益華電腦 (CDNS) 2003 Q1 法說會逐字稿

Good afternoon and welcome to the Cadence Design Systems first quarter 2003 conference call.

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

Later, if you have a question, you may press the one followed by a four on your touch-tone phone.

As a reminder, this conference is being recorded Tuesday, April 15th, of 2003.

I would now like to turn the conference over to Mr. Bill Porter, Chief Financial Officer of Cadence.

Please go ahead, sir.

Good afternoon.

This is Bill Porter and I'm here today with Ray Bingham, President and Chief Executive Officer, and Penny Herscher, Executive Vice President and Chief Marketing Officer.

Welcome to our first quarter earnings conference call for 2003.

The webcast 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 the difference in results, please refer to the 10-K for the period ended December 28, 2002.

All numbers reflect earnings, excluding goodwill and unusual items.

GAAP earnings and reconciliation of the numbers are available in the earnings press release we issued this afternoon, which is also available on our website, www.cadence.com With that, I'll turn the call over to Ray Bingham.

Thank you, Bill.

And good afternoon.

At the beginning of this year, we shared our strategic goals for the year, and our financial goals for the first quarter.

We said 2003 would be about taking share.

And we believe we are doing that in many areas.

We also, this quarter, made good progress in achieving our financial goals for 2003.

We achieved earnings per share of 4 cents, and a total revenue of $256 million, with 82% of our Q1 product business booked under subscription licenses.

All within the guidance we presented to you last quarter.

Further, we continued to execute well and with the financial discipline needed to ensure that we are strong in position when the market improves.

As we outlined for you at our analysts day in New York last February, there are three elements to our strategy that we believe add value to customers from design to volume.

First, we partner with our customers.

Second, we provide the most advanced technology in the industry.

Third, we have developed strong third party relationships.

This strategy enables us to help both global IDMs and fabless [PHONETIC] semiconductor companies that need a range of solutions and services.

I'll discuss our progress in each of these three critical areas.

To partner effectively with our customers, we must first understand the difficult technical challenges they face.

At 130 and 90 nanometers and below, designers have to pack hundreds of millions of transistors onto a single chip the size of a fingernail and then put them into flip chip packaging to distribute thousands of I-O pins.

Cadence has the production-proven capability to help customers address these challenges today.

In addition to technical challenges, competitive dynamics, and a poor economy, these things are focusing companies to focus on their core competencies and to rethink how they leverage partners.

This represents a huge opportunity for Cadence.

Many of our customers in the global leader category are consolidating on fewer partners and developing closer relationships with their suppliers.

For example, this quarter Cadence closed two large deals with global IDMs in Japan, including NEC.

Both deals included most of our products.

In 2002, we set out to greatly expand our presence in the important fabless market.

And we did.

We continued to do so in Q1 of this year.

For example, this quarter Invidia, a market leader in graphics chips and one of the most important and progressive fabless semiconductor leaders, selected our new Incisive Verification Platform, including software simulation and emulation for verifying its next generation of 3-D graphics chips.

These technologies were chosen after an extensive evaluation and benchmark process that included Mentor and Access systems.

An important result of our platform approach is that both simulation and emulation sales are being leveraged through the sales of the complete Incisive Verification Platform.

We saw substantial proof of this in emulation, where we took share and achieved a record quarter for Cadence.

The Invidia win builds on the string of fabless wins over the past several quarters with such leaders as ATI, Marvel, Crimson, and Via.

Another important fabless win in Q1 was with Real Tech, a major Taiwanese IC designer of consumer network and computerr peripheral ICs.

Real Tech was using a competitor's back end flow that for several rounds of evaluation, they decided to adopt First Encounter Ultra from our encounter platform.

This represents a strategic win as we continue to break into a competitive stronghold in Real Tech's back end flow with this new technology.

Our leadership in China further demonstrates our commitment to the fabless market.

Cadence was the first EDA company in China.

We have five sales and support offices there, as well as R&D teams in both Shanghai and Beijing.

In fact, according to analysts, Cadence is a clear number one in China and has more than doubled its size since 2001.

This quarter, we continued to work with the Chinese government to initiate a project that is aimed at helping develop the local Chinese electronic design market.

Through the Sushu IC-based project, we'll help incubate many start-ups around the Yang Shi delta region in eastern China using the full spectrum of our advance design tools.

This project builds on our joint investment with the Beijing government and the Beijing design instrument, where together we have built a design university that will train hundreds of Chinese chip designers.

Let me turn now to progress on the second aspect of our strategy, our technology platforms.

Briefly, our platforms align best in class solutions with critical customer challenges, and we create our platforms around these challenges.

Just to remind, they are digitalize implementation, custom and analog implementation, [INAUDIBLE] verification, [INAUDIBLE] package [INAUDIBLE], and design for manufacturing.

Cadence alone has the technology to solve the customers' [INAUDIBLE], digital and analog, chips and systems, through concept, through volume production of the end product.

Think about it; digital is certainly important, and we are strong in digital.

But nearly every chip in the world has some digital, and some analog and custom.

Cadence is the primary supplier in the $600 million custom and analog market.

What that means is that just about every high-end chip in the world has to go through Cadence.

Probably in digital, and almost certainly in custom and analog.

Finally, every chip has to go from silicon to package and on to board.

And we are unique in that capability as well.

That's why we say we are the only full line ED supplier that can address the whole problem, from concept through volume production of the end product.

And we do this through technology, methodology services and design capability.

Now, let me focus in on our most recent platform introduction.

Just six months after announcing our Encounter Platform for digital IC design, we rolled out the Incisive Verification Platform according to schedule, and it couldn't have been timelier for our customers.

Verification is widely recognized as a critical, if not the critical, challenge facing our customers today.

The Cadence Incisive Verification Platform enables design teams to run full chip verification up to 100 times faster throughout the entire design cycle and compresses total functional verification time by up to 50%.

Speed and efficiency are the key issues in verification.

Incisive directly addresses both by supporting an unified methodology, which is based on the world's first single hurdle verification platform.

With Incisive, design teams can use one fast, efficient environment throughout the entire flow.

This excites customers because the benefits are big.

The technologies that enable the speed up come straight out of Cadence R&D, from the software integration of systems C in the Incisive engine, to the hardware processor-based architecture of Palladium.

Homegrown Cadence technologies are winning in customer accounts, such as Invidia, as I mentioned earlier, as well as ARM.

It's worth noting here we work with ARM in two ways; as a partner and as a customer.

As a customer, ARM, the world's leading provider of 16 and 32 bit embedded processor technology, has extended its existing technology collaboration with Cadence in the area of logic, emulation, and acceleration.

Arm will use the Incisive Verification Platform in its core design flow to enable improvements in compile time and verification speed, strong support for industry standards such as system C, the emerging assertion based techniques and the ability to support a variety of verification IP components.

Now, let me turn to our industry-leading encounter platform.

Industry in this digital platform continues to be strong, with most of the major semiconductor companies already using it.

In continuing to advance the encounter platform leadership, we have recently announced a definitive agreement to acquire privately held Get the Chip, which provides the world's most advanced nanometer scale synthesis technology to top chip and system design companies.

Major companies have enthusiastically embraced the Get the Chip technology, which has already enabled designs of over 50 million gains.

This is a really important strategic move for Cadence.

Get the Chip is for high end SOCs and will be integrated into our Encounter Platform.

We'll focus our strategy on big designs that need next generation synthesis to be competitive.

The Get the Chip technology produces superior input to physical design, giving customers rapid timing closure and high performance designs.

It's also faster, and in order of magnitude, higher capacity because it's a new architecture that's designed for today's chips.

I'm also delighted to bring the outstanding Get the Chip technology team into Cadence.

At our recent analyst day, I had the opportunity to introduce the Cadence technology dream team.

Our dream team now has a new member.

Dr. Chi Ping Su, President and Chief Operating Officer of Get the Chip, will be joining the Cadence Encounter team in charge of all syntheses reporting to Ping Chow. [PHONETIC]

By the way, this is another example of a key differentiator for us.

That is, how we integrate both homegrown and acquired technology.

Now, in the custom and analog space, which enables wireless and consumer products, we enjoy a very strong leadership position.

In fact, if a company is doing custom and analog design for such applications such as wireless hand sets, networking, consumer electronics such as digital cameras and camcorders, it's highly unlikely they are doing it without Cadence.

We are by far the leaders in this area.

We continue to pull ahead as a result of our continued investment in these technologies.

Because of this custom and analog technology will be increasingly critical to the development of most chips, we continue to invest in this area.

For example, our recent acquisition of Celestry brought with it the leading pass by simulation technology, Ultra Sim.

We are rapidly integrating it into our Incisive Verification Platform and our custom IC solution.

Chosen by customers this quarter such as RICO in Japan and IDT New Wave in China, Ultra Sim's full chip capabilities are addressing simulation challenges with splice-like accuracy and the speed to resolve our customers' most difficult design capacity issues.

Another investment was the purchase of assets from Antrim, which brought us Activea.

Activea gives us analog automation that can reduce the overall analog design cycle time by 30%.

We've integrated this technology into our custom IC solution that's already gaining traction with customers.

In fact, we expect it to drive the next generation design collaboration and IP capture.

Customers are reporting great success with the Cadence technology portfolio.

A key enabler of that success is our third strategy area, strategic third party partnerships, which are critical to IDMs and to support our -- and our support of the growth of the fabless market.

One of our key relationships here is with TSMC.

Cadence and TSMC teamed to distribute TSMC-developed libraries.

This further demonstrates TSMC's commitment to its ongoing relationship with Cadence.

We also continue to strengthen our technical partnership with Artisan as part of our commitment to support choice for our customers.

Now, not only was ARM a significant customer for Cadence this quarter, as I mentioned earlier, but we also announced a new five-year agreement with ARM that gives us early access to Arm's IP products.

This early access allows us to fine tune our products for ARM IP in advance of when our customers use our own products in their designs.

Ultimately, what this means is that our customers will be able to build systems with verified reusable hardware and software IP blocks faster and with greater confidence that the systems will be manufacturable the first time.

Our collaboration will benefit a host of systems designers with deliverable such as our Incisive Verification tools combined with the ARM integrator logic tile products.

Our signal integrity solutions combined with ARM's signal integrity libraries for specific foundries.

And finally, Cadence design foundry provides customers with experience based on our track record of success, with more than 30 ARM based designs.

Another way we are helping customers succeed is by helping them avoid time syncs that are outside the airport competencies.

This brings me to open access.

Here is the problem.

Today if customers are doing a custom analog design, they use one data base.

If they are doing digital place en route, they use another, and so on.

The problem is that the current database technologies are old, they are slow and think have limited capacity.

They are pre-nanometer era, and they only touch one part of the problem.

Customers have told me, frankly, that they are fed up with having to deal with multiple vendor databases and to maintain internally developed CAD databases just to keep up.

That's why they are supporting open access.

Because it's for the whole problem, custom and analog, as well as digital design.

In fact, there have been about 2500 downloads of the open access API and source code, and we expect proliferations to increase as we start shipping our custom platform on open access.

As for Cadence, our December release of SOC Encounter is on open access.

Our custom IC platform is in beta open access, scheduled for production around the end of June.

We have several coalition members working very closely with us on open access adoption.

Now, let me close by saying that our strategy is on track, we are gaining share in the fabless market, partnering closely with global customers who are consolidating on fewer vendors.

We are winning with our customers because our platforms are working, with solutions that address both digital and analog design, chips and systems delivered through both software and services.

We continue to grow and acquire technologies that will give customers a clear path beyond competitive legacy tools.

Our design technology portfolio is the most complete in the world.

And now it's also the most advanced.

Finally, in one of the toughest business climates on record, we have significantly reduced our costs both year-over-year and quarter-to-quarter.

We continue to execute with the fiscal discipline needed to ensure we can respond to market changes.

Bill Porter will now talk in more detail about our financial results, and then we'll take your questions.

Bill.

Thank you, Ray.

Good afternoon.

During Q1, we continued to execute to our targets in a customer environment that remains difficult, with customers having limited visibility into end markets.

Total Q1 revenue of $256 million was at the high end of our target range.

For the quarter, product revenue was $141 million.

Maintenance revenue was $82 million, and services revenue was $32 million.

We booked 82% of our Q1 product business under subscription licenses within our target range of 80 to 90%.

Revenue from backlog came in as expected, with approximately 80% of software product revenue coming from graveled backlog in Q1.

Average contract life was three years and payment terms were linear.

We saw customers continue to manage tightly to their budgets, reducing spending in areas such as maintenance and services.

In Q1, we achieved earnings per share on a pro forma basis of 4 cents on net income of $10 million.

On a GAAP basis, including amortization of acquired intangibles of $25 million, amortization of deferred stock compensation of $10 million, and write-off of in process technology for the Celestry acquisition of $2 million, net of tax effect we had a loss of $19 million or 7 cents per share.

Please refer to our website, cadence.com, for a detailed reconciliation between GAAP and pro forma earnings.

North America contributed 53% of the revenue, Europe 17%, Japan 21%, and Asia 9%.

Total cost and expenses were down 10% from the first quarter of 2002 reflecting the actions we took in Q4.

We are on target for total costs and expenses in 2003 to be down 12 to 14%, including the impact of Get the Chip.

We expect the Get the Chip acquisition to be two to three cents dilutive in 2003, which should bring us in at the lower end of our 50 to 55 cents guidance range for pro forma EPS.

Quarter-end head count was approximately 5200.

DSOs increased slightly from 104 days in Q4 to 105 days, due to seasonably lower revenue in Q1.

As revenue grows in Q2, DSOs should decline into the 80's, then moving into the 70's by 2003 and the mid-60's in 2004, as we move through the license transition.

The quality of receivables remained high, with receivables 90 days passed due at 2%, at the lower end of our historical range of 2 to 3%.

Long-term installment contract receivables declined to 105 million from $113 million in Q4.

We expect long-term receivables to continue to trend down, due to fewer term licenses.

Deferred revenue decreased from $213 million in Q4 to $209 million in Q1.

We expect deferred revenue to trend down over time, due to fewer annual maintenance billings and more subscriptions for quarterly billings.

However, as you know, deferred revenue can fluctuate from quarter-to-quarter.

We ended the quarter with $239 million in cash, down $132 million from Q4, as a result of stock repurchases, repayment of debt and restructuring payments.

Pro forma cash flow from operations, excluding restructuring payments, was approximately $22 million.

Operating cash flow would increase in Q2 and throughout the year as we built layers of subscription revenue.

Capital expenditures, as expected, were $17 million were down 47% from the $32 million in Q4, primarily due to reduced levels of IT spending.

During the quarter, we reduced long-term debt by $42 million to $10 million at quarter end.

We repurchased 6.2 million shares of Cadence stock for $62 million in the quarter.

Our remaining authorizations at the end of Q1 was $370 million.

Our view of 2003 remains tempered by the cautious behavior of our customers with respect to their budgets, and the high degree of uncertainty they face in their own markets.

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

For Q2, we expect total revenue to be in the range of 265 million to $275 million. 65 to 70% of software product revenue to come from [INAUDIBLE] backlog.

And pro forma EPS to be in the range of 9 to 10 cents.

For 2003, we expect pro forma earnings per share to be in the range of 50 to 55 cents.

In summary, we continue to execute to our targets in a difficult customer environment.

We delivered our new Incisive platform, which is seeing early market success.

And with the acquisitions of Get the Chip and Celestry, we continue to invest in our market leading Encounter and custom analog platforms, With that, operator, we'll open it up to questions.

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 and you would like to withdraw your registration, 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.

Eric Asiles with American Technical Research, please go ahead.

Good afternoon.

Couple of questions.

One was if, Bill, if you could give us what were subscriptions as a percentage of your product or software revenues?

Subscription bookings were 82%, Eric.

And that's the level of detail we'll be providing going forward.

I tried.

Okay.

How about book-to-bill?

Positive?

Yes.

And I'm assuming that the tax rate was funky, a little bit because of the write-off related stuff?

Did you still use the 26.5% tax rate?

Yes, we use 26.5%, that's correct.

Okay, and just sort of looking forward, Bill, I guess my questions relate more to you.

G&A continues to, I think of all the line items, I know revenues are going to start going up as the subscription bookings unwind, my only question is in what's in G&A that prevents you from perhaps writing that line item down further?

The one thing that's in G&A, Eric, as you probably know, is we had the Mentor trial, so that will come down for us in Q2 just because those were expenses that were heavier in G&A Q1.

Thanks.

The next question will come from the line of Jennifer Jordan with Wells Fargo.

Yes, good afternoon.

I was wondering if you could comment on anything you are seeing from the customers in this environment?

And also if you could mention what's going on in your PCB group, in terms of any performance there?

And any other color you can add on the SOC Encounter?

Jennifer, the big things on the plus side, I think I mentioned, the things that customers are looking for is efficiency and production of risks in the things that they do, and so those things are playing out pretty favorably for us.

The same time, it's a very difficult environment for customers.

And they continue to work their costs of design, their costs of manufacturing, their enterprise costs very aggressively.

There's a lot of restructuring going on among customers even today.

If you are looking at Japan for example, the change in corporate formats at some of the major players.

All of these things signal that customers are looking fundamentally at how they do business and rethinking -- rethinking the leverage that they can get from vendor consolidation, rethinking their leveraging -- their ability to leverage IP, certainly continuing leveraging foundry and manufacturing model relationships.

Ray, when you look at the way people are behaving right now, do you get any sense of as the results come in and continue to be mixed from the semiconductor industry, is there any concern as you get into Q2 you could see them kind of slam on the brakes like they did last year, or do you feel it's pretty much people have a good sense of where they're going and it's more of the same sideways?

Jennifer, it feels sideways to me.

There are some reasonable indications about volume increases being sustained.

I think the big problem is their ability to price those increased volumes to any kind of a meaningful revenue gain.

That speaks to capacity.

But it seems like to me the big moves, by and large, have been made.

Okay.

Thanks, Ray.

The next question comes from the line of Raj Seth with SG Cowan.

Please go ahead with your question.

Thank you very much.

Bill, can you talk a little bit about the pricing environment and whether or not you're continuing to get pressure on terms?

You mentioned that this quarter that the subscription deals you signed were linear in nature.

Are customers still pressing on you folks for any of the nonlinear type deals, several of which you have done in the past?

And I'm assuming that your bookings growth expectations here continue to be flattish; is that correct?

In terms of terms and conditions, Raj, customers are pushing for every advantage they can.

And we are just being disciplined about what we will accept.

That's why we did see the linear payment terms that I referred to earlier.

But, you know, things are very hard so they are doing whatever they can to, you know, to get an advantage.

And we just have to be patient about it.

In terms of, you know, bookings, we're not changing our outlook for bookings, but I think we all acknowledge there's a lot of risk out in the customer environment and for us, we're just going to have to manage that risk through the expense side of the equation because I don't think there's much that we will be able to do on the spending side.

That will happen based on what customers let go in their budgets.

Okay.

Thanks.

Finally, Ray, when you bought Ambet some time ago, one of the things you guys did is you got aggressive on price selling it as a stand alone synthesis product trying to get, I think, a toe hold in the synthesis space.

Will you take this Get the Chip technology, which you talked about integrating in the broader platform, and sell it as a stand alone?

Is there anything -- how do you plan on pricing that, if you do?

Raj, just a little context then I'm going to ask Penny to respond to the strategies around that product.

That -- Ambet was purchased almost six years ago.

It's provided a very credible foundation for us in establishing our physical synthesis capabilities.

It's worked well for us.

And I see, as I indicated in my remarks, the Get the Chip acquisition as a very strong addition to that capability.

Penny, do you want to talk about strategies?

Sure.

The [INAUDIBLE] [ INAUDIBLE ] by the Cadence product [INAUDIBLE].

That's the product that you referred to that Cadence took a very aggressive pricing strategy.

The Get the Chip technology is premiere advanced technology for high end big SOCs.

It will be priced according to the value that it delivers to its customers and we won't be looking to use price as a differentiateor, because frankly with this technology, we don't need to.

If you are doing a very big complex chip and you want to get rapid timing closure through the back end implementation, whether you're using the PC from Cadence or a PC from Synopsis, you get better results faster by using Get the Chip on the front end.

We will be pricing it accordingly.

We will continue to [INAUDIBLE] all the products in the Encounter Platform on available [INAUDIBLE], as well as available in the SOC Encounter product.

Great.

Thank you.

The next question will come from the line of Rich Balero with Needham.

Please go ahead.

Thank you.

I think you mentioned that you had a record [INAUDIBLE] in your emulation I'm wondering if that's correct and how far does that go back in terms of timeframe for the record?

It is correct, and it goes back the full four years that we have been in the emulation business.

So can you give any color in terms of what maybe drove that?

Was the Incisive strategy and the pricing around that, did that have a factor in that, or was it just pure competitive wins?

If you could give some color on the success there.

Well, it was a combination of things.

Not all of the -- not all of the wins were part of the Incisive platform.

There was quite a bit that was stand alone.

And what that tells me is that the Palladium advantage is working very, very well for customers.

Recall the Palladium is a relatively new product for us.

Certainly the inclusion of emulation and easy access to emulation on the Incisive Platform is a big deal for customers.

Emulation has been out of reach of a lot of customers because it's such a big investment item.

As part of the Incisive Platform, not only do they get bigger, faster verification solution but they get very easy access to emulation.

Okay.

Based on this first quarter, would you expect now to have a year-over-year increase in emulation '03 over '02?

Yes.

And one more question just on, you've given Encounter bookings metrics, you know, for the last couple quarters, I think.

I was wondering if you could give maybe a year-over-year Encounter bookings growth metric, you know, as you've been giving?

No.

It's -- we -- in the I inaugural year of Encounter we wrapped up, I believe we gave year-end numbers for the year as a whole.

Let me just leave it we are very pleased with the way Encounter is playing, and with the addition of Get the Chip, it's just a much more potent platform than even before.

Great.

Thank you.

The next question will come from the line of Jay Leshaur with Merrill Lynch.

Please go ahead.

Thanks.

First few business questions then some on technology.

Following up on the earlier questions, Bill can you say whether software product bookings were lower year-over-year?

And excluding any incremental bookings you might get from Get the Chip for this year, wouldn't it be perhaps you would have lower product bookings this year as compared to flat?

And secondly, on the business side, and it does kind of tie into technology, what do you see in terms of the usage of the remix rights that customers have in their contracts?

And do you somehow exclusively price or value the option of being able to gain access to new technology through remix? [INAUDIBLE] obviously trying to distinguish itself in some way from your remix practices, if you could talk about that?

Sure, Jay I'll take your last question first. and yes, we do charge a premium for customers to have that remix right.

And as you know, we also limit the remix right.

So this is not an unconditional, unlimited right.

It's the ability to mix in reasonable amounts of new technology so customers can get started in a seamless way, but that just gets them started and eventually they will need to come back.

In terms of levels of detail, you know, I'm not going to get into the levels of detail or bookings year-over-year, because as I indicated, we need to be directional for the year and not be on kind of a shortl-term treadmill, but look out on a longer horizon.

And we will do that and make sure we are looking out at that piece, but not get on a quarter-to-quarter discussion of bookings.

As far as technology is concerned with respect for Encounter p\Platform, can you make any distinction in terms of penetration into new accounts, that is, formally non-Cadence accounts, as opposed to upgrades from within your own physical design back end up into Encounter Platform?

Um -- Jay, the -- in my remarks I mentioned Real Tech in Asia, and that's not an unusual situation.

It's a -- it's been a great strategic wedge for us to move into some of the back end flows that were not ours historically, particularly in the fabless area where we are making good progress.

All right, but you don't want to provide that split.

At least before the merger, SDC had been doing a fairly large percent of its business into a lumpy account.

You gave one example of that, I suppose, but what is the trend there more broadly?

Um -- yes.

It's a level of granularity that I cannot get into, Jay.

Suffice it to say that it's a very effective tool, and we continue to, as part of the take-share story, be successful in that area.

Okay.

In Q4, you had a record core quarter for emulation, at least as far as revenues were concerned, since even before the acquisition of Quick Turn.

So here a quarter later, what turned things around to now give you a record positive quarter there?

Um -- Jay, I'm not sure about the first part.

The record core quarter.

But, so without giving that to you, and I think -- I think just acknowledging that we don't give that level of granularity, what's happening is that a relatively new technology, Palladium, and a powerful platform, Incisive, is getting traction with customers.

Okay.

And lastly, I guess just from a strategic standpoint, do you think that you, and perhaps all of EDA can, this year, increase share of R&D budget?

It would seem that at least in terms of reported results in 2002, EDA somewhat underperformed as an industry.

What happened with your customers R&D?

And again, I know there are differences in terms of license model effects and so forth.

But on a reported basis you wanted to perform.

So do you think organically this year EDA can somehow begin to do what you've always hoped to do and capture more share of that budget?

Jay, I haven't analyzed the whole industry, but looking at it from Cadence's perspective, we actually see it going the other way, where EDA is becoming a higher amount of the customers' R&D budget, which obviously customers watch, too, so we end up in negotiation about how we can help them manage the overall -- the total cost of ownership.

The license model mix definitely will change in terms of numbers.

But in talking to customers, I haven't seen what you're describing as customers saying they want EDA to go down as a percentage of their R&D.

If anything, it's climbing and to be frank, they are complaining about the fact that it's climbing.

So it's climbing.

I wasn't suggesting that was the case, I was asking whether in fact you could, increase your share.

I think we are.

Okay.

Thanks, Penny.

The next question will come from the line of Gairo Timajanian, with RBC Capital Markets.

Please go ahead.

Thanks very much.

I wanted to see if you could add some color on the PSD revenue number, which looks like it was down about 50% both sequentially and year-over-year.

The only color to add is that consistent with the things really throughout this downturn, the things that are selling and have really strong energy are the things that designers must have to do the new generation of chips and systems.

PFC has had a reasonable performance last year, did not have a particularly good performance this quarter.

Okay.

And is that primarily the PCB product still?

Are there other products that are in that category now?

It's PCB and packaging.

So where we continue to be strong is the high speed market.

Again, a lot of abstract is coming off the big SOCs and our major accounts where you have to put a big chip into a slow chip package and [INAUDIBLE] it out off the board.

We are very, very powerful in that market place.

So the high end market we continue to actually do competitive replacement, programs to do competitive replacement to show the value of technology to our customers and we are very, very pleased with the progress.

It's the overall PCB market is really hurting, and so we get affected by that like everybody else does.

Okay.

On the product costs and the gross margin side, actually was better than it's been in recent quarters and in fact, continues a downward trend.

Couple questions there.

How are you doing this and do you expect it to stay down at the level that it's at?

Yeah, Gairo, that reduction will be continuing, and it's's really us getting away from some OEM arrangements for licensing technology.

The biggest being numerical, but there are others, you know, that we have been moving off of over time.

So that is the big impact and you will see it continue.

So we could expect that to go down again in Q2?

I'm not going to get to that level, but product costs at the level they are can be sustained.

Okay, great.

Thanks a lot.

The next question will come from the line of Bren Stevens with UBS, please go ahead.

Hi, Penny.

Maybe this question is for you.

Regarding Get to Chip, what's different about the get to chip products that will allow you to attack the physical synthesis market?

Um -- I'll try not to get too technical, but when you do optimization of design, you can either do a broad global optimization looking at big shots of chip, which is what Get the Chip does, or you can do small local optimizations based on bottom up block space due of the design, which is what competitors products do.

By having an order of magnitude which is greater than 10 X capacity in its architecture, the Get the Chip products enable us to -- our customers -- to do broad global optimizations designed early in the design stage and then to [INAUDIBLE] optimization of the blocks.

So it's very consistent with our approach to prototyping, which is in our Encounter approach.

It's a philosophy of design.

We read the whole -- the whole chip and look at big portions of the design with very high capacity, globally optimize, and then focus in on small portions of the design to figure out further optimizations.

To do that, fundamentally, you have to rewrite from scratch with an architecture that thinks in advance about how big the chips are.

Mmmm-hmmm.

That's why Get the Chip is getting the results it is.

Okay.

So it is specifically geared to those larger gate chips?

Yes.

And just a follow-up question.

Any strength by geometry in 90 nanometer or so forth, or any breakouts you can give us on that?

Quite probably because the size and speed of designs for the Get the Chip technology really shines.

It's going to be .15, 13 and 90 and below.

Okay, and then how about just Cadence over all for this quarter, what are the trends right now?

We don't break out our business by technology now because our customers are so large, it would be very difficult to do that.

We do see customers continuing to be concerned about 90 nanometer and working with their foundry to make sure they are doing the tools and modeling necessary to do 99 meter and continuing to invest in one study, which is where the encounter platform plays so well.

Okay, great.

Thank you very much.

The next question will come from the line of Armond Chando of Lehman Brothers.

Please go ahead

Hi.

I have a few questions.

I'll go one at a time to make it easier.

Bill, first of all for you.

Just to make sure I heard you right.

You said that you had a linear -- in terms of payment you had a linear; is that different than the 20, 30, 50 split you talked about in the past?

I'm not sure that when you talk about 20, 30, 50, Armond, but our bookings for the quarter, from one of the things that people are interested in is were they linear?

And the answer is yes, over the term of the three-year contract.

So you can think about that as a third of the business in each area.

And along with that, bookings split, and the payment terms were also split the same way with the bookings.

So in other words is this different from the past?

I was under the impression that the payment terms allowed you to pay 50% or so in the third year and, you know, sort of back-end loaded.

I wanted to make sure I was not confused there.

Yeah, I think you might have been, Armond.

If there is a customer where you're looking at share, occasionally you will look at a contract like that, but that is not what I would call a -- you know, standard arrangement.

What I was referring to was our portfolio, this time, which has all of our contracts in it, which is linear over three years.

Okay.

Thank you very much.

The next question I have is, can you talk roughly, sort of, you know, if you look at the sort of the three buyers of EDA, generally the IDMs, the fabless companies and the systems companies, sort of what you're seeing in each if you can talk qualitatively and where do you expect more strength versus others?

Armond, I think that the way I would redivide that is between semiconductor and systems. and I would say that semiconductor companies are -- continue to pretty equally struggle with the secular downturn.

Among the systems companies and a few semiconductor companies that serve systems companies, the bright spot, the one bright spot that we see is around consumer products.

And so there are a couple of chip companies that are focused on exactly the right vertical in consumer products, and there are a few systems companies that have some very good things going in consumer products that happen to be hot right now and that's a bright spot but there aren't many of those around even authorize the systems companies.

Well, thank you very much.

And then last question I have is, you talked quantitively about customers being a little bit concerned about the 90 nanometer designing, and you know I think there's obviously been some questions about yields in 130.

Could you talk a little bit about, say versus last year, roughly, you know, what kind of share of say -- what kind of -- how many designs are going on or what percentage of designs in the digital side are going on for the leading edge of technologies and how -- you know what your share is roughly speaking if you can't be quantitatively -- in terms of leading edge process technology; thank you.

We don't break it out by designs going into each technology.

There are so many customers it would be hard for us to do that.

But, when we look at one study in 90, there were yield problems in the past from one study, which is part of what's making up of an entire industry in partnership with our customers.

Being careful, be cautious and partner us to make sure that we're doing the tool work necessary.

But one thing I would say is, almost every high end design in the world is going to be going through Cadence technology.

Now, it will also probably be going through our competitor's technology.

That is the nature of the beast.

If any one of us was to try and claim some percentage share of 130 or 90, it would be misleading because you take a complex chip and it's very unlikely at some point in the flow it won't go through fine tool from Synopsis from Mentor and from Cadence.

Thank you.

And then just last question on Get the Chip acquisition.

Is get the chip going to be, you know, I think historically you're talking the. [ INAUDIBLE ] Encounter, which had the option of plugging into a synopsis design compiler and then come back into your routing and, you know, physical design tools.

Is this going to replace the need to go to an alternative designer, or will it also have that option?

Just curious on that.

Part of our philosophy is to allow our customers to take which tools they want in the flow and because of our open approach, to make it possible for them to integrate other suppliers into the flow.

So we never block that.

The Get the Chip technology that is in production today, which is the RFC product, will enable customers to stay within a Cadence flow as an alternative to going out to a design compiler for a synopsis, so yes, it does replace that step.

But as I said earlier, we are very much focusing on the high end customers, the big chips.

This is new technology, it's not something something that would be appropriate for us to take very broad very fast.

So we're going to be very focused on winning on the most difficult chips in the world from a size or timing perspective.

But it would keep -- it would enable customers, should they choose to, to stay within a Cadence flow for the entire synthesis portion of the flow.

Thank you.

And then, I'm assuming you said -- you said .15 micron and below.

So that's probably the majority of designs at this point, wouldn't it be?

No.

The majority if you look at sheer numbers, are still at .18 and .25.

Okay.

Thank you very much.

Appreciate it.

The next question comes from the line of Dennis Wasung with Adams Harkness and Hill.

Please go ahead.

Thank you.

Couple of questions.

First off along the lines of the Get the Chip acquisition.

What is the timeframe where that product will be fully integrated into the Encounter Platform?

From a technology perspective, I don't have an answer for you, Dennis.

We'll know within a month, probably.

From a customer's perspective we have a lot of customers using the Get to Chip product within an Encounter flow, [INAUDIBLE] flow.

So from a practical perspective, customers can use the product in a flow today.

We need to bring the R&D teams together to do the planning necessary to be able to describe at a technical level how we'll integrate them together.

But Chi Ping Su will be heading up the combined synthesis team and they will have the [INAUDIBLE[ team and the PCS team with the Get the Chip team, so it's going to be his job to figure out the integration past for us and we are just delighted that he's joining Cadence.

Is the acquisition closed already?

Sorry, I couldn't understand that.

I'm sorry, is the acquisition completed at this point?

It's not closed.

Okay.

We expect it will close in a matter of a few days.

Okay.

And along the line of the Encounter integration in general with some of the other tools from SPC, Plato, Simplex and whatnot, can you just kind of characterize the integration level that you're at today?

Is it pretty much a seemless flow within that environment right now for designers?

The release that we shipped in December is a [ INAUDIBLE ] of a full integration, that we are very pleased with where we got in December.

To be honest, we always have more improvement to do.

These are very complex technologies and we will be doing incremental improvements for the next year.

But from a customer's perspective, it's one product with one flow with the product you described.

Okay.

Switching gears to the emulation side of the market.

I think last quarterly we talked about price being an issue with some of the competition out there.

Has that changed substantially?

And also has sort of the leasing model of emulation capacity taken on as a pretty significant piece this time around?

We saw less of the negative pricing behavior this quarter than we saw last quarter.

So that's a good things.

Certainly the leasing model or the easy access model that the platform provides is a positive thing for many smaller customers.

And we're seeing it play out that way.

Okay.

And just another comment in general, I guess, or question about the emulation market.

It seems like it's becoming, at least from customers I talk to, it seems to be coming to be becoming a more important verification technology.

Would you characterize that as something that where customers traditionally who have not used emulation are beginning to come around to it as they need more verification performance?

Is that just a fundamental shift we are seeing in the industry at this point?

Yes.

It's a shift in that with the capacity and complexity of verification, customers need approaches beyond the traditional logic simulator to verify the design.

And so whether it's [INAUDIBLE], Whether it's assertion-based techniques or emulation or acceleration, they are looking for an unified environment which they can sit in and use the appropriate technique to get the speed and efficiency they are looking for.

Okay.

Great.

The design for manufacturing space, DFM, any updates along those lines?

And I guess, how is the business going in that side of the company?

We are working in stealth mode on the execution of our strategy and we ill announce it when we are ready.

Fair enough.

And lastly, just I guess a broader question for the customer environment.

Has there been any change at all within the last few months from your view of the customers and their, I guess their outlooks or their just attitudes in general towards spending on these?

Obviously, things are tight, but any noticeable changes in the last three to six months?

No.

I think that it's clear that they are determined to get their own business models and cost models as tight as it can be.

And that means that things that are discretionary are not purchased and things that they have to have in order to develop new products, they do purchase.

Okay.

Great.

Thank you very much.

The next question will come from the line of Manny Husini with Soundview Technology Group.

Please go ahead.

Yes.

Not to beat a dead horse but I want to get more clarification on the environment spending environment at the customer side.

It seems like the number of. [ INAUDIBLE ] isn't really increasing or at least not increasing as fast as it did last year.

So my question is, to what extend would customers need to go and spend more than what they already have in order to design at 130 nanometer?

And I have some other follow-up questions.

It's the cost per design that's increasing.

So it's the number of takeouts is relatively flat or even if you took -- they say the number's going to come down at the time because the chips are getting bigger and more complex.

You can get more integration on them.

The cost per design is increasing.

And from the [ INAUDIBLE ] technology that's needed to do the design.

Sure.

Customers know that they need to spend more per designer per year to do designs.

Sure.

But given if there is a very modest recovery in the overall semi in the latter part of '03, would that be fair to say that customers could come back to you guys and actually down take bookings by five to ten percent and push out the rest of it to '04?

Um -- I don't know what down take means.

Down take meaning right now the consensus for booking for this year is like flat booking.

So down take something like five to ten percent less than expected in bookings.

It's always possible for customers against future commitments to push things out or buy less than what we currently anticipate.

That's certainly a possibility.

What we see today is a tight environment.

Customers are being very careful.

They are being selective about what they buy, but they are certainly investing in the ability to develop products at the new geometries and they are investing in the new technologies around verification that we've already discussed.

Sure.

And going back to your strategy, should we expect any kind of revenue contribution for -- from your third party partnerships in the future years, like you go to TSMC and they them with libraries.

Is this a business model down the road that would help you to generate any kind of revenues?

As a general case, no.

We go to our third party partners as co-suppliers in the design chain. [ INAUDIBLE ] in special cases.

In that case, there's a potential for future revenue. [ INAUDIBLE ] production design.

But in the general case, no we are not looking to our partners for revenue.

It's more about selling together and supporting the customer together to make the customer successful.

Sure.

Just can you put any kind of color on the deals -- on the deal you announced a couple quarters ago with IBM, supporting IBM and also utilizing some of those people to support other customers.

I think you may be referring to the investment we made in their test business?

Yes.

Um -- the business directly back to IBM and their customers is going well.

The reports that I'm getting from both IBM at the senior and at the engineering levels is very encouraging about their satisfaction with what we are providing back to them, as well as our ability to work with our customers.

We have not yet seen the full product [INAUDIBLE] of that technology into the kings flow.

That's later this year.

Sure.

And any color on the financing part of the Get the Chip acquisition?

Stock or cash, or should we expect a significant hit to the cash balance for the June quarter?

Um -- Manny, we are not going to comment on specific terms of the transaction.

You'll be able to see the results when we publish our Qs.

Thank you.

The next question comes from the line of Bill Fairics with DA Davidson.

Please go ahead.

Okay.

Um -- first of all, these are mainly housekeeping.

Bill, there's an extra schedule in your release that shows some extraordinary legal is that related to Mentor, all the Mentor trial?

Um -- not sure, Bill, what you're referring to.

$11 million.

Looks like it's footnote D in the pro formas. 11 million 100 -- what is that?

That's just some litigation expenses that we just have not commented on and I don't think we, you know, we would comment on this specifics for those.

Did it get into this release by accident?

Nope.

Okay.

It's been there every quarter.

It's just something we have not commented on the specifics for.

It's one of those areas you just don't comment on.

But you have published a schedule for it?

Yes.

Just so people know it's a litigation item.

Okay.

Thanks.

And then -- um -- I notice in the 10K you've begun to disclose a backlog.

I was wondering if you could give the comparable year-end 2001 number for the 1.4 billion?

What that might have been?

Yeah.

We just started to disclose backlog this year.

And we will do it on a going forward basis because it's important to understand the subscription model.

You know, we didn't do it in the past, didn't think it was important and I'm not going to go back in history to do that.

Okay.

And then two more housekeeping.

Depreciation and amortization.

Sure.

It' get that for you.

Do you want it for the quarter?

Yeah, for the quarterly you just reported.

Okay.

And did you sell receivables in the quarter?

Yeah.

We had and you'll see in our cash flows $20 million of receivable sales, same as we did last quarter.

For depreciation and amortization for the quarter, it was $57 million.

For both.

Okay.

For both, yes.

Great.

Thanks very much, Bill.

You're welcome.

The next question comes from Alex Dunoe with UBS Warburg.

Please go ahead.

Yes, thank you.

I was wondering if, with regards to developments in the wireless market, if you're seeing any developments you can point to wherein there are new opportunities with integrations of the radio functions, either within radio modules, or even where we're starting to see direct down conversion and into bay span modules?

Nothing specific that we could point to that would effect our business, except to say that the continuing integration of RS and analog on to chip plays to our position of being able to integrate all the technologies together.

These developments that we're seeing here at UBS in terms of what the market is doing on that front, are they occuring at any geometries that are challenging the tools at this point for you, or is it just like you said, the ongoing integration trend?

Um -- the -- well, the integration of analog and RF on chip is very challenging and continues to be challenging.

So it's an area we invest in because of the noise issues associated with that.

But not beyond the general case.

Okay.

Going back to some of the previous questions that were asked on the 90 nanometer mode, is it the case that obviously the benefits to the customers are substantial, the challenges are substantial, are you able to price your tools into this market such that the fact that fewer companies are doing this a number of the design seats are going to this fewer, that the actual pricing. that you're able to match that with what you are doing in the market?

The way the pricing man tests itself is as to move from one study to 90 nanometer you need to adopt -- the customer needs to adopt -- new methodologies and new tools.

Those new methodologies and tools get priced appropriately with the value of moving the customer on to 90 nanometer.

So the answer is, currently you are able to price to make up for what those unit volume discrepancies might be relative to past upgrade cycles?

Not -- it's not that you go to the customer and say, well now you are on 90 and there are fewer design sets for you to pay for, it's more that they are -- there are additional products the customers believe they need to buy to move on to the 90 nanometer employed and that's how we grow our business, by providing more new additional tools and capabilities that they might not have needed in an earlier noticed.

Okay.

Is it your perception at this level in terms of the developing the 90 nanometer mode, there are substantial challenges still to be overcome -- the opportunity for market share to shift as we move into this next process mode?

Yes.

We very much believe that.

And a lot of our strategy around having the best technology and investing in major customer relationships and major foundries is we believe we are at the beginning of the shift to Cadence because of the technologies needed nor 90.

There are still actually many unsolved problems at 90 nanometer.

So it's a tremendous opportunity for us as customers move from 180 to 130 and from 130 to 90, they want to talk to Cadence.

Ray, I was wondering if I could get you to take a shot at in a macro sense, you know last year we saw the EDA industry for the first time contract.

Are we in a position for the overall industry to see that again?

And, if you're, you know, giving us a range or idea, what kind of semiconductor industry ingrowth that might be predicated upon?

Well, I think the primary driver, Alex, is the license model shift that Cadence is going through, the biggest part of that being felt this year.

And so the numbers are almost certainly going to show a year-over-year decline --

Good point.

-- in the EDA industry.

Underneath that, I think that business bookings, though they are not all visible to me, bookings are likely to be down year-over-year for the industry as a whole.

And I think that is related to the general health of the semiconductor industry.

It's certainly possible that if we were to get that long hoped for elusive second half upturn, that that would -- that would be offset somewhat, though not at the revenue level, it would be in the bookings numbers.

Great.

Okay.

Thank you very much.

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

Please go ahead.

Yes.

Just a couple quick questions.

One relates to upgrades to the SOC Encounter platform and to the nanometer router.

Can you give us any indication how that's working within your own platform base and kind of percentage of people who you are seeing start to make that move based on how they are designing now?

The SOC Encounter product includes both the new NanoRoute and the very robust Walk About.

The reason we do it that way is because NanoRoute is an extraordinary router.

But as we have said for awhile it's new technology and routers take time to mature.

So customers doing big chips can route the chips through NanoRoute [INAUDIBLE] but on the core Cadence continue to mature the technology, they can use Walk Abouts.

It would be very hard for me to answer --

Maybe the better way to ask it is can you give a sense of how many of the customers who have been using SEPKS have made a transition to the SOC encounter platform?

Um -- no, I couldn't give you the number.

It's a lot because of the [ INAUDIBLE ], but no, I don't have a breakout.

Okay.

That's all right.

Second question, Penny, was related to the paladium platform and I think this has maybe gotten worked over by everyone else.

But I'm wondering about, as you see -- there was some mention about the idea that emulations becoming a bigger and bigger important part of that market of the it looked back in 2000 like emulation was maybe a $100 million market where do you see it now and where do you see it going as it starts to build back up in importance?

Jennifer, I think it's difficult to miss the fact that it is becoming more important as is verification itself.

And it's -- it is a powerful way to verify the large leading chips, and thereby manage a lot of bulk design and manufacturing risk.

So I think that's a big deal.

I think the market size last year was quite a bit larger than the number you mentioned.

Okay.

And I do see it becoming more important this year and next.

The market size specific to emulation was larger?

Yes.

Okay.

Great.

That's it.

Thanks.

All right.

Let me just summarize very briefly.

We feel like we're executing well.

We are delivering new technology into the market place from Cadence R&D and by integrating things that we're acquiring.

Most importantly, we are assembling a very impressive team that is delivering the goods.

Thanks for joining us, we will talk to you next time.

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

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