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Executives

Lisa Ewbank - VP of IR

Aart de Geus - Chairman and CEO

Brian Beattie - CFO

Analysts

Rich Valera - Needham

Raj Seth - Cowen & Company

Matt Petkun - D. A. Davidson & Company

Jay Vleeschhouwer - Merrill Lynch

Tim Fox - Deutsche Bank

Sterling Auty - JPMorgan

Terence Whalen - Citi

K.C. Rajkumar - RBC Capital Markets

Synopsys Inc. (SNPS) F4Q08 (Qtr End 10/31/2008) Earnings Call December 3, 2008 5:00 PM ET

Operator

Ladies and gentlemen thank you for standing by and welcome to Synopsys Incorporated Earnings Call for the fourth quarter and fiscal year 2008. 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.

Lisa Ewbank

Thank you, Sandy. 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 forecast, 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.

In addition to any risks that we highlight during this call, important factors that may affect our future results are described in our 10-K, our 10-Q for the third quarter and in our earnings release for the fourth quarter issued earlier today. 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 and supplemental financial information can be found in our fourth quarter earnings release and financial supplement. All of these items are currently available on our website at synopsys.com.

With that I'll turn the call over to Aart de Geus.

Aart de Geus

Good afternoon. I am happy to report a strong Q4 and fiscal '08, strong technology and competitive momentum and most notable in this environment, strong revenue backlog for fiscal '09.

Let me begin with our financial results. In Q4 and fiscal '08, we either met or exceeded virtually all of our goals despite a major change in the environment starting in mid-summer. Specifically, we delivered non-GAAP earnings per share of $0.43 for the quarter and a $1.71 for the year. That $0.14 above the mid point target we communicated at the beginning of ‘08.

With Q4 revenue of $353 million, we grew our business 10% for the year to $1.337 billion. These results were achieved under a predictable business model with more than 90% time-based revenue.

To discipline expense control and focus on efficiency, we improved non-GAAP ops margin over last year from 20% to 23%. We excited the year with over $900 million in cash and no debt. While we grew our overall backlog, most importantly our one year backlog is almost $1.2 billion. In other words, we have over 80% of 2009s targeted revenue already in hand.

Our excellent results in '08 provide the uniquely solid foundation going into '09, especially in the context of a global economy that is highly unpredictable. Our working assumption is that the current recession is likely to last through at least to 2009. Consumer and business caution are already leading to more conservative spending and demand for electronics will certainly be affected.

Not surprisingly, cost management is key for our customers, as they revisit every aspect of their operations for efficiency and strategic effectiveness. In many ways the economic stress is accelerating efficiency initiatives that have been visible for a while, such as the move from internal manufacturing to external foundries, for example.

In the last two years, we have also seen increased segment consolidation as customer seek efficiency through market share gains, where they have strong offering. At the same time, they cannot compromise on technology and today's chips require advanced EDA capabilities.

To balance cost and efficiency, we see customers actively reducing the number of their suppliers and choosing key partners that are technically strong, financially healthy and safe, and that can help to reduce design costs in the overall design flow. This is why Synopsys is uniquely well positioned to be the partner of choice.

One, we are financially stable with a strong cash position, no debts, good cash flow, strong backlog and a conservative business model, making us a stable partner as customers actively derisk their future. Two, we have strong well integrated technology and a comprehensive solution that is complemented by crucial IP and very experienced global support, ready to help customer streamline their overall cost of design.

And three, we have the strategic vision and resources to continue to invest in the key technologies of the future. Indeed, in the last 18 months, a growing number of customers have chosen preferred relationships with Synopsys. In Q4, we announced another primary partner relationship with Sanyo, which chose to standardize on our design and verification platforms.

We also expanded to other large customer relationships, one of which is scheduled to become our primary partner relationship overtime. Within these companies, we are displacing competitors in place-and-route, functional verification, custom designs and physical verification.

Going forward, we plan to come out of the present economic slump and even stronger company. To that end, our strategy is best characterized as both cautious and bold. Our objectives are to financially out-execute others by adapting to the new landscape, while fundamentally staying the course in terms of business model and financial principles, to competitively solidify and expand our position to the most cost efficient complete design solutions and to strategically invest to expand our total addressable market.

Well this means financially for '09 is the following: Solid revenue growth of approximately 5% starting with the unique foundation of over 80% of '09 revenue in hand today.

Steady operating margin, around 23% driven by active cost reductions and pointed investments to further strengthen our competitive position and continued solid non-GAAP earnings per share in the $60 to $72 range. Brian will provide more detailed guidance in a moment. Let me comment, that our guidance is in broader ranges, than we have typically given reflecting the market uncertainty, but also to give us more freedom and execution as opportunities may arise.

Moving on to those competitive landscapes: We are uniquely well positioned to provide a comprehensive solution as customers seek to simply their EDA commitments. Those of you, that have followed Synopsys for some time, know that we have spent years moving to a complete solution by developing, acquiring and integrating best in class tools from the system level through simulation, synthesis, place-and-route all the way down to the physics of manufacturing.

After that a strong semiconductor IP portfolio and a global support force capable of assisting with the most difficult designs in the world, and Synopsys stands out as the lead contender for our customers EDA needs. The strength of our technology portfolio has been crucial in growing the trust of our customers, as they select preferred partners. In 2008, we delivered a multitude of technology advances, ranging from broad support of multi-core processing to expanded low power capabilities.

Our physical design solution, IC compiler was further strengthened by a brand new router delivering 10X faster performance and better quality of results. We are seeing significant customer wins including business from competitors. On the manufacturing side, we also integrated formally separate pre-manufacturing steps map synthesis and map data prep giving customers a dramatic and highly differentiated improvement in overall throughput.

This brings me to the third tenant of our strategy. Focused investments in our long-term growth, in practice this means three things; solidifying our core EDA anchor solutions and expanding our customer presence. We are rolling out our analog custom design solution, thus filling the last meaningful hole in our offering and investing in the emerging system level solutions area.

I already mentioned some of the progress made on our traditional anchor products. However, the highlight for Q4 was the roll-out of custom designer, our longer awaited analog mixed signal design solution. Custom designer is a modern open platform built to link well with IC compiler and other Synopsys solutions. It’s easy to use, easy to adopt and has a large number of differentiated features that’s a path old competitive technologies.

Customer feedback has been excellent especially regarding the ease of adoption and stability of the code. Even with limited customer availability we had our first orders in Q4. Our IP business also deserves mention. We not only added a significant collection of new course to our offering, but also grew the business as outsourcing semiconductor IP for costs reasons is becoming more main stream.

Finally our FPGA based rapid prototyping system is seeing excellent momentum. In the both chip verification and embedded software development our solution go straight to the heart of one of the key cost and time challenges in modern chip and system design. On Monday we announced that we were acquiring the CHIPit assets ProDesign, a significant broadening of our rapid prototyping offering that plays well in to our long-term vision of moving further towards system level design and verification.

In summary and not withstanding the macroeconomic challenges, we will continue to invest in these areas of opportunity for Synopsys. To conclude, we had an outstanding 2008 in every key financial and operational metric. Even with the economic stress around us, Synopsys is heading into 2009 with very solid financial, technical and business foundation.

Our strategy for 2009 is simple. We intend to weather the storm and take advantage of the near-term recession and come out of the other side even stronger by being a financially conservative, competitively aggressive and strategically focused.

With that now I will turn the call over to Brian Beattie.

Brian Beattie

Thank you, Aart and good afternoon everyone. In my comments today I will summarize our financial results for the quarter and yearend and provide you with more details of our 2009 guidance. As a reminder, I will be discussing certain GAAP and non-GAAP measures of our financial performance. We have provided reconciliations in the press release and financial supplement posted on the website.

In my discussions, all my comparisons will be year-over-year and also specify otherwise. Synopsys delivered solid fourth quarter and full fiscal year results, executing well at many fronts. In fact our consistent performance throughout the year enable us to meet or exceed all of our original 2008 targets including revenue, operating margin, EPS and operating cash flow.

Now let me provide some additional details on our financials. Q4 revenue increased 12% to $352.8 million and annual revenue grew 10% to $1.337 billion. One customer accounted for slightly more than 10% of Q4 and fiscal year revenue.

Turning to expenses, Q4 GAAP expenses were $287.5 million, which included $9.3 million of amortization of intangible assets and $14.7 million of share-based compensation. For the year, GAAP expenses were $1.118 billion, which included $44.1 million of amortization of intangible assets and $65.5 million of share-based compensation.

Total non-GAAP cost and expenses were $280.5 million in Q4 and $1.026 billion for all of 2008. We held cost in line with our original 2008 expense budget even with the addition of Synplicity. For all of fiscal 2008, we achieved our operating margin target of 23%, an increase of about 300 basis points in Q4, non-GAAP operating margin was 20.5%. We continue to derive companywide operational discipline and expense control.

Our strategy as Aart mentioned, is to reduce expenses in certain areas, so that we are able to invest in others that will drive long-term growth. In FY ‘08 we focused on the design and development phase of reengineering and our entire development to cash process to maximize efficiency. We hired in lower cost geographies and we reduced capital spending by 13%, as we centralized IT resource management.

Turning now to earnings, GAAP earnings per share were $0.32 for the quarter and $1.29 for the year. Non-GAAP earnings per share were $0.43 for the quarter and $1.71 for the year, both above 2007 levels and our target ranges for 2008 driven by solid top line growth, expense management and lower taxes.

Our non-GAAP tax rate was 21.3% in Q4 and 24.1% for the full year, both well below our target ranges due primarily to the reenactment of the federal R&D tax credit in United States in Q4 and certain one time tax adjustments.

Our revenue visibility remain strong, up front revenue was 7% in Q4 and 5% for all of FY ‘08 well within our range of less than 10%. The average length of our renewable customer license commitments for the quarter and fiscal year remained approximately three years.

As Aart mentioned, we have greater than 80% of revenue in hand for the coming year and more than 90% for the coming quarter. We increased overall backlog to the book to bill slightly higher than one.

Now turning to our cash and balance sheet items: At year-end, cash and short-terms investments totaled $951 million, up $74 million sequentially, due to a strong operating cash flow of $114 million. For the year, operating cash flow was $331 million, meeting our original target established in December of '07. Of our total cash balance, 53% is in the U.S. and 47% is outside the U.S.

In terms of cash flow, we believe a fairly good indicator of operating cash flow overtime is EBITDA, while of course its not a perfect indicator operating cash flow tends to fluctuate around longer term EBITDA trends. At this time, we are targeting operating cash flow of approximately $200 to $220 million in FY '09. The decline from '08 is due to both less schedule collections and increased disbursements.

On the collection side, the slightly lower level is primarily driven by three factors. First, because of schedule renewals in '09, we're planning for our book to bill moderately lower than one. Second, we thought it was prudent to collect as much cash as possible in '08. And third, while we haven't seen a material change in our customer's ability to pay us, we're being conservative in our cash collection assumptions, given the uncertain economic environment.

From the cash outflow side. We are currently expecting higher payments due to increased expenses, including a full year impact from Synplicity and higher tax payments. Having said that, our cash flow continues to be very strong and based on our current, we expect EBITDA to be roughly flat in fiscal 2009. Given the volatility in the global financial markets, I'd also like to take a minute on this call to comment on our cash portfolio, as it relates to our investment guidelines and strategies.

Our Board requires that all our holdings have very high credit ratings of AA or better. As a result, we invest our domestic cash exclusively in highly rated municipal bonds and tax exempt AAA rated money market funds that hold municipal securities. Our cash outside the U.S. is invested in AAA rated money market funds and time deposits, with what we consider healthy financial institutions.

And finally, we have had no exposure to auction rate securities or mortgage-backed securities and are very pleased with the high quality and conservative risk profile of our investment portfolio. Now, continuing along with or cash and balance sheet items, capital expenditures were $12 million in the quarter and $39 million for the year. In Q4, we purchased 2.4 million shares of Synopsys stock for $50 million.

For the full fiscal year, we purchased 9.6 million shares for $220 million spending 75% of our '08 free cash flow and buying back about twice as many shares as we issued during the year. We have approximately $210 million remaining on our current authorizations. Also recall, that we spend a net $181 million in cash on our acquisition of Synplicity in Q3, both the stock buyback and our Synplicity acquisition, were sourced from our U.S. cash reserves.

Q4 net accounts receivables totaled $147 million and our industry leading DSO was flat sequentially at 38 days, reflecting a high quality of our AR portfolio and the timing of invoices. Deferred revenues at the end of the quarter were $680 million.

Now at the end of the year we had approximately 5,700 employees. This was an expected increase on a year-over-year basis due primarily to our acquisition of Synplicity, to generally flat with Q3 as we put a hiring freeze in place in the fourth quarter. As Aart discussed, we just announced the signing of a definitive agreement to acquire the CHIPit assets of ProDesign's to accelerate our efforts in the fast growing rapid prototyping market. It's expected to be an all cash deal and financial terms were not disclosed. We don’t expect a material impact to our 2009 guidance.

Now let me address our first quarter and fiscal 2009 guidance and then provide some additional comments on our expense assumptions for the year. For the first quarter of FY '09, our targets are revenue between $332 million and $340 million. Total GAAP cost and expenses between $276 million and $291.5 million, which includes approximately $13.8 million of share based compensation expense.

Total non-GAAP costs and expenses between $253 million and $263 million down from $280 million in Fourth quarter, other income and expense between zero and $3 million, a non-GAAP tax rate of approximately 27%, outstanding shares between 145 million and 150 million, GAAP earnings of $0.26 to $0.31 per share and non-GAAP earnings of $0.40 to $0.42 per share. We expect greater than 90% of the quarter's revenue to come from backlog.

Now for fiscal 2009, here are the key metrics. Based on what we know now, we expect revenues between $1.38 million and $1.41 billion, other income and expense between $4 million and $8 million, a non-GAAP tax rate of approximately 27%. Outstanding shares between $145 million and $150 million, GAAP earnings per share between a $1.07 and a $1.26, which includes the impact of approximately $58 million in share based compensation expense. Non-GAAP earnings per share, of a $1.60 to a $1.72 and again cash flow from operations of approximately $200 million to $220 million.

We have a unique window of opportunity in front of us. Our position as a company is to take full advantage of it. Even as we invest in technology development and advancing our customer relationships, we will closely manage expenses to reach our margin targets. In 2009, we are focused on several expense control initiatives. We are planning to hold, employee cost relatively flat, including diligently managing our headcount levels, and reviewing our contractor costs.

We are now in the implementation phase or reengineering our global quote to cash process, with a goal of making the process faster and easier, for both ourselves and our customers. We are rolling out, enhanced internal reporting and the analytic tools to better control and manage global expenses such as travel and procurement. And we are reducing our capital spending by another 15% in 2009 to approximately $30 million to $35 million.

Now finally, to help you with your modeling, let me provide some additional 2009 commentary including our quarterly expense profile. We expect total cost and expenses to increase generally inline with or slightly less than, our targeted revenue growth. We believe this is the appropriate expense level to take full advantage of this unique opportunity we have in front of us. It also reflects the near term revenue transition, and integration of Synplicity.

We are expecting a typical quarterly expense profile throughout the year, with a modest sequential increase in total expenses in both Q2 and Q3, and a traditionally higher Q4.

We expect our operating cash quarterly profile to be similar to last year, with the net operating cash out flow during the first half of ‘09 due primarily to the timing of our annual incentive compensation payments. While, these assumptions are based on the current environment and our internal operating targets, our management team is fully prepared to react quickly on expenses, should things materially change.

We will continue to be physically conservative and focused on responsible investing to enhance our leadership and emerge from these challenging times in a stronger competitive position. While our near-term goal is to expand our competitive presence, while sustaining margins in this environment, we remain committed to longer term operating margin targets of mid-to-high 20s.

In summary, we are very pleased with our fourth quarter and fiscal 2008 results. While the economic environment is uncertain, we enter 2009 in excellent financial condition and look forward to another year of solid business execution.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And our first question will come from the line of Rich Valera with Needham. Please go ahead.

Rich Valera - Needham

Thanks, good evening gentlemen. Brian, you talked about EBITDA expected to be flat in ‘09 versus ‘08, can you give us the EBITDA number for ‘08 if you have that convenient?

Brian Beattie

Yes, I do just, 2008 the number came in at $364 million.

Rich Valera - Needham

Great. Looking at your expected share account for fiscal ‘09, it doesn’t look like you plan to get particularly aggressive on a buyback. This, despite the fact that it would appear that buyback is quite accretive at current stock levels. Is there anything that would make you get more aggressive on a share buyback or do you really want to keep that much dry powder around for other opportunities?

Aart de Geus

Yes. It's a great question. We're just constantly looking at the capital structure even more so now of what cash we have on hand, where we hold it and obviously how it's invested. So, it's an awful lot of visibility going into how that cash has been managed. I also outlined the amount of the cash that was both in the US and the amount of cash that was outside of the US. So, again that narrows the ability of using that cash in the US for things like stock repurchases and for some of the M&A investments we have here locally too.

So, we constantly look at where we're going spend that cash or lot of great opportunities both in terms of the operating piece of it. We need to maintain the flexibility given the current credit markets we've got, and again look for M&A opportunities that present themselves in this environment. So, the buyback program is still very consistent in part of that structure as well. We still have dollars remaining on our authorization and we'll continue to balance those opportunities as we move forward.

Rich Valera - Needham

Brian, you mentioned you expected a book-to-bill slightly less than one in fiscal '09. Can you elaborate on that, how much of that is due to a renewal schedule, which maybe is little lighter than fiscal '08 and how much of that is due to expectations of maybe lower run rates on renewals due to the weaker macro environment?

Brian Beattie

I’d say it’s almost all related to the renewal schedule as we look forward to the contracts that are up for renewal in 2009. It just looks like again a moderately decline in that book-to-bill ratio for the year, so really on renewals.

Rich Valera - Needham

So, I guess just to follow-up on that. What has been your experience, you have in October closed your quarter obviously October was a very challenging period to be doing business? What was your experience in closing deals in terms of run rate, are you successfully maintaining run rates at this point, are you seeing a lot of pushback on customers trying to actively reduce run-rates? If you could give any color, that would be helpful.

Aart de Geus

Maybe I can't comment on that, this is Aart. In October, we actually continued to grow our run rates and I think that's a good sign because, that means that the people investing with us are investing for the longer term. I think one of the aspects on their renewals is I wouldn't be surprised if people become a little bit more cautious about long-term renewals, just because they look at the uncertainty around us in the world and are just cautious in making commitment.

And so, I'm glad you bring up the notion of run rate because that's clearly what we are paying a lot of attention to, as that is a key health indicator for our business going forward and so -- so far so good in our business.

Rich Valera - Needham

And Aart, how do you think that will manifest itself, do you think your duration, your average ratio will actually go below three, where people want shorter commitments like one and two year as opposed to the average three year deals?

Aart de Geus

The honest answer is I don't know. I just think that with this amount of change around us, there will be changes. And so it could go either way actually. You could go the directions where people say, "I don't want to make long-term commitments, I don't know what's coming towards me". And that would say shorter duration, you should see that also. So, no, I want to make a bigger commitments from a preferred partner point of view; let's go longer duration.

And so because none of us has faced the economic situation we have around us, we are trying to execute very thoroughly, while leaving ourselves a fairly high degree of flexibility, and how we get there is by paying great a deal of attention to the very basics of what is good business. Ultimately, we'd like to see this as an opportunity for Synopsys to strengthen its position with the customers that matter most.

Rich Valera - Needham

Okay. Thank you and good luck in '09.

Aart de Geus

Thank you.

Operator

Our next question will come from the line of Raj Seth with Cowen & Company. Please go ahead.

Raj Seth - Cowen & Company

Hi, thanks. Aart, just to follow-up to the previous question. Can you talk a little bit more about what changes you've actually seen over the last few months in your customer base? Maybe a little color on how some of the conversations you are having with key semiconductor executives, how those are going, what's the tone of those conversations at this point?

Aart de Geus

Well if there's one uniform phrase coming out of the vast majority of the customers, it is this term of "no visibility" and they immediately characterized, it doesn't mean that there is not a substantial amount of business comes in, it just is not clear when and exactly how. And that brings about a fairly high degree of caution. The second aspect is that people look around the economy and all come to the same conclusion, which is okay; cost management is absolutely essential and there are two or three ways to look at that.

The first way is not to do projects that go nowhere. In normal times its always difficult to cut these things, in stress times people find a way to do that and reinvest the efforts in those projects that are more promising. Second is to look at every one of your processes, including the design process and see how you can streamline it more. And that is why we are moving more towards integrated design flows, fewer vendors, looking at which IP wants you internally versus externally, all of these things are on the table; and as you well know, for many years we have essentially prepared the company for that direction. I think that moment is upon us now

Raj Seth - Cowen & Company

And do you see that I mean a normalized environment for people even when business gets slower? Not to cut R&D projects, key product development projects in 2001, 2002 and when facing a deep downturn, they did? Are you beginning to see that in your customer base or is that not started yet?

Aart de Geus

Not massively so. I think rather than cutting projects it's almost more like people are looking at their entire business unit structure and they have five business units why don’t I sell this one to somebody who is in the same segment and can do better. In other words, you get to what I would call a "segment consolidation" long before you get a lot of project cutting.

Now underneath, I think there is no question that people are looking at every aspect of their business and partially because of the economic stress. It gives management internally the mandate to do something and therefore they are actually moving more rapidly than they would normally.

So, I think that over time we will get there. We have not seen any slowdown in the most advanced chips and I wouldn’t expect to see a big slowdown. We have seen that a number of customers are hanging around longer at the older notes and I think I have shared that trends with you now for at least 18 months or so. This does not mean that it will have sophisticated design; it just means that people are squeezing even more out of the older more amortized notes for cost reasons. The word cost is pretty much essential to the vocabulary of old top executives.

Raj Seth - Cowen & Company

And if I might ask a couple more questions? You mentioned share and have mentioned share a couple of times over the last couple of quarters. Your view that you are taking some share and some of the bigger deals you have done. Any sense for how much share you have gained over the last year or any projection about how much share you think you might be able to gain over the next year given the chaos amongst some of your competitors?

Aart de Geus

Well, the term share has been misused many times in many of the EDA earnings releases. At the end of the day it is sustainable revenue, so that gives you the share. We are growing our revenue and I think one of the key reasons we are able to do that is because a number of customers are making growing commitments with us and because of the quite conservative revenue recognition model that we have, I think the revenue you see is really where we are as a company.

So I think the opportunity space is clearly impacted by the overall economic down pressure. There's no question about that. On the other hand it is precisely because of that, that customers are going to move faster in some of their efficiency pushes and I do think that we are well positioned to help them with that and hopefully that will actually have positive impact on our growth potential.

Raj Seth - Cowen & Company

I promise. Last question: you mentioned TAM expansion as an objective and you talked about being maybe a little careful in terms of use of cash for strictly buybacks etcetera. When you think about where you want to take the footprint of Synopsys from a TAM perspective, where are the areas you want to expand over the next 12 to 18 months.

Aart de Geus

Well, two comments. First I want to make sure that people understand. We are not adverse to buying back our own stock. We are just very, very cognizant that we are in a time period where cash is king again and so we like the cash position that we have. We clearly see that one could potentially expend in the agencies that we've already have a footprint in and a couple of that spend out as clearly, how we can invest internally or otherwise in what we do in the IP and the Rapid Prototyping in the moving towards the system side. But I wouldn't discount, also the fact that, some of our core Anchor tools are becoming stronger and therefore more competitive as we approach customers to focus more on Synopsys as their primary partner.

Raj Seth - Cowen & Company

Okay. Thanks for all that.

Aart de Geus

You’re welcome.

Operator

Our next question will come from the line of Matt Petkun with D. A. Davidson & Company. Please go ahead.

Matt Petkun - D. A. Davidson & Company

Hi, good afternoon. Aart, when you guys provided initial guidance last year or not last year, last quarter. I think one of things you suggested is that you don't want to set the bar too high because you saw that your competitors would likely be facing a tough environment and would be perhaps willing to do some potentially natural things on the pricing side? At least judging by their equity valuations, their situations haven't improved. How is the pricing environment right now? And how do you maintain appropriate pricing in an environment like this?

Aart de Geus

Well, I’m of the school that you don't want to move a lot on pricing because pricing tends to never come back and so far we've done okay with that. I think, the pricing is actually interesting and often I think a lesser consideration than the decision to invest with vendors that are stable and going to be there for the long run. So, let's not forget that, that many companies right now are looking around and say how can I derisk my future, while, driving my internal efficiency.

And so that is actually I think the bigger consideration for many of our customers and I do think that, as all the competitors have a move more ratable business model. There is a natural better ability of industry to be more careful with the pricing practices anyway.

Matt Petkun - D. A. Davidson & Company

Okay. Then just looking at the revenue mix the upfront portion of your business is up nicely year-over-year almost 28% and environment that I’d think would be challenging to get upfront deals done. Is that mostly Synplicity business? Please remind us if the mix of through Synplicity. How much the hardware business should be as the portion of that total business.

Brian Beattie

Sure. Our model, just to clarify again, is that we would have less than 10% of our revenues coming from upfront transactions and by of the majority more than 90% coming from transactions that are done on a time-based environment.

So, that still the tend of our underlying business model through the last several years and of course go into ‘09 and ‘10. So, we are aiming to keep it up below 10, so you have the consistency and predictability around that the top line in the business side. So, relative to the achievement in the quarter, while the upfront were again well within that less than 10% range for both Q4 and the total year. And it does include now the addition of the hardware piece of Synplicity.

In overall, we’re not really breaking out the details of Synplicity in that level, but if you recall we had talked about the range of $21 million to $23 million of revenue coming from Synplicity in 2008 in our numbers and they delivered against that model. So, that’s a little bit more breakout of the revenue line.

Matt Petkun - D. A. Davidson & Company

Okay. And then just a follow-up on that, are one of the things the Synplicity was really hoping to launch this year was really some tools that help people not just get prototypes on to these FPGA boards, but actually helps take those boards up to, simulators like you’ve provide or is that offering now up and running you perhaps gaining share relative to emulators, as a result or at least increasing the addressable market?

Aart de Geus

Well, it's a good question because there is no question that the whole verification side of the design flow is becoming much, much larger. And that is extenuated by the way, by the fact that there is a lot of embedded software that goes with lot of the chips. And so in that context, the Rapid Prototypin to emulation space is one that we are highly interested in. And of course, the challenge with emulator is notwithstanding that for some applications they are great, is that they are very, very expensive and a bulky machines that are not particularly flexible for many applications. And so your description is actually correct.

What we're doing is connecting it more and more to our simulation environment and this is a really multi-stage effort because there is both connecting downwards to the RTL simulation but also upwards to our virtual prototyping, which is essentially the software version of Rapid Prototypin. And then in there addition, we added yet another tenant with the CHIPit's acquisition, which adds some more capabilities that also allow us to play in some of the end applications that are software rich and where there's also some real time capabilities.

We have, I think at this point in time, a very good portfolio. And the pieces will continue through a multi year both evolution and integration. But it's an area that we're bullish and positive about.

Matt Petkun - D. A. Davidson & Company

Okay, One final question. There wasn't tremendous amount of growth, in fact the growth is now slowing, it looks like in your manufacturing related revenues, DFM related revenue if you will. Is that mostly just due to lower CADs business this year, as the overall capital equipment markets have declined? And how do you see DFM offerings expanding over the next couple of years?

Aart de Geus

Well, I think in general the results in a market that is highly played by all in all very few customers, fluctuates quite a bit from quarter-to-quarter and from year-to year. The offering is doing well. I think that what we are going to see is that the manufacturing guys are under as much cost pressures as anybody right now, because they get immediately hit by anything that touches volume. And so my guess is, that will be an area that will be fairly careful in it's spending in the near-term.

Having said that though, it is a very, very good anchor point for many of our other tools and we debate continually if we actually should split this out or not in our counting. But being all the way down into TCAD, which is almost the atomic level, all the way up to the place-and-route, is actually good position for us. So, I think you're just going to see some fluctuations.

Matt Petkun - D. A. Davidson & Company

Okay. Thank you.

Aart de Geus

You're welcome.

Operator

Our next question comes from the line of Jay Vleeschhouwer with Merrill Lynch. Please go ahead.

Jay Vleeschhouwer - Merrill Lynch

Thanks. Good afternoon. Aart, how would you compare the current environment, what we saw back in '01 and '02? I suppose in one respect at least it's very much the same with EDA almost certain to decline as an industry this year, as it did in '02. But what other differences or similarities might there be between this environment and that last EDA recession?

Aart de Geus

Well, I think one has to move to the big picture immediately, which is there's a reason people are talking about a global recession because it is touching pretty much every aspect of the modern economy. And as a matter of fact, when discussing with many of the semiconductor guys, they will all say, well, there are some big differences in '01 we had way too much inventory. In '01 there was oversupply and at this point in time the semiconductor people think, "hey we are a victim here; this has nothing to do with our industry". Having said that, the victim or not, you are part of it and so the pressure is coming from a much more global perspective.

Now zooming in on to your question, is still making the question what's the impact all the way into our industry. Well on one hand, we are obviously subject to the same cost pressures of all of our customers wanting to save money. On the other hand, we are the core of the very thing that differentiates them and keeps them alive.

Secondly in the last few years, many customers have essentially greatly decreased their R&D spending on the manufacturing side, thus freeing up some of that money to go towards design.

Now design has become more complex and so the combination of all of those things leads them to look at design not as a whole set of point to task, but more and more as a profit that needs to be orchestrated and managed to efficiency and productivity and predictability.

And those are exactly the angles that we've taken for a while and I think they are starting to resonate more than they did in the past partially because pressures always makes you look at what's essential.

Jay Vleeschhouwer - Merrill Lynch

Would it be fair to say that at the technology level one difference between now and then is that backend one or two. There was really only one important product upgrade going on at the time physical synthesis, we are to-date or might be perhaps multiple technology upgrades than necessarily need to incur?

Aart de Geus

I would almost go the opposite direction which has -- lot of focus at that time was on product upgrades and so on. Nobody is talking to us about products today. It's all about what's the overall solution and how do we manage productivity.

What can you do to help me bring my cost down and so the dialog in times of economic pressure invariably moves up and it invariably moves to the executive who says well you know I may not understand completely EDA. I know it's important but help me understand why and where and how much should I spend on this?

And it all goes back to the cost equations, and so that doesn't mean that they are not fabulous technical advances, and we are certainly proud of quite a number of the new products and new capabilities that we have. It's just that I think we have moved to more of an economic dialogue than just the technology dialog. That doesn't mean that you can bypass technology.

I think technology has to be not only good enough it has to have legs going forward and one needs to have a vision where it's heading, but the economic priorities it's only a key in the dialog.

Jay Vleeschhouwer - Merrill Lynch

Brain, with respect to the book-to-bill comment for '09, you alluded to it's been largely a function of the renewals calendar. When we look back at progression of '06 bookings, the worst quarter clearly was Q1 pretty lower bookings number, the rest of the quarter is above six, three years ago assuming you were here to the three durations. Russia not that bad second, third and fourth quarters of '06 did reasonably well particularly well Q4. So, would you say that the issue for '09 is largely a weak renewals calendar in Q1, why not release in first half and perhaps the rest of the year it starts looking normal?

Brian Beattie

Yes, on a quarterly renewal basis it's really not the most critical metrics of when deals renew, if they renew on time if they renew a quarter in advance or that relative to the financial performance of the company. I think said we do profile as we laid out some of the discussions around Q1 revenues around the expense profile, we see throughout the year. But it's pretty consistent of when the deals are up for renewal. They get negotiated anywhere between three months to a year in advance to those renewal dates to try to identify the new capabilities, number of seeds, the new product offerings and again we have to be pretty flexible if you work through these opportunities in front of us.

Jay Vleeschhouwer - Merrill Lynch

Aart, with respect to the analogue product, the custom designer, you've got the second version and GA coming in the spring. Do you think that could trigger over the remainder of ‘09 after it goes to general release, perhaps a few ten to millions of dollars of incremental bookings from that product line?

Aart de Geus

Well, as you know we never talk about specific bookings for a specific product. Let me remind you that one of the key things, why we wanted to have a good position in custom design is because we wanted to have a complete solution. And I think that was the strategic objective that we wanted to meet and I think subject to continued improvement, I think we have just made fantastic strides in that.

Presently having said that, I think the product is actually looking quite good and I already started to communicate to you, I think in the spring that we saw that the quality of the product was very high in other words, very few bug issues and so on. What we know now is that the adoption in, is actually better than something what I would have suspected and so those are all good thought.

Now you have to put that under the umbrella of the overall landscape of change and so we will absolutely drive a business, who are custom designer because there is an opportunity, there are a number of customers I would like to work with alternatives to what's been on the market and I looking for the new features, at the same as I said earlier, I think most of the dialogues with customers is about overall solutions and this is just great timing for us to have fill this gap.

Operator

Our next question will come from the line of Tim Fox with Deutsche Bank. Please go ahead.

Tim Fox - Deutsche Bank

Hi, thanks. Good afternoon. First question, just going back to the book-to-bill one more time, if I might, the lower outlook for revenue now for '09, you obviously knew what the renewal calendar was last quarter heading in to '09 and you’re talking also about maintaining run rates and additionally picking up some market share. So, I’m just wondering, how to fill in that blank of why the lower outlook for '09?

Aart de Geus

Well, first there is no blank to fill. Meaning that, I think there is a little bit of a misconception on the word "renewal". Many people think, you do a pretty good deal and therefore all these things renew constantly and sort of they, a three year cycle. That's actually not the case.

Our field people continually interact with the customer, many of the renewals are earlier and they’re not really a renewal, you sell them additional things, you sell them more things and so our objective is to continually growth the run rate with the customer, renewal or no renewal as a matter of fact.

Secondly, I think that we do try to look at roughly how many and which ones are the deals that would likely to come about and as we looked at the weather forecast on the outside, you currently do one thing, which is be as conservative as you can possibly be and there is no point whatsoever in renewing with customers that have one objective, which is get into a much, much, much lower cost point unless you can grab significantly more market share.

And so the way we are looking at this is, a combination of conservative, but stay very much on the ball or focusing on the run rate and precisely because we have a very, very good backlog for ‘09 and already substantial backlog for '010 and '011. This allows us to sort of weather the storm and be judicious in how we worked the new opportunities.

Tim Fox - Deutsche Bank

Okay, that's helpful. And Brian again going back to the cash flow and just looking at the guidance. Your GAAP net income looks like it down about 13% or so, but cash flow guidance is down about 60%. I am just wondering could you help maybe with the puts and takes you talked about and guide us through what are the major changes that really driving that 60% drop in cash flow. I mean are you looking at any major diversions in D&A or stock-based comp or is this going to be more of a deferred revenue change, you can help us try to understand the puts and takes so that will be helpful?

Brian Beattie

You bet. I mean cash as it's to sell critical right of watching each to the inflows and outflows that are coming and it's a good metric. As we look at the year in front of us here, we see both that we're going to have slightly less collections than we had seen in 2008 and that we are going to see some increased disbursements. So at a high level that's really what cash is all about. When we looked at the collection side of the equation, we over achieved our cash collection target actually by about $25 million in our fourth quarter, as you can see we came in very, very strong in cash for the entire year.

And just believe it's better to have the cash in our pockets, if you like, given the environment that we're in. So, from a swing perspective of what happens from '08 going to '09 that is contributes about $50 million right, its kind on both sides of the equation. And that's as I said about $25 million of being overly achieving the targets we had set out for ourselves in that fourth quarter. The other thing is we're just again being conservative in the cash collection environment, given how critical cash is to everybody. We want to be conservative to the payments that are already lined up.

But again, anticipating with terms of new business activity and other things that there maybe a slowdown or we aren't seeing that detail yet, but as far as forecasting of full year in advance, to start it's prudent to include that. And then again that last element on the collection side is that moderate book-to-bill reduction that we're seeing, that's going to contribute as well.

On the other hand the disbursement side, while we're holding the operating margins at about 23% for the year. We're committing to higher revenues between 3% and 5.50%. But at the same time of course, expenses will go up, reflecting the full year of Synplicity. So, disbursements being higher, the collection side being down slightly, contributed to that $200 million to $220 million of positive operating cash flow, a very strong number still.

Tim Fox - Deutsche Bank

Great. And then CapEx for '09, any sense what that might be at this point?

Brian Beattie

Yeah. We're forecasting between $30 million and $35 million of cash which is a further reduction of 15% from this year's level which we already reduced the '08 numbers if you like by 13% from the '07 level. So, again just cash is so critical, we've done I think a pretty fair job on taken up that cash during '08 and look forward to conserving that again in '07 from expense management perspective. Watch on the CapEx side and then be able to use that cash for the appropriate investment side, as we go forward.

Operator

We have four minutes left for the conference. Our next question will come from the line Sterling Auty with JPMorgan. Please go ahead.

Sterling Auty - JPMorgan

With the book-to-bill commentary that you make can you give us some idea of the magnitude change in bookings you expect in '09. Do you expect it will be up, flat, down, down double-digits just give us a sense based on that book-to-bill comment?

Aart de Geus

Well, normally, we don’t comment on bookings at all as you know. What we give out is at the end, what our backlog looks like for the coming year. And so again I don’t want to get the feeling here and we overstate this discussion point, because the correlation between the bookings and the run-rate is not a simple one at all. As a matter of fact, yeah there are many situations where lowered booking maintains a better run-rate and that is the objective to hold on to. There is lot of uncertainty right now, in terms of what customers want to do and so in many situations we are best off if they don’t do anything that's a matter of fact.

Now, having said that, our objective is to continue to grow the run-rate for the year, and so we’ll see how the economy holds up for that, but our business outlook not withstanding the landscape around us is actually quiet bullish. We think that we are as strong a position as we've been in many years given the utilization of our tools, the opportunities space compatibly that we have and the strength of the technology.

And so what you hear, us do here is essentially work against a plan that is built for conservatism. And you see us manage the balance sheet in exactly the same fashion because nobody we talk to can really predict what’s happening in the beginning or in the midst or the end of next year. And so I think we are reasonably well braced for many scenarios and as things turn up that is great. Just nobody knows that that will happen and therefore we are well prepared with the overall plan that we have put in place.

Sterling Auty - JPMorgan

Okay and then Brian, can you give a sense you’ve given us you've given us the revenue guidance and the revenue growth guidance, but what would that guidance be on an organic basis?

Brian Beattie

Well those numbers are all inclusive of course reflecting both the impact of the, primarily Synplicity acquisition, but breaking at just organic growth the company over its history has acquired many companies and continued to grow. So we really don't split them out. I think we are being conservative in both organic this does not include any additional M&A opportunities. This is really a forecast of where we see the company growing as we move forward. So 3.2% to over 5.5% is our combined overall revenue growth rates for 2009.

Sterling Auty - JPMorgan

All right, last question. Aart, there has been a couple of questions about the last time around in terms of the slowdown. One thing the last time around was the concern about shelf ware and what happened with R&D headcount and reductions. Can you give us some commentary in terms of what you are seeing from your standpoint from your customers right now on the headcount side and maybe what you might manage or do differently this time around to minimize the shelf ware issue?

Aart de Geus

Sorry, could you clarify what do you mean with shelf ware issue, you mean that demand in the software?

Sterling Auty - JPMorgan

Sure, well if you've got a 100 engineers at a customer and there are five or ten of them, and you had a 100 licenses there. They are not going to come back and buy more licenses until they get back above 100 engineers in a simplistic fashion?

Aart de Geus

Sure, now I understand thank you. Well first in terms of people. So far we have not seen major reductions in workforce in the engineering side of things and frankly I think that the first reductions are going to be much more on the production and manufacturing side, because those are things that are really impacted by volume and it invariably tends to be towards the end of any issue that people start to cut into R&D.

Now having said that, I think there is no question of people will look at which project have a future and will mostly try to sell off the assets that don’t any longer fit their strategy. So, I think we are going to see a number of businesses essentially trading hams more than anything. And invariably the engineers go with that and then it’s a matter of working out the fine points of what happens to the software as they move owner.

On the software issue, I think that sort of secondary to that first point, meaning that I don’t there is much software right now. Remember that one we came out of the crazy ‘99 and 2000s, where if you just had clicks that were viewed as revenue and that permeated the entire industry. So, people were growing so much, they were just buying on the future. I think that is long gone, as a matter of fact if there is anything that CFO have changed in after ‘01 is that, they are not buying ahead of needs very much.

Lastly, I think that’s for many of the more modern shaft the utilization of software has dramatically grown up or grown I should say until from that perspective its more a matter of negotiation of how much do you get for the budget that you have available than anything and our objective should be the discussion with customers because that brings us straight back to productivity to how they can simplify their flows and how we can become a more important supplier to them rather than having debates on numbers of copy.

Sterling Auty - JPMorgan

Okay. Thank you.

Aart de Geus

You’re welcome.

Operator

Our next question will come from the line of Terence Whalen with Citi. Please go ahead.

Terence Whalen - Citi

Thanks. I appreciate you putting me in. This one is just a real simple one on operating margin. Brian, I believe you said with the revenue growth of 32% to 55% in fiscal ‘09 you would expect expenses to be inline or undergo that slightly. Would that mean that operating margin would be slightly upper, I thought you had mentioned maybe operating margin would be down slightly if you could just reconcile those and that's from me.

Brian Beattie

Yes, you bet Terence. We are really looking overall at about a flat margin story at a very healthy 23% level right, where we came in for this year. So, we are working around that based on the scenarios for both revenue and expenses, but it's a roughly flat numbers. So, maintaining the profitability levels that we've achieved deal both it can be additional revenue and to be able to invest in those opportunity it's right in front of us to be able to grow for the future here.

Terence Whalen - Citi

Okay, great. Thank you.

Aart de Geus

You’re welcome.

Operator

And our last question will come from the line of K.C. Rajkumar with RBC Capital Markets. Please go ahead.

K.C. Rajkumar - RBC Capital Markets

Hi. Can you talk to any specific initiatives that you want to see taken and especially seasonal marketing folks to gain customer share, not market share, but customer share at the expense of your main competition.

Aart de Geus

Certainly we have a quite a number of very active discussion with customers about the notion of productivity and predictability. Let me distinguish the two, productivity is clearly how you can get as much out as possible for the amount of dollars that you spend. And when I say dollars you spend, I’m not talking just about EDA out of pocket cost, but overall design cost.

And that is really the key that, that we have to go after, because if we can look at that picture, the way that we can save our customers’ money, while for Synopsys is growing. Secondly on predictability, which is the other, is the time dimension, is that with more and more of the complex chips, people are finding that they have a hard time knowing exactly when the project is finished because their design methodologies a little bit all over the map and need to become more structured, more standardized, and more disciplined. And that of course ties directly to the first topic which is how can you work with fewer vendors to get a better solution.

And so those dialogues are very, very active right now. And I think that we will see that economic pressure will actually help customers make moves that otherwise, internally are hard to do, because change management is always hard. Whereas, when it becomes economically harder, top down management can actually have more impact and I think we are already starting to see the beginnings of that.

K.C. Rajkumar - RBC Capital Markets

Do you expect the launch of the custom designer tool to help you gain customer share next year, or is it that more of fiscal '10 story?

Aart de Geus

No, I think it is a fiscal '09 story and it is obviously, gaining share from virtually zero and specifically the custom-design area. And so there are customers that already have done tape outs with our tools today, which is very encouraging. At the same time, it is also in the much bigger picture which is by virtue of having a more complete solution, we become much more attractive to customers that really have a need of selecting fewer vendors to be economically more viable. And we now have a check mark in that category, as well.

K.C. Rajkumar - RBC Capital Markets

Okay. Any quick thoughts on, what is going to be the revenue for following fiscal '09 beyond the first quarter?

Brian Beattie

Well, I think we gave earlier guidance and maybe we can take this up in the Q&A session, the individual Q&A interactions. But there is guidance for '09 revenue in the documents I've send out I believe. And so if we can refer you to those, there is a lot more detail there.

K.C. Rajkumar - RBC Capital Markets

Lastly, do you expect the base of 32 nanometer tools to pick up next year?

Aart de Geus

I think it has already picked up, because the 32 nanometer chips are already in design, the technologies are being honed for roll out in 2009. As a matter of fact, I am looking at my sheet here that we are, tracking 32 active designs today. We already have a number of tape outs at 32 nanometer and I know that there is a whole bunch of people that are gearing up for making the technology available commercially, pretty much in the second half of '09. So, the technology train hasn't path decelerated at all.

K.C. Rajkumar - RBC Capital Markets

Finally, would you have any quick thoughts on I think you have addressed this earlier. But if one or two point to couple of specific risks which you can anticipate into next year, beyond the usual macro stuff through guidance what could they be?

Brian Beattie

Well, it's obvious, that the macroeconomic picture is one of uncertainty that pretty much all of us have never seen so far. Now having said that, both the high-tech field is impacted, but is also crucial within that the semiconductor field is impacted bit even more crucial and I would argue that line of reasoning applies to us as well. So from that perspective, I think continued investment in high-tech will absolutely be a necessity.

Now the fact is that, when everybody is looking for money, the negotiations are going to be harder than before. People will plead that they need more technology for less money. We should be prepared and we should not be careless about that. I think many of our customers will hurt and we need to be able to a really good partner in that. But at the same time we also provide the very value that allows them to differentiate survive and do well. And so I think we are crucial for that picture.

Lastly, I expect that in United States within the new administration there will be additional emphasis on high tech and so I think that supports all of the arguments I just made that the semiconductor industry will continue to be very important in the years to come.

With that I think it’s time to close this earnings release. We appreciate the time that you spent with us. As usual Brian, Lisa and myself available for additional comments and questions right after this. Thank you for all the support in '08. We look forward to your support in '09. Find to be in many ways a very interesting challenging but also high opportunity year for us. And so we appreciate the time you spent with us in this earnings call. Good bye.

Operator

Ladies and gentlemen this conference will be available for replay after 4:00 pm till Wednesday, December 17th at midnight. You may access the AT&T teleconference replay system at any time by dialing 1-800-475-6701, and entering the access code of 968632. International participants may dial 320-365-3844. Those numbers again are 1-800-475-6701 and 320-365-3844 and enter the access code 968632. That does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.

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Source: Synopsys Inc. F4Q08 (Qtr End 10/31/2008) Earnings Call Transcript
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