益華電腦 (CDNS) 2006 Q3 法說會逐字稿

Good afternoon.

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

At this time I'd like to welcome everyone to the Cadence Design Systems third quarter 2006 earnings 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] At this time, I'd like to introduce Ms. Jennifer Jordan, corporate Vice President of Investor Relations for Cadence Design Systems.

Thank you.

Ms. Jordan, you may begin.

Thank you, Michelle.

Welcome to our earnings conference call for the third quarter of 2006.

The webcast of this call can be accessed through our website, www.cadence.com.

It will be archived for one week.

With me today are Mike Fister, President and CEO; and Bill Porter, Executive 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 December 31, 2005, and our 10-Q for the period ended July 1, 2006.

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 website for reconciliations of GAAP and non-GAAP measures use in today's discussion.

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

Thanks, Jennifer.

Q3 was another good quarter for Cadence.

Revenue grew 9% year-over-year led by sales of our verification and custom platforms.

Business fundamentals and outlook for 2006 were unchanged.

Last quarter, we spoke about how we view our business by looking at the macro environment and the needs of our individual customers.

I want to give you a brief update on that.

Generally, we've not seen any change in the environment or in our customers' behavior from the second quarter.

Industry forecasts for semiconductor growth for 2006 span from 6% to 12%.

Analysts' estimates for semiconductor R&D spending remain in the high single digits in the second half of 2006.

EDAC's recent numbers for the 12 months through 2006 showed the industry having grown about 8% and CBN Live, a Silicon Valley event, had healthy industry participation, up 25% over last year with more than 650 customers attending.

I've talked in the past about how the advantage we have with Cadence' breadth, as well as our technological depth.

Breadth is absolutely required to leverage the core of EDA design into adjacent market segments and successfully bring to the market new, holistic solutions for designing complex electronic chips and systems.

Let me take a moment to talk about two such holistic initiatives that we are currently engaged in to take things to the next level.

First, a Power Forward Initiative.

The objective is to enable design and production of more power efficient electronic devices.

Today, over 400 user inputs from Power Forward advisers have been incorporated by Cadence into the Common Power Format, or CPF.

This captures all power specific information in a single file to link design, verification, and implementation.

In the third quarter, Cadence and SIT reached an agreement to accelerate industry education about CPF through SIT's low-power coalition.

A second example of a holistic initiative is the Cadence Logic Design Team Solution.

This new solution expands our leadership on the front end beyond functional verification.

It leverages the full strength of Cadence by expanding both the Incisive and Encounter platforms.

As with the front-ended Torino, it rearchitects the way RTL design is done moving from [INAUDIBLE] sequential and typically ad hoc processes to concurrent ones.

The result is that our customers can address a growing [INAUDIBLE] predictability crisis from RTL specification and logic [INAUDIBLE].

While we receive strong testimonials for the Cadence Logic Design Team Solutions from major multi-faceted customers, such as Kawasaki Microelectronics, to smaller, focused enterprises, such as the KeyLogic Corporation.

Functional verification continues to be the fastest growing segment of our business.

We have more than 10 successful competitive stimulation displacements within [INAUDIBLE] the enterprise, driven by our leading edge Verifications Process Automation Solutions.

In addition, the Xtreme III hardware acceleration platform, which we launched at CBN Live in September, is off to a strong start.

Redback Networks, a provider of video broadband networks, chose the Xtreme III system for its ability to deliver high visibility and performance at each step of the design process through a combination of our transaction-based acceleration capability and Incisive's plan-to-closure methodology.

With strong growth in consumer electronics, our customers are increasingly pressured to improve their time-to-market and productivity in areas of mixed signal design and full custom design.

As we said we would, the full production release of our next generation Virtuoso Custom Analog Platform is now available to customers.

This follows a very successful early adopter program that allowed us to incorporate feedback from more than 20 companies since its limited release in June.

Full custom design capabilities is critical not only for mixed signal applications, but also for full custom design of digital applications, such as memories and micro processors.

An early adopter of our new Virtuoso platform, Micron Technology, continues to recognize our leadership with the Virtuoso platform and leverages our full custom capability to bring its memory and imager products to market.

In Digital IC, where we've had engagement through 45 nanometers we continue to deliver innovative technology.

We're shipping the Encounter timing system, or ETS, which rounds out the digital flow allowing customers to complete and sign off designs entirely within the encounter platform.

We already have numerous public testimonials from ETS users. [Affaris] is standardized on ETS, [Mijitsu] is incorporating it into their ASIC implementation flow for final sign off, and [Faraday] is using it in production.

We also have a great response to ETS from the foundries.

CSMC is validating it for 65 nm flow, while UMC and SMIC are endorsing ETS for signoff timing and signal integrity analysis.

The number 65 nanometer [tape out], completed with the Encounter platform continues to grow, including a first [tape out] of a 65-nanometer low-power chip using the ARM Coretex-A processor core.

This is the first wireless application processor platform based on the ARM Cortex-A8, and it's targeted to be the best performing processor available for wireless hand set applications.

We have [INAUDIBLE] effort to leverage our analog mixed signal capabilities, targeting the fast growing wireless and networking markets.

Customers report the kits are saving them time and improving productivity.

This quarter, S5 Wireless, a fabulous company focused on bring extremely low cost wide area location and telemetry to market, reported saving weeks of their engineers' time using the AMS kit.

To look at Package Board, our focus on building both our direct and alternate channels is paying off.

The number and diversity of our customers in this market segment is best served by a combination of targeted channels.

In the direct channel, improved field focus is drawing sales of our Allegro products to semiconductor and networking companies, and increasingly the [INAUDIBLE] and automotive accounts.

In the alternate channels, our partners are demonstrating their expertise in growing the business for our low price, high volume OrCAD PCB products.

In addition, we continue to make progress with our new System and Package Solution, which Amcore selected as the basis for its System and Package Initiative in its design centers worldwide.

In design-for-manufacturing adjacency, we announced collaborations with both Brion and Clear Shape for lithography-aware design flows that use a consistent interface to link Cadence digital design optimization and verification technology. [INAUDIBLE] resolution enhancement technologies all focused on reducing critical problems lithography-induced yield problems and mask-design challenges.

We've also been collaborating with ASML on advanced resolution enhancement technology and optical proximity correction software that was used to produce silicon at 32 nm.

Finally, I will be speaking at the NASDAQ London conference during the first week in December.

I look forward to seeing many of you there.

But now I will let Bill take you through the numbers.

Thanks, Mike.

In the third quarter, we again executed on our strategy and produced strong financial results.

Total revenue was up 9% year-over-year.

Non-GAAP operating margin improved 3 percentage points compared to 28% compared to Q3 of 2005.

We had another good cash flow quarter, where we recorded operating cash flow of $60 million, a 12% increase compared to Q3 of 2005.

GAAP earnings per share for Q3 were $0.14 compared to $0.07 in the same quarter last year, up 100%.

Non-GAAP earnings per share were $0.26 for the quarter, compared to $0.21 in Q3 of 2005, a 24% increase.

Total revenue for the third quarter was $366 million compared to $337 million in Q3 of 2005, up 9%.

Product revenue was $245 million, maintenance revenue was $87 million and services revenue was $34 million.

Revenue mixed by geography in Q3 was 54% North America, 22% Europe, 13% Japan, and 11% Asia.

The tone of business was good across all geographies.

In the quarter, approximately 49% of our product business was represented by [rateable] licenses.

This percentage is lower than our typical rate in the mid-70s because we elected to continue to work several contracts for better value.

Our forecast for [rateable] mix in Q4 is in the low 80s and in the 70s for the year.

For the year, we expect to generate approximately two-thirds of revenue from backlog.

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

Q3 total costs and expenses on a non-GAAP basis were $265 million, down from $270 million in Q2.

Our non-GAAP operating margin in Q3 was 28%, up from 25% in Q3 of 2005.

We looked for a non-GAAP operating margin of about 34% for Q4 and 27% for 2006.

Head count at the end of Q3 was about 5,200.

The quality of receivables remained high in Q3.

With receivables 90 days past due at 1%, within our historical range of 1% to 3%.

Total DSOs were 93 days compared to 100 days in Q2.

We still expect DSOs to settle into the mid-to high 80s by the end of 2006.

Q3 operating cash flow was $60 million versus $54 million in the third quarter of 2005.

For 2006, we expect to generate operating cash flow of at least $425 million.

Capital expenditures were $13 million for Q3, keeping us on track to spend approximately $75 million for the year.

We repurchased 6 million shares in Q3 at a cost of $98 million.

Cash and cash equivalents were $758 million at the end of Q3, compared to $826 million at the end of Q2.

Stock-based compensation expense was $24 million for Q3.

And for 2006, we continue to estimate stock-based compensation expense of approximately $100 million.

Our non-GAAP measures exclude stock-based compensation expense.

Now I'll turn to our outlook for Q4 in the year 2006.

For Q4, we expect revenues to be in the range of $405 million to $415 million.

GAAP EPS should be in the range of $0.20 to $0.22, and non-GAAP EPS in the range of $0.34 to $0.36.

For the year 2006, we expect revenue to be in the range of $1.458 billion to $1.468 billion.

GAAP EPS should be in the range of $0.50 to $0.52, and non-GAAP EPS in the range of $1.04 to $1.06.

Other income and expense for 2006 should be in the $48 million to $52 million range.

I'm confident that we're making progress against our objectives, to demonstrate growth, execute consistently, and achieve our operating targets.

Operator, we'll now take questions.

[OPERATOR INSTRUCTIONS] We'll pause for a moment to composite the Q&A roster.

Your first question is from Jay Vleeschhouwer of Merrill Lynch.

Good afternoon.

This is Woojin Ho for Jay.

A couple questions.

The EDAC market data is indicating for the past number quarters a much more positive slope for physical design applications, PNR, specifically.

Can you say with certainty that you're gaining share in that category?

Yes, I think we're doing just quite well.

The [INAUDIBLE] is not only doing most chips, but if you bundle that with Encounter, we're doing all the hard ones and moving down nicely to try to start to proliferate that across the continuum, especially on the strength of our segmented product offering.

Okay, now are there any notable trends or Cadence activities directed at all towards the global or strategical regional accounts, i.e., any particular targeted sales or product programs that you've undertaken?

Yes, sure.

I mean the segmented product offerings allow us to go and accelerate at the right level of capability.

If you go to many places in some of the -- what we characterized as emerging geographies, they're not tackling necessarily hard ones.

They may be at 90 nanometers as opposed to 65.

Many of them stay at 130 nanometers.

That's one element of exactly what we do.

The second element is that we retargeted the sales force almost a year ago with a focus on, as you say, regional accounts and of, seen nice growth and some of the testimonials that I offer are indicative of that because they may not be the biggest companies in the world, I think in some respects they're employing leadership though by innovating at a higher level of distraction.

And, Mike, lastly, do you view either design or methodology support services as any kind of leading or coincident indicator?

And, if so, how do those look to you?

It's a very valuable tool for the Company.

We use the services capability either to demonstrate new technologies, help our customers over a capacity, you know, buffer that they may have poorly anticipated.

They may need more capacity in a particular part of the design cycle and/or to kind of learn and rotate that intelligence that we get down into our basic developments and so it's a strategic element of our business for all three of those.

As you can see from Bill's comments it's nicely subscribed, that means it's very busy.

We're using it a lot in the translation and the consolidation with accounts big and small.

It's a very mature part of our Company and business and it acts in many different capacities for us.

Great, thank you.

Sure.

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

Hi.

Good afternoon.

Nice job on the quarter.

First question for you, Mike, lots of design activity and strong unit growth forecast in the memory space, both on flash and D-ram, and you know, given the heavy use of custom tools and analog mix signal simulation with the memory suppliers, how much is Cadence benefiting from the positive trends we're seeing here, and more specifically, with respect to Nanflash, which is a relatively new product segment, is the team seeing an expansion of the market opportunity here, as this segment continues to grow pretty rapidly?

Harlan, one of the testimonials to offer on a particular Nanflash, but to your point, it was interesting that Micron was a testimonial for us.

At CBN Live in San Jose, we had some particular sessions with those kind of guys.

There's an awful lot of our new Virtuoso focused at helping drive those technologies and drive them not only to density but time to market.

I think your intuition is good.

Stay tuned and what we'll try to do is funnel some testimonials that show some real progress there.

Okay, great, I think you might have eluded to this a little bit earlier, but at Cadence Live we had the opportunity to speak with several of your customers, lots of discussions on the rollout of your next generation of the Virtuoso platform, for most of the customers that we talked to, it wasn't a question of if, but when they would transition.

I guess the question is, can you give us a sense as to the upgrade opportunity ahead of the team as customers start to transition, and maybe over what period of time?

Another good question.

It's one of the reasons in the comments I put in just how broad the engagements were of the early adopters, over 20 companies.

Bill noted particular strength in that part of the business this quarter and it wasn't coincidental.

It was linked with the new Virtuoso platform.

It's something that will take over a year for some of our customers to embrace.

They're at different parts of their design cycles in terms of transition.

Some will bias it on a nodal transition, a process node, some will bias it on a calendar time transition, and some will focus it on a product transition.

So what we're focused on now doing is working with customers in a very targeted way across those three different time continuums and focus first on the people that are going to move right away and then let the other ones move along as they come.

One other thing I would point out is that that product is segmented into the three tiers, the LXL and GXL.

That's going to be an advantage to for customers intersected, even mid-cycle based on product transition or complexity.

Okay, great and then my final question.

I know you made some commentary about not seeing a whole lot of changes in terms of customer spending patterns from a macro level, but outside the memory space, semiconductor fundamentals have been pretty mixed at best.

We've heard about excess inventories in some segments of the market space, lower demand at the margin in certain segments, like wireless for example, and so I'm just wondering, you know, given that your customers have not pulled back on spending for design tools, what is it that they're focused on, what is it that's not causing them not to pull back here?

Is it a focus on 65 nanometer and design execution, is it DFM related issues?

Is it verification issues?

What are the challenges that are forcing your customers to continue to spend?

They're all across the board.

There are definitely people focused on high integration for cost and many times that's a forward-looking process approach at 65-nanometer, which may, itself, have a mixed signal notion to it because the structures don't port very nicely in the analog domain.

I think verification is avery astute comment on your point, these are systems on a chip, in a truer sense of the word and we're seeing an awful lot of progress focused on considering those, making the trade-offs, as they approach those chips and also trying to get the applications migrated for time-to-market and ramp of the device.

And the third thing I would say is that many of those are very, very complex digital systems and the testimonial that I mentioned that used the ARM Coretex core is a speed power product.

They're trying to build a high performance device at really low power.

It's one of those things we looked forward to with Power Forward, it's a great demonstrable [INAUDIBLE] it makes a very good advantage of not only the totality of our Encounter system, but now as you can see, the improvements in the timing system in test, and I think those are all very thoughtful on our part to try to help those customers make those changes.

Okay, great, thanks a lot, Mike.

Sure.

Your next question comes from Tim Fox of Deutsche Bank.

Hi.

Thank you.

Good afternoon.

Bill, if I could just start with a couple questions first.

Can you talk a little about the drop in the percentage of [rateable], pretty precipitous drop, to 49%, can you go into what drove that for this quarter?

Sure, Tim.

There's a tension that we look at between achieving quarterly metrics and creating long-term value.

And one of the things that we've been open discussing is that our objective is to provide better solutions to customers and get some better value in return.

During Q3, we achieved our primary targets of revenue growth, operating margin expansion and cash flow growth, and then we consciously made a trade-off to work several contracts for better value at the cost of a lower [rateable] percentage for Q3.

For example, one contract that I'm familiar with, we've continued to work, and it's expected to close in Q4 for 25% more than we could have got at the end of Q3.

So as we look at it, our model hasn't changed, we are forecasting a [rateable] mix in Q4 that's higher than normal, in the 80s and we'll be at about 70s for the year.

We don't expect year end backlog or just book-to-business to change.

We're still looking at at least $1.8 billion of backlog.

So what was really about making a short-term trade-off, or a secondary metric and get better value as we worked to provide better technology to our customers when they need it, and so we wanted that ability to increase that value and look things over more than a quarter's horizon.

Okay, I think, I think I get that part of it.

On the cash flow front, I think you reiterated your view for about $425 million in cash flow from operations for the year, do you anticipate this similar level of sales of receivables this year as you did last year?

Is it more normalized in 06?

I would look at about the same level, Tim.

Okay.

It's pretty normal for us, as you know, our program is we can generate at least 25% of our product business from term licenses, and when you look at just the rough numbers of, you know, close to a billion dollars in product, that's going to generate about $250 million a year and we like the use of that cash to do things like repurchase stock.

We think it's a good trade-off and something we're very comfortable with doing.

It's a true sale program.

Okay, Mike, if I could, just maybe a couple quick ones for you.

Any change in the competitive front in emulation?

I know we've heard some recent noise from some of the competitors in the market.

But wondering if you're seeing any increase in competitive dynamics there?

Any share loss, just comments there?

Thank you.

Yes, you know, the, with some, some I guess, amount of pride I was talking about Xtreme III and completed that segmentation down another level and had a couple of testimonials there.

There's definitely some, you know, I've heard some rumors of competitive product and read about it, I haven't seen any losses.

That's such a strong part of our business.

I don't, I don't know that I'm really looking backwards.

I'm looking at the total complexity of our product offering and the emulation links nicely with what we're doing on Incisive.

It'll take another linkage with Design Team.

I think that's really the strength that we're seeing and it bodes well for us in the future.

Okay, and just finally, both of the major competitors in the space have done some recent acquisitions in the system level design area, I know you typically refer to that with your verification platform, do you have any views, or has your view changed at all about expanding your system-level capabilities beyond just the verification part of that element?

We're innovating internally that way and moving up nicely.

Have announced a program we call Builder that fits nicely up above verification as someone tries to construct their, their platforms for tests, for architectural exploration as well as for verification after you get it fixed.

Then, have been less public with that about another incubation, but it's out there.

And I believe the strength of what we're doing is going to be the strong linkage of those technologies to our implementation flow.

And the big idea there, Tim, is you want to be able to test an idea as it would be implemented before you implement it.

That's the strategy that Bill and I have described a couple of times, like the Analyst Day and such.

It's very thoughtful what we're doing and I think the completeness of our strategy is one that builds nicely upon the implementation and verification foundations and then kind of innovates us at stack.

So beyond that, we're certainly collaborating with several companies in that space where they've made point-wise engagements with customers and that's kind of the strategy that we're onto.

Very good, thank you.

Nice quarter.

Sure, thank you.

Your next question comes from Matt Petkun at D.A. Davidson.

Hi, good afternoon.

Bill, just a point of clarification.

I'm sorry, I misunderstood.

When you said 49% of the business is [rateable], did you mean -- and I know I misheard you -- that 49% of new bookings were booked under [rateable] licenses, or that 51% of your revenue came from backlog?

It was the first, Matt.

Okay, then I guess I missed the percentage of total revenue in the quarter that came from backlog?

It's still in the low 60s.

I didn't mention that, but that's the answer.

Okay, I think previously you said about two-thirds, and I don't want to read too much into anything, but I mean, that would seem to make sense if you had more one-time deals in the quarter than --

It's within that normal range of a couple points here or there.

Great, and then you know, your Analyst Day, not Analyst Day, but [ inaudible ] provided that analyst dinner, you gave us some clarification in terms of what you're seeing in percentages.

I think it was specifically on the Encounter side for digital in terms of product tiering, between L, XL and GXL.

Can you give an update on that and maybe share how it's going for you also on the Incisive enterprise versus other levels of product tiering?

Sure, Matt.

Let me reiterate, the mix that we're expecting is around 10% to 20% in GXL, about 20% to 30% in L, and the rest in XL, and that experience is primarily around our digital platform.

What we've seen so far, really focused on the high end, is around mid-teens in GXL.

We've got about three-quarters now of experience and we're seeing, I'd say very similar, but very early trends in the rest of the platforms.

So really, I think the best data we have is around digital.

We are seeing continued anecdotes from the field that the segmentation helps us compete, particularly with the Ls, as we're able to move in at a base level and then we can work with our customers to sell up as their needs get more complex.

So that is getting good feedback.

And then also, particularly across the geographic accounts, we are continuing to see some good early intake of the kits, primarily around mixed signal, as we can help the smaller companies get time-to-market improvement.

That also interplays a bit with the services that was asked earlier.

The services teams can help with those smaller customers, particularly as they move into some new technologies.

So the early indications are continuing to be good.

At this stage, I think it's still too early for me to quantify that we've got the 1% to 2% growth that we're targeting from both segmentation and kits, but we're still feeling the early progress is good and we're going to continue to focus efforts there.

We see good returns, particularly with the segmentation and moving up the stack with smaller customers on the kits business.

And one other thing, the segmentation of the [INAUDIBLE] on the verification side, is a little bit different.

I don't think it's going to stratify that way.

Enterprise is across the continuum of designers and verification engineers.

That's a characteristic of extremely big organizations, and so on.

So, it's a lot more targeted around the size of the company that we're penetrated on and we're focused at the high end companies to start off with.

It's almost irrelevant in some respects what the distribution of the enterprise segmentation strategy is right now.

Okay, that's a good point.

One other final question from me, I know you guys, I think it was this quarter, launched the Xtreme III in the Emulation product line.

What, I know you're not going to give specifics, but I'm just wondering how much hardware is right now roughly is a percentage of the total?

It seems like that has been one of a couple markets where you've been gaining a lot of share.

I'm just wondering if you could provide some updates on that?

Yes, Matt, the Xtreme just released at the end of the quarter and I think it's going to continue to fill out our strong business in Emulation.

It's a very natural move from Simulation up to the hardware acceleration and then to Emulation.

We don't break out specifics for the hardware business.

Besides, it has been doing well.

It is, adds to capability that others don't have to our full product line.

We think it's going to continue to grow.

Okay, thanks a lot.

Nice quarter.

Thank you.

Your next question comes from Stuart Muter of RBC Capital Markets.

Yes, thanks.

Good afternoon and thanks for taking my questions.

I guess first question, is really Japan revenues dropped off as a percentage fairly substantially from Q2 to Q3.

Could you talk a little bit about what was driving that?

Yes, Stuart, it's nothing more than the mix of business by geography which does have some volatility depending on which contrasts get closed and are revenued in a particular quarter and a particular geography.

As we look at our Japanese business, it continues to be very strong.

We have a very good pipeline.

As we look at Q4 and as we continue to look out into that business.

It's really based on the strength of the technology and the customers in Japan are investing.

We've seen that, we expect that to continue.

You're seeing just a little bit of stronger business in North America and Europe this quarter.

We still see the trend as we look at it on a weighted average basis, four quarter basis, to continue to do well in Japan.

So Bill, you think it'll be higher as a percentage in Q4?

Generally, I expect, yes, it will.

Okay, and a quick question for Mike, in terms of the early feedback on 45 nanometer, what are your customers struggling with at 45 nanometer?

Does it continue to be designed for manufacturability?

Is it continued power?

Can you talk a little bit about what you're hearing with the early feedback on what are the design challenges at 45 nanometers?

It's very early, good question though.

It's a trade-off of density and power.

You know, on those kind of process technologies, you can put a lot of stuff on there.

Say you want to integrate for value and that's why power is such a huge, huge component of care.

The pure performance of those, when you trade off power, like that wireless chip example that I was mentioning is manageable, and often times it's not just an element of, you know, hooking the transistors together.

It' the conception of the chip and then the proving that it works.

That's why the verification linkages is so interesting, and that's why the Design Team is notable.

If I could characterize it, and it sounds probably characteristically [Fister-nerdy], it's increasingly becomes a system design problem as opposed to just a semiconductor design problem.

As they go into production, I think we'll see a whole raft of DFM- associated opportunities.

The approach that we take, say for example on a Power Forward, or even with the breadth of the Encounter offering is to look across that barrier of implementation down into the manufacturability.

We'll see, about a year from now, ask the question again and I think it'll shift more to a production kind of a mantra, like 90 was a year ago.

Okay, that's helpful.

Thanks very much.

Sure.

Your next question comes from the line of Quincy [Finn] at Tiger Management.

Hey, guys, my question was regarding the fluctuations in the [rateable] revenue, but you guys seem to have already touched on that so that's it.

Okay.

Operator, are there any more questions?

[OPERATOR INSTRUCTIONS] Your next question comes from Rohit Pandy of HSBC Securities.

Thank you.

I have about four or five questions here.

Bill, or Mike, if I look at the Digital IC design revenue contribution, that's the lowest this quarter compared over the past 10 quarters.

What drove down the contribution?

Rohit, for digital, and we have a strong portfolio from across the different product lines, and they will perform and out perform in different quarters is our experience.

And so as you look at that trend, you'll see that we'll have fluctuations by product group, you know, for example in Q1, Digital was down, in Q2, Digital was up.

I think as we just look at Digital for the year, it's probably a little lower than we expected and on the contrary, Custom is exceeding our expectations, really based on the success of Virtuoso.

I think normal fluctuations is something that we see because of the just strength of our overall product portfolio.

When we look at our digital technology, it continues to strengthen.

We're not seeing competitive losses.

I think we are continuing to see good progress introducing initiatives like Power Forward.

We're exciting about the Logic Design Team Solution and we're getting good feedback on, as Mike described, on Encounter Timing System.

I would chalk it up to normal fluctuations and a continuing good trend with that technology.

If I could add one thing, Rohit, And I think you know this, as you, in the advance process nodes like 65 nanometer where a few of the testimonials were focused, Virtuoso is another surrogate for Digital as a full custom tool.

We're probably going to blur in our own minds to confuse the world just how pure Digital is for digital, but I concur totally with Bill's comments.

When I look at what your revenue growth quarter-by-quarter, it's been slowing down since the first quarter, so should I expect it to reverse looking forward?

How should I think about it.

You were 12% for the first quarter and the second quarter,8.5 % for the third quarter.

How should I think about the year-over-year growth?

Rohit, as we look at growth, we look at it over a longer term horizon.

It's a little bit of large numbers.

We've consistently set that we would grow in, you know, the high single digits.

We've done better than that.

We've been very pleased we've been able to grow a little faster than that.

But we plan our business around R&D growth.

As we look forward, we think there can be some fluctuations in growth rate, but we're pretty pleased we've been growing the business over the last few years, faster than the industry, and I think we've tried to plan the business conservatively so we can, hopefully, overachieve to some of those growth rates.

On the accounting side, this quarter, you have a credit for the non-deferred compensation, how does that work?

I'm sorry, I don't understand that question.

You have a credit for the non-deferred compensation, usually that's an expense, I'm looking at the pro forma reconciliation, and it's on page--

Okay, I understand your question now.

Yes, okay.

With non-deferred comp, what happens when the value of the portfolio goes up, it hits our compensation expense.

Okay.

And then there's an offsetting increase in other income.

So the net impact on your P&L is zero.

But it hits you in two different lines.

So on the contrary, when the value of the deferred comp portfolio goes down, you get a credit in compensation expense, and on the other side you get a reduction in your other income from the portfolio.

Again, it nets out to zero.

That's the way it needs to be accounted for.

Okay, and last one on the rateable, it went down to 49% and you said to, it was a trade-off made.

So should I think that your overall backlog should be higher now because you were able to extract more value out of the customers by pushing back the renewals from this quarter?

As I I described it, Rohit, it was really the quarter change.

As we look at the full year, we expect our backlog to be about the $1.8 billion level that we were predicting all along.

This is really a trade-off between Q3 and Q4.

The model itself, I think, remains.

This is about making choices versus for a secondary metric versus really getting value that I described in that particular example.

So was it logistics, like you could not close deals or was it you just start, you capture the value [INAUDIBLE] by pushing it to the fourth quarter?

If we wanted to focus and just get that business closed, I believe we could have, but we would have given up too much value.

Okay, got it.

This is really about making the choice for a longer term.

Got it.

That's all I have.

Thank you.

Your next question comes from Rich Valera of Needham & Co.

Thank you.

I was following up on earlier Virtuoso questions.

Mike, I was wondering if you could give us a sense of the ASP difference for the new Virtuoso versus the old one, just to give us some sense of the revenue opportunity if your customer base were to all upgrade over time?

Yes, it's less about pure ASP than it is buying in at the level that you want to or that you need to, and we bundled in, in the GXL, a lot more DFM-oriented capability, and so I think what will happen in the ASP uplift, and, as Bill said, we'd love to share this at the Analyst Day when we get out there in a couple of months, more than by anecdote, we'll get sell-out from the mid-level which is about where we had Virtuoso before up into the GXL level, and the price points will help to not give somebody technology that they can't use and, therefore, harken the debate about why it should be cheaper.

It will more allow them to participate over time if they value the features.

Does that make sense?

What I'm saying?

Yes, yes, I think it does.

And, you haven't mentioned alternative pricing models recently.

Just wondering how that's going?

If that's still a significant initiative?

If there is any forward movement on the alternative pricing front?

Yes, Rich, this is Bill.

I think we would continue to, what I would say, is experiment with the number of innovations around pricing in addition to what we've talked about in terms of our segmentation.

The level is about the same level we talked about in 2005 at our Analyst Day.

We still look at that.

Don't really have much to say.

We've talked, and we still experiment around, particularly some of the DFM technologies, because, again, we think there's some volume application.

But still, it's early days.

So as part of getting better value to customers, you want to give them better solutions and continue to see, is there different opportunity to improve how we package and how we price.

I would also chime in, Rich, it's interesting to me to see customers that are thinking out further in time, looking for ways that are more shared risk reward, either around pockets to their business, or big pieces, and you know, that's one of the reasons we, that's where we, as you know, have done most of the experimentation that Bill was talking about.

It takes a very mature relationship to have that conversation.

You want to be viewed as an equal as opposed to lesser than equal.

You know, when we do the Analyst Day, we're definitely going to have some of our experience to share there.

I believe with a lot of passion, just like I did when I came into the industry, that's both valued by some of our customers and will be in some time, in some segments, especially the manufacturability segment, the way that we have to operate to really be effective as a business.

Thanks, and just one final one for Bill.

You pulled out the other income of $48 million to $52 million for the full year, is that higher than you'd expected previously?

And if so, what is that?

It's up just slightly, Rich, from the update I gave last quarter.

We're just continuing to see a slight pick-up from our other interests, or our interest income, excuse me, from our portfolio, is a little bit bigger.

Okay, could you remind us what it was last quarter?

The range?

I think it's up a couple million from the total range we gave last quarter.

But I can check.

I don't have that in front of me.

Okay, that's great.

Thanks very much.

Your final question comes from Sterling Auty of JPMorgan.

Yes, actually, Bill.

I jumped on a little bit late, I heard some of the description on the last question that was regarding the [rateable], I guess I'm still not clear, I understand what you guys have done for some time in terms of walking away from business where you did not think you were getting the value out of the customer.

In totality, if I look at the declined deferred revenue, how much of that was seasonality, versus the [rateable], I just want to gauge how tough the quarter may have been?

Sure, Sterling.

I think there's really two different questions.

Let me separate.

The deferred revenue, that was really a mechanical difference in dates.

What I mean by that is, in Japan for example, they generally will bill on semi-annual cycles.

Last year, our end of quarter, which was October 1 was really the end of Q3.

So we billed a lot of items the last day of Q3 and it increased our deferred revenue.

This year, October 1 fell into Q4.

Those increased billings in Japan happen in Q4, so you do not see the pick-up in deferred revenue.

That's why you don't see the increase in deferred revenue this year that you did last year.

It's really a seasonal billing.

That's separate from what we decided to do this quarter as we looked at our portfolio of business.

And based on the strength of the technology and the richness of our pipeline, we could see that we were going to hit our primary targets and based on the mix of business that we were still discussing with a number of customers, those decisions were to continue to work, those contracts were essentially subscription business, a little longer so we can get that value that I gave the example of.

But did it cause you to push other business to a more up front?

Or was that business was already heading in that direction?

No, that business was already heading in that direction.

That's why we could see, based on the mix, which contracts that we would continue to work.

Okay, all right, thank you

Ladies and gentlemen, this concludes today's Cadence Designs third quarter 2006 earnings conference call.

You may now disconnect.