Good afternoon. My name is Sheryl, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence First Quarter 2019 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, Cheryl, and I would like to welcome everyone to our Q1 2019 earnings conference call. I am joined by LeFoutin, CEO and John Wall, Senior VP and CFO. The webcast of this call is available through our website, cadence.com, and will be archived through June 14, 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 ks and Form 10Q, including the company's future filings and the cautionary comments regarding forward looking statements in the earnings press release issued today. And by the way, we just filed our Q1 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 Hansen 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 comparable GAAP financial results. Reconciliations are available at the Investor Relations section of cadence.com. Copies of today's press release dated April 22, 2019, for the quarter ended March 30, 2019, related financial tables and the CFO commentary are also available on our website. And now I'll turn the call over to Littmann.
Good afternoon, everyone, and thank you for joining us today. Cadence achieved excellent operating results for the Q1 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, and John will provide more details shortly. While there's some uncertainty in the overall macro environment, we are confident about the multi percent that are continuing to drive strong design activity. In addition to technology trends like AI and 5 gs, design activity is being fueled by workloads, System Companies Building Custom Solutions, New Silicon Products and digital transformation of industries such as automotive, aerospace, medical and other industry industrial applications.
Our business is mission critical to finish and development, which is cornerstone of all design activity. As we have stated, our system design enablement or FTE strategy drives growth in our core EDA and IT business, broadened our switch in system companies and targeted verticals and drive our expansion into newer adjacent areas. We executed well on this strategy. And today, I want to highlight this next phase, which is called Intelligent System Design. The foundation of uncertainty continues to be delivering design excellence via our core EDA and IT business.
In addition, we are building upon our core competency in computational software to expand into 2 new areas: system innovation, where we are expanding into new system domains and pervasive intelligence where we will apply AI in our algorithm mobile to our core business and specific verticals. Our intelligent system design strategy will enable us to provide more capabilities and value to our customers We are also expanding our current total addressable market from about $10,000,000,000 to estimated $50,000,000,000 over the next 5 years. To highlight some of this, some of our recent activities in the software innovation space, in Q1, we announced for the partnership with Greenfield Software, which opens new opportunities in the estimated more than $2,000,000,000 embedded systems, safety and security spend. And earlier this month, we entered the system analysis market an estimated $4,500,000,000 total addressable market opportunity by introducing our 1st product, 3rdreeD Solver, a next generation solution for electromagnetic field simulation. Clarity is a true 3 d solver which delivers up to 10x faster simulation performance while virtually unlimited capacity without compromising accuracy.
CerityU's state of 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 input digital and sound loss business achieved 12% year over year revenue growth, driven by strong adoption by new customers and proliferation of our existing customers at constant note. Today, more than 100 7 nanometer designs have kicked out using our typical solutions. And multiple 5 nanometer designs are underway using our solution as well. Our hardware assisted verification products, an important part of our verification suite, had another quarter.
Horizon V1, our flagship simulation platform added 2 new customers that are doing machine learning design, including SambaNova Systems. We also had 13 repeat orders, including 3 significant expansions, one of which was at Anapuna Labs, an Amazon Company. Our Pingtan S1 advertising platform, which enables earlier software development also added 2 new customers and received 7 new orders. Palladium cloud continues its steady momentum and now has more than 10 customers, several of which have made repeat orders. Our IT business also showed double digit growth year over year.
Sensi Data continues to win targets from machine learning, vision and audio applications in the automotive, consumer and surveillance segments adding 8 new customers in the quarter. In the design IT space, our new 112 gig Longreach 30 IP was adopted by a marquee semiconductor company. And we launched an industry first complete silicon proven LP GBP-five CDR5 solutions. As I have said earlier, our strategy broadens our reach in system companies and targeted verticals. One of our most successful verticals is aerospace and defense.
So we recently announced that we are working with Small Rock Summit where our EDA IT solutions have supported a shortened product development cycle and advanced node pickup. Lastly, I want to highlight the new Cadence Cloud First Platform, the latest addition to our cloud portfolio, which extends our cloud leadership in EDA and provides customers with very compliant productivity, flexibility and scalability benefits. CloudBus enables hybrid cloud environments and is ideal for serving peak to month. It provides fast and easy access to pre installed Haven device tools in either AWS or Azure Cloud environment. It was used by DIRCOR Networks to achieve a 10x productivity improvement running cadence, campus, timing, high dock solution on their 7 nanometer level 2 chips.
With that, I want to turn over the call over to John to review the financial results and provide our outlook. Thanks, Zitru. Good afternoon, everyone. JV achieved broad based growth across the online business during Q1 with demand for hardware and IT exceeding our original expectations. Revenue, operating margin and cash from operations were all strong in Q1.
And as hardware and IP has become a larger part of our overall business, our recurring revenue mix percentage is now in the high 80s. Now let's go through the key results for the Q1 starting with the P and L. Total revenue was $577,000,000 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 $539,000,000 Full principal value and cash outstanding was $400,000,000 Operating cash flow for Q1 was $185,000,000 DSO was for 42 days. During Q1, we repurchased $81,000,000 of KB shares.
Now I will provide our updated guidance. For Q2, we expect the following results: revenue in the range of $575,000,000 to $535,000,000 non GAAP operating margin in the range of 31 percent to $0.36 GAAP EPS in the range of $0.34 to $0.36 and non GAAP EPS in the range of $0.52 to $0.54 Our updated guidance for fiscal 2019 is as follows. Revenue in the range of $2,305,000,000 to $2,335,000,000 non GAAP operating margin of approximately 0.31 percent GAAP EPS in the range of $1.39 to $1.47 non GAAP EPS in the range of $2.04 to $2.12 Operating cash flow in the range of $665,000,000 to $705,000,000 and for the year we expect to use approximately 50% of free cash flow to repurchase Hayden 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 $185,000,000 of operating cash in the quarter. And looking at our revised outlook for the year, I'm pleased to see improvements in operating income consistently flowing through 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. And with that operator, we'll now
take questions.
Interesting comments on your foray into the system analysis market. And obviously, you started here with an electromagnetic based solver. There are obviously many solvers that you could potentially roll out there to have a complete portfolio for that market. So 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 solvency, just any sort of sense of your real aspirations in the market?
Yes, Rich, Leku here. And we did not hear the first portion of your question, but I guess it's about the 3 d cover that we announced. And we are delighted. And this first product, 35 is a truly 3 d Prover and is a next generation solution that is for the electromagnetic field simulation. And this is our first entry to the system analysis.
And clearly, we have other projects now in the working on development. We are excited because couple of things. 1, clearly, we look at our core competence, the core competency that we have in the computational software and that's what our EDA background form. And then also our 3 d, some of our packaging technology that we have. That combination can give us a very unique opportunity to really drive in a next generation disruptive.
That's why we can claim that we can't find the performance. And then this is very cloud enabled. And then so that we can really provide a truly next generation, uniquely optimized for cloud and autonomous distribution they're proceeding and so that they have something unique to offer. And then stay tuned and we're going to have more product coming up. This is our 1st entry to the system analysis market.
Great. Thank you for that. And if I could just circle back to your last earnings call, where you referenced a major one of the marquee centers that you talked to customer and mentioned that you were pretty aggressively ramping up your AE hire and support this customer. So given that you've kind of given us some takedown on the expense side for that customer, is there anything you're willing to say about your revenue expectations that maybe 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. Yes. I think we're excited about this marquee U. S. Semiconductor company, as I mentioned in the last earnings call.
It's a great true and wild engine win. And we are very excited. It's the 30 days of partnering with this customer to extend rest of our engagement. It's across all our different tools. And we are excited about it.
And clearly, everything we know is already built into our guidance for the year. But overall, clearly, we support a very important customer that we have to build out our AE and R and D support and to really proliferate across the PMA requirements. Thank you.
Your next question comes from John Pitzer of Credit Suisse.
Yes, guys. Thanks for letting me ask the question. Look, maybe first to you. In your prepared comments, you did talk about some pockets of uncertainty out there in the environment, which made sense given what some of your traditional funding questions have came up. I'm just kind of curious, to the extent that you guys continue to do better than expected in Dayton Ray, what do you think it is about your business that's allowing you to buffer these trends?
Is this just your ability to address nontraditional customers? Is it the new large win that's offsetting this? Maybe can you help us give us a sense as to why you seem to be boosting some of the uncertainty trends out there? Yes, John, it's a very good question. So let me just talk about this uncertainty.
I think we all know from the market rate, geopolitical and also some of the slowdown in some segment of the industry like automotive and others. But we are excited to know on couple of drivers and especially AI and in a high gs and autonomous driving and then also the industrial edge that's something that I'm very passionate about. And because we are moving into, I call it, the big data environment. It's all about data and data analytics. So in a way, it's driving a lot of new requirements for the semiconductor.
So one I mentioned about the workload specific or you call it domains, uncertain process computing, then a proper CTO, GPU that's a good place for them. But right now the workload has changed. So because the workload specific is more application related. And that's also driving more satisfaction and also the there's clearly a lot of more I think about the memory. There are some new innovation on memory.
There's a new innovation of storage. And some of you have heard about the MG, MB controller is a lot of disaggregation of the storage because of less and less data that needs to be disaggregate the storage and network. And also the other part is high speed connectivity that able to scale and the connectivity speed that's required in the hyperscale. So all this kind of driving a very strong design activity, and we are in the middle of it, well positioned to capture that. This is why I think from our point of view, the design activity has increased substantially.
We are excited about supporting some of our customers to really embark on some of these opportunities. That's helpful. And then, John, just probably as a follow-up on the op margin guidance, both for the fiscal Q2 and the full fiscal year. It's a slight downtick that you just put up in the fiscal Q1. Is that nothing more than the expense of onboarding the new large North American customer?
Can you talk about some of the other puts and takes that may have op margins going down throughout the fiscal year on what's going to be rising revenue? Sure, John. Good question. I mean, for the year, looking at here, our annual merit increase is going to affect in July, that impacts the second half of the year. And of course, over the course of the year, core investing in R and D and field resources to support separation of our solutions with market shaping customers.
And I think customer is pure, it's not also one customer.
Your next question comes from Nick Steves of RBC Capital Markets.
So the first one is kind of the operating margin long term targets. I know you guys are historically positive 30%. Do you guys are above that for 3 quarters in a row? And I'm wondering if you guys can maybe provide some sort of high level commentary on where you think that could go in 3 to 5 years? And then secondly, I noticed that you didn't provide commentary.
You guys are now breaking out China as a separate geography. And it seems like the numbers there have a lot more volatility and that it used to be kind of 8% of revenue in mid-thirteen in December now it's back down 10. So maybe you could talk about a little bit why you guys are disclosing China now as a separate kind of geography? Hi, Mitch. 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 and geography table in the CFO commentary and in our 10Q. Generally, any lumpiness in percentage of revenue was probably caused by our IT and hardware businesses. But that will our IT and hardware revenue is generally more lumpy than the rest of our business. And 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.
And you mentioned like over the next few years, so while we're not giving guidance over the next few years, if you think a little over the longer time period and compare our current guidance for 2019, let's say, for our 2016 results, you get a perspective on how we've been able to scale the business in recent years. Just to add to what John is talking about on the China side, if you look at historical 2016 about 8% and then 2017 about 9%. And then last year is under 10% and this year is 10%. Overall, we have done well in China. And clearly, China is very committed to compete in the domestic semiconductor industry and they're making great progress.
And we are well positioned to support other China, I mean globally, in Asia and other places. We want to be the trusted partners again. Operator?
Your next question comes from the line of Jay Peltjour of Crescent Securities.
Thank you. Good evening. Let's do a technology question first for you regarding what you call now your intelligent system design strategy. And the question is, over the last number of years, perhaps the most important thing you've done, particularly digital, is to pursue your parallel architecture with a common data model across the portfolio, and that's obviously helped you on digital tool side. And the question is with respect to the new Intelligent Kitchen Design target, how extensible or leverageable is that platform or architecture for the last 100 years for that new strategy or is there some additional rework or new technology you have to insert into the portfolio to pursue that.
And in any case, in the meantime, what additional opportunity do you have to further integrate the tools? For example, you've got some more it's doing to better integrate the Novus with Genus? Is that something you could comment on as well? Good question, Jay. Let me try to answer your question.
So I think that intelligent system design, it's a count of 2 pieces. 1 is the design excellent, and that is our core EDA and IT. So we are very laser focused, make sure that our vision of talent, we are the best of 2 in every category and that's what we aspire to do. And so that we are delighted on the digital and sign off sector we grew in the last quarter 12%. Clearly, we are continuing to succeed in the new components.
And then right now in the some of the there are there are frustration on some of our children customers are in the most advanced node, in the 7th of 5th, we are moving on 3 nanometer. And so I think we're excited about continuing to drive that. And then we move on to the system innovation, that is moving to the system domains. And as I mentioned earlier, we're really using our and we went to a full 13, we have had our core competency and the computational software and then the digital implementation that we have and it can be scaled into the system level. And that's why we're excited talking to embark on that into this, I call it the 1st mover.
It basically is the embedded system safety and security space with Trinhil. We're very delighted in that strategic partnership with that so that we're starting to move into that space. It's about $3,000,000,000 market that we're excited about. And the last thing that we're looking at is the whole, we call it the system analysis space. And that's about $4,500,000,000 And then it's about time to have some innovation solutions to provide, to provide a cloud enabled and scalable and then using our strength to apply because if you recall, we also have the PCD business and also the 3 d technology so that we can really apply that into this 3 d software.
And that is just the beginning on the EM electromagnetics fuel simulation area. And next in June, we have continued the development and investing in this space And it's a big market, dollars 4,500,000,000 and customer level. And so far, it needs to get back from our potential customer. And highlight too, and I'll endorse our approach and then see the benefits of the performance and we're excited about it. And then finally, we're going to use that pervasive, intelligent, using AI and machine learning.
And then basically, we're going to apply into what's called inside and outside. Now inside basically using AI machine learning to drive performance improvement, productivity and performance improvement across all our product lines in terms of EDA tools. And we already see significant improvement on that. And then 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 have been some interesting trends in Japan, which for years, as you know, was quite weak and lost share in terms of total EGA. But usually you've now seen a few quarters in a row sequential improvements in Japan and year over year including in Japan on both quarterly and trailing 12 cases. 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? Yes. Good question.
I think Japan is important market for us. A couple of areas Japan is very strong. And I have to name a few. Automotive, they are very, very strong. Also, I mentioned earlier, the edge to industrial IoT, the microcontroller, and there's a lot of controller collecting data.
And then the whole key player in Japan that we are very excited to keep up with them. And also the whole video surveillance consumer related area and that AI machine learning can really play a role in it. And so I think it's a very important market and then recovering very nicely. And then we're right now in a way in keeping pace looking a couple of key customers that we want to be the trusted partner going forward. Thank you.
Your next question comes from Sterling Auty of JPMorgan.
This is Jackson Ader on for Sterling tonight. A couple of questions from our side. The first would be looking at the outperformance here in the quarter, it seems like it's coming from the 2 areas you called out or IT and hardware, which are typically the 2 more volatile areas for revenue. So what is giving you the constant sense to raise the full year guide from above just this quarter's decline? Is there something in fundraise licenses, the payment ahead of what you thought?
Or is the pipeline building better than what you thought? I think, Jason, let me start with and then John will fill in. First of all, I kind of highlight that it's a very broad based strength across the product lines. And even though we highlight the hardware, the IP, even though we highlight the physical growth 12%. And then the other part is also very exciting for us.
It's a custom analog system connect area and also the high school about 8%. And then we are excited about that's why we're investing in this whole system analysis as part of this analog custom interconnect system level. And that area has been doing well. And so I think overall, I would say that it's across the board. And then also some of the new newly announced people of the products and that we already drill into our guidance for the year.
Hi, Jackson. This is John. Yes, we had a great season Q1 performance for IT. But of course, IT is lumpy and probably benefits against a better comparison Q1 2018. On the hardware side, if you recall, our functional verification revenue grew in the high teens in 2018.
And the last time we spoke to you, we were expecting functional verification revenue in 2019 to be approximately flat year over year. So Q1 now behind us and with better visibility into the hardware pipeline, we're now expecting modest growth in our functional verification segment, despite the difficult compare. But we saw uptick in demand in Q1 for our hardware products. We expect that to continue into Okay, great. That's helpful.
Follow-up question is kind of 2 quarters. So the first being, you've mentioned, Lucu, the $40,000,000,000 TAM over the next few years, right, expansion from the 10,000,000,000 dollars that you've seen kind of in the past. What would you say you currently address of the incremental point? And then 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 would you see as the main competitor for this Clarity 3d solver?
Thank you. Yes, good question. And we're excited about this kind of expansion. That's one of the very important factors for Cadence. And so that's why we have this opportunity on the intelligent system design.
And first of all, I think clearly our foundation continues to grow in terms of design excellence. All our EDA tools continue to drive the growth with semiconductor company and also system company to drive differentiation. And the second part we're going to address is that system innovation. And so clearly, the opportunity in front of us is to hold embedded system safety and security. Our partnership that we think here is very important part of our synergy.
And now we're starting to move into the system analysis space. So, in the interest rate about 3,000,000,000 and then market analysis is about RMB3 1,000,000,000. Clearly, in the system analysis, about RMB4.5 billion. And then pricing overall, we continue to marching forward. Stay tuned.
And then we're going to be over time, we're going to be quite nice to hear some of the success we have. And then clearly, on the competition side, on the system analysis, there are a couple of them I think you're well known. They have some more legacy solutions. And then, but the customer over time will require the increase on the system capacity and also shift less approach, I mean, to bring more simulation and then larger design and that will require solutions that need more capacity and also higher performance and that will replay into our strength in terms of algorithm that succeeds and massive distributing multi construction capability. And so I think the other thing that really is we find a unique opportunity or unique qualification we have to play in the market.
The next question comes from Jason Celino of
for the full year. First half of twenty nineteen guidance has seen kind of 11.7% growth and then decelerates kind of 6.7% for the second half. I appreciate your comments on kind of the updated hardware outlook. How conservative is guidance for 2019? Hi, Jason.
This is John. Everything you know is in our guidance. You're right to cut off, so look kind of flat compared to the second half. And that's mainly because of functional fabrication, which includes both software and hardware products. That's quite lumpy and our visibility into demand for Q2 looks like Q4 is a very tough compare deal.
Okay. And then as far as IT revenue for the quarter, I mean, you guys have both strong quarter. I mean, how should we think about IT as a whole, growth wise, for the full year? Well, I'll break you to our IT results for Q1. But I see in Q1 benefits from a relatively easy compare versus Q1 to 2018.
So we're not guiding to get into the hot groups, but we're very pleased with our IT results for the Q1. Yes, first of all, we kind of talk about this 10 cylinder, larger proliferation, adoption for the machine learning, vision, audio and also automotive consumer experience. We add new keep new customers. On the design IT side, clearly, we have the 112 gig long reach 30 IT, and this is a must have for the hyperscale infrastructure. And we're at the beginning of it, and we are delighted our key semiconductor company adopted and then more to come and stay tuned and we'll have more update for you.
Okay. Thanks, Yan. That answers all my questions.
Your last question comes from Dale Manda of Barclays.
One thing is that's kind of the changes. The recognized revenue is expected to come over time at a rate of revenue. Saying that these guidance is 85% to 90%, which is around 90%. It's a big help in the platform products in the way that you've seen huge amounts of the turn off. Is that what you're saying?
Yes, Gal. Our offering revenue comes phenomenally from 2 main sources, IP and the hardware part of our functional verification group. The expectation for better functional verification growth leads directly to that revision of our outlook for the recurring revenue mix. We're now at the high 80s for 2019. And then the second question is just linked to your cloud offering.
In the past, your customers kind of like to mix and match different processes. And when you move to the cloud, especially when you start doing design in the cloud, my question is, can tools be matched as previously premise? And if no, does that mean that protection tools can be more sticky, So, 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.
And in some way, we're starting to drive the performance and productivity for our customers by moving to the cloud, so you can address the peak load. And also, you can get all of these distributors to the unlimited server that the cloud infrastructure provides and that is a tremendous value to our customers. Perfect. And just as a follow-up on that, would you say that when you're seeing the adoption of the cost in the future, would you expect coming for diverse capacity like you mentioned from existing customers that potentially will invest in their own infrastructure. Would you think the new customer, the sequence companies have given the service will apply for a larger portion of that option in the future?
It will depend on the customers. And then, you know, they can use a hybrid, you know, using their own premise. And then when they address the people with cloud or they want to go from scratch and some of the startup, and once it's the all cloud, we're also open to that. So I think there's a lot of different models. And then we basically want to make it available to our customer for whatever we choose 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. And then basically, we are supporting them. And they have an option to have a customer manage or using the Cadence manage or the provision count.
We will now turn the call over to Mr. Tom for closing remarks.
Thank you all for joining us this afternoon. In summary, our business is mission critical to silicon development, which is a cornerstone of all design activities. Through our strategy, we are capitalizing on multiple technology ways 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 in 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 1st Quarter 2019 Earnings Conference Call. This completes today's call.