益華電腦 (CDNS) 2003 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Cadence Design Systems fourth quarter 2003 earnings release conference call.

All participants are 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 one followed by the four on your telephone.

As a reminder, this conference is being recorded, Wednesday, January 28, 2004.

I would now like to turn the call over to Mr. Alan Lindstrom, Director of Investor Relations.

Please go ahead, sir.

Thanks you, Operator.

This is Alan Lindstrom.

Welcome to Cadence's fourth 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 archived for one week.

With me today are Ray Bingham, President and CEO, Bill Porter, Senior Vice President and Chief Financial Officer, Lavi Lev, Executive Vice President and General Manager of our Implementation division and Ping Chao, Executive Vice President and General Manager of our Design and Verification division.

Ray and Bill will present out prepared remarks, Lavi and Ping will participate in the Q-and-A session which follows.

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

For information on the factors that could cause a difference in our results, refer to the 10-K for the period ended December 28, 2002 and 10-Q for the period ended December 27, 2003.

All numbers reflect earnings excluding goodwill and unusual items.

GAAP earnings and reconciliations of the numbers are available in the press releases which is also available on our Web site.

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

Thanks, Alan, good afternoon.

Things executed well in the fourth quarter with revenues totaling $308 million and pro forma earnings per share of 24 cents.

For the full year, Cadence revenue totalled $1.1 billion and pro forma earnings per share 51 cents, well within guidance and notably accomplished our goals for the quarter and for the year.

Before I get started, let me take a minute to address the restatement mentioned in the headline of our press release.

As part of our year end review of our investment portfolio, my Cadence team found we have accounted incorrectly for certain minority investments.

We immediately took action to correct the error which we are reporting along with our Q4 2003 results.

The impact in '03 just to illustrate was about 1cent positive on earnings and in 2002 the impact was about 2 cents negative.

This error, while it certainly concerns us from a process standpoint is not material and impacts almost entirely the other income and expense line to the P&L..

Additionally it has no affect on operations or cash flow.

Bill Porter will address this in more detail later as he participates in the call.

Now let's turn to the results of our operations. 2003 was a transitional year for the semiconductor industry where after three long years, we saw an uptrend at the end of the year.

It was a transitional year for Cadence as well.

We set the plan for the environment, we executed that plan on multiple fronts, technology, integrations of the technology, design change, and of course, our financials.

The aggressive market demands of system chips, SOCs, require a new generation of technology to quote in timing and ramp yield.

These chips are dominated by wires and are very congested with building blocks of IP that require Cadence technology like Virtuoso to create.

Encounter to connect things together.

Incisive to verify.

This market sweet spot, complex chips at 130 nanometer and below from 2 million to 100 million transistor is growing and playing to our technology strengths.

Now address how we performed technology platform by technology platform.

The Cadence encounter digital platform has an excellent fourth quarter.

Q4 is a turning point of our digital solutions.

Here's what we achieved at the expense of a couple of our competitors.

We won 25 new SOC encounter logos.

We achieved competitive displacements against both synopsis and [INAUDIBLE] on several accounts.

Most of these were top 20 global IC companies.

We're winning because of our superior ability to handle large chips and deliver the best quality of silicon using key technologies like First Encounter, RTL Compiler, NanoRoute and CeltIC for signal integrity.

In the quarter, in fact, NanoRoute completed its 150th takeout including a takeout ahead of schedule with Toshiba in their digital consumer division.

We delivered ahead of schedule the fourth major release of the Encounter platform in 13 months.

It includes the integration of NanoRoute and RTL Compiler.

The benefit for the customer is improved ease of use, higher performance and therefore, higher productivity for the customer.

At a major communications company, we defeated [INAUDIBLE] head-to-head on chip size and synthesis.

At [Invida], the combination of RTL Compiler and NanoRoute led to repeat synthesis business and new NanoRoute business.

We more than doubled our RTL Compiler engagements with customers in Q4 to over 100 generally delivering 10% better quality of silicon than the competition.

What that means to the customer is that they are able to produce faster, smaller, cheaper chips.

Additional leadership is our focus this year.

We accomplished a lot in 2003, but now I'd like to mention a few things we recently announced.

In Q4 that build our momentum in the marketplace as we go ahead in 2004.

We launched new technologies into the broad market with Encounter Tests based on IBMs legendary technology, Encounter Test is the first to address the complete set of Nanometer testability requirements.

We also continued to extend our digital leadership in emerging areas before partnerships with NEC and another with [INAUDIBLE] to provide the only combined ASIC and structured ASIC design solution in the market today.

We partnered with Toshiba to produce the first functional X Architecture Silicon.

In addition UMC became the first pure plate fountain to engage with us on X. The X Architecture promises to reduce total wire length thereby making the chips faster, smaller and cheaper.

Incisive verification continues to be a key area of customer investments as they struggle to quickly and efficiently verify large complex SOCs.

Cadence enjoyed a record quarter for Incisive, which was [INAUDIBLE] a year ago.

We completed the integration of Incisive Conformal, which came from the [BURPLEX] acquisition.

Our customers tell us it's a must-have technology for functional integrity of digital custom and memory designs. 36 new customers adopted the Incisive platform in the fourth quarter.

In fact, for the first time, our integrated solution, the Incisive platform, exceeded .2 of sales in functional verification.

This is a great validation for us in our integrated platform approach.

Cadence also enjoyed a record quarter of Incisive XLD.

Incisive XLD provides the industry's only acceleration on demand capability, which allows customers to choose simulation or hardware based acceleration at run time.

Among customer wins with [INAUDIBLE] we chose Cadence Incisive XLD based on the strength of the technology and the support team.

As we continue to develop the Incisive platform, we saw two things.

Customers were asking us for higher levels of abstraction to speed verification as the associated verification IP for the platform.

We responded to our customers with a new alliance with 0-In Design Automation to make assertion-based verification a reality.

Finally, to solve the whole verification challenge customers need verification technology, IP and multi language support.

With that in mind that we have been [INAUDIBLE] thereby expanding Cadence leadership in language standards a factor as a record quarter for Incisive.

Let's turn to our Virtuoso platform, the [INAUDIBLE] industry standard.

Custom analog and mixed signal technology is increasingly important for IC design.

We are investing to sustain our leadership in this important market.

Required [celestrion] the beginning of '03 which contributed simulation technology known as UltraSim to this platform.

Q4 was our biggest UltraSim quarter ever helping us win 20 new customers.

We added processed migration and layout optimization technologies to the platform through our acquisition of Q Design Automation. 12 new customers adopted our new spec environment which provides better analysis and consequently leads to better yields.

OpenAccess has been a key part of our development strategy for the Virtusos platform.

Integrating Virtuoso and OpenAccess we delivered real productivity gains and customers loved the openness.

In the fourth quarter we introduced a new product to contribute to the Silicon-Package-Board platform that we'll announce later this quarter.

That product is SPECCTRAQuest EE, which bring our innovative signal integrity technology to the front end [INAUDIBLE] the overall design cycle.

Customers such as [INAUDIBLE] have told us they see this product as extending the value we have to offer to more of their design team.

We completed the year of investment and tangible momentum in what we call open collaboration.

In the complex world of electronics, no one company can go with them all.

Only Cadence is responding in an open, collaborative way to this challenge.

Integration isn't just about EDA tools, it requires optimization from system to silicon and it often includes our customers own tools.

A good example of open collaboration is the progress of OpenAccess, moving from first availability to production design flows in less than a year.

You may have read the success HP is having in deploying the new 90 nanometer design flow using OpenAccess.

They are not alone.

LSI Logic, Motorola, IBM, Phillips and Fujitsu are deploying OpenAccess into production.

This represents worldwide adoption from the user community supportive by two of the top three EDA suppliers.

Customers are looking to Cadence not just as a tool supplier but as a business partner with Cadence with superior technology and services is uniquely qualified.

An example of this business partner role is the value by the engineering organization or engineering collaboration model which helps customers minimize risk and downtime while they adopt and migrate to the next generation of technologies.

This model is working for large and small companies worldwide from industry leading start-ups like audio to establish leaders like IBM.

As a result we delivered continuous improvements in our services margin over the year and we've seen a notable uptick in services bookings in the fourth quarter.

Now let me turn the call over to Bill to take you through the operating numbers.

Bill?

Thanks, Ray.

First I'd like to go into more detail on the statement we intend to make.

Cadence has generally invested in venture-backed technology companies [INAUDIBLE].

The investments were made directly or through our affiliated capital funds.

During the fourth quarter of 2003, Cadence undertook a normal review of our equity investments.

Most of these investments are treated by Cadence as passive investments using the cost method.

Our review determined that for 10 of these investments, we should have been using the equity method of accounting either because we held more than 20% of the voting stock or because even though we held less than 20% of the voting stock, we were deemed to have the ability to exercise significant influence over the investing company because of board representation or business relationships that are determined to be material to that company.

If Cadence had used the equity method rather than the cost method during the affected periods, we would have reported the prorata share in the other income or losses from the investments in the other income line of our income statement.

As a result, Cadence determined that it will restate its financial statements to correct the accounting treatment for these minority investments for its fiscal year 2002 in the first, second and third quarters of its fiscal 2003.

Cadence will also reflect in its restated 2002 and 2003 financial statements other adjustments that are immaterial both individually and in the aggregate.

The impact on our financial statements of this restatement is small amounting to an increase in GAAP net income for the first three quarters of 2003 of $1.8 million or 1 cent per share and a decrease in 2002 net income of approximately $4.9 million or 2 cents per share.

Detailed schedules relating to the adjustments are available on our Web site.

These changes have no effect on Cadence's cash flow or operations.

Now I'd like to turn to our operating results.

In 2003 we successfully completed the first full year of our transition to a higher route of license mix and returned to year over year revenue and earnings per share growth.

We rationalize our cost structure reducing total cost and expenses for the year by 14%.

We put in place a more flexible and cost-effective liquidity structure of the convertible bond offering and repurchased over 17 million shares of our common stock.

We are now in a largely renewable model having booked nearly 95% of our business under renewable licenses, subscription and term over the past two years.

We are looking forward to a stronger renewal cycle in 2004 and 2005.

Turning to the environment, we see improving market conditions for our customers, although pricing pressure remains in the semi-conductor industry.

While business is looking up, operating margins for many of our customers remains below desired levels, therefore we expect they will continue to exercise caution in their spending decisions.

Now I'll review our results for the quarter.

Earnings per share for Q4 on a pro forma basis were 24 cents on net income of $65 million.

At the upper end of our target range and up from 2 cents in the fourth quarter of 2002.

On a GAAP basis, earnings per share were 9 cents per share.

For the full year 2003 pro forma EPS was 51cents compared with 61cents in 2002.

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

Total Q4 revenue was $308 million up 12% year over year.

Product revenue was $199 million, maintenance revenue was $79 million and services revenue was $30 million.

Revenue for the year totalled $1.1 billion.

Total bookings for the year were approximately $1.3 billion and we finished the year with a total backlog of approximately $1.6 billion.

We booked about 75% of our Q4 product business under radical licenses.

Now that we have five quarters of experience with our higher [[routable]] mix, customer behavior appears to be settling in to the range of mid-70s to low 80s compared with our initial expectations of an 80-90% range.

As a result, we are adjusting our range to 75-85%.

Professional licenses continue to make up about 5% of the mix with the remainder term licenses.

As expected, approximately 60% of product revenue came from backlog in Q4.

As we continue our license transition, we expect product revenue from backlog for the full year 2004 will be about 65%.

Average contract license stable at around three years as we continue to follow our disciplined approach to managing contract license.

The revenue mix by geography by Q4 was 64% for North America, 16% for Europe, 13% for Japan and 7% for Asia.

Total cost and expenses on a pro forma basis were $220 million in Q4 representing a decrease of 17% from the same quarter a year ago.

Costs were somewhat higher than we projected primarily due to the effect of a weaker dollar and higher R&D including investments in the synthesis year.

Year end head count was approximately 4800.

Our pro forma operating margin for the purpose of Q4 was 28% up from 4% in Q4 of 2002.

Operating margin will drop seasonally in Q1 before rising toward our 31% target by the end of 2004.

We have increased our focus on structuring payment terms to receive more cash in the initial year of our contract than under our standard quarterly payment terms.

This practice has the effect of increasing short-term DSOs.

The result is in Q4 short-term increased to 102 days from 97 days in Q3.

However, this practice does not effect total DSO which includes short-term accounts receivable and long-term installment contracts receivable.

Therefore we believe the most meaningful metric to measure our progress is total DSO, which declined one day to 138 days in Q4.

As part of our continual focus on improving cash flow, we are targeting total DSO to reduce approximately 30% to around 100 days by the end of 2004.

The quality of receivables remained high with receivables 90 days past due at 1% improving from our historical range of 2-3%.

We finish the year with $385 million of cash.

In Q4 we generated approximately $62 million of operating cash flow or $77 million on a pro forma basis after excluding $15 million of restructuring costs.

Pro forma operating cash flow for the year was $227 million up 73% from $132 million on a comparable basis in 2003.

For 2004 we expect operating cash flow to at least equal operating [INAUDIBLE].

Net cash used for acquisition payments and required intangibles was $73 million.

Capital expenditures were $29 million for the quarter.

Capital expenditures of $84 million were down 37% in line with our expectations.

Capital expenditures for the purpose of 2004 expected to be roughly flat to 2003.

Our strategy is to use our cash from operations for acquisitions and share repurchase.

During Q4, we used our operating cash flow for acquisition payments and as a result did not repurchase any shares.

However, for the year we repurchased 17.4 million shares at a cost of $214 million.

Our repurchase authorization remains at $217 million.

Now I'll turn to our outlook for Q1 in the year 2004.

For Q1 we expect total revenue to be in the range of $260-270 million.

That should make up 75-85% of the total software bookings and about 70% of product revenue should come from backlog.

We expect total costs and expenses to increase approximately 5-7% sequentially in Q1.

Due to incentive planned costs and seasonally higher benefit costs, this is in contrast to 2003 when along with many of our customers we did not earn a bonus.

Pro forma earnings per share for Q1 should be in the range of 8-10 cents.

On a GAAP basis including amortization of required intangibles, restructuring and other charges, Q1 [INAUDIBLE] expected to be in the range of to minus 1 cent to positive 1 cent per share.

For 2004, we expect total bookings in the range of 7-10%.

Because of the timing of our renewals and normal seasonality, we expected bookings and revenue will be weighted to the second half of 2004.

Total revenues should be in the range of $1.175 to $1.225 billion.

For the year we expect total cost and expenses to be approximately 1% up from 2003.

Pro forma earnings per share for the year should be in the range of 70-77 cents.

On a GAAP basis, the results for 2004 are expected to be in the range of 43-50 cents per share.

Please refer to our press release or Web site for a detailed reconciliation of pro forma to GAAP for our business outlook.

We will now take your questions.

Operator, do we have questions on the line?

Ladies and gentlemen, if you would like to register a question, press the one followed by a four on the 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 your are using a speaker phone, please lift your handset before entering your request.

One moment before the first question.

Our first question comes from the line of Rich Valera with Needham and Company.

Good evening, gentleman.

First up, Bill, on the booking side, you mentioned the bookings number for the year, can you give us what that was on a year over year basis?

No, Rich, for total bookings, that's going to be the number.

When we look forward, you'll be able to measure our progress with backlog but not going into a detail of total year over year bookings.

You had set the goal of being, I guess, down 10% year over year, can you comment with respect to that goal or not?

Yeah, our bookings were downgraded 10%.

I think we're going to leave that as it is for 2003 and we've led our outlook for 2004.

Great, thank you.

And with respect to your maintenance line just kind of think about how we should model that for 2004.

It was down sequentially.

Can you just talk about what you're seeing in terms of maintenance renewals and what you would think about in terms of that line overall for 2004?

And similarly on the services line, sounds like you saw some encouraging signs of life on the services side, how should we think about that for the entirety of '04 on a year over year basis?

Sure, just generally both of those areas should see, I think, slow by steady growth in 2004.

We did see some reduction both in maintenance and in service in Q3-Q4 but I don't think that's indicative of what we are seeing in terms of general strengthening of that business as we get into next year.

Great.

And just if someone could comment on the emulation side where if you could give a sense of how strong that was in the quarter and what you think the outlook is for emulation, you know, just maybe in a broad sense in '04?

This is Ping Chao.

The Q4 emulation business is our best quarter, and we have, I'd say six or seven new logos and -- let me see what I've got here.

We beat our booking plan and we have some large orders from the major customers.

That's probably the level of detail we'll go into there.

Basically good business and good momentum we still see in emulation so we expect that to continue particularly as it is partnering very well with the Incisive platform.

Great.

And just one final question, Bill.

In think you mentioned total expenses up 6-7% sequentially in the first quarter.

So essentially are some of the incentive payments for '04 paid in the first quarter?

Is that why we are seeing that potential uptick?

It's not paid, we will be accruing as we go through the year and in 2003 we did not accrue or earn a bonus.

You can see a comparison where we do have incentive payments in each quarter of -- incentive compensation in each quarter of 2004.

And the other thing that goes from Q4 to Q1 is we have normally an increase in benefit cost from payroll taxes, for example, so those are really the increases from Q4 to Q1.

Okay, that's helpful.

Thank you, gentleman.

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

Please proceed with your question.

Thanks, good afternoon.

I'd like to return to the bookings questions.

First, Bill, most of us had been assuming that in Q4 you would have to have the strongest comparisons in bookings you have seen in three years or by most calculations by more than $100 million sequential increase in software bookings at least.

Did you in fact see that?

And secondly in terms of the outlook for 2004, do you think that you can recoup most if not all of the software bookings decline that you experienced last year which by our calculation was a more than 10% decline to under $900 million?

Jay, we had a good Q4.

We had very good sequential increase in bookings.

Not quite to the level that we would have liked to to get to an overachievement level when we were targeting midyear but good nonetheless.

I think as we look out to 2004, we see ourselves getting pretty close to where we need to be for -- I'd say a parity but not going to get into much more detail than that.

Parity meaning back to where you were in 2002.

Be able to recoup all of our ground in 2003.

I think for the most part that's correct, yes.

In terms of how you get there by product line, maybe Lavi can jump in on this as well, your majority competitor had a strong upgrade cycle that was a significant increment to their results last year, do you think you will be similarly dependent or driven upon a singular product upgrade cycle like that this year or do you think your business could turn out to be reasonably more broad-based then that in terms of the components to bookings by product area.

Jay, let me start and I'll ask Lavi to give detail.

I'm sure that you're familiar with my view that what we saw last year with a major competitor and what we expect to see is somewhat driven by new technology and heavily driven by the timing of renewals and I think that that is pretty easy to see and what happened last year and I believe it will be demonstrated again this year except that this time it will be our renewal technology and our renewal cycle.

We have a lot of new technology that we've been developing for our business over the last couple of years.

I expect that '04 will be a very strong digital year.

Nonetheless, as you saw in our Q4 report verification Incisive platform was very strong.

We saw good results with Virtuoso on OpenAccess.

There's a lot of strength as a result of the investments that we've been making and of course, the coincidence of the timing of our renewal cycle.

I'll try to be brief but still to cover the broad-base of offering that as we speak will continue to resolve into the year.

By now our platforms have basically integrated and we are enhancing them and rolling them out.

Maybe I'll start with the digital space, which is the most watched.

As we speak, we are rolling now our 3.3 release of Encounter, which closes most of the gap that we were constantly talking about with [INAUDIBLE] while keeping our technical superiority.

As of now, customers are getting into their hands a flow that we shrunk the setup time of it from the moment you take it out of the box until it is running from weeks to days.

We greater signify the number of steps to implement the design, improved timing.

People are getting 200 pico seconds, it's a whole lot of time.

Slack improvement, placement algorithms, visual [INAUDIBLE] improvement, across the board support, Linux support [INAUDIBLE] so this is a major step for us per our commitment to deliver this ahead of schedule.

We will supplement it with yet another release that we completely close the integration gap and keeping our superiority there.

We are starting to consistently upbeat [INAUDIBLE] our multi mode simulation is gaining popularity, so this, although we are established in this space, we completely refreshed it.

In the Silicon-Package-Board, we are now supporting almost every operating system available, HP, IBM, this is a release this quarter.

Your seeing here activities across our platform base with each one of them regardless of the market position being very established, Virtuoso or in highly competitive situation, it's frequently refreshed and we are actually getting the feedback from our customers consistently buying it.

For example the digital we are now beating [INAUDIBLE] in their sweet spot which is flat design.

Completing flat designs that they were very comfortable with.

Now get into a size that even they cannot do and we are doing those on the design they cannot compete, our signal integrity at times and other places [INAUDIBLE].

So though things are competitive, all of our platforms are being refreshed on time and customers respond very well to those.

One last one on the bookings again, in terms of the back-end loading for the year, do you think in each of the third and fourth quarter, you will have multiple 10% plus customers, that is, two or three customers who each account for 10% of quarterly bookings?

We're not going to get into that level of detail.

I'm sure we'll have many large contracts in the whole year, not just in the second half.

Okay.

Thanks, Bill.

Our next question comes from the line of Raj Seth with SG Cowen.

Please proceed with your question.

Thank you.

First, maybe a follow-up for Lavi.

Can you talk a little bit, you mentioned a bunch of product areas, can you talk about what the strategy is at the bottom of the flow in the physical verification space, what you're doing there and what we should expect in the so-called design for manufacturing space that Mentor and synopsis are talking up?

First of all, we don't see something that is the bottom of the flow, it has to go throughout the flow.

We look at it as basically the target of all of this is to manufacture or to yield as many living small reliable chips out of the wafer.

Really three components in there.

Your design what we call the designs throughout not only the product of the flow.

All the modules in the flow have to take into account signal integrity, reliability and so on and this space we are clearly leading with our reliability and signal integrity tools.

The other area is the area of ramp which means when those chips come from the fab, you need to quickly test them, quickly go through the fab in case you need it [INAUDIBLE] here again we are leading with technology we required from IBM and designed that is embedded into our synthesis and implementation software and the third one is where you get those initials from, the design for manufacture that is the processing, [INAUDIBLE] and so on in this area as you know [INAUDIBLE] we bought the K-2 and starting to roll their products into the market.

We have promising that are close partners are impressed with and this is the area that we are not hands down, there yet as we are placing a lot of effort and focus on.

Two out of those three areas we are leading and refreshing like the rest and a third one we are still working on and investing.

How about the physical verification space.

The physical verification space, the two areas that's the interactive verification space where we have the worlds best tools and the digital batch where we are lagging significantly behind Mentor.

This is an area of investment for us and major focus.

We are not ready to open our plans right now.

I think we demonstrated in the last couple of years that when we set our mind to do something, digital, for example, we are clearly getting there.

So but we are at this point not ready to announce our plans there.

Definitely recognizing that we are behind Mentor in the batch digital space.

One last one for Ray, if I might.

Ray, you mentioned that your customers are still are under some pressure last night while they suggested that the EDA sector isn't feeling the upturn, obviously there's signs in the customer base.

Given your conversations with executives and your experience, how long a lag do you think.

Are we a couple quarters away before you start seeing customers begin to open their pocketbooks in a more dramatic way?

How long before EDA feels it?

Raj, I don't think there's a rule of thumb we can applied after the kind of downturn we've seen.

People are very gun shy.

If they're not gun shy, they are using the experience as the high ground to keep cost controls on their organization so that they can continue to determine, look and see if this upturn is going to be sustainable for them.

Having said that, need drives a lot of things.

You've heard me pound the table about the role of renewals in the industry and certainly among the EDA companies and their businesses, but also these new technologies.

As people see the recovery come, more products and more projects are committed to the more advanced geometries and that is driving another kind of need which is the need to upgrade to new tool flows.

The kinds of conversations we are seeing with customers irrespective of renewal cycle is a very encouraging sign.

So whether it's one quarter, two quarters, three quarters, can't say.

I think it will be customer specific.

I think it will be influenced, of course, by the fact of operating businesses and the renewal cycle but it's upon us and makes us all, I think, a little more bullish about what particularly '05 can bring.

Are you seeing design starts, there's a shift toward finer geometry?

Is that something you expect to see in the future?

I think we are seeing design starts begin to increase.

The forecasts I've seen as well as the experience we're having working with customers on very big SOCs is getting under way with more velocity than we've seen in the past couple three years.

Great.

Thank you.

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

Please proceed with your question.

Thanks.

I was wonder going you could help characterize the quarter by size.

Was Q4 characterized by small size or 10% bookings in the quarter?

We do have one 10% revenue customer in the quarter.

I would say we have a handful of large contracts in more than $10 million range.

So pretty well spread we have a number of large contracts and one big customer contract.

Okay.

You said you expect bookings to grow 7-10% this year and the way I've got things modeled, looks like revenue is likely to grow faster than that because of the license model shift.

Is that your expectation as well and do you think that trend might continue in 2005?

Sure.

The way the math works is as we continue to do the layers, we will have revenue accelerate particularly in 2005 faster than bookings growth.

We should expect to see good bookings growth, we believe, in that year as well.

You think good bookings growth in '05 as well.

Could that be above '04's level as renewals continue into '05?

A little early to put a call on '05 but the general indication is as the economy does well, the business will as well.

Okay.

And lastly, this morning Synopsis put out an announcement they signed an agreement for verification platforms.

I think I remember a year ago ATI used the flow for a design.

Do you have a sense of what's going on there and do you know if they have completed designs with encounter?

Don't know the details of the announcement.

I saw it as well.

Don't know what it means.

I can tell you our relationship with ATI together with the foundries continues to progress in the way that we had expected.

We're seeing it across the entire flow and seeing particularly in relation to improving Silicon in the extraction at 90 nanometer.

Yes, ATI with the foundries at 90 nanometer and the platforms are producing excellent results for us.

Okay.

Thank you very much.

Our next question comes from the line of Rohit Pandey with CSFB.

Thank you.

A couple of questions.

Firstly on bookings.

The synopsis, Mentor and Magma giving the elaborate bookings data, why Cadence does not provide more bookings guidance?

We'll look to provide additional details for bookings as we go through 2004.

You see where we are the base for 2003 and look carefully what we think the right answer is keeping everybody in tune with the business going forward.

So we should expect to see more on bookings [INAUDIBLE] going forward?

I don't think you'll see us follow, we're going to step back and look at it and we'll be providing additional metrics.

Then I have a question on the technology front.

The incisive platform is in good shape for acquisition and alliance with [CoWare] [INAUDIBLE], do you think there's some area in verification where you need to work and what's your strategy there?

This is Lavi.

I think I understand where I need to go with this.

Various companies have strong point features, [INAUDIBLE] a proprietary software that they are operating successful within certain areas.

Incisive for us is the main strength on top of the technologies there, the supreme integration of all the technologies and integration to the rest of the platforms so I don't know here exactly what you're referring to from the technological point of view but rest assured we are constantly watching all of those things that brings the maximum value to the customer to make sure we either provide them directly or enable customers with them through open access or collaboration with other companies to integrate for our platforms.

This is our highest priority and the thing we constantly watch.

Seems if we are deficient [INAUDIBLE] priority to our customers, we let go but on those we are more carefully watching.

So do you need to do any [INAUDIBLE] in the verification space or do you have in-house people working on that?

I think the way to think about this is we don't feel like we need to own every technology.

The whole philosophy and strategy around OpenAccess is that we own the anchor technology, the leadership technologies we need to own and have tightly integrated with where we see the opportunity to partner or to provide an environment like OpenAccess for others to join in.

We can do that.

At this point, we don't see anything on the horizon that we, quote, need to acquire.

Okay, thank you.

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

Please proceed with your question.

Good job, gentleman in the fourth quarter and congratulations.

Just a couple questions.

One is you commented again on the operating leverage coming back into the model in the fourth quarter.

Do you see that as a fairly steady ramp up or because you were expecting slightly more weighted bookings toward the fourth quarter, we should expect a bigger jump in Q3 and 4?

Not quite sure I understand the question, Jennifer.

I guess I'm asking about as you see operating leverage come back into the model, are you expecting it to be a fairly even ramp in terms of imbruement or some type of jump you're seeing in the quarters, the fourth quarters more back end loaded.

For Q1, of course, operating margin will be down sequentially.

It normally is.

As we progress our target for Q4 is to be back to 30% operating margin which we expect to do.

It gets to be fairly even in Q2 and Q3.

Okay.

That's kind of what I'm looking for.

Okay.

And then if you could comment a little bit on the progress you're making with your synthesis product now that it's more integrated and where you see yourself gaining leverage, any particular product areas or accounts where that's making more significant progress?

Let me comment on that.

On the synthesis front, as you know we had completed the acquisition of second quarter last year and since then we made tremendous profit [INAUDIBLE] for this particular integration and as it comes on different fronts, first of all what you see is that we integrate the team and then the record [INAUDIBLE] acquisition, merger integration, people with high morale, we literally did not lose anybody, people as well as the team from Cadence [INAUDIBLE] so that's a lot of accomplishment, if you understand the problems.

Then on the technology fund, we deliver top merger release production release in December last year which covers obviously the quality [INAUDIBLE] in the marketplace in terms of the timing and size and all those measurements.

We also put in the new features, design forecasts, [INAUDIBLE] other than just very long, so one of the things I mentioned earlier was integration of composite with a counter platform.

Come together.

At the same time we announced new technology through the fourth quarter and, I think Ray mentioned fourth quarter we increased our customer engagement to over 100 and this is phenomenal, as you can imagine.

Now we basically win technically on all those engagements so this is, I can't think of any better situation than this one.

Thank you.

Our next question comes from the line of [INAUDIBLE] with Newburg, Ray and Berman.

Please proceed with your question.

Hi, just looking at your P&L for second quarter of last year when you did $275 million in revenue and 9 cents in earnings.

Seems like you same revenue and same earnings number.

I'm trying to understand what the benefits are and the restructuring you went through during the last twelve months?

Well, we will, as you know, continue to move through this transition.

We are finished one year of moving to the higher model.

Our target is to finish this year 30% operating margin by the time we hit Q4 and our goal for 2005 is to have the full year be at a 30% operating margin which is really what you'll see the full leverage because of the transition will essentially be done.

You'll still see some ramping of market improvement throughout the 2004 because we're not yet through 2/3.

You will see that complete by end of 2004 and you'll see that leverage back in our model.

Both from an operating earnings perspective as well as cash flow perspective.

And you also see continued improvement of operating cash flow throughout the 2004.

I think that's when you'll see the leverage returning but really gets punctuated in 2004 when we stay above 30% operating margin.

Just one more quickly, to get to your target 30% margin number, are you expecting that your operating expenses will remain flat in the next three quarters or four quarter as soon as.

They will be flat as I mentioned for 1% once we increase because of the sequential move from Q4 to Q1.

Essentially flat for most of the year.

Thank you.

Our next question comes from the line of Dennis Wassung with Adams, Harkness.

Pleads proceed with your question.

Thank you.

A couple of quick questions.

First off, I was wondering, Bill, if you could repeat the prescription revenue and bookings in the quarter.

I think I missed that number.

Sure, you have another question?

Sure.

Sort of along those lines, talking about the mix of the subscriptions moving down to the 75-85 range versus prior expectations, I'm curious what's driving that?

Are you seeing change in customers attitudes toward this business model or license model or is it just the way things are shaking out after getting deeper into the process?

I think it's just normal shaking out.

We had set the goal at 80-90 early on.

And as you know for the past year, we've been operating around that 80% level.

I think it's going to be fairly normal that we could see a swing that could go 5% either way.

So that, I think, is just the experience.

For the quarter, we did expect 60% of our business to come from backlog and we did receive that 60%.

As we looked into 2004 that will go up for the year to 65%.

For Q1, it's going to be 70%.

70% for Q1?

Okay.

And the final question, sort of technology questions here.

On the analog and customs space, just curious what you're seeing there, is that market growing and obviously we saw the synopsis acquisition today, small company in the analog space, curious to what you're working on sort of the automated analog design process, what's happening in that space.

Obviously you have a large incumbent position and interested in what's happening there in terms of growing that business in terms of stabilizing or re entrenching in that base.

A quick comment from me and then on to Lavi.

This is a market that grew very quickly in the 99-2000, 2001 time frame.

It hasn't grown as fast in the past couple years.

I think that's that's just more reflection of the environment we've been in.

What I see, I think what we are operating to is that this is increasingly important technology for any IC maker and certainly critical for people making system chips.

It's a very strong position for us.

It's unquestioned leadership on our part and it's critical to anyone that is increasingly designing in multi mode.

We have invested in it, we are investing in it and no surprise to me that others might envy this market position given its strategic nature to our customers.

So we're not done.

Lavi?

Yes, just wanted to add a few more things.

I think the fact that synopsis picked ADA, the only thing around to pick indicating that they also see that this an area they need to start doing something about; although, we believe that we don't see them in any one of the accounts in capabilities and rapid design capabilities are missing compared to where we are and where we are with our partnership but they were supposed to do it so they are starting their journey.

We are long, long way away in this.

We are now concentrating on other things which is integrating established capabilities into continuing the integration into the platform, bundling it with other simulates, linking it to the layout like ten stages ahead.

We believe that the more you will put into one chip to lower size, the more analog you have to deal with it.

It has to be done in integrated ways.

We are linking the whole thing together.

Synopsis is starting the journey which is one more testimony to the growth that this area will experience.

Our next question comes from the line of Erach Desai with American Technology Research.

Please proceed with your question.

Good afternoon.

I'd like to go back to the product bookings to the software bookings questions that Jay and Rich started asking.

I don't know if I didn't hear it properly but for most of the year last year you had a benchmark internally.

I don't know if you gave us the numbers but the bookings, software bookings would be down 10%.

I'd really like to understand where the full year '03 relative to that benchmark came out.

Erach, we were down more than 10%, and I think we're going to leave it at that level.

Okay.

Then, too, what Jay was asking if you're looking for 7-10% bookings growth, I don't see how you get to '02 bookings levels at the end of '04 and you've done acquisitions along the way.

What's wrong the in that line of thinking?

I indicated that we should be approaching that level and I think we will approach that level.

Not going to get into a real precise level, our business is going to be getting on the product level close to where we were.

Okay.

Trying to get a better understanding of the first quarter guidance.

If I make a reasonable -- I don't you don't want to go into the detail but if I make a reasonable assumption for service and maintenance, it would seem like the product revenues would be about 165, down about 18% sequentially.

Could you give us some color on what the mix was in Q4 that brings us to the sequential down tick?

Because my assumption would be that with 80% roughly, subscription revenues you should be not seeing much of a sequential decline.

I think, as I mentioned, one year in to 80% does not make 80% of revenue coming from backlog.

I did indicate that we'll have 70% of our product revenue coming out of backlog in Q1.

I think that helps you triangulate what you need to from a bookings perspective.

Product revenues were 119.9 in Q4, can you give us a sense of what that breakup was in subscription terms and perpetuals?

I gave you the bookings number and let you know how much came out of backlog which was 60%.

That's just the level I need to get into.

It doesn't tell me what's the term part and the subscription part which are two different things.

Okay.

Could you tell me what if there were any receivables sold in the quarter?

Yes, we did continue to follow our normal program.

We had about $54 million of receivables sold on a nonrecourse basis during Q4.

5, 4?

5, 4.

Thank you.

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

I'd like to return to your earlier comment about hoping to negotiate an improved portion of cash paid in the first year of a contract.

A year ago early in January when you talked about a disappointing Q4 and guided then as '03, you talked about a lengthening of payment terms and that was going to diversely affect your revenue, I'm sure you recall that situation at the time.

Are you suggesting now that you might be able to reverse that and improve the payment terms perhaps with the same customers or others from a year ago?

And in order to get that improved cash up front, what are you having to give up in return?

Deliverables or other things that would meet qualifications?

Jay, this is just a matter of focus.

We have, in fact, seen our teams going in and incenting them to get a little bit more cash up front and incentives work.

That's one of the reasons why you saw deferred revenue up $30 million is because we have three-year contracts.

We are able to get a larger portion of the cash up front.

This isn't about giving anything away.

This is just about the normal give and take.

It's more focused.

People realize it's important particularly in today's cash environment and customers in their business are doing the same.

I think you'll just see that as the environment improves and the focus continuing to improve on it.

It's simple to that.

And lastly, maybe Lavi, can you talk about your remix experience?

Are you seeing customers take advantage of your remix options which they don't always seem to do but perhaps doing more now to take advantage of the new and improved encounter?

Jay, I'll take it.

We do see customers use it.

It's a valuable part of our offerings to customers.

They like it and they particularly like it now as they see new technologies coming out in every single platform area.

Thank you, Ray.

Let me just close the call with a couple of thoughts. '03 we assembled and integrated great technology that was needed to win the digital battle.

It included key acquisitions in that area like get the chip at [BURPLEX].

We built and delivered three new technology platforms over the last year or so.

Encounter followed by Incisive in February and completely renovated platform, Virtuoso.

Solid and ahead of schedule.

We take a lot of pride in that.

This year is a collection of existing and new generation technologies and the people who develop them.

Every technology is leading edge, everyone is differentiated and everyone is integrated. [INAUDIBLE] We strengthen our design chain relationship, we help partners deploy OpenAccess into production and financial goals each quarter.

The decisive actions we took to strengthen our technology, information and financials are beginning to bear fruit as customers gain greater advisability into plans.

Our progress in '03 positioned us well for '04.

We are poised to take share we believe in leading edge to exploit the market sweet spot for fast complex SOCs and develop those indispensable business partnerships with our customers through platforms, services and open collaboration.

This, in turn, will enable enterprise to create nanometer electronics profitably.

Thank you for joining us.

We'll see you at our analyst day, March 9th in New York.

Thanks very much.

That does conclude the conference call today.

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