益華電腦 (CDNS) 2007 Q4 法說會逐字稿

Good afternoon.

My name is Molly, and I will be your conference operator today.

At this time, I would like to welcome everyone to the Cadence Design fourth quarter and fiscal year 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) Thank you.

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

You may begin your conference.

Thank you, Molly, and welcome to our earnings conference call for the fourth quarter and fiscal year end 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 30th, 2006 and our 10-Q for the period ended September 29th, 2007.

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

Cadence management believes that in addition to using GAAP results in evaluating our business, 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 financial measures used in today's discussion.

I'll now turn the call to Mike Fister.

Thanks, Jennifer.

Overall, I'm pleased with our accomplishments and results for Q4 and 2007.

Q4 bookings exceeded plan and we grew backlog to $2 billion.

We reached a 30% non-GAAP operating margin level for the year and continued to build enterprise level relationships with key customers.

At the same time, it's no secret that the economy is under pressure.

A fourth quarter survey of CEOs put their confidence at the lowest level in seven years.

Speaking with semiconductor and electronics customers, their tenor is increasingly conservative, reflecting concerns about the tightening semiconductors ASPs and the need to run their businesses more efficiently.

Therefore, we too are going to be conservative in how we forecast and run our business in 2008.

Throughout 2007, we continued our strategy to concentrate on key customer focuses at the enterprise level, such as improving productivity, reducing turnaround time, and codifying methodology -- especially up the stack.

This approach allows us to demonstrate that our solutions and services have measurable impact.

Functional Verification was the best performing product area in the fourth quarter, led by our Advanced Verification Solutions and Incisive Enterprise.

Employment system level verification and validation has a clear impact on customers' time to market.

Cadence continues to outperform in this market subsegment.

The fourth quarter was our strongest ever for hardware assisted verification.

We shipped over 1 billion gates of systems worldwide.

This businesses included new engagements, renewals, and upgrades to our most advanced solutions.

In fact, we have yet to have a competitive loss in this arena.

A leading European company which is renowned for selectivity just chose Palladium III as its emulation platform after an extensive evaluation of the current competitive alternatives.

(inaudible) customers, NVIDIA was named Technology Company of the Year in the January 2008 issue of Forbes magazine.

The article highlights their decision to adopt emulation at a defining moment in their competitive history in order to speed time to market.

There's a picture of their Palladium center in the article.

Quoting Brian Kelleher, the Senior Vice President of Engineering at NVIDIA, "We continue to invest in Cadence's most advanced emulation solutions in order to meet the demands of getting new graphics chips to market every six to nine months."

As promised with Mentor Graphics, we publicly released Open Verification Methodology.

OVM has generated extremely high levels of interest.

In fact, there were nearly 1,500 downloads in just the first two weeks.

Already it's won the Electronic Design Magazine 2007 Technology of the Year Award in the EDA category, and is a finalist for the InternatIonal Engineering Consortium's Design Vision Award.

Our latest release of Incisive Enterprise now fully supports OVM, providing best in class verification capabilities for SystemVerilog, e, SystemC, or any combination of these languages.

Customers have clearly picked up on this differentiation and we have good momentum here.

In the systems area, we announced the technology collaboration and sponsorship with BMW Motorsports.

Formule 1 race cars are sophisticated systems that require control and coordination of hundreds of parameters and also very short development windows.

Cadence is partnering with BMW Motorsports to develop new design flows and methodologies for their automotive systems.

We experienced strong growth in digital design in 2007 driven by consolidations and competitive wins that were founded on our Low-Power leadership.

Customers are saving time in the market while dramatically improving the power consumption of their designs using the Cadence Low-Power Solution.

With more than 200 projects underway, and over 50 tape-outs to date.

With ARM, we introduced new implementation reference methodologies for two ARM processors, which will leverage the Cadence Low-Power Solution to enable advanced Low-Power design techniques.

These methodologies allowed designers to exploit ARM's intelligent energy management technology and realize up to 60% reductions in energy consumption.

STARC released its PRIDE reference flow during the fourth quarter.

PRIDE uses the Cadence Low-Power Solution to deliver this fully automated flow for architectural exploration, design, verification and implementation of Low-Power SoCs at 65 nanometers and 45 nanometers.

It also takes advantage of our unique design for manufacturability technologies, to reduce overall design time and increase production yields for high volume products.

STARC confirmed a 3X improvement in design time using the Cadence Low-Power Solution for architectural exploration to floorplan, while the CPF base flow enabled up to a 40% power reduction in the pilot designs.

Our design for manufacturability approach delivers an end-to-end solution, especially at advanced nodes.

In the fourth quarter, [TSoC] qualified our Litho Physical Analyzer for its customers' 45-nanometer designs.

This significant step for us because it signals that this foundry partner is recognizing the leadership of this important DFM solution for advanced nodes.

And IBM has adopted Cadence DFM Solutions for both processor and ASIC yield optimization.

The IBM processor group uses Cadence Chip Optimizer for post route design optimization, critical [area reduction] via insertion, litho fill and yield rules compliance.

Our analog mixed signal capability is a key area of differentiation.

The Virtuoso solutions provide breadth, capability and automation for analog, full custom, digital chip finishing, mixed signal RF and memory design that are unmatched in the industry.

This year we focused on transitioning a number of major accounts to new Virtuoso platform, and as with any migration this process takes time and we're making very good progress.

Toshiba chose the Virtuoso UltraSim for its design at 65 nanometers and below because the solution includes a reliability analysis flow that enabled Toshiba to meet their stringent reliability metrics, estimates the cost of test and debug, and meet their market window.

This is just one example of the strength of Virtuoso's multimode simulation technology.

Our enterprise focus, leveraging the breadth and depth of our great technology, proven methodologies, and our world class services and support team is predicated on measurable results and that's what customers require to meet their demands and survive or thrive in a changing and challenging environment.

Now I'll let Bill speak to financials.

Thanks, Mike.

The results for the company's key operating metrics for Q4 were total revenue up 6% year over year, non-GAAP operating margin of 38%, improving 500 basis points from Q4 of 2006, and operating cash flow of $194 million.

For the year 2007, total revenue was up 9%, non-GAAP operating margin improved 300 basis points to 30%, operating cash flow was $402 million, and book-to-bill exceeded 1 for the year, and backlog grew from $1.9 billion to $2 billion.

GAAP earnings per share for Q4 were $0.41, compared to $0.16 in Q4 of 2006.

For the full year 2007, GAAP earnings per share were $1.01, compared to $0.46 earned for 2006.

GAAP earnings per share for Q4 and the full year included an income tax benefit of $28 million, or $0.10 per share from the settlement of a tax dispute with the IRS for the years 1997 through 1999 related to our transfer pricing arrangements.

Non-GAAP earnings per share for Q4 were $0.46, compared to $0.38 in Q4 of 2006, up 21%.

For 2007, non-GAAP earnings per share increased 25% to $1.35, from $1.08 for 2006.

Total revenue for the fourth quarter was $458 million, compared to $431 million in Q4 of 2006, up 6%.

Product revenue was $328 million, maintenance revenue was $100 million, and services revenue was $30 million.

Revenue for the year totaled $1.62 billion, up 9% from $1.48 billion in 2006.

Revenue mix by geography in Q4 was 50% for North America, 17% for Europe, 22% for Japan, and 11% for Asia.

In the quarter, approximately 70% of our product business was represented by routeable licenses, compared to approximately 50% in Q3 and our forecast of 50% for Q4.

The routeable mix has become more variable from quarter-to-quarter, and less meaningful to us as a metric.

Our key metrics are revenue, operating margin and cash flow generation.

As a result, we're not going to be forecasting or reporting this going forward.

Estimated contract life on a dollar weighted average basis approached four years, due to average contract length increasing for EDA card customers to approximately 3.6 years.

In Q4, total cost and expenses on a non-GAAP basis were $286 million, compared to $290 million in Q4 of 2006.

The non-GAAP operating margin in Q4 was 38%, and 30% for the full year 2007.

Year end headcount was approximately 5,300.

Total DSOs for Q4 were 111 days, a decrease of 1 day from Q3.

DSOs were higher than our mid-90s estimate because we were unable to sell a portion of our accounts receivable due to reluctance by banks increase their exposure to the semiconductor industry.

The quality of receivables remained high with less than 1% of receivables at 90 days past due.

Operating cash flow for Q4 was $194 million, compared to $205 million in the fourth quarter of 2006.

For the year, we generated $402 million in operating cash flow, compared to our forecast of $450 million.

Cash flow was below our forecast because of our lower than anticipated accounts receivable sales in the fourth quarter.

Capital expenditures for 2007 were $82 million, including $21 million for work on our new engineering building.

Cadence repurchased 1.5 million shares of stock in Q4 at a cost of $27 million.

Approximately $128 million remains under our current stock repurchase authorization.

Cash and cash equivalents were $1.06 billion at year end.

Now I'll turn to our outlook for Q1 and the year 2008.

As a result of our discussions with customers in Q4, and our assessment of an increasingly aggressive pricing environment that we have not seen during the past few years, we believe it is prudent to plan our 2008 business conservatively.

For Q1 we expect revenue to be in the range of $280 million to $290 million.

GAAP EPS should be in the range of $0.06 to $0.04 net loss and non-GAAP EPS in the range of $0.03 to $0.05 of net income.

For the year 2008, we expect revenue to be in the range of $1.49 billion to $1.54 billion.

We expect backlog to grow to $2.1 billion at the end of 2008.

For 2008, we are targeting a 27% operating margin.

GAAP EPS should be in the range of $0.69 to $0.77 and non-GAAP EPS in the range of $1.11 to $1.19.

For the seasonal pattern in 2008, we expect to generate 18 to 19% of annual revenue in Q1, 19 to 22% in Q2, 26 to 29% in Q3, and 31 to 34% in Q4.

Also note that Q4 will contain an extra week, due to the timing of our 2008 fiscal year-end, which will increase Q4 operating expense by approximately $17 million.

Other income and expense for 2008 should be in the range of $31 million to $35 million.

For 2008, we expect to generate operating cash flow of at least $350 million.

We expect DSOs to be approximately 125 days at the close of 2008.

Capital expenditures for 2008 should be in the range of $70 million, with an additional $37 million for work to complete our new engineering building.

The current environment is more uncertain and the value discussions are longer and harder than in the past several years.

However, our strategy is intact.

Our technology has never been stronger, and we're dedicated to preserve the value of the solutions we are providing to customers.

Operator, now we'll take questions.

(OPERATOR INSTRUCTIONS) Our first question comes from the line of Jay Vleeschhouwer with Merrill Lynch.

Thanks.

Mike, Bill, help us understand the different components of the outlook here.

So you have a down revenue expectation for the year.

You've just grown backlog and had positive book-to-bill.

You're apparently expecting to grow backlog again in 2008.

But the environment is substantially more difficult than you've seen in a while and so there's several questions.

One, is this anything akin to 2001, 2002, when the bottom fell out of R&D spending, or are you still anticipating some more gradual deceleration in R&D?

And has there been any fundamental change in your competitiveness or the timing of your renewals in '08?

Because I think most investors will find the outlook substantially disappointing versus '07 and perhaps conclude that there's just a basic change in your competitiveness.

Sure, Jay.

Many parts to the question.

Let me see if I can take them one at a time.

For the R&D spend, as we look at the different forecasts that we monitor, we have seen them coming down.

The best estimate that we have now is around 4% for R&D spending growth for 2008, from the approximate 7% that we saw in 2007.

So I think we will probably see them come down.

But that's something we will wait to see.

From a competitiveness perspective, we don't see any change.

In fact, we think we continue to do very well head to head in all of our major technologies, based just on the strength of those platforms and the ability for those things to work together much better than any of our competitors.

So this is not about competitiveness.

This is really about our ability to get better value from the 40% of the business, approximately, that we do in turns every quarter.

As we've discussed historically, in 2007 we generally would see about two-thirds of our business coming from backlog.

In 2008, that's probably around 60%.

So there's 40% of the business that we will generally book and turn in a quarter, and it's that part of the business where in our judgment the value discussions that we had in Q4 were more complex, they took longer.

And as we see more concern with our customers and their businesses, and we see harder pricing discussions, we think it just bodes well for us to take a little bit more time to close that business because we will preserve that value.

We think we will get the business but we think it's just better in this environment to take a little bit more time and not put undue pressure to close it just to meet an expectation.

After the last call there was a fair amount of skepticism among investors or some that the EDA cards were merely a stopgap measure or rear guard action, if you will, to stave off a challenge in the business, whether it was bookings calendar or something else.

Are you still as convinced as you were that the EDA cards were in fact the right thing to offer as a licensing mechanism and a way to deliver technology?

And we haven't heard you say anything at all about expense reductions to mitigate the decline in your revenue outlook.

I think EDA cards are brilliant.

I get a kick out of -- it was a stopgap measure.

We took $1 billion worth of bookings.

That wasn't an accident.

That was over a prolonged period of time.

The value of those things is exactly the opposite.

What it is allows is an objective conversation with a customer about the use of technology where they're probably trying to prolong the discussion with their engineers and give them less technology than they need.

And the fact that we use --- the customers in the predominant number of situations use the technology faster, it has continued to grow, it's reinforcement that it's a very thoughtful way to go have that kind of conversation with a customer.

It continued this quarter again aggressively, and it's an advantage we have that garners more value because people use the technology when they need it.

And so the way that Bill characterized it is extremely accurate.

I spend quite a lot of time out there with the customers.

You said it yourself, on the tails of a great booking year, it's not the bookings.

What we want to do is we're going to go work the next levels of business for value.

That's a continuous process.

And EDA cards are one of the essential ways that we do that.

Just to provide a little bit more information, Jay, for the Q4 business, in the fourth quarter the cards represented about 40% of our business level.

And so that continues to increase.

We have also continued to see that about 44% of our customers are consuming the technologies faster than they would under a straight line rate.

So again, we're seeing the customers liking what -- the ability to have more flexibility and the predominant number of them are still using it faster.

We also saw that a number of customers, particularly the smaller ones, did increase their contract lives a bit for the cards and that was one of the things I mentioned.

And I think it also provides us some competitive differentiators because the customers are a little bit more uncertain about their environment.

So they want the ability for another quarter or two to use the technology, if they think they need to.

But I think what we'll see, and we have been seeing, is they in fact use it faster.

All right.

And expenses?

I do think that as you look through and do your modeling, that our expenses for 2008 will be down from 2007, and so that is going to be -- continue to be a focus for us.

We, as part of our normal operating cycle, did some expense reductions in the fourth quarter, where we made some investments and then we also made some disinvestments and I think that's part of our normal cycle that we'll continue to look at that in 2008.

So you should expect 2008 expense levels to be lower than 2007.

All right.

Thank you.

Your next question comes from Harlan Sur with Morgan Stanley.

Thank you and good afternoon.

Again, maybe if you could just help us out here.

As you mentioned, Mike, things appear to be tracking very well through December.

You mentioned it was a strong bookings quarter.

And then thinking about it near term, it really appears that most of the weakness at least near term is with your view on the March quarter, and if we just take a look at the model it seemed like the company is just recognizing revenues off of backlog in Q1.

I mean, is that a fair statement, that you're not really anticipating any upfront business in the quarter?

No, Harlan, I don't know that that's quite correct.

I think as you look for, again, for the year, we would expect about 60% coming out of backlog, about 40% of the business will be in turns.

It's not quite that high in the first quarter.

We do a little bit less in turns, just because it's seasonally a lower bookings quarter for us.

But I think nonetheless we still expect that the business will do for turns, we are going to have to have longer and more complex discussions with customers.

So we're giving ourselves the ability to have those conversations.

But there's still a fair amount of turns business and I think you could see from the way we're looking at the business, we want more time to work that, particularly in the first half of the year.

Okay.

And, I know you talked a lot about pricing pressure and wanting better economics, but again, as we look at the near term environment and as we look at your pipeline, are you seeing any signs that customers are wanting to push out or cancel or are we just talking about them wanting more favorable economics?

We're not seeing anything in terms of what I would say is cancellations.

And I think we still have a good book of business or I would say a good pipeline.

But I think the conversations on what customers are expecting, in terms of price and value, are going up significantly and I think that's where we just need to be more patient.

Customers are in a tough box, Harlan and I think you probably see it.

They're trying to deal with a complexity of a device that's probably an order of magnitude more complex than it was.

They're hiring software and verification experts at two or three times the rate that they're hiring the digital people.

So they have a cost bubble they have to deal with, and many times they have a bubble of geocentricity as they expand to emerging geographies and they have to deal with the bubble of their existing workforce.

I think the beautiful thing is automation is a way out of that because it unlocks people to try to think at different levels.

But they're holding on to their cost pretty preciously and sure, anybody can go and give the stuff away to them.

We're not going to do that.

We spent years going and driving value for what we do and I tell you, I'm committed that we're going to keep doing that because once it's -- once you give it away, it doesn't come back.

And the technology strength is the reason that we can do that.

End-to-end service in the solutions orientation.

And so the cyclicity of the business next year isn't that much different.

It's just that we got a very uncertain environment for customers and we obviously see a wide range from the biggest companies in the world to the smaller ones in the world across all different elements of the world.

And I'm telling you, there's a skittishness, a worry out there that is a real concern for them.

We'll spend a little bit more time at Analyst Day looking at our pricing, but our experience in 2007 is we've seen a pretty stable pricing environment, as we've examined the data for segmentation.

And in fact we'll show that for the 10% of the business, for example in digital that is in the GXL category, we're able to see that we're able to improve pricing based on the value that we're getting for some of this newer technology.

And that's really what we're trying to protect here, because if in this environment we are not going to be patient, we have the risk of giving up some of the gains that we've made with the segmentation and the technology really over the past couple of years.

So that's why we think it's important to work a little harder and demonstrate the value and be patient to get the same level of value in return.

So you brought up a good point, which is the whole strategy of segmentation as a means to counteract pricing pressures and pricing competitiveness out there in the industry.

So I'm surprised that we're not seeing the segmentation really sort of kick in here for the business model and help the business as it relates to the tough times that we're going through here in 2008.

It does.

It does and it does it in places where we're often aligned in the manufacturability approach where we imbed those tenets into the high-end technology.

That's why we get that price uplift in those categories.

I don't remember the exact phenomenon.

We'll have it at Analyst Day of the Virtuoso new entrants that people are trying that out.

Most of them do it at the XL or GXL level.

By a long, long margin.

That's differentiated features.

What we I think have to be realizing is while there's a lot of advanced node design, that's a small fraction of what people's total design continuum is.

So we're out there with the advanced features and all those -- there's a lot of falldown nicely and have been doing, it's one of the reasons we see the uplift.

But you've got to see that pervasive waterfall across all the constituent designs that a company does, big or small.

And so I think we're greatly positioned.

We tried to talk about it in the prepared remarks and time will prove that that really is the case as the market segment share shifts from the bookings that we got last year already have demonstrated.

It would just be crazy if we went and hurried that to ruin the pricing that we've been able to generate.

Remember, we came up with that segmentation as a proaction to be able to go and drive these kind of changes years ago.

And those are well laid, thoughtful strategies.

I think they're going to continue to pay off.

Okay.

Great.

Thank you.

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

Thanks.

Good evening.

Bill, do you know what the duration of the backlog was in '07 versus '06?

In other words, did it go up in '07 versus '06 and could we -- do we know what the backlog is on sort of a duration weighted basis?

I don't think the duration has changed in any significant degree.

I think the only thing, again, as we mentioned in Q3 and Q4, we've seen the contracts lengths kind of move slightly above 3.5 to get to the four level.

But in general we're still seeing that same average contract length.

And so again, from what we see coming out of the backlog, where it's generally been about two-thirds, this year it's going to be about 60%.

So that's incorporating slightly the contract length and slightly a little bit of the mix that we saw with EDA cards.

That's not a demonstrative difference year-over-year.

Okay.

And with respect to the license mix, I think you mentioned in the prepared remarks that it's become more volatile.

Can you just explain that?

I mean, historically these mixes have been pretty steady for most EDA players over large periods of time, unless there was sort of a conscious shift in one direction or the other.

What is it that's making your mix become suddenly so volatile, if you can elaborate on that, thanks?

I think our recent experience, for example in Q3, where we saw the mix move to more of the EDA cards, which has been happening over time, and then in Q4, we actually saw a higher number of traditional subscription contracts, more than we had forecast.

And so I think it's just one of those things where customers are making their decisions based on what their needs are at the time.

It's not -- we're not trying to drive our business to a particular mix.

It's going to really be based on what the customers are coming to.

I think the trend towards cards will continue.

I don't think that will change.

But we will see customers change their minds based on their business needs and I think my only point is, it's not the major driver for us.

The major driver for us is going to be revenue, improving our margins, and getting cash.

The mix of business is just something that will fall out, based on how we serve the customers.

Great.

And with the accounts receivable, I found that surprising that the banks actually wouldn't buy them.

Just one, did you shop them around or is it sort of the one bank you always deal with just kind of got a little skittish?

And two, if that's the case, would you consider shopping them around?

And aren't these your -- usually your highest quality receivables and it just seems kind of unusual that they would not be willing to take receivables from customers presumably of the likes of Intel, they're very well established companies.

If you could just elaborate on that, thanks.

I'd say before what we've seen in particularly in the last six months, particularly in the fourth quarter, and we do have a number of banks.

We don't have a bank.

We have programs with a handful of very high quality banks.

What we traditionally would see was it would be a matter of what particular rates we would get quoted and what we would choose or not choose to take the -- to sell the business, based on the economics.

This time it was a little interesting.

We were getting actually pretty interesting rate quotes, but the banks, I think my guess is their credit process was -- and this was in more than one case -- said that they had enough of a certain level of exposure.

And it could be for particular customers but I think it was probably a combination of both semiconductor and customers.

And they chose that they were not going to purchase even though the quotes we were getting were pretty reasonable and this happened pretty close to the end of the quarter.

So I think they were going through different levels of approvals than we had visibility to in the past and I think that's just tightened up.

Your current headcount, is it similar to the 5,300 you reported for the end of the year?

It is about the same level but we would expect that that will come down by the end of Q1.

There was some cost reduction activities that we did and you can see in our reconciliation in the fourth quarter.

And you'll see that headcount number come down by about 200.

Okay.

That's helpful.

Thanks very much.

Your next question comes from Sterling Auty with JPMorgan.

Yes, thanks.

Question is if we go back when the pricing pressure really hit, we saw a bigger move to subscription by yourselves, basically the whole market.

So if the pricing and the value discussions are getting tougher, why not move more to subscription than even the 60/40 mix that you're talking about for 2008?

Yes, Sterling, I don't know that that actually provides you with any difference than what we're doing right now.

I mean, I think what we're doing is more visible.

But I think the ability to compete is going to be based on the technology and having patience.

I think as you compare, over the long-term, it's the amount of business that you're able to win.

And I fully admit that our model is a much more transparent model than one that is 100% routeable.

It's one of those that you're (expletive) if you do, (expletive) if you don't.

We're pretty visible, you can see.

And we saying we're being patient.

You can see that in our model.

I think others may not have that same level of visibility.

But I think we are winning competitively and that's really what we're about.

The bookings progress that we did all throughout last year without knowing how the market segment share shift is going positively in our direction, to me that's one of the transparencies of the EDA card in that we subsegment stuff that we give access new technology to and stuff that we don't.

And you can see bookings push-out, if there was going to be such a thing, with transparency in ours.

It may be less visible in other potential models.

In any respect it's the way the customers want to buy it now.

Someone is hanging on to a cost that they have -- the development cost or EDA spend or whatever it is that they want to do and they choose to lock it in with a term for a fixed amount of time with some variability on usage model that the EDA card affords them that luxury of doing.

And they don't want to pay for access to new technology, that's all fine with us because we don't want to give away new technology.

I think that's the risk that people run with large, large and long-term subscriptions.

I don't know that you can extrapolate -- I wasn't really around in 2001 -- extrapolate back any kind of a particular business model as the salvation to it.

It's always what customers want to do to be able to buy and mix and the access to new technology is a value conservation mechanism that we -- I have a lot of passion for.

Second question would be, and you kind of touched on this, but just to kind of do it in a concise fashion, based on what you see and based on your guidance, how much of what we're seeing here in the numbers do you think is a Cadence specific issue versus a broader issue for EDA?

Well, I don't know -- I think it's the industry.

We're the leader in the industry, biggest, a lot of large numbers for us, so I guess if someone does a fraction of that, maybe they don't see it as acutely.

We're certainly by the projection we're making not inconsistent with some of the semiconductor equipment manufacturers and a few of those other -- let's call it supply in interest that come into the major semiconductor industry.

And I think the good part about a solutions enterprisewide approach is that it unlocks the productivity in either time or manpower or let's call that a cost equation, a predictability equation that really allows those customers to attack some of those problems.

So maybe we're on the edge of conservative.

We both said that that's what we were going to be.

It's just prudent to do that because then you plan expense basis correctly and timing and you try to predict out with good accuracy and that's what we're doing.

And I don't know what everyone else is going to do, but that's what we're going to do and I think it's not inconsistent with some of the big bellwethers that supply back into the semiconductor industry at large.

I guess what I would add is -- I think you're seeing us do something in terms of leadership on pricing and how we're packaging our product and as we compare in different customers, where we're doing leading edge designs and then getting value for it, that makes sense.

But we're also seeing in some of those accounts where we have others that are more willing to give the technology away for we don't think the right value and we're not -- we're choosing not to participate in that, even though it's going to take us a little bit longer to prove our value equation.

And Bill, last question.

Over the years there's been volatility in the amount of receivables that you have sold.

You talked about the issue in the quarter.

But as we think about 2008, sale of receivables and overall level of cash flow, can you give us just a general indication of what your thoughts are in terms of levels?

Sure, Sterling.

As you saw, my cash flow forecast for 2008 is down and that reflects primarily the ability to sell some of those receivables.

So the level that I'm looking at for 2008 is probably similar to 2006, which is in the neighborhood of about $40 million below, $40 million to $50 million below what we saw this year.

So we're taking that experience into account.

And that's why it's reflected in a lower cash from operations number primarily in 2008.

Okay.

Thank you.

Your next question comes from Mahesh Sanganeria with RBC Capital Markets.

Hi, guys.

This is KC calling in place of Mahesh.

I had a couple of questions.

I heard you folks use a curious phrase a couple of times, wanted to pick up on that.

The phrase is giving it away.

Are you saying that that's what you guys have been doing in recent past?

Are you guys saying that's what some of your competitors are doing?

And is it possible that this extremely conservative guidance which you're looking for '08 wants you to view '08 more as a reset year wherein you can take the pressure off yourself, building (inaudible) and get better pricing from your customers so that you can reemerge stronger in '09?

I think the -- KC, giving it away is a -- not just a euphemism for some of the pricing, especially in the highly commoditized segment.

Backend digital place and route, highly commoditized pricing, very aggressive.

You can go do your own checks about just how crazy that can be.

What we do in selling the segmentation range is compartmentalize competitive offerings that are not as feature rich and choose to be as aggressive in the pricing as we want to or not.

And by selling the mix of the segmentation, we actually blend it and it blends to holding our own or up, as Bill intimated before.

That's a conscious strategic approach to that kind of a phenomena in the world.

The customer conversation can be, since they have a continuum of designs, I really only need the really good stuff for some of the designs and I can use yesteryear's technology for other pieces of it.

So it always bodes well for advanced node migration for people that are future rich and that's why you often see questions or have questions about that dynamic.

There's still some people doing a lot of technology development at 0.18 micron or 0.13 micron or being able to use tools to just do backend place and route.

So it's a real phenomenon that is blended by the technology, the element of commoditization and the usage of it.

There's nothing about 2008 that's a reset year for us.

What we're trying to convey with some insight, depth of insight, is with the breadth of the technology -- because it spans all those three conditions I just talked about, is that the customers themselves are going through a heck of a migration in 2008.

Complexity is way up, ASPs are way down, the volume is hard to make up for it.

They're spending more money to develop the stuff and they're trying to figure out a way out of that box.

And I think we're part of the solution.

But, that alone isn't going to solve, if they've got people in the wrong spot or they have the wrong talents or their ASPs are terrible.

And so pragmatically, what we're going to do, what we've done is forecast with as much visibility as we could for us and for you guys now to see what the potential impact of that is.

And while conserving the hard-fought value for what we've done with differentiated technology across that whole continuum and that's a -- unfortunately, it's a complicated world out there but that's the world that we live in.

Okay.

If I could ask another question on your average contract life span, up until Q3 you folks typically had a three year life span.

For Q3, now for Q4, you folks are reporting a close to four year life span.

If I would assume that the order which you received in Q3 and Q4 of '07 was roughly flat with what you had in '06, would it be a fair take-away that the -- if the number of years increased from three years to four years that the spend per year has actually shrunk?

Well, I don't know that -- I don't think that math works for me.

The transparency of the model that we report average contract life back to your earlier question gives some insight into what the bookings duration is, that was the term used.

And the fact we remain relatively constant is a testimony for holding out that value and let's say the garnering -- the value of new technology.

It allows us or engages us.

When someone wants to engage for new technology we have a different discussion with them.

That's a beautiful thing.

Because they pay more money in the end for it.

They value that technology more in the end.

The good news of a consolidation, whether it's with a big company or smaller ones, when they -- we bind together as partners, is that the conversation naturally becomes more of one of well, what -- let's make a longer relationship because I'm entrusting my confidence in you, Mr.

Cadence.

And so it's natural for those to go out a little bit longer, even in that case, and when you parlay onto the fact that they're trying to spend their money over a period of time more slowly, and the card enables them to do that, that those contract lives would tend to push out.

The beautiful thing, and that's why we reported it to you, is that people use the cards more quickly.

That's a key indicator that says some of this is their own creation.

They're hoping they can squeeze the engineers to use the licenses longer, and we make a bet with them, and then in fact the engineers are right and they use the stuff faster.

And even better they pay us a little bit more money for the ability to use it faster.

So that's a very -- I hope and will become understood well informed strategy to once again have an objective conversation about value, whether it's new technology or the time use of a license of technology that currently exists.

And I think the ability -- the opportunity that we have to engage people as we continue to innovate in new technologies with different business discussions and sell them more is a wonderful thing.

That's the conservation of value ultimately for our new technology access.

KC, I would just add that Q3 as we mentioned at the time, particularly one large customer, took the average over.

In Q4, as Mike clarified, I think we are seeing the impact of the cards.

And I think what we will see over time is that there's going to be your contractual length and I think we're also going to see another metric which's going to evolve which is what their practical usage will be.

My bet is and I think what we're seeing is that usage is going to be less than four years and it will probably be three or lower, but that's going to take time to demonstrate.

So that's the thing that we expect will happen, is customers will use it faster.

But in these times where they're more uncertain, if they say hey, we want an extra quarter or two in the event that we need it, before it expires, we absolutely don't see any issue with that because I believe we will see it being used up in that three-year horizon, at least, from what we've seen in the past.

Okay.

Sounds fair.

I heard you folks say that you're going to suspend giving the routeable percentage information for future quarters.

Would you guys be willing to give some other metric for orders, so that we can go ahead with the models?

Would you want to start giving out the actual order flow or maybe an idea as to the quarterly book-to-bill ratios?

KC, I think what I'm saying is how much business do we expect to come out of backlog, which is about 60%.

That I think gives you the indication of what we have to turn for the year and that's what we're planning on talking to on an annual basis.

Because I think the quarter-to-quarter variations are not that important.

We include that as we give our forecast.

It's really, as you look at 2008, we expect about 40% of our business to come from our pipeline and that's the piece of the business that we're watching for price.

That's where I think you try to do in your models with coming up with this different routeable percentages.

I think I'd be very careful with bookings on the quarterly basis.

Too much frequency of that puts a target on your chest when you go talk to a customer, especially a purchasing agent who says I need -- you need my business this time.

And we've proven in the last years and will continue to prove it because we're in this for the long-term, that having a little bit of obscurity or ability to use that to work business has generated a lot of value for us.

And so I think we'll stick with the simple metrics now.

We'll consider it because we're going to get together at the Analyst Day and see if there's some other insight we can do, but for now we're being as transparent as possible as to how we plan the business and giving you insight into it.

One last question, quickly.

Would you want to comment on your plans for buybacks going forward?

In terms of use of our cash, it really hasn't changed.

We're still looking, one, to see how we can grow the business with our cash.

And two, also, to do buybacks.

But it's still in that priority.

So we will always consider it.

We have active discussions with our Board about the topic.

But again, the priority, particularly with valuations the way they are, we can see the ability to add to our portfolio, particularly as we expand into the adjacencies.

And we want to take advantage of that and we also will look at the value that can be driven from stock buyback.

Great.

Thank you.

Your next question comes from Raj Seth with Cowen and Company.

Thank you.

Bill, I wonder if we can talk a little bit about expenses.

I haven't plugged the numbers in yet, but just order of magnitude, your guidance I think you mentioned '08 expenses would be down relative to '07.

Can you give me an idea of about how much they're down, and given the very tough outlook that you've described, why have you decided not to cut expenses more aggressively?

Thanks.

Sure, Raj.

I mean, again, I think we're looking at driving value and that takes some time.

In terms of the expense levels, as you work it through the models, you can see that we are going to continue to be more efficient in the business.

It will result in expenses being down most likely a couple of percent.

That's how you'll get there when you work the margin versus the revenue range.

And we do that very carefully so that we can make sure that we're not over the longer term going to impact our ability to deliver the best technology and continue to have the best field force to be able to work with customers.

So we're selective.

We're always looking for efficiencies.

We just do it carefully.

We don't try to do it with a kneejerk reaction just because we think that the environment is getting harder, that we're going to do something that is going to hurt the business longer term.

But we've always focused on expense.

We're going to continue to do that from an efficiency and an effectiveness perspective.

And I mean, obviously there's a ton of uncertainty in this whole semi complex.

Is there something that you might look for that would cause you to get more aggressive with regard to cost reductions?

Or is there anything you're looking for?

Or how do we think about the calculus that goes into making that decision?

I don't think there is any event that we're looking for.

This is something that we do as part of our D&A and we're always making some judgments.

We're trying to be nimble because that's what it requires to be successful in the business.

But we want to make sure we're looking out to see what the impact is on any -- both investments and disinvestments that we make.

So we do it very carefully.

That calculated methodology got us to 30% operating margin, which is a pretty amazing number, unparalleled in our peer group for sure.

It puts us nicely in a down revenue year at 27%, that's still pretty amazing at that level.

And we do that by continuously aggressively performance managing out the people that could do better, by looking at investments and investing geocentrically and the team has done a nice job doing that.

And I think we can parlay those efforts that we used in the last years and apply them this year just like we're going to and they'll be just as effective.

And Raj, just a couple of other things.

When you start to peel it back, again, we're probably having 1 percentage point of impact as I mentioned on the detail relating to our 53 week year this year.

That's $17 million.

That's 1% of margin.

So if it wasn't one of these things happens every five to six years, that would be another point in margin for us.

And I think the other thing that's a little bit of a headwind, again, that we're expecting in 2008 is currency.

We still see probably another 1 point of margin impact because we're seeing the strong -- the weak dollar impacting our cost base, particularly outside of the U.S.

And again, that is probably about another 1 point worth of margin.

So we just have to be careful.

I think if those things were different, in a little different currency environment and with a different fiscal year we'd be at 29, just to be careful with where we are.

We're looking at those.

We want to make sure that we're managing this, both to have technology to deliver to customers, and as well getting the value for it.

So we're balancing this.

Bill, just a quick one.

The backlog you talked about $2 billion or whatever the number was.

Just so I'm clear, entering calendar '08, how much of that gets recognized in the next four quarters?

For the year, Raj, we expect about 60% of that business to come into revenue.

Okay.

Now, that also we do a little bit of that business from bookings in the year.

So we don't just do it as of the beginning of the year.

That's the metric that I'm referring to, which is the 60%.

Okay.

Thank you.

Your next question comes from Tim Fox with Deutsche Bank.

Hi, thank you, good afternoon.

Just circling back to some of the earlier questions, if I could.

You mentioned bookings were greater than 1 for the year.

Fourth quarter were ahead of plan.

R&D spending looks like it's going to be up about 4% this year, and yet you're suggesting that in your guidance if you sort of hold maintenance and services flattish a down 9 or 10% license year.

It seems that if you're a big skeptic here, that you're either losing significant share heading into '08 or anticipating really losing some share or that in some meaningful way you've really sucked the pipeline dry on the renewal front.

Can you just kind of help reconcile what was a pretty decent year, decent quarter, decent outlook for R&D spending with such a deceleration in your license business and help the skeptics understand that?

Yes, Tim.

When we look at our experience in Q4, we had a very good bookings quarter, but we also saw that customers were getting much more aggressive in their pricing requirements, what their ask was, and so as we project -- and we don't think that difference is going to get any easier, particularly in the first half of '08 and really through '08.

And so that's really the driver for us.

We have and we can see our pipeline, but we can also see that if we try to close that pipeline, what I would say is the same rate we would have in different economic times, we would give up more value than we're comfortable with.

In terms of the share component, I think we will continue to demonstrate as we announce consolidations and competitive wins across all the major technologies that we are not losing share and this is really a matter of just being patient with customers versus any share.

I don't think you're going to see any significant share shifts from any of our competitors and I would be patient to see if that happens.

But I don't expect it.

All right.

You said it yourself.

You're convincing your ownself or whoever the cynics are.

Even in the places where we're leading market segment share position in analog and verification -- we created the verification category as far as I'm concerned.

The biggest quarter ever in hardware verification.

Digital was stronger than we projected.

That's a byproduct of the consolidations on the Low-Power technology, where we're once again a clear leader in that.

Market segment share shifts were inevitable.

The question the cynics should ask themselves is: our bookings and our progress is transparent.

Is everyone else's indicative of that same kind of transparency or not?

I don't know.

I only know what ours is.

But I tell you the market is of a relatively constrained side.

When we're growing like that, I think there's equally opposite question to pose to the cynics.

It isn't that we're projecting that that relative position goes upside down in '08.

As a matter of fact, it's the contrary.

We're going to continue to reinforce that because it's a value equation more than it is a pure volume equation.

Leading edge technologies are all in our favor, for high performance digital, for mixed signal characteristics, everything has got mixed signal on it.

For system and package where IC packaging is a co-design, for verification and verification where software is at the adjacency, and even for the perpetual cynic, DSM at advanced geometries is a -- [to correct my] construction technique and our approach and that's one of the reasons the digital stuff is embedded, Virtuoso has embedded those high-end characteristics in the high-end [and] segmentation model.

You cannot do 65 nanometer and 45-nanometer design without modeling those characteristics and parasitics into the design.

We'll see what happens.

We're in it for the long-term.

It's not just a -- that we hit the ball nicely out of the park in '07.

'08 will be what it is.

The semiconductor industry will hopefully -- the customers will see their way clearly to find their way out of their cost box.

We're going to be part of the solution and we'll see what happens as time moves along.

All right.

If I may on the EDA cards, just a couple of questions.

I think you mentioned, Bill, that 40% of the business was from the EDA cards.

Just a little surprised that the upfront mix was back to 30%, given that the EDA cards were at least last quarter were primarily term based.

Can you just talk a little bit about what were the mix of the EDA cards?

Were they mostly term versus subscription and why was it that you were at about a 30% upfront level, given that high level of card adoption?

Tim, the trend that we talked about with the cards has not changed.

It continues to increase.

And the amount of the term versus the -- the term versus the subscription cards is still running at around a four to one.

So that hasn't changed.

What we did see in Q4 is we saw some customers that wanted more traditional subscriptions and that is what took the mix higher than we were forecasting.

I think the overall trend for the cards is going to continue.

Customers like it.

If they choose to be price sensitive, they buy the cards and then when they are ready to buy some new technology, they will buy a new card.

If they want the flexibility, which some do, they will get the subscription card, but that's still not the predominant purchasing choice.

I think that will continue.

Some customers, again, like traditional models and we saw some of that happen in Q4.

More than we had estimated and I think customers are still trying to figure out what's best for their business.

It's lumpy.

Anyone who says that the world is all subscription or all term doesn't understand how people buy.

Even geocentrically, some customers prefer to buy traditional subscription.

That's a fact of life.

And it's hard to predict.

That's why we keep trying to predict it and be wrong.

The good thing is is that we're selling across all those continuums and we've got a great mechanism to do it with the card for value.

We have time for one last question.

Your last question comes from Terence Whalen with Citi Investment Research.

Hi, thanks for making some time.

I have a couple quick ones.

The first one, Bill, is on your operating cash flow target for '08, I think you said a number of roughly $350 million.

Really quickly, what amount of factoring receivables is built into that $350 million estimate?

Then I have a follow-up.

Sure, Terence.

As I indicated, it's going to be about the same level we saw in 2006.

So it was about $40 million to $50 million below what we did this year and you can see this year we did about $215 million.

Okay.

Great.

Then very quickly, another one administrative item.

$8 million in legal costs and G&A.

What was that exactly and what are legal costs expected to be going forward?

Terrence, periodically we will have to make some reserves.

This is one of those times.

I think all I'd say is why don't you just watch our regulatory filings.

When we can describe it, we will.

At this point, I'm really not at liberty to say what it was about.

Okay.

And then lastly, my question comes back to the topic of duration.

I think people are a little confused because you talk about a very visible model, yet the average contract duration was told to be about three years.

I think up to 3.5 over the past three years.

Now it's crossing over to four.

I guess my question is, in May of '04 when new management came in, were there any executive decisions made to adopt a longer contract duration?

Because it appears to us, looking before new management came, the company was underperforming with sales declines of 20% year on year.

But then remarkably when that occurred, when new management came in, we saw sales growth very consistently of 10% year on year.

So it seems like consistent with how things have played out and the order gap we're seeing in '08 that maybe an executive decision of adopting higher contract duration was used to boost sales which now put us in a place of a dearth of contracts.

Can you comment on whether average duration over that time actually went closer to 3.5 years versus three years?

Thanks.

Well, Terence, I've been here throughout all those periods and I can tell you there has been no decision to change contract lengths.

For those who I have talked to and I've talked to many of you, I think what we have always seen is generally larger customers have a tendency to try to go slightly longer to get more visibility and a little bit more price protection and we have seen smaller customers have a tendency to generally go shorter and that has given us an average duration of around three.

So it has not been over that level.

What we have seen I think recently and in particular with the cards -- that is starting to drive that average duration higher because the smaller customers, and that's what we saw in Q4, on average have gone to about 3.6 years versus what historically has been three or under.

Again, I think what we're seeing there is they want the flexibility to use the cards longer and we don't think they will.

But they have that contract flexibility.

So that's really the change here.

The larger versus smaller customers, I think the larger customer behavior has not changed and it's going to continue to be that way.

I think the smaller is changing because we're giving them some additional flexibility with the card mechanism.

I don't think it's anything other than that simple explanation.

Last I heard, added up the arithmetic, we've steadily grown the backlog over this time with the contract life continuously reported.

That's more backlog, my friend, not less.

And the confidence that customers have that drives even a small company to extend the duration is a technology commitment to us.

That's in light of all the big consolidations that we've done across the board.

So the transparency of ours is trying to be reporting those trends so that you can associate them for whatever you want to do with it.

But I think the technology prowess and the consolidation record that we have is a testimony to technology value and durability.

Okay.

Thanks for taking my questions, guys.

Good luck.

Thanks.

This concludes the conference call we had today.

Thanks for the participation as always and we look forward to seeing many of you at Analyst Day in a month or so.

Operator, you can disconnect the call now.

This concludes our conference call for today.

Thank you for participating on the Cadence fourth quarter and fiscal year 2007 earnings call.

You may all disconnect.