Q3 2019 Earnings Call

Ladies and gentlemen, this itself. After today's call is scheduled to begin momentarily until that time your life will get replaced the whole. Thank you very much fewer patients.

At this time I would like to welcome everyone to cadence third quarter 2019 earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speaker's remarks, there will be a question and answer session. If you'd like to ask a question. During this time simply press Star then the number one on your telephone keypad. Thank you I will now turn the call over to Alan Lindstrom Senior director of Investor Relations for Kate. Please go ahead.

Thank you, Josh and I would like to welcome everyone to our third quarter 2019 earnings Conference call I'm joined today by lip Bu time, CEO and John Walsh, Senior Vice President and CFO .

A webcast of this call is available through our website cadence dot com and will be archived through the 13th of December 29 tea.

A copy of today's prepared remarks, we'll 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 the 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 Cadences. 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, we issued today.

In addition to financial results prepared in accordance with generally accepted accounting principles.

Yeah.

We will also present certain non-GAAP financial measures today.

Okay mismanagement believes that in addition to using GAAP results in evaluating our business. You 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 directly comparable GAAP financial results.

Reconciliations are available at the Investor Relations section of cadence Dot com.

Copies of today's press release dated October 21st 2019 for the quarter ended September 20 years 2019 related financial tables.

And the CFO commentary are also available on our website.

And now I'll turn the call over to lip Bu.

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

I'm pleased to report that cadence achieved excellent operating results for the quarter of 2019, delivering 9% year over year revenue cool.

Based on now strong execution and string off our technology and business, we are again, raising our outlook for the year.

Given the uncertainty opt to ongoing trade situations with China.

Well I would hope Shoom cauldron export limitations remain in place for the rest of the yeah.

John will provide more detail or no outlook shortly.

Our global economic and geopolitical uncertainty continues.

Long term trends such as E Hi, Fiveg crowd and Aiotv continues to drive strong design activity.

The move to domain specific computing and system companies building custom silicon as well as a host of innovative silicon startups.

All pushing that technology and bundle and driving the need for high performance low power computing.

Hi, Ben with connectivity and high density storage.

Oh, we intelligence system design should the G focus I push on US well go next you might the resulting opportunities.

True building out our portfolio and providing more capabilities and value to our customers.

The foundation of Pasha Touchy, it's the design excellence Seckman, which comprise of I'll call you D and IP business.

Well now provide somewhat the key quarterly highlights in DC area.

A key element of our approach has been too closely collaborate with our ecosystem partners and focus on Mcus shipping Costamare.

In Q3, we deepen our partnership with Samsung through a comprehensive agreement across our digital custom and verification product portfolio.

Early this year, we had reported a brick true why ranging when we're done my key U.S. semiconductor company.

I'm, particularly pleased that we augmented that partnership with our largest ABA IP order.

That include Oh, what Tensilica process, a family and I would design IP portfolio, including Ultra high speed. So do you.

And its recent open innovation platform, even TSMC recognized cadence with full hardness off the a awards, including an award for joined the bundle men of six now need to design infrastructure.

And one for Charlie deliberate of crowd based Productivities solution.

Oh, well cadence crop portfolio has great momentum with over 50 customers using our solution in the crop.

Okay, then called radio products, and close cooperation without crop infrastructure and foundry partners.

Enabling our customers to realize meaningful scalability, performing and flexibility benefits from using to come.

Our call bus model is useful hybrid cloud infrastructures.

Where a customer one too often yeah, I'm proman up I'm, probably me infrastructure with bus capacity.

From the topic how to address Pik note.

Continuing strong perforation off our digital and sign up solutions.

Especially with Mochis shipping customers at the most advanced nodes have driven share gains and double digit year to date revenue growth.

In addition to numerous seven they're not meet the tape outs.

Yeah, I'm more Dan.

15 customer engagements at five and treat that not meet a using our digital flow.

Mediatek has deployed Oh, well digital full flow in production for seven nanometer design.

Admin inox.

Leading in elite a in technologic a in data connectivity solutions.

No, but we placed the incumbent solution for all off the up production seven nanometer designs.

We also had a digital flow competitive win for seven down on meta design with a leading Japan is imaging company.

Wouldn't.

Use cadence picture tofu flow, which is based on common engines and includes Janice Innovus Tempus and pick a says to achieve the best quality all results and the fastest converging off the a highly into innovative.

And completely integrated.

Digital automotive radar on chip.

Next I will discuss highlights of our system design and verification solutions.

Oh Palladium Xinyuan emulate huh.

And the recently introduced.

So Jim X one M.P.G.H. bass pro typing platform now provide a comprehensive solution across IP and Src verification.

Hardware software regressions and audio software development.

Growing somebody going system design complexity and the high cost Ophelia continues to drive strong demand for all Palladium zone one.

In Q3.

The one added eight new customers and had key I have eight key expansions.

Rounding off our hardware family, it's a pool Kim X one.

Which is a perfect complement to our Palladium zone one.

I'm excited by the strong customer interest in Protium X one.

Oh Global my key customer significantly expanded.

Existing hardware footprint.

But the additional xinyuan capacity and Protium X one as well.

It can get one of the largest hardware or does Alba fall cadence.

We had some photo fool voting vacation suite wins in Q treat including a major customers in Asia.

And on automotive semiconductor company in EMEA.

In IP I will focus strategy and strong portfolio has enabled us to benefit from the continuing IP outsourcing trend.

In Q3, we had our best elbow quanta for IP with year over year revenue growth exceeding 20%.

It was especially strong quarter.

Our tensilica products.

I didn't know wins in or do you.

Imaging computer vision and mission Dunning.

In system innovation segment, although intelligence system design strategy.

We introduced the shelves, yes, Calamos Saba.

Which joins the car T. Three D.E.M. salva in a growing suite of our system analysis products.

Celsius, it's the industry first complete your natural tomo close simulation solution for that you'd electronic system from I see two system auto physical and close yes.

Based on the proven massive massive leave pelo architecture that.

Do you leave us up to 10 X. Foster performance.

With food acute Betsy.

I was just and they both.

Design teams to mitigate tomo issues at an earlier stage.

Thereby reducing system development determinations.

Bosch and have both endorsed this exciting new products and well in the midst of earlier discussion with silver other customers.

Clearly tea.

Which was announced earlier this year continue its strong momentum with for competitive wins during the quarter.

More than 30 active customer engagements underway.

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

Thanks, a boom and good afternoon, everyone.

I'm pleased to report, we met or exceeded all of our key operating metrics in Q3.

As a result of continuing robust demand for our solutions.

Strong execution across our business, we're increasing our outlook for fiscal 2019.

Before we get into the Q3 results I would like to take a moment and talk about the ongoing trade uncertainties.

With more companies recently added to the entity list the situation remains fluid and we will continue to closely monitoring.

For the purpose of providing guidance for 2019, we've assumed that the current export limitations remain in effect and the entity list remains unchanged for the remainder of the year.

Now, let's go through the key results for the third quarter, starting with the piano.

Total revenue was $580 million up 9% year over year.

non-GAAP operating margin was 31.7%.

GAAP EPS was 36 cents.

non-GAAP EPS was 54 cents.

Next turning to the balance sheet and cash flow.

At the ended the quarter cash totaled $655 million, while the principal value of debt outstanding was $350 million.

Operating cash flow for Q3 was $139 million.

Dsos were 43 days.

During Q3, we repurchased $75 million of Kate and shares.

Now I will provide our updated guidance.

For Q4, we expect the following results.

Revenue in the range of $590 million to $600 million.

non-GAAP operating margin of approximately 30%.

GAAP EPS in the range of 33 to 35 cents.

non-GAAP EPS in the range of 52 to 54 cents.

And we expect repurchased $75 million of Kate and shares.

As a result, our updated guidance for fiscal 2019 is now as follows.

Revenue in the range of 2.3 to seven.

Two $2.337 billion.

non-GAAP operating margin of 31.5% to 32%.

GAAP EPS in the range of in the range of $1.50 cents to one dollar and 52 cents.

non-GAAP EPS in the range of $2, an 18 cents to $2.20.

And the operating cash flow in the range of $700 million to $740 million.

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 our execution in an uncertain environment.

Our strong dependable results reflect the broad diversity of our global customer base.

We remain focused on driving growth in our core business highlighted by the proliferation of our digital full flow.

We continue to invest in growth opportunities with market shaping customers, a new product areas.

In closing I would like to thank our customers partners and of course our employees.

For their continued support and with that operator, we'll now take questions.

At this time I would like to remind everyone wants to ask a question to please press Star then the number one on your telephone keypad now, we'll pause from compile the culinary roster.

And your first question comes from Adam Gonzales with Bank of America. Your line is open.

Hi, Thanks for taking my question congrats on the strong results.

For the first one I'd like to focus on the IP business I know IP can be a little bit volatile from Rev. Rec standpoint, but can help us understand how sustainable.

This large boost you saw in Q3 is should we expect a little bit of reversion in Q4 to skew through you kind of represent an inflection.

The latter can you walk us through what the sustainable drivers there. Thanks.

So Adam yes, yes, as if we mentioned in his prepared remarks, the Q3 was our best ever quarter for IP business with impressive.

Revenue growth exceeding 20% year over year, I mean, if I look back over the last four quarters. The trailing four quarters were also up 20% year.

Year over year on IP, but we always see that's revenue for IP can be lumpy in any single quarter Hoffer even year.

But we do believe that it's a it's mostly be sustainable over the long term.

Got it thanks for my follow up I guess can you just give us a in early view on 2020 growth based on the bookings momentum that youre seeing today.

Sorry can you repeat the question.

Just if you haven't early view on what 2020 growth could be directionally, if not an absolute value just based on the momentum that you're seeing today for the overall business Oh.

Oh, what we're not giving any guidance on 2020 right now like we states can be it can be lumpy in any one quarter hoffer even year.

We'll provide that guidance and at the end of <unk>.

Got it thanks.

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

Hey, guys. Thanks for taking my question and congrats on another strong quarter.

I I realize that you're probably going to be filing your 10-Q.

Three hours or so, but can you give us a preview into what the repeating.

Remaining performance obligations words conclusion at the quarter.

Yeah, I think it's I think is filed already the contracted but on satisfied performance obligations were approximately 3 billion at the into Q3, including approximately 200 million over IP axis arrangements, those IP axis arrangements or noncancelable commitments from customers where product selection in quantities are determined by customers each quarter.

Okay.

Sets of about $200 million sequentially not mistaken.

Alright.

Multipart question on your systems analysis business look through you mentioned, a four wins for clarity in your prepared remarks.

In relation to those four wins in the early activity in that 30 engagements that you have.

How successful are you and your ability to separate the licensing deals from existing customers in other words monetize them above and beyond your existing.

The run rate existing customers and can you share with us what your typical deal size, maybe for these types of wins and as well, perhaps when you can start to recognize from revenue from these four early clarity wins.

Yes. Thank you for your question, Gary I think couple of things.

First of all I think.

We have our approach of D or not this system analysts this space and Thats something is really our call compete on all computation the software and now we can apply into this.

Complex system analysts this space and then we have this tuniu Proto initially we announced a community that is the treaty E.M. Salva.

Delighted we have for competitive wins and a this is a very new product for us and we have more than 30 active customer engagements are going forward and so we're excited about that and that Meanwhile, we just announced our Chelsea us tomo Salva and again back to that computation of software strength that we.

We have and we clearly demonstrate that up to 10, x. performance and customer delighted to see outperform and I, specifically spell out Bosch and they both endorsed our new products and why me adult earlier discussion. So he's doing a very early stage of our you know in <unk>.

Emerging into a D.

System analysts this and more and more our customers love that because you know beside the E.D.A. beside the IP. They want to look at the total system solution simulation, what they fit the whole system power and I'll come all envelopes and something that we can really demonstrate and provide the best solution.

For the customer so just do very early and a interim about pricing a again you know it's not part of our E D and so and now we do it differently and that basically now close to the market competitive.

No pricing and then but in a very early stage of winning and then state you overtime, we will unfold and keep your progress update.

Okay, all right. Thank you guys.

Thank you.

Your next question comes from Jackson Adder with JP Morgan Your line is open.

Great. Thanks, guys. Thanks for taking the question.

Can we just start with with hardware.

Looks like.

Verification was to segment the probably struggled the most year over year and we've seen inventory balances picked up the last couple of quarters. So I'm. Just curious is this maybe a building of a of some hardware head of pipeline or are we are we seeing any kind of struggling.

Close rates not hardware business.

Now let me start first checks and then and then jungle a few more detail about the inventory and so I think first of all I think function verification, we mendo fastest growing challenge for our customer and I've mentioned in Q3, we are delighted to.

Deepened our partnership.

With Samsung to a comprehensive.

Agreement across not just teacher tell custom and also vilification products and end up podium Xinyuan and now have been doing great and the customer love. It on the hub of humiliation, but now we at the Protium X one APG based prototyping, Doug we can provide a comprehensive solutions.

Across IP, and Esso, Siebel suffocation, especially for hardware software regression and earlier software development that combination and using the same fun and software and make it easier for the customer and then so I think we clearly see that you know it new customer and eight key.

Expansions and so I think we are just delighted and now they place protium.

Keeping a lot of opportunity for us and that we also highlight a global marquee customer significantly expanded existing hardware footprint with additional view, one capacity and add on to pull Kim X one as well because I think that one SLR just wonder if the largest hardware.

Audis for cadence so I think all in all our we see string and then I think John can highlight the reason off building up the inventory I guess, yeah Jackson as a as their boost says I mean, our hardware solutions are proving to be very robust in the marketplace and caustic demand is good.

Q3 results were slightly up on Q3 18.

But we were building inventories heading into Q4, because weve a strong pipeline going into Q4.

Okay that makes sense.

And then one quick question a follow up on the 30.

Customers that clarity engagement or it can you give us any kind of be history sense for those are significantly different from the cadence or customer base in India.

Yeah, I think you know both and not just on semiconductor many other system company and because it's really see the value opt out up to 10 X. performance and also tie in very well with the from the system simulation down to the silicon some insulation that 40 integrated into.

Compete that customer live.

Okay. Thank you.

Thank you.

Your next question comes from Rich Valera with Needham <unk> co. Your line is open.

Thank you first just a clarification.

Congratulations on the on the large IP order that you mentioned was from from the marquee customer you had referenced previously I just wanted to clarify is the the significant hardware order as well from the same marquee customer was that a different one.

Yes, So I think probably mentioned earlier is that IP deal is with global.

You know some Mike you asked semiconductor company multi use semiconductor company and Dan the hardware and now clearly is a marquee grow both my key companies.

And our day already all customer, but they are increasing their hardware capacity last approach them that they like a lot and so that the 40 integrated and make it though one not the largest hardway orders.

Got it today are different customers, though is that just to be to be perfectly clear.

Yes, yes, yes, okay. Thank you and then moving onto the system products first just wanted to understand you mentioned that bosh and arm had endorsed and I think you said both of these products and just wanted to clarify that that wasn't factored into our Smith of both Celsius and clarity and then if that's the key.

Case have either of them actually purchase clarity or are they among those for for competitive wins you have four for clarity.

Yeah, I think we've mentioned Bosch and and Dos Celsius product and a D. Karate, we mentioned above four competitive wins, and then plus and at that 30 active customers. So does that differentiation here.

Got it understood and then I noticed a tough subject I just wanted to see if you're willing to say sort of anything about China as we look into next year.

You know this year, you've had a number of customers.

Put on the entity list and you had the benefit of getting revenue from them for for in some cases three quarters of the year in some cases, maybe a couple of quarters as we head into next year. If the entity list sort of stays the same you'd have kind of a full year.

Since headwind from those customers, but I guess recently, there's also been some policy put in place.

In China, whereby they were actually providing incentives for for companies to purchase both EA tools, and IP, which could conceivably be a tailwind for you I'm in the country. So just wondering if there's anything you can say about sort of China as we look into next year. There's there's a lot of sort of factors at play I know you want to give numbers, but just any.

Any thoughts there lift it would be helpful.

Sure. So let me just touch on first of all I think are clearly cadence will pass and we'll continue to comply with the United State Department of Commerce export control and as I mentioned, a situation is fluid and we monitoring comfortably and even with this uncertainty.

We assume our current export limitation remain in place for the rest of the year. So we our guidance already provide everything we know in this and we are not and so I think this is kind of way we are John yes, yeah and period, when we're not going to speculate in terms of.

That plays out for next year, but you're correct in your assessment that.

It's in some cases for some customers we had revenue in the first half for the year and the second half of the year is quite different now we do have some headwinds. If there is no change those headwinds will persist into next year.

Okay. Thanks, Thanks for taking the questions gentlemen.

Thank you no worries.

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

Yes, good afternoon or another question on the IP. Just curious is this sequential growth solely due to the one large customer or did you see a broad base increase and IP demand as well.

Yeah, Let me start first and now clearly the you know I will focus or that GE and that strong portfolio, an IP and in fact, we keep on adding more IP portfolio.

Beside the Tensilica and out the memory connectivity and a and then we are excited up our high speed study that we bought from a new semi.

And that hundred NPL kick Sodi is a must have from a lot on datacenter infrastructure build up and the hyper scale guys really like it and so I think we have a very well be placed with our portfolio and we are laser focused on our strategy focus on does.

Leading customer and then focus on the advanced nodes and add a and then focused on something that we can scale and then so far I think we have a very broad portfolio. By Meanwhile, we are very delighted and I mentioned earlier this mark Maki semiconductor company be site, we have Ah why ranging win and now.

Now we add on this largest IP much US include Tensilica family I will also include the design IP portfolio.

Hi excited about he just add on top of it and were very pleased with the progress and ER in IP is like the building block off the system.

So you really need the I stopped me call. It the star IP that a mass half and we had really focus on the side. Yeah. We're very pleased with the consistent execution, there and IP and they had a very strong finish the last year. They there is very strong Q1, Q2 was kind of flat on Q2 last year and then we had a strong Q3, but as with all these things of course, it creates a tough come.

We are going forward.

Do you see any natural seasonality in that business or is it purely project based.

Its purity project based than I mean, there's some it is kind of random from a seasonality standpoint.

Okay, and then finally, John in the press release, you mentioned kind of a reorganization of some international offices they had yes.

The impact on taxes going forwards wonder if there's something you can see all that.

I mean, that's a GAAP only thing I mean in October 29 team, we initiated a series of transactions involving a an internal realignment of our international operating structure and that realignment make significantly increase our foreign deferred tax assets as you know deferred tax assets a recognized twin the depreciation of yes. It is expected to offset.

At future profits, so theres a lot of calculations that go into trying to estimate to the value. We've not completed our analysis and cannot yet estimate the impact.

But we we expect to complete the analysis and record the income tax impact in the fourth quarter of 2019, we wanted to highlight that in our CFO commentary because our occurring GAAP guidance in the.

Basically doesn't account for for this change. So we just wanted to highlight that that pieces open.

Okay, but no knowledge gap impact going forward.

Right.

Okay, great. Thank you.

Your next question comes from Mitch Steves with RBC capital markets. Your line is open.

Hey, guys. Thanks for taking my question is too for me just regarding China in terms of historical last quarter, you guys can have a blue blow a quarter, where being up 68% and now it's up about 21% is there anybody can further theres potentially some hardware Poland just given the hallway dynamics last quarter that and that's the reason why it's down sequentially or am I reading too much into it.

Overall, China was what 10% of revenue in Q3, no that's down from 12% in Q2, but flat from Q1. It was anything was 10% in Q1 as well, but you know we've seen variability in our China revenue mix over the last six quarters. It's ranged from a low of I think 8% back in Q2 18.

Too high of about 13% in Q4 18.

Back in Q4, 18, we did experience a hardware pulling and we did see the first half was quite strong for for hardware.

Q3 has been a little bit lighter for hardware and that's showing up in gross margin, but like I say, we hardware pipeline is strong for for Q4, an hardware can be lumpy in any one quarter.

Okay that makes sense. It and then secondly, our media is probably one of the better ways play savings over the next like five to 10 years.

One thing I'm noticing here as like your employee count is actually increasing pretty significantly going from like 4% growth to 8% I just want to be clear here, if I look out over the next let's call. It three to five years that your Opex still gonna under grow the revenue line is that fair assumption because it looks like it's actually pretty close now at this point.

Yeah, we're not guiding anything on 2020, right now, but books, but you're right to point out that your head count has grown because we're investing in opportunities for proliferation at market shaping customers and a new products and in some way were very excited about the environment because you know as I mentioned.

You know de couple of big driver, AI, Fiveg cow, and Aiotv and a whole data infrastructure.

You stopped because our E and all this driver that's a very big changes requirement I need it and so we have a suite of.

Our dog and system company, they'll all tied to meet the new requirement. So there's a lot on innovation happening and so we see a design activities increased and that's why I think or so we have a proliferation of our digital flow and also somewhat the key market shipping customer that we are being adopted.

And so while building up the engineering and also the FP support to when some of this a cow and ample roof rating and that's why you're not John and I, We only increased Ah Hey, cow when we see the deployment and also the commitment from the customers.

Got it it's very clear thank you.

Thank you.

Your next question comes from John Pitzer with Credit Suisse. Your line is open.

Yes. Good afternoon, guys. Thanks, Let me ask the question listen I guess my first question is just on the relatively new North American customers clearly additive to the September quarter. I'm wondering if you could just help me understand how we should be thinking about sizing that business over multiple years, and how that business scales for you and.

We continue to move down nodes.

Yes, so I think clearly we don't Guy any 2020 outlook.

By way excited about I don't know quite sure Neil North America, we only have mentioned up our marquee and out in the summer U.S. semiconductor company. We're excited about that partnership and we're expanding beside the tool expanding the IP proliferation and apart we will continue we're excited to.

Got it.

So let me Paul just going back to your comments about a high.

Kind of curious if you could size, how big that businesses either as a percent of overall revenue were or maybe of the growth and I guess specifically.

The semiconductor industry, when 10 or 15 years without a lot of venture capitalists money and Thats clearly changed around AI and there is somewhere between 40 to 60 potential AI startups that are getting funded it I'm just trying to get a sense of how important that is two to your gross in the near term and kind of do you think that.

All these companies are going to be viable or is it more likely that this consolidate and if it's the latter how do I think about kind of the I revenue stream unfolding from here.

Yeah, I think you're not AI implication to the whole industry can be quite significant.

If you look at the University like MIT Day School called the school outcome, New school of computing. They just waste 1 billion for that same thing with CMU, Kentucky Mallon.

And I'm on the trustee and now they are just offering de high degree for undergrad and then you can see it a soft Bang ER vision fund tool is focused on a high. So you can see the AI implication and in fact, you are correct. If you look at the semiconductor growth recently and income of funding.

A lot is driven by E. Yeah. It's not just semiconductor is applied into all the different vertical industries. So the impact can be quite huge and.

We're excited by this opportunity that design activities increased a lot and so I think all in all I think clearly we have a very good position we have the not the AI machine learning application to our tool.

So we see significant improvement in some of our various tool in tumble P. P. Eight runtime and verification. So we are embarking on improving our tool. So that we can get the best pulled out to meet the customer requirement and the AI development, it's not just the start up.

All the big Hyperscale Guy and all the Big South system company. They all have various degree Alta investment into AI and then we also our Tensilica. That's a very clear good engine for some of the I application like audio video and various our does and now we are tied to be.

The software stack on top of the AI platform. So that we can provide a solution to a customer for the various vertical market. They tried to address.

So I could take a quick financial wanting for jobs, John just given what you guys do the September quarter ended the year ago quarter I'm, just kind of curious your op margins sort of guidance for the December quarter can you help me understand why would be down sequentially year over year, rather than just an abundance of conservatism on your part.

[laughter] yeah. So.

And we haven't changed how we guide I mean, we guide the same we all the time that but essentially it's the same as where we were at this time last quarter last quarter, we guided Q3 at 30% for op margin on Q4 for 30%.

In Q3, the beat was mainly on the gross margin side I mean, we assume gross margin comes out at about 90% in our estimates and we did better in Q3. It came out at I think was 91.6% and we landed at 31.7% for for op margin. So most of the.

Most of the beat on the Op margin side in Q3 was the result of gross margins by expectation for Q4 is that we have a significant hardware pipeline heading into Q4. It was kind of similar it reminds me of where we were at this time last year and last year, our gross margin tick down I think 200 basis points from Q3 to Q4.

Sure.

So we're expecting about 30% and that's that's because you've got a combination things happening right you've got.

Q3, and Q4, our we're assuming that.

But theres no change in export limitations right now.

We're also investing in proliferation opportunities markets, you've been customers on an in new product areas. So that's what's that's what's driving the numbers.

That's helpful. Thanks, guys.

Your next year.

JC showered with Griffin Securities. Your line is open.

Thank you good evening question for you John first.

Noted in your prepared remarks, the 200 million or 212 to be precise.

Yeah, the ita commitments a this is not a.

Metric that I think you've disclosed before until tonight's Q.

Was that a mountain dew, mostly if not solely due to a single customer or is it fairly broadly base in terms of numbers of IP customers comprising that.

And then secondly, just on longer term media market question for.

Yes, Jay Thanks pointed that out yes the.

So that was an issue we had with how remaining performance obligations were calculated in the past.

Yeah, we.

Reported backlog under the old rules and we would have include our IP axis arrangements.

And then under the under the New rules. The remaining performance obligations didn't include IP axis arrangements and it didnt seem.

To be consistent with how we report in the past. So we worked with our auditors just to say that we wanted to disclose it because as you say no as of Q3, we it's $212 million because the exact number.

But the $3 billion that we haven't contracted but on satisfied performance obligations is a is more comparable to.

The backlog that we headed into last year.

Okay. Thank you for that.

Uhhuh.

Maybe a two part technology or market question.

First you often use the term market shaping customer.

And it's frankly are somewhat odd expression.

How do you defined customers.

Fall into that category and more specifically how do you.

Dedicated resources to those customers in terms of.

And so for and then or growth question.

We've seen a number of categories in India.

Extended periods of consecutive growth for example.

The industry data at of course your numbers.

The custom category has had more than 30 consecutive.

Trailing 12 month period.

Implementation work in 16.

PCB well so that's all very good of course, but.

Historically.

<unk> growth cycle for particular category last for more than three to 40 years, three or four years E.

But we've now seen multiple categories that are meeting or beating historical periods of consistent growth. So.

What's your thinking in terms of sustainability, what's different now vis-a-vis the different categories.

Yeah. So Jay Thank you for dish questions and I'll, Let me address one each time, so first of all up our market shaping customer.

In our definition is not there clearly the leaders.

Index sector and so they are the most demanding customer.

But because down lido doubt driving the innovation driving the performance and we want to be the or not.

Partners for Damned Atrocitie partner to enable innovation to continued our leadership in the marketplace in order in the various different vertical market or deep enough platform that did create we want them. We wanted me to partner for them and that is how we define the market shipping customers.

In terms of growth in art I mentioned, how you can see on my passion clearly and now we we are not creating the changes we are right with the wave and.

The beauty apart you notice.

In this particular junction off the industry that's enough five different wave are driving the growth and changing the landscape opted requirement is it just mentioned one example is AI and now we are moving into I call it that data centric.

Not me is all about data and then two days only 2% not that data being analyzed and being utilized so there's a humongous opportunity and then this is applying to across all the different vertical and it really driving a change to the memory striving to achieve the storage are driving the domain specific.

Perfect.

Processor, so in a way its workload specific depend on different book load deepen markets require different.

You know rather than just CPR GPU, Oh, Gee, that's a new Clos off.

Workload that requires a different type of processor and networks are driving the memory storage the infrastructure in tumbled able to cope with the data massive massive exposing of data and then so all these condo require new innovation.

To support at night for example, the program, but plenty to scale out storage and networking and then skew I'll note that the top of rack or the way to Thompson.

On the spine in come out the infrastructure chopping it cannot be per second to 51.2 Terabit per second suites, and all the high speed interconnecting and Thats why the study is so important for high speed and that's why.

Okay, then boarded and then we're going to triple down it to rodeo drive the requirement that the hyper skew and a big infrastructure play a need that so I think this kind of be driving a lot of.

New innovation in semiconductor side, and we are learning and we are tied to beat the trust a partner to fill few somewhat gives requirements and that's why I mentioned earlier that design activity increased a lot and were excited about it and it just up beginning of it.

Thanks very much.

Thank you.

Your next question comes from Jason Keybanc Capital markets. Your line is open.

Hey, guys. Thanks for taking my question just two from me today first fun with your Q4 pipeline for your hardware business.

You talked about more modest growth this year following a tough comp from last year, but.

The pipeline hold could we see some upside to that modest growth commentary that you've provided previously.

Yes, Jason the I'm, just kind of hard to move the needle in one quarter I mean, if you look over the the total year, we're expecting kind of low to mid single digits growth for functional verification for the year. Although if you do look over like the trailing four quarters to the end of Q3.

I think folks who verification is up.

Kind of high high single digits, but the challenge this year has been tough comps and.

The unlike say, we enter into Q4 optimistic with a strong pipeline.

Okay, Great. Thanks, and my next question has to do with your system analysis business. So you announced a new electromagnetic solver and.

In April timeframe, and then you've got came out with your second solve or the thermal solver in September .

I'm not necessary looking for Ken.

Specific timing, but can you just remind us what other smaller as we could expect.

Yeah, So I think and now this is Jeff our initial entry to the system analysis, using our call competition on computational software and stay tuned I mean, we are just beginning a we have a first put out came out in April I took already pointed out we could tractions and not the SEC.

And put our CMO people love the performance damn excited about it a wheel well continue to be investing and you tie ins also very well with our.

PCB business and a that the whole system modeling system simulation would be really exciting area for us So stay tune and we will update you when we announced and in new products.

Okay. Thanks.

That's all for me thanks.

Thank you thanks.

Your next question comes from Josh with Hilton Berenberg. Your line is open.

Yeah, Hi, thanks for taking my questions.

It appears as if the drivers of design starts today address a broader set of companies relative to previous drivers such as maybe mobile I'm just curious how does having a broader set of addressable companies benefit pricing.

So you're having a broader set of.

Of companies benefits us because a cadence revenue and growth generally tracks design starts, but the more design starts are the better.

Better it is for cadence business, yeah. So I think you're not a we'd like to broaden the customer and applications, so that weekend or Rudy.

Find new opportunity and new solution to support them.

Either in the automotive for Fiveg, Oh, AI I know all crawl all huge opportunity in industrial Aiotv and providing the solution for the system infrastructure player and so that we can broaden the customer requirements and that great that diversity to our customers always good.

Okay that was that makes sense then just as a follow up a in the prepared remarks, you mentioned customers are adopting a full digital slow.

It was my understanding that companies tend to build their flow using products for both you and other competitors. So we're just starting to see customer standardizing their flow from one vendor.

Yes. So I think you know when you moved out the geometry, and now to seven to five to three.

I'll try to integrate different put out different tufan different customer demand that you had to appeal to internal team to do all the integration and also you have a lot opportunity to fail and because of different to have different and out methodology and so customers starting to really focus on getting.

A full flow the passing out I think it's very important I will focus first of all used to have the best of breed 20, each product line Lyda Innovus, we mentioned earlier place and Ral right now is a majority.

When 70% of the customer dumping it in the most advanced nodes and now we have the agenda has come out a very strong and then tempus come out and Pegasus that customer starting to see that not only the best of breed of product and also how to integrate them how to optimize them and cold relations among.

All the different flow.

We have been talking about last few years and so right now we can no only had the best of breed for each product now we can integrate and that's why you're starting to hear that we mentioned a lot about digital full floor that down customer depend completely on non us on the most advanced node in the seven and five and tree.

And that's the way we can don't continue to support the customer.

Thank you those are helpful.

Our last question comes from Krish Sankar with Cowen and company. Please go ahead. Your line is open.

Hi, Thanks for taking my question I'll leave you had two of them. One that you guys are definitely getting a good traction hyperscale customers.

I'm kind of curious I feel hyperscale customers build your own silicon Oh.

Our deal requirements put media different than your traditional semiconductor customers do this Q1 week, so one way towards IP blocks or whatever that there's any color would be helpful on them out of follow.

Okay.

Clearly we are excited about the hyper scale players are down they cannot be are very important for our industry. Because they are quietly building up as I mentioned earlier Dow workload requirement have change and is somewhat more about data and then so that domain specific processing development and Oh.

So in the server.

Into it that data storage network.

Scale out cannot be even more and more important for them and great Panos, Las and great customer and we love them and then first of all they are debit different on our semiconductor. Please.

Time to market is more important to them and also performance scalability is most important to them and that part I think we worked very from the early days, we already working and partner with them and we also very excited about the crowd infrastructure that we also support the cow infrastructure using some of our to do that.

We're continuing to leadership on that so I think.

In multiple multiple both expect we're working with our partners Indeed cow and were excited about opportunity.

That's very helpful to go and then a follow up for either you or John well you can size the hard goods market. This year, how big is it into two bed.

Sub segments like Sbgs.

I'll begin today any color there.

Yeah, I don't have any breakdown in terms of the market did it I can share with you today.

But but we're very very happy with with how our year is going on with the strong pipeline that we have leading into into Q4.

Gotcha, Thanks, John Thanks.

Thank you thanks.

There were no further questions at this time I'll turn the call back to live for closing remarks.

Thank you all for joining us this afternoon.

Next phase of our strategy intelligence system design brings new opportunities in design Exelon system innovation, and obey safety intelligent and I expect that total addressable market.

We are capitalizing on multiple technology trends.

And further proof rating our solutions with a broader base of customers.

And you come in closing I would like to thank all our shareholders.

Customers and partners.

The board of directors.

Now hardworking employees for their continued support.

Thank you for participating in today's cadence third quarter 2019 earnings Conference call. This concludes today's call and you may now disconnect.