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 Third Quarter 2020 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.
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, Mike, and I would like to welcome everyone to our Q3 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 December 18, 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 more 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 ks 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
the
are available at the Investor Relations section of cadence.com. Copies of today's press release dated October 19, 2020 for the quarter ended September 26, 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 our glitches or handoffs should take a little longer than usual.
And now I'll turn the
call over to Luca.
Good afternoon, everyone, and thank you for joining us today. I'm pleased to report that Cadence achieved outstanding financial results for the Q3 of 2020. We exceeded our financial outlook on all key metrics as the Cadence team continues to successfully navigate through challenges posed by the pandemic. We also raised our outlook for the year. John will provide more details in a moment.
The data centric revolution led by AI, data analytics, hyperscale computing continues to fuel strong semiconductor and system design activity, and our intelligent system design strategy uniquely position us to enable our customers to accelerate their innovation. Now let us move on to the major highlights for the Q3. Design Excellence is the foundational layer of our strategy and includes our all EDA chip design solutions and IP portfolio. We significantly deepened our partnership with the global marquee customer through a wide ranging expansion of our EDA software and hardware portfolio. This customer is now accelerating the proliferation of our digital workflow across their design teams.
Momentum continued for our digital sign off solutions with 9 full flow wins and major market shaping automaker tape out, their highly innovative, complex 7 nanometer design using our digital FUFO. Our verification suite comprised of best in class core engines across simulation, formal analysis, simulation and prototyping is particularly well suited to address our customers' founding verification challenges. Hardware at its highest ever revenue quarter with Palladium Z1 and Protium X1 continuing to get new design wins and significant expansions, particularly at AI and hyperscale customers. We introduced Xyleum ML, which use machine learning to improve the regression throughput of our premium logic simulator by up to 5x. On IP front, the top vertical end markets for our design IPs in this quarter for hyperscale, enterprise and automotive.
With the major hyperscaler adopting our PCIe and high bandwidth memory IP for use in 3 nanometer design. Tensilica have a strong loyalty and wins for true wireless stereo and functional safety applications and was adopted by an automotive company or ADAS. In system innovation, I'm very excited by the strong momentum of our new system products, both organically developed as well as those we obtained through the AWR and Integrin acquisitions earlier this year. Earlier this month, we expanded our system analysis portfolio with the addition of the current 3 d transient solver that delivers up to 10x faster system level EMI simulation. Felicity and Celsius continue to ramp nicely with broadening adoption, particularly in verticals such as AI, mobile and hyperscale segments.
System companies like Paradigm and Rockley Autonics are deploying our clear to quality EM simulator for production use. In the 5 gs millimeter wave area, integration of our AWR and integrand acquisitions continue smoothly, and the business is tracking ahead of our internal expectations. In Q3, we added more than 15 new customers in the end markets that included 5 gs, Automotive and Aerospace and Defense. Kadant has a strong has a long successful history in advanced packaging, which has become a linchpin technology for many system companies, particularly automotive and hyperscalers to deliver complex system level chip designs. In Q3, our innovative Allegro technology was used by a market shipping automaker for their wafer level system packaging needs.
Now let let us turn it over to John to go over the results in more detail and to update our outlook.
Thanks, Lip Bu, and good afternoon, everyone. I'm pleased to report we exceeded all of our key financial metrics for the quarter. We had a strong revenue quarter in China as a result of better than expected hardware and IP sales in the region. This was the main driver of the improvement in our profitability for the quarter contributing approximately 2% to our non GAAP operating margin. Looking at the key results for the Q3, starting with the P and L, total revenue was $667,000,000 Non GAAP operating margin was approximately 36%.
GAAP EPS was 0 point 58 dollars and non GAAP EPS was $0.70 Next, turning to the balance sheet and cash flow. Our cash balance was approximately $1,300,000,000 while the principal value of debt outstanding was $700,000,000 Operating cash flow for Q3 was $207,000,000 DSOs were 41 days and during Q3 we repurchased $75,000,000 of Cadence shares. Before I provide our updated outlook for the remainder of fiscal 20 20, I'd like to take a moment to share the assumptions embedded in our outlook. Fiscal 2020 is a 53 week year and the extra week will add approximately $45,000,000 of revenue to Q4. We have seen higher than expected levels of hardware and IP sales activity in China during Q3 and we have assumed this will continue in the middle of Q4.
As a result, our outlook includes approximately $40,000,000 for this increased level of hardware and IP sales activity in the second half. You will recall that we had removed $70,000,000 of bookings from our backlog at the end of Q2 due to COVID-nineteen related customer credit risk. The credit situation slightly improved during Q3 and we revised that estimate down to $58,000,000 And as usual, our outlook continues to assume that the export limitations that exist today for certain customers remain in place for the remainder of 2020. Embedding the aforementioned assumptions, our updated outlook for Q4 is as follows: Revenue in the range of $720,000,000 to $740,000,000 non GAAP operating margin of 34% to 35%, GAAP EPS in the range of $0.48 to $0.52 non GAAP EPS in the range of $0.72 to 0 $0.76 and we expect to repurchase $130,000,000 of Cadence shares. And for fiscal 2020, that means we now expect revenue in the range of $2,643,000,000 to $2,663,000,000 non GAAP operating margin of 34% to 35%, GAAP EPS in the range of $1.97 to $2.01 and non GAAP EPS in the range of $2.68 to $2.72 We expect operating cash flow to be in the range of 840 dollars to $870,000,000 and we expect to use approximately 50% of our free cash flow to repurchase Cadence shares in 2020.
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 naturally, I'm pleased by this quarter's results, but we always recommend that you shouldn't focus too much on the results of any single quarter. What I'm most pleased about is the improvement in our 3 year revenue growth factor. The fact that our team continues to operate very effectively during a pandemic And we're on track to achieve greater than 50% non GAAP incremental margin
for the 4th year running.
I would like to close by thanking our customers, partners and our hardworking employees for all that they do and I'd like to remind them all that their health and safety continue to be our first priority. And with that operator, we will now take questions.
Your first question comes from Gary Mobley from Wells Fargo.
Hey, guys. Let me first extend my congratulations on strong second half progression. Related to the second half of the year, I wanted to ask about what seems to be about $65,000,000 in extraordinary China related revenue that maybe you didn't otherwise expect when the fiscal year started coming in the second half. To what extent is that influenced by some of
the late sec export restrictions
and perhaps some customers over in China trying to get under the wire, so to speak? And then related to some of the little arrow related export restrictions, have you further done some top down analysis on your existing customers and the serviceability of those existing customers?
John, we can't hear you.
Sorry, I was on mute. Hi, Gary. That's a great question. Yes, in terms of China, the strength in China was higher than expected. Like like $45,000,000 for the extra 53rd week of revenue and probably $40,000,000 for this kind of spike in China revenue that we believe is mostly non recurring revenue.
But it's you saw that the China percentage is about 17% in Q3. That's 4% higher than the previous record level. And like I say, our valuation of that is about $40,000,000 to the second half. Split about 2 thirds, 1 third between Q3 and Q4. But it's I understand the concern about is there a pull forward from next year.
It's too early for us to say right now. What we can say is that extra revenue is generally and predominantly non recurring in nature. But I won't know until early next year when I look at the pipeline whether it impacts 'twenty one. And that's a follow-up, Owen. That's John.
And clearly, hardware and IT are the big growth for us. And again, we're complying with all the U. S. Export control regulations. And then China semiconductor still a very strong growth engine.
Okay. And related to margins, I mean, you guys are just killing it on the operating margin. And I guess that's contrary to what we would have thought given the higher mix of hardware related revenue. What's sort of the, I guess, inner workings there as it relates to hardware mix? Is the China related hardware mix that much more profitable than, say, domestically originated hardware sales?
Yes, Gary, naturally, I mean we're continuing to invest in R and D, but hiring was slower than expected in Q3. And also the pandemic is helping margins with a little less T and E. We seem to be creeping up into the like 33% to 34% range. We're probably at the high end of that range for as long as the pandemic helps us to keep certain expenses lower. But for Q3, we got an additional margin benefit of about 2 percent for that extra hardware and IP revenue in China, which is mostly non recurring and one time in nature.
I've assumed that continues into the middle of Q4 and we get about 1% extra benefit in Q4. And the extra week is actually about 0.5% of a headwind to margins in Q4. That's which at the baseline for margin is probably in the 33% to 34% range. And there's some one time things that are helping us in Q3 and Q4.
Got you. All right. Thank you. Your next question comes from John Pitzer from Credit Suisse.
Yes. Good afternoon, guys. Thanks for letting me ask questions. Congratulations on Salzuzov. John, just a follow-up on that.
Could you help us better understand how much of a tailwind kind of the pandemic has been relative to OpEx, I. E. When we get back to a more normal state, how do we think about kind of op margin relative to target?
Yes, John, great question. Like you say, I think we're probably solidly into the 33% to 34% range for operating margins right now. But with the pandemic related items kind of lower T and E and things like that helping us to land at the higher end of that range. If we didn't have a pandemic, we'd probably be towards the lower end of that range. But and then when you look at the kind of the bridge from our Q3 performance of 36% margin, which had the benefit of like 2% for that extra China revenue.
For Q4, I'm assuming 1% for the extra China revenue and then about 0.5% of a headwind because of the extra week. If you back out the extra week and Q4 was in a normal 52 week year that we probably at 35%, but it will come in at about 34.5% we think at the midpoint including the extra week.
That's helpful. And then just going back to China, I'm sure you saw, I think on Thursday evening of last week, the Department of Commerce came out with some new emerging technologies to put on the export list. And it's oftentimes difficult to translate government language into industry language. But there was some commentary around computational lithography software. I'm just curious, is there anything that came out of that ruling last week that would impact sort of EDA?
And I guess as you look out over the course of calendar year '21, what are the puts and takes as U. S.-China tension continue to impact your business?
Yes, it's a good question. As I mentioned earlier, we're complying with all the export control regulation. And clearly, the situation is very fluid as of last week. And we continue to monitor closely about this computation and any impact to the EDA. And clearly, we continue to drive global customer success and providing the best tool and IP, But meanwhile, we're complying with the regulations.
And it's very fluid. We're just monitoring closely, do the best thing and we can.
But just a follow on, is there any benefit from Chinese customers to order more than they need now if they're concerned about potentially being cut off later? Or does that not really help them in a situation where the ban tighten?
Hi, John. You can certainly speculate on that, but I mean we can't really tell what the motivation for our customers is for the additional purchases during Q3. At the moment, we can't really tell with a high degree of certainty if the strength in China in the second half is a shift from 2021 revenue into 2020. I think you're right to be cautious about it, but we can't tell if it's a shift or if it's just what I can tell you is that it is one time generally in nature. Most of it is one time revenue because it's coming from hardware sales and IP.
But whether it impacts 'twenty one or not, I don't know. We'll know more in January, I'd say.
Thanks guys. I appreciate it. Congratulations guys.
Thank you.
Your next question comes from Mitch Steves from RBC Capital
Markets. I've got 2. I'm going to start with the proverbial kind of M and A question. Assuming that NVIDIA arm closes, do you guys see any impact from that and maybe some comments on kind of the speculation around AMD and Diodes as well? I think that was a big topical point several years ago, but I just want to get a rehash and any sort of impact you guys think from the recent M and A transaction may occur?
Yes, I think let me try to answer that. And first of all, we are not able to comment on any speculations on the NVIDIA and ARM. I mean, clearly, they are a great company, and ARM is a very important partner for us, for Cadence, and we're well positioned with ARM to serve our common customers. I think clearly, time will tell and I'll get approval. And so I think that's on the NVIDIA and ARM.
And then on the AMD and Xilinx, they are all very good company and we like them a lot. And clearly, over the years, we managed well through consolidations, and we have very proactive engagement with the companies. And then any consolidation, they are all unique respect to the vendor. They are all good company, and I think I cannot go beyond comment any beyond that.
Okay. Maybe just to clarify that. So I guess on the ARM and video piece, in a scenario, so we'll just go through the scenario that RISC V loses market share to ARM, does that impact at all the EDA space?
Yes. And again, we are supporting customer and then depending on whether they go with ARM or with 5. And but clearly ARM is very well positioned with that ecosystem in place and the software, and we continue to work closely with ARM. And then meanwhile, keep a close eye, if the customer wants to have reached 5, then we will support the customer.
Okay, perfect. And then my second one is just going back to kind of the 3 d solver opportunity. From what we've seen, chiplet architecture is continuing to take off and that requires a lot of RF. And it seems like you guys are very well positioned on that. So I guess, why is there not more, I guess, more marketing or more logos to talk about on that front?
Because it seems like the product you guys have is significantly better than ANSYS. So maybe you could talk about what you guys are seeing now? Is that COVID issue in terms of getting more sales? Or is it just not something you want to highlight yet?
Yes. I think this system design and analysis is a very important growth engine for us. And clearly, we're excited about the system complexity on the advanced design like 5 gs, automotive and HPC application. And so clearly, the system level and other systems are very critical for them. We're delighted with the organically developed and also the AWR Integral acquisition that we have.
So we have a very nice portfolio that our customers are delighted with us. And then clearly, the 15 new customer more than 15 new customer in this quarter for Clarity and Celsius is very exciting for us. And we also announced the Creality 3 d function solver that show 10x faster system level EMI simulation. So I think all in all, we're excited about the opportunity and we like to be under promise, over deliver. And meanwhile, we do the right the marketing at the right time.
But so far, I think we take one step at a time and then to support our customers, that's more important.
And Mitch, I would just like to add to that that we recognize revenue ratably on our systems analysis products. It's still early days. Our plan is to win mindshare first and then market share will follow. Yes, we've got plenty of repeat orders from new system companies and more than 15 came from AWR and Interbrand.
Okay, perfect. That's a great quarter. So I'll jump out of the queue.
Thank you.
Your next question comes from Vivek Arya from Bank of America.
Thanks for taking my question and congratulations on the strong results. For my first one, I'm curious about how you think about your non China growth this year. It's about 6 you thought the non China growth would be at this point of the year? Just anything that has surprised you in terms of the non China aspect versus what you thought before, whether it is customers or end markets or what have you?
Hi, Vivek. This is John Wall here. I'll take that question. But certainly 2020 was always going to be a very unusual year. I mean, we have the extra 53rd week for revenue that we're operating in the middle of a pandemic.
You're seeing some China revenue spike in the second half of the year for us. That's and we always tell people not to focus too intently on any one quarter. Personally, the way I look at it is I tend to track the 3 year CAGR. If you look at our CFO commentary, you'll find on Page 2 of the commentary, I put the 3 year CAGR view on there because I find that view particularly helpful myself. But I mean adjusting for the impact of the occasional 53rd week that impacts our numbers.
You'll see there that our 3 year revenue CAGR was showing a consistent level of about 8% revenue growth per year up to about 2018. It ticked up to 9% last year in 2019. And then based on our guidance for the remainder of this year, 2020 now looks like it's going to be a solid 10% 3 year CAGR growth year, albeit with a China tailwind. But even if you assume that $40,000,000 China revenue spike is one time only and back that out of our second half. Our 3 year CAGR is still close to around 9.5%.
So I think our typical contract cycle 2 to 3 years. So if you stand back and take like a 3 year view of things that you'll probably get a more discernible trend in terms of what's happening with each line of business. But it's difficult to look at any 1 quarter and extrapolate from that.
Right. And I appreciate that, John. I was actually looking just year to date, the non China growth was about 6% and was 9% last year. And what I'm trying to discern is, is there some macro impact there, I. E, if let's say next year, hopefully the global economy picks up, does the non China growth also start to reaccelerate that?
That's what I was trying to get a better sense for.
Yes, we're certainly seeing strong design activity in China. But I don't know, Lip Bu, have you anything to add to that?
Yes. I think Vivek, in terms of longer run, I think I'm quite bullish about the semiconductor in system design. Clearly, the opportunity, and I call it the 5 generation waves and they're going to increase the design activity. And then meanwhile, we continue to work with the market shipping customer. I highlight this quarter, we expand and deepen our partnership with the global marquee customer and in the proliferation of our digital flow.
So I think all in all, I think we have to take a longer term yield further than look at quarter to quarter.
Got it, Limbu. And just a follow-up. As you look at next year, outside of
hyperscale, what are the other 2 or 3 end
markets that you're seeing the a and the
hyperscale are the good drive engine. And the hyperscale are the good drive engine for Cadence. And clearly, besides the hyperscale in terms of massive infrastructure tier scaling, and then the other part is some of this industrial automations and also the automotive, some of these we highlight in the ADAS and the system level requirement, I think those are all bright spot. I mean, it's very hard to predict quarter to quarter or next year. But I think in the long run, I'm very excited about the opportunity and we are well positioned for Cadence.
Your next question comes from Joe Bruin from Baird.
Great. Hello, everyone. I'll maybe be guilty of analyzing one particular quarter, but it does look like a pretty meaningful acceleration in growth for systems analysis. And I'm just wondering, it sounds like the new solver products are moving in the right direction, but because of the ratable recognition, maybe not contributing as much to that number. So are we really just seeing kind of the broader secular trend in terms of companies spending more on their PCB modeling tools and of course that benefits Allegro.
And as the other products start kicking in or as you continue to get momentum on AWR, you're looking at above company rates of growth continuing. Is that the right way to think about recent performance?
Yes. I think we're really excited about this system design and analysis space. And this is one of the if you recall, we have this design excellence as a foundation. And then now we are moving up into this, I call it, the intelligent system. And we are very delighted with integrating with some of our current tools and make it very compelling to our customers in terms of driving some of the system analysis and the performance, EM solver related area and thermal related in the design.
And then meanwhile, we continue to drive some of the organically developed Clarity and Celsius and able to show clearly a differentiating performance. And now we also announced the additional of the Clarity 3 d transient solver that's able to show the performance on the EMI system level simulation. So I think all in all, I think this is a growth engine for us. We're excited by stating.
Okay, great. Thanks, Lip Bu. And then one more question in thinking about kind of the interweaving of tailwinds and headwinds into maybe next year's environment because it sounds like China could see some normalization, dollars 40,000,000 is 200 basis points worth of growth. But one interesting thing that came up is, some of the end markets that are adopters of your IP, things like automotive aerospace, are markets that obviously have had a pretty difficult 2020. So along the lines of an earlier question, just in terms of maybe cyclical recoveries in some of your end market exposure, do you think there is enough there where China perhaps normalizes, you actually get a bit of an improvement in other areas and it essentially is a wash, so we're still looking at kind of the targeted high single digit growth profile?
Yes, John, you want your answer?
Yes, of course. Yes. Joe, so this is John. Generally, you don't get too dramatic a shift in our results given the ratable revenue model that we have and that most of our contracts are time based in over 2 to 3 years. That's why I included the 3 year CAGR view on Page 2 of the CFO commentary because that tends to be
a way how I look
at it. I'm always looking to see can we improve that 3 year CAGR view. But I mean, if I'm looking out to 2021, of course, we're not giving guidance. We'll be in a better position to give guidance for 2021 in the New Year when we have a better visibility into the pipeline. But 2020 has been a great year.
It's been a bit weird, but wonderful. But I'd be more inclined to kind of extrapolate for 2021 off of prior year numbers and look at 3 year CAGRs than try to extrapolate anything off of a 2020 year that's impacted by so many one time things. But that's kind of the way I look at it.
Okay, great. Thank you.
Your next question comes from Jason Celino from KeyBanc.
Hey, guys. Thanks for taking my questions. One clarifying point on that marquee customer you talked about beginning. It's been a full year since we've heard of another marquee customer expanding on the IP side. This expansion today, what does that entail and any other details maybe you could clarify?
Yes, sure. So I think this global marquee customer, we are very excited. This is our wide ranging expansion of our EDA software and hardware portfolio. And they are accelerating proliferation of digital full flow across their design team. So this is something stay tuned.
We are very excited about this partnership and we are delighted. Clearly, our product is really stand out in terms of performance. And then the other part is also clearly demonstrate the trusted relationship we have and also our technology leadership of our key software and hardware solutions for their most advanced challenging design.
Okay. Great.
And Jason, I would just like to add there
that we have many marquee customers and this one is a different marquee customer to the one we talked about last year.
Great. Thank you for the clarification. And then one question on the system analysis customer wins you talked about. You actually mentioned 2 end markets, automotive and aerospace and defense. This is the first time you talked about those verticals for Clarity and Celsium.
Is that is this the case? And then are these more of a new net new customers to cables or are they kind of cross sell
wins? Yes. I think we mentioned 2 customers, Teradyne and Rockley Photonics, using our Coogee EM simulator. And we also mentioned about clearly 5 gs, automotive and aerospace, we have traction in the income of 15 new customer. As you recall, these are the new organically developed products.
So we don't have new this product in the past. So this is exciting for us. And we are this is just the beginning. And so stay tuned, we will have more.
Your next question comes from Jackson Heder from PAP Morgan.
Just following up on the marquee customer win that you talked about. And, Lipra, I mean, in your prepared remarks, you went through a number of different digital full flow wins in customers and expansion. And I guess I'm just curious, what should we maybe be expecting from that digital design segment? Because even, John, if I look at your 3 year CAGR on that on the digital segment, it's slowed down this year relative to 2019. So just seeing whether we should be expecting some acceleration as we head into 2021 given all the strength you've seen in digital full flow?
Yes. So I think let me kick start and then John can fill in. So we're delighted. We have 9 full flow wins and also this marquee global marquee customer proliferation. And the other part in our earlier part this year, we're talking about the innovative eye special that provides unified placement and physical optimization engine that able to show the 20% improvement PPA and 3x faster throughput.
Those are good. And then meanwhile, we are very laser focused on the market shaping customer, working with them in the different design group and then also different tools that right now we are pushing more of the full flow and we are very excited the progress we've made and taking.
Yes. And Jackson, the again, we wouldn't focus too heavily on any 1 quarter. Q2 and Q3 for digital were particularly impacted by the customer credit situation that we had. Now that's slightly improved during where we had about $70,000,000 of bookings at the end of Q2 that we took out of our backlog because we didn't expect to get paid. Updating that €70,000,000 about €30,000,000 of that is gone of the other €40,000,000 that's left.
But we expect to recover about $12,000,000 and we still think there's about $28,000,000 that we won't recover. So that's improved the situation slightly in Q3, but I'm expecting a strong Q4 and you can see that in the guidance, not just from the extra week as well. And if you look at the entire year, we're expecting all of our product categories to grow high single digits or double digits.
Okay, great. And how about just a
follow-up, checking in on the cloud, on cloud adoption, any kind of either usage metrics that you guys track or maybe a revenue cloud
order so far in Q3. And we've good momentum with 1 cloud order so far in Q3. And we've good momentum with 150 customers that have adopted our cloud solutions now.
Okay, awesome. Thank you.
Your next question comes from Tom Diffely from D. A. Davidson.
Yes. Good afternoon and thanks for the question. So, Whitbo, just want to jump back to the processor question earlier. Just the fact that we're seeing the industry move just from Intel based to all these other players, AMD, the graphics chips, ARM based, that has to be good news for you. The more designs you have at the leading edge, the better,
I would assume. Is that correct? Yes, that's correct. And clearly, the general purpose GPU and GPU will be continued to do well and you can reflect that in NVIDIA performance. But I think the workload has changed a lot into not just the compute, there's a lot of application domain specific and then optimization.
So you'll see a different class of processor in the AI machine learning, in the training, inference. And so there's a lot of new suite of development either from start up or the established company. And also the hyperscale guys also really drive some of the process optimize for their specific application and solution and the service that they try to drive. So those are great news for us. That means that we have more design activity and not only for our tool and also our hardware emulation because some of them are really complex design.
And then also some of the system analysis because of the system level know how, we highlight in my remarks, some of the hyperscale guys, also type of dry wafer level packaging challenges. So I think we are excited about all this opportunity.
Okay. And I also wanted to get your view on just consolidation in general and what that means to EDA. And over the last 5 years, there's been several high profile of customers of yours that have consolidated and it seems like it had very minimal impact on EDA and your ratable business with them. I'm curious, that the way you think it is going forward as well where you don't worry too much about consolidation among your customer base?
Yes. I think consolidation always, I pay attention to it and we try to be proactive engagement for the acquire or the being acquired company and we make sure that we are creating a win win to continue business. And clearly, on all this consolidation, R and D is the last place they want to cut. So they're going to continue to drive innovation, continue to drive efficiency, and that's why we want to be a partner for them. And so far, we managed well through consolidation in our customer base that have taken place.
And then each consolidation has their own unique way in terms of respect to vendors, But we are very respecting of what they try to do, and we try to be a great partner, work out a win win, and then we very proactive with them.
Okay. And as a final follow-up here, John, when you talked about the extra week, and it sounds like it was $43,000,000 or $45,000,000 of revenue, Did I understand you correctly that the actual cost impact is more than that?
No, it's not more, but it is a headwind for margins though. But the extra week is about $45,000,000 to revenue and about $33,000,000 to non GAAP expense. But so if you back those out, you'll find that the margin for 52 weeks is higher. But we're kind of running at a 33% to 34% kind of baseline for margin closer to the high end of that range because the pandemic is helping margins at the moment. But and then for Q3, we're 2% higher than that 34% because of the benefit of that spike in revenue in China that we've seen.
We expect that to continue into the middle of Q4. So at about 1% to that, you get to 35% for Q4 for a normal 13 week quarter Q4. But when you add the 14 week, if you add in the 45,000,000 revenue and the 33,000,000 of expense, you'll find that the margin impact backs it back down to a midpoint of 34.5.
Your next question is from Jay Flayshauer from Griffin Securities.
Lip Bu, let me start with you in terms of a question about the long term implications of intelligent system design and computational software strategy. And then for you, John, a shorter term question about hardware. So Lip Bu, we heard a good deal over the summer and again last week at the Cadence Live events about your computational software strategy in terms of system design. You've spoken of it, Anurud has spoken about it, of course. And the question is 3 fold, which is what are the implications in terms of your
R and D, specifically the organization or methodology of
your R and D as you orient Cadence towards this new strategy or opportunity. Similarly, in terms of sales and pricing that might be for you too, John. And then last and certainly not least, the role and competencies that you look for in applications engineers, which I believe are your 2nd largest part of headcount after engineering visavis the new strategy.
Jay, thank you so much for the good questions. So a couple of things. So clearly, our core competence is computation software and then the intelligent system design is something that we believe is the right thing for us, it's adjacent to us and also customer needs that. So besides just providing the EDA, silicon development and now they were looking at the whole system analysis in terms of the thermal envelope. And then as you correctly point out, clearly, the application, the domain specific optimization are required.
And so those are things that fit into our computation software really well, and we'd like to gradually expand into that area that is adjacent to us. So in terms of your first question in terms of R and D methodology, Clearly, we are very laser focused on the initially focused on the tool that are really important to our customers and like the Celsius and Clarity, and we clearly have the advantage to able to show multiple time improvement. Those are important to the customer. And we validate that. We repeat orders.
That mean they're driven. They like to buy more and then proliferating more. And so we're going to double down on that, and we're delighted with the additional of the 3 d Clarity transient solver that showed again tremendous improvement to our customer, and they are delighted on that. In terms of the pricing, I think John can talk to you more. We are very disciplined.
We want to make sure that we provide the best solution to the customer. We want to price it correctly and then to serve the terms of talent, we are very laser focused on some of the talent that Anar Arun, myself and the team are looking for the best talent in that space, clearly from the R and D and then also the FAE that's able to effectively serve the customer. Those are our priorities. And then John, back to you.
Yes. I think Lip Bu, you covered most of it there. Was there something that you were asking, Jay, that Lip Bu hasn't already covered?
No, no, that's fine. So turning to you John, the shorter term question, you noted record hardware for the quarter and that's certainly substantiated by the increase in hardware cost of revenues that you show in the 10 Q. Interestingly though, your inventories increased from the Q2, in which I assume are most if not entirely hardware. So in spite of the revenue upside in hardware, did you sustain an inventory build anticipating perhaps Q4, Q1 2021 ship scheduling by 1 or both of the marquee customers?
Yes, Jay, I mean we continue to maintain our inventory levels due to ongoing strong demand for the hardware products. We don't want to be caught short of inventory with the demand that's out there. The Palladium Z1 emulator is doing so well and so is the Proteum X1 platform, that prototyping platform. So we're continuing to build inventory.
Okay. And then lastly, if I may, the physical verification and yield optimization category has been doing very well for a number of years now. Obviously, Mentor is the market leader there and their numbers have been quite strong. But could you update us on going on with Pegasus? Anurud was quite definitive about that opportunity a year ago with DACC when you talked about the respective changes in physical verification over the next number of years.
So what's actually happening for you there?
Yes. So I think let me try to answer that. We are very excited about the Pegasus solution. It took quite a few years for us to develop and the engine is really good. And then first of all, we want to make sure that the advanced node in the foundry partners are certified because this is right into their manufacturing side.
So make sure that the foundry partners certify this is a tool they will support. We are very delighted. The key foundry partners are certified in the whole range of certification on the different process node in the most advanced process node. And then now we're also starting to have multiple customers starting to embrace it and then starting to use it. And then stay tuned.
I think 2021 will be a very important year for us with all the certification in place for the most advanced node. And then now customer can confidently using that for their production design. So I think stay tuned. Your
next question comes from Pradeep Raman from UBS.
Hi. Thanks for taking my question. I had a couple. First, just in terms of your memory exposure, how I guess, in terms of your share, do you feel like you have more share in memory versus logic? Or are they sort of comparable?
And the reason
I ask is there's a lot of M and A speculation going on. And this is not specific to an M and A question, but in general, I'm trying to understand your exposure to memory. Yes.
I think, Anat, let me try to answer your question. So I think memory is more and more important in this whole data analytics, and you want to be close to the memory and the storage. So this is one of the big area for the hyperscale, hyper scalers and also the whole infrastructure play. So memory is very essential. And so fairly from NANDs to HBM to some of the new memory development.
And so clearly, we have a very strong foothold, and then we work with multiple of the memory customer. I think in the past, we highlight some of the memory success we have and not only on the tool and the solution and also in the IP, some of the DDR, the PCIe memory controller and PHY, and we are well positioned some of the key IP we have. So I think stay tuned. I mean, this is area we have good position. We're going to continue to expand on
it. Okay. And my follow-up is a little bit more on system analysis. But I guess with the AWR and Integrand acquisition, 1, how does your prior 700,000,000 TAM sort of inflect? How much higher does it inflect?
And 2, where are we with respect to the share gain on the organic side? Are you close to like 5% share already? Or how should we think about share in this space as well?
Yes. So I think, first of all, I think it's as you've already pointed out, for the currency and Celsius market we are addressing, the TAM market is about $700,000,000 And we are just at the beginning. And some of the big incumbents, I think clearly, 1st of all, we have to demonstrate the performance is better, make sure that the customer really validate it. One of the key excitement for me is repeat orders. And when the customer using them and they're starting to come back and buy more, that is a very clear validation of performance is good.
They like it. And then now the customer is starting to suggest all of the tools that they require to have, and we're working closely with them. And that's why we have the 3 d transient solver come out. And then, Satya, we have more exciting things we are working on internally developing. And then John and I, we always have a very discipline in terms of investing the R and D when we see the customer interested and then give us feedback what they want, and then we can really look at ourselves.
We can really developing that, have a clear differentiating opportunity. And then plus the 2 acquisitions we make in the AWR and then Integrin, clearly in the whole 5 gs and millimeter wave area. And the system level, they're starting to like automotive, starting to see that this is a really good value they want to have, and we are delighted to have continued to exceed our internal expectation. That is very encouraging for me.
Okay. And a quick follow-up. I guess I just want to clarify this. So you said there were 15 greater than 15 customers for Clarity and Celsius this quarter and that's independent from 15 customers for AWR
and Integrand or are they
the same or I just want to understand that?
Yes. I think we mentioned about 15 new customers. Clearly, something that we are very proud of and clearly this opportunity. And we add on this end market that we go after, And this is all together and on this whole system analysis.
Your next question comes from Rich Valera from Needham.
Thank you. Wanted to ask a question on your in your prepared remarks, John, you mentioned that system design and analysis was one of the drivers of your increased full year guide. And I was wondering if you could say, was it the new system, the new organic system simulation tools or the AWR Integrand acquisition that was driving that?
It's the combination of both. And the commentary really stems from the fact that we expect that to be our fastest growing segment for the year
now. Got it. That's helpful. And then you mentioned that you were actually behind plan in terms of hiring in Q3, but yet look at you added about 300 heads, which is the most you've added in a while. So just wanted to try to understand that dichotomy there.
Yes. We're continuing to invest in R and D and a lot of that investment is in headcount. The reason I called out slower than expected hiring was that that was part of the reason why we had such a strong operating margin in Q3 in comparison to what we guided. We're just slightly slower on hiring. That was a part of the contribution to lower expenses in the quarter than we expected.
Got it. Makes sense.
Okay. Thanks very much.
Your next question comes from Josh Matilton from Berenberg.
Hi, guys. Thanks for taking my questions. I just wanted to follow-up on the Systems and Design and Analysis segment and maybe from a different perspective. Given that Clarity and Celsius are still in very early innings, when we look 5 years out, should we think about this segment as a percentage of revenue?
Yes. I don't think we disclosed that, but clearly, we're excited about this opportunity. As we mentioned, this is kind of the early ending. And then we have some encouraging from our customer repeat orders. And then over a period of time, we'll build a broader portfolio and so that we have a whole solutions to provide.
So we are just in the beginning. So we are excited about the very nice growth area, and we're going to continue to innovate and continue organically develop and through acquisition to build out this opportunity. I think this system design and analysis, something that part of our intelligent system design strategies.
That was helpful. And then I kind of
just wanted to follow-up.
In terms of the Clarity and CELSIUS wins to date, are you seeing them being more competitive replacements or are your customers allocating incremental budget to supplement their existing simulation capabilities?
Yes, I think this is a new business for us, and we're always excited to see that all this new opportunity and design wins is new to us and for this category of products. And I think more important, we are excited about the repeat orders from the customer. John, do you want to add
on? Yes, I agree with you Lip Bu. I mean, given it's such a new business for us, it's hard for us to tell in terms of what budget is coming out from customer space. I suspect it's additional budget, but it's very, very difficult to tell and it's difficult for us to speculate on that.
Thanks, guys.
Our final question comes from Krish Sankar from Cowen.
Yes. Hi. Thanks for taking my question. I had 2 of them. First one, Mitbu.
I think there were some questions on consolidation. And clearly, your customer consolidation has not really impacted you or even synopsis for that matter. How much of that is the fact that your customers as they consolidated did not cut EDA budgets or even raise the EDA budgets versus as your customers consolidated, even the suppliers consolidated between you, Synopsys and Mentor, that kind of was the tailwind that you had?
Yes, it's a good question. We're monitoring very closely, as I mentioned, on the consolidation. And you're correct, we manage well on all this consolidation. But one thing is, clearly, I mentioned R and D is the last place in the past. And then usually, like I mentioned earlier, it's 5 generation of waves.
And there's so much design activity, we don't see any slowdown. And then some of the talents, when they consolidate, they become somewhere else and then they showed up. And so R and D is clearly the Double E Computer Science is very badly needed in term of university. We'd love to see more because a lot of design activity, and we don't see any slowdown at all.
Got it. That's very helpful. And then as a follow-up,
I don't know if you can answer to either Lip Bu or John. Can you disclose if you've gotten any letter from the government requiring a license to ship to any Chinese customer?
Yes. John, you want to answer? I don't think go ahead.
Yes. So Krish, we're doing everything we can to support our customers, but we're not disclosing any specific communications with government.
And I will turn the call back over 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 auto addressable market. I very delighted to share that Cadence has been recognized by Fortune and the Great Place TO Work Institute as one of the world's best workplace for 5th time. This recognition is a result of our global employees' commitment and dedication to innovation, to delighting our customers and to taking care of our communities and each other. And lastly, on behalf of all our employees and our Board of Directors, we give our heartfelt thanks to those, all of them on the front lines, who continue to work tirelessly to fight this pandemic.
Thank you all for joining us this afternoon.
Thank you for participating in today's Cadence 3rd quarter 2020 earnings conference call. This concludes today's call. You may now