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 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, Jesse, and I would like to welcome everyone to our Q1 2018 18 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 15, 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 ks and Form 10 Q, including the company's future filings and the cautionary comments regarding forward looking statements in the earnings press release we issued today. In addition to financial results prepared in accordance with generally accepted accounting principles or GAAP, we will also present certain non GAAP financial measures today. Cadence Management believes that in addition to using GAAP results in evaluating our business, it can also be useful to review results using certain non GAAP financial measures. Investors and potential investors are encouraged to review the reconciliation 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 23, 2018, for the quarter ended March 31, 2018, related financial tables and the CFO commentary are also available on our website. Finally, note that our 10 Q will be filed later this week. Now, 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 Q1. 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 datacenter, 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. Now 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.
1 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 continued its strong market momentum in Q1. We collaborated with IMAG, an international research and innovation hub on the industry first 3 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 broadened 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 7 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 5 new customers and we booked 17 repeat orders. And Protium S1 targeting the prototyping market continue to ramp as customers realize faster design bring up due to common front end with our Palladium Z1 platform. During the quarter, we added 4 new Proteum customers and booked 5 repeat orders.
Our hardware products nicely complement the software solutions in our verification suite, Axilium for parallel simulation and Jasper Go for formal verification. 30 additional customers adopted Xyleum 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 introduced 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 5 nanometer nodes, lead to more than a 3x reduction in FinFET layout effort.
1 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 chipmakers 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 7 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 processor, 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 4th year in the row.
Our commitment to innovation can be seen in more than 20 significant new products that Cadence team has developed in the past 3 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 have been building a culture that differentiates Cadence. We can be proud of what we have accomplished. I'm 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 7 nanometer designs.
And 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, and good afternoon, everyone. 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 Q1 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. So alongside our new GAAP rules, we will also provide you today our Q1 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 Q1 starting with the P and L. As reported under the new rules, total revenue was $517,000,000 Non GAAP operating margin was 27.8%. GAAP EPS was $0.26 and non GAAP EPS was 0 point 4 0 dollars Under the old rules for direct comparison against our Q1 2017 results, total revenue was $525,000,000 non GAAP operating margin was 29.5 percent, GAAP EPS was 0 point 0 point 4 $4 Please note that approximately 0 point 0 $4 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 $6,000,000 of the $8,000,000 difference in revenue for Q1 between new rules and old rules is attributable to changes in revenue recognition for IP. Now turning to the balance sheet and cash flow.
Cash and short term investments were $752,000,000 at quarter end of which approximately 30% was onshore. Debt outstanding at quarterend was $695,000,000 Operating cash flow was $158,000,000 During Q1, we used $50,000,000 for share repurchases and $40,000,000 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 Q1 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 $510,000,000 to $520,000,000 non GAAP operating margin in the range of 27% to 28%, GAAP EPS in the range of $0.20 to 0 point 22 dollars non GAAP EPS in the range of $0.39 to $0.41 and DSOs of approximately 40 days. Our updated guidance for fiscal 2018 is revenue in the range of $2,055,000,000 dollars to $2,085,000,000 non GAAP operating margin in the range of 27% to 28%, GAAP EPS in the range of $0.86 to $0.94 non GAAP EPS in the range of $1.57 to $1.65 We are increasing operating cash flow to a range of $510,000,000 to $550,000,000 an increase of $25,000,000 at the midpoint.
And we expect to continue to repurchase Cadence common stock at the rate of $50,000,000 per quarter during 2018. Please note that we expect revenue under the old rules will be approximately $30,000,000 higher than under the new rules, with $20,000,000 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 new rules or under the old rules is now revenue of approximately $2,100,000,000 representing growth of 8% compared to the previous estimate of 7%. Non GAAP operating margin of approximately 28.6%, GAAP EPS of $1.01 and non GAAP EPS of $1.70 This quarter, I especially urge you to read through our CFO commentary, which was included with our 8 ks 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. And you can see how all of our lines of business performed throughout the Q1 of 2018. Functional verification had a particularly strong quarter with great momentum across the entire 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'm pleased with our performance across all lines of business.
Like to thank the extended Cadence team for their financial discipline and for their drive and passion to make our customers successful. With that operator, we'll now take questions.
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 want 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 the end of the year. I'm just curious why you're not getting more aggressive on your share buyback? And with respect to capital allocation, how would you characterize the M and 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 and then I'll ask Lip Bu to take the second part on M and A. But Board and Management at Cadence are laser focused on creating shareholder value. And 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.
But so that's all in focus right now.
Yes. On the M and A front, Gary, I think the Board and the management are laser focused on creating shareholder value, strategic driven and disciplined approach. And our M and A philosophy have always been very disciplined and we had to tie into our EDA, STE strategy and also focus on customer with differentiating technology products and then attracting the best talent in terms of managerial or technical talents and 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. And so that had been our discipline for doing that.
So I think we're going to continue laser focus on our internal development and using M and A to supplement our organic growth.
Okay. A question about the mix between systems companies and merchandising 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 and merchant IC companies was for the Q1? And I guess even more specific, what would you guesstimate your non IC design revenue contribution in Q1?
So 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. 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.
Yes. If I can add is our system and IC business are doing well. And we first of all focus on our tool and IP supporting our IC customers. And meanwhile, we approached system design enablement to tailor some of our solution and IP to meet the customer in the system side in terms of driving some of the success, especially in the PCB and the system integrity analysis side. And then now we're starting to really pursuing the automotive and then we have great success this quarter last quarter.
Same thing with aerospace and defense that we highlight this quarter that we received multiple large orders from several of these defense and contractor and aerospace companies. We are delighted some of this vertical market we are pursuing. And same thing with automotive and the last quarter we highlight a very strategic relationship with the market shaping automotive maker and in term of software and hardware IP service solutions. And then the other part we also signed last year in the beginning a large design IP with a major semiconductor customer, automotive customer. And then the other part, we are also very pursuing the cloud data center, the optimization and in terms of driving some success and solution for them.
Clearly, NIO semi 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 over to somebody else. Thanks.
Your next question comes from Monika Garg with KeyBanc. Your line is open.
Hi. Thanks for taking my question. The first on the IP, so if I just look under ASC 606, IP is kind of down $10,000,000 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 in the revenue otherwise?
Hi, Monica. Thanks for the question. Yes, 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 $5,000,000 to IP revenue back in Q1 2017. So you have to allow for that when you're considering growth. Also IP revenue recognition was impacted most by the 606 revenue transition.
Dollars 6,000,000 of the $8,000,000 difference between 605 and 606 revenue for Q1 was related to IP. So on an apples to apples basis, IP was actually up year over year, but and 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. And that's despite the fact that in our 10 ks, we highlighted that the acquisitions that we did in 2017 are not expected to generate significant revenue in 2018.
And then Monica, I think just to add on, clearly, this we're excited about the IP business and outsourcing trend is continue. And clearly, we have some of the most differentiating IP under this new refined augmented strategy and focus on the most advanced nodes. And then the other part is some of the Tensilica, we highlight this new the Q6 and then also the new semi acquisition for the high speed 30 and then also the DDR and PCIe. So we have a very good portfolio to drive some of the success for our system and semiconductor customers.
Thanks for the details. Lip Buzhan, 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?
Yes, we just announced recently and so far the response from customer is very positive because clearly this is based upon the success of the Vision P6. They are very widely broadly adopted for the application processor. And meanwhile, this is a higher performance and also we are quietly building up our software capability, the algorithm capability and that we can providing the overall solution for not just a vision, not just the audio. And then now we can really driving some of the embedded vision and an on device artificial intelligent application that will be broadly hopefully will be broadly adopted.
Got it. Just the last one. After the muted performance in emulation last year, of course, given a very strong performance in 2016, Q1 was very, very seems very strong in the functional verification. Maybe could you provide more details? Thank you.
Sure. So I think as I highlighted, clearly, we are very pleased with our system verification suite and that grew 20% year over year. And with that, clearly our hardware business as John highlighted, we have a strong backlog from last year. And then Q1 also a very strong quarter both for Palladium and Protium. We highlight the 5 new customer and then 17 repeat orders for Palladium.
And then for Protium that is a prototyping, we are also very delighted with 4 new Protium S1 customers and 5 repeat orders. And then Accelium, if you recall, is the integration of Rocketech and Incisive, and then we completely integrate together. We're delighted this quarter we have 30, three-0 new customer adopting it. So 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.
And 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 Fleschow with Clifton Securities. Your line is open.
Thank you. Good evening. For John first, a 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.
But you mentioned A and D a number of times and strengthened it from that end market. And historically, in EDA, Aerospace and Defense has tended to prefer upfront licenses unless that's changed. So perhaps you could comment on any increments of that kind in the quarter from upfront licensing? And then for Lip Bu, you highlighted some advances in sub-ten nanometer. And I'm wondering if the deals sorry, the flows of from prior contracts carry forward into sub-ten 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 7 and below that you're going to have to compete for? Thanks.
Jay, I'll take the first part of your question. That's, I was certainly pleased with the performance of all our lines of business in Q1. Approximately 90% of our revenues recognized over time and was no different for Q1. So there was nothing unusual. And as you know, with our ratable model, the strong Q1 tends to have a bigger impact on the entire year.
But so you'll see that the Q1 the strength in Q1 has carried through into strong guidance for the year. But and we continue to see strength in our custom IC and digital software business too. But I'll pass it over to Leland.
Yes. So I think Jake, a couple of points. And one, I think I highlighted with IMAIC collaborations, we announced 3 nanometer core triple patterning test chip and successfully tape out. We're very pleased with that. And then clearly our volume business is in the 14, 16 nanometer in terms of from a customer point of view, but while moving very rapidly into the 7 nanometer and 5 nanometer, A lot of our design activity, a lot of our IP engagement is in the 7 and 5 nanometer.
And so far like every new process node, there's opportunity for us to help our customer to win in the market place so that they can proliferate. And so clearly, we're excited about the opportunity in front. The tool with the distributed processing and then massively parallel that have been our advantage. And right now, we're using machine learning, deep learning to even drive further advantage in terms of PPA runtime 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 than 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. But EDA is a competitive business and pricing can vary from sector and product to product. But 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 3 months ago?
Hi, Faran. This is John. Yes, strength in the quarter was broad based. Functional verification had a particularly strong quarter with great momentum across the entire verification suite as Lip Bu mentioned earlier. But we continue to see strength as well in our custom IC and digital software business.
And our IP business performing in line with our expectation it's going to be the fastest growing part of Cadence on an apples to apples basis. So 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. We expect that I think we said last quarter that we expect all of our businesses to grow this year.
Got it. And then in emulation, Mentor Graphics recently claimed that they have taken leadership and market position in emulation. Can you just talk about the competitive dynamics in the within the emulation market? And how are we in terms of the product introduction cycle?
Yes. So Fahad, this is Lip Bu. And clearly, the hardware business, we are very pleased with our performance. And in term of Z1 and also our Proteum S1, this is a prototyping site. And clearly in the verification, this is very important for the verifying for their design.
And we're excited in our hardware and software really complement the full suite to really providing our customer. So I think overall, we are very excited about what we have and we make great progress, 20% year to year growth. And we respect our competitors and in what they are doing. And so we continue to compete in the marketplace.
Got it. And then one last question on the OpEx linearity through the year. Can you just talk about how we should model OpEx for the year?
Right. So with the transition to the new revenue rules, if you're using the 606 numbers, that you'd expect the commission expense to be more flat throughout the year. But so I think that will 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 Rich Valera with Needham and 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. And presumably hardware was down meaningfully more than that given the relative stability of software.
And now it seems like hardware is probably up quite sharply in the Q1. So 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.
Yes. This is Lip Bu, Rich, and thanks for the questions. And as I mentioned multiple times, hardware is a very lumpy business. And we have last year, I think the first half had 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 customer and 17 repeat customers and then orders. And then the Proteum, we have 4 new Proteum customer and 5 repeat customer. And so overall, I think it's not just the hardware and also our software, Axilium, we have 30 new customers in this quarter. Finally, we put it together with the Rockitag integrations and for the parallel simulation.
And then the other part is the formal verification for JasperGold. So overall, I think it's like John mentioned across the board the whole verification is strong and we're very delighted to provide that entire verification suite for our customers.
Got it. And then you specifically in 4Q called out, I think, real strong bookings, real strong hardware bookings, and 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, but 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. And hardware is a very important component of our entire portfolio. We typically view it as the complete verification suite. But 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. And 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%.
I'm sorry, 9%. Okay. So yes, 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, 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 was likely to be the fastest growing group.
Yes. If I can add, it's just we are excited about our digital flow. And 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 7 nanometer. Last quarter, we highlight Premier, the hyperscale and moving into the 7 nanometer, they're using our entire suite. And overall, I think it's just a continued proliferation with the market shipping customer and we are continuing to expand that footprint.
Just stay tuned.
Got it. Thanks very much and 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. So it sounds like 606 has about a 10% impact to IP this year. Wondering does that reverse next year or are there additional one timers in the out year that would impact that as well?
So last quarter, we talked about the our expectation for the difference in total revenue between the two sets of rules was 40,000,000 dollars And we thought in 2019 that, that would drop into about $25,000,000 in 2019. But now we think it's $30,000,000 and a similar proportion for the out years. And I think if you look at IP, we think $20,000,000 of the $30,000,000 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. Yes.
Okay.
And the same ratio of IP as a percentage?
That's a good guess.
Okay. So I guess when you look at the new kind of refined IP strategy in the markets that you're serving now versus before, are you do you believe you're growing in line with the double digit market growth or are you going slower faster than that at this point?
We're not giving specific.
Yes. I think clearly, as we mentioned, this refined strategy and augmented roadmap, I just want to highlight to you, we are pursuing more scalable and more profitable focus and we are focusing on the most advanced nodes and we are focused on customer success and we are focused on the Star IP like the Tensilica, like the new semi ultra high speed to 30. So we're going to continue to build on that, the high differentiating IP, they are the most leading edge and then we really focus on scalability. We don't do that kind of one off type of things and really focus on the quality.
Okay. And then just looking broader at the IP market, what is the penetration of outsourced or merchant IP? What percentage is still done in house? And where do you think that percentage goes over time?
Yes. I think as I mentioned, the outsourcing trend continue. I think clearly from the 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, in our that's why we want to position ourselves as a reliable, trusted, high quality IP provider. I think 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 terms 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 distributed data center, vertical data center, the automotive and then in terms of the mail aero related area, that's a lot of very unique IP that over time we can build and acquire to do that.
Okay. So at this point do you think we're at the halfway point then from an outsourcing trend line?
Yes. I can't put out where we are. All I can say is like the baseball terminology and still in the early round.
Okay. All right. Thank you.
Thank you.
Your next question comes from the line of Sterling Auty with JPMorgan. Your line is open.
Hey, guys. Thanks. Just want to follow-up on that line of question on IP. And I apologize if you said it earlier, I'm bouncing between calls. But I get lots of questions around the autonomous driving, artificial intelligence, etcetera.
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?
Yes. So 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 vision sensor related. So I think we have 2 parts. 1 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.
And like last quarter, we highlight the premier automotive maker adopting some of our key IP for doing that. And then the other part is really addressing some of the AI on the vision, audio and then on this on device AI application and beyond. And so 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. And so there's a lot of room to grow there.
And 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 kind of a perpetual payment for that capability?
No, not much. I think pretty much the same and their requirement for their design. And so 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 with AI. And so there's a lot of new compute architectures that 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.
That's great. One last question. We talked about digital and your growth and kind of 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 virtual, so custom IC new platform is a significant major enhancement that able to drive all the way down to 5 nanometer process nodes and then with our leading partners in the foundry. And also I think we drive some of the new innovative methodology and technology that drive more than 3x reduction in FinFET layout effort. That is huge in terms of customer love it. And we just highlight 1 of the customer, Bosch, and they see tremendous value for that.
And 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 from the line of Mitch Steves with RBC Capital Markets. Your line is open.
Hey, guys. Thanks for taking my question. So I wanted to touch really quick on the system side. So 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. And then we have a very unique position beside our tool. We have IP and we also have the PCB side and the system simulation, experience the power critical for them. And then the only difference on the system guy and time to market is more critical for them because they want to win in the marketplace, 1st 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.
And clearly, they appreciate the value that we provide. And so I think we are delighted to work with them. Our job is basically to make sure that our tool and IP help them to design the most complex chip, the most complex system they have. And in some way, we partner with some of our partner like Metworks and we are delighted to work with them and now clearly with our PC PSSPICE and with their tool, we make a more integrated solution from the system level design all the way to chipboard implementation, that is a really welcome from automotive and then some of the new aerospace and we're delighted. And so and we also last quarter, we do an acquisition on SFM and really driving the e CAD, MCAD rivalry creation and this whole McHenry Tronics is really ticking off.
So we're excited about all this opportunity in front of us.
Got it. And then 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. So 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?
Yes. So far, I think overall, our revenue growing and so our semi growing and our system also growing very fast. And so we are delighted. I think both engines are growing nicely. And then John, you may want to highlight?
Yes. Just to highlight that
we haven't updated the analysis on the mix for Q1. But at the end of last year, the mix was still around 40% for system companies. And 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.
Okay, perfect. Thank you.
Thank you.
That's all the questions that we have for today. Lip Bhotan, 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. And we are proud of the innovative and inclusive culture that we are building at Cadence. I would like to take this opportunity to thanks 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