益華電腦 (CDNS) 2003 Q3 法說會逐字稿

Welcome to the Cadence Design Systems third quarter earnings release conference call.

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

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

At that time if you have a question, please press the 1 followed by the 4 on your telephone.

As a reminder, this conference is being recorded, Wednesday, October 15, 2003.

I would now like to turn the conference over to Larissa DeCarlo, Vice President of Investor Relations.

Please go ahead, ma'am.

Thanks, operator.

This is Larissa DeCarlo.

Welcome to Cadence's third quarter earnings conference call for 2003.

By now you should have seen our press release on Business Wire.

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

With me today are Ray Bingham, President and Chief Executive Officer, and Bill Porter, Senior Vice President and Chief Financial Officer.

Ray and Bill will present our prepared remarks.

Also here today are Lavi Lev, Executive Vice President and General Manager of Implementation, and Penny Herscher, Executive Vice President and General Manager of Design Verification.

Lavi and Penny will be available to take your questions along with Ray and Bill.

Please remember that today's discussion will contain forward-looking statements and that our actual results may differ materially from those expectations.

For information on factors that could cause a difference in our results, please refer to our 10K for the period ended December 28, 2002 and our 10Q for the period ended June 28, 2003.

All the numbers reflect earnings, excluding goodwill and unusual items.

GAAP earnings and reconciliations of the numbers are available in the earnings press release we issued this afternoon, also available on our web site.

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

Thank you, Larissa.

Again this quarter, Cadence executed well.

Third quarter revenue totaled $269 million and pro forma earnings per share was 12 cents, well within our guidance. 81% of our Q3 business was booked as subscription licenses.

During the quarter, I met with a lot of customers around the world.

What they tell me suggests that we are seeing the welcome first signs of a gradual recovery.

The foundry business has shown some improvement; fab utilization is up.

Some customers are beginning to sound more optimistic about certain end markets.

For example, we see consumer electronics IC volumes increasing; however, with the exception of flash memory, ASPs continue to be flat to down, which limits much top line growth.

Nonetheless, customers everywhere continue to be tightly focused on costs.

Cadence is differentiated by our leadership across most elements of the $4 billion EDA market.

Because we are involved in virtually all aspects of EDA, we have a unique perspective on the challenges designers face.

We use this perspective to create integrated solutions that span customers' entire design process.

Our technology platforms optimize design volumes like automated visual and customized C design.

By delivering world class technology and integrating the tools that designers use, we are able to directly impact customers' productivity.

Since announcing our platform strategy in mid '02, we have launched three significant platforms, part of an aggressive technology rollout.

First, the encounter platform targeted specifically at nanometer semiconductor processes.

Then the Incisive verification platform that delivered the first ever comprehensive verification environment.

In the past quarters, the Virtuoso platform for custom analog design was delivered.

Early next year we will release the silicon package board platform.

As you can see, we are executing as we told you we would.

Now, let me take you through the progress we've made on each of these platform offerings.

Incisive is our verification platform.

It provides customers with the highest performance verification system available.

Incisive is differentiated by a single kernel architecture, unified environment, embedded assertions, acceleration on demand and now industry-leading forward-verification.

Cadence is the leader in the verification market, which is increasing in importance as systems [INAUDIBLE], complexity increases exponentially.

This quarter, we continued to improve Incisive performance by cutting set-up time in half and doubling the run time speed of simulation acceleration.

We also made two key strategic moves with Incisive this quarter.

First as a result of acquiring BURPLEX, we were able to add conformal, which is the market-leading full verification solution.

And we've created, secondly, a precedent-setting alliance with CoWare.

Cadence and CoWare are taking a new approach to collaboration.

Our goal is to develop a unified solution for electronic system designs through to RTL implementation.

The alliance involves joint development, cross licensing, according the go-market strategy and a Cadence investment in CoWare.

In summary, the Incisive strategy, which we started to execute on in January, is working, and we're gaining competitive wins across the world.

Our regulation products, for example, are winning at customers like ZTE, a leading networking company in China, who chose Cadence over both Access and Mentor.

In Japan, JVC chose Cadence simulation over Access and Ferris and also leveraged the Incisive capability and business approach.

Here in the U.S., Nvidia placed significant orders for new generation technology.

These wins showed a significant momentum the Incisive platform is gaining.

34 new logos in the last two quarters.

Encounter is our platform for designers who work on integrated digital circuits.

This segment has been the primary focus of our acquisition strategy over the past two years.

That activity is now largely complete and beginning to bear fruit.

We give you a couple of examples.

Get2Chip provided us with what is clearly the world's strongest synthesis technology for nanometer scale design.

It is being used in production by several leading edge companies, and their feedback to us is highly encouraging.

NANORAP is now widely recognized as the leading routing technology for nanometer designs.

It is integrated into Encounter and achieved its 100th production tape-out this quarter.

First Encounter goes from strength to strength.

It is now used in 75% of all chips over 5 million gates.

With new Encounter releases every four months, our integration of this platform is ahead of schedule.

With the September release of Encounter 3.2, we improved timing closure, delivered low power design capabilities and continued to drive integration and ease of use.

The result is shorter overall development time for design teams.

In fact, customers using 3.2 can now complete complex design in approximately 1/3 of the time that it takes with competitive tools.

Encounter is now interoperable with the Virtuoso platform through open access, facilitating SOC productivity.

And Encounter is the preferred choice for big, fast chips.

This is a new technology, it is on the ascent and it's the basis of the new generation of design technology.

In the $600 million custom and analog mix signal market, Cadence continues to be the clear leader.

We continue to invest in this platform, as well.

In September, we announced in the Virtuoso custom design platform.

It's the world's first comprehensive platform for fast, silicon-accurate custom analog RF and mixed signal design.

The platform integrates new capabilities such as the ultra-slim high-speed simulator, which eliminates costly resyms of the design and therefore shortens time to market.

Our successful launch of the Virtuoso custom design platform is being ratified by customers like Silicon Labs, for instance, which produces analog-intensive mixed signal ICs.

Finally, Silicon Package Board is slated to be launched as our fourth platform early next year.

It is targeted at the IC packed of PCB design market.

During this past quarter, we rolled out the tightly integrated Silicon Package Board product line version 15.0.

The 15.0 release extended our high-speed design support for gigabit speeds and added support for the emerging system and package design market, providing the strongest modeling and signal integrity capabilities for complex package designs.

This Linix-based environment is both powerful and cost effective for advanced packaging board design teams.

We also announced a new designing kit for the Intel IXP 2800 network processor, which continues our strategy of helping leading IC companies speed the design in of their chipsets.

As you can see, we are executing.

We're executing to our strategy of developing and integrating world class technology into our platforms.

Customers are responding positively to the strategy and it is evidenced by AMB's decision to extend their usage of the Encounter and the Incisive platforms for processor design and increase their usage at the same time of products like Conformal, Fire and Ice and Voltage Storm.

Beyond platforms, openness and interoperability play an important role in allowing customers to deliver products on spec and on time.

We've led the industry with our contribution of our open access database to the SI-2 coalition.

It is the highest performance, highest capacity electronic design database bar none and is gaining terrific momentum.

This quarter, nine new EDA companies joined the open access coalition, including notably, Mentor Graphics.

Also, PDF Solutions just announced PDF-X, another commercially available product built on the open access database.

Our continued investment in services is designed to drive customer productivity, improve our products, and thereby increase our product sales.

This investment is paying off as evidenced by two customer stories that I will mention.

BridgeCo is the leading supplier of rich media networking solutions.

This was a competitive win that started as a design service opportunity and expanded to include software and virtual cad services.

Numerix is a fast growing semiconductor company that has developed the world's lowest power GPS chipset.

Its target applications include mobile phones, tracking devices and the automotive industry.

Cadence equipped Numerix with tools and provided design and supply chain services for developing their base band processor chip.

The Cadence design family routine took their design, performed the layout work, take the chip out to TSMC, and got working samples back to Numerix in time for them to launch their products at the annual GPS trade show in September.

I'm going to turn to Bill and ask him to talk about our financial execution.

Bill?

Thanks, Ray.

There are some signs of life in the economy.

However, until customers see top line growth that they believe to be sustainable, we do not expect them to increase their R&D budgets in a significant way.

Within this cost-conscious environment, I am pleased that in Q3 we were able to execute according to our plans.

Total Q3 revenue was $269 million, in the middle of our target range.

Product revenue was $152 million, maintenance revenue was $83 million and services revenue was $34 million.

We booked 81% of our Q3 product business under subscription licenses, within our target range of 80 to 90%.

About 70% of software product revenue came from ratable backlog in Q3.

Due to higher seasonal revenue in Q4, revenue from our ratable backlog will be about 60%.

As we continue our subscription model transition, we have to make -- software product revenue from backlog in 2004 will be about 70%.

Average contract life was three years.

We continue to believe that a disciplined approach to managing the length of contracts is of strategic importance.

In Q3, we achieved earnings per share on a pro forma basis of 12 cents on net income of $33 million, in the middle of our target range, up 33% from Q3.

On a GAAP basis, including restructuring charges of $63 million and other items of $28 million, net of tax effect, we had a loss of 6 cents per share or $15 million.

Please refer to our earnings press release or our web site, www.cadence.com, for a detailed reconciliation between GAAP and pro forma earnings.

In Q3, revenue by geography was North America 58%, Europe 20%, Japan 13%, and Asia 9%.

Total cost and expenses on EBG basis were $224 million in Q3.

This is an 18% decrease from the same quarter one year ago.

In Q4, we expect another sequential decrease in total costs and expenses resulting in fourth quarter costs being down about 19% from 2002.

These levels keep us on target to achieve an operating margin of 30% by the end of 2004.

Head count is approximately 4800.

Gross margin for Q3 was 85%, at our target range.

Operating margin for Q3 on an EBG basis was 17%, up from 14% in Q2.

We expect operating margins to be in the high 20s in Q4 on the way to our goal of 30% operating margin by the end of 2004 as we complete the license model transition.

DSOs were 97 days, in line with our expectations for Q3 of the mid-90s.

As you will recall it was our shift to a much higher subscription mix in the second half of 2002 that caused our DSOs to move above historical levels.

We believe DSOs have peaked and will now drop to the low 90s or high 80s in Q4.

Our goal for the end of 2004 is DSO in the mid-70s.

The quality of receivables remained high, with receivables 90 days past due at 3%, within our historical range of 2 to 3%.

In Q3, we generated $70 million of operating cash flow, up 90% from Q2.

Operating cash flow which tracks with operating income will continue to improve as operating income increases.

We ended the quarter with $394 million in cash.

Capital expenditures were $15 million; we're on track to reduce Cap Ex by 40% over last year.

As you know, during Q3 we raised $420 million through the private placement of convertible bonds.

We also implemented a cost spread that limits dilution of the conversion of the notes at a price below approximately $23 per share.

The result is that Cadence now has more liquidity at a lower cost.

We used $152 million of the proceeds from the notes to repurchase 11 million shares of our common stock.

Under the current authorization, we have board approval to repurchase an additional $218 million of common stock.

Now we'll look to our outlook for Q4 and the year.

Our view remains tempered by our customers' caution.

Therefore, we continue to expect bookings for the year to be down about 10%.

For Q4, we expect total revenue to be in the range of $295 million to $305 million.

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

And about 60% of software product revenue to come from the ratable backlog.

Pro forma earnings per share for Q4 should be in the range of 23 cents to 25 cents.

On a GAAP basis, including amortization of acquired intangibles, restructuring and other charges, Q4 earnings are expected to be in the range of 9 cents to 11 cents.

For 2003, we expect total revenues to be in the range of $1.095 billion to $1.105 billion.

Pro forma earnings per share for the year should be in the range of 48 cents to 50 cents.

On a GAAP basis, including amortization of acquired intangibles, restructuring and other charges, the results for fiscal 2003 are expected to be a loss in the range of 5 cents to 7 cents.

Q3 was all about continued execution, and I am pleased with the progress we've made.

We have executed our plans to reduce costs and are making steady progress integrating recent acquisitions into our major platforms.

I am confident that together these actions will enable us to continue to deliver market-leading technologies and solutions to our customers.

Now we'd like to turn the call back to Ray before we take your questions.

In closing, let me say that while anecdotal data suggests the environment may be improving, customers continue to be cautious about their spending.

We're focused on executing well our financial plans while delivering great new technology.

We delivered 11 new capabilities to the market in the past quarter, improving every single platform with better integration and stronger capabilities.

This focus resulted in a good Q3 with wins with several of the industry's most cutting-edge customers.

Companies like Nvidia, Ericsson, Crocket, Microsemi, [INAUDIBLE] Networks, and AMD.

As we move into our fourth quarter, I'm confident that Cadence technology and the Cadence team are the strongest in the industry.

Now we'd like to take your questions.

Thank you, ladies and gentlemen, if you would like to register a question, press the 1 followed by the 4 on your telephone.

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

If your question has been answered and you'd like to withdraw your registration, press the 1 followed by the 3.

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

The first question will come from the line of Raj Seth with SG Cowen.

Go ahead.

Hi, thank you very much.

Bill, a question on the subscription mix.

First, of the non-subscription piece of what you booked, how much of that was perpetual and how much was term?

The perpetual piece is in the 5% range, Raj.

The remainder is term.

And how do you -- there's a lot of discussion right now in -- in the market about customers increasingly not being as attracted to perpetuals.

Are you feeling any of that?

Obviously this quarter, the mix was at the lower end of the range.

How do you think about that?

Do you see that?

Well, Raj, that's such a small part of our business that it's not something that we pay much attention to.

Okay.

So for you, term -- term will remain the predominant non-subscription license type.

If I could add, I think that this is not news.

Yes.

Customers have been -- have been moving away from perpetuals for some time.

They see better value, particularly in an economic downturn, but they see better value from a -- from the ability to -- to over the shorter term of a term license or subscription have both the flexibility and the lower cash outflow that's implied by the license types.

True.

A couple more if I might.

Can I assume that the subscriptions are all linear in terms of the recognition over the three-year term?

And were there any conversions of existing subscriptions into terms this quarter?

Raj, the -- they're predominantly linear, there are always mixes of, you know, licenses.

But predominantly, that's what we've been experience -- experiencing.

And how about conversion of existing subscriptions into terms?

Nothing significant.

There's always some movement of licenses.

Okay.

And finally, a question for you, Ray, as you look out into next year, obviously the environment's tough, it's been tough this year, bookings are down 10%.

Any reason that you wouldn't be able to grow with the growth of R&D assuming R&D growth is in the 5%, you know, high single digit range?

Well, Raj, I -- I won't go to your question -- there's a lot of optimism building about what next year might deliver.

At the same time, we see most customers still being very careful about costs, and I think that that will remain so until there is a -- a larger type of top line improvement among our customers.

But relative to whatever R&D grows you ought to grow roughly with that rate, correct?

We -- we believe that we are in a position to -- to make a lot of opportunities on whatever spend there is.

The technologies that we've been building, the customer relationships we've been investing in will serve us very well in any growth environment.

All right.

Thanks.

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

Please go ahead.

Yes, good afternoon.

And good job here in what is still a challenging environment.

Following up on Raj's question about the -- the mix this quarter, in your past guidance, you said the range that you're looking for to come from subscriptions is 80 to 90%?

You don't see a change in the range, is that correct?

And Bill, do you have any sense of next year with people's inclination to do more term licensing, if it will be toward the upper end of that range or toward the lower end of the range?

Jennifer, we have been, you know, operating at the low 80% range really for the past, you know, four quarters now, and we don't see that really changing anytime soon.

Okay.

But at the same time, you do give a certain percentage in term at this point rather than strictly perpetual?

Sure.

And as I mentioned earlier, perpetuals are only, you know, in the 5% last part of our business.

It's primarily the PCB line of the business and, you know, occasionally you will see it in the Asian markets.

Okay.

And does that mean it's safe to assume that term will run about 12 or 13%.

Yes.

It's going to be the difference.

Right.

Okay.

And then you also mentioned this idea that it's still -- it is still challenging and to follow up on Raj's question about R&D, have you heard any customers who are interested in keeping their R&D budgets flat relative to the past year, even as they may grow the total -- keep the portion for EDA flat as they may grow the total R&D budget.

Jennifer, if I could add, I think that with few exceptions, very few exceptions, customers are focused on keeping their cost down.

When you can't grow the top line, you try to grow bottom line and that's been happening in the semiconductor industry by -- by -- by ferocious cost controls.

We've seen that and we've continued to see it last quarter.

Now, there are, you know, obviously some -- some early indications of improvements.

Intel's announcement yesterday was -- was -- was a -- was a nice pointer but at the same time there, were two other semiconductor companies that have reported in the last two days that -- that didn't have such positive things to say.

Uh-huh.

So, you look at that and you say, hmmmm.

Therefore costs are still going to be under the microscope, and therefore every vendor, including EDA vendors, are going to be tasked to find a lower cost of ownership.

Uh-huh.

Excellent.

Bill, could you -- I mean for Lavi, if he could comment what is happening with the Encounter platform as it -- it comes into greater integration?

And if he feels there might be any more interest or demand from customers as -- as some of Cadence's base is more likely to move to 90 nanometer next year?

What that presents for opportunity for you all?

It definitely does and we're currently involved with roughly -- in 200 tape-outs using Encounter in both 130, 90 nanometer, we see a tremendous productivity improvement for customers.

For example, a shipment was done at the .13 microns, that's about 2 million transistors, half a gigahertz and multiple clock domains.

We've got about the 3X speed up on the list to tape out versus two competitors.

One of them could do the job in about three days.

The other in about five days.

We did it in about 24 hours.

So, things are working very well for us there.

We're improving from release to release.

We are having releases at about every four to six months and as the interest grows in 90 nanometer and people might -- might take more risks as hopefully the economy improves, the validity of our solution and the improvement of productivity that it provides becomes much more attractive to our customers.

Great.

And Lavi, I understand that you're also charged with working in the analog department and what do you see coming there?

Are there any competitors who are to be very concerned about?

And what's the opportunity that you see in analog?

Well, there are two opportunities there.

One is just strictly analog design, where designs are interfacing with -- with humans.

You need more and more analog content and we provide a tremendous productivity and solution for -- for our customers but moreover, analog design is introduced more and more into digital chips and then the fact that our Virtuoso platform and our Encounter platform are interoperable with each other through open access, allows people to start and complete the whole entire task under one roof, which is Cadence solutions.

So, this again makes our solutions much more attractive for those users.

Okay, great, thank you.

The next question comes from the line of Medhi Hosseini with SoundView Technology Group.

Please go ahead.

Good afternoon.

I have a couple of questions.

First, in terms of your revenue mix, why is it that Japan was down by such a big percentage?

And also in terms of going into 2004, some of these renewal cycles that have been pushed into next year, to me it seems like that business is going to be up for grabs.

What are you going to do to prevent competitors from coming in and trying to penetrate into your existing customer base?

Medhi, on Japan, if you look at our history you will see normal fluctuations like what you're seeing this quarter.

It's really affected by, you know, renewal cycles and just how the market is reacting overall.

Just the cautiousness, but primarily the renewal cycle in Japan.

So, we're very pleased with the performance of our Japan business.

We have completed the integration of the work that we needed because you know when we acquired the Intertech distribution channel.

So, there's very good operational progress and you will see the results of that as we progress through the year.

If I could add, on the -- on the renewals side and the risk that you might think about on a -- on the occasion of a renewal, actually our experience over years of renewals is very positive.

That's buoyed at this particular time by the fact that we come to the renewals not only with great existing technology, but a lot of new technology, organized in a highly interoperable way that is playing very well as we planned the renewals even today for next year.

Okay.

So, I understood.

Let me -- I have a question regarding the whole industry EDA, which it could be tied in to your renewal cycle for next year, but let me extend the question differently.

When you look at your existing available markets, it seems like they're under pressure and are going to remain under pressure going into 2004.

Going back to that, you had talked about other areas that you're trying to penetrate.

Would it be fair to say that there's a significant risk is on these renewal cycles because the world EDM industry's facing the tough office environment, some of the new initiatives it going to take some time to turn into revenues.

So, again, what are you going to do to reduce that downside risk?

Well, any time you're selling into a market where customers are focused on costs it makes it more difficult, of course.

But we believe that we come at that opportunity with some pretty significant advantages.

Customers are going to be increasingly focused on total custom ownership.

They're looking at the virtues, the benefits of consolidating on far fewer vendors and far fewer platforms as a matter of efficiency, particularly now that those new technologies that they need for the next generations are available to them in a more interoperable and open way.

We think we benefit significantly as we approach those renewals by the fact that we cover most of the technologies in EDA.

We come at it with new technologies that we've invested in it.

We come at with on the platform of the old open access database that makes it easier, faster and cheaper for customers to operate their design environments.

So, I think we bring a lot to that situation, even if the market continues to be constrained next year.

Who knows what the economy will bring, but even if it's constrained, I think we have the better of the arguments.

Sure.

And just one last comment or question.

It seems like consumer market is very much of the design activities are from and given the short product launch cycle and urgency to get the new product out the door, what are you doing to reduce the cost, to improve productivity?

Well, I -- I think really that the story is great technology, well integrated in an open environment and a flexible business model.

That's -- that's the story -- not just for the consumer market, but for every chip developer, every system developer.

They all have the same problem.

And -- and the -- and the thing that's resonating in the marketplace today is great technology, well-integrated, open environments and -- and the right kind of channel and business model to serve that market.

Got it.

Thank you.

Thank you.

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

Please go ahead.

Thanks, good afternoon.

First for Ray, to follow up on the earlier questions from Raj and Medhi on bookings.

On the face of it, isn't the pretty significant disparity in bookings performance this year as between yourselves on the one hand and Synopsis, Mentor or even Magma on the other, with their growth indicative of a loss of share on your part in terms of EDA budgets or spending commitments?

I suppose the point of the question is one share is lost in EDA as would appear to have been the case for you this year.

Isn't it difficult to win back or isn't it extended process in order to do so?

Secondly, perhaps for Lavi, in terms of the way Cadence itself internally is gauging its own competitiveness in the automated IC design flow, when do you think you will be where you really want to be in terms of ease of use and integration?

When you benchmark yourselves internally against where Magma or Synopsis with their flows might be superior in some way?

Do you think that it would be with the first or second quarter releases next year of Encounter?

That you get close or catch up?

Jay, I'll start with your first question about share and then -- and then let Lavi talk about the product capabilities that you ask about.

On the share side, I think that it's very important that -- to understand that -- that the business cycles at each of the companies you've mentioned are different.

The things that they offer are different and they are not all purchased at the same time.

Our renewal cycle is -- is based in -- in the -- the history of when we did earlier contracts and it varies from company to company.

Our -- our cycle is also heavily influenced by the introduction of new technology.

As we -- as we bring new technology into the marketplace.

That will, of course, accelerate that cycle.

The fact that -- that others have a -- a stronger renewal calendar this year or are, in the case of one large competitor, turning over the combination of -- of -- of their -- their native installed base and their acquired installed base, those don't by themselves indicate at all that there is any shift in share going on.

Rather, as I look at the lengthening of the -- of the bookings lives that I see going on, what I see is -- is perhaps a fortressing of -- of -- of a legacy base going on.

But that's not a shift in share.

That's a -- that's a defensive move in my mind.

When -- when I go through customer by customer, account by account, I do not see, cannot find, the kind of share shifts that one might presume, if you look at a slice of time.

This is a business that you have to look at like any business, over a period of time.

In '02, we looked like we were taking massive share because we had a rich renewal cycle.

In '04 and '05, the same thing may very well happen again.

I -- I doubt that I will get very far claiming huge share shift just because that's a rich renewal cycle for us or '02 was a rich renewal cycle for us.

Lavi?

Yes, just wanted to repeat how we are grading ourselves against the competition in the -- in the digital flow.

There we are -- we believe that we are ahead in our technology and behind in the ease of use and integration.

Superior question, we believe that we will be comparable as to ease of use and integration within the next -- within the first two quarters of next year.

We're just one or two highlights that the digital flow that we will get to that same level of integration is a flow that we'll keep this tremendous productivity enhancement that we are talking about of about 300% versus the competition.

It is a flow that is -- is open and integratable with -- and interoperable with analog solutions, custom solutions, package and board solutions, which the competitors do not have.

That front, to get to their level of ease of use, it will take us roughly the first two quarters of next -- of next year.

Okay.

A follow-up on that, then, Lavi.

So, that's still 6 to 9 months away, maybe in EDA terms, that's relatively brief period given the length of cycles, but how likely is it that customers might anticipate that road map being implemented such that we could get to a bookings inflection point even before then?

Before you actually deliver the product in the state you think it ought to be in.

And just a follow-up question in that respect for Bill.

Your bookings outlook for the year suggests -- still, a material sequential increase in Q4.

Even within the context of being down 10% for the year.

By our calculation and you can help us here, it looks as though sequentially Q4 you would need to have the largest sequential increase in bookings that you had since the fourth quarter of 2000 and if that's right, how realistic is that?

We will start with the first question.

The probability that this thing will happen is highly likely.

It is already happening with those designs that we reported with close partners as we reported a 300% productivity boost.

The chip package board or IO flow planner is already integrated into encounter and is already interoperable with the Virtuoso platform.

We know exactly what we need to do.

Our partners and customers are complimenting us on a very aggressive and -- very aggressive progress that -- and results that we are getting.

So, it's highly likely that we will achieve that goal or overachieve that.

Jay, to our bookings I'm not going to get into specifics, but we do have a large seasonal increase in Q4 and, you know, we believe that it's very achievable.

Okay.

Is our inference correct that it would be the largest such increase in several years?

And can you answer whether there were any customers that accounted for more than 10% of your bookings in Q3?

Or might there be any such in Q4?

Jay, I'm not going to get to that level of detail on the specific history and in terms of over 10%, we don't have anything that's over 10%.

For the quarter.

Either one, third quarter or fourth?

I'm not going to talk about the future, Jay.

Okay.

Thanks, Bill.

And next is Dennis Wassung with Adams, Harkness and Hill.

Please go ahead.

Thanks.

A couple of quick questions.

Bill, I believe you mentioned something about the Japanese distributor integration that you just completed.

Is there any revenue impact from that agreement?

Dennis, as I mentioned last time, there isn't a significant change in how our revenue will happen out of Japan from our acquisition of the distributor.

The distributor market was not that significant for us.

So, really no change between now and the situation how it would have been?

Nothing significant.

Correct.

Okay.

Also on the product side, you talked a little bit about the chip package board platform.

Curious as to what the timeframe is for that release, and also if you could talk about the DFM platform and what you expect in terms of timing for that rollout?

Okay, on the chip package board we have already released the IO flow planner that -- that enabled designers to design the -- the audio while it's part of the digital package.

The digital design of the general chip design.

We've released a version 15.1 on limit [INAUDIBLE].

We are releasing a 3-D field soldier for super high speed PCB design.

So, all of this is already being released and in the first -- during the first half, beginning of '04, so, the beginning of '04, we will release our silicon package board platform into the market.

Regarding the design for manufacturing, there we are -- we are focusing in on the two areas.

The areas of physical diversification and analysis, and there we upgraded and released our Fire and Ice, the QXE, which is our specific extraction for digital gains.

We tested it with a leading foundry and brought the industry-leading accuracy speed and capacity.

We can handle 90 nanometer with copper interconnect.

We also announced the power grid analysis and the electro migration, which is both of them are for reliabilities and very physical diversification of the design.

Targeted at analog design this time with a Virtuoso analog Voltage Storm option and the Virtuoso analog Electro Storm option.

So, this is what is done on the physical verification.

On the equipment side, the manufacturing side, we are product typing the K-2 products and we are having a various internal incubation projects and we are working with Mac manufacturers and code developing solutions with them.

Okay.

How does the new PDF solution tool -- PDF-X play into your strategy at this point?

The PDF is being used for yield analysis and optimization and it's part of the relationships that we have with external companies and we are working with this as part of our -- as part of our flow and our offering to the customers to do yield analysis.

Okay.

And last question.

Over on the design for test side, you guys had a pretty substantial product release because I show the international test conference a couple of weeks o'clock.

I'm just curious in terms of revenue impact this?

Is this something already generating revenue?

I know the technology was acquired from IBM.

Is it sort of -- the IBM technology productized as well as added to?

And how that plays into the product map at this point?

Dennis, this is Penny.

So, the product release for production is in October of the test capability.

It's generating revenue today with a handful of customers, but it's on a limited engagement because it's not in production.

The material revenue impact will be in 2004.

The work that's been done has been taking production idea and technology and making it more accessible to the standard market.

So, that will ship in October.

Great.

Thank you.

The next question will come from the line of Arnab Chanda with Lehman Brothers.

Please go ahead.

Thank you.

I got a question.

If you could review the competitive landscape in the back-end on the digital side a little bit in terms of what your capabilities or perhaps shortcomings are, versus the competition in sort of the high gig count and submicron designs?

Thank you.

Well, this is -- this is a complex question to ask -- to answer quickly, but our -- our main strength, if you want to have a -- get a very short answer, is complex chips that are -- that are challenging or or challenged with single integrity congested routing, which is routing in areas that are really dense and filled with stuff, rich in hierarchy, they need the code design with analog.

They contain analog.

You really need to take into account where your IOs are.

These are chips that -- that we -- we excel and we have no problems beating the competition.

Beyond that, the question starts to be pretty involved here, so, I will limit it to that answer for now.

Thank you.

And one follow-up for Bill.

You talked about, you know, it seems like the operating margins are going up very high, sort of the high 20s in the fourth quarter this year.

I just want to make sure that, yeah, you had talked about 30% plus at the end of '04.

Is that something that you think you can exceed or is that something that is a goal that you'd like to achieve?

We certainly will have this Q4 will be for the quarter.

As you know, our goal is to have 30% for the year and we will get back to a 30% level by the time we hit Q4 of next year and I think time will tell to see whether we will be able to get above 30% on sustained basis, but our goal right now is to get to that 30% level and sustain it.

And just to make sure, you don't need any additional cost cuts to get there?

We believe our costs are right where they need to be.

This is really layering in with the technology wins.

The subscriptions and that will allow to us get to the 30%.

We are, of course, continuing to work on costs as a normal part of our operation.

But we don't need anything of a significant nature to get there.

Thank you very much.

The next question comes from the line of Rich Valera with Needham and Company.

Please go ahead.

Thank you.

Bill, just a follow-up on that margin question.

It seems that to get to the high end of your EPS for the fourth quarter, the 25 cents, that you would need about 30% operating margins unless I'm mistaken, and I guess if that's the case, is that 30% in the fourth quarter of next year really pretty conservative goal?

We will need to get up into the high 20s for the math to work and you're right, Rich, for Q4.

And that's just, you know, lines with the revenue guidance and the cost guidance we've given.

And when we get to next year, we will have to see but we're continuing to target at least a 30% level by the end of Q4 and we'll just have to determine how much better we can do but that's -- that's a long ways off.

Understood.

And just in terms of the absolute level of total expenses, understanding that -- that revenue will be down most likely in -- in Q1 of next year.

As it typically is seasonally.

Can we assume that we would model down then, sequential overall expenses in Q1?

Off of the Q4?

Rich, I'm not going to get into any modeling at this stage for next year.

When we talk about guidance for 2004 then I think we will be able to provide you with insight into Q1 expense levels.

Fair enough.

And just one broader question.

Either for Lavi or Penny.

You guys announced that you would be supporting system Verilog I guess about a week ago and you didn't really talk much about products or anything and I guess you will more in the future, but I wondered if there's any sort of details you can provide in terms of -- you know, your plans to embrace system Verilog, which products might have it first and what forms it might take?

The primary impact of system Verilog is to be an Incisive product line.

We've been involved in the process for the last couple of years.

We have been doing road map work around how we integrate the system Verilog capabilities into Incisive and we will be disclosing all those road maps in the next couple of months.

But it is premature right now.

But the primary impact is into Incisive.

Next is Erach Desai with American Technology Research.

Please go ahead.

Good afternoon.

I have four specific questions.

One is -- is it fair to assume the product bookings in third quarter over second quarter were down sequentially?

No, that's not a fair assumption.

Okay.

Did subscription revenues in dollars go up sequentially from Q3 over Q2?

Yes, they did.

Which means the math would suggest that since your product revenues were down -- were down sequentially, that -- that the other non-subscription revenues came down?

I'm not going get into all the pieces Raj -- or excuse me, Erach, when we give the percentage that's coming out, I think you can work it back, you know.

There are lower elements of other types of revenue.

Okay.

We can take this offline, but it's not that clearly working for me.

Could you tell me what the amount -- the dollar amount of receivables were sold in the third quarter?

Yes, about $6 million.

Great.

And finally, perhaps more just in a -- in a directional sense, I'm just trying to assess, when you -- and I'm sure that each deal is unique, but from an average standpoint, what is the typical remix of new technology that is a part of a subscription license, typically?

The normal range is 10 to 20%.

Every year or every six months?

I'm sorry.

Every year or every six months?

Generally it's 10% a year, sometimes it will go a little bit higher than that, depending pending on the customer.

Okay.

Thank you.

Your next question comes from the line of Garo Toomajanian of RBC Capital Markets.

Please go ahead.

Hi, Bill, I know you don't want to into bookings details, but I wanted to get a sense whether or not software product book-to-bill was above or below one.

It was above one, Garo.

Okay.

And, Ray, I know we talked about R&D expenditures and what might be happening next year.

Regardless of what happens, do you think that Cadence will do better or worse than the industry in general?

The EDA industry, that is?

Well, Garo, I can't predict what other competitors will do.

I -- I think we've given our indication of what we expect for next year in general terms.

It's driven by a combination of new technologies and leveraging renewal opportunities.

We think that -- I think that that will give us an opportunity for some share shift and certainly a very strong statement about what's happening in our installed base.

Okay.

So if R&D -- relative to say R&D growth, then, do you think you could do better than the R&D growth in general?

I don't know what R&D growth is going to be.

Right.

But I thought you said earlier that you thought that depending on what R&D growth does that will kind of determine what happens to EDA growth.

I think that in a premiere spending environment, of course we'll -- we'll create a tie that lists a lot of boats.

That's a natural thing.

Okay.

Thank you.

Your next question will come from the line of Sumit Dhanda of Banc of America Securities.

Please go ahead.

Hi, guys.

First of all, am I right in assuming that the next quarter, meaning the December quarter, will be a 14-week quarter?

Yes, we will have that extra week that we normally get every -- however many four years or so, yes.

And that should presumably at least help in terms -- a little bit in terms a sequential ramp in bookings so that you can hit your top line estimates for the next quarter, right?

Well, I would not think that an extra week -- that doesn't change customers buying behavior significantly.

It's, you know, whether it's 13 weeks or 14 weeks...

Okay.

That's not going have a significant difference.

Okay.

And the other question I had for you was on the emulation front.

Could you talk at least in qualitative terms how this product line fed for you this quarter relative to the last quarter?

Sure, I can take that one.

Q3 was the softer quarter than Q1 and Q2.

Okay.

I would remind you that emulation is a very lumpy business and we are advancing the technology dramatically at the moment, so we're working with a handful of high end customers and you should expect to see it be lumpy.

It's just that type of business.

Would I be fair in assuming that you will probably see it pop back up again in the December quarter in that business?

Well, we can discuss that in January.

Okay.

The -- two other sort of housekeeping questions for you, Bill.

Number one, the ratable percentage out of backlog that you mentioned, 70%, was that including or excluding subscription maintenance?

That still has the same normal percentage that we have for maintenance.

Okay.

So you exed out the 7 or 8% to get without subscription maintenance.

Correct.

And in terms of the term component, you said perpetuals are roughly 5% in the just concluded quarter, the remainder is suggesting that about 17% or so was term.

How is that relative last quarter?

And if you could give us an indication what the percentage might look like next quarter?

It's really hard to get to that level, but it's been pretty steady in the perpetuals.

It's been that way for about a year.

We've been averaging in that 5% or so level.

So, no significant change to the term component over the last couple of quarters?

No, you can see that the difference is term.

So, it varies a couple of percent, we're at 81 or 83%.

Okay, good, thank you.

The next question comes from the line of William Frerichs with DA Davidson and Company.

Please go ahead.

Good afternoon.

First of all I want to congratulate to you for the settlement with Mentor Graphics, which seems like a good idea.

Does the litigation standstill only cover emulation or does it cover other technologies that you might be competing against them with?

Bill, thank you for your comments.

It just -- it just covers emulation.

Okay.

And secondly, on the CoWare transaction, was there a transfer of head count from Cadence to CoWare?

And is there any kind of an accounting impact on your side from that?

Bill, yes, there was a transfer of head count.

The head count associated with R&D and sealed resources for SPW was transferred as we licensed the SPW business to CoWare and no, there was no accounting transaction as a result of that.

Okay.

But a slight decrease in -- in costs, I guess, as a result.

Slight.

Very immaterial in Cadence terms, but it's obviously material to CoWare.

Okay.

And you made reference in the opening remarks to the Nvidia emulation purchase and I want to make clear that that was Q2 business in terms of the orders, is that --

Actually was Q2 and Q3, Bill.

Okay.

And finally, what with the numbers, Bill, for Cap Ex and depreciation?

Cap Ex was $15 million, Bill, for the quarter.

And depreciation -- you want depreciation and amortization?

Or...

Yes, both, please.

Oh, okay.

Just one second, I will get that for you.

In total it's $50 million for depreciation and amortization excluding the deferred comp.

Okay, great, thank you.

Sure.

Your last question will come from the line of Rohit Pandey of CS First Boston.

Please go ahead.

Thank you.

A couple of questions.

Last quarter you said the book-to-bill was solidly above one.

Are you saying that again this quarter?

Yes, book-to-bill is above 1.

Solidly above 1?

Yes.

Okay.

Then a couple of other questions.

This one is for Ray.

We often hear about increased fabless activity in non-Japan Asia.

Have you seen this there?

And do you expect it to show up in your top line at some point in time?

The fabless opportunity is something that we see worldwide.

Certainly Asia as a market growing faster than other markets and most of that is in non-Japan Asia is fabless.

And -- and given our -- our success in -- in developing the supply chain, including the -- the fabs and foundries and the new technologies that we're bringing that are aimed at those fabless companies, including the kinds of stories that I mentioned at the -- at the end of my -- of my presentations, around services leveraging software -- software opportunities with fabless companies.

Tell us that we're on the right track.

Okay.

This one is for Penny.

What component of the Incisive platform do you see gaining traction?

More of the hardware or the software component?

It's both.

Obviously the software verification is used much more broadly than typically the hardware and in particular, the advanced verification capability as well as simulation based on raw performance.

Okay.

And in the past, you have actually this one is for Ray.

In the past, you have spoken about expecting double-digit earnings growth the next year.

Do you expect this to be skewed toward the second half of the year or more uniform?

Well, we really don't have anything to say yet about -- about next year.

As Bill said, it's a long way down the line.

And -- okay.

On your R&D expenditure, is the expenditure uniform across the different platforms or are you spending more R&D dollars on certain platforms right now?

I -- certainly we -- the R&D expenditure across various platforms varies from platform to platform.

But is there some platform you're focusing on right now?

Could I say you have more R&D expenditure on the Incisive as compared to Encounter?

Well, if you look at the focus and the investment that we have made in the Encounter area over the last two years --

Uh-huh.

You'd have to conclude that that has been our primary -- primary focus item.

We have -- we have developed internal technologies, we've ramped head count, we have acquired that come with head count.

That's been a very large effort over the last couple of years.

Okay, and then a question for Lavi.

The move from 130 nanometers to 90 nanometers, why does that need new EDA tools?

Or the customers who already bought the tools for 130 nanometers, do they need to buy tools again at 90 nanometers?

Or would the other tools do for them?

Well, when you move from 130 to 90, you have a couple of problems.

One is just the physics becomes more complex and your ability to analyze more complex problems has to be improved.

And the tools that -- the tools that are being used from 180, some of those are pulled from 180 and 250 and they reach their end of capacity.

You have issues of further integration into the shape of many more digital devices, analog devices and the code design and optimization that you now cannot escape from and this is where if you could live in the past with the simple tool that can do just digital, straight-forward digital design, it needs to handle tremendous capacity, interact with other domains like analog and package, as a result, you need to -- the whole -- the whole new suite of tools if you thought that you just did -- you just did them with simple digital design, you need a whole suite of tools to be added in order to enable you to finish in any reasonable time, the task of design implementation in something that.

If I bought my tools at 130 nanometers, do I need to buy again at 90?

Or does it take care of my needs at 90 nanometers.

If you do the design -- if you built -- bought your tools for 130 nanometer and are doing 90 nanometer design, you're running into problems in single integrity, your ability to do audio design, you're not able to do analog design together with it if you just bought it there and however, if you bought Encounter for 130 nanometer, this platform is built all the way from 130 and down.

If you bought the tools for 180, then you would run out of steam at around this geometry.

Okay, thank you.

Operator, I think that brings us to a natural conclusion.

I'd like to thank everyone on the call for their questions and their interest.

We'll look forward to talking to you throughout the coming months.

Thank you very much.

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

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