益華電腦 (CDNS) 2002 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

And welcome to the Cadence Design Systems third quarter 2002 earnings release conference call.

During the presentation, all participants will be in a listen-only mode.

Afterwards, we'll conduct a question and answer session.

After that time, press your star followed by one.

This is being recorded Tuesday, October 15th, 2002.

I'd like to turn the call over to Lisa Eubank, Vice President of Investor Relatioins with Cadence Design Systmes Please go ahead, ma'am.

Thank you.

Good afternoon, everyone and thanks for joining us.

With Us Today Are Ray Bingham, President and Ceo, Penny Hersher, Executive Vice President and Chief Marketing Officer, and Bill Porter, Chief Financial Officer.

The web cast of the call can be accessed through our web site, www.cadence.com and will be archived for one week.

I'd like to read the safe harbor statement.

The discussion today will contain forward-looking statements and actual results my differ materially from those expectations.

For more information about factors that can cause a difference in results, please refer to the 10-K for the period ended December 29th, 2001 and 10-Q for the period ending June 29th, 2002.

All numbers reflect earnings excluding goodwill and unusual items.

With that, I'll turn the call over to Ray Bingham.

Thanks, Lisa, and good afternoon.

I'd like to describe for you today why we believe the Cadence leadership role and its role with its customers is expanding.

This is occurring because of some of the fundamental shifts we see in the marketplace.

Let me describe some of these shifts.

First, I'd like to talk about our customer situation.

Clearly, the economic environment is difficult for our customers with no improvement in sight.

I don't think there's any question about it.

Customers face the challenging environment month after month and as visibility shows no sign of improving, they're becoming increasingly conservative in the way they operate and, of course, in their purchasing decisions.

We saw the impact of this conservatism during the quarter.

The same time, demand for technology and services to deal with the complexity of nanometer design continues to increase.

Customers simply cannot get advanced designs done in time to meet market window with the old tools and old approaches.

As a result of the combined effect of the economic and technical pressure, we're seeing a shift in the structure of our customer's business.

They're consolidating vendors, relying more and more on partners they can trust to provide them with a more comprehensive solution.

This is allowing Cadence to allow to have a different conversation with its customers.

Cadence represents a way for customers to save money by incorporating a more integrated solution and thereby avoiding the costly process of coming together dozens of costly tools.

This allows Cadence to be a preferred design part to receive a larger piece of the customer's R & D span, while at the same time helping customers contain or even reduce the customer's total spend.

A great example of this shift is the expanded relationship we announced with IBM earlier in the quarter.

As I worked with their leadership of technology -- the leadership of their technology group over the past several years, we've developed a common vision of what is needed to win in the marketplace.

The result of this relationship and shared vision is a series of significant agreements intended to simplify the chip design process for both of our customers.

Under product licensing agreement, IBM will extend its use of existing Cadence solutions and add new ones.

In its design of microchips for internal and external customers.

Through this partnership with IBM, we'll be able to leverage not only the large IBM ASIC and COT customer base, but also a huge design change that includes both Cadence and IBM customers.

Under the second agreement, Cadence acquired from IBM technology and people associated with IBM's test technology for incorporation into the Cadence product family.

These what are we see as production-proven, best-in-class test technologies and methodologies in use of top-tier IBM customers in the market today.

Under the third agreement, the two companies plan to collaborate on future technology to address growing chip design challenges as we move from 90 nanometer to 65 nanometer and even beyond.

Let's talk about how Cadence is executing on this strategy and how that strategy uniquely positions Cadence to take a leadership role in solving the problems our customers are facing in this difficult environment.

Our strategy hinges on our growing success with the five technology platforms we deliver.

The Encounter Systems for Digital IC, the custom and analog IC Platform, System Verification, Design for Manufacturing, and Printed Circuit Board.

Together, these platforms compose the most complete design technology portfolio in the world.

Our ability to play the design partner role for our customers is critical because the requirements for design are changing dramatically.

At nanometer design, process nodes are 130, 90 or even 65 nanometers, wires are everything.

In design of a chip demands a different approach, one that allows designers to see the actual wires from the very beginning of the process.

This enables designers to start tweaking the design from the first day and everyday, rather than waiting weeks and months as they do the old front end and back end methodology.

In a context of that strategy, the investment we've made in our digital flow is working for us.

Sparked by the acquisition of four technology powerhouses during the past year and a half, our digital IC business is showing great momentum in marketplace.

First the Encounter System, the leading edge digital platform for nanometer design.

There's clearly tremendous demand for this brand new methodology for the most advanced designs, which drove many of our top contracts in the quarter.

Penny will talk more about Encounter in just a bit.

In the June quarter, we've completed the most recent of our acquisitions to fill out our design platform or rather our digital platform.

Simplex and Play-Doh have now integrated the technology and the people.

Both are delivering bookings significantly ahead of plan in Q3.

They have great momentum.

My leadership team, a strong combination of new and existing talent is aligned and they are executing.

I see this as a key strategy for the new Cadence, combining the new and the existing chip design capability and EDA expertise.

And it is working.

This past spring, we communicated our vision of the evolution of nanometer design.

Our strategy for solving customer problems and our technology road map.

I believe we're solidly on track.

My key executives have been on the road for the past 75 days talking to 80 major customers about our new technology and the road map going forward.

We're getting very positive feedback.

We launched the Encounter System on September 18th, ahead of schedule, providing a platform that solves the most difficult nanometer design problems.

The success we're experiencing, I think, is an indicator of a bright future for Cadence and for Cadence's customers.

We're in production today with the most advanced integrated design technology in the market.

Although, we're positive about the long-term outlook, of course, the short-term outlook of the environment causes us to be cautious.

We're now planning that 2003 will be another difficult year for our customers because of their high degree of uncertainty.

Their lack of visibility into their businesses leads us to take a cautious approach to our expectations for the next year until we see evidence of a recovery.

Cadence is the largest EDA company.

It's one of the largest and most stable software companies in the world.

We have a strong franchise of visibility renewable revenue model, growing market share, positive cash flow and an expanding relationship with our customers.

Because we're confident in our business and our future, during the past quarter, we repurchased 8 million shares of our stock.

Almost 100 million dollars worth.

In summary, Cadence leadership role is expanding because we are uniquely positioned to solve our customer's most difficult design challenges.

We're executing on our strategy and although the short-term economic environment is difficult, I think the long-term outlook is very positive.

Now I'd like to ask Penny Hersher, our EVP and Chief Marketing Officer to talk about the market and what's happening with customers.

Thanks, Ray.

As Ray mentioned, Cadence as the most complete technology portfolio in the world.

Let me take you through the highlights of the quarter.

First in Digital IC, I'll recap last month's news about the release of the Cadence Encounter System.

This is a unified architecture that combines prototyping and implementation into a single function.

The platform integrates three, best-of-class nanometer technologies.

First Encounter for prototyping, NanoRoute, the world's fastest nanometer routing and signal integrity all with a single data with significantly higher capacity in production today.

This new methodology is critical as design comes from nanometer design.

In our competitor's world of front end and back end design connected by translators, it is very time consuming and difficult and sometimes impossible to close timing.

Our use of a single data model solved these problems.

Within the Cadence Encounter System, we released the latest upgrades version 2.1 into production in August, ahead of schedule.

This is a fully integrated nanometer design flow and it's capable of handling 50 million gates hierarchial.

We also institute a new low price configuration nano Encounter configured,.

It's a flat, not hierarchial design up to 10 million gates.

The Cadence Encounter System continues to drive bookings.

In Q-1 of this year, its first quarter on the market, 12 IBM or ASIC customers purchased Encounter, including Toshiba, TI and Mitsubishi. 10,000 semi conductor customers also purchased Encounter as well as the world's leading independant foundry, TSMC.

In Q2, momentum accelerated growing 13% sequentially with purchases by six more IBM ASIC customers, and 12 semiconductor companies, including Marvell Semiconductor and Silicon Image.

The technology power of the Cadence Encounter System, which demonstrated again in Q3 with bookings growing of more than 17% sequentially, including purchased by seven IBM and ASIC customers, including IBM and 17,000 semiconductor companies.

As can you hear, we're seeing worldwide adoption of the Encounter technologies of large and small customers.

Let me give you a few examples of customer successes.

AMD reviewed its commitment to a broader range of technology in Q-3.

AMD has selected the Cadence Encounter Systems of integration into its design methodologies.

NEC computers division, a user of the tool selected Cadence's Encounter for its process technology designs over the synopsis of its product.

The top five ASIC's vendors discontinued this engagement after an extensive evaluation of Encounter.

This customer takes a shipment that replaced them with Cadence and the customer's desire to consolidate with fewer vendors.

Samsung selected the Cadence Encounter System as part of its multimillion dollar contract for our system chip package and solutions from Cadence.

And global advanced semiconductor supplier for consumer communication in the PC industries faces a multimillion dollar contract with Cadence Encounter System including both Encounter and Nano Encounter after a cometitive evaluation against inaudible] .

Near Magic with Apollo used it partway for Micro Designs.

They were extremely pleased and have collected it as the centerpiece of their physical design flow.

In addition, integrity is a critical part of the one-study nanometer design so the integration within the same Cadence Encounter System offered three best-in-class technologies in an easy-to-use environment.

As a result, Near Magic was decided to switch the office flow to the fully Integrated Encounter Solution.

Also in Q-3, Agear announced a collaboration with Cadence for an ac design kit for the Encounter System.

Agear believes by using First Encounter, its customers can get to market up to six months faster, meaning lower cash and time investments and faster product delivery.

Encounter is catching on with customers.

Nine out of the top ten ASICs users of the Encounter System and we're working with six of those on nanometer and a couple of cases 65 nanometer projects.

Our second platform, the mixed signal continues to drive these customer relationships as more and more analog content goes into the most advanced digital chips.

One of our key competitive advantages is the franchise market-leading customs and the end of the nanometer digital flow.

Consistent with what we seen in the past, 14 of our top 20 customers purchased from our custom platform and 12 of those also purchased our DigitalIC platform at the same time.

One example is IT Semiconductor, using its recently expanded Cadence custom analog design environment, the design team recently achieved first time Silicon for its SE-4100 GPS Radio IP, the world's smallest, most integrated state-of-the-art Power Conduction GPS Radio.

Our systems verification platform anchors the front end of the design flow for many of our customers.

Our software simulation solution continues to lead and the verification acceleration component to the platform.

Following that a quick term is becoming an even more critical for our customers as the design complexity increases.

Our industry-leading Palladium System incorporates a faster, more effective process solution, generating a lot of the excitement to our customers.

And in the third quarter in a row, looking at verification acceleration grew year-over-year even during difficult economic times.

One of our key wins was a competitive replacement against Mentor at LGIC , again demonstrating our technology leadership acceleration.

The design for manufacturing platform shows significant growth driven by the need for designer -- to bring designer manufacturing closer together.

This need is dramatically increasing at 90 nanometer.

Our platform serves these needs to sign up level of extraction and analysis recently acquired by Simplex and our Customer Analog Physical Veification Solutions .

In Q3, 20 customers in the quarter purchased from the Cadence designed manufacturing product line.

As an example, ARM selected Cadence from the Pacific signal integrity sign up tools of the competitive solutions as part of the multimillion dollar contract.

It recognizes it meets the challenges of the modern-day Silicon pressures and Silicon partners and expect the tools to continue to do so in the future.

Finally, our second quarter system also demonstrated growth during the quarter with bookings increasing both year-over-year and sequentially.

In the first half of the year, we picked up six points of share with our leading high PCB Packaging Solutions.

As an example, Samsung selected Cadence PCB tools as part of its multimillion contract.

This is gaining considerable momentum.

Just two weeks ago, op access got in from industry consortium Sammy.

It's will link the design and manufacturing world.

Sammy believes that the model may save the semiconductor industry billions of dollars in manufacturing costs.

During Q-3, we began beta testing on the open access database code with HP, Motorola and the Miracle Technologies.

Our scheduled for production and availability are solutions of applications of open access.

It's the digital and customs beta in Q-4 of 2002 with limited production in Q-1, 2003.

Now, let's turn over to the final component of our strategy execution, our integrated services offering.

We've now completed the reintegration of design services into Cadence and are already seeing increasing service engagements with our major customers.

With Cadence design specifically, the integration of the two teams, formerly [inaudible] and Simplex is on track as is the turn around in our business.

We are executing well, and our financial metrics are on track.

As an example of our success in working with customers to drive leading edge technology within Cadence, it works with the network devices to achieve first Silicon success on the world's first MP-48, single chip, bold new black traffic manager and atm.

In conclusion, we are executing our strategy to build deep customer relationships through our unique position within the industry.

We provide technology to ship across the full section of design needs through our five platforms integrated with a complete service offering to be able to take on more of the customer's design challenge and hold a different conversation with the customer to address the technology and financial structure challenges.

With that, I'll turn it over to Bill.

Thank you, Penny and good afternoon.

We made good progress during the quarter.

We continue to grow the business.

Product bookings were up 10% year-over-year.

I believe this demonstrates Cadence's technology momentum and the growing role we are playing with our customers.

Our customers are looking to mix in our new technology.

It's helped us grow subscription bookings from 48% last quarter to 60% in Q-3.

We expect that trend to continue as we move into our 70% to 80% target range for rival licenses in Q-4.

When our transition is complete, we will have one of the highest mixes of rival revenue in the software industry, and when combined with our renew renewable license model, will provide a high degree of predictability for revenue.

Contract duration continued to average about 2 1/2 years.

Also during September, we saw customers take a more cautious approach than making cautious commitments than in the past.

Lack of visibility continues to be a problem for the customers.

As a point of context, we estimate that about 90% of our business is through renewable licenses with existing customers.

During Q-3, most of our customers renewed at the 40 to 50% premiums we've been experiencing.

However, a few customers did choose to split up their renewals and spread those renewals out over a time, deferring components of the purchase until there were business outlook improves.

While these customers are being more tentative, we do, however, expect even for these customers the renewal premium will still reach the 40% to 50% range when it's completed their programs over the next several quarters.

So with this background, let me summarize the numbers for the quarter.

Earnings per share excluding goodwill and unusual items were 15 cents on net income of 40 million.

Total revenue for the quarter was 327 million.

Product revenue at 210 million and maintenance revenue at 83 million.

Services revenue was 34 million.

Approximately 40% of software product revenue came from subscription backlog in Q-3.

Now, looking at the geographys, North America contributed 59% of revenue.

Europe 19%.

Japan 14%, and Asia 80%.

Asia and North America continue to show strength.

Europe was steady, and business in Japan remains weak.

Moving on to the balance sheet.

As a result of the license transition, we are going through, DSO's increased to 82 days, up four days due to lower revenue from the licensed mix change and three days due to reduced sales and receivables.

Looking forward, while we complete the license mix transition, we expect DSOs could trend up a few days in the mid 80s before settling back to the mid 70s by the end of 2003 and in the 60s again in 2004.

The quality of receivables remains very healthy and unchanged with receivables 90 days past due at 2%.

Installment contract receivables increased sequentially from 81 million to 99 million.

We sold 24 million in term receivables on a nonrecourse basis. 34 million less than in Q-2, reflecting our decision to hold more of these high quality receivables ourselves.

Consistent with our strategy to move to a higher subscription mix with quarterly billings, deferred revenue decreased at 193 million, a sequential decrease of 39 million.

During the quarter, we drew from our 375 million revolver and ended the quarter with 95 million dollars of debt, which we used to finance our purchase of the IBM test business for 70 million and repurchase of 80 million shares for nearly $100 million.

We expect to generate operating cash flow over the next five quarters, which should allow to us repurchase additional stock and repay this debt.

Our debt levels with debt flow, depending on distribution of a worldwide cash portfolio.

Ending cash balance was $164 million.

Finally, let me look into the business outlook for the rest of the year and into 2003.

We expect product bookings growth in Q-4 to be flat to up 5%, compared with the prior year, resulting in bookings growth for the year in the 7% to 10% range and earnings per share in the 74 to 76-cent range.

We believe these would be very positive results in the context of the difficult environment that our customers in technology companies in general face.

In Q-4, we expect earnings per share to be in the 14 to 16-cent range.

Also in Q-4, we anticipate 70% to 80% of software bookings to be under subscriptions.

In 2003, we continue to expect earnings per share to be approximately a dollar.

So in summary, we continue to gain momentum as we've grown the business at a rate that we believe is faster than the industry.

A reflection of our technology and the role we play with our customers.

With that, I'd like to open it up for questions.

Operator?

Thank you.

Ladies and gentlemen, if you would like to register a question, please press the one followed by the four on your telephone.

You will hear a three-tone prompt to acknowledge your request.

If your question has been answered, please press the one followed by the three.

If you are using a speaker phone, please lift your hand set before entering your request.

One moment, please, for the first question.

Our first question comes from the line of Bill Freerich, TA David and Company, please proceed.

Bill, I was curious about the recolver.

I noticed you classified the 90-odd million as long-term debt.

Could -- might you pay this down within a year?

Oh, of course, Bill.

The structure of the revolver allows it to be a long term because that's the first piece we pull down, but of course, we'll be able to repay it, if we choose, within the next four quarters.

Okay, great.

Thank you.

Our next question comes from the line of Ross Sets with SG Cowen.

Please proceed with your question.

Hi.

Thank you.

Bill, can you talk about what assumptions underlie your expectation of a dollar and earnings next year even if that's just order of magnitude?

How should we think about expenses next year relative to the run rate exiting this year and what are you thinking about in terms of bookings growth?

Sure, Ross.

For next year, we're planning the business conservatively on the top line.

We'll see growth but it will be modest.

And we're just going to continue with the programs that we have been already executing as we have been integrating some of the companies and looking at overlap.

So we're going to continue on our path of looking for opportunities to be more efficient.

I think that's really the tone.

There isn't anything dramatically different than what we're already doing.

And then Q-4, is it safe just to assume flatish expenses?

Is that what gets us to the numbers?

Yeah, I think that's generally a good approach.

We'll look to always do better.

And finally, forgive me if I've made a mistake here.

You've reported for the last three quarters, 62 cents cumulatively.

You are giving guidance in Q-4 for 14 to 16 cents, which suggests 76 cents to 78 cents and your guidance for the year was 74 to 76.

I'm sort of missing two cents there.

Can you help me?

I think you just caught our math there, our apologies.

Thanks.

Our next question comes from Garo with RBC Capital Markets.

Please proceed with your question.

Thanks.

A couple questions.

Bill, I think one of the things that you mentioned was that you are seeing bookings, overall bookings growth production because of a number of customers that are still renewing and increasing their renewal sizes but they are pushing out some of the components of the orders.

Do I understand that correctly?

No, I think you've got it correct.

And in terms of overall semiconductor industry growth, is there some number you guys are basing most of your assumptions on?

I think it -- it's Ray.

I think that our view, and certainly the way we're planning our business is that semiconductor industry will continue calm as they are today.

I see a variety of assumptions about what will happen for 2002 as a total.

I think there's still some optimism in the numbers, based on what I see, and so our view is that the best way to plan our business going forward is that there's just not going to be a lot of lift in the semiconductor industry next year.

Okay.

And do you think that they'll maintain roughly the same levels that R & D's spending then?

I think that's our planning assumption is that our leverage is in playing a larger role with they companies as exemplified by the IBM-type transaction.

That is not a singular act for us.

It's a theme that we're seeing throughout the industry.

But I also don't see our customers backing away from their commitment to product development at R & D. They continue to be very conscious of the need to develop new products and be in a position to drive through this thing.

Thank you.

Our next question comes from the line of Manage Goil with Neuberger Berman .

Please proceed with your question.

I have a few short questions.

Was there any contribution to revenue and expenses from the acquisition that you closed in this quarter?

No.

Um, so if I look at your, you know, guidance that you are reducing, bookings guide guidance, they are slightly higher than expected and they are endorsing dollar in earnings, I find a disconnect there.

Could you walk me through that, please?

Yeah.

You're talking about next year?

I'm talking about '03.

I think Bill really answered the question very adequately.

We've not completed our planning work but our view at this point is that we'll see modest growth next year, and we also see the opportunity to continue to move on structural cost, expenses, just the basic business model that happens naturally as a result of the kinds of acquisitions that we have done over the last 12 to 18 months.

I see.

Um, just on a separate subject, Ray, you know, if I look at synopsis which are a sort of after the close of acquisition of it's almost impossible to gauge with the true growth of the company is, and Cadence, there has been some substantial change in the bookings from subscriptions so even though the number is not comparable anymore, do you have any view as to what the true growth of the industry is, either this year or next year?

My view of the industry growth, if you distill out, and it take some deriving to do it, but if you distill out these various business models and the rate of which we're going through these business model changes or licensing model changes, is that the industry was at best flat this year.

And that next year, as we come out of our license model shift and accelerate out of that in the second half of next year, a matter of just mathematics and its synopsis, the other larger player, has achieved stability, I think that we will look to modest growth for the industry next year.

By that, I mean low, single digits.

This final question.

Do you think you may have to book more charges to get to your optimized operating expense number?

Don't know of any at this time.

Okay, thank you.

This is Bill.

Let me just add one clarifying point.

The bookings growth that we are referring to, that's an apples to apples comparison.

There is no effect of license model change in there.

So that's true product growth.

All right.

Thank you.

Actually, what I was referring to was earlier, the guidance was for 15% and now it is down to 7 to 10 while the EPS guidance has remained the same and operating expenses were this.

So I could not connect those.

Good question.

Thank you.

Just to remind in a largely subscription model, current period bookings don't change the revenue growth all that much.

It's one of the merits of the model.

Mm-hmm.

In the short term.

Thank you.

Our next question comes from the line of Jay Flashhower with Merrill Lynch.

Please proceed with your question.

To follow up on the earlier line of questioning about next year.

Bill, how likely is it that you could commit to increasing your expenses less than the increase bookings the next year, or perhaps not at all?

Are you prepared to commit to doing the synopsis is planning for, which is to keep the expense run rate through next year, flat with their producted Q-4 expense rate?

That's number one.

Second, isn't there a risk notwithstanding your expectation of the closer relationship with your customers that EDA and hall, anyway, could under perform R & D, that is to say, that as an industry, perhaps including yourselves, you might not even grow at whatever R & D does increase by next year.

Then a follow-up, thanks.

Jay, in terms of the expense levels, we do not need to increase expenses to hit our plans for next year.

In fact, we can keep expenses flat and reach our goals.

So that's not a problem.

With respect to the industry, Jay, we do expect R & D to grow modestly and for EDA to track R & D as customers move through 130 and nano nanometer.

They routinely describe the need for more EDA technology, and I believe they are in a situation where they would like to be able to increase their investment in new technology so, in all of the customers, I don't see any basis to think that EDA wouldn't track R & D well.

Okay.

Just by way of follow-up, for Penny, could you talk about what you are seeing with respect to the three main customer types that you have, global accounts, strategic and territorial at the synopsis meeting a couple of weeks ago.

For instance, they suggested that it was predominantly the territorial or smaller accounts that were holding back the business.

Is that something that you are seeing as well?

So we classified three levels just so the audience.

Global accounts for large customers and territory accounts.

We see the caution across the industry, so the enterprise level and major accounts, we see some companies able to renew at the same levels and some wanting to stagger their renewals looking for better visibility in their business.

And the geography accounts have been under pressure for a number of quarters now.

So no significant change there, but the last three to six months, we have seen some of the majors get careful about the sequences with which they spend their R & D dollars.

Lastly, Bill, to verify your bookings comments, you are up in the third quarter 10% so that would have put product bookings at about 280 million.

You are talking about up 5%, or up to 5% in the fourth quarter which would put you around the 305 level.

So in principle, what you are saying is you would say only about a $25 million or so sequential increase in product bookings, which would be the smallest increase sequentially from third to fourth over the last three years?

A lot of numbers, Jay.

Directionally, we'll see a more modest increase from Q-3 to Q-4.

Than you've seen in the past?

That's correct.

Thank you.

Our next question comes from the line of Jennifer Jordan with Wells Fargo Securities.

Please proceed with your question.

Yes, good afternoon.

Good job on the rev line there in a tough time.

I'm just wondering if you could highlight for us, maybe Penny could highlight a little more the way customers are approaching things the way they stagger out in the large renewals.

For example, that they are staggering out renewals of existing licenses for the place and route product in favor of bringing in more licenses of Silicon Encounter or kind of what is the sort of way those things are working?

The demand for the new technology is very high so different customers have different situations.

Some see their need for new technology outpacing their renewals of the existing technology.

Maybe they think less of the existing and more of the new.

In one case, we saw a customer whose own project had slipped and in contrast to previous behavior, they decided to time their renewal with the timing of the projects instead of timing everything with a single renewal.

There's no one universal trend, but what is underlying is the demand for the Encounter platform, the Encounter System, and for our customer analog continues strong and for our new technology required is strong.

Okay.

That's it for now.

Our next question comes from the line of Tim Kline with Piper Jaffray.

Please proceed with your question.

Yeah.

I guess, Ray, could you give a little color.

A quarter ago we were sitting and there were lots of questions about the belief that you could sustain 15% bookings growth goal for the year.

Obviously that doesn't -- that isn't attainable anymore.

What was one of the biggest surprises, obviously, for you as versus expectations going into the quarter in terms of customer behavior and the renewal discussions, et cetera?

Sure.

There's a lot to be happy about in this quarter, but this is not one of them.

We will, with what we've reported for the year, so far, we think significantly outpace the rest of the industry in the growth of the bookings on an apples to apples basis.

That's very positive and that remains in tact.

We didn't see or were not seeing based on what we think is a identifiable theme that emerged at the end of this past quarter that kind of seasonal uplift that we would typically see here at the end of Q-3 and frankly, we're trampoling that into Q-4.

And it's what both Penny and I have commented on.

Customers that are operating on the margins.

Some of them whose balance sheets are getting thin or who have reported big layoffs or for whatever reasons decided they are going to prioritize their renewals and stagger them and sometimes it's along the lines of new and old technologies.

Sometimes it's whatever projects they're working on.

There haven't been that many cases, but what happened at the end of the quarter that caused our bookings to come in somewhat lower than we thought, 10% was a good number, but it wasn't quite what we were planning.

It leads me to believe that we haven't seen the end of this, and we need to be more cautious in our outlook for that 15% plan that we had thought we could deliver to.

Okay.

Then the follow-up question is, um, are you prepared at this time, and if not this time, when might we get some sort of sense of the sensitivity to the dollar and earnings for '03 in terms of, you know, what's the sensitivity in terms of bookings, growth that that dollar, you know, and earnings would be sustainable and what kind of bookings growth would it take for to you exceed that and conversely, to fall short of that?

Well, that's sensitivity that I think you can best do with your model.

We, of course, worked that aggressively, but not a kind of analysis that we would share outside the company.

I think there are milestones that you can look at.

Certainly, the fact we are taking share, growing faster than the industry, even in this environment is one of those milestones that suggests that we're executing well, the strategy's working, the new technology is certainly getting traction in the marketplace.

Another milestone would be what Q-4 looks like.

Relatively stronger Q-4.

It's something if I were sitting in your chair, I would look at.

But beyond that, I think it's all of us trying to plan prudently in an environment where customers are struggling and continue to struggle and are getting tired of struggling.

Well, thank you.

Best of luck.

Sure, thanks.

Our next question comes from the line of Jeff Macy with Needham and company.

Please please proceed with your question.

Hi, good afternoon.

First question on the IBM deal.

I was wondering, you kind of mentioned that you were taking a lot of R & D dollars there.

I was wondering if you thought that maybe you had pushed maybe one or more of your competitors out there or kind of reduced what they are getting from IBM.

Um, well, I don't any we said taking R & D dollars, but certainly, we are expanding into their EDA platform, and of course, that comes at the expense of the opportunity that some of our competitors might otherwise see.

And Penny, you mentioned a number of customers over the last, you know, few quarters that have adopted the Encounter System.

I was wondering if you had a sense of what percentage of those were just previous Cadence customers that were just, um, taking on the Encounter system versus, um, customers that were replacing some of their existing flows?

Sure.

The list I gave where I listed each customer with all in Q-3.

And they are mixed.

Many of them are existing Cadence customers, but just as many are into the traditional other base.

One of the beauties of the Encounter System is that we designed it best to act as a prototyping system on top of a different place or route system.

It gets quite the efficiency for the single beta model when we do that or the customers to adopt the complete flow with the single model.

Just moving into the Encounter approach to design and the prototyping and the benefits of the continuous convergence is so compelling that customers across all competitive segments are moving to use Encounter.

From that, we're then able to work with a customer's type with the full flow and benefits the Nano Route technology and we can solve more of the customer's problem at the time.

But it's both a success and traditional customer base as well as a success in other environments.

One last quick question for Bill.

I missed something that you said in your presentation about something about 4% of the software revenue was from backlog.

What was that exactly again?

What I said, Jeff, was that 40% of our product revenue came from subscription backlog in the quarter.

Okay, great.

Thanks.

Just let me clarify, you know, for Q-4, the range is 14 cents to 16 cents.

Apologize for the math error on the year.

Thank you.

You're welcome.

Our next question comes from the line of Mida with Salvia.

Please proceed with your question.

[inaudible] Mostof my questions have been answered.

There's a couple of follow-up questions.

In regards to your moderate growth for product booking going into 2003, to what extent this downtake is driven by any yield issues at .13 micrometer and any delay in bringing up nanometer process technology?

And I have follow-up questions.

Mida, I think that, quite the contrary.

The move to 90 nanometer technology is compelling customers towards this Encounter platform, and the 90 nanometer related offerings that are included on that platform.

That's actually what's driving, I believe, the demand that we're seeing and the success we're seeing in the marketplace with this product.

Sure.

And then any color on the current yield issues from .13 and to what extent it's preventing your customers from re-signing contracts?

We have a standing connection, any direct connection from customers continuing to work through the yelled issues -- yield issues at one study and our size of our colors.

The -- in fact we medicationed the customers are trying to get a handle on how to manage their yield issue.

It drives them towards the manufacturing technology and the encounter-based signal integrity approach because it's through the use of those type of technologies that you can mitigate following the yield issue.

Now, we're so working so close with our customers to do what we can to help us stand, the sources of yield problem that we see driving customers to continue technology adoption rather than slow down on the EDA side.

Sure.

Just some clarification.

You are talking about a 10% year-over-year growth in bookings, and you close the second quarter.

So if you were to strip away Simplex, what bookings would it be just for Cadence?

What would be the organic growth for bookings?

Mida, because of the way we use acquired technologies, we don't really look at our business that way.

The Simplex technologies and respective technologies are being integrated to largest platforms of existing Cadence technologies that are just the form of our business.

So new extrapolation of what might have been is just -- is a math exercise from our point of view.

It's not really how we sell our technology.

Sure.

In regards to the $70 million that you paid to IBM, I'm just trying to figure out a way to quantify or at least graps revenue generating potentials that would come out of that deal if you could share anything, we would really appreciate it.

Sure, there are really three places that that will be driven.

One is, of course, a component of our software platforms.

So it gives us a stronger, more compelling platform to offer in the marketplace as well as a point technology.

So there's a product play there for our customers and IBM's customers in both their ASIC and COT, their foundry business.

The second two places, and they're related, is services back into both our customer base, IBM's customer base, around test and testability.

Now, the third area is services back into IBM.

Sure.

Thank you.

Our next question comes from the line of Alex Ganya with UBS Warburg.

Please proceed with your question.

Yes, thank you.

I believe you were seeing bookings to bookings on an apples to apples basis.

You were expecting it for the year of 7 to 10%.

Can you help me understand apples to apples.

Would that mean it would be considerably higher we were still by, you know, the former method of accounting for licenses?

Alex, what I mean by that is, you know, we're not incorporating any maintenance into the calculation of the apples for apples.

So this is straight product versus straight product comparisons.

And the average life hasn't changed as well, so this is just what we've been seeing all along and reporting all along.

Okay.

Does that answer your question?

Yes, it does.

And I was wondering if you could help me with what happened with head count sequentially?

Where we are now and how it has fluctuated because of the acquisitions, and then how it might have been trimmed back through actions and other areas.

Sure.

Just give me a second while I pull out the -- while we're researching that number, if you have a follow-up question, Alex?

It's somewhat of a subjective answer, but I'm wondering if, you know, I find it comforting, your viewpoint on the industry.

Clearly, you are seeing the difficulties out there in your customer base and it's reflecting in the building of your expectations.

But is there some reason why a $1 number in guidance is important in terms of hitting any, you know, debt covenants you want to have in your resolver or ability to access capital, you know that leads you to -- would lead to you make difficult decisions on expenses or, you know, pulling down debt to buy back shares.

Is there a reason for this?

No.

Nothing along the lines that you mentioned.

We get to $1 by doing two things.

We're looking at the strategies, we're breaking into the market brace and what we think those strategies will deliver in terms of product and services, bookings and revenue.

And we're looking at the alignment of the rationalization and the further scrubbing in this environment of what it costs us to deliver on those strategies.

We've worked them hard and we've come up with a number that in this environment we think we can deliver.

Okay.

Alex, to get back to your head count question, just for reference, last quarter, we ended with 5700 below 5762 to be exact.

That's the number you made reference.

We ended this quarter with 5600.

So down, you know, about 140 heads.

Okay.

And the piece of that is only around 100 so there's just overlap in other areas of the business that just continue to come out.

Okay.

And between that 5700 to 5600 level, were there any other net additions from the acquisition that would make the magnitude larger or is this pretty much apples to apples again?

This is pretty much apples to apples because the head count was all in by the end of Q-2.

I got it.

And I have a question for you, and this may come from some sour grapes, but one criticism I had heard in some of the head count reductions is that Cadence might be getting a little vice president rich here.

Can you address that claim in your opinion?

Well, I'm not even sure how to take it.

But I'll make this comment.

We are continuously looking at our organizations and aligned with the strategies that we are pursuing in the marketplace and I can tell you, my staff will tell you, productivity is something we major internally very aggressively.

The span of control is something we look at very aggressively.

And so it's, I think, that's value speaks for itself.

The rest of it, I think, is just stuff people talk about.

Okay, very good.

Thank you.

Our next question comes from Arnep Shanda from Lehman Brothers.

Please proceed with your question.

Thank you.

I have a quick question about -- I have a couple questions if I may.

First is, um, could you talk about if there are certain areas in the current environment that are stronger versus weaker.

You know, you talk of verification being stronger.

I guess I am surprised you would have thought that chip designs would be slowing down at times like these.

Whether there are certain areas within, say, back end, front end that are more strong than others.

If you could give a qualitative color that would be great.

I'll take that one.

We continue to see a lot of demand in the back end or what we call fiscal limitation of the digital platform and the custom analog platform.

We saw growth in verification acceleration, we saw growth in manufacturing and the probably the softest segment is the software verification and very well from a technology perspective there.

So the key component of our strategy as we have the different conversations with our qufts and helping them with their full design flow.

So the systems companies continue to be weaker.

And if you look at the R & D spend statistics and the expectations for 2003, the systems companies have the softest R & D spans but the IBM companies continue to spend so that drives all of our business.

Thank you for that.

And one other question about the physical implementation platform.

You are saying you gave a couple examples where people hadn't moved from a mixed synopsis Cadence flow to a full-on Cadence flow.

Is it current in the industry that customers are trying to standardize or on one platform versus another and, you know, what sort of going on there because in the past I think we were reluctant to do that.

There are two different dynamics going on, Arnep.

One is the customer's desire to solve the technology challenge, which is around the nanometer characteristics, the need to have a nanometer ready router, the need to have the virtual prototyping flow.

So that is one dynamic is that driving customers to select the full Cadence system because its benefits of the capacity of the single data model are already in the technology.

The other dynamic that's occurring is the customer's desire to reduce or maintain their R & D span.

That's driving them go to fewer vendors.

We do end up in a dialogue with our customers around the numbers and suppliers they are purchasing from and both the financial and technical benefits of moving to just a handful of suppliers.

Who those two converge, the customer will typically select the platform.

Even so, we're realistic about the fact we're unlikely to provide everything, and that's why we have the investments of open access because of our strong belief that its ability allows our customers to continue to select point tools such as the tools they need to but within an integrated Cadence environment.

Thank you.

And the last question about 2003 again, not to beat a dead horse, but obviously, you know, from your qualitative commentary, it seems like you are not expecting to recover at least in the first half, so in terms of ow our models, is it fair to skew the revenue growth towards the second half and maybe is it fair to expect any kind of growth you see in the first half as a result of the business model change?

If you could talk about that a little that would be great.

Thank you.

I think we've been consistently last quarter indicate we didn't see growth in the first half of the year from a revenue perspective because of the model change and we expected to see growth in the second half of the year.

We still expect those same dynamics from a revenue perspective even as we look at 2003 today.

So that's in the momentum chroorly, I think, we'll be picking from a revenue perspective in the second half.

From a planning perspective, we're not assuming any dramatic change in bookings outlook throughout 2003.

Thank you very much.

Operator, I think that at this point, we've exhausted our time.

Let me thank all of the participants for your questions, four your interest in our progress as a company.

I look forward to seeing you next time.

Operator: Ladies and gentlemen, that does conclude the conference call for today.

We thank you for your participation and ask that you please disconnect your lines.

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