益華電腦 (CDNS) 2007 Q2 法說會逐字稿

Good afternoon.

At this time, I would like to welcome everyone to the Cadence Design Systems second-quarter 2007 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 session.

(OPERATOR INSTRUCTIONS).

I will now turn the call over to Ms.

Jennifer Jordan, Corporate Vice President of Investor Relations for Cadence Design Systems.

Thank you.

Welcome to our earnings conference call for the second quarter of 2007.

The webcast of this call can be accessed through our website, www.cadence.com, and 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 30, 2006 and our 10-Q for the period ended March 31, 2007.

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 financial measures, and to both our earnings press release and our website for reconciliations of GAAP and non-GAAP financial measures used in today's discussion.

Now I will turn the call over to Mr.

Fister.

Thanks, Jennifer.

Our results for Q2 again corroborate our technologies and strategies continue to be aligned with our customers' needs.

Revenue grew 9% over the same period in 2006, and non-GAAP EPS was up 30% on the same basis.

In the semiconductor environment, which I would continue to characterize as mixed, we saw good underlying design activity and accelerating movement to more advanced process geometries.

We continued to execute your strategy of growing our core business while expanding into the systems and manufacturing adjacencies.

To illustrate our continued progress, let me focus on some of our achievements this quarter.

Functional verification again delivered excellent results in the period.

We're leading the market segment with solutions that improve our customers' productivity while helping them manage the verification challenge across teams and at higher levels of abstraction.

The customers who are working up the stack with advanced verification capability rely on Cadence Incisive Enterprise to get their designs done on time and functionally correct.

UK-based Imagination Technologies has had great success delivering SoC IP platforms into consumer graphics and multimedia systems for major semiconductor companies and systems OEMs.

These platforms require advanced verification solutions that can be easily integrated into their existing design flow and across multiple engineering teams.

Already a user of Incisive Enterprise from the front end design through test bench simulations, Imagination Technologies expanded its usage of both Incisive Enterprise to and Incisive Formal Verification to ensure overall quality and time to delivery.

Another aspect of our improving our customers' productivity is facilitating the adoption of new methodologies.

Siemens IT Solutions and Services saw an advantage in choosing Cadence's SystemVerilog Solutions because they were easiest to adopt and most practical for the logic design and verification teams.

Our acceleration and emulation solutions also improve our customers' productivity when it comes to hardware and software co-design and co-verification.

Sun Microsystems used Incisive Extreme to cut by roughly half the development cycle on the design of the 32-bit processor UltraSPARC T1.

Xtreme's ability to hot-swap simulation between software and hardware environments greatly reduced Sun's time to bring-up and allowed them to boot the Solaris operating system on the UltraSPARC design before committing it to silicon.

During the second quarter, we released a design with verification component of our Logic Design Team Solution.

The integration of verification and logic design capabilities is resonating with customers.

For example, G2 Microsystems, a firm designing ultra-low power Wi-Fi chips, adopted the complete Logic Design Team and Encounter low-power solutions to maximize their designers' productivity.

Moving to 65-nanometer digital design accelerated in Q2 with strong demand for low power flows, and some leading-edge customers are already driving the 45-nanometers.

Our particular strengths in low-power and advanced routing are fueling our competitive success at both these nodes, where numerous customers have taped out designs using Cadence Low-Power Solutions.

TSMC announced support for the Cadence Low-Power Solution and qualified our Encounter GXL technologies for their 45-nanometer reference flow.

Canon expanded its IC digital implementation capability by adopting Encounter GXL, including low-power capability.

We delivered the industry's first low-power kit in the second quarter, providing end-to-end methodology with an ARM-based reference design and IP covering logic design, functional verification and physical implementation.

In addition, the number of customers adopting the Encounter Timing System doubled in only the second full quarter of availability.

ETS allows customers to complete their design entirely within the Cadence digital flow.

Our custom IC business continues to track according to plan.

It helped drive our excellent performance in the Asia-Pacific region this quarter, where we had great success with memory companies.

As you may recall, memory is one of the five drivers of the Virtuoso platform, the others being wireless, analog, mixed signal and RF.

The advanced demands of leading-edge memory design resulted in the expansion of Virtuoso technology at several leading memory and electronics companies in Taiwan and Korea and a significant competitive win in North America.

A leading US memory company has chosen to move its custom design flow to Cadence, due to the advanced capabilities the new Virtuoso 6.1 platform provides.

We also collaborated with TSMC to deliver 65-nanometer RF process design kit for the new Virtuoso platform.

The combination of TSMC process technology and libraries with the Cadence design flow provides an end-to-end solution for designers of wireless SoCs.

A key test of our DFM strategy is enabling the creation of process-friendly designs by building yield awareness into both our Encounter and Virtuoso flows.

TSMC's 45-nanometer reference flow drives on several Cadence DFM technologies, including QRC Extraction, the first extraction tool qualified at 45 nanometers, as well as CMP predictor and Chip Optimizer to maximize yields.

Additionally, we worked with STARC, the research consortium for the Japanese semiconductor market, to develop a design flow that addresses the most pressing 65-nanometer DFM challenges.

With the purchase of Invarium this month, Cadence gains the next-generation technology to address litho, etch, mass accuracy and manufacturability requirements at 45 nanometers and below.

In June, we delivered on schedule a major upgrade of Allegro, our silicon packaged board platform.

This upgrade includes highly automated board planning and routing technology and new RF capabilities.

In the quarter, Allegro won a PCB competitive replacement at a major North American systems company, and we also had several good IC packaging and system-in-package wins, as our SiP solutions continue to gain momentum.

In conclusion, we had another great quarter, and I'm very pleased with the progress.

Now I'll turn it over to Bill.

Thanks, Mike.

The results for the Company's key operating metrics for Q2 were total revenue up 9% year over year, non-GAAP operating margin of 28%, improving 300 basis points from Q2 of 2006, and operating cash flow of $101 million.

GAAP earnings per share for Q2 of 2007 were $0.20, compared to $0.10 in Q2 of 2006.

Non-GAAP earnings per share were $0.30 for the quarter, compared to $0.23 in Q2 of 2006, up 30% year over year.

Total revenue for the second quarter was $391 million, compared to $359 million in Q2 of 2006.

Product revenue was $264 million.

Maintenance revenue was $94 million.

Services revenue was $33 million.

Revenue mix by geography in Q2 was 52% for North America, 17% for Europe, 17% for Asia and 14% for Japan.

We saw particular strength in our broad-base accounts.

During the quarter, one customer accounted for 18% of revenue.

In the quarter, approximately 75% of our product business was represented by ratable licenses.

Estimated contract life on a dollar weighted-average basis was approximately three years.

Total costs and expenses on a non-GAAP basis for Q2 were $280 million, compared to $277 million in Q1.

Our non-GAAP operating margin in Q2 was 28%, compared to 25% in Q2 of 2006.

We are on target to achieve a 30% operating margin for the full year 2007.

Quarter-end headcount was approximately 5,200.

Total DSOs in Q2 were 102 days, compared to 100 days in Q2 of 2006.

We expect DSOs to be in the mid to high 80's at year end.

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

Operating cash flow for Q2 was $101 million, compared to $115 million in the second quarter of 2006.

For 2007, we expect to generate operating cash flow of approximately $450 million.

Capital expenditures in Q2 were $18 million.

For 2007, we are targeting normal capital expenditures in the $75 million range plus $22 million for work on the new engineering building.

Cadence did not repurchase any common stock in Q2.

Approximately $406 million remains under our current stock repurchase authorization.

Cash and cash equivalents were $1.129 billion at quarter end.

Now I'll turn to our outlook for Q3 and the year 2007.

For Q3, we expect revenue to be in the range of $395 million to $405 million.

GAAP EPS should be in the range of $0.20 to $0.22, and non-GAAP EPS in the range of $0.31 to $0.33.

For the year 2007, we expect revenue to be in the range of $1.585 billion to $1.635 billion.

GAAP EPS should be in the range of $0.85 to $0.93, and non-GAAP EPS in the range of $1.28 to $1.36.

Other income and expense for 2007 should be in the range of $40 million to $45 million.

I see 2007 progressing as planned, and I expect that we will attain our growth, profitability and cash flow goals for the year.

Looking beyond this year, we should be able to grow the business profitably while expanding our operating margins above 30%.

Operator, we will now take questions.

(OPERATOR INSTRUCTIONS).

Jay Vleeschhouwer, Merrill Lynch.

Mike, I'd like to ask you a somewhat broad question about how changes among your semiconductor customers might affect EDA and you.

We've seen, in just the last few days and weeks, a new relationship between ST and IBM.

ST also seems to be doing some work with Freescale.

There were some reports out of Japan yesterday about some of the Japanese semiconductor companies perhaps pooling some of their R&D resources and the like.

So, as any or all of that plays out, how do you think that could affect EDA?

It's not unanticipated, the kind of things that have been happening.

A lot of it is around new process technology generation, some around more efficient use of outsource possibility.

In any case, I think EDA was one of the first things that disaggregated, not too lately followed by semiconductor equipment and even IP blocks.

So I think, for those of us who can invest money and provide valuable solutions, we become extremely valuable, and it gives us even more targeted opportunities as it consolidates.

The customers, when they do that, aren't just sloughing off costs; they're also focusing where they grow.

It has typically been around systems kind of things -- platform design, software integration and verification resources -- because these chips are amazingly complex.

You know that's right into sweet spot of where we aimed our adjacency penetration, and where we are achieving extremely nice growth.

So I think it bodes well for us, both in the alignment of our technologies and the direction of the Company, and to make a possible transition for our customers as they evolve to be a little bit more system or platform-centric.

A technology question for you.

I appreciate what the Company has been saying for a number of months now regarding your somewhat different view of BSM than perhaps the way it has been described to date elsewhere in the industry.

You've made some small acquisitions.

The question is, though, as reported, your DFM revenue was still a very small percentage of the total, but it's apparent that it's a very real problem.

You just have to go to the DATE or DAC shows to see that or otherwise talk to the customers.

At what point to you think that you run the risk of, in some way, falling behind, necessitating either a redoubling of efforts on the internal R&D side or, more to the point, something along the lines of what you did five and six years ago on the digital side, and just go out and have to buy some things to get your portfolio to where it really needs to be?

Yes, I think it's confusing because, as you know, I and we are very passionate about the way that the world evolves.

The world evolves from a physical sign-off, which is where most people report their DFM revenue, including us -- and that's an historical artifact -- to broadening it to include kind of a correct by construction or, I'm going to say, the big D in DFM; that's a design proaction for manufacturability.

The growth in our digital business or our full custom business is representative of progress in DFM, because those are technologies that we embed into the high-end strata of our Encounter/Virtuoso platforms.

So we are making nice progress there.

I don't know if we're getting any credit for it.

The [completer] or additions that we've done, either with partnerships and sometimes with acquisition -- our completer technologies that really fill out the componentized approach that we're taking, and that is both allowing us to do that up the stack in design proaction and down into manufacturing sign-off.

I think that the testimonies that you saw today or you heard about today from Bill and I in the memory spaces are a great corroboration of just how much progress we are making there.

People are adopting full custom.

They are doing that in anticipation of the DFM stuff or because they are doing it up the stack.

Those are 45 and 50-nanometer process technologies, and it bodes very nicely for the progress we are making with some big digital customers at the same kind of targets.

So I am not unhappy with exactly what we're doing.

I think that the development teams are right on par to change the world in DFM as it continues to move down the process curves.

On final one for Bill.

This quarter, too, you had a large customer account for a substantial portion of your revenue, which we have seen in a number of quarters now over the last year.

Is this embedded now, do you think, and the way the business comes in, that there is just going to be, as a matter of course, every quarter a substantial percentage of revenues coming from a single customer?

Between now and the end of the year, for example, we know that there's three or four customers coming up for substantial renewal, representing together anywhere around $0.5 billion of bookings.

So are you anticipating that over the next two to three quarters, we're going to see substantial amounts of upfront revenue or reported revenue coming from just a small number of customers?

As you know, our customer profile -- and we've been pretty explicit -- we have 35% of the business that comes from around 15 accounts.

So what you're seeing is the success we're having with some of the large global customers that's just an indication of the strength and the breadth of our technology.

I do expect that we will continue to have this kind of success going forward.

But the thing I just emphasize is the success isn't just isolated to large customers.

As I mentioned in my prepared remarks, we're seeing really good results across the broad base of accounts.

So I think it's a combination.

With the large customers we're having success.

You see that as the occasional 10%-plus customer, and it is happening frequently, because we are having good success there.

But we're also having good success in our broad base of geographic accounts.

So I think it's that nice portfolio of large and small customers, just like we have the success with the portfolio of our technologies.

Mahesh Sanganeria, RBC Capital.

Mike, I just want to follow up on something you mentioned in your prepared remarks about the low-power.

Can you help us understand the low-power design, the point tools, a little better?

Are you selling mostly that with the digital flow and with your platform, or that goes even with the Synopsys platform?

Basically give an idea of what the market size is.

Probably, this one is growing much faster than the other segment, so a lot more color on that will be helpful.

Yes, I'm an old digital designer.

We are going to change the world and evolve just like we did when the world was totally vertical, by looking at a homogeneous or what I would call holistic flow that approaches the hard problems like power.

What that does is it preserves the intention of the designer all the way through the process from synthesis, logic design, circuit design, test and back and forth.

That's the way we approach low-power.

The kind of testimonials that are in the remarks that we had and we're seeing in the industry every week are people taking advantage of that holistic or homogeneous flow and then applying it and seeing huge impacts on power, and that's because it's not just some circuit design trick or a logic design trick; it's a consistency of all those things additively improving the power.

We did that by not only saying but by integrating them across all facets of our tool chain, and that's Encounter Digital, that's Virtuoso, that's the verification technologies.

It's into what we call DFM, and that's what allows it to happen.

I think other people will try to emulate that.

I believe, to tell you from 30 years of doing it, it's going to be very darn difficult, because we had to change source fundamental pieces of the code across every one of those tools and architect it in, to do that.

I often describe that, or my colleagues on the development side, as optimizing between the pieces.

You get amazing results; we see 40% power reductions in ARM core integrated ICs, just by using the tools.

We just only scratched the surface of what we can do.

So it's not a point tool where we have got some kind of trick for like multiple thresholds or multi-VTs or something.

Of course we've got that, but it's by allowing all those pieces to work and not have one trick undo another trick.

That's the kind of cleverness that's involved in that holistic flow.

As you know, power is one of the bigger barriers now for either building big chips or building chips that have to run on a battery.

So we just use this is one of the first demonstration places to show the power -- no pun intended -- of looking at the problem end to end or as a holistic mass.

So on the market segment side, I don't know; to me, what it does is it continues to drive the value of the total offering of the Company.

It's interesting in consolidating customer situations, even in ones that don't use Cadence end to end; it's interesting in people who adopt our whole digital flow or people who adopt our Logic Design Team, which is a front end plus verification.

So they can adopt sub-pieces of it with some success, but the real big wins are than people adopt the whole flow homogeneously.

Does that help you?

Yes, that's very helpful.

I just have a question for Bill.

Your R&D expenses went up in the quarter.

Can you describe that a little bit?

I think that would be just the normal increase that we would see in the second quarter from adding a little bit of headcount, and that's when we have our merit increase, which comes in in Q2.

So, going forward, we should expect that to remain flattish?

Yes, it should.

As you know, we're managing our costs and expenses on a total basis, and we do continue to expect to get very good leverage in our operating margins.

So costs are going to be growing at that lower rate, and then we will see the leverage in the model.

So it looks like you took some expenses out of SG&A and increased the R&D.

So that's how you're going to manage it?

Yes, and again, the expenses aren't going to grow significantly throughout the year.

They are all relatively constant.

There's going to be small ebbs and flows, depending on the different line items.

But in total, relatively modest growth, and that's just how we're investing in the business.

We can get good leverage, both in the field and good efficiencies on our R&D teams with better outputs.

Terence Whalen, Citigroup.

A quick one for Bill.

Bill, it seems like the stock buyback wound down this quarter.

Can you explain that, and also give us your outlook for stock buyback and your considerations going forward?

We pick our times to be in the market, and as I've described to many of you, our objective for the use of our free cash remains to make investments that will help us grow in the adjacencies and also to repurchase shares.

As you've seen from some of our announcements, we were active in making some select investments, particularly in the DFM areas in Q2 and then also in this quarter.

So we keep ourselves busy on both fronts, but our objectives remain the same, and I think you'll be seeing us active on both fronts.

But we don't telegraph that in advance.

Then a quick follow-up regarding acquisitions.

It looks like the cash outlay for Invarium was pretty modest.

You've also made another DFM acquisition, and then outside of Cadence we've seen a couple other acquisitions from the other top players.

Is there any change in perspective, do you think, for either the industry or for Cadence regarding acquisitions within EDA?

Just to be clear, we announced Invarium after the quarter closed, just so you don't have the wrong impression on what was closed during the quarter.

In terms of our acquisitions in the core, again, I think we've been pretty consistent that most of our dollars are going to be going to funding growth in the adjacencies, both in our increases in headcount as well as from our increases in acquisition dollars.

So that's really where the focus of our dollars will go, and we continue to also grow the core nicely.

But that's primarily organic.

Harlan Sur, Morgan Stanley.

Great job on the quarterly execution.

Mike, it seems like we're in a bottoming process here in the semiconductor industry.

I'm just wondering, maybe you can talk about some of the demand trends you're seeing in the different end markets -- consumer, communications, computing -- and trends towards migrating towards the advanced technology nodes in each of those segments.

Not much has changed.

The elements of consumer are really, really hot, exciting.

Those are all mixed-signal trends.

Some of them stay at 180 or 130.

There's a lot more aggressive moves to try to get to 65 by some people.

I'm kind of skipping over 90, as we've talked about before.

In any case, those are extremely complex chips and kind of tripping over not only mixed-signal but verification.

A lot of them have big cores on the die, so there's software co-design issues, and that's one of the things that makes them fun.

The computing electronics is up and down.

There's elements of communications, especially around wireless, that are very exciting.

Seen some announcements of some of our wireless companies especially building ultra wideband product or something that had been testimonies to the technology.

Those are kind of a mixture of 90 and 65, probably.

On big digital, the biggest of the big are moving aggressively to 45 nanometers and have stepped up their 65-nanometer designs.

We're doing all the most complex chips on the digital side, and they tend to be extremely power-conscious kind of to the previous conversation.

So it doesn't always have to be advanced node movement that funds the need for evolution of the tools.

In general, I think we're an unlocking capability for our customers to either move up that abstraction software, verification or whatever, or try to attack productivity or time to market.

That has been wonderfully consistent over at least my three years, and I think it's going to persist for the next bit of time, too.

So we're participating across all those things.

It tends to make our business a little counter-cyclic, so we don't have to worry about if one is a bit slower and one isn't, or any particular customer.

Cueing off some of the DFM focused questions, it actually does seem like, from my perspective, that the Cadence team is very focused on DFM.

I think more recently, you brought on board a pretty seasoned executive in the space with a great track record.

I know you've made some small acquisitions, the most recent being Invarium.

Is the message here that you're just trying to accelerate the progress and penetration into this emerging market segment, or -- how would you characterize the DFM strategy as it stands today?

It's the Revolution to something that has been relatively static in the industry for almost since the mid-90s, at least from my participation as a chip developer.

Our team, especially Jim, had to get a lot of the rest of the pieces into play, including get the Catina technology integrated nicely in, which they did a wonderful job of.

That was a foundation with the PVS to kind of componentize the platform both of the stack for correct by construction and then sign-off.

In the modeling technology approach, that's an evolution of physical rules.

It's not about just how close the wires are.

Now you've got to model all the things around three dynamics -- lithography, metallization, that's what the [persagis] thing has got to do with, and chemical etch.

[Are the way] that we change that whole industry.

I can appreciate some level of abstractness in that, because we are very focused with some big companies at different elements of it, and we embedded the correct by constructive things up into the design stack.

But yes, we are passionate about it.

Jim has continue to evolve the team.

I think it is very exciting to see what's going on there, and I and he are both intimate with the customers all around the world.

I like our position.

We're not trying to just replace some other incumbent, because that will happen as a byproduct of the revolution.

We're trying to change the way that our customers can really work with the ecosystem -- us, the foundries, the IP guys -- and achieve better results.

That's the kind of change that we're facilitating.

Thank you and, again, congratulations on a nice execution.

Tim Fox, Deutsche Bank.

Just following on the earlier question about the activity at the advanced nodes, can you characterize in your view, Mike, where we are in the mainstream customers' move to 65?

We've heard of a number of competitive benchmarks that are going on.

Some customers are struggling mightily.

Just wondering how active do you see that benchmarking activity now, and where you think we are in that cycle?

Yes, I was getting a talk at one of the CDNLive!'s a week or two ago, and we are at eight active process nodes now, as opposed to four, which would have been historical to participate in.

So it's not all about the rush to 65 or 45, although that's an important element of demonstration of new technologies, attacking these DFM things, got help us, building the big, verifiable systems.

For the big digital guys have been at 65 and now some of them moving aggressively to 45, that's kind of another year in transition.

The now mixed signal people trying to go either to 90 or skip over 90 into 65, we are very far along in that transition.

But there's a lot of legacy that will move over there, over the next few years.

So I think, as a proving ground, I'm excited about what we have been able to do with some of those lead vehicles at 65 around complexity, power and manufacturability, or what's called predictability in general.

Sometimes that's first-time-right, sometimes it's parasitics -- you know, speed, power for sure.

Those guys, those leading-edge customers, are good kind of Roto-Rooters for the process.

There's a lot to show that the toughness of 90 actually learned a lot as it went to 65, and the ramp rates can be faster.

The thing I think is difficult to project, and where some of the struggle is, is that 45 because the learning curves don't totally apply to 45.

In fact, they may not apply very well.

They are mostly around manufacturability, fancy stuff like lithography, like I characterize as lithography or metallization.

So that's the biggest dynamic.

There's one other dynamic that's just a practical one.

Some of our customers -- and this goes all the way back to the first question -- are trying to decide how to make massive improvements in their cost basis, and they are considering mega-consolidations.

We have been very proud of a few of the ones that we have been able to be public testimonials on.

That requires big changes in their mindset and the engineering teams, and so that's another source of complication to this whole thing.

They are trying to get their design teams to figure out how to move where they may have tens if not hundreds of designs in the middle, between the old and the new way.

So it's not just about process technology, but in any case, they value when you get results.

That's why these things around power and complexity and time to market are resonating, I think.

It takes a complete technology portfolio to do that, whether you're doing a pure digital or a mixed-signal device.

Everyone is struggling with that right now.

Secondly, we have heard from one of your competitors that their new emulation product is doing fairly well, at least in the early stages of its delivery.

Just wondering, have you have seen anything out of the competition, any change in the dynamics to the Palladium family?

Well, I'll tell you, we continue to have great success at not only enterprise level but anything that's advanced certification.

You can tell in the prepared remarks about some of the co-verification or co-design for software and silicon.

I think we've only scratched the surface of that.

It's not just a Palladium thing; for us it's done in Xtreme.

The complexity -- or, I'm saying, the complement of that entire line is very intriguing.

The only place we've seen is some upgrade potentials in the competitive installed base, and I'll tell you that we have not lost anything to any of our competitors in our Palladium space.

Lastly, just one quick one for Bill.

Did you say bookings from time-based were 75%?

I did.

That 18% revenue customer -- was that more weighted to an upfront, just given the size of that revenue?

Yes, that would be -- essentially, any customer that has that level of revenue in a quarter would be a term contract, just to be specific.

It's all term.

Okay.

Thank you, very good quarter.

Matt Petkun, D.A.

Davidson.

Just real quickly, I know you guys haven't given the exact number in the last couple of quarters.

But roughly what percentage of the revenue in the quarter came from backlog?

The percentages for the year continues to be two-thirds.

There's a lot of talk, obviously, about DFM.

I think it's pretty clear to all of us that probably the closest revenue opportunity in terms of adjacencies is probably going to be in DFM.

But Mike, I was wondering if you could give us more insights as to what might be going on in your mind, in terms of system-level design.

Obviously, you talked about getting into higher levels of abstraction in your verification product lines.

But are there are other elements that you are looking at, in terms of offering system-level design technology, perhaps even things outside of traditional EDA offerings?

Yes.

The first thing I would say is I don't know if I would say that the nearest revenue opportunity is DFM.

I actually think that, as we revolutionize that, that has got a relatively slow and predictive fulfillment cycle, because you want to be calculated about the customers you do, and that's why there's so much discussion.

The fastest-growing part of the business is in the verification of the stack, as I call it, in that element of design.

That's because there's large numbers of engineers that are being specialized to go and do that verification, and we can start to touch the software side and the systems side.

We do that through the emulation, simulation and the BPA, the process architecture that we did when we emerged with Verisity.

That's the simplest part of the tools.

We are already out there with tools that are called ISX; that appeals to the soft dynamic, software environment.

We are out there with a tool already active called Builder, which allows engineers either a verification or design engineers to make trade-offs in the construction.

How many cores should I have?

How much memory should I have?

Those kind of trade-offs.

We are out there with the incubated technologies that we described at Analyst Day at CTS and then one that we did [in Maine] that are way up the system stack.

If you study the Hitachi announcements, you would find that they were a testimonial using that CTS technology.

So the thing that makes magical from an old silicon designer is that you can test the idea predictively through all that kind of fancy tool mumbo jumbo as it will be implemented in the IC.

I've shown that as stair steps that lead all the way down into implementation.

That's the thing that makes our technology strong, and why that part of the business is growing great.

That's the thing that has isolated the pieces of system design environment that some of the historical analysts have held out as the golden Nirvana.

I think it's a holistic view, once again.

Probably a lot of people discount that as marketing hype.

I'm incapable of that; I'm a technology guy.

I think that's which really going to revolutionize the systems design penetration, and it's just an unlimited ability to grow up that stack, as it's 10 or 100 times the size in total available market that the core EDA design space has been.

So I really think that that's a lot of where the future is, and especially in the immediate one.

We have enjoyed great success over the last year and a half or two years, and I think we only touched the surface of it.

Mike, if you could comment a little bit on the pricing environment, both in digital design as well as in verification?

As the caller earlier noted, the total spend on the semiconductor side continues to consolidate, but it really doesn't seem like in the EDA market there has been a reduction in funding for both new design implementation softwares, new verification.

Obviously, with Mentor coming in and deciding to finally play in the implementation space, I just wonder what your view on pricing is, both in the current quarter and as you look through the remainder of this year.

I don't know.

In the digital stuff, it's highly commoditized in the low end of it.

It's got nothing to do with Mentor making an investment or not.

It will be fascinating to see how that turns out over time.

It's the incumbents that are -- you know, Magma, Synopsys and Cadence.

We enjoy a major market position in the back-end stuff.

When we segmented the product line, it stratified that usage by function, so that we get more value for the more complex functions when you're doing a more complex chip or not.

Bill has reported that we've seen some nice trends there, and we will continue to report on those.

The thing that really makes the value go is that holistic thing like power.

That's why that's a mega- change, because it drags digital into verification, where there's not as much.

We are very, I think, differentiated in our verification offering.

The pricing is not as aggressive.

Now, in a piece of it, like Palladium versus somebody else who builds an imitator or a competitor to Palladium, maybe there is some pricing competition.

But increasingly, we are not just selling it Palladium against that.

We sell Palladium with our Incisive product line as a kit itself, as a holistic entity.

They drag each other, because they are inter-optimized between the pieces.

In any case, these kind of holistic bindings for preference that demonstrate the interoperability to a business thing -- power, time to market, productivity -- that's what customers pay for.

Well, the last point I would make is a verification, it's very interesting, and it happens on pieces of the other product line.

You can let the computer automation and spawn multiple licenses per engineer, so it's not just a pure seat.

In the simulation, we have shown our customers how, if they buy 100 licenses and let 100 of those things go at once, one engineer can analyze those 100 things and he can get the thing done faster in terms of calendar days.

We do that a little bit with our Encounter back end, because we can spawn it across 20 different servers and decrease the amount of run-time that it takes to do that.

So there's isolated pieces in verification and counterplace and route, and even manufacturability, where that's going to be material, and that's the third reason why customers spend more money.

Once you get in there and you show them the value, always appealing to those business processes, they will pay more money because it allows their engineers to be more productive.

I'd just like to add, as we give our customers more choice with segmentation, that in itself is helping us competitively.

Then, as we continue to differentiate the technology, as Mike's described, particularly with our GXL or our high-end capabilities, then customers have choice.

Then, if they need that functionality, which many times they do, they are more willing to pay for it.

We're also seeing that start to resonate, and we're hearing others are starting to follow in the industry, following our lead with segmentation.

I think that will, overall, be a good environment for pricing.

Customers have choice, and then you win with technology.

I think we got the holistic technology that will help us win.

(OPERATOR INSTRUCTIONS).

Sterling Auty, JPMorgan.

It's [Sackett] for Sterling here.

Bill, two questions for you.

First, deferred revenue was down a little over $20 million sequentially.

Any thoughts on what caused that?

On deferred revenue, that is just the timing of when we can get customers to part with their cash.

So I would not look into anything.

As you know, if we can get customers to pay cash ahead on a subscription, it ends up in deferred revenue.

If they pay as they go, then it doesn't.

So that's just a matter of timing of billing and the recognition of revenue.

I would not read too much into that.

Secondly, just on the adoption of the new Virtuoso platform, I think Mike said that it was on plan.

Can you give us an idea of where you are relative to the 50% by mid-2008?

I think we're making good progress against what we laid out at Analyst Day, both in terms of how we're working with customers and it's going to take some time to get them to move through an upgrade cycle.

But we're getting good feedback.

They like the roadmap and they are making decisions to go with that product line.

It's not always apparent when you look at the table, because the table is influenced more by revenue-able transactions.

As we look at the total book of business for custom, it is tracking right into the range that I described at Analyst Day, which was between 10% 20%.

So I just wanted you to know that we do feel that we're making good progress with that product line.

It takes a lot of effort, and so customers are putting that effort in.

But we see good success, so we're comfortable that we're on the right track with Virtuoso, and it is a competitive differentiation for us.

Just one follow up on that, since you brought up the Analyst Day presentation.

Digital has just been performing so well, and at Analyst Day I think your expectations for that over the year would be 0% to 10% growth.

It's just been doing so well in the first half.

Do you expect a slowdown in the second half to be, I guess, on par with that 0% to 10% (multiple speakers)?

No, I don't expect it to slow down.

I think that's the power of a portfolio.

You get strength out of the different components, not always being able to predict exactly what's going to outperform.

But I would be surprised if we were within the range.

I would expect to be above the range that I described at Analyst Day.

Raj Seth, Cowen and Company.

Bill, shifting gears a little bit, just a quick question.

Is there a material difference in the contribution at the operating line, segment to segment, given higher R&D intensity or support requirements?

I've got a follow-up.

No, I think, throughout our largest business segments -- custom, digital, verification -- contributions are relatively consistent amongst all of those.

Clearly, we're investing a little bit more in DFM, so we're not going to have that same level of contribution.

The more mature product areas -- you get a little bit better contribution, for example, from silicon package board because it doesn't change as fast.

So that's how I would describe the contribution levels.

So I guess you answered the second part, which is the R&D intensity or where you are spending R&D dollars is roughly proportional to the revenue we see outside of DFM, which is obviously small and has some outside, short-term investment.

But it's relatively proportional to the revenues we see among the major segments today.

Yes, I think that's correct.

We have a little bit more effort in R&D and DFM, because it does influence some of the other technologies.

As we described, it has the effect of helping both custom and digital.

So we look at that holistically, because it will drive business, and also for verification.

So we do get that drag-along effect from the DFM capabilities across all the product areas.

Rich Valera, Needham & Company.

Bill just a clarification on your response to a previous question on Virtuoso.

You said it was tracking towards the 10% to 20% mentioned at Analyst Day.

Did you mean on a bookings basis it's tracking there?

Yes, and I just said it's on a business level, right?

So, just so that it's not always apparent, just from the revenue table.

Sure.

Should that 10% to 20% business level through the first half translate into higher revenue for Virtuoso in the second half, or is it still just pretty dependent on deal renewal and deal activity going to revenue?

Well, clearly, over time it will show up.

But it doesn't always come that quickly.

A lot of it does depend on the mix of the upfront business will impact those tables.

As usual, you have to do a weighted average over a longer period of time.

But the business itself will show up; it's just a matter of time.

I can't say it's all going to pop in the second half.

With DSOs, they were over 100 again this quarter.

I'm not sure if this was an increase or not, but I think you say you want to see mid to high 80's by the end of the year.

Is that the same target, or has that moved up?

In general, how do you feel your progress with DSOs has been?

We were 100 in two days this year versus 100 in Q2 of last year, so we were up a couple of days.

What I had estimated last quarter was to be in the mid 80's by the end of the year, and based on where we are so far, I would say mid to high 80's.

So a slight upward revision to the DSO estimate.

I think what we're seeing is the environment is a little mixed.

We see some of the customers deciding to hold onto their cash a little bit more than others.

So I think that's just having a slight upward pressure on DSOs.

But as I mentioned, I think we can work our way through that in terms of getting to our operating cash flow targets for the year, and we're focused on doing that.

Sort of up a follow-up to some of the questions on stock buyback, but I guess more general.

Obviously, there has been a lot of talk about private equity.

I think that sort of speaks to what's sort of the ideal capital structure for Cadence.

I think you are more aggressive, certainly, than some of your big competitors as far as capital structure, but still theoretically have pretty significant capacity for additional debt.

Could you just talk about how you think about that, and do you think you are pretty close to an optimal capital structure, or would you consider making any significant changes, depending on the conditions or whatever else?

I think we will use our cash to grow the business.

I think, again, that's the place I would focus.

I think we also realize that we have additional capacity to add leverage.

We have led others in doing that, and I think we will continue to look at that to provide the best value to our shareholders over time.

It's really to grow the business, to use our balance sheet in both what we have got in terms of cash and also what we have and borrowing capacity, if that's what it takes to really grow the business, which is where we think the most value that can be created.

Erach Desai, America's Growth Capital.

Mike, If I may ask, how do you -- you had some commentary on the call and then I think in response to Tim's question, you had some very good color in terms of how many active technology nodes there are right now.

Perhaps that's part of the answer.

But I'm just wondering how Cadence, you guys, are internally quantifying production design starts -- if that's the way to measure it, or whatever -- by the various nodes.

Because some of the data and analysis that I'm looking at that comes from a proprietary source seems to suggest that mainstream production is still relatively at 90-nanometer and 135-nanometer, in terms of design start production.

So I'm just curious where your thoughts are on -- with all this talk about 65 and 45, et cetera.

I don't disagree with you.

I think there's a lot of predominant volume in 0.25-micron, too.

So we're looking at it across all the different process nodes.

We're looking for the lead vehicles or the Roto-Rooters or process learning curve, whatever it wants to be, whether it's 65 or 45, for mixed-signal or for high-performance digital, and quantizing that as a surrogate to drive volume or design wins in the future.

Those are good for us learning vehicles for the special functional things that we have for a complex chip or a big mixed-signal chip.

The volume is certainly in 90, and there's a lot of active designs in 65 and 45.

We're looking at design starts, and we analyze it every quarter.

We use that with outside sources, and corroborate it with the customers every time that Kevin or I go out and talk to them.

So you get to triangulate it across many different things.

In any case, (multiple speakers).

You get some great data directly from your customers, so --

Of course, of course.

One of the biggest values that we have -- and I can only speak of it as, I think, our competitive differentiator -- is we are highly analytic about it, as opposed to talking about it drinking beers or something.

So it is valuable interchange to be able to do that, especially as corroboration of where our customers are spending money, because somebody who is making a decision about a 65-nanometer design is going to spend a lot more money if they do it there than to do it at 90.

So they've got to see a productivity increase or something to be able to justify that cost, and we sometimes are the unlocker of being able to do that.

I think that there's a growing sentiment that says that the metrics to be able to measure those productivity and such has not been as methodical as it could be.

So what is really fascinating is to watch those kind of analytics applied, so that people are making good trade-offs as opposed to just running to the most advanced process node they can find.

A lot of the customers are than valuing staying at 90 longer or operating at 130.

We're skipping the process node entirely.

I think it's great sophistication for the industry, and will ultimately add a lot of value to what we do, because that's what we help them do.

That's a very useful answer and it speaks to, I guess, to some level an ROI analysis at an enterprise level for your end customers, especially those larger customers, rather than a point tool decision, per se.

You've got it, my friend.

That's why we look at it holistically.

That's why we talk about it at the enterprise level.

That's why we appeal to a business-level dynamic.

In the IT industry, we call it total cost of ownership.

That's what drove the IT change or revolution.

That's what will drive this revolution.

It values is somebody who can do that by experience and by total technology package.

So yes -- no, I think it's a good evolution.

A question for Bill.

Bill, perhaps Jay asked it more diplomatically, so I'll try and be more direct.

It is a fact that over the last three or four quarters you have been getting, let's say, 18% to 35% of revenues upfront in terms of any given quarter.

By my calculation, it looks like you sold about $110 million in receivables in the second quarter.

If I look back to the 1998-1999 timeframe -- and I know that's aging it or whatever, but history sometimes is a lesson -- I think there was a similar kind of numbers.

Perhaps the percentage of upfront business was a little more than the 18% to 35% range.

So I guess what I wondering is, why won't history repeat itself, or why is it different this time that one large deal will not potentially cause a hiccup, which is exactly why you went to the subscription model, for that not to happen?

Well, let me just help out a little bit with clarifying some of your information.

For sale of receivables in the second quarter -- and if you look at our cash flow, it's about $35 million.

So maybe you looked at a wrong number, not $100 million.

In terms of our model, I think we have been very consistent that we have about 25% of our bookings.

It translates into about a third of our revenue happens from our pipeline every quarter.

So do we have the risk that, gee, if we miss the right mix of business or we don't get a contract, could that cause a blip in results?

Absolutely, it could.

Have we been successful with this book of business over the past almost four years?

We have.

So I think that's just the nature of our business and our model.

If something is -- and you know, as we've been very upfront, a lot of the business happens the last two weeks of a quarter.

So that's just the way it works.

We're able to be consistent, because we have good technology across our portfolio and we have an ability within the field to work a lot of business that funnels down.

But it doesn't eliminate the risk.

So I think we're comfortable with the business model, but it's not going to be 95%, because that's just not the model we're on.

But we have had good success in generating revenues, increasing our margins and continuing to generate cash from that model.

I'll definitely grant you that you have been able to execute to that sort of hybrid model, however long you refer to.

I probably don't have the data.

But it just seems like -- and this is only on a comparative basis, it's not right or wrong -- that Synopsys as your largest competitor is clearly running a lot more conservatively, in terms of taking large deals upfront and, therefore, revenue recognition upfront.

Again, as you look at the ability for them to grow their business, it will be the strength of their technology over time.

I think we will see really where we end up competitively.

I think that's the thing to pay attention to.

The models are different; we recognize that.

But I think we've had good success and we will continue to have success, based on the strength of our team.

There are no further questions at this time.

Well, Bill and I were excited to tell you about the quarter and delivering on the operating metrics and the strategy to grow the core business and expanding the adjacencies.

Thanks for participating in all the good questions, and we look forward to seeing you at CDNLive!

in Silicon Valley in September.

This concludes our conference call for today.

Thank you for participating on the Cadence second-quarter 2007 earnings call.

You may all disconnect.