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Synopsys (NASDAQ:SNPS)

Q2 2011 Earnings Call

May 18, 2011 5:00 pm ET

Executives

Aart de Geus - Co-Founder, Chairman and Chief Executive Officer

Lisa Ewbank - VP, IR

Brian Beattie - Chief Financial Officer

Analysts

Paul Thomas - Roth Capital Partners LLC

Sterling Auty - JP Morgan Chase & Co

Thomas Diffely - D.A. Davidson & Co.

Raj Seth - Cowen and Company, LLC

Unknown Analyst -

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Synopsys earnings conference call for the second quarter of fiscal year 2011. [Operator Instructions] As a reminder, today's call is being recorded.

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

Lisa Ewbank

Thank you, Beth. 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 discuss forecasts and targets and will make 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 quarterly report on Form 10-Q for the quarter ended January 31, 2011, and in our earnings release for the second quarter of fiscal year 2011 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 on 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'm pleased to report that we had a strong second quarter, keeping us well on track towards meeting our objectives for the year. Against the backdrop of a healthy electronics and semiconductor market, Synopsys is well-positioned as yet another wave of eagerly awaited electronic products and advanced technologies are heading to market. Our strength is supported by our clear industry leadership position, our unwavering commitment to state-of-the-art technology and support in traditional EDA and our continued drive towards high-growth adjacencies such as IP.

Financially, in the quarter, we delivered revenue of $394 million and non-GAAP earnings per share of $0.45. Supported by strong orders in the quarter, the run rate of the business grew and the outlook for the second half is solid. Looking forward, we are best well on track towards our earnings per share objective for the year.

Before commenting on our products, let me give some color on the customer landscape. Overall, the electronics industry remains healthy, and demand for new product is high. After an extremely strong 2010 recovery year, the outlook for semiconductors is solid with expectations of upper-single-digit growth this year. Simultaneously, that very recovery in worldwide economic stability are bringing challenges to our customers. First, time-to-market pressure is back. With the rapid growth in the mobile and consumer markets, the race is on to deliver complex products, often using the most advanced technologies. Notably, we are seeing accelerated adoption of the 28/32 and even the 20/22 nanometer nodes. Thanks to our investments and relationships, Synopsys is well-placed to effectively serve these customers.

Second, the features of these new end products are taxing every aspect of electronic design, ranging from the integration of hardware and software, to the reuse of sophisticated IP blocks, to the detailed physics impacting power consumption and manufacturing yield. The interaction of these effects is precisely one of the driving reasons for customers to select Synopsys as a key partner.

And third, with the economic recovery, the employment market has become more competitive as well. And while business is strong, many customers are very focused on how to improve their productivity to make up for increasing compensation costs.

These challenges and opportunities have recently led to several notable consolidations in the semiconductor industry, which we believe will continue to be a trend in the foreseeable future.

Looking at our products, we see continued strong interest in the rapid adoption of leading-edge solutions. This was quite visible at our users group meeting in March. We had record attendance, with over 2,300 attendees from more than 200 companies. Not surprisingly, popular themes were the ongoing quest for faster turnaround time in every aspect of the design flow and the never-ending push for performance while reducing powerful mobility in battery-operated devices. There was also particularly strong interest in our sessions on reusable IP, which incidentally, registered the highest rating in the history of the conference.

Let me focus for a moment on our implementation tools. At the conference, we introduced DC Explorer, a breakthrough in logic design that enables much faster chip completion. It's great benefit is that it correlates well with the downstream physical implementation and allows engineers to find and correct issues much earlier.

We're also seeing strong momentum with our In-Design physical verification solution, IC Validator. This quarter, 2 Top 20 semiconductor companies have started to standardize on Synopsys through final signoff, thus no longer needing a separate physical verification tool.

Moving to functional verification. We delivered outstanding results and speed improvements to drive a number of competitive wins, including an important displacement at a leading communications IT company for use in its high-profile, next-generation chip.

In analog implementation, we see continued momentum with Custom Designer. Tapeouts are growing nicely, including one of the Top 20 established companies recently completing a 40-nanometer high-performance analog design. A number of top semiconductor companies are benchmarking our solution with increasingly positive results as they are exploring the adoption of Customer Designer in their flows.

Finally, in manufacturing, another major customer is deploying Yield Explorer companywide. The value proposition is compelling. Yield Explorer offers large gains, as even a small change in yield dramatically improves their bottom line.

Now let me turn to our high-growth adjacencies, which continued to see strong results. The IP and systems areas is expected to represent about 20% of our revenue in 2011, a scale that is meaningful in driving overall revenue growth.

First, to IP. There are many building blocks on a chip: Processors, graphics cores, connections to external elements such as cameras, microphones, data interfaces, many types of memory, analog blocks, and so on. Historically, companies designed these internally. But outsourcing of reusable elements is accelerating, driven by a combination of customer desire to focus limited resources on differentiating projects and the availability of very sophisticated, reliable third-party IP.

Synopsys offers a broad portfolio of IP mapped into the key manufacturing processes. After 15-plus years of investment and execution, we are the second largest IP company in the world, and our portfolio includes a rich collection of key building blocks.

Starting with interface IP. We supply all of the top interface blocks including USB, PCI Express, HDMI, et cetera, and are either #1 or #2 in each.

Moving to memory IP. We find that about 50% of the modern chip area can be memory. As the #1 provider of memory IP, we can have dramatic footprint on advanced design.

Finally, looking at analog IP. We see many applications that require digital to analog, and vice versa, translation. An example of this would be connecting to an external microphone. We're also #1 in this rather fragmented market segment.

In Q2, we continued to see very strong demand for our IP products. This was particularly true in vertical markets such as mobile multimedia, smart phones, tablets, cameras, digital home, including set-top boxes in digital TV and wireless infrastructure.

This increasing demand has a twofold impact on our business. First, customers are significantly more willing to outsource as they see the time-to-market advantages of a commercial IP reuse approach to design. We see many opportunities to leverage our past investment and grow our business. Second, with the demand for additional title, the process-specific porting and the increased complexity of many IP cores, we need to continue to invest to meet demand and drive future revenue growth.

Now turning to the systems space, where our primary focus is to enable customers to handle the increasing challenges of hardware-software interaction. Central to this is our portfolio of prototyping solutions, featuring both software models and FPGA-based prototypes.

Prototyping accelerates both embedded software development and system validation by using models of the chip long before the design is actually finished. This approach can accelerate software delivery by 6 to 9 months. Traditionally, customers have built prototypes internally, but here too, increased complexity and sophisticated commercial solutions are attractive for outsourcing. For example, a major communications IC company is now ramping up its use of our virtual prototypes and has already started to provide the models to its end customers to help them accelerate their software development.

Also, during the quarter, a top global imaging company expanded its use on a broad range of our system solutions, including prototyping and high-level design. Overall, our FPGA-based rapid prototyping solution, again saw good growth.

To conclude, we executed very well in Q2. Our technology pipeline delivery and adoption remained strong, especially as we focus on advanced technology. As a result, we are well on track to meeting our financial objectives for the year.

Let me now turn the call over to Brian Beattie.

Brian Beattie

Well, thank you, Aart, and good afternoon, everyone. In my comments today, I will summarize our financial results for the quarter and provide you with our guidance for Q3 and the full year.

As a reminder, I'll be discussing certain GAAP and non-GAAP measures of our financial performance. We've provided reconciliations in the press release and our financial supplements posted on our website. In my discussions, all of my comparisons will be year-over-year, unless I specify otherwise.

Synopsys delivered a strong quarter, meeting or exceeding virtually all of the quarterly financial targets that we provided in February. Q2 financial results were highlighted by strong orders, solid growth in both revenue and non-GAAP earnings and considerable operating cash flow generation.

Additionally, we repurchased $170 million worth of Synopsys stock during the quarter. Total revenue was $394 million, an increase of 16% and at the high end of our target range. We delivered revenue growth across all product groups, with particular strength from our IP and systems products. One customer accounted for slightly more than 10% of second quarter revenue.

Turning to expenses. Total GAAP costs and expenses were $342 million, which included $19 million of amortization of intangible assets and $13 million of stock-based compensation. Total non-GAAP costs and expenses of $307 million were slightly above our target range, and as expected, increased year-over-year and sequentially. The year-over-year increase was due mainly to our acquisitions, while the sequential increase was driven primarily by timing of quarterly expenses, such as the variable compensation impact that resulted from strong orders in Q2 and the first half of the year. As a result, non-GAAP operating margin was 22% for the quarter and 23% for the first half of fiscal 2011.

For the full year, we expect expenses to be slightly higher than originally anticipated, as we address near-term cost pressures, such as employee compensation. However, we have increased confidence in our annual EPS guidance and in fact, are raising the lower end of the range.

Turning now to earnings. GAAP earnings per share were $0.53, substantially above our target range, and up from $0.26 a year ago. This was due primarily to the onetime impact of a $32.8 million, or $0.21 per share, GAAP-only tax benefit associated with an IRS settlement for fiscal years 2006 through 2009.

Non-GAAP earnings per share were $0.45, an increase of 10%, driven by solid top line growth and a lower effective tax rate. Our non-GAAP tax rate was 21% for the quarter, well below our target range, driven primarily by a more favorable U.S. tax rate expected for the year because of the items settled in the 2006 through '09 IRS audit. As a result, we now think that a non-GAAP tax rate for FY '11 of between 24% and 25% is a reasonable estimate.

Upfront revenue was 6% of total, well within our target range of less than 10% up front. The average length of our renewable customer license commitments for the quarter was 2.8 years. We continue to expect average duration over time to be approximately 3 years.

Now turning to our cash and balance sheet items. Our balance sheet remained strong with $840 million in cash and short-term investments. Of our total cash balance, 27% is onshore and 73% is offshore. We generated $96 million in cash from operations in the quarter, and we are raising our operating cash flow target for the year to approximately $300 million, up from our prior range of $230 million to $250 million, to reflect increased collections driven primarily by timing of deals.

Continuing on with our cash and balance sheet items. Capital expenditures were $10 million for the quarter. For the year, we continue to expect capital spending of approximately $50 million to $55 million.

During the quarter, we purchased 6.2 million shares of Synopsys stock for $170 million, delivering on our commitment to increase our buybacks to help us meet our current goal of keeping share count roughly flat at about 151 million shares over time. During the first half of the fiscal year, we spent $235 million, repurchasing 8.6 million shares. And we have $80 million remaining in our current authorization.

Continuing on with our balance sheet items. Q2 net accounts receivable totaled $210 million, and DSO was 49 days, which is within our target range. Deferred revenue at the end of the quarter was $626 million. And we ended Q2 with approximately 6,540 employees.

Now let's address our third quarter and fiscal 2011 guidance. Our GAAP targets exclude any future acquisition-related expenses that may be incurred in Q3 and beyond. For the third quarter of FY '11, our targets are: Revenue between $378 million and $386 million; total GAAP costs and expenses between $319 million and $337 million, which includes approximately $13 million of stock-based compensation expense; total non-GAAP cost and expenses between $292 million and $302 million, down from Q2; other income and expense between $0 and $2 million; a non-GAAP tax rate between 24% and 25%; outstanding shares between 149 million and 153 million; GAAP earnings of $0.25 to $0.31 per share, and non-GAAP earnings of $0.41 to $0.43 per share. We expect greater than 90% of the quarter's revenue to come from backlog.

Now our fiscal 2011 outlook: We reiterate that we expect revenue between $1.5 billion and $1.525 billion; a growth rate of approximately 8.5% to 10.5%; other income and expense between $1 million and $5 million; a non-GAAP tax rate of between 24% and 25%; outstanding shares between 149 million and 153 million; GAAP earnings per share between $1.33 and $1.46, which includes the impact of approximately $56 million in stock-based compensation expense and the IRS settlement of $32.8 million; non-GAAP earnings per share of $1.70 to $1.77. We've increased the low end of our guidance range by $0.03. And as I mentioned earlier, we're targeting cash flow from operations of approximately $300 million.

In summary, we continue to execute well in Q2, highlighted by top and bottom line growth and very solid cash flow generation. So with that, turn it over to the operator for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question will come from the line of Raj Seth with Cowen and Company.

Raj Seth - Cowen and Company, LLC

Brian, just a couple of quick ones for you. Can you talk about what happened in sales and marketing? You had a $20 million sequential bump. I don't think I've seen that before. A little unusual. Can you explain that? And then just a clarification on the tax comment. I thought you guided the whole year at 24% to 25%. The first half was, as I recall, closer to 21%. You guided the third quarter to 24% to 25%, I think. Does Q4 go up, or did I sort of misread what you were trying to say about the full year?

Brian Beattie

Yes, you bet, Raj. Okay, on the first question, the sales and marketing expense. That effect, it reflects the total expense increase sequentially from Q1 to Q2. It's primarily in that sales and marketing line. And it's all about commissions. As you know, we take a proportional expense accrual on the total bookings levels that go throughout the year, and we're just indicating Q2 has a very, very strong quarterly bookings number for it. So therefore, it takes into account the very significant amount of bookings that came in on the quarter, reflects commissions and, to some extent, some of the variable compensation, on top of that, for the rest. The second question about the tax rate. You're right. When we look at our total year, our guidance is 24% to 25%. And what we reflect in there is both Q1, where the rate came in at 21% -- and as you know, that reflected the approval through the government of the R&D tax credit, and that had about a $5 million impact in Q1 and took us to 21%. In the second quarter, we're at 21% as well, which reflected the impact in 2011 of the audit that was just completed by the IRS for our years -- '06 through '09. And clearly, it made it very clear for us on how we treat certain actions in '11. We're able to flow that through and make all of the year-to-date adjustments totally accurate. So those are again, the onetime impacts you factor into your year. And then, on the year at this point, 24% to 25% does reflect some increase in the higher rates in Q3 and Q4 to reflect the onetime events happened in the first half. And we're still working through on the tax rate to optimize that overall.

Raj Seth - Cowen and Company, LLC

So just so I'm clear. Given your guidance, what would you expect in Q4? What should we assume the tax rate to be in Q4? Because by implication, if the whole year's 24% to 25%, the first half is much lower. Q3 is in line, that suggests Q4 is higher. Am I -- is that correct?

Brian Beattie

It's going to be in the range of about 25%, 26% even for the year as we get through all the onetime costs in the first half.

Raj Seth - Cowen and Company, LLC

Okay. And if I might, just a question or 2 to Aart on the IP business. Aart, you -- this has obviously been a real area of growth for you, standout area of growth. We showed a big sequential uptick, I believe, with that IP -- no, it wasn't, actually, forgive me. I was going to say you saw a big sequential increase in that, but it was actually a verification. So forgive me on that. Can you talk a little bit about -- you talked about service, some porting costs, et cetera. What are -- within your broad portfolio, what is it that's really hot right now and driving growth? Or is it more bundled sales that are driving growth in IP? And sort of where is the attention from customers focused today?

Aart de Geus

Sure. Well, I think top-down, we see a little bit of growth everywhere in the company, but IP clearly stands out. And if you look at what's happening there, is that there are a lot of customers that are now using very large blocks in order to get very quickly to market, a. And so it's interesting that there are a number of customers for example, in the Far East that almost start from scratch, and very quickly have sophisticated chips. This is in contrast to existing companies that have been doing their IP for many years themselves, where the trend towards outsourcing is a natural outcome from 2 things, I believe. One is that, there's a desire to just be more productive and more cost efficient, and designing your own stuff doesn't do that. But the second, thing is that -- and many of these IP blocks, themselves, are becoming very sophisticated, and not every company has the skill set in-house. And so the result for us is that there's been a very high demand across the board for many blocks, from very small to very complex ones, with many requests for porting to an enhanced set of technologies, because simultaneously in the background, there's acceleration towards the smaller geometries. And so we're supporting, actually, a quite broad spectrum of silicon technologies with a very broad spectrum of IP blocks.

Raj Seth - Cowen and Company, LLC

And Aart, how do you think about the associated service opportunity? Because beyond porting, I would imagine many of your customers would love it if -- and there are third-party service providers of course. But how do you think about where and how Synopsys should play on the associated, somewhat broader than porting, but service, I would think, opportunity? Is there any change there in your strategy?

Aart de Geus

There's no explicit change in strategy. I think the thing -- the term "think about it" is the right word because the challenge with service is always the same. The people that are really interested in top-notch services are also interested in top-notch talents to do that. That tends to be very expensive and not always easy to provide, and therefore the cost equation is hard to completely justify in the business model. And so we're comfortably rethinking that because with the IP, certainly there's an opportunity to be closer to a number of these customers. And we are actually doing some very sophisticated implementations with customers of subsystems, including supporting their processor work and the blocks we provide around that. And so there's an opportunity space there. The financial equation has not been all that simple, so I don't want to jump to any conclusions yet.

Raj Seth - Cowen and Company, LLC

Right. If I might, one last question, a little bit different topic area. Apple gets a lot of attention for deciding to take in-house app processors and do their own A4, A5. I'm curious, do you think, given what you see in the market, that any other large company might choose to do something similar, where they can get a cost-based flow, do their own design, pay a boundary margin but avoid maybe some of the margin that's going to some of the semiconductor suppliers today? Do think that will become a trend, or is it to your earlier point, that it's very hard, even with IP-based designs, to do some of those. Is that more of a one-off particular to Apple, in your view?

Aart de Geus

Well, just to make clear before I answer, we never comment about any specific actions that one of our customers may take. But in general, what you're describing, we have actually seen at a few customers that are seeing the benefit of being very well -- working directly with us on their most advanced designs, because, by the time you optimize a processor primarily for speed and power and the blocks around that, you're talking about very sophisticated designs. If you add to that, which is a given in that field, that you want to be on the most advanced silicon technologies, you're adding a whole set of other dimensions where the EDA provider, and in this case, you could say also service provider, which we are in these situations, has to have very good connections to the silicon technology. And so this becomes very much a team sport where everybody has to rely on the few partners they work with. And so yes, we have seen some of the large companies that have a very high return on investment by shining in that dimension, that they are bringing in more of design in-house and both for competitive reasons, I have to be, of course, extremely careful with the information. But also for competitive reasons, very aggressively driving the future.

Operator

Next, we go to the line of Sterling Auty from JPMorgan.

Sterling Auty - JP Morgan Chase & Co

So just to kick off, I want to follow up on the variable expense. Brian, can you quantify for us relative to the guidance that you gave for the quarter, how much over did the variable expense portion come relative to that guidance?

Brian Beattie

Again, we achieved that high end of our target. Our revenue is just slightly up and our expenses are just slightly up to that basis.

Sterling Auty - JP Morgan Chase & Co

Right. But if you look at that midpoint of range, are we talking about the variable expense was $5 million or $10 million higher than what you thought going into the quarter?

Brian Beattie

Yes, I'm not going to quantify on that. Be relative to the amount of accruals we made on that commission shifting. But when you looked at where our guidance was, we came in slightly above that. And just think about that as the timing on the commissions for the total year basis just got put into the quarter. Our guidance into Q3 reflects that our expenses are coming down as we'd anticipate that profiling changes into Q3.

Sterling Auty - JP Morgan Chase & Co

Yes. I got you. Aart, in terms of the contract duration has continued to come down here. I think it's probably in a healthy way because you're still talking about strong order levels. Is it that you're seeing more of the products being bought, or more licenses of the existing products? In other words, what is driving the healthiness in that demand on the order front?

Aart de Geus

Well, in general, we are not yet on the conclusion that the duration is coming down. I think there's always a fair degree of variability from one quarter to another. But in general, I think our business, we still consider essentially a 3-year business, certainly for the core EDA tools and everything that's sort of in that ilk. Regarding other parts of the business, there, you have a little bit different business model because the IP is not in quite the same vein, and so you can see spikes up and down. And that would, on average, bring the durations down. But fundamentally, I don't think we see a big change in our business model.

Sterling Auty - JP Morgan Chase & Co

I'd be remiss not to ask if you had comments in terms of Japan?

Aart de Geus

Well, obviously, we have seen with stupor the events that happened there, like everybody else. It was interesting to see how, in some areas, specifically, semiconductor technology, the diagnostics were very, very fast in finding out where the real shortcomings were. And it appears that, from what we see, the customers that are hurt are people that are either directly affected in their business, so where their factories have been hit, or that are systems companies that need a variety of almost mechanical parts, and automotive is very obvious in that. In the semiconductor field, after, I would say, about 8 to 12 weeks, the number of commentaries about this went way down, and the expectations is that in about 2 quarters total, this is less visible for the semiconductor industry because alternatives have been found. Now having said that, obviously, a number of Japanese companies are working very hard on reestablishing their business flow. And we are doing the best we can. Initially, mostly by helping them work during the power outages, because many of the software programs run much longer than the 8 or 10 hours that they have. But today, I don't see that there's much impact on our behavior. There has certainly not been any impact on our business.

Sterling Auty - JP Morgan Chase & Co

And last question. You mentioned just over 10% revenue customer. Were there any 10% bookings customers?

Aart de Geus

We never disclose individual bookings. But your revenue performance is still correct.

Operator

Next, we go to the line of Paul Thomas with Bank of America Merrill Lynch.

Paul Thomas - Roth Capital Partners LLC

I guess on the last call, you did talk about 3Q revenue being down slightly and 4Q being down slightly. And obviously, the guidance still implies that for the full year. I just want to understand, was the first half of '11, it was mostly IP and systems prototyping revenue, and that's not expected to follow through in the second half of the year? I guess the in-market drivers you talk about, tablets and mobility, I mean, obviously those things are still in place. So what is it in the second half of the year that's sort of not following through from the first half?

Brian Beattie

Well, just to clarify some of the positions on that. As you look for the first half and the second half, we're still projecting an increase in revenues in the second half, compared to the first half. And just as we identified last quarter, that our second quarter, based on a very high level of visibility we have to all of the contract terms, conditions and project deliverables, they were really scheduled to come in into the second quarter. And they did exactly do what we had forecast. If you wanted to break down, even sequentially from Q1 to Q2, about 2/3 of the increase in the revenues came into the IP and systems group. And clearly, that reflects about a 24% overall sequential growth in IP and systems. So very strong. But even as you look at that, each one of those are specific contracts that reflect on percentage completion in terms of revenue models and specific deliverables that are completed by the engineering teams and delivered in the second quarter. So we had that level of visibility. The other 1/3 of the growth sequentially was in our core business. And it really just reflects the visibility we had to the specific contracts, of when they mature, when they deliver, and when new ones start up, if you like. So that kind of takes you from Q2 to Q3. And then in -- excuse me, Q1 to Q2. And then in Q3, just a very slight decline that we're projecting at this point, just because of the visibility. Very strong growth we have in the customer deliverables in Q2, and still well on track for our total year commitment. And it's all just very normal fluctuations in the contract terms, conditions as we move forward, as we assimilate a number of the acquisitions we had last year and reflect all of that in our business model moving forward.

Paul Thomas - Roth Capital Partners LLC

Okay. Fair enough. That's very helpful. I guess you comment on core too, obviously, being up. That was 1/3 of the growth. But with respect to, I think what Aart said, about high single or I guess, mid to high single-digit, the core EDA growth for the year, sort of your market expectation, that also looks like there's going to be some acceleration expected from that segment in the back half of the year. Is that the right way to think about it?

Brian Beattie

No. I'd say to clarify, on the core business, we are a very good quarter, as we said, reflected in the numbers. On a year-over-year basis, we're up 3.9%. And our indications around the core business is in that low to mid single-digit growth rates for the core business, and then the double-digit growth rate on our IP and systems business.

Paul Thomas - Roth Capital Partners LLC

Okay. Very helpful. Then let's see, maybe the last one. On the duration. So you talked about the 2.8 but still having the expectation for a 3-year average duration. Last quarter, you had some of that because guys were coming back mid-contract to redesign. Was any of that happening in this quarter to bring that to the low end? Or was that mostly natural renewals?

Aart de Geus

A little bit of both, mostly natural renewals. We have a number of products that people are interested in. And so it feels to me a little bit like businesses is back to business as usual before the whole downturn. And in that situation, no contract gets renewed the last day of the contract for a couple of reasons. A, because neither party ever wants to be in a situation where the other party feels that they're being held hostage. But more importantly, because very often, there are new products, there are new capabilities or there are increases in utilization that people want to have. And invariably, our sales team will then take the existing contract and then essentially amend it or scratch it and renew it for the next 3 years or so. And so it feels very much to me like we're into a normal business season.

Operator

Next, we go to the line of Tom Diffely with D. A. Davidson.

Thomas Diffely - D.A. Davidson & Co.

Just a couple of industry questions for you today. If you look at the several large semiconductor guys, they're talking about increasing the R&D spending by about 10% this year. And I was wondering, in your mind, how close is the linkage today to -- from R&D spending to EDA spending? And how does that translate? Is it a couple of quarter delay before you start seeing the extra spending? And how does that spending materialize at your place?

Aart de Geus

Well, in many ways, this question should have touched directly to the previous one, which is the duration, because as R&D spending jumps up or jumps down, we are much more mitigated because it tends to end up in 3-year agreements. Now the fact that R&D goes up, I think there's no question it's good news. And it ties directly to one of the things that I expressed in my opening commentary, which is that the pressure for time-to-market is on, but it also expresses the fact that a number of our customers are seeing increased emphasis on all the software that's attached to the designs that they're doing. In other words, things are more complex and are under more time pressure. And those are all good things for our industry because that's precisely the core skills that we bring to the party. And our job is to make sure that we have products that they can pick up. In that context, I wouldn't be surprised if we also saw a continuation of growth of the IP reuse business, because that's actually one of the cornerstones to get to market more quickly.

Thomas Diffely - D.A. Davidson & Co.

Okay. I was just kind of curious, when you're in the middle of, say, a 3-year contract in the second year of it, and your customers raise their R&D, do you see much pickup in the EDA spend? Or is it for other things, like the IP, that you see?

Aart de Geus

Sometimes. I think whenever a customer has more budget, as you can imagine, their general managers immediately have 10 ways to spend it. And we want to be as close as possible to those people at that time. At the same time, there's also a certain steadiness to what we do and what they do, because -- just because they increase their budget doesn't mean that tomorrow, they have 10% more engineers or do 10% more chips. I think the correlation is not one-to-one right there in that minute. But in aggregate, there is certainly a linkage between the 2, and this bodes well for us.

Thomas Diffely - D.A. Davidson & Co.

Yes, okay. And then maybe, have you ever quantified the market opportunity going from, say, the 32-nanometer node down to the 22-nanometer node for EDA?

Aart de Geus

Well, this is a question that literally comes back every node. And there's always 2 perspectives, one is the perspective that with every node, people will buy dramatically different tools. And that perspective is just not quite correct. And the reason is that much of the design that's done is being tuned for the next node and actually is predicated on being successful with the previous one, otherwise the degree of difficulty is just astronomical. On the other side of the spectrum though, is the fact that with the new node, and we can it see it very clearly for 28 and now for 20, there are a number of new technical challenges that are actually very difficult to meet. And one of the -- the reason we are particularly bullish on the offerings that we have is because I think Synopsys has an enormous degree of competence, both in its technology and its support and services in these advanced nodes. And not surprisingly, we are involved in virtually every most advanced chip in the world, to help them move there. And so as much as we simultaneously would like to increase our billing to them, the first objective, of course, is to be the chosen partner in that move forward. And I think very often, we are.

Thomas Diffely - D.A. Davidson & Co.

Okay. So when you go from one node to the next, you think your opportunities may be better from a market share point of view, market gaining that it is from a market growth point of view?

Aart de Geus

Yes. I think you captured exactly the essence. And we certainly think that we have very high market share in the advanced nodes.

Thomas Diffely - D.A. Davidson & Co.

Okay. And then just finally, any update on the pricing environment? With the improved market, has price become less of a tool for your more aggressive competitors?

Aart de Geus

Well, the reality is it's always a very competitive market. I do believe that with some of the competitors doing maybe a little bit better than a few years ago, there's only the opportunity for focusing a little bit more on the value delivered than focusing on the price. And for the earlier comment of R&D budgets going up, we should aim our pricing at those R&D budgets. Now having said that, it's a very competitive field with a very rapidly changing set of technologies. And so that will never go away. But I don't feel that the pricing has become -- has changed substantially towards the negative, no.

Thomas Diffely - D.A. Davidson & Co.

Okay. I appreciate your insights.

Operator

[Operator Instructions] Next, we go to the line of Jay Vleeschhouwer [ph] from Griffin Securities.

Unknown Analyst -

A question about your IP growth and profitability, a bit of a follow-on to Roger's earlier question. Historically, the IP business has been much less profitable than the tools business, though in your case, I'm sure you've seen improvements in profitability as it's grown. Could you talk about from here, how you think about the margin leverage in the IP business as you continue to see the kind of growth that you have been experiencing? Could you reach your fiscal '11 or fiscal '12 earnings objectives if, for instance, because of the investments you need to make in scaling the IP business, you see little or no margin improvement in that business for the time being?

Aart de Geus

Excellent question, because it is a topic of constant discussion here as to how to balance of these things right. There's no question that the IP business has growth opportunities. There's also no question that we'll need to make investments to build new titles, port to more silicon technologies. And the -- obviously, the investment comes before the revenue. And so in that context, we are focusing on gradually improving the margin in that business, but we're also very much interested in growing the business itself because that opportunity is there. And every year, we visit those questions. And as a matter of fact, during the year, multiple times. But for a given year, we set ourselves a number of objectives. And so in aggregate, just to make clear what we said earlier, we are very much on track for the company to meet the earnings objectives we have set for this fiscal year. As we go forward, we will revisit that exact question because, simply put -- and you will understand this better than we do, it is all about, how do we grow the value of the company? And that is obviously a balance between the profitability versus the growth rate. And this is an example where we have opportunities in both dimensions. So balance will be the key. But so far, I think we're doing very well because we're improving both.

Unknown Analyst -

Second question is with respect to geographic results, specifically in Asia-Pacific, which is now, at least in the first half of the year, solidly your second-largest region and has been showing some very good year-over-year growth, including Q2. The question is do think that you can sustain that kind of disproportionate growth in Asia Pac? And can you talk about the investments that might need to be made in order for that to happen? And is it fair to assume that there's a strong correlation between the Asia Pac growth as a region and your IP business?

Aart de Geus

Well, first, I think we are in a very good situation to continue to do well in Asia Pac for a number of reasons. One, we have established now for many years a stellar team in multiple countries. And when we talk about Asia Pac, obviously, many people immediately focus on China, as being so visible on the world stage. But clearly, there are other countries, such as Taiwan and Korea, that are major participants in the semiconductor market, and to a lesser degree, India and Singapore and a few others. And so it's actually a very broad region that all has its own needs and its own behaviors. And the good news is I think we have very high-quality teams in each region that are well-connected. So from the perspective, will we be able to continue to support and participate in the regional growth? The answer should be a resounding "yes". From the perspective of, is there a big difference in the business types? Well, a little bit in China. I would say, partially because there's much less history than in the other country, but there's also an extremely, extremely rapid learning ramp, partially helped by people that have learned in the West, partially by the fact that the governments have been very proactive in the semiconductor and high-tech segment. And in that context, there are a number of companies that are essentially joining -- jumping, sorry, straight to system-on-a-chip design using losing large blocks, using advanced tools, and not being encumbered by any not-invented-here flows from the path. At the same time though, a number of multinationals are in these countries as well, and are taking advantage of the entrepreneurial and rapid movement. So bottom line is I think we're in a good position from both perspectives, and yes, I do think that we will continue to see, relatively speaking, good growth in that area of the world.

Unknown Analyst -

Okay. Just a couple of last ones for Brian. Your service and maintenance revenues, at $49 million, had an unusually large sequential and year-over-year increase. I think this was your best quarter in that category since the fourth quarter of '05. The question there is, is that partly a function of perhaps the waterfall effect of previous bookings flowing now into maintenance recognition? Or was it, in part, tied to the previously mentioned services related to IP?

Brian Beattie

It's the latter part, Jay. The growth in our business now -- almost a $200 million run rate in overall services. Most significant part of the growth is coming from our business units, themselves. And in particular, as I was saying, about half of the growth in the whole systems and IP area is in the services piece itself. So this reflects a number of the acquisitions that we made recently that have a more significant percentage completion model of revenue recognition. So we'll sign up to a project, and as the project is completed, we make the milestones committed to in the contract and we take the revenue. So all of the growth you're seeing there is coming primarily from our services group and some other slight growth from the other business units that's coming through. So that's just reflecting the new businesses we've got and a larger amount of services work that goes along with the new businesses. And I think that's going to continue to grow.

Unknown Analyst -

Okay. And then lastly, on the duration question. I understand what you're saying that the recent shortening is not necessarily a structural thing or permanent thing. So the question is, even with an expectation of an average of 3 years, would you foresee doing, or customers asking for, 4-year and 5-year deals? And would you be willing to do those, assuming the run rates were no worse than what you had before?

Aart de Geus

Well, we never comment specifically on our business practices. I would say that in general, the ranges tend to be very uniform for most customers. There are always some exception, and the exception needs to be really justified, why it makes sense either strategically or economically. But in general, I think our business model is relatively uniform.

Operator

You have a follow-up question from the line of Raj Seth with Cowen and Company.

Raj Seth - Cowen and Company, LLC

Aart, could you just take a minute and discuss whether or not you think there's any opportunity for sort of software to serve as application service provider type model in EDA? And if so, if you guys at Synopsys are doing anything in that domain?

Aart de Geus

Well, software as a service. There are many, many different forms of that. I can tell you only what we have done or are doing. We recently introduced to some of our customers, a cloud computing capability that is aimed specifically at the simulation field and aimed specifically at the need for some customers to have some peak availability of simulation. And the challenge for a number of customers is they may be late on a project, they see, maybe, an opportunity to go faster to market or so, and lo and behold, suddenly they need 2,000 computers for 2 weeks. Well, many customers cannot either afford it or are just limited by their computer environment, by the facilities, by the process to buy these, et cetera, et cetera. And so the -- what we have available is the capability that, for which we have teamed up with Amazon, to make it possible for customers to literally, on very short notice, have available, let's say, 2,000 computers with our VCS simulator. We charge a price per hour for the customer. And that's, of course, a function of the number of hours that they're willing to commit. Of course, we pay Amazon for the privilege of using their computers. And as part of the business model, the price is not discountable by our field force because that is very important in these type of business models. And we're now looking at is this of interest to customers. We have already navigated through many of the technical issues on how to make this practical, to many of the legal issues on how to make sure that the security is there, to some of the service issues in terms of how can you quickly make it work. But the business model has to still be proven, and this is early. So essentially, literally, just mentioned it to our customers in our users group meeting. And I think the next 12 months will tell if there is some life in that business model.

Raj Seth - Cowen and Company, LLC

Right. I appreciate that. That was what I was...

Operator

At this time, I'll turn the call back over to our host and presenters for any closing comments.

Aart de Geus

Well, we appreciate the time you just spent with us. Hopefully, you heard that we finished with a very strong and solid quarter Q2 with an excellent outlook towards the end of the year. And as usual, Brian I will take some of your questions after the call. Have a good rest of the day. Bye-bye.

Operator

Ladies and gentlemen, that will conclude our conference for today. We thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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