益華電腦 (CDNS) 2016 Q2 法說會逐字稿

Good afternoon.

My name is Nicole, and I will be your conference operator today.

At this time, I would like to welcome everyone to the Cadence Design Systems second-quarter 2016 earnings conference call.

(Operator Instructions)

Thank you.

Alan Lindstrom, Senior Group Director of Investor Relations, you may begin your conference.

Thank you, Nicole.

And welcome, everyone, to our second-quarter 2016 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 September 16, 2016.

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

Before we start, I'd like to call your attention to our CFO commentary, which was included in the 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, 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, they can also be useful to measure results using certain non-GAAP financial measures.

Investors and potential investors are encouraged to review the reconciliations 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 July 25, 2016, for the quarter ended July 2, 2016, and related financial tables can also be found in the Investor Relations portion of our website.

Now I'll turn the call over to Lip-Bu.

Good afternoon, everyone, and thank you for joining us today.

Cadence continues to gain momentum through innovation, execution and a relentless focus on helping our customers succeed.

We delivered good operating results for Q2.

Revenue was $453 million, up 9% year over year.

Non-GAAP operating margin was 25%.

Non-GAAP EPS was $0.29, and operating cash flow was $80 million.

Let us start with the environment.

As they have been for some time now, semiconductor business conditions remain challenging, as we remain mindful of the consolidation activity in the semiconductor industry.

While we do not expect a material impact on our business in 2016, consolidation will present both challenges and opportunities for us over the next few years.

But at this point, it is too early to estimate any potential impact in the future.

In any event, I want to emphasize the growing opportunity we have with systems companies.

A key aspect of our System Design Enablement strategy is to increase our system customer base and participate in new verticals.

Q2 was a strong quarter for us, from digital implementation to PCB and across new world verticals, including automotive, [mirror arrow] and medical.

In fact, three of our five largest software contracts were with system customers.

Cadence signed a conference of agreement with Canon, which includes the IP.

Business was also good with our semiconductor customer base, one example being a comprehensive multiple-year agreement with SK Hynix.

Looking at our Q2 business highlights, I will begin with system design and verification.

Palladium Z1 continued its strong momentum, and we had a another record quarter for hardware revenue.

Nine new systems and semiconductor companies embraced Palladium Z1 enterprise-class capabilities -- capacity cycle capabilities, including Real Text, Imagination Technologies, and SocialNet.

We also completed the acquisition of Rocketick Technologies, and integration is underway.

Rocketick brings revolutionary multi-core technology that will provide industry-leading simulation performance, using massive parallelism on standard x86-based market cost servers.

And revenue for our formal solution, which includes JasperGold, grew nearly 20% year over year to a new high for us.

Turning now to our System Interconnect and Analysis business, which includes two support and IC packaging design and system analysis.

This quarter, we introduced our next-generation Allegro and OrCAD product families.

These new releases are our most significant in over 10 years, and they support flexible board design, now commonly used in automotive, consumer electronics, mobile and wearable applications.

Revenue for our [Tegrity] analysis tools grew 11% year over year.

Also an exciting virtual reality company adopted our PCB solution.

Next, let us move onto our Digital and Signoff product group.

Our digital signoff flow continued to gain momentum with market-shaping customers.

In addition, we significantly expanded our business with Northrop Grumman, which adopted Cadence's full digital flow, including Innovus [Janus] to support their future SoC design requirements.

And Cypress Semiconductor adopted our full digital flow for automotive design.

Stratus, our high-level synthesis solution, which enables system design through a level of abstraction, had its best bookings quarter so far.

We continue to invest in strong ecosystem support.

Cadence delivered design kits for 10-nanometer implementation of ARM Cortex-A73 and Mali-G71 core, which were designed with Cadence digital and signoff tools.

Cadence and ARM also delivered the industry's first end-to-end hosted design solution for IoT design.

Intel Custom Foundry certified our implementation and signoff tools for its 10-nanometer FinFET process.

And SMIC and Cadence released a 28-nanometer low-power reference flow.

Now let us turn to IP, which is strategic business for us, and it's important component for our System Design Enablement strategy.

Under the leadership of Pieter Vorenkamp, who joined us in April, we are continuing to refine our strategy to focus on sustainable and scalable growth.

Tensilica had its best booking quarter ever, with the completion of a major renewal with a leading semiconductor company.

This customer significantly increased both the scope and size of its relationship with us.

Packaging artificial intelligence and machine learning, we released the new Tensilica Vision P6 processor.

In another exciting application, a leading virtual reality headset used multiple Tensilica core.

In design IP, we have made significant process on 7-nanometer products, and signed our first major 7-nanometer contracts.

In summary, Cadence once again delivered good results in challenging environments.

Business with system companies was strong across vertical segments, including automotive, mirror arrow, medical, and mobile.

Strong, broad-based demand for the new Palladium Z1 contributed to our best hardware revenue quarter ever.

The innovative next-generation Allegro and office product family strengthen PCB and IC packaging design and analysis.

And Digital and Signoff Solutions have momentum with our market-shaping customers, and we are growing our business with both systems and semiconductor companies.

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

Thanks, Lip-Bu, and good afternoon, everyone.

For Q2, our innovative new products and strong execution contributed good results in a challenging environment.

Total revenue was $453 million, up 9% year over year, including record hardware revenue.

Non-GAAP operating margin was 25%, in line with our expectations.

GAAP net income per share was $0.17.

Non-GAAP net income per share was $0.29, up 7% over the year-ago quarter.

Operating cash flow was $80 million, and we repurchased 100 million shares of stock for $240 million, which represents over 3% of shares outstanding.

Now let's turn to our outlook.

There are no changes to our FY16 outlook for the midpoint for bookings, revenue, operating margin, EPS or cash flow, while we have narrowed the ranges on bookings, revenue and EPS.

We expect bookings in the range of $2.02 billion to $2.8 billion, which equates to 8% at the midpoint.

Revenue in the range of $1.8 billion to $1.83 billion, which would be a 7% growth at the midpoint.

Non-GAAP operating margin of approximately 26%.

GAAP EPS in the range of $0.70 to $0.76, and non-GAAP EPS of $1.17 to $1.23.

And operating cash flow in the range of $380 million to $420 million.

For Q3, we expect revenue in the range of $440 million to $450 million.

Non-GAAP operating margin of approximately 25%.

GAAP EPS in the range of $0.17 to, $0.19, and non-GAAP EPS in the range of $0.27 to $0.29.

Approximately 90% of revenue is expected to come from beginning backlog.

You'll find guidance for additional items in the CFO commentary.

Finally, note, why we are maintaining our full-year revenue guidance, we do expect revenue to decline from Q2 to Q3 due to timing of certain hardware transactions.

We expect Q4 revenue to ramp to a midpoint in the neighborhood of $470 million.

So with that, operator, we will now take questions.

(Operator Instructions)

Mitch Steves, RBC Capital Markets.

Hey, guys, thanks for taking my question.

Just real quickly on the hardware platform, just given that was -- we saw material revenue for the quarter was the highest ever.

Can you give us an idea of how much it was up year over year, what the incremental dollars you saw for the product line on a year-over-year basis?

Yes, we don't give that kind of detailed guidance on our individual business segments.

What we have said is that we expect hardware revenue to be up year over year at better margins, with, obviously that is driven by the Z1 product.

Got it.

And then secondly, if I were to think about the [separate] segments within the remaining EDA tool piece, is there any segment that's growing faster than others?

Or if PC believes you can potentially gain share at this point?

Yes, I think it's -- Lip-Bu -- I think across the board, I think that products are moving nicely.

Just to highlight on the digital side, we are continuing to good momentum with our market-shaping customers, and I highlighted a couple of key -- like mirror arrow, Northrup Grumman and then Cypress and a few others.

And clearly we continue to drive the advanced notes, and also with our ecosystem highlight by ARM and also TSMC, Intel Custom Foundry and SMIC custom board.

And then on the custom analog side, in April, we announced the next generation of the Virtuoso platform and environment suite that consists of an explorer, assembler, compliance, and will be driving a holistic flow and [from] a suite that we can really provide, and then for the customer within the platform.

And then meanwhile, we really doubled down on the advanced node -- the 10-nanmoeter, 7-nanometer applications.

So I think overall, [in our doud, I] look healthy.

And on the IP side, I think we mentioned earlier, we refined our strategy under the leadership of the very capable Pieter Vorenkamp, and I'm very pleased with what he has done.

He's very strong in execution and very strong in delivering to customers, and he pays a lot of attention to the customers.

[I would not drive the difference], and he is very strong in the analog area, and more than 100 patents filed or pending filing -- pending patents.

So I think he's a very strong technical -- and he brought in a very strong team come together.

So stay tuned.

Got it, thanks.

And I just have a very small one.

For the buyback, is there any change there, just given you guys have been buying back about $240 million a quarter?

And that's my last one.

Yes, so we've been buying $240 million a quarter, and we bought 10 million shares in Q2.

I may have said 100 million.

We bought 10 million shares in Q2.

We plan, as always, to complete our buyback, and believe we have substantial liquidity to do that.

Thank you very much.

Thank you.

Gary Mobley, Benchmark.

Hi, everyone, good afternoon and congrats on the strong quarter.

I wanted to start out with the big news from last week, that is ARM Holdings being acquired by SoftBank.

Given that ARM seemingly is going to be run autonomously, as has been the case for decades now, it would seemingly have little impact on your business.

But maybe if you can give any insight as to how Cadence's relationship with ARM may change, if at all?

Whether there might be any change in the marketplace in terms of trust factor?

Or how valuation expectations for some of your M&A targets may have changed in light of the March valuation multiple ARM received?

It's a good question.

This is certainly is a very exciting development in our industry, and then ARM is a very strategic partner for us.

We're looking forward to a continued relationship, and then expand from that.

So stay tuned.

We are really excited about it.

Okay, all right.

And I have a follow-up question relating to the extension in the expected contract life, now up to 2.6 years, as you expect it to end, presumably, this year, 2016.

And that's up a bit from your prior expectations.

Is there one large contract that is driving that up?

Yes, generally, we always focus on deal quality and maximizing deal quality.

We don't focus on contract term.

And it will vary and it has varied, and it will continue to vary from quarter to quarter.

Generally, larger companies prefer longer terms; smaller companies prefer smaller terms.

We've said for the year, we expect it to be closer to 2.6 years, which was within our original 2.4 to 2.6 range.

So we're kind of in the neighborhood we expected to be when we started the year.

Okay.

Hoping you can give me an update on and your perspective on the IP business.

If I'm not mistaken, you were all along expecting the IT business to be flattish in 2016.

And if I'm not mistaken, that was primarily a function of the consolidation taking place in the industry.

But are you any more optimistic on that business, or I guess more pessimistic, conversely, on the business?

Yes, first of all, we did not say that.

But I think overall, the IP is a very strategic -- very important to us.

Especially in our whole [fusion] of System Design Enablement, is a very key component of that.

And then we grew from zero to over 10% revenue.

And then now the new leadership of Pieter Vorenkamp, since he joined in April.

We are delighted for him to refine the synergy, and then reviewing what we have, and we then make sure that we can really drive the future of sustainable and scalable growth for us.

Saying that, clearly we continue to enjoy success in our IP business.

Tensilica, as I mentioned in my script, had the best booking quarter ever, with the completion of a major renewal with a leading semiconductor company.

And then we also did a focus on the artificial intelligence machine-learning with our new Tensilica Vision processor.

And we also have leading virtual reality headset using multiple Tensilica closed wire -- and that is on the Tensilica side.

On the design IP, I mentioned earlier, we made significant progress in the 7-nanometer development, and we signed our first major 7-nanometer contract.

And some of the IP side, I mentioned Tennant.

We signed a comprehensive agreement with Tennant, including the IP.

So overall, I think we continue to enjoy success in our IP business.

But give Peter a little bit of time to fine-tune his synergy, and then when we are ready, we will introduce you our strategy going forward.

And as we go through this transition, we are expecting more modest results in the IP business this year.

Okay.

That's it for me.

Congrats again.

Thanks.

Thank you.

Rich Valera, Needham & Company.

Thank you, good afternoon.

I was wondering if you could give any color on how things are going with the consolidations that you've seen so far?

How you think you're faring in those, and if you think you're maybe being able to gain some share?

And then relatedly, how have you seen the pricing around those in the ones that you've done so far?

We've heard some chatter that there's perhaps some fairly aggressive pricing as the various EDA vendors compete to gain or retain share, particularly on the digital side.

So any comments there would be helpful.

Thank you.

Sure, Richard, thanks so much for the question.

Clearly the whole semiconductor consolidation will continue, even though it's not the same attitude as 2015, that over 100 billion consolidation on the semi sector that is relevant to us because they are customers.

And we expect this year will be slower, but still very active year.

And in saying that, I think consolidation -- usually, the consolidator wants to drive efficiency and then drive more productivity and then more synergy doing that.

As we mentioned earlier, we don't expect any material impact to us in 2016, but in the longer term, there is some opportunity and challenges for us in the next couple of years.

So to answer your question, I think, clearly the consolidation, it will happen, it will continue.

But I think the consolidating company will be stronger, and also drive more efficiency and pay more attention to productivity.

And then in some of the pricing point of view, as you know, EDA is a very competitive business, sector to sector, product to product.

From Cadence's point of view, we continue to be very disciplined and then drive value.

And I think the best way to continue the success is collaborating deeply with our customers, and then developing and innovating.

I always strongly believe the best product wins.

But meanwhile, we have to drive value and be disciplined on that.

And at this point, I will stop there.

And I think just a few data points.

Our booking range at $2.02 billion to $2.08 billion still has the same midpoint.

And our revenue range of $1.8 billion to $1.83 billion still has the same midpoint.

So you're seeing no impact in 2016.

So, fair enough.

That's actually a good segue to my next question, Geoff, since you did tweak up your duration slightly.

And I mean, if you're just picking the midpoint previously up from 2.5 to 2.6, that would be a 4%.

And I know there's small numbers here, so you could say it's rounding.

But it would imply that you actually have a slightly lower bookings run rate on a time-weighted basis.

Is there anything to that, or are we just talking kind of rounding here?

Yes, I think it's just noise or rounding within the scheme of things.

Our bookings -- we've been quite happy with our bookings this year, and we haven't changed the midpoint.

And the range has been tightened, so we're quite happy with what we're seeing.

Great.

And just one final one, Geoff.

Any update on the status of the search for your replacement?

Lip-Bu will take that one.

Okay, thanks.

So I think let me touch on that.

We are in the middle of a comprehensive and thoughtful search.

A lot of interest in this position, as you can imagine.

We are [veritable model] and it's a very strong platform that people like to be here.

And we will let you know when we have something to tell you.

And then meanwhile, Geoff has committed to stay until March 2017.

Well, I'm glad to hear that.

Thank you, gentlemen.

Thank you.

Jay Vleeschhouwer, Griffin Securities.

Thank you, good evening.

A couple first for Geoff, and then I'll turn to Lip-Bu for a couple product questions.

Geoff, for you first, a geographic question.

It looked as though your -- going to the 10-Q, out tonight -- that your Americas revenue was down sequentially from Q1, albeit up year over year.

Was that mostly just some timing of contracts perhaps related to IT or maybe hardware -- or whatever you can describe?

And then secondly, on the other hand, your Japan business was up for the second quarter in a row, year over year.

And so we've been perennially asking about a possible bottoming in Japan.

And so the question there, is this it?

And then a follow-up for you, Geoff, on emulation, and then for Lip-Bu.

Obviously, we don't guide individual geographic segments of our business.

But you did get parts of our business, both the hardware and the IP business, which are more variable parts of our business.

And it turns out, in North America and Japan is exactly how you described it.

I don't think I have more relevant comments than that.

Okay.

On emulation, according to the queue, your cost of hardware was up just over $10 million, year over year.

When we combine that with your comments about record revenue for hardware, it would seem to suggest that your emulation absolute cost of revenues might have gone down sequentially, even with record revenue.

Which would of course have led to a good sequential increase in emulation margin, perhaps a few hundred basis points, and perhaps even more so year over year.

So does that sound about right, that you had at least a several hundred-basis point improvement in profitability in emulation, and it's not at all sustainable?

Without obviously commenting on your specific numbers, because we can't do that, Z1 was the majority of sales in Q2.

And margins on the Z1 are better than the prior XE.

So having a record quarter, all good stuff.

Okay.

For Lip-Bu, the question on digital and signoff.

The percentage of revenue from that segment actually went down a little bit sequentially and year over year.

But the specific question I would like you to address is if you could comment on the expansion and deployment of Tempus, Voltus, Genus, and certainly for Novis, that you've been seeing?

In other words, you've commented on previous calls about having had several dozen customers adopt Tempus and Voltus and so on.

But what isn't entirely clear is if you could comment on what's been going on after initial acceptance?

Is there broader deployment then expansion beyond perhaps initial design projects for those new products?

Yes, good question, and thank you for asking.

Clearly our digital and signoff flow -- as you know, we have Innovus [for placing route] and Genus for synthesis, and then Tempus for signoff, Voltus for, you know, the power.

And so I think these are all very new products coming out last year, even some of them are later part of last year.

So clearly from engagement from customer, we are delighted with the progress we make with the market-shaping customers.

We are the leader in the industry.

They are very big customers for us.

And so I think, first of all, they start to evaluate our tool.

And then secondly, put some projects and see what they work.

And the next thing is, you know, a couple of adoptions.

And then to make that it's stable, it can be count on it, on the more advanced note.

Then just having to proliferate across the product groups.

So we are in the various stage of that proliferation.

And now it's the baseball season, and clearly in the second and third and fourth innings, this is the most critical period coming up right now.

A lot of customers look at the tools and [how you saw] can I count on this for the production?

And that's where we are in this multiple [cow].

And so stay tuned.

We're going to continue to drive that.

The main reason from Q2 to Q1, because Q1, we have one important order with the foundry, and this is one of type.

And then clearly part of the proliferation, you'll be continuing in Q3 and Q4, and the beginning of next year.

So I think this is in a critical period, and we continue to highlight to you some of the success we have, like Cypress.

We have announced a full flow that we are extremely excited about Northrup Grumman, and this is a new [era side], and then using our full digital flow, and then for their future SoC design.

This is a really exciting for us.

And then we're going to continue over time to tell you some of the success we have.

But so far, I am pleased with the progress we've made.

And we expect good growth in 2016, overall, against 2015, for the digital business.

Okay.

And lastly, if I may, for Lip-Bu, referring to automotive, which was of course a major subject at DAC last month.

You talk about it earlier.

And at DAC last month, there was a very interesting presentation by NXP, and they showed some interesting demos of technology that would seem to play to your strength in custom, in terms of automotive telematics and so forth.

So the question is really for you, what, so to say, is going on under the hood for Cadence, with respect to automotive?

What have you really done in terms of organization, investments, resources -- particularly to drive the needs in IT and IP, and at the systems level for automotive?

Yes, that's a very good question.

And automotive is a very important particular market we go after in our whole System Design Enablement.

And this is a very important strategy.

And then we have a very nice complete portfolio besides the digital file.

The analog mix is critical in some of the applications for automotive.

We have a lot of success in that.

And the other part is the IP.

Tensilica is [predicted] to play very well in the whole [ADAC] auto piloting-related area.

And then we have multiple engagement in that.

It's very critical in some of the whole machine-learning, deep-learning, and then artificial intelligence and application for the whole automotive driving-related area.

And of course, on the IP front, we also have our audio.

Our audio, we have a lot of success in that.

And then the other part, very important for us, is the PCB.

Clearly, we just announced our new generation of Allegro and OrCAD, and then also through our acquisition [tiquity], that we grew 11% year to year.

And then clearly that will provide the signal integrity power [analogist] for the automotive application.

So I think all in all, we have many important.

And then, the other part is [apply], I think, on the vertification front, that we also incorporate some of the function safety requirements into our [touring] offering and solution.

And that is very welcome by the automotive -- either Tier 1 or the direct automotive company, and that they see a lot of value from Cadence.

Thanks very much.

Thank you.

Monika Garg, Pacific Crest Securities.

Hi, thanks for taking my question.

I had a question on the IP side.

First half of 2016 is actually lower than the first half of 2015.

Could you provide some detail?

Is there some change of strategy?

Yes, I think, you know, first of all, let me chip in first, and then Geoff can address the numbers.

I think clearly, as I mentioned earlier, we just have a new leader, and he is reviewing our business and then refining our strategy.

Importantly, the first phase is to grow from 0% to 10% of our revenue.

Now we're going to driving some of the matrix that we're looking for in terms of sustainable, scalable, profitable operations.

And then clearly in some of the three pieces in our [in that] Tensilica is a great opportunity.

We're going to [have a cow] on that.

And then the design IP, clearly we are really focused on the most advanced note 7- and 10-nanometer.

And then the VIP continues to drive differentiating vertification IP.

And then together with our vertification suite, to tie in with the customer support on driving the productivity.

We see the trend of outsourcing more and more coming to the IP.

So we strongly believe the IP strategy is the right one, but it's important to somehow find a way to really sustainable and then driving efficiency.

We have more than 1,000 people employees in this area, and we're going to really drive to become a profitable center for [automobile].

So I think all in all, we want to really drive this year maybe moderate growth.

But then going forward, will be a stronger [growth going forward].

And then, so all through the mix, it's down as a portion of our overall mix.

That's because of the strength of a lot of the rest of our businesses.

It's actually [down] (corrected by company after the call) for the first half of the year versus the first half of the year last year.

But we do expect more modest results this year versus last year, as we've said.

Okay.

Then, Geoff, on the emulation side, margins are going to be up year over year.

But as a Company, operating margin guidance is modestly lower year over year.

Are you just being conservative?

Or otherwise, why are we not able to see any operating margin leverage this year?

Whenever we guide, we always put everything we know into the guidance, that we know at that point in time.

When we guided this year, we clearly guided at a midpoint that was lower than our actual achievement last year, and that's what we knew at the time.

We continue, I think, to execute well, and we'll see how it plays out.

Got it, thanks.

And just last one -- the emulation side.

You've seen very strong growth.

How fast you think this market is growing, and how big do think this market could be?

Yes, Monika, maybe I would have broadened a little bit of your question.

Clearly we see a tremendous opportunity in the whole vertification.

And it's the fastest growing challenge for our customers.

As you know, whatever they design, they need to be verified in whether these designs are really working.

And we have a four engines within that vertification, and we've tried to really drive, tighten that friendship together.

And first of all, we have the JasperGold.

This is a function vertification.

It is very critical piece of the vertification -- formal vertification -- and growing at about 20% year to year.

And we're very excited about it.

Then we have the incisive simulation to our acquisition on the Rocketick, and that is a very revolutionary technology, with a very massive parallelism multi-core on the [fender system], actually a [fixed-based] server.

And that gives us a tremendous performance into the simulation side.

And we are doing the integration to make a really strong offering to our customers.

Then the [hut-made] emulation, and then not just emulation -- right now we are starting to drive they are already sliding in the simulation side.

And then we also have the [protium].

That is the prototyping.

And we are really driving some of the next-generation development coming up.

So I think all four will tie in and drive this whole vertification, that is where the bottleneck for our system company and also customer, and also our semiconductor customer.

And then that really can holistically tie-in together.

But it's something that we are working on.

Stay tuned.

And then on the hardware side, this is a more successful launch of Cadence emulation.

And then we're going to continue driving the next-generation [feds up] throughput and a more scalable -- in fact, it's already quite scalable to 9.2 in the billion [gate].

And then over 2,000-plus concurrent users.

And we're going to continue driving the excellent in terms of scalability, and then driving the power [down] continuously.

And so I think we're going to be an important platform.

And then we're going to also find a lot of new use of use model.

And then for simulation and then also tie-in with our prototyping, protium, next generation coming up, are going to be a very compelling vertification offering for our customers.

That's all for me.

Thanks.

Thank you.

(Operator Instructions)

Sterling Auty, JPMorgan.

Thanks.

Hi, guys.

Wanted to talk a little bit about the comment that you made around the guidance for the September quarter, specifically on the hardware emulation.

I think you mentioned some timing of deals.

I was just curious if it's deal-closure timing that you are referring to, or is it lead times on the manufacturing of emulation devices that's going to impact that hardware?

And if you would be so willing to possibly give us -- are you expecting that emulation area revenue to be up, down, or flat sequentially?

Yes, so the timing here is about closure.

It's just about the timing of customer demand and when the customers want the product.

And so it will decline -- hardware will decline from Q2 to Q3, as we said -- I think, importantly, retaining the full-year guidance, right?

And by the way, Q1 and Q2 were record quarters, right, for us in hardware.

So some timing between quarters, it's going to rotate.

We're retaining the full year, and that leads to Q4 at a $470 million midpoint.

And are these deals that are actually -- whether they are follow-on deals or just timing of shipments, they are large orders from the same customers?

Or is it new customers discussions that you're still -- you're just anticipating when you think you'll close those deals?

Yes, so it's large customers.

And these are large deals, as you're probably aware.

The price of Z1 is quite large, and they are frequently buying more than one system from us.

So it's just the timing of when they want the product.

Okay.

And you've made a number of comments around the IT business and the change in leadership, et cetera.

But I guess what I'm curious is how long you think the turnaround takes?

So in other words, when do we hit trough revenue or trough declines?

I don't want to say growth, but you get the idea.

When do we hit the bottom and we start to see acceleration in that part of the business?

Yes, Sterling, this is Lip-Bu.

It's not a turnaround, it is just refining our strategy.

And Pieter came from a very strong background on execution, customer satisfaction.

And if you recall, he is the Senior Vice President of Operation Engineering, working very close with the Foundry partners to drive, you know, to really silicon-proven IP.

Basically, we very quickly are ramping the revenue on the more than 10% revenue.

And then right now, we really want to really drive quality, really drive customer satisfaction, and then really prioritize what really makes a difference in some of the Tensilica, in some of the design IP.

And really find the differentiation that can satisfy the customer.

And then it's not hard to do some of this one-off type of thing more, and not proliferating.

And then to our leading customer and then helping them to really drive differentiating products.

So I think you can see that we highlight those differentiating like Tensilica.

Even in the VIP side, we've highlighted 7-nanometer process node.

In fact, we're the first Company to contract a VIP with Canon.

More system companies, more leading [H], you know, customers.

And so we really drive more into the quality of the customer, driving more quality of the product offering IP.

And give Peter a little bit of time.

He just completed his visiting with officers.

And then he'll fine-tune the strategy, present to our team, and then to our Board.

And then stay tuned.

We will come out with our strategy going forward.

Great.

And then last question around R&D spending.

I think R&D expenses were up a shade under 15% year over year, so growing faster than revenue.

I think that probably ties to some of the comments there you made about the investments you're making there to help gain market share, especially in some of these larger digital customers that you've won.

And I guess my question is, when do we see the peak of those investments and start to see more leverage coming out of the R&D line?

So a couple things.

You're right.

This is largely the investments we're making in innovative products across our product lines.

One more thing that's clearly playing, and it's just the timing of shutdowns this year versus last year.

Last year was in Q2.

This year, our summer shutdown will be largely in Q3.

So you're seeing a little bit of a timing impact there.

And again, for us to get return on these investments, of course, is proliferation and innovation continuing.

So stay tuned.

Got it.

Thank you, guys.

Thank you.

Tom Diffley, D.A. Davidson.

Yes, good afternoon.

Geoff, staying on the same operating expenses, what drove -- or what is behind the roughly 30% increase in the G&A this quarter?

I think it's largely the same thing.

It's the timing of the shutdown.

Last year, it was in Q2.

This year, it's in Q3.

Okay.

It just seemed like the combined several quarters in a row is kind of [step] function higher this year with what you just posted?

We do make investments in our technical sales organization also.

That's an important part of our strategy with our customers.

Okay.

And then when you look at your guidance for the GAAP earnings this year, it's down 4% or 5% this quarter versus last quarter.

What is the delta there between the GAAP and non-GAAP difference?

So the biggest delta between GAAP and non-GAAP, we're going to always have three things that are going to be a delta between GAAP and non-GAAP.

First is stock compensation.

Second is amortization of intangibles related to M&A.

And third is, we use a standard non-GAAP tax rate, while our real tax rate fluctuates.

So those are the three things that always make the difference up.

Okay.

So which one of those changed then this quarter when you brought down the GAAP number and kept the non-GAAP as is?

So I think our tax rate is that --

What?

Yes, so there is a couple things.

Obviously the Rocketick acquisition.

But I think the more prominent thing is the changes in our expectations of a GAAP profitability, and therefore, the GAAP tax rate.

Okay.

And Lip-Bu, the last two quarters, you've been talking a lot about success with the systems customers.

How big is that business for you today, and how big do you think it gets over time?

Yes, good question.

And we're very excited about this System Design Enablement strategy that we have.

And I highlight, three of our five largest software contracts this quarter happened with the system companies.

And so we continue to drive success here in the new mirror arrow, success in the automotive side, and in the mobile and the medical-related.

So I think all in all, we are excited about this whole.

And then we have a really good portfolio of product that the system company appreciate that.

And are clearly the mixed-signal analog digital, you know, the packaging, the IP portfolio and the whole system analysis.

And this is really well come from them.

And somewhat, the percentage of revenue sometimes is very hard to calculate.

Some of the system company also have the semiconductors.

And we're growing from the 40% upward.

And so we continue to drive that.

And even though with all this consolidation, we are really excited about this whole system opportunity for us.

And then we're heavily engaging with some of these vertical and new verticals we are embarking on.

Our earlier discussion on automotive, we really excited about it.

You know, I'm very big believer in the whole VR/AR.

It's a tremendous opportunity.

We have a couple success either in [TTB] or the Tensilica IP front.

And then there's a whole suite of new changes in the whole hyper scale web services, you know, the cloud data center, that's in [comply] enough to work on the programmable, different workload on the IO, more memory-related.

That's another opportunity for us.

So we are excited about this vertical, and we are, with this customer, are really excited about our portfolio that we can offer.

Great.

All right, thank you.

Thank you.

Krish Sankar, Bank of America.

Yes, hi.

Thanks for taking my question.

I had a couple of them.

One, Lip-Bu, if you maintain a current traction or momentum in emulation, do think exiting calendar 2016, you could be number one?

Or do you think it's going to take a longer time?

Yes, the whole hardware emulation, we are excited about it.

We clearly have a very strong leadership team.

They have very strong technical team that I'm very pleased with.

And Palladium Z1 is the best launch we have, and the most successful one for us.

And then also we have more-use model I mentioned earlier.

And this is a very scalable platform.

And if you do design hardware emulation, the scalability and accuracy is critical.

And so this is something that a customer will buy.

And if there is a best one.

And so I think all in all, we like this.

And as you know, Q1 and Q2 is a record quarter for us.

And Q3, a little bit because of timing.

But overall, as a whole year, is a very strong growth percentage growth for us.

We are excited about it.

And then stay tuned.

I mean, we're going to be driving not just the emulation, we're going drive simulation, and we're going to drive prototyping, whole suite of product, and then tie into the whole vertification I just talked about, providing the total throughput solution to our whole vertification suite offering to our customers.

So I think this is something we believe is a double-digit growth for us, and then [we love it].

And again, we think, based on all the market things that we see and the market studies we see, that we are number one, and have generally been number one over the past quite a number of years.

Got you, all right.

And then in your core area business, stripping out emulation and systems and IP, I'm just curious, how is the bookings trending year to date versus last year?

I know you guys only give annual booking guidance and update it.

But we're just curious on how it's trending year to date on the core ADA side?

Yes, I think overall, we like what we have and in some of the product offerings.

Digital, clearly we drive a lot of innovation, massive parallelism.

And then the customer love it.

Right now it is more a proliferation and execution focus in our custom analog and [de facto] and standard for the [death cage].

And then we don't sit still.

We continue to drive the advanced node.

We have whole new suite of new development, I mentioned earlier, to drive performance and then drive acceptance and then compliance.

And then in the new suite that we've got offering.

And then we also have a focus on the mix signal, so we can help our customer in term of mixed-signal offering power, low-powering offering.

And then now we also have the PCB, and then with our system analysis, and then with the IP, with a really focus on the differentiating IP that we can offer.

I think we have a very good portfolio, a lot of customers really impressed what we come out with.

Stay tuned.

We continue that culture of innovation.

It don't stop here.

I know we can double down and triple down on that.

And I strongly believe the best product wins, our job is basically providing the best tool for our customers to design and increase their productivity and the time to market.

And that's our job.

And then a final question -- did you say what the percentage of revenue from systems was?

Yes, I mentioned earlier 40% and north of that.

We continue to drive success there.

Got it.

Thank you.

There are no further questions at this time.

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

In closing, we are continuing to innovate and deliver design-enabling solutions to our customers.

And we're looking forward to continuing to execute on our strategy and create value for our shareholders.

So I want to thank all our hard-working employees worldwide, and shareholders, customers and partners, for their continued support that make this possible.

Thank you all for joining us this afternoon.

Thank you.

This concludes today's conference.

You may now disconnect.