Good afternoon. My name is Cheryl, and I will be your call conference operator today. At this time, I would like to welcome everyone to the Cadence first quarter 2019 earnings conference call. Call lines have been put on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. If you would like to ask a question during this time, please press star and 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, Cheryl. I would like to welcome everyone to our first quarter 2019 earnings conference call. I am joined by Lip-Bu Tan, CEO, and John Wall, Senior VP and CFO. A webcast of this call is available through our website, cadence.com, and will be archived through June 14th, 2019. A copy of today's prepared remarks will also be made available on our website at the conclusion of today's call. Please note that today's discussion will contain forward-looking statements and that actual results may differ materially from those expectations. For 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 cautionary comments regarding forward-looking statements in the earnings press release issued today.
By the way, we just filed our first quarter Q a few minutes ago, so it's now available. 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, 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, competent GAAP financial results. The reconciliations are available at the investor relations section of cadence.com. Copies of today's press release dated April 22nd, 2019, for the quarter ended March 30th, 2019, related financial tables, and the CFO commentary are also available on our website. I now turn the call over to Lip-Bu.
Good afternoon, everyone, and thank you for joining us today. Cadence achieved excellent operating results for the first quarter of 2019, delivering 11% year-over-year revenue growth and 32% non-GAAP operating margin, with broad-based strength across our product lines. As a result, we are increasing our outlook for the year. John will provide more details shortly. While there's some uncertainty in the overall macro environment, we are confident about the multiple trends that are continuing to drive strong design activity. In addition to technology trends like AI and 5G, design activity is being fueled by workloads from supercomputing, system companies building custom silicon, new silicon products, and digital transformation of industries such as automotive, aerospace, medical, and other industry industrial applications. Our business is mission-critical to silicon development, which is cornerstone of all design activity.
As we have stated, our system design enablement or SDE strategy drives growth in our core EDA and IP business. This, our switch in system companies and targeted verticals, and guides our expansion into newer adjacent areas. We executed well on this strategy, and today I want to highlight its next phase, which is called intelligent system design. The foundation of this strategy continues to be delivering design excellence via our core EDA and IP business. In addition, we are building upon our core competency in computational software to expand into two new areas: system innovation, where we are expanding into new system domains, and pervasive intelligence, where we will apply AI and our algorithm know-how to our core business and specific verticals.
Our intelligent system design strategy will enable us to provide more capabilities and value to our customers, while also expanding our current total addressable market from about $10 billion to estimated $50 billion over the next 10 years. To highlight some of our recent activities in the system innovation space, in Q1, we announced a strategic partnership with Green Hills Software, which opens new opportunities in the estimated more than $2 billion embedded system safety and security space. Earlier this month, we entered the system analytics market, an estimated $4.5 trillion total addressable market opportunity by introducing our first product, Clarity 3D Solver, a next-generation solution for electromagnetic field simulations. Clarity is a true 3D solver, which delivers up to 10X faster simulation performance while virtually unlimited capacity without compromising accuracy.
Clarity uses state-of-the-art distributed processing technology, making it uniquely optimized for the cloud and on-premise distributed computing, and has been endorsed by Teradyne and HiSilicon. Turning to our core business, our digital and firmware business achieved 12% year-over-year revenue growth, driven by strong adoption by new customers and proliferation by existing customers at advanced nodes. To date, more than 100 seven-nanometer designs have taped out using our typical solutions, and multiple five-nanometer designs are underway using our solution as well. Our hardware-assisted verification products, an important part of our verification suite, had another good quarter. Palladium Z1, our flagship emulation platform, added two new customers that are doing machine learning designs, including SambaNova Systems. We also had 13 repeat orders, including three significant expansions, one of which was at Annapurna Labs and Amazon Web Services.
Our Protium S1 prototyping platform, which enables earlier software development, also added two new customers and received seven repeat orders. Palladium Cloud continues its steady momentum and now has more than 10 customers, several of which have made repeat orders. Our IP business also showed double-digit growth year-over-year. Tensilica continues to win designs for machine learning, vision, and audio applications in the automotive, consumer, and surveillance segments, adding six new customers in the quarter. In the design IP space, our new 112 gig long-reach SerDes IP was adopted by a marquee semiconductor company, and we launched an industry-first complete silicon-proven LPDDR5 PHY solution. As I have said earlier, we have significantly broadened our reach to system companies and targeted verticals.
One of our most successful targeted verticals is aerospace and defense, where we recently announced that we are working with Northrop Grumman, where our EDA IP solutions have supported a shortened product development cycle and advanced node tape-outs. Lastly, I want to highlight the new Cadence CloudBurst platform, the latest addition to our cloud portfolio, which extends our cloud leadership in EDA and provides customers with very compelling productivity, flexibility, and scalability benefits. CloudBurst enables hybrid cloud environments and is ideal for serving peak demand. It provides fast and easy access to pre-installed Cadence design tools in either AWS or Azure cloud environments. It was used by Dell Networks to achieve a 10x productivity improvement running Cadence Tempus timing sign-off solution on their seven-nanometer networking chips. With that, I want to turn over the call over to John to review the financial results and provide our outlook.
Thanks, Lip-Bu. Good afternoon, everyone. Cadence achieved broad-based growth across all lines of business during Q1, with demand for hardware and IP exceeding our original expectations. Revenue, operating margin, and cash from operations were all strong in Q1. As hardware and IP have become a larger part of our overall business, our recurring revenue mix percentage is now in the high eighties. Now let's go through the key results for the first quarter, starting with the P&L. Total revenue was $577 million. Non-GAAP operating margin was 32%, GAAP EPS was $0.43, and non-GAAP EPS was $0.54. Turning to the balance sheet and cash flow. At quarter end, cash totaled $539 million. Our principal value of debt outstanding was $400 million. Operating cash flow for Q1 was $185 million. DSO was 42 days. During Q1, we repurchased $81 million of Cadence shares.
Now I will provide our updated guidance. For Q2, we expect the following results. Revenue in the range of $575 million-$585 million. Non-GAAP operating margin in the range of 31%-32%. GAAP EPS in the range of $0.34-$0.36 and non-GAAP EPS in the range of $0.52-$0.54. Our updated guidance for fiscal 2019 is as follows. Revenue in the range of $2.305 billion-$2.335 billion. Non-GAAP operating margin of approximately 31%. GAAP EPS in the range of $1.39-$1.47. Non-GAAP EPS in the range of $2.04-$2.12. Operating cash flow in the range of $665 million-$705 million. For the year, we expect to use approximately 50% of free cash flow to repurchase Cadence stock. You will find guidance for additional items as well as further analysis in the CFO commentary available on our website.
In summary, I'm pleased with our performance in Q1. We achieved strong operating results highlighted by 11% year-over-year revenue growth, 32% operating margin on a non-GAAP basis, and the generation of $185 million of operating cash in the quarter. Looking at our revised outlook for the year, I'm pleased to see improvements in operating income consistently flowing through to cash, as illustrated by the increase in our operating cash flow guidance for the year. We'd like to thank our customers, partners, and of course, our employees for a solid start to 2019, and we look forward to updating you on our progress throughout the year. With that operator, I will now take questions.
At this time, I would like to remind everyone, in order to ask a question, please press star, then the number one on your telephone keypad now. We'll pause for a moment to compile the Q&A roster. Your first question comes from Rich Valera at Guggenheim Securities.
Interesting comment on your foray into the system analysis market. Obviously you started there with an electromagnetic-based solver. There are obviously many solvers that you could potentially roll out and have a complete portfolio for that market. Just wondering how aggressively you plan to go after that market. Will you go after the mechanical static side of it as well as sort of the more electronic-centric solvers? Just any sort of sense of your real aspirations in the market. Thanks.
Yeah, Rich, Lip-Bu here. We didn't hear the first portion of your question, I guess it's about the 3D solver that we announced. We're delighted. This first product, Clarity, is a truly 3D solver and is a next-generation solution that is electromagnetic field simulations. This is our first entry to the system analysis. Clearly, we have our other products now in the working on development. We are excited because a couple of things. One, clearly we look at our core competence, the core competency that we have in the computational software and also our EDA background form and also our 3D, some of our packaging technology that we have. That combination can give us a very unique opportunity to really drive a next-generation disruptive. That's why we can claim up to 10 times the performance.
This is very cloud-enabled and then so that we can really provide a truly next-generation, uniquely optimized for cloud and on-premise PC system computing. We have something unique to offer. Second, we're going to have more products coming out as this is our first entry to the system analysis market.
If I could just circle back to your last earnings call, you referenced a major win with a marquee semiconductor customer and mentioned that you were pretty aggressively ramping up your AE hiring to support this customer. Given that you've kind of given us some insight down the expense side for that customer, is there anything you're willing to say about your revenue expectations at when you might expect to generate incremental revenue from this customer, whether it be this year, next year? Any color at all you can give on that? Thank you.
I think we're excited about this marquee U.S. semiconductor company, as I mentioned in the last earnings call. It's breakthrough and wow, engine win. We are very excited. It's the early days of partnering with this customer to expand rest of our engagement. It's across all our different tools.
We are excited about it. Clearly, everything we know is already built into our guidance for that year. Overall, clearly, to support a very important customer, we have to gear our AE and R&D, of course, to really proliferate across their requirements.
Understood. Okay. Thank you.
Thank you.
The next question comes from John Pitzer of Credit Suisse.
Yeah, guys. Thanks for letting me ask a question. Maybe first to you, in your prepared comments, you did talk about some pockets of uncertainty out there in the environment, which makes sense given what some of your traditional end customers have been up. I'm just kind of curious, to the extent that you guys continue to do better than expected and beat and raise, what do you think it is about your business that's allowing you to buck these trends? Is this just your ability to address non-traditional customers? Is it the new large win that's offsetting this? Maybe can you help us give a sense as to why you seem to be bucking some of the uncertainty trends out there?
Yeah. John, it's a very good question. Let me just talk about this uncertainty. I think we all know from the marketplace, geopolitical, and also some of the slowdowns in some segments of the industry, like automotive and others. I'm very excited on a couple of our drivers, and especially AI and in 5G and autonomous driving and then also the industrial edge. That is something that I'm very passionate about. Because as we are moving into, I call it the big data environment, it's all about data and data analytics. In a way, it's driving a lot of new requirements for the semiconductor. One I mentioned about the workload specific, or we call it domain-specific process computing. They're not proper CPU, GPU, that's a good place for them. Right now, the workloads have changed. Because it's a workload specific, more application related.
That's also driving faster computing and also clearly, a lot of more writing about the memory. There's some new innovation of memory. There's a new innovation of storage and some of you see the NVMe controller into a disaggregation of the storage because the massive data that need to be disaggregate the storage and networks. Also the other part is high-speed connectivity that is able to scale and the connectivity speeds that are required in the hyperscale. All this is driving a very strong design activity, and we are in the middle of it, we are well-positioned to capture that. That is why I think from our point of view, the design activity is increased substantially. We are excited about supporting some of our customers to really impact on some of these opportunities.
That's helpful. Then, John, just to give you the follow-up on the op margin guidance, both for the fiscal second quarter and the full fiscal year. It's a slight downtick from what you just put up in the fiscal first quarter. Is that nothing more than the expense of onboarding the new large North American customer? Can you talk about some of the other risks you take that might have op margins going down throughout the fiscal year, and what's going to be driving them?
Sure, John. Good question. I think looking at the year, our annual merit increase is going to effect in July. That impacts the second half of the year. Of course, over the course of the year, we're investing in R&D and field resources to support acceleration solutions with market-shaping customers. I say customers plural, it's not all for one customer.
Perfect. Thanks, guys. Appreciate it.
Thank you.
The next question comes from Nick Theos of RBC Capital Markets.
Hey, guys. Thanks for taking my question. The first one is on the operating margin long-term target. I know you guys historically target 30%, but you guys are above that for three quarters in a row. I'm wondering if you guys can maybe provide some sort of high-level commentary on where you think that could go in three to five years. Secondly, I noticed in your prepared commentary, you guys are now breaking out China as a separate geography. It seems like the numbers there have a lot more volatility, meaning that it used to be 10% to 8% of revenue, and then 13%, in December, now it's back down to 10%. Maybe you could talk about a little bit why you guys are disclosing China now as a separate geography.
Hi, Nick. I'll take the second part of that question first, if you don't mind. In terms of calling out China separately, yes, you'll see that in our revenue by geography table in the CFO commentary and in our 10-Q. Generally, any lumpiness in the percentage of revenue was probably caused by our IP and hardware businesses. Our IP and hardware revenue is generally more lumpy than the rest of our business. Again, in relation to your first question, we're not really ready to have a long-term target right now. We're always looking at how to improve operating performance.
You mentioned, over the next few years, while we're not giving guidance over the next few years, if you take a look over a longer time period and compare our current guidance for 2019 with, say, 2016 results, you'll get a perspective on how we've been able to scale the business in Asia initially.
Just to add to what John is talking about on the China side. If you look at the historical 2016, about 8%, then 2017, about 9%, then last year it was under 10%, and this year is 10%. Overall, we have done well in China. Clearly, China is very committed to build the domestic semiconductor industry, and they're making great progress. We are well-positioned to support not just China, globally, in Asia and other places, we want to be the trusted partner for them.
Operator?
The next question comes from the line of Jay Gesheider of Griffin Securities.
Thank you. Good evening. Let me do a technology question first for you regarding what you call now your intelligent system design strategy. The question is, over the last number of years, perhaps the most important thing you've done, particularly in digital, is to pursue your parallel architecture with a common data model. Of course, if you follow, that's obviously helped you on the digital tool side. The question is, with respect to the new intelligent system design target, how extensible or leverageable is that platform or architecture from that number of years for that new strategy? Or is there some additional rework or new technology you have to insert in order to pursue that? In any case, in the meantime, what additional opportunity do you have to further integrate the tools? For example, is there some work you're doing to better integrate Innovus with Genus?
Is that something you could comment on as well?
That's a good question, Jay. Let me try to answer your question. I think that the intelligent system design is broken down into two pieces. One is the design excellence, and that is our core EDA and IP. We are very laser-focused on making sure that our foundation is solid. We are the best of tool in every category, and that's what we aspire to do. That, we are delighted on the digital and the sign-off sector, which grew in the last quarter 12%. Clearly, we are continuing to succeed in the new customers. Right now in their proliferation on some of our certain customers are in the most advanced node, in the seven, the five, we are moving on three nanometer. I think we are excited about continuing to drive that. We move on to the system innovation.
That is moving to the system domains. As I mentioned earlier, we're reusing our, even through our co-searching, we found that our core competency and the computational software and the digital implementation that we have, it can be scaled into the system level. That's why we are excited starting to embark from that into this, I call it the first mover, is basically is the embedded in the system safety and security space we can fill. We are very delighted in that strategic partnership with that we're starting to move into that space. That's about $3 trillion market that we're excited about. The next thing that we're looking at is the whole, we call it the system analysis space, that's about $4.5 billion.
It's about time to have some innovation solutions that we can provide that provide a cloud enable and is scalable, using our strength to apply, because if you recall, we also have the PCB business and also the 3D technology, that we can really apply that into this 3D Solver. That is just the beginning on the EM, electromagnetic field simulation area. Continue, we have continued the development and investing in this space, and it's a big market, $4.5 billion, Customer loves it. So far, the initial feedback from our potential customers, we highlight two that have endorsed our approach, they see the benefit of the performance, we're excited about it. Finally, we're going to use that to pervasive intelligence between the AI and machine learning.
Basically, we're going to apply into we call it the inside and outside. Inside, basically using AI machine learning to drive performance improvement, productivity, and performance improvement across all our product lines in terms of EDA tools. We already see significant improvement on that. Finally, we're also working with our leading customers that are now using AI to optimize their flow and methodology so that the customer can really drive the performance on machine learning, deep learning, and other applications, and that's kind of our approach.
Lastly, geographically, there's interesting trends in Japan, which for years, as you know, was quite weak and lost share in terms of total EDA. You're now seeing a few quarters in a row of sequential improvements in Japan and year-over-year improvements in Japan, both quarterly and trailing 12 quarters. The question therefore is, are you beginning to redirect or grow your investments in Japan to sustain that growth, either with sales or AE or anything else?
Good question. I think Japan is an important market for us. In a couple of areas, Japan is very strong and I'll just name a few. Automotive, which is very, very strong. Also, I mentioned earlier the edge to industrial IoT, the microcontroller, and there's a lot of controllers collecting data. Also a key player in Japan that we are very excited to team up with them. Now also the whole video surveillance, consumer-related area, and that AI machine learning can really play a role in it. So I think it's a very important market, and then they are recovering very nicely. Right now, we're engaging with a couple of key customers that we want to be that partner going forward.
Thank you.
Thank you.
Your next question comes from Sterling Auty of J.P. Morgan.
Hey, guys. This is Jackson Ader on for Sterling tonight. A couple of questions from our side. The first would be, from looking at the outperformance here in the quarter, it seems like it's coming from the two areas you called out, or IP and hardware, which are typically the two more volatile areas for revenue. What is giving you the confidence then to raise the full-year guide above just this quarter alone? Is there something in premise licenses that came in ahead of what you thought, or is the pipeline building better than what you thought?
Yeah. I think, Jackson, let me start first. Then John will fill in. First of all, I kind of highlight that it's a very broad-based strength across our product lines. Even though we highlight the hardware, we highlight the IP, we highlight the physical growth 12%. The other part is also very exciting for us is the custom analog system connect area, and also it's a nice growth, about 8%. We are excited about that's why we're investing in this whole system analysis, which is part of this analog custom interconnect system level. That area has been doing well. I think overall, I'd like to say that it's across the board, and then also some of the newly developed products, and that we already built into our guidance for the year.
Hi, Jackson, this is John. Yes, we had a very pleasing Q1 performance for IP. Of course, IP is lumpy and probably benefits against the better compared in Q1 2018. On the hardware side, if you recall our functional verification revenue grew in the high teens in 2018. The last time we spoke here, we were expecting functional verification revenue in 2019 to be approximately flat year-over-year. With Q1 now behind us and with better visibility into the hardware pipeline, we're now expecting modest growth in our functional verification segment. It's always a difficult compare. We saw a pickup in demand in Q1 for our hardware products. We expect that to continue into Q2.
Okay, great. That's helpful. Follow-up question is kind of two-parter. The first being, you've mentioned the $40 billion TAM over the next few years, right? The expansion from the $10 billion that you've seen kind of in the past. What would you say you currently, I guess, address of the incremental 20? Secondly, obviously, part of this is going to be the Clarity 3D Solver that was announced a couple of weeks ago. What do you see as the main, or who, I guess, do you see as the main competitor for this Clarity 3D Solver? Thank you.
Yeah. Good question. We're excited about this kind of tension as one of the very important focus for Cadence. That's why we have this opportunity on the, as we call it, the intelligent system design. First of all, I think clearly our foundation continues to grow in term of design excellence. All our EDA tools continue to drive the growth with the semiconductor company and also system company to drive differentiation. The second part we're starting to address is that system innovation. Clearly the opportunity in front of us is this whole embedded system safety and security. Our partnership with Arm here is a very important part of our strategy. Now we're starting to move into the system analysis space. In the embedded space, about $3 billion.
Market analysis is about, clearly is a system analysis, about $4.5 billion. I think overall, we continue to marching forward staging. We're going to be, over time, we're going to be highlighting to you some of the success we have. Clearly on the competition side, on the system analysis, there are a couple of them I think you probably know well known. They have some more legacy solutions. The customer over time require increase on the system complexity and also shift left approach, which means doing more simulation and larger design. That will require solution that need more capacity and also higher performance. That will really play into our strength in term of algorithm expertise and massive distributing multi-processing capability.
I think those are the things that really we find a unique opportunity, a unique qualification we have to play in this market.
All right. Thank you.
Thank you.
To ask a question, please press star one on your telephone keypad. The next question comes from Jason Celino of KeyBanc.
Hey, guys. Thank you for taking my question. Can you hear me all right?
Yes. Go ahead.
Good raise for the full year. First half of 2019 guidance between 10% and 11.7% growth, then decelerate 10% and 6.7% for the second half. I appreciate your comments on the updated hardware outlook. How conservative is the guidance for 2019?
Hi, Jason, this is John. Everything you know is in our guidance. You're right, the first half does look kind of flat compared to the second half. That's mainly because of functional verification, which includes both software and hardware products. That's quite lumpy and our visibility into demand for Q2 next year, Q4 is a very tough comparable.
Okay. As far as IP revenue for the quarter, you guys had posted a strong quarter. How should we think about IP as a whole growth-wise for the full year?
Well, I'm very pleased with our IP results in Q1. For IP, Q1 benefits from a relatively easy compare versus Q1 2018. We're not guiding individual product groups, but we're very pleased with our IP results for the first quarter.
Yeah. First of all, Henry, kind of talking about is the Tensilica, the proliferation, adoption for the machine learning, vision, audio, and also automotive consumer variants. We add two new customers. On the design IP side in a [query] that we have the 112 gig long reach [30 IP], this is a must-have for the hyperscale infrastructure. We are just at the beginning of it, and we are delighted. Our key customers at the company adopt it, there are more to come and then stay tuned, and we'll have more updates for you.
Okay, thanks. That answers all my questions.
Great. Thank you.
Your last question comes from Gal Munda at Bernstein.
Hi, guys. Thanks for taking my question. This is for Muneesh. John made me smile by some of his guidance. One thing that definitely changes the recognized revenue is the recognition timing of the original revenue. He's saying that this could be 5%-10%, 5%-90%, which clearly is around 90%. Is the main delta in the hardware products just the way that you've seen Q2 demand kind of turn off? Is that the reason for it?
Yes, Gal. Our revenue comes predominantly from two main sources, IP and the hardware part of our functional verification group. The expectations of better functional verification growth lead directly to that revision of our outlook for the recurring revenues. We're now expecting high 80s for 2019.
Okay. My second question is just linked to your cloud offering. In the past, your customers kind of like to mix and match different parts of the process. When you move to the cloud, especially when you start doing design in the cloud, my question is, can tools still be matched as easily as previously on-premise? If not, does that mean that Cadence tools can be much stickier or do you not expect any changes in the workflows or anything like that in terms of standards?
Cadence Cloud does not change our business model. It just offers our customers another way to optimize their investment in Cadence tools. We're not really expecting any difference in how our customers use our tools.
In some way, we try to drive the performance and productivity for our customers, by moving to the cloud where you can address the peak load, also you can parallelly distribute it to the unlimited server that the cloud infrastructure provides. That is just a tremendous value to our customers.
Perfect. Just as a follow-up on that, would you say that when you're seeing the adoption of this cloud in the future, would you expect different business coming for diverse, possibly, like you mentioned, some existing customers who potentially will invest more in their own infrastructure? Do you think the new customer [decisions companies] given this product will account for a larger portion of that adoption in the future?
It will depend on the customer. They can use a hybrid, using their on-premise, and then when they address the peak load with the cloud, or they want to go fresh as a startup and want to be all cloud, we are also open to that. I think there's a lot of different models, and then we basically want to make it available to our customer for their good use and make sure that it's secure, and then make sure that it can drive performance and productivity for them. That is our main driver for using the cloud. Basically, we are supporting them, and they have the option of the customer manage or using the Cadence managed or the public cloud.
Thank you so much.
Thank you.
Thanks.
We will now turn the call over to Lip-Bu Tan for closing remarks.
Thank you all for joining us this afternoon. In summary, our focus is mission critical to silicon development, which is a cornerstone of all design activity. Through our strategy, we are capitalizing on multiple technology waves and further proliferating our solution with a broader base of customers. Next phase of our strategy, intelligent system design, brings new opportunities in the design excellence, system innovation, and pervasive intelligence, and an expanded total addressable market. In closing, I would like to thank all our shareholders, customers and partners, board of directors, and our hardworking employees for their continued support.
Thank you for participating in today's Cadence first quarter 2019 earnings conference call. This concludes today's call. You may now disconnect.