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Cadence Design Systems Inc (NASDAQ:CDNS)
Q3 2019 Earnings Call
Oct 21, 2019, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon. My name is Josh, and I will be your conference operator today. At this time, I would like to welcome everyone to Cadence Third Quarter 2019 Earnings Conference Call.

All lines have been placed on mute to prevent any background noise. After the 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. Please go ahead.

Alan H. Lindstrom -- Senior Group Director of Investor Relations

Thank you, Josh. And I would like to welcome everyone to our third quarter 2019 earnings conference call. I am joined today by Lip-Bu Tan, CEO; and John Wall, Senior Vice President and CFO.

The webcast of this call is available through our website, cadence.com, and will be archived through the 30th of December, 2019. A copy of today's prepared remarks will also be available on our website at the conclusion of the call today.

Please note that the discussion today will contain forward-looking statements, and that actual results may differ materially from those expectations. For an 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, October 21, 2019, for the quarter ended September 28, 2019, related financial tables, and the CFO commentary are also available on our website

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

Lip-Bu Tan -- Chief Executive Officer

Good afternoon, everyone. And thank you for joining us today. I'm pleased to report that Cadence achieved excellent operating results for the third quarter of 2019, delivering 9% year-over-year revenue growth. Based on our strong execution and strength of our technology and business, we are again raising our outlook for the year.

Given the uncertainty of the ongoing trade situations with China, our outlook assume current export limitations remain in place for the rest of the year. John will provide more detail on our outlook, shortly. While global economy and geo-political uncertainty continues, long-term trends such as AI, 5G, Cloud and IoT continues to drive strong design activity.

The move to domain specific computing and system companies building custom silicon, as well as a host of innovative silicon start-ups, are all pushing the technology envelope, and driving the need for high-performance, low-power computing, high bandwidth connectivity, and high density storage.

Our Intelligent System Design strategy, focus -- position us well to maximize the resulting opportunities through building out our portfolio, and providing more capabilities and value to our customers. The foundation of our strategy is the Design Excellence segment, which comprise of our core EDA and IP business. I will now provide some of the key quarterly highlights in this area.

A key element of our approach has been to closely collaborate with our ecosystem partners, and focus on market shaping customers. In Q3, we deepened our partnership with Samsung through our comprehensive agreement across our digital, custom, and verification product portfolio.

Early this year, we had reported a breakthrough wide-ranging win with a marquee US semiconductor company. I am particularly pleased that we augmented that partnership with our largest ever IP order that included our Tensilica processor family and our design IP portfolio, including ultra-high-speed SerDes.

At its recent open innovation platform event, TSMC recognized Cadence with four partners of the year awards, including an award for joint development of 6-nanometer design infrastructure. And one for joint delivery of cloud-based productivity solution. Our Cadence cloud portfolio has great momentum, with over 50 customers using our solution in the cloud. Cadence cloud-ready products in close collaboration with our cloud infrastructure and foundry partners are enabling our customers to realize meaningful scalability, performance and flexibility benefits from using the cloud.

Our CloudBurst model is used for hybrid cloud infrastructures, where customer want to augment their on-premise infrastructure with best capacity from the public cloud to address pick load. Continuing strong proliferation of our digital and signoff solutions, especially with market shaping customers at the most advanced nodes have driven share gains and double-digit year-to-date revenue growth.

In addition to numerous 7-nanometer tapeouts, there are more than 15 customer engagements at 5-nanometer and 3-nanometer using our digital flow. MediaTek has deployed our digital full flow in production for their 7-nanometer designs. At Mellanox, a leader in data connectivity solutions, Innovus replaced the incumbent solution for all of their production 7-nanometer designs. We also had a digital full flow competitive win for 7-nanometer design with a leading Japanese imaging company.

Uhnder used Cadence digital full flow, which is based on common engines and includes Genus, Innovus, Tempus and Pegasus to achieve the best quality of results and the fastest convergence of their highly innovative and completely integrated first digital automotive radar-on-chip.

Next, I will discuss highlights of our System Design and Verification solutions. Our Palladium Z1 emulator, and the recently introduced Protium X1 FPGA-based prototyping platform now provide a comprehensive solution across IP and SoC verification, hardware/software regressions, and earlier software development. Growing system design complexity and the high cost of failure continues to drive strong demand for our Palladium Z1. In Q3, the Z1 added eight new customers and had key -- and had eight key expansions.

Rounding off our hardware family is the Protium X1, which is a perfect complement to our Palladium Z1. I'm excited by the strong customer interest in Protium X1. Our global marquee customer significantly expanded their existing hardware footprint with the additional Z1 capacity and Protium X1 as well, making it one of the largest hardware orders ever for Cadence.

We had several full Verification Suite wins in Q3, including a major customer in Asia and an automotive semiconductor company in EMEA. In IP, our focused strategy and strong portfolio have enabled us to benefit from the continuing IP outsourcing trend. In Q3, we had our best ever quarter for IP with year-over-year revenue growth exceeding 20%. It was an especially strong quarter for our Tensilica products with additional wins in audio, imaging, computer vision and machine learning.

In System Innovation segment of our Intelligent System Design strategy, we introduced the Celsius Thermal Solver, which joins the Clarity 3D EM Solver in the growing suite of our system analysis products.

Celsius is the industry first complete electro-thermal co-simulation solution for the electronic systems from ICs to a system or to a physical enclosures. Based on the proven massively parallel architecture that delivers up to 10X faster performance with full accuracy, Celsius enables design teams to mitigate thermal issues at an earlier stage, thereby reducing system development iterations. Bosch and Arm have both endorsed this exciting new product, and we're in the midst of earlier discussion with several other customers.

Clarity, which was announced earlier this year continued its strong momentum with four competitive wins during the quarter, and more than 30 active customer engagements under way.

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

John M. Wall -- Senior Vice President and Chief Financial Officer

Thanks, Lip Bu. And good afternoon everyone. I am pleased to report we met or exceeded all of our key operating metrics in Q3. As a result of continuing robust demand for our solutions and strong execution across our business, we are increasing our outlook for fiscal 2019.

Before we get into the Q3 results, I would like to take a moment and talk about the ongoing trade uncertainties. With more companies recently added to the Entity List, the situation remains fluid and we will continue to closely monitor it. For the purpose of providing guidance for 2019, we've assumed that the current export limitations remain in effect and the Entity List remains unchanged for the remainder of the year.

Now, let's go through the key results for the third quarter, starting with the P&L. Total revenue was $580 million, up 9% year-over-year. Non-GAAP operating margin was 31.7%. GAAP EPS was $0.36 and non-GAAP EPS was $0.54.

Next, turning to the balance sheet and cash flow. At the end of the quarter, cash totaled $655 million, while the principal value of debt outstanding was $350 million. Operating cash flow for Q3 was $139 million. DSOs were 43 days, and during Q3, we repurchased $75 million of Cadence shares.

Now, I will provide our updated guidance. For Q4, we expect the following results. Revenue in the range of $590 million to $600 million. Non-GAAP operating margin of approximately 30%. GAAP EPS in the range of $0.33 to $0.35. Non-GAAP EPS in the range of $0.52 to $0.54, and we expect to repurchase $75 million of Cadence shares.

As a result, our updated guidance for fiscal 2019 is now as follows. Revenue in the range of $2.327 billion to $2.337 billion. Non-GAAP operating margin of 31.5% to 32%. GAAP EPS in the range of -- in the range of $1.50 to $1.52. Non-GAAP EPS in the range of $2.18 to $2.20. And operating cash flow in the range of $700 million to $740 million.

You will find guidance for additional items as well as further analysis in the CFO Commentary available on our website. In summary, I am pleased with our execution in an uncertain environment. Our strong dependable results reflect the broad diversity of our global customer base. We remain focused on driving growth in our core business, highlighted by the proliferation of our digital full flow, and we continue to invest in growth opportunities with market shaping customers, and new product areas.

In closing, I would like to thank our customers, partners and of course our employees for their continued support.

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

Questions and Answers:

Operator

[Operator Instructions] And your first question comes from Adam Gonzalez with Bank of America. Your line is open.

Adam Gonzalez -- Bank of America Merrill Lynch -- Analyst

Yeah, Thanks for taking my question and congrats on the strong results. For the first one, I'd like to focus on the IP business. I know IP can be a little bit volatile from rev rec standpoint. But can you help us understand how sustainable this large boost you saw in Q3 is? Should we expect a little bit of a reversion in Q4? Does Q3 kind of represent an inflection? And if the latter, can you walk us through what the sustainable drivers are? Thanks.

John M. Wall -- Senior Vice President and Chief Financial Officer

So Adam, yes. As Lip-Bu mentioned in his prepared remarks that Q3 was our best ever quarter for IP business with impressive revenue growth exceeding 20% year-over-year. I mean if I look back over the last four quarters, the trailing four quarters, we're also up 20% year-over-year on IP. But we always say that revenue for IP can be lumpy in any single quarter, half or even year. But we do believe that it's -- it's relatively sustainable over the long term.

Adam Gonzalez -- Bank of America Merrill Lynch -- Analyst

Got it, thanks. For my follow up, I guess can you just give us an early view on 2020 growth based on the bookings momentum that you're seeing today?

John M. Wall -- Senior Vice President and Chief Financial Officer

Can you repeat the question?

Adam Gonzalez -- Bank of America Merrill Lynch -- Analyst

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

John M. Wall -- Senior Vice President and Chief Financial Officer

Oh, we're not giving any guidance on 2020 right now. Like we say, it's, it can be -- it can be lumpy in any one quarter, half or even year. We'll provide that guidance at the end of the year.

Adam Gonzalez -- Bank of America Merrill Lynch -- Analyst

Got it. Thanks.

Operator

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

Gary Mobley -- Wells Fargo Securities -- Analyst

Hey guys, thanks for taking the question. And congrats on another strong quarter. I realize that you're probably going to be filing your 10-Q in about three hours or so, but can you give us a preview into what the remaining performance obligations were at the conclusion of the quarter?

John M. Wall -- Senior Vice President and Chief Financial Officer

Yeah, I think it's, I think it's filed already. The contracted but unsatisfied performance obligations were approximately $3 billion at the end of Q3, including approximately $200 million of our IP Access arrangements. Those IP Access arrangements are non-cancelable commitments from customers, where product selection and quantities are determined by customers each quarter.

Gary Mobley -- Wells Fargo Securities -- Analyst

Okay. So it's about $200 million sequentially, if I'm not mistaken. All right. I have multiple question on your Systems Analysis business, Lip-Bu you mentioned four wins for Clarity in your prepared remarks. In relation to those four wins in the early activity, in the 30 engagements that you have, how successful are you in your ability to separate these licensing deals from existing EDA customers? In other words, monetize them above and beyond your existing revenue run rate, existing customers. And can you share with us what your typical deal size maybe for these types of wins and as well, perhaps when you can start to recognize some revenue from these four early Clarity wins?

Lip-Bu Tan -- Chief Executive Officer

Yeah, thank you for your question, Gary. I think couple of things. First of all, I think we have our approach of the -- you know the System Analysis space. That's something is really our core competent of computational software. And we can apply into this complex System Analysis space and then we have these two new products. Initially, we announced Clarity that is a 3D EM Solver. We are delighted. We have four competitive wins. And this is a very new product for us, and we have more than 30 active customer engagements going forward. And so we are excited about that. And then, meanwhile, we just announced our Celsius Thermal Solver. And again, back to that computational software strength that we have, and we clearly demonstrate that up to 10X performance and customers are delighted to see our performance especially Bosch and ARM. They both endorse our new products and we are in the middle of earlier discussion.

So it's still in the very early stage of our emerging into the System Analysis, and more and more our customer love that because you know besides the EDA, besides the IP, they want to look at the total system solution simulation with [indecipherable] the whole system, power in our thermal envelopes, and something that we can really demonstrate and provide the best solution for the customer. So it is still very early. And in term of our pricing, again, it's not part of our EDA. And so and now we do it differently, and they are basically close to the market competitive pricing, but in a very early stage of winning. Stay tuned. Over time we will unfold and give you a progress update.

Gary Mobley -- Wells Fargo Securities -- Analyst

All right. Thank you guys.

Lip-Bu Tan -- Chief Executive Officer

Thank you.

Operator

Your next question comes from Jackson Ader with JPMorgan. Your line is open.

Jackson Ader -- JP Morgan Chase & Co. -- Analyst

Thanks, guys. Thanks for taking the question. Can we just start with hardware? So it looks like Verification was the segment that probably struggled the most year-over-year. And we've seen inventory balances pick up in the last couple of quarters. So I'm just curious, is this maybe a building of some hardware ahead of pipeline? Or are we seeing any kind of struggling close rates in that hardware business?

Lip-Bu Tan -- Chief Executive Officer

Now, let me start first Jackson. And then John will give you more detail about the inventory. And so I think first of all, I think function Verification remained a fastest growing challenge for our customer. And I've mentioned in Q3, we are delighted to deepen our partnership with Samsung to a comprehensive agreement across not just digital custom and also Verification products. And then Palladium Z1, have been doing great and the customer love it on the hardware emulation, but now we have the Protium X1 FPGA-based prototyping that we can provide a comprehensive solution across IP and SoC verification especially for hardware/software regression and earlier software development, that combination using the same front end software and make it easier for the customer.

And then, so I think we clearly see that in our -- in new customer and its key expansions. And so I think we are just delighted and are very pleased. Protium is giving a lot of opportunity for us. And we also highlight a global marquee customer significantly expanded their existing hardware footprint with additional Z1 capacity and add-on the Protium X1 as well because that one is a larger one or the largest hardware orders for Cadence. So I think all in all, we see strength. And then I think John can highlight the reason of building up the inventory.

John M. Wall -- Senior Vice President and Chief Financial Officer

Yes, yeah, Jackson. As Lip-Bu says, I mean our hardware solutions are proven to be very robust in the marketplace and cost demand is good. Q3 results were slightly up on Q3 '18 but we were building inventories heading into Q4 because we have a strong pipeline going into Q4.

Jackson Ader -- JP Morgan Chase & Co. -- Analyst

Okay that makes sense. And then one quick question, a follow-up on the 30 customers at Clarity engagement. Can you give us any kind of industry sense for those or is it significantly different from the Cadence customer base in EDA?

Lip-Bu Tan -- Chief Executive Officer

Yeah, I think you know both and not just on semiconductor, many other system companies and because this only see the value of the -- up to 10x performance and also tie in very well with the from the system simulation down to the silicon emulation. That fully integrated, it's a complete that customer love.

Jackson Ader -- JP Morgan Chase & Co. -- Analyst

Okay, thank you.

Lip-Bu Tan -- Chief Executive Officer

Thank you.

Operator

Your next question comes from Rich Valera with Needham & Co. Your line is open.

Richard Valera -- Needham & Co. -- Analyst

Thank you. First just a clarification. Congratulations on the large IP order that you mentioned was from the marquee customer you had referenced previously. Just wanted to clarify, is the significant hardware order as well from the same marquee customer, or was that a different one?

Lip-Bu Tan -- Chief Executive Officer

Yeah. So I think what we mentioned earlier, is that IP deal is with a global US semiconductor company -- marquee US semiconductor company. And then the hardware you know clearly is a marquee global marquee company and they are already our customer, but they are increasing their hardware capacity plus the Protium that they like a lot. And so that they are fully integrated and make it one of the largest hardware orders.

Richard Valera -- Needham & Co. -- Analyst

Got it. So they are different customers so as that just to be perfectly clear.

Lip-Bu Tan -- Chief Executive Officer

Yes, yes. Yes.

Richard Valera -- Needham & Co. -- Analyst

Okay, thank you. And then moving on to the system products. First, just wanted to understand, you mentioned that Bosch and ARM had endorsed and I think you said both of these products, and I just wanted to clarify that that was in fact an endorsement of both Celsius and Clarity. And then, if that's the case have either of them actually purchased Clarity? Or are they among those four competitive wins you have for Clarity?

Lip-Bu Tan -- Chief Executive Officer

Yeah, I think we mentioned Bosch and ARM and all they are Celsius product and the current year, we mentioned about four competitive wins and then plus another 30 active customers. So there is a differentiation here.

Richard Valera -- Needham & Co. -- Analyst

Got it. Understood. And then I know this is a tough subject. But I just wanted to see if you're willing to say sort of anything about China, as we look into next year. This year you've had a number of customers put on the entity list and you had the benefit of getting revenue from them for, in some cases, three quarters of the year, in some cases maybe a couple of quarters. And as we head into next year if the Entity List sort of stays the same, either kind of a full year in essence headwind from those customers, but I guess recently, there's also been some policy put in place in China whereby they are actually providing incentives for companies to purchase both EDA tools and IP, which could conceivably be a tailwind for you in the country.

So just wondering if there's anything you can say about sort of China as we look into next year. There's a lot of sort of factors at play. And I know you don't want to give numbers, but just any thoughts there, Lip-Bu would be helpful?

Lip-Bu Tan -- Chief Executive Officer

Sure. So let me just touch on, first of all, I think clearly Cadence has and will continue to comply with the United States Department of Commerce export control. And as I mentioned, the situation is fluid and we are monitoring carefully and even with this uncertainty, but we assume our current export limitations remain in place for the rest of the year. So our guidance has already provided everything we know in this and we are not. And so I think this is kind of where we are. John?

John M. Wall -- Senior Vice President and Chief Financial Officer

Yes, yes. And clearly when we're not going to speculate in terms of how that plays out for next year, but you're correct in your assessment that in some cases for some customers, we had revenue in the first half of the year and the second half of the year is quite different, now we do have some headwinds. If there is no change, those headwinds will persist into next year.

Richard Valera -- Needham & Co. -- Analyst

Okay. Thanks for taking the questions, gentlemen.

John M. Wall -- Senior Vice President and Chief Financial Officer

Thank you.

Operator

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

Tom Diffely -- DA Davidson -- Analyst

Yes, good afternoon. Another question on the IP. Just curious, is the sequential growth solely due to the one large customer or did you see a broad based increase in IP demand as well?

Lip-Bu Tan -- Chief Executive Officer

Yeah, let me start first. And I'll clearly the -- you know our focused strategy and strong portfolio and IP and in fact we keep on adding more IP portfolio beside the Tensilica and the memory, connectivity and then we are excited of our high-speed SerDes that we bought from new semi and that 112 gig SerDes is a must-have from a lot of data center infrastructure build up and the hyperscale guys really like it. And so I think we have a very -- we are very pleased with our portfolio, and we are laser focused on our strategy, focused on the leading customer and then focus on the advanced nodes and then focus on something that we can scale. And then so far I think, we have a very broad portfolio. But meanwhile, we are very delighted, and I mentioned earlier, this marquee semiconductor company. besides we have a wide-ranging win and now we add on this largest IP not just include Tensilica family. Also include the design IP portfolio. We are excited about it. Just add on top of it and we're pretty pleased with the progress. And our IP is like building block of the system, you really need to -- start recording the star IP that are must have, and we are really focused on the star IP.

John M. Wall -- Senior Vice President and Chief Financial Officer

Yeah, we're very pleased with the consistent execution there in IP and they had a very strong finish to last year. They had a very strong Q1, Q2 was kind of flat on Q2 last year and then we had a strong Q3. But as with all these things, of course, it creates a tough compare going forward.

Tom Diffely -- DA Davidson -- Analyst

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

John M. Wall -- Senior Vice President and Chief Financial Officer

It's purely project-based. I mean there is, it is kind of random from a seasonality standpoint.

Tom Diffely -- DA Davidson -- Analyst

Okay. And finally John, in the press release you mentioned kind of a reorganization in international offices that you had --

John M. Wall -- Senior Vice President and Chief Financial Officer

Yes.

Tom Diffely -- DA Davidson -- Analyst

The impact of taxes going forward, just wanted if there is something you can say on that?

John M. Wall -- Senior Vice President and Chief Financial Officer

Yeah, I mean that's a GAAP only thing, I mean in October 2019, we initiated a series of transactions involving an internal realignment of our international operating structure. And that realignment may significantly increase our foreign deferred tax assets. As you know, deferred tax assets are recognized when the depreciation of the asset is expected to offset future profit. So there is a lot of calculations that go into trying to estimate the value.

We've not completed our analysis and cannot yet estimate the impact, but we expect to complete the analysis and record the income tax impact in the fourth quarter of 2019. We wanted to highlight that in our CFO Commentary because our current GAAP guidance in the -- basically doesn't account for this change. So we just wanted to highlight that that piece is open.

Tom Diffely -- DA Davidson -- Analyst

Okay. But no non-GAAP impact going forward?

John M. Wall -- Senior Vice President and Chief Financial Officer

That's right.

Tom Diffely -- DA Davidson -- Analyst

Okay, great. Thank you.

Operator

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

Mitch Steves -- RBC Capital Markets -- Analyst

Hey guys, thanks for taking my question. Just two from me. Just regarding China in terms of historical, last quarter you guys kind of had a pull [indecipherable] quarter with it being up 68% and now it's up about 21%. Is there any way to confirm, there is potentially some hardware pull just given the Huawei dynamics last quarter that and that's the reason why it's down sequentially or am I reading too much into it?

John M. Wall -- Senior Vice President and Chief Financial Officer

Overall, China was 10% of revenue in Q3. Now, that's down from 12% in Q2, but flat from kind of Q1. It was, I think it was 10% in Q1 as well, but we've seen variability in our China revenue mix over the last six quarters. It's ranged from a low of I think 8% back in Q2 '18 to a high of about 13% in Q4 '18. Back in Q4, '18, we did experience a hardware pull-in and we did see the first half was quite strong for hardware, Q3 has been a little bit lighter for hardware and not shown up in gross margin. But like I said the hardware pipeline is strong for Q4 and hardware can be lumpy in any one quarter.

Mitch Steves -- RBC Capital Markets -- Analyst

Okay, that makes lot of sense. And then secondly I mean EDA is probably one of the better ways that's placed I mean over the next five years to 10 years. One thing I'm noticing here like your employee count is actually increasing pretty significantly going from like 4% growth to 8%. I just want to be clear here. If I look out over the next, let's call it three years to five years that your opex is still going to under grow the revenue line, is that a fair assumption? Because it looks like it's actually pretty close now at this point?

John M. Wall -- Senior Vice President and Chief Financial Officer

Yeah. We're not guiding anything on 2020 right now. But you're right to point out that the headcount has grown because we're investing in opportunities for proliferation of market shaping customers and new products.

Lip-Bu Tan -- Chief Executive Officer

And in some way, we are very excited about the environment, because you know, as I mentioned the couple of big driver AI, 5G, Cloud and IoT and then the whole data infrastructure, is because of AI and all this driver, there is a very big changes requirement needed. And so we have a suite of start-up and system company, they all try to meet the new requirements. So there is a lot of innovation happening. And so we see design activities increase and that's why I think also we have proliferation of our digital flow and also some of the key market shaping customers that were being adopted. And so we're building up the engineering and also the FAE support to win some of these accounts and then proliferating and that's why John and I, we only increased headcount when we see the deployment and also the commitment from the customers.

Mitch Steves -- RBC Capital Markets -- Analyst

Got it. It's very clear. Thank you.

Lip-Bu Tan -- Chief Executive Officer

Thank you.

Operator

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

John Pitzer -- Credit Suisse -- Analyst

Yeah, good afternoon guys. Thanks for letting me ask the question. I guess my first question is just on the relatively new North American customers clearly added to the September quarter. I wonder if you could just help me understand how we should be thinking about sizing that business over multiple years and how that business scales for you as that customer continues to move down nodes?

Lip-Bu Tan -- Chief Executive Officer

Yeah. So, I think clearly we don't guide any 2020 outlook. But we are excited about. I don't know quite sure, new North America, but we only mentioned about marquee, the US semiconductor company. We're excited about the partnership and we're expanding besides the tool expanding the IP proliferation and that part we will continue, we're excited about it.

John Pitzer -- Credit Suisse -- Analyst

That's helpful. I mean just going back to your comments about AI, I think I'm kind of curious if you could size how big that business is either as a percent of overall revenue or maybe of the growth? And I guess specifically the semiconductor industry went 10 years or 15 years without a lot of venture capitalist money and that's clearly changed around AI. There are somewhere between 40 to 60 potential AI start-ups that are getting funded. I'm just trying to get a sense of how important that is to your growth in the near term? And kind of do you think that all these companies are going to be viable or is it more likely that this consolidates and if it's the latter, how do I think about kind of the AI revenue stream unfolding from here?

Lip-Bu Tan -- Chief Executive Officer

Yeah, I think the AI implication to the whole industry can be quite significant. If you look at the university like MIT, there is a school called -- new School of Computing, they just raised $1 billion for that. Same thing with CMU, Carnegie Mellon, and I'm on the Trustee and now they are just offering the AI degree for undergrad and then you can see the SoftBank, the Vision Fund tool is focused on AI. So you can see that AI implication. And in fact you are correct, if you look at the semiconductor growth recently in term of funding a lot is driven by AI. AI is not just semiconductor, it's applied into all the different vertical industries. So the impact can be quite huge. And we are excited by this opportunity that design activities increase a lot.

And so I think all in all, I think clearly we have a very good position. We have the AI machine learning application to our tool. So, we see significant improvement in term of our various tool in terms of PPA run time and verification. So we are embarking on improving our tool. So that we can get the best product to meet the customer requirement and the AI development is not just the start-up, all the big hyperscale guy and all the big system company, they all have various degree of investment into AI. And then we also, our Tensilica, it is a very clear good engine for some of the AI application like, audio, video and various others and then we are trying to build a software stack on top of the AI platform, so that we can provide a solution to our customer for the various vertical market they try to address.

John Pitzer -- Credit Suisse -- Analyst

So if I could just do a quick financial one in for John. John just given what you guys do in the September quarter and in the year ago quarter, I'm just kind of curious, your op margin sort of guidance for the December quarter. Can you help me understand why it would be down sequentially year-over-year rather than just an abundance of conservatism on your part?

John M. Wall -- Senior Vice President and Chief Financial Officer

Yeah. So we haven't changed how we guide. I mean we guide the same way all the time but essentially it's the same as where we were at this time last quarter. Last quarter we guided Q3 at 30% for our margin and Q4 for 30%. In Q3, the beat was mainly on the gross margin side, I mean we assume gross margin comes out at about 90% in our estimates and we did better in Q3, it came out I think was 91.6% and we landed at 31.7% for op margin. So most of the -- but most of the beat on the op margin side in Q3 was a result of gross margins. My expectation for Q4, is that we have a significant hardware pipeline heading into Q4, it was kind of similar, it reminds me of where we were this time last year.

And last year, our gross margin ticked down I think 200 basis points from Q3 to Q4. So we're expecting about 30% and that's because you've got a combination of things happening, right? You've got Q3 and Q4. We're assuming that but there is no change in export limitations right now. We're also investing in proliferation opportunities, market shaping customers and in new product areas. So that's what's -- that's what's driving the numbers.

John Pitzer -- Credit Suisse -- Analyst

Thanks.

Operator

The next question comes from Jay Vleeschhouwer with Griffin Securities. Your line is open.

Jay Vleeschhouwer -- Griffin Securities -- Analyst

Thank you. Good evening. Question for you, John, first, you noted in your prepared remarks $200 million or $212 million to be precise in IPAA commitments. This is not a metric that I think you disclosed before until tonight's 10-Q. Was that amount to do mostly, if not solely due to a single customer? Or is it fairly broadly based in terms of numbers of IP customers comprising that? And then secondly just on longer term EDA market question for Lip-Bu.

John M. Wall -- Senior Vice President and Chief Financial Officer

Yes, Jay, thanks to point that out. Yes that was an issue we had with how remaining performance obligations were calculated in the past. We reported backlog under the old rules and we would have include our IP Access arrangements and then under the new rules, the remaining performance obligations didn't include IP Access arrangements and they didn't seem to be consistent with how we reported in the past. So we worked with our auditors just to say that we wanted to disclose it because as you say now as of Q3, it's $212 million is the exact number, but there is $3 billion that we have in contracted but unsatisfied performance obligations is more comparable to the backlog that we had at the end of last year.

Jay Vleeschhouwer -- Griffin Securities -- Analyst

Okay, thank you for that. For Lip-Bu maybe a two part technology or market question. First, you often use the term market shaping customer and it frankly a somewhat odd expression. How do you define customers that fall into that category and more specifically, how do you dedicate resources to those customers in terms of commitments, and so forth?

And then a growth question. We've seen a number of categories in EDA have extended periods of consecutive growth. For example in the industry data, of course your numbers, the custom category has had more than 30 consecutive trailing 12-month period of growth, IC implementation more than 16, PCB is 12. So that's all very good of course, but historically EDA growth cycles for a particular category don't last for more than three years to four years -- three years to four years each, but we're now seeing multiple categories that are meeting or beating historical periods of consistent growth. So what you're thinking in terms of sustainability or what's different now, vis-a-vis the different categories?

Lip-Bu Tan -- Chief Executive Officer

Yeah. So Jay, thank you for these questions. And let me address one each time. So first of all, our market shaping customer the definition is that they are clearly the leaders in their sector. And so they are the most demanding customer but because they are leader, they are driving the innovation, they are driving the performance and we want to be the partners for them, the trusted partner to enable our innovation to continue our leadership in the marketplace in the various different vertical market or the platform that they create, we want them, we want to be the partner for them, and that is how we define the market shaping customers.

In terms of growth, I mentioned, you can hear my passion clearly in a way, we are not creating the changes, we are right with the wave. And you know the beauty part in this particular junction of the industry that's of five different wave are driving the growth and they are changing the landscape of the requirement. I just mentioned one example is AI and now we are moving into I call it the data centric economy. It's all about data.

And then today, only 2% of the data are being analyzed and being utilized. So there is a humongous opportunity and then this is applying to across all the different vertical. And if you are really driving a change to the memory, driving the churn of the storage, driving the domain specific process. So in a way it's workload specific depending on different workloads. Different market require different rather than just CPU, GPU our FPGA, there is a new class of workload that require different type of processor and then we're also driving the memory, the storage, the infrastructure in term of able to cope with the data, massive, massive explosion of data and then so all this is going to require new innovation in order to support that and for example the programmability the scale out the storage and network and then scale out the top of the rack all the way to topping on the spy in term of the infrastructure 12.8 TB per second to 51.2 TB per second switch and all the high-speed interconnecting and that's why the SerDes is so important for high speed. And that's why Cadence bought it, and then we're going to triple down to really drive the requirement that the hyperscale and a big infrastructure player needed.

I think this is going to be driving a lot of new innovation and semiconductor side and we are learning and we are trying to be the trusted partner to fulfill some of these requirements and that's why I mentioned earlier that design activity increased a lot and we're excited about it and it's just a beginning of it.

Jay Vleeschhouwer -- Griffin Securities -- Analyst

Thanks very much.

Lip-Bu Tan -- Chief Executive Officer

Thank you.

Operator

Your next question comes from Jason Celino with KeyBanc Capital Markets. Your line is open.

Jason Celino -- KeyBanc Capital Markets -- Analyst

Hey guys, thanks for taking my question. Just two from me today. The first one, with your Q4 pipeline for your hardware business. You talked about more modest growth this year following a tough comp from last year. But if the pipeline holds, could we see some upside to that modest growth commentary that you've provided previously?

John M. Wall -- Senior Vice President and Chief Financial Officer

Yes, Jason, It's kind of hard to move the needle in one quarter, I mean if you look over the total year, we're expecting kind of low to mid single digit growth for Functional Verification for the year. Although if you do look over like the trailing four quarters to the end of Q3, I think Functional Verification is up kind of high 00 high single-digits. But the challenge this year has been tough comps and like we said, we enter into Q4 optimistic with a strong pipeline.

Jason Celino -- KeyBanc Capital Markets -- Analyst

Okay, great, thanks. And my next question has to do with your system analysis business. So you announced the electromagnetic solver in April timeframe and then you came out with your second solver, the thermal solver in September. I'm not necessarily looking for specific timing, but can you just remind us what other solvers we could expect?

Lip-Bu Tan -- Chief Executive Officer

Yeah. So I think this is just our initial entry to the system analysis using our core competence on computational software and stay tubed, I mean we are just beginning. We have first product came out in April as you correctly point out we good tractions and now the second product came out, people love the performance. They are excited about it. We are continuing to investing and its high-end also very well with our PCB business and that the whole system modeling system simulation will be a really exciting area for us. So stay tuned and we will update you when we announce any new products.

Jason Celino -- KeyBanc Capital Markets -- Analyst

Okay, thanks Lip-Bu. That's all from me. Thank you.

John M. Wall -- Senior Vice President and Chief Financial Officer

Thanks.

Operator

Your next question comes from Joshua Tilton with Berenberg. Your line is open

Joshua Tilton -- Berenberg Capital Markets -- Analyst

Yeah, hi, thanks for taking my questions. It appears as if the drivers of design starts today address a broader set of companies relative to previous drivers such as maybe mobile. I'm just curious how does having a broader set of addressable companies benefit pricing?

John M. Wall -- Senior Vice President and Chief Financial Officer

So yeah, having a broader set of companies benefits us because Cadence revenue growth generally tracks design stocks, but the more design stocks are there the better it is for Cadence business.

Lip-Bu Tan -- Chief Executive Officer

Yeah. So I think we like to broaden the customer and applications, so that we can really find new opportunity and new solution to support them either in the automotive or 5G or AI and Cloud, our huge opportunity in industrial IoT and providing the solution for the system infrastructure player and so that we can broaden the customer requirement and that greater diversity to our customers is always good.

Joshua Tilton -- Berenberg Capital Markets -- Analyst

Okay that makes sense. And then just as a follow-up, in the prepared remarks, you mentioned customers were adopting a full digital flow. It was my understanding that companies tend to build their flow using products from both you and other competitors. So we're just starting to see customers standardizing their flow from one vendor?

Lip-Bu Tan -- Chief Executive Officer

Yeah. So I think you know when you move down the geometry you know to seven to five to three, try to integrate different products, different tools from different customer that mean that you have to build an internal team to do all the integration and also you have a lot of opportunity to fail because the different tools will have different methodology. And so the customers are starting to really focus on getting a full flow the best -- I think it's very important, our focus first of all, is to have the best of breed for each product line like the Innovus we mentioned earlier for place and route right now is a majority in over 70% of the customer topping it in the most advanced nodes. And then now we have the Genus come out very strong and then Tempus come out and Pegasus. The customers are starting to see that not only the best of breed of product and also how to integrate them, how to optimize them and correlations among all the different flow that we have been talking up our last few years. And so right now we can not only at the best of breed for each product now we can integrate and that's why you're starting to hear that we mentioned a lot about digital full flow that our customers depend completely on us on the most advanced node in the seven and five and three and that's the way we are going to continue to support the customer.

Joshua Tilton -- Berenberg Capital Markets -- Analyst

Thank you. Those are helpful.

Operator

Our last question comes from Krish Sankar with Cowen & Company. Please go ahead, your line is open.

Krish Sankar -- Cowen & Company -- Analyst

Yeah, hi, thanks for taking my question. Lip Bu, I had two of them. One is you guys are definitely getting a good traction with your hyperscale customers, I'm kind of curious as your hyperscale customers build their own silicon, how is their requirements for EDA different than the traditional semiconductor customers? Do they see one way to -- one way toward IP blocks or whatever it is? Any color on that would be helpful. And then I have a follow-up.

Lip-Bu Tan -- Chief Executive Officer

Okay. Clearly, we are excited about the hyperscale players. They are going to be very important for our industry, because they are quietly building up. As I mentioned earlier, their workload requirement have changed and it's more about data and then so that domain specific processing development and also in the server into the data storage network, scale out going to be even more and more important for them and great partners for us and great customer and we love them. And then first of all, they are bit different on our semiconductor players, time to market is more important to them and also performance scalability is most important to them and that part, I think we worked very from the early days. We are already working on partner with them and we are also very excited about the cloud infrastructure that we also support the cloud infrastructure using some of our tool to do that and we continue to leadership on that. So I think in multiples, expect we're working with our partners in the cloud, and we're excited about the opportunity.

Krish Sankar -- Cowen & Company -- Analyst

That's very helpful, Lip-Bu. And then a follow up to either you or John, is there a way you can size the hardware market this year. How big is it? And this is that the different segments like FPGA apps, how big are they? Any color that would be helpful.

John M. Wall -- Senior Vice President and Chief Financial Officer

Yeah, I don't have any break down in terms of the market data that I can share with you today, but we're very, very happy with -- with how our year is going. And with the strong pipeline that we have leading into Q4.

Krish Sankar -- Cowen & Company -- Analyst

Thanks, John. Thanks Lip-Bu

Lip-Bu Tan -- Chief Executive Officer

Thank you.

John M. Wall -- Senior Vice President and Chief Financial Officer

Thanks.

Operator

There are no further questions at this time. I will turn the call back to Lip-Bu for closing remarks.

Lip-Bu Tan -- Chief Executive Officer

Thank you all for joining us this afternoon. Next phase of our strategy, Intelligent System Design brings new opportunities in Design Excellence, System Innovation and Pervasive Intelligence and an expanded total addressable market. We are capitalizing on multiple technology trends and further proliferating our solutions with a broader base of customers. And in closing, I would like to thank all our shareholders, customers and partners, the Board of Directors and our hardworking employees for their continued support.

Operator

[Operator Closing Remarks]

Duration: 52 minutes

Call participants:

Alan H. Lindstrom -- Senior Group Director of Investor Relations

Lip-Bu Tan -- Chief Executive Officer

John M. Wall -- Senior Vice President and Chief Financial Officer

Adam Gonzalez -- Bank of America Merrill Lynch -- Analyst

Gary Mobley -- Wells Fargo Securities -- Analyst

Jackson Ader -- JP Morgan Chase & Co. -- Analyst

Richard Valera -- Needham & Co. -- Analyst

Tom Diffely -- DA Davidson -- Analyst

Mitch Steves -- RBC Capital Markets -- Analyst

John Pitzer -- Credit Suisse -- Analyst

Jay Vleeschhouwer -- Griffin Securities -- Analyst

Jason Celino -- KeyBanc Capital Markets -- Analyst

Joshua Tilton -- Berenberg Capital Markets -- Analyst

Krish Sankar -- Cowen & Company -- Analyst

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