益華電腦 (CDNS) 2020 Q2 法說會逐字稿

Good afternoon.

My name is Mike, and I will be your conference operator today.

At this time, I would like to welcome everyone to the Cadence Second Quarter 2020 Earnings Conference Call.

(Operator Instructions) I will now turn the call over to Alan Lindstrom, Senior Group Director of Investor Relations for Cadence.

Please go ahead.

Thank you, Mike.

And I would like to welcome everyone to our second quarter 2020 earnings conference call.

I am joined today by Lip-Bu Tan, Chief Executive Officer; and John Wall, Senior Vice President and Chief Financial Officer.

The webcast of this call is available through our website, cadence.com, and will be archived through September 11, 2020.

A copy of today's prepared remarks will also be available on our website at the conclusion of today's call.

Please note that the discussion today will contain forward-looking statements and that actual results may differ materially from those expectations.

For information on factors that could cause a difference in our results, please refer to our filings with the Securities and Exchange Commission.

These include Cadence's most recent reports on Form 10-K and Form 10-Q, including the company's future filings and the cautionary comments regarding forward-looking statements in the earnings press release we issued today.

In addition to financial results prepared in accordance with Generally Accepted Accounting Principles, or GAAP, we will also present certain non-GAAP financial measures today.

Cadence management believes that in addition to using GAAP results in evaluating our business, it can also be useful to review certain results using non-GAAP financial measures.

Investors and potential investors are encouraged to review the reconciliation of non-GAAP financial measures with their most direct comparable GAAP financial measures.

The reconciliations are available at the Investor Relations section of cadence.com.

Copies of today's press release dated July 20, 2020, for the quarter ended June 27, 2020, related financial tables and the CFO commentary are also available on our website.

Note that Cadence is continuing to adhere to social distancing practices, and therefore, we are conducting today's earnings call from our respective remote locations.

Apologies in advance if there are any glitches or handoffs that take a little longer than usual.

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

Good afternoon, everyone, and thank you for joining us today.

I'm very pleased to report that in an environment of continued uncertainty, we achieved excellent financial results for the second quarter of 2020.

We exceeded our financial outlook on all key metrics as the team successfully navigated through challenges posed by the pandemic.

In view of continuing, strong broad-based demand for our innovative solutions, combined with the robust design environment, we are raising our financial outlook for the year.

John will provide more details on our Q3 and annual financial outlook shortly.

We are all going through unprecedented times, and I hope that you and your family are staying safe and healthy.

In this environment, our top priority continues to be ensuring the safety and well-being of our employees, customers and communities.

Our employee base has adapted well to working from home, which appears to be the new normal, at least for the foreseeable future.

Our R&D and customer deliverables are tracking well.

And our sales and application engineering teams continue to engage effectively with our customers.

We're increasing our investment in infrastructure and collaboration platforms in order to maintain high level of employee productivity.

Fueled by the generational drivers, such as 5G, AI and hyperscale computing, the data-centric revolution is accelerating semiconductor demand and design activity.

As a result, we are seeing widespread demand for our EDA software, IP and hardware solutions, and our Intelligent System Design synergy has us very well positioned to benefit from these trends.

Now, let us look at some of our design excellence highlights for the quarter.

We deepened our partnership with Renesas to accelerate their innovation through a wide-ranging expansion of our EDA and hardware solutions.

Our new digital full flow with the innovative iSpatial technology continues its momentum with 10 new full flow wins during the quarter.

We expanded our partnership with Micron through a broader proliferation of our EDA solutions, including the deployment of our digital full flow for the development of their next-generation products.

Cadence collaborated with TSMC and Microsoft to ensure customers to accelerate design timing signoff using Cadence Signoff Solutions and TSMC technology on Microsoft Azure.

Our Cadence Verification Suite delivers the best verification throughput and had several wins across mobile, networking and medical verticals.

We deepened our relationships with a leading medical technology company as they expanded usage verification suite, digital and custom analog solutions.

Our Xcelium simulator has been steadily proliferating with multiple migrations from competitive simulators underway.

We had another outstanding hardware quarter, with the compelling value proposition of the integrated Z1 and X1 combinations being increasingly attractive to customers.

The Palladium Z1 emulator with its unique custom chip-based architecture continued to win new customers and significantly expanded capacity at existing key customers.

Our Protium X1 prototyping platform has ramped strongly based on the differentiated ability to provide very fast bring-up time and high performance.

The growth of analog, mixed-signal and RF designs is driving the need for high-performance and accurate circuit simulations.

Our massively parallel Spectre X circuit simulator continue proliferating at multiple customers like Skyworks, and won several competitive displacements, including at a market shaping hyperscaler.

Q2 was a especially strong quarter for our IP business as it again delivered double-digit revenue growth.

Our refined strategy of focusing on Star IP at the most advanced nodes continue to pay off.

Robust demand continues for high-speed SerDes and DDR IP, and Tensilica has particular strength in HiFi true wireless studio and vision application as well as strong loyalties.

Our System Innovation segment execute very well delivering double-digit revenue growth.

Several market shaping customers across multiple verticals have successfully used our 2.5D and 3D IC advanced packaging solutions on production design.

Integration of AWR and Integrand is progressing well with the teams working on developing a comprehensive high-frequency RF platform.

Business momentum was strong and AWR added 6 new customers in Q2.

The new system analysis tools continue to gain momentum with over 125 engagements underway, multiple new wins and expansions at several existing customers.

New Clarity customers included a market shaping hyperscaler and new Celsius customers include ASUSTeK.

Now I would like to take a moment and talk about inequality and racial intolerance.

These significant societal issues have led to heartbreaking events over the past few months, are very close to my heart.

At Cadence, embracing diversity and fostering inclusion are key tenets of our culture.

We believe that by being open to different views and perspectives we learn from one another and together, we become stronger as one team.

We have several related initiatives underway, including training, pay equity, community donations, recruiting and career advancement support, among others.

We are committed to treating each other with respect and dignity and are proud to take stand against racism, prejudice, intolerance and violence.

Now I will turn it over to John.

Thanks Lip-Bu, and good afternoon, everyone.

I am pleased with our results for Q2 and updated outlook for fiscal 2020.

For Q2, we exceeded all of our key financial metrics for the quarter.

Back in April, we were expecting that some Q2 revenue might shift to Q3, in part due to the pandemic-related challenges that we thought would delay a number of our Q2 IP deliveries and hardware installations into July and Q3.

On reflection, business was stronger than we expected, and our team adapted well to the delivery challenges presented by the COVID-19 pandemic.

Ultimately, those anticipated delivery challenges did not have the impact to our Q2 results that we originally feared.

As with last quarter, our recurring revenue model gives us strong visibility into revenue for the remainder of fiscal 2020.

Based on our experience in Q2, we are much less concerned about our ability to substantially overcome any hardware and IP delivery challenges caused by the pandemic, and we factored that experience into our estimate of how much of our second half revenue we expect to record in Q3 and Q4.

I will share more on the assumptions embedded in our outlook in a moment.

But first, let's go through the key results for the second quarter, starting with the P&L.

Total revenue was $638 million.

Non-GAAP operating margin was approximately 35%.

GAAP EPS was $0.47, and non-GAAP EPS was $0.66.

Next, turning to the balance sheet and cash flow.

Our cash balance was approximately $1.2 billion, while the principal value of debt outstanding was $700 million.

Operating cash flow for Q2 was $345 million.

DSOs were 45 days, and during Q2, we repurchased $75 million of cadence shares.

Before I provide our updated outlook for fiscal 2020 and what we expect for Q3, I'd like to take a moment to share the assumptions embedded in our outlook.

Our outlook continues to assume that the export limitations that exist today for certain customers remain in place for all of 2020.

Our outlook also assumes that the COVID-19 pandemic will remain a challenge for the remainder of the year.

As a result, we have taken steps to prepare our workforce to work from home for longer and we are anticipating that a number of our smaller customers will experience liquidity challenges that will likely result in some of those customers being unable to meet their contractual payment commitments.

We have taken the precaution of pausing revenue recognition on bookings from customers where we believe there is significant uncertainty surrounding our ability to collect payments.

The financial impact of nonpayment on those accounts has already been factored into our outlook for the remainder of the year.

And with that, our updated outlook for fiscal 2020 is as follows: revenue in the range of $2.585 billion to $2.615 billion; non-GAAP operating margin of approximately 33%; GAAP EPS in the range of $1.84 to $1.90; non-GAAP EPS in the range of $2.50 to $2.56.

We expect operating cash flow to be in the range of $810 million to $840 million; and we expect to use approximately 50% of our free cash flow to repurchase Cadence shares in 2020.

And here's how much of our annual outlook that we currently expect to record in Q3: revenue in the range of $630 million to $650 million; non-GAAP operating margin of approximately 32%; GAAP EPS in the range of $0.49 to $0.51; non-GAAP EPS in the range of $0.59 to $0.61; and we expect to repurchase $75 million of Cadence shares.

You will find guidance for additional items as well as further analysis in the CFO Commentary available on our website.

In summary, Cadence delivered another quarter of strong revenue growth and expanding profitability.

And we're pleased to raise our outlook for the year.

Before the pandemic, Cadence operated from around 50 sites across the globe.

We are now effectively operating from a distributed network of more than 8,000 homes.

We are blessed to have many strong leaders located across the world and I'm very impressed and thankful for how our employees are not only rising to the challenge, but positively thriving as they remain intensely focused on delivering successful outcomes for our customers and partners.

Finally, I would like to close by thanking our customers, partners and our hard-working employees for all that they do, and I'd like to remind them all that their health and safety continues to be our first priority.

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

(Operator Instructions) Your first question comes from Ruben Roy from Benchmark.

Congrats for continuing to perform so well in such challenging times.

John, I want to start and just kind of drill into the commentary on the smaller customers and the liquidity challenges that you're talking about.

Are these ongoing conversations you're having with customers?

Have you seen some of this in the numbers that you've reported and guided to for Q3?

Or is this more sort of anecdotal thinking as you think about the guidance for the full year?

Thanks, Ruben.

Good question.

But yes, I mean as we said, business was stronger than expected, particularly in hardware and IP.

And last quarter, we were concerned that compliance with some containment measures around the globe would impact everyone's day-to-day operations.

And we expected those measures to impact us in 3 ways.

We thought if our customers' offices remain closed, that would impact us on the -- on our ability to install hardware.

On the IP side, access to our own IP labs was impacted.

We were fearful that, that would impact our ability to complete delivery on our IP.

And then the other thing we were concerned about was that if the shelter-in-place restrictions were prolonged, we were concerned that the pandemic would disrupt the normal business and operations of many of our smaller customers, and that would impact their liquidity.

And ultimately, we were preparing for collections challenges on those accounts in the event that some of those customers were unable to pay us for what they purchased.

On reflection -- as I said in the script, on reflection with Q2 behind us, business was stronger than expected.

Our team adapted well to the delivery challenges.

The issue, though, on collections from smaller customers remains, but the potential collections impact is a concern.

We received a number of requests from customers to delay their payments to us.

We've chosen to continue to provide services to those customers, and some will eventually get back on track and pay us.

But many, despite theirs and our best efforts, may not be able to get back on track.

And we'll likely fail to collect on a number of accounts.

And our best estimate of that is we basically reserved for about $70 million worth of bookings right now as of the end of Q2.

To put that in context, over the 3-year period, from 2017 to 2019, we didn't collect on $36 million worth of orders.

So our -- we paused revenue now on $70 million worth of bookings.

So we're covered for twice the experience we had over the previous 3 years.

Very helpful detail, John.

I guess just for a quick follow-up.

I was looking at the core IP design.

Tool performance in the June quarter and down a little bit sequentially on the digital side, up a little bit on the custom IP side.

It would seem that maybe that's where you're seeing some of the near-term issues?

Is that the way to read into what's going on with those line items and upcoming quarters?

Yes, absolutely.

The -- so the impact on collections with -- particularly with smaller customers is more heavily slanted towards our software business.

So we paused revenue on a number of contracts where we think collections are challenging.

But -- and that impacts the software business more than it would, say, hardware or IP because in many cases, on the hardware side, because we get revenue upfront, we expect payment upfront.

So you don't have as much credit exposure there.

On the IP side, much of our IP revenue is coming from royalties and royalties are typically with customers like with our top 100 customers, which are very good credit customers.

They have strong balance sheets.

But this is really isolated to that group of customers that are kind of outside our top 100s.

And it's the kind of the smaller customers.

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

I guess, first, John, just following up on the last question.

Is there a geographic bend to the small customers that you're worried about?

Sorry, could you repeat that, Tom?

I didn't -- sorry.

Yes.

Is there a geographic bend towards the customers that you are concerned about with smaller customers?

Or is it broad-based across the world?

No, particularly.

I mean the -- if there's any particular demographic that's been hit, it's smaller customers, it's right across the globe, but very much in smaller customers.

And it's probably mostly in software over IP or hardware.

Okay.

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

Yes.

I think on the -- certainly, on the royalty side that I think royalties for the first half are like 25% higher than they were like for the first half of 2019.

But -- and the -- yes, it's hard to break it down in terms of where there is strength in different parts of the business.

I think it's kind of across the board, we've seen strength across the board.

The challenge on the credit side are quite random in the smaller pool of customers.

Okay.

It sounds like a lot of customers or a lot of players out there are seeing strength in high-performance compute, offsetting some weakness in consumer.

But from what you say, it sounds like you're continuing to see strength across the board.

So it's kind of a new...

Yes.

Well our royalty revenue is related to the consumer electronics market mainly.

But -- and we're seeing strength there, like you say, 25% up.

I mean I think the royalties were around $21 million for the first half of the year compared to just under $17 million for the first half last year.

IP was strong.

On the design IP front, our refined strategy of focusing on Star IP at the most advanced nodes continues to pay off.

Demand for high-speed SerDes and DDR IP continue to be strong, with deployments at leading mobile, networking, hyperscale and storage customers.

And then on the Tensilica side, the highlights there were our customizable, scalable DSP IP, including deployments in true wireless stereo and vision applications helped along with strong royalties to have a very strong performance for Q2 revenue in IP.

And then, Tom, just to add on, this is Lip-Bu.

I think clearly, beside -- it's kind of a broad-based but I think your question on the data center cloud, hyperscale, we see very strong demand because of the infrastructure.

When people work from home, there's a lot of scaling.

So we see also very strong in that area, too.

Your next question comes from John Pitzer from Crédit Suisse.

John, maybe different sides of the same coin.

But I wonder if you could just help me understand, as you look at the September quarter, what's driving gross op margins down sequentially?

I would have thought that perhaps in the current environment, there were some costs that you might have to incur around COVID mitigation actions that actually might dissipate as we go into the back half of the year.

And I guess, similarly, over the last several years, the operating cash flow has been more front-end loaded, first half-weighted than second half.

But just relative to your guide, it feels like second half is only about 30% of the operating cash flow.

I'm wondering what might be driving that.

Maybe it's the same thing, maybe it's different.

Yes, John, the -- yes, good question.

But in terms of -- on the op margin profile, there's a couple of things in that question.

So let me unpack it a little bit.

But in terms of the op margin profile, the expectation that we had and -- when we gave guidance for Q2 was we thought that some revenue might shift from Q2 into Q3.

Our experience was an actual fact that there was a net shift the other way.

We thought that maybe -- I mean if you look at our Q2 guidance, we went out with a midpoint of $590 million, having followed Q1, which was $618 million, when typically you would expect Cadence to be pretty much -- I mean $618 million, you would expect $618 million, $620 million or something for Q2.

So we were expecting about $30 million to push from Q2 into Q3.

As it happened, we -- about $10 million has moved -- maybe just less than $10 million has moved from Q2 into Q3.

There was about $10 million of deliveries that we couldn't get done in the quarter that will now revenue in Q3.

But we had approximately $20 million that came the other direction.

And that was customers that -- as things lifted in June, we had customers on -- in new bookings in the second quarter that wanted to accelerate the installation on what they purchased.

But -- and of course, as our guys had time, when they were trying to -- when they had some customers that they couldn't deliver to, they just kept on going down through the list.

I mean typically, at Cadence, you probably have maybe 2/3 of your orders or bookings in any one quarter would fall into like the last month of each quarter.

So it's unusual for such a high amount to get delivered in the quarter.

And -- but like I said, we -- our experience in Q2 was there's probably some shift of revenue from Q3 into Q2.

Net-net, maybe about $10 million -- $10 million to $15 million from Q3 to Q2.

On the expense side, in contrast to that, we -- because of the uncertainty in Q2, we held up some of the offers on hiring that -- until late in the quarter.

Once we got comfortable that we're good for revenue in the quarter and that it looked like customers were very resilient, our team was very resilient in terms of overcoming the challenges, then we released the offer letters and hiring accelerated into the end of the quarter and has continued at the start of this quarter.

So that's probably meant that some expenses shifted from Q2 to Q3 and some revenue shifted from Q3 to Q2, and you end up then with like a 35% operating margin in Q2 compared to our guidance of 30% and then Q3 is at 32%.

Also, you mentioned operating cash flow, I think, but if you recall, I mean last quarter -- I mean I hesitate to say it, but last quarter, we were mentioning this.

We had deliberately closed some strategic business early in the year.

And what you're seeing is we got paid for that business.

So you're probably seeing an uptick in cash and an uptick in deferred revenue.

I wouldn't be surprised if -- my expectation right now would be deferred revenue will burn off from this level through the end of the year because we deliberately aimed to get paid early.

That's helpful.

And then as my follow-up, Lip-Bu, it's nice to see that China, as a percent of revenue, has remained fairly stable over the last several quarters at kind of low double digits.

That doesn't prevent us from still worrying about the concern that perhaps there's some buy forward going on in China, just given U.S.-China relations and how critical you are to the overall semiconductor supply chain in China.

Wondering if you could just handicap what you're seeing in China today.

Is there a risk that there's pull forward?

And how do you try to manage through some of the ebbs and flows of the tensions between the governments of the U.S. and China?

Yes.

Good question.

So I think overall, our China business remain quite good.

And then the Q1, Q2, as John mentioned, I think, clearly, the hardware and IP, which are more upfront revenue and that help.

And I think -- overall, I think we're providing the tool and IP globally to our customer.

And meanwhile, we're complying with the U.S. regulations.

And it's very fluid and very -- we are closely monitoring it.

But so far, I think all the uncertainty and we already built into our estimates.

So I think, overall, we are confident.

I think we continue, I think, 12%.

I think quarter-to-quarter, sometimes it varies.

But I think overall, it's a strong business in Asia and China for us.

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

The first one, I kind of want to drill on just kind of the geographic movements here.

It looks like the U.S. is up pretty significantly.

So I know you guys are concerned about kind of the what I assume are the smaller players not being able to make payments and kind of rolling off some money for you guys there.

But is there any chance -- or maybe I'm thinking about this incorrectly, any chance that basically the larger players end up investing more?

Because what we picked up is that a lot of these larger companies are actually pushing forward on the tech front with chip design.

So when does that actually offset and actually be a benefit to you guys if the larger customers end up spending more in EDA tools, while the smaller ones kind of get brushed off to the side?

Yes.

I think, Mitch, good question.

I think that geographically, I think -- overall, I think all the -- across the board was we see strong design activity.

We don't see any slowdown.

I think this silicon Renesas in the industry with all the generational drivers like AI, 5G, hyperscale and this -- we move into this kind of data-centric big data that it's really driving a lot of silicon development and the design.

And to answer your question in terms of the big guy, the -- we call it market shaping customer.

I think you kind of -- you can read from my script that clearly are highlighting all this full-flow and all this proliferation with market shaping, and those are the leader in the industry.

We pay a lot of attention.

And this is a golden opportunity to double, triple down in R&D for the next-generation products.

So when this cycle recover, there will be a much stronger leaders.

And so answer your question, the design activity doesn't slow down.

Actually, those big guy are really, really driving the R&D, and we are delighted to be the trusted partner to work with them.

Yes.

And then, Mitch, John Wall here.

I mean just the fact that we raised the year despite the fact that we had some -- we have some collection challenges at the smaller customer base illustrates that larger customers are investing more in R&D.

Got it.

Understood.

And then just kind of switching gears.

I didn't hear much about 3D Clarity.

It's been maybe 2 quarters or so you guys are talking more about COVID and core EDA.

But can you maybe provide an update on what is going on with the 3D Clarity product in terms of customer wins, backlog interest, anything like that?

I realize that the environment is a little bit strange, but I think it would be interesting to hear what's happening with the 3D Clarity product front.

Yes.

So happy to share with you.

I think currently, we have a very strong -- this is a good market for us.

The TAM market is about $700 million.

Clearly, our product, as we mentioned earlier, customers see up to 10x performance and continue providing the accuracy.

This time, we highlight market-shaping hyperscale that go with us.

And then we have over 125 engagements in this -- together with Celsius.

And so I think a lot of momentum, a lot of multiple new wins and more important expansion of the -- at the existing customers.

So I think overall, very excited about the product we have, and we continue to really drive the differentiation and engaging with the leading customer that can see the value.

Okay.

Great.

Just one really small one.

Should bookings continue to go up this year?

Or is it going to be flattish kind of a $3.7 billion?

Sorry, your question again?

Just a really small one.

On the backlog you guys provide now on a quarterly basis.

Should we expect that to be more stable or go up?

Because I realize last year was up 20%.

This year, it's pretty stable at $3.7 billion for a couple of quarters.

I'm just trying to understand what we should expect from your backlog.

John, you want to highlight that?

Yes, Mitch, I mean we don't guide bookings.

But given that we closed some business early in the year, deliberately closed some business early in the year and pulled out some business from later in the year, I'm not surprised that our RPOs have kind of -- were flat from Q1 to Q2 but I wouldn't expect a dramatic change between now and the end of the year.

Your next question comes from Gary Mobley from Wells Fargo.

Congrats on a strong quarter.

I wanted to start out by digging a little bit deeper into the China conversation.

And so I know we have this new mil/aero rule as part of the newest export restrictions, and I know you guys have been working hard to try to answer some of the topics on it.

And perhaps don't have 100% clarity as we see here today, but maybe if you can give us an update as you see it today, how it impacts maybe your fourth quarter or even looking at fiscal year '21 and beyond?

And Gary, are you asking about this new direct product rule from the military end user use rule?

That's right.

Okay.

So I think overall, our outlook included all the estimate on the impact on the trade restriction.

Clearly, we're monitoring very carefully.

We're complying to all the requirements and make sure that our customer not commit to us not turning to the military use.

And so it's a lot of more work, and we are working towards that.

And compliance is the #1 priority for us and delight and support the customer is equally important.

But I think we make sure that we're complying to order requirements.

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

Okay.

But it's not mistaken, it doesn't go into effect until September.

So not really much of an impact so much in fiscal year '20, right?

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

Okay.

As my follow-up, I wanted to shift gears and talk about sort of the setup for fiscal year '21.

I realize you're not going to give any sort of preliminary revenue guidance for the year.

But if I'm not mistaken, the extra week and some acquisitions may be contributing to roughly, what, 200 basis points of revenue growth this year.

And so we get on the flip side of this year, should we think about an equal amount of perhaps a headwind looking into next year?

Yes.

I think the acquisitions are pretty small.

It's that 53rd week definitely needs to be a consideration when you think about next year, Gary, that -- I mean when I think last quarter, I said that I expect revenue impact for that extra week to be about $40 million.

Right now, I would say it's probably closer to like $43 million.

But -- and then on the expense side, the -- I would guess, on a non-GAAP basis, maybe about $33 million.

It's -- we've got a full impact, a full week of expense.

But on the revenue side, it will be that recurring revenue part of our business that we get the extra revenue for.

So I think the impact of that 53rd week, my own modeling, when I do it, I kind of assume $43 million for revenue, about $33 million for expense.

And naturally, you have to adjust for that if you're comparing a 53-week year to a 52-week year.

But like you say, we're not guiding 2021.

Your next question comes from Rich Valera from Needham.

Let me add my congratulations to the Cadence team for another strong quarter in tough conditions.

So John, just wanted to follow up on the questions around the strength in the quarter, which I understand, I guess, was driven by less than feared dislocation in the hardware and IP businesses.

Is that also what accounted for the increase in your overall annual guide?

Or were there some other product areas that contributed to the increase in the full year guide?

Yes.

I think we were very pleased with how our IP business is doing.

I think it's mainly the functional verification business, that product category.

I think that's probably the one that's increased the most, really strong hardware quarter, outstanding hardware quarter.

I mean the compelling -- it's a compelling value proposition with the integration of Z1 and X1 as a combination that's increasingly attractive to customers.

The Z1 emulator with its differentiated custom chip-based architecture, and we're continuing to win new customers and significantly expand capacity at existing key customers.

And then with Protium X1, the prototyping platform there has ramped up strongly.

And it's got a unique ability to provide very fast bring-up time and high performance, that the cross-selling between Z1 and X1 and vice versa was very, very resilient and apparent in Q2.

And it continued -- I mean the early weeks of July, we're already seeing that strength continue.

But now I gave a range of $20 million again for Q3 on revenue, and that was partly because we did see a shift from Q3 to Q2 for revenue, slight shift, net shift.

And that was maybe on the hardware side, we saw that customers looking for earlier delivery, I'm not sure how much of the pandemic is driving that behavior and customers are thinking that get the hardware in now, but Q3 is strong again.

And again, we've included that in the guidance.

That's very helpful.

And for my follow-up, just wanted to ask another one on the system analysis products.

You've been giving kind of a quarterly wins number, I think it was 30-plus last quarter, and you seem to maybe have pivoted towards an engagement number.

Is there an equivalent engagement number from Q1 that we could use to compare to sort of how that's expanded over the last quarter?

And will you, at some point, maybe revert to giving out wins as opposed to engagements?

Yes.

I think this is a very strong product offering for us.

The 2 products have been well received on the Clarity and Celsius.

We highlight a couple of win that we have.

And then -- and also, we have over 125 engagements and multiple new wins.

And we kind of thought it and give boring number of wins that we have.

I think it's significant enough that we just kind of laminate into this 125 engagement that we have.

And then more important is that the expansion at the existing customer, that means that they see the value, they want to buy more, and that's very exciting for us.

Your next question comes from Pradeep Ramani from UBS.

I had a couple questions on China.

When you look into the back half of the year and maybe in 2021, are you feeling sort of better or worse about design activity on the leading edge, especially in China?

Is there any change in how you perceive that?

And secondly, in terms of the military end user rules, did I understand you right when you said that you -- it's already in the guidance, but are you -- have you finished determination of that?

Or are you still sort of working through the process?

Yes.

So let me answer the first question, and then John can answer the second one.

On the China side in the second half, we continue to see strong business as a lot of China company, semiconductor company are scaling and then more and more into the advanced development.

And so clearly, as long as it's in the entity list, we will not be able to do business with them, but some of them are not.

They are still growing.

And we're clearly supporting them globally.

And I think overall, we see strength in the semiconductor and in China in the second half of next year.

And then we're not guiding next year.

And then the military side, maybe John can highlight that.

Yes, Pradeep, we've included -- we've considered like military end use and direct product rules and basically all export limitations that exist today in determining our outlook for the remainder of the year.

Now, that's based on our existing customer base and the products that we sell today.

But to the extent that there's potentially a new customer in Q3 that we haven't dealt with before, we haven't taken that into consideration.

I don't know until we see that new customer how it impacts us or not.

But based on everything we know today, we factored what we know today into the outlook.

Okay.

And my follow-up, I just want to drill into the IP strength -- sustainability into the back half of the year.

Do you think IP is sort of sustainable in H2?

Or -- and is it being driven by any specific geography?

Or is it more broad-based?

Yes.

IP is all hard to predict quarter-to-quarter because there's more upfront and lumpy, except the Tensilica that we have a continued strong loyalty income coming in.

But clearly, we are delighted in Q2, have a strong and IP business.

And then clearly, our Tensilica is really shine and especially in the HiFi and true wireless studio and vision applications.

And then meanwhile, continue to really validate in our STAR IP refined strategy in terms of the high-speed SerDes experience for the hyperscale guy, and then DDR and IP become more and more critical in some of these Gen 4, Gen 5 opportunity.

So we are pursuing that.

But it's a little bit lumpy quarter-to-quarter.

Your next question comes from Jay Vleeschhouwer from Griffin Securities.

John, I'd like to follow-up on 2 things that you mentioned in a conversation we had last month.

First of all, you noted that there is very little difference for Cadence in terms of the kinds of resource or customer coverage requirements that you have vis-à-vis semiconductor customers versus systems customers.

And that would seem to make sense.

The Apple-designed infrastructure, for instance, would seem to be not terribly different from a typical semiconductor company.

But the question is, are you thinking about that at all differently for the next number of years in terms of perhaps changes in resource requirements, resource intensity, anything of that kind as between semiconductor versus systems customers, particularly as you try to drive your computational software strategy?

And I'll ask the second question as well.

You noted in that conversation that you'll typically bring on applications engineers or AEs after you have customer commitments in hand.

And AEs are typically your second largest number of openings after R&D.

We noticed that at the end of the quarter, your number of AE openings were lower than 3 months, 6 months and 12 months ago.

Is that because you had a surge of prior hiring and added capacity?

Was it circumstantial based on what happened in Q2?

Or -- and maybe reconcile that comment about AE capacity versus customer commitments.

Sure, Jay.

Thanks for the question.

The -- let me take the second part of your question first, if I may, but in terms of -- I know you do excellent analysis.

And I read your software standard regularly to keep track of what's happening on the hiring front.

The -- but what we've seen with -- in terms of AEs, we had a number of AEs lined up to hire and we paused -- we probably took them off our openings because we had identified the candidates.

And then we released those offer letters towards the end of the quarter and then into this quarter.

So there's a pick.

There will be a pick-up in hiring; you'll see a pick-up in headcount by the end of Q3.

And then I mean we continue to hire AEs.

It's -- they are fundamental resource for us in terms of supporting our customers.

And I think in terms of resource requirements between system companies and semi companies, we like to say, look, we win with the winners.

We take on at the lower process nodes, the toughest designs and design challenges of our biggest customers and work very, very closely with them to solve those.

But -- so the -- our resource requirements on the bigger accounts are very, very heavy, but those are very demanding customers.

And as a result, our products get better and better.

And by the time they cascade out to the broader base of customers, there's less maintenance required and we found that, that's the kind of sweet spot for us from a margin perspective that we put a lot of effort upfront at the lower process nodes and then make sure that the products are very, very robust when they go through a broad release.

You said, I think, that you have about $70 million that you've circled with regard to small customer bookings risk.

Would it be fair to say that, that amount represents barely 3% of your total annual bookings?

Would that give you envelope of risk relative to total bookings?

Interesting.

I mean I don't think the annual bookings is the right thing to measure it against, Jay.

I would measure it against total backlog because the bookings that we've identified, the $70 million of bookings is out of that backlog.

But -- so it won't -- that's not -- the $70 million is not an annual number.

It's across that entire -- in that pool of $3.7 billion of backlog orders, I think we have $70 million of risk where we have collections issues, and we're anticipating that we won't be able to collect on that $70 million.

But that $70 million legacy is -- relative to our experience from 2017 to 2019, we had a total experience of only $36 million that we couldn't collect.

That was about $12 million a year on average.

If I go back to the great financial crisis, like 2008 to 2010, and we look at that pool of smaller customers, between -- in those 3 years, 2008 to 2010, it was about $70 million -- our experience was about $70 million for those smaller customers at that time.

So our reserve, I feel comfortable that, that's the right level and that -- and we've identified the right pool of customers that we think that we're not going to collect on it.

And I think that's the accurate number that we should have in our guidance.

Your next question comes from Joe Vruwink from Baird.

Lip-Bu, I wanted to go back to your opening remarks.

You called out 5G, AI, hyperscale.

Maybe if we can broaden that to also include things like automotive, industrial Internet of Things, all the newer growth vectors.

In your view, has COVID caused the trajectory of any of those opportunities to maybe change for good or bad?

So for instance, an industry like automotive going through the struggles that it is right now, does that cause the automotive opportunity to change perhaps for the worst in contrast to something like hyperscale computing or artificial intelligence that might actually be changing for the better?

Just curious on your thoughts there.

Good question, Joe.

I'll just share my personal view.

In terms of automotive, clearly there is some slowdown.

And in terms of the industry -- but meanwhile, I think the AI, machine learning, ADAS developments still continue.

And so we are delighted, engaging with multiple leaders, working on that.

And in this quarter, we highlight the deep collaboration with Renesas that has been a great partnership for that.

But that is on the automotive side.

In terms of the industry, now clearly, they also get affected -- the COVID.

So -- but meanwhile, they are very quietly digital transformation, industrial 4.0, is continuing.

And so we are not engaging heavily with some of the leaders.

And then in terms of drive some of this big data implementations and more software defined, and we are engaging very actively.

The one that I'm most excited about is this transformation of the AI machine learning.

This all about data.

How do you organize data?

How do you analyze the data?

How do you store the data?

And hyperscale guy are being big time on this, and we are delighted to be their trusted partner, providing the tool and IPs for them.

So I think that part, I think, we see a tremendous increase of design activity.

That's great.

And then one follow-up.

I think you called out that this quarter, you secured 10 new wins on your full digital flow product.

I think you called out 50 wins there over the course of 2019.

I guess, as you step back and look at the broader EDA industry, do you see more of the industry revenues or certainly the incremental growth in EDA revenues going towards a full-flow type product?

And in that context, how would Cadence maybe compare and thinking of the traditional EDA industry revenue growth profile, how might Cadence actually look compared to the industry over the next few years in your view?

Yes.

Good question.

Digital is a bigger TAM market for EDA, and that's something we pay a lot of attention to it.

And then clearly, we continue to innovate, continue to drive success, and we highlight this iSpatial that make the whole digital place and route and synthesis more effective integration and then to drive the productivity and performance.

And then we are pushing very hard on the full flow because each engine, we have the best-of-class.

And then right now we are basically tell the customer, when you move down the geometry to 7 to 5 to 3, you cannot do the mixed max.

You want to really and now have a fully integrated solution that you can count on to drive the performance PPA run time and then that is critical for their success, but time pass is critical.

And we want to be the trusted partner to work with them.

So we are delighted to highlight the Renesas.

We are highlighting the Micron, expanding proliferating for their next-generation development.

We are going deep with TSMC and some of the key foundry partners to really drive the advanced nodes and become a must have.

And that is something that we try to drive.

So far, we like what we have and we continue to drive the innovation through massive parallelism, drive with AI machine learning, we have a lot of data how to drive the performance, and we've also moved aggressively into the cloud.

Some of the tools, we've moved into cloud native so that we can drive the performance that can delight the customers.

Your next question comes from Jackson Ader from JPMorgan.

Given some of the announcements the last couple of weeks on semiconductor, one particular semiconductor merger, I thought it would be maybe worth it to hear or look through just kind of strategically, how does maybe the merger of 2 customers, how does it generally impact Cadence in the short run and then in the long run?

Does it impact decision-making?

Does it impact total loan expense, that sort of thing?

Good question.

So far as you can tell from our past record, we managed well through consolidation in the customer base.

And in some cases, we are also engaging actively on both sides.

So when they do the merger, we are delighted to see that and a much stronger platform.

We can even do more with them.

And so both companies that you allude to are very good company, great companies.

And so far, I think the consolidations, each one are unique and in their own way.

And then -- but we now try to be the trusted partner to work with them.

And then to continue to grow and then drive better solutions for them to have a bigger footprint for them to be successful.

Understood.

And then a quick follow-up.

One of the presentations today from Cadence at the virtual deck was on cloud deployments and the increasing demand for cloud deployments.

I was just curious when we see some other software businesses that have either -- are transitioning from on-premise to the cloud or have multiple offerings or multiple deployments of on-premise to cloud deployments, there's a pretty significant uplift in terms of revenue from customers that have cloud deployments versus on-premise.

So John or Lip-Bu, I was just curious, do you see a similar uplift in revenue associated with cloud deployments relative to on-premise?

Yes.

I can start first and then John can fill in more.

Clearly, the cloud solution for EDA to the customer are very important.

We want to provide the flexibility from the different range of use model, either the customer-managed or Cadence-managed, and then you're using the cloud for the software and even include the hardware platform and that's that we provide them a compelling productivity and a scalability benefit.

And at the end of the day, we really want to drive the productivity and performance.

And then if you have unlimited server, by theory, you should really drive the performance better and also more cost-effective for the customer.

And so we want to create that flexibility for them to do that.

And we are delighted.

And we highlight the key point of collaboration with TSMC and Microsoft to have the cloud for the signoff tool, Tempus and Quantus.

And then using our cloud bus gives them the flexibility, and they can optimize the throughput and the cost.

And I think that is the way to go.

I think we're going to be very cautiously moving towards the cloud, specifically the new product like the system analysis tool we develop as a cloud-native and so it will be much easier and people -- customer can see the benefit using the cloud.

And then for the old EDA tools, we're kind of tool by tool, try to move it into optimizing the cloud and stay tuned.

So far, we are making great progress.

And we highlight that over 125 customers adopted our cloud solution.

So that is increasing.

We are delighted at.

Your next question comes from Jason Celino from KeyBanc.

Just one for me.

Most of the reference customers that you've announced for Clarity have been semiconductor companies and other electronics ecosystem companies.

But today, you kind of talked about a new hyperscaler win.

One, was this hyperscale customer already a customer and they expanded?

And then also, if you think about with some of the expansions, are they adding the Celsius product?

Or are they expanding that have to do with their performance?

Good question.

So I think, clearly, this is a new product for us, Clarity.

And so any other new product -- new customer we highlight are new to us in the way that they are -- we don't have the distance before so we're delighted to highlight the hyperscale market shaping, hyperscale for the Clarity and ASUSTek for the Celsius.

And we are delighted.

We have 125 engagements, multiple new wins.

I think most important, our customers see the benefit and using our performance up to 10x better than incumbents.

And I think the most important thing to highlight is the expansions at the existing customers.

And that is a very validation of what is really good.

They use it and then they like it, they buy more.

And that is the good volition of good products.

Yes.

Jason, for Clarity, specifically, I think in relation to your question, but one of our new customers for Clarity this quarter included a market shaping hyperscaler.

We didn't have that -- it's not a new hyperscaler for us, but new for Clarity for us.

Okay.

And then one quick follow-up.

Was this hyperscale customer using it to supplement their simulation processes or more of like adopting it for kind of all their needs on the electromagnetic side?

Yes.

I think that one, again, is an existing customer, but I think it just continue to expand some of the product usage.

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

Congrats on the solid results.

Just a minor clarification question, but on the collection issue that you're experiencing with some of your smaller customers, is this concentrated at customers that have a particular end market or application exposure?

Or is it more broad-based?

It's more broad-based, Adam.

Yes.

I mean it's broad-based, not just across the customer base, but across the globe.

But the thing that's consistent is that it's typically smaller value orders and smaller value customers.

And what we're trying to do there is that we continue to provide services to those customers, even though, in some cases, I don't think we'll get paid.

But what we've done is we paused revenue on about $70 million of bookings and it's likely that we won't get paid.

So there won't be a P&L impact because we're not taking the revenue but -- and we'll continue to help those customers for as long as we can.

But -- and hopefully that we won't lose good companies as part of this pandemic.

Got it.

That's helpful.

And then my second question, and apologies if this was asked before as the connection cut off for me in the middle of the call.

But the implied second half revenue guidance, the split between Q3 and Q4 seems to be heavily favored towards Q4.

Is that really just the extra week in the fiscal year that's driving that?

Yes, the extra week is a big part of that.

And also, of course, I mean I'm trying to estimate learning from Q2, what we expect to fall -- or what would we expect to record in Q3 versus Q4?

That's why I give a slightly wider range for Q3.

We went with $630 million to $650 million.

If we see an experience similar to Q2, where there was a shift of some revenue from Q3 into Q2, if we see that again, there may be a shift from Q4 into Q3, which means we'll be up at the higher end of that range.

That -- but I'm not -- I don't have any doubt about the remainder of the year, really.

It's just what falls into Q3 versus Q4.

It's our best guess right now based on the experience of Q2.

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

Thank you all for joining us this afternoon.

Our Intelligent System Design strategy is playing out very nicely as we benefit from new opportunities in design excellence, system innovation and pervasive intelligence and an expanded total addressable market.

I'm very impressed and proud of the dedication and commitment shown by our employees, continue innovating and delighting our customers, especially during this uncertain time.

We are all in this together, and I am convinced that we will collectively come out of this unfortunate situation stronger as a company, as a community.

And lastly, on behalf of all our employees and the Board of Directors, we want to give our heartfelt thanks to extremely brave and courageous health care workers and other on the front lines, who -- they continue to work tirelessly to fight this pandemic.

Thank you all for joining us this afternoon.

Thank you for participating in today's Cadence Second Quarter 2020 Earnings Conference Call.

This concludes today's call.

You may now disconnect.