Cadence Design Systems, Inc.

Good afternoon. My name is Josh, and I will be your conference operator today. At this time, I would like to welcome everyone to Cadence's third quarter 2019 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you'd like to ask a question during this time, simply press star, then the number one on your telephone keypad. Thank you. I will now turn the call over to Alan Lindstrom, Senior Group Director of Investor Relations for Cadence. Please go ahead.

Thank you, Josh, and I would like to welcome everyone to our third quarter 2019 earnings conference call. I am joined today by Lip Bhutan, CEO, and John Wall, Senior Vice President and CFO. The webcast of this call is available through our website, cadence.com, and will be archived through the 13th of December, 2019. A copy of today's prepared remarks will also be available on our website at the conclusion of the call today. Please note that the discussion today will contain forward-looking statements and that actual results may differ materially from those expectations. For more information on the 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 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 October 21st, 2019, or the quarter ended September 28th, 2019, related financial tables and the CFO commentary are also available on our website. And now I'll turn the call over to Lipu.

Good afternoon, everyone, and thank you for joining us today. I'm pleased to report that Cadence achieved excellent operating results for the third quarter of 2019, delivering 9% year-over-year revenue growth. Based on our strong execution and strength of our technology and business, we are again raising our outlook for the year. Given the uncertainty of the ongoing trade situations with China, our outlook assumes current export limitations remain in place for the rest of the year. John will provide more detail on our outlook shortly. While global economy and geopolitical uncertainty continues, long-term trends such as AI, 5G, cloud, and IoT continues to drive strong design activity. The move to domain-specific computing and system companies building custom silicon, as well as a host of innovative silicon startups, are all pushing the technology envelope and driving the need for high-performance, low-power computing, high-bandwidth connectivity, and high-density storage. Our intelligent system design strategy position us well to maximize the resulting opportunities through building out our portfolio and providing more capabilities and value to our customers. The foundation of our strategy is the design excellence segment, which comprise of our core EDA and IP business. I will now provide some of the key quarterly highlights in this area. A key element of our approach has been to closely collaborate with our ecosystem partners and focus on market shipping customers. In Q3, we deepened our partnership with Samsung through a comprehensive agreement across our digital, custom, and verification product portfolio. Early this year, we had reported a breakthrough wide-ranging win with a marquee US semiconductor company. I am particularly pleased that we augmented that partnership with our largest ever IP order that included our 10-silica processor family and our design IP portfolio, including ultra-high-speed 30s. At its recent Open Innovation Platform event, TSMC recognized Cadence with four Partners of the Year awards, including an award for joint development of six nanometer design infrastructure and one for joint delivery of cloud-based productivity solution. Our Cadence cloud portfolio has great momentum, with over 50 customers using our solution in the cloud. Kadant cloud-ready products and close collaboration with our cloud infrastructure and foundry partners are enabling our customers to realize meaningful scalability, performance, and flexibility benefits from using the cloud. Our cloud-based model is used for hybrid cloud infrastructures where customers want to augment their on-premise infrastructure with bus capacity from the public cloud to address peak load. Continuing strong proliferation of our digital and sign-off solutions, especially with market shipping customers at the most advanced nodes, have driven share gains and double-digit year-to-date revenue growth. In addition to numerous 7-nanometer tape-outs, There are more than 15 customer engagements at five and three nanometer using our digital flow. MediaTek has deployed our digital full flow in production for their seven nanometer designs. At Mennanox, a leader in data connectivity solutions, Innoverse replaced the incumbent solution for all of their production 7 nanometer designs. We also had a digital full-flow competitive win for 7 nanometer design with a leading Japanese imaging company. UNDA used Cadence digital full-flow, which is based on common engines and includes Janus, Innovus, Tempus, and Pegasus to achieve the best quality of results and the fastest conversion of their highly innovative and completely integrated first digital automotive radar on chip. Next, I will discuss highlights of our system design and verification solutions. Our Palladium Z1 emulator and the recently introduced Proteum X1 FPGA-based prototyping platform now provide a comprehensive solution across IP and SOC verification, hardware software regressions, and earlier software development. Growing system design complexity and the high cost of failure continues to drive strong demand for our Palladium Z1. In Q3, the Z1 added eight new customers, and I have eight key expansions. Rounding off our hardware family is a Proteum X1, which is a perfect complement to our Palladium Z1. I'm excited by the strong customer interest in Proteum X1. A global marquee customer significantly expanded their existing hardware footprint with the additional Z1 capacity and Proteum X1 as well, making it one of the largest hardware orders ever for Cadence. We had several full verification suite wins in Q3, including a major customer in Asia and an automotive semiconductor company in EMEA. In IP, Our focused strategy and strong portfolio have enabled us to benefit from the continuing IP outsourcing trend. In Q3, we had our best-ever quarter for IP with year-over-year revenue growth exceeding 20%. It was an especially strong quarter for our 10 silica products with additional wins in audio, imaging, computer vision, and machine learning. In system innovation segments of our intelligent system design strategy, we introduced the Celsius thermal solver, which joins the QWERTY 3D EM solver in a growing suite of our system analysis products. Celsius is the industry's first complete electro-thermal co-simulation solution for the electronic systems from ICs to system or to physical enclosures. Based on the proven massively parallel architecture that delivers up to 10x faster performance with full accuracy, Celsius enables design teams to mitigate thermal issues at an earlier stage. thereby reducing system development iterations. Bosch and Arm have both endorsed these exciting new products and were in the midst of earlier discussion with several other customers. Clarity, which was announced earlier this year, continued its strong momentum with four competitive wins during the quarter. and more than 30 active customer engagements underway. With that, I will now turn the call over to John to review the financial results and provide our updated outlook.

Thanks, Lipu, and good afternoon, everyone. I'm pleased to report we met or exceeded all of our key operating metrics in Q3. As a result of continuing robust demand for our solutions, and strong execution across our business, we are increasing our outlook for fiscal 2019. Before we get into the Q3 results, I would like to take a moment and talk about the ongoing trade uncertainties. With more companies recently added to the entity list, the situation remains fluid and we will continue to closely monitor it. For the purpose of providing guidance for 2019, we've assumed that the current export limitations remain in effect and the entity list remains unchanged for the remainder of the year. Now let's go through the key results for the third quarter, starting with the P&L. Total revenue was $580 million, up 9% year-over-year. Non-GAAP operating margin was 31.7%. GAAP EPS was $0.36, and non-GAAP EPS was $0.54. Turning to the balance sheet and cash flow, at the end of the quarter, cash totaled $655 million, while the principal value of debt outstanding was $350 million. Operating cash flow for Q3 was $139 million. DSOs were 43 days, and during Q3, we repurchased $75 million of cadence shares. Now I will provide our updated guidance. For Q4, we expect the following results. Revenue in the range of $590 to $600 million. Non-GAAP operating margin of approximately 30%. GAAP EPS in the range of 33 to 35 cents. Non-GAAP EPS in the range of 52 to 54 cents. And we expect to repurchase $75 million of cadence shares. As a result, our updated guidance for fiscal 2019 is now as follows. Revenue in the range of $2.327 to $2.337 billion. Non-GAAP operating margin of 31.5 to 32%. GAAP EPS in the range of $1.50 to $1.52. Non-GAAP EPS in the range of $2.18 to $2.20, and operating cash flow in the range of $700 to $740 million. You will find guidance for additional items as well as further analysis in the CFO commentary available on our website. In summary, I am pleased with our execution in an uncertain environment. Our strong, dependable results reflect the broad diversity of our global customer base. We remain focused on driving growth in our core business, highlighted by the proliferation of our digital full flow, and we continue to invest in growth opportunities with market-shaping customers and new product areas. In closing, I would like to thank our customers, partners, and of course our employees for their continued support. And with that, operator, we'll now take questions.

At this time, I would like to remind everyone who wants to ask a question to please press the star, then the number one on your telephone keypad now. We'll pause for a moment to compile the Q&A roster. And your first question comes from Adam Gonzalez with Bank of America. Your line is open.

Adam Gonzalez Hi, yeah. Thanks for taking my question and congrats on the strong results. For the first one, I'd like to focus on the IP business. I know IP can be a little bit volatile from a RevRec standpoint, but can you help us understand how sustainable This large boost you saw in Q3 is, should we expect a little bit of a reversion in Q4? Does Q3 kind of represent an inflection? And if the latter, can you walk us through what the sustainable drivers are? Thanks.

So, Adam, yes, yeah, as Lipu mentioned in his prepared remarks, the Q3 was our best ever quarter for IP business with impressive revenue growth exceeding 20% year over year. I mean, if I look back over the last four quarters, the training four quarters were also up 20% year over year on IP. But we always say that revenue for IP can be lumpy in any single quarter, half or even year. But we do believe that it's relatively sustainable over the long term.

Got it. Thanks. For my follow-up, I guess, can you just give us an early view on 2020 growth based on the bookings momentum that you're seeing today?

Sorry, can you repeat the question?

Just if you have an early view on what 2020 growth could be directionally, if not an absolute value, just based on the momentum that you're seeing today for the overall business.

Oh, we're not giving any guidance on 2020 right now. Like we say, it can be lumpy in any one quarter, half, or even year. We'll provide that guidance at the end of our year. Got it.

Thanks. Your next question comes from Gary Mobley with Wells Fargo Securities. Your line is open.

Hey guys, thanks for taking my question and congrats on another strong quarter. I realize that you're probably going to be filing your 10Q in about three hours or so, but can you give us a preview into what the remaining performance obligations were at the conclusion of the quarter?

Yeah, I think it's filed already. The contracted but unsatisfied performance obligations were approximately $3 billion at the end of Q3, including approximately $200 million of our IP access arrangements. Those IP access arrangements are non-cancellable commitments from customers where product selection and quantities are determined by customers each quarter.

Okay. Sets up about $200 million sequentially, if I'm not mistaken. All right. I have a multi-part question on your systems analysis business. Lipu, you mentioned four wins for clarity in your prepared remarks. In relation to those four wins in the early activity in the 30 engagements that you have, How successful are you in your ability to separate these licensing deals from existing EDA customers? In other words, monetize them above and beyond your existing revenue run rate to existing customers. And can you share with us what your typical deal size may be for these types of wins and as well perhaps when you can start to recognize some revenue from these four early clarity wins?

Thank you for your question, Gary. I think a couple of things. First of all, I think we have our approach of the system analysis space. That's something that's really our core component of computational software, and that we can apply into this complex system analysis space. And then we have these two new products. Initially, we announced the Curity, that is a 3D EM solver, We are delighted. We have four competitive wins. And this is a very new product for us. And we have more than 30 active customer engagements going forward. And so we are excited about that. And meanwhile, we just announced our Celsius thermal solver. And again, back to that computational software strength that we have. And we clearly demonstrate that up to 10x performance. And customers are delighted to see our performance I specifically spell out Bosch and Arm. They both endorse our new products and were middle of earlier discussion. So it's still in the very early stage of our emerging into the system analysis. And more and more, our customers love that because beside the EDA, beside the IEP, they want to look at the total system solution simulation, whether it fit the whole system, power, you know, thermal envelopes and something that we can really demonstrate and provide the best solution for the customer. So it's still very early. And in terms of our pricing, again, you know, it's not part of our EDA. And so, you know, we do it differently. And basically, you know, close to the market competitive, you know, pricing. But, you know, in a very early stage of winning. And stay tuned. Over time, we will unfold and give you a progress update.

All right. Thank you, guys.

Thank you.

Your next question comes from Jackson Adder with JPMorgan. Your line is open.

Thanks, guys. Thanks for taking the question. Can we just start with hardware? So it looks like verification was the segment that probably struggled the most year over year. And we've seen inventory balances tick up the last couple of quarters. So I'm just curious, is this maybe a building of some hardware ahead of pipeline or are we seeing any kind of struggling close rates in that hardware business?

Let me start first, Jackson, and then John will give you more detail about the inventory. And so I think first of all, I think function verification remains the fastest growing challenge for our customer. And I mentioned in Q3, we are delighted to deepen our partnership with Samsung to a comprehensive agreement across not just digital custom and also verification products. And then the Palladium Z1 have been doing great and the customer loved it on the hardware emulation. But now we add the Proteum X1 FPGA-based prototyping that we can provide a comprehensive solution across IP and SOC verification, especially for hardware-software regression and earlier software development, that combination using the same front-end software and make it easier for the customer. And so I think we clearly see that in our eight new customers and eight key expansions. And so I think we are just delighted and very pleased Proteum is giving a lot of opportunity for us. And we also highlight a global marquee customer, significantly expanded their existing hardware footprint with additional Z1 capacity and add on the Proteum X1 as well, make that one as one of the largest hardware orders for Cadence. So I think all in all, we see strength, and then I think John can highlight the reason of building up the inventory.

Yes, yeah, Jackson. As Libu says, I mean, our hardware solutions are proven to be very robust in the marketplace, and customer demand is good. Q3 results were slightly up on Q3 2018, but we were building inventories heading into Q4 because we have a strong pipeline going into Q4.

Okay, that makes sense. And then one quick question, a follow-up on the 30 customers, clarity engagements. Can you give us any kind of industry sense for those, or is it significantly different from the cadence customer base in EDA?

Yeah, I think both, and not just on semiconductor. Many are the system companies, because you really see the value of the up to 10x performance, and also tie in very well from the system simulation down to the silicon simulation that's fully integrated it completes that customer love.

Okay, thank you. Thank you.

Your next question comes from Rich Valero with Needham & Co. Your line is open.

Thank you. First, just a clarification. Congratulations on the large IP order that you mentioned was from the marquee customer you had referenced previously. And I just wanted to clarify, is the significant hardware difference order as well from the same Marquee customer, or was that a different one?

Yeah, so I think what we mentioned earlier is that IP deal is with the global, you know, US semiconductor company, Marquee US semiconductor company. And then the hardware, you know, clearly is a Marquee, global Marquee company. And they are already our customer. but they are increasing their hardware capacity, plus the Proteum that they like a lot, and so that they're fully integrated and make it one of the largest hardware orders.

Got it. So they are different customers, though, is that just to be perfectly clear?

Yes, yes, yes.

Okay, thank you. And then moving on to the system products, First, just wanted to understand, you mentioned that Bosch and Arm had endorsed, and I think you said both of these products, and I just wanted to clarify that that was, in fact, an endorsement of both Celsius and Clarity. And then if that's the case, have either of them actually purchased Clarity? Are they among those four competitive wins you have for Clarity?

Yeah, I think we mentioned Bosch and Arm endorsed the Celsius products. And the currency, we mentioned about four competitive wins and then plus another 30 active customers. So there's a differentiation here.

Got it. Understood. And then I know this is a tough subject. I just wanted to see if you're willing to say sort of anything about China as we look into next year. You know, this year you've had a number of customers put on the entity list and you had the benefit of getting revenue from them for, in some cases, three quarters of the year, in some cases, maybe a couple quarters. And as we head into next year, if the entity list sort of stays the same, you'd have kind of a full year, in essence, headwind from those customers. But I guess recently there's also been some policy put in place in China whereby they're actually providing incentives for companies to purchase both EDA tools and IP, which could conceivably be a tailwind for you. in the country. So just wondering if there's anything you can say about sort of China as we look into next year. There's a lot of sort of factors at play. I don't want to give numbers, but just any thoughts there, Lipu, would be helpful.

Sure. So let me just touch on, first of all, I think clearly Cadence has and will continue to comply with the United States Department of Commerce export control. And as I mentioned, the situation is fluid. and we're monitoring carefully. And even with this uncertainty, but we assume our current export limitation remain in place for the rest of the year. So we, our guidance already provide everything we know in this and we are not. And so I think this is kind of where we are, John.

Yes. Yeah. And we're not going to speculate in terms of how that plays out for next year, but you're correct in your assessment that In some cases, for some customers, we had revenue in the first half of the year, and this second half of the year is quite different now. We do have some headwinds. If there is no change, those headwinds will persist into next year.

Okay. Thanks for taking the question, gentlemen.

Thank you.

No worries. Your next question comes from Tom Diffley with DA Davidson. Your line is open.

Yes, good afternoon. Another question on the IP. Just curious, is the sequential growth solely due to the one large customer, or did you see a broad base increase in IP demand as well?

Yeah, let me start first. Clearly, our focus strategy and a strong portfolio on IP, and in fact, we keep on adding more IP portfolio. Beside the Tensilica, the memory connectivity, and we are excited about high-speed sorting. that we bought from a new semi and that 112 gig 30 is a must have from a lot of data center infrastructure build up and a hyperscale guy really like it. And so I think we have a very, we are very pleased with our portfolio and we are laser focused on our strategy, focus on the leading customer and then focus on the advanced nodes and then focus on something that we can scale. And then so far I think we have a very broad portfolio But meanwhile, we are very delighted, and I mentioned earlier, this marquee semiconductor company, besides we have a wide-ranging win, and now we add on this largest IP, not just include 10 silica family, also include the design IP portfolio. We are excited about it, just add on top of it, and we are very pleased with the progress. And IP is like the building block of the system, You know, you really need the, I call it the star IP that a must have, and we are really focused on the star IP.

Yeah, we're very pleased with the consistent execution there in IP, and they had a very strong finish the last year. They had a very strong Q1. Q2 was kind of flat on Q2 last year, and then we had a strong Q3. But as with all these things, of course, it creates a tough compare going forward.

Yeah, do you see any natural seasonality in that business, or is it purely project-based?

It's purely project-based, and it's kind of random from a seasonality standpoint.

Okay. And finally, John, in the press release, you mentioned kind of a reorganization of some international offices that you had.

Yes.

The impact on taxes going forward, I wonder if there's something you can say on that.

Yeah, I mean, that's a gap-only thing. I mean, in October 2019, we initiated a series of transactions involving an internal realignment of our international operating structure. And that realignment may significantly increase our foreign deferred tax assets. As you know, deferred tax assets are recognized when the depreciation of the asset is expected to offset future profits. So there's a lot of calculations that go in to try and estimate the value. We've not completed our analysis and cannot yet estimate the impact. But we expect to complete the analysis and record the income tax impact in the fourth quarter of 2019. We wanted to highlight that in our CFO commentary. because our current GAAP guidance basically doesn't account for this change. So we just wanted to highlight that that piece is open.

Okay, but no non-GAAP impact going forward? That's right. Okay, great. Thank you.

Your next question comes from Mitch Thies with RBC Capital Markets. Your line is open.

Hey guys, thanks for taking my question. Just two for me. Just regarding China in terms of historical, last quarter you guys kind of have a blowout quarter with it being up 68% and now it's up about 21%. Is there any way to confirm that there's potentially some hardware pulling just given the Huawei dynamics last quarter and that's the reason why it's down sequentially or am I reading too much into it?

Overall, China was, what, 10% of revenue in Q3. Now that's down from 12% in Q2, but flat from kind of Q1, I think it was 10% in Q1 as well. But, you know, we've seen variability in our China revenue mix over the last six quarters. It's ranged from a low of, I think, 8% back in Q2-18 to a high of about 13% in Q4-18. Back in Q4-18, we did experience a hardware pull-in and we did see the first half was quite strong for hardware. Q3 has been a little bit lighter for hardware and that's shown up in gross margin. But like I say, the hardware pipeline is strong for Q4, and hardware can be lumpy in any one quarter.

Okay, that makes a lot of sense. And then secondly, I mean, EDA is probably one of the better ways to play 70s over the next, like, five to ten years. But one thing that I'm noticing here is, like, your employee count is actually increasing pretty significantly, going from, like, 4% growth to 8%. I just want to be clear here. If I look out over the next, like, let's call it three to five years, that your OpEx is still going to undergrow the revenue line. Is that a fair assumption? Because it looks like it's actually pretty close now at this point.

Yeah, we're not guiding anything on 2020 right now. But you're right to point out that, yeah, headcount has grown because we're investing in opportunities for proliferation and market-shaping customers and new products.

And in some way, we are very excited about the environment because, you know, as I mentioned, you know, the couple of big driver, AI, 5G, cloud, and IoT, and then the whole data infrastructure is because of AI and all this driver, there's a very big changes requirement needed. And so we have a suite of startup and system company. They all try to meet the new requirement. So there's a lot of innovation happening. And so we see a design activities increase. And that's why I think also we have a proliferation of digital flow and also some of the key market-shaping customers that were being adopted. And so we are building up the engineering and also the FAE support to win some of this account and then proofreading. And that's why, you know, John and I, we only increased the headcount when we see the, you know, the deployment and also the commitment from the customers.

Got it. It's very clear. Thank you. Thank you.

Your next question comes from John Pitzer with Credit Suisse. Your line is open.

Yeah, good afternoon, guys. Thanks for letting me ask the question. I guess my first question is just on the relatively new North American customer, clearly additive to the September quarter. I'm wondering if you could just help me understand how we should be thinking about sizing that business over multiple years and how that business scales for you as that customer continues to move down nodes.

Yeah, so I think clearly we don't got any 2020 outlook, but we're excited about, I don't know quite sure, new North America, but we only mentioned about Marquis, you know, the U.S. semiconductor company. We're excited about that partnership, and we're expanding beside the tool, expanding the IP proliferation, and that part will continue. We're excited about it.

That's helpful. And then as my follow-up, just going back to your comments about AI, I'd be kind of curious if you could size how big that business is, either as a percent of overall revenue or maybe of the growth. And I guess specifically, you know, the semiconductor industry went 10 or 15 years without a lot of venture capitalist money, and that's clearly changed around AI. And there's somewhere between, you know, 40 to 60 potential AI startups that are getting funded. And I'm just trying to get a sense of how important that is to your growth in the near term, and kind of do you think that all these companies are going to be viable, or is it more likely that this consolidates, and if it's the latter, how do I think about kind of the AI revenue stream unfolding from here?

Yeah, I think, you know, the AI implication to the whole industry can be quite significant. If you look at the university like MIT, they call it the new school of computing, They just raised $1 billion for that. Same thing with CMU, Carnegie Mellon. And I'm on the trustee. And they are just offering the AI degree for undergrad. And then you can see the SoftBank, the Vision Fund tool is focused on AI. So you can see the AI implication. And in fact, you are correct. If you look at the semiconductor growth recently, and in terms of funding, a lot is driven by AI. AI is not just semiconductor. is applied into all the different vertical industries. So the impact can be quite huge. And we're excited about this opportunity. The design activities increase a lot. And so I think all in all, I think clearly we have a very good position. We have the AI machine learning application to our tool. So we see significant improvement in terms of our various tools in terms of PPA runtime and verification. So we are embarking on improving our tool so that we can get the best product to meet the customer requirement. And the AI development is not just the startup. All the big hyperscale guy and all the big subsystem company, they all have various degree of investment into AI. And then we also, our Tensilica, that's a very clear good engine. for some of the AI application, like the audio, video, and various others, and then we'll try to build the software stack on top of the AI platform so that we can provide a solution to our customer for the various vertical market they try to address.

That's helpful. Then if I could take a quick financial one in for John. John, just given what you guys did in the September quarter and in the year-ago quarter, I'm just kind of curious, your out-margin sort of guidance for the December quarter is, Can you help me understand why it would be down sequentially year over year other than just an abundance of conservatism on your part?

Oh, yeah. So we haven't changed how we guide. I mean, we guide the same way all the time. But essentially, it's the same as where we were this time last quarter. Last quarter, we guided Q3 at 30% for up margin and Q4 for 30%. In Q3... The beat was mainly on the gross margin side. I mean, we assume gross margin comes out at about 90% in our estimates. And we did better in Q3. It came out at, I think, 91.6%, and we landed at 31.7% for op margins. So most of the beat on the op margin side in Q3 was the result of gross margins. My expectation for Q4 is that we have a significant hardware pipeline heading into Q4 it was kind of similar. It reminds me of where we were this time last year. And last year, our gross margin ticked down, I think, 200 basis points from Q3 to Q4. So we're expecting about 30%. And that's because you've got a combination of things happening, right? You've got Q3 and Q4. We're assuming that there's no change in export limitations right now. but we're also investing in proliferation opportunities, market-shaping customers, and in new product areas. So that's what's driving the numbers.

Perfect. Helpful. Thanks, guys.

Our next question comes from Jay Fleschauer with Griffin Securities. Your line is open.

Thank you. Good evening. Question for you, Don, first. You noted in your prepared remarks the $200 million, or $212 to be precise, in IPAA commitments. This is not a metric that I think you've disclosed before until tonight's queue. Was that amount due mostly, if not solely, due to a single customer, or is it fairly broadly based in terms of numbers of IP customers comprising that? And then secondly, just a longer-term EDA market question for Philippou.

Yes, Jay, thanks for pointing that out. Yes, that was an issue we had with how remaining performance obligations were calculated in the past. We reported backlog under the old rules and we would have included our IP access arrangements. And then under the new rules, the remaining performance obligations didn't include IP access arrangements and it didn't seem to be consistent with how we reported in the past. So we worked with our auditors just to say that we wanted to disclose it because, as you say, now as of Q3, it's $212 million is the exact number. But the $3 billion that we have in contracted but unsatisfied performance obligations is more comparable to the backlog that we had at the end of last year.

Okay, thank you for that. For LitBoo, maybe a two-part technology or market question. First, you often use the term market-shaping customer, and it's frankly a somewhat odd expression. How do you define customers that fall into that category, and more specifically, how do you dedicate resources to those customers in terms of commitments and so forth? And then a growth question. We've seen a number of categories in EDA have extended periods of consecutive growth. For example, in the industry data, of course, your numbers, the custom category has had more than 30 consecutive trailing 12-month periods of growth. IC implementation, more than 16. PCB, 12. So that's all very good, of course, but historically, EDA growth cycles for particular categories don't last for more than three to four years each, but we've now seen multiple categories that are meeting or beating historical periods of consistent growth. So what's your thinking in terms of sustainability or what's different now vis-a-vis the different categories?

Yeah, so, Jade, thank you for those questions, and let me address one each time. So first of all, about market shaping customer, you know, the definition is that they are clearly the leaders in their sector. And so they are the most demanding customer, but because they are leader, they are driving the innovation, they're driving the performance, and we want to be the, you know, the partners for them, the trusted partner to enable their innovation to continue their leadership in the marketplace. in the various different vertical market or the platform that they create. We want to be the partner for them. And that is how we define the market-shaping customer. In terms of growth, I mentioned you can hear my passion. Clearly, we are not creating the changes. We are right with the wave. And the beauty part in this particular junction of the industry, there's a Five different waves are driving the growth, and they are changing the landscape of the requirement. As I just mentioned, one example is AI. And now we are moving into, I call it the data-centric economy. It's all about data. And then today it's only 2% of the data being analyzed and being utilized. So there's a humongous opportunity. And then this is applying to across all the different vertical. And it's really driving a change to the memory, driving the chain of the storage, driving the domain-specific processor. So in a way, it's workload-specific, depend on different workload, different market, require different, you know, rather than just CPU, GPU, or FPGA. There's a new class of workload that require different type of processor, and that will also driving the memory, the storage, the infrastructure, in terms of able to cope with the data, massive, massive exposing of data. And then so all this is going to require new innovation in order to support that. For example, the programmability, the scale out the storage and network, and then scale out the top of the rack all the way to top on the spine in terms of the infrastructure, 12.8 terabit per second to 51.2 terabit per second switch and all the high-speed interconnecting, and that's why the 30 is so important for high-speed, and that's why Cayden bought it, and then we're going to triple down on it to really drive the requirement that the hyperscale and the big infrastructure player need that. So I think this is going to be driving a lot of new innovation in semiconductor side, and we are learning, and we are trying to be the trusted partner to fulfill some of these requirements And that's why I mentioned earlier the design activity increased a lot. And we're excited about it, and it's just the beginning of it.

Thanks very much.

Thank you.

Your next question comes from Jason Salino with KeyBank Capital Market. Your line is open.

Hey, guys. Thanks for taking my question. Just two for me today. You know, the first one, with your Q4 pipeline for your hardware business, You know, you talked about more modest growth this year following a tough calm from last year, but, you know, if the pipeline holds, could we see some upside to that modest growth commentary that you've provided previously?

Yes, Jason, it's kind of hard to move the needle in one quarter. I mean, if you look over the total year, we're expecting kind of low to mid-single digits growth for functional verification for the year. Although, if you do look over like the trailing four quarters to the end of Q3, I think functional verification is up, you know, kind of high single digits. But the challenge this year has been tough comps, and like I say, we enter into Q4 optimistic with a strong pipeline.

Okay, great. Thanks. And my next question has to do with your, you know, system analysis business. So you announced the electromagnetic solver in 2020. you know, April timeframe, and then you came out with your second solver, the thermal solver in September. You know, I'm not necessarily looking for, you know, specific timing, but can you just remind us what other, you know, solvers we could expect?

Yeah, so I think, you know, this is just our initial entry to the system analysis using our core computation software. And stay tuned. I mean, we are just beginning. We have first product came out in April, like you correctly point out, with good tractions. And now the second product came out. People love the performance. They're excited about it. We will continue to investing. And it tie in also very well with our PCB business and that the whole system modeling, system simulation will be a really exciting area for us. So stay tuned, and we will update you when we announce any new products. Okay. Thanks, Lipu. That's all from me. Thank you. Thanks.

Your next question comes from Joshua Tilton with Burenberg. Your line is open.

Yeah, hi. Thanks for taking my questions. It appears as if the drivers of design starts today address a broader set of companies relative to previous drivers, such as maybe mobile. So I'm just curious, how does having a broader set of addressable companies benefit pricing?

So yeah, having a broader set of companies benefits us because Cadence revenue and growth generally tracks design starts. But the more design starts are, the better it is for Cadence business.

Yeah, so I think we like to broaden the customer and applications so that we can really find new opportunity and new solution to support them, either in the automotive or 5G or AI, or cloud or huge opportunity in industrial IoT and providing the solution for the system infrastructure player so that we can broaden the customer requirement and that greater diversity to our customer is always good.

Okay, that makes sense. And just as a follow-up, in the prepared remarks, you mentioned customers were adopting a full digital flow. It was my understanding that companies tend to build their flow using products from both you and other competitors. So are we just starting to see customers standardizing their flow from one vendor?

Yeah, so I think, you know, when you move down the geometry, you know, to seven to five to three, try to integrate different products, different tools from different customers. That means that you have to build an internal team to do all the integration. And also you have a lot of opportunity to fail because the different tools have different methodology. And so customers are starting to really focus on getting a full flow, the best. I think it's very important. Our focus, first of all, is to have the best of breed for each product line, like the Inovus we mentioned earlier for place and route. Right now it's a majority, over 70% of the customers are adopting it in the most advanced nodes. and then now we have the Janus come out very strong, and then Tempus come out and Pegasus, the customer starting to see not only the best of breed of product, and also how to integrate them, how to optimize them, and correlations among all the different flow that we have been talking about last few years. And so right now we can not only have the best of breed for each product, now we can integrate, and that's why you're starting to hear that we mentioned a lot about digital full flow, that our customers depend completely on us on the most advanced node in the seven and five and three, and that's the way we're going to continue to support the customer.

Thank you. Those were helpful.

Our last question comes from Krish Sankar with Cohen & Company. Please go ahead. Your line is open.

Hi, thanks for taking my question. Libu, I had two of them. One is you guys are definitely getting a good traction with your hyperscale customers. I'm kind of curious. As your hyperscale customers build their own silicon, how are their requirements for EDA different than your traditional semiconductor customers? Do they see one way towards IP blocks or whatever it is? Any color alert would be helpful. And then I had a follow-up.

Okay. You know, clearly we are excited about the hyperscale players. They are going to be very important for our industry because they are quietly building up. As I mentioned earlier, their workload requirements have changed, and it's more about data. And then so that domain-specific processing development and also in the server into the data storage network scale-out is going to be even more and more important for them. And they are great partners for us and great customers, and we love them. And then first of all, They are a little bit different on our semiconductor players. Time to market is more important to them, and also performance scalability is most important to them. And that part I think we work very – from the early days, we are already working in partner with them, and we are also very excited about the cloud infrastructure that we also support the cloud infrastructure using some of our tools to do that, and we continue the leadership on that. So I think In multiple aspects, we're working with our partners in the cloud, and we're excited about the opportunity.

That's very helpful, Libro. And then a follow-up for either you or John. Is there a way you can size the hardware market this year? How big is it? And within that, different step segments like FPGA apps, how big are they? Any color that would be helpful.

Sure. I don't have any breakdown in terms of the market data that I can share with you today. But we're very, very happy with how our year is going and with the strong pipeline that we have leading into Q4. Gotcha.

Thanks, John. Thanks, Litlu. Thank you. Thanks.

There are no further questions at this time. I'll turn the call back to Litlu for closing remarks.

Thank you all for joining us this afternoon. Next phase of our strategy Intelligent system design brings new opportunities in design excellence, system innovation, and pervasive intelligence in an expanded total addressable market. We are capitalizing on multiple technology trends and further proliferating our solutions with a broader base of customers. And in closing, I would like to thank all our shareholders customers and partners, the Board of Directors, and our hardworking employees for their continued support.

Thank you for participating in today's Cadence Third Quarter 2019 Earnings Conference Call. This concludes today's call and you may now disconnect.