half, most of which came in Q4. And some of those invoices were very old, which meant that$ 22 million of the $26 million was recognized in revenue before the end of the year. And that was in relation to if you recall, in the middle of the year, during the pandemic, we had some smaller customers that weren't able to pay us, and we reserved for those. And we help them out that our engineers and team at Cadence were determined to help them whether they were paying us enough, but some of those customers turned around and managed to survive, and we weren't sure if they would.

But so that collections windfall, kind of distorted, maybe some of the revenue timing in the quarter during in the year, but didn't really impact that $26 million and really impact the year, because originally we had it in the year, then we took it out in the middle of the year. And then like that $22 million of that $26 million collected got recognized. In relation to the extra week, we thought that was going to be $45 million. And it was but the extra week, of course was a 2% tailwind for -- in terms of helping us achieve 50% on the Rule of 40 in 2020. And what was the 2% tailwind in 2020 is a 2% headwind now and in 2021, when we go from a 53 week year to a 52, week year. And then, I guess we had a really strong second half in China. I mean when I stepped back from individual quarters and halves, but I would say this, our business is very strong in all regions.

And across all of the product categories, the three year revenue target CAGR, they're up to 11% now in 2020, and at the midpoint, it's 11% for 2020 -- at the midpoint of our outlook for 2021. That's 11%, too. So we're already off to a very strong start, as well as in the first half of 2021. But it's too early really to say that it's not sustainable in the longer term. So the second half, we have kind of music revenue guidance. When I looked at the second half of 2020 in China, what I noticed was that with a higher than normal proportion of upfront revenue in our recurring revenue mix for the region in China. For Outlook in 2021, I've assumed we returned to our usual recurring revenue mix in the region. And that along with the fact that we were less week in the second half in 2021 versus the 2020. That's what contributes to the like conservative revenue growth outlook for the second half.

[GaryMobley]

Okay, that's very, very helpful, John. I wanted to ask you about the materiality of the software from Systems Analysis product group, including the backup, I guess, there's that various documentation that NUMECA had roughly $30 million in annual revenue? Is that a pretty good approximation? And for the overall Systems Analysis category how materials is now is it somewhere in the ballpark of what 1% or 2% of revenue now and how much is it contributing to your overall growth? Thank you.

[JohnWall]

So Gary, system analysis is a business of doing great, I mean bookings and revenue grew strongly in 2020. The operating margin profile is better than EDA, which allows us to invest in the business where we're generating strong incremental margins that improve our overall operating leverage. In relation to the NUMECA, when we issued the original press release, we highlighted that the impact of 2021 is pretty immaterial, it's pending we expected to close, it's imminent in terms of close, I would expect it to close this week. And as usual, of course, we'd expect purchase accounting rules to initially limit the revenue that we can recognize on NUMECA in the first year, so we expect that to be temporarily dilutive to earnings in 2021. And that's already embedded in our outlook. So from that perspective we don't have, anywhere near as much revenue in 2021, as you're expecting.

[Operator]

Your next question comes from a line of Mitch Steves from RBC Capital Markets.

[MitchSteves]

Hey, guys. Can you hear me? Yes. So the first one is just on the 45% systems exposure now. I'm just really curious about why that's trending up so quickly. About three years ago, I think it was closer to like low 40s or 40%, which have metric but now we're suddenly at 45%. And it sounds as they might even go higher. So maybe can you help us understand what exactly is going on with that business that's causing to spike up? And then secondarily, regarding your 50% flow through and the operating margin include that you've been doing. But is there any difference between the systems and semies onboarding in terms of profitability for you guys? Those are my two questions. Thank you.

[LipTan]

Mitch, maybe I can answer the first question first, about the system company. And then we provide this end to end PDF portfolio. And also with our intelligent system design, we are moving up into the system analysis, an area and also the packaging side and then as you can tell, this generation waves in the 5G, and also the hyperscale. And then autonomous driving, and really the system companies starting to engage by actively with us, because we are providing a suite of solutions that we're looking for. So I think it's kind of accumulation of the last 12 years on tenure working on it. So we are delighted and now getting closer to the 45% of the revenue. And for them, clearly, the system, the packaging not just silicon development is critical for them. And we can provide an integrated solution for them so that they can design a complex system that they're looking for. And so we are excited about this opportunity, and our strategy, not investing and behind it, and so we are glad to see the performance.

[JohnWall]

Yes, Mitch and to the second part of your question there that, like I say there's a higher than normal profitability, I think, for us in the system analysis business, and it's been growing really fast for us. I mean if I look at incremental margins, I call it my prepared remarks this, where we're at -- it's a midpoint of our outlook for 2021, we're expecting our non GAAP operating margin to grow by about $550 million over the five year period from since 2016. And that's about 51% of the revenue growth if you calculate the revenue growth over that period of time, and then when I compare the midpoint outlook for 2021, against to 2019, I did the same exercise and I got 51% again before the impact of NUMECA, with NUMECA it kind of takes it just down under 50%.

[MitchSteves]

Okay, so just to clarify and make sure I understand this correctly, system analysis, it sounds to me and maybe I'm reading this too much into this. You're seeing like a step function in your 3D clarity business, or am I reading too much into this?

[LipTan]

I think we also have all this hyperscale guy and some of the system company service provider, they're quietly also building a semiconductor custom silicon design. And so our entire suite from the design excellent, from the EDA, IP, and then plus our system analysis plus upon acquisition we make in AWR and Integrand of providing a lot of system for the 5G and also the industrial group.

[Operator]

Your next question comes from the line of Pradeep Ramani from UBS.

[PradeepRamani]

Hi, thanks for taking my question. Congratulations on a great quarter and a very solid guide. I just had a couple of questions, maybe on last one and then have a follow up. How are you thinking in terms of the mix you're seeing coming out of China versus the rest of the world? I mean last quarter returns a little bit more towards IP and hardware, but it feels like your growth is now increasingly becoming more broad based in China and driven by EDA and software as well. Is that a correct read?

[LipTan]

Yes, let me answer that. It's Lip Tan. So clearly APAC is a strong growth of region for us. And then we have done well in China on Q3 and Q4. And then as you know, China is heavily investing in semiconductor industry. So in some way, now we have broad portfolio of EDA to IP, and even the system analysis, and some of the packaging, and then the 3D packaging, and it becomes critical for them. And so I think overall, we support the customer globally. And then China especially strong and we will continue to complying with the order export control requirements, but meanwhile, so far, knock on wood, we see strong momentum over there.

[JohnWall]

And Pradeep I would that there, that's the -- like if you step back from looking at any individual quarter or half, and you look at the three year CAGR, I think our growth is accelerating across all regions in our outlook for 2021.

[PradeepRamani]

Great. And for my follow up, you had a very strong year on IP. How do we think about the sustainability of growth in IP going forward? Given of course, there are longer term drivers, but just coming off of such a strong year?

[LipTan]

Yes, so I think it's a good question. IP is tending to be lumpy. But so far, we like in and did IP outsourcing trend. And we have a strong portfolio, in terms of DDR, CIE, and also the SerDes is a must have for the hyperscale. And also some of the Tensilica in terms of audio, and also the automotive sector. So overall, we are delighted last year, it's a strong year, but as you know it's a very lumpy upfront. And so we never continue to focus on it.

[Operator]

Your next question comes from the line of Jason Celino from KeyBanc Capital Markets.

[JasonCelino]

Hi, sorry about that. Sorry, I was on mute. The first question on NUMECA acquisition. I know it's pending. But maybe can you speak to the, what is so attractive about that business? I know CFD is a pillar physics part of the market? And then make versus buy there. I mean what factors went into acquiring versus just building in?

[LipTan]

Anirudh, do you want to take this one?

[AnirudhDevgannd]

Yes, definitely. Yes, that's a good question. So as you know, we are pretty excited about our move into system analysis, which is driven by our expertise in computation software, or numerical mathematical software. And we have a lot of expertise in that organically, as we saw in the development of clarity, which is a 3DM Solver, that been generating a lot of good results. And the second thing we are excited about is the customer synergy, a lot of customers, as we discussed, we have a lot more system companies, and they are asking for the system analysis capability, okay. And then the question becomes whether to organically develop or to acquire, and we look at the space. And in terms of system analysis, CFD is a very critical area, is one of the largest market segments with lot of vertical application, and NUMECA has very good technology, more than 450 customers. So we are pleased to welcome them to Cadence with this pending acquisition. And I think that can be used as a basis to expand further expand and expand more in R&D with our competition software strength, and expand more with our customer base. So we are very happy to use them with their expertise in CFD to expand into this very, very exciting area for us.

[JasonCelino]

Okay, and then my quick follow up with this is I think you mentioned that it was a 3x TAM expansion with acquisition in the CFD. Does that 3x TAM expansion also include other physics like structurals, or is that just CFD alone? Thank you.

[AnirudhDevgannd]

So in terms of system analysis that is a pretty big segment, and it's about $6 billion, we estimate and the other good thing about it is that it is growing rapidly. There is always more need for more and more simulation. What the estimate is clarity in Celsius is about $800 million in addressable market, which is EM and thermal. And CFD is about 1.6. So CFD, triples are TAM from 800 to about 2.4.

[Operator]

Next question comes from a line of Jason Ader from JPMorgan.

[JacksonAder]

Great. Thanks for taking my questions, guys. The first question is in the 175 Cloud customers, what does that mix in terms of systems versus semiconductor companies look like?

[LipTan]

Yes, we don't have a breakdown on that. Clearly, we are very excited in our customer and is clearly our solution provide that flexibility. And also different use model and either as a Cadence manage. And so overall, we providing EDA software and Palladium platform are the most important is providing the productivity and scalability. So I think overall, we are excited about 175 customers; we didn't pick down in terms of semiconductor or System Company, but overall, both are strong for us.

[JacksonAder]

Okay, and then, John, you mentioned that not expecting China to be as active in upfront revenue in 2021. So, any particular reason? I mean, was it politically driven, why that particular geography had a bigger mix of hardware in IP in 2020?

[JohnWall]

When we have more hardware in any one quarter in any one region, you're going to have a higher mix of upfront revenue in that region in that quarter. And we saw that with a strong Q3 for in the functional verification space and a lot of that strength within China. And when I was looking for signs of a pulling in Q3, and to try and figure out that, was there some acceleration of purchasing that came out at 2021, or did it come out of Q4, where people just preparing with the pandemic, where they're just trying to get their hardware delivered earlier for fears of delays due to the pandemic, but and then what we looked at I was waiting for the view of the pipeline, pipeline for 2021 is very strong. And when I look at that, and compared it to one and a half of what was different about the second half of 2020, for China, what I did notice is because of that hardware, but we had a higher mix of upfront revenue in the region in the second half than we would normally see. I'm not sure if that's sustainable. I mean, it looks like we're off to a strong start, again, in Q1. But for the purposes of determining an outlook for 2021, I assume that sort of a safe is to assume a return to our usual recurring revenue mix, which could prove to be conservative for the second half. But I'd rather go with outlook, assuming that we return to the usual recording revenue mix, than assume that that's growth that we saw on the second half of 2020 continues. I mean, if it does, when we have increased visibility into revenue, the second half, we can update our outlook at that time when we see it. But I just I didn't want to go with too stronger second half right now until I have a clear visibility into the pipeline into the second half.

[Operator]

Your next question comes from a line of Joe Vruwink from Baird.

[JoeVruwink]

Great. Hi, everyone. John, you've been referring to the tables in the release. And I'm interested in the one that breaks it down three year CAGR adjusted for the extra week by product group. If you think into 2021 and again, just adjusting for the week comparison, would you expect kind of similar dynamics between the product segments where IP and system design should remain kind of the fastest growers? Or are there any new developments at a product level to consider as 2021 goes on that might influence some of the trend we've seen?

[JohnWall]

Good question. I mean, we don't -- we're not guiding by individual product category. But if you see, if you look at the three year CAGR for 2018-19 and 2020 on that, you see that don't change dramatically year-over-year, particularly on the three year CAGR view but the books -- the ones you call the IP and system design analysis are kind of are the smaller dollar values but so they have the benefit of growing from smaller numbers. And in the past, we've seen those go faster, but in relation to new products that I think that the amount of innovation that we've seen and new product releases and preparation that we've seen from the R&D group They haven't slowed down at all. If anything, they're accelerating in their new product development, even through the pandemic, which has been fantastic. But typically on an earnings release, we wouldn't announce any new products; you'll see those CDM lives, which probably start around late March, April time.

[JoeVruwink]

Okay, great. And then this next question might be product development related, but because if I heard Anirudh correctly, systems design is maybe a $6 billion total opportunity. And given the solvers you introduced or the new CFD being acquired, you're up to $2.4 billion. And so is -- are there other categories or additional things that you have in mind that we can maybe expect you growing into over the next few years?

[AnirudhDevgannd]

Yes, that's a good point. And first of all, I want to highlight that we are building out this multi physics platform. And CFD is a pretty big segment of that market. So we started with finite element and electromagnetic and then now go to CFD. And there are a lot of commonalities there. So I believe that it presents a lot of opportunities to us like we mentioned tripling our addressable market. Now there might be more in the future, we always look for that. But at the same time, the current electromagnetics and CFD already has a large market segment that we busy addressing. So the answer is yes, if some opportunities come we will systematically expand but already, that's a good opportunity for us.

[Operator]

Your next question comes on line of John Pitzer from Credit Suisse.

[JohnPitzer]

Yes. Good afternoon, guys. Thanks for me ask questions. Congrats on the solid results, John as you rightfully pointed out in your preamble, if you adjust for the extra week, and some of the unexpected revenue in 2020, your initial guide for 2021 is already embedding sort of double digit growth. And I know you said that it's too early to say if that's the new norm, but I guess I'm kind of curious what are you looking at to be able to make that call that this might be the new normalized growth rate and Lip-Bu, as you talk about, potentially a double digit secular growth rate? What do you think is driving that? Is that sort of specific to Cadence and your strategy? Do you think this is core EDA customers? Do you think it's the proliferation of customers into non traditional areas like hyperscale systems and autos? Could you give us a little bit of help on that that would be appreciated?

[JohnWall]

So John, I can take care your -- the first part of your question, then I'll pass it over to Lip-Bu. In relation to the strong first half guide, and strong first quarter guide, most of our revenue is software. And most of it's recurring revenue, we expect recurring revenue to make up 85% to 90% of our revenue for the year. So it's very, very predictable, and very, very predictable, certainly, in the near term, but where I had some difficulty was projecting what upward revenue might be out in Q3 and Q4. So the output for the second half is more conservative than the -- I mean the first half is very, very predictable in terms of great visibility into the pipeline, we're off to a really strong start in Q1 already on the upfront business, and so much that revenue is recurring in the first half but yeah we're seeing accelerating revenue growth. The challenge in the second half, of course, is we're lacking very tough comps, against the second half of 2020. And I just don't have the visibility into the upfront pipeline for Q3 and Q4 yet.

[LipTan]

Yes, on the second question, now let me describe, I think, is kind of exciting about this renaissance of semiconductor with the five generation waves happening at the same time, AI, machine learning or about data, data analytics, 5G, and then the cloud infrastructure has to change because all this massive data coming in, and then how do you address that network scaling, and then storage is aggregation. So it's a lot of changes to the infrastructure. And there's a lot of fueling a lot of design activity. So that's why we see a lot of design activity not just from the semiconductor players, now the system player, and then the whole industry 4.0 they all move into AI machine learning, the digital transformation that drive a lot of semiconductor. So overall, the industry is moving in the right direction to us. And meanwhile, I think clearly Cadence with intelligent system design strategy really tie in really well from the design excellence that providing the tool in IP. Now we move to the next level of system innovation that Anirudh talk about the system analysis, and of the CFD and the physics and multiphysics model, then the next thing is move up into the pervasive intelligence that using AI machine learning data analytics, drive all the vertical industry, that is major transformation going on. So I think we are well positioned to capture that opportunity.

[JohnPitzer]

And then guess my second question is, clearly when you look at China's region, from Q4 of 2019, to the back half of last year, it almost doubled as a percent of revenue. And John, you clearly talked about, potentially some one times that came in the back half of the year that you're not embedding sort of in the guide for 2021. I'm just kind of curious as we think about currently China at about 17%, what's kind of core embedded as a percent of revenue when your 2021 guide realizing that that's subject to change. And if you think longer term with China's aspiration, is this about the right level as a percent of revenue? Or would you expect this on a secular basis to continue to grow over time?

[JohnWall]

Again individual quarters, I wouldn't focus too heavily on any one individual quarter or even half. I mean, it was a tremendous second half for us in China. And 2020 was a strange year. I mean, with pandemic with the extra week in Q4. I mean, you'll see in Q3 we have a lot of strength in our functional verification group in Q4, you'll see the software businesses performed really, really well. Of course, it had the benefit of the extra week was a 14th week in your normal 13 week quarter but and we have one less week in the second half of 2021. But we're very, very pleased with the growth we're seeing in China. It looks like it's continuing on. We're seeing that strength continue on into Q1, the pipeline is strong seeing in the first half. I just wanted to be conservative in the outlook for the second half until I have better visibility into second half upfront revenue pipeline.

[Operator]

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

[TomDiffely]

Yes. Good afternoon. Maybe first just a clarification for John. When you look at your expectations for 8% revenue growth and 8% OpEx growth and the lack of leverage there. Did you say that was primarily due to just NUMECA acquisition increased cost?

[JohnWall]

No, it's not. Certainly not primarily due to the NUMECA acquisition. I think in terms of expense growth, our headcount is up 8%. Our headcount increased by 8% during 2020. And we're investing heavily again and in hiring in 2021. NUMECA will come into the mix where we hope for the second half of Q1 and then the remainder of the year from an expense perspective, we expect merit to hit this, merit increases will be July again. So that will be -- you'll see a slight uptick there in expense in Q3 and Q4 and the growth and expenses through the year that would typically come from that as being offset by some more efficient infrastructure spend that we have planned as the year progresses, if you look at our 10-K that we filed, you'll see that we initiated a restructuring plan in Q4 2020 to optimize our spend on infrastructure but expense mix in 2021. I think if you compare 2021 versus 2020, you're probably seeing in 2021 we're spending more on people and less on places and we were in 2020. That's kind of driving some of the margin profile.

[TomDiffely]

Okay, that's very helpful. And then follow up for Lip-Bu, when you look at the cloud, you talked about 100 satisfied customers, what do you think the long-term adoption is for EDA with the cloud and do you think some of your really large customers will move the majority to the cloud at some point? And if they do, what does that do to your cost structure?

[LipTan]

Now very good question. So now this is still a very early stage, we are very encouraged with 175 customers. And clearly, we want to make sure that our initial product in terms of system and analysis, we can be cloud native, because we start from scratch. And then some of the EDA tool, we have different stage of moving to cloud native. And then the really the Holy Grail is basically drive the productivity efficiency for our customer. And then our partnership with the hyperscale partners and infrastructure planners and also the foundry partners are critical in this effort. And so right now we have across small, medium, large customer embracing on cloud. And truly, I think as you can imagine, you have unlimited usage of machine server at your exposure, and then so that you can really drive the performance, productivity significantly. So I think that's as a trend we are just in the beginning early stage but we are very encouraged with the customer support in order to continue to grow, clearly, our partnership with the hyperscale partners, and also the foundry partners are critical. Because of their PDK or the different solution they have, we want to make sure that we work with them together, and support our customer, and also addressing the needs of customers.

[Operator]

Your next question comes from a line of Gal Munda from Berenberg Capital.

[GalMunda]

Hi, thanks for taking my question. The first one, I just wanted to follow-up briefly on NUMECA and more generally on your ambitions within the kind of mechanical simulation space. If you think about the convergence that's happening with NUMECA, now you said you have the CFD, you have the finance element analysis as well. So like how far do you think your portfolio is based on what you have to be able to take it where you want it to be in R&D terms versus potentially doing more of those tuck-ins in the C&E space?

[AnirudhDevgannd]

Yes, that's a good question. Let me take that. This is Anirudh. So like I mentioned this move is driven by three factors, right, and our strength and competition software. Our customers are asking for more and more system analysis, system design capabilities, like Lip-Bu mentioned, and the overall need for simulation. And I think we are still in the early innings. But we feel confident about this space, as demonstrated by our results in clarity and other products. And CFD is a pretty important area. I mean I think one of the biggest segments in system analysis. And the good thing about CFD, it has lots of vertical applications all the way from automotive, aero and defense all the way to medical. So I think that's a pretty significant expansion of our platform. And we are happy with this progress. We are patient and like John mentioned, this segment is profitable. So, we will continue building across this. And keep providing the best solution to our customers.

[GalMunda]

Making sense. Thank you. And then just as a follow-up, maybe just expanding a little bit on the growth drivers of the businesses, Lip-Bu, you mentioned, there's Moore's Law-based growth at the leading edge customers, and there is more than Moore's Law, which is kind of the system side. Considering the investments you're making on the system side, can you just comment a little bit on the growth, how it maybe 2020, how it corresponded between the leading edge and the systems companies in terms of that contribution to get you whatever we want to say, 13% to 15%, depending on which number we're looking at? Thank you.

[LipTan]

That's a very good question. And so I think we are very well positioned to be able to do both, and then clearly the hyperscale, mobile and they are driving a lot into the Moore's Law. And as I mentioned that we are very delighted, we have more than 100 projects on five nanometer and below process node development with our customers. And we have earlier collaborations on two nanometer process. So I think we know this is a very advanced, and we were delighted and we are very honored to work with the marquee customers that are pushing the envelope, and we're really excited about that development. On the other hand, we are so well positioned in our custom mixing, analog, and packaging, and like the 5G wireless industrial group, they are really moving into this mixed signal. And clearly the most in Moore's and so that we are very well positioned and we double down with some of this AWR and then the Integrand acquisition driving from the RF microwave requirement, especially in antennas side of some of these 5G integrations and then we have really good solution for that and customers see the benefit of working with us.

So I think we are very well positioned on both sides. That's why we highlight that from our portfolio point of view. And those both engines are really taking off. And we are very excited engaging with the best company to work with us.

[Operator]

Next question comes from a line of Rich Valera from Needham.

[RichValera]

Thank you. Let me add my congratulations on the rule of 50 last year. Question I think is for Anirudh on the system analysis, go-to-market, just wondering data you have been doing through the standard sales channel? And what do you -- do you have any overlay sales and/ or specialized applications for system? And how are you thinking about scaling up any kind of dedicated system resources as you scale up that business?

[AnirudhDevgannd]

Yes, thanks, Rich. It's a great question. And of course, one is developing great product. And the other is go-to-market or helping our customers deploy those products. And the second part is as important as the first part. And especially for the system business, there are multiple facets to it. In the semiconductor business, or the big, large system companies we operate mostly to a direct channel, okay. But if you remember, we also have our Allegro business, which is our packaging business, we do quite well in PCB and packaging with Allegro and Allegro does have already, we do have an indirect channel. And like Lip-Bu mentioned earlier cloud is important going forward. So for the system business, I envision three channels, we will be building three channels, one is the direct channel, because lot of the big companies and big system and semi companies, anyway wants system tools, like you mentioned, and expanding our indirect channel like we have for Allegro and expanding it to overall system design analysis.

And then the SaaS channel, which are cloud based channel for, especially for smaller companies that don't have lot of data centers, and are more attractive to use on the cloud. So as we go through the system design and analysis we do have to build out these three facets of our go-to-market. And we are working all of them in different stages. But the sense of a direct channel helps us with our big customers. And then indirect and SaaS can help us with some of the smaller longtail customers. But that's a very important part of the overall go-to-market strategy.

[RichValera]

Understood, and thanks for those details. And then John, follow up for you. You're given a backlog reserve number last quarter of $58 million, which I think it comes down from $70 million originally, and I'm assuming that came down materially in the fourth quarter, can you tell us where that is today?

[JohnWall]

Yes, of course, Rich. But yes we collected -- we had a collection windfall of $26 million in the second half out of that $70 million, but I think the majority of the balance of the $70 million is lost. I mean, those customers have, and many of those customers have closed their doors. I think we're in single digits and millions in terms of the ones we're left tracking, that could potentially be recoverable. But right now in my outlook, I'm assuming it's not recoverable. But you're talking maybe $9 million, $10 million left over that $70 million that could possibly be recovered. But like you say, right now I'm assuming it doesn't get recovered. We recovered $26 million of the other $60 million.

[Operator]

Your final question comes from a line of Jay Vleeschhouwer from Griffin Securities.

[JayVleeschhouwer]

Thank you and like to direct both of my questions to Anirudh. First, we've heard for years of course from the EDA companies for ongoing design activity among your customers that that's remained robust. We've also heard of the general direction of design style or types from general purpose chips to more to specialty kinds of designs, what we don't often hear about is how customers design methodology may be evolving and I'm wondering if there are any issues that we might want to talk about regarding for example, hierarchical versus flat which has been consideration for chip design now for two decades or more is, are there any new applications or issues for that as it might pertain to or affect any of your EDA tools or new technologies such as AI spatial or design space exploration. And then relately there are a number of questions this evening already regarding system analysis and your broader ambitions in computational software. One thing we see on the other side of engineering software, the world you're approaching towards a unified data platforms and common platforms for data management and the like, which you don't really seem to have. You do have multiple stacks for your various functional areas. Could you talk about how you're thinking about unifying or moving to a more common platform of that kind?

[AnirudhDevgannd]

Hey, Jay. These are great questions. Well, first of all, we want to make sure that we have best in class product, right. So whether that's digital design or verification and system analysis, so we always as you know this technology business best product wins. And at the same time, have a unified platform to go with it. And this is how we did digital implementation; this is how we did verification. So both parts are important to have best in class products, whether that's a finite element, electromagnetics or CFD, and then there are opportunities to combine them in a much more unified way, especially around data like you mentioned. So I completely agree that the need for unification but we also at the same time, want to make sure first, that the products are best in class you want a unified team, but each player has to be in a strong player.

But there are a lot of opportunities for data platforms and analytics, like the Lip-Bu also mentioned earlier. Now, in terms of your first question of new methodologies, I mean, there are several things happening, if I have to pick one or two key things that are happening, what we see with the customers. So one big trend, which you probably already know is this move to 3D-IC, I think this is going to be significant for next several years. And it just changed a lot of methodologies in our customer base. And this is multiple, high end digital chips, or even analog RF chips on a package. And that I think is driving a lot of change, especially in cloud, in hyper scalar companies all the way to Consumer Company. And we do have historically a lot of strength in package, packaging with Allegro; of course we have a leadership platform in advanced node with Innovus. And then now the analysis tools with Clarity and Celsius. Because thermal is a big thing for 3D-IC. So I think this whole methodology of 3D-IC integration is one significant change that we do see in the customer base. And we are very excited about that because I think Cadence s in a unique position because of historical strength in analog and packaging, and digital and the new strength and system analysis.

And hierarchical you mentioned, I think that's always a big thing as things get bigger. And if you look at 3D-IC, this is another way to do hierarchical because if you have four chips on the package, you don't have to redesign all four of them. This is reused at a much higher level. So but I do think 3D-IC is a significant trend that is going to happen and we are well positioned for it.

[Operator]

I will now turn the call over to Mr. Lip-Bu Tan for some closing remarks.

[Lip Tan, Chief Executive Officer]

Thank you all for joining us this afternoon. I'm very excited about the growing market opportunities and business momentum going into 2021. Our intelligence system design strategy is playing out very nicely, as we benefit from new opportunities in design excellence, system innovation, and pervasive intelligence and then expanded total addressable market. We excelled in the challenging year, thanks to the deep partnership with our customers and our partners and the strong commitment of the outstanding Cadence team. And lastly, on behalf of all our employees, and the Board of Directors to give heartfelt thanks to those on the front lines who continue to work tirelessly in their effort to put this pandemic behind us. Thank you all for joining us this afternoon.

[Operator]

Thank you for participating in today's Cadence's Fourth Quarter 2020 Earnings Conference Call. This concludes today's call. You may now disconnect.