益華電腦 (CDNS) 2005 Q2 法說會逐字稿

At this time, I would like to welcome everyone to the Cadence Design Systems second-quarter 2005 financial results conference call.

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

After the speakers' remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS).

Speaking on today's call will be Jennifer Jordan, Corporate Vice President of Investor Relations, Mike Fister, President and Chief Executive Officer, and Bill Porter, Senior Vice President and Chief Financial Officer.

I would now like to turn the call over to Jennifer Jordan, Corporate Vice President of Investor Relations for Cadence Design Systems.

Please go ahead, ma'am.

Thank you, Derek, and welcome to our earnings conference call for the second quarter of 2005.

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

With me today is Mike Fister, President and CEO, and Bill Porter, Senior Vice President and CFO.

Please note that 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 ended January 1st, 2005, and our 10-Q for the period ended April 2nd, 2005.

In addition to financial results prepared in accordance with Generally Accepted Accounting Principles, or GAAP, we will also present certain non-GAAP financial measures today.

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

Please refer to our earnings press release for a discussion of non-GAAP measures and to both our earnings press release and our Web site for reconciliations of GAAP and non-GAAP financial measures used in today's discussion.

Now I'll turn the call over to Mike Fister.

Thank you, Jennifer.

Good afternoon and thank you for joining us as we discuss our performance in the second quarter of 2005.

We had a great quarter.

We reported revenue of $321 million.

On a GAAP basis, it was a breakeven quarter.

We had non-GAAP EPS of $0.17 per share.

At the Design Automation conference last month, we unveiled our consolidated verification strategy, sometimes termed Enterprise EPA.

We announced the first fab with X chip with ATI and TSMC.

We demonstrated the inner-operability of encountered digitalized C platform and the Virtuoso custom-designed platform on Open Access 2.2.

And we gave you a peek at our technology roadmap, including Torino, our next generation digital technology.

As I meet with customers, they have once again corroborated our three-prong strategy, which is growing the core business through technology innovation, expanding into adjacencies such as verification and manufacturability, and investing in new business and pricing models.

Let me take a few minutes to go into the highlights of the quarter.

Verification is at the top of our customers' agenda when I visit them.

They already see the benefits of the Verisity acquisition that we completed early in Q2.

Combining Verisity's portfolio with our Incisive platform means that our customers can truly deploy process automation to leverage the full range of our verification solutions, IP and services. (indiscernible) customers to more efficiently manage their time and resources to resolve their verification challenges and make sure the designs do what they are intended to do.

For example, at a major semiconductor company in Korea, we were able to demonstrate significantly better design quality and a faster design cycle time by using Specman Elite and Incisive against incumbent (ph) solutions from other companies.

This convinced the customer to proliferate both Specman Elite and Incisive.

It also paves the way for the customer to adopt new Cadence Enterprise VPA methodology.

Now I know there's been a lot of speculation in the trade press about the ability to convert verification to a single language.

I'm amazed by how much credibility this speculation is given.

Let me go on the record right now.

Driven by our customer demand, we are committed to supporting the multi-language environment, including E, System Verilog, and SystemC.

We're the only company offering a complete solution from process automation through emulation.

The segmented offerings of Extreme, Palladium, and the leading edge Palladium II, our customers are shaving six to nine months off their time to market by enabling early software development.

As systems become more complex, the amount of software embedded within the silicon is enormous.

Instead of waiting for first silicon, Palladium enables customers to concurrently develop the software that drives the silicon.

This segmented offering helps customers choose the product tat best meets their needs.

This quarter, we've seen that adding the Extreme product to the lineup broadens the market fort emulation, resulting in more customers selecting Palladium and Palladium II.

Good things are happening in digital as well.

We have excellent momentum in the market, and it was our best quarter for Synthesis.

Encounter RTL Compiler has now been adopted by more than 100 customers and is proliferating all around the world. (technical difficulty) that the world's leading companies are increasingly using RTL Compiler for their most complex chips. (indiscernible) add acceptance (indiscernible) down.

For example, Canon adopted RTL Compiler, citing its proven ability to increase chip performance, reduce power, cut turnaround time, and increase productivity.

As a result, major ASIC suppliers, Fujitsu, NEC and Toshiba, are supporting external and internal customer usage of RTL Compiler.

Cadence NC released its 6.0 Reference Flow that includes the Encounter low-power methodology.

Customers like our approach because it simply makes low power easy.

Tanbridge (ph) Technology, a company that has developed a multithreaded baseband processor aimed at the 3G multi-media market, selected the Cadence low power flow after receiving positive references from the silicon design chain low-power initiative.

You may recall that earlier this year through the initiative, we demonstrated a 40% power savings on a 90 nm chip with ARM and TSMC.

Our business has evolved over the years from point tools to flows to platforms and now I'll focus on vertical solutions or kits.

We've been methodically validating our approach to these kits with customers and partners because we want to ensure that the approach we take will both be comprehensive and valued.

We've also been working with the design chain in the industry ecosystem because credible reference designs and IP are integral to the success.

I have had a chance to talk to some of our largest customers and it's really exciting to see them encourage the direction we are taking.

They have even more ideas for kits and some are expressing their willingness to share in investments for other vertical market segments.

We'll talk more about kits at CDNLive!, which is our new expanded user group meeting in September.

The breadth and depth of Cadence technology makes us the only provider of solutions that capture the entire gamut of the design process.

It's also one of the keys to our success in the ongoing vendor consolidation trend.

It was clearly demonstrated this quarter when Bosch, the world's largest supplier to the automotive industry, consolidated their spend with Cadence because of our leadership in custom and mixed signal design.

As you can see from our product mix data, it shows about 30% of our business is in customized C; our continued investment in the Virtuoso platform is well-placed.

The breadth of our offerings isn't only a driver in the digital and custom world.

Motorola turned to Allegro, our silicon packaged board platform, because our codesign process is increasingly required to get their desired performance in the required timeframe.

Now before I turn the call over to Bill, I'd like to take a minute to express my thanks to Ray Bingham.

He is retiring from Cadence this month after twelve years of dedicated service.

Ray made significant contributions not only to Cadence, but the entire industry and that will have a long-lasting impact.

Now here is Bill with some details on the financials.

Thanks, Mike.

A key to our success is strong execution in our core business.

We again saw good results across our product portfolio with particular strength this quarter in Custom IC, where a refreshed and expanded product line is driving increased business; in verification, where we already are seeing the benefits of the Verisity acquisition; and in digital, where we had our best Synthesis quarter to date.

I believe the strength of our diversified portfolio has been a significant driver of our consistent results over the past 2.5 years.

GAAP earnings per share in Q2 were breakeven.

Non-GAAP earnings per share of $0.17 were up 21% year-over-year.

Total revenue for the second quarter of $321 million was up 12% year-over-year.

Product revenue was $202 million, maintenance revenue was $90 million, and services revenue was $29 million.

Revenue mix by geography in Q2 was 49% for North America, 25% for Japan, 17% for Europe, and 9% for Asia.

We saw good results across the geographies, led by North America and Japan.

As we enter Q3, we are watching Europe for signs of softness through the challenging economic environment that our European customers are facing, as well as the typical summer slowdown.

As many of you know, we organize our field into our global accounts, which are managed centrally and our regional, also called geo, accounts.

A trend we've been watching over the past year and a half is the increase in business we've seen with our geo accounts.

I believe the continuing growth in these accounts is testimony to our strengthening technology across the broadest base of our customers.

As our geo accounts tackle more challenging designs, they are adopting leading-edge Cadence technology that's been proven at our global accounts, creating a waterfall effect.

Organizationally, we have also strengthened our field operations with the addition of Lung Chu as President of our Asia region.

In the quarter, approximately 76% of product business was represented by ratable licenses.

That is licenses where revenue will be recognized over time.

Over two-thirds of our product revenue was generated from backlog, which is the same level as we're expecting for all of 2005.

Contract life, calculated on a dollar weighted average basis, remained about three years.

Q2 total cost and expenses on a non-GAAP basis were $255 million, up $15 million from Q1, mostly as a result of the acquisition of Verisity and from financing costs associated with the sale of some international receivables.

We've increased our overseas cash to provide ourselves flexibility as we evaluate our repatriation options under the Homeland Investment Act.

Quarter end headcount was approximately 5,000.

As we told the last quarter, we saw an opportunity to improve the efficiency with which we deliver our design services in Europe, which resulted in a reduction in our workforce in Scotland by about 60 positions in Q2.

Total restructuring and other charges in the quarter associated with this action as well as the Verisity transition were approximately $14 million.

Our non-GAAP operating margin in Q2 was 21%, up from 19% in Q2 of 2004.

We remain on track for an operating margin of approximately 24% for 2005.

Receivables quality remained high in Q2 with receivables 90 days past due at 2%, within our historical range of 1 to 3%.

Total DSOs were 102 days compared to 120 days in Q1.

We expect DSOs to decline to the mid to high 80s by the end of 2005.

Operating cash flow for Q2 was $129 million.

For the first half of 2005, operating cash flow totaled $196 million, and we remain on track to generate over $400 million of operating cash flow for the year.

CapEx through the first half of the year was $33 million, less than half of our $75 million target for the year.

Cash and cash equivalents were $544 million at quarter-end compared to $657 million in Q1.

Net outlays associated with acquisitions in the quarter, primarily Verisity, were $276 million.

Now I'll turn to our outlook for Q3 and the year 2005.

For Q3, we expect revenue to be in the range of 320 million to $330 million.

GAAP EPS should be in the range of $0.05 to $0.07 and non-GAAP EPS in the range of $0.18 to $0.20.

For the year 2005, we now expect revenue to be in the range of 1.275 billion to $1.315 billion.

GAAP EPS should be in the range of $0.21 to $0.27 and non-GAAP EPS in the range of $0.75 to $0.81.

Now I'll turn it back to Mike to wrap up before we take your questions.

Let me recap Q2 highlights.

We had a great quarter and executed on our product release and financial targets.

Halfway through the year, our metrics are on track.

Customers are acknowledging the completeness of our verification strategy with their purchases.

We continue to have great success in digital and are especially proud of the progress we've made in the Synthesis market.

The good performance in custom validates the work we've done to stay on top of this key market segment, including our work on Open Access.

We saw good growth in both our global and geo accounts, and we're on track to introduce some product segmentation in the next step on kits at CDNLive! in September.

Operator, we are now ready for some questions.

(OPERATOR INSTRUCTIONS).

Jay Vleeschhouwer, Merrill Lynch.

Good afternoon.

Mike, Bill, I'd like to ask a couple of questions around the bookings issue, of course.

Bill, I think on the last call, you talked about an expectation of ending the year with 1.8 billion in backlog.

Is that still your expectation?

And also, with respect to the notion of bookings run rate on average per customer, is there in fact a broad phenomenon you're seeing with many customers, where you aren't increasing your run rate of future business with them?

Yes, to your first question, I do expect that we will end the year at at least the $1.8 billion level for backlog.

So I don't see any change there.

In terms of run rate, that is more anecdotal as we're not having a precise measure of that.

I think in particular as we look at the strength across our geos as we talked, we're clearly picking up momentum there on a run rate basis and as I think you know, we've been focusing on continually addressing the needs of our customers, which means selling as we go as opposed to just trying to sell on a three-year cycle.

And so I think we are picking up run rate, but at this stage, I don't have a precise metric to measure that for you.

Mike, with respect to the various business models you've talked about, feature-based pricing, node-based pricing, and one you did mention, kit pricing, can you update us on where you might be in the first two?

And are you beginning to actually see an inflow of orders for the couple of kits that you do have?

Yes, we've continued to kind of go and test those through the quarter and I'm very encouraged by the response that we get back from our customers.

Big and small, people really appreciate the -- I'm going to say the evolution of our business model from a purely subscriptive (sic) base has shares, risks and reward.

And as you know, Jay, we're still kind of polishing our modeling so that when we come out and show you what the net effect is, you'll actually be able to model it for yourself.

On the feature-based pricing, we had made progress beyond some of the pure hardware models.

I think the adding extreme is another derivative of that because you've kind of got now a good, better, best backup.

And even with some of the digital technology that you'll see at CDNLive!, that's kind of where we're going to roll out most of the segmentation as I was alluding to in my comments.

So, so far so good.

I am happy with the response we've got so far and looking forward to showing in some more detail in September.

And then finally, you made an interesting reference to the synthesis momentum you're having is causing a kind of waterfall effect to use your term.

Elaborate on that if you could in terms of what it means for simulating other business in the digital area, perhaps in PnR and elsewhere.

If you had a record quarter now in Synthesis, should we subsequently see accelerating momentum and record results elsewhere in the digital IC product line?

Yes, for those on the call, I think you know that our strategy on the Synthesis wasn't just to go compete on small features.

It was to go and apply the technology where it's highly differentiated; that is the most complex digital chips in the world being built.

And to clarify the comments and the increased testimonials that we come out with, even at the DAC, we were talking about our own measured market segment share penetration, we can see that that works.

The concept of the waterfall is that once you apply that at the high end, the most complex usages, it seamlessly works at less complex usages and so-called waterfalls down into those simpler IC's.

And that is the proliferation we're seeing.

It is also rewarding when you see a systems company like Canon appreciate the results you can get so much that they basically pick it and then they drive a waterfall down to the supply base, Jay.

And that's why the comment -- the insight on the ASIC suppliers have been picking it up from that lead.

So we're seeing both kinds of proliferation, so it's down the product line from the most complex to simplest devices and from system specifiers to some of the rest of the supply chain.

And I think it dramatically increases our ability to continue the penetration that we have with our digital products on a whole.

Harlan Sur, Morgan Stanley.

Good afternoon, guys, and great execution on the quarter.

Bill, can you comment on deal closures at the end of the quarter relative to the last couple of quarters?

And secondly, I know that last quarter you said that you were still working on some deals that didn't close in Q4.

And so I was wondering if you were able to get closure in Q2.

Harlan, I'd say the run rate, in terms of business closures environment, just feels marginally better.

I think as we've always known that it was going to be just a year that we were going to work hard.

I think as the technologies continue to pick up momentum, and again, I'd refer back to the proliferation in the smaller accounts, we're just doing better across the board, so with more customers.

And so I think generally, I'd say the close rate is feeling a little better, but it's really the technology that continue to take hold.

In terms of working contracts, that's ongoing and there's always some business that continues to work across any quarter end.

And I don't want to get any more specific than that, but I like the business level that we are doing and I like the tone of the business we are doing with all the customers we're talking to.

So I'd say on the net, it's positive and some business is just always going to move.

So I don't think it's worth commenting any more specifically than that.

Okay, great.

Thanks.

And then question for you, Mike, thus far, if we look into the earnings season, the earnings performance, the outlook and the sentiments among your semiconductor companies has been better than expected.

So I'm just wondering if you're seeing this reflected in their recent EDA spending patterns, whether it be in terms of customer engagement activity or pricing.

Good question, Harlan.

We're definitely seeing some more of their optimism transmit into their engagements with us.

And it doesn't even have to be an optimistic company.

Even some of the companies that didn't have so rosy an outlook turn to technology to be able to build the next products to kind of move them out of whatever the morass could be.

And I've traveled around extensively, that's quite one of my ways of checking the heartbeat, I think it's consistent across geographies.

On the pricing, where we have highly differentiated products, we command more value because we demonstrate more value.

And on verification, synthesis, those are good examples where we can consistently see that value return to us.

On the areas where we have less differentiation, it's tough; it's aggressive out there as Bill was saying, and that's why the breadth of our product line, I think, favors our kind of progress.

So, yes, I think a little bit of optimism is transmitting itself and what we're all waiting to do is not get too rosy on projecting a call in the second half until we see a little bit more.

Okay, great.

Thanks.

And then one final question for you, the Palladium product cycle has been one of the I think key drivers for Cadence over the past couple of quarters, and I'm just wondering, did we see that momentum continue into the second quarter?

And do you expect that to continue through the second half of this year?

Good question again; we did.

And it's not only in the Palladium and Palladium II upsell that we had talked about the last couple of quarters, but when we added the Extreme line, just as we predicted, we can see customers that would buy into Extreme and then pursue the opportunity to also add Palladium products into their mix.

It also gives us a price aggressive position to take into some of the competitive domains where we wouldn't have normally gone with Palladium.

So it's kind of a good, better, best stack-up now as opposed a better, best stack-up and that strength has continued through Q2, and I don't see any lack of it on the horizon.

There's a lot of -- it's very neat.

As you demonstrate a method that allows people to prove that their chips are right and you can show them that it's a capacity problem, that is, we can converge there and find their errors faster, they approach and they buy it as a capacity problem.

That is, they consider buying a lot more of it so they can make their products manifest better, faster.

And so I do think it's a very exciting part of our product portfolio.

Okay, great.

Thanks.

And again, congratulations on the quarter.

Raj Seth, S.G. Cowen.

Thank you.

A couple for you, Bill.

You mentioned 255 million in OpEx.

I know embedded in your Q3 guidance there is effectively an assumption made about expenses, but more generally, how should we think about OpEx going forward?

You've added some cost post Verisity.

How do I think about that generally in the second half?

And I know you don't want to get into '06 too much, but for those of us that are beginning to think about it, how are you trying to manage that line?

Sure, Raj.

In terms of total costs, I would just say marginally, we should see some cost reductions in Q3 versus Q2.

There was some cost that we had to incur for transitions and other things.

And I think we'll see that come down a little bit and flatten out for the rest of the year.

So I'm fine with that and we're continuing to work costs pretty heavily, as you know.

And then as we look at the year in total, the 24% operating margin is something that we're seeing on the horizon and we're working to get back and that looks pretty much in our sights.

As we look out to 2006, the only thing I would comment on is that we do have the same target in terms of our long-term operating margin goal of 30%.

And we'll have to see as we exit the year and just how fine-tuned we'll be towards that goal or not, but it is clearly a goal for us to achieve.

It's too early to really say whether it's 2006 or a little after that.

Okay, thanks.

On another topic, you mentioned receivable sales relating to international receivable sales.

Is all of the receivable sales we saw -- I think it was 111 million, are they all related to that?

Yes, they are.

This is to make sure that our international portfolio is very liquid as we approach the second half of the year.

And I think you'll start to see a number of companies declare their intentions there as the laws become more clear and as people get everything lined up.

Okay, and last question for me, you're generating a lot of cash now.

You obviously soaked some up with the Verisity acquisition in the quarter.

But I'm curious what your philosophy is going forward now as that's going to start piling up.

How are you thinking about either taking out your convert or buybacks?

Or sort of what's the philosophy there?

What are you going to do with all this cash, which should (indiscernible) pile up?

Well, as you know, operating cash flow is one of our key metrics and we're continuing to focus on that not only this year but going forward.

And as, I'd say in the short term, you should see us just continue to build some cash on our balance sheet.

We want to make sure we have the most flexibility to invest in the business and be in a position to retire our debt.

Probably kind of in that order.

And then we'll always consider repurchase, but it's probably down the priority view at this stage of the game.

Okay, thanks.

That's helpful.

Hey, Raj, I'm glad you noticed.

I think that that cash asset on the balance sheet is something that differentiates us and we are going to work hard to keep it that way.

Okay, thanks.

Tim Fox, Deutsche Bank.

Hi, thank you.

Good afternoon.

Bill, is there a way to think about how growth came in organically year-over-year, excluding Verisity?

Because you had revenue from Verisity for most of the quarter, but still with the deferred revenues, it wasn't that big of a contributor.

Yes, Tim, the way I would look at Q2 and I think for the remainder of the year, it's primarily organic growth is what we are seeing.

We are seeing some good momentum coming from the whole verification product line.

For example, the purchase price or the purchase accounting that we lose, we only picked up 24% of the deferred revenue and I've been forecasting picking up 25%, so just around there.

So there isn't a lot that we're just picking up from deferred.

So really it's just kind of the normal business.

This quarter, strength in particular in custom, and then also we saw good strength in both verification and digital, and actually across the rest of some of the product lines as well as SPB.

So I think across the board we're seeing good organic growth and it's getting just some good momentum from the Verisity products.

Okay, and just one other to fall on Raj's questions about expenses.

G&A picked up obviously pretty significantly.

You mentioned there was some expense costs related to the receivables.

What percentage of that increase was from Verisity and from other related expenses?

It seems like quite a significant quarter-over-quarter jump.

Not a large percentage from Verisity, Tim.

Maybe around -- I'm just going to make a guess at it, probably 15, 20%, something in that neighborhood.

The rest of it is really the financing costs and we just got a few other costs that are probably not going to be recurring in Q3.

Okay.

And one for Mike, the past couple of quarters, Japan has exceeded the normal percentage of business by a fair amount.

Can you talk a little bit about what's driving growth there?

Is this part of the renewal cycle of contracts?

Or is this part of the synthesis strength you're seeing?

If you could just touch on that, that would be great.

Tim, it's a good question.

It's a very interesting part of the world and they aggressively embrace technology from companies like ours as a way to offset or apply some of their resources to other more highly valued things.

And this is not only on the semiconductor side, but on the systems side of those companies.

They are the largest computer companies in the world.

What they do is they look at our tools and methods as a way to apply more of their system development resource to be able to build semiconductors.

And that's kind of a physical design sentiment.

On the verification front, these people, especially based on some of the consumer electronics, which you know is a very hot trend as a market segment, are building some amazingly complex chips instead.

And so the verification technologies that we have are being applied to try to prove the goodness of these things.

And it's just a nice time to be in that part of the business and be associated with the companies that we have.

We have very high-level relationships that allow us to talk strategically as opposed to as a simple supplier.

The combination of those three things makes for good business momentum in Japan.

Thanks.

That's it for me.

Congratulations.

Yue-Shun Ho, Wells Fargo.

Good afternoon.

Just starting off with the income statement, I have a couple of questions.

First of all, I see that your (indiscernible) revenue came down below 30 million.

I haven't seen that in a while.

And off of the (indiscernible) pretty high too.

Is that more of a one quarter thing?

Or how should we be looking at that in terms of the trend?

And then also, following up on the operating expense question, I noticed -- well, yesterday (ph), you had a much more presence in DAC, and yet you had a much higher margin expense in Q2.

How -- and I guess can you explain where that came from?

Yue-Shun, in terms of your first question on services revenue, I think we've been pretty flexible in how we use those resources.

We've had them -- what I would say do more strategic business in Q2, which means occasionally, we'll take a little bit less revenue, but they will be very important projects for our customers, and in many cases, helps us just grow our total book of business with the customer.

And so that's what you're really seeing.

As you know, we did pull back a little bit in just service resources in Q2, so that's going to have a small effect, but it's really just how we're focusing those very valuable resources to grow our overall business.

We're looking at how we balance out the total.

And so I wouldn't read too much into just service at a particular line.

It's really part of our portfolio that we're trying to take advantage of.

And in terms of the second question, in DAC, we did have more of what I call a focused presence at DAC, because there, we are also looking at having our Cadence Live! event in Q2 where we can focus even more of our resources directly one-on-one with our customers.

But the impact on expenses was not that significant, so I'd say relatively minor.

It's more of a focus as opposed to a significant cost difference.

So how -- I'm just curious as to -- there was a sequential increase of like 7 million from Q1.

I guess you are spending a lot more with customers?

Yes, I'm not really --

Just trying to get a sense of why such a big increase;

I'm looking year-over-year and sequentially as well.

And I guess I also want to see what kind of trends should we be seeing going forward the next couple of quarters.

Sure, I guess I wouldn't try to predict the individual line items.

What I would say is just look at total cost and expenses because that's how we're doing the trade-offs.

And as I mentioned, I think we will see some reduction in total costs and expenses from the Q2 levels, both in Q3 and Q4.

And so that's how we're doing trade-offs in the business and that's I guess how I would just recommend you think about it.

Okay.

And then going onto your product revenue, obviously, custom wise, you had a good quarter and I saw that you were up over 40% both year-over-year and sequentially.

Can you talk about where you are having successes?

Is it more of like expanding market size?

Or all of you are also facing (ph) competitive?

And should we see that same momentum going forward?

In particular in custom, I think one thing to just look at, if you think about the total book of business in both Q1 and Q2, it's been writing -- if you average the two, it's about the run rate that it was running at last year.

So it was a good quarter in Q2, but it's not what I'd say extraordinary.

It's just a very consistent strong business for us in custom.

We have continued to enhance that product line.

As you know, we've added some strength from the Linear.

We've added capabilities with performance around Open Access.

So in total, that business continues to have very good momentum and our customers increasingly have to deal with mixed signal.

And so we're seeing marginal improvements in terms of picking up additional share because we are the share in that market.

It's just the market itself continues to have a need for that solution.

I think the leverage of that business is twofold.

One, as Bill pointed out in mixed signal, you get a lot more analog content, so it has a drag effect for digital affinity with our digital tools as many of them as people use.

The second is when you have a very complex high-speed design, more of that stuff uses that same kind of custom content to be able to model the effects of the high performance digital.

And that also has a drag effect.

So the large market segment share position we have and the ability to pull other tools and capabilities across is really a strength to look forward to both mixed signal design and very high performance digital design.

Okay yes, final question, can you give an update regarding the post (indiscernible) verification.

I understand you have a (indiscernible) lithography.

Are you still on track to bringing new products in the second half?

We are.

They are -- stay tuned for the CDNLive! stuff and we'll show you the whole rollout.

We have a number of them in beta in various customers now, so as you do your probing, you probably can sense that.

And it's not trying to be too coy.

We just want to show kind of the whole portfolio so you can see as that impacts and complements the current digital products and some of the competitive offerings in the DSM space.

Garo Toomajanian, RBC Capital Markets.

Thanks a lot.

I noticed that -- and I apologize ahead of time if you already covered this -- I noticed that custom IC revenue was up quite a bit in the quarter to what I think might be recorded (ph) around $100 million.

Was that due to a number of orders for that technology or one big order?

And can you maybe talk about what drove it and if you think that will continue in the second half of the year.

Garo, this is Bill.

The strength is broad-based and it's not from one particular customer.

We actually saw it across the board, a number of customers, number of geographies.

So it's -- I think that's not a fluke.

Also, though, when you looked at it and as I mentioned, you average Q1 and Q2, it's running around that 27%, maybe 28% of the business.

So it was probably a little lower in Q1 just based on some of the timing of business, a little higher in Q2 as a percentage.

But overall, I think the trend that Mike mentioned really are what's driving the custom business.

So I would expect, continue to see good custom business driven by analog mixed signal throughout the year.

I wouldn't see it growing as a general percentage of the business much larger than it is today, just because we've got strength across the board.

Okay, good.

On the pricing front, I know that there was a recent Gartner report saying that they think that pricing is a big factor in restricting EDA market growth in the past few years.

And I know that you guys and others have been talking about trying to improve the pricing environment.

I'm wondering just what you're seeing in terms of your inability and maybe the actions of your competitors in trying to contain pricing in the last quarter.

We were talking about a minute ago, Garo.

Not -- with the highly differentiated products in verification and synthesis, we can demonstrate more value, so we get better pricing.

And I think that -- I don't know;

I haven't analyzed everybody's ambitions in this space, but I can understand ours.

It's the growth and the complement of our historic business in physical design with those new business areas is what's going to drive better pricing value for us because of the differentiated products.

I think in stark contrast to some of our competitors who may not have as much breadth, that maybe stuck more in a dog-eat-dog commodity, where the differentials are relatively less pronounced.

And so it doesn't mean that we're not going to participate in some of those.

We'll be smart and selective about those.

We'll be patient about trying to demonstrate the value, but that's the name of the game with the pricing.

And I think we're all looking forward with some enthusiasm to show you the benefits of some of the shared benefit pricing strategies around the X technology later in the year.

Garo, this is Bill.

I'd add that we are seeing the ability with segmentation, particularly in verification, where customers really are conscious of price with like Extreme to help them in the short-term and then to continue to upsell them just based on the performance of products say on the lower-cost price points and move them up.

So that really helps when customers are running into cost pressures.

And the breadth of the product line as we continue to segment it is going to continue to help us because we're going to have very good offerings across the board, which helps us get in where they are cost sensitive and where they are not, we've got the performance and the features on the high end.

So that I think is a differentiation that will help drive pricing, and we are starting to see it -- what we have on the market and as we continue to roll those out, I think you'll see continued success there.

Sterling Auty, JP Morgan.

Thanks, a couple of questions.

Bill, I know you touched on it, but let me be specific.

Can you give us exactly what the contribution to the quarter was from Verisity?

Sterling, no, I'm not going to give any specific numbers from the legacy Company.

In terms of total verification, good product proliferation across the board.

And as I mentioned, Extreme did well, as well as Palladium, so there was very good tandem between those products.

We also saw some good momentum with some of the vManager and Specman product with certain accounts, and that's going to take some time to build as well.

So across the board, I think good progress, but I'm not going to get into specific product or legacy acquisition numbers.

Okay.

Fair enough.

I thought it was worth asking.

Second question is, was there any 10% orders either in revenue or in bookings in the quarter?

There were no 10% revenue customers.

And I think as I commented in the past, I don't comment on 10% booking customers.

Okay.

And then, can you give us what the headcount was at the end of the quarter?

I missed it if you gave it.

Sure, Sterling.

It's 5,000 at the end of Q2.

Okay.

And as we think about expenses, where do you think headcount kind of trends over the coming quarters as you go through the integration?

I think headcount remains relatively flat.

As you can see from Q1 to Q2, it was up and that's primarily from the acquisition.

But as we go through the rest of the year, it will be kind of your normal churn, but we're not going to see any dramatic increases or decreases, I don't think.

Okay.

And since nobody asked it, I'll throw it out there.

Now that we're post DAC, is there any kind of -- any fallout at this point from the litigation from your two close competitors?

Really not ours to comment.

I think the momentum you're seeing from us is based on our product performance.

You probably have to talk to them to see what's happening in that squabble.

Okay, great.

Thanks, guys.

Rich Valera, Needham & Co.

Thank you.

A question for you, Mike, on the Synthesis.

You've had some great success in terms of the number of customers you have won.

I was just wondering where you stand in terms of converting them into really significant revenue and market share.

Normally, in EDA, you kind of win a seat or two initially and then it can take awhile for that to build into a real order.

Sometimes you actually have to wait until there's a renewal with one of your competitors.

So just wondering where that stands in terms of building into a really meaningful revenue stream and how you might look at market share in the sense this is market in light of your success there?

Yes, Rich, good question.

I have a lot of enthusiasm for where we position the technology.

As we were talking before, it's a lot of potential and proliferation goes down.

It's a simpler design, and across -- basically as being a specified technology to use down the design chain.

Those are both elements of proliferation that we're actively seeing now.

I'd like our chances to be the incumbent at 65 nm with the technology -- all the trials.

So we're involved, I think in every trial that's going on that I can count.

And I'm sure you get a lot of rhetoric from other people who are also touting that they are involved in trials.

But what I know about ours is that the tests that we're doing are working very well.

And so you get a seamless (indiscernible) from the 65 back into the 90 or 90 back down to the 65.

Both reactions.

And it's got to drag affect the business.

So I think it's going to be very meaningful for us and it's why we were crowing about it at the DAC and why we were trying to show you as many testimonies as we can with customer adoption.

Would you care to comment on one competitor has obviously had a very significant piece of that market for a long time and no one has really made much material headway against them.

Would you care to hazard -- a year from now or a couple of years from now, do you think you'll have a significant piece of that market -- more than 5 or 10%?

We were saying by some measures of our own computation, we reckon that we were about 15% penetrated into DAC.

And I don't know how to forecast it for you because I'm sure for as much as I would show you my own speculation, it would be hard to corroborate it externally.

So the way I'm going to -- I've got it calibrated in my brain is to go out customer by customer looking at the design, where we win them, flash (ph) the proliferation trends, all of those look positive.

And I think it bodes well for us to take an appreciable presence in that market, especially based on the strength in the (indiscernible) around the back-end stuff.

The tools work as a kit.

This is a micro kit, and this is placed in our out-signal integrity.

And as customers see the value of that, it's pretty compelling.

So I guess the whole (indiscernible) I like our chances to be a significant player here.

Rich, this is Bill.

From my perspective, continuing to see what I would say both seeing and proliferation in terms of synthesis, I think you are going to be seeing some dollars that people are going to pay attention to.

So I wouldn't just say this is seats going after that we're not getting paid for.

I would not give that indication at all.

There is real dollars and they will be meaningful.

And I think we're going to be very timely when we talk about references because we really want to talk about usage, and I think that's where you're going to see people really kind of latching on as using the product.

And we'll wait for those, but it's happening in the market.

And as you go out and talk to people, you'll get some indication.

We'll talk more about real usage along with proliferation, and those will be coming later on.

Thanks.

That's helpful.

And Bill, there's been quite a bit of discussion about the G&A line with the big increase due to the -- I think the receivable sales.

Did you say actually how much of that increase specifically was due to that sort of non-recurring item?

That total will be around $4 million, Rich. 2Q versus Q1.

Great.

And I know you said your cash flow target for the year, but I missed it.

Could you just refresh me what that was, Bill?

Sure.

We're continuing to expect at least $400 million of operating cash flow for the year.

And we're just about halfway there right now.

Raj Seth, S.G. Cowen.

Hi, thanks.

Bill, in '03, you had what you described as not a very strong renewal cycle going.

And you talked about at the time, the end of '04 getting a little bit better and '05 getting better still.

As we move into '06, why shouldn't we be a little cautious given a three-year cycle and the fact that '03 wasn't a strong renewal year for you?

Why doesn't that happen again at some level?

Yes, Raj, I think that's a question that's kind of been out there for a little bit.

We have with our strong portfolio, as I think I've mentioned in the past, been working just to continually sell to our customers what they need as they need it.

And then moving away in many cases from just the big three-year sale.

And as you look at our business growth, particularly in the geos, that's what you are seeing.

You don't see those customers usually just do one large buy.

And also, with some of the larger accounts, they have been budget constrained and so we've been continually working with them to give them more of a product when they need it.

So that has been an effort, and I think you'll see the pipeline that we've been developing continue to grow from '05 to '06.

So I'm really not looking at the business in a renewal fashion and that's really something that's not in our vocabulary as much as just continued view and pipeline of the business and strength.

In general, when I look at just kind of run rate, R&D spending is a good kind of average view of total top line spending in the industry, and I think that's probably viewed as growing at about 6 or 7% next year and that's probably a good just placeholder for now.

One other thing, Raj.

Our pipeline in technology is deep.

So somebody who used to buy in analog technology now has got an opportunity to pile on a digital.

In another year, maybe they're going to pile on even more DSM and you know we've got the Katina (ph) technology out there in beta, active beta, with a lot of customers.

We just added a whole potpourri of verification technology.

So there's multiple opportunities to engage with these customers and continue to broaden the depth of penetration or the portfolio usage that we have.

And this isn't kind of a onetime event every once in a while that you have to engage in.

I think if we drove the business that way, it would be back in the history and we'll get the economics that were associated with that.

And so that's really the kind of arsenal that we have and it's one of mindset but it's also one of rich technology.

And we throw in a dose of customer reality why the strategic relationships are so important beyond just having dinner with somebody.

What we're doing is we're talking about how the usage of the technology allows them to offset and trade their costs around.

And some of the penetration is that way.

We're just showing them how they can change the distribution of their own developers or captive EDA content of their companies, and it's good business for us.

Mike, given all of these product cycles that are beginning, etc., and what Bill described as a placeholder for '06 -- I forget the exact number he used, but 6% or so.

What do you think you can grow in excess of the market, whatever that turns out to be next year?

It's so hard to predict.

I think it would probably be throwaway no matter what I said.

If I pick a low number, you're going to think I'm sandbagging.

If I pick a high number like other people might do, it may be non-credible.

But we -- I think we captured it well on our analyst call.

What we said is we tried to show the three components of organic growth and then the new adjacencies in the new business model.

Showed steady progress on all three of those fronts through the years.

By the time we're coming out of this year or maybe by the next analyst call for sure be able to show you how you could model those pieces.

If we grow at the organic rate of the industry and we get any movement in the other two business model, we're going to grow faster.

And it's just up to us to give some kind of a model that you can assimilate with confidence that will allow us to have an accurate prediction for '06.

Raj, the other point that I would just emphasize is, as you know, we're working hard on demonstrating value and improving pricing and value in the industry.

And that does take some cycles.

And so that will be something that we're going to see some benefit on, possibly in '06 and more benefit as we change in '07.

So it's not going to pop all at once and it's just because we want to work as consciously and slowly and build up that value chain.

That's helpful.

I Looked forward to that business model discussion in a quarter or so.

Thanks.

Well I guess there's no more questions as the operator told us that was the last one.

So with that, I'll thank you again for joining us and wish you a good afternoon.

That concludes today's Cadence second-quarter 2005 earnings conference call.

You may now disconnect.