新思科技 (SNPS) 2002 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Synopsys fourth quarter fiscal 2002 earnings conference call.

At this time, all participants are in a listen-only mode.

Later we will conduct a question and answer session, and instructions will be given at that time.

If you should require assistance during the call, please press zero -- star, followed by zero.

Today's call is scheduled to last one hour.

Five minutes prior to the end of the call, I will alert the conference of the time remaining.

And as a reminder, today's call is being recorded.

During the course of this conference call, Synopsys may make predictions, estimates, and other forward-looking statements regarding the company.

While these statements represent the best current judgment about the company's future performance, the company's actual performance is subject to significant results and uncertainties that could cause actual results to differ materially from those that may be projected.

In addition to any risks that may be highlighted during this conference call, important factors that could cause the company's actual results to differ materially from those that may be projected in this conference call are described in the most recent 10-K, 10-Q, S-3, and 8-K reports of Synopsys on file with the Securities and Exchange Commission.

At this time, I would like to turn the conference over to Aart de Geus, Chairman and Chief Executive Officer.

Please go ahead, sir.

Thank you.

This is Aart, I have with me Brad Henske, our CFO.

I'll start by reviewing our performance for the quarter.

I will then provide a progress report on the strategic initiative we laid out at our investor day meeting in October.

Finally, Brad will cover our financial results in detail, and finish up with guidance for the coming quarter and next fiscal year.

Synopsys ended its fiscal '02 year on a powerful note.

We had a solid fourth quarter that saw strength in both our implementation and verification platforms.

Book to bill was well above one.

As (ph) we start by looking at landscape around us, there is no question that our customers continue to be under tremendous economic pressure.

Although I do not believe things have gotten materially worse in the last 90 days, I do see that the expectations for a fast recovery in '03 have been tempered.

Customers are now managing expenses with longer-term caution in mind.

All the more does our performance in the quarter demonstrate our strong position within the EDA industry.

In tune with our surroundings, we are managing our business aggressively and our expenses carefully.

Looking forward, we feel confident that we will emerge from the present downturn with a clear market share gain.

There are several reasons why we believe that we are outperforming our peers in this tough economic environment.

Clearly, the acquisition and excellent integration to date of Avant! has strengthened our competitive position significantly.

It is also having a material impact on our ability to close business.

There are three key reasons for that.

First, customers have watched us closely during the initial integration phase and have already concluded that we are well on track and executing above their expectations.

They are confident that their past investments are not only safe, but in good hands.

In addition, the resolution of the Avant!-Cadence litigation completely puts to rest any doubts that may have lingered.

Second, the on-schedule introduction of our post-merger integrated product road maps resonated well with customers.

They are engaging us with their input, feedback, and -- this is a good thing -- their impatience.

The good news here is that customers are increasingly committing to work with us on future products while, meanwhile, buying our existing products.

Third, our field force quickly learned to benchmark, sell, and support a much broader product portfolio.

Today we are actively engaging customers on all the acquired products and supporting them worldwide.

With our much broader product portfolio, we now have the best complete IC design solutions.

As we explained in our investor day presentation, we are looking at IC design as addressing two fundamental task sets -- design implementation and design verification.

In the first, the designer focuses fundamentally on the cost, the performance, the power, and the manufacturability of the chip.

In the second, the designer verifies functional correctness of the chip or the system.

To address these complex tasks effectively and efficiently, we are configuring our product offerings around two distinct, integrated platforms - an implementation platform and a verification platform.

In addition, we offer a strong collection of intellectual property blocks which are reasonable pieces of design, as well as the services to support our customers on their most ambitious chips.

Let me briefly review all three areas.

Our implementation platform had a strong finish for the year.

First, we are especially proud of the Physical Compiler (ph) Astro combination, or PC Astro (ph) for short, which did quite well.

Inclusive of the Avant! historic results, PC Astro orders, including Apollo, grew 51% year over year.

As expected, our Synthesis flagship design compiler (ph) is moving to mostly renewals as customers are spending their strained budgets primarily on the more painful physical design challenges.

The corollary is that our upgrade opportunity with Astro is very much alive and well.

At this point, we have upgraded about 30% of our place and route (ph) installed seats from Apollo to Astro.

These upgrades have accelerated significantly since the Avant! acquisition announcement, and the momentum has increased as Astro has had another round of quality improvements.

Second, with the addition of the Avant! tool set, we have @also significantly expanded our franchise in design for manufacturability.

This product line, which includes OPC, Optical Proximity Correction, and TCAD (ph), Technology CAD (ph), had a notably strong quarter.

And third, in Q4, we also introduced SOC-BIS (ph), which stands for System On Chip, Built-in Self-test (ph).

This very powerful technology reduces the amount of work that expensive testers have to do on each chip that is built.

It does have the potential to significantly reduce manufacturing costs.

As you can imagine, this is a welcome message to customers eager to reduce equipment expenses.

Our verification platform is also showing significant achievements.

VCF (ph), which is the simulation software at the heart of this platform, had its best quarter ever.

In Q4 alone, we had 12 orders for VCF that exceeded $1 million each.

Both our verification road map and present offerings are in tune with customer expectations.

In Q4, again, we saw significant number of customers standardize on Synopsys for their verification needs.

One major customer cited their decision to use VCF was driven entirely by its integration with our test bench and analog mixed signal verification products.

Which brings me to the next highlight - our analog mixed signal products, including Nanosym (ph) and H-spies (ph), had an outstanding Q4.

We continue to benefit from customers' increasing need to verify analog and digital content on the same chip.

And we are reinforcing our leadership position in mixed signal verification.

As you can see, verification is an increasingly important segment of our business, and we will be making aggressive strides in fiscal '03.

For example, VCF 7.0, which shores up (ph) at the foundation to a whole new generation of verification capabilities, will move to general availability during calendar Q1.

In the area of IP, we closed our acquisition of inSilicon during Q4.

This acquisition complements our existing set of standards-based IP and adds a number of high-end IP blocks to our designware (ph) library.

During Q4, we also announced availability of complete solution, enabling designers to quickly add Bluetooth capability to system on chip design.

One of the areas that has been seriously challenged by the economic environment is our services business.

It continues to underperform, even against our own internal expectations, with the consulting and training pieces the most impacted.

As we do not see a quick return to growth, we are taking appropriate steps to manage this business accordingly.

(inaudible) we have a complete portfolio for IC design tools, we are putting a great deal of emphasis on our front-to-back platforms.

In this vein, we have recently made some organizational changes at the executive level to focus on the platforms and to better manage what is now a billion dollar-plus company.

First, we have centralized the marketing and corporate applications functions across all business units.

Sanjeev Call, (ph), until recently SVP and General Manager of the IC implementation business unit, is heading up the newly created corporate marketing and applications group.

Second, intellectual property and professional services business units have been consolidated under John Shelton (ph) for a tighter customer focus and streamlined internal efficiencies.

Third, Jerry Lee, previously Vice President of Engineering, has been promoted to Senior Vice President and General Manager of the IC implementation business unit.

Fourth, Deirdre Hanford, who started as Synopsys' very first fuel (ph) application engineer 15 years ago, will lead our worldwide field application services group.

Finally, Paul Lo (ph), formerly president of Avant!, takes on the role of Vice President of Research and Development for all physical implementation design products.

On the competitive front, we see customers gravitating towards suppliers that can offer complete solutions.

This preference favors both Synopsys and Cadence at the expense of individual point (ph) tool providers.

It also sets up Cadence as our primary competitor across a broad spectrum of tools.

We see early evidence that we are gaining ground.

Our technology lead, as well as our increasing field savvy with the new products, bodes well for the competitive battles in the coming year.

Looking forward, we are in a very strong position to meet the challenges of ever-shrinking geometry.

Specifically, as a first, TSMC ph) already qualified Synopsys signal integrity suite of tools for 130 and 90 (ph) nanometer process technologies.

Although the number of designs done at 90 nanometer is still very small, we have strong evidence that over 80% are being done with Synopsys, and we have already seen the first take off.

Now I would like to give you some more color on our end markets.

Recent semiconductor industry association suggested that we are in the beginning stages of recovery.

The facts are as follows -- in February of this year, semiconductor sales were down 46% from the October 200 peak.

By October 2002, they had improved 13 points, but were still down 33% from the all-time peak.

Despite the improvement, we are not seeing marked optimism in customer attitudes or recent buying behavior.

If anything, more customers this quarter came to believe that '03 would hold a gradual recovery and almost all the executives I have talked to in the last two months complained about a significant lack of visibility.

We had felt for a while that expectations of a semiconductor recovery in '03 were overly optimistic.

Fortunately, we based our own financial assumptions and budgeting on more conservative views, and we will continue to watch our expense profile carefully.

In the event that things improve sooner, our lean operating model can only serve as well.

Geographically, there has been no real change since last quarter.

North America and Europe are holding up, but not showing any improvement, with percent of our overall revenues at 65% and 15% respectively.

Japan at 12% remains weak.

Asia Pacific, at 8%, led by China, continues to be a bright spot with solid overall growth.

China in particular is a highlight for us.

In Q4, we closed two very important agreements, one with the Ministry of Science and Technology of the People's Republica of China, and the other with the Chinese Academy of Science in Bejing.

They will be using Synopsys Flow (ph) for all new chips (inaudible).

In summary, although the economic landscape is very tough, Synopsys executed well in Q4 and all of '02. 2002 was a year of fundamental transformation for us, and the Synopsys that is entering 2003 is dramatically different from the Synopsys of a year ago.

In one year, we moved from leading front-end tool provider to leading semiconductor design software supplier.

Every indicator tells us that the merger integration is proceeding extremely well, and we are excited about the R&D work in the pipeline for next year.

With that, I will turn it over to Brad Henske for details regarding our financials.

Thanks, Aart.

As we had previously announced, Synopsys produced excellent financial results in Q4 2002, despite the difficult environment.

Our revenues came in slightly above our target range, expenses were significantly below target, and earnings before goodwill per share was 96 cents, well above the top of our target range and consistent with our preannouncement of November 4.

Orders met our expectations.

As a reminder, earnings before goodwill, or EBG, represents earnings on a diluted basis excluding amortization intangible assets and in process R&D and is the basis for this financial presentation.

As Aart mentioned, while the objective data shows that the semiconductor market has been slowly recovering, one would not get that impression from talking to many of our customers.

They continue to be quite concerned.

That (ph) economy is driven by two things.

First, recovery is not the sharp uptick many had hoped for, but is a slow climb.

Second, the gap in results between those semiconductor companies who are going to be successful long-term and those who will be less successful is getting wider and wider.

From the perspective of customer buying patterns, market conditions drive (ph) more of same behavior than we have seen in previous quarters.

Customers are buying quantities of software only equal to what they need immediately, but at the same time are making longer-term commitments to technologies they want to standardize on.

Looking through the quarter, we are broadly distributed across a large number of customers.

Pricing and discounting continue to hold steady.

We have seen no significant shift in license duration or mix for the year.

Payment terms continue to be a hot issue both on new business, where we're extending them when it makes business sense, and even on old business where we are getting requests for payment relief.

We do not grant these requests without a significant intangible long-term loyalty to commitment to Synopsys in the form of a new contract.

Let me now turn to Q4 results.

Total revenue for the quarter was 309.3 million, the largest quarter in Synopsys history.

Our total revenue grew 68.5% versus the same quarter reported last year.

Including Avant! pre-merger historic results, revenue grew 9% from the same quarter last year.

Total software revenue, including maintenance, grew 81%, or 13% including the Avant! historic results.

Total revenue grew more slowly than software revenue because of the lower performance in our consulting and training businesses.

Ratable license revenue was 137 million for the quarter, or 59% of software product revenue.

Services revenue totaled $78.9 million, up from the prior quarter due to increased maintenance renewals and now having a full quarter of maintenance for the Avant! tools, offset by conversion of old maintenance to DSL.

On a combined basis, it is down compared to last year, driven by the decline in consulting and training, the transition of all TBL (ph) maintenance into the ratable reporting line, and less perpetual maintenance renewals driven by the economy.

For the quarter, 73% of our software product bookings were ratable licenses.

The average duration of TSLs (ph) booked in Q4 '02 was 3.7 years, which makes the average duration for all of 2002 3.3 years, down from 3.4 in 2001.

We booked 27% of our software orders and licenses where the revenue was or will be recognized at the time of shipment, essentially perpetuals.

This was only slightly above our target range for the quarter, primarily due to the fact there were several orders totaling more than $30 million that were booked, but could not be shipped during the quarter.

They have largely been shipped in Q1.

Excluding those orders, perpetuals were only 20% of software bookings at the low end of our expectation.

Aggregate orders for Synopsys grew 14% in fiscal 2002 from 2001.

Including Avant!'s pre-merger historic results, orders were essentially flat year over year.

Total software orders, including the Avant! historic results, grew 2% year over year.

Consulting and training fell 32% on the same basis.

Our aggregate EBG operating expenses, including cost of goods, were 196.9 million, which was well below our target range for the quarter of 210 million to 215 million.

The overperformance versus expense targets was driven primarily by lower year-end accruals for bonus pipe compensation.

While we were generally at or above our guidance targets for Q4, we did not reach the full attainment on orders or revenue for our 2002 compensation plans created at this time last year and subsequently for the Avant! acquisition.

The shortfall was driven by the market conditions, which we have described throughout the year.

In addition, we have set aside budget for any surprises from the Avant! acquisition, and to a lesser extent, Codesign (ph) and inSilicon.

We are happy to report there were none.

EBG operating earnings for the quarter were 112.3 million, up sixfold from 17.6 million the same quarter a year ago.

Our operating margin was 36%, consistent with our forecast to exit the year above 30%.

Other income and expense was a loss of 1.5 million against guidance of positive three million to six million.

The difference was driven by four write-downs in our venture portfolio totaling approximately $4 million.

The settlement with Cadence, which eliminated the expected 1.2 million in interest income from our insurance assets and the fact that the company did not have any investment gains in Q4 of '02.

Earnings before goodwill and other merger-related charge amounted to 96 cents, well above our guidance range, and up 146% from the same quarter a year ago.

Diluted share count was 76.4 million, in line with our guidance of 74 million to 78 million shares.

Earnings per share on a generally accepted accounting basis, or GAAP, was a loss of $1.31 per share or 97.8 million for Q4 of '02.

Differences included the write-off of our long-term insurance asselt as part of the settlement with Cadence of $241 million, which I will talk more about in a minute.

Amortization of intangible assets of 32 million, integration expense, related expenses for inSilicon and Codesign of $11 million, including an asset impairment adjustment of 3.4 million and in-process R&D costs of $5 million, offset by the tax impact of these amounts, totaling 118 million.

The settlement between Avant! and Cadence was announced on November 13th.

The parties have finally and completely resolved all issues with respect to the cross-complaints and have entered into releases to effect the settlement.

As part of the settlement, Cadence will be paid $265 million dollars by AIG, our insurer.

There is no incremental impact on Synopsys.

Recall (ph) it is part of the insurance policy, we booked a long-term asset of 240 million for the funded deductible portion of the policy, including accrued interest -- that was written off as an acquisition expense in a subsequent event reportable in this Q4.

Operating cash flow for the quarter was $165 million, driven by strong collections.

This excludes the impact impact of a settlement with Cadence and acquisition costs.

The payment terms mix generally held constant this quarter, with some lengthening in payments greater than one year.

The mix of payment terms continues to be under significant pressure, and therefore quarterly cash flow will -- likely to continue to vary through next year, driven by fluctuations in collections.

In Q1, we currently expect to collect approximately 260 million from existing commitments.

Capital expenditures were $14.5 million, primarily for equipment and software for our engineering and field staff.

Cash and short-term investments continue to be strong, with our Q4 balance ending at $415 million or $5.43 per fully diluted share.

Q4 accounts receivable totaled 207 million.

For the quarter, DSO was 61 days, down significantly when compared to the prior quarter.

This is due in part to the timing of large cash collections realized during the quarter.

We expect DSO will return to a range more consistent with what the company has reported in the past of roughly 70 days and do not view it as material.

Deferred revenue at the end of the quarter was 411 million, up 8% from the same quarter a year ago and down 32 million or 7% from the previous quarter.

The quarter to quarter decline in deferred revenue reflects the impact of extended payment terms granted to our customers on subscription licenses.

The difference between our orders and revenue in any given quarter goes either onto the balance sheet as deferred revenue or into backlog.

The sum of those two was approximately $1.3 billion as of December 1st of this year as we expect to report on our 10-K in January.

It has grown $500 million or 65% since the same time last year, and well represents strength of our business.

As a general matter, deferred revenue represents commitments that have been billed or paid, and backlog contains committed with (ph) future installments.

The extension of payment terms has caused the mix to shift significantly to backlog, driving down the deferred revenue.

During the quarter, we repurchased approximately 3.1 million shares for 130 million, and an average price of approximately $42.53 per share.

Since the current program is authorized in July 2001, we have repurchased 4.3 million shares for a total of 190 million at an average price of $44.30 a share.

The Avant! acquisition prevented us from repurchasing more through most of the period.

This program expired at the end of October, according to its terms.

We expect that our board will approve a new plan at our board meeting next week.

We will continue the share buyback program in the coming quarters as an efficient way to return excess capital to our shareholders.

Headcount totaled 4,291 employees for the quarter, up 114 from the prior quarter, reflecting the mergers of inSilicon and Codesign and ongoing investment in R&D.

We eliminated 78 headcount as part of our integration efforts for those acquisitions.

Finally, I would like to describe our expectations for the future.

As I mentioned earlier, our customers' performance continues to be volatile, and visibility is difficult to achieve.

Therefore, we will continue to give detailed guidance for only a quarter forward.

For Q1, we expect revenue of 262 million to 273 million, total expenses of 203 million to 208 million, other income and expense of 9 million to 12 million, including approximately 5 million to 7 million of investment sale gains, outstanding shares sales of 76 million to 79 million, a tax rate of 32.5%, earnings before goodwill of 63 to 68 cents per share.

Perpetuals of 18 to 23% of product orders.

On a side note, I will observe this guidance is several million dollars in revenue and several cents a share above our perspective of Q1 from three months ago.

We expect revenue to be down in Q1, versus Q4, due to the seasonal manner of our business.

Q4 is historically the strongest bookings quarter of the year and Q1 the weakest.

Typically seasonality for orders shows that the quarter's first through fourth are very roughly 15, 25, 25 and 35% of the total year's business respectively.

As we stated in the pre-announcement, we continue to expect we will manage the business to generate $3.25 in earnings per share for the year.

We do not need growth in orders in 2003 to achieve this and have 720 million dollars of 2003 revenue already in deferred revenue and backlog.

As result of order mix and TSL (ph) duration in Q4, we have taken about $40 million out of our expense plan for 2003 and plan to run approximately flat with Q1 guidance levels for the remainder of the year.

For the fiscal year 2003, we continue to expect our orders mix will be approximately 22 to 27%, perpeptual licenses and duration of subscriptions will be roughly 3 to 3 and a quarter years.

In 2003, we expect that our reported revenue will be made up of approximately 20 to 25% product, 50 to 55% subscription and 20 to 25% services revenue.

Thank you for your attention.

We will now open for questions.

Ladies and gentlemen, if you wish to ask a question, please press the one on your touch-tone phone.

You will hear a tone indicating you have been placed in queue.

You may remove yourself from queue by pressing the pound key.

If you are using a speakerphone, please pick up the handset before pressing the numbers.

Once again, if you have a question, press the one.

Operator, do we have questions?

First question is from the line of Jay Vleeschhouwer with Merrill Lynch.

That must be the other Jay.

Anyway, couple of questions, first on the product side.

You previously stated that by June of next year, you expect to ship multiple Synopsys products integrated into the Avant (ph) technology.

So, two parts about that.

One, what are the interim developmental and customer testing steps that you anticipate before GA of the products?

What is the revenue potential from integrated products?

Will those be incremental revenue sources from having integrated the technologies or will they simply be maintenance or subscription releases?

Then a follow up

That is correct one of our first targets is to take full advantage of the fact we have a very powerful database.

That we have found very good ways to take some of the existing Synopsys product and connect them to the database.

Most importantly, to move towards what we call a platform that connects all the tools well together.

So, a number of the capabilities that are reflected out of that will go into beta imminently.

I think the rollout will continue throughout next year as the capabilities are solid.

Whatever we do, we always, always go through beta pipes (ph) with our customers.

In terms of does it open up new revenue opportunity?

The first thing it does is clearly strengthen our competitive position.

Because this enters immediately to needs our existing customers have always had and that they are really looking forward to.

I think as we integrate more, at some point in time, we cross the line between integration and new products.

We have not announced new products, but rest assured the R&D power in the combined company and those announcements will be made during next year.

Okay.

Second question has to do with the overlapping of Synopsys and Avant contracts.

Obviously there are a lot of customers in common, but not necessarily the same contract terms or period.

What have you been doing since the merger?

What might you be able to do in '03 in terms of consolidating or rationalizing the contracts you might have in common?

In many ways that is a process that will take a period of time.

Some of the contracts we would like to consolidate because they are coming up and due anyway.

So, both for simplification reasons or because we see the opportunity to sell newer products, we would like to take them on.

As Brad said, you know, we like to look at these things every time opportunity for furthering the commitment in the long term.

All right.

Lastly, just for Brad.

You are taking 40 million out of your expense plan for '03.

You previously been targeting keeping the expense rate flat with Q4, now it is lower off on a Q1 base.

Looks like as we are talking about the same earnings number of course, that there would be at least a similar $40 million reduction out of your revenue forecast for the year, which in turn suggests higher number coming out of the booking forecast for '03.

So, is implicit in this arithmetic that bookings could conceivably even be down next year?

You were right all the way down to the last clause, which is the change we made in expenses was driven by mix we booked in Q4.

Our bookings plan actually for next year is up slightly versus where it was three months ago.

OK.

Thank you.

Next question comes from the line of Bill Frerichs with DA Davidson and Company.

Please go ahead, sir.

Good afternoon.

Aart, I was wondering if you could address the positioning message behind the reorganization of your management?

Certainly.

There are really two things that we are optimizing for.

One is the in fact that we have such a tremendously rich product portfolio that it is time for us to move much more to what we refer to as the platforms, which are integrated collections of technologies and implementation and verification.

One of the key drivers to do that effectively is to bring the marketing and corporate application functions together.

Because they de facto define both the shape, as well as the utilization of the platforms.

So, that is one of the things at the heart of things.

The second thing is we are a significantly larger company now.

We are extremely well positioned in the management team we had in place when we merged with Avant.

We now have 12 - almost 12 months since the announcement.

About 5 months since the acquisition, under our belt.

So, it was time to take the strength and amplify them and the areas where there were issues, correct them.

So, shuffling people is actually sometimes a very good thing to also bring some new energy and new ways of looking at things.

Combining the IT and services was an appropriate way of dealing with the service challenges and strength of the IT.

The main point is to underscore the platform?

Absolutely.

Great.

Thank you.

Next question comes from the line of Raj Seth with SG Cowen.

Please go ahead, sir.

Thank you.

First question for Brad is for you.

I am wondering if you can help me with Q1 numbers a little bit.

You gave guidance for revenues, let's call it in the 270 range.

I'm assuming and tell me if I am wrong, that you come in with subscription backlog that ought to be similar to what you showed perhaps a bit more in Q4, like 140 million.

I assume that maintenance is perhaps down a bit from Q4, call it 75.

You have $30 million that I thought you said you were pushing from Q4 into Q1 of perpetual bookings, which leaves me with something like 25 million or so that I need to get incremental to what I would assume is flowing in off of either subscription backlog or maintenance, which suggests bookings next quarter are 125 million.

Am I doing something wrong there?

Because the number seems awful small?

So, it's the right analysis.

The number is somewhat small, but Q1 is low bookings quarter on product side.

What are estimates predicated on in terms of bookings growth Q1 to Q1 a year ago, if you can tell us?

We would like to not get into quarterly bookings numbers largely because we don't think the fluctuation quarter to quarter in bookings is particularly meaningful.

We expect growth versus Q1 last year.

Okay.

Maybe you can help me with that off line.

Aart can you comment on the competitive environment - in particular touch on pricing?

Mentor (ph) mentioned the pricing environment is as tough as it has been for many years.

I am curious if the problems that people are having with .13 yields high mask costs are gating the rate of transition toward .13 and more aggressive geometries on the design side or if that is not having a meaningful effect?

OK, first on the pricing, the reason we do not see as much pricing pressure is we don't compete much with Mentor (ph), except in a few areas.

We don't see the same landscape.

In general, I think pricing is not so much the issue as does the customer had a budget, yes or no.

It is clear when they have little budgets, they will try to get much lower pricing.

At some point in time, we say no because that is the only way of doing decent, long-term business.

I do not see we have seen any pricing change in the last few quarters.

Secondly, regarding the .13 and mask (ph) costs, there's no question that from a manufacturing point of view, there has been a few surprises in the spring of .13, regarding the resulting yields.

That has not had that much impact on design.

It has had an impact on the economics of manufacturing, of course.

I think most of the yield problems are pretty much behind us.

Looking forward, there is worry that mask (ph) costs are growing rapidly.

It is only for .09, these numbers start to be pretty scary.

The good news for us in that is that that puts more emphasis on the necessity to have very strong verification tools.

Be it physical verification tools or verification tools period, before one goes to the process of setting a mask (ph).

So, we are starting to see the first chips coming out at 19 nanometer.

It is still far away in terms of volume.

But, I don't think there is major disruption that is driven by technology one way or another.

Okay.

If I might, one last one.

Are there any bright spots in the customer base?

Are there -- you described at a high level, that the tone of the conversations you are having with customers.

Do you hear anything that is encouraging in sub-segments or within any of the major customers you have been speaking with?

With some of the major customers that we think are strong customers, I see they have very much the same behavior we have, which is quietly try to build strength if you are strong, and absolutely aim at exiting downturn with growing market share, while simultaneously, be very careful with expenses.

We behave exactly like that.

So, some of the stronger customers are definitely going to take advantage of the fact some of the other ones are weaker.

In terms of segments that still remain sort of on the ball, the consumer area remains quite strong.

The automotive area, storage gets good news on the some of the local area network, wireless 802.11 wireless family.

Geographically, I would say the far East, specifically China.

Thank you.

That is helpful.

Next question comes from the line of Garo Toomajanian with RBC Capital Markets.

Please go ahead, sir.

Thanks very much.

Brad, in taking $40 million out of the expense budget for next year, where will the cut come from?

In particular with keeping expenses flat through the year, is there something you are thinking of -- what has to go there basically?

I think a chunk will come out of our consulting business, given how that is performing.

The rest is bits and pieces everywhere.

You don't expect to see any increase in expenses through the year for things like bonuses or sales incentives?

No, those are generally accrued throughout the year.

Okay.

Aart, you mentioned you believe yield issues are largely behind us at .13.

Does that mean, in your point of view then that you believe .13 is more cost effective now and will precipitate a faster move to 2.13 and perhaps next year?

Let me not say more than I know.

In the spring there were big yield surprises.

I think those are behind us.

What the fabs are saying, they are now really in mode of tuning up .13 and when they are there, that means their economics are moving in the right direction.

Regarding utilization of .13, some people that in the spring had held back and stayed on .18 or .15 felt really good about themselves because they did well.

The ones on .13 felt they were a little bit too much on the leading edge.

That feeling is gone.

All the advance design today is on .13.

The exceptions is a few are on .09, primarily pipe cleaners for the future.

Okay.

I know that maintenance has been for customers who are not perpetual licenses, had been an issue and customers had been dropping through the year.

What happened in Q4 on maintenance trends?

Have you seen anybody come back on maintenance?

We have seen some come back on.

Others continue to trop off.

The net was a modest negative.

Thanks very much.

A question from the line of Jennifer Jordan with Wells Fargo Securities.

Please go ahead.

Good afternoon, gentlemen.

Couple of quick questions.

The first was follow-up on the issue about .13.

Do you have, Aart, any sense of at what point does this become something beyond the advanced design stage and into the general proliferation of all designs?

Just to clarify.

I think the .09 is in event stage. .13, chips are coming out and products are in utilization.

The people using .13 are really the people motivated or differentiated by high performance and high complexity.

In some cases, high volume.

So, I don't want to give the impression that .13 is a cake walk.

It is a design that today is getting good results and you see in a number of the graphics manufacturers or others. .09 is definitely not a cake walk yet.

Right, Aart, if you had to estimate though what percentage of designs are getting done at .13, 25 to 35%?

What point do we get to the place where people have moved off .15 and .18 and into .13?

I don't have the graph in front of me, but my guess would be that .13 is somewhere between 20 to 25%. -- of design starts.

The bulk is still at .18.

Clearly on the manufacturing side, bulk is still at .18.

Okay.

I guess I am asking because that seems to bring a greater acceleration of new tool purchases for you in the future, assuming those companies survive into the upturn?

They will survive.

The people that can afford and do advanced designs like that are typically companies that have well established basis.

It is clear that .13, physical phenomenon that before were negligible, such as signal integrity issues, are now much more of a concern, that plays into our hands.

We have a rich, strong portfolio of signal integrity analysis tools and integrity issue avoidance capabilities.

So, that is definitely coming helping the back end of the product portfolio.

Brad, could you address the idea of extending the payment terms to people and the slightly longer it seems contract length this time around?

Sure.

So, the longer contract lengths, if you look over the history, is within the range of where this has bounced around quarter to quarter and actually year over year, the average contract length is down slightly.

It is mostly a function of what do the particular customers that are buying in a quarter want to do.

To some extent in this quarter, we saw customers, at least some, look and say, "Oh, yes, this is a tool set I want to standardize on and sign up commitments out into the future."

From payment terms perspective, of all the attributes of contracts among the deal size and pricing and various other terms, the one that's under material pressure is payment terms.

You know, we have seen this the last couple of quarters and continue to see it today.

We continue to see payment terms push out.

Recall, as revenue recognition matter on subscription license, we will not grant payment terms any farther than quarterly in advance.

So, we get paid or bill to get paid prior to any revenue being recognized.

Our perpetuals are collected within a year, consulting as it is performed.

We can push on that, but we will reach the stops.

Yes.

Thank you.

Next, question from the line of Arnab Chanda.

Please go ahead.

He is with Lehman Brothers.

Thank you.

Couple of questions.

A quick housekeeping one for Brad first.

The guidance that you gave for the whole year, other than the first quarter, does it contemplate investment incomes or ongoing item or should we exclude that?

Other than the first quarter, I think a few million more.

Not more than that.

Part depends on what happens throughout the year.

Okay.

Excellent.

I mean, part of it depends on what happens throughout the year.

Do you need to give clarification as to where those are coming from?

Is it a stock investment or some kind of options or ...

No, investment gains typically tend to be one of two things, either the result of the sale of investments in venture portfolio or the result of sales of pieces of our business, which has been relatively little, but some.

Thank you.

Second question.

One of the things going on in the semiconductor industry, we all know the industry is not cylical, but given the perpetual nature of most of the contracts in the industry, there is not much correlation to the cycles.

Are you seeing resistance or interest in modifying the payment terms to reflect if they are in a good time or bad time so you can share a little more of the pain or pleasure?

That would be interesting.

Well, I think, as I mentioned, we are in the pain cycle now.

We are seeing customers push hard on payment terms.

At some level, that is actually okay.

Given the cost of money these days, payment terms is relatively cheap for us to give out.

Given that we're holding pricing and discounting in constant, that feels like a good trade for the environment.

I see.

Okay.

Great.

Hello.

I am sorry.

Were you going to add something?

No.

Great.

Last question.

Could you talk little bit about how active your system company customers, idm versus fabless (ph) customers and who effect the mask costs are having on their interest in licensing your tools?

At this point in time, I do not see any major change yet.

I think people are looking at mask (ph) costs a bit as a future issue, given that most have still not moved to the most advanced technologies.

They are worried about mask (ph) cost.

In my opinion, they should be worried more about the cost of the design because that is really where with much high complexity the money will be spent.

The mask cost just happens to be very visible ticket, if you do something wrong or if you ship a chip that is not working yet.

So, the corollary to that, I think, is that what we are going to see is increase in verification.

It will be gradual because all things actually tend to be gradual.

But there is no question that when somebody sends out a set of masks that are have a problem, their management will come down hard on the question.

So, how did you do verification, and invariably, most customers will say we didn't do enough.

That is the time we want to be there.

Great.

Just to follow-up, this is really the last question.

What -- do you think the mask (ph)costs have effect of the design cost going down?

Does the verification that you can collect because of that importance of mask costs kind of offset the reduction of design starts a bit?

Design starts have been going down for 15 to 20 years partially just because the complexity work can be put on individual design and has gone up dramatically.

Secondly, because SDGH have filled the gap for the smaller stuff.

I would not put mask cost as the driver for design starts going down.

I would start with the economy around us.

That is by far and away the biggest driver.

The economy goes up and starts will go back up.

The fact mask costs are increasingly, you have to deal with that.

That is just a part of doing business.

So, we will help address the issue of design cost and mask cost, but fundamentally, it is the economy.

I hate to say the economy is stupid, but that is I think the answer to this.

Thank you very much.

Next, question from Arash Desi (ph) with American Technology Research.

Please go ahead, sir.

Thank you.

Couple of questions.

One was with regard to fiscal first quarter, revenue guidance.

You know, whoever, Brad or Aart, if you go back and look at five-year history and knowing that you have been in a license model change mode throughout the set of odd years, Synopsys typically revenues have been between minus 5% and plus 5% sequentially.

Your guidance suggesting something like down 14 or 15% of the midpoint, below what was consensus of 286 million for the first quarter.

So, I just guess I am trying to get clarity into why this is more than seasonal down?

I think you are right.

It is seasonally down.

Typically it has been less than this.

It is partly function of customers and the license mix.

We expect in Q1, as I noted, the amount of perpetuals we expect to book in the quarter will be less than average for the year.

The quarter is small book accident quarter.

It is more how the numbers play out.

Okay.

Fair.

The other one was a clarification perhaps for Aart, I don't know if I misheard or didn't get the full picture, but perhaps if you could clarify the management changes a few things.

Does Paul Lo (ph) end up working reporting for Jerry Lee in terms of the new IC implementation?

Whatever you called it, I am sorry, group.

Correct.

Okay.

Second, related to organizational changes, is Deirdre Hanford reporting to Vicki Andrews, which she always did, or is there a change there?

Neither is true.

She reports to office of the president and did so before.

Okay.

Deirdre Hanford will be doing field services, is that correct?

Field application support.

So, those are the engineers in the field that support our customers.

Other than corporate AEs basically?

That is right.

Sometimes we call them application consultants.

Field AEs is the appropriate term.

That was split from the sales force several years ago.

Fair.

The only other question was clarification, Brad.

That is, you had cited couple of times that your revenues this quarter were above the target range of 309 (ph).

From what I see, in terms of what you guys guided, I believe the guidance was 307 to 312 million for fiscal third quarter, was that wrong or did I miswrite it last quarter?

Let me check. 305 to 312, slightly above midpoint.

Fair.

Thank you.

Or about the consensus estimates.

Question from Jeff Macy with Needham and Company.

Couple of quick questions.

First of all, do you see the percentage of the customers R&D budgets spent on EDA tools for 2003 to be at similar levels that were experienced in 2002?

Yes.

Then, secondly, Brad, could you go over again the information that you gave about -- you said orders up 14% in 2002 and gave other percentages there.

Could you go over those again really quickly please?

Sure.

Orders up 14%.

Turn the page.

Inclusive of the Avant historic results, i.e. adding their standard of business to our history, Avant orders were roughly flat year to year.

For the software business, excluding consulting and training and related pieces, that grew apples to apples 2% year over year.

Consulting business was down by a third.

Great.

Thanks.

Next, question from the line of Tim Klein with US Bancorp Piper Jaffray.

Please go ahead.

Yeah, Brad, first on the bookings growth for fiscal '03.

Just as part of Jay's question.

You had said the booking is up slightly from where it was three months ago.

But, can you give us little more specificity around the growth rate?

You just told us growth rate in bookings for apples to apples for '02 to 01 was slightly flat.

Is it up or down (inaudible) for fiscal '03?

We are not giving booking guidance this year.

This time next year, we will tell you what it was.

Fair enough.

What is it -- you said revenue guidance is higher for Q1.

Is that just due to higher backlog, close rates, pipeline, what gives you that confidence from a quarter ago?

You know how the business works, right?

Specifically what dollars are coming out of backlog and what business do we expect to do?

We are three months better visibility.

Okay.

In terms of the pricing environment, I guess to confirm, you are not doing any more discounting than you had bee doing in recent quarters?

No, we said historically, discounting is volatile quarter to quarter.

Discounting actually improved just a bit Q4 over Q3.

The improvement is inside the measurement era.

We will call it flat.

Last question.

Aart, looks like you are gaining share versus Cadence.

Can you talk little bit about the especially like with the Astro product, are there specific, the more color you can give around the win rate per se?

Have you taken business directly away from Cadence in the placed area or is your momentum there more from capturing other opportunities within the Synopsys customer base?

Well, I was careful in my statement.

Right now we see engagements in respective installed basis and that the engagement at margin tend to be with smaller players, where we are doing better and better.

What we have seen is that astro, specifically, which we inherited in June, and at that time have started to see strong migration from Apolo to Astro, has become significantly more robust.

This is partially helped by additional push on frankly, quality management that I think we have good experience with.

At this point in time, we feel that Astro is doing extremely well and will not go into benchmarking mode.

That is the landscape.

It is a little early to call winners and losers here, especially in a market where customers prefer to not do anything.

But, the ones on the margin side are giving a lot of interest.

Okay.

Thank you very much.

Next, question from Alex Gauna with UBS Warburg.

Your line is open, sir.

Okay.

Thank you.

You already touched about your expectations for some revenue contraction prior to previous expectations in keeping with the expense cuts.

But, considering the share buyback program that has led to better than expected results this past quarter and your comments that the first quarter is tracking ahead of expectation.

Can you quantify perhaps, more precisely what is changing that is preventing you from raising the 3.25 cent guidance we have had for sometime?

Sure.

If you look outside in the semiconductor market lately, I think that the environment that we are in is extraordinarily difficult for our customers.

And I think most of them will tell you that they barely have visibility through the quarter they are in.

Never mind the next one or next year.

I think the advantage Synopsys has got is the ubiquity and essentially of the tools, number one.

Secondly, the stability of R&D spending as a general matter and are tied to that.

Thirdly, our ratable license model.

It is those things that allow us to generate an earnings expectation for next year.

Be clear part of our commitment to manage to $3.25 in earnings is moving expenses up and down as we see the world move around.

So.

Obviously you already stated that in the beginning of the call.

Yes, I have looked outside the window.

What the question was could you quantify what you have seen over the last couple of quarters in terms of your expectations from the top line and perhaps your need to deploy?

You mentioned you would be open to share count buybacks, what sort of latitude are you looking at in terms of deploying cash to bring the share count down?

Our strategy for share buybacks is pretty straight-forward.

Synopsys generates more cash than we can use in the business, either for capital expenditures, which are relatively small or for acquisitions.

You know, we believe it is not efficient to pile it up on the balance sheet.

Therefore, above working capital and our need for acquisitions and other things, we return to shareholders in the form of share buybacks.

That is our fundamental objective with it and we will continue on that basis.

Okay.

Aart, you had mentioned you saw particular strength in Nanosim, your analog mixed signal, can you perhaps give some reasons for the strength?

Where the deployments were going in the particular application areas?

Sure.

The reason there is interest for Nanosim.

What Nanosim is in the family of fast circuit simulation.

We see increasing number of chips that have some portion of analog on the chip that one would like to verify, together with a lot of digital.

So, fundamentally, it is mixed signal mixed chip verification, where this comes to bear.

Nanosim is fast at that and can very well handle the embedded memories in such a chip.

There should be no surprise we find more and more embedded memory.

It is not uncommon you would find 10, 20, 40, 100 memories on a single chip and verifying with Nanosim and the rest much our tools for the digital side is effective.

Would it be fair to say some of this is correlated to increased systems on a chip, design activity out there?

Sure.

In broader sense of the word system on a chip, initially we defined it as SOC for short.

It is something that has a processor core and some memory.

Now, increasingly, chips are complex things and contain analog portions and may contain specialized other blocks.

You are absolutely right.

More of that will bring about more the need for mix transistor level and digital simulation.

Is this need concentrate indeed any idea?

IDM leading in the thrust or perhaps Asia to a degree catching up and increasing their ability in system on a chip?

No, I think it is very broad.

I think many consumer products have some component of analog because they have to talk to screens and analog requiring interfaces.

So, in general, I would say that they are all over the place.

Okay.

Thank you. we are arriving at the end of the time slot.

Let's take one more question and call it quits.

All right, sir.

From the line of Jennifer Jordan with Wells Fargo.

Please go ahead.

I want to follow-up about replacement cycle for Apollo Astro.

At one point, prior to the merger, Avant talked about being on run rate to get the replacement to 45% done by the end of the year.

I believe you said you were about 25% done.

Any sense of what that discrepancy was in terms of -- was it just the downturn made people less reluctant to upgrade or it took longer to get your sales force into gear to continue that process?

I am not sure what the commitment of let say, the previous administration were.

The reality is that between the time of the announcement and June that whole part was in limbo, as we took it up, it started moving rapidly.

The second piece of reality was that we were able to deal with quality issues that were good for broader distribution.

The third piece of reality, which is the most important, we are charging for the upgrade.

So, we think that the 30% is great.

We think it is going to keep growing, including this year.

So, in that sense, I have no bad news and only good news.

Thank you.

With that, this concludes our call.

We appreciate all the support you have given us through what was a formidable transition for our company in the last year.

If I could summarize the essence of what we tried to convey to you, obviously the landscape is tough, but I think it is fair to say as a company we feel very solid.

The results support that.

We will manage aggressively and conservatively moving forward.

Thank you very much for your time.

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