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Synopsys, Inc. (NASDAQ:SNPS)

F3Q09 Earnings Call

August 19, 2009 5:00 pm ET

Executives

Lisa L. Ewbank – Vice President of Investor Relations

Aart J. de Geus – Chairman of the Board & Chief Executive Officer

Brian M. Beattie – Chief Financial Officer

Analysts

Raj Seth – Cowen & Company

Matt Petkun – D.A. Davidson

Rich Valera – Needham & Company

Sterling Auty – JP Morgan

KC Rajkumar – RBC Capital Markets

Paul Wick – J&W Seligman & Co.

Operator

Welcome to the Synopsys, Inc.’s earnings conference call for the third quarter of fiscal year 2009. At this time, all participants are in a listen only mode. Later we’ll conduct a question and answer session, 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’d like to turn the conference over to Lisa Ewbank, Vice President of Investor Relations.

Lisa L. Ewbank

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.

In addition to any risks that we highlight in this call, important factors that may affect our future results are described in our 10Q for the fiscal quarter ended April 30, 2009 and in our earnings release for the third quarter or fiscal year 2009 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 third quarter earnings release and financial supplement. All of these items are currently available on our website at www.Synopsys.com. With that I’ll turn the call over to Aart de Geus

Aart J. de Geus

I’m happy to report that we again made excellent progress towards our year’s objective. In Q3 we demonstrated solid financial results, substantial technology advances and continued customer momentum. Summarizing our financial results we delivered above targets non-GAAP EPS of $0.47 with $345 million in revenue. We achieved this within our predictable business model with more than 90% time based revenue. We continued our focus on cost control and we exited the quarter with a very strong cash position.

Turning to the economic environment around us, we see that bankruptcies have subsided, that inventory corrections are driving in increasing activities, and most importantly that the natural level of consumption is gradually stabilizing the semiconductor market. That said forecasts are now on average that our customers will end 2009 with revenue down about 15% to 20%. While semiconductor executives are cautious in a still uncertain economy and expect a gradual recovery lasting into 2011.

Accordingly, at Synopsys we are planning for continued industry stress through 2010 although we see a great opportunity to further strengthen our competitive position as customers focus on the best, most reliable long term options. Given this backdrop, we have assertively managed our business to not only adapt to the downturn but also take full advantage of it. Expense controls are offsetting marginally weaker revenue. We are driving long term segment share shifts with customers moving to us and we continue to make aggressive technology investments all focused on reducing our customer’s total cost of design.

For fiscal ‘09 the result is that we’ve been able to adjust expenses to offset slightly reduced revenue expectations and provide earnings in excess of our original targets for the year. We’re also increasing our operating cash flow forecast to reflect the improved customer collections environment. We expect to exit this fiscal year with a slightly down revenue run rate. From an orders point of view, contracts are now renewing closer to the end of their duration as customers are still cautiously delaying their decisions. Contract length though, remains stable. While durations fluctuate a bit from quarter-to-quarter, we continue to see the average range around three years.

Behind our customer’s trust and commitment to Synopsys lies the recognition that we’re providing them several clear advantages. First, a continuing stream of technology advances. This quarter we again delivered substantial new capabilities to our customers. Second, a global support organization that materially impacts the success of IP design as we help customers achieve better chip sizes, speed, power, yield and most importantly, meet difficult schedules. And third, an intense focus on the total cost of design, which can be considerably improved by integrated EDA solutions with links to manufacturing, systems and sophisticated IP blocks.

Each key semiconductor company such as Exar, Intel, Marvell, National Semiconductor, Panasonic, Renesas, Toshiba, Wolfson, and others are counting on us to be their primary EDA partner as they drive forward the product that will carry them out of the recession. Technology leadership is critical in this equation and in truth we again delivered great new value to our customers. Starting with our Galaxy Implementation Platform, we introduced brand new in design physical verification capability with IC Validator. This is remarkable as the in design integration lets customers diagnose and fix issues during place in route long before final signout, thus minimizing disastrous schedule delays.

In June, we also shipped a complete new Galaxy release with extended core features throughout the flow and enhanced low power performance. Our customers are seeing notable success. Insignia for example, used IP Compiler to tape out the lead product of their high performance, automotive microcontroller platform. At the recent Design Automation Conference, several customers including Toshiba, Renesas, and Samsung described the excellent results using Galaxy and the in design capability integrating IC Compiler with synthesis, signoff, and physical verification.

Our goal is for these successes to result in segment share gain and while shifts occur gradually, I can tell you that we’re actively replacing competitors at a number of important customers. The central theme remains the same technology differentiation and risk reduction. One effort that precisely fits that description is collaboration we announced last month with our ARM and the IBM/Samsung chartered common platform. Together we are developing a comprehensive new solution for high volume mobile applications at 32 nanometer. The target integration of advanced rough processors, connectivity IP, manufacturing technology and a state of the art design flow will be instrumental in reducing cost and time to market.

Turning to verification, our discovery release also included many new advanced features in both digital and analog. In Q3, we’re released CustomSim for unified analog simulation. It combines the speed and accuracy of what used to be three separate tools into a single, flexible, easy to deploy solution. We delivered multi core technology in our core of VCS functional simulator resulting in a 2X speed up. Given that the simulator is used in the majority of the advanced chips in the world, a speed up of this magnitude has major economic impact as customers are able to reduce expenses for costly computer hardware.

Turning to our strategic investments, we continue to see excellent progress in both analog mix signal implementation and in our IP systems space. Custom Designer, our new analog mixed signal design solution went into general availability in June with two major new features, schematic driven layout and an advanced analog simulation environment. Customers can now complete full analog mixed signal design using only Synopsys as evidenced by two tape outs in the quarter. Interest has been significant with requests for demos and evaluations exceeding our capacity to fully handle at the moment.

To support the deployment of technology molds through open standards, TSMC announced the availability of the first 65 nanometer interoperable process design kit or iPDK for short. The iPDKs are based on the open access standards and works seamlessly in our products. Moreover, TSMC also announced that they have chosen Custom Designer as their iPDK development and validation platform.

Moving to our IP business, last quarter’s acquisition of the analog business group of MIPS has generated great feedback from our customers. The integration is right on track and added a rich library of analog IP as well as HTMI connectivity cores. We continue to do well in this business and again introduced significant new products in Q3 including several connectivity titles and key power optimization IP.

In addition, we were the first company to achieve certification for a USB analog [inaudible] of 32 nanometer. Finally, tying it all together at the high end, our systems solution is also progressing well. At DAC we demonstrated our newly integrated virtual platform an FPGA based rapid prototyping solution developed to accelerate embedded software development. Customer reaction to our technology momentum has been extraordinary.

During the quarter, we had a record breaking user group attendance at a number of events. Most notably was well over 2,000 attendees in our India meeting alone. In summary, Synopsys continues to execute well amid the uncertainty around us, we’re actively working with customers to help them successfully navigate the recovery and in turn are positioning ourselves for even greater strength in the future. With that, I’ll turn the call over to Brian Beattie.

Brian M. Beattie

In my comments today I’ll summarize our financial results for the quarter and provide you with our 2009 guidance. As a reminder, I’ll be discussing certain GAAP and non-GAAP measures of our financial performance. And we’ve provided reconciliations in the press release and financial supplement which is posted on our website. In my discussions, all of my comparisons will be year-over-year unless I specify otherwise. Now as Aart highlighted, Q3 financial results were solid. We delivered bottom line growth, expanded non-GAAP operating margins and generated considerable operating cash flow.

Let me now provide some additional details on our financials. Total revenue was $345.2 million within our target range and with greater than 90% of our Q3 revenue coming from beginning of quarter backlog. Our IP and systems business performed particularly well this quarter driven primarily by our digital and analog IP course. This of course includes the very small revenue portion from our acquisition of the analog business group from MIPS Technologies. Even excluding this transaction, business was quite robust. One customer accounted for slightly more than 10% of third quarter revenue.

Now turning to expenses, total GAAP costs and expenses were $284.1 million which included $11.4 million of amortization of intangible assets and $14 million of share based compensation. Total non-GAAP costs and expenses declined 4% to $251.9 million and were below our planned range despite absorbing the analog business group acquisition. The decrease was driven primarily by timing of quarterly expenses such as variable compensation as well as companywide cost control.

As a result, non-GAAP operating margin was 27% for the quarter. Q4 operating margin is expected to decline sequentially due to lower revenues and traditionally higher Q4 expenses driven primarily by variable compensation. This is consistent with the quarterly expense profile we outlined entering the year and similar to year ago trends. While quarterly expenses can be lumpy due in part to the timing of large transactions, for the year we continue to expect total expense growth to be slightly less than our targeted revenue growth even with our recent acquisitions.

Turning now to earnings, GAAP earnings were $0.32 per share down from $0.39 a year ago. As you’ll recall, Q3 ’08 GAAP earnings included a onetime $17.3 million tax benefit associated with the IRS settlement for fiscal years 2000 and 2001. Non-GAAP earnings were $0.47 per share exceeding our target range, and includes the slight dilution from our recent acquisition. Our non-GAAP tax rate was 26% for the quarter and for the entire year we continue to expect a non-GAAP tax rate of approximately 27%. Our revenue visibility remains strong with greater than 90% coming from beginning of quarter backlog. Up front revenue was 5% of total, well within our target range of less than 10%. The average length of our renewable customer license commitments for the quarter was about 2.8 years.

Now turning to our cash and balance sheet items, we entered the quarter with $1.08 billion in cash and short term investments. Of this balance, 55% is held within the United States. We generated $232 million in cash from operations in the quarter including an expected annual payment from a large customer. We are raising our operating cash flow target for the year to approximately $190 to $210 million driven primarily by an improved customer collections environment.

This target does not include any impact from our tentative tax settlement from the IRS that we detailed last quarter. While still subject to further approval by the Federal Government, we would expect the settlement to result in cash payments of approximately $50 million over the next 12 months which would be fully offset by tax benefits in future years. We also expect that the settlement would finally permit certain tax refund claims of around $35 million from other years to be paid to the company in 2010.

Now continuing on with our cash and balance sheet items, capital expenditures were $9.9 million in the quarter. For the full year we expect cap ex to be approximately $35 to $40 million including some additional Q4 expenditures as we consolidate our Bay Area facilities. While this is a slight upward revision to our original target range, it’s roughly flat with last year. We did not repurchase stock in the quarter and have approximately $210 million remaining on our current authorization. Recall that we acquired the analog business from MIPS Technologies during the quarter in an all cash deal funded from our US cash balance. As always we’ll evaluate the best uses of cash each quarter including company operations, investments and stock repurchases and at the same time we value the flexibility that our cash provides.

Q3 net account receivables totaled $136.8 million and DSOs declined 15 days sequentially to 36 days reflecting the high quality of our current account receivable portfolio and the timing of invoices. Deferred revenue at the end of the quarter was $618.6 million. We ended the quarter with approximately 5,990 employees, an expected increase due primarily to the analog business group acquisition. While we have selectively grown our headcount primarily through acquisition, more than a third of our total employees are located in lower cost geographies.

Now, moving on to guidance; for the fourth quarter of FY ’09, our targets are revenue between $335 and $343 million reflecting some caution regarding the level of up front and turns business. Total GAAP costs and expenses between $297 and $313 million which includes approximately $15 million of share based compensation expense. Total non-GAAP costs and expenses between $272 and $282 million, other income and expense between zero and $3 million, non-GAAP tax rate of approximately 26%, outstanding shares between 146 and 149 million, GAAP earnings of $0.14 to $0.21 per share and non-GAAP earnings of $0.39 to $0.33 per share. We expect greater than 90% of the quarter’s revenue to come from backlog.

As a result our 2009 outlook is: revenues are approximately $1.357 to $1.365 billion representing growth of about 1.5% to 2%; other income and expense between $11 and $14 million; a non-GAAP tax rate of approximately 27%; outstanding shares between 144 and 146.5 million; GAAP earnings per share between $1.16 and $1.23 which includes the impact of approximately $58 million in share based compensation expense; non-GAAP earnings per share of $1.71 to $1.75; and we’ve increased the low end of our guidance range by $0.9 and the top end by $0.3. As I mentioned earlier we are targeting cash flow from operations of $190 to $210 million which does not include any impact from our tentative tax settlement with the IRS. We will provide 2010 guidance in our next earnings call in December reporting Q4 results.

In summary, we continue to manage the business well in what is a difficult economic environment. I’m pleased with our consistent execution and solid financial results, highlighted by operating margin expansion and solid cash flow generation. With that I’ll turn it over to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Raj Seth – Cowen & Company.

Raj Seth – Cowen & Company

Aart can you talk - don’t talk explicitly about bookings, but how, even qualitatively, how have bookings come in here in Q3? I think last quarter you suggested that Q1 was weak, Q2 I thought was closer to your expectation. How’s the bookings environment feel how bookings have been coming in, even qualitatively if you can make any comment?

Aart J. de Geus

We don’t give any quantitative comments but qualitatively I would say it is sort of back to expectations. The Q1 was extraordinary just because almost every company was in shell shock and just delayed all decisions. I think we’re now back to business as usual with one difference from the past which I eluded to which is that all the contracts tend to go a little bit longer towards the end of the contract which is actually very reasonable behavior given the situation and given that the contract that we are closing are coming in just fine. I think this is exactly the type of situation for which we are well equipped.

Raj Seth – Cowen & Company

So run rate I think last quarter you talked about it being - annualized run rate sort of at par or slightly below, same general trend.

?

Aart J. de Geus

Yes that has not changed partially because we’re really reflecting what’s happened early into the year. I remain a little bit cautious about will there be further consolidation or changes in the semiconductor industry but at the same time I also see a number of signs that people are definitely seeing some light at the end of the tunnel or at least preparing for that.

Raj Seth – Cowen & Company

You mentioned some incremental caution on some of the turns business that you would normally see in Q4. What’s driving that or is that a minor effect?

Aart J. de Geus

I think it’s a minor effect. It’s more that, in a situation where people live with uncertainty are cautious, turns business can be easily delayed by a day, a week, or a month and if those happen to be the dates that cross the boundary of a quarter one tends to be a little bit more sensitive to that. However, the quality of our business model is such that we enter with the quarter with a high degree of confidence in our revenue and so it’s really just on the margin I would think.

Raj Seth – Cowen & Company

One last one if I might, Brian talked about a strong balance sheet, you’ve got a $1 billion in cash. You’ve talked for some time and I think it’s been clearly the smart decision; preserve optionality and you stop buybacks and you just sat on the cash. At what point do you start considering buybacks again? I mean you’ve got clearly excess cash sitting here, what triggers a decision to maybe begin to deploy that cash rather than just sit on it?

Aart J. de Geus

Oh well we actually make that decision every quarter and so this is not just something you put on the shelf for a long period of time. I think you’ve got correctly the fact that we looked at having optionality in our option space. We have that. I think there’s many changes to come in the industries around us and so right now we like the fact that we have a high degree of freedom of what we’re going to do but there’s also no question that buyback could be one of the things that we can use the cash for.

Operator

Your next question comes from Matt Petkun – D.A. Davidson.

Matt Petkun – D.A. Davidson

A couple questions from me, first just when I look at the sales and marketing line item Brian, you’ve been running consistently at rates at, or in this quarter below last year’s rates on a year-over-year basis. Is it fair to say that you’ve made some structural changes and we could expect that maybe you’re getting a little bit more leverage out of that group? Obviously some of it relates to the bookings activity this year versus last year. But more directly I’m wondering how we should think about that number moving into Q4?

Brian M. Beattie

Yes Matt, I’d say that the majority of the reasons on the quarter-to-quarter profile as well as the increase projected effectively in the fourth quarter is related primarily to variable compensation. We indicated again that is one of the factors there relates, and not only it’s tradition in the fourth quarter, not only there, we look at the fourth quarter and this fourth quarter actually will be lower than last year’s fourth quarter and we forecasted along the lines. So I’d just say that’s the primary area of variation from quarter-to-quarter, it’s on variable compensation. We’re also seeing some really significant improvements on the travel areas. We’re down about 40% year-over-year as well as below our budget on travel savings and benefits. So again, just focused at this business to optimize the margin and cash flow.

Matt Petkun – D.A. Davidson

Then Aart, looking at this analog IP business it’s obviously early days but I’m wondering if any of the conversations you’ve had, do you see any opportunity to maybe pull through some of your, some digital design opportunities especially in the areas of wireless video?

Aart J. de Geus

Well Matt, this has absolutely been a very good buy for us because, not only does it add a substantial catalog of analog IP blocks, it also adds some very strong IP designers. Very few people know that we have over 450 analog designers within Synopsys at this point in time. So right here at a minimum there’s a strong incentive to make sure our analog tools do very well within the company.

Having said that, this was one of the acquisitions where I got an enormous amount of unasked for positive feedback from customers almost right away. What that tells me is A, they were really looking at the company as having an opportunity to strengthen the products that they were getting and go further with that and B, that there’s a strong desire to see Synopsys take a stronger position in that direction as well. And yes, it has some impact on the tools going forward, although I think that will take a little bit longer time.

Matt Petkun – D.A. Davidson

Then just one other question, Brian you said that some of your guidance for Q4 was related to upfront, your caution on upfront and turns based business, are you saying that you think that bookings could be delayed and so the upfront portion and the turns portion of that business could be affected because when I look at your upfront revenues in general, they’ve been relatively stable the last three quarters in a tougher environment?

Brian M. Beattie

Yes, I think you’re exactly right. The impact on the business from quarter-to-quarter, again we’re discussing here pretty slight variations from one to the next built into the guidance and with, as you saw in the third quarter 95% of the quarter coming over from the previous quarter in terms of bookings and visibility, we’re in a real strong position so, we’re just dealing with that extra 5%. Our commitment is when we provide that guidance, we’re looking at what we’ve already got booked for the quarter as well as anticipation.

So good performance on the time-based licenses continuing each quarter-to-quarter and just a little bit of caution around the deals that we’re going to close where we’ll be able to take revenue on those deals in the quarter. So as you know if they close at the very end of the fourth quarter, then there’s very little revenue associated with that and we’re just cautious relative to the timing. As Aart said, as customers are effectively waiting, in some cases, until the end of their contracts to be renewed. And we say when they renew them not if they renew them but it’s again, has an impact slightly on the revenues and we just need to be cautious as we look at the fourth quarter.

Matt Petkun – D.A. Davidson

Okay so just to be clear, when I’m looking at the potential for a sequential decline in revenues that would be the upfront portion recognized in time based licenses is primarily where you’re seeing that, is that correct?

Brian M. Beattie

No, no. It’s actually the time based licenses is pretty solid actually. It’s just the line called upfront revenues itself. So I’ll break it down for you, upfront and time based licenses and the sequential decline there is in that upfront portion just associated with the type of transactions and you can see it’s a small number anyways. But that amount of variability that we have some visibility to now in the quarter is where we would anticipate the decline.

Operator

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

Rich Valera – Needham & Company

Aart, in your prepared remarks you mentioned you expected to exit the fiscal year at a slightly lower, I think you said revenue run rate which is the first time I’d specifically heard you call it out. I guess from parsing between upfront and time based, I’m just trying to understand where is the lower revenue run rate coming from, is it because of the lower bookings that happened in the first quarter or two or is it something you’re seeing more recently like this concern over upfront that you’re talking about in the fourth quarter?

Aart J. de Geus

Let me clarify, first when we look at the revenue, there’re multiple components to that. What we refer to as the revenue run rate which is not a very, very firm number because it’s difficult to actually calculate it, is essentially a measure of repeatability of all the large contracts. So the only reason the revenue run rate is slightly down is because early in the year there were a number of companies that frankly just disappeared. Meaning that there were bankruptcies, there were companies that went out of business and part of that was in our backlog, part of were going to be renewed and they’re gone.

Having said that, we have seen a complete decline of those, actually I’m not even sure there were any bankruptcies in Q3 now that we’re talking about it. So this has gradually improved during the year and we wanted to make sure people understand that the semiconductor industry is still in beginning of recovery mode. It’s not massive recovery partially because what you see is mostly from inventory corrections. Having said that, overall the future does look a lot better than certainly the last three of four quarters and we are in a very solid position. So, this was to give you a sense of how we look at the business exiting what we see the de facto as probably two to two and a half year recession and we have many other things that we can do on top of the existing revenue run rates and that we will do to grow the business from there.

Rich Valera – Needham & Company

So you’re last couple of sentences there were intriguing but it sounds like sort of all things equal without any acquisitions presumably you would expect 2010 to be a down revenue year from 2009 and I know we don’t want to get in to guidance but it sounds like kind of that’s what would be implied by your run rate statement.

Aart J. de Geus

As you said, we don’t want to get in to guidance right now. I think we are trying to make sure that we don’t get ahead of making predictions too quickly on both the basis of what happened earlier this year which gives some caution but also on the basis of how things feel right now which feel much more positive and the fact that I think we’re executing particularly well. You may recall, if you look way back in some of our earnings releases, that probably about four of five quarters ago already I warned that we were going to start paying more attention to expenses in light of potential revenue shifts if there was a recession.

There’s been obviously a massive recession. I think we’re sailing through this with flying colors as a matter of fact and the very fact that we will deliver growth in ’09 according to the guidance we just gave, I think is a solid sign for that. So, we’re just trying to be very complete in how we let you know about the picture without wanting to give guidance before giving guidance. Just the fact that we had, I think, outstanding results in Q3 shouldn’t let us dance on the table. Yes, this is in an environment that’s tough but I think Synopsys is executing particularly well.

Rich Valera – Needham & Company

One final one if I could. You mentioned TSMC rolling out the iPDKs which would seem to be a boom for folks like yourself trying to break in to the analog design space. Could you give us a sense of what your sense is of how significant those are? Folks have been trying to use open access and pie cells for a while to sort of break in to established Cadence accounts. What do you think the iPDKs might mean for that effort

Aart J. de Geus

In general, all fields go through evolutions and that is true for the analog field, it’s true for many other fields. The open access coalition and effort have been some very, very good efforts for many years that actually were pioneered by Cadence who has added a lot of value to that. This is not any different than Synopsys many years ago pioneering many of the other access formalisms around digital design because we all know very well that our customers use a number of tools from a variety of sources that have to work together.

Simultaneously it’s also clear that with the smaller geometries, it is more and more important for the availability of libraries to not only be there for all of the tools but also not become too costly and be complete in terms of the technology terms. So, the iPDKs are really the next evolution that the entire industry is signing up for and the fact that TSMC is leading the pathway in providing the data is a good sign because they are by far, by far, the largest foundry in the world so we all rely on the quality of the models they provide so iPDKs is a very good thing.

Operator

Your next question comes from Sterling Auty – JP Morgan.

Sterling Auty – JP Morgan

I want to circle back Aart to the comment that you made in your prepared remarks about the stress on the industry and I wanted to get some clarification. So, you’re seeing the improvement, inventory replenishment in some sectors, you mentioned that they need to feel confident in the improvement before you start to see some improvement in your own business. But, I wanted to make sure, did you say that stress would continue in to 2010 or to 2010? It would seem to me that if they see a decent back half that they should start improving their spend and demand in the beginning of 2010?

Aart J. de Geus

Let me start by saying let’s not over stress the fact that I’m not the oracle on what is going to happen in the semiconductor industry. I may talk to a lot of people but it’s a hard industry to completely predict. What I meant to say is actually through 2010 meaning that if you look at the present semiconductor industry, just to give you some rough numbers, the first quarter it shot down 38% and that’s where everybody sort of hit the brakes. Then, it shot back up by virtue of inventory replenishing and many short term orders.

Now, the expectations, and the jury is actually still very much out, the expectations are for the semiconductor industry to end at about -15% to -20% down from let’s say ’07 to ’08. I can certainly confirm that that is the gut feel that I’m getting from all the execs I talk to. After that, the semiconductor industry will most likely behave like it always did which is ups and downs but a gradual return that some have said will go all the way to 2013. I think it’s much more likely that it’s through 2011 but in other words, 2010 is a gradual recovery year.

How do people behave in such a situation? Well, in such a situation they have clearly seen that there’s been a big disruption in the past year. They have clearly seen that a number of companies did not do well, others have gained strength but it’s not visible yet, and most likely there will be some consolidation or rearrangement of the industry. So, during that time, those that have hard needs will absolutely spend more but most others will just sort of try to lay low a little bit in their expenditures.

I think that they will focus a great deal on spending more with those people where they can simultaneously save somewhere else. Therein lies some of the opportunities for us because we touch more than DDA budgets, we touch actually the total cost of design. So, what we have tried to do is to increasingly focus on interaction with customers on the basis of their overall economics. That by the way is a great opportunity that has been accentuated by the recession which is we talk to high levels in companies about their economics instead of the details of cross capacitants coupling somewhere in some tool.

The picture I tried to project is one that said we at Synopsys have a great opportunity to really strengthen and broaden our position while at the same time setting up a growth pattern for the future that is predicated on knowing that people have to simultaneously be cautious in their expenditures.

Sterling Auty – JP Morgan

The next question is actually for Brian based on your comment, if we looked at it, your total expenses were $14 million below the midpoint of the guided range for non-GAAP expenses. How much of that coming in below was that variable component that you mentioned?

Brian M. Beattie

Oh, most of it. I don’t want to say all of it here because there have been a lot of very good actions taken by the team on minimizing compensation and taking the right actions to keep the spending rate low that we indicated we would do at the beginning of the year. But, the rest is just timing that’s going to be moving in to the fourth quarter as I was indicating. Then, you’d anticipate Q1 drops as it has pretty well every year from the Q4 levels just based on the timing of variable compensation related to commissions, any incentive plans and so on in place and very traditional flow.

Sterling Auty – JP Morgan

Then help me reconcile if most of that came from variables coming in lower, that would suggest to me then that actually your bookings in the third quarter were below what you anticipated when you gave guidance last quarter?

Brian M. Beattie

Well, we indicated a couple of things last quarter and we’re reiterating this quarter that contracts are renewing closer to their expiry date. Again, as you know, with our business model if the contract hasn’t expired yet it does not have an impact to our revenue profiles. We’re in a great position to work through the best thing, provide the best value for the customers and the right thing for Synopsys. If it closes at the end of one quarter, it’s fine; if it closes three days later and flips in to the fourth quarter, that’s fine too.

But, it’s something that we’re watching and certainly it’s been a trend we’ve seen throughout the year of closing off the agreements closer to the expiry of them itself. So, we’ll work it through. Yes, there was a little bit of a shift in those deals that moved in to the fourth quarter and that’s what we factored in to our plan but again, as we’re tacking it through great financial results for the year.

Sterling Auty – JP Morgan

The last question is on cash flow, based on the cash flow guidance that you gave for the full year, it would indicate the lowest fourth quarter cash flow that you’ve generated since 2002 so if you had maybe some of the bookings slip in to the fourth quarter did you see actual collections get pulled forward and collected earlier than you would have thought?

Brian M. Beattie

I’d say most of it was really from a returning level of confidence with our customers. As we got through the first quarter that was the highest level of uncertainty and the highest level of announced bankruptcies, slow payments and so on. Then, we saw the second quarter again coming back to a stability level and with more confidence returning in the third quarter there appears to be a sense of recovery that the customers were very good on paying exactly on their due dates and we’ve got very deep relationships with them so the cash inflow came in strong during the quarter and as a result we were able to increase our operating cash flow levels as we indicated just based on better performance, more certainty around collection and more confidence as we go in to the fourth quarter that the collections and the spending profiles will be profitably managed, both sides of it, to generate increased operating cash flow for the company in 2009.

Operator

Your next question comes from KC Rajkumar – RBC Capital Markets.

KC Rajkumar – RBC Capital Markets

To pick up on the question of cash flow, can we conclude that the strength in cash collection is a sign that the customers are actually loosening up their purse strings? Was the improved collection coming from just a few customers or was it more broad based?

Brian M. Beattie

Well, an increase in confidence and cash flow on expected dates from the scheduled customers that we had scheduled through the agreements. As you know, we take all of our backlog and profile that in terms of revenues going forward and cash to be collected forward by customer, by quarter. The customers paid as expected, again just based on the relationships that we’ve been able to build up and there was far less activity related to slow payments and announcements of bankruptcies. Still a couple of small ones but overall the performance was again stabilizing this quarter and a slight level of improvement going forward. So, they just paid per the terms and the agreements, nothing in advance and very little in arrears of their expected dates.

KC Rajkumar – RBC Capital Markets

Sort of a broad question, I’m trying to understand [inaudible], would you at least say that your top line will be in the same direction as your customers? Meaning that if your customers are going to see an up kind of turn that will be the same direction that you would expect your top line?

Aart J. de Geus

I think you’re asking us for guidance for ’10 that we don’t want to give yet. I think generically the answer is yes because we do follow the semiconductor industry. The reason one should not answer your question with yes is because the semiconductor industry moves with incredible ups and downs. In aggregate the stability of semiconductor is actually quite good but in quarter-to-quarter or even year-to-year it can easily bump from 20% to -20%. Whereas we would love to take the 20%, I don’t think we want to take the -20%, which we just saw by the way.

So, just to maybe categorize some of many of the questions I just heard in the last few minutes both in terms of cash, in terms of orders, in terms of business profile, I do think that our customers are in aggregate more confident that things are solidifying and therefore are moving back a bit more to business as usual. It’s just that the business as usual right now is not at the same level as it was ’07 and ’08 yet and that will take some time.

If you take those comments in conjunction you would have to say, “Well, that’s actually a great opportunity for Synopsys.” Because, with the massive downturn we have been able to hold the fort so to speak meaning that we’ve done very well and with the expected upturn or return, we have an opportunity to build on the strength that we have carefully cemented over the last year and a half as this was happening. So, we see actually great business opportunities, it’s just that like nobody was really capable of completely calling the downturn in Q4/Q1, one cannot really completely call the upturn exactly either.

KC Rajkumar – RBC Capital Markets

You talked about taking advantage of the downturn and looking to have positive shift towards you guys, is it fair to assume that for the coming couple of years at least that your top line would outgrow that of your peers?

Aart J. de Geus

The part of the challenge with that statement is that many people have gone through model changes. However, what I can say is that I think we have a model that is incredibly solid but more importantly than that is that model is now built on a product portfolio and a customer penetration that is very, very solid. So, that allows us to build on top of that basis going forward and the fact that we now lead the industry and have an opportunity to really help customers that are trying to save money while at the same time spending well with us, I think is a great opportunity for us to fuel the growth going forward.

KC Rajkumar – RBC Capital Markets

Lastly, on the op ex, have most of the temporary savings, have most of them been unwanted?

Aart J. de Geus

I’m not sure which temporary savings you’re talking about. What we have done is systematically gone through the company and prioritized all the savings that we could do. Some were obvious things that one should do, some are things that one can do if there was a worse recession or what have you. Luckily for us, we’ve been able to do very well with a number of things that have reduced our day-to-day spending. I think Brian mentioned already the travel line which is a very visible example but it’s also making sure that we invest in those areas that will have a return going forward.

We expect to continue that behavior so far for me to say that there’s not more places that we can save but it’s also clear that there are opportunities for us to invest be it in R&D, be it in M&A, be it in special support situations of customers that we can help through the downturn. All of those are essentially building solidity for the future. We’re doing all of those.

Operator

Your next question comes from Paul Wick – J&W Seligman & Co.

Paul Wick – J&W Seligman & Co.

Could you just talk about the uptick in maintenance and services on the income statement and what was the cause of that and whether it’s sustainable?

Brian M. Beattie

The slight uptick in terms of the service revenue that’s up year-over-year and up sequentially is driven by a couple of large consulting contracts that we had in the quarter and to a much lesser extent the new acquisition we had with Chipidea. We had a number of the contracts, they’re in the IP area specifically where we have multiple deliveries, the company’s been working on them for some time and completed those in the third quarter allowing us to take revenue on all the deliverables. So, it is a little bit of a catch up, it does fluctuate from quarter-to-quarter based on the milestone completions so that’s part of the elements that have contributed to it in the third quarter specifically. It’s not exactly consistent quarter-to-quarter, it just depends on those big consulting deals that we do.

Operator

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

Rich Valera – Needham & Company

I just wanted to follow up on the run rate question, my understanding now as you’ve said it is that it sounds like the lower run rate is due largely due to some customer bankruptcies early in the first half of your year but that things are more stable now. I just wanted to clarify that in fact the run rates you’re seeing now on renewals are close to flattish or whatever you were referring to X the bankruptcies in the first half. Is that correct?

Aart J. de Geus

We don’t quantify the run rate number for a variety of reasons but I think your statement in general terms is actually very correct.

Operator

We have no further questions at this time. Presenters I’ll turn the call back to you.

Aart J. de Geus

Thank you again for attending this quarter. I think that in an environment that is to say the least very interesting, we feel that we’re actually fairing very, very well and have been able to take advantage of some of our strength and will continue to play those out going forward. As usual, Brian and I will be available for follow up questions the next few hours. Thank you and have a good day.

Operator

Ladies and gentlemen we thank you for your participation as well as using AT&T’s Executive Teleconference service. You may now disconnect.

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Source: Synopsys, Inc. F3Q09 (Qtr End 07/31/09) Earnings Call Transcript
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