益華電腦 (CDNS) 2002 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, welcome to the Cadence Design Systems 4th Quarter 2002 Earnings Call.

All participants will be in a listen-only mode.

Afterwards we will conduct a question-and-answer session.

If you have a question, press the one followed by the four on your telephone.

This conference is being recorded Tuesday January 21st, 2003.

I would now like to turn the call over to Bill Porter, Chief Financial Officer.

Good afternoon and welcome.

With me today are Ray Bingham, President and CEO, and Penny Hersher, Executive Vice President and Chief Marketing Officer.

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

First, the Safe Harbor statement.

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

For more information about factors that could cause a difference in results, please refer to the 10K for the period ended December 29th, 2001, and the 10Q for the period ended September 28th, 2002.

All numbers reflect earnings excluding goodwill and unusual items.

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

Good afternoon, thank you, Bill.

2002 was a defining year for Cadence.

It has become clear that our customers most critical issue is achieving first silicon success and ramping quickly into volume production with their most advanced designs.

Everything we've done in the past 12 months was focused on solving these technical and business problems our customers face.

Before I outline our strategy and the key actions we've taken in 2002, let me spend a moment on the market shifts that is have made the past year so challenging for our customers.

It really comes down to two trends, increasing difficulties of advanced design and manufacturing, and the continuing difficulty for the semiconductor market.

Together these trends create challenges for all electronics companies.

A complex system on a chip IC may cost $25 million to develop, the cost of a single manufacturing mask set in excess of $1 million.

To meet these challenges our demand strong technology across the board.

Cadence has moved aggressively to strengthen our offerings over the past year to respond to the challenges our customers are struggling with.

However, we know that is it it is no longer enough simply to develop great technology.

We must also be so closely aligned with our customers success that we function as a virtual extension of their design capability.

This new level of customer alignment is the focus of our strategy.

During 2002, we greatly strengthened our team.

We've aligned our customer approach technology and partnerships to deliver customer success from design to volume for electronics products.

The result was we grew our bookings 5% year over year and we delivered our bookings target in the fourth quarter.

Our customers are looking for complete solutions to their toughest problems.

They're looking not for vendors, but for partners.

They're looking for a design partner with strong industry relationships that support and enhance their entire design chain.

Our customers are looking for a partner they can trust to execute relentlessly and deliver on commitments.

Cadence is that partner for an increasing number of leading companies.

One such leader is ATI Technologies.

ATI, a world leader in the design and manufacture of innovative 3-D graphics and digital media silicon solutions has made the strategic decision to choose Cadence as their premiere EDA design partner.

We will provide ATI with access to our internal research and development team, as well as onsite migration support.

This will allow ATI to standardize on SC&C encounter and a wide spectrum of other Cadence technologies.

We're honored by such customer relationships, it implies a higher level of trust than we're ready to deliver.

While technology is not enough, it's clearly a critical element in making our customers successful.

Ours is the most complete and advanced design technology portfolio in the world.

In 2002, we focused our technologies offerings in 5 areas, digital IC implementation, custom and analog implementation, verification, self and packaged board, and design for manufacturing.

We offer best in class solutions that address the whole problem for our customers in each of these areas.

The Cadence Encounter platform for digital IC design is so compelling that in the 4th quarter, we captured share from competitors in addition to captures share of new customers.

The numbers speak for themselves.

In the 4th quarter, bookings for the Encounter platform, which comprises all of our digital IC solutions, were up approximately 50%, compared to the 4th quarter of 2001.

Encounter platform bookings for all of 2002 were up by 1/3 over 2001.

Obviously, we're pretty delighted by this market reception.

In fact, our total product market bookings were up 5% for the whole 2002.

Total maintenance bookings were up over 5%, even with the restructuring of Cadence Design Services, into Cadence Design Foundry, net total services bookings were flat for 2002.

Extraordinary performance for a year when our customers were struggling to contain costs, this speaks to the critical value our our customers place on our technology services and our support, particularly as they struggle with the challenges at 130 and 90 nanometer.

Our success is not limited to digital IC, however.

Sun, a leading provider of industrial strength hardware, software, and services has recently extended and expanded its use of Cadence tools for the design and analysis of a broad spectrum of multi-gigahertz, [INAUDIBLE] micro processors, complex ASICS and state of the art multi-layer printed circuit board designs.

Cadence relationships in technology strengths are fundamental to our business, but there's more.

In order to solve the whole problem for customers today, we're building partnerships with silicon foundries, IP companies and other EDA tool providers.

In the fourth quarter we announced a 5-year agreement with Artisen Components to jointly develop tightly integrated systems including IP libraries, design technology and semiconductor process data, that to manages the risks of today's design.

The first result of this collaboration is a system to address signal integrity, a critical risk factor for our customer's designs.

Also in the 4th quarter, we announced that the Encounter platform was qualified to be a part of the TSMC reference flow.

This month we announced we are partnering with TSMC to accelerate time to volume for customers by offering complete solutions that include libraries created by TSMC and distributed by Cadence, integrated by Cadence tools, methodologies and services.

We are pleased to be the first whole line distributor for TSMC's libraries.

The need for strategical links to manufacturing was the primary motivation for our acquisition of Celestry.

We announced that last week, Celestry brings two essential technologies to Cadence: device modeling and fast whole circuit simulation.

The events to device modeling is critical to customer success.

Device models correlate transistor performance to silicon, just as interconnect modeling correlates wire performance to silicon.

Celestry's leadership in device modeling compliments our existing leadership in interconnect modeling.

With this acquisition, we have the best wires, the best transistors, the best modeling period.

Celestry also adds the best, fastest full-circuit simulation technology to our customized E-platform, giving Cadence a leadership position in the full array of accompanying design techniques, enhancing our competitive position in the market.

Through their leadership in device modeling, the Celestry team has developed deep, longstanding relationships with both foundries and IDMs.

These relationships, and addition of Celestry's engineering team in Taiwan, will enable us to remain close to the manufacturing requirements for our customers' most challenging designs.

I'm especially delighted to add [Chiong Liu], Celestria's CEO and President to my technology team.

This team with deep expertise in technology and design business and marketing is now the envy of any company in the electronics industry.

You'll be able to meet with and interact with several members of this extraordinary group at our Analysts Day, on February 7, in New York City; you'll also hear more of the details about the strategy I've outlined here.

And also hear firsthand from customers about how Cadence is executing the strategy for their success and ours.

We believe 2003 will be another challenging year for our customers, because of the high degree of uncertainty in their end market.

Our customers lack of visibility into their business needs prompts us to take a cautious approach to expectations in 2003.

However, as we execute on our customer and technology focus strategy, we expect to continue to gain share.

We're absolutely confident of our long-term outlook.

We are deepening our customer relationships as we focus on their success.

We are aligning our technologies and partnering with other industry leaders to deliver the critical solutions customers need.

The successes that we are experiencing, despite the state of the semi-conductor market, tell us clearly we're on the right track.

Now let me turn it over to Penny Hersher, our EVP and Chief Marketing Officer, who will give you more detail about the market and market momentum.

Penny?

Thanks Ray.

Ray has outlined the essence of the Cadence Strategy.

I want to take you into some more details to help you understand how we are executing and the impact of the strategy on our customers.

Our ability to develop and sustain strategic relationships our customers require is evidenced by the many large renewals we won in Q4.

Including seven in the 10 to $100 million range.

An Ray mention Cadence has one of the most complete design technology portfolios in the world, and also the most [advanced], and we are determined to continue our technology momentum by increasing our investment in R&D in absolute dollars for 2003.

The Cadence Encounter platform for [INAUDIBLE] design, which offers a unified solution, combining both prototyping and implementation, continues to drive our bookings momentum and many major account relationships.

We've already told you about the growth to the Encounter platform.

In addition, Q4 bookings included new purchases by two IBM and ASIC customers, 24 [INAUDIBLE] semi-conductor companies and 8 systems companies.

Let me give you just a few examples of the customer successes we've seen with the Encounter platform worldwide.

ST MicroElectronics with selective Cadence First Encounter, a silicon virtual prototyping of its system on a chip designs at 90 and 130 nanometer silicon geometry.

This builds on the success in the Cadence mixed signal solution already in place.

NEC, chose the Cadence Encounter platform to upgrade one third of its existing digital IP solutions for 130 nanometer and 90 nanometer processes.

This allows NEC to realize a 2X productivity and a 3X data handling improvement on designs of up to 5 million gates [flack].

Transmatter's adoption of the Cadence Encounter platform assures that company a predictable schedule for addressing 130 and 90 nanometer implementation and signal integrity.

This greatly accelerates the Transmatter's design closure.

These customers are adopting Cadence technology, benchmark by benchmark, and design by design, because it is the best in the market.

In the custom analog space, our completion of the acquisition of the assets of Antrin announced in December for next generation analog prototyping and behavioral characterizing and modeling support to allow custom IC implementation roadmaps. build the road maps.

Coupled with the Celestry acquisition, this takes the Cadence custom platform from strength to strength, in a market segment where four out of five designers already use our platform.

Qualcom, uses the Cadence custom and mixed signal design platform, coupled with their existing Cadence substrate solution, to meet the challenges of increased analog content in their design.

The company also plans to offer their current DST capabilities with IBM's advanced design for test capabilities in 2003.

Through close collaboration with a large semi-conductor company, we successfully ported our custom design platform to Linux.

With Linux ports, along with ports to each of our IT technologies is slated to be available for commercial release in early 2003.

This will give our customers total flexibility with regard to workstations and operating systems, as well as significantly improved performance.

Our third platform is verification.

The Cadence verification platform uniquely includes not only system and functional level verification and test bench tools, but also world class verification acceleration capabilities to give customers both speed and flexibility, in deploying verification across their enterprise.

Many of our major deals this quarter, such as ATI, HP and Sun already mentioned, included substantial verification purchases.

In Japan, Epson made a major investment in Cadence technology, including system verification, digital and customized implementation, and functional verification.

Epson has standardized on the Cadence verification platform of [INAUDIBLE] simulation solutions, enabling them to speed their total turnaround time for critical functional verification.

You'll be hearing a great deal more about this platform in Q1.

It brings greater productivity for our customers, in what has become one of the most time-consuming phases of IT design.

The Cadence design to manufacturing platform centers on the need to bring design and manufacturing closer together.

The [INAUDIBLE] on the manufacturing side for some time now, and has dramatically increasing at 90 nanometers.

We are providing leadership on the design industry, we work across the design chain to provide solutions for our customers today, and to bridge the design-to-manufacturing gaps that loom in the 65 nanometer future.

In this space, our combined analog physical verification and [synop] electrical verification bookings grew 25% year over year in 2002.

We understand the need to strengthen our digital DLCS technology.

In fact, entire design-to-manufacturing space will be an area of intense investment for Cadence in 2003.

We continue to see competitive wins in the silicone package board platform market, as customers such as Samsung recognize the value of an integrated solution for highspeed or design.

Combined with the world's leading IT package design solution.

Supporting all of these platforms, is the open access database.

Open access just the latest of a series in open-end spaces and standards, produced by Cadence, going back to [Lefta], veralog, and even GDS-2.

Open access achieved a critical milestone in Q4, but we delivered a production quality final release of open access database to SI-2 ahead of schedule and with greater functionality than originally promised.

HP has signed a substantial new multiyear contract to deploy forward cross-section of our design software and services.

The key to this agreement is Cadence's strong support for open access, and HP's own tools and processes that require intra-operability.

HP is accessing a broad Cadence design flow, with particular emphasis on the Encounter platform and our verification solution.

I cannot overstate the importance of open access to customers.

It's the fastest, most capable database in the industry, engineered by Cadence with strong participation from leading semiconductor customers.

It's available to any EDA or electronics company in the form of downloadable soft code, managed as Open Source by SI-2.

We strongly encourage our partners and our competitors to take advantage of this typical opportunity to increase the quality of tool integration, afforded by a high-speed common database.

The Cadence Encounter platform is integrated with open access, our custom IC platform integrated with open access which will be complete in the first half of 2003.

With Cadence Design Foundry, Q4 is our first full quarter as are integrated part of Cadence.

It is clear already that our strategy to focus on high end designs, that both enable our customers and enrich our knowledge of cutting edge design is working.

The Cadence Design Foundry is still working with Avanda Network Devices, to help them achieve their first silicon success for their [Sertar AP 61-100].

The design foundry team is enabling Avanda to meet its tight market goals for this complex chip, the industry's first single chip, full duplex OP-48 traffic manager, asynchronous transfer mode segmentation and reassembly integrated circuits.

In conclusion, we have a clear definitive strategy.

We are executing on this strategy with relentless focus.

As we mentioned, you will will have an opportunity to hear more on the strategy and its impact on our customer's success at our Analyst Day on February 7th.

We continue to build these customer relationships through our unique and expanding leadership position within the industry.

We provide the most advanced technology available across the full spectrum of design needs through our five platforms, with integrated methodology and design service offerings.

They're helping to solve more of our customers' design challenges.

They're working as our customers' partners to address the technology and business challenges.

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

Thank you, Penny.

Good afternoon.

As our customers continue to struggle to contain costs in an increasingly competitive environment in Q4, Cadence continues to grow its product bookings, both quarter over quarter and year over year.

In fact, for 2002, Cadence's total bookings grew by over 5%.

Even though Q4 product bookings were in the range we expected, revenue was impacted as customers increasingly requested flexibility in terms and conditions, including access to new technology and flexible payment terms.

As we previously announced, this led to a much higher percentage mix of subscription contracts for the 4th quarter, 83%, which was above our expected range.

This movement to a more radical model , while reducing revenue in the short term, provides improved revenue visibility going-forward.

Total revenue for the quarter was$276 million, with product revenue at 156 million, and maintenance revenue at $84 million.

Services revenue was 36 million.

Approximately 65% of software products revenue, including subscription maintenance came from backlog in Q4.

As we previously discussed, subscription maintenance adds approximately 7 or 8 percentage points.

For the first quarter of 2003, we expect the comparable number to be in the range of 75% to 80%.

In Q4, we achieved earnings per share, excluding goodwill and unusual items of 3 cents on net income of 9 million.

For the year, earnings per share were 63 cents.

Cash flow from operations for the quarter was $40 million.

North America contributed 58%, Europe 16%, Japan 16%, and Asia, 10%.

In the quarter we received $265 million from the Avanti settlement which contributed to our ending cash balance of $371 million.

We have taken a number of cost management actions to align our business with our strategy which will enhance our efficiency and competitiveness going-forward.

These actions include eliminating duplications resulting from acquisitions, removing layers of management, and globalizing our IT infrastructure.

In addition to streamlining our infrastructure, we have downsized the ORCAD portion PCB business to align with our focus on high-speed board and chip integration, part of PCB.

By supporting mainstream customers through a value added reseller.

Even in the face of these actions, we are increasing our investment in R&D, because we're determined to continue our technology momentum.

These activities resulted in total restructuring expenses of $70 million, with severance of $23 million, facilities closures of $15 million.

And asset write-offs of $32 million.

As a result of these actions, we expect our costs in 2003 to be in the 12 to 14 or to be 12 to 14% lower than 2002, taking into account the recent addition of Celestry.

Quarter end headcount was approximately 5300.

As a result of the lower revenue due to the higher subscription mix, DSOs increased to 104 days.

As we move through the transition, DSOs will decline moving into the mid 70s by the end of 2003, and the mid-60s by 2004.

The quality of receivables improved with receivables 90 days past due at 1%, better than our historical levels of 2 to 3%.

Long term installment contract receivables increased $10 million to $109 million.

We sold $19 million in term license receivables on a non-recourse basis, compared to $81 million in the 4th quarter of 2001.

The decline in receivables sales reflects our move to a higher subscription mix, with correspondingly fewer term licenses.

Deferred revenue increased by 19 million to 213 million, due to an increase in product deferred revenue.

Although deferred revenue can fluctuate from quarter to quarter, going-forward, we would expect deferred revenue to trend down due to fewer annual maintenance billings and more subscriptions with quarterly bills.

We repurchased approximately $2.2 million shares of Cadence stock for $27 million and a quarter.

For the year we purchased approximately $12.8 million shares.

Our remaining authorization, as of the end of Q4, was 430 million.

Our view of 2003 remains tempered by the cautious behavior of our customers with respect to their budgets and their visibility into their own markets.

For Q1, we expect product bookings to be down sequentially due to the first quarter seasonal effect.

Total revenue to be in the range of 245 to 255 million.

Subscriptions to make up 80-90% of Q1 software product bookings.

Earnings before goodwill to be in the range of 3 to 4 cents.

For 2003, we expect product bookings to be roughly flat and EBG to be in the range of 50 to 55 cents.

Our move to a much higher subscription mix will result in a more predictable revenue model.

So in closing,I wanted to provide you a window into what the transition is expected to look like and where we will end up.

Movement to the new bookings model with 80 to 90% of subscriptions is complete.

It will take some time for revenue to catch up, be we should be largely through the revenue transition in two years.

We expect that 65 to 70% of software revenue will come from backlog in 2003, followed by 75 to 80% in 2004.

Operating margins should be in the 15 to 20% range for 2003, and 25 to 30% for 2004.

Operating cashflow is also being affected by the license mix transition.

As Cadence has moved away from perpetual and term licenses, both of which have more front end loaded payment characteristics.

We saw reduction of cashflow in 2002, when compared to 2001.

Subscription licenses will build layers of cash flows as we move through the transition.

We expect to see a stronger recovery of cashflow in 2003.

Let me at this point, operator, invite questions from the call.

Thank you, sir.

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 and you would like to withdraw your registration, please press the one followed by the three.

If you're using a speaker phone, please lift your handset before entering your request.

One moment please for the first question.

Our first question comes from Raj Smith, with SG Cohen, please proceed with your question.

Bill, you've talked about a change in term flexibility and conditions, et cetera, in particular, in your previous announcement, you talked about nonlinear terms on some of the subscription licenses and -- I think, correct me if I'm wrong, the renegotiation of some deals that were in the backlog.

I'm curious if you can help quantify how much of this has gone on or give me an idea on how to model this.

If I think about a subscription contract going-forward, how should I assume revenue as recognized across the term, which I think is now three years?

There's actually two things I think you're raising in your question, the first is, we talk about flexibility and payment terms for contracts, what we mean by that is, if we don't get an equal payment terms across the contract, it becomes something that is radical.

That's just the revenue treatment of a contract.

In terms of modeling what happens with our backlog, let me give you a little context there.

The backlog is not necessarily linear, because, you know, as we've discussed, some customers as part of their renewal negotiations have asked us for longer terms to reduce the impact on their near-term budgets, and then in other cases our larger customers, you know, as part of consolidating vendors will take increasing levels of software over time.

So that's the reasons why we have seen some of the backlog become nonlinear.

The way to model, we've given -- as I've indicated at the end of the call, a percentage of revenue that will come from backlog, we expect in 2003 and 2004.

I think that will help you lay out what those layers will be with a three-year horizon.

Okay.

Penny, you talked about competitive wins and sure gains in your prepared comments.

Who do you win a share from, I guess?

And I'm curious if in any of these -- if you can talk about competitive displacements, talk about who you're actually displacing, is it Synopsis you're taking share from, is it Magma.

Where are you winning share and can you be specific and talk about any names where you've displaced on the incumbent provider?

Sure, Raj.

The type of growth rates we talked about, we studied 33% growth in our digital IT business, 2002 over 2001, is significant enough that we're pretty confident with taking shares from both Synopsis and Magma.

I can't give you any specific customer awareness this quarter.

I did list several last quarter.

But we are seeing, as we go in with the new technology around the Encounter platform all the way from virtual prototyping through to full-signal integrity, we are so far ahead of the competition technically that we can go into an existing customer relationship or in some cases, new customer relationship and put in migration plot in place to displace the incumbent.

And it's probably just because Avanti - it's not because Avanti has a broader base, we're probably doing it more often in the Synopsis base than in the Magma base.

But it's a comfortable opportunity for us to bring the new technology to our customers.

One last quick one, how large was the Celestry transaction in dollars?

We've not announced that.

Okay.

Thank you.

The next question comes from the line of Garo Tumajinian with RBC Capital Markets, please proceed with your question.

On the Celestry topic, can you give us some color in terms of what you might expect in terms of a revenue contribution or maybe in terms of license model changes or whether you expect the acquisition to be accretive or dilutive.

There will be a need for a model change there, so we don't expect there to be significant increase in our top line in 2003.

But we do expect that, you know, the acquisition will be accretive for the year, but not significant.

Thanks.

On the TSMC relationship that you guys are now -- have now taken on there, you're going to be distributing libraries for them.

What kinds of expenses are you now looking at incurring because of that?

The incremental expenses if any at all, we expect to be quite small.

If you think about our offerings as platforms and us providing real benefit to customers as well as to TSMC by integrating, then the libraries into our tools, into our platforms, any incremental cost or focus is going to be small.

Clearly in order to be successful it will need to be marketed, packaged and there's work to be done.

But relative to the opportunity and relative to the platforms, these things we will participate in, it's really not measurable.

Is there any revenue you're receiving from TSMC as part of the deal or are there any payments you're making to TSMC?

We're not disclosing the financial terms of the library agreements.

Thanks very much.

The next question comes from Eric Desai from American Technology Research.

Please proceed with your question.

Bill, if you wouldn't mind first, perhaps dissecting your revenue guidance for the first quarter.

In the sense that if I were to assume even a little modest sequential downtick in maintenance and flatness, or even perhaps sequential down in services, you're still looking at product to revenue coming down off these levels of 156 million, another 15 million.

Did I read that correctly, first of all?

That's approximately correct.

I'm not going to get into that level of detail, you can assume maintenance is relatively flat and services also will be relatively flat.

Again, perhaps in terms of some understanding of the product revenue dynamics here, the subscription portion should continue to rise or be flat sequentially, and, therefore, you're expecting the term and perpetual part to be going away or becoming very small?

We will still have approximately that same level of business -- our model is 80 to 90% for subscription..

So we're going to expect somewhere in that range for perpetual and term licenses of our total bookings.

Right.

I understand roughly what numbers you're looking at.

In the reported revenue in the reported product revenue, what was the mix by the various license types?

The $156 million, how did that divvy up on a percentage basis?

Are you asking for the --

For the quarter you just reported, yes.

For the 4th quarter, 65% of our revenue came from subscriptions, including the maintenance component.

So the remaining 35% would be from the perpetual and terms components.

Okay.

And within product?

Yes.

Okay.

Sorry, I didn't catch that earlier.

That's okay.

The three cents for the quarter, I must have a miscalculation, what happened in your other income line?

Maybe I'm missing something there.

For Q4 we had 1.5 million in expense in Q4 or other income, or other expense, excuse me.

That was related to just stock -- you bought back stock and --

No, that's primarily foreign exchange related.

Okay.

One other question.

As -- maybe Penny or Ray, whoever wants to expand on this, is there anything unique, special in the IBM relationship that you announced on the Linux platforms you announced, I guess, earlier today or yesterday, and whether and if you can give any indication of how the dollars flow in that particular deal?

Eric, that's a pretty status quoting relationship, there's nothing unusual about it.

Putting products onto Linux with IBM's help

But you're still going to be selling it?

The software - there's no unique distribution capable given to IBM or -

Nothing unique there.

Thank you.

The next question comes from Jay Vleeschhouwer with Merrill Lynch.

Thanks.

I would like to pursue the earlier line of questioning on the renegotiation of backlog.

Bill, could you be more specific as to what the quarterly or annual decrement to revenues is as a result of that renegotiation, we've estimated as of the third quarter you had a net subscription remaining of just over half a billion dollars, and some material portion of that was renegotiated, leading to a more adverse effect on revenues than even longer durations or lower bookings expectations.

So could you be more specific as to the amount or proportion of backlog that's been renegotiated or perhaps the number of customer transactions that comprise that renegotiation?

Yeah, Jay, I think I framed the impact going-forward fairly well and the percentage of revenue that's coming out.

As we've had negotiations pretty much throughout 2002, one of the things that customers were looking at is how they could maintain their budgets and still try to get software that they needed.

So they're -- you know, there was some large customers, some push out on that contract which is reflected in those percentages that I've given you.

And, you know, it's something I think we're going to see during this environment as we try to get the technology to our customers.

It's -- I think it's fairly well modelable from the guidance I've given you.

You talk about one of the reasons for the renegotiation, was giving customers some access to new technology which presumably they would have had anyway under new subscriptions, can you talk about the degree to which customers had been employing their remix of options they already had, or if you changed the remix percentage?

That is, if you raised the percentage of the contract value, that is remixable to make up a word, and for Penny, on the Encounter platform comments, in all previous calls since the SPC acquisition and the naming of Encounter platform, you talked sequentially about it in terms of bookings growth, now you're talking about it year over year, which is fine.

I'm wondering if Encounter platform was up, down or sideways sequentially in terms of bookings.

In terms of the remix it really hasn't changed, so we're still in the 10% range of what customers are allowed to remix.

So as, you know, obviously, they don't have enough capabilities to remix in our new technology so they, you know are adding on to their contracts as part of those negotiations to add on for new technology, that's where we get into looking at the total existing arrangement as well.

And, Jay, on the sequential experience with the Encounter platform, you can see that it was a very big year with acceleration across the year.

That includes not only new users as I mention, but also, we're absorbing the old market, including our own install base at a very rapid pace.

The sequential growth from Q3 to Q4 was about 10%.

Okay.

Just a couple follow-ups, if you'll indulge me.

On quick turn, we calculated that the product revenue component of quick turn, was below $10 million in the quarter, which if right would suggest that that was the worst performing quarter for quick turn product revenues since the acquisition, perhaps even before the merger, could you talk about what the potential is for restoring the growth in that business, and trying to make it more material again.

And lastly, for Penny, you gave us one end of a new product release or an update this quarter.

Could you talk about anything else you may be rolling out after the first half of the year?

Thanks.

Jay, on the quick turn or verification acceleration platform, the 4th quarter was lighter than we have been experiencing, and I believe we talked about it on our last conference call as having been -- having lost a -- an engagement that we expected to win in 4th quarter.

We saw some very aggressive price competition in the quarter, and did, indeed, miss an order.

Nevertheless, you heard the -- in the comments, the significant wins, not only of the quarter, but for the year we saw a -- quite a good year compared to the prior year, and from what we can see, even with more shrill competition, a promising 2003.

To address your specific questioning on previewing, all I said is that you'll hear more on verification this quarter.

As each piece of technology comes out, we'll announce it.

Thanks so much.

The next question comes from the line of Jennifer Jordan from Wells Fargo.

Thanks, everyone.

I wanted to follow-up one more time on this idea of the contract mix being renegotiated.

And first I'm wondering, is this something you're finding is unique to you or is it something that's also brought on by the competitive environment in the industry and how tough it is for consumers?

Well, Jennifer, generally what we have been seeing is customers are coming to us saying they have been able to work similar arrangements with our competitors and they're asking for us to help them out in a similar regard.

This is something we're seeing in the industry.

This is not unique to Cadence.

I think I asked you this before, but I'm curious, if it's something to say it's somewhat strategic that if you have a higher level of renewals in the future, it makes difficult for others to capture shares in that time period.

Jennifer, I think that part of the value of a highly renewable license model, is just that.

If you're playing a strong hand, which we believe we are, every time there's a renewal, you have an opportunity, for customer convenience, for reasons of vendor consolidation, for reasons of delivering an integrated platform, to expand your footprint within the customer.

That's indeed the kind of experience we are having with the renewals that we have.

I guess I'm referring to the idea of the somewhat tiered structure where some of these contracts are more back end loaded.

It seems by the time you get to that point, you're going to be renewing a larger license installation.

Well, I guess in theory, that would be right.

I think that, well, there is certainly some back end loading of some contracts, I wouldn't characterize it as severe or generally how we do business.

Okay.

Thank you.

The next question comes from the line of Bill Frerichs with D. A. Davidson and Company, please begin your question.

Raj started out the questioning with the possibility of renegotiating some of the term deals that were previously backlogged.

I was wondering if you have renegotiated some term deals that were previously taken to revenue?

Bill, we do not negotiate anything that we've taken revenue on.

Okay.

So there's no particular restriction on you in your future ability to put book things as term or perpetual?

That's correct.

My second question is, in the -- in Ray's opening statement -- I think it was Ray, you talk about a five-year agreement with Artisen to develop libraries that are better integrated with Cadence products.

And the very next breath talked about a deal to distribute TSMC libraries that are also, as you well know, distributed by Artisen and I was wondering how you are not at cross purposes in these two initiatives.

First, to be accurate what happens, Artisen develops their own libraries and distributes them.

And the libraries we're developing for TSMC are TSMC development libraries.

They're different development strains.

Right, but they do the same thing.

They do the same thing.

But for a slightly different market.

So if you look at TSMC's market or how the customer base is made up, what they see is that there are different performance points in the marketplace both for speed performance and power performance, and so they wanted to augment and compliment Artisen's position and offerings in the marketplace.

They also wanted to broaden their market reach outside of the traditional Artisen base and to get access to Cadence's market position and Cadence's relationships.

So what we see when we look at the two partners we have, is they're serving different points in the market for us, and so we don't see any conflict and we worked very hard, actually, with both companies to make sure that we're not in a competitive position between two -- caught between the two.

And so we now have a structure setup where we're working closely with Artisen, and we're also delighted to be representing TSMC as they expand their market reach into some of our traditional customers.

And supporting TSMC's strategies to have flow onto their fab coming from both TSMC libraries and Artisen's libraries.

I want to follow-up.

Obviously, we're going to get some enthusiasm going for open access, and I would guess that Mentor Graphics is going to fairly important that.

And yet you guys find yourselves in Federal Court in San Francisco at the moment.

I was wondering if it might actually help open access to do a little horse trading at this point?

Bill, you're sitting in the wrong chair.

Certainly, the atmosphere of litigation on the one hand is not probably conducive to partnering intimately.

On the other hand, however, open access, I think, rises quite a bit above that.

Open access is not a Cadence product at this point.

Open access is a SI-2 product, it is supported by and really owned by that organization and its constituent members, which is the major semiconductor companies around the world.

We help with it, it certainly was originally our technology, we're helping to drive it, it matters to us that it's successful, but -- and I think that if Mentor -- or for that matter any other EDA company ignores it, they are -- they're really ignoring their customers, I don't think they'll do that.

I think that as open access continues to become more and more a part of how customers do their designs.

They'll just be off -- it will just be obvious that it's in Mentor's and anyone's interest to accommodate that in some way.

Thanks a lot, Ray.

Thank you.

The next question comes from the line of Arnett Chanda with Lehman Brothers.

If you could describe your strategy with regards to IP, would you actually sell your own IP or would you be sort of a broker, intermediate broker for IP companies or IP oriented, things such as libraries.

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

Sure.

The high end of the market, the microprocessor IP -- like [Aurum] and IPM Power PC, we team up with the other suppliers to model and support their processor in an outside environment.

In the middle of the market we team up with soft IP providers, but we do provide our own hard IP, particularly in the analog area where we have a lot of unique IP for our customers through outside foundry strategy.

And in the infrastructure or commodity part of the market which is library and memory compilers, we again team up with leading suppliers like Artisen and TSMC.

So we do not have a key deponent of our strategy to provide IP ourselves.

We think that would potentially put us in competition with our primary customers, except in areas where we have very unique and specialized skills, and those we do provide out through our design service franchise.

This is obviously different from your major competitor, and would you maybe want to -- is this something that is likely to change, or you know, how is it different from Synopsis trying to actually acquire certain kinds of IP?

I can't comment on Synopsis' strategy, it would be inappropriate for me to do so.

But what I can do is tell you is we're very focused on not being in competition with our customers and partnering up with our customers.

And the other providers in the industry to give our customers the solution they need to solve the problems.

In the IP case, whether it's IP or people in the manufacturing chain or foundries, we recognize while we have the greatest breadth of software tools, our strategy is predicated on teaming up with the other leaders and forming partnerships to service our customers.

Thank you.

One last question, you talked about how customers are likely -- are trying to standardize on the certain single flow.

Could you talk about what percentage of customers do you think have standardized on one flow versus another, whether it's yours or someone else's, and where do you think that would be by the end of 2003.

Thank you.

We can't comment from a -- you know, from existing customers of Cadence or existing customers of other flows.

We're tracking market share as it unfolds and we track it customer by customer to move them on to our platform.

But it's early days yet to be able to talk too openly about where we are specifically winning a standardized Cadence environment, except as we mentioned the specific customers in the call, like ATI.

Thank you.

The next question comes from the line of Bren Stevens from UBS Warburg.

Penny, you spoke about the encounter platform and how that was helping customers with 90 nanometer issues.

Are there any other tools that are doing well regarding those issues, maybe that TSMC libraries helping out at all?

In 90 nanometer most of the focus is in the IC implementation world, which is both digital and custom analog implementation, and in particular the interstatement into manufacturing.

All the areas are centered around signal integrity and preparing the designs for manufacturing.

We put those all onto the Encounter platform because we've integrated all our signal integrity technologies into the Encounter environment.

It's really focused on the physical implementation process of the IC, it's the most useful 90-nanometer.

And how do you see those ramping, how is 90 nanometer and those issues flowing through into revenue?

You're referring to tools that specifically address 90 nanometer?

Exactly.

I think the way to think about the market is that virtually every customer that has moved to 130 is really still trying to get effective on 130 and ramp their designs at that level.

There are still a lot of manufacturing yield issues, a lot of those are related to design, and so their continues to be a proliferation of design tools into up into 130 that has yet to happen for many, many customers.

There is certainly work being done at 90, and even some decisions that are being made at 90.

But ramping and proliferation are way ahead of us at this point.

Great.

Thank you.

The next question comes from Simmett Donda with Banc of America Securities.

First off on the seasonality that you talked about expecting in the March quarter, as I try to estimate your bookings have done over the last year or so, it seems it's typically been down 25 to 35% sequentially from Q4 of the prior year.

Are you expecting seasonality to be more pronounced this quarter?

It's going to be roughly, I think, in that range.

Okay.

So is it going to be at the high end of the range or --

I'm not going to get into that level of detail.

But I think you're historical ranges are not that far off.

Okay.

The second question I have for you was really, in terms of the subscription maintenance bookings, are these impacting directly the maintenance revenue line?

Or do they show up in the product line at this point in time?

I remember there was some confusion regarding that some time ago.

Subscription maintenance is staying in the maintenance line.

Okay.

Just providing with a kind of an apples to apples comparison.

And no plans to transition over to reflecting on the product --

I haven't made any specific plans at this stage.

The final question I have for you, you mentioned that 65% of the revenues were -- sorry, subscription type revenues, and of that, 7 to 8% were maintenance, is that accurate?

That's correct.

Of the remaining 35% could you give the breakout between perpetual and term?

I don't want to get to that level of detail.

We look at them as primarily the same.

It's just contracts that we take in the quarter that we revenue in the quarter.

Okay.

Thank you.

You're welcome.

Next question comes from the line of Tim Klein with US Bankcorp Piper Jaffrey.

Please proceed with your question.

The first question, concern regarding the linear area of bookings.

Can you give us some sort of, I guess, more defined context of how the flexibility is being manifest in your bookings.

Specifically, can you tell us or give us some color on what is the mix of, for the bookings in Q4, what's the mix of that that you'll see in the next 12 months versus the following 12 months versus the following 12 months, assuming the average is three years, and how might that compare to a year ago, so we can have some better feel for how those books are playing out.

In terms of percentage of the business, and the percentage of business that will be subscription is going to be in the 80 to 90% range, really, for 2003 going-forward.

Right.

No, I'm sorry, the translation from bookings to revenues, so for the bookings that you booked in Q4, how much of that will be recognized revenue in the next 12 months versus the following 12 months versus the following 12 months?

Okay.

Yeah, in terms of specifics, three-year contracts are average -- the average of what we saw in Q4, so that will basically come out over a three-year period.

And then I think the best way is to step back and look at it in total, take those percentages that I gave for 2003 and 2004, and, you know, that will allow you to tune your models.

So for 2003, we expect 65 to 70% from backlog and in 2004 it's going to be 75 to 80%.

So that gives you the feel for, you know, based on your bookings assumptions, how that backlog rolls out.

Okay.

Yeah, that's fair.

I understand.

I was looking for a little more detail about, for instance the bookings in Q4.

What percentage will be recognized in three years versus say a year ago.

What percentage would have been recognized in three years.

Again, I'm trying to get a better understanding of your comments about flexibility and things being nonlinear.

Okay.

Yeah, last year we would have had contracts that averaged about 2 1/2 years, so we basically have seen half a year lengthening in our contract term year over year.

Okay.

That's fine, we'll take it offline.

Penny, in terms of the Encounter business, you made reference to new purchases, can you define what are new purchases?

New purchases would be a customer that was previously using somebody else's virtual IT implementation platform, such as Synopsis, Avanti, or Magma, that we are displacing with Encounter.

That would be our position.

Or it would be a customer who had previously only used our previous generation of technology such as Silicon Ensemble and made the decision to bring up an Encounter-based product, including the Encounter product.

Okay.

So when the digital prototype product, since nobody's used -- there's no competing product, I presume -- maybe there is, but is there a competing product for that, which product do you view?

I mean, that seems to be pretty much a new class, so how do we do we view -- is it each one of those on a new purchase or -- I'm trying to understand how the context of --

It's a methodology that you bring up.

When you move on to the Encounter approach.

You're bringing up the methodology that starts this virtual prototyping, which is the first First Encounter product within the SOC Encounter platform.

And there are a series of products underneath, like the PKS capability, the nanoroute capability, the specific and cell-fixed signal integrity capabilities, and so on.

They all fit into methodology, but it's a new generation of digital design.

There is no other product in the marketplace that's in the same league of Encounter products, and we believe no other product in the marketplace is in the same league as the nanoroute routing capability.

Plus our signal integrity and electrical verification is way ahead of the competition.

When the customer looks at the system, what they're technically doing is deciding to move from an old methodology which is a front-end, back-end based methodology into a new, fully integrated virtual prototyping based methodology.

They may not move everything at once, they may start with virtual prototyping and signal integrity, then move in and bring up PKS and nanoroute, they may do it all at once.

It depends on the situation of where they are in their design schedule.

What we're counting is the customers making decisions to move on to methodology to starts with virtual prototype.

That's the beginning of moving away from front-end back-end and moving into the next generation of flow.

That's the material event in terms of us ramping market share in digital.

Okay.

That's helpful.

One quick follow-up.

Can you give us any sort of data that helps us understand the Encounter suite is not just First Encounter.

I know it's still early, but any data that would indicate other products in the suite are getting greater traction and people are looking at it as more of a platform than just, say, First Encounter.

First Encounters are hot products.

They account for 33% year over year growth, one of our biggest businesses.

It's coming from the adoption of the methodology and all the products -- which are all integrated together for shipping and production together on a single architecture.

And at 33%, that's an apples to apples -- I mean, that's year over year.

That's in two bookings of the 2001 for our entire digital implementation product line.

If you go back to the points over the years, the types of customers we've been able to identify as having standardized on Cadence as a premiere design partner, including the platform, you think about companies, looking backwards, like ATI, the relationship with IBM, the Phillips announcement, Marvel Semiconductor, and then imagine the kind of growth we talked about in those terms, I think it becomes much clearer.

Great.

Thanks.

The next question comes from the line of Jeff Macy with Needham and Company.

Please proceed with your question.

A couple quick questions.

I was wondering if you could tell us roughly what percentage of the Encounter platform deals are with existing customers who are upgrading from a previous Cadence suite, versus deals that are from new customers that were won from the competition, and secondly, I was wondering you could talk a little bit about the PCB tools market, what you're seeing there and what your expectations are for that market in 2003.

Thanks.

We can't break it out.

You know intuitively that for the kind of growth rates we're posting, that share is being taken.

You can trace it back even to some of the customer announcements we've been able to make by name.

But are not able to break it out more specific than that, it's just one of those things that you can conclude quite easily if you look at the industry data from either of the public sources and the numbers that are being posted here.

It has to be happening both in our customer base as well as in the customer base of our competitors.

I think that PCB like some of the other areas of EDA, in a very difficult environment is not one of those areas that is not moving as quickly.

So while we've been able to create some very impressive competitive displacements and some consolidations because the interconnect between chip and package and board becomes more and more important, it's still a market that just isn't showing a lot of growth.

It didn't show a lot of growth in '02, and I don't think will show any growth in '03.

Thank you.

The next question comes from the line of James Pond with CP&E Partners.

I have a series of questions.

Let's start with the simple stupid question, just trying to figure out your I just want to understand how this affects your basic earning power here, I don't really care what's going on next quarter.

I understand how does the [INAUDIBLE] effectively, um, the changes in expenses affects your basic earning power.

If I understand your company right, you have around 1.4 billion in orders, approximately.

Is that correct?

That's a little bit low, but --

I want to be conservative here.

Sure.

And your expense base next year your earnings will be 12 to 15% off this year's, that's including your cost of sales, correct?

We said 12-13, that's correct.

As I calculated that should be around $980 million in expenses for 2004, give or take, correct?

All right.

So eventually sometime in 2005, 2006, assuming zero percent growth, that's conservative, you should have an operating growth around 400 million and change, correct?

And a corresponding EPS after the tax rate.

I don't think we want to go through this level of modeling, but understand where you're going, I think you're conceptually you're in the right area.

That would imply a very, very high EPS compared to what you're guiding for 2003.

I understand that because you're changing the rate of the policy and number of subscriptions.

But I -- so I guess my other question is, did you guys buy any stock back last quarter?

We bought a couple million shares, yes.

Okay.

But if you don't have any growth the next two or three years, you just managed your expenses and kept your bookings the same, wouldn't that imply that your stock is an incredible bargain at this point?

Where am I missing - there's a disconnect here.

I'll leave that to the professionals because I figure, you're doing the math and we do expect growth going-forward.

Then why aren't we being more aggressive in buying back shares is my question.

I think we look at the opportunities to use our cash both for acquisitions and for stock and we will continue to do that.

I think that's probably about it for the follow-ups.

We can take it online if you want.

Thanks.

I think we have time for one last question.

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

More than one.

A couple things, first, when we talk about flat bookings in 2003, are you encompassing the possibility of a small decline, perhaps a couple percent.

Is that included in your description of flat.

Secondly, about the 4th quarter, how much of the bookings occurred in the last -- subscription bookings occurred in the last two weeks of the quarter, such that you were unable to take any of those into revenue at all.

Jay, if I may, flat just means flat.

The degrees of freedom that one models around that, I think, is something that is individual to the analysts.

As to linearity and what happens in the last couple weeks of the quarter, in this environment, which us increasingly hard for customers, their purchasing people, the people that are negotiating contracts are keen on every negotiating advantage, including pressing the negotiations right to the end.

It's a very important part of why we think the right thing to do is to transition to a more and more radical model.

It allows us to accommodate both the difficulties of the environment as well as give customers what they need at the technology and structuring levels.

Of course, the business is back and loaded, whether it's a subscription deal where all you're looking to do is get the booking and not revenue or whether it's a term license or perpetual license that might be revenue varying.

Everything is happening in the last weeks of the quarter.

All right.

You had your sales kickoff meeting last week, I believe, I was just wondering if you could talk about any of the programs or initiatives or sales techniques that you might be emphasizing or employing this year that, perhaps, would have been not in place last year or -- what are you changing in your sales practices, and then as far as duration is concerned, you talked about moving up to three years, estimating three years, wouldn't it be better to talk about a range for duration, not unlike Synopsis which talked about 3 to 3 1/4 years.

It remains to be seen if they'll get that range but wouldn't it be better if you, for yourself talked about range of duration as well?

Jay, let me talk about that, and then I'll talk about that and then I'll talk about our sales meeting and then we'll wrap up the call if I may.

As to duration, it's a little bit like saying flat.

It's whether that's plus or minus a percent or plus or minus two percent, it's flat.

We believe that we can manage our business to around three years in terms of duration of licenses.

And that's based on the kind of experience we had in the last couple of quarters.

As it relates to the sales kickoff meeting, I think that the keynote there is winning.

And that means winning market share, which we believe we have been doing in this environment.

We grew at the bookings level in 2002, significantly we grew in the most contested market, that being the digital platform.

We grew by delivering new technology in a forum that is making customers more productive in solving big problems for them.

And we believe that we have technology deliverables that are coming behind that in digital, of course than any other four platforms as well that customers are very excited about.

On how our channel we're engaging, that's a great strength of this company.

We know how to create large relationships, large intimate relationships with customers.

We happen to call it a premiere design partnership.

We've announced a series of them this year that I think were quite impressive.

It's a capability that I believe Cadence brings to the marketplace in helping the market grow up and deal with customers as a partner in a pretty important way as the problem gets just bigger and bigger and more and more complex.

The -- I believe that our sales team walked out of 2002, for all of the challenges in 2002, feeling like they had won.

And I believe they're going into 2003 feeling like they can win again.

Operator, let me close the call with that.

Let me conclude by just saying, I think we're executing well on a powerful strategy.

Our positioning is pretty unique through technology partnerships and a commitment to be the partners with our customers.

Long term we think is pretty positive.

We're the largest EDA company and one of the largest, most stable software companies in the world.

That comes with a strong brand and a visible renewable revenue model that combines with, their other assets to give us growing market reach, positive cash flow and then expanding relationships with some of the most important customers in the world.

Thank you for joining us, and we'll look forward to seeing you on the next occasion.

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

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