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Cadence Design Systems (NASDAQ:CDNS)

Q3 2013 Earnings Call

October 23, 2013 5:00 pm ET

Executives

Alan Lindstrom

Lip-Bu Tan - Chief Executive Officer, President and Director

Geoffrey G. Ribar - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Analysts

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Shawn Yuan - RBC Capital Markets, LLC, Research Division

Richard Valera - Needham & Company, LLC, Research Division

Auguste P. Richard - Piper Jaffray Companies, Research Division

Jay Vleeschhouwer - Griffin Securities, Inc., Research Division

Monika Garg - Pacific Crest Securities, Inc., Research Division

Thomas Diffely - D.A. Davidson & Co., Research Division

Operator

Good afternoon. My name is Justin, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence Design Systems Third Quarter 2013 Earnings Conference Call. [Operator Instructions] I will now turn the call over to Alan Lindstrom, Group Director of Investor Relations for Cadence Design Systems. Please go ahead.

Alan Lindstrom

Thank you, Justin, and welcome to our earnings call for the third quarter of fiscal year 2013. The webcast of this call can be accessed through our website, cadence.com, and will be archived for 2 weeks. With us today are Lip-Bu Tan, President and CEO; and Geoff Ribar, Senior Vice President and CFO.

Please note that today's discussion will contain forward-looking statements and that our actual results may differ materially from those expectations. For information on the factors that could cause 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 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 measure results using certain non-GAAP financial measures. Investors and potential investors are encouraged to review the reconciliation of non-GAAP financial measures with their most direct comparable GAAP financial results, which can be found in the quarterly earnings section of the Investor Relations portion of our website.

A copy of today's press release, dated October 23, 2013 for the quarter ended September 28, 2013 and related financial tables can also be found in the Investor Relations portion of our website.

Now I will turn the call over to Lip-Bu.

Lip-Bu Tan

Good afternoon, everyone, and thank you for joining us. Our record of strong execution continue as Cadence delivered solid Q3 financial results. Total revenue was $367 million, non-GAAP operating margin was 24% and operating cash flow was $98 million.

First, let me comment on the environment. While demands for EDA products has been good this year, the environment remains challenging, with macro uncertainty and softness in semiconductors. As we mentioned, last quarter, most customers continue to innovate and invest in new design activities, but some are facing more challenges.

Now let us review some of our Q3 highlights. Q3 was a strong quarter for Palladium. Palladium has a strong position in over 70% of the top semiconductor companies, and this year, we grew our leading position with 25 major expansions and 9 new customers. More than 40% of our Palladium business is now with system companies and this figure is growing. This quarter, we announced the new Palladium XP II system, which delivers 2x the verification productivity, higher gate density, low power consumption and represented 1/3 of Q3 Palladium emulation orders, including a transaction with Japan's National Institute of Information and Communications Technology. System development suite centered on Palladium was also enhanced with Broadcom and NVIDIA reporting orders of magnitude hardware/software verification speed-up. Q3 Palladium revenue was strong, and is now running ahead of our year-to-date estimates. But it's still expected to be down overall for the year.

Our investments in expanding our IP business is producing results. We are winning new Tier 1 customers at the most advanced nodes, growing the business and gaining market segment share. Over 200 customers use our Tensilica course in associates, such as baseband IP for 4G LTE modems and audio and imaging IP for mobile, home and automotive application processors. Cadence has built a strong internal IP development team, focused on providing complete IP solutions for digital, analog and mixed-signal IP. We just released a new lineup of high-speed analog and digital data-converter IP, and we have already a design win with a key consumer electronic company.

Cadence received a TSMC Partner of the Year Award for our analog and mixed-signal IP based on the quality of results we deliver.

FinFET technology use breakthrough 3D transistor to reduce power and increase performance, and has a potential to significantly extend Moore's Law. Our early and deep investment in FinFET technology and design flow development are beginning to pay off. We have previously announced FinFET test chips with ARM, IBM, Samsung and TSMC, and we are working with many Tier 1 customers as they progress toward production designs at the 14- and 16-nanometer nodes.

Virtuoso is the leading tool for developing FinFET cell libraries and foundation IP, and is used on nearly every design at 14 and 16 nanometers. The Cadence digital and custom/analog platforms have both received TSMC certification for the 16-nanometer tool [ph] flow, and TSMC recognized Cadence with a Partner of the Year Award for the 16-nanometer FinFET infrastructure.

We recently introduced Spectre XPS, our next-generation FastSPICE simulator, which can deliver up to 10x faster throughput than computing simulators using 2 to 3x less system memory. Spectre XPS delivers orders of magnitude improvement in simulation performance for designs that continue to grow in size and complexity. We already have about 1,000 customers deploying Spectre XPS in active design, including Texas Instruments. We're extremely proud of our ability to continue to deliver innovative internally-developed technologies, including Tempus and Virtuoso EAD last quarter, and Spectre XPS and Palladium XP II this quarter. These products deliver order of magnitude improvement in performance and productivity over computing solutions.

In summary, we continue to drive consistent operational and financial execution as today's results demonstrate. The introduction of Palladium XP II boosted emulation sales. We are rapidly integrating our IP acquisitions, releasing new internally developed IP and winning new business across the customer spectrum. We are actively working with many customers and partners on production FinFET designs, and our talented development teams continue to introduce innovative new products like Spectre XPS.

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

Geoffrey G. Ribar

Thank you, Lip-Bu, and good afternoon, everyone. I'll review the results for the third quarter, present our outlook for Q4 and update the outlook for 2013. Total revenue was $367 million compared to $362 million for Q2 and $330 million for the year-ago quarter. Year-over-year revenue growth was 8%. Revenue for Tensilica in Q3 was $11 million after adjustments for merger accounting.

Product and maintenance revenue was $342 million, and the services revenue was $25 million. Revenue mix for the geographies was 48% for the Americas, 20% for EMEA, 20% for Asia and 12% for Japan.

Total costs and expenses on a non-GAAP basis for Q3 were $278 million compared to $277 million for Q2 and $257 million for the year-ago quarter. Q3 headcount was 5,862, up 95 from Q2. The increase was primarily due to hiring in R&D and technical field support.

Non-GAAP operating margin for Q3 was 24% compared to 24% for both Q2 and the year-ago quarter. For Q3, we recorded GAAP net income per share of $0.13. Non-GAAP net income per share was $0.21 compared to $0.21 for both Q2 and the year-ago quarter.

Operating cash flow for Q3 was $98 million compared to $75 million for Q2 and $92 million for the year-ago quarter. Total DSOs for Q3 were 26 days compared to 24 days for Q2 and 34 days for the year-ago quarter. Our DSO target remains 30 days.

Capital expenditure for Q3 was approximately $12 million. Cash and short-term investments were $716 million at quarter end, with about 45% in the U.S. During the quarter, we paid down $50 million on our revolving credit facility. We have approximately $310 million of cash, U.S. cash and short-term investments, which when combined with the expected cash flow for the fourth quarter is more than sufficient to fund the operations and retire our 2013 convertible notes in December.

Approximately 90% of orders booked in Q3 were ratable. The weighted average contract life was 2.6 years. On a weighted average basis, run rates on Q3 renewals increased over the prior contracts.

Now let's address outlook for the fourth quarter and our update for fiscal 2013. For Q4 2013, we expect revenue to be in the range of $370 million to $380 million. This includes approximately $13 million for Tensilica, which is net of deferred revenue adjustments due to merger accounting. The Q3 revenue contribution for Cosmic and the IP business we acquired from Evatronix is small, as we're undergoing integration and convert them to U.S. GAAP accounting.

Q4 non-GAAP operating margin is expected to be approximately 25%. GAAP EPS for the first quarter -- fourth quarter is expected to be in the range of $0.11 to $0.13. Non-GAAP EPS for Q4 is expected to be in the range of $0.22 to $0.24. We expect Tensilica to be breakeven on a non-GAAP basis for the quarter after adjustments for merger accounting.

Now for our update of fiscal 2013 outlook. Bookings are expected to be in the range of $1.56 billion to $1.58 billion, an increase from last quarter's range of $1.53 billion to $1.57 billion. We expect weighted average contract life to be approximately 2.6 years for the year and to book at least 90% of our business for the year under ratable arrangements.

We expect revenue to be in the range of $1.453 billion to $1.4563 billion (sic) [$1.463 billion] for 2013, which is up from the range of 1.14 -- $1.44 billion to $1.47 billion we expected after Q2. This includes approximately $29 million for Tensilica, which is net of adjustments due to merger accounting. Like Q4, the 2013 revenue contribution is small for Cosmic Circuits and the EP -- the IP business we acquired from Evatronix.

Non-GAAP operating margin is expected to be 24% on an annual basis for 2013. Non-GAAP other income and expense for 2013 is expected to be in the range of negative $14 million to negative $10 million.

For 2013, we're assuming a non-GAAP tax rate of 26% and weighted average shares outstanding of 293 million to 296 million shares. GAAP EPS is expected to be -- for 2013 is expected to be in the range of $0.55 to $0.56. Non-GAAP EPS is expected to be in the range of $0.85 to $0.86 compared to our prior range of $0.80 to $0.89.

For 2013, we expect operating cash flow to be in the range of $340 million to $360 million. DSO for 2013 are expected to be approximately 30 days. Capital expenditures for 2013 are expected to be approximately $45 million.

In Q3, Cadence continued its strong record of operation on financial execution, with key operating metrics exceeding expectations. While the environment continues to present challenges with some customers adjusting spending, I am confident in our ability to help our customers design and build great products while delivering strong financial performance.

Operator, we'll now take any questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Sterling Auty with JPMorgan.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

The announced emulation product in the earnings release, is that enough to prop up emulation revenue growth until the next generation is released, or should we expect declines until the new platform?

Lip-Bu Tan

Yes. Sterling, this is Lip-Bu. So first of all, I think as I mentioned in my remarks, Q3 was a strong quarter for Palladium XP, and this is a new product, our Palladium XP II, and it's a very good product and clearly improved the modification productivity and gate density and the lower power and so far, have been very well received. And clearly, as I mentioned in the Q3, significant percentage -- 1/3 of a percentage of our revenue come from Palladium II, so it's a very good product. And clearly, we are developing our next generation, but we will let you know when we are ready to announce the products.

Operator

Our next question comes from the line of Mahesh Sanganeria with RBC Capital Markets.

Shawn Yuan - RBC Capital Markets, LLC, Research Division

This is Shawn Yuan sitting for Mahesh. Lip-Bu, can you comment about the competitive environment in the emulation business, specifically what's your market share there? And have you seen any shift in market share in the hardware business?

Lip-Bu Tan

Yes. So first of all, as I mentioned in my remarks, and clearly, 70% of the top semiconductor company are using our Palladium, and then the above 40% of our revenues come from the system companies, so we are very well positioned in terms of the marketplace. Clearly, the core design, core verification requirement, time-to-market challenges, a lot of these customers really love our products, and we have 25 expansions on this key account and meanwhile, we have 7 new -- 9 new customer with us on this year. So I think overall, we're holding well. And then meanwhile, as we guided and that is ahead of our year-to-date estimates and for the year, but the whole year, we still want to make sure that we're still guiding down for the overall for the year.

Shawn Yuan - RBC Capital Markets, LLC, Research Division

Okay. And a follow-up. So considering that most of the semi companies are missing their guidance this quarter, have you seen any cautions from your customers?

Lip-Bu Tan

Yes, I think regarding to this whole environment, clearly, the microeconomics and the semiconductor clearly, is quite uncertain. Many of our customers are doing quite well, but there's a few having softer demand and clearly, reduce their visibility. 20 years in our soft semiconductor environment, some of the customer clearly facing some challenges and are restructuring and reduced their EDA spending. As I mentioned earlier, Japan continue to be very challenging, and also in Q3, we have a few customer in the region reducing their spending. And so overall, definitely, have some impact to our growth rate. That is not just Cadence alone. I think it's for the industry also. But seeing that, clearly, we are really excited about long-term trend. I think that EDA can continue to grow very positively. And then on the Cadence side, we are excited about the tremendous progress we made in the last few years in terms of innovation, technology, customer and ecosystem partners engagement. Clearly, we want the mission that we deliver highest value to our customers.

Operator

Our next question comes from the line of Rich Valera with Needham.

Richard Valera - Needham & Company, LLC, Research Division

In light of the current challenging environment you described in some detail, wondering how you're thinking about the overall growth rate of EDA, kind of core EDA, over the next couple of years? I mean, I think historically, you've talked about that being maybe a mid to upper single-digit type of growth rate. I'm just wondering if you can give us any color on how you're thinking about core EDA growth over the next couple of years.

Lip-Bu Tan

Yes. Rich, it's a good question. And clearly, from a Cadence point of view, we are very focused on getting the value to our customer, and so that they can design the most challenging, incredible products that can change our lives. And so we're very much focused on providing the EDA tools and mixed-signal SoC IP-related in our solution to them, so that they can do very innovative stuff. And in saying that, in the last few years, we have been very focused on building that innovative product internally. And in the long run, I think that we'll be growing our opportunity here. And then clearly, I think the investment we make in the IP side. And most of the SoC right now, IP become very important in terms of IP plug building up the complex chip. And then the other part we see also tremendous growing in the system companies going vertical. And so I think all in all, I think long-term, I'm bullish. And in terms of the growing the EDA requirement, because a chip design is getting more and more complex. When you move down the geometry, going to be even more challenging. And EDA, too, I think is a very critical part of the design, and we are very well positioned to support some of this complex design from system level, all the way to the semiconductor design capability. So I think it's important we continue to drive innovation, keeping the order of magnitude improvement so the customer can call on us as a trusted partner to design the product. So all in all, I think the industry, all the data I can get is single-digit, mid-single-digit growth, as you can tell, we will outgrow that.

Geoffrey G. Ribar

And I think, just to add on a little bit, obviously, after an extended period of time where our semiconductor customers have had some challenges and we've talked about some specific challenges in Japan, we've also had some customers come back to us and touch us for adjustments or restructuring deals going forward. There's a small number of customers doing that. So we do -- we are increasingly cautious, I think, overall on the business. Again, I don't want to overstate it. We don't believe it's a long-term trend, but it isn't -- something that could have impact on EDA in 2013 and 2014.

Richard Valera - Needham & Company, LLC, Research Division

Okay. My next question, I guess, really, sort of related is with respect to Japan, which you called out multiple times as being a pretty big headwind and certainly, had a big negative year-over-year comp there in this quarter. I'm just wondering when you think that might stabilize. Your comps certainly get easier as you move into 2014. Do you think there's a stable plateau we can reach there maybe in '14 or back half of '14? Just wondering how you're thinking about that Japan business, which has been going down quite a bit over the last few quarters.

Lip-Bu Tan

Yes, it's a very good question. This is Lip-Bu. Clearly, we're watching the Japan environment very closely. Clearly, there's a lot of challenges in Japan semiconductor industry. There's a lot of big corporation going through restructuring. Seeing that, there's some very exciting bright spots is a system company they are doing quite well, especially in the automotive side and also some of the consumer. The imaging company, they are doing extremely well. We are very well positioned to work with them and enable them with the tool and IPs and the Palladium to help them to design the greatest products. But saying that, we are very cautious and this is going to be -- not a short term. It may be a little bit longer period of restructuring, repositioning. And I think the -- I'm encouraged, I think, clearly, the Japanese customer and they are starting to make the right changes and then refocus the area that they are good at. And then we, as a trusted partner, we work very closely with them, make sure that we provide them the best tool and best IP to support them.

Richard Valera - Needham & Company, LLC, Research Division

Great. And then Geoff, just a question on your tweak up in your bookings. Was that related to duration, or is that sort of a real -- sort of apples-to-apples increase in bookings? And if so, could you talk about where that came from within any color on sort of area of strength that generated that?

Geoffrey G. Ribar

Yes. So it didn't have any impact, duration wasn't the cause of this. This is just a general increase in the general strength of bookings kind of across-the-board, so bits and pieces here and there. So nothing material to report.

Richard Valera - Needham & Company, LLC, Research Division

And final one -- I actually have one more. It sounds like emulation was or is ahead of plan for the year, but you're not changing -- at least you're not changing your revenue guidance. I'm wondering, is this strength in emulation somewhat an offset to perhaps some of the incremental weakness you're seeing in Japan? Or any color on that will be helpful.

Geoffrey G. Ribar

Sure, sure. I think you got it exactly right. Hardware is ahead of our expectations for the year, but we are still guiding down on the year. It is helping to offset some challenges in other places, clearly.

Operator

Our next question comes from the line of Gus Richard with Piper Jaffray.

Auguste P. Richard - Piper Jaffray Companies, Research Division

A couple of quarters ago, you introduced Tempus a new timing closure product. I'm just wondering if you can give us an update on how that is progressing.

Lip-Bu Tan

Yes. Gus, this is a good question. I'm delighted to share with you. First of all, I think the signoff timing, as you know, is a very critical piece of the design process. And this product that we announced have a massive parallelism engine that can skew up to 100 CPU, and then clearly, we also can drive up to 10x faster performance. And this is what we announced. And we are working with dozens of customers and we are delighted. We have couple of paying customers. And clearly, the product show orders of magnitude of improvement in performance and the scalability. This is just one of the examples of our innovation culture at Cadence that we have very strongly embraced and encouraged.

Auguste P. Richard - Piper Jaffray Companies, Research Division

And then a quick one for you, Geoff. I noticed that the SG&A was down sequentially or flat -- sorry, I'm looking at the wrong line. Could you just talk about the trend of SG&A and what to expect going forward?

Geoffrey G. Ribar

Yes. So we -- as I said, when we talked about headcount being up, the headcount, the 95 people, the headcount was up was largely R&D and really the technical side of sales. I think that's where we continue to make our investment. It's in those areas. G&A, in particular, we're managing, I think, well and appropriately under the circumstances.

Auguste P. Richard - Piper Jaffray Companies, Research Division

Okay. And then last one, Geoff, I think this is your 3-year anniversary at Cadence this week, and Lip-Bu, you've been there for I think about 4 years, and I'm just wondering if you can kind of...

Geoffrey G. Ribar

5, 5 for Lip-Bu.

Auguste P. Richard - Piper Jaffray Companies, Research Division

Five, sorry, my mistake. If you just take a step back and sort of look at the progress you've made so far and then sort of what -- where you need to put more effort and what has gone a little bit better than planned, and just kind of give us some thoughts on what the strategy is going forward.

Lip-Bu Tan

Yes. It's a very good question. Let me start first. Clearly, it's quite a journey for the last 5 years. We've made tremendous progress as a company. And we put the financial strength back and then focused on the products, and in the advanced node in the most critical area, and also in the IP and our business has become more and more important. We did a couple of acquisitions. Right now, we are integrating quite well and we're starting to have a series of innovation, new product coming up on the IP -- very capable IP development team. And so I think going forward, clearly, we're now going to continue to double down in terms of innovation and R&D. I think the industry's looking forward for the innovation to help solve the most challenging design, either in the advanced node or the mixed-signal in terms of our performance, low power and some of the system-level time-to-market pressure, that's why I think our Palladium continue to do well. And then the -- so I think all in all, I think they continue to drive execution, continue to drive innovations and continue to improve the quality. And I think that is our challenge and we're looking forward to that and to support the industry. The most important, to support our customers to make sure that they can really continue to innovate, create some of the greatest, incredible products that we all can enjoy.

Operator

[Operator Instructions] Our next question comes from the line of Jay Vleeschhouwer with Griffin Securities.

Jay Vleeschhouwer - Griffin Securities, Inc., Research Division

Geoff, for you first. Could you talk about the considerations that went into narrowing your cash flow expectations for the year rather than raising the expectation for cash flow for the year? And back on the subject of plating and emulation, you announced XP II relatively late in the quarter. I can understand how it would have had an effect on orders, but you also talked about it having had an effect on revenues. Normally, emulation products have fairly long lead times unless they're largely software upgrades. Could you talk about how you were able to convert XP II to revenues so quickly that late in the quarter? And in the context of your expectation that the emulation will be down for the year as a whole, would it be fair to say, however, that Q1 will have proven to be the bottom in absolute revenue?

Geoffrey G. Ribar

So first on the cash flow, we didn't change the range at all. It was $340 million to $360 million last quarter, so we've kept the range unchanged. We've narrowed it a little bit because we're, obviously, getting closer, but the midpoint stayed unchanged just because we're getting closer to it. As far as PXP II, of course, we had that in development for a period of time beforehand, and we had the product ready when we announced it. We announce things when product is ready. And so that's why we're able to take orders and ship some products in the quarter. Again, what Lip-Bu was talking about, the better performance, that was largely on orders, right? Not just on shipments. And we tend to talk about emulation still as a year. We're running ahead of plan. Clearly, we had a nice quarter in emulation. But we still expect to be down for the year. We're not really talking about individual quarters though.

Jay Vleeschhouwer - Griffin Securities, Inc., Research Division

All right. One other area where you've had some growth on a year-over-year basis is system interconnect. A lot of that over the last year was helped by the Sigrity acquisition, but you've now gone past the 1-year anniversary of that. Could you talk about the performance you're seeing now in PCB or system interconnect generally, and what your thoughts are there for the next year?

Lip-Bu Tan

Yes, so let me start on that one, Jay. First of all, the PCB business continues to do well. And clearly, customer looking to end-to-end design. We are in a very unique position to be able to provide that end to end in terms of design capability, so that you can really address the power, signal integrity while you are developing before you do the very hard PC board. And that Sigrity turned out to be a very good acquisition for us. And we're able to provide that power analysis in our signal integrity analysis way in the beginning of the design. And the customer love it. And they continue to really welcome and then embrace our offering. And then clearly, that is very important for the high-end consumer system company, also very important for some of the infrastructure customers that they see a tremendous value for providing their hardware PC board. And I'll make sure that whatever you design, still within that power envelope and signal integrity challenges that they may have. I think overall, I have to say that this is a very good business for us, and then we will continue to invest in the area. And Sigrity acquisition had been very good -- well integrated to our Allegro product lines, and have been very well received by our customers.

Jay Vleeschhouwer - Griffin Securities, Inc., Research Division

Okay, lastly for you, Lip-Bu. Could you talk about the management changes that you made over the summer? In terms of changing assignments, and roles and so forth, what are you thinking in terms of the kinds of technology or measurable business results that you would like to see ensue from those changes that you might not have had, had you kept the old structure in place or the old management arrangement in place?

Lip-Bu Tan

Yes, so I think very good question. Last quarter, we make some of the management reorganization, with that same objective. One is clearly better alignment of our product groups; and then secondly, to accelerate our growth and then increase focus on the key opportunity we are addressing; and then thirdly, is to leverage the unique strength of Cadence team to compete more effectively against our competitor and also can serve our customer better. And so I think we can clearly breakdown down to 4 group: One is Digital signal -- Signoff Group that is very focused on the digital. There's a lot of challenges from the customer feedback. And then secondly, is the System Verification Group, that really put the hardware, software, all verification related into one umbrella, that can really service and focus on the customer needs. And then the third group is IP. IP, from design to verification, how can we tie in via Silicons our proven solution to our customer. And then finally, Custom and Packaging -- PCB packaging into one group. And it is a very important custom/analog mixed-signal and all the way through IC and Packaging very related. This is a very important group for us. So I think all of them, all 4 of them are really focused on growth, focused on focus, and focused on giving the best solutions to the customer, and that they can be more effectively compete in the marketplace.

Operator

Next question comes from the line of Monika Garg with Pacific Crest Securities.

Monika Garg - Pacific Crest Securities, Inc., Research Division

First question is on the digitalized [ph] and device segment. If I look at it, the segment grew nicely in Q1 and Q2 year-over-year, but flat in Q3. Is there kind of any particular reason or seasonality in contracts or something?

Lip-Bu Tan

Yes, so let me try to address that first. And first of all, clearly, this primary timing of the contract renewals and also associate revenue recognition. And we also have -- the other thing is clearly, we have a lot of the new product coming up that we mentioned earlier in Tempus, Signoff, and also now heavy investing into our digital flow in the advanced nodes. And so clearly, we are getting much stronger in terms of product line and clearly, EDI is a very competitive situation. A lot of investment needed on the 16-nanometer and 14-nanometer. We are delighted to be certified by TSMC and then also kind of support us on the 16-nanometer, the panels of choice and panel of the year award. But saying that, it continue to be very competitive and continue to be challenging in terms of EDA budget, and so it may have some seasonal impact because of timing of some of the contracts.

Monika Garg - Pacific Crest Securities, Inc., Research Division

And, Lip-Bu, you talked about softness in the Japanese semi industry, maybe could you talk about trends that you're seeing in other geographies?

Lip-Bu Tan

Yes. So I think Japan we kind of singled out that it's challenging. We also mentioned a few customers in the other region also facing some challenges, and then they also request for EDA spend reductions. We work with them, and we continue to support them and then give them the solution that they can turn around and be successful again. So I think all in all, it continues to be uncertain and challenging environment. That is not only to Cadence. This is pretty much known when you hear other earnings call, a lot of mix results from various of our customers.

Monika Garg - Pacific Crest Securities, Inc., Research Division

And then EVE somehow on their earnings call, you talked about it. They think that customers could likely follow, like they would track a 10-nanometer, which means the customers have prepared both for EUV and multiple patterning at the 10-nanometer node, right? So the question is do you think this dual-track strategy will benefit the EDA industry? And if yes, would you be able to quantify some of the benefits?

Lip-Bu Tan

Yes. So I think that the EUV is kind of more further out. And clearly ASML and a few others are working on it. So very heavy investment is needed. And clearly, that is very challenging, but it could be a few years out. In the shorter term, I think most of the customer, Tier 1 customer we support and then try to get them into the production next year is more on the FinFET advanced node 14, 16, double, triple patterning, so they can extend the Moore's Law. Seeing that, we also engage with some customers and foundry panels on the 10-nanometer discussion, but it's in a very early stage of engagement.

Monika Garg - Pacific Crest Securities, Inc., Research Division

I have question for Geoff. Geoff, you talked about like 25% operating margin target, and you're kind of close to that. Next quarter, you are guiding to 25% of margins. So the question is do you think there is operating line when you're beyond 25% of the model? And maybe could you talk about how to think about it, provide some guidance on that?

Geoffrey G. Ribar

Yes. So one of the achievements that we've been quite proud of is getting to the mid-20s. We never said 25% but getting to the mid-20s. Now we did that this year in an environment. We did a couple of acquisitions with merger accounting that could have provided some headwinds, but we still managed to get there. We do believe there's leverage in the model, going forward. But with the acquisitions and with growth potentially being slower, we are going to pay attention to that. And so we do expect to have leverage. We do understand the growth. We'll give you a better read on future growth when we give guidance in 2014 and the impact on any new targets for operating profitability when we guide 2014.

Monika Garg - Pacific Crest Securities, Inc., Research Division

Okay, and then just the last one for me. I mean given the challenges in manufacturing, double pattern, triple quad, EUV, some customers are really looking at 3D designs, maybe stacking the chips, right, think that is, of course, not 3D NAND or hybrid memory cube in DRAM, you're seeing some larger customers start to talk about the 3D stacking the ISO. So maybe could you talk on the high-level how it could beneficial to EDA, if you think it could be?

Lip-Bu Tan

Yes, very much so, and we are investing in the 2.5D and 3D capability. We're clearly working with our foundry partners. So I think some of this 3D technology clearly can benefit in terms of scalability. And clearly, the challenge, really, is the design cost and then how to bring the cost down. And we are working with some of our customers to work on that. When is it going to be massive deploy, very hard to tell, but I think we are working very closely with our foundry partners driving some of the 3D development and make sure that our tool is ready to support it. It's very challenging. And I think the timing of deployment, it will depend on the cost. We can bring the cost down, then there'll be more production in terms of volume and more massively scale. And so those are the challenges facing, but we are very much on top of it just like FinFET.

Operator

Our next question comes from the line of Tom Diffely with D.A. Davidson.

Thomas Diffely - D.A. Davidson & Co., Research Division

Geoff, first a question on the revolver. Maybe a little detail on the activity over the last quarter or 2 in light of a pretty big cash balance that you have?

Geoffrey G. Ribar

So, Tom, you kind of broke up, but I think you're asking on the revolver, the line of credit?

Thomas Diffely - D.A. Davidson & Co., Research Division

Yes.

Geoffrey G. Ribar

Yes. So we paid that down about $50 million, so we're down. We took it from $100 million down to $50 million outstanding at the end of the quarter.

Thomas Diffely - D.A. Davidson & Co., Research Division

Okay. I mean just in light of the cash that you have on hand, I was wondering what the need of the revolver is in the first place.

Geoffrey G. Ribar

The revolver always provides a certain amount of assurance and security, right? And I think the other thing is, obviously, the interest rate environments are very attractive, and having a revolver in that type of situation with the rates kind of locked in is only a good thing for the flexibility for the corporation.

Thomas Diffely - D.A. Davidson & Co., Research Division

Okay, understood. And then, Lip-Bu, I was hoping for more kind of a big-picture view of emulation and how you've seen that, your view of that market has changed over the last few quarters or year, and what you believe the actual size of the market is and the growth potential.

Lip-Bu Tan

Yes, I think to continue now the discussion I have, the hardware emulation become more and more important in terms of time-to-market challenges. And clearly, in our Palladium, it's very well received, and clearly, we see growth in that system companies, more than 40% are supporting that. And then clearly, 70% of top semiconductor company are using the Palladium. Clearly, the XP II that the new product that we announced is a very good product, 2x the verification activity, and then clearly, we have more embedded software built into it. We also increased the density, and so the substantial improve on that. And we're also starting to work on -- rapidly into the simulation acceleration, which have been traditionally strong for our competitor. And so we are also moving in. So I think all in all, we're excited about the hardware emulation, hardware/software code design code verification. It's become really challenging for our customer. That's why we put that whole verification system group under one roof, under one leader. And then driving the hardware/software inspiration more effectively. And then also beside doing the emulation, we're also moving into simulation of acceleration. And so that will be the top now on that effort.

Thomas Diffely - D.A. Davidson & Co., Research Division

I guess in general, going forward, do you see that as more of a -- obviously, it's a bigger space, but is it a more stable space than it used to be? I mean obviously in the past, you had some pretty big swings up and down through the cycles for EDA.

Lip-Bu Tan

Yes, clearly I mean this is a hardware product, always will be lumpy. And that's why even though we are ahead of the year-to-date estimate, we are still expected to be down for the year because now in this very challenging environment, the hardware is always very lumpy. And we continue to drive value, continue to drive success with the leading top semiconductor company and also leading system company to make sure that we provide the solution for them, addressing the time-to-market challenges. But saying that, I think we continue to be cautious.

Geoffrey G. Ribar

So, Tom, again, as I think Lip-Bu said earlier and I said earlier, this is certainly a challenging environment and is increasingly challenging and we're increasingly cautious. We're proud of our emulation performance, and we're proud of our financial results in those. But clearly in this environment, we can see some impact on our revenue for 2013 and likely into 2014 also. It's a challenging environment.

Operator

Our final question comes from the line of Sterling Auty with JPMorgan.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

I wanted to zero in on some of the comments that you've made here late in the Q&A, around the tougher environment. So first question, I guess, would be looking at the R&D budgets for semiconductor companies, I think they've been set -- and it doesn't sound like anybody has asked for budget back. So do you think that your end customers will use the budgets that are currently authorized so we should see kind of that a decent finish to the year, or are you concerned that maybe there's an ask back where they don't completely spend the budgets they have currently authorized?

Geoffrey G. Ribar

So 2 points. Certainly, the guidance we give takes in our best view of the environment for Q4. Having said that, we have had some ask backs from customers, or restructurings from customers. And again, we care a lot about customers and we're responsive when they are in a situation where they need that. That has clearly had some impact on Q3 results and Q4 results. We're very proud of what we've done so far. But those restructurings and things that have already happened will likely impact 2014 so...

Sterling P. Auty - JP Morgan Chase & Co, Research Division

And, Lip-Bu, as you're look and have your conversations with customers, do you think whatever we see in terms of the budget and the spending is being either hampered or constrained by a lack of headcount growth because we haven't seen a pickup in bookings? Or that lever versus the additional licenses per engineer for certain products maybe not going through again because of the environment?

Lip-Bu Tan

Yes, I think it's hard to generalize. Clearly, and as I mentioned, some of the companies are doing quite well, especially in the -- some of the leader in the mobile smartphone area and also in the automotive area. And clearly, the PC related, it's kind of having a challenging time and are declining. And then the server and the infrastructure are actually doing quite well. And so I think it's kind of a customer-to-customer. Some of the budget, they have a reduction because they are restructuring. And then some of them, actually, are growing, and they are engaging quite heavily in the new innovation and the new development, and then some of the new products that are going come out and then some of the system company are moving in to do vertical integration. We are excited about that. So I think in some area, they have the engineering reduction. I think you can tell, which of the company. And then some of them are growing, and they're hiring. And we are heavily engaging with those that are hiring and winning. We are on the mission that we provide the tool for them to make sure that they can do other incredible development innovation product that are going to come out. And so all across-the-board, I'm kind of cautious, optimistic and clearly some of the challenging one, we work through with them. They will have some impact in Q4 and then some in 2014. Some of them, we are growing with them. We're working closely with them. You may not see the revenue jump right away, but we are well positioned for the future. In the longer term, we grow with them.

Geoffrey G. Ribar

We're quite proud of our performance under a challenging environment, right through Q1, Q2 and Q3.

Operator

That was our final question. I'll now hand the call back over to Cadence President and CEO, Lip-Bu Tan for closing remarks.

Lip-Bu Tan

Thank you. In closing, Cadence continue to deliver great technology to our customers, and our business results reflect this. While the macro environment remain uncertain, with some customers continuing to face challenges, Cadence is well positioned to continue executing and supporting our customers by introducing great new products.

Lastly, I would like to recognize our hard-working employees for these results and thank all of our shareholders and customers and partners for their continued support. Thank you, everyone, for joining us this afternoon.

Operator

Thank you for participating in today's Cadence Design Systems Third Quarter 2013 Earnings Conference Call. This concludes today's call. You may now disconnect.

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