益華電腦 (CDNS) 2004 Q4 法說會逐字稿

Good afternoon.

My name is Miles, and I will be your conference facilitator today.

At this time I would like to welcome everyone to the Cadence Design Systems fourth quarter 2004 financial results conference call.

All lines have been placed on mute to prevent any background noise.

After the speaker's remarks, there will be a question-and-answer period. [OPERATOR INSTRUCTIONS]

Speaking on today's call will be Alan Lindstrom, Director of Investor Relations, Mike Fister, President and Chief Executive Officer, Ray Bingham, Executive Chairman, and Bill Porter, Senior Vice President and Chief Financial Officer.

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

Mr. Lindstrom, go ahead.

Thank you, operator.

Welcome to our fourth quarter and year end 2004 earnings conference call.

The webcast of this call can be accessed through our website, Cadence.com and will be archived for one week.

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

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

For information on the factors that could cause a difference in our results, please refer to our 10-K for the period January 3rd 2004, and our 10-Q for the period ended October 2nd, 2004.

In addition to financial results prepared in accordance with Generally Accepted Accounting Principals, or GAAP, we will also present certain nonGAAP financial metrics today.

Cadence believes in addition to using GAAP results in evaluating our business, it can also be useful to measure results using certain nonGAAP financial measures.

NonGAAP net income or loss and the other nonGAAP financial measures used in today's discussion exclude amortization of intangible assets and deferred stock compensation, in-process research and development charges, integration and other acquisition related expenses, restructuring charges and equity and losses from investments.

NonGAAP net income or loss is adjusted by the amount of additional taxes or tax benefits that Cadence would accrue if we used nonGAAP results instead of GAAP results to calculate the Company's tax liability.

Please see our earnings press release for reconciliation of GAAP to nonGAAP net income or loss and our website for a reconciliation of all nonGAAP measures used in this discussion.

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

Thank you, Alan.

Good afternoon.

Cadence reaffirmed its leadership in 2004, delivering solid financial results for the fourth quarter and for the year.

In line with our estimates providing proof that our business strategy and strategic investments are paying off.

Our 2004 revenue of 1.2 billion was 7 percent higher than 2003, and the highest of all EDA companies.

Our full year operating cash flow, more than doubled, to $371 million.

In a few minutes Mike will discuss the details of the quarter and our plans for this year.

Bill will then follow with a complete look at the financials.

I'll begin with a look at the environment in which we're operating.

The big drivers of our business during 2004 were wireless, consumer, and high-performance computing.

Our customer's customer wants faster, cooler, and cheaper devices, and wants them now.

The sectors and trends play right into Cadence's end-to-end product strengths, leveraging the combination of our long held leadership in analog mixed signal, and our renewed leadership in digital.

As the industry looks ahead, 40 percent of the almost 9,000 design starts in 2005 will be RF wireless.

For Cadence, that adds to the demand for our mixed signal RF and low power design technologies.

While economic forecasters have been guarded, and chipmakers have trimmed their outlooks for this year, analysts projections still show some growth in semi-conductors.

And more important for us, growth in R&D spending.

It's obvious that managing inventory remains a challenge for customers.

But those customers describe demand for their products as strong.

The challenges aren't just economic.

The industry is clearly in transition to smaller geometries, keeping place with [more of a], The number of design starts at 90-nanometer and below is rising.

For example one of our customers, a major IDM focused heavily on the consumer and multi-media areas has 50 90-nanometer projects in it's pipeline, and more companies are getting serious about 65-nanometer.

All this plays to Cadence's unique strengths of an end-to-end product line that expands chip to package to board.

We're optimistic about 2005 from the perspective of our customer's customer.

Consumer devices for entertainment, productivity, and communications are converging.

Complexity and cost pressures are driving the move to 90- and 65-nanometers and to systems in a package.

Governments around the world see the electronics industry as an engine for economic development.

New markets are driving the industry.

This year China will be the largest chip consumer in the world, ahead of Japan and the United States for the first time.

As chip design activities grow in China, India, and Russia, we have increased our investments and strengthened our teams in those geographies, mirroring the expansion of our customers, Cadence is well positioned to better serve global customers.

We look back at 2004 as the year that our investments have over the past five years really began to pay off.

We rebuilt our leadership in digital with Encounter and our customers recognized it.

ATI, Fujitsu, and Toshiba are designing some of the world's largest and most complex chips using our Encounter platform.

In fact using Encounter, Fujitsu has achieved first pass silicon success on 66 consecutive designs.

We continue to combine and enhance our strength in analog, digital, and RF to meet the needs of the growing wireless market.

In 2004 we completed the integration of Neo-Linear technology into the Virtuoso platform, enabling a 5 to 10 times productivity improvement in analog circuit optimization.

We've invested in advanced technologies, anticipating our customers challenges, such as manufacturing.

Some of these technologies are in early stages of customer usage.

We haven't rushed products to market, but we have committed the time to develop and nurture a game changing technology that provides path to innovation and solves design challenges.

That's one of the strengths our size affords, and it provides Cadence a competitive advantage.

For example, one of our advanced technologies you've heard about is X. We're helping customers solve their interconnect driven manufacturing challenges in a new a new and innovative way with the X architecture.

In 2004, Toshiba produced the first X chip for production for HDTV.

We built OpenAccess to innovate our technologies, reduced the cost of integration for the entire industry, and stimulate new innovation.

Because collaboration is vital in today's virtually aggregated design chain, OpenAccess has become a global initiative.

The OpenAccess coalition has doubled in size in the past year to 32 members.

We significantly strengthened our partnership with ARM, following their recent acquisition of Artisan.

ARM's CPU's are in 90 percent of all wireless handsets.

We've increased our share of their business as a direct customer, and are working with them as a strategic partner in such areas as physical implementation, verification and emulation.

There were a lot of skeptics when we adopted our ratable business model.

It has now become an industry standard.

With it we built an enviable record backlog.

The backlog provides Cadence with a consistent and reliable stream of revenue, strong cash flow, and growing profitability, generating high-quality earnings with good revenue visibility.

We've executed consistently and have now met our targets for nine consecutive quarters.

We also continue to broaden our customer relationships from the CAD department to the Board room.

This enterprise level approach is working.

You can measure it in our success with many companies like IBM and Fujitsu.

This approach requires extra depth at senior management levels.

This is a particular strength that Mike has brought us, and he has proven to be a perfect fit.

And as you saw in our November announcement we continue to augment our ranks with key appointments in development, marketing, and strategy.

In 2004, Cadence cemented its position of leadership.

In customer success, in global reach, in technology, in our team and in our financial strength.

And now here is Mike for an in-depth look at Q4 performance.

Thanks, Ray.

Good afternoon, everybody.

Q4 capped a strong year for Cadence.

Fourth quarter revenue totaled $343 million, a 10 percent increase over Q4 2003.

For the full year Cadence revenue was $1.2 billion as Ray said, a 7 percent over 2003.

We achieved our goal of 30 percent operating margin in the quarter, and exceeded our projections on cash flow.

I see our results as a testimony to the strengths of our end-to-end product line, our customer centric approach, and a truly dedicated team of global reach.

The front end of the design flow, kind of what we call the designers desktop is a great example of our our end-to-end product line, creates pulls through for Cadence.

RTL Compiler our census product picked up 15 endorsements from the design chain, and 58 new customers.

It's important to note that RTF Compiler continues to win more than 90 percent of its competitive comparisons, but of course benchmarks aren't everything.

Our focus is clearly on customer success.

RTL Compiler opens the door for other Cadence products, and formal verification, simulation and test.

We saw that in Q4 that a number of companies including OmniVision and startups like [Amber Island and Fiden].

Our formal verification product strengthened it's market leadership position in 2004 as well, and closed out the year with well over 400 customers around the world.

I hope you can see why we're so optimistic about our front end offerings.

On the digital back end, using SSC Encounter, Toshiba takes the 90-nanometer, 24 million gauge chip, and adopted Encounter for their standard digital design flow, and we strengthened our position in low power.

Working with ARM, we developed library support for the new ECF set timing model standard, which is necessary for optimizing low power designs.

It's been well received, adopted by two of the three leading digital flows including Magma's.

A few minutes ago Ray spoke of the opportunities of the RF wireless market in 2005.

I agree with him.

Cadence is uniquely able to address this market with end-to-end solution from mixed signal, including RF to analog and digital.

Wireless chips are getting more complex with large amounts of analog content, increasing challenges for full chip design and verification.

We're uniquely focused on helping our customers what they want to design.

For example we helped rising Micro Electronics, which is a company based in China, develop their first chip for handsets that combined STDMA and GSM standards.

They used a combination of Encounter and Virtuoso.

Just last week we launched an additional new wireless capabilities and flows for Virtuoso in the fast growing vertical market.

Verification is an important adjacency to me because of the dominant role it plays in design of chips today.

We extended our leadership position in this space with a Q4 introduction of the Palladium II hardware-based emulator.

Palladium II achieves an industry first in concurrent hardware/software development by reaching 256 million gate capacity, with increased throughput and a reduced hardware form factor.

Concurrent development is very important in helping customers meet ever strengthening types of market demand.

In just one quarter we shipped more than 50 systems to customers include InVidia, ATI, Nitasha Communications Technology Limited, and Texas Instruments.

Many of these customers bought Palladium II without even requesting a competitive benchmark.

This is also a great example of extending product lines.

We consciously introduced Palladium II, as a premium emulation system, and not a direct replacement of the original Palladium product.

Many of our customers upgraded from Palladium to Palladium II, while other continued to buy Palladium, which is appropriate for the less challenging chips.

As you're well aware we announced our attention to purchase Verisity, following regulatory process there is not much to share with you now.

But Verisity's verification process automation and hardware acceleration products are a great compliment to Cadence in simulation and in-circuit emulation offerings.

Overall these are just a few of the recent product and customer successes that reinforce Cadence as the leader in EDA.

I'm impressed with the quality of our whole team, the clear dedication of customer success, and the exciting array of products and technologies.

Part of the opportunities I saw when it came to the Company, was a chance to create and capture value for the products we provide to our customers.

For too long EDA has commoditized itself by focusing on functions and features, and not appreciating the cumulative affect of the entire offering.

Cadence will create additional value, will be the better product segmentation, focused on vertical markets.

We're also going to introduce our new technologies in a very thoughtful way around these vertical markets and segments, and take a more measured approach with closed business with our customers.

We have an outstanding portfolio of products that our customers can leverage to gain an advantage in the markets in which they compete.

We will win the business when it's ready, and at a value level commensurate with what we deliver.

I'm serious about this and I've reinforced that with our team.

As we move through 2005, we are optimizing our organizational structure.

We will move Cadence from a business unit model to a functional one and we are also driving for greater efficiencies to benefit customers, shareholders and the Cadence community.

This will not only allow us to better serve our customers, but do so in the most efficient manner possible.

And because of our focus on efficiency, we will reduce our global workforce in Q1 by about 200 positions.

As has been our practice, we will continually review and optimize the way we look at our business, and how we measure it.

In 2005 we will expand our strong customer focus and rededicate ourselves to our customer's success, we will sharpen our spotlight on quality, developing and delivering products that customers need in order to efficiently compete, and our over arching goal is to be, and be recognized as the indispensable design partner in the electronics industry.

I hope you'll be able to join us at our annual analyst day, Tuesday March 1st in New York City, where you'll not only get to hear more about our growth opportunities, exciting product road map, but also spend time with the management team.

Now I'd like to turn it over to Bill to get a complete look at our results.

Thanks, Mike.

Cadence delivered solid financial results in Q4 with revenue, earnings, and cash flow, all meeting or exceeding our expectations.

The fourth quarter and 2004 were marked by strong execution.

Our financial model is predicated on a consistent base of revenue from backlog, target nonGAAP operating margin of 30 percent, and strong cash flow.

In 2004, we met our goal of generating two-thirds of revenue from backlog, achieved a 30 percent operating margin in Q4, and exceeded our goal of 325 million in operating cash flow.

Book to bill exceeded 1 for both Q4 and the year, and backlog grew $100 million to approximately $1.7 billion.

We have good momentum entering 2005, delivering 9 percent year-over-year bookings growth in the fourth quarter.

As Mike mentioned, we are taking a more measured approach to when we close business with our customers.

In Q4, we chose not to close some business in order to continue to increase the value we expect to receive for our technology, which resulted in bookings growth for the year in the low single digits.

GAAP earnings per share for Q4 were $0.20, compared to $0.05 in the same quarter last year.

NonGAAP earnings per share of $0.26 were up 18 percent year-over-year, and at the upper end of our targets range.

For the full year 2004, GAAP earnings per share were $0.25, compared to a net loss of $0.07 in 2003.

NonGAAP earnings per share were $0.66, compared to $0.50 in the prior year, an increase of 32 percent.

Total revenue for the fourth quarter of $343 million was up 10 percent year-over-year, and near the upper end of our target range.

Product revenue was $227 million, maintenance revenue was $83 million, and services revenue was $33 million.

Revenue for the year totaled $1.2 billion, up 7 percent from 2003.

Revenue mix by geography in Q4 was 45 percent for North America, 30 percent for Europe, 14 percent for Japan, and 11 percent for Asia.

We saw a strong finish to Q4 with overall strength in Europe and North America, as well as very good breadth of business in Japan and Asia.

In the quarter approximately 75 percent of our product business was represented by ratable licenses, that is licenses where revenue will be recognized over time.

Revenue from backlog also came in as expected with about 60 percent of our product revenue from backlog in Q4.

For 2005, we again expect to generate at least two-thirds of revenue from backlog.

Contract life calculated on a dollar weighted average basis was three years.

In Q4, total cost and expenses on a nonGAAP basis were $239 million, up from $232 million in Q3, largely as a result of higher commissions and incentive costs.

Year end head count was approximately 4900.

We plan to continue to optimize our operations.

This quarter we're reducing our workforce by approximately 200 positions.

This will result in an estimated restructuring charge of $18 million for Q1, and ongoing annual savings of approximately $30 million.

Growing our top line and holding a line on costs, has allowed us to make good progress over the past two years in expanding our operating margin.

In Q4 we achieved our goal of a 30 percent operating margin on a nonGAAP basis.

We are continuing to make progress toward achieving a 30 percent operating margin for the full year.

Our 2004 operating margin was 22 percent.

We expect the operating margin to improve to approximately 24 percent for 2005, on our way to 30 percent for 2006.

The quality of receivables in Q4 remained high with receivables 90 days past due at 1 percent, within our historical range of 1 to 3 percent.

Total DSOs fell to 126 days compared to 132 days in Q3.

DSOs will arrive seasonal in Q1, where we expect DSOs to decline to the mid- to high to mid-80s by the end of 2005.

We make good progress in growing cash flow in 2004.

Operating cash flow for Q4 was $137 million, compared to $62 million in the fourth quarter of 2003.

Improving cash flow is one of my key objectives for the Company, and I'm very pleased with the progress we have made.

For the year, we generated $371 million in operating cash flow above our goal of $325 million, and more than double our results from 2003.

Capital expenditures for 2004 were $62 million, yielding free cash flow of $309 million.

For 2005, we expect to generate operating cash flow of at least $400 million, while capital expenditures should be in the range of $75 million.

Cadence did not repurchase any shares of stock in Q4 in anticipation of the Verisity acquisition.

Cash and cash equivalents grew to $557 million at year end from $424 million in Q3.

With the cash we are generating we expect to comfortably absorb the Verisity acquisition in 2005.

Now I'll turn to our outlook for Q1 and for the year 2005.

As you've heard from Ray and Mike, we're encouraged about 2005.

As we complete our license model transition this year and we continue to have thoughtful renewal discussions, we believe bookings become less meaningful as a short-term performance measure.

For 2005, bookings growth should approximate revenue growth, and I expect to grow backlog.

The key financial metrics that I will be looking at to evaluate the progress of our business on a quarterly basis, are revenue, earnings, and cash flow.

Our outlook includes the impact of our planned acquisition of Verisity, which we assume closes around the end of the second quarter.

Our GAAP earnings per share outlook includes the expected impact of the new accounting standard for stock option expensing.

We will be excluding the impact of stock option expensing from our nonGAAP earnings per share metric.

Q1 we expect revenue to be in the range of 280 to $290 million, reflecting a fairly typical seasonal decline.

GAAP EPS should be in the range of $0.01 to $0.03, and nonGAAP EPS in the range of $0.13 to $0.15.

For the year 2005, we expect revenue to be in the range of 1.24 to $1.3 billion.

GAAP EPS should be in the range of $0.23 to $0.31, and nonGAAP EPS in the range of $0.73 to $0.81.

As I look at our results for 2004, I am pleased with our consistent financial performance and the great strides we have made in offering our customers the broadest and deepest set of design technologies on the market today.

We are better positioned than ever to execute on our technology and business goals in 2005 and beyond.

Operator, we'll now take questions.

Thank you, sir. [OPERATOR INSTRUCTIONS] And we will pause for just a moment to compile the Q&A roster.

Your first question comes from the line of Tim Fox with Deutsche Bank.

Hi, thank you.

Good afternoon.

Regarding your outlook and some mention in the call about taking in more measured approach to doing deals.

Can you just elaborate a little bit more about what's driving this more measured approach?

Will it result in any changes to pricing and remix, things like that?

Tim, it's Mike Fister, sure it will.

What we have said consistently is that -- and actually tested with customers, we would like to drive our pricing to be a fair measure of our value.

I hear consistently from customers that they will pay us more and they will pay us for the value that we deliver.

I think the industry as a whole has been guilty of, you know, going into a commodities spiral and taking, you know, a calculated approach, a measured approach with customers and not let's make a deal at some period end, is the way to go in and enforce that.

To reinforce that our value is real and that's what we're doing.

Tim, to your question on remix, I don't think it has any impact on what we're doing.

This is just considered discussion with our customers to get to the right value measurement.

Okay.

And the 200 job cuts that you mentioned, are they in any particular area in the company?

No.

They are pretty much across the company in terms of areas.

Generally they will be located in the corporate area in the San Jose area geographically.

That's it for me right now thank you.

Your next question comes from the line of Harlan Sur with Morgan Stanley.

Good afternoon, guys.

Great execution on the quarter.

Question for you Bill.

With respect to Verisity's deferred revenue, about how much of that in percentage terms are you assuming will not be recognized due to the purchase accounting affects?

Harlan, I believe they ended the year with about $50 million in deferred revenue.

Their experience with their access acquisition is that they had to write off about 75 percent of it.

So we're making a similar assumption as we look at 2005.

Okay.

And then are you also making any assumptions of that 75 percent that you will not be recognizing, how much of that is recognized in the first year?

The -- assuming that we're closing sometime at the end of Q2, it would be about half.

Okay.

About half.

Okay, great.

And then noticed that the service revenues were down again sequentially for the second quarter in a row.

Try to help us out here, because I thought design activity with our customers has been fairly robust.

Maybe you could tell us, you know, what's going on there, and maybe tell us what the active number of projects that the services team is currently engaged in right now?

Harlan, don't have a number of service projects, so I don't -- won't get to that level of detail.

But in terms of service revenues, I think as we've mentioned, we're using services to really enhance our wins with customers.

So in some cases they are revenue producing, and in some cases we're using those resources to help out with test chips in other wins.

So it will vary a little bit quarter to quarter.

And that's being very successful with us to win business.

We'll use it tactically.

I think it will be relatively flat next year, might grow a little bit.

Again, with that caveat, we're going to use it to close business.

Maybe from a qualitative perspective, what's the activity level and engagement level like in that business right now?

The team is very well utilized, if that's your question.

I think we're probably sitting over the 80 percent utilization level, maybe even slightly higher than that.

Could be in the mid-80s.

Harlan, Mike Fister.

I think my characterization of it is, well you guys we're being very thoughtful about growing that, our not growing, so we don't get into an overcapacity.

As Bill says, we use it as a strategic mechanism, we use it for customer acquisition, we use it for new technology proofing.

It's really doing exactly what we want it to do with the goals we have in line.

Harlan if you take a look at our financials you'll see the margin also with services continue to improve, we're up a couple of points from Q3 to Q4 to 36 percent.

Okay, great, thanks.

Final question for you, Mike.

In a conference call last week, one of your competitors in the physical implementation space, they basically said that they aren't really seeing Cadence all that often when engaging with customers.

This is, I'm assuming for current generation 90-nanometer tools.

Seems a little bit contrary to what I've been hearing, but I'd like to get your thoughts on the competitive environment and maybe some color on benchmarking activity at the 90-nanometer node.

We're doing well with the platform at 90-nanometers.

We've even got customer interest out in 65, we're picking our first partners.

I was a little befuddled by that, because we've taken designs, penetrated companies where they had been in the stronghold, and it was with our platform.

I'm a little bit mystified as to where they don't see us.

My sense in general is, they probably operate on a lower end niche than we do.

We're coming down from the top with the Encounter, and it proliferates from there.

I like our success and our benchmarks so far with all the customers we've done them with, we've done very well with that technology.

Okay, great.

Thank you.

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

Thanks.

Good afternoon.

Bill, I'd like to ask you about the bookings topic in a couple of ways.

First of all, what's the evidence in terms of organic growth of business with any given customer on average.

That is run rates on average.

Last week for instance, mentor on its call, gave a number of examples of expanded value per contract with customers who just in real or organic growth.

On the other hand Synopsis did a large renewal this past quarter with no apparent improvement in run rates with that particular customer.

So the question for you is what's really going on on a per customer basis to suggest that you are, in fact, growing your business and run rate?

Sure, Jay.

The best way that I see that is we look at the share in each of our accounts and we look at it by technology.

We can see very directly that we're continuing to gain footprint in digital.

And that's all something that is incremental to our current base.

Our position in analog mixed signals continues to stay strong, so that's going to be fairly steady.

And we're seeing very good success with our new technologies, RTL Compiler continues to make good progress, [Conforma] makes good progress, and the whole verification, including Palladium, is all incremental business.

We're seeing all that as additional footprint, and that's additional business in each of our accounts.

So I can't give you a generic percentage, but I'd say we're growing each of those businesses across the board.

Okay.

So with the perception of EDA perhaps, or EDA budgets on the whole being fairly flat, you're suggesting that you're gaining share of budget on average?

Sure.

That's, again, where they need the technology, that's where we're selling it in.

They may not need it right now.

We'll be real patient, because we know they are going to need it and that's how we get a little bit more value on the contract side.

All right.

And you're outlook for 2005 that includes the incremental bookings for Verisity?

Yes, it will, again that being closed around the end of Q2.

If you exclude Verisity, obviously -- well not obviously, your bookings would perhaps be flat to down otherwise?

Is that what we might back out of that outlook.

I don't know that it would be that significant, Jay.

Okay.

Couple of technology questions for you, Mike.

You said at the meeting in San Francisco in December, and, again, alluded to it this evening about products for vertical markets or tool kits for vertical markets, can you enhance on that comment?

What does that really mean, and which verticals and when?

And lastly on the product side, you've talked about having manufacturing aware physical design, called the Patina project, could you talk about where you stand with that?

Yeah, I think the introduction to the wireless capability flows is one of the first instances of that.

And that's going to follow, Jay, a flow followed by product orientation.

That probably allows us to encapsulate that better for need.

The targets that we have are around mixed signal, mixed signal with wireless.

That is the chips that our mixed signal consumer and then some that have a wire radio on them.

High-speed digital and maybe high-speed digital with a power [care about], since so much stuff is dominated by low power.

It amounts to us basically mixing and matching some of the technologies so they interact and drive efficiency.

Could be productivity or time to market.

You'll continue to see those kinds of things roll out through the year.

I think the Palladium II is another wonderful example of marketing applied to EDA, there you have a good and better orientation between Palladium and Palladium II.

You heard me talk, you see we sold up customers to Palladium II, and we persisted the Palladium 1 line so we could exactly do that, and then use that to continue to migrate the line down for either less complicated chips or at the price, you know, matures over time.

So those are two good examples of maturity and marketing applied to EDA.

You've only begun to see it come out from us.

Both of them are generating value.

The second part of the question was?

The manufacturing aware physical design.

We do have an incubating technology that is code named Patina.

It's an early pilot with some customers.

It's a cleaner sheet of paper approach to the platform for data interchange.

All the way seamlessly, from the design core and the manufacturing pieces of the equation.

It's very exciting.

What we'll do is pile that through this year, and talk about broader deployment of that sometime next year.

What we'll try to do is continuing between Bill and I give you guys insight as to how we would monetize that.

We're going to monetize that in unique ways that are around benefits sharing, because it's a tremendous value to the customers that will be able to use it.

Jay, does that properly answer your question, sir?

I guess I'll wait until the analyst meeting.

Okay, sir.

Your next question, gentlemen, comes from the line of Jennifer Jordan with Wells Fargo Securities.

Yes, congratulations, gentlemen, on a good quarter here.

Couple of quick questions, the first as you mentioned realigning teams within Cadence, so they are aligned along function as opposed to along business unit.

Could you talk about what that really means for you?

Hey, Jennifer.

It's Mike.

What we're doing is taking like the development that -- pieces that were kind of dis-paired, or segregated across different pieces of business units and aggregating them into one central core.

You got to meet Jim the other day and Jim's doing that.

We do the similar thing with the marketing.

Across the company marketing view allows us to not only perpetrate the value more consistently, the branding of the Company, but also drive the pricing strategies more uniformly.

And as those two are two examples, you can see there's an efficiency there, because you lose some of the hierarchy that was incumbent in this aggregation.

And, you know, it's what allowed us to go and streamline the Company, as Bill and I both said that we're doing now.

And I think it's got the opportunity for us to really operate very efficiently.

Okay.

So basically I should be looking at places where either products had some overlap looking across different product segments, or where marketing or sales efforts had overlap, and those things are being brought into one vertical unit, is a better way to think about it.

We think about them as functional organizations.

The marketing of those things, the particular products feeds into that , the development of the products feeds into that, the sales of the product feeds into that.

It's a very simple streamlined organization to try to drive efficiency for us.

How is this -- could you give us some characterization of how people are receiving it so far?

Inside the Company?

Uh-huh.

They think very highly of it.

They like it because it makes a lot of sense.

Certainly it allows us to have very good career orientation inside the functionals.

That is if you're a marketing person, you don't have to worry about if you're a marketing person, if you're product line X, Y, Z, you're building your career around the totality of marketing, similar in the design space, and the Cadence sales space, and so on, and so on.

It's what leadership companies do at this size, and we're going to go get multiple benefits from it.

So it's part of moving away from the sort of point tools all aggregated together approach?

Yes, ma'am.

You've got it exactly.

Okay.

You mentioned just a minute ago with the Patina project, that you're working on different methods of monetizing the value of benefit sharing, and we saw just PDF once again, have trouble with its gain share strategy.

Could you talk a little bit about what you might do differently there?

One of the reasons we talk about it more as sharing the gain as opposed to gain share.

I think that will be the commentary tonight.

It's probably a longer conversation than this, because the subtleties will seem subtle to people, they will be very dramatic.

The main idea of any of us is if we build a business proposition for a customer where they realize and get a demonstrated gain, we would like to share in a piece of it, we have already experimented with this with a number of customers.

It's hard to give you an exact testimonial by name.

But it gives us a lot of confidence to be able to take that and move it forward, apply it in a wider domain.

Some of those customers that we had done these experiments with, with such positive results are our early Patina pilots.

Great.

We're conserving the knowledge that we gained in doing that.

Thank you so much.

Uh-huh, pleasure.

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

Thank you.

Mike, is there any implication for the organization of the channel that follows the segmented strategy that you're talking about?

Well, I suppose a couple of positive ones.

One, I don't think we'll have to be a lot bigger.

That's what typically people ask us.

We've got one of the best channels in the whole industry between our sales and application engineers, it's a true value to the Company.

I think what we'll show you and we'll probably do this around the analyst day, to give you a bit more insight, it's a cordoning of customers into groups.

We've got a strong geographic focus.

There are few, you know, customers that we could all name that are, you know, big market makers.

That's something we're going to be very thoughtful about treating and thinking about it in an entirety.

Many of those customers are global, so you really want to have that kind of a big focus on them.

That kind of a thought process.

Because you're doing stuff with people who have got engineering orientation in the United States and China and India, and all different kinds of places.

I'm also very passionate about the ability to expand the alternate channels with the indirect distribution that we have with some of our more mature products.

Products in our Incisive line and the verification, and the credit circuit board stuff, and very optimistic between Bill and I about some benefits we get in actually expanding our base with us.

So that's the impact where we got a great, you know, human mass to work with across the Company that's already global in Kevin's world.

That's the honing and tuning that we're doing there.

Is there an opportunity and maybe you partially answered this, to segment your offering horizontally, sort of high end/low end, and I'm curious how with the growth of designers admittedly trailing edge to start in the far east, how you plan to capitalize on that opportunity?

That's exactly a part of the marketing application of EDA.

If you -- I think we've got a chance to talk with some of you about this.

But the good/better orientation of Palladium and Palladium II was an example of that.

Certainly around our verification technology, Incisive, we're just about, you've just seen the beginning of that professional version, versus a not.

A more featuresque rich version, as opposed to one with fewer features.

I think around geography we can get the same sort of thing.

Right now in EDA people absorb all the technology and use 20 percent of it, then they wish the price was lower.

Maybe we're going to package the 20 percent they use, and then sell them up every time they go and use more features.

Lastly, Raj, I think there's an opportunity to differentiate around a process nodes.

What works at 90 nanometers doesn't necessarily directly extrapolate to 65.

The physics are different, so are the functions we use to support the physics.

We'll have a very nice seemless continuum for people who get on the train at 90, and then move to 65, but probably we'll be able to offer upgrade paths for them.

That's some of the marketing that we're doing around the products, whether it applies to a vertical or it applies to a horizontally segmented offering, as you put it.

Would you characterize your momentum in the IC companies as meaningfully different from system companies?

And you have a lot of experience with the system companies.

What do you do to extract more dollars there?

Is there any sort of summary that you could give on your strategy to get more dollars there?

Two things.

One, that's one of the beauties of coming into the Company.

Let's say with Ray and I, Ray and I multiply our contact base beyond a traditional contact that he and Cadence has with someone new, that me and the rest of the people.

We consciously split that up.

The systems companies are penetrable in our industry because as the printed circuit board was their pallet, if you can take the artist analogy, silicon would be their pallet and we make it easier for them to do that I think the systems in package flows are one example of that.

So what we're going to do is eke up from the bottom taking our experience in printed circuit and applying to where they would have done that on printed circuit board, being able to have them get a better use out of silicon.

And in making the product simpler to use, we're going to make it you don't have to be a digital IC logic designer to be able to implement logic on a print circuit.

I think it will be very interesting to watch the industry grow over the years that way.

Okay, thank you.

Your next question comes from the line of Erach Desai with American Technologies.

Couple of questions.

One, Bill, could you give the breakout of what were term and perpetual licenses -- license-based revenues and product-based revenues?

Erach, we just give out the percent of our business, which is ratable, which is 75 percent.

Okay.

That's bookings, then.

Correct.

And as I mentioned that we had a little over 60 percent of our business coming from backlog.

So that gives you, how much is coming out on the ratable side on revenue.

There's two kinds of ratable.

I'm interested in perpetual versus term, say.

Yeah, we don't measure it at that level of granularity, Erach.

The other sort of [nitty] item, Bill, is also while your product revenues increased by, I don't know, 40, 50 million sequentially, your cost of product went down sequentially.

And I'm just trying to understand how that works?

Sure, Erach.

As you know, cost of product is only variable for the most part, when we're talking about some of our hardware.

The rest of cost of product is pretty flat.

So we're, you know - we saw a little bit of volume difference there.

And business is very leveragable.

So as we do more business, it drops right through.

Okay.

Mike, a couple of, I guess, philosophical questions, if I might.

The first being, just as you sort of have taken a first look going into a fresh year and reducing the workforce by 200, how do you philosophically view the 350 million that Cadence puts into R&D every year?

And how do you intend to measure the return on that?

Even for it's a different question, but even also measuring a return on something like Verisity where, It appears from Jay's question and following his logic, that including Verisity in the bookings looks like overall Cadence bookings would not grow this year.

Yeah.

I'll let Bill -- I think Bill answered that our bookings grew, even with Verisity factored in.

The way I approach development is to look at the -- how we are to target, and how we are in terms of measured efficiencies.

This is something as you get to meet Jim you'll get a kick out of.

It's just a machine.

What you do is you take whatever the baseline you have, and then you just go for cost and improvement.

If we could do a product in one year, we should try for 11 months next time.

If we do it with 100 people, we should be able to do it with 70 the next time.

If we did a product and had to do 5 different re-spins on the thing, we're going to do it with two different re-spins.

It's going to be more perfect.

In the financial measures, Bill has got a machine in place to look at the margin on the operations, you know, the kinds of returns that we get for the number of -- amount of revenue and products we can get out of the crew, and keep putting pressure on to get more and more productivity out of them.

So that's the way we philosophically do it.

We do in the hardware business, we do it in the software business.

I think we've identified we can go and drive some more efficiencies and we are going to go demonstrate those now.

Does that help you?

I guess.

So basically looking at some metrics and sort of looking to improve metrics sequentially, and then also productivity improvements?

Yeah, we have competitive [des parts] with some of our colleagues in the industry.

Part of the great thing about having ties, Bill has his, Ray and I both have ours, so do Jim and Ajay and Kevin and everyone else.

We're thoughtful about measuring pieces of businesses, and seeing if we've got a lot more or a lot fewer people and try to see we're operating as efficiently as we can.

Thank you.

Thanks.

Your next call comes from the line of Sterling Auty with JP Morgan.

If I look at the maintenance revenue in the quarter, vis-a-vis the jump in deferred revenue, can you talk to number one just kind of renewal rates.

And number two, did some of that maybe come later in the quarter?

Well, they are not always the same, Sterling.

The deferred revenue picked up across both product and maintenance.

So it wasn't strictly maintenance as we look at it.

As you know we're focusing on continuing to improve how we get cash from some of our contracts.

Some customers, in some cases, are paying ahead of revenue, so we're going to have a pickup in deferred revenue, both on the maintenance and on the product line.

So we'll see that for maintenance revenue, we always continue to see some undercurrent of older products dropping off, and newer products just coming on.

So you're not going to necessarily see the same type of growth rate.

So it bounces around a little bit as well.

The comment that you made in terms of the cost of product and the product gross margin, if you will, it made it sound like there was more software in the mix in terms of the revenue.

Let's say this quarter versus last quarter.

Is that the correct interpretation?

Yes, slightly.

But again, it's not that significant.

We're talking 12 million, versus 11 million essentially in [COGs].

Not a lot of delta there.

Last question would be, as you look out over '05 from two stand points, number one we've seen the consumer in the wireless market obviously be strong, given the vertical solutions you're bringing to market, it sounds like you feel that's going to continue to be the end markets that really drive the R&D and the purchasing.

Is that correct?

And the second question, as we look at some of the contract renewals that happened this past year, it seems like the shift might be more towards the synthesis side as well as more integrated product suites.

Can you talk to how maybe the product portfolio will change with upcoming releases to kind of capture that opportunity?

Yeah, I think, -- this is Mike Fister.

Certainly in Ray's overview of the environment, doesn't look likes there's any kind of quantitive change, consumer wireless, high definition TV, a whole laundry list of good things to go.

They all bode nicely to either our base core technologies or the potential to optimize them in the vertical slots for efficiency and productivity, especially with such time to market pressures.

One of the things this is neat I think looking into 2005 that we're optimistic about is the proliferation of our Encounter, because we're so highly penetrated across the customer bases, and the synthesis technology.

That's why we were crowing about that.

The thing that is the only modulator is we're going to do it for value.

That capability and RTL Synthesis, and RTL compiler in particular, is measurably better than our competitors.

So where there's is inexpensive to free, then they should keep using that stuff.

When they want to use the best, they will come and buy ours and we'll proliferate out from there.

The vendor consolidation is also to our benefit.

The breadth of technology we have allows us to especially with the leverage, the drag affect where we're strong and analog we drag our digital across, where we're strong in digital it drags in our synthesis and vice versa, all these permutations, those are the kinds of things we're going to continue to build our product line out on.

We're going to do it on what you heard us refer to as end-to-end, thinking about the problem end-to-end, front-to-back, synthesis to layout, all the way into the manufacturer, all the way back even further forward in the verification spaces.

And so that's the concept that's associated with the way people build integrated circuits, and then groups of integrated circuits in to packages and boards.

And I think it applies very nicely to the foundation pieces that we got.

Does that make any sense?

Absolutely.

The last question I actually want to kind of visit the Verisity acquisition, in terms of the HSR, is it your anticipation that you would get a second request for information, any sense as to how they are really kind of defining the market space to make the HSR decision?

Sterling, this is Bill.

We never will know whether we'll get another request.

We'll just have to wait and see how that happens.

But the product lines are very complimentary, and I think that just gives us hope that it will just be very smooth.

We just have to wait for those things to come in.

Thanks, guys.

Your next question comes from the line of Rich Valera with Needham & Company.

Thank you.

Bill, in your comments, you mentioned, I think, that you chose not to close some business in Q4.

I was wondering if you could characterize that business with deals you decided the terms were just too unfavorable and you walked away, and you think you might close them in the first half, or was there something else going on there?

Rich, I think it was we were continuing to work the value.

I think there is no definite timeframe that we've put on it, but it is just how we can help them accomplish what they are looking for, our customers.

And if we can help accomplish mutual goals, then we'll know the right time to close.

We're very much involved.

It just needed a little bit more time, maybe a traditional view would have been, okay, let's just take it because it will help our short-term metrics.

That's exactly what we wanted to avoid, because we could have taken it, bookings would have looked better.

As we look at it, there was just a little more work to be done, and it will close when we're ready, both the customer and us.

So, not to put words in your mouth, but you would hope to close some of that business presumably in the first half of this year?

Again, we're in the going to put a timeframe on it, we could have closed it and we're just going to have to wait until it's ready.

Fair enough.

Rich, one more point, you know.

We can watch somebody using equipment like how much Palladium emulation cycles they use.

We have a relative understanding if they need more capacity.

And those people who need capacity, they will pick a time to buy, they can either pick the end of December or January or June, or whatever they want.

That's why building accomplishing goals, we try to help them understand their utilization of it, we get insight from doing that, it has a timeliness to it.

Some of our customers, or competitors may be forced to take it early, and they are leaving value on the table when they do that, some of it is just us proving the value to a customer.

If he comes along and says I'm not so sure if I really need this or not, and we can spend another month, quarter, or two quarters proving that he does, then that's the brilliant accomplishment of both people's souls.

Fair enough.

Just one final question, a competitor of yours came out last week and said that they were -- they had come out with a beta version of a DRC LVS tool, essentially a caliber killer, if you will, that had very high performance.

What is your guy's plans in that batch oriented DRC LVS?

Do you see that as a strategic area you'll go after, or do you plan to really address that much more in the implementation flow, and sort of as the strategic portion,and cede the sort of checking part of it to other competitors.

Maybe three thoughts there.

One, we enjoy some customer penetration with our legacy tools.

And we enjoy the relationships with those customers and continue to evolve that capability.

Two, we are thoughtful about where the competitors are strong and the opportunity t, especially with an end-to-end orientation, be a better value to our customers than they may have buying it the way they do.

Notice I didn't say just, take away market segment share for them, we demonstrate a better value.

I think your intuition on a better integrated approach to that is a good one, especially as manufacturing and decor design are so inextricably linked anymore.

Doing signoff after the chip is done, and then having to go back and make sure you didn't put a lot of errors into the flow, is a heck of a worry, for those of us who have big chips in our lives.

So we're kind of doing two or three things at once.

When we get closer to being able to show some of the products to talk about, then we'll be excited to do that.

Great.

Thank you guys.

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

We're wondering with Synopsis moving to more subscriptions if you guys are seeing any more changes in license sites the customers are looking for?.

You said 75 percent of bookings were ratable this quarter, that was the same as in Q3.

But any change expected in maybe 2005 in terms of what happens there?

No, Garo, this is Bill.

I don't really see a perceptible change.

I think 75 to 85 percent is the level that we've been operating at.

And I think that seems to be relatively constant.

As Mike mentioned as we go look at some of these newer ways to work with our customers to demonstrate value, and monetize value, that's going to be different all together than the way we talk of things today.

I think when we have those a little more defined we can talk about them.

Those obviously will be different.

Okay.

Mike, I want to ask you about one of the comments you made about Palladium.

I thought I heard you say there were 50 units sold in 2004.

Was that right?

Yeah.

Do you know about how many of that was in Q4?

No.

We don't break it out that way, to tell you the truth.

The 50 units we talked about were Palladium II.

So we -- that's a very -- you know, I think I told some of you when I came into the Company I was very enthralled with Palladium line, because I remembered it back from the old quick turn days.

It's just not anything like itself.

This stuff is amazing.

It's for people who do big and complex chips, it's a godsend, not only in terms of the logic emulation.

We run code on the thing now with some of our customers.

They run firmware, buyers, drivers they do pre-silica, post-silica, they do it for validation, as well as verification.

I think it's one of our best footholds into the verification adjacency, and I'm very excited about what we can continue to do with that product line.

So that's the sense I want to leave you with with that.

It's got two big ideas, it's a place in that adjacency that offers a lot of value, a huge care about to design guys, because we spent so much money in that when we build complex semi-conductors.

And we're applying some of our early marketing to it, and we're being able to demonstrate sellup and good/better orientation.

And that's the thing I think you should take from that whole product line.

Okay.

Good.

And lastly I know, Bill, one of your comments is you wanted to defocus our attention from bookings a bit.

You did mention -- if I look at the midpoint of your revenue guidance, looks like 5 percent of revenue growth is your expectation in 2005, I think you said that bookings and revenue should grow in line with one another.

Can you talk about why you think bookings isn't as pour to look at or less important now, and just confirm that 5 percent bookings is probably the right number to be looking for?

Sure, Garo.

As I say, revenue and bookings will be approximately growing together.

So if you pick the midpoint, that's not a bad way to start.

And in terms of short-term metrics, as we described, you can work contracts and work arrangements with the customers a little longer, and so if we were to close something this quarter or next quarter or the quarter after, that's the right time to do it, so the booking itself can be larger, if it's not just connected to be, okay, your bookings and your revenue have to be in line every quarter.

I got it.

So that flows then with Mike's comments about basically delivering on value.

Absolutely.

So it just gives us the flexibility to work it until it's done.

I think many times people were equating bookings with growth.

And you get growth, but you can get it in a more selective way by pricing.

That's where you're going to see us focus.

I understand.

Great.

Thank you.

Ladies and gentlemen, we have reached the end of the allotted time for questions-and-answers.

Gentlemen, there are any closing remarks?

Yeah, I just wanted to add on as you heard from Ray, Bill, and I, we're very excited.

Q4 capped a strong year for the Company.

We not only reaffirmed our industry leadership, but we executed very well in a challenging environment.

As the industry saw it, and many of our competitors certainly saw it, we're proud of the cash flow increased to $371 million in revenues, climbed to $1.2 billion.

That income rose to $74 million on a GAAP basis, and $201 million on a nonGAAP basis.

More importantly I think our business strategy and investments and technology in people have really paid off, as Ray said.

Customers across the globe returning to the Company, to help them be successful with smaller geometries and managing the complexity, and meeting the time to market needs.

We've been talk about that, every since we were at that last year.

There's no doubt 2005 presents a challenging environment but we're really optimistic and we're going to continue to build on our success.

Thanks again for joining us, and good-bye.

We'll see you next time.

This does conclude today's Cadence Design Systems fourth quarter 2004 financial results conference call.

You may now disconnect.