益華電腦 (CDNS) 2005 Q3 法說會逐字稿

Good afternoon.

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

At this time, I would like to welcome everyone to the Cadence Design Systems third-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.

Please go ahead.

This is the Operator.

Please hold one moment.

We are experiencing technical issues.

Ms. Jordan, please go ahead.

Yes, thank you operator, again, and welcome to our earnings conference call for the third quarter of 2005.

I believe I was within our disclaimers.

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 factors that could cause a difference in our results, please refer to our 10-K for the period ended January 1st (technical difficulty).

In addition to financial results prepared in accordance with Generally Accepted -- (technical difficulty)

Operator?

Yes, ma'am?

There's a large delay between when I speak and when the recording is coming over, apparently.

(Operator Instructions).

Okay, we'll start from the beginning again.

Are we ready?

Yes, ma'am.

Go ahead.

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

The webcast of this call can be accessed through our Web site, www.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 July 2nd, 2005.

In addition to the 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 (technical difficulty) --

(technical difficulty) our strategy is to grow our core design business and through technology innovation expand into agencies such as verification and manufacturability that offer incremental growth, as we pursue new business and pricing models.

The completeness of our verification solutions again drove major customer wins.

Momentum grew in our digital businesses across the board with customers choosing our technology because of its performance of large, complex chips at 90 and 65 nanometers.

I was pleased to see more than a dozen of you at our inaugural customer driven user event, CDN Live!, that we held in Silicon Valley this past September.

There was an audience of over 500 customers across 130 companies.

We announced our first kits, our digital segmentation and a significant entry into the physical verification space.

Consistent with what we've said about the importance of BRAT (ph), we also experienced solid performance from our custom analog and system package board businesses.

With that summary of the context, I'd like to share a few more details.

Just days ago, we introduced our segmented verification family, Incisive HDL, Incisive Design Team and Incisive Enterprise.

This segmentation leverages our technology verification IP, management tools and methodology to provide customers plan to closure solutions tailored to their resources and verification environment.

Incisive Design Team combines a proven process automation methodology with broad system Verilog support, putting as on track to establish leadership in system Verilog.

Verification sales, driven by great momentum in Specman, extended beyond our top tier of customers.

In addition, two European semiconductor companies standardized on our verification solutions this quarter.

One of them, Nikrinoss (ph) in Germany, told us that our complete portfolio puts their engineers "in the pole position" for their next design challenges.

At the same time, we know how to truly deliver our customers at an enterprise level.

To do this, we must enable them to take full advantage of their existing investments in verification.

Consequently, we stepped up our support for the IEEE e-language standardization process.

We expect final approval in the first quarter of 2006.

Customers are finding that the more time invested on verification up front, the faster they get to market with minimized design risk and a higher level of confidence.

Our verification process automation and management tools are vital to their productivity.

And we are continuing to see pull-through of hardware and simulation sales from customers adopting solutions.

In North America, we continue to enjoy hardware platform wins at numerous key customers, several of which were coupled with competitive simulation displacements.

In Asia, we saw significant wins both on the software and hardware front at some of the largest semiconductor and systems customers.

Now turning to our digital businesses, we are especially pleased with our momentum.

In the third quarter, we had competitive wins at major semiconductor companies in North America, Europe and Japan.

A key component of these competitive wins, as I said before, is our performance at advanced geometries on big and complex chips.

For example, in the first week of October, we made the first public disclosure of a 65 nanometer production design completion. (indiscernible) S3 used in Cadence encounter platforms to design a consumer computing device under contract from a major European customer.

Further, ST Microelectronics broadened its relationship with us, including having chosen us as the first cache (ph) platform to be supported with 65 nanometers.

RTL Compiler's progress also contributed to the overall success of our digital offerings.

Agere takes out a 90 nanometer design using RTL Compiler and Encounter Test.

In addition, we've seen accelerated adoption in the wireless and consumer application areas for RTL Compiler's time to market and quality of silicon results continue to distinguish it from the competition and helped us to command premium price points.

And by the way, there are now over 130 customers worldwide using RTL Compiler.

And although power is a key customer concern and that is impacting retooling decisions, customers are choosing Encounter because we provide a methodology to attack this design constraint using synthesis, formal verification and the power integrity solution.

In fact, two customers (indiscernible) out 65 nanometers designs using our Encounter low-power methodology, which includes advanced power savings techniques such as multi supply voltage, dynamic voltage frequency scaling, IP and dynamic power management software.

Entry (ph) for the Industrial Technology Research Institute in Taiwan takes out a low-power test chip using the full Encounter platform with this low-power methodology.

As a further demonstration of our progress with the design chain, you will see introduced a silicon validated low-power flow using the Encounter platform and we will introduce the second version of the 90 nanometer power management with ARM and TSMC in a few weeks, for which we will have a reference design in Q1.

As you may have heard at CDN Live!, we announced our first segmentation initiative, the L and XL versions of Encounter with functionality targeted at mainstream and leading-edge designs, respectively.

This quarter, we will release the third tier of our digital line, Encounter GXL.

It will feature advanced capabilities for very large-scale and very high-performance designs, at 65 and 90 nanometers that are beyond those available in our L and XL series.

As promised, we delivered our first Cadence kit.

With the support of companies like IBM, our first kits, the AMS Methodology kit and the Optimization Methodology kit for ARM processors, span to wireless, networking and personal entertainment markets.

We also disclosed some future insights into the kit's road map, which will include a focus on the automotive segment in the coming year.

Cadence kits are designed to improve productivity.

They allow customers to focus their resources on developing the best products, not on building design infrastructure.

Physical Verification System, or PVS, which by the way is on 082.2 also debuted.

PVS improves schedule predictability and simplifies the management of rural (ph) complexity that arises in sub-wavelength photography and manufacturing, giving customers more time to focus on yield optimization.

Fujitsu is already using the product in production, for 90 and 65 nanometer processes and a number of additional customers are currently evaluating the technology.

During the quarter, we continued to validate the direction of Terena (ph) technology with key customers.

We now expect to demonstrate the first capability around the middle of next year.

Our market-leading customized C solutions were again an excellent contributor in the period.

With a supreme focus on execution, we delivered the Virtuoso infrastructure release on 082.2 and we are on target to deliver a major upgrade, called Virtuoso 6.1, in the first half of next year.

This version will include advanced capabilities for constraint driven design, design for manufacturing in yield and design and IP reuse.

Our sophisticated Allegro system package board solution coupled with the clear road map for codesign and system in-package resulted in competitive displacements at a major wireless company.

We have engagements underway with several major semiconductor partners to develop advanced chip (ph) solutions in the wireless, consumer and communications market segments, using Cadence technologies and methodologies.

Customers see the value not only in the depth and breadth of our technology, but also in our vision of how to improve their productivity, manage their costs with the introduction of innovative efforts like product segmentation and kits.

We are seeing this reflected in decisions of our customers.

Sun Microsystems expanded its relationship with us to address EDA and system challenges at 90 nanometers and beyond.

And Sharp chose our leading technology for IC, LCD and system products.

These type of decisions give us the confidence that we are on the right track to become the indispensable partner of the electronics industry.

With that, I'll turn it over to Bill for his comments on our financial performance.

Thanks, Mike.

In Q3, we again saw strong execution led by the performance of our verification and digital solutions.

We saw good growth in both custom, analog and silicon package board.

I'm pleased with the continued positive progress against our targets for both top-line growth, operating margin and cash flow.

GAAP earnings per share in Q3 were $0.07, flat compared to the same quarter of last year.

Non-GAAP earnings per share grew to $0.21, a 24% increase over the $0.17 we posted in the third quarter of 2004.

Total revenue for the third quarter of $337 million was up 12% year-over-year.

Product revenue was $218 million, maintenance revenue was $87 million and services revenue was $32 million.

Revenue mix by geography in Q3 was 53% for North America, 21% for Europe, 20% for Japan and 6% for Asia.

Results were good across the geographies, led by North America and Japan.

Again, we saw a diversified mix of business between global and geographical accounts.

In the quarter, approximately 74% of our product business was represented by ratable licenses.

Approximately 60% of product revenue was generated from backlog.

For the year, over two-thirds of product revenue was targeted to come from backlog.

One customer accounted for approximately 22% of revenue in Q3.

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

Q3 total costs and expenses on a non-GAAP basis were $254 million, essentially flat compared to Q2.

Quarter-end headcount was approximately 5,000.

Our non-GAAP operating margin in Q3 was 25%, up from 23% in Q3 of 2004.

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

Receivables quality remained high in Q3 with receivables 90 days past due at 3%, within our historical range of 1 to 3%.

Total DSOs declined to 90 days compared to 102 days in Q2.

We are on our way to our target range of the mid to high 80s for Q4.

Operating cash flow was $54 million.

Through the first three quarters of the year, we have generated $250 million of operating cash flow and we are tracking to our target of at least $400 million for the year.

Year-to-date capital expenditures stand at $50 million.

I expect the CapEx for the year will be in line with our $75 million target.

Cash and cash equivalents were $619 million at quarter end compared to $544 million in Q2.

As you may have seen today, we are also pleased to announce that we will be solely listed on the NASDAQ and will begin trading under the ticker symbol CDNS on October 31st.

After careful analysis, we determined that the electronic trading platform is the preferred marketplace for many of our institutional investors.

The decision is aligned with our focus on reducing costs.

Our association with the NASDAQ is also an opportunity to reinforce our position as a technology and market leader.

Now I'll turn to our outlook for Q4 and for the year 2005.

For Q4, we expect revenue to be in the range of $360 million to $370 million.

GAAP EPS should be in the range of 17 to $0.19 and non-GAAP EPS in the range of $0.27 to $0.29.

For the year 2005, we expect revenue to be in the range of 1.31 to $1.32 billion.

GAAP EPS should be in the range of $0.25 to $0.27 and non-GAAP EPS in the range of $0.80 to $0.82.

With that, operator, we'll take a few questions.

(Operator Instructions).

Tim Fox, Deutsche Bank.

First question, Bill, on your guidance for 4Q, just back of envelope here, it looks like it implies OpEx has to come down quarter-over-quarter.

Is that correct?

It probably comes down a bit, Tim, so I think your math is right.

Okay.

Second question was around that deferred -- it looks like total deferred went down sequentially off a fairly strong Q2.

Was there anything in particular there around deferred revenue?

No, that really just gets into the timing of invoicing, and I would expect, given that we would see some maintenance renewals in Q4, that we would see deferred revenue probably creep back up.

But it's really about timing.

Okay.

And maybe, Mike, if you could talk a little bit about your competitive wins.

You picked up a couple.

Can you elaborate a little bit more on some of the areas of strength?

In particular, in verification, you mentioned both hardware and software.

Can you talk a little bit more about where that strength is coming from?

Tim, I was pleased with the customer response on Specman; especially it took us into some broader segments.

CVA platforms in Palladium and Extreme continue to do nicely.

And what we get is drag business across all elements of that, and I think it emphasizes the breadth of that position.

And then what happens is, we continue to see reinforcement where we see drag across all elements of the business.

So where we are strong in verification is dragging people to look at high-performance digital.

And where high-performance digital is there, it's dragging verification and vice versa.

So I think the one-two punch of strength and verification in digital is extremely encouraging.

And I'd go further.

I don't think either Bill or I could be disappointed with the strength of the business across the whole Company.

We rattled off a few things on Allegro and the Virtuoso platform, the release of -- kind of the pre-release of Virtuoso 6.1 -- has got a lot of enthusiasm in the customer base.

And in general, it was an extremely upbeat quarter for CDN Live! because we showed road maps projected across all the different elements of the business and got an awful lot of positive reinforcement there.

So that's kind of my two cents on it.

This is Bill.

I'd just add a little bit more color on your question on costs and expenses.

Costs and expense is a little bit up year-over-year just because of the strength of the business and some of the additional incentives that we paid, both in terms of commissions and across the work force for delivery of technology.

So that's basically the reason.

So good results, a little ahead of ourselves on compensation and we expect that to come down a little bit as we continue to have strong business in Q4.

Okay.

And lastly if I may, are you still comfortable looking out into '06 around the long-term growth being essentially in line with R&D with maybe a couple percentage points coming longer-term from some of the agencies that you are playing into?

Yes, Tim, I am.

I don't see anything changing.

You know, we've talked about the R&D in the industry is essentially at 5 to 7%.

That probably tracks with our core business.

And for us, we have to be successful as you are seeing us execute and moving into the adjacencies to get up some additional points of growth.

So I think that outlook longer term is the right way to think about it.

We will talk about '06 when we get to our conference call on February 1st for Q4 results, once we have a better idea of just the environment in semiconductors for 2006.

Thank you.

Nice quarter.

Sterling Auty, with JP Morgan.

I just want to revisit the issue on deferred revenue, Bill.

You know, you have the 22% customer in the quarter.

Was part of that or a chunk of that sitting in deferred revenue and that came off?

I mean, did you expect this kind of decline in deferred revenue in the quarter?

Sterling, the deferred revenue has nothing to do with the 22% customer.

We had a little bit that had to roll off from our acquisition from Verisity, so there's some of that that is mechanical.

And the rest of it really does get into just timing of invoicing.

The large customer that we had, as you can imagine, based on looking at our receivables, they are short-term so we will be getting paid within a year for that customer, so that's all basically going to be in our -- that's in our receivables.

Nothing is sitting in deferred revenue.

Okay.

And then from a macro level, Mike, can you just talk about some of the things we've been hearing out of the semiconductor companies over the last couple of weeks?

I mean what's your sense as to what's hitting their revenue line versus what they are doing in ramping up 65 nanometer and starting to tool up at 45 nanometer?

I think the advanced processes, Sterling, are really the investment focus for a very, very small number of companies.

I'm very proud of our digital success, the 65 nanometer that I mentioned, and I think bodes very nicely for those class of customers that we have leadership position coming with the digital technology and all the rest of the associated things around Virtuoso and verification.

The majority of semiconductor companies across let's say a consumer electronics automotive electronics, all the kind of traditional personal entertainment, there's a kind of a cyclacy (sic) or a spottiness to it.

Some of it is great and some of it isn't and I think that's why we like to be thoughtful and conservative and methodical about measuring and marching along and doing it and looking at them individually in those kind of categories.

And in the quarter, we had good successes across all different types of those companies.

So I guess finally what I would say is companies that are doing well are investing in technology to try to keep doing well and companies that may be struggling a little bit are investing in technology to try to get back onto the winning track.

And I think those both bode positively for us, especially with the breadth of technologies we have across the Company.

Rich Valera, Needham & Co.

Mike, for your new DRC tool, the PVS tool, I was wondering if you had any special go-to-market strategy for that, sort of like what the Company did with debt (ph) to chip, probably going back almost two years now, where you had sort of a dedicated AE force to really drive that product into the field since you knew you'd be doing lots of competitive benchmarks against an entrenched competitor, which is a similar situation you faced with PVS again.

Yes, we are definitely going to bulk up the application specialists to go and demonstrate the wears of that product capability.

It's something that couples nicely with the high-performance digital or even the Virtuoso design style.

And we have a focused list of customers, and you saw Fujitsu was a great testimonial, that we were working with kind of in advance and that we are working with down the line.

And some of that, Rich, is because we know when people have the opportunity to integrate the new capability into their workflow.

And so far, so good.

The feedback from CDN Live! as we debuted it was very flattering.

It was consistent with the kind of feedback that we got from customers as they saw the preview of it.

And we didn't make a heck of a lot of fanfare way in advance.

We figured we would just let our products do the talking.

And I think there is a lot to be excited about there.

So we are going to go, you know, Kevin is going to go take some guys and really go put some weight behind the target focus list of customers and I like our chances to make a difference with the PVS.

In terms of winning benchmarks and I guess really two things.

One, when do you think you could be winning competitive benchmarks leading to sales?

And then two, material contributions to revenue, would that be more of maybe a second half of '06 or an '07, be sort of material contributions there?

That's a very good question.

We are winning now and I think it bodes nicely for definitely penetration ramp and even throughout the end of this year but into '06 for sure.

I don't know in terms of major market shift how to be predictive about that.

And you know I think that's why we said -- I made the statement I did.

Kind of let the product do the talking and see what happens.

I think one of the key features of the product is the ability to impact the clock wall time.

You know, the scale across literally 100 processors really allows that batch intensive process to be done and concentrated and it is very engaging to customers because they spend a lot of time sitting and waiting for the final results before they can push the button, so to speak.

And so that combination of things I think are good strengths of the product and we will just have to see how fast it invades the totality of the industry.

Fair enough, and just one more question if I could.

During your analysts' day earlier this year, you talked about success-based pricing models, and I think the number that you provided was that they accounted for about 15 million of revenue in 2004, but you thought that would grow meaningfully in '05 and into '06.

Is there any update you can give us, either quantitative or qualitative on your success-based pricing models?

I would speak to qualitative and I think Bill promised you that at the end of the year, we would give you some kind of a quantitative look.

It's engaging to customers, and you probably wouldn't expect me to say anything different.

But I think if you go and poll, as customers consolidate the number of supply sources that they use and in our lingo, partners that they are going to engage with, this becomes a much more interesting proposition.

Because what we are basically doing with the shared risk reward is we are putting skin in the game and that is a very engaging process to them.

You know, that's kind of what they have to do with their customers.

And the thoughtfulness for us kind of being a little bit I don't know coy or conservative, whatever word you might use, is really trying to amass enough experience across a number of customers to have a predictive model for how we think that it's going to impact the overall business.

And we continue to have good progress through the quarter.

It's very much synced with some of these nice customer consolidations that we are having, experiencing and continue to experience.

And I think by the time we get to analysts' day in February, we'll have enough collective experience to not only report some quantitative insight but to be able to predict how that's going to model forward.

Great, that's helpful.

Thanks, guys.

Garo Toomajanian, RBC Capital Markets.

Another question on PVS, actually, I'm wondering if when you go to market with that next year if you expect to have sign-off capabilities at major foundries and IDMs.

I'm basically wondering if sign-off is a big part of the rollout push here.

Yes, it is, Gar.

Sign-off is -- we are actually going to market with it now and we are continuing to work with the variety of factories on sign-off.

It's just work to do, to do that kind of a checkoff and checklist.

And I guess what I've found is that it's kind of a combination between the fabs and the IDMs and kind of get into a three-way discussion of when is the right time to invest the money in doing it.

And so it kind of paces some of the penetration, I suppose.

I think that's probably the root of your question, and it's why we are not trying to predict a home run or a strikeout.

It's really, you know, you are going to hit lots of singles and doubles and triples en route to really having this be a market leader position that we hope it will be someday.

Bill, can you repeat the number for the percentage of booking as subscriptions?

Did you say 74?

I did, Garo.

It was 74%, yes.

Okay.

Probably a question for Mike.

In Mentor's call last week, they observed that customers are starting to focus a little less on cost reduction and more on improved performance and power and time-to-market, and you kind of hinted at that as well, at least with your more leading-edge customers.

I'm wondering if you're seeing any changes in customer focus or urgency and what you think that means for the industry and for Cadence.

Boy, I don't know.

I wouldn't have given away cost reduction.

There's a lot of pressure out there to be, you know, lean and mean, and I think it's representative of the pressure that they face.

Certainly the low power plays prominently and they are go-forward and current kind of concerns.

And I think that bodes nicely for us because the successes that we see around Encounter and generally moving forward into RTL Compiler are a byproduct that we focus that on low power and they have a lot of demonstrables now.

So if I had to order them, I think time-to-market is probably the number one thing, and that may be what Mentor was talking about.

If you can impact time-to-market and it costs a little bit more to do that, that's probably worth it.

And in the end, we really believe that the consolidation is the thing to watch.

And customers have to consolidate to really save costs or at least it's an easy way to demonstrate cost savings.

It's certainly a key strategy of ours.

It emphasizes the breadth of our Company as opposed to just pocket depth and I think it makes a nice combination of customer requirement and our capabilities.

From talking to customers, do you get the sense at all that they feel they may have underinvested in design infrastructure in the last couple of years or not necessarily?

Well, that's a tough question.

There's definitely customers that I think thought they were using less of the technology than they really are, and we can of course monitor that for them and together, and when we do, I think that's a source of some of our business.

You know, we say hey, you really are benefiting by using more of the technology because you are already doing it.

And that's kind of the key automation is knowing that you are getting good value out of it.

But in terms, do they think they underinvested?

I wouldn't know how to respond.

I mean it's kind of very individual as we go along, and --

Okay, that's fair.

Thank you.

Harlan Thor (ph).

A great job on the quarter.

Bill, a question for you.

Can you talk about your design services pipeline?

I've heard it still knocks off from a capacity perspective and demand seems to be strong, but maybe you can just shed some more color on that front.

Sure.

For design services, that continues just to be a feeder for our total business and we are not trying to grow that as an individual line item.

So we will look at it and again use it strategically where we can help a customer transition to use more of our offerings in consolidation, as Mike was indicating.

And we will also look where they have particularly difficult problems where we can help them uniquely.

But that's where we are using it and we are running at a very good utilization rate.

That's part of just continuing to -- manages that business well.

But I think that's how we are looking at it.

So I think it looks fairly steady going forward.

Strategic use to win business, not to look at growing in any significant way.

Okay, great.

And then can you just also comment on deal closure at the end of the quarter relative to the prior quarters?

I'd like to say that the business pipeline was good and we were continuing to win business and we are continuing to work business that we think could benefit from us spending a little bit more time.

And we've been doing that I think pretty consistently all year.

As you could see from our costs going up, we were able to get more than I think our fair share of wins, but also I think as we work pricing with a number of our new programs, we have to be patient because some of those take a little bit more time.

And so I think the close rate is going well within our expectations but also, we are consciously waiting for things to be where we want them to be for the time to close them.

I would say one other thing, Harlan, is that on the closure, especially in a consolidating environment, we have quite a number of benchmarks or trials that we do with customers and some of those take a long time or you know, we're being patient about doing that, being very methodical and they are being very methodical.

And I think the encouraging thing from my part and is very difficult to kind of show that is that those benchmarks bode real well for us.

You see them in the micro testimonials as we progress quarter to quarter and there's no slowdown in that.

The acceptance of the technology on the digital side, especially with RTL Compiler and in general, the strength and verification bodes very nicely for projected future deal closures.

And then another question for you, Mike, again, just stepping back, if we take a look at the end market trends just over the last couple of quarters, I think what we've been seeing is a large demand coming out of the emerging economies, so things like low-end handset sales, low-end broadband modems, low-end set-top boxes.

And so we are now seeing that a lot of the semi companies are making a more accelerated move to integrate more RF than analog integration into their SoC's.

And so I'm just wondering if you are seeing that trend as it relates to any of your incremental business in your Virtuoso product line?

Oh, sure.

You know I think it's an insightful observation on your part and you can add a lot of things to that list -- display drivers, audio pieces for MP3 players and so on.

And the integration, as those products either get smaller or drive to lower cost are mostly affected or many times affected by integration on silicon.

I think it bodes very nicely for us because not only do we have strength in the Virtuoso side, but the optimization between the platforms on Encounter and Virtuoso, we can demonstrate.

And that's because our tools don't only interoperate, they enter-optimize.

The last thing that I think we will find very interesting as we watch it fulfill is a lot of the kit strategies and they are focused directly at that.

The wireless kit is targeted right in that sweet spot, and the methodology kit that we first introduced, one of them was totally focused on analog mixed signal.

So the fanfare that we receive, which in terms of positive feedback from the broad customer base, I think is another testimonial to your statement.

Just one last question for you.

So can you give us an update on X Architecture?

I know that TSMC a few weeks back announced they had qualified X for their 90 nanometer technology.

So are any of your partners actually starting to use X at 90 nanometers?

Well we have both -- we have TSMC and UMC qualified at 130 and 90, and that's continued to roll out nicely.

We have one of the designs that we talked about is targeted for 90.

And we have, in the pipeline, and of course we haven't been able to testimonial, many more either design potential from one of those two announced customers and/or new customers coming along.

And so that's the tricky part of modeling the X forward or not.

You have both of those phenomena.

That is, once a company adopts the technology in cruises (ph), they can proliferate it and then we can win new customers. and we are certainly pursuing both of those right now.

All right.

Thank you and great job again on the quarter.

Jay Vleeschhouwer, Merrill Lynch.

Bill, in light of your performance of the year to date and the outlook for Q4, would you be prepared to say that your product bookings this year can at last exceed the last high level of $1 billion that you last achieved in 2002?

Do you think you'll finally get back to that level?

And also, when you look at your next 12-month revenue profile, what would be the evidence you can give that on average, you are improving your run rates with customers?

That you are growing your renewals, you are increasing your capacity and breadth of products with enough customers to improve that run rate?

For the bookings question, Jay, as you know, we take a snapshot of that on an annual basis, so I will wait for that until we get to Q4 when we will talk about what our total backlog is for the year.

Still expect that to be around that $1.8 billion level.

And so I think that's the time to really talk about that.

As you know, our short-term metrics really are just top-line revenue, margin and cash flow, so I will hold the bookings for the year.

In terms of the question on run rate and improving utilization or usage by our customers, that's a good question.

We are looking at studying that.

We have a number of different initiatives for improving pricing and to help our customers and right now, quite frankly, we are looking at that a lot of different ways.

I don't have, besides just anecdotal information, a systematic way to measure it.

It's one of the things that our pricing team is looking at.

So I hope to have something just to show some progress there, even if it's just enough data points to go through and do some projection.

But for this stage, all I could tell you is, we are looking at it, we're trying a number of things, we're getting some results, but it's hard to speculate yet or to project across the board how we're doing there.

And I think certainly, anecdotally, it's positive.

The question is, do we have enough data points to predict a trend.

And Jay, I would love to see the segmented pricing effect because I think that demonstrates and drives a seamlessness so that the customers can use the technology more broadly and they don't (technical difficulty) the class or perceive that's the class in niches.

And it's cost savings because of offsets training costs and all different other elements of support that goes nicely with a consolidation trend.

So that's as much the reason I have in the back of my mind.

You kind of want to see a few more of those trends all come together because they are important data points to the anecdote of just how much business did we do with a particular customer, A, B or C.

In terms of the number one customer in the quarter, was that perhaps an example of expanded value or capacity in that case?

And do you expect some ongoing level of meaningful revenue with that customer even if not necessarily the amount that you did in the third quarter?

It was certainly a demonstration of capacity and we had new capabilities that we're engaging, but we didn't have to mortgage every new capability to be able to do that.

And I certainly think it was a byproduct of demonstrating that the breadth of our technologies were impactful to either the time to market that was asked about earlier or the cost efficiency that is implicit in everybody's mind as they try to keep up with the world as it moves on.

Jay, this is Bill.

I'd add that we, I think, when we worked with this particular customer, they continued to utilize more of our technology than they have historically.

So as they look at it, they are seeing very good proliferation and utilization.

The other point that you are asking is, do we expect to have future business with this customer, and we do.

We have a number of engagements across multiple fronts, and I think that's just going to happen naturally over time as we can demonstrate value, which we think we can.

In terms of bookings by geography, did each of your regions grow year-over-year in the quarter?

And for year-to-date, if you listened to Mentor's call last week, there were some regions where they did not perform so well year-over-year.

And I'm wondering if there were any instances where that was the case for you.

I think I would point you just to our revenue by geography.

Again, that's a good indicator for us.

And we did see pretty good growth across all of our regions, and particularly, North America, of course.

And as you can see by doing the math, that's where our large customer was located.

That's something that's apparent from the numbers.

Across the board, we had good results in all geographies.

So we're very pleased that it was widespread and also the strength is across multiple product lines.

You know what, Jay, one more point from me.

I think what's equally as telling and I don't know how the rest of the industry acts, but it certainly has been a target focus for us and a measurable, is to look at growth beyond a traditional tier company and expand into the broader geographic accounts, as we call them.

And this last quarter, we had testimonials in -- with the digital technology this quarter, we were talking about testimonials that expanded out the verification with the Specman.

So I think that bodes as a very nice barometer of potential to grow the business footprint that we have and maybe even as the whole industry.

Lastly, you and your peers are increasingly mentioning automotive electronics market as an incremental or new vertical opportunity, and that's probably right, given the amount of semiconductors going into automotive.

But how do you manifest that in terms of actually turning that into incremental business?

So now that you are all agreed on it as a market, what are you actually doing to capture more EDA business there?

I don't know if the gang effect of agreeing is that material to me.

It is certainly a focus for us.

It's a focus that we will drive by the kit orientation.

And it's really a kit orientation, not a traditional, you know, I'm going to call it niche technology or niche tool capability.

Because by looking at this thing holistically -- and the holistic point that I look at and maybe would be interesting for you is to look at it from the system side down, and that's where the verification plays, and you know that was a material part of our strategy to go expand the Company.

And I think the Bosch testimonial last quarter was a very neat indicator of that.

I mean, there's somebody who has not built a lot of semiconductors and certainly aren't specifying a lot of them, and they felt the value in the tools enough to be an overt testimonial for it.

And that is why it's an interesting market of growth expansion.

The kit orientation allows us to parlay that plus some of the other design capabilities so you can actually test your ideas all the way down to implementation and then all the way back up to prove the goodness of the fundamental idea and/or to test the soft environment, the reprogrammable environment, so that you can do it in parallel with some of the chip development.

Because the time to market is really kind of the same, working or ramping, not just when you get the first silicon.

And so that's kind of my fascination with it.

I think it's a great demonstrable for system-level design, is market expanding outside the traditional reach of EDA, and it bodes nicely for some of the technology bridge that we built consciously with the verification technology.

Thanks.

Raj Seth, S.G. Cowen.

First, Bill, in your Q4 guidance, are you assuming any big revenue deals of the sort you had in Q3?

I think the mix will just have to come through, Raj.

It's really hard to predict how the individual contracts will come down.

But we have a pretty good pipeline going into Q4.

Again, I'm not sure exactly on the timing of when certain of them will close.

We'll just work them to whenever they are ready, but we have a number of small ones and we have some recently good-sized ones as well.

But any that are especially large?

Again, I don't think it's worth looking at that level.

I think we have some very good-sized contracts that we are working and I could think of a number of what you would say good, large contracts that could close in Q4.

Okay, thanks.

That's fair.

Mike, any sense for what percentage of the design starts today are done at 90 and how fast is that now growing?

Well, it's growing.

The predominant number of starts are still at 130 and boy, there's still a lot of them even at 180 and there's a fair number at 90.

The phenomena, probably consistent with your intuition or analysis, is that a lot of the volume starts have moved to 90 and some of them even now forecasting 65 nanometer.

We obviously got one this quarter that was testimoniable (sic).

And I don't think that that's outside a traditional volume learning ramp curve that you'd see with any process.

The thing that we are intrigued with there of course is that's always a potential shift of incumbency for the digital platform and certainly with our technology, we're targeted there and doing well.

And I think increasingly, the physics of that, both for the breadth of our technology, especially with the inclusion of the analog characteristics, is most of the phenomena is in the analog-ish phenomena.

A wire isn't a wire; it's a transmission line.

So good news for us, bad news for digital designers all over the place, and just when you thought it was safe, the wire was just going to be a wire.

And that's as much of anything that directs the development and I think a lot of the customer's thought process around consolidation because they've got to be planning for the future as well as kind of existing in the present.

So is most of the investment today would you say -- and clearly, some is around enabling integration that you talked about.

But is a lot of the infrastructure investment that's going on today simply adding capacity to do 90?

Or do you feel like a lot of 90 capacity is already there and the decision cycle for 65 is what will drive growth over the next 12 months for you?

In the tier of customers, there's a lot of investment going towards direct and towards 65.

And I think a number of our customers -- I would say of the other class of customers that aren't let's say a big IDM moving that way, are certainly either looking for ways to streamline, optimize the 130 or move to 90.

And we are lucky or thoughtful, so we focused our investments to do both of those things.

We are primed in helping them realize their moves to 90, including the analog migration, which is a very difficult migration for most people.

And with the Encounter broad platform and with even application of RTL Compiler advanced synthesis, we can make the 130 nanometer stuff more efficient.

So you've kind of got such a wide variety of customers, on purpose, we focus across the continuum, because I think we can help them, that there's big pockets of investment across all three planes.

One more if I might.

Is this a market where we are going to see technology decisions made for example at 65 over some period of time and then whatever market share shifts are likely to occur sort of occur in that period and then they begin to evidence themselves as people build capacity at that node?

Or does it work differently?

And if it does work that way, when does that 65 window close for key decisions at the largest semiconductor companies?

Boy, that's an interesting question.

I might have to think about it some more.

Certainly, the 65 nanometer window is open for a long time, in my opinion.

We are just seeing the very, you know, tip of that iceberg.

And for the most aggressive investors in 65 nanometer, like I think ST Microelectronics obviously addresses, it was a, I think, a very good testimony of our technology to be a first mover with them on 65 nanometer.

The prime to the mass migration that I think could very well be equal to or slower than the 90 nanometer move because it's complicated; it especially has got a lot of analog structures you're trying to migrate.

And that's why I don't know that I really look at it that way.

I think the world has kind of changed from some forward-looking guy invests in technology, drives volume learning and then everybody else rushes to it, so there's more pace to it now.

People look at the number of people staying at the 130 nanometer, and so I think it's actually an opportunity for us as opposed to anything else because we can show creative or inventive cost or productivity savings at 130.

We can show migration for cost or volume ramp at 90 and then even out at 65 and kind of participate all along the chain.

And you don't just -- just because someone had incumbency at 130 doesn't mean that they won't be repriced with a more efficient or productive piece of technology.

Lastly, and I'm sorry for rambling here, the seamlessness of technology, I think, will become more valuable.

That is, traditionally, let's say if we would have used words like the most complex chips were done on the most advanced geometries and those simpler ones might have been on the previous generation.

That's exactly why we segmented the product line because what we can do is with one continuum of product, one continuum of training, one continuous support, they can use Encounter L on let's say 130; they can use Encounter GXL at 65 nanometers; and they can be going and blowing with Encounter XL at 90.

And it's this tremendous asset that really hasn't been in play before.

And so I'll think about it some more and maybe when we get together, I'll have a better thought, but that's kind of off the top of my head, a few ideas.

Okay.

I appreciate it, thanks.

There are no further questions at this time.

Okay.

Well with that, once again, thanks for calling in and I'm very excited.

I'm pleased we delivered on our strategies, demonstrating growth, in not only verification but in the core digital and the rest of the businesses.

We introduced segmentation in our first kit and we continued to deliver new technology across the board.

I look forward to telling you more about this at an analysts' dinner on December 6th in San Francisco and invite anyone to attend who can.

Thanks very much.

This concludes today's conference call.

You may now disconnect.