新思科技 (SNPS) 2007 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to Synopsys Incorporated's earnings conference call for the second quarter of fiscal year 2007.

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) 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, Pamela.

Good afternoon, everyone.

With us today are Aart de Geus, Chairman and CEO of Synopsys, and Brian Beattie, Chief Financial Officer.

During the course of this conference call, Synopsys may make forecasts, targets, and other forward-looking statements regarding the Company and its financial results.

While these statements represent our best current judgment about future results and performance as of today, the Company's actual results and performance are 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 this call, important factors that may affect our future results are described in our Annual Report on Form 10-K for fiscal 2006, our quarterly report on Form 10-Q for our first fiscal quarter, and in our earnings release for the second quarter.

In addition, all financial information to be discussed on this conference call, as well as the reconciliation of the non-GAAP financial measures to their most directly comparable GAAP financial measures, can be found in our second quarter earnings release and financial supplement.

All of these items are currently available on our website at www.synopsys.com.

With that, I will turn the call over to Aart de Geus.

Good afternoon.

I am pleased to report that Synopsys had another very strong quarter, which further solidifies our outlook for the fiscal year.

We continued our excellent business execution, with strong revenue and earnings growth, solid cash flow, and on our very predictable business model.

In technology, we see momentum, with new product introductions and customers adopting our complete platforms.

We also continue to evolve our go-to-market approach for value capture and simultaneously invest in future growth.

Let me begin with some financial highlights.

In Q2, we delivered excellent earnings growth.

Non-GAAP earnings were $0.35 per share, more than double the same period last year.

As a result, we are raising our earnings guidance for the year.

Revenue in the quarter grew 7% year-over-year to 293 million.

We managed costs well.

Non-GAAP expenses were 229 million.

Our plan is to take a portion of these savings and invest in growth initiatives, while holding total expenses for the year to a slight increase as we had planned.

With our revenue and expense performance, we met our 2007 operating margin target ahead of schedule.

It was 22% in Q2.

We anticipate the full year operating margin to be approximately 20% as we drive towards our mid to high 20s target over the coming years.

Before delving into technology highlights, let me comment on the overall semiconductor landscape.

Interacting with our customers we see a broad spectrum of challenges and expectations.

Whereas some companies are doing very well with solid results and expectations, others are reporting tepid results.

While it is difficult to predict short-term fluctuations, we are optimistic about the industry's long-term growth perspective.

Technology drivers, such as VoIP, internet video, and consumer electronics in general, all provide a solid basis for sustained growth in semiconductors.

Our view is supported by continued growth in advanced design starts, driven by the demand for complex multi-faceted consumer devices.

In fact, in the last 6 months, the active 65-nanometer designs we track have increased more than 50% to 441.

Even at 45-nanometer, we already track more than 50 designs and 9 tapeouts, virtually all are relying heavily on Synopsys.

The migration to 65 and 45 nanometer is visible, not only in logic and IC design, but in the memory sector, as well.

At the same time, customer budget pressures are intense.

Technology development and capacity costs are making customers rethink how they differentiate.

Recent announcements show a shift by some IDMs to a fab light business model.

Some are also forming manufacturing consortia as a way to share costs.

Synopsys is well-positioned to help customers meet their new requirements.

During Q2, we saw a number of companies increase their commitment to Synopsys.

In fact, we expect business for the year to be stronger now than our initial plan.

SD Microelectronics, we present a great example of how we help customers solve the competing challenges of extremely demanding technology with the need to minimize the cost of high volumes.

In fact, SD achieved first silicon success for a complex 65-nanometer consumer chip by using Synopsys throughout the entire flow, from IP to implementation, to verification and final signoff.

Complex chips especially benefit from using our complete flow.

Only powerful integrated platforms can truly tackle this maze of interrelated design objectives.

Our investments in these kinds of platforms over the last few years are paying off.

This brings me to the product highlights for the quarter.

Let me begin with our Galaxy implementation platform.

Galaxy integrates the industry's de facto standards in both synthesis and signoff, with state-of-the-art physical designs.

In Synthesis, where we have a clear market lead, our new topographical technology is having a major impact.

It has an uncanny ability to accurately predict and avoid downstream place and route issues.

This capability, which I like to refer to as clairvoyant synthesis, substantially reduces costly physical iterations.

Design compiler topographical is not only consistently winning benchmarks, but customers such as [High] Silicon, and Cypress Semiconductor are seeing great improvement in correlation and performance.

ST Microelectronics is adopting DC topographical in their 90 and 65 nanometer ASIC design flows, for both internal design groups and external customers.

In physical design, IC Compiler is performing well.

Our upgrade ramp is right on track with more than 100 engagements, and many tapeouts and active designs all the way down to 45 nanometer.

As an example, after carefully evaluating all options, Renaissance chose IC Compiler for their production IC design flow.

Our products have better quality results through multi-mode optimization, much faster turn around time, and overall ease of use.

In Signoff, we continue to enhance our Gold standard technology by integrating features, such as low power and variation aware design.

Fujitsu standardized on PrimeTime and Star-RCXT as their Signoff solution for their 65 nanometer design flow.

Meanwhile, Synopsys is the leader in advanced low power designs, thanks to a comprehensive end-to-end solution that optimizes for power in every phase of the design flow.

In Q2, Synopsys and [ARN] announced an IC Compiler based joint flow for high performance, low power applications on advanced design.

Another key challenge at the most advanced technology node is yield.

The latest consumer products are all built on the latest technology node.

Companies are forced to quickly ramp production of hundreds of thousands, or even millions of devices to satisfy channel demands.

Fortunately we anticipated this a number of years ago, and began to assemble key technologies in both the design and the manufacturing domain.

We have integrated the two domains to enhance yield at 65 nanometer, and especially at 45 nanometer and below.

Today, our design for manufacturing strategy is bearing fruit with DFM revenue growing in the double digits.

Our first integrated product was PrimeYield, which links data directly from the fab into the designs.

During Q2, we announced several technology advances.

Ease of use and performance enhancements to PrimeYield, A single user interface for physical verification, PrimeYield, Mass Synthesis, and TCAD, and we linked our Proteus lithography technology with our mass data prep.

This linkage reduces run time by 20 to 30%.

During the quarter, we also announced the availability of an advanced Hercules physical verification suite.

This suite supports the latest release of 65-nanometer design kits from IBM.

Now to Discovery, our verification platform which is also doing very well.

A number of years ago, we made four predictions.

One, verification needs would grow faster than Moore's Law.

Two, next generation verification and debugging had to be broader, more integrated, and faster.

Three, support for the system Verilog language would be key.

And four, smaller geometries would bring a greater need for analog and analog mixed-signal verification.

We systematically developed our technology around these predictions.

Our recent business successes with double digit growth are evidence of our vision and our momentum.

In digital, the rapid migration to system Verilog, supported by the raw speed advantage of our verification solution accentuates our differentiation.

Today Synopsys is by far the leader in system Verilog solutions.

In analog mixed-signal, we have had great technical end market progress, as well.

In Q2, we introduced AMS 2007, which allows users to easily balance accuracy and performance.

Past solutions were either more accurate, such as HSPICE, or faster such as NanoSim and HSIM.

With our new technology, customers can have both.

In addition with AMS 2007, we improved the links between our analog and DCS based digital verification.

Moving now up to systems and IP.

We have had good momentum, as well.

This adjacency is growing at about 20%.

We are both participating in and benefiting from a rapidly evolving IP industry, as more and more large customers were outsourcing their IP needs.

Internally developed IP unless it is highly differentiated is no longer economically viable.

Instead, companies such as Synopsys become the partners of choice, especially in standard space IP.

The keys to the IP business are reused competence, quality, and long-term trust in the supplier.

We do well on all three counts, and have spent years developing a strong portfolio.

Today we are one of the top IP companies in the world, and #1 in a connectivity IP, with standards such as USB and PCI Express.

Over the past several quarters, our analog productivity IP has been especially successful.

In fact, we were recognized this quarter by Analog Zone, a premier source of information for design engineers as having "the best connectivity IP." We received this recognition for our analog mixed-signal IP course for the PCI Express, SATA, and XAUI standards.

Against this backdrop of excellent financial results and technology momentum, we are tuning our go-to-market approach to capture more value for what we provide.

That includes expanding our products and focus to better address new markets, such as mature technology nodes of 130 nanometer and above.

Connecting better to customers by segmenting their needs, and offering them solutions optimized for those needs, and improving our communication of the value we deliver to customers.

As part of our strategy, we just introduced a new product.

IC Compiler Express targeted to the more mature technology nodes.

We have long been viewed as the leader for the most complex designs.

We believe this new target will expand our addressable market.

IC Compiler Express is currently in limited availability, and we already have our first customers.

In addition, we are refining our sales approach to demonstrate the value of our complete platforms, and get fair compensation for the critical role we play in getting chips to market on spec and on time.

To wrap up, all around us we see encouraging indicators of momentum.

Synopsys won the prestigious IBM Beacon Award for "its complete EDA solution that supports and complements our advanced process technologies, and enables our clients to meet their manufacturing needs." It was the first Beacon Award ever for the IBM Samsung charter's Common Platform ecosystem.

In the first half of the year, we are seeing record attendance at our User Group Meetings across the globe.

In fact, we have to move our San Jose venue to accommodate more than 1,500 engineers, a 20% increase over 2006.

Finally, our expertise in advanced designs and DSM is cementing Synopsys as the trusted advisor while semiconductor companies tackle the intricacies of migrating to 45 nanometer designs.

Summarizing Q2, it was all about strong execution.

We delivered strong earnings growth and cash flow, and we are moving into the second half of the year with greater confidence in executing our plans and commitments.

With that I will turn it over to Brian, who will provide more detail on the financials.

Thank you Aart.

As a reminder, I will be discussing certain GAAP and non-GAAP measures of our financial performance.

We have provided a reconciliation of our GAAP to non-GAAP results in the press release and financial supplement posted on our website.

Q2 was another quarter of solid execution for Synopsys with strong revenue, earnings, and cash flow.

More than two years ago, we committed to improving our operating margin to greater than 20% during fiscal 2007.

In Q2, we reached that goal ahead of schedule, achieving 22% operating margin, a sequential increase of more than 400 basis points.

While some of these increases are due to timing of expenses, I am nonetheless extremely pleased with our expense discipline, and our ability to meet this operating margin objective early.

Let me now provide some additional detail on our financials.

As a reminder, our fiscal first quarter included an extra week that occurs every 7 years, Q2 obviously did not include that extra week.

Total revenue was 293 million, up 7% year-over-year, and down slightly compared to Q1 as expected due to that extra week last quarter.

One customer accounted for more than 10% of our Q2 revenue.

GAAP earnings per share were $0.28 in Q2 with costs and expenses totaling 255.6 million.

This included a 26.2 million of amortization of intangible assets and stock based compensation, also included in our GAAP earnings is 12.5 million of Other income related to the legal settlement with Magma.

Non-GAAP earnings per share were $0.35 in Q2, above our target and more than double the same period last year.

This overachievement is due to both the timing of expenses through the year, and a very good expense and tax management.

As a result, we are raising our annual earnings guidance.

Continuing with expenses, non-GAAP expenses were 228.6 million for the quarter, a sequential decrease of 7%.

R&D was 85.3 million, Sales & Marketing 75 million, and G&A came in at 20.3 million, all of which were down sequentially.

This was mainly due to the extra fiscal week last quarter, as well as normal quarterly expense fluctuations.

However, as Aart mentioned, we also had some expense savings in Q2, which we will be able to reinvest in targeted business initiatives, while keeping our annual expense target unchanged at a very modest 2 to 3% growth.

As a result, our non-GAAP operating margin increased to 22% in Q2.

For the full year, we now expect our operating margin to be approximately 20%, an increase of about 600 basis points over last year.

As expenses fluctuate from quarter to quarter, we expect our operating margin to dip a little in Q3, and then increase again in Q4.

The non-GAAP tax rate was 24.1% in Q2, reflecting our restructuring of international operations, and resulting in improvement to our annual tax rate for FY '07.

Turning now to bookings, 93% of Q2 product orders were booked as time based licenses with only 7% up front.

We continue to have one of the most transparent and predictable business models in software.

The average length of our renewable customer license commitments in Q2 was 2.6 years, which is within our historical range.

Regionally Asia Pacific had the strongest quarter, thanks to excellent execution from the team.

Turning now to cash.

Cash and short-term investments increased $88 million sequentially to $768 million.

Our operating cash flow was also 88 million in Q2, which includes 12.5 million related to the settlement with Magma.

In Q2, capital expenditures were 13 million.

And we repurchased 2.4 million shares of our stock for $63 million.

As we announced during the quarter, our Board increased our buy back authorization to $500 million.

Our diluted share count increased slightly to 150 million shares, due to a combination of higher stock price and the timing of share issuance and buy backs.

Q2, net accounts receivable totaled 167 million, and DSOs were 52 days, which is within our historical range.

Deferred revenue at the end of the quarter was 606 million.

At the end of Q2, we had approximately 5,100 employees.

A slight drop sequentially, and the third quarter in a row we reduced our head count.

On a year-over-year basis, our head count is flat as we have offset acquisitions and growth in low-cost regions, with reductions in some of the higher cost areas.

For the third quarter of FY '07, our targets are, revenues between 295 and 305 million, total GAAP cost and expenses between 268 and 284 million, which includes approximately 16 million of stock compensation expense.

Total non-GAAP cost and expenses between 243 and 253 million, an increase due to timing of expenses through the year.

Other income and expense between 3 and 6 million, a non-GAAP tax rate between 26 and 27%, outstanding shares between 146 and 151 million.

GAAP earnings of $0.13 to $0.20 per share, and non-GAAP earnings of $0.28 to $0.31 per share.

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

Now looking at the total year of 2007, we are raising the bottom end of our revenue range with our new target between 1.19 and 1.205 billion.

Non-GAAP expenses to be between 2 to 3% higher than FY '06.

On a non-GAAP tax rate between 25 and 26%, an improvement of 6 to 7 points over last year.

Outstanding shares between 146 and 151 million.

GAAP earnings per share between $0.78 and $0.89, which includes the impact of approximately 69 million in stock based compensation expense, non-GAAP earnings per share of $1.27 to $1.33.

We have increased the low end of our guidance range by $0.04 cents, and the top end by $0.02.

This of course is up from $0.77 in 2006.

Operating margin for the year of approximately 20% and over the next four quarters, we expect approximately 970 million of our beginning of quarter backlog to turn to revenue.

We expect cash flow from operations to be greater than 275 million.

And with that, I will turn the call over to the operator for questions.

Thank you.

(OPERATOR INSTRUCTIONS) First we will go to the line of Harlan Sur with Morgan Stanley.

Hi, good afternoon.

Good job on the quarter.

Aart, first question for you.

I know you started off by providing us with an update on 65 and 45 nanometer design starts.

Still pretty strong, I think it was up about 18% sequentially for 65.

Can you also give us the 65 nanometer tapeouts you tracked in Q2?

Sure.

194 tapeouts for Q2.

And yes, I think it is up quite strongly.

As a matter of fact, we upforce most of the data for 90 nanometer.

And it tracks, it's virtually identical to 90 nanometer delayed by eight quarters.

And 45 is identical again delayed by eight quarters.

So so far the advanced nodes are moving along just fine.

Great.

And the environment for your customers as you mentioned in your opening remarks, as well, continues to be mixed and in some cases fairly challenging.

Is the team seeing any signs of softness out there within your customer base as it relates to tool spend?

I don't think so.

I think that people are cautious, because it's a turbulent seas.

At the same time, it's a little bit winners take all type of market where you have to bet, otherwise you can't play.

And so the advanced designs demands a lot of tools, a lot of technology, and that is of course where we are primarily and advanced designs by definition is part of the winners' crew.

In general, though, I think we will see some up and downs for some of the customers.

And we will be careful to invest especially in those people that we see as winners.

Okay.

Great.

And on the Galaxy platform, there has been, recently there have been a few very high visibility bake-offs or evals for physical implementation at 65 or below.

I think Synopsys and competitors are right now involved in a pretty big bake-off at one of the biggest [fiber] semi companies in the world.

Question for you, Aart, is how has IC Compiler fared in some of these recent evals?

IC Compiler is doing great right now.

I am not sure which eval you are referring to.

In general, we never comment on individual customers anyway.

Evals is sort of this continuing effort.

And frankly there are a number of customers that sometime call an eval, just finishing their chip.

And more often than not, we have seen that somebody has had challenges in getting closure with a competitor, and then under the guidance of an eval, they ask us hey, what can you do?

We partially like those, partially feel that it is a little bit overusing our goodwill.

But what is always clear though, is that the most difficult chips we can finish and we are finishing many, especially the ones where there is a combination of timing challenges and low power.

And that is absolutely where our strength is.

Okay.

Great.

And quick question for you, Brian.

Nice job on the team for controlling expenses for Q2.

But for Q3, the expenses are growing at twice the rate versus revenues.

It does look like op margins will probably drop below 20% as you said.

Maybe a little bit more color from the team in terms of, I think you mentioned investments in growth initiatives.

What sort of programs are we talking about here?

Well, I put all of that in context of good expense management through the quarter.

And leading into Q3 and the rest of the year, our total year guidance as we said is with revenues growing in the range of 8.5 to 10%, we committed pretty early on to limiting the growth for all of '07 to 2 to 3%.

And in fact, to highlight that point, 2% of that is due to the extra week we have in 2007 compared to last year.

So you have got to look at us holding expenses flat for the year, while driving up the revenue growth of 8 to 10%.

You are going to get some fluctuations from one quarter to the next, just based on timing of expenses, how they come through and their profile for the quarter.

I would really kind of focus on the trends and the expense management to show our continued focus on the op margin improvement.

Okay.

And just any color on growth initiatives maybe from either you or Aart?

Well, the growth [initiative's up].

Well, I think the main focus for us has clearly been that putting together tools in more coherent flows and platforms is absolutely starting to pay off.

And so as we can illustrate to customers that by using a more complete solution from Synopsys, they can not only significantly reduce their time to market risk, but in many situations get better results.

That is a great way of moving us forward from a business perspective.

The other thing that we are doing in this tuning of our sales force to the market is to get a much better understanding of what is really, what are really the key concerns of the customers.

And although very often they formulate as technical concerns, very often it is business concerns and business direction.

That ties to my earlier comment of seeing fairly choppy waters in the semiconductor market.

And the more we can be responsive to the needs of those customers as they decide where to go, the better.

Okay.

Great.

Thank you very much.

You are welcome.

Thank you.

And next we will go to the line of Rich Valera, Needham & Company.

Thank you.

Good afternoon, gentlemen.

Aart, in your prepared remarks, you referred to a new analog mixed-signal product, which I think you said combined the best of HSPICE and NanoSim, sort of the accuracy of HSPICE with the speed of NanoSim.

Can you go into a little more detail on that product?

Is that a combination of these two products?

Or is that a completely new product?

It is right to highlight it.

Because my comments were on the simplified compared to the technology that is on an (inaudible).

What we are referring to here is what we call the XA option to a number of tools, that allows them to dial up or down accuracy versus speed in a much more continuum fashion, between the HSPICE real which is very, very precise, to the NanoSim or HSIM which is very, very fast.

A number of customers have always had this wish of well, you know, I would be willing to give up a little bit on accuracy, if I could just get a lot more speed.

And being able to navigate staff that space in a continuous fashion is what this capability offers.

We have decided to offer it as an additional option to these existing products because that is the best way to get a quick return on the value that we provide.

So it is actually sort of both products essentially, and you have a way of sort of seamlessly switching between the two to trade off speed and accuracy?

It is more a set of algorithms that have been implemented in those products and allows one of the products to take over a couple more of the capabilities of another.

That is maybe the best way of thinking about it.

Understood.

And Aart, you mentioned that IC Compiler was doing well and that Galaxy was, but that segment was only up about a 1% year-over-year it looks like, which is pretty modest growth relative to the rest of your business.

Should we expect that to, I thought sort of once IC Compiler got sort of going on the upgrade cycle, that we might see better growth out of that.

Is this just sort of a lumpy quarter?

Should we expect to see that growing at a higher rate for the balance of the year?

Two comments.

First, you are correct about the quarter.

Although, if you look at the trailing 12 months, it's already 3X that.

The other thing is if you look at core EDA, which actually combines with the verification, it's about 9.5 or so percent.

So the reason I am saying that is because very often in the larger deals, the products trade-off within a pool of technology.

And at times that makes our own general managers unhappy because who deserves the credit, and it's not always completely trivial to allocate in those pools.

However, all-in-all, IT Compiler is actually doing very well.

And we also see that by the rate of adoption in production, and the still very high degree of support.

I think most of our physical support has now entirely switched from PC/Astro to IC Compiler.

Is the modest revenue growth to do with pricing?

Is the pricing continuing to be quite aggressive in the digital implementation area?

I think that pricing in any form of large deals will absolutely stay aggressive.

That is precisely one of the reasons, of course, why we are investing in adjacencies that leverage off off the core EDA.

Although I think core EDA this year is doing better than it was in the last few years.

And largely due to the fact of having both technology strength and implementation.

IC Compiler, but also Synthesis and Signoff, and a very strong Verification offering.

So I think that is the way to look at this is that core EDA tends to be more linked to the existing budgets of the customer migrating gradually, whereas all of the adjacencies are our opportunity to sell on top of those budgets.

Just one final one, if I could.

You guys (inaudible) provide this metric of bookings turning to revenue over the next 12 months, and that had been sort of steadily going up for several quarters, and it sort of flattened and actually ticked down this quarter.

Is there anything to read into that metric?

No, as a matter of fact, the thing to understand is that as we are completely, or right at the end of our move to a ratable model, you sort of get a gradual balance between the two.

And secondly, I think we will see reasonably large fluctuations quarter to quarter, just as a function of what the deals are that come in in the coming quarters.

Let's assume you have some very large deal.

For the next 6 to 8 to 10 quarters after that by definition, the bookings ratio will be down.

That is just fine as long as we grow our run rate with these accounts.

That is really the thing that we are focusing on.

I am absolutely on the side that one should not pay too much attention to the bookings number, much more to how we grow the revenue over time.

Fair enough.

Thank you very much.

You are welcome.

Thank you.

Next we will go to the line of Raj Seth, Cowen & Company.

Hi, thank you.

I just had one quick one.

Brian, you have got just under 800 million in cash.

You talked about buy back being refilled this last quarter.

I am curious when you think about this business, how much cash do you need to run the business?

And if you might think about, it certainly seems that you have the opportunity to more aggressively buy back and still leave plenty of cash on the balance sheet, given the cash generation characteristics here.

How do you think about that?

Cadence obviously is a little more levered up.

Is that something you would consider?

How does the thought process work?

Yes, I think we are in really good shape in terms of the cash flow.

It is just a critical asset to the company and getting close to 800 million is an excellent credit to all of the hard work we put into it.

We are always looking at the capital structure that we have got in place, to determine how we can best use the cash, which of course includes M&A activities, the buy back levels, which we recently increased to bring that back up to $500 million.

It shows that we plan to be aggressive, and I think the Q2 activity also reflects that we were aggressive in the second quarter spending that amount back in buying back our stock.

Another part is again looking at funding the ongoing operations.

Also you look at where the cash is, how much is in the U.S.

and how much is internationally, and balance that to the overall use of those same things.

Is M&A going to be local?

Is it going to be offshore?

and how do we leverage up the cash assets?

We continue to look at all those, we have been aggressive.

We continue to be one of the largest in the industry, in terms of using our cash flow to acquire our stock back.

And of course all the operations focuses on continuing to drive good strong cash inflow to the Company.

We are holding our commitment at bringing in more than 275 million of cash this year.

So it is really a good focus and continues to provide those assets.

So, Brian, do you think you need, this level of cash obviously you are spending a lot of what you generate, but this level of cash would seem to be even despite the commentary on potential M&A, et cetera, would seem to be in excess of what you need to run this business.

Do you disagree?

Well, I would say it is a real strong position.

It is way more than the minimum amount of cash you need to just get by.

But again having that flexibility to invest in M&A in the right opportunities of new growth initiatives inside the company, I think are an excellent asset yes for the, to give you that level of flexibility and timing to invest when you need to.

Any update on the pending IRS dispute?

You are not holding cash for that potential outcome are you?

And when would you expect a resolution?

Yes, we have had, again, as you know this takes quite a while getting addressed, but we have had some movement in this past quarter, in that the appeals process began in April.

And we don't believe there will be a settlement of that during FY '07, but in our initial meetings, I think both sides feel good about moving fairly quickly to a positive conclusion for everybody.

So again, the cash is not related to the tax issue, we believe we are adequately provided for on that basis in any case.

Okay.

Thanks very much.

Thank you.

And next we will go to the line of Jay Vleeschhouwer with Merrill Lynch.

Thanks.

Aart, I would like to follow-up on an initiative you mentioned at the Analyst Meeting and which you did again today.

Let's call it run rate compiler.

And could you be a little bit more specific as to the early results you are seeing as to the focus on run rate, and the ways you are going to be able to substantiate that that is in fact occurring that you are growing the business organically as you are aiming to do?

Well, there's only one substantiation, which is called revenue, and our job is to keep growing revenue.

Actually I would argue our job is more importantly to keep growing earnings.

And so obviously the earnings can grow by both growing the revenue or improving the ops margin.

Right now we are doing both.

I think the fact that we are a bit ahead on our ops margin is very positive, because it allows us to put some of that into the earnings, some into investments for future growth.

Having said that, when you have a ratable business model, it is fairly complex to compute how the deals impact the long-term outlook, but I think we are well on top of that.

And quarter by quarter we are absolutely tracking how we are growing the run rates with individual accounts where transactions are done.

And by the way, our sales this year are more compensated for that than they were in previous years.

And so, all of these things are heading in the right direction.

Given the comment you just made about ops margins being at least as important as revenue growth.

And when you tie that into the concept of run rate, is the profitability by customer at all a meaningful or a measurable part of the business?

I think that is an excellent question because I think it is meaningful, it is partially measurable, and it is an opportunity for us over time to improve our operations.

I don't want to give the impression that today that is something that is managed very, very precisely.

However, I think we are increasingly aware that if we could improve the profitability by customer, that that is yet another opportunity to improve our overall business operating model, or to achieve other things with customers.

And so, I think it's a good question for which I hope that in the next few quarters I will have a gradually better and better answer, because we are definitely looking at that.

Okay.

Brian, you mentioned the duration was only 2.6 years.

And you are right, that is within the range we have seen, but it is nevertheless the lowest in 3 years.

Was there something anomalous in the quarter that resulted in it being at least somewhat lower than we have seen in the last 10 to 12 quarters?

Yes, I wouldn't read anything into any of the trends.

It does fluctuate from quarter to quarter.

In particular this quarter, we had a couple of our deals had a shorter term to them than some of the other quarters that we have had.

It came in at 2.6, and anticipate for the rest of the year it gets up again.

It was just based on the mix of the actual orders closed in the quarter.

Okay.

I wouldn't read anything else into it.

Lastly Aart, you highlighted consumer electronics a number of times.

Can you talk about what your positioning is for other important or incrementally important verticals?

Wireless, of course ties into your AMS comments.

Automotive, Imaging, other sorts of other technology sectors where the electronics demands seem to be accelerating as well?

It's interesting you mention wireless, some people would now readily put wireless in the consumer segment, given how powerful the cell phone is, and how much the cell phone is becoming sort of the ultimate communication, [play] machine and everything.

At the same time, it is clear that in a number of other segments we are doing well, memory would be a good other example, that in the past we didn't pay as much attention to.

Automotive has been an okay segment for us.

It is not our primary focus because it tends to be very analog mixed-signal centric, where we have strong simulation and some very good system tools.

But it is not our center of gravity.

The type of segmentation that we prefer is segmentation that goes by very fundamental needs.

The fundamental needs tend to be needs such as very high volume, therefore you need to make sure that the yield is there, and that the chip has been absolutely minimized in area.

Typically where there are very high volumes, tend to be also very advanced in functionality, therefore there is a lot of verification that's there.

And so the, our value formulation is very much in solving a set of 5 or 6 macro problems and trying to be at best there, and then transcend the different traditional verticals.

Thanks, Aart.

You are welcome.

Thank you.

And next we will go to the line of Terence Whalen, Citigroup.

Thanks for taking my question.

This question is for Brian.

Brian, you mentioned that there were some quarter to quarter changes in expense timing.

I was hoping to get a little bit more color on that.

And then in addition, I was hoping to get a little bit of a longer term view of the opportunity for expense saving.

What inning are we in in terms of keeping expenses at only 1 or 2 points growth?

Could that actually be sustained for 1 to 2 years to come?

Good question.

Yes, Terence.

We are looking again really clearly at each one of our line of expenses.

Both going from the first quarter to the second quarter, and a very significant drop that we were able to put in place, and the actions in the quarter continue to be underspending relative to our plans, keeping the head count, and having it come down slightly in the quarter.

All of this again is focused on margin and earnings improvement as we go forward.

So while we are again proud of achieving a target we set some two years ago, and increasing our margin numbers for '07 by 600 basis points, we are not stopping there.

And you heard Aart say that again committed to continue to drive to mid to high 20s in margin.

So clearly that requires spending to grow significantly less than revenue growth.

We are focused on that element and optimizing the resources we do have in various areas.

So again, as you look at the drops from Q2 to Q1, primarily they are due to the extra week, we also had a gain on some sale of land, which is a few million dollars in the second quarter.

And then as you look forward to Q3 and Q4, again, keeping that expense commitment in place at the 2 to 3% is what we are committed to doing.

Again this is also to highlight a point that our business is stronger in 2007 than we anticipated at the beginning of the year.

So again at the expense that there is higher business being completed we also have expense accruals to put in place for that as we go through the year, plus the (inaudible) full-year impacts of acquisitions, foreign exchange costs, and other things, all of that saying still flat year-over-year in 2007.

So again, a tribute to the team for a lot of hard work in making that come through.

And the trends going forward in '08 and beyond are focused on continuing to improve operating margins.

Great.

And then a follow-up if I could for Aart.

Aart, you mentioned IC Compiler Express initial reception has been quite positive.

Can you also kind of expound on whether segmentation is just for digital design?

Or is that an area that could also, or strategy rather that could be proliferated on into Verification, as well?

Thank you.

Sure.

Let me start right away with the second one, which is Verification absolutely can be stratified into different segments.

And we see today that there are very different behaviors in different customer categories.

If you take, for example, the other processor, the VSB, the graphics guys, they use an immense amount of Verification, largely because their products are very complex, are going into broad distribution, and are expected to be flawless.

At the same time, you look at people that are let's say in the wireless communication segment, there Verification is growing rapidly, but I think there is a long way to go before they can assure the same degree of coverage of the first group I mentioned.

If you then look at a segment I mentioned earlier, which is memory, you see there again there is a big change, because traditionally memory has been very transistor level verification.

And now the complexity of the memories is bringing about a surrounding of digital control that is great for us, because not only are we very, very strong in digital, but we are also very strong in analog mixed-signal, meaning the combination of digital and analog.

And so each of one of those sort of talks their own language when they talk about Verification.

And the same is true for the vast majority of our products.

I think the forays into the less advanced technologies, forays may not be the right term.

We are spending a little bit more attention is primarily a broadening of our potential addressable market, that in the past we just didn't pay all that much attention to.

And so we may as well, leverage all the technology that we have built, by making it easier to use somewhat simplified, and the right cost point for people that are maybe less demanding.

Thank you.

You are welcome.

Thank you.

And next we will go to the line of Dennis Wassung, Canaccord Adams.

Thank you.

Good afternoon.

I guess first a quick follow-up on the operating expenses.

I know you had a couple of questions on this.

You talked about the new initiatives [inaudible] more costs are coming back into the model here, I was just curious, I think this was asked, I didn't really catch an answer.

Do you expect to see a lot of that -- I guess the resurgence and the expenses coming on the R&D line?

Just new product development efforts?

Or specific R&D efforts?

Or is there a sales and marketing push expansion in specific areas that we should look for as well?

Just trying to understand the dynamic there.

Okay.

Well, Aart, maybe --

Well, let me start in general.

Just to be crystal clear, we have committed a number of years ago to keep improving the ops margin.

We are continuing to do that.

At the same time, we gave our self a timetable that I think we have rigorously met and that we are exceeding now, the way we're looking at that is to say, hey, there are opportunities to invest some of that in future growth, and simultaneously stay ahead of schedule.

And so I think that is good news in both the what goes to the bottom line, as well as what we can invest for the future.

Now when we look at our investment, it is absolutely clear that you fundamentally have two groups that you want to invest in.

Either R&D development on our new things or fields, it is typically not the first one, which is infrastructure which you want to keep either flat or optimize more on.

There the decision has to be whatever gives us the best chance of growing our footprint, and our success rate with the customers.

And in some cases, it is clearly in R&D because there are infinite new projects possible there.

In some cases it is also to go for a different approach with the customer, take over more of some of the things they do, and involve our overall solution with them.

We now have the luxury to look a little bit at both of those things.

And we will decide on a very ROI evaluation basis.

Okay.

That helps, thank you.

And secondly, the DSM and yield side of the equation, you made some comments about some of your products becoming more of a common interface.

I am just wondering if you look at your DSM group in general, [it has had a nice] steady growth past year, I am wondering if where the strength is, if there's a specific area or is it strong across the board?

Is OPC a big driver for that?

Is PrimeYield taking a bigger piece of this pie.

If you could maybe talk about what is driving that growth at this point?

Well, fundamentally if you look at DSM, obviously it means different things to different people, because it has both the D word and the M word.

So let me start actually with the M side, which is if you look at TCAD, that is obviously deep inside of the manufacturing chain, be it focused on either process development or device development or manufacturing optimization.

And those are sort of the key areas to focus on.

Then the second grouping is everything that has to do with masks.

And there we have the various forms of radical enhancement technologies, and of fracturing, and a variety of verification things.

The third one has to do with the whole yield measure test chip, et cetera, area.

And the fourth one which is where really the design [work] comes back in, is how do you close the loop, with all this information into design, and that is where PrimeYield over the years will hopefully become what PrimeTime is today in timing.

And a number of years ago, we obviously pioneered the ability to predict timing in such a fashion that you could rely on it and design towards it.

We are heading in the same direction towards predicting yield and designing towards it.

And so those are the centers of gravity and then from quarter to quarter, there are big fluctuations as to which one happens to have big deals.

But it is really the aggregate picture that we are after.

And as you look at your total suite of offerings in this area, do you feel like you have the complete picture at this point?

Or is there a specific technology that you are missing?

I guess do you feel that you have an adequate offering at this point for 65 and 45 nanometers and below?

Well, we know that we have an adequate offerings for 65 and 45, because we have a number of customers that do their entire flow with us, and are doing very well with it.

On the other hand, whenever you talk about emerging technologies the word complete has never applied in the 20 years that we have had Synopsys.

So there is always new investments and new opportunities, although I must say I think that EDA is in a very different phase, in that we have much more complete solutions today, and whenever possible we like to amend them ourselves, or then acquire technology that fits in, but all-in-all, I think we are as complete as anybody on the market today.

Thank you.

You are welcome.

Thank you.

Thank you.

We are now five minutes prior to the conclusion of our conference so we will take our final question from the line of Matt Petkun, D.A.

Davidson & Co.

Hi, thanks for taking my question.

Just to follow-up on Dennis' question.

To be a little bit more specific.

So when we look to sequential changes and expenses from Q2 to Q3, you are talking about investing in R&D.

Should it be the R&D line item on a non-GAAP basis that grows more rapidly sequentially than the SG&A line item?

Well, I think, don't overemphasize too much these changes from quarter to quarter.

I am sure Brian will give you a more refined answer here.

But from my perspective, the only numbers that really matter is sort of the rolling 12 month averages.

Because from one quarter to another, the way some of these things fall in one quarter or another can change radically the actual distribution.

Now having said that, clearly if we make additional investments, they tend to be in the R&D and potentially in some aspects of the field, rather than anywhere else in the company.

And we are very careful with making these additional commitments to be much sharper about what (inaudible) reach our invest on each one of those.

You want to add anything, Brian?

Yes, I would say as you look specific on the line by line basis that from Q2 to Q3 we will see an increase recognizing we had a several million dollar gain on sale of that land that was in the G&A area.

That will be an increase from Q2 to Q3 in G&A.

From a Sales & Marketing perspective, again as the business continues to grow, there will be expenses there associated with higher commission activity and higher business, and that continues to go up as the business grows.

But again, all-in-all, keeping in line with that 2 to 3% growth for the year.

And then the R&D as Aart says is really focused specifically on getting more development, more capacity and capability while driving efficiency through the team, and obviously leveraging lower cost areas to the extent we can.

And so again, that is the message on each one of the lines for the operating expense.

And then Aart, I was hoping you could give us a bit of an update on what you are seeing in the world of system level design and ESL, specifically kind of noting the fact that it was about a year ago that you acquired Virtio to do some more kind of embedded software platform to development debugging.

I am wondering kind of what is going on there?

Has that market really developed?

And what do you expect from it going forward?

Well, we are engaged in quite a number of places with Virtio, and I think that is a direct reflection of the fact that increasingly people developing software would like to have some degree of modeling of the hardware, before the hardware is fully developed or even built.

And so the level of interest is very high, and the number of engagements is high.

I think it will take a little bit of time for the market to develop.

But there is one other angle that one should not forget, which is the whole angle of IP as actually in my opinion, the much more important ESL success factor today.

Because a lot of people have thought about ESL, why don't you just create designs from a higher level.

Well, the way you create designs from a higher level is to start with much higher level building blocks.

And we are absolutely seeing that that vision is materializing more and more literally quarter by quarter, because in the whole wave of companies looking at their cost structure, and by the way quite a number doing that by virtue of being investigated by private equity opportunities.

They are all coming to the conclusion that a lot of these design activities on the individual blocks, have completely no return on investment for them and are not differentiated.

And for those companies being able to come to us and saying, can you develop the basic building blocks and provide them to us, is a very promising approach for them to save money, and of course for us to grow our business.

And now tying this back to Virtio.

The reason I am enthusiastic about that, is because I think that the content of software in these building blocks is growing.

And by the way also the Verification aspect of these building blocks, because Verification is by far the largest consumer of EDA software period.

And so I think there are great opportunities as these things come together.

And so that is the vision we are pursuing.

Okay.

Thanks so much.

That concludes our earnings release, we really appreciate the time that you spent with us.

We think that we are coming off a very strong quarter, and definitely feel momentum in both the technology direction and the business direction.

And so from that perspective, feel that the year is in very good shape.

If you have further comments or questions, as usual Brian, Lisa, and I will be available after the call.

Thank you very much for spending an hour with us.

Thank you.

And ladies and gentlemen, that does conclude our conference for today.

We thank you for your participation, and for using the AT&T Executive Teleconference service.

You may now disconnect.