Good afternoon. My name is Shannon, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence Design Systems fourth quarter 2016 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 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 Design Systems. Please go ahead.
Thank you, Shannon, welcome everyone to our fourth quarter 2016 earnings conference call. With me today are Lip-Bu Tan, President and CEO, Geoff Ribar, Senior Vice President and CFO. The webcast of this call can be accessed through our website, cadence.com, will be archived through March 17th, 2017. A copy of today's prepared remarks will also be available on our website at the conclusion of today's call. Before we start, I want to call your attention to our CFO commentary, which was included in our Form 8-K filing today and is available on our investor relations website at cadence.com. The CFO commentary should be referenced with both today's conference call remarks and the earnings press release issued today. Please note that today's discussion will contain forward-looking statements that our 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 issued today. In addition to the 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 measure 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, which can be found in the quarterly earnings section of the investor relations portion of our website.
Additionally, a copy of today's press release, dated February 1st, 2017, for the quarter ended December 31st, 2016, related financial tables can also be found in the investor relations portion of our website. Now I will turn the call over to Lip-Bu.
Good afternoon, everyone. Thank you for joining us today. 2016 was another great year for Cadence. I'm pleased to talk to you about our results, accomplishments, and strategic direction. We delivered strong financial results in the fourth quarter and for the full year. Revenues of $469 million in Q4 and $1.816 billion for the year, representing growth of 6.7% over 2015. Non-GAAP operating margin was 27% for the quarter and 26% for the year. Non-GAAP EPS was $0.34 in Q4 and $1.21 for the year, up 11% over 2015. I will address the environment and strategy before turning to the 2016 product highlights. Starting with the environment. Semiconductor business conditions appear to have improved slightly with the expectations of low single-digit growth for 2017. Expected improvements are sector specific, though. Macro uncertainty remains.
We are focused on key emerging and high-growth areas, including automotive, virtual and augmented reality, cloud infrastructure, IoT, machine learning, and aerospace and defense. We have successfully managed through the ongoing customer consolidation to date. We expect just a minimum impact on revenue from consolidation in 2017 and believe we are successfully positioned for larger opportunity in the future. At the same time, our relentless focus on innovation, execution, and customer success is driving momentum in the marketplace for us. The opportunities continue to grow with system companies. Turning to our strategy. We are steadily executing our system design enablement or SDE strategy, the key points of which are to drive increased adoption of our core EDA portfolio, leverage our refined IP strategy for scalable growth, maximize the market opportunity of our system solutions, invest in emerging and new growth areas, and develop partnerships with an expanded ecosystem.
SDE offers additional growth opportunities as we expand beyond a horizontal focus on semiconductors and tap into significantly larger market through addressing systems companies and new vertical market segments. In 2016, we make measurable progress executing our SDE strategy. Expanding our ecosystem is important to developing opportunities outside our traditional markets. We announced several important partnerships for our SDE ecosystem in 2016. For example, Cadence and Arrow Electronics launch an integrated cloud-based version of our OrCAD Capture. We partnered with MathWorks to streamline system-level design and circuit-level implementation for mixed-signal IoT and automotive applications. We grew our system business in aerospace and defense with expanded partnership with Northrop Grumman and BAE Systems. Let me turn to some of our product highlights and customer successes in Q4 and 2016. Innovation is at the heart of our success. We have introduced nearly 20 significant products over the past three years.
Several of our products won awards in 2016, including Palladium Z1 and Virtuoso Analog Design Environment. We have a robust product pipeline plan for 2017. Investments in our digital sign-off products are beginning to pay off as we gain even more momentum with the top 20 semiconductor companies. Revenues was up nearly 20% for the year with these customers. Overall, digital and sign-off growth was 9% for the year. We are set up for additional penetrations in 2017. We added 60 Genus customers, 30 Innovus customers, and more than 20 new customers using our full digital and sign-off flow. Sixteen of the top 20 semiconductor companies are now using Innovus, including four of the five top mobile chip makers. Innovus was used to tape out a large GPU design, which helped a customer realize 15% power savings over the previous design.
We are currently working with over 45 customers on advanced node design, with more than 12 7-nanometer engagements. In Q4, Qualcomm entered into an agreement with Cadence that represents an expanded commitment to Cadence products, including hardware and IP. Our verification suites provide complementary connected solutions that are based on strong core engines. It includes Incisive for simulation, JasperGold for formal verification, Palladium for emulation, and a Protium for FPGA prototyping. We are pleased to report that Palladium Z1 had a phenomenal full year on the market. Total hardware revenue surged to a record high. We gained 29 new Palladium Z1 logos in 2016, 11 of which were system companies, and this is the fastest adoption of a new emulation system in Cadence history. In Q4, several leading semiconductor companies adopted Palladium Z1, including Cavium and Innovium.
Customer demand for the Palladium Z1 remains strong due to its enterprise-class capabilities, which are ideally suited for large emulation farms. We expect another strong year in 2017. JasperGold, which is a formal verification segment leader, continues its adoption and proliferation, leading to a record revenue in 2016. Integration of the proven Rocketick technology with our simulation platform has gone very well. Feedback from key customers in earlier adopter engagements on the integrated platform has been very positive, with significant simulation speed-up due to the revolutionary multi-core parallel simulation technology. For custom analog and mixed-signal design, Cadence continues to invest in and provide the most advanced set of custom analog and mixed-signal tools for customers. Adoption of our next-generation products, like the new Virtuoso Analog Design Environment suite, is ahead of our expectations. Virtuoso Advanced-Node Platform is now being used by over 100 customers.
Over 70 customers are using Spectre XPS, our FastSPICE simulator on SRAM designs, and we are expanding into mixed-signal applications. It was a solid year for our package and board business. We delivered a comprehensive system design solution for TSMC advanced wafer level Integrated Fan-Out packaging technology, known as InFO. We released our next generation for Allegro and OrCAD product families with the support for flexible board designs. We just delivered our newest version of our Sigrity analysis portfolio, which significantly speeds up power and signal integrity sign-off for boards. Next, I would like to talk about our IP business, which is a key component of our SDE strategy and an important business for us. IP business opportunity remains strong as outsourcing continues. 2016 was a year of strategic refinement.
We are significantly increasing our focus on standardized off-the-shelf IP, certain strategic vertical market segments, and the most advanced process nodes. Our IP business returned to year-over-year growth in Q4, and we expect about 10% growth for 2017. IP highlights for 2016 included the largest ever renewal for our Tensilica technology, the announcement by Microsoft that 24 Tensilica processors are at the heart of the HoloLens, the delivery of the 7-nanometer DDR IP to our top-tier Asia Pacific customer. Q4 highlights included a large design IP contract with a Japanese customer, primarily for automotive applications, and adoption of our data center IP by a large U.S. semiconductor company. On the organization front, I'm sad to report that Peter Vollenkemp recently left Cadence in order to spend more time with his family after the death of his son last year.
We were fortunate that Babu Mandava, a long-time colleague of mine, could step in as a Senior Vice President and a General Manager of the IP group. Babu has been a CEO and held multiple senior operating roles at semiconductor companies. I am confident Babu will drive scalable, sustainable, and profitable growth for our IP business. Finally, I'm pleased that Geoff Ribar has decided to extend his retirement date by a year. Geoff is an accomplished CFO and important business partner to me, and an invaluable leader at Cadence. Before turning over to Geoff, let me quickly summarize my comments. 2016 was another great year for Cadence, and we are well-positioned for 2017. System design enablement is expanding our opportunities beyond EDA and extending our customer reach. Our digital and sign-off tools are well on their way for advanced node design with market-shaping customers.
Customer enthusiasm for the Palladium Z1 led to a record year for hardware. Our refined IP strategy set us up to drive scalable, profitable growth. Our next-generation tools are helping customers succeed and are solidifying our position as a leader for custom analog and mixed-signal design. There are macro challenges ahead, but also opportunities specific to Cadence. Through innovation and execution, we are positioned to build on our success and to further proliferating our solutions with market-shaping customers. I will turn the call over to Geoff to review the financial results and provide our outlook.
Thanks, Lip-Bu, and good afternoon, everyone. 2016 was a great year for Cadence all around. We delivered strong innovation, customer successes, execution, and robust financial results. Overall, we are in a good position as we start 2017. Key results for Q4 in 2016 were total revenue of $469 million for the quarter and $1.816 billion for the year. Non-GAAP operating margin was 27% for the quarter and 26% for the year. GAAP net income per share was $0.14 for the quarter and $0.70 for the year. Non-GAAP net income per share was $0.34 for the quarter and $1.21 for the year. Operating cash flow was $197 million for Q4 and $445 million for the year. Stronger than expected collections in Q4 drove operating cash flow upside. Note that bookings were $2.057 billion for 2016. Weighted average contract life was 2.6 years for both Q4 and 2016.
The recurring bookings and revenue mix was approximately 90% for 2016. DSO at the end of the year was 33 days, down one day from Q3. Primarily due to the end of life of Palladium XP, we recorded an inventory charge of $13 million for Q4, following a charge of $5 million in Q3. As part of our ongoing efforts to operate efficiently and effectively and optimally allocate resources, we undertook a restructure in Q4, which resulted in a charge of $26 million. This included the cost of voluntary retirement program that we announced on our last earnings call. Earlier this week, Cadence entered into a new five-year, $350 million senior unsecured revolving credit facility with a group of lenders. This credit facility replaces the $250 million facility originally entered into in December of 2012.
We also completed our $1.2 billion stock repurchase program in Q4 with the purchase of 9.3 million shares of stock for $240 million. Over the course of the program, we repurchased a total of 51.9 million shares, about 18% of shares outstanding at the start of the program. Also this week, the Cadence Board of Directors renewed its commitment to optimizing capital allocation and shareholder value by authorizing the repurchase of $525 million of Cadence stock. The actual timing and amount of repurchases will be subject to business and market conditions, corporate and regulatory requirements, acquisition opportunities, and the other factors. Now let's turn to our outlook. For fiscal 2017, we expect revenue in the range of $1.9 billion to $1.95 billion, which would be 6% growth at the midpoint.
Non-GAAP operating margin of approximately 27%, GAAP EPS in the range of $0.89 to $0.99, non-GAAP EPS of $1.32 to $1.42, and operating cash flow in the range of $430 million to $470 million. For Q1, we expect revenue in the range of $470 million to $480 million, non-GAAP operating margin of approximately 25%, GAAP EPS in the range of $0.19 to $0.21, and non-GAAP EPS in the range of $0.30 to $0.32. Approximately 90% of revenue is expected to come from beginning backlog. You will find guidance for additional items in the CFO commentary. I want to add a few additional comments on outlook. Bookings for 2017 are expected to exceed $2 billion, with a weighted average contract life of 2.4 to 2.6 years. Going forward, we do not intend to comment on bookings or weighted average contract life.
We introduced bookings guidance in the early days of the license model transition, but the model has now been mature for several years. Retaining flexibility over the timing of bookings will facilitate our goal of driving consistent, scalable revenue growth within the context of stable revenue recognition model while preserving the quality of bookings. I also want to remind you, as in the past, that the hardware and IP have become a larger portion of our business. There may be more variation in quarter-to-quarter results. I want to conclude by talking about my own plans. As you know by now, I'm extending my retirement date until March 31, 2018. Cadence is very important to me, and I decided that I wanted to continue to partner with Lip-Bu for another year as we drive the company forward towards our goals. With that, Shannon, we'll now take questions.
At this time, I would like to remind everyone, in order to ask a question, please press star, then the number 1 on your telephone keypad. We will pause for a moment to compile the Q&A roster. Your first question comes from the line of Farhan Ahmad from Credit Suisse. Your line is open. Please go ahead.
Hi. Thanks for taking my question. Lip-Bu, can you provide some color on growth by difference end market segments that you expect between your functional verification digital IC in this year?
Yeah. Farhan, I think your question is the growth on the functional verification and the digital side. I think overall, I think I will give you the high level, then Geoff can provide you more detail. Far in term of our verification side, we are doing well, and this is the fastest-growing for our customers Our verification suite, that as I mentioned in my script, now we have Incisive in simulation, JasperGold for formal verification, Palladium for emulation, then the Protium for FPGA. Just let me address one by one. First of all, I think the JasperGold, as I mentioned, we have a record revenue in 2016. This is a segment leader and is very well received by the customer.
Our simulation, Incisive right now with the Rocketick's integration has done very well, and the key customer in the early adopter engagement have been very positive. They see tremendous simulation speed up with the multi-core parallel simulation. I think stay tuned. I think that one we should do very well. Hardware, we have a record in our first year, full year in the market. We mentioned couple of 29 new logos. 11 are system company. We mentioned couple of leading semiconductor company, include Cavium, Innovium. I think overall, we are very excited about this whole verification suite that we provide, and it's really critical for our customers, so we are excited about it. On the digital front, I think we are doing really well.
I mentioned to you, we are really focused on the top 20 customers, and that we see the more than 20% growth in these customers. Overall, our sign-off and digital are growing at the 9% for the year, and we expect additional proliferation in 2017. We mentioned about 16 of the top 20 semiconductor already embrace and adopt Innovus. 4 of the top 5 mobile chip designer, then they are using us. Also we are very proud in our performance on the large GPU design. We also highlight the Qualcomm enter a very important agreement with us in the expanded commitment to the Cadence. I think overall, the digital, all the investment we make, and now we are starting to see the payoff, and the proliferation will accelerate in 2017.
A little bit of color. We don't guide specific key questions, but a little bit of color perhaps. We do expect good growth across our core software business, especially in digital and sign-off. We expect IP to rebound and have at least 10% growth. We expect another strong year for hardware, but want you to recognize we're coming off a phenomenal year with record revenue, meaning that the year-over-year comps may be difficult in hardware.
Got it. Lip-Bu, can you talk about maybe VR and AR and the role that your IP is playing in HoloLens and how big of an opportunity do you see that growing for you over time?
Yeah. We are excited about this whole AR/VR. I mentioned couple of area that we are double, triple down on it. Now clearly, the AR/VR is a very important area. Then clearly the machine learning is very important. Then those actually, the Tensilica and couple of our tool can really is helping our customer to design the best product. Then so on the AR/VR, clearly this is emerging the whole experience, for not just entertainment, like the gaming or entertainment like games, the live game broadcast. Also I think for education, for multiple applications. We are seeing that quietly building up. Then Tensilica being the programmable low power and the engine, that turned out to be very useful for that. Then same thing for the machine learning. Then the other part in this whole AR/VR, audio play a very important role.
Then we have the kind of industry-standard audio, that can be really exciting. Then you touch a little bit about the Microsoft. We are very happy they announced they are using 24 Tensilica processor for their HoloLens, and then they are making good progress in the marketplace. We're excited about it.
Thank you. That's all I have.
Thank you.
Your next question comes from the line of Monika Garg from Pacific Crest. Your line is open. Please go ahead.
Yes. Hi. Thanks for taking my question. Geoff, first, this new revenue recognition model. Maybe can you talk about when do you expect to implement it and any impact to your current revenue recognition model?
Yeah. I'll start. We do expect to retain a recurring revenue treatment, but we're currently working through the details of the new standard with our advisors to determine how we will implement it and what impact, if any, it will have. There's still a lot of work to do, so stay tuned.
Any initial assessment, do you think it could impact your model or not?
Yeah, again, we expect to retain recurring revenue treatment, Monika.
Got it. Okay. A couple of months back, Siemens announced acquisition of Mentor. Maybe could you talk about how do you see that impacting the EDA industry and Cadence?
Sure. This is Lip-Bu, Monika. I think clearly Mentor is a good competitor and it will remain the important competitor. We are not the place to comment or speculate, as they are pending for transaction. One thing that highlights the importance of SDE and then the EDA is part of that SDE system design enablement. We are excited about that. It tie into our overall strategy in term of more supporting to the system company and some of the new vertical market that I highlight, like for example, in the military and defense, automotive and then some of this industrial application like IoT and machine learning across all the infrastructure in the cloud and the intelligent into the medical. I think they're going to be a lot of opportunity open up.
Got it. Just the last one. Customized design for two consecutive years has grown less than 5%. Anything particular there? Do you think customized design is a lower growth market than digital? Thank you.
Yeah. Custom analog as you know we are the leader. Clearly, when you have the positions, sometimes the growth is not going to be higher. We continue to drive the leadership, and then we drive the most advanced set of custom and analog. In fact, right now we also try to tie in with our strength in the digital side to provide the mixed signal solution to our customers. In fact, we have couple of new encouragement point in our adoption of our next generation product, the new Virtuoso suite. Actually, it's ahead of our expectation, and we are very pleased with that. Also adopt by over 100 customers.
The other part is that the Spectre XPS, our new FastSPICE simulator. Now we have over 70 customer on the SRAM side. Now we're starting to apply and expand into the mixed signal side. I think all I can highlight is that, we have a strong position. We continue to drive the leadership on that. The other part is, we also drive some of the new emerging opportunities like IoT, automotive, and then the mixed signal application that we can really drive, continue the leadership.
Got it. Thank you so much.
Thank you.
Your next question comes from the line of Mitch Steves from RBC Capital Markets. Your line is open. Please go ahead.
Hey, guys. Thanks for taking my question. I just had one kind of on the actual systems side of the business. So far, just based on your comments, sounds like R&D spending hasn't really been impacted by consolidation, so the semiconductor piece should be fine. How do we think about the systems piece in terms of how that growth rate is comparing on a relative basis to overall semiconductor R&D spend?
Yeah. Mitch, let me try to answer that. That is why I think it is important to understanding our system design enablement strategy. This is expanding beyond our EDA towards the expanding to also the system company and some of the new vertical that we are pursuing. Just like we did in the semiconductor side, the ecosystem partnership become very important. Like, for example, in the semiconductor side, in the early day, we are very focused on Arm, we are very focused on TSMC. Same thing, we are starting to very focus on networks that we announced on the system level design and circuit level implementation, Arrow Electronics, and then some of this packaging become very important with TSMC. Some of the vertical we are pursuing, couple of them we highlight is the aerospace and the defense.
With our expanded partnership with the Northrop Grumman and the BAE Systems, continue stay tuned, we will tell you more. Also our expanded partnership with the GE Aviation side. On the automotive side, we highlight a couple of pointers to you. Mobileye engaging with us on the Palladium Z1, Infineon engaging with us on the automotive function safety. Some of this enablement in term of automotive application on the TSMC 16 nanometer FinFET. We have a dedicated team right now on the automotive and the aerospace and defense. We also highlight some of the IP engagement with the Japanese customer on automotive application. Data center is another area that we are focusing on. Beside our data center IP, our hardware, with Cavium, Innovium and the engagement. I think stay tuned.
I think over time we are going to kind of show you how we are going to expand that strategy. Some of that strategy, I think we highlight, not just new area actually is enhance our core EDA to drive even more adoptions, leverage on some of the refined IP strategy that we focus on, to drive some of the success in the expanded ecosystem.
Just a little bit, Mitch, on the numbers. The systems business is approximately 40% of our business. It has expanded our TAM, and it is growing nicely.
Okay, got it. Thank you very much.
Thank you.
Your next question comes from the line of Krish Sankar from BofA Merrill Lynch. Your line is open. Please go ahead.
Yeah. Thanks for taking my question. I had a few of them. First one either Lip-Bu or Geoff, I'm just trying to understand on your guidance, is there a way you can quantify the negative impact from the semiconductor customer consolidation and the positive from your share gains and product traction? Or is the impact of semi consolidation overblown that it's really de minimis? I had a few follow-ups.
Yeah, Krish. It's really de minimis, had minimum impact on the revenue from consolidation. Again, I think there's also opportunities that come from consolidation to us that are harder to track for 2017, right? It's de minimis for 2017.
Got it. A couple of other questions. One is, your hardware business, I'm guessing that includes emulation and FPGA prototyping. Is there a way to quantify the market size in 2017 for each of those two categories?
I think it's kind of hard. I think what we've generally said is both of these businesses are growing because of a secular trend, which is benefiting the whole industry. Certainly as you saw, we had a record year last year in hardware, particularly driven by the Z1.
In some way, for the advanced node complex silicon and systems design, hardware emulation is very critical. That they can shipping the product faster because whatever they design, they can verify much closer. This hardware-software co-design, co-verification is really the bottleneck. We're going to see continued growth. Palladium Z1 is really enterprise class. People love it. The customer, when they're starting to use Palladium, and they just find they want to buy more because the capacity requirement, the benefit they receive, and then time to market improvement is tremendous value to them, and that's why we see very good growth for us.
Got it. The final question, the operating margins expanding about 100 basis points this year. Is it primarily a function of some of your digital investments winding down now that you're getting the traction, or is there something else going on that actually, high 20s, 30% op margin in the future is probably a reality?
Glad you noticed that our operating margin improved by 100 basis points. I think it's less that we are continuing to make investment, but I think we're seeing the results of the investment show up with extremely strong digital growth last year, particularly in Q4, and we expect that growth to continue into the next year. Plus, the results from all the rest of our businesses rolling in.
Geoff and I, we continue to drive the productivity, efficiency, and to drive success and then scale the business.
Got it. Thanks, guys. Thank you.
Thank you.
Your next question comes from the line of Jay Vleeschhouwer from Griffin Securities. Your line is open. Please go ahead.
Thank you. Good evening. Lip-Bu and Geoff, you noted a couple of times that semi consolidation had had a minimal impact, and that in itself is not too terribly surprising. The question really is when we consider actual levels of semi R&D, is there some rate of growth that you think you do need to see to sustain your growth in EDA? The reason I ask is when we look at a composite of semi R&D, at least for the third quarter of last year, the latest data available, semi R&D does appear to have somewhat declined sequentially. Q1 through Q3 of last year was flat to slightly down year-over-year, not too terribly much. That helped you keep a minimal impact.
At what level of growth, if any, do you think you really need to see in semi R&D, setting aside systems customers, to sustain your core EDA growth?
Yeah. Jay, let me start first. I think now clearly our focus on the leading company, the top 20, when they do more and more consolidation, actually it's very interesting. They actually spend more money in R&D because they want to continue their leadership. By focusing on the right customer and really drive efficiency, drive the most innovating products to help them, I think we're going to see that opportunity for us. That's why I think the impact is minimum. Secondly, we are very well-positioned to getting greater opportunity going forward. Also, I think I mentioned earlier, the system company, the SDE strategy that we're pursuing, we get that.
Also, I think that China, the fabless semiconductor company, when are very determined to build a domestic semiconductor ecosystem industry, and we are well-positioned to work closely with those customer to help them successful. I think overall, I think we do the right thing focus with the right customer and engage heavily on the customer with the innovation product. At the end of the day, I always strongly believe the best product win.
Okay. Follow-up question is how you're thinking about some of your internal investment priorities for 2017 and beyond. When we consider your need to hire people or bring people on, one thing we noticed recently was an unusually large increase in job openings that you're looking to fill in Asia, much more pronounced than we've seen before. Again, that in itself is also logical given the importance of that market to EDA. How are you thinking about your headcount expansion plans, at least in that part of the world from a geo perspective and then from a product perspective? One other area that we noticed that you seemingly are looking to spend more on or add people in is synthesis, which is interesting too, because Synopsys seems to be doing the same thing and Mentor to some extent.
Perhaps you could talk a little bit about what's going on in the synthesis market that has otherwise been pretty flat as far as revenues are concerned for the last many years.
Jay, let me try to answer the R&D side, then Geoff can talk about the other portion in term of internal priority. From the R&D point of view, I think clearly we will continue investing in the digital and in sign-off because we are proliferating with the leading customers. Secondly, we're going to continue double down on some of the verification side because that's where the bottleneck on some of the customer shipment. In term of the digital front, I just go a little bit deeper and we are right now very focused on the full flow. Not just the place and route, the sign-off, synthesis is very important. We have a new product came out, very well received, and right now our priority focus is full flow.
There's a customer looking for full flow optimization productivity gain in term of the PPA, perform on power and area and the runtime so that they can drive their efficiency. I think that part we're going to continue to double down. The other part we are really exciting is the IP business, because the outsourcing trend is accelerating. Also the Tensilica, we talked a little bit more earlier in the machine learning. I'm a big fan of the machine learning and the VR/AR and then some of these infrastructure changes, that they're more programmable and they're more power efficiency, and that really play into the Tensilica strength. I think all in all, I think we have all the right elements.
I think the key challenge for us is really drive customer success recruit the best talent in the industry, outside the industry, globally, if we can get one, continue to do the innovation make sure the customer successful, in their timely fashion, in their design the tape out. I think that's our high priority.
All right. Lastly for Geoff on emulation. Your cost of revenue for product and maintenance increased sequentially by about $19 million from the third quarter. Just to be clear, $13 of that was due to the write-down for XP2, which perhaps has reached end of life now, therefore the remaining $6 or so would've been largely tied to a sequential increase in hardware from Q3, therefore there would've been a strong, by inference, sequential increase in emulation revenue for the quarter, possibly leading to a record quarter for hardware in Q4.
Yes. On the reserves, yes, we took a $13 million charge in Q4 for XP, not just XP2, but XP, right? As we're reaching the end of life of that product. That was on top of a $5 million in Q3. That was the major thing. We're not breaking out hardware beyond that in Q4. As we said, hardware was a record year last year, mostly driven by Z1.
Okay. Thank you.
Your next question comes from the line of Richard Valera from Needham & Company. Your line is open. Please go ahead.
Thank you. Lip-Bu, I was wondering how you would characterize the macro environment for your customers entering 2017 versus 2016. I know you mentioned that semis look a little bit better this year with at least some growth expected, can you just put in your own words how you think about the environment this year versus last year?
Yeah. As I mentioned, the environment, from what I see, is improved slightly. I think it's not in general. I think it's more sector specific from my point of view. The thing that I like, what I see and engage with the customer, I think automotive, as you all know, the ADAS, the self-driving, is a lot of excitement going on right now. The AR/VR, there's a lot of whole suite of new player coming up. The cloud infrastructure, that's something that I'm very dear to my heart. Clearly, the scalability of the hyperscale web services, they're driving the new changes. In term of more programmability and more scalability, in term of the storage requirement.
Of course the IoT, not just the consumer IoT, a lot of industrial IoT to drive productivity and to drive efficiency and more intelligent and machine learning, deep learning on the cloud and on the edge. There's a lot of a new changing landscape and of course the whole aerospace and defense application and the requirements. Those I think are going to drive the 2017 semiconductor growth. I'm excited about it. I think Cadence are well-positioned to capture some of this. Clearly they are driving some of the most advanced nodes and design. Also they're looking a holistic approach, from just design all the way to verification, to the PCB board packaging design, all the way to the system hardware, software design and verification. I like what we have in our portfolio.
All right. Thank you for that, Lip-Bu. A question for Geoff. First, glad to hear you'll be staying on for another year, Geoff. Question, just wanted to revisit the operating margin. It is nice to see that you're guiding for about a percentage increase this year. Just wondering, going back a ways, there was a point when you guys talked about kind of a target incremental operating margin. I know you kind of got away from that as you got into the investment mode here. Is there any thought of getting back to that sort of target as you move forward? Some kind of target for leverage in the model, or are we going to kind of play this year by year?
Yeah. Our strategic priority, Rich, remains to develop innovative products and to derive customer value, customer success. That remains our concentration. As you noted, we started guiding 2015 at 25%, 2016 at 26%, and this year at 27%. We are seeing the impact of those investments working out. I think that's a positive. We're concentrating on a strategic priority, which is innovative products.
Got it. Just with respect to the written-down emulation product, if you sell that product, are you guys going to call that out in your COGS? I mean, essentially you have sort of zero cost inventory, I guess, now?
Yeah, if we happen to sell stock, it would be largely at zero cost. We also have maintenance requirements going forward on the XPs that are out there in the field. That will also consume some inventory. If we're selling at zero COGS, as you know, the SEC requires you to disclose how much was sold at zero COGS. We'll let you know.
Okay, very good. Thanks very much, gentlemen.
Thank you.
Our final question comes from the line of Sterling Auty from J.P. Morgan. Your line is open. Please go ahead.
Yeah, thanks. Hi, guys. I wanted to drill into first the 20% growth with the top 20 semi companies. Is there additional color you can give us in terms of how much of that was expanding usage by more design teams versus taking down additional tools, versus selling to new, maybe top 20 that you weren't doing as much or maybe any business with previously?
Yeah. Sterling, let me start first. Clearly, we are excited in our investments starting to pay off now. I think clearly in terms of our entire new suite of tools that we develop, and clearly customers see the benefit in terms of the performance, power area, and runtime, and it can help them to drive these complex design. The top 20 semiconductor companies, plus several top-tier system companies are really adopting our Innovus. Right now we are working closely with them in terms of full flow design. That is very important so that they can really count on us to design their most complex chip and can be fabricated in the most advanced node, the 10, the 7 nanometer, and towards later on to the 5 nanometer. I think overall, they basically start with work with us and then adopting some of our tools.
Now we are starting to not just a couple of projects. Now there are some group of the design and either is a CPU or either is a GPU or either specific SOC, that they are starting to adopt, making us as a standard for the design. That is huge for us. Right now, there is baseball terminology. We are in the third inning now, and then the fourth and fifth inning will be really driving the success in terms of fully proliferate across all their engineering teams.
Got you. One follow-up would be, Geoff, I think the non-GAAP R&D expenses dropped sequentially more than I've seen, in my memory anyway. Was that just the timing of the restructuring, or what other items drove that? Is there any snapback that we should expect in that R&D spend in the first half of 2017?
A couple things always happen in the later half of the year for us, Q3 and in Q4. First is, the Social Security goes down, and frequently to zero as people go over the Social Security cap. Second is the vacation time goes up in the second half of the year, both in Q3 for the summer and in Q4 for the holidays. Those two, obviously, are the biggest drivers, and you should expect some snapback in R&D in Q1 as a result.
Got it. Thank you, guys.
Thank you.
I would now like to turn the call back to Mr. Lip-Bu Tan for closing remarks.
In closing, 2016 was a year of great success, and 2017 present us with exciting opportunities. I would like to thank all our shareholders, customers and partners, board of directors, and hardworking employees for their continued support. Thank you all for joining us this afternoon.
Thank you for participating in today's Cadence Design Systems fourth quarter and fiscal year 2016 earnings conference call. This concludes today's call. You may now disconnect.