Good afternoon. My name is Jesse, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Cadence first quarter 2018 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number 1 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, Jesse, and I would like to welcome everyone to our first quarter 2018 earnings conference call. I am joined by Lip-Bu Tan, CEO, and John Wall, Senior Vice President and CFO. The webcast of this call is available through our website, cadence.com, and will be archived through June 15th, 2018. A copy of today's prepared remarks will also be 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 the cautionary comments regarding forward-looking statements in the earnings press release we issued today.
In addition to financial results prepared in accordance with generally accepted accounting principles or GAAP, we will also present certain non-GAAP financial measures today. Cadence management believes that in addition to using GAAP results in evaluating our business, it can also be useful to review results using certain non-GAAP financial measures. Investors and potential investors are encouraged to review the reconciliation of non-GAAP financial measures with their most direct comparable GAAP financial measures. The reconciliations are available at the investor relations section of cadence.com. Copies of today's press release dated April 23rd, 2018, for the quarter ended March 31st, 2018, related financial tables, and the CFO commentary are also available on our website. Note that our 10-Q will be filed later this week. I'll turn the call over to Lip-Bu.
Good afternoon, everyone. Thank you for joining us today. I'm very pleased to report that Cadence achieved excellent operating results for the first quarter. Based on the strength of our Q1 business and continuing momentum, we are raising our guidance for the year. John will provide details in a moment. The data-driven economy is being propelled by key technology waves of mobile, cloud data center, edge computing, automotive, and most significantly, machine learning. These technologies create massive amount of data, which need to be processed, analyzed, transmitted, and stored. This require power-efficient processing, high bandwidth transmission, and high density storage, which in turn are driving an increase in design activity and broad-based demand for our innovative System Design Enablement solution. I will review some of the highlights from Q1.
Our system design enablement strategy enables us to increase our footprint with system companies and tailor our solution for vertical market segments. One of these vertical segments is aerospace and defense, where in Q1, we expanded our business with large orders from these companies. Turning to products, our digital and sign-off business continues its strong market momentum in Q1. We collaborated with imec, an international research and innovation hub, on the industry first three nanometer test chip tape-out using Cadence Innovus implementation systems and Genus synthesis solution. We continue to proliferate our digital solutions within market shipping customers, and we broaden adoptions among other customers, including a major defense contractor that would use our digital flow for in-house chip design. Both a leading networking company and a top communication processor company adopted our digital flow for seven nanometer designs, continuing our momentum at the most advanced process node.
We achieved strong performance with our system design and verification solutions in Q1. The Cadence Verification Suite marked a strong quarter as the business grew over 20% year-over-year. Palladium added five new customers, and we booked 17 repeat orders. Protium S1, targeting the prototyping market, continued to ramp as customers realize faster design bring up due to common front end with our Palladium Z1 platform. During the quarter, we added four new Protium customers and booked five repeat orders. Our hardware products nicely complement the software solutions in our verification suite. Xcelium for parallel simulation and JasperGold for formal verification. 30 additional customers adopted Xcelium in Q1. Our custom and analog design business continue to do extremely well, and we lead the market with our flagship Virtuoso product line.
We introduce major enhancements to our Virtuoso custom IC design platform that improves electronic system and IC design productivity. A new set of innovative methodologies and technologies, including support for five nanometer nodes, lead to more than a 3x reduction in FinFET layout effort. One of our automotive customers, Bosch, endorsed the new system saying that their long-term collaboration with Cadence has led to crucial innovation in both electrical aware and the new electrical-driven layout design. Customers, including defense contractors, analog semiconductor companies, and mobile chip makers, are adopting our Virtuoso system design platform, especially for products using heterogeneous multi-die integration. Our IP business, with its refined strategy and augmented roadmap, is well-positioned to take advantage of continuing outsourcing trends. Momentum for our flagship DDR and PCIe products continue with significant wins, especially for seven nanometer designs.
We announced the new Tensilica Vision Q6, our latest processor for embedded vision and on-device AI applications, built on the new faster processor architecture. The Vision Q6 builds upon our highly successful Vision P6 that is used in many leading application processors, including Kirin 970 SoC from HiSilicon. Finally, I want to talk about the culture we are building at Cadence that underlines all our success. We are committed to driving an innovative and incisive culture that embrace the diversity of our global workforce. The strength of our culture is highlighted by the recognition we received from Fortune. We earned the number 38 spot on the list of Fortune's top 100 Best Companies to Work For and are proud to make the list for the fourth year in a row.
Our commitment to innovation can be seen in more than 20 significant new products that Cadence team has developed in the past three years. We are also focused on supporting our global communities and have been recognized by the Fortune as a best workplace for giving back. Since I joined the company, one of my top priorities had been building a culture that differentiates Cadence. We can be proud of what we have accomplished. I am encouraged by the progress we are making, and we will continue to make our culture central to our business strategy. Before turning it over to John, let me quickly summarize my comments. We drove excellent results through consistent execution and broad-based proliferation and adoption of our solutions to meet the needs of the data-driven economy. We are raising our guidance for the year on the strength of our business.
Our growing aerospace and defense business had a strong quarter. We continue to grow adoption of our digital flow for seven nanometer designs. We introduced a major upgrade of our flagship Virtuoso platform product line for custom analog designs and a new higher performance Tensilica processor for vision and AI applications. With that, I will now turn the call over to John to review the financial results and provide our updated outlook.
Thanks, Lip-Bu. Good afternoon, everyone. I'm very pleased to report we exceeded all of our key operating metrics in Q1. As a result of strong execution across our business, we are increasing our outlook for fiscal 2018. Before we get into Q1 results, I'd like to remind you that Cadence has now adopted the new revenue accounting standard known as ASC Topic 606 for fiscal 2018. These new rules, as we often refer to them, are now GAAP for Cadence. The numbers I present for our first quarter are based on these new rules, unless otherwise stated. Please also keep in mind that the numbers for 2018, under the new rules, are not directly comparable to those of 2017, which were reported under ASC Topic 605, or for ease of reference, the old rules. Cadence used a modified retrospective transition method on adoption of the new rules.
Under this transition method, rather than recast prior periods, we are required to dual report our 2018 results. Alongside our new GAAP rules, we will also provide you today our first quarter results for 2018, as reported under the old rules. These results, under the old rules, are directly comparable to 2017. Having covered that, let's go through the key results for the first quarter, starting with the P&L. As reported under the new rules, total revenue was $517 million. Non-GAAP operating margin was 27.8%. GAAP EPS was $0.26. Non-GAAP EPS was $0.40. Under the old rules, for direct comparison against our Q1 2017 results, total revenue was $525 million. Non-GAAP operating margin was 29.5%. GAAP EPS was $0.30. Non-GAAP EPS was $0.44.
Please note that approximately $0.04 of the year-over-year improvement in our non-GAAP EPS is directly attributable to the reduction in our effective tax rate resulting from the recent U.S. Tax Cuts and Jobs Act. Please also note that $6 million of the $8 million difference in revenue for Q1 between new rules and old rules is attributable to changes in revenue recognition for IP. Turning to the balance sheet and cash flow. Cash and short-term investments were $752 million at quarter end, of which approximately 30% was onshore. Debt outstanding at quarter end was $695 million. Operating cash flow was $158 million. During Q1, we used $50 million for share repurchases and $40 million to pay down borrowings under our revolving credit facility. As reported, DSOs were 41 days. Under the old rules, DSOs were 38 days. I will now provide our updated guidance.
On the heels of strong execution in our first quarter and continuing momentum for our business, we are raising our outlook for the year. We now expect revenue growth of approximately 8% for 2018 on an apples-to-apples basis under the old rules. For Q2, we expect the following results. Revenue in the range of $510 million-$520 million. Non-GAAP operating margin in the range of 27%-28%. GAAP EPS in the range of $0.20-$0.22. Non-GAAP EPS in the range of $0.39-$0.41, and DSOs of approximately 40 days. Our updated guidance for fiscal 2018 is revenue in the range of $2.055 billion-$2.085 billion. Non-GAAP operating margin in the range of 27%-28%. GAAP EPS in the range of $0.86-$0.94. Non-GAAP EPS in the range of $1.57-$1.65.
We are increasing operating cash flow to a range of $510 million-$550 million, an increase of $25 million at the midpoint. We expect to continue to repurchase Cadence common stock at the rate of $50 million per quarter during 2018. Please note that we expect revenue under the old rules will be approximately $30 million higher than under the new rules, with $20 million of that difference attributable to changes in revenue recognition for IP. There is no impact to our cash flows or to how we operate our business. As a result, our implied 2018 guidance at the midpoint under the old rules, is now revenue of approximately $2.1 billion, representing growth of 8% compared to the previous estimate of 7%. Non-GAAP operating margin of approximately 28.6%. GAAP EPS of $1.01. Non-GAAP EPS of $1.70.
This quarter, I especially urge you to read through our CFO commentary, which was included with our 8-K filing today and is available on our website. There you will find additional information and comparisons and reconciliations for the new and old revenue accounting rules. You can see how all of our lines of business performed throughout the first quarter of 2018. Functional verification had a particularly strong quarter with great momentum across the entire Cadence Verification Suite. We continue to see strength across all lines of our core software business, and our IP business is performing in line with my expectation that it will prove to be the fastest-growing part of our business for 2018 on an apples-to-apples basis. To sum up today's call, I want to highlight that I am pleased with our performance across all lines of business.
I'd like to thank the extended Cadence team for their financial discipline and for their drive and passion to make our customers successful. A very large part they have all played in raising our revenue growth projections to 8% for the year. The hard work is starting to pay off. With that, operator, we'll now take questions.
At this time, I would like to remind everyone, in order to ask a question, please press star on your telephone keypad. We will pause for just a moment to compile the Q&A roster. Your first question comes from Gary Mobley with Benchmark. Your line is open.
Good afternoon, everyone. Thanks for taking my question, and congrats to a good start to the year. I wanted to start with a question about capital allocation. You mentioned that you raised your cash flow outlook for the year. You have 10 percentage points more of your cash in the U.S. now versus at the end of the year. I'm just curious why you're not getting more aggressive on your share buyback. With respect to capital allocation, how would you characterize the M&A environment out there with respect to valuation expectations from some of the targets and whatnot?
That's a good question, Gary. I'll take the first part, then I'll ask Lip-Bu to take the second part on M&A. Board and management at Cadence are laser focused on creating shareholder value. As you know, we regularly review capital structure and capital allocation to balance investment needs, risk, liquidity, and capital return. Also, as we said in the last call, in the first half of this year, we plan to review our overall tax position in light of the new Tax Act, including our options for the use of repatriated cash. That's all in focus right now.
Yeah, on the M&A front, Gary, I think the board and the management are laser focused on creating shareholder value, strategic driven and disciplined approach. Our M&A philosophy have always been very disciplined, and we have to tie into our EDA, SDE strategy, also focus on customer with differentiating technology products, then attracting the best talent in term of managerial or technical talents, also able to provide a compelling return on investment and acquisition. We review with our board, with our management, hold ourselves accountable for all the key acquisitions. That had been our discipline for doing that. I think we're going to continue laser focused on our internal development and using M&A to supplement our organic growth.
Okay. A question about the mix between systems companies and merchant IC companies. I know you probably get asked the question a lot, and I don't know if you have an exact figure you can state from your Q1 results, but what do you estimate your mix between systems companies to merchant IC companies was for the first quarter? I guess even more specific, what would you guesstimate your non-IC design revenue contribution in Q1?
Gary, I can tell you that we haven't drilled into the mix for Q1, but the last time we measured the mix, it was around 40% system companies. I know that hasn't changed in a while, but that's because we've seen growth from both the systems business and also our semiconductor business.
If I can add, is our system and IC business are doing well. We first of all focus on our tool and IP supporting our IC customers. Meanwhile, we approached System Design Enablement to tailor some of our solution and IP to meet the customer in the system side in term of driving some of the success, especially in the PCB and the system integrity analysis side. Now we're starting to really pursuing the automotive, then we have great success this quarter and last quarter. Same thing with aerospace and defense that we highlight this quarter, that we receive multiple large orders from several of these defense and contractor and aerospace companies. We are delighted some of this vertical market we are pursuing.
Same thing with automotive, in the last quarter, we highlight a very strategic relationship with a market-shaping automotive maker in terms of software and hardware IP service solutions. The other part, we also signed last year in the beginning, a large design IP with a major semiconductor customer, automotive customer. The other part, we are also very pursuing the cloud data center, the optimization, and in terms of driving some of success and solution for them. Clearly, nusemi is a great acquisition for us so that we can really provide that ultra-high-speed connectivity for them.
Okay. Thank you for that. I'll turn the floor to somebody else. Thanks.
Your next question comes from Monika Garg with KeyBanc. Your line is open.
Hi. Thanks for taking my question. First on the IP. If I just look under ASC 606, IP's kind of down $10 million year-over-year. Could you maybe give us an idea how much of it is just due to accounting ASC 606, and what would have been the revenue otherwise?
Hi, Monika. Thanks for the question. In Q1 of 2017, if you remember, as part of our transition to the new revenue accounting standard, we recognized an extra quarter of royalties. That added about $5 million to IP revenue back in Q1 2017. You have to allow for that when you're considering growth. Also, IP revenue recognition was impacted most by the 606 revenue transition. 6 million of the 8 million difference between 605 and 606 revenue for Q1 was related to IP. On an apples-to-apples basis, IP was actually up year-over-year. I made a point in my script to call out the fact that I still expect that to be the fastest growing part of our business for 2018.
That's despite the fact that in our 10-K, we highlighted that the acquisitions that we did in 2017 are not expected to generate significant revenue in 2018.
Monica, I think just to add on, clearly we're excited about the IP business and the outsourcing trend is continue. Clearly, we have some of the most differentiating IP under this new refined, augmented strategy, and focus on the most advanced nodes. The other part is some of the Tensilica we highlight this new, the Q6. Also the nusemi acquisition for the high speed SerDes, and also the DDR and PCIe. We have a very good portfolio to drive some of the success for our system and semiconductor customers.
All right. Thanks for the details. Lip-Bu, as a follow-up, I think you talked in your comments about Tensilica processor for vision and AI. Maybe could you provide details on interest you are seeing from customers regarding this product?
We just announced recently. So far the response from customer is very positive. Clearly, this is based upon the success of the Vision P6. They are very broadly adopted for the application processor. Meanwhile, this is a higher performance. Also we are quietly building up our software capability, the algorithm capability. Then we can providing the overall solution, for not just the vision, not just the audio. Now we can really driving some of the embedded vision and an on-device artificial intelligence application, hopefully will be broadly adopted.
All right. Just the last one. After the muted performance in emulation last year, of course, given a very strong performance in 2016, Q1 seems very strong in the functional verification. Maybe could you provide more details? Thank you.
Sure. I think as I highlighted, clearly we are very pleased with our Cadence Verification Suite, that grew 20% year-over-year. With that, clearly our hardware business, as John highlighted, we have a strong backlog from last year. Q1 also a very strong quarter, both for Palladium and Protium. We highlight the five new customer. Then 17 repeat orders for Palladium. For Protium, that is a prototyping, we are also very delighted with four new Protium S1 customers and five repeat orders. Xcelium, if you recall, is the integration of Rocketick and Incisive. Then we completely integrate together. We're delighted this quarter we have 30, three zero, new customer adopting it. We overall, I think, verification is critical for all the complex design.
I think we have an entire suite from hardware and software able to provide to customer the most compelling. Also clearly customers see the benefit of the quicker design using the same front end as the Palladium Z1. That is very attractive for them.
Thank you so much.
Thank you.
Your next question comes from the line of Jay Vleeschhouwer with Griffin Securities. Your line is open.
Thank you. Good evening. For John first, couple of questions and then finish up with Lip-Bu on the end market. John, were there any unusual increments to upfront or perpetual revenues in the quarter, besides hardware, which obviously did quite well, and it looks like, just doing a quick inference, that you might even have had a record quarter for emulation. You mentioned A&D a number of times and strength from that end market, and historically in EDA, aerospace and defense has tended to prefer upfront licenses, unless that's changed. Perhaps you could comment on any increments of that kind in the quarter from upfront licensing. For Lip-Bu, you highlighted some advances in sub 10 nanometer, and I'm wondering if the flows from prior contracts carry forward into sub 10 nanometer.
In other words, were the implementations done for 14 and 20 and so forth extensible down to under 10? Or are we going to see a whole new round of selections for seven and below that you're going to have to compete for? Thanks.
Jay, I'll take the first part of your question. That I was certainly pleased with the performance of all our lines of business in Q1. Approximately 90% of our revenue is recognized over time, and that was no different for Q1, so there was nothing unusual. As you know, with our ratable model, the strong Q1 tends to have a bigger impact on the entire year. You'll see that the strength in Q1 has carried through into strong guidance for the year. We continue to see strength in our custom IC and digital software business Two. I'll pass it over to Lip-Bu.
Yeah. I think, Jay, in a couple of points, one, I think I highlighted with Imec collaborations, we announced the 3 nanometer quad ripple patterning, test chip, and successfully tape out. We're very pleased with that. Clearly, our volume business is in the 14, 16 nanometer in terms of from a customer point of view. We're moving very rapidly into the seven and five nanometer. A lot of our design activity, a lot of our IP engagement is in the seven and five nanometer. So far, like every new process node, there's opportunity for us to help our customer to win in the marketplace so that they can proliferate. So clearly we're excited about the opportunity in front, the tool with the distributed and the processing and then the massively parallel that have been our advantage.
Right now we're using machine learning, deep learning to even drive further advantage in terms of PPA runtime and also some of the verification we are applying our machine learning, deep learning capability into our tool. At the end of the day, it's supporting our customer to faster to design and verify so that they can go for production and win in the marketplace.
Just to finish up with John. Could you talk about your philosophy on pricing, specifically as part of your management of what you call deal quality metrics? Are you looking at pricing or, let's, to be more specific, suboptimal pricing in the case of any specific customers more at an account level? Or are you thinking in terms of pricing more broadly, in terms of how you might apply price increases or less discounting and so forth?
Hi, Jay. Yes, we're very disciplined and value driven and very focused on pricing here at Cadence. EDA is a competitive business and pricing can vary from sector to sector and product to product. We believe the best way to derive value from our products is to collaborate deeply with customers and deliver innovative and clearly differentiated solutions and that make our customers successful.
All right, thank you.
Your next question comes from Farhan Ahmad with Credit Suisse. Your line is open.
Hi, thanks for taking my question. Can you just talk about the division and guidance for the year from last quarter to this quarter? What are the specific parts of the business that you think are stronger now compared to three months ago?
Hi, Farhan, this is John. Yeah, strength in the quarter was broad-based. Functional verification had a particularly strong quarter with great momentum across the entire Cadence Verification Suite, as Lip-Bu mentioned earlier. We continue to see strength as well in our custom IC and digital software business. Our IP business performing in line with our expectation, that it's going to be the fastest growing part of Cadence on an apples-to-apples basis. It's pretty broad-based.
Sorry, I meant for the year, not just for the quarter.
Similarly, it's pretty broad-based across the year. I think we said last quarter that we expect all of our businesses to grow this year.
Got it. In emulation, Mentor Graphics recently claimed that they have taken leadership and market position in emulation. Can you just talk about the competitive dynamics within the emulation market? How are we in terms of the product introduction cycle?
Yeah. Farhan, this is Lip-Bu. Clearly in the hardware business, we are very pleased with our performance, in terms of Z1 and also our Protium S1, this is a prototyping site. Clearly in the verification, this is very important for their verifying for their design. We are excited in our hardware and software really complement the full suite to really providing our customer. I think overall, we are very excited about what we have, and we make great progress, 20% year-to-year growth. We respect our competitors and in what they are doing. We continue to compete in the marketplace.
Got it. One last question on the OpEx linearity through the year. Can you just talk about how we should model OpEx for the year?
Right. With the transition to the new revenue rules, if you're using the 606 numbers, you'd expect the commission expense to be more flat throughout the year. I think that'll probably take away some of the expense profile. It should be reasonably flat throughout the year.
Got it. Thank you. That's all I have.
Okay, thank you.
Your next question comes from Richard Valera with Needham & Company. Your line is open.
Yes, thank you. Would just like to follow up on the emulation question. It seems like it's a pretty dramatic turnaround, that the whole category of verification was down about 5% year-over-year last year, I believe you said in your last call. Presumably hardware was down meaningfully more than that given the relative stability of software. Now it seems like it's hardware is probably up quite sharply in the first quarter. Just wondering if you can give any color on what might account for that dramatic turnaround year versus year. Was it simply a matter of just really difficult comparisons in 2017 off the real strong 2016, or is there anything else you could point to in the product or the marketplace for that pretty dramatic turnaround? Thank you.
This is Lip-Bu, Rich, thanks for the questions. As I mentioned multiple times, hardware is a very lumpy business. Last year, I think the first half have a little bit soft start, but we have finished very strong in the Q4, that momentum carry us in the Q1. As I mentioned, we have in our hardware Palladium Z1, we have 5 new customers and 17 repeat customers and then orders. The Protium, we have 4 new Protium customers and 5 repeat customers. Overall, I think it's not just the hardware and also our software, Xcelium, we have 30 new customers in this quarter. Finally, we put it together with the Rocketick integrations and for the parallel simulation. The other part is the formal verification for JasperGold.
Overall, I think it's like John mentioned, across the board, the whole verification is strong, and we are very delighted to provide that entire verification suite for our customers.
Got it. You specifically in Q4 called out, I think, real strong bookings, real strong hardware bookings, clearly that's translated into a nice Q1. Anything you'd say specifically about bookings? I know you've said numbers of customers, new customers and repeat customers, would you say that you had another strong bookings quarter for the hardware business in Q1?
I would say that, again, we don't talk about bookings on a quarterly basis. Hardware is a very important component of our entire portfolio. We typically view it as the complete verification suite. I would say that we've been very disciplined and value-driven on pricing, to ensure that we get the value that we believe the hardware is worth.
Great. Then just one more, if I could on digital. I don't know if you said specifically how fast digital grew. It looks like it was kind of a double-digit number, but did you say that specific number, John?
No, it was 9%, Richard.
I'm sorry, 9%. Okay. Yeah, I know that was double-digit last year. Would you be willing to hazard whether you think that might be a double-digit growth business again this year or not willing to go there at this point?
No. We're generally not going to guide or comment on individual product line growth rates for 2018 other than to say that we thought IP would likely be the fastest-growing group.
Yeah, if I can add, it's just we are excited about our digital flow. As I mentioned, couple of very successful one we have, the leading networking company adopting us and then the top provider of the communication processor adopting us on the seven nanometer. Last quarter, we highlight premier and the hyperscale and moving into the seven nanometer. They're using our entire suite. Overall, I think it just continued the proliferation with the market-shaping customer, and we'll continue to expand that footprint. Just stay tuned.
Got it. Thanks very much. A very nice quarter, gentlemen. Thanks.
Thank you.
Thank you.
Your next question comes from Tom Diffely with D.A. Davidson. Your line is open.
Yes, good afternoon. Another question on the IP front. It sounds like 606 has about a 10% impact to IP this year. Wondering, does that reverse next year? Are there additional one-timers in the out year that would impact that as well?
Last quarter, we talked about our expectation for the difference in total revenue between the two sets of rules was $40 million, and we thought in 2019 that that would drop into about $25 million in 2019. Now we think it's $30 million and a similar proportion for the out years. I think that if you look at IP, we think 20 of the 30 is IP for this year. Haven't drilled into impact in 2019, but all we're saying is that we expect the impact between 606 and 605 is slightly smaller than we thought it would have been last quarter.
Okay. You said that same ratio roughly holds then for the out year?
I think so. Yeah.
Okay. The same ratio of IP as a percentage?
That's a good guess.
Okay. I guess when you look at the new kind of refined IP strategy in the markets that you're serving now versus before, do you believe you're growing in line with the double-digit market growth, or are you growing slower, faster than that at this point?
We're not giving specific.
Clearly as we mentioned, that is refined strategy and augmented roadmap. Just want to highlight to you, we are pursuing more scalable and more profitable focus. We are focusing on the most advanced node, and we are focused on customer success, and we are focused on the star IP, like the Tensilica, like the nusemi ultra-high-speed SerDes. We're going to continue to build on that, the high differentiating IP. They are the most leading-edge. We really focus on scalability. We don't do that kind of one-off type of things and really focus on the quality.
Okay. Just looking broader at the IP market, what is the penetration of outsource or merchant IP? What percentage is still done in-house? Where do you think that percentage goes over time?
As I mentioned, the outsourcing trend continue. Clearly from our customer point of view, unless they really need to have that IP to differentiate their product offering, some of the industry standard, and as long as reliable. That's why we want to position ourself as a reliable, trusted, high-quality IP provider. Over time, there's a lot of room for growth, and we're excited. That's why John mentioned this will be our highest percentage of growth in term of our product line, and we're excited about this IP, and especially applying to some of the key vertical, either the hyperscale data center, the distributor data center, vertical data center, the automotive, and then in term of the mil-aero related area. There's a lot of very unique IP that over time we can build and acquire to do that.
Okay. At this point, do you think we're at the halfway point then from an outsourcing trend line?
Yeah. I can't put down where we are. All I can say is like the baseball terminology, still in the early round.
Okay. All right. Thank you.
Thank you.
Your next question comes from the line of Sterling Auty with J.P. Morgan. Your line is open.
Hey, guys. Thanks. Just want to follow up on that line of questioning on IP. I apologize if you said it earlier, I'm bouncing between calls, but I get lots of questions around the autonomous driving, artificial intelligence, et cetera. What is the core IP that you've built at this point, and what kind of demand traction are you seeing for those elements within the IP franchise?
Yeah. I think, Sterling, first of all, we are focusing on some of this, we call it high speed connectivity side, and either the USB or PCIe or high speed SerDes, addressing some of the data storage related requirement, and then using the Tensilica to drive some of the AI, autonomous driving and how to work with the vision sensor related. I think we have two part. One is to providing our tool and IP to help our customer to design some of these ADAS and then some of this requirement for autonomous driving. Like last quarter, we highlight the premier automotive maker adopting some of our key IP for doing that. The other part is really addressing some of the AI on the vision, audio, and then on this on device AI application and beyond.
There's a lot, and the AI machine learning is so broad. You can move into beside the data center, beside the mobile autonomous driving and even some of the medical genomic sequencing. That's a lot. It's fascinating, and we're just touching the surface. There's a lot of room to grow there.
On those types of opportunities, has anything changed in terms of the mix of contract structure you're getting in terms of upfront versus annual subscription versus a perpetual payment for that capability?
No, not much. I think pretty much the same, and their requirement for their design. Clearly there's a lot of opportunity, as I mentioned earlier. I just want to add on to it. The whole silicon photonics, the whole quantum computing and with AI. There's a lot of new complete architectures going to come out on the hardware and software, and we are fascinatingly exciting. They're going to drive the semiconductor development growth. We see the design activity increase a lot for us.
No, that's great. One last question. We talk about digital and your growth and the improvement in that space. We don't talk as much about the analog side, where you guys have been so dominant through the years. Have you seen anything change on the competitive landscape in the analog franchise?
Not a lot. Clearly, we double, triple down on our leadership, and that's why we highlight this Virtuoso custom IC new platform is a significant major enhancements. They're able to drive all the way down to 5 nanometer process nodes, and then with our leading partners in the foundry. I think we drive some of the new innovative methodology and technology that drive more than 3x reduction in FinFET layout efforts. That is huge in terms of customer love it. We just highlight one of the customers, Bosch, and they see tremendous value for that. We also see defense contractor, analog semiconductor company, mobile chip makers rapidly adopting our Virtuoso new tool that we just announced, and the response has been overwhelming.
Great. Thank you.
Thank you.
Your last question comes to the line of Mitch Steves with RBC Capital Markets. Your line is open.
Hey, guys. Thanks for taking my question. I wanted to touch really quick on the system side. I know you guys can't disclose customers, but is there any way to maybe give us some information on how they spend? Meaning that when a systems company spins up to kind of create their own chips, do they spend any differently than the kind of the standard semiconductor customer?
In general, pretty much the same. They all want to design the silicon or their system. We have a very unique position. Beside our tool, we have IP, and we also have the PCB side and the system simulation, especially the power are critical for them. The only difference on the system guy, and time to market is more critical for them, because they want to win in the marketplace. First mover advantage is critical for their success, and they are more focused on the time to market, and also they are focused more on the quality of the products. Clearly, they appreciate the value that we provide. I think we are delighted to work with them. Our job is basically make sure that our tool and IP help them to design the most complex chip, the most complex system they have.
In some way, we partner with some of our partner, like MathWorks, and we are delighted to work with them and now clearly with our PSpice and with their tool, we make a more integrated solution from the system level design all the way to the chip board implementation. That is a really welcome from automotive and then some of the new aerospace, and we are delighted. We also, last quarter, we do an acquisition on SFM, and really driving the ECAD, MCAD library creation. This whole mechatronics is really taking off. We're excited about all this opportunity in front of us.
Got it. Just one small one. A couple of years ago, you guys had talked about systems essentially increasing as a percentage of revenue, but it sounds like that's stayed the same. Maybe, I guess, what happened over the last couple of years, that essentially caused that to be essentially the same, versus original expectation of growing as a percentage of revenue?
Yeah. So far, I think overall, our revenue growing, and so our semi growing, and our system also growing very fast. We are delighted. I think both engine are growing nicely. John, you may want to highlight.
Just to highlight, we haven't updated the analysis on the mix for Q1, at the end of last year, the mix was still around 40% for system companies, it's exactly as Lip-Bu highlighted, that both system, the growth that we're seeing across system companies and the semiconductor businesses is pretty much the same.
Perfect. Thank you.
Thank you.
That is all the questions that we have for today. Lip-Bu Tan, I turn the call back to you.
In closing, through continuous innovation and execution, we are well-positioned with our System Design Enablement strategy to further proliferate our solution with broad base of customers. We are proud of the innovative and inclusive culture that we are building at Cadence. I would like to take this opportunity to thank all our shareholders, customer and partners, board of directors, and hardworking global employees for their continued support. Thank you all for joining us this afternoon.
Thank you for participating in today's Cadence first quarter 2018 earnings conference call. This concludes today's call. You may disconnect.