Cadence Design Systems, Inc. (NASDAQ:CDNS) Q4 2015 Results Earnings Conference Call February 3, 2016 5:00 PM ET
Alan Lindstrom - Senior Group Director of IR for Cadence Design Systems
Lip-Bu Tan - President and CEO
Geoff Ribar - Senior Vice President and CFO
Krish Sankar - BofA
Rich Valera - Needham & Company
Gary Mobley - Benchmark
Jay Vleeschhouwer - Griffin Securities
Gus Richard - Northland
Monika Garg - Pacific Crest Securities
Sterling Auty - JPMorgan
Tom Diffely - D.A. Davidson
Srini Sundararajan - Summit Research
Good afternoon. My name is Mike and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence Design Systems Fourth Quarter 2015 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session.
[Operator Instructions] Thank you. I will now turn the call over to Alan Lindstrom, Senior Group Director of Investor Relations for Cadence Design Systems. Please go ahead.
Thank you, Mike, and welcome everyone to our fourth quarter 2015 earnings conference call. With me today are Lip-Bu Tan, President and CEO; and Geoff Ribar, Senior Vice President and CFO. The webcast of this call can be accessed through our website, cadence.com, and will be archived through March 18, 2016. A copy of today’s prepared remarks will also be available on our website at the conclusion of today’s call.
Before I start, I want to call your attention to our CFO commentary, which was included in our 8-K filing today and is available on our Investor Relations website at cadence.com. Since we are providing the CFO commentary, Geoff’s remarks will be streamlined and certain metrics not discussed in today’s call including historical comparisons will appear in the CFO commentary. The CFO commentary should be referenced in conjunction with both today’s conference call remarks and the earnings press release issued today.
Next, please note that today’s discussion will contain forward-looking statements and that our actual results may differ materially from those expectations. For information on the factors that could cause a difference in our results, please refer to our filings with the Securities and Exchange Commission.
These include Cadence’s most recent reports on Form 10-K and Form 10-Q, including the company’s future filings and the cautionary comments regarding forward-looking statements in the earnings press release issued today.
In addition to the financial results prepared in accordance with Generally Accepted Accounting Principles, or GAAP, we will also present certain non-GAAP financial measures today. Cadence’s 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 measures which can be found in the quarterly earnings section of the Investor Relations portion of our website.
Additionally, a copy of today’s press release dated February 3, 2016 for the quarter ended January 2, 2016 and related financial tables can also be found in the Investor Relations portion of our website.
Now I will turn the call over to Lip-Bu.
Good afternoon, everyone and thank you for joining us today. 2015 was another excellent year for Cadence, so I am especially pleased to be able to talk to you today about our accomplishments and strategic direction.
First let us review our Q4 and 2015 financial highlights. Cadence produced excellent financial results. We delivered revenue of $441 million for Q4 and $1.7 billion for the year, growth of 8% over the prior year.
Non-GAAP operating margins was 29% in Q4 and 27% for the year, up from 25% for 2014. Non-GAAP EPS was $0.31 in Q4 and $1.09 for the year, up 16% over the prior year.
Execution of our system design enablement strategy drove revenue growth from both semiconductor and system companies in all areas of our business core EDA, IP and system integration. A key part of our strategy is to increase our engagement with new vertical segments and we have notable wins in aviation, automotive, and medical.
Demonstrating our constant commitment to innovation, we delivered nine new different shading products. We continue our pioneering work in advanced node technology, with our ecosystem partners, including partnering with Imecs to tape out the first 5-nanometer test chip. And yesterday, we launched our first new product of 2016, the Modus Test Solution.
This innovative new technology can reduce SOC test time by up to three times, with no impact on area or routing. Strategy, innovation, execution and customer success are driving strong results for our shareholders and we have momentum going into 2016. Geoff will provide more detail shortly on our 2015 results and our 2016 outlook.
Now let us address the environment. Semiconductor business conditions remain challenging, as the industry experienced negative growth in 2015. We remain mindful of ongoing consolidation in our semiconductor customer base. While we do not expect material impact on our business in 2016, consolidation could pose a challenge to industry growth over the next few years.
Now, let us talk about some of the product highlights and customer successes in 2015. In digital and signoff, Cadence revenues are nice the digital floor with the release of Innovus for Implementation, Genus for Synthesis and Joules for power estimation.
Digital and signoff revenue grew approximately 35% at the accounts we targeted. Adoption of our new digital and signoff portfolio continued in Q4, including a large agreement recently closed with global foundry that supports the newly acquired ASIC team from IBM.
Broadcom also renewed investment in Cadence and add the technology to their digital floor, based on total performance evaluation. High silicon adopted Innovus for production DSP designs, enabled them to reduce area by 20% while meeting their frequency goal. And ARM using our full digital floor tape out is 10-nanometer test chip. Overall, we have more than the dozen digital floor wins in 2015.
IP is a key component of our overall strategy and is now 12% of our revenue, with growth last year of 17%. We continue to expect IP to be a great business for us, but we are projecting more moderate growth this year as we refine our strategy to focus of sustained, scalable growth.
In terms of production, product highlights, Tensilica Vision P5, DSP, our latest vision and imaging processor built strong momentum with key design wins at three application processor vendors in Q4.
System design and verification revenue grew 12% in 2015, driven by strength across the product line. Our system development suite attained record revenue in 2015, driven by strong core verification technologies, integrated tightly together to offer a compelling holistic solution.
We launched our new Palladium Z1 enterprise emulation platform in November and recognized revenue in Q4. Palladium Z1 now has orders from more than 10 customers, including PMC Sierra, Nvidia and Huawei and the most successful launch of any new Cadence emulator.
For custom analog design, Virtuoso is the market leading analog and mix signal design platform. In Q4, we delivered the new Virtuoso Advanced Node Platform for 10-nanometer FinFET Design with initial support for 7-nanometer design.
Over 80 customers are now using Virtuoso for advanced node design, including over 25 for 10 and 7-nanometer nodes. Security analysis tools had their best year ever. Our printed circuit board and analysis products won an important competitive replacement with an automotive manufacturer.
In summary, 2015 was an excellent year for Cadence. System design enablement is escalating our opportunity beyond EDA. We have tremendous momentum in digital and signed off market segments, and our Palladium Z1 Enterprise Emulation platform is off to a very quick start.
There are micro challenges ahead, but also opportunities specific to Cadence. Through innovation and execution we are positioned to build on our success and to further proliferating our solutions with market shipping customers. Now, I would turn the call to Geoff to review financial results and provide our outlook.
Thanks, Lip-Bu and good afternoon, everyone. Our CFO commentary should be referenced in conjunction with both my remarks and earning press release issued today. Overall, 2015 was one of the best years in Cadence's history. Our innovation is paying off, and our execution was superb.
Now, for the results of Q4 and fiscal 2015, bookings totaled $1.9 billion, an increase of 7% over 2014. The book-to-bill was 1.12, and yearend backlog was $2.3 billion, up 10% from the prior year. Weighted average contract life for Q4 was 2.8 years.
For the year, it was 2.58 years, within our expected range of 2.4 to 2.6 years. Revenue for Q4 was $441 million. Revenue for the year was $1.7 billion, up 8% year-over-year. Without the extra week in Q4 2014, year-over-year growth would have been 9%. Over 90% of the revenue for the year was recurring in nature.
Non-GAAP operating margin for Q4 was 29%. For the year, it was 27% compared to 25% for the prior year. The positive variance relative to our initial guidance for 2015 was due to effective resource management, lower than planned headcount, better than expected hardware margins, and favorable foreign exchange trends.
GAAP net income per share for Q4 was $0.26 and $0.81 for the year. Non-GAAP net income per share for Q4 was $0.31, up 15% year-over-year. For 2015, non-GAAP net income per share was $1.09 compared to $0.94 for 2014, up 16%.
Operating cash flow was $123 million for Q4 and $378 million for the year. Cash and short-term investments were $711 million at year end, unchanged from end of Q3. DSO were 35 days, an increase of seven days from Q3. We repurchased 5.5 million shares of stock in Q4 for $120 million.
For the year, we repurchased 16.3 million shares for $333 million. At year end, $960 million remained in our current $1.2 billion repurchase program.
On January 28th, 2016, we entered into a three year, $300 million term loan. We also drew $50 million on revolving credit agreement.
Now let's turn to our outlook for fiscal 2016 and the first fiscal quarter. For fiscal 2016, we expect bookings in the range of $2 billion to $2.1 billion, which equates to an 8% growth at the midpoint. Revenue in the range of $1.79 billion to $1.84 billion, which would be a 7% growth at the midpoint.
Non-GAAP operating margin of approximately 26%. GAAP EPS in the range of $0.72 to $0.82, and non-GAAP EPS from $1.15 to $1.25, which is up 10% at the midpoint over 2015.
Operating cash flow in the range of $380 million to $420 million. Weighted average contract life to be in the range of 2.4 to 2.6 years.
Approximately 70% of revenue from beginning backlog and weighted average diluted shares outstanding of 280 million to 295 million shares. Note that backlog is expected to grow 10% in 2016 based on the midpoints of the guidance.
For Q1, we expect revenue to be in the range of $440 million to $450 million. Non-GAAP operating margin to be in a range of 24% to 25%. GAAP EPS to be in the range of $0.17 to $0.19, and non-GAAP EPS in the range of $0.26 to $0.28, at least 90% of the revenue from beginning backlog.
There are several factors that will impact the seasonality of operating expenses and margin for the year. First is the fact that both payroll tax and vacation expense seem to be higher in the first half of the year than the second. Second, pay increases occur in Q3. And third, an expected ramp in head count throughout the year.
You'll find guidance for additional items in the CFO commentary. Note that we have increased our DSO target from 30 days to a range of 30 to 35 days. We think this is prudent in light of the current economic uncertainties. Our cash flow was strong for 2015 and we expect cash flow to grow in 2016.
Cadence had a great 2015. We had momentum going into 2016. Our strategic priority remains to develop innovative products, help our customers be successful, and proliferate our solutions with market shaping customers.
So with that, operator, we'll now take questions.
[Operator Instructions] Your first question comes from Krish Sankar with BofA.
Yeah, hi. Thanks for taking my question. I had two of them. First one is for Lip-Bu, you kind of highlighted the semi M&A could be impactful in the next couple of years. Is there a way you can quantify it? If not, just trying to figure out qualitatively have you seen at your customer site any kind of EDA purchasing decisions slowing down?
Okay. That would be your first question, so let me answer that. So first of all, I think, we recognize 2015 in term of consolidation more and larger consolidation if I assume it correctly, more than 100 billion transactions. So that is the relative industry. By consolidation clearly we'll create stronger and more focused company that can do more innovative design.
Long-term impact to EDA is very hard to predict. But we expect -- actually, we do not expect any material impact to our business in 2016. But I mentioned that consolidation could pose a challenge to our industry growth over a few years.
But meanwhile, I think the consolidation actually provides opportunity for us to proliferate our newly innovative solution as customer looking for differentiating product development. So I think to answer your question, the consolidations for us, I think there is a trend, which is expected.
But, meanwhile, there is a lot of pocket opportunity that we can grow our business with our solution that’s also unique and the best and in a way that we can proliferate with great execution.
And I guess a couple of things, Krish that we looked at and considered before we mentioned that we don't see an impact in 2016, we certainly looked at whether customers would have greater economic power. We looked at market share shifts; we looked at potential for engineering synergies. We also looked at the past acquisitions that all through they were smaller -- a little bit smaller in scale over the past several years, where we've generally not inhibited our ability to grow our business with those customers.
Of course, we are also getting increasingly competitive with our technology during that time. So those are some of the factors we looked in and we’re looking at that, we don't see an impact on 2016 for us.
Got it, got it. All right. And then as a follow-up, when you look at your customers, like they seem to be slowing down, Moore’s Law I mean, no matter which way you dissect it, it's probably not at the same pace as like several years ago.
Kind of curious, if they are slowing it down and kind of moving to the tick tock talk schedule, is there an opportunity for you guys to lower your R&D, I mean at 33 to 34, 35 percentage of sales, it seems like a very high number especially given the fact that your customers are consolidating, they are doing some financial engineering and slowing the technology Cadence?
Yeah, so let me try to answer your question. First of all, I think in term of our customer, I should breakdown to two parts. One is the semiconductor side. One is the system side. On the semiconductor, when they consolidate that means they really want to drive more of the unique solution that can win in the marketplace, continuing their strength in the leadership. And they will be really driving more advanced node, more efficient in terms of driving the result and performance.
And that's why our innovative products with that in mind when we do all this innovation product to really providing the solution to help them in term of their productivity, time to market and also at one time in a performance PPA and that is critical for them.
And also the whole system SOC in term of mixed signal, digital and analog come together and also how to verify in a very holistic way it would be important to that time to market. That is the first part.
Second part is we are very excited in the whole system companies that we mentioned quite a few times and that are our system design enablement synergy. And that being IP is a very critical part of that, but more than that, there is a sea change in that industry in terms of application driven design.
And just give you example, like [Indiscernible] is a big example and people, customers are starting to look at kind of the work load, looking at what application, the IO, data, analytical and there's a sea change in the architecture changes.
And when we design some of our two end solution, we have that in mind so that we can really engage and support and give them the solution they need to drive some of this new design and some of the system company, I call it market shipping customer, they are really driving a very different system approach to the application and that our solution will be really nicely fit with them to optimize the application they want to drive.
Got it, got it. Very helpful. Thanks a lot Lip-Bu.
Your next question comes from Rich Valera from Needham & Company.
Sorry. Thank you. Geoff, just wanted to ask you about how you're thinking about the leverage in the business longer term, looks like you're guiding for effectively negative leverage in the business this year, 26ish% op margin off a 26.7% last year. And that was a fairly elevated level of spend last year, as you had indicated you were investing pretty heavily to pursue some of your new wins.
So, just wanted get your thoughts on how you think about leverage longer term, is there a point when you start letting some of the natural leverage in the model flow through and when might that be?
Yeah, Rich, good question. So, we are really focused as our strategic priority on developing innovative products. We want our customers to be successful. And we are attempting to proliferate our solutions with these market shaping customers.
For example, I think you can see some of our digital successes that we highlighted during the past year with very good customer names, strong growth in our digital business, particularly with the top targeted customers, but also overall. We believe that's the best long-term focus for shareholders and the best long-term return for shareholders. So, we are concentrating on that as our strategic priority.
Got it. And then your verification business was the strongest it's been from a percentage of total sales, and I guess two years in the fourth quarter. Wondered if you could give any color on what drove that. Was it emulation? Any color on that and how that momentum might carry into next year.
This is Lip-Bu. Let me try to answer that and then Geoff will fill more detail. So overall, we are very excited about our Z1, as I mentioned most successful launch of any Cadence emulator. Couple of reason, one is clearly -- is a first true emulator in the market with the enterprise class reliability, and also the capacity is five times in terms of throughput capacity improvement and then you know clearly we have a lot of overwhelming positive feedback from customer, I mentioned more than 10 customer already place orders and some already repeat orders coming and we are shipping as fast as we can produce, and so something that we are really excited.
And in term of respond to the customer and it is something that customer really want in terms of true capacity improvement and performance improvement, speed, footprint and cost of ownership and that is something really, really important for them, and besides by saying that the latency in this Palladium XP II remains very strong.
Great. Just one more for me, if I could. Geoff, I think you said 920 million or so left on your buyback, which would normally be over four quarters. Should we think of that as a pretty linear buyback over those four quarters?
Yes, we bought back 240, on our current plan we have 960 that remains. And as you know, we tend to buy pretty linearly and at…
Got you. All right. That's it for me. Thanks, gentlemen.
Your next question comes from Gary Mobley from Benchmark.
Good afternoon. Thanks for taking my question. I had a question on the divergent trends in backlog and deferred revenue. And I know deferred revenue is only representative of a small portion of your backlog. But for 2015, your backlog was up 10% and you're expecting a like increase in 2016, but yet your deferred revenue at year end was down about 8% year-over-year. What's the dynamic explaining that?
Yes, so for our business model deferred revenue means different than a lot of probably other software companies that you're familiar with. Deferred revenue for us is just cash that we've taken upfront, that we haven't recognized revenue for. One of the things we work hard to do is try to match billings, collection and revenue recognition in the same period.
As we're doing that, deferred revenue will continue to decrease for us. For us, that's – it’s a liability, not necessarily an asset, as you would sometimes consider with the other companies.
Understood, understood. All right. And in your description of the IP business having grown 17% in 2015 and the expectation of slowing growth looking out into 2016, I think you might have used the adjective rational or more prudent in describing your approach to managing the IP business, does that mean that you’re deemphasizing any portion of the IP portfolio?
Yes, and I mentioned that first of all in the last few year we kind of grew the business, from zero, you know, slightly small to all the way to 12% of the revenue and growing at 17% last year. And it's time for us to kind of refine our strategy to focus and make sure that is sustainable and scalable growth and also for customer delight. And so I think those are the things that we are putting into effect and so that we kind of project more modest growth for this year.
And again, remember, we -- as we said last year, we grew at 17%, it’s very close to what our plan was.
And if you remember, our IP business, there is three portions, one is the Tensilica. This is very exciting for us because this whole vision in our image processing and for object detection, for Big Data or for video sovereign and so very broad application. We are very excited. We are continuing to invest on that.
And in our design IP for order industry standard IP, we continue to invest in that. And then thirdly is the verification IP that tie in very well with our whole verification development suite and that tie in with all the incisive and the JasperGold that we just launched was very responsive from customers. So, I think we tried a mixture that we're really providing a holistic solution to our customer in their overall design so that we can really strengthen the solution to the customer.
Okay. Just a final question on the industry backdrop. Independent of the massive wave of chip industry consolidation that we've seen, we don't -- we haven't really seen any sort of robustness in the end markets you serve.
You've got a decline in EPC market, flattening mobile handset market, and just in general, decelerations in the electronics production supply chain, if you will. And despite that, you're managing to grow your bookings and deferred revenue 8% to 10% per year.
I was wondering if you have taken a stab or care to take a stab today at sort of commenting on what percent of your customers' R&D budget you can occupy now and how that's trending?
If I understand your question clearly, we continue to drive success with our customers, even though they are consolidating, but we continue to proliferating our innovative products.
The other part that we are growing quite rapidly is a system design -- system customer, and I mentioned earlier, couple of pocket [ph] opportunity. You highlight PC slowdown that is true, but we see some of this new application coming up really strong in the video related area, in term of the IoT and then most of this, the image vision related area, automotive in term of dash autopiloting, and then all these are driving a lot of data and sensor to the crowd.
And that's why I mentioned earlier about the Big Data, data analytics, across multiple vertical markets all the way through medical, video surveillance and they want to have all this data to improve their business, even in the retail stores.
So, I think those kind of are driving the silicon development and also driving the system company doing vertically integrated, and so I think those are the opportunities for us that are on two sides.
One is stronger, consolidation company that we continue to grow with them and proliferate with them, and there’s a new breed of system enablement because we are uniquely positioned for our two, our IP, and then our system integration, hardware/software co-design litigation, and so that can really address the power signal integrity and time to market requirement from system company point of view so they can go to market much faster than a very compressed timetable.
And I think one more thing, Gary, that's important. Remember, we're mission critical to our customers, whether they are IC or system companies. And our increasingly differentiated technology is clearly helping us with our customers.
Congratulations on the good execution in a tough environment. Thanks, guys.
Your next question comes from Jay Vleeschhouwer from Griffin Securities.
Thank you, good evening. I’d like to ask first a question about the emulation business. You had guided to an increase for the year in that business, albeit it might not have been much of an increase. When you look at your cost of product and maintenance revenues sequentially and even year-over-year, there was hardly any change at all, which would suggest that unless you had a pretty extraordinary increase in the gross margin for emulation, that you might not have had much of an increase in that business either sequentially or year-over-year and perhaps the business was not up year-over-year as you had guided.
So perhaps you are over inferring from the cost numbers, but could you comment on whether or not you did in fact increased that business and is it possible that to the extent your Q1 guidance for revenue is somewhat above consensus, that in fact we're seeing carry-over of emulation business backlog into Q1 from Q4? Then couple of other questions.
So couple of points, Jay. Revenue did grow -- our emulation business did grow year-over-year, driven by both strong sales and margins for Palladium XP. As we also said, when we started shipping and recognizing revenue on the Z1 -- Palladium Z1, our next generation, we expected hardware, revenue to grow and margins to improve. I also will tell you we had one of our best quarters ever in hardware in Q4 ever.
Okay. Looking at your new products or asking about your new products, is there anything you can say in terms of adoption, particularly for Innovus, Tempus, Voltus in terms of, for example, design sizes or where they are being adopted?
In other words, are they being brought in largely for new programs? Are you seeing any displacement of incumbent implementation and sign-off tools? All of the above for any of the products on the digital side?
Also, in terms of your sales pitch for the new tools, you've made the point that you have a much more highly integrated flow now, lots of common engines, particularly around timing and so forth. Is that commonality across the tools in fact leading to new business that you could identify?
Yeah, Jay, that's a good question. Let me try to answer your questions. So as I mentioned earlier we revolutionized our digital floor from ground up and Innovus versus our Implementation, Genus are Synthesis, and then the Tempus our sign off and then Joules Power are now Design.
And so couple of things, just to give you a little bit of history. Nine months ago we announced the Innovus. We launched the products. Right now, we have more than 60 customers, six zero customers worldwide, and then eight of the top 10 semiconductor adopting the flow.
On the Genus side, we launched the products about six months ago. After the launch, we have more than 40 customers, four zero customer adopting, and then clearly in our Tempus, I think we have announcement that we surpassed 200 tape-outs in Q3 we announced that. And we are approaching more than 100 customers.
And then on the Voltus that is a power sign-off, and then 17 out of the 20 top tier semiconductor company adopting and well over 100 customers overall.
And we are really exciting. Yesterday we launched our Modus Test Solution that reduced the SOC test time and then clearly is a ground breaking technology that reduced the time for test chip and also can really catch the potential manufacturing defects so that they don't have to ship bad parts of products.
And that is very critical for customer success. And we are excited Global Foundry, TI, Micro semiconductor, Cequent [ph] and they are adopting the Modus, very well received from the [Indiscernible] code we just launched.
So, I think, overall, it is a very exciting time for us. Truly is a very breakthrough technology that we have in the digital flow. And by the way, we also doubled; tripled on the most advanced node and then we highlight the 10-nanometer test chip with ARM using the complete digital floor, integrated floor. We have more than 10 full flow wins in 2015. So, all in all, I think clearly, it's not just for the new -- the customer also replacement of some of the existing tool providers.
A follow-up, if I may on Modus, and then I'll wrap-up, I've got a corporate question. The market for test is not a particularly large addressable market. According to the industry data, it's almost certainly less than $150 million TAM. And that includes hardware.
And the question is, is that a large enough space to address now to have warrant in the investments in R&D and presumably now the sales resources for relatively small TAM that has also proven over the years to be pretty lumpy and inconstant.
And do you have now with the test have what some might call a verification continuum? Do you have in fact the wide enough panoply of products for verification? And then I'll wrap it up, thanks, on the corporate side.
Good questions. I think you're absolutely correct. Its 150 million TAM market, but clearly it kind of be a more and more bottleneck now in terms of customer want to be able to ship products.
It's our fully integrated floor that we are emphasizing; so on the whole system design verification and the whole digital front providing a solution to sharpen the design time, verification time and also the test time, and the customer spend a lot of money on the testers. But using this, usually you can augment that to really drive some of the design success and then time-to-market is critical for some of these companies.
All right. Lastly, on the corporate side, you recently had your annual sales meeting, of course, everyone in your industry does, and I'm wondering if anything came out of that in terms of new priorities or organizational structure, perhaps around the verticals or anything of that kind that you might care to comment on?
And also related to that, is there anything unique or specific about the development of your systems customer base in terms of incremental or new investments or organization that you need to make to grow that part of the customer base further?
Jay, good questions. And we have a very successful sales kickoff that we have a team come together and to look at how we are moving forward this year. I think that is very emotionally charged. We have a very strong leader and very passionately driving the success to the customer and the message that really work closely with our customer, providing the solution, make them successful and then a big churn of a portion talking about whole system design enablement synergy, and then how can we proliferate into some of the market shipping customer and we mentioned early in the past last quarter general tricks and then some of the automotive, aviation, and, you know, the whole crowd infrastructure, big data.
And so I think we are excited about the opportunity to us and how can we proliferate our products and then continue to drive excellent execution to make the customer successful?
Thank you for the question.
Your next question comes from Gus Richard from Northland.
Yes. Thank you for taking my question. Lip-Bu, you've highlighted a couple of vertical markets, avionics, automotive, etcetera, early on, and I was wondering if you could give a little color as to how you engage with those customers? And is that opportunity sort of bigger as it compares to a semiconductor company.
What I'm trying to ask is do you have a bigger revenue opportunity for a fixed number of designers at a vertical company?
Good questions. I think this vertical market is very dear to my heart and the way I am understanding to do successfully is to listen and understanding their requirement and then look at the holistic way, how can we help them to make sure they are successful in whatever application they want to drive and in whatever the productivity they are looking for and then the vertical integration that they are planning to do. And then try to learn what they try to do and then the solution they try to provide.
And then the best way to success is collaborating with them and then look at our portfolio and see how we can strengthen that and how are the pieces that we don't have, and either we organically developing that or through M&A to get that so that we can provide a overall solution to meet the requirement.
And as I say, a very exciting time for my team and myself to learn new things and then along the way try to adopt and what is the best practice. And also learn what are the requirements they have, and they all had different requirement in term of redundancy and safety, function that they need to have. And then how can we incorporate our tool in IP to provide a holistic, secure environment solution for them. So I think those are the way we are going to grow the business with them and to work closely and collaborate with them.
Thank you. And then just sort of a follow-on, you are very clearly outperforming the industry and your peers. Can you sort of attribute where your outperformance is coming from, is it the fact you are doing better at the vertically integrated companies, is it the new emulation tools to get new digital design flow, what is driving -- what do you attribute the outperformance to?
Yes, I think you know, clearly we're still a long way to go. I mean, we’re continuing to be humble and work hard with customer. And I think the one single point that I can point to and I always believe the best product win. And so we continue to innovate, continue to drive and listen to the customer carefully, and then responding to the customer needs and then closely collaborating with our customer and also our IP and foundry partners, even the equipment semiconductor equipment company to work closely with them, make sure that we are providing the solution in a very proactive way and then suggest a solution and learn from them.
And then all in all, I think this is something that we continue to do and a mission that we continue to drive excellence in execution to proliferate our product and adopting by the customers.
Okay. Thank you very much.
Sure. Thank you.
Your next question comes from Monika Garg from Pacific Crest Securities.
Hi. Thanks for taking my question. The first one, on the emulation side. You released a new platform end of last year, so last time when you had a new platform; you had seen significant growth in that segment. Could you kind of walk us through -- kind of what kind of growth we should expect in 2016 in the emulation segment?
Yes. So, so good question. We're going to, as we've said before with the new emulation platform, we expect good hard work, growth in 2016 and for improvements in margin. We really are not at this stage going beyond that.
And also I think just to add-on besides our new Z1 that we're excited about. Clearly, momentum also increased for our ProTM and that is our FPGA-based prototyping platform and also continue to drive emulation also simulation-related. And so we want to make sure that we have provided overall solution to our customers.
I just wanted to kind of ask again what Krish had asked in the beginning. So this year, you have recreated number of times, lot of consolidation are closing -- a lot of big consolidations, they are closing this year or they have closed and you are very sure that is an impact the revenue growth this year, then maybe could you give us quantitative kind of impact you expect going forward next couple of years, especially given your commentary that you expect it to pose some challenge to EDA industry growth rate?
Yes. So again, Monica, we said we don't expect and see any implications for 2016. It could impact the industry more in the long run. Again, the key factors we'll go back to our economic power change in economic power. Second is there are going to be market share shifts? And then third, will there be energy synergies within those customers?
We've navigated, we believe, quite well over a period of time under the past acquisitions. Of course, no guarantee that that's going to happen going forward. The consolidation also has offered opportunities for us, right, to deliver innovative new products to customers in a way that we've been quite successful with. So it's very hard for us to quantify two years out, or what the direct impact is going to be.
Okay. Just the last one here from me. Service revenue increased significantly in 2015, was there any reclassification of revenue in that segment?
Sometimes some of our revenue that's IP is considered services if there's enough customization of that IP, so that some of the things that we'll call IP will also be called services.
Got it. Thank you so much.
[Operator Instructions] Your next question is from Sterling Auty from JPMorgan.
Yes, thanks. Hi, guys. Just wondering, I guess I wasn't completely clear when you talked about focusing a more sustainable growth within the IP business. Is that focusing more on the profitability so you want more repeatable designs, or is it a different type of structural change to the IP business? If you could give some more color, that would be great.
Sure, Sterling. Clearly, IP is a very important portion of our synergy. We have a nice growth when we get started few years ago. Our goal is to grow -- book more than 10% of revenue. And then from emerging start that we have, through M&A and also organic growth we've reached that stage now, so we have 12% in terms of growth.
Any of the new business -- you'd running to look at performance matrix and then see how can we sustain in scalable in terms of growth. We have a matrix just like our EDA business, and so we've tried to make sure that they map into the matrix and it's scalable and then we can have good business for us.
So I think this is kind of Phase II of the growth and we're trying to redefine and then reclassify and then really tie into our overall matrix with the company.
That makes sense. And then in terms of the emulation contribution, specifically to the upfront revenue versus the ratable, you still have greater than 90% coming from ratable sources. But just kind of curious how that mix is going to get impacted here as you get that spike in the emulation business?
Yeah. So we've said that we expect Q1 to be remain 90% ratable. Obviously, we're not guiding Q2, Q3 or Q4 at this stage. We'll let you know when we do that. Again, part of hardware, there's also a maintenance piece that's always part of our hardware business also, which is ratable over period of time. But we're quite happy with the emulation platform and then the new prototyping platform and how they are going.
Sounds good. Thank you, guys.
Your next question is from Tom Diffely from D.A. Davidson.
Yeah, good afternoon. Another question, following up on the previous one. When you look at through the ramp, projected ramp of emulation over the next year or two, what do you think, if any, would be the impact on the overall corporate margin structure?
So again, I think when we look at it, we do believe it will help the overall corporate margin, just because it's also helping their margin, improvements in margin in that particular business. Right. Strong revenue and good margins.
Okay. So both margin dollars and percentages will go up overtime with that?
Yes, and it's all baked into our guidance, as we're giving our guidance.
Yeah, okay. And then Lip-Bu, you talked a little bit about negative industry growth for 2015. I wonder if you could share with us what you think the actual growth rate was for the industry and if there are any particular segments that were particularly weak during the year.
Yes, I mentioned earlier that the negative growth is the semiconductor industry.
And yes, that is published information. And then clearly, they are projecting this year is a very low single-digit growth and so that's for the semiconductor industry.
Again, remember, 40% of our business is now system companies. So…
I was wondering if you had a similar number for the EDA industry specifically.
Yes, I don't think I have it offhand, but I think clearly you can just add up the three big I plus a few others and PDF and other. So I think you should be able to get that, the growth rate.
Okay. So you talked about nine new products released last year. How does that compare to the Cadence in previous years and which one or two products do you think are the major revenue drivers going forward?
Yes, I think couple -- first of all, I'm very, very proud of innovating culture that we implementing at Cadence. And that engine is really going very rapidly and this culture is very -- I'm very happy to see that.
And then the nine new technologies differentiating product, sometimes it's very hard for me to be telling who is your favourite child and they are all very good, but clearly, you can see that we help us a lot in the digital and sign-off side.
And clearly help us a lot into our hardware emulation side. Clearly, you see that in the system verification side and some of the innovation is happening now. We're excited about it. And then augment with great acquisition like Jasper and they have a very strong and under custom analog and we continue to drive some of the innovations and then the PCP business is also growing nicely with our Sigrity acquisition.
So, all in all, I think we're excited about it. Out of the gate 2016, we're already first new product coming up. Modus test is very, very breakthrough technology we're excited, customer love it and stay tuned we have a few more coming up, but for this year, we are just as excited about the innovating culture and meanwhile using the M&A to augment that.
I guess you really can't choose between your kids there.
I can't choose.
And so, when you look at your M&A question one more time, obviously, with your ratable model, there's not an impact for this year. But are you seeing any type of delays happening with renewal cycles when this -- when these M&A programs go through?
I think obviously the transactions take some time to close when our customers consolidate, right. They also then have to work through their own integration, both planning and execution on their – in addition, the timing of the corporate mergers doesn't necessarily reflect the timing of the contract renewals for us either. So we have taken all of those things into consideration when we guided 2016 and said we don't anticipate any impact in 2016.
Okay. All right. Thank you.
Our last question is from Srini Sundararajan of Summit Research.
Hi, thanks for taking my call. Just wanted to ask you what will be the percentage of adjacency revenues in 2016?
I'm sorry. We didn't get – we didn't understand.
Yeah. From the adjacent areas like medical or automotive, what would be the total contribution for revenues from the adjacent industries?
Yes, first of all, we didn’t have that breakdown for the call, but – and I think Geoff already highlight 40% of our revenue come from the system company. We are working on it and then try to calibrate some of this vertical. Stay tuned. Down the road we may provide that, but overall, we are excited about that opportunity.
The system company contribute 40%. It will be growing. And so we are excited about and we have a complete, very nice portfolio. They are able to support the solution for the system company to drive some of these application driven changes that they are planning to do.
Okay. One more question. Do you have any comments on the 5-nanometer work done at Imec? Anything that you noticed? Anything important?
Yes. As I mentioned earlier, and we are pushing the envelope in the advanced node to be ahead of customer requirement for adoptions and then our tool has to be there to be ready. So we are heavily engaged on the tool and IP front, on not just 10-nanometer, 7-nanometer, we are also doing research on the 5-nanometer.
The one that we highlight last quarter, we announced that with Imec. This is quadruple patenting and using the EUV on the 5-nanometer. We are delighted they chose us to be the platform of choice to work with them on the 5-nanometer. So we will continue the effort to be on the leading edge of the advanced nodes.
I will now turn the call over to Cadence President and CEO Lip-Bu Tan for closing remarks.
In closing, 2015 was a year of great success and 2016 present us with exciting opportunities. I would like to thank all our shareholders, customers and partners, Board of Directors and hard working employees for their continued support. Thank you all for joining us this afternoon.
Thank you for participating in today's Cadence Design Systems fourth quarter 2015 earnings conference call. This concludes today's call. You may now disconnect.
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