Cadence Design Systems, Inc. (CDNS) Q2 2018 Earnings Conference Call Transcript

Cadence Design Systems, Inc. (CDNS -1.14%)
Q2 2018 Earnings Conference Call
July 23, 2018 5:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good afternoon. My name is Rob, and I will be your conference operator today. At this time, I would welcome everyone to the Cadence Second Quarter 2018 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. If you would like to ask a question during this time, simply press *, then the number 1 on your telephone keypad. Thank you.

I will now turn the call over to Alan Lindstrom, Senior Group Director of Investor Relations for Cadence. Please go ahead.

Alan Lindstrom -- Senior Group Director of Investor Relations

Thank you, Rob, and I would like to welcome everyone to our Second Quarter 2018 Earnings Conference Call. I'm joined by Lip-Bu Tan, CEO; and John Wall, Senior Vice President and CFO.

A webcast of this call is available through our website, cadence.com, and will be archived through September 14, 2018. Note that today's discussion will contain forward-looking statements, and that 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 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 we issued today.

In addition to financial results prepared in accordance with Generally Accepted Accounting Principles, or GAAP, we will also present certain non-GAAP financial measures today. Cadence management believes that in addition to using GAAP results in evaluating our business, it can also be useful to review results using certain non-GAAP financial measures. Investors and potential investors are encouraged to review the reconciliation of non-GAAP financial measures with their most direct comparable GAAP financial results. The reconciliations are available at the Investor Relations section of cadence.com.

Copies of today's press release dated July 23, 2018 for the quarter ended June 30, 2018, related financial tables, and the CFO commentary are also available on our website.

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

Lip-Bu Tan -- Chief Executive Officer

Good afternoon, everyone, and thank you for joining us today. Cadence achieved excellent operating results for the second quarter, with revenue increasing 8% year-over-year, and on GAAP operating margin of 30%. John will provide details in a moment. Our system design enablement strategy is perfectly positioned to enable the data-driven economy, and the multiple key technology waves driving it. We are increasing our footprint with system companies and tailoring our solution to vertical market segments. Not only is the cloud data center one of the most significant technology drivers, it also enables us to bring innovative design solutions and increase productivity to our customers.

This past month, at Design Automation Conference, we introduced the Cadence Cloud, the industry's first broad cloud portfolio for the development of the electronic systems and semiconductors. Benefits from using Cadence Cloud include improved productivity, intelligent scalability, optimized security, and flexibility. We collaborated with Amazon Web Services, Microsoft Azure, and Google Cloud to deploy our cloud-ready products in customer-managed cloud environments. We also launched Palladium Cloud, which is a cloud-based emulation solution that easily addresses peak requirements of existing customers and brings emulation to new customers and markets.

Finally, in conjunction with the Cadence Cloud, we launched Liberate Trio, the first unified library collectivization solution that employs machine-learning techniques and optimized for the cloud. Cadence Cloud is endorsed by our close partners, ARM, and TSMC, and more than 20 customers are using Cadence Cloud, including Annapurna Labs, an Amazon company, and CNEX Labs.

Additionally, the aerospace and defense vertical had another strong quarter. A major aerospace and defense company selected Cadence as the primary vendor for SOC design and verification, including our software and hardware products. We also won a significant research contract with DAPA to develop advanced machine learning technologies that speed up and optimize power, performance, and area results. Watch for more announcement on this exciting project tomorrow.

Now I will review a few additional highlights from Q2. Momentum continues to build up for our IT business. It was another strong quarter for our flagship DDR and PCIE products. We prototyped the world's first DDR5 test chip, achieving a data grade of 4,400 maker transfers per second in TSMC's 7-nm process. We had significant wins for DDR with a major semiconductor company for PCIE, with the leading storage company, and while working with our mobile customers on a 7-nm sensor application. Tensilica added five new models -- new logos, with wins for applications in IoT, wearables, phototonics, and crypto mining.

Moving on to our system design and verification solutions, in Q2, our broad base renewal with LG Electronics included adoption of our Xcelium parallel simulator. Other key Xcelium adopters included a large Chinese customer and an AI processor start-up. Palladium added six new customers, with nine repeat orders. Two of the new customers are using Palladium Cloud. NCA Computing chose Palladium Z1 for the development of their next generation ARM-based server chip. Palladium Z1 was chosen for its scalability, for the launch design, state of the art debugging features, stability, and availability over the cloud. Digital signoff -- digital and the signoff continue to be very -- continue to do very well, with 8% year-over-year revenue growth. Our digital and signoff solutions continue to proliferate with existing market shipping customers and win new customers. More than 20 customers adopted our full digital floor in the first half of 2018.

Continuing over innovating in signoff, we enhanced our Voltus IC Power Integrity Solution with the extensively parallel algorithm that provides up to five times better performance, with gigascale capacity and cloud reading. HiSilicon verified that the new Voltus Solution can deliver improved performance results for their future 5G silicon development. Cadence also played an important role in enabling modern technologies, such as RF, MEMS, and Sensor through providing advanced tooling and packaging solutions. We launched a comprehensive new Virtuoso RF Solution, partnering with National Instruments to streamline the line and verification process of analog and RFICs and modules. In advanced packaging, we already support TSMC info and co-ops chip integration solutions. And we've now added support for the new TSMC Wafer-on-Wafer stacking technology.

Reliability also becomes more critical as semiconductors proliferate in new vertical segments like automotive, medical devices, industrial, and aerospace and defense. This quarter, we introduced the Legato Reliability Solution, the industry's first software products that meet the challenges of designing high reliability, analog, and mixed signal IC. Infinien successfully used this solution to speed up simulation runtimes by a factor of more than 100. Like reliability, function safety is very important to automotive, industrial, and aerospace and defense. ROHM used their Cadence Automotive Solution for safety verification, which is a critical component in its ISO 26262 compliance to change for automotive chips. Hitachi used our JasperGold platform to develop and receive certification for an industry safety controller.

Before turning it over to John, let me quickly summarize my comments. We drove excellent results through consistent execution and broad-based proliferation an adoption of our solutions to meet the needs of the data-driven economy. We introduced the Cadence Cloud, the first broad portfolio of cloud-based EDA technologies. Our growing aerospace and defense business had another strong quarter. Our flagship IP products are doing very well in the marketplace. Adoption of our Xcelium parallel simulator is growing. Our digital and signoff solutions are proliferating with market-shaping customers and winning new customers. And Cadence Solutions are helping enable continued innovation in electronics through modern technology.

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

John Wall -- Senior Vice President and Chief Financial Officer

Thanks, Lip-Bu, and good afternoon, everyone. I'm pleased to report we met or exceeded all of our key operating metrics in Q2. And as a result of strong execution across our business, we are increasing out outlook for fiscal 2018. Before we get into Q2 results, I'd like to remind you that Cadence adopted a new revenue accounting standard known as ASC topic 606 for fiscal 2018. These new rules, as we often refer to them, are now GAAP. The numbers I present for our second quarter are based on these new rules unless otherwise stated. Please also keep in mind that this is the first year we are reporting under the new rules, which are not directly comparable to those of 2017, which were reported under ASC topic 605, or the old rules. For all four quarters of 2018, we will show our quarterly results as reported under the old rules to allow comparison to 2017 on an apples-to-apples basis.

Having covered that, let's now go through the key results for the second quarter, starting with the P&L. As reported, total revenue was $518 million. Non-GAAP operating margin was 30%. GAAP EPS was $0.27, and non-GAAP EPS was $0.43. And under the old rules for direct comparison against 2017, total revenue was $515 million, up 8% year-over-year. Non-GAAP operating margin was 30%. GAAP EPS was $0.26, an non-GAAP EPS was $0.44.

Now turning to the balance sheet and cash flow, cash in short-term investments totaled $825 million at the end of Q2, with approximately $475 million of that cash here in the U.S. Cash outstanding at quarter end was $650 million. Operating cash flow in Q2 was $205 million. During the quarter, we used $50 million for share repurchases and $45 million to pay down borrowings under our revolving credit facility. As reported, DSOs were 39 days. Under the old rules, DSOs were 36 days.

I will not provide our updated guidance. For Q3, we expect the following results. Revenue in the range of $510 to $520 million; non-GAAP operating margin in the range of 27 to 28%; GAAP EPS in the range of $0.22 to $0.24; non-GAAP EPS in the range of $0.40 to $0.42, and DSOs of approximately 40 days. For fiscal 2018, we now expect revenue in the range of $2.07 to $2.09 billion; non-GAAP operating margin of approximately 28%; GAAP EPS in the range of $0.95 to $1.01; non-GAAP EPS in the range of $1.64 to $1.70; and operating cash flow in the range of $535 to $565 million. We now expect the difference in revenue under the new and old rules to be approximately $25 million. As a result, under the old rules, our implied 2018 guidance at the midpoint is now expected to be revenue approximately $2.105 billion; non-GAAP operating margin of approximately 29%; GAAP EPS of approximately $1.06; and non-GAAP EPS of approximately $1.74. And our operating cash flow is expected to be approximately $550 million.

Please note that we expect our operating cash flow to be the same under both the new and old rules, because our transition to the new rules in 2018 is just an accounting change. And as a result, there is no impact to our cash flows or how we operate our business. For more details on the impact of the transition to the new rules on our financial statements, please see our CFO commentary, which was included with our 8-K filing today, and is available on our website.

To sum up today's call, I want to highlight that I am pleased with our progress. On an apples-to-apples basis, we are now expecting annual revenue to increase by more than 8% compared to the 7% revenue growth we achieved in 2017. We expect non-GAAP operating margin on the basis of the old rules to improve to approximately 20% for the year compared to 27.5% last year. And it's pleasing to me to see so much of the improvement in profitability flowing through to operating cash, which we now expect to land at a midpoint of $550 million for 2018, an increase of approximately $80 million over last year.

Before I finish, I'd like to thank the extended Cadence team for their operational discipline, their drive and passion to make our customers successful, and for the very large part they have all played in allowing us to raise our guidance for the year. And with that, Operator, we'll now take questions.

Questions and Answers:

Operator

At this time, I'd like to remind everyone, in order to ask a question, press *, then the number 1 on your telephone keypad now. We will pause for a moment to compile the Q&A roster. And your first question comes from the line of Monika Garg from KeyBanc Capital Markets. Your line is open.

Monika Garg -- KeyBanc Capital Markets -- Analyst

Hi, thanks for taking my question. First thing, if I look, I just see is 605 equal operating margins, as you highlighted, John, particularly at 29%. Where do you think operating margins could be in the next two to four years?

John Wall -- Senior Vice President and Chief Financial Officer

Hi, Monika. Yes, we believe there is still room to grow operating margin. We're confident in our model and believe that our system design enablement strategy opens up additional growth opportunities for us.

Monika Garg -- KeyBanc Capital Markets -- Analyst

All right. Then, you know, if I look at the guidance, the first half revenue is going like 8.5% kind of less -- 8% less year-over-year, while the back half is close to 6%, looking at the guidance. Any reason why we would see deceleration in growth in the back half?

John Wall -- Senior Vice President and Chief Financial Officer

Well, overall, business is good. I wouldn't focus too intensely on the result of any one individual quarter or one half or the other. Our focus is more on improving year-over-year. Business is very strong for all the reasons that Li-Bu talked about. I mean, for 2018, we're now looking at over 8% revenue growth, and almost all of that is organic. And like we said, on GAAP operating margin, I mean, that's up to 29% compared to 27.5% achieved last year. The other thing to note, on cash, the first half was particularly strong for operating cash flow due to the timing of the collections. And that's just a shift between quarters within this year.

Monika Garg -- KeyBanc Capital Markets -- Analyst

All right, thank you. The last one here is for Lip-Bu. Lip-Bu's synopsis entered the software security market about four years back. Would that market be interesting for Cadence, and could you talk about your views on Cadence M&A strategy? Thank you.

Lip-Bu Tan -- Chief Executive Officer

Sure. So, I think there are two parts of the question. Once is on the security side. Clearly, we are also looking at that and then how to provide really high quality design for our customers, including stronger in verification and security is part of it, and then to drive the success to our customer. So, that's one. And then the second question, regarding the -- can you repeat the second question again?

Monika Garg -- KeyBanc Capital Markets -- Analyst

Yes, just wanted to understand your views, how you look at the M&A strategy for Cadence.

Lip-Bu Tan -- Chief Executive Officer

Yeah, M&A, we have a very disciplined approach to the M&A. And clearly, we want it to fit into our overall strategy, and also providing the customer with a difference in technology, and also recruiting to bring in the top talent, either in the managerial or technical side. And at the end of the day, it's really focused on the shareholder return.

Monika Garg -- KeyBanc Capital Markets -- Analyst

Thank you so much.

John Wall -- Senior Vice President and Chief Financial Officer

Thank you.

Operator

Your next question comes from the line of Gary Mobley from Benchmark. Your line is open.

Gary Mobley -- Benchmark -- Analyst

Hi, everyone. Thanks for taking my question. Can you hear me OK?

John Wall -- Senior Vice President and Chief Financial Officer

Yes.

Gary Mobley -- Benchmark -- Analyst

I wanted to start out asking about the strength of the IP licensing in the second quarter. Can you speak to what drove the strength, the repeatability of the second quarter strength? And then conversely, it looks like your emulation business was weak during the quarter. And we know that's an upfront revenue recognition product line. And so, can you confirm that emulation was weak in the quarter, and what's your outlook for the balance of the year in emulation?

Lip-Bu Tan -- Chief Executive Officer

So, let me start first, and then John will fill in. So, overall, we really like our refi IP strategy, and it's working well for us. It's another strong quarter for us in the DDR and PCIE. We mentioned a couple of key ones. The first DDR5 test chip is working at 7-nm at TSMC, and I highlight a couple of key success with the customer, DDR, with a major semiconductor company, PCIE with the leading storage company, and also working with the leading mobile customer on the 7-nm sensor application. So, overall, I think the IP business is doing well, and like I also mentioned, find new logos, and then going up over 10% of the revenue. And so, I think we're quite happy with our leadership and also our IP portfolio. And as you know, we recently just added the acquisition of new semi. Even though will be minimum impact for this year, going forward, that will be exciting for us. It's very critical for the hyper scale; the infrastructure, I think, is an exciting one for us.

In terms of emulation, I think clearly, we're also quite pleased with our performance. We mentioned our six new customers, and nine repeat orders, and then two for the Palladium Cloud. And so, we're excited about that. But I just want to highlight it's a very lumpy business. Quarter to quarter may change. But overall, we are -- we like what we have. This is the third full year of continue to do well. And overall, we really focused on the verification suite that consists of Jasper, Xcelium, Palladium, Protium, and VIP. Overall, the verification suite is coming up nicely.

Gary Mobley -- Benchmark -- Analyst

Okay. I just had a follow-up question about your SaaS model, or Cadence Cloud. Should we assume that there's really gonna be no change to revenue recognition, average license duration, and perhaps no change to the operating expense model to Cadence? And should we view it really as more of a point of differentiation vis-a-vis your larger competitor?

John Wall -- Senior Vice President and Chief Financial Officer

That's a fair assumption, Gary. Cadence Cloud offers customers another way to optimize their investment in Cadence tools. It's a valuable addition to our product portfolio for both customers and Cadence, and it's too early to say more than that.

Gary Mobley -- Benchmark -- Analyst

Okay. But no -- you don't expect a change in the revenue recognition or the average license duration?

John Wall -- Senior Vice President and Chief Financial Officer

I don't, but it's too early to say that definitely.

Gary Mobley -- Benchmark -- Analyst

Okay, fair enough. Thank you, guys.

John Wall -- Senior Vice President and Chief Financial Officer

Thank you.

Operator

Your next question comes from the line of Jay Vleeschhouwer from Griffin Securities. Your line is open.

Jay Vleeschhouwer -- Griffin Securities -- Analyst

Thank you. Good evening, Lip-Bu and John. Lip-Bu, let me start with you regarding the overall EDA landscape in the following sense. We've seen more and more examples of partnering in the industry. Answers with Synopsis, answers with Mentor, and then earlier this month, quite interestingly, Synopsis with Siemens. And also, in the parallel universe of technical software, we've seen examples also of more and more partnering. And it's becoming a little more evident that Cadence hasn't really been participating in these kinds of relationships. And I know you're very much focused on your own internal development, and Anirudh's done a great job with that. But do you think that it's become increasingly important for you to participate in some of the kinds of relationships that we've seen more and more around you in the industry?

Lip-Bu Tan -- Chief Executive Officer

Yeah. So, I think you have two parts of the question. So, one is about the overall EDA. And I think overall, I have to say that the EDA is very good, driven by the strong design activity, especially when we drive the whole data-driven, and also the whole technology wave in terms of machine learning, deep learning applications. So, we see the increase in the design activity, and we are very pleased to see that. So, overall, from the EDA say, we are excited. And then the other part is also the broad-based demand for our innovative system design enabled solution has been quite well received. So, overall, we are excited about the overall EDA environment.

Regarding the partnership, we mentioned a couple of them, and clearly, we are also working on that. And so, I think it's important to really focus on what customer needs. And we partner in some cases with our peers and also ecosystem partners. We're working together to support the customer success. And a couple of them that we highlight in the past, partnership with the Metworks, and a partnership with National Instruments, and many others. And so, we continue to do that. And then we have our great success also.

Jay Vleeschhouwer -- Griffin Securities -- Analyst

With respect to technology, let me ask you about three products that, if they succeed, might stimulate some incremental growth for you. But you haven't really talked about them. Number one is Pegasus, which you announced over a year ago at DAC. What's the status of that? I know it's hard to share shift in that market, but it is an important new product for you. Secondly, Synthesis. They're clearly at under 10-nm from incremental requirements for Synthesis, so do you see that as perhaps a source of incremental business for you? And then lastly, you've just launched Sigrity 2018. Could that stimulate some resurgent growth in PCB for you, as we saw six years ago?

Lip-Bu Tan -- Chief Executive Officer

Jay, these are good questions. Let me address one by one. Pegasus, as you know, this is the -- for the manufacturing-related area. We're excited about the design we have with the massive parallelism and also cloud-enabled, so that we can really addressing all the cloud requirements. And then the other part is, clearly, when we are very focused on the certifications from some of the foundry partners. And we are excited about that, and stay tuned. And then on the Synthesis side, Jay, we are making great progress with multiple customers in the most advanced nodes. And then the Sigrity, in terms of the product, and then so far, we have great success, and tied in with the Voltus approach, I think is very good. But so far, we are not guiding any specific product line. And clearly, with respect to the Sigrity 2018, we have a new 3D capability that help the PCB that is quite unique.

So, overall, I think all this already built into our guidance for 2018. But just back to your point, just truly, we are making great progress. Stay tuned.

Jay Vleeschhouwer -- Griffin Securities -- Analyst

Thanks very much.

John Wall -- Senior Vice President and Chief Financial Officer

Thank you.

Operator

Your next question comes from the line of Rich Valera from Needham & Company. Your line is open.

Rich Valera -- Needham & Company -- Analyst

Thank you. Lip-Bu, question for you on the macro environment you're seeing with your customers. There's been some noise in the semiconductor industry around kind of where we are in the cycle, concerns about particularly in the memory side of the market. And as well, there's been some issues on the semi cap side, with some push outs of expected capex, none of which I would expect would affect your business. But I just wanted to get your sense on the demand trends within EDA, how they are now versus, say, a couple of quarters ago, and just how you see it as far as the strength of the industry and your customer base. Thank you.

Lip-Bu Tan -- Chief Executive Officer

Yeah, good question. So, I think on the macro side, clearly, as I mentioned earlier, we've seen design activity increase. And due to a couple of factors I mentioned earlier, the next decade could be the big data, data analytics, and they change the whole workload and become a more data-driven economy. And we are very well positioned for doing that. And then also, some of the new technology, like 5G, the machine-learning, deep learning, and some of the new photonics and related, silicon photonics-related area, and we are very well positioned for that. So, I think overall, EDA is more related to the design activity. And we really see the increase of that. So, I think overall, I'm cautiously optimistic on that.

Regarding the memory, clearly, the memory related to data, memory, and storage will be critical for us. We are delighted. We have making great progress on the memory player and the customer we highlight in the past two quarters. We continue to make progress on that. And we also have very good progress on some of the storage related. We just highlight some of the IP engagement with the storage player. And so, I think overall, the demand trend is continuing to look good. And regarding the semiconductor cycle, as we all know, there's a cycle, but I'm very cautiously optimistic because we see the design activity has increased a lot. So, we are excited, and we are very well positioned for that.

Rich Valera -- Needham & Company -- Analyst

Thank you. I appreciate that color, Lip-Bu. And one more on China, if I could. You've talked really sensibly in the past about your knowledge of that market and your, I think, penetration of that market. I just wanted to get your sense on the opportunity there, but also how you see that market potentially being affected by the current trade situation with the U.S. Do you think that they may be driven to actually do more internal development of all types of technology, including EDA? And what are surely just the opportunities and risks for cadence in the China market, if you could? Thank you.

Lip-Bu Tan -- Chief Executive Officer

Good question. So, overall, we have done well in China. It's a growing opportunity, and we pay a lot of attention on that. And China, as you know, the government is very committed to build their own domestic industry to be self-sufficient. And we continue to be -- and I think most important for us is really to be the best trusted partner to our customers globally, including China customers. And we make sure that our tools and our IP are supporting them for the developments. And that's something that's a high priority for us. And then overall, we paid a lot of attention about the trade war. And then clearly, we hope for the best. But meanwhile, we really make sure that we are well positioned to support our customers.

Rich Valera -- Needham & Company -- Analyst

Okay, that's helpful. And one final one. And I'm assuming this is still the case, but last quarter, you had talked about IP likely being the segment of your business, all your segments, that was likely to grow the fastest this year. I think you were looking at that maybe as another double-digit growth year. Is that still the case? I would assume so from the commentary, but just wanted to confirm that.

John Wall -- Senior Vice President and Chief Financial Officer

Yes, Rich, the -- yeah, I mean, when I look at the results, we're not guiding revenue by individual product groups. But what I can say is that, yeah, we continue to expect IP to be our fastest-growing product group for 2018. Yeah, that's true.

Rich Valera -- Needham & Company -- Analyst

Perfect. Thanks very much, gentlemen, appreciate it.

John Wall -- Senior Vice President and Chief Financial Officer

Thank you.

Operator

Your next question comes from the line of Mitch Steves from RBC Capital Markets. Your line is open.

Rich Steves -- RBC Capital Markets -- Analyst

Hey, guys. Thanks for taking my question. I really have two. The first one's a bit nuanced. So, I know you guys kind of benefit when the U.S. dollar strengthens. Is there any way to quantify what the tailwind of that was this quarter?

Alan Lindstrom -- Senior Group Director of Investor Relations

There was a tailwind, Mitch, but it was minimal.

Rich Steves -- RBC Capital Markets -- Analyst

And is that gonna be the same case next quarter as well, assuming the rates are the same?

Alan Lindstrom -- Senior Group Director of Investor Relations

Assuming the rates are the same, it would be already embedded in our guidance.

Rich Steves -- RBC Capital Markets -- Analyst

Okay. Perfect. And then the second question is just more of kind of a thematic one. So, the semi cap guys are all talking about how kind of EDA design is more integrated with what they're doing. So, is there reason why I guess you would integrate both a semi cap company and an EDA company in the future?

Lip-Bu Tan -- Chief Executive Officer

Yeah. So, I think, Mitch, first of all, I'm not gonna speculate. And so, clearly we work closely with all our ecosystem partners, and ranging from the IP to the foundry, and including the semi cap equipment. And so, I think this is a whole ecosystem. And we focus on what we do best in terms of providing the tools in IP to be the best partner for the customers.

Rich Steves -- RBC Capital Markets -- Analyst

Got it. And then again, just one last one. At DAC, there was a lot of private companies on the automotive side specifically that I noticed. Is that market still fragmented, or how do you guys view the automotive space, specifically for design?

Lip-Bu Tan -- Chief Executive Officer

Yeah, we're very excited about automotive vertical, and clearly, we are very well positioned on that. As you can tell, the automotive might now have a lot more electronic components, and then also, everybody from tier one to the automotive maker, they're putting a big effort into the aiding the income of machine learning, deep learning, to thrive in a crowd-connected device. And we are very heavily engaging with them and are thinking of adding these great platforms. We have great opportunity in terms of the IP and also the tool, and we are well positioned for supporting them.

Rich Steves -- RBC Capital Markets -- Analyst

Perfect. Thank you.

John Wall -- Senior Vice President and Chief Financial Officer

Thank you.

Operator

Your next question comes from the line of Tom Diffely from DA Davidson & Company. Your line is open.

Tom Diffely -- DA Davidson & Co. -- Analyst

Okay, good afternoon. Maybe first, to follow up on Rich's question on China, do you have more exposure on the printed circuit boards side of your business there or is it more on the chip design side of it?

Lip-Bu Tan -- Chief Executive Officer

Can you repeat the question again?

Tom Diffely -- DA Davidson & Co. -- Analyst

Yeah. Your exposure in China, is it more exposed to your PCB design tools or to your chip -- actual chip or semiconductor design tools?

Lip-Bu Tan -- Chief Executive Officer

I think we are more -- we don't have that breakdown. But I think clearly more on the chip design activity. And then the PCB side, clearly we have some engagement from Allegro, and then the packaging related area. But overall, it's a good opportunity for us, and we continue to support our customers.

Tom Diffely -- DA Davidson & Co. -- Analyst

Okay, great. Just a couple questions, then, on the cloud. The industry for several years has been talking about moving to the cloud, and there's been some small little movements here and there. But what do you think it is about the increases or the advances in security that make now the right time to be more aggressive on moving toward the cloud?

Lip-Bu Tan -- Chief Executive Officer

Yeah. I think you have a good question, and clearly, cloud datacenter and Cadence Cloud is a high priority for us. We are delighted. We're collaborating with Amazon, Microsoft, and Google to provide cloud readiness to our customer-managed cloud. And that's something that is exciting. And we highlight a couple of offerings on Palladium Cloud to Liberate Trio that is cloud available, and Pegasus on the cloud available. And we have great traction in terms of customer adoptions and endorsement by ARM and TSMC. So, overall, I think the securities issues that the last two years, we have been working through with our foundry partner and our IP partners. And more importantly, to make sure that our customers are satisfied and then really feel comfortable to deploy in their customer-managed cloud. And that's something that's exciting. And we have rolling out product by product available in a very broad way to provide the cloud to really drive productivity, scalability, and optimized security and flexibility to the customer. And we're very focused on the customer success here.

Tom Diffely -- DA Davidson & Co. -- Analyst

Okay. So, when you talk about customers, is it mainly the smaller customers that can really benefit from the economics of the movement to the cloud, or are you also seeing some of the larger customers move there, so it's more of an individual capacity overflow point of view?

Lip-Bu Tan -- Chief Executive Officer

And to answer your question, both. And so, very excited to see some of the major customers really want to be in the cloud. And that can really drive the -- at the end of the day, it's driving the productivity and the performance of their design. And when you can able to position all your design into spread over the vertical, unlimited server, and that can be really, really drive the performance, and they see the benefit, that that is really the key thing for us, for Cadence to really embark on it. And them some of the smaller companies also benefit from it. So, in the end, either the small company or big company is really the bottom line is drive the performance, and then the scalability and the productivity for their design.

Tom Diffely -- DA Davidson & Co. -- Analyst

Okay. And then finally, when you look at three to five years, what percentage of your business, or what is your vision as far as how big the cloud becomes as a percentage of your overall business?

Lip-Bu Tan -- Chief Executive Officer

It's a little bit too early to give the guidance. And then clearly, we are excited about this new Cadence Cloud, and we are focused on that, and then focused on customer success. And we are delighted the leading hyper scale web service cloud guy is partnering with us. And we are also very excited TSMC and ARM are endorsing and supporting us. And this is a major effort, and we are clearly the leader in this.

Tom Diffely -- DA Davidson & Co. -- Analyst

Okay. Thank you.

John Wall -- Senior Vice President and Chief Financial Officer

Thank you.

Operator

Our final question comes from the line of Sterling Auty from JPMorgan. Your line is open.

Sterling Auty -- JPMorgan -- Analyst

Yeah, thanks. Hi, guys. I wanted to continue the line of questions on the Cadence Cloud. Can you help us understand, what is the pricing structure for your solution in the cloud versus the traditional on-premise solutions?

John Wall -- Senior Vice President and Chief Financial Officer

Hi, Sterling. This is John. A key part of our strategy is to become increasingly mission critical to our customers. And Cadence Cloud offers customers another way to optimize their investments in Cadence Tools. We believe that Cadence Cloud will make our product portfolio more valuable.

Sterling Auty -- JPMorgan -- Analyst

Okay. But does that mean, are you pricing on a per user, some sort of per process, or metered pricing, like traditional Amazon, just to understand how this opportunity will grow?

John Wall -- Senior Vice President and Chief Financial Officer

Again, it's a valuable addition to the product portfolio, and customers will pay for the value they receive. I mean, generally, operationally, we focus on three keys things, which I believe creates a virtuous cycle. We lead with innovation, which makes us become increasingly mission critical to our customers, and then we drive operational excellence across the company. That virtuous cycle creates gains for Cadence that improve cash flow, and then we use that cash flow to reward employees, return value to shareholders, and invest in product development and new innovations to continue that virtuous cycle. And as Lip-Bu said earlier, when our customers look at Cadence Cloud, they'll focus on productivity, scalability, security, and flexibility.

Lip-Bu Tan -- Chief Executive Officer

And in some ways, I think, Sterling, the feedback from our customers is really divided, because they see clearly performance improvement, productivity improvement, and that means that we can really support the pricing that we want to support the customer success.

Sterling Auty -- JPMorgan -- Analyst

Yeah. And when you looked at -- obviously, the first solutions here seem to be in the verification and then emulation area, which makes perfect sense, given the elastic capabilities of those cloud platforms. Wondering what the gross margin impact as that particular set of products? Is it actually better for you gross margins, given the low margin hardware that you typically have to ship with it, or is it actually maybe neutral to the gross margins?

Lip-Bu Tan -- Chief Executive Officer

Yeah, Sterling, I think a little bit too early to tell, but so far, we are very encouraged in some of the customers' feedback, and also a very strong partnership with TSMC and our hyper scale partners, and to scale out and really be able to provide that unlimited service that the customer can enjoy, and the scalability and the productivity and the time to market for their benefit. And hopefully, that will really drive the success of the cloud.

Sterling Auty -- JPMorgan -- Analyst

Got it. And then very last question on the cash flow and collections, John, you mentioned just this was collections that you expected, so it sounds like some of the collections perhaps came earlier in the year than we would have expected, anyway. Can you just walk through what drives the change in the timing of those collections? Was it anything to do with either early renewals or other things that maybe allowed further upsell into those customers?

John Wall -- Senior Vice President and Chief Financial Officer

No, it was mainly on the IP and hardware side. We received some IP and hardware payments in the first half that would normally have fallen more evenly across the year. And that caused the first half to be particularly strong for operating cash flow. But this is just a shift between quarters within this year, though.

Sterling Auty -- JPMorgan -- Analyst

Understood. Thank you, guys. I appreciate it.

John Wall -- Senior Vice President and Chief Financial Officer

Thank you.

Operator

I will now turn the call over to Lip-Bu Tan, Chief Executive Officer, for closing remarks.

Lip-Bu Tan -- Chief Executive Officer

In closing, through continuous innovation and execution, we are well positioned with our system design enablement strategy to leverage the multiple technology waves that further proliferate our solutions with a broader base of customers. We are proud of the innovative and inclusive culture we are building at Cadence. I would like to thank all our shareholders, customers, and partners, board of directors, and hard-working employees globally for their continued support. Thank you all for joining us this afternoon.

Operator

Thank you for participating in today's Cadence Second Quarter 2018 Earnings Conference Call. This concludes today's call. You may now disconnect.

Duration: 46 minutes

Call participants:

Alan Lindstrom -- Senior Group Director of Investor Relations

Lip-Bu Tan -- Chief Executive Officer

John Wall -- Senior Vice President and Chief Financial Officer

Monika Garg -- KeyBanc Capital Markets -- Analyst

Gary Mobley -- Benchmark -- Analyst

Jay Vleeschhouwer -- Griffin Securities -- Analyst

Rich Valera -- Needham & Company -- Analyst

Rich Steves -- RBC Capital Markets -- Analyst

Tom Diffely -- DA Davidson & Co. -- Analyst

Sterling Auty -- JPMorgan -- Analyst

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