益華電腦 (CDNS) 2015 Q3 法說會逐字稿

Good afternoon, my name is Mike, and I will be your conference operator today.

At this time, I would like to welcome everyone to the Cadence Design Systems' third-quarter 2015 earnings conference call.

(Operator Instructions)

Thank you.

I will now turn the call over to Alan Lindstrom, Senior Group Director, Investor Relations for Cadence Design Systems.

Please go ahead.

Thank you, Mike, and welcome, everyone to our third-quarter 2015 earnings conference call.

With me today are Lip-Bu Tan, President and CEO, and Geoff Ribar, Senior Vice President and CFO.

The webcast of this call can be accessed through our website, Cadence.com, and will be archived through December 18, 2015.

A copy of today's prepared remarks will also be available on our website at the conclusion of today's call.

Before I start, I want to call your attention to our new CFO commentary, which was included in our 8-K filing today, and is available on our Investor Relations website at Cadence.com.

Since we have provided the CFO, Geoff's prepared remarks will be streamlined, and certain metrics not discussed in today's call, including historical comparisons will appear in the CFO commentary.

The CFO commentary should be referenced in conjunction with both today's conference call remarks, and the earnings press release issued today.

Next, please note that today's discussion will contain forward-looking statements, and 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 the non-GAAP financial measures with their most direct comparable GAAP financial measures, 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 October 26, 2015, for the quarter ended October 3, 2015, and 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 and thank you for joining us today.

Cadence delivered strong operating results for Q3:

Revenue was $434 million, up 8% year-over-year, non-GAAP operating margin was 27%, above the high end of our guidance range.

Non-GAAP EPS was $0.28, also above the high end of our guidance range, and operating cash flow was $87 million, which keeps us on track for our guidance of $360 million for the year.

Let us first address the environment.

Semiconductor business conditions remain challenging, and lower semiconductor growth for the year now appears likely.

As we reported last quarter, we remain mindful of the ongoing consolidation in our semiconductor customer base.

While we do not expect a material impact on our business near-term, consolidations could pose a challenge to industry growth over the next few years.

Now let us turn to the Q3 highlights.

Our System Design Enablement strategy continues to create new vertical opportunities.

In Q3, we signed a significant contract with GE Aviation for IP, hardware and system-level design services.

A biomedical technology company adopted our low-power mixed-signal design flow.

We became the provider for the functional verification environment of a leading automotive chip supplier.

And a global automotive supplier significantly expanded its contract for functional safety verification to reduce their effort for ISO 26262 compliance.

In the digital and sign-off space, the theme for this quarter was continued innovation, adoption, and proliferation of our new products.

We expanded our digital footprint across multiple growing industries, and across multiple process nodes.

We now have over 30 customers using the Innovus implementation system for their advanced-node production designs.

This includes seven of the industry's top ten semiconductor companies, where our digital implementation position has increased significantly.

In just three months since its launch, the Genus Synthesis Solution has already been purchased by multiple customers, with many more in evaluation.

Cypress Semiconductor is standardizing on the Cadence full digital flow and Spectre XPS for full custom verification for their next-generation 40-nanometer mainstream products.

Innovation continued with the introduction of another new digital product, the Joules RTL Power Solution.

Joules delivers time-based RTL power analysis 20 times faster than previous solutions.

One of our most exciting announcements of the quarter was that the nano-electronics research institute, IMEC, and Cadence completed the tape-out of the world's first 5-nanometer test chip using EUV, combined with 193 immersion lithography and quadruple patterning.

In signoff, our Tempus Timing Solution surpassed 200 tape-outs, while the Voltus Power Solution and Quantus Extraction Solution continued to add new customers.

Cadence earned a Partner of the Year award from TSMC for joint development of the 10-nanometer design infrastructure.

IP is a fast-growing part of our business, is one of the key tenets of our System Design Enablement strategy.

The new Tensilica Vision P5 fourth-generation imaging DSP was introduced in Q3, with significantly improved capabilities and performance.

The Vision P5 already has a major design win, and we believe the Vision market presents a huge opportunity, especially in mobile, ADAS, and IoT applications.

Design IP had the best quarter ever.

Two major customers, a systems company and a semiconductor company, have adopted our 14/16-nanometer multi-protocol SERDES PHY for production designs.

Ours is the first multi-protocol SERDES PHY at this node.

We also released a broad portfolio of design IP for TSMC's 10-nanometer FinFET process, for which we already have secured multiple design wins.

We received a TSMC Partner of the Year award for analog/mixed-signal IP.

Now, let us turn to system design and verification.

Verification remains the fastest growing challenge for our customers, who must deliver functionally correct products, within ever tighter market windows.

Addressing the verification problem requires a holistic approach, with the integration of multiple complementary products, which we provide with our System Development Suite.

The Suite had an all-time record quarter in Q3, driven by growth in North America and China.

The exciting news for hardware is that we have begun shipping our next-generation emulation platform.

Purchases of Palladium XP II, the existing platform, continued at a good pace in Q3, with strong sales to systems companies.

Sales of Protium, our FGPA prototyping platform, ramped significantly in Q3.

Formal verification had a very strong quarter.

A large systems company renewed and increased its JasperGold capacity by 50%.

This was our largest order ever for formal verification.

As companies in China move towards the leading edge, they are adopting formal technology, and in Q3, we had our largest formal verification order so far in China.

Our system interconnect business, which includes PCB, Sigrity system analysis and IC packaging tools, again delivered strong growth, with revenue up 9% year-over-year.

Our Allegro System-in-Package technology now supports TSMC's Integrated Fan-Out packaging technology, also known as InFO.

InFO advanced wafer-level packaging technology provides cost-effective system scaling to increase bandwidth, and will be an ideal solution for mobile and IoT applications.

In summary, Cadence continued to deliver strong operating results in an environment that remains challenging, The System Design Enablement strategy is bringing more innovation, and an increased vertical focus to our business and solutions.

In digital and signoff, we saw continued innovation, adoption, and proliferation of our new products.

We are steadily introducing new products and gaining customers in IP.

We have started shipping our next-generation emulation platform.

And our PCB, system analysis and packaging solutions posted another strong quarter of growth.

Now I will turn the call over to Geoff to review the financial results, and provide our outlook.

Thanks Lip-Bu, and good afternoon, everyone.

As Alan mentioned at the start of our call, we introduced our CFO commentary this quarter.

As a result, I will be focusing on the quarter highlights and operational drivers in my prepared remarks.

You will find all of the numbers in the CFO commentary, which are included in our 8-K filing today, and is also available on our website.

The CFO commentary should be referenced in conjunction with both my remarks and the earnings press release issued today.

Now for the Q3 results.

As Lip-Bu discussed, the environment remains challenging, and the pace of customer consolidation seems to continue unabated.

So I am especially proud of the way we have been able to achieve good results in this environment.

Total revenue was $434 million, up 8% year-over-year.

Revenue exceeded our expectations due to the timing between Q3 and Q4 of certain transactions.

As Lip-Bu said, we began shipping our next-generation emulation platform.

We expect to begin recognizing revenue in Q4.

Total costs and expenses on a non-GAAP basis were $316 million, up 9% year-over-year.

As previously discussed, the growth in expenses this year reflects the investments we are making in R&D and technical customer support.

Non-GAAP operating margin was 27%, unchanged from 2014.

Results exceeded our expectations due both to higher revenue and better expense management.

GAAP net income per share was $0.25.

Non-GAAP net income per share was $0.28, up 8% year-over-year.

In addition to higher revenue and better expense management, lower than assumed interest expense contributed to the better than expected non-GAAP EPS.

Operating cash flow was $87 million, compared to $88 million for Q3 2014.

Cash and short-term investments were $711 million at quarter-end, compared to $744 million at the end of Q2.

DSOs were 28 days.

Our new stock repurchase program is off to a strong start.

We repurchased 5.9 million shares of stock in Q3 for $120 million.

Our program target remains $1.2 billion by the end of 2016, and we expect the pace of repurchases to pick-up in Q1 2016, after the final settlement in December of the warrants associated with the convertible debt we retired in June 2015.

Now let's turn to our outlook for the fourth quarter.

We expect revenue in Q4 to be in a range of $434 million to $444 million.

This expectation takes into account the timing of certain transactions between Q3 to Q4.

Also please recall that Q4 2014 included an extra $15 million of revenue, due to the extra week in our FY14.

This is also a good time to remind everyone that while our software and maintenance revenue is highly predictable, revenue for both hardware and IP is lumpier, which may contribute to increased variability in quarterly revenue as these businesses grow.

Non-GAAP operating margin is expected to be in the range of 27% to 28%.

GAAP EPS for the fourth quarter is expected to be in the range of $0.20 to $0.22.

Non-GAAP EPS for the fourth quarter is expected in the range of $0.28 to $0.30.

Now for our FY15 outlook.

Bookings are projected to be in the range of $1.87 billion to $1.93 billion, unchanged from last quarter.

Revenue is expected to be in the range of $1.695 billion to $1.705 billion.

The midpoint is unchanged from last quarter, and hardware revenue is expected to increase in 2015 compared to last year.

Non-GAAP operating margin is expected to be in the range of approximately 26% to 27%.

This is up from our prior expectation of 25% to 26%, due to strong execution and expense management.

As we discussed last quarter, remember as you think about next year that our investments in hiring for R&D and technical customer support have ramped throughout the year and will continue to do so in Q4.

Hence, we will exit 2015 at a higher expense run rate than where we are at present.

GAAP EPS is now expected to be in the range of $0.75 to $0.77.

Non-GAAP EPS is now expected in the range of $1.06 to $1.08, which is up $0.07 at the midpoint from our initial guidance for 2015, due to strong execution and expense management.

We expect operating cash flow to be approximately $360 million, unchanged from last quarter.

You will find additional guidance for the additional items in the CFO commentary.

So with that, operator, we'll now take your questions.

(Operator Instructions)

Gary Mobley, Benchmark.

This is my first question on your call so hopefully I don't ask it in the wrong way, or offend anybody.

But I wanted to start out by asking about the sequential decrease in deferred revenue, is there anything to read into that as far as customer licensing activity?

No.

For us, deferred revenue is really just cash that we have collected upfront, and we work very hard to match our cash collections with our revenue, so that's nothing, it's just the normal variability with that.

Okay.

Appreciate the fact that you haven't changed your outlook for total bookings for the year, but have you have seen any early indication as to how your customer consolidation in particular on the semiconductor side has impacted the licensing pipeline?

Whether it be shorter license duration, or maybe just in general hesitation on your customers part to commit to licensing activity?

This is Lip-Bu.

Let me start.

Clearly, the environment, the semiconductor business conditions continue to be challenging, as I mentioned.

Clearly, the softer semiconductor growth for the year similarly.

Saying that, I think clearly the ongoing consolidation in our customer base will continue.

They potentially will have challenges in the longer term.

We do not expect any material impact in the short term, and so overall, I think we see consolidation will continue, and the pace will continue, but meanwhile, I think it is a great opportunity for us to continue driving new product, new solutions that meet the customers' challenging requirements in terms of design.

Also, we see a new breed of system Company that are engaging heavily with us.

That's a great opportunity in some of the verticals.

So overall we don't see any significant change in some of their behavioral patterns?

Geoff?

Appreciate the response, and as an extension to that response, I'm not asking you to name any specific licensing opportunities with the system OEM, but can you share with us your opinion as to how the consolidation in the semiconductor industry might increase verticalization amongst your system OEMs?

In other words, taking on more responsibility for SOC designs as a part of overall system design, and how that impacts your business long-term?

Good question.

Let me try to answer.

So clearly I think the consolidation, the increase in the system OEM, the system Company, those are great opportunities for us, because we have a whole suite of product and offerings that has met that requirement.

So first of all, I think clearly our much improved digital flow, we can talk more about it.

And then secondly our custom analog will then continue to be moving to the advanced node.

And then our IP portfolio has been increasing substantially and in the system engagement and also our PCB security system analysis hardware-software co-design, co-location.

So we call it the System Design Enablement that we provide, turned out to be a very welcome solution from the system company.

They want to look at the entire stack, besides the [two], besides the IP and also the hardware-software design, so that time-to-market will be critical success and we have a key solution they're looking for, and that's something that we are very excited.

Okay.

That's it for me, thank you.

Rich Valera, Needham & Company.

Thank you.

Lip-Bu, I just want to clarify your comments on the impact of M&A.

So you are saying you are not seeing anything short-term.

What is that you are thinking you're going to see long-term?

Are you just saying it could be headwind the industry in general?

I just wanted to clarify what you were saying about the longer-term potential impact from semiconductor M&A?

Sure, I think it is a very good question and clearly as I indicated earlier, we don't see any short-term behavior changes.

But I think it is more the impact in the longer term.

The main reason I'm saying that is because the longer-term, the EDA is complex, very difficult to predict.

But we are clearly seeing that more consolidation and the customer has a greater economic power, and that also has the engineering synergy that will result with fewer ED assists.

Saying that, clearly there's great opportunity for us when we have the whole portfolio of solutions that we can provide them.

To them it's very important time-to-market, that help them to solve their most complex design in the 16, 14, 10, and 7 nanometers.

And we believe we have the right solution, the best product in the marketplace to provide the solution for them to make their time-to-market challenges.

Especially the hardware software packaging system design envelope, that can analyze and the power is critical, and some of the massive parallel is critical for their success and that's where we tend to shine.

Great, thank you that.

Had a couple questions on your emulation box, shipping the new box, congratulations on that.

One, just wanted to get a sense of how you see the manufacturing ramp for that going, where you stand with your contract manufacturing partner, are they up to speed?

And how you think that trajectory goes?

And then if you could talk at all about what kind of order book you have for that new box, and when do you think you maybe catch up with that production, assuming you do have some backlog already built up?

Good question.

We are extremely pleased with Q3 that we were able to have begun shipping our next generation innovation platform.

We expect to recognize the first revenue in Q4, and we are delighted to see the bookings picking up, and so I think as we expected and predicted, that we organize the team with a very strong operation, manufacturing with contract manufacturing in place, so this time around we are able to scale more efficiently.

So I think to answer your question, we have the right management team in place for the manufacturing brand, and the orders coming in very nicely and we are happy with that, and our first recognition of revenue in Q4.

And this revenue is expected revenue is already included in our guidance.

Great.

Geoff, would you be willing to say anything at this point?

One, I'm guessing, though, but would you say if you think emulation revenue is up sequentially in Q4 versus Q3, and then any thoughts on emulation revenue in 2016 versus 2015 at this point?

Sure.

The things that we've said is we expect emulation revenue to be up in 2015 versus 2014, which we already said.

At this stage, we are not ready to guide 2016, of course, we will do that in Q4, as well.

Okay, that's it for me, thanks gentlemen.

Jay Vleeschhouwer, Griffin Securities.

A couple of short-term product questions first.

Following up on Richards question just now about emulation.

For the business to be up year-over-year, which you reiterated would be the case, would it be fair to say that in Q4 you would probably have to have a record quarter ahead of what you did with emulation in Q4 of 2012 and Q4 of 2013, to eke out something for the year?

The second product question is, at your CDNLive customer event in Boston early last month, it was mentioned that in October the month just ending of course, that Genus would become generally available commercially, and that you would ship a new version of Innovus 15.2, as well.

Could you talk whether either of those two events for Genus and Innovus occur?

I will take the emulation question.

I think what we are willing to say is 2015 is up over 2014 for emulation, and that's all we are going to say at this particular point in time.

Then on the digital question you have, and first of all, we are very delighted with our Innovus penetration, only six months since we launched the product, as I mentioned in my remarks over 30 customers using the Innovus for advanced node production design.

And that includes seven of the industry top ten semiconductor companies, and they have increased significantly with us.

So to answer your question on the Genus side.

Three months since launch, we have over 40 customers evaluating on our solution and then quite a few of them already have multiple purchase with us, and we are delighted with the progress that it is making.

And then the fact, we are really excited is the IMEC of the 5-nanometer test chip using Innovus.

So Innovus is clearly proliferating very rapidly, across all the top customers, and we are delighted to hear that.

So I think all in all, I think clearly we're able Innovus has mentioned 2.0, we don't ever stop, we continue to work on it, and the time how we are going to launch, we will announce that.

But so far we continue to really see it is well received by the customer in the most advanced nodes, and stable performance that is really working well for customers and proliferate across all the product line, all the engineering team.

Okay.

Maybe we can talk about the issue of semi customer consolidation in the context of EDA consolidation.

Over the last number of years, as you know, EDA has become increasingly consolidated, the big three including yourselves.

You now have well over 80% of total industry revenue.

Wasn't that long ago, about 75% or so.

So your increase in consolidation has occurred as your customers have become increasingly consolidated, but now the question becomes, how much more consolidation can there be in EDA to perhaps help offset the consolidation among your customers?

When you break down the remaining, let's call it $900 million or so of EDA revenue that is not Cadence, Synopsys and Mentor, four or five companies account for the bulk of that.

Ansys, Zuken, Keysight.

Altium and of course, [Trent] is gone now.

So that leaves you lots of little companies that probably wouldn't be all that material if you were to acquire them among the remaining non-big three companies.

So I guess the question is how are you thinking about further consolidation that would be meaningful from a revenue and technology standpoint for you in EDA, and perhaps where does that lead you to perhaps doing something outside of EDA, as Synopsys has done with Coverity?

Good question, and clearly our customers are consolidating, but this is a great opportunity for us, as I mentioned earlier.

We continue to double down on our product development.

I'm very pleased and very proud of my team.

The last two years, we have 12 new products, organically developed.

And so clearly, we are going to continue driving the innovation culture within Cadence non-stop, and we continue to drive the innovation culture and development side.

And saying that, clearly we continue to look outside, and clearly the M&A, we really focus on the disciplined approach to our M&A.

We really have to fit our culture, our facility that we plan to build in that System Design Enablement strategy, we already laid out.

And clearly have to have a differentiated technology, and clearly we can bring in content management, CM, and then finding the talent that can augment our current team, and of course, they will providing the recent investment that is attractive to us.

So all in all I'm saying is that continued focus on our internal development, work closely with the Tier 1 customer, so we can learn from them and drive the solution that they need, and then get the technology using the M&A to augment and supplement our internal development where it makes sense.

So I think overall, we have a very balanced approach, and we review with our Board, with our management team, every investment, acquisition remains with the synergy and execute well for us, and we're not just buying for revenue.

We really focus on the product, the technology, and the customer needs.

Last one for me, if I may, for Geoff.

Would it be fair to say that the larger than expected revenues in Q3, owing to the timing effects, was related to IP, and specifically IP services engagements?

No.

I think what we're going to say is that there was timing of certain transactions between Q3 and Q4, that allowed us to exceed in Q3, and so keep the second half of the year unchanged.

Okay, thank you.

Gus Richard, Northland.

Yes, thanks for taking my question.

It looks like R&D expenses are coming down a little bit in the second half.

Is that a function of the maturing of your new digital tools that you are supplying?

If they are coming down, it is because of shutdowns and vacations and those types of things.

We are continuing to make investment, as I think I said in my prepared remarks, which will lead to our run rate and expenses being higher by the end of Q4 than they currently are right now, and certainly higher than they were at the beginning of the year.

Okay, got it.

Then in terms of the emulation product, can you just describe what triggers were in effect in the fourth quarter?

And you've obviously shipped some tools, are you waiting on customer acceptance, or how is that going to work for you since it is capital equipment?

Yes, I think again it is great news that we're shipping our next generation emulation platform.

We will recognize, we expect to recognize revenue starting in Q4.

There is, of course, acceptance criteria that has to be met for revenue accounting and hardware.

And after the first article, does that change going forward, and then it will be a little bit smoother in terms of recognizing revenue?

The acceptance criteria remains very similar.

Okay.

All right.

Could you just talk a little bit about the growth of overall EDA, as you see it over the next couple of years?

It looks like the core digital implementation has grown about 4%, is that what you think the industry growth rate is going to be?

How do you think you can do vis-a-vis that, in terms of market share?

Because of how we round in those schedules, it looks like it is 4%, but digital revenue was actually up 7% year-over-year, and as always, there's a lot of noise in quarterly revenue at the product group level.

So it's up 7% year-over-year, and we're, of course, not commenting on long-term EDA growth.

And Gus, just to add on to what Jeff mentioned earlier, clearly our customer is facing a lot of challenges in terms of the complexity of design, and then clearly when you move down the geometries of 14, 16, and then some of them are moving to 10 and 7, and clearly [double-trip what's happening in the EBIT], and EDA become so essential for the design, and that's where we see the opportunity we need to triple down in terms of some of our solutions that provide the needed solution at the end of Q4, and then we start looking for other opportunities.

Okay, got it.

Thank you to much for taking my question.

Monika Garg, Pacific Crest Securities.

Since you released the new emulation platform, could you maybe talk about how do you expect the benefits on the operating margins of the new platform?

Yes, obviously Monika, we are not going to be citing individual product categories and product gross margins at this stage.

Okay.

Then Geoff, you still have more than $1 billion left to your share repurchase which you announced last quarter.

Maybe, could you talk about how you plan to finance the same?

Sure.

We have been consistent in saying that the repurchase program we funded by US cash on hand, future US cash flow and additional debt.

Also there of course a lot of time between now and the end of 2016, and don't forget we have a $250 million undrawn credit facility also at this time.

We remain committed to the repurchase program.

Then the last one here, the service revenue has ramped in 2015 almost up 30% plus year over year, maybe you could talk about any particular reason for that?

No, services revenue is going to be just based on business demand and how business demand comes out, so we're quite happy with our business there, and are doing quite well with that business.

Got it.

Thank you so much.

Sterling Auty, JPMorgan.

Wanted to start with, can you actually quantify for us the timing impact in terms of the revenues?

So how much revenue came into the third quarter from the fourth quarter?

We kept the year unchanged, Sterling, I think that's probably the best way to look at it, right?

So how the numbers played out were based on timing between Q3 to Q4, but we are not going to specify which, how much.

Then there was a question a little bit earlier, but I just wanted to ask it this way, when you look at the last Palladium cycle, how me quarters does it take to get to either peak revenue or fully ramped revenue?

So I think that the key point is how we did in the last time, 2011 -- and 2010 and 2011 was materially different than we are at this time.

The cycle is clearly different, based on the fact that 2010 and 2011, we were coming out of the Great Recession.

We also had, when emulation first became a requirement, once you get under 40-nanometer.

So we expect this cycle to be different of course, than that cycle was.

We are seeing strong customer demand building a good backlog, and we expect healthy adoption rates, but we want you to keep that in mind.

Okay.

Then, can you give at least some qualitative color as to, you talked about the strength in the IP business in the quarter.

How much of that would have been stuff that benefited primarily the third quarter versus a lot of your IP business was still ratable as well, so how much benefit would we see in the fourth quarter and into 2016 from the strength in the IP business this quarter?

The IP business was up about 27% quarter -- or year over year, right, from the prior Q3.

That business is lumpy as I mentioned in my prepared remarks, and will likely continue to be lumpy.

There is some part that's recurring, and there's some part that is lumpy, and so the revenue will fluctuate more as we continue to grow that business.

So that's a little bit of a qualitative comment.

Hopefully that helps.

Okay and last one from my side, the warrant settlement in December, the last part, because there's been lots of questions around it, can you give just some color around what the logistics around that look like, in terms of how it settles, any cash impact, if any, et cetera?

Sure.

So the warrants would settle from the early part of September to the early part of December.

They are net share settled, so no cash involved with that, and potential dilution is already in the share count.

So I think those are probably the three -- the main points, Sterling.

Thank you.

Tom Diffely, D.A. Davidson.

Yes, good afternoon.

First I guess, Lip-Bu, is there some way you can give us a little more color on the capabilities of new emulation tool, as per the previous version or the competitive landscape?

Sure, clearly we continue to improve on our performance in the power and most important, clearly we will provide you more each year, when we announced the new platform.

Okay.

Is there a certain customer type or chip type that it is designed for initially, or is it a fairly broad all-encompassing?

Clearly, I think not just the semiconductor company in the high-performance complex design that need the [toggling agents] and since a company will really appreciate that, because they can find the box earlier, that can help them tremendously in their time to market so anything that's below 40-nanometer complex design, this is almost a must-have, and we have a good, strong footprint.

Clearly, our product development, or clearly our customer has exposed with, they love it, and so we continue to get their bookings.

Okay.

I guess switching gears then, when you look at IoT as potential driver going forward, obviously, there will be simpler chips with very high units.

How do you view IoT as a potential incremental driver for EDA?

Good question.

So I think clearly IoT is very exciting.

But I think it's a couple of factors that drive the growth.

One is IoT is connecting and collecting data and mostly it goes to the cloud, and so that whole cloud, big data infrastructure, and that is a real stronghold, and we are delighted in a lot of our digital and verification portfolio we can provide in helping our customers succeed on that.

On the IoT side, really the low-power is critical and also, clearly the IP block becomes very important to them.

We are now seeing the new Tensilica Vision P5, and so Tensilica being a programmable engine, clearly has a huge opportunity for IoT application, because it is something that you can programmable, and then see what sticks, and then providing the solution, the diagnostic or monitoring the data they can collect on a human being and go up to the cloud.

So that high-speed connectivity, wireless capability will be critical, so our IP design, IP benefits on it.

And then clearly our digital, a lot of those designs are mixed signal.

And so clearly the mixed signal analog becomes critical and of course, only to be within the power analog, and that's where our packaging becomes very exciting, and a lot of customers using our PCB, and also our system so that we are able to analyze the system, so we don't have to do this again, because you can predict and the performance more accurately and same thing for our Joules that can provide a whole power estimation that is critical for IoT.

So I think all in all, from this vertical mountain, we are very excited, because we are building up all the building blocks in, providing a solution for our customers.

Okay, and then how long do you think it takes for that to really get hot?

How long to get what?

How long until this market really is a robust market for you?

It sounds like you are putting all the pieces in place, but at what point do you think both the units and also the infrastructure is going to create a big business for you?

I think clearly, we are just in the early stage of evolution, and clearly if you look at the bids, and some of this Tier 2 from our whole watch, they are all starting into the floor of getting the data that can be useful for data analytics.

Frankly speaking, I think the business model needs to be clearer, in terms of my personal belief, that data analytics will be a big driver.

So I think you're going to say that proliferating very rapidly in terms of healthcare, in terms of the treatments.

And then over time people, are going to come out with a better solution to keep a smaller way of our -- being.

And also more connected to our community, our family members.

And to me, that is a very holy grail moment there.

And then the other part is also the IoT link up to some of the smart devices, connected device, and also of dumb devices can be connected.

So that low-power is critical, that's where I think Cadence solutions will be shining, and providing to the customer in the low-power environment, providing the latter targeting.

Okay.

That's helpful.

Then Geoff, over the next couple years, when you see an increase in your business moving towards IP and hardware, how do you view that impact on the margin structure?

So it is a good question, it's something we think about all the time, but right now, we are not guiding beyond 2015.

We will let you know a little bit more when we guide 2016 in the January, February timeframe.

Okay, thanks.

Mahesh Sanganeria, RBC Capital Markets.

Yes, thank you.

Geoff, you are increasing the operating margin guidance by 100 basis points, that's pretty significant.

So can you talk about a little bit what is driving that?

One of the things you talked about vacations and time off, or shutdowns.

Pretty sure that's not the only thing.

Is the timing of your projects are moving out, or what drove that upside?

No, I think the timing of our projects remain on track.

It has been strong execution, foreign exchange, and expense management have clearly contributed.

We will continue to ramp expenses in R&D and technical customer support through the year, and honestly into Q4 also.

So just remember that we will exit 2013 at the higher expense run rate than we currently are running.

Again, for us, it has been strong execution, thus far, foreign exchange and expense management.

Great and in terms of your expense trend, would you be done by end of 2015, or the pace will continue into 2016?

We are not counting 2016 at this stage.

Okay.

Then in terms of the revenue, if I look at the segment of course, there is rounding issues but this year you are doing strongest in IP of about 20%, and followed by functional verification more than 10%.

Is that how we should be looking at going forward, those are the long-term -- are those the strongest growth segments for you?

So again a couple points.

We don't guide individual segments, Mahesh, it is just that something we don't do, and clearly right now, we are not guiding 2016.

Stay tuned for January/February timeframe.

Okay, let me try asking a different way.

You talked about a significant market share, potential market share gain in digital design.

So the question is, when do we see that in numbers?

Is it something, because of the way you recognize the revenue, should we be seeing that two years down the road, three years down the road, when do we see those in the numbers, from the current growth rate?

There's always going to be a lot of noise in the quarterly revenue at the product level group, but fundamentally, winning and proliferating will precede the revenue growth and revenue ramp in digital.

Just to give you the numbers again, we were up 7% year-over-year in digital.

So quite happy with how we're doing.

Okay.

Thank you.

Krish Sankar, Bank of America.

I have two quick questions, one for Geoff.

On the mechanics of the buyback, would the warrants settling between September 10 and December 10, is it fair to assume the $120 million in buyback in Q2 was done before September 10, and any buyback in Q4 will start after December 10?

No.

No, Krish, we pretty much buy on a regular basis.

We do not want to have us being in the market impact the warrant settlement, but we pretty much buy on a steady basis, if not on a daily basis, when business is open.

Okay.

All right.

Another question for Lip-Bu, I think it has been spoken quite a bit now, but from a consolidation impacting, maybe in the long run, we're just trying to figure out if you look at it, some of these M&A deals that are being announced have not yet completed yet.

So is it fair to assume, based on the time lag, any impact on EDA budgets would be more of a 2017 event, not a 2016 event, is this the right way to think about it?

Yes, I think, good question, I think the consolidation, as mentioned earlier, is getting bigger and bigger.

And clearly we will spend carefully, and we are very proactive, so we continue to engage with the acquiring company and also the acquired company.

I mentioned that we have a very strong footprint going forward, and clearly some of this consolidation, the first thing they cut in order to drive efficiency is always G&A.

That would be obvious, and some on the engineering side, we watch carefully, in terms of how they are allocating and the resources.

That's usually the last thing they want to change, and by the by, there goes some of the engineering talent, you will grab somebody, because good talent.

I think keeping track of the talent, where they go to, make sure that we continue to engage and providing the solution.

So I think it to a hard and very complex to predict, but we keep a very close eye, and proactively, so we reach out to the acquired Company and make sure that we continue to increase our footprint in providing the best solution, and clearly they are going to drive some of their engineering synergy and immediately result in fewer EDAs, but hopefully not at our expense.

So hopefully we will continue to increase because we have a better solution for them, to design the most complex chip, and they can depend on us.

If I can squeeze in one last, how many contract manufacturers do you have for the current new emulation platform?

We don't provide that, and because from the competitive point of view, but we have a very strong leader driving the whole supply chain, and clearly, we have the whole mapping out, even though we started developing other products.

So we are very strong in terms of plan and execution, and I am very regular updates from him.

So I think clearly all in good places, and of course we are also managing the risks associated with managing the risk.

And so I think you can read between the lines, we have a very strong plan in place for the manufacturers.

Got it, thanks a lot, gentlemen.

Thank you.

Farhan Ahmad, Credit Suisse.

Thanks for taking my question.

I just had a very high-level investor question.

Earlier, you highlighted some of the concerns that around more and more M&A in the semi space, I wanted to get some insight into how much of your revenues are coming from semi customers versus some of the new systems companies that are doing semiconductor design?

And you started the call by highlighting some of your wins in aerospace, autos and biomedical, and I just wanted to see if there is an offsetting effect to the M&A, in terms of systems companies becoming bigger and bigger part of the overall semi design, and that is something that is not captured in the other semi venues.

So I wanted to understand if you could provide some commentary on that, that would be really helpful.

Yes, very thoughtful question.

So I think a couple of things, Farhan.

I think, as I mentioned the consolidation will be continuing.

Meanwhile we have been emphasizing on this system design development enablement, and that's basically providing the entire vertical solution spec from IP tools and PCB and the whole system design and verification, and the reason we believe that is a strategy important and successful going forward, to meet the requirement of some of these verticals that you mentioned earlier.

We are very excited about some of these vertical.

As I mentioned earlier, the IoT, the cloud infrastructure and then the massive cloud infrastructure building up.

And it's in automotive, it's part of the connected devices.

And some of the medical field and DNA sequencing and all this big data requires in terms of cancer treatment and a few others, and those can be a clear application for some of our IP portfolio, and some of our EDA flow, and also some of our hardware PCB and the system analysis requirement.

So all this ties very well and synergistically providing a solution to address some of this vertical.

And to answer your question, the system company right now is for more than 40% of our business, and some of it is very hard to categorize, because some of the companies, system companies, also have a semiconductor subsidiary, and so we have to be very careful how to quantify that.

But overall in general, is the fast going increasing and also we have the right platform for other system companies.

We mentioned one in my remarks, GE Aviation, a very good example in EDA, and then the hardware emulation, and even some of the high-end system-level device services, that we can provide a solution for them, and that is critical for some of these vertical markets.

Thank you.

That's all I had.

I will now turn the call over to Cadence President and CEO, Lip-Bu Tan, for closing remarks.

In closing, I am very proud to highlight that the Great Place to Work Institute has recognized Cadence and our hardworking employees, by including Cadence in their 2015 list of the world's 25 Best Multinational Workplaces.

I would like to thank all of our employees, shareholders, customers, and partners for their support.

Thank you all for joining us this afternoon.

Thank you for participating in today's Cadence Design Systems third-quarter 2015 earnings conference call.

This concludes today's call.

You may now disconnect.