益華電腦 (CDNS) 2020 Q1 法說會逐字稿

Good afternoon.

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

At this time, I would like to welcome everyone to the Cadence First Quarter 2020 Earnings Conference Call.

(Operator Instructions)

And we'll now turn the call over to Alan Lindstrom, Senior Group Director of Investor Relations for Cadence.

Please go ahead.

Thank you, Josh, and I would like to welcome everyone to our first quarter 2020 earnings conference call.

I am joined today by Lip-Bu Tan, Chief Executive Officer; and John Wall, Senior Vice President and Chief Financial Officer.

The webcast of this call is available through our website, cadence.com, and will be archived through June 12, 2020.

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

Please note that the discussion today will contain forward-looking statements and that actual results may differ materially from those expectations.

For information on the factors that could cause a difference in our results, please refer to our filings with the Securities and Exchange Commission.

These include Cadence's most recent reports on Form 10-K and Form 10-Q, including the company's future filings and the cautionary comments regarding forward-looking statements in the earnings press release issued today.

In addition to financial results prepared in accordance with generally accepted accounting principles, or GAAP, we will also present certain non-GAAP financial measures today.

Cadence management believes that in addition to using GAAP results in evaluating our business, it can also be useful to review results using certain non-GAAP financial measures.

Investors and potential investors are encouraged to review the reconciliation of non-GAAP financial measures with their most direct comparable GAAP financial results.

The reconciliations are available at the Investor Relations section of cadence.com.

Copies of today's press release dated April 20, 2020, for the quarter ended March 28, 2020, related financial tables and the CFO commentary are also available on our website.

I would also like you to note that we are adhering to social distancing practices, and therefore, are conducting today's earnings call from remote locations.

Apologies in advance if there are glitches or handoffs take a little longer than usual.

And now I'll turn it over to Lip-Bu.

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

I am pleased to report that in the difficult environment, Cadence achieved excellent financial results for the first quarter of 2020.

We are all going through truly unprecedented times, and I hope that you and your families are safe and healthy.

I will start by commenting on the rapidly evolving COVID-19 situation.

Our first priority continues to be ensuring the safety and well-being of our employees, customers and communities.

At this time, the vast majority of our global employee base is working from home, and that transition has gone very smoothly.

From a business continuity perspective, our infrastructure, collaboration of platform and tight communications has enabled us to maintain a high level of productivity, and our R&D innovation projects and customer deliverables continue to track well.

Our sales and application engineering teams have also adapted well with this new work model and have continued engaging productively with customers on the business, training and support fronts.

As I stated earlier, there has been a silicon renaissance in the industry, with strong design activity being driven by generational technology drivers such as 5G, AI, hyperscale computing and industrial IoT.

So far, even in the current environment, we do not see any slowdown in design activity.

And I do believe this period is to be an opportunity especially for market-shaping customers to further invest in R&D and accelerate their innovation.

Our business is predominantly tied to semiconductor R&D.

And in addition, our broadly diversified customer base, over $3.7 billion of backlog and highly ratable business model all serve to highlight the resiliency of the business, particularly in challenging times -- sorry, resilience of our business, particularly in challenging times.

After careful assessing the situation, at this time, we feel comfortable reaffirming our revenue guidance for the year.

In a few moments, John will provide more details and commentary on our Q1 results and guidance for Q2 and the year.

Our Intelligent System Design strategy enables us to maximize these opportunities while tripling our TAM through proliferation in our Foundation Design Excellence segment and expanding beyond EDA into system innovation and pervasive intelligence.

Now let us look at some of the design excellence highlights for the quarter, starting with digital and signoff.

Our Cadence digital full flow, which has been proven through hundreds of advanced node tape-outs, have significantly enhanced to further optimize our performance and area, or PPA, results, across multiple application areas.

The new full flow featuring our innovative iSpatial technology, which includes unified placement and physical optimization engines, plus machine learning capabilities, delivers up to 3x faster throughput and up to 20% improved PPA.

The new full flow is being used by several leading customers and was endorsed by MediaTek and Samsung Electronics.

Additional digital and signoff highlights for the quarter include: a major Asian hyperscale company successfully used Cadence digital full flow to tape-out a machine learning inferencing chip and is deploying full flow at 7- and 5-nanometers.

A marquee Asian electronic system company completed its first production Cadence digital full flow tape-outs on 5-nanometer low-power process, beating its power targets.

And a market-shaping semiconductor automotive customer committed to Cadence as its primary EDA vendor for digital design.

Our Cadence Verification Suite wins in the marketplace because it delivers the best verification throughput driven by its 4 best-of-class engines: Xcelium, Jasper, Palladium and Protium.

In Q1, we had multiple verification wins across various verticals, including cloud, data center, automotive and networking.

Our hardware family had a banner quarter, with Palladium Z1 adding 4 new customers and 9 major expansions.

Our Protium FPGA-based prototyping platform continued its strong momentum, adding 6 new customers and 6 repeat orders as the X1 is increasingly deployed in Palladium accounts.

Protium X1's strong momentum is a result of this unique differentiation in having a common front-end compiler with the Palladium Z1, that also provide superior performance and capacity scalability for earlier software development and hardware regression.

Both the Z1 and X1 platforms show particular strength at hyperscale system companies in addition to momentum at market-shaping semiconductor customers.

Our IP business delivered double-digit revenue growth as our compelling offerings continue to benefit from the ongoing IP outsourcing trend with design wins and expansions at several top-tier customer companies as well as start-ups.

Tensilica did particularly well and was adopted for multiple audio applications as well as by surveillance and mobile customers.

In Design IP, there was a strong demand for our DDR portfolio as well as our high-speed SerDes and PCIe IP, particularly in data center, AI and high-performance computing segments.

Now I will highlight our progress in system innovation segment of our Intelligent System Design strategy.

Earlier this year, we completed the acquisition of AWR and Integrand, and we have received very positive response to the acquisitions from many of our partners and potential new customers.

The integration is progressing well on all fronts, and we are combining these technologies with our Virtuoso and Allegro platforms, which will enable us to offer a comprehensive platform for designing high-frequency RF millimeter wave products.

Our system analysis tools carried forward their strong momentum into the new year, and we now have more than 30 customers, including Renesas, ROHM and Enflame.

In addition to providing significant better performance and capacity without compromising accuracy, Clarity and Celsius also provide a tighter integration with our flagship Virtuoso and Allegro design platforms.

With that, I will now turn the call over to John to review the financial results and provide an updated outlook.

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

Let me begin with a few comments on the COVID-19 pandemic.

Our first priority remains the health and safety of our employees, partners and customers.

And while some of our employees in China are already back working from our Cadence offices in the region, a vast majority of our global workforce are currently working in a remote environment.

Our team continues to be very effective even though many are working from home.

For this, we are very proud and very grateful.

Even with the global disruption and uncertainty created by the COVID-19 pandemic, I am pleased to report we met or exceeded all of our key operating metrics in Q1.

Now let's review the key results for the first quarter, beginning with the P&L.

Total revenue was $618 million.

Non-GAAP operating margin was 32.2%.

GAAP EPS was $0.44, and non-GAAP EPS was $0.60.

Next, turning to the balance sheet and cash flow.

In mid-March, we borrowed $350 million under our revolving credit facility as a precautionary measure to provide additional liquidity in light of the recent global economic uncertainty caused by the COVID-19 pandemic.

As a result, at the end of the quarter, our cash balance totaled $946 million, while the principal value of debt outstanding was $700 million.

Operating cash flow for Q1 was $218 million.

DSOs were 42 days.

And during Q1, we repurchased $100 million of Cadence shares.

Before I provide our guidance for Q2 and fiscal 2020, I'd like to take a moment to address some points that I think are important to understanding the assumptions embedded in our outlook.

Our guidance continues to assume that the export limitations that exist today for certain customers remain in place for all of 2020.

The shelter-in-place orders that are in effect today as a result of the COVID-19 pandemic create some logistical challenges related to fulfilling some hardware and IP product orders, for which we recognize upfront revenue upon completion of delivery.

At the low end of our revenue range for Q2, we are assuming that the government-mandated or recommended shelter-in-place orders in effect today will remain in place for the remainder of the quarter and any hardware or IP products that we cannot deliver before the end of our Q2 will be delivered in the second half of the year.

On the other hand if, starting sometime in May, we can get sufficient physical access to complete hardware and IP deliveries, we expect to be closer to the high end of our revenue range for Q2.

Assuming we have sufficient physical access to complete hardware and IP deliveries by the end of Q3, we do not expect any negative impact to our full year guidance from the delivery delays we are assuming for Q2.

For Q2, our guidance is as follows: revenue in the range of $580 million to $600 million, non-GAAP operating margin of 30%, GAAP EPS in the range of $0.28 to $0.32, non-GAAP EPS in the range of $0.50 to $0.54 and we expect to repurchase $75 million of Cadence shares.

For fiscal 2020, our guidance is as follows: revenue in the range of $2.545 billion to $2.585 billion, non-GAAP operating margin of 32% to 33%, GAAP EPS in the range of $1.58 to $1.68, non-GAAP EPS in the range of $2.40 to $2.50.

We expect operating cash flow to be in the range of $775 million to $825 million, and we expect to use approximately 50% of our free cash flow to repurchase Cadence shares in 2020.

You will find guidance for additional items as well as further analysis in the CFO commentary available on our website.

In summary, I am pleased with the results we delivered in Q1, and I have been impressed by the resilience of our business model and the agility and capability of our global team at Cadence to continue to operate so effectively in this environment.

The world is facing unprecedented times, and we are all deeply sympathetic to anyone who has been impacted by the COVID-19 pandemic.

We are clearly all in this together.

So I would like to close by thanking our customers, partners and our hard-working employees for all that they do.

Please note that we are adhering to social distancing practices and, therefore, are conducting today's earnings call from remote locations.

My apologies in advance if there are glitches or handoffs that take a little longer than usual.

And with that, operator, we'll now take questions.

(Operator Instructions) Your first question comes from Rich Valera from Needham & Company.

Congratulations to the Cadence team for delivering some very solid results in obviously challenging conditions.

With that, I just wanted to ask about your China revenue in the quarter, which was actually up as a percentage of revenue year-over-year despite a very tough comp since last year.

You didn't have the entity list restrictions on Huawei or several other likely Chinese customers.

So I'm just wondering if you could talk about what drove the strength in China this quarter.

Was it new customers?

Was it sort of a ramp in demand from existing customers and if there's any color in terms of which products were in high demand there?

Yes.

Rich, Lip-Bu here, so let me start.

Our business enable design of future electronic products.

Our China business remained quite good for us.

Q1 was aided by both hardware and IP business, which has mostly upfront revenue, and John can provide more colors and details here.

Yes.

Rich, I would say this is an unusual.

Our China revenue over the past 9 quarters has fluctuated between a low of 8% back in Q2 2018 and a high of 13% both this quarter and in Q4 '18.

Q1 revenue was higher due to both hardware and IP business, which are mostly upfront for revenue.

Great.

And then just question on the new system and product ramp.

I heard your new customer count, it sounds like that's up to 30, which is great.

Just wondering if you can provide any anecdotal evidence of customer penetration, i.e.

customers that have ordered a single license, have proved it out and then they will come back to order multiple license and if you've seen any customers sort of scaling up the way presumably you'd like to see.

Yes.

I think so far, I think we are very pleased with our system analysis tool that carried momentum into Q1.

As you already pointed out, we have more than 30 customers on the Clarity and Celsius product line.

And clearly, I think we're providing fair high performance, better results and then the scalability and then not compromising any accuracy.

Great.

And just one quick one for you, John.

I noticed your non-GAAP EPS stayed the same, but your GAAP EPS actually went up.

Any -- can you just quickly explain the delta there?

Yes.

Just a slight difference in our assumptions for the M&A integration between what we had in the forecast at the start of the year and where we are now.

Your next question comes from Jay Vleeschhouwer with Griffin Securities.

A couple of questions, first, on China and geographic mix generally.

According to the 10-Q, this evening, your China revenues were a record at about $84 million.

You explained the reasons why it was so strong.

But looking out over the next number of years and thinking about all the issues that surrounded China over the last year and where U.S. government policy may go, how are you thinking about perhaps geographic risk mitigation, again, notwithstanding the very good results in China this quarter?

How do you think about perhaps mitigating the dependency there by perhaps focusing on the other parts of the world?

Europe, for instance, had a very strong year in 2019 for EDA.

So perhaps that would be a region to think about refocusing on, as an example.

So that's question #1.

Question #2, you highlighted the newer products, Clarity and Celsius.

How would you compare your experience thus far with those 2 products with the previous generation of [signoff] products, Tempus, Voltus, Pegasus, which we frankly haven't heard a great deal about?

Is your experience in terms of customer adoption meaningfully different?

Or would you expect it to be different than the prior generation of signoff tools that you introduced?

Yes.

So let me get started, and then John can show in some more details.

So first of all, I think we will expect to do everything we can to support customers, complying with all the application law and regulations.

And we want to provide the best tool for our global customers.

That includes China, Asia Pacific, EMEA and U.S. So that is our philosophy: give them the best product and then support them in their design.

And in terms of the new products, and clearly, I think we are very pleased with the system analysis product, the 2 that came out and clearly show the differentiation, and we are delighted.

And now quarter-by-quarter, we have more and more customers coming with us.

It's a big end market for us.

These 2 products, the TAM is about $700 million.

So I think we will aggressively pursue that.

And clearly, we have a big advantage in terms of performance.

In terms of the Voltus and Pegasus, we continue to do well, and then we will continue to update you from time to time.

Pegasus, most important with the foundries, make sure that the various process node is certified.

And I think over the last few quarters, we highlighted a couple of process nodes at different foundries have been certified, and now we are starting to really drive in some of the customer success and then stay tuned in the coming quarters.

Yes.

And Jay, I would add to that, that I think you can see from our results and from our guidance for the year, that our business benefits from the diversification we see across products and platforms and geographies that -- and as much as we encourage investors not to look at any 1 quarter.

I mean China contributed 10% of our annual revenue in 2018 and 2019, and we're happy to get off to a strong start for 2020, but hardware and IP are lumpy for revenue.

And so you should never focus on any 1 single quarter.

Okay.

Just a quick detail question for you, John.

If I'm reading the Q correctly, it looks like you took some inventory reserve on a hardware.

If so, could you comment on that?

Jay, I presume you're referring to the section where we say we include inventory reserves in our hardware COGS...

Yes.

But we consistently do that.

I mean I don't think there was any significant change in inventory reserves from quarter-to-quarter.

But generally, if we have a hardware system that's out being demoed or on loan, we'll take depreciation or amortization for that into our P&L and include it in COGS, even though we haven't sold it yet.

Next question comes from Mitch Steves with RBC Capital Markets.

I really had 2, the first one is a little bit more for Lip-Bu.

When I look at your comments about design activity, some of the checks, at least we're picking up, is that they're trying to actually accelerate the design activity.

So can you maybe give us a little bit of a broad overview what you're seeing in China and in data centers, and I guess any sort of way you want to spice up the market in terms of what design activities are looking like across the different end markets or however you want to do the verticals?

Yes.

So let me try to give you a little bit more color.

As I mentioned earlier, we are going through this silicon renaissance in the industry.

Clearly, we see strong design activity driven by this generational technology driver, like the 5G, including the RF front, and then the AI, the machine learning across different platforms and then the hyperscale in this environment, actually they deploy even more and they are all finally building up their own silicon team.

And then the whole digital transformation of the industrial group, we see a lot of -- so I think clearly, so far, as we see today, we don't see any slowdown in activity, especially, I call it, the market-shaping customer.

They double down, triple down in their R&D, and we are delighted to support them and that kind of -- we see the opportunity in the design activity.

And in some way, our business very much predominantly ties with the semiconductor R&D, and that really benefit us.

And then we have been very focused on the market-shaping customers, and they have been really -- we are really excited to support them in all their various designs.

Got it.

And then second one is for John, just a little more on the financials.

So China is up pretty significantly.

Is there any way to talk about if that's just going to be sustainable or if that's some pull-in from hardware?

I mean what do you guys think about the China percentage of revenue?

I think that was a little bit surprising, but maybe you can maybe give us maybe a high level of comment on what full year should look like if it should be around that type of revenue percentage or not.

Sure.

Yes.

I mean we -- it was large in the first quarter and it was mainly due to hardware and IP business, IP revenue business.

At the start of the quarter, I mean, I think it's IP that surprised me in Q1 to the upside.

At the start of the quarter, we thought that we would have lower royalty revenue in the region and we were a bit too conservative in Q1, I think.

So IP outperformed based on my expectations for Q1.

And then in terms of China for the year, like I said, it's ranged by quarter from a low of 8% in Q2 '18 to a high of 13% now this quarter and as well back in Q4 '18.

But we're happy to get off to a strong start for 2020.

And I'm thinking double digits in terms of -- we're continuing at least double digits with the China contribution to our annual revenue is reasonable.

Your next question comes from John Pitzer with Crédit Suisse.

Congratulation on the solid results.

John, you did a good job with the June quarter revenue guide, kind of helping us understand the puts and takes around COVID between the low end and the high end of the range.

But I'm just kind of curious, was there any absolute impact to June revenue from COVID that you've also included?

Because even at the high end, you're coming in sort of below where the Street was.

And then when you look at the full year number, would you have raised the full year revenue outlook, had it not been for COVID, i.e., are you building in some cushion on absolute dollar basis there as well?

Thanks, John.

Thanks for the question.

It's a great question, and thanks for the opportunity to clarify.

But I guess when I sit and look at Q2, I think it's fair to view our guidance for Q2 as being a little bit conservative and maybe more conservative than normal.

But when I look at the impact of COVID-19 on our revenue, like for hardware, we don't have our usual physical access to customer sites to deliver product.

And then it's hard to predict when we'll get that access.

But if we deliver some hardware in the last week of June, it becomes Q2 revenue.

If we deliver hardware -- if those hardware products slip through the first weeks of July, it's Q3 revenue.

In both cases, they're 2020 revenue.

So I have more confidence in the year than I do for Q2 in terms of making those deliveries in time to fit Q2 revenue.

When we said that we're prioritizing the health and safety of our employees and our partners and our customers, we don't want to try and drive for too early delivery and particularly if we don't have physical access.

We can't control it if we don't have physical access to a customer site.

On the IP side, the physical access is to our own Cadence sites because that's where our labs are for IP.

And IP revenue is generally determined by just how much IP we can deliver in the quarter from our labs.

We're already a little bit behind because we haven't had access to our labs.

And it's not like a demand issue.

It's one of timing in terms of the delivery of revenue.

But -- and then -- so like I say, Q2 is -- I suppose the paradox of having a predictable revenue stream, it's very predictable for the year, but it's just less predictable in terms of what we can get done in June versus July at the current moment.

That's helpful.

And then, Lip-Bu, maybe you can help me better understand.

A lot of us out here are trying to figure out how the next several quarters might play out for the overall semi industry.

And for better or worse, we're kind of using the global financial crisis as a starting point, but there are some significant differences.

But when I go back and look at Cadence's performance through the global financial crisis, you were going through sort of an accounting change, which I think heightened sort of the volatility through that.

But you also saw a situation where things got bad enough where customers were cutting sort of R&D.

And I guess just given sort of the magnitude of the economic impact we're all expecting from COVID, why shouldn't that be kind of a baseline assumption as we go into the back half of the year?

Or are there enough sort of incremental drivers like hyperscale that really didn't exist back during the global financial crisis or in China that didn't really exist that you think offsets that?

Because right now, at least how you're playing out the year is June is sort of the trough in revenue, and it's a pretty shallow trough.

And I understand the business is just a lot more predictable than the global financial crisis.

But what other puts and takes do you see out there?

Yes.

So a couple of things, I think clearly we are going through an unprecedented time in terms of economy and unemployment and this virus across all the different regions.

So I think -- first of all, I think most important for us is to protect our employee and customer safety and well-being.

And I'm saying that I think clearly the impact of the economy in the semiconductor is really range on product to different products.

Clearly, the hyperscale and the video conference-related area and e-commerce area, I think is really a benefit.

And some of the sectors will be a little bit harder, especially in the consumer area and also in terms of the automotive-related area will be more challenging.

And so I think it's not across the board.

I mean there are some very exciting areas.

And then clearly, I think we are more tied in with the R&D budget.

And so I think good news is all the market-shaping customers in various hyperscale player and in various high computing area, we see the benefit of it and expect it at infrastructure sites.

And so I think that part, we continue to benefit and we took to go down on it.

And then clearly, we cannot look at quarter-by-quarter.

Some quarter, maybe a little bit more in China, some area maybe geographically higher.

But overall, I think we are very, very strong in the resiliency of our business, especially the ratable model and also the backlog and our very diverse customer base that really put Cadence in a very well position to do that.

And then lastly, Lip-Bu, just as a follow-on.

There was a couple of earlier questions that touched upon the strength in China, and it was up nicely, albeit it seems to make sense relative to the ambitions that the Chinese semiconductor industry has.

But I'm just kind of curious, given the heightened rhetoric around U.S.-China relations and the idea that the U.S. might actually make foundries for licenses to ship to certain customers, is there a risk that some of your Chinese customers are buying ahead?

And how do you -- how would you handicap that risk?

Or how would you help us think about that?

Yes.

It's a good question.

Overall, I would say that China business remained quite good for us.

And then like John mentioned earlier, we assume that export restriction will remain and we're complying to that.

And then meanwhile, we are doing everything we can to support the customer globally and then for all the new innovating design.

And so I think all in all, I think we have a careful assessment of the situation.

We felt that we can reaffirm the whole year because it's a ratable model, and we have a very -- $3.7 billion of backlog and so we can manage much better that way.

And then again, by partnering with customers deeply and be their trusted partner and work with them and that is the best way to really drive success together.

And John, this is John here.

I would just like to add to that, that 85% to 90% of our revenue is recurring in nature.

So any additional -- or kind of any pull-forward buying wouldn't increase our revenue.

But the revenue is time-based.

That would occur maybe on IP and hardware, and there was no evidence of that in Q1.

Your next question comes from Gary Mobley with Wells Fargo Securities.

Congratulations on the strong results as well.

I wanted to start out asking a follow-up question to John's line of question about what's different this time versus the financial crisis of '08 and '09.

And just thinking about how you diversified your customer base to include system OEMs, I see your backlog metros continue to grow about 15% year-over-year, much faster than revenue growth.

Is it the new class of system OEMs who are taking control of their own IC designs, deal-leading driver of that growth?

And as well, are the average deal sizes for system OEMs materially different than what you would traditionally license to merchant IC customers?

Okay.

Gary, I think good question.

So let me touch on the first, and then John can give you more detail on the deal side and others.

And so I think overall, we are excited about this generation of technology drivers.

5G is deploying.

And then the hyperscale and the infrastructure is already deploying.

And then the other part is also the high computing area for AI machine learning, either it's a start-up or mature big company, they are all diving in big time into the whole -- or just semiconductor silicon also to the whole system level.

So the packaging, also we benefit from it.

And so I think all in all, I think we see strong design activity, it doesn't slow down at all.

And then clearly, we continue to build the backlog because of ratable business, and so that will not be depend on quarter-to-quarter.

So far, that model has worked out very well for us.

I just had a follow-up question...

I'm sorry.

Gary, just adding there.

But I think the biggest difference between where we are now and where we were back in '08, '09 is that, I mean, we have incredible visibility now into our backlog.

I mean we've got $3.7 billion worth of backlog.

We're very, very diversified, and we have a lot of visibility into the second half of 2020.

Okay.

And the last time you gave fiscal year '20 guidance, I believe you mentioned that the extra week in the fiscal year and the 2 acquisitions you recently closed on were adding in sum about 300 basis points to the 10% growth you were expecting.

I presume the weekend -- extra week impact doesn't change.

But are you still looking for the same amount of contribution from the acquisitions?

Yes.

So Gary, it's about $40 million.

The extra week is worth about $40 million of additional recurring revenue to the year in 2020.

And we're expecting about $20 million from the combination of AWR and Integrand, the 2 acquisitions we completed in early Q1.

So yes, $60 million to the year.

Yes, I'm not expecting any more or less than that for the year right now.

Your next question comes from Joe Vruwink from Baird.

Just in regards to some of the product discussion and the new product offerings, is it possible to say with things like full digital flow or maybe the case of adding simulation to Allegro or Virtuoso workflows, how much this is increasing average contract value with the customer versus maybe a traditional measure of, say, wallet share with your customers?

Yes.

It's very difficult to bifurcate.

Okay.

So no sense other than like on simulation, it's hopeful to maybe define that as a $700 million opportunity between Clarity and Celsius, but other than that, no sort of uplift guidance maybe you can provide?

Well, I think it's too early to tell right now.

But certainly, I mean, it's very welcomed by our customers and our customers are very happy with the products we've provided.

But it's very difficult to kind of bifurcate the value of one product versus others in an arrangement where there's multiple products being provided to customers.

The only thing that I add on to that is basically, with these 2 acquisitions clearly give us a lot more opportunity in terms of a more comprehensive solution to provide to some of the key customers.

Okay.

Great.

And on your operating margin outlook for the year, I believe the second half is implied to be closer to the 34% level.

Is that really just a reflection of the revenue guidance and maybe the particular revenue mix that you anticipate for the back half of the year?

Or are there maybe some other OpEx items or costs that are more in your control that factor into this view as well?

There's 2 real drivers there, Joe.

One is the M&A that we lost some of the revenue and the purchase accounting.

So we lost some of the deferred revenue and purchase accounting.

It impacts the first half of the year more than the second half of the year, so it kind of skews some profitability towards the second half of the year on the acquisitions we brought in at the start of the year.

And then I guess the other impact is because we're assuming some deliveries that would normally happen in Q2 fall over into Q3, that you kind of have a slightly more back end-loaded margin profile for the year.

I mean, originally, I was thinking it would probably work out something like 31.5% and 33.5%, and now I know we're guiding to 31% and 34%.

Your next question comes from Tom Diffely with D.A. Davidson.

So John, you talked about how access to customers provide a little bit of conservatism in your second quarter outlook.

But I'm curious, what are you seeing on the actual manufacturing fronts, just with ambulation?

Are you seeing any supply chain difficulties?

No, not right now.

I mean we have a strategic sourcing group that have been working closely with all our suppliers.

We think we have ample inventory, and we have good second source suppliers.

The issue we have with revenue and predicting revenue for Q2 is really down to whether we can have physical access to customer sites to be able to deliver the physical product.

I mean that's where we've got some uncertainty.

And because of the uncertainty, I'm assuming some of that will naturally fall into the second half of the year.

Yes.

No, that makes sense.

And then, Lip-Bu, I'm curious, through this crisis, have you seen or hear any of your customers talking about acceleration to the cloud?

Yes.

So I think, clearly, we provide our teams multiple way and then cloud is one of the big areas that we focus on.

We are delighted that we're clearly extending our leadership in the cloud offering by providing customers with compelling productivity, flexibility and scalability benefits.

And so we mentioned that we passed 100 customer-plus.

And so I think we're continuing to make progress on that.

Okay.

And is that bigger on the emulation side or on the design tool side?

I think that's across multiple different products and will depend on the product offering we will provide them.

Your next question comes from Adam Gonzalez with Bank of America Securities.

Congrats on the excellent results.

Just wanted to follow up on some of the comments that my peers have made on your China sales and how strongly they've grown.

Can you talk about the availability of domestic substitutes in the region and how far behind China is an EDA in terms of being able to provide a complete competitive full flow suite of products?

Yes.

I think so far, now we're monitoring closely.

In China, there's a couple of small top point tool solution provider.

And clearly, from Synopsys and Cadence, we did 25, 30 years of simulating and providing -- and able to provide a full flow and the most advanced nodes.

But clearly, we don't underestimate that because clearly they get a lot of government funding, and so we keep a very close eye on that and not only from their progress and also from the recruitment point of view.

And we make sure that our team is committed with that, and then we can continue driving the R&D China, Beijing, Shanghai side.

Great.

And my follow-up is on the Digital IC design and signoff segment.

I saw there's been a deceleration in year-on-year sales growth for the last 3 or 4 quarters.

I don't know if that's just a rounding error with the percentage of sales that you give.

But is deceleration just a function of tougher comps?

Or is it the timing of bookings?

Do you expect the trends in that segment to turn around in the near term?

So Adam, one thing I'd point out is certainly for Q1 and Q2 this year, we're lapping very tough comps because Q1 and Q2 last year were not impacted by the export limitations we currently have in China.

That makes sense.

And if I can sneak in one last question.

You talked about the Q2 outlook and how it really reflects just a few different scenarios and how long you have -- whether or not you have access to customer facilities.

But if these work-from-home orders were to be put in place longer than people currently think, is there a chance that customers might switch their consumption of these hardware products more to a cloud-based model?

I think it's too early to tell.

We're quite happy that we had a really solid bookings quarter in Q1 with particular strength in Japan.

And I think we've had 15 new Cadence cloud customers in Q1, including several larger customers.

But I think it's too early to tell right now.

But yes, I don't think there's much more we can say.

Your next question comes from Jackson Ader with JP Morgan.

The first is, I realize that the impact on revenue is just about logistically getting on site.

But what about the difficulties or maybe some execution challenges you've had on getting deals across the finish line maybe for software deals?

I would expect or I think a lot of people would expect that there would be more moving pieces for larger deals, just moving around internally at your customers with everybody working from home.

So I'm curious to hear whether you've seen any impacts on that side.

So Jackson, our ability to close business hasn't changed, that we have very, very close contacts with our customers.

We're a very customer-driven company.

We always stay close to our clients.

But -- and also, I think we got a little bit lucky.

I mean toward the end of last year, Lip-Bu and I talked with the management team, and we looked at -- when there was a yield curve inversion back in August, we looked at the data for previous recessions, and the data suggested that a recession often happens within 8 to 14 months following a yield curve inversion.

So at the end of last year, we made it our business to try and close as much strategic account business early in the year as possible, and we managed to do that.

Excellent.

Thanks for the color.

And then the follow-up question on -- is it possible that there could be maybe any trickle-down effects from the delayed either hardware or IP delivery?

Would that change maybe activity later in the year if people aren't able to get their tools in time?

So basically, the delivery -- I don't think we've had any problem with closing business.

The challenge is being in executing and delivering the -- completing the delivery on the business.

Demand continues to be strong.

And it's just really getting access to a customer's facility to be able to deliver hardware.

And in our case, in the IP case, getting access to our own facility into the Cadence labs to complete our -- the IP deliveries that we've already contractually signed up to.

Your next question comes from Ruben Roy with Benchmark.

John, you've had a lot of questions on China, and I think I understand the near-term dynamics.

But I was wondering if you could refresh my memory on export restrictions.

Obviously, there's been some chatter in recent weeks around potentially tightening rules for some sorts of high-technology product shipments into, not just current entity list companies in China, but potentially to a broader swath of Chinese firms.

And I'm wondering if you can remind us what portions of your product lineup are subject to export restrictions.

Are the hardware and IP products, some or all subject to those restrictions or if you've heard anything new on potentially tighter rules for your products specifically?

Well, most of our products are U.S. origin.

So they're impacted by the export limitations.

Our ability to deliver products and services to certain customers in the entity list is limited.

So therefore, we would expect our revenue in China to be higher if we didn't have those export limitations.

But for the purposes of guidance, we just state our assumptions that we assume nothing will change.

And right now, like I say, because most of our technology is U.S. origin, we are impacted by those export limitations across the board.

Right.

Okay.

Okay.

And then just a quick follow-up, John, on sort of the assumptions.

You walked through the assumptions on how to think about Q2 guidance low end to high end on the potential of getting back to work.

How are you thinking about your own operating expenses and margins?

Obviously, you've kept your full year guidance static, but do you have any embedded assumptions and sort of when you expect things to normalize, if there will be a normalize coming up, embedded in those assumptions for the year?

Yes, sure.

I mean that's -- effectively, we're continuing to hire, although hiring has slowed because it's more difficult to complete the whole interview process and the onboarding process.

But we're continuing to hire.

And typically, we hire after getting contractual commitments from customers.

But Lip-Bu and I are very careful about adding investment dollars until we see the commitment from customers.

So in our guidance, there is impact, of course, if hardware falls into the second half from the first half, the cost of goods sold associated with those hardware products will also fall into the second half.

Originally, I was expecting like 31.5% margin in the first half of the year, followed by 33.5% margin in the second half.

That's more skewed now towards 31% first half, 34% second half, because of unexpected shift of some hardware and IP revenue from Q2 into Q3, really.

Your next question comes from Jason Celino with KeyBanc.

In terms of operations in China, obviously, those were impacted from kind of coronavirus first and your global workforce.

What types of learnings were you able to apply to your other segments in North America and Europe once you saw kind of those restrictions put in place?

Well, so one thing I learned is -- I mean last quarter, I thought there would have been a bigger impact to our royalty revenue.

And as it turned out, it wasn't as big an impact as I thought, because in some cases, some products do better and some products do worse, but -- and I think we benefit from diversification across our products and platforms.

Another thing we learned is that there is a lead time, I guess, in terms of hardware orders that -- we were able to complete hardware orders in the latter part of the quarter in China because the hardware was already on-site and being demoed by the customer.

So we didn't have any additional physical delivery to complete the revenue cycle to be able to take revenue.

Whereas if we haven't got the hardware on-site for the customer, we have to wait for the customer sites to open.

So that was the learning that we had.

And therefore, the impact to our Q2, you see that in our Q2 guidance.

We're expecting that some revenue that we would normally be taking in Q2, we're expecting to fall into Q3 now.

Got you.

Okay.

So from a progress standpoint, customer engagement standpoint, is there anything else that mirrors or differs from what you saw in China customers versus North America or Europe?

I don't think so.

I think we're a company that operates in -- like in the technology industry, and we can never predict the future but we always assume -- we're working in an industry where we always assume that tomorrow will be very different from today.

And so we operate very, very closely with our customers.

And that close client relationship allows us to be resilient, flexible and agile and very, very effective in times of change.

I think we're also very diverse.

We have people in 47 sites across 22 countries, all very, very close with the customers.

So we're able to navigate with change, and we're able to move with change very easily.

And I'm delighted with how effective the teams have been.

Your last question come from Krish Sankar with Cowen & Company.

I had a couple of them, mainly for John.

John, thanks for all the color on the China sales.

I was just trying to figure out you said some of the outperformance was in IP in China.

Within IP, can you say was it more on the cloud data center?

Was it mobile?

Was it auto?

Any color would be helpful.

It was certainly on the IP side, but I don't think we'd give any further color in terms of which part of IP.

But IP was very strong in Q1, and we were delighted with that.

Got it.

Got it.

And then obviously, some of your emulation and prototyping hardware is assembled and tested by the subcontractors.

Which specific geographies are your subcons in right now?

So most of our hardware is made in the U.S., in the Americas.

But yes -- and we're in very close relationships with our suppliers.

We've second source suppliers.

We also have ample inventory.

I don't think we have any supply chain issues.

Got it.

Got it.

And then just a final question, I'm guessing it's not an issue.

But if you look across your whole customer spectrum, if you look at some of the smaller customers, do you worry about potential payment issues for them in the second half or so if the economy goes into a recession?

That's a very good point.

In our guidance, we're anticipating some natural credit deterioration and particularly in the longer tail of customers.

We've said many times in the past that our top 40 customers, we generate 55% to 60% of our revenue from those customers.

And thankfully, they're in a very strong position.

Many of them read like the who's who with the strongest balance sheets in the world.

But in the longer tail, naturally, we would be concerned about some credit deterioration.

So we built in some anticipation for natural credit deterioration in the long tail.

But now if the shelter-in-place order remains in place for much longer than the end of Q2 and we don't see improvement in the second half, that could impact the businesses of our customers and our customers' customers and cause credit quality to deteriorate more than we're currently anticipating.

I haven't got that.

I haven't anticipated a great depression or anything.

But we have assumed that there may be some credit deterioration if this lasts through the end of June.

And that's all.

I mean we can't predict the future.

I can only share with you what in our assumptions.

Got it.

Can you quantify that credit deterioration or...

No.

It's only slight.

Like I say, it's maybe kind of 5% to 10% slower payments because that could impact our revenue timing because you become more variable -- you have variable consideration.

So we have a typical recurring revenue pool, but -- and if you assume everyone's creditworthy, that's very even every quarter.

If there's any credit deterioration, that can cause a little bit of a delay because you have to wait until you collect cash to recognize revenue.

There are no further questions, I'll turn the call back to Lip-Bu for closing remarks.

Thank you all for joining us this afternoon.

Our Intelligent System Design strategy is playing out very nicely as we benefit from new opportunities in design excellence, system innovation and pervasive intelligence in an expanded total addressable market.

In this time of uncertainty, I'm very impressed and proud of the dedication and commitment shown by our employees to continue innovating and delighting our customers.

We are all in this together, and I'm convinced that we will collectively come out of this unfortunate situation stronger as a company, as a community.

And lastly, on behalf of all our employees and our Board of Directors, I want to give our heartfelt thanks to the extremely brave and courageous health care workers and others on the frontline, and they are tirelessly working to fight this pandemic.

Have a wonderful day.

Thank you for participating in today's Cadence First Quarter 2020 Earnings Conference Call.

This concludes the call, and you may now disconnect.