益華電腦 (CDNS) 2004 Q2 法說會逐字稿

Good day everyone and welcome to the Verisity second quarter 2004 earnings conference call.

Today's call is being recorded.

At this time for opening remarks and introductions, I would like to turn the call over to Mr. Charlie Alvarez, Verisity's Chief Financial Officer.

Please go ahead, sir.

Thank you and good afternoon.

This is Charlie Alvarez and on behalf of the company I'd like to welcome you to Verisity's Second Quarter 2004 Earnings Call.

On today's call I will highlight the financial results for the June quarter 2004, Moshe Gavrielov, our CEO will follow with the discussion and the highlights of our operating performance overall design environment and market opportunities and then I will finish with our outlook for the September quarter and fiscal year 2004.

After that we will be happy to take your questions.

As a reminder, this call is being web cast and recorded and will be available for replay on our Investor Relations web page at www.verisity.com.

Before beginning my comments I'll read the following Safe Harbor Statement.

During the course of this conference call we will make forward-looking statements.

These forward-looking statements are subject to risk and uncertainties that may cause actual results to differ materially.

These forward-looking statements include but are not limited to statements with the words like expect, believe, anticipate, continue to, may, potential, will, or the negative of those terms.

For discussion of the relevant risks, please refer to the risk factor section of our most recent SEC filings including the company's Form 10-K filed on March 12, 2004 and Form 10-Q filed on May 10, 2004.

Additionally, during the course of this call, Moshe and I will be making reference to pro forma net income and loss and net income and loss per share that excludes certain non-cash charges that have not been calculated in accordance with generally accepted accounting principles.

These measures differ from GAAP and that they exclude non-cash charges related to equity issuance's, amortization of cash, based deferred compensation, and amortization of intangible assets all resulting from the acquisition of Axis Systems, which was completed on February 9, 2004.

For a more complete discussion of the nature of these pro forma items please refer to our Form 8-K filed on April 22, 2004.

Verisity provides these measurements in addition to GAAP financial results because it believes they provide a consistent basis for comparison between quarters that is not influenced by certain non-cash expenses and therefore provides a helpful alternative perspective to understanding Verisity's underlying operational results.

Further these pro forma measures are some of the primary measures Verisity's management uses for planning and forecasting.

These measures should not be considered an alternative to GAAP and those pro forma measures may not be comparable to those provided by other companies.

We are very pleased with the financial performance we achieved in the second quarter.

Revenues grew sequentially and met the high end of the guidance that we provided to you on our last call.

Also we reduced our sequential non-GAAP loss by 43%.

And we continue to maintain a strong balance sheet with over $53 million in cash and cash equivalents.

I will now review the financial highlights of the second quarter, which ended June 30, 2004.

On a GAAP basis after the effects of purchase accounting we achieved revenue of 13.7 million hitting the high end of our guidance range.

This was up sequentially from the first quarter 2004.

License revenue of 7.8 million --was 7.8 million in the second quarter up 33% from the first quarter and contributed 57% of total revenue.

The second quarter maintenance revenue was 5.7 million up 14% from the first quarter, and revenue from other services of 214 represented the balance of total revenue.

Revenue in the second quarter from time based licenses accounted for 91% of license revenue a decrease of 98% of revenue in the first quarter of 2004.

Time-based license revenue was up 22% sequentially.

Existing customers accounted for approximately 99% of revenue and 95% of bookings in the quarter.

With revenue consistent with past quarters and our ratable model.

Our bookings this quarter improved sequentially and year-over-year.

As a result our book-to-bill ratio, which is our book-to-revenue ratio was very favorable.

We reported gross margins of 90% in the quarter.

Our operating expenses excluding non-cash charges were 13.6 million in the quarter sequential increase of 15%.

This expected increase of Q2 expenses reflects additional investment made to integrate our product lines and reflects the full quarter of operating expenses generated by Axis versus the two months of Axis operating expenses generated in Q1, plus costs associated with Sarbanes-Oxley act requirements.

Non-cash charges related to equity issuance's, amortization of deferred, cash based deferred compensation and amortization of intangible assets associated with the merger were approximately 3.1 million in Q2.

Other income and expense was a net 115,000 income.

The effective tax rate for the second quarter was 42% again largely due to the addition of Axis to the overall P&L.

Our GAAP net loss for the quarter was $2.5 million or $0.11 per fully diluted share based on 23.3 million shares outstanding.

Our pro forma net loss for the quarter was 561,000 or $0.02 per fully diluted share.

This pro forma loss is based on GAAP revenue.

This was an improvement over the guidance of a net loss of 4 to $0.05 per share from our last call.

Turning to the balance sheet highlights, cash and cash equivalents were 53.1 million at the end of the second quarter.

Accounts receivable ended the June quarter at 14.6 million.

The average weighted days outstanding for the June ending receivables balance was 14 days an improvement from 19 days in the first quarter and well below our target of 30 days net payment terms.

Traditional DSOs were 97 days at the end of June but again DSOs are not metric for the health of our receivables due predominantly to the ratable revenue model.

More importantly our receivables measured by their aging remain solid.

Total deferred revenues were $40.2 million at the end of June, up 40 -- 4.1 million sequentially.

This represents the billed or paid up portion of backlog that will be reported as revenue in subsequent quarters.

That completes the highlights of our June quarter.

I will now turn the call over to Moshe for his comments.

Thank you Charlie and good afternoon to you all.

This is Moshe Gavrielov the CEO of Verisity.

Second quarter of 2004 was clearly a very good quarter that demonstrated significant improvement in terms of business momentum.

The highlights of Q2 include hitting the high end of our revenue target and exceeding our EPS target, favorable book-to-bill ratio accompanied by the expansion of our backlog deferred revenue significant multiyear license expansion reorders and renewals from our key semiconductor systems and star IP customers.

Successful adoption by our key customers of the products we released for full customer shipment during this quarter including the very successful Xtreme server platform, the unique vManager product.

The announcement of two integrated solutions SpeXsim and SpXtreme within a few months completing our acquisition with Axis systems.

Last, but definitely not least, the successful completion of the first full quarter of the new Verisity combined with a significant contribution from the Axis Systems team and the much expanded product portfolio.

In the second quarter, Verisity's renewed -- Verisity renewed its momentum at both the major and mid-sized semi conductor companies.

This was driven by very significant deals struck with 10 worldwide semiconductor players.

As a result of these successes, the percentage of revenue contributed by the semiconductor sector was approximately 56%.

On the systems side, significant new orders and multiyear agreements came again from leading customers from all three major geographies.

The overall percentage of Q4 revenue -- sorry of Q2 revenue contributed by the systems sector was approximately 34%.

In addition, we received one very substantial order from a leading player in the star IP marketplace.

Revenue from small customers came in at 10% in Q2.

As I mentioned in my introduction, several of these orders from our key customers in all three categories were long-term multiyear purchases that highlight their commitment to our leadership technology.

During the first half of 2004, the license count of our flagship Specman Elite product has already grown at 13 out of our top 26 accounts.

This is a promising mid-year data point given our past experience with license renewals and growth occurring primarily in the second half of the year.

It's my expectation that 2004 will be no exception in this regard.

In terms of the overall industry environment, we definitely continued to see expansion in the overall design activity, the number of projects being pursued by customers, in particular in our international market.

Not withstanding this ongoing improvement in the general environment, development budgets continue to be scrutinized carefully.

We expect this climate of ongoing caution to continue in the second half of 2004.

As we discussed at DAC the new Verisity is moving very rapidly to expand its product offering in the front-end verification market utilizing three synergistic parts.

The first of these is the enhancement of our industry leading VPA product line.

This includes the new versions of Specman Elite, vManager, e-Analyzer and eVC's.

This quarter in particular I'm thrilled with the broad interest level in vManager.

In the past, our customers have already found that applying massive parallel simulations utilizing numerous Specman Elite licenses results in a faster rate of bug discovery and verification closure.

The task of planning, deploying these simulations, analyzing failures, and coverage, and generating reports, becomes a significant challenge. vManager very uniquely provides the means to automate those tasks, a fact it has not been lost on our leading customers.

It has already translated into numerous purchases and continues to generate a large number of additional opportunities.

In parallel, the second leg is comprised by the platform products.

In May, we announced our next generation Xtreme server product.

It is the industry's first multipurpose multi user high performance event based verification server and extends the capabilities of the Xtreme 2 platform to allow up to 12 users to run simultaneously with the same performance and features.

Xtreme server targets and addresses the functional verification complexity system level design as well as traditional system on a chip and hardware software development.

I'm very pleased with the rollout of this product, which has already resulted in numerous sales to our leading platform customers.

As a result of the very successful integration of the Axis team and products into the Verisity fold it is my extreme pleasure to announce the promotion of Steve Wang, the Axis System Co-Founder and Integration Executive to the role of General Manager of the platform team.

I'd also like to use this opportunity to thank Mike Tsai, CEO of Axis Systems who has led the platform divisions since the acquisition for his contributions and support.

Following the successful transition of the platform business stewardship to Steve, Mike will be leaving Verisity at the end of the month.

Notwithstanding the success of the existing stand alone VPA and platform products the most significant growth potential for the new Verisity is undoubtedly through solutions that combine the most advanced technologies of both the product lines.

The first of these called SpeXsim was announced and delivered only two months after the merger was consummated.

It will enable our current customers to rapidly scale their purchases as they move to the requisite next generation verification methodologies.

SpeXsim is already being sampled to several of our key customers and continues to receive positive feedback both its functionality and its performance.

It is on track to ship in volume in the second half of 2004.

In addition, we announced in May our absolute unique SpeXtreme product, which is specifically targeted for high performance chip and system level verification, provides seamless integration of several of our most advanced VPA and platform capabilities, enabling performance improvements of 20 to 100 eggs per simulation acceleration and a smooth transition to megahertz frequencies in system level emulation.

It is currently on schedule to be available for shipment in the fourth quarter 2004.

Since the beginning of the year, I've spent most of my time working on the consummation of the Axis acquisition and integration of the two companies.

I'm obviously very pleased with the progress we have made.

In parallel, I've also had the opportunity to present the capabilities and plans of the new Verisity to tens of executives all over the world at our combined key strategic accounts.

Given their understanding that functional verification continues to be the major technical challenge they face in bringing successful products to market in a timely manner, they continue to see Verisity as the clear technology leader with a path to be their broad line verification solution provider.

Now pass the meeting back to Charlie who will provide financial guidance for the combined company both for the third quarter of 2004 and the entire year.

Thank you Moshe.

First I will reiterate our earlier cautionary statements about the uncertainties faced with respect to forward-looking statements we make in this call as well as the outcome of our operations relative to those forward-looking statements.

We cannot assure you that our results will be consistent with these statements due to a number of factors.

Please refer to our recently filed 10-K and 10-Q's for more detailed explanations of the risks we face.

We do not plan to update, confirm or change this guidance until our next earnings conference call except by press release in the case of internal events and this is consistent with Reg FD.

I will now move to summary of our outlook for the third quarter and the fiscal year 2004.

Our outlook for 2004 remains unchanged.

We currently offer our customers a comprehensive suite of verification process automation and infrastructure solutions that can solve their toughest verification problems.

We're also early on in the life cycle of some of the new products, which will serve to fuel our growth in the second half of the year.

As I stated on our past conference calls, we are cautious about the timing and enclosure of new orders and deployment of new incremental licenses by our customers, which can be delayed, related to revenue recognition.

Although we have seen some improvement in the overall health of our customers, customer-spending patterns have improved only very modestly as they continue to closely manage the quantity and timing of delivery of new licenses.

We remain committed to our ratable revenue model with time-based licenses contributing 91% to the second quarter for both revenue and license revenue and bookings.

As a result with a time based model and some of the customers cautiousness in respect to the timing and deployment of new licenses it does take longer for improved bookings to translate into corresponding revenue growth.

With this as background, we expect revenue for the third quarter of 2004 to be approximately 15 to 15.3 million, up sequentially between 9 and 12%.

Target gross margin for the third quarter is between 89 and 90%.

With our, consistent with our plan to continue to invest in R&D in order to accelerate the integration on the remainder of the product lines and our focus on channel development, we expect our operating expenses excluding non-cash charges to grow sequentially by about 7% to 8% for the September quarter in 2004 with the distribution of these expenses by function R&D and SG&A to be approximately in the same proportions as in our actual results for the second quarter of 2004.

Non-cash charges related to equity issuances, amortization of cash based deferred compensation, and amortization of intangible assets associated with the merger are expected to be approximately 5.5 million in Q3 of 2004, and 13.3 million for the year.

Non-cash charges in the third quarter will increase due to the acceleration of compensation charges associated with Mike Tsai's departure at the end of the month.

Future charges will be lower by the same amount.

We expect the other income and expense line to be net income of about 115,000 per quarter.

We are using an effective tax rate for forecast purposes in Q3 and for 2004 of about 40% and we will be analyzing this further -- analyzing the effects of the Axis merger on our tax model and refine this as more information becomes available.

Full basic weighted shares, average shares outstanding in the second quarter for earnings per share purposes were 23.3 million and we expect this to increase by about 150,000 to 200,000 shares in the third quarter.

And this is due to a GAAP loss.

Basic shares outstanding are used instead of fully diluted shares outstanding.

The foregoing guidance should yield a GAAP loss per share of about 15 to $0.16 per share and a pro forma loss per share of about a penny to two pennies per share in the third quarter.

With our current visibility, and the steady customer shift and more affordable time-based licenses our revenue guidance for fiscal 2004 remains approximately 56 to $58 million.

We believe this revenue range along with the focus on execution can yield GAAP loss per share of between 39 and $0.43 per share.

And we now expect a pro forma loss per share of between $0.05 per share and $0.09 per share in 2004.

This is about a $0.02 per share improvement over our previous guidance.

And this is on approximately 23.1 million shares outstanding for the year.

In summary, we are very pleased with our financial results.

We feel that with the rollout of our new VPA solutions coupled with our infrastructure solutions and our recently announced integrated solutions that we are well positioned in the marketplace to capitalize on this much larger market opportunity.

This concludes our comments, and at this time we will open up the lines for Q&A.

Thank you sir. [OPERATOR INSTRUCTIONS].

Our first question today comes from Garo Toomajanian with RBC capital markets.

Thank you.

Charlie, you mentioned that total deferred revenue was up.

It looks like short-term deferred revenue was down a little bit, but long term was up actually up 50% sequentially.

Is that because the average duration of time based-licenses, you think, is increasing?

No, because the way we account for, in our back log in that sort of thing, we only take the first year.

So when you see the long-term coming up, it's the same sort of duration of the major deals we have.

They are typically two to three years.

The only difference here is the customers are paying for all two or three years where you see the long-term go up.

And that's what occurred.

So we had consistent commitment to, you know, multiyear deals this time around but in a couple of cases customers actually paid for their entire two to three-year commitment and that shows up in the deferred revenue line as well.

Okay, that's a good sign.

Is there a difference in the average duration between Specman orders and the Axis orders?

No, the larger deals are approximately the same on the order of three years.

Okay.

Now, the timing of you know, the Axis deals and the Verisity contracts are you know, we're working with that such that some customers do want to merge their contracts as they increase the technology and you know, so the starting and stopping point of the deals may be a little bit different.

But there's quite a bit of commonality, you know, in respect to the, you know, overall duration of the deals.

Okay.

You mentioned before going into guidance that you know, there have been some order delays.

Has that sort of situation gotten better, or worse, than it's been in over the last few quarters?

I would say it's gotten better.

I don't know if it was delays so much in the orders but the deployment of the licenses.

Yes.

And you know I think on whole those licenses were deployed probably earlier than expected by the customers in a minor way.

Okay.

I think you know, we've seen some, you know, anecdotal evidence that you know, they are using the licenses up sooner and getting the incremental licenses sooner.

Okay.

And I guess, cash flow from operations was that positive then with deferred revenue up?

No, it's going to be down just a little bit in the quarter.

The deferred revenue was driven you know by strong bookings, but as you can tell by the receivables, they happen, you know, towards the end of the quarter.

A lot of the big deals close at the end of the quarter.

So we'll see that cash coming in you know July and August timeframe.

So overall, the operating cash flow was down just a little bit.

But we expect it to be positive next quarter.

Okay.

And lastly, can you break out time-based licenses and perpetuals by bookings, meaning booking as time based licenses?

Percentages?

Yes.

Of the licenses the booking were the same as the revenues, 91% was time based and 9% perpetual.

That's the same as revenue then?

Yes.

They're almost identical.

Okay.

Super, thank you.

Yes.

Thank you sir.

Our next question comes from Dennis Wassung with Adams, Harkness & Hill.

Thank you.

Can you hear me?

Yes.

Great, a couple of quick questions.

First off, some of the bookings strength you had in the quarter.

I'm curious as to how much sort of the combined offering of solutions, knowing that a couple of these tools really aren't released yet, but how much of that played into some of the big bookings you had in the quarter?

I think you know, in terms of the numbers, that we announced, there was very little impact.

In terms of the psychology, I think there is significant impact.

But you know, there wasn't huge revenue by combined products, because those products were just getting to the point and some of them will only get to the point in Q4 that they're shipping for revenue.

Some of them hopefully will happen earlier than that.

So, the results that we've talked about don't, you know, the numbers aren't affected but I think the psychology of the customer is.

So when you look at some of these larger orders, I guess I'm curious as to whether customers are expecting to transition the licenses they're getting from the current orders, into the new tools, or is it more as they expand later this year, or into next year that's I guess that's when they would add the newer tools?

It's when they expand, Dennis, as opposed to you know, in the current deals.

Okay.

And secondly, you talked about Specman license expansion at 16 in the top 26 customers in the first half of the year.

I guess when you are looking at that number is there something you're expecting coming into the first half and not really expecting, and just anymore characterization around that would be helpful.

Okay.

If I said 16, I misled you guys.

It was 13.

It was a half of the 26.

And that's a little higher than I had expected, because the renewal cycles at most of our significant customers happen in the second half of the year.

Or they reach their anniversary in the second half of the year.

And we were expecting more of those, more of the growth to happen then.

This indicates that more, that quite a few actually increased their commitment at an earlier point and you know, obviously by the end of the year, I would like it to be, probably realistically, 20 of the 26 or three-quarters to have a delta in terms of their Specman licenses realistically.

And I think you mentioned something about this but I missed it earlier in your comments.

But was there a characterization of the total installed base in sort of your expectations for expansion this year or in the first half?

We didn't give any information on the total installed base.

It sort of generally tends to grow.

The other thing, which happens is, there are a lot more products and sometimes, you know, the customers are just buying a whole lot more products, rather than just buying more Specman licenses.

VManager, we believe, and it already has been purchased by several customers.

We believe that that in of itself will help grow the Specman installation and usage.

And is that sort of how -- I guess how is that really been the I guess the impact of that tool so far, as you see some of the stronger bookings and expansion is that driven by vManager today?

Not yet.

That's ahead of us you know, because, the customers who have bought vManager and deployed it, they haven't bought large numbers of vManager yet.

They've bought onesies, twosies, but once they have those and they start seeing the benefit of that and, a) I think they will buy more vManager but b) it will provide us an opportunity to sell or provide the customers with a lot more Specman licenses because they will see the benefits of broad deployment.

Okay.

Charlie, is there material vManager revenue in the mix at this point?

No, because the time-based nature of our models, so again, with the sampling sizes that Moshe is talking about now and that goes into the backlog and rolls out over a 12-month period, that doesn't impact revenue significantly, not in the second quarter anyway.

And should pick up as we move into the latter part of the year but again, you know, gradually as, you know, the revenues do spread out over time.

Okay.

And lastly, on the revenue side you guys did a little better than expected.

I'm just curious as to from what side of the business that came from, the Axis or I guess core Verisity side and also whether you had any 10% revenue on bookings customers in the quarter?

Both sides were strong.

You know, on the platform side we were able to start recognizing all of the new business that had booked, so that was good.

You know, we lost a lot in Q1 you know, due to the purchase accounting so now we can start counting everything that comes in.

But both product lines were strong and we had two 10% booking customers in the quarter and one 10% just slightly above 10% revenue customer.

Okay.

And do you know how that characterized from Q1?

In Q1 we had two of our revenue customers that were just above 10%, one of them is a repeat, one just dropped you know, just slightly below 10% this time.

And then there were two 10% bookings customers, different names.

Different from Q1.

Okay.

Yes.

Thank you.

Thank you sir.

Our next question comes from Raj Seth with S.G. Cowen.

Hi, thank you.

Moshe in your prepared comments you mentioned something about design starts or effectively you saw some encouraging signs on the design start side.

Can you talk a little bit about where you're seeing activity?

And then I've got a follow-up.

Okay.

As I said, you know, I had the opportunity -- I traveled a lot, and you know, those DAC and all sorts of events of that nature, which were great opportunities to talk to executives.

And best I can tell they were really focused on doing design and the level of activities going up there.

And you know, they're looking for engineers and they appear to be hiring.

If you look at it internationally, I would say it's stronger by far in Japan and Asia, and then some extent in Europe it's a little stronger than it is in North America.

So I would say of the three major territories, Asia and Japan in particular are strongest, and Europe is second, and North America is still a little less strong.

But North America too appears to be doing better than it has in the past.

Right.

Any particular in the application areas that are either hot or soft from your perspective?

You know, I would say of the three, communications continues to be the softest.

But it's, again, much better than we've seen it in the past.

But you know, consumer is doing well, and you know, a lot of these, you know, system on a chip programs which are now, you know, very difficult to categorize as to which sector they belong to, appear to be moving ahead very quickly.

Right.

And finally, in the past we've talked and I know that there were some customers probably more in the U.S. than outside the U.S that had some concern or maybe put their finger on the pause button, given system Verilog developments.

As you've gotten around and talked to customers now that perhaps it's clear it's going to take some time for that standard to be established, etc., have attitudes with regard to what's happening or not happening with system Verilog as it potentially influences their decision to buy Specman from you?

Have they changed at all or any change there?

Well, I think it's definitely still something the customers continue to look at.

In reality until there is a solution which is out there and is better than the other alternatives, I think given the challenges the customers face, they -- you know, they won't touch it, because they have to get their products done.

And they don't want to insert additional risk.

But you know strategically they continue to monitor it.

And we're also committed to supporting the major design and insertion (ph) part of system Verilog as we have a very broad multi language product offering.

So we will also provide solutions for that through an expansion of our SpeXsim capabilities.

You know everyone is looking for it, you know waiting for it to come out.

And again, the big point to make is once it does come out in order for it to be used you know, it will only get used if it's better than the alternatives.

And we think there are numerous alternatives, which are very productized, competitive, which will make this into a long transition process.

Yes.

Thank you very much.

Thank you, sir.

Our next question comes from Tim Fox with Deutsche Bank.

Hi, good afternoon.

Just two quick questions.

First on the ASP front.

Can you comment at all whether you're seeing any more competitive pressure on both the Specman side as well as some of the hardware based platform offerings?

How is the pricing in those two segments?

You know, I think it -- it's about the same.

I think it's a very competitive environment out there, across the board.

Customers are very good at making it that way.

And I don't expect that to change radically.

I do think that as the design activity goes up and there's more of a premium on getting the products out, which is the traditional modus operandi, there will be a realization that you know, it may be penny pinching may not be actually as beneficial as it looks now.

But I can't tell you that there's been a huge change, and that's why both Charlie and I have used the same cautionary language there.

You know, it's not as if anyone is out there spending with abandon.

Right, right, okay.

Secondly, on vManager, could you just remind us what you think the install rate may be as a percentage of Specman seats as you go out there?

I mean how do we think about the market size of a vManager at a particular customer site?

Well, vManagers are potentially numerous usage models.

But I think what we will see is initially, it will be a function of the number of engineers doing verification as opposed to the number of machines that the engineers have at their disposal.

So the number will probably, you know, the potential market in terms of the number of licenses is probably quite a bit lower than the potential market for Specman Elite.

However, as the usage model, as the customers start seeing the benefits, we think that they'll be using more than one vManager license per verification engineer, and they will also require some for the verification manager.

So if you are looking for a number, I would say it's probably at best in terms of the number of licenses, it could be somewhere between 10 to 20% of the number of Specman licenses at the very best.

Okay.

Finally if I may actually, Charlie can you talk about whether there's any overhang left on the shares?

I know that there was a three quarter rollout period, where shares were distributed.

Is there anything left on there, do you know?

Not that I -- not that's perceptible to us.

You know, they've been distributed as far as we know.

They've been free, free certainly to be distributed.

So we haven't seen that sort of phenomena out there.

Okay great.

Thank you.

Thank you.

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

Yes, gentlemen, I believe most of my questions have been covered today.

I just want to follow up again on the vManager and then on your comments about making Specman accessible to look at the System Verilog language or to work with the, compatible with the System Verilog language.

Do you see, you mentioned at your DAC conference another product that you're working that has the view or another platform that has the view of working across multiple verification methodologies.

Could you talk a little more about how these things fit into that and when you see that product coming?

Okay.

So, we very strongly believe that and have no doubt that for the customers who are doing the leading edge designs, as they move up the verification scale, undoubtedly the Specman solution will continue to be absolutely the best solution out there.

And what we are doing is, we also believe that there will be a plurality of design languages that will be used out there.

And we're absolutely committed to providing the best support for all of these design languages.

I would even be as bold as to say that we're probably very close to that at this point in time, if you look at the support for Verilog, HDL and SystemC, we are probably ahead on the combination of those three against most of the other players in this market.

Now, what we intend to take SpeXsim not Specman, but take SpeXsim, which has the combination of the Specman capabilities and the design capabilities and it supports very low 3 HDL and will support SystemC and expand that to support the System Verilog design parts and we have announced that we'll do that and we are at this point quite committed.

We do think that system Verilog has some excellent extension of Verilog, which will provide the customers with significant benefits.

We're also in parallel working on solutions that will enable the customers to have a language, I wouldn't say language neutral, but a non-language specific input, because some of the customers are just looking at something, which takes away any language portion and those are directions we're looking at.

We believe that that will be mostly limited to the low end of the market, and that's sort of in our plans.

So in addition to supporting all of the existing languages, we will support some approach, which will not be language based, which will probably be applicable for the low end.

For the high end, there's just no way to do it without learning a powerful language and we believe that our capabilities are absolutely top-notch.

And that's what our customers are continuing to tell us, that as long as we continue to provide these capabilities, and they continue to design these more and more complex products, they absolutely are committed to our technology.

One last question, I guess, to switch subjects a little bit.

Could you talk -- you were asked about if there was any pricing pressure that you've seen related to simulation.

Could you talk about customers' response to the simulation product combined with the -- with your offering, and how -- how that might have had an impact in competitive situations this quarter?

Well, again, as I said none of the numbers reflect any of these new integrated products, which will have an integrated simulation engine, but absolutely, they are thrilled with the fact that they will have a comprehensive state of the art well integrated solution with support.

Their simulation needs as well, and we think it's a great opportunity for us and it will help drive our business.

And that's why you know we heard from these executives that they now, very much see us as a viable leading supplier of their entire verification solution.

No one else has a combination of VPA simulation and hardware platforms and the ability to move and integrate the three together in the same way that we do and that is causing some increased interest in our offerings.

All right, thank you.

Thank you.

Next we do have a follow-up from Garo Toomajanian with RBC capital markets.

Thanks Zack.

Can you tell us what the rough split in bookings was between Axis products and Verisity products?

No, we're not going to break those out.

Nice try, Garo.

And you won't in the future, too, then I take it?

No, no.

Okay.

It's not appropriate now, in the future you know, there is going to be blended deals and the new integrated products and there is just going to be you know sort of a confusing impossible thing to do so we just choose not to go in that direction now.

Okay.

Services revenue did not grow as fast as license revenue.

Is there anything to read into that.

Or I guess how would you explain that?

No, we don't expect a lot from the service revenue.

It's primarily training.

And some of our verification alliance partners are providing training out there too, more local to the customers.

And you know, that -- that is sort of up and down seasonally too as well.

So there's really nothing to read into that.

But you don't expect this to necessarily grow as fast as license?

No, no, we don't expect the -- the installed base of users is fairly well trained.

Some of the companies now have such a large installed base they are doing their internal training.

So, we have trained you know, experts within companies.

So, it is an area we focus on because we want the customers to be trained on the tools but not necessarily to generate revenue for us.

It is more to make sure the customers are trained in whatever most efficient way to be trained.

Whether it be us, our verification alliance customers or internally their own experts doing the training and so we do monitor that training but not just from the revenue perspective.

Okay.

And do you have a number on the -- the number of Specman seats installed right now.

We are going to provide that at year-end.

Okay.

What was it at the end of '03?

It was about 13,000.

Okay.

Great, thank you.

Thank you sir.

Next we also have a follow-up from Dennis Wassung from Adams, Harkness & Hill.

Another question along Garo's line of questions.

But on the book-to-bill, you said it was favorable, you said backlog was up pretty substantially.

You have given us a little bit more detail on the book-to-bill in the past.

Any other part you can give us, sir.

Is it closer to 1.5 or any kind of range?

I don't think we've given it.

I think you've speculated on it and we played a little guessing game, but no, It was very strong but that is as far as I will go there.

Would you say it's much stronger than a typical Q2?

Yes, it was a strong Q2.

Fair enough, thanks.

Once again that is star 1 if anyone has a question.

Next we move back to Jennifer Jordan with a follow up from Wells Fargo Securities.

Yes, gentleman you mentioned already starting to see maybe some combination of customers wanting to, or you mentioned that perhaps you were about to see the combination of customers wanting to re-negotiate their contracts to combine the two, the Axis contracts with the Verisity contracts.

Have you seen that starting already and do you have an estimate of kind of a percentage of contracts that's out there that it would fit into that category?

Yes, we have seen that from a few customers and my guess right now, there's probably you know, half a dozen that are in that sort of situation, but I think more will be -- more will be coming.

And you know, part of it will be just trying to align the two contracts, and the various terms of the contracts, and that sort of thing.

So as not to cannibalize revenue streams and you know, is to also incorporate you know, the right technologies for the customers.

You know, we don't just jump ahead and sell products but we want to sell solutions there.

So we are encouraging the customers to look at the best-combined solutions, also encouraging them to look at some of the, you know, new integrated products too.

So, depending on the customers we'll work with them on doing that but we want to make sure they are getting the best out of the combined use of our tools here, the best solution.

Great.

And were those, are you generally finding that the contracts from Axis and your contracts have a similar duration?

Yes, they have a similar duration.

I think you know, some are a year, a few two years, and some of the large ones three years and that's not unlike ours.

Again, for internal booking and backlog tracking that sort of thing, we're conservative and only count the first year's bookings.

So, that's why we still think in terms of one year deals but you know underlying that our contracts were you know up to three years in very similar sort of terms.

But all of them taken very ratably in respect to revenue.

Great.

And just for clarification since Dennis just asked the question about book-to-bill and backlog, when you are talking about book-to-bill and backlog are you really just talking about the first year of course of bookings?

We're just talking about the first year of a multiyear deal unless we're paid up front for the entire deal and then, you know, it is a conservative way of looking at things because while we have non-cancelable PO's, as customers can change their mind going into financial difficulties.

So, we have always been conservative in that respect.

However, once they've paid it's a pretty sure bet that you know we have seen the benefits for that zone in the cases where we have been paid for the second and third year do we count that as a booking otherwise it's a one year horizon.

Great, thank you so much.

[OPERATOR INSTRUCTIONS] We move back to Raj Seth with a follow up for S.G. Cowen.

Hi, just a quick question for you Charlie any thoughts to buy back some shares here?

You've got a lot of cash you're generating or will generate next quarter cash again.

What are you thinking about that?

We have absolutely given it thought Raj in that you know both pros and cons from investors and analysts and had discussions with our board and at this time, you know, we've decided to hold off doing that.

We don't think that's the best use of our cash, while we think the stock is on there you know valued here, I think we want -- we would really see the opportunity to raise that to our performance, and we'll you know at least in the near term you know want to keep our cash for investment activities, potential investment activities and refueling the business.

Okay, thanks.

And sir, nobody else has signaled.

I'll turn the conference back to you for any closing or further comments.

Thank you.

To summarize I'm gratified by the progress we've made in Q2, our quick integration of Axis Systems has allowed us to offer our customers a broader and more robust product suite which will ultimately drive both bookings and revenue growth.

With this much expanded and very differentiated product offering our sales organization is primed to attack what is expected to be a $1 billion market in 2006.

We appreciate your interest in Verisity's business, look forward to talking to you again at the Q3 earnings conference call.

Thank you very much.

And that does conclude this Verisity second quarter earnings conference call.

We do thank you all for your participation.

You may now disconnect.