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Synopsys, Inc. (NASDAQ:SNPS)

F1Q10 (Qtr End 01/31/10) Earnings Call Transcript

February 17, 2010 5:00 pm ET

Executives

Lisa Ewbank – VP, IR

Aart de Geus – Chairman and CEO

Brian Beattie – CFO

Analysts

Richard Valera – Needham & Company

Ryan Goodman – Bank of America

Sterling Auty – JPMorgan

Jay Vleeschhouwer – Ticonderoga Securities

K.C. Rajkumar – RBC Capital Markets

Operator

Ladies and gentlemen, thank you for standing by and welcome to Synopsys Incorporated earnings conference call for the first quarter of fiscal year 2010. 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.

And 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, Tony. 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 will 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, our actual results and performance are subject to many risks and uncertainties that could cause actual results to differ materially from what we expect.

In addition to any risks that we highlight during this call, important factors that may affect our future results are described in our annual report on Form 10-K for the fiscal year ended October 31, 2009 and in our earnings release for the first quarter of fiscal year 2010 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 the current report of Form 8-K that we filed today, our first quarter earnings release and our 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 de Geus

Good afternoon. I am happy to report that we started the year with great energy and momentum, and obtained excellent results in Q1. We delivered revenue in line with expectations, solid expense management, and earnings slightly above target. In addition, we made a number of strategic moves that we believe will increase our total available market substantially in the long-term. We feel that 2010 will be a year of positive evolution for Synopsys.

Before I share some of our strategic perspectives with you, let me briefly summarize last quarter’s financial results, where we met or exceeded all of our Q1 targets. Specifically, we delivered non-GAAP earnings per share of $0.41, with revenue of $330 million. Through disciplined expense control and focus on efficiency, we are on track to meet our ops margin target of 24% for the year. These results were achieved under our predictable business model, with more than 90% time-based revenue. With yet another strong set of technology deliveries and continued excellent field execution, we are solidly on track to meet our targets for the year.

Now to our strategic direction. As we introduced to you in our last earnings call, we see 2010 and ‘11 as the time to benefit from the economic recovery, while actively broadening our opportunity space. We are pursuing three fundamental strategies. One, accelerate our execution momentum and expand our core EDA leadership. Two, broaden our EDA TAM [ph] by aggressively fielding adjacent products and capabilities. Three, expand our TAM outside of core EDA by aggressively driving the emerging systems space.

Before elaborating on our strategies, let me briefly describe the customer environment that is the backdrop to our actions. Whereas the macro economy is still somewhat mixed, and most executives continue to be focused on risk and cost management, the plethora of new electronics applications will help semiconductors be one of the key growth segments in the economy going forward.

Just looking at new products shown at the Consumer Electronics Show, one finds massive growth in mobile Internet devices ranging from smart – or I should say, very smart phones, to notebooks, netbooks, tablets, and e-book readers, all featuring the convergence of what used to be simpler, stand-alone applications. There are immense bandwidth and complexity drivers in high-definition, 3D video, and Internet protocol TVs. There are new growth opportunities in low-power management, smart grids, and automotive. And bringing it all together, we see mobility and Internet connectivity on a scale that dwarfs anything seen so far.

With China and India consumer bases simultaneously expanding at a rapid clip, the growth opportunities for electronics appear very robust. For semiconductor executives, this landscape presents growth opportunities requiring redeployment of existing resources, even while the short-term economic situation forces a focus on cost management. This widely opens the doors for Synopsys.

Designing and verifying all these complex new products requires great technological sophistication in chip design, but increasingly also in the crucial interaction between hardware and software, which brings me to our latest strategy acceleration, expanding our TAM outside of core EDA up into Systems. Over the past several quarters we have made great progress into this space. Specifically, we added major new capabilities in the automotive and consumer segments to augment our ability to model and verify complex systems.

With the acquisition of VaST, we are not only adding a number of key connections to customers, we also added some important processor models and are already engaged with one of our primary EDA partners in this area. The addition of CoWare, which we announced last week, would grow our capabilities in the consumer space, most notably with strong relationships in Japan, and with technology aimed at verifying hardware and software simultaneously.

One method to accomplish this is virtual prototyping. This capability is promising, as most system companies now perform these tasks internally in an ad-hoc fashion, yet are increasingly interested in outsourcing to a well-structured and complete commercial solution. Complemented by our FPGA-based rapid prototyping, our solution will compete well with more expensive and in unwieldy emulation products, enabling system validation on a much broader scale than before and allowing customers to accelerate embedded software development.

Finally, in the systems area, I would like to highlight our silicon IP business, which is growing very nicely as the outsourcing of non-differentiating IP accelerates amid the convergence of cost pressures and the availability of high-quality products. We’ve seen high demand for almost all of our titles, from analog IP to connectivity standards such as HDMI. One exciting example is the new USB 3.0 standard, which was highly visible at last month’s Consumer Electronics Show.

Synopsys has been the leading provider of USB interfaces for a while, and was the first to bring to market a complete IP solution of this latest incarnation. USB 3.0 is more than 10X faster than previous versions and capable of transmitting live high definition video. For example, a movie that used to take hours to load can now take just minutes. This opens the door to many exciting new products, and indeed the standard is rapidly gaining momentum. Super-speed USB 3.0 is a complex piece of IP with very sophisticated analog/mixed-signal capabilities, which brings me to our second strategy, broadening the Synopsys EDA TAM.

In this area, Custom Designer is a great example of how we built a very competitive capability from scratch in a market segment that has seen limited innovation for a long time. In December, we released a greatly enhanced version, and with Synopsys having over 450 analog/mixed-signal designers, all of our new analog IP products are being designed using our own Custom Designer. In Q1, we also acquired a small company with excellent shape-based router technology that we believe will accelerate and expand our product differentiation.

We’ve already seen a number of customer tape-outs, including most recently a chip used in Digital Imaging Systems’ high-performance camera modules. Another promising product is Yield Explorer, a recent addition that is finding traction with customers focused on improving their chip COGS by diagnosing yield issues and thereby accelerating yield ramp. It’s another good example of growing our adjacent EDA capabilities by effectively straddling design and manufacturing.

This brings me to the center of gravity of the company, our strong core EDA solution and our opportunity to further strengthen its category leadership. Our primary partner program continues to make excellent progress, as we help our customers reduce or at least stabilize their total cost of design, while providing increasingly integrated solutions with steadily improving productivity metrics. There are many examples of where this is happening. We continue to see migration to Synopsys and away from competitor tools.

At one large customer, use of Synopsys’ implementation and verification solutions increased from about 40% of total to about 90%. In another case, the customer was able to reduce the number of vendor tools from four to one. It’s important to note that these transitions are not easily done, and they occur over time. So the very fact that we can see tangible progress is very positive. As we help our customers become more efficient and automated, they can increasingly re-purpose their most precious engineering talent towards more differentiating activities.

In Q1, Synopsys again released a broad set of technology enhancements ranging from substantial multi-threaded, multi-core speed increases to major advances in integrating complete design flows. Our ability, for example, to do physical verification directly in the design flow with IC Validator saves substantial design time. At yet another large international customer, we are displacing our competition as they standardize on IC Validator for their 32 nanometer design flows. The strength of IC Compiler and the integration with IC Validator combine to provide a truly state-of-the-art physical implementation flow.

The integration of VCS-based simulation and low-power verification is another example of great innovation rapidly increasing customer impact. Toshiba Information Systems, for example, was successful in verifying the low-power functionality of a mobile multimedia application, and they can now reuse the verification infrastructure for additional designs.

In analog, TSMC has adopted CustomSim, which brings together multiple transistor-level simulations in an integrated solution, for its sub-40 nanometer memory INTELLECTUAL PROPERTY characterization. We also made a small acquisition in the simulation acceleration space, as we continue to invest in technology enhancements.

Bringing this all together, our Lynx Design System helps customers who want to shift internal CAD management resources to more differentiating projects. For 65 nanometer and below, Lynx provides a comprehensive design system, with built-in methodologies, foundry-ready checks, and an advanced management cockpit. The complete low-power flow can be up and running in just a couple of weeks.

In summary, Synopsys is executing very well and we are on the move to expanding our total available market. Our technology and support engines are providing our customers the best guarantees for success, and many of them now want to also engage more closely with us to help them differentiate with their customers. That means an expanded role that requires expertise beyond traditional EDA, down to manufacturing, and increasingly at the intersection of hardware and software. Our internal investments and recent acquisitions are all aimed at driving our strategy and growth in that direction, and 2010 promises to be an exciting year for Synopsys.

With that, I’ll turn the call over to Brian Beattie.

Brian Beattie

Thanks, Aart. And good afternoon, everyone. In my comments today, I will summarize our financial results for the quarter and provide you with our Q2 and 2010 guidance. As a reminder, I’ll be discussing certain GAAP and non-GAAP measures of our financial performance. We have 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, we continue to execute well, meeting or exceeding all of the quarterly financial targets that we provided in December. Total revenue was $330.2 million, well within our target range, with greater than 90% of Q1 revenue coming from beginning-of-quarter backlog. Our IP and systems business again performed very well, achieving double-digit growth in Q1 and the trailing four quarters. One customer accounted for slightly more than 10% of first quarter revenue.

Turning to expenses, total GAAP costs and expenses were $275.1 million, which included $17 million of stock-based compensation, $10.7 million of amortization of intangible assets, and $1 million of acquisition related costs. Total non-GAAP costs and expenses were $244 million, which was slightly below our planned range and declined 2 percentage points compared to a year ago, even with the addition of the Analog Business Group from MIPS Technology.

The decrease was driven primarily by timing of quarterly expenses, including external professional services, some hiring, and other one-time expenses that shifted out of the quarter, along with company-wide cost control. As a result, non-GAAP operating margin was 26.1% for the quarter, a very good start towards achieving our goal of approximately 24% for the entire year.

Turning now to earnings, GAAP earnings were $0.88 per share, substantially above our target range and up from $0.37 a year ago. This was due to the one-time impact of a $91.6 million or $0.61 cents per share GAAP-only tax benefit associated with the IRS settlement for fiscal years 2002 through 2004. There was no non-GAAP P&L impact as a result of this settlement.

Continuing on with earnings, non-GAAP earnings of $0.41 per share slightly exceeded our target range, due primarily to timing of our quarterly expenses. Our non-GAAP tax rate was 27.6% for the quarter. And for modeling purposes, we think that a 27% non-GAAP tax rate is a reasonable estimate for the full year.

Our revenue visibility remains strong with greater than 90% coming from beginning-of-quarter backlog. Upfront revenue was 6% of total, well within our target range of less than 10%. The average length of our renewable customer license commitments for the quarter was 3.2 years.

Now turning to our cash and balance sheet items. We ended the quarter with approximately $1.1 billion in cash and short-term investments, which of course was prior to the VaST Systems acquisition we closed earlier this month. It also does not include the expected impact of the recently announced definitive agreement to purchase CoWare. Of our total cash balance, 49% is held within the United States. As expected, there was an operating cash outflow of $45.4 million in the quarter. This was due primarily to the typical Q1 payments of annual incentive compensation to our employees related to FY ‘09 performance.

Continuing on with cash and balance sheet items, capital expenditures were $8 million in the quarter. And for 2010, we now expect capital spending to be in the range of $40 million to $45 million, which includes planned expenditures to consolidate our Bay Area facilities to reduce long-term expenses. During the quarter, we purchased approximately 1.2 million shares of Synopsys stock for $25.3 million and have approximately $475 million remaining on our current authorization.

As Aart highlighted, we are excited that we closed the acquisition of VaST Systems Technology as well as signed a definitive agreement to acquire CoWare. The terms of these deals are not being disclosed, but we do not expect these transactions to have a material impact on 2010 revenue or our non-GAAP earnings for 2010. Over the past six quarters, we have closed five acquisitions, in addition to the definitive agreement to acquire CoWare. And as we’ve recently highlighted, we are well positioned in 2010 to more aggressively put our balance sheet to work.

Q1 net accounts receivable totaled $142 million and DSOs were 39 days, reflecting the high quality of our current AR portfolio and the timing of invoices. Deferred revenue at the end of the quarter was $547 million. We ended the quarter with 5,875 employees. This was an expected year-over-year increase, due primarily to the acquisition of the Analog Business Group, but down slightly from our Q4 headcount.

Now let me address our second quarter and fiscal 2010 guidance, which is a base case that naturally does not assume any future acquisitions or stock buybacks. For the second quarter of FY ‘10, our targets are, revenue between $331 million and $339 million; total GAAP costs and expenses between $278 million and $295 million, which includes approximately $17 million of stock-based compensation expense; Total non-GAAP costs and expenses between $252 million and $262 million; other income and expense between zero and $3 million; a non-GAAP tax rate of approximately 27%; outstanding shares between 148 million and 153 million; GAAP earnings of $0.22 to $0.28 per share; and non-GAAP earnings of $0.38 to $0.40 per share. We expect greater than 90% of the quarter’s revenue to come from backlog.

As a result, our current fiscal 2010 outlook is, revenues of approximately $1.33 billion to $1.35 billion; other income and expense between $4 million and $8 million; a non-GAAP tax rate of approximately 27%; outstanding shares between 149 million and 154 million; GAAP earnings per share between $1.55 and $1.74, which reflects the one-time tax benefit I highlighted earlier and includes the impact of approximately $68 million in stock-based compensation expense; non-GAAP earnings per share of $1.52 to $1.62; and we are targeting cash flow from operations of $200 million to $220 million.

Finally, to help you with your modeling, let me provide some additional 2010 commentary for revenue and expenses. For the balance of the year, both total revenue and total expenses, we expect a sequential increase in Q2 followed by a moderate decline in Q3, with Q4 then showing a sharper sequential increase. For all of 2010, we currently expect to maintain our 2009 non-GAAP operating margin as well as operating income.

In summary, we are pleased with our Q1 financial performance and are positioned very well for 2010 and beyond.

With that, I’ll turn it over to the operator for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) And our first question will come from Richard Valera with Needham & Company. Please go ahead, sir.

Richard Valera – Needham & Company

Thank you. Good afternoon. Aart, I was wondering if you could give any qualitative commentary on bookings in the quarter, including any progress on the few slip deals you mentioned last quarter that from the 2009 into 2010?

Aart de Geus

Sure. As you know, we don’t give any specific color to the bookings expect for the fact that we have de facto reiterated that we are on track for this year and the bookings only support. So fundamentally, as expected, and my own sense is that business has returned to be a little bit more normal than the equivalent Q1 of last year, which of course was a very radical quarter in every aspect. So fundamentally we are in good shape.

Richard Valera – Needham & Company

Great. And I don’t expect much of a change here, but in terms of renewal run rates, are you maintaining the flattish run rate that we’ve been seeing for the past couple of quarters?

Aart de Geus

Yes, I think flat to up is probably the way we would characterize it right now.

Richard Valera – Needham & Company

Great. And then with respect to CoWare, this technology has been around for a while. And I guess for a long time a sort of missionary sales that they can be getting some progress there in terms of accelerating the deployment into the market. Do you have any specific ideas of how you can accelerate the deployment of the CoWare tools in terms of both using your larger sales force and/or tying it together with some of your existing products?

Aart de Geus

Well, at this point in time, this deal is not closed. So it’s a little early to give specific details on what we would do. But generally if you look at the systems area, it’s a very broad space. And I think even in my intro comments, I made a couple of comments around the fact that in the core implementation of the application, people are really focusing on the productivity. In the systems space, they are really focusing on how do they get the attention of their customers. And that increasingly mean how can they best support the development of applications that are exciting, and therefore the whole interaction of this boundary between the hardware and the application software is growing in importance. And so I think you’re correct in stating that the whole systems arena has been a missionary arena for a long time, but (inaudible) is starting to come here.

Richard Valera – Needham & Company

Okay. That’s helpful. And then finally, Asia-Pac looked like it was pretty strong from a revenue perspective this quarter. Is there anything beyond sort of normal quarterly noise in there, or should we – is there anything more we could read into that as far as the strength of Asia-Pac?

Aart de Geus

No, I don’t think you can read anything in the specific number for the quarter because these tend to fluctuate. I’ve always been saying, hey, you have to look at the longer period of time, and there you would see that Asia-Pac of course has been doing well, which is not a surprise given the sharp evolution of the economies that are involved there, and I expect that to gradually continue over the coming years.

Richard Valera – Needham & Company

Okay, thank you.

Aart de Geus

You’re welcome.

Operator

Thank you. And our next question in queue that will come from the line of Ryan Goodman with Bank of America. Please go ahead.

Ryan Goodman – Bank of America

Hi, guys, thanks. I had a question on the OpEx. I think I understand there is going to be a bit of an uptick in the guidance for the next quarter and that sounds like more of a timing issue. Maybe I’m reading too much into it, but you lowered the share count a little bit in the FY ’10 forecast, but there was no change at the EPS level. Any chance you could just add some color what’s going on there?

Brian Beattie

Yes, Ryan. What we’ve looked at is a lot of the expense savings that we saw in the year, as I said, related to primarily some of the external professional services, some of the hiring and other costs. And anticipation is most of that shifts in the Q2 and beyond in the quarter. From our other areas, we are just continuing. Of course, we have to acquire the assets and people from the VaST Technology stream that’s built into our guidance as well, starting this quarter and moving through the rest of the year. And other than that, our share count is down slightly. We did a small buyback in the first quarter of just over 1 million shares. And I think we’ll start seeing the impact of that. And of course, it ties to the price of the stock as well that’s in the guidance.

Ryan Goodman – Bank of America

Okay, cool. Thanks. And then on the cash flow, I noticed that didn’t move as well. It was a little better than I had modeled. And it seems to just be after a better start on the year. I’m still – I know this came up last quarter too, but can you talk a bit about why you are taking what I would consider a bit of a conservative bias there? I mean, it seems like revenue is doing fine, the bookings in particular are looking to be a good year. So why guide where you are in the cash flow now?

Brian Beattie

Well, I’d say, first off, we have a very good forecast and our history has become very, very close to those cash forecast because of the way we profile out planned collections by customer by quarter over the next three years. So it’s fairly close to the actual profile, and that gives you the most collection item. And then you’ve also got your expenses, which we have to manage. So again the fact we are reiterating a positive cash flow of $200 million to $220 million is a pretty strong signal. We’ve started a negative 48, which is pretty typical, which is even better than last year’s numbers. But as you see, it really ties into the net income flow and it does over time match up with the EBITDA less the taxes paid in a long-term profile. So we think it’s very appropriate. We still have three years of the year to go, and we will get tighter as we get through, but we are fairly confident with $200 million to $220 million range for ’10.

Ryan Goodman – Bank of America

Okay, great. And then I just have kind of a high level question for what you’re seeing out there. In terms of the semiconductor market itself, I mean it’s been out to a nice start for the year. R&D spending looks to be fairly well, but there is already starting to be some chatter that there is going to be an inventory build, which could catch up with the semiconductor market, at least by the back half of the year. Could you talk a little bit about implications you see for that just to the EDA market in general?

Aart de Geus

Sure. Fundamentally, we see that there are very few implications because what you’re describing, we have already seen for the last quarter as we talked to semiconductor executives because they knew that they were replenishing inventory, they knew that the first half was probably going to look pretty solid and probably the second half ultimately – the market needed to find a natural balance. For EDA, we are a relatively stable industry, and for Synopsys specifically, I think we are in a very good shape, because if there is one thing that the semiconductor execs will continue to do is they will stay careful on their expenses. And therefore there is going to be a continued attention to how productive can they be with their tools, and that has certainly been the core tenant of our main strategy for a while and thus I think we can help them to be successful.

Ryan Goodman – Bank of America

Okay, great. Thank you.

Aart de Geus

You’re welcome.

Operator

Thank you. And our next question in queue that will come from the line of Sterling Auty with JPMorgan. Please go ahead.

Sterling Auty – JPMorgan

Yes, thanks. Hi, guys. I have three questions. The first one is, the comment about the run rate being flat to up, can you characterize what’s driving that contract’s run rate value? Is it that you actually are getting more licenses per engineer or more products? What constitutes the value in that run rate being flat to up?

Aart de Geus

How many ways can I say yes? It is absolutely that we are rolling out more technology, the utilization is up. And fundamentally, we have the benefit of a number of customers that are gradually migrating towards us. And so it’s fundamentally [ph] yes to your question.

Sterling Auty – JPMorgan

And I guess the pushback is, I wasn’t looking for a yes or no. We are in an economy where unemployment is 10%. There is also arguments as to how much that hit the R&D engineering department and your core customer base. I think it’s great that it’s flat to up. I think it’s a positive sign, and I was hoping that’s what you’ll hear. But I often get questions from clients saying that they just have better utilization with more licenses per engineer, or is it that because of the smaller design nodes, it’s all about more products per – that are needed to design. So I think there is just an – to connect the dots and understanding that’s needed by the investors, to understand how the run rates can grow from here.

Aart de Geus

Sure. I apologize. I didn’t mean to be flip at all. Let me take it in layers. The first layer is, with the exception of last year seeing a few companies disappear, where a number of certainly of the top engineers got rehired. I’m sure there are some people that are unemployed. But in general, I would say in the engineering ranks with chip design, we have not seen massive lay-offs. We see people really trying to tune their companies and reduce their out-of-pocket expenses. But they all know very well that the engineering resources are very precious. So, no major change there. Secondly, we do see that a number of engineers are using more copies of given software per engineer, and this is especially true in areas such as the application where, be it simulation of some of the other tools, the more you do, the better the product gets.

Third, we do see that people are still moving forward towards the more advanced node and the more advanced nodes do have a number of capability requirements that do stress the extremes of the tools. And so people will try to buy the best possible tool they can get, and we are often in that class. So all of these have moved together, and I cannot say that I see a sharp downturn economically in terms of engineering utilization or engineering period at this point in time for the last 15 months. And similarly, I don’t think that there is going to be a sharp upturn because people will remain focused on cost, but that is actually not bad for Synopsys as we are very much focused on their productivity per engineer.

Sterling Auty – JPMorgan

Got it. Next question is for Brian. In terms of the expense timing, as you mentioned contractors, but can you give us a little bit more detail in terms of was there anything in terms of either will it be sales commission on timing of deals or do you have maybe more accruals because the G&A line seemed to be an area that came in much lower than I would have expected in the quarter?

Brian Beattie

You’re right. It was all the areas other than commission. They basically came in per the plan, but it was really under-spending of some of our legal costs, some of the other G&A-type expenses that we had for the quarter. Hiring across the board, really just a start out of the first quarter, we had a one week shutdown, for example, which helped take down our expenses in the quarter as well. And again, that is back to business as usual in the second quarter. So just shifting out those expenses through Q2 through Q4.

Sterling Auty – JPMorgan

Okay. And last question is, on the cash from operations, the improvement that you saw year-over-year, can you connect the dots for me in terms of was there anything there from the tax payment, was there anything there in terms of whether the compensation level that you pay in the first quarter may be not as big as what you saw last year? What were the big items that help that improvement year-over-year?

Brian Beattie

Yes. I’d characterize, again, a reduction that was nice, about $80 million in the prior year. This year it came in about $40 million as an outflow still and primarily related to lower expenses that we saw in the fourth quarter. The actual payments in terms of variable compensation are down year-over-year. And I think that is what contributed to the performance, plus again it’s very susceptible to cash collections from particular customers or cash outflows. And I think that kind of characterizes mostly related to still some lower expenses under variable compensation in 2009.

Sterling Auty – JPMorgan

All right. Thank you.

Brian Beattie

Okay.

Operator

Thank you. (Operator instructions) And we will take our next question in queue from Jay Vleeschhouwer with Ticonderoga Securities. Please go ahead.

Jay Vleeschhouwer – Ticonderoga Securities

Hi, thanks. Good afternoon. Brian, another cash flow question. In terms of getting to your range for fiscal ’10, would it be fair to assume that given the net income outlook for the year that you would have to have something in the order of a $50 million to $60 million improvement in working capital versus fiscal ’09, for example, in accounts receivable, deferred and the like. And if so, could you perhaps talk about how you achieve that level of improvement implied for fiscal ’10? Secondly, with respect to the acquisitions of CoWare and VaST, would it be fair to assume that given how small they are and also given the services requirement of their respective businesses that neither is particularly profitable and perhaps you could talk about ways that you can improve upon that profitability once you’ve acquired them?

Brian Beattie

I’ll maybe take the second question first, Jay, in a way looking at the acquisition. In our guidance, we have included the VaST acquisition since it has closed. And CoWare, as you know, is subject to the normal government reviews and so it will be factored into our guidance going forward. Nonetheless we indicated that they would not be material to the FY ’10 revenues or to the earnings impact. And with every deal, we look at the expense state to identify the synergies. We look at the key skills that are required to deliver what we build as our business case. And obviously, that’s the way we’ve done it. And we’ve done, I’d say, as I said, five acquisitions in the last six quarters, with one more pending. And so we’ve gotten very good at the integration process and the flow through there, and still are targeting on the same level of operating margins we have while we expand into additional segments to expand our TAM.

If I look at the overall cash flow for the year, I think it’s very consistent on a year-over-year basis. This year, the guidance of $200 million to $220 million compares to $37 million. It matches up with some of the slight reductions we’re seeing on the earnings level. Most of those earnings, as you know, relate really to the non-operational items that we saw coming into the year. The other income and expense, some of the foreign exchange impacts, a slightly higher tax rate, as we shifted from ’09 to ’10, and it’s very consistent with that net income shift. The rest related to working capital is very consistent. Industry leading DSOs in the 30s and our collections are looking very, very well, even stronger than what we saw in ’09 as we now exited through the recession and our customer environment. So again, very confident, and $200 million to $220 million for FY ’09 operating cash flow.

Jay Vleeschhouwer – Ticonderoga Securities

Two follow-up questions. Aart, on the last call, you mentioned a new metric, logo profitability. And I’m wondering if you could describe any notable trends you may be seeing there across your largest customers. In other words, are there any significant differences among your larger customers in terms of profitability and for the ones that may not be so profitable? What are the ways to improve upon that? And then finally, there was an enlargement in your duration where Cadence had somewhat a shorter duration in the last quarter. So a little bit more of a gap between the two of you now in duration. Perhaps you could comment on that.

Aart de Geus

Well, I’ll be careful to talk about logo profitability given that every customer would like to know about everybody else how well they are doing, and it’s non-stop looking at ways to improve their own outlook. What I was probably alluding to although I must confess I don’t quite recall what I said at that time, is that we are in a face of the industry where efficiency, productivity, profitability actually really matters. And therefore many customers are focusing on how can they become more effective in the task that they are doing potentially at lower cost, potentially with fewer people in order to be able to invest more in those areas where they can differentiate more.

And in that sense, we ourselves follow the same line of thinking, which is how can we execute as well as possible all the things that we have done so far while investing and growing the total available market around us. And so we have to live up in many ways to the same profitability improvement objectives internally as our customers do, and I think we’re pretty much in line with that thinking. Regarding duration, fundamentally we’ve said for long time we are very steady around the three years that can go up 3.2, 3.3. It can go down to 2.6, 2.7, 2.8. It varies from one quarter to another. But in essence, our business model is remarkably stable. And so far so good with that. I have no indication of change whatsoever.

Jay Vleeschhouwer – Ticonderoga Securities

Thank you.

Aart de Geus

You’re welcome.

Operator

Thank you. And our next question in queue that will come from the line of K.C. Rajkumar with RBC Capital Markets. Please go ahead.

K.C. Rajkumar – RBC Capital Markets

Hi, guys. How would you characterize the EDA spend for the year? Cadence had made an estimate of 1% to 6%. Would you say that’s a right ballpark?

Aart de Geus

We can comment only about really our numbers at this point in time. We are extremely stable in our core businesses. As you can see, we are now investing in some of the areas that would not traditionally be called Core EDA, and we see great opportunities there. I think 2010 is far from over. Earlier, somebody mentioned that customers on one hand were optimistic about the first half because they see a lot of demand for the business and indeed even some shortcomings in manufacturing capacity. They are still very cautious for the second half. And all of that tells me that it’s probably going to be fairly steady for the year. But we certainly had a very good Q1 and feel strong about our year. And so that’s the answer and that’s only when it comes [ph] for Synopsys.

K.C. Rajkumar – RBC Capital Markets

When you talk to your customers, do you guys sense that they are planning to increase their EDA spend on average this year compared to last year?

Aart de Geus

Well, I think that on the Core EDA, they will probably stay very focused on how to improve the efficiency. And I think they are going to increasingly look at where to put their R&D money to see if they can increase their differentiation when interacting with their customers. And there are a number of areas where they can obviously do that because you can’t differentiate by having smaller chips and cheaper chips, and that takes an enormous amount of very sophisticated engineering work. And we are well equipped to help them with that, which can also differentiate by providing more of a system solution. And the term system-on-a-chip is actually well chosen about ten years because we are here today and we can see that more than 50% of the engineering employees in our customers are already software employees. And so I suspect that we will see more spending in that direction. And by the way, that’s one of the key reasons why we have also invested in broadening our TAM in that same arena.

K.C. Rajkumar – RBC Capital Markets

Okay. You folks mentioned that you don’t want to expect material revenue and EPS (inaudible) from VaST and CoWare this year. Would you expect something along the lines of (inaudible) next year?

Aart de Geus

Well, the first year in acquisitions like this, they are all with financial haircut. There is a partial year and so on. And I think we made very clear statements that for this year it’s fairly immaterial. Obviously, we do this with the whole purpose to grow our business. And so yes, it will have an impact on next year and moreover we think that our system strategy will have even more momentum than it’s already starting to see.

K.C. Rajkumar – RBC Capital Markets

And I guess looking to consolidate the various assets that you guys have acquired in systems into one continuous product so that it can better leverage or serve them and (inaudible).

Aart de Geus

Well, one has to understand that the system arena is actually a huge market. There are many different things that go under that banner. And many things that are interacting from deep software involvement to very sophisticated hardware application techniques, all the way to touching some of the physical edges and looking at the optimization of architectures. And I’m just naming a few here. And so what is interesting is that the focus on this area is growing as the customers are starting to see an opportunity to differentiate themselves more there.

And obviously there are different bets. And earlier, one of the speakers mentioned the fact that the term missionary endeavor was very appropriate for the last decade or so. Well, I think at this point in time, there are so many technical challenges in this area around verifying systems, around modeling complex IP, there are many opportunity for us. And so certainly from an infrastructure point of view, we will seek out immediately efficiency, but from a technology roadmap point of view, I think we will talk about that when we are much further along.

K.C. Rajkumar – RBC Capital Markets

Lastly, into this year and next year, would you see the systems and the IP segments as going faster for you guys than EDA – than the Core EDA?

Aart de Geus

The answer in general terms is yes. And we’ve seen that already with IP. These are new areas. They are today at least in the markets that we play in much smaller than what we do in Core EDA or adjacencies to that. But the problems that it’s quite substantial. And so yes, we do think that there will be more growth there and that is precisely the reason why we are investing there.

K.C. Rajkumar – RBC Capital Markets

Okay, thank you.

Aart de Geus

You’re most welcome.

Operator

Thank you. At this time, we have no additional questions in queue. Please continue with any closing remarks.

Aart de Geus

In that case, thank you very much for spending time with us. We are looking back on a strong Q1 and we are looking forward actually to a year that’s shaping up in very interesting terms for us. And as usual, Brian and I will be available for any questions or comments that you have afterwards. Have a good rest of the afternoon.

Operator

Thank you. And ladies and gentlemen, that does conclude your conference call for today. We do thank you for your participation and for using AT&T’s Executive Teleconference. You may now disconnect.

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Source: Synopsys, Inc. F1Q10 (Qtr End 01/31/10) Earnings Call Transcript
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