新思科技 (SNPS) 2005 Q3 法說會逐字稿

Ladies and gentlemen, welcome to Synopsys Inc. earnings conference call for the third quarter of fiscal 2005.

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. [OPERATOR INSTRUCTIONS].

Today's call will last one hour.

Five minutes prior to the end of the call, I will announce the amount of time remaining in the conference.

As a reminder, today's call is being recorded.

At this time, I would like to turn the conference over to Lisa Ewbank, Vice President of Investor Relations.

Please go ahead.

Thank you, Beverly.

Good afternoon, everyone.

With us today are Aart de Geus, Chairman and CEO of Synopsys, and Rex Jackson, Acting CFO, Senior Vice President, and General Counsel.

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

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

In addition to any risks that we highlight during the call, important factors that may affect our future results are described in our Quarterly Report on Form 10-Q for the second quarter of fiscal 2005, which is on file with the Securities and Exchange Commission and in our third quarter earnings release.

Both of these documents are available on our website.

In addition, we would like to advise you that all financial information to be discussed on this conference call, as well as the reconciliation of any non-GAAP financial measures disclosed to their most directly comparable GAAP financial measures can be found in our third quarter earnings release and financial supplement.

Both of these documents are available on our website at www.synopsys.com.

With that, I would like to turn the conference over to Aart de Geus.

Good afternoon, and thank you for joining us.

Earlier this year, we set out three objectives -- increase revenue, improve our operating margin, and grow earnings under a predictable, stable business model.

Our strategy to meet these objectives is three-fold.

One, gain market share through superior technology and preferred vendor status; two, expand into new growth markets; and, three, improve our financial discipline, predictability, and profitability.

I'm very pleased to report that in our third quarter, we continued in the strong direction set in the first half of the year, making excellent progress on all our objectives and strategies.

Let me first summarize our financials.

Revenue was 251.5 million and non-GAAP earnings were $0.10 per share, both at the high-end of our target range.

Our transition to the most predictable license model in the industry is going well.

We booked 92% rateable and 8% upfront licenses.

Book-to-bill was approximately 0.9, notably higher than our internal target.

With a very strong first half we expect orders to be higher than planned for the year.

We're progressing well towards our goal of a 20% operating margin in 2007.

We're reflecting our solid performance in slightly higher 2005 targets for revenue and earnings.

From an operational perspective, we continue to re-engineer key processes throughout the Company.

We're also driving efficiency by streamlining organization and augmenting our presence in lower cost geographies.

During Q3, we rebalanced our field forces around the globe and shifted resources to serve Asia/Pacific where our already strong presence continues to grow.

The resulting efficiency gains will have the most impact beyond 2005, but the early savings from these actions largely offset the severance charges in Q3, which we absorbed in the P&L.

We will continue our cost focus going forward.

Regarding our CFO search, we are making good progress, and hope to announce an appointment in due course.

Moving now to the business update, let me first comment on the overall environment.

For the second half of the calendar year, forecast for the semiconductor industry, although still all over the map, are becoming more positive.

Our customers report a sense of gradual gains in business strength and movement to newer technology notes of 90 and 65nm appears to be well on track.

The majority of our customers are now driven by consumer and market needs.

As a result, they are focused on cost, time-to-market, and the amount of functionality they can put on a chip.

Our long-term product strategy meets these needs well.

While maintaining technical leadership to give our customers the most advanced technology, we're now focusing on improving the overall economics of design as well.

By addressing productivity, not through a set of point tools, but through a complete tuned solution, Synopsys delivers value that no other EDA company can easily match.

By using our platform, customers can simultaneously optimize for chip area, timing, signal integrity, power, test, and yield.

The benefits of this approach are visible and measurable.

Customers understand both the technical advantages and the economic savings in selecting Synopsys as their preferred vendor, and we have recently had a number of important companies commit to us.

In Q3; for example, we reached an agreement with one of the top fabless semiconductor companies in the world to be their main EDA provider and help them aggressively move to 65nm.

In the process , we grew our business across all product groups, and just last week, after a heavy competitive battle, we closed a multi-year growth contract with a large networking company.

They chose Synopsys as their primary provider based on their criteria of technology strength, support strength, and company strength overall.

Now let me turn to the results achieved by our platforms.

Galaxy, our implementation platform delivers better productivity than anything else on the market.

Specifically, IC Compiler, our new physical solution, went into general availability this quarter with consistently strong reviews.

At two public forums, seven customers, including Qualcomm, ST, ARM, Agere, Freescale, and SGI cited 8 to 10% better quality results, and most importantly, up to 50% better overall time-to-results.

This productivity improvement gives them substantial economic benefit.

No competitor can match these results today.

At this point, we've already received orders and revenue from several customers, and we fully intend to use our differentiation to capture market share.

We're applying the same productivity focus to our synthesis.

Our new Design Compiler was launched in May.

DC 2005 is unique in that it can predict downstream layout behavior much better than before, reducing costly iterations.

Hereto, customers are the only objective judges and ARM, IDT, and SGI have already reported four to nine times improved correlation between synthesis and layout.

In this picture, low power and yield are the two major challenges that can only be addressed through an integrated design flow.

Low power has grown in importance, not only because of its relevance to consumer markets, such as, digital cameras and cellular phones, but also because of physics of smaller geometries have become much tougher.

Synopsys is very strong in this area, consistently achieving 15 to 20% better results than any competitor.

In low-power benchmarks, we are virtually undefeated.

Our mainstream, low-power solution is used at 70% of customers today, including 10 of the top 12 chip vendors worldwide.

Our advanced low-power full flow is already in use at seven of the top 12 vendors.

Yield optimization is another Synopsys differentiator that has a big impact on the cost of chips.

Our investments during the last two years are paying off, as Galaxy's design-for-yield capabilities continue to drive business.

For example, Renesas Technology tapes out in 90nm design for wireless applications using Galaxy to meet its yield goals.

And the largest foundry in the world, TSMC announced Reference Flow 6.0, incorporating Galaxy low-power and high-yield technologies for their 90 and 65nm processes.

Finally in physical verification, our Hercules product has built a distinct advantage through its proven distributed computing capabilities, which was showcased at the Intel booth at the Design Automation Conference.

In one customer example, Hercules reduced the run time from 43 hours down to 1 hour and 48 minutes.

Our overall technology leadership position is visible in the statistics for advanced tapeouts at 90 and 65nm.

Of the approximately 223 90nm tapeouts completed today, more than 80% used Synopsys place and route.

And 13 of the 16 65nm tapeouts completed used Synopsys place and route.

This brings me to Design For Manufacturing, which had an outstanding quarter. 90, 65 and 45nm designs are dramatically more demanding in terms of lithography.

Of these geometries, design-related yield challenges cannot be ignored.

Our internal DFM investments and external acquisitions are paying off as Synopsys has emerged as the only vendor with manufacturing aware technology in all stages of the process.

Whether you're looking at yields, optimization in the physical tools, optical proximity correction, fracturing, or our TCAD offering, we had a strong showing in Q3.

Most notable was Texas Instruments adoption of our DFM environment for its design of 65nm and beyond.

Our agreement features not only an expansion of mass technology, but also large scale adoption of Hercules physical verification.

Now to Discovery, our verification platform.

Similar to Galaxy, Discovery drives productivity by seamlessly integrating many of the simulation, verification, and testbench tasks.

Hereto, the measurable evidence of five times faster performance is having a positive impact on our business picture.

Discovery drove competitive displacements at three large customers and expansion of our installed-base at six of the largest system companies in the world.

During the quarter, companies, such as, Faraday, ST, and Silicon Logic Engineering cited significant performance improvements with Synopsys new VCS.

In Q3 we also closed the Nassda acquisition, further solidifying our strong analog/mixed signal position.

The integration is progressing well, and customers are happy to see us take over that business and work with them on future road maps.

Moving on to IP and Services, we can report IP results ahead of plan driven by the strength of our analog and digital course, as well as a number of large IP subscription agreements.

The success of this business is linked to Synopsys having the most complete portfolio of analog and digital connectivity IP in the industry and a strong track record of quality.

In Q3, we made excellent progress in evolving our portfolio.

We taped out a number of highly different shaded mixed-signal cores supporting multiple high-speed protocols, such as, PCI Express.

We got silicon validation of our second-generation USB analog core, and we were first-to-market with Digital PCI Express 1.1 Upgrade.

Our Service Business, which supports customers for methodology and flows all the way to detailed design tasks, also had another strong quarter.

When our team streamlines a customer's flow, productivity arises enormously.

This quarter, our service and application engineers were called in to perform a number of tapeout rescues to help customers finish their designs.

In one such situation, a customer could not make a test flow converge, largely due to a mixture of unaligned point tools from other vendors and poor methodology.

After substantial effort, we not only got the chip to tape out, but we also demonstrated the value of closer proximity to Synopsys.

I'm confident that this customer will start their design with Synopsys Solutions next time instead of finishing with them.

At the end of the day, what our customers care about most is a reliable partner, with a complete solution who can offer measurable advantages in productivity.

Synopsys is well placed to deliver these customer requirements, and this quarter's results substantiate that.

With that, let me hand it over to Rex.

Thank you, Aart.

As a reminder, I'll be discussing certain non-GAAP measures of our financial performance, which are reconciled to GAAP results in the Press Release and Financial Supplement posted on our website.

With our solid Q3, we continue to make progress on our objectives to improve financial discipline and predictability, and to drive both topline and bottom line growth.

As Aart mentioned, total revenue for Q3 was 251.5 million, at the high-end of our target range.

Q3 revenue was up 3% sequentially, though down from the 282 million reported a year ago, reflecting our shift to an almost fully rateable license model.

We expect to return to positive year-over-year revenue comparisons in Q4.

We continue to see the positive impact of our license shift and the split between upfront and time-based or rateable licenses.

Upfront license revenue in the third quarter was 16 million, approximately 6% of total revenue.

Time-based license revenue was 189 million, 75% of total, and our highest ever.

Service revenue, which includes both maintenance and consulting, was 47 million or 19% of total.

For the third straight quarter more than 90% of revenue came from backlog.

From a product perspective, 77% of revenue came from our core Galaxy Design and Discovery Verification Solution, 18% came from our IP and DFM businesses, and 5% came from professional service.

One customer accounted for more than 10% of revenue in the third quarter.

We're pleased with the operational discipline, which drove solid non-GAAP earnings of $0.10 per share, non-GAAP expenses of 233 million, which included 4.5 million in severance costs, were at the mid point of our target range.

Non-GAAP expenses, exclude 24 million in amortization of intangible assets, and to first stock compensations.

In operating expenses research and development was up slightly sequentially, due primarily to the Nassda acquisition.

Sales and marketing also increased sequentially, due primarily to the severance costs I just mentioned.

Non-GAAP other income net was 2.9 million and our non-GAAP tax rate was 28%.

On the orders front, book-to-bill was approximately 0.9, higher than our internal target.

Every product area performed above expectations for the quarter.

We continue our execution on orders mix. 92% of product orders were booked as time-based licenses with only 8% as upfront in-line with our stated goals and versus the split that ranged from 20 to 57% upfront licenses before the shift.

The average length of our renewable customer license commitments continues to be approximately three years.

From a geographic perspective, North America was very strong this quarter.

Europe, however, continues to be weak as some of the larger companies struggle in their recovery efforts.

Asia/Pacific was steady, with a cautious, yet positive tone and Japan had another robust quarter.

The cash flow from operations was 64 million in Q3, reflecting both solid results and collections and the Nassda litigation settlement of 33 million.

CapEx was approximately 13 million.

Cash and short-term investments were approximately 500 million, down sequentially as expected due primarily to the Nassda acquisition.

Geographically, approximately 102 million of our cash is in accounts in the United States, with 397 million in accounts overseas.

During the quarter we repurchased 195,000 shares of stock at an average price of $16.65 per share, as we used cash for the Nassda acquisition.

As of the end of the quarter, approximately 437 million remained in our repurchase program.

Going forward, we will continue to evaluate the best uses of cash each quarter, including Company operations, investments, and stock repurchases.

Q3 accounts receivable totaled 109 million, down 26 million from last quarter and DSOs from 39 days, down from 50 days last quarter.

In both cases, reflecting strong collections.

Deferred revenue at the end of the quarter was 450 million, down 45 million sequentially as expected, reflecting timing of customer installments.

Of the approximately 22 million of Nassda deferred revenue at the close, we were able to carry over approximately 7 million.

Headcount totaled 4,781 employees at the end of Q3, a slight increase over last quarter, and included the impact of Nassda and some growth in low cost geographies, largely offset by the reduction in our field courses.

In summary, Q3 was a well-executed and well-managed quarter.

Before moving to our expectations for Q4 and fiscal 2005, I would like to comment briefly on the IRS claim we mentioned in June.

For those not familiar, we have received a report from the IRS claiming Synopsys owes an additional 477 million in taxes, plus interest with respect to our fiscal years 2000/2001.

This claim relates primarily to the establishment of our Irish subsidiary, which sells products outside North America.

In claiming we undervalued the transaction, the IRS has asserted theories we strongly believe are inconsistent with applicable law.

The IRS is made similar, unsuccessful assertions against many other companies.

Because we maintain that our position is correct, we filed a protest last month and we'll go through the appeals process, which can take up to several years to resolve.

We believe we have adequately provided for this item.

Now looking forward to Q4 and fiscal '05, please note that all of our target numbers are estimates only and are based on our judgment as of today.

Actual results may be affected by many factors, including industry conditions, mix of licenses actually sold, pricing, payment terms, tax payments, and the risk factors referred to earlier.

For the fourth quarter our targets are -- revenue between 248 and 258 million; total non-GAAP expenses between 227 and 237 million; other income and expense between 0 and 4 million; a non-GAAP tax rate of 29%; outstanding shares between 142 and 150 million; and non-GAAP earnings of $0.07 to $0.11 per share.

We again expect more than 90% of the quarter's revenue to come from backlog.

For the full year, our targets are -- revenue between 985 and 995 million, an increase in the top-end of our range of 5 million and the bottom-end of 25 million over our previous targets given at the end of Q2; a non-GAAP tax rate of 31%; outstanding shares between 142 and 150 million; and non-GAAP earnings per share between $0.36 and $0.40, an increase from our previous range of $0.31 to $0.39 per share at the end of Q2.

We continue to expect cash flow from operations to be approximately 200 million.

Over the next four quarters, we expect approximately 820 million of our beginning of quarter backlog to turn to revenue.

We are currently going through our annual planning process of 2006 and beyond, and we'll provide our financial targets for 2006 during our next earnings call after Q4.

With that, I'll turn it over to the Operator for questions.

Thank you.

Ladies and gentlemen, [OPERATOR INSTRUCTIONS].

Our first question comes from Garo Toomajanian with RBC Capital Markets.

Please go ahead.

Thanks.

Rex, I was wondering if you could both repeat the impact from Nassda on deferred revenue and what you expect for deferred revenue, really the treatment of DR there going forward?

And also what was the impact of Nassda in the quarter?

So the deferred revenue at close was 22 million, of which we expect to carry over approximately 7 million.

And as far as the end quarter performance, we tend not to get to that degree of granularity.

Okay.

Question for Aart, sounds like DFM has turned out to be a real key issue for success in customers who are moving to 90nm.

And it sounds like you're expecting that to continue as people move down to 65.

I'm wondering if you're seeing any other sort of new technology requirements that are becoming sort of "can't do without" items as people look at 65?

Well, already before 65, at 90 I would say that low power is a killer.

And this is visible even in external statements of some companies that have been in the processing world and have seen that both power dissipation and power leakage is a big issue.

And at 65 that just gets worse or from our perspective, better as an opportunity.

And so that is probably the other major theme.

Somewhere in-between the low power and the yield is actually signal integrity, meaning that the quality of signals on chips becomes more and more suspect, therefore, being able to deal with that as you do your synthesis, as you do your place and route, as you do your extraction is absolutely imperative.

And I think what gives us an advantage over competitors is not only that we deal with each one of these problems very well, but that we deal with them in aggregate simultaneously and that is really where technical problems impact productivity.

Okay, and as you point out, things like power and signal integrity have been issues, is there anything sort of new that you think might be coming up as sort of a key factor at 65?

So far the people that are using 65 are reasonably optimistic that the ship is not keeling over with smaller geometries.

Okay.

What is clear is that the optimization for yields becomes much more important and you can certainly put that under the classical DFM from the manufacturing side or you can put it on the design side.

But what we have put special attention on is what are all the things that we can do in the place and route to specifically improve the yield.

And so per your opening comments, why are people especially interested in Synopsys is because by having solutions in the entire flow we have by far and away not only the best shot of understanding all the problems, but also effecting the integration that can resolve them simultaneously.

Okay, and question again for Rex, I think.

What are your expectations about G&A senses in Q4 and beyond, Magma litigation claims construction hearing I think started this week.

I'm wondering if you're expecting G&A expenses to start ticking up based on some of that?

Well, we do have some pressure from the standpoint of compliance with SOX as most public companies do here as we head into the fourth quarter, litigation expenses are in and of themselves not material.

But we expect expenses to be fairly consistent with the ranges that we've given.

Are there any additional expenses due to the IRS audit?

They are nominal.

Okay, great.

Thank you very much.

Thank you.

We'll now go to the line of Jay Vleeschhouwer with Merrill Lynch.

Please go ahead.

Thanks.

Good afternoon.

Aart, couple questions around bookings.

When you look at perhaps your top dozen or two customers, what are you seeing in terms of those that are increasing their run rates with you, either currently or that you would expect them to do over the next year as opposed to accounts that may be keeping you flat or even cutting you back, again, either currently or in terms of any expectations for the next year?

Secondly, product question, you said that IC Compiler should on average yield more revenues per customer or per seat than similar PC and Astro configurations.

And I realize it's early still, but are you beginning to see that upsell revenue effect per license as a result of IC Compiler?

Okay.

Well, obviously we are watching with great interest how renewals come in, and I would say, and this is off the top of my head.

I don't have the exact numbers, but I would say that 80% of the deals that we do are larger.

And so -- than the deals that we had before.

And so that means that there's maybe 10 to 20% of customers that are truly struggling and, therefore, not only want to reduce their budget with us, but want to reduce typically their budget overall.

Even in those situations where there are budget reductions, I think we fare very well in terms of how the reductions effect us versus our competition.

And so maybe putting it even more positively, my sense is that with the number of people we are starting to make gradual progress towards a preferred vendor status.

And we're at the very large people, of course, then to have many suppliers, all the mid range companies are probably faster at moving towards preferred status.

And then with the large guys, they are, I think we're making just good progress in capturing a little bit more of the budget overtime.

So all-in-all, pretty well.

IC Compiler is very helpful in that context because IC Compiler is clearly our demonstration of being on the next generation solution.

And all the people that have touched IC Compiler are reporting strong results and quite a number are now in the process of factoring it in in their rollout plans as they roll out new technology.

The price point for IC Compiler is I believe about 35% higher than the aggregate of PC Astro, and so it only brings the potential for some uptick overtime and we have seen now this quarter already orders and some revenue.

And so I think that shift has started and now it will be partially up to us and partially up to our customers to see how much we can accelerate it.

Rex, in your comments about geographic performance, you highlighted Japan, and the question about that is to what extent are you seeing the customers with whom you did the large orders two and a half years ago in the spring of 2003 beginning to do perhaps early or at least incremental expansion business in the interim prior to the nominal expiration dates of those deals?

And then lastly back to Aart, you mentioned that you are focused on cost, but how much more can or should you do?

Do you think that your cost structure is still by and large inappropriate given the revenue outlook?

So taking those in order from a geographic perspective, we obviously give you kind of a high-level allocation.

I wouldn't comment on individual customers or the status of individual customer deals.

From a cost perspective, obviously as Aart indicated and as I indicated, we are focused heavily on operational disciplines in driving cost out of the Company where it's appropriate.

Obviously, concentrating on lower cost geographies because that's where our customers and support requirements are trending as well.

But in terms of putting an actual number on it, that would be an FY '06 issue.

Maybe if I can comment a little bit on the deals.

I think that the very fact that we have a lot of powerful new technology does bring people to the table either incrementally or wanting to renegotiate things.

And in general, my sense is that the renewals are becoming more smeared out in general, if I can put it in those terms, which is a good thing because that means that our customers are continually engaged with us and you mentioned earlier IC Compiler.

I think we want them to be engaged with us because there's some real productivity benefits here that will have a big economic impact on them if they can't adopt things more quickly.

Just to reiterate maybe a different way what Rex said, we are very much committed to manage the Company even better from an expense point of view.

At the same time, we also very much see the opportunity of both gaining market share and moving to this preferred vendor status.

And so it's going to be a balance between those two things.

But the best thing we can do is really go after all the inherent processes in the Company and see if we can move them closer to be at either revenue generation or value creation and that is what we're doing.

Thanks, Aart.

You're welcome.

Thank you.

Our next question comes from Harlan Sur with Morgan Stanley.

Please go ahead.

Great.

Good afternoon, and nice job on the quarter.

First, just a couple of housekeeping items.

I think you mentioned the multi-year contract with the networking company.

I was just wondering was this a networking chip company or a large networking OEM like a Cisco or a Lucent?

Well, normally we don't comment on specific customers for many good reasons, and so given that there are not that many companies, if you don't mind, I won't answer this question.

But --.

Was it a chip company or was it an OEM?

Well, there are too few companies and it's too easy to guess.

Got it.

If I can just answer it differently, the progress that we're making is clearly with people where they are doing advanced chips and where they see some lead apps.

The complexity of the advanced chips is bringing such pressure on productivity that by moving more coherently with us, they can truly impede the problems that they are seeing with not finishing chips, with not getting on specs, et cetera.

And I expect that going forward we're going to see more companies select a primary vendor in order to get the benefit of these integration.

And the company I mentioned here is essentially not only saw that benefit, but also saw the benefit of the point of technology that we offer.

Great, and then I guess on that same note, just in general, are you seeing any spending differences between your semi customers versus your systems OEM customers?

You know, I couldn't tell you that I am seeing any big differences.

I do see that there are gradual shifts where everybody is moving up the food chain a little bit, if I can put it like that, meaning that the semi customers are doing more and more a little bit of systems design or chipsets, certainly embodies systems -- by virtue of system on a chip, but almost moving to subsolutions.

The system guys are moving up towards truly broad solutions with a lot of embedded software.

And in all fairness, you can see that we are providing more embedded capabilities by virtue of our IP business.

And so, I think that's a natural trend in the industry and bodes well for us because we're well connected to the people that could use our IP.

Okay, great.

And then one more question for you, Aart.

At DAK we heard from many of your early partners in IC Compiler.

As you mentioned, performance results were very compelling, but at least back in June, customers were still waiting for certain critical features, such as, support for [multiDVD] domains, integrated floor planning, and powerware placement.

And so maybe you can provide us with an update since DAK, as to what are some of the new features that have been incorporated into the IC Compiler platform?

I want to be careful to not say more than I know in specifics.

I am well aware of some of the features and I'm well aware of the technical progress, which is completely on track versus both customer expectations and our own internal plans.

But to be honest, I don't know what the exact release date is.

So maybe we can take that offline.

Maybe the macro answer is really that with the capabilities that IC Compiler has today, a number of people are seeing substantial productivity improvements.

The capabilities that you're referring to will be especially helpful to them as they use some of the low power issues -- or deal with some of the low power issues.

So I think we're well on track with that and we don't see any issues in delivering.

Okay, great.

Then one last question for Rex.

With regards to the litigation with Magma, so I believe the Markman hearing started on August 15th; is that correct?

That's correct.

It was Monday.

Okay, great.

And then so maybe you can help us with laying out the set of events that happens between now and trial date that's set for April of 2006?

Sure.

So there was the Markman hearing, of course was February update yesterday on the 15th.

There is a hearing currently scheduled for September, which we anticipate will be kicked into early October for reasons associated with the Judge.

The trial is still scheduled for April 2006, so those are the big sign posts on the calendar.

As you can imagine, there's discovery and motions practice and that sort of thing that will happen between now and then.

Okay, great.

Thank you very much.

Thank you.

We'll now go to the line of Rich Valera with Needham & Company.

Please go ahead.

Thank you.

Rex, first just a quick one for you on the severance costs.

Was that 4.5 million?

Yes.

And that was mostly in sales and marketing?

It was entirely in sales and marketing.

Great, and I know you guys haven't given bookings guidance and probably don't want to, but historically Q4 has been a strong quarter, even last year in a very tough year you had a positive book-to-bill.

Is there any reason we shouldn't expect a positive book-to-bill in your fourth quarter this year?

Well, as you said, as you know, we never give bookings indications ahead of schedule.

Bottom line is I think we feel very comfortable that the bookings year will be strong.

And I think we alluded to that in the pre-prepared remarks and so at this point in time, Q4 looks fine.

And the only other thing I would add to that is, and confirming Aart's correct, we obviously are forecasting a better bookings performance this year than we had originally anticipated and we also would expect our backlog as we exit the year to be higher than the exit on FY '04.

Great.

That's helpful.

Aart, with regards to the competitive landscape, you made some reference to the new Design Compiler in your prepared remarks.

I'm just wondering if you could give a little more color on your view of the competitive landscape there as you're probably well aware, two of your nearest competitors have made some claims about competitive end roads in the synthesis space recently.

Just wanted you to give us your feel of how you feel you're positioned in the market and how you feel the market share trends have been recently?

Have they been gaining market share against you?

Well, we cannot see much of gains on market share on that part.

I'm sure that they probably sell some into their existing installed-base.

One of the things that makes us feel quite bullish on synthesis, which is an area clearly we have been in the lead for many, many years, is that we are coming out with our own next-generation capabilities, which is quite substantially different from what we had before.

And the difference brings -- comes back to this fundamental notion of moving more and more to productivity improvements.

What the new Design Compiler, Design Compiler 2005, has is an ability to essentially look ahead as to what the place and route system will do, and therefore, pardon the expression, "how to do dumb stuff."

Because if you have that look-ahead capability, sort of be a little clairvoyant, if I can put it like that.

You can reduce the number of iterations that tend to occur late in the cycle where they are most expensive.

And the reason this is so relevant is that if you look at overall productibility -- I meant predictability and productivity, two difficult words.

If you look at productivity overall it is very much impacted by how often you have to come back on earlier decisions.

And by optimizing that, we think that we can make a significant impact again on the overall economics of design, and in the process, take yet another step towards becoming measurably so the partner that can offer the best solution overall.

And so it's in that context that Design Compiler will stay very much state-of-the-art on its own, but also state-of-the-art in the context of a broader productivity solution.

Great, and one other sort of big picture question.

The big foundries, particularly TSMC have started to seemingly get a little bit more into the IP area, they've sort of offering some libraries and I think there's talk of them offering more on the embedded memory side.

How do you see them longer term in the IP area?

Do you see them a competitor for you?

No, not at all.

As a matter of fact, we see them as a strong partner.

Most people don't know that today we distribute TSMC libraries and there is a good reason for that, which is we have broad access to many customers that optimize their designs with these libraries.

Secondly, it's very clear that TSMC is uniquely equipped to know more about their silicon than anybody else.

The same is certainly also true for in embedded memories, which are even more linked to the specifics of the silicon.

So going forward, where we see us go is that we will have an even tighter relationship in helping and working with TSMC, optimize their libraries for yields for better results.

We have been doing this already for a little while, and I do see them completely as a strong partner for Synopsys.

Great, thank you.

Thank you.

Our next question comes from Sumit Dhanda with Banc of America.

Please go ahead.

Yes, hi, guys.

Couple of questions.

First, Aart, can you comment on the general renewal pipeline that you're seeing at this point in time?

I know this was not a big area for renewal, but do you see that picking up going forward?

And are you seeing more early renewals than you had anticipated?

I would say, in general, the answer is a little bit yes.

And the reason I see it a little bit yes is that although renewals have somewhat of a natural cycle they can greatly be influenced by either the need of the customer to somehow reduce costs and that can be very urgent, or they can be influenced by new technology becoming absolutely essential.

Incidentally, both of those are good for us.

Good for us in the sense that if the customer wants to reduce costs, we are uniquely equipped to help them consolidate some of their needs and have done so with some accounts recently.

And I expect that to continue as, oh, a broader solution is not only economically better for them, but technically significantly better as well.

Secondly, the other thing that triggers earlier renewal is, of course, exciting technology, or the need for it.

And so IC Compiler I think is exciting technology.

Low power is clearly a need that customers perceive sometimes through pain.

And so when that occurs, we are suddenly completely willing to engage immediately with them on any renegotiation they would like to go into.

Okay.

The other question I had was you talked about rebalancing your forces and shifting resources and that's going to lead to some cost efficiencies.

Could you perhaps quantify that a little bit, or is it too early to tell right now?

Well, we have been a little cautious about being too specific because very often there are people involved and that can be -- one needs to be careful on how to do it well for those that may be effected.

What we have communicated is that in this last quarter we took a number of steps specifically with our field force and not only to optimize it, but also to balance it towards those geographies that have high promise or high growth.

The same applies to the rest of the Company as well, and in addition, it is clear that all attrition and changes we tend to in general fill by having rebalanced towards the lower cost regions.

As we go into the '06 planning or maybe differently put, as we communicate to you our plans for '06, at the end of this coming quarter, I think we will be able to give you a little bit more details about this.

But I think to the earlier question, I believe Jay, cost is now part of our vocabulary and so we're learning the discipline to do it well, but we also want to do it in such a fashion that the long-term growth is really maximally leveraged.

Okay.

Thank you very much.

You're welcome.

Thank you.

We'll now go to the line of Dennis Wassung from Adams Harkness.

Please go ahead.

Thank you.

Few questions.

I guess first for Aart on the DFM side of the equation, I'm curious if some of the growth you're seeing here in the last few quarters and kind of going forward, is it really driven by 65nm right now?

And to that end, you talked about TI making a big investment with DFM.

I'm wondering what drove that, was it OPC, TCAD -- you also pointed to Hercules?

Anything else you can give us on that would be helpful.

Sure.

I think, in general, you're right. 65nm is a strong driver.

We saw some of that already at 90.

But what is happening is that the size of the problem in terms of just the sheer amount of verification, the sheer amount of radical enhancements, tricks that you have to apply, is growing massively.

And so not only do -- are these problems more complex in terms of being able to understand what the implications are of changes, the sheer computing that is attached to it go through the roof.

And so if there's one core differentiation to our product, it's something that I think we thought out very well a number of years ago, which is to instrument well distributed computing.

And some of that has become very visible and very measurable, especially on the 65nm problems.

I think this was one of the key drivers that motivated TI to massively bet on Synopsys as its solution for DFM.

Now, a company like TI will be very cautious to at the same time make sure that the accuracy of what we do is guaranteed and of high quality.

Because any tool that touches the tapeout or thereafter deals with an enormous amount of data where a single mistake can be fatal.

And so we have I think very proven tools that are now also leading edge in terms of their computational abilities and those are really the drivers that make us bullish on this area.

So was that a competitive displacement, or is that kind of an acceleration or I guess just a growing effort for you on that, on the TI account?

Well, I always am hesitant to comment on specific accounts because one tends to put words in the mouth of a customer.

Let me rather comment in a generic fashion.

I think one couldn't call a competitive displacement 65 because people are just moving there and so then we are the new player in town, or the player that is really growing there.

At 90, clearly we are replacing existing players.

Okay.

And a quick question for Rex.

On the IRS claim, you made a comment that you believe you have adequately provided for this item.

Can you just describe what you mean by that and is there any sort of financial impact you have to take now in terms of reserves or anything along those lines?

So I meant that predominantly just that, that we've taken a hard look at the case, and/or the claim and our arguments there is et cetera.

We've assessed it and consider the existing provisions that we have for this issue sufficient.

Okay, and I guess last question for you, Aart, just it's sort of a broader environment question.

You talked a little bit about the semiconductor industry and signs improving.

What are you seeing at this point in terms of the EDA spending environment?

Are things improving at this point?

We're seeing relatively good results from Cadence, yourselves here, coming in at the higher end of expectations.

Are you starting to see or feel the, maybe a little bit more growth coming on the EDA side of the, I guess in terms of the core EDA markets?

Well, I think that it varies quite a bit as a function of how well the individual companies are doing.

And so I think the difference between the companies that are doing well and those that are struggling are becoming a little bit more marked.

And those that are doing well are now starting to think, hey, could they accelerate their lead by moving to the small geometries faster or moving to them at all as their competitors may have a hard time.

And so with those companies, I do think that we'll see an increase in spending around EDA.

The other category of companies are the ones where the spending may stay either flat or even go down a little bit, but they will try to get better value by virtue of consolidating their suppliers.

And then, of course, there is a category of companies that do both, and in both of these, we do very well.

And so I think in aggregate, we will see actually a market that is quite healthy for us going forward because the value of EDA is unquestioned right now.

The solutions that we have are working well, and we can offer customers both an acceleration in technology return and/or a reduction in aggregate costs, and so for Synopsys we are moving rapidly to preferred vendor status.

Thank you.

You're welcome.

Thank you.

We'll now go to the line of Raj Seth with SG Cowen.

Please go ahead.

Hi, thank you.

Aart, if I could follow-up on that last question a minute.

Can you put a number around what you would expect industry growth to be, say, over the next year?

Is this a 5% growth market?

A 10% growth market?

How should we think about that?

You know, we debate this question internally, Raj, every week.

And that tells you that we have a hard time putting a number on it.

Partially, because these contrary trends of on one hand more technology being needed and some companies doing well, on the other hand consolidation occurring, makes it actually quite difficult to predict the market growth per say.

What I can say is that I think that in the core markets, this will probably be flattish to slightly up.

I think that in the adjacent markets, this is new territory and there I think we absolutely see growth.

But I couldn't tell you honestly with any high degree of certainty these numbers with a 5% accuracy.

I do want to reiterate, though, that in the context of this market, we feel that the completeness and the strength of the technical solution at the moment where cost is still very relevant in design bodes well for us.

And so it is from that perspective that I am not particularly worried about the market.

I want to worry more about how quickly can we make our customers adopt some of the new technologies because there we will do well.

If the market is growing "X" over the next 12, 18 months, what do you think -- and I recognize this is probably a little tough.

But what do you think the share gains that you're suggesting will allow you to outgrow whatever the market growth does?

In other words, what kind of delta is there, you think, on Synopsys growth relative to wherever the market growth comes in?

It's a good question, and the short answer is it's positive, but that's obviously not what you're looking for.

The hesitancy you find in my answer is that we are now clearly in the land of doing multiyear agreements with companies.

And what we are seeing here is that the EDA market will be somewhat unpredictable, whereas our own business is becoming more and more predictable.

And so I think that by the time we arrive at the end of Q4, we hopefully can give you a little bit sharper answer to this question as we share with you where the plans are for '06.

And this time around as we're making our plans, we are looking simultaneously also at '07 and '08.

And I think that will make for a much better planning and hopefully also a sharper insight on what the market itself can do.

One other, if I might.

You've talked about preferred vendor status, et cetera, and moving to preferred vendor status.

What does that mean?

Does that mean that large semis will consolidate buying around one principle supplier?

Or is that just a reflection -- a continued reflection of the general consolidation towards bigger suppliers you've been seeing for a year or so?

And if it means one supplier, among the top 20, let's say, semiconductor manufacturers in the world, do you think by the end of '06 they will have picked a single provider, let's say, RTL, the GDSII, to do the majority of the design that they are doing in-house?

I wouldn't go quite as strong as you formulated as single vendor, because customers will not only not have a complete solution from one vendor because there's always some additional capabilities maybe once or there may be some good niche company offering something.

But when we talk about preferred vendor, it is the one that they count on to deliver things if that vendor has them.

Secondly, if he's the vendor in which they invest to actually drive their productivity forward.

And it's actually my second statement I think that's the most important because as much as many of these decisions get triggered by the desire to manage expenses and costs like any good company would, the return is very much based on, can you get a flow to really improve your productivity.

And what is interesting is that the combination of a desire to manage expenses and for the first time a much, much better understanding how much productivity is impacted by actually having a well-tuned flow, that is where we play.

And so the last component in that equation is actually the support to help get them there, meaning that none of these transactions is like, well, you decide today and a month later you have one supplier or so.

No, it's a gradual transition to many chips in the works.

And I think one of the things that Synopsys has been doing well is to have a base of support around the world with all of the big players that is recognized as high quality, completely dedicated to making sure that tapeouts happen no matter what, and that that assurance is the best guarantor as they migrate more and more to a preferred vendor situation.

Thank you.

Last quick one, and I'll just listen for the answer.

Can you talk a little bit about pricing, particularly what you see in some of the mid tier accounts?

Sure.

I'm not sure that I can actually distill it by account tiers, but in aggregate we do watch the discounting as it happens and we did not see a degradation of discounting on our part this quarter.

We did see some pretty far-out negotiation situations, as clearly some players are trying to just hang on.

And I think that will continue for a while, but our job, and this is where -- why I'm excited, but also see still a lot of work to do, is to get to a place where we can measurably demonstrate productivity.

Because once we anchor this around the word measurables -- measurable, then suddenly you're talking real value.

And once you're talking real value, the cost equation, of course, is important, but I think we'll pale in comparison.

And that is really the shift that our industry has to go through.

And that is the shift, I hope, that we are leading in because that will put us on a whole different value proposition than a collection of point tools where you have all the -- all your suppliers just beat each other up.

And we are three minutes to conference end time, there are two questions in queue.

Do you wish to proceed?

One more would be great.

Absolutely.

We'll go through the line of Tim Fox with Deutsche Bank.

Please go ahead.

Hi, thank you.

Aart, maybe just one question, not to beat the expense issue to death.

But you mentioned that the 20% operating margin was still a commitment for fiscal '07.

Wondering if this is what you consider a quote/unquote long-term operating margin target for you or if this is just an intermediate step?

Tim, I think I get this question every quarter and my answer, is you know, more comes after 20 and so it will be between here and where we are today and 20, we have a lot of work to do, and so we want to focus on that for right now.

Can it be higher after that?

There's no reason to say no, because a good company can do very, very well.

And as you know in the past, we have been higher than 20%.

Where we stand today, we first have to make it there and so that's what we're focusing on.

But most importantly, I think as we are maybe much more conscious and also speak about it more, we as a company are maybe learning the skill of expense management better than we have in the past and of course that starts with me.

Okay.

That's fair.

One other question for you, Aart.

You're now sitting I guess on 500 million in cash.

You've maintained that you've got a buyback program in place.

Do you foresee any other M&A opportunity going forward, and if so, which segment may that be in?

Would it be in some of the revenue growth segments you've been referring to earlier on the call?

Well, as usual, you never can really in practice comment about future M&A.

As a company, we are certainly capable of doing M&A and have done a lot in the past.

I think generically speaking, we have become more cautious in terms of the valuations that we're willing to pay.

And if I can put that in historical perspective, I think one of the key objectives for the last 10 years or so was to get to the point of having a complete solution.

We're pretty much there.

And so from that perspective, that imperative, which did cost us a lot of money at times, is sort of gone.

Now the imperative is how do we leverage the Company to get our earnings per share back up and there's internal things, such as, the cost controls that you mentioned.

Most importantly, actually most importantly is the revenue growth, and if there are M&A opportunities that satisfy those criteria, we for sure would consider them and cash is a fantastic asset to be able to do that on a moment's notice.

Okay, and lastly, more of a housekeeping question I guess for Rex.

You mentioned book-to-bill was about 0.9 in the quarter.

Is that -- just a reminder -- was that total bookings, or is that product bookings, and if it is total should we assume that there is any difference between the product and non-product bookings growth?

It's total.

And there is no difference between -- there's no distinction as you described.

Great.

Thank you.

Okay.

Okay.

With that, we appreciate your participating in the call.

As usual, Rex, Lisa, and I will be available afterwards and we appreciate your time.

Bye-bye.

Ladies and gentlemen, this conference will be available for replay after 5:30 p.m.

PT today.

You may access the replay service by dialing 800-475-6701 and entering in the access code 791814.

International dialers may call area code 320-365-3844.

Again, those numbers are 1-800-475-6701 and area code 320-365-3844, entering in the access code 791814.

That does conclude our conference for today.

Thank you for your participation, as well as for using AT&T's Executive Teleconference Service.

You may now disconnect.