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Cadence Design Systems (NASDAQ:CDNS)

Q2 2011 Earnings Call

July 28, 2011 5:00 pm ET

Executives

Alan Lindstrom -

Geoff Ribar - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Lip-Bu Tan - Chief Executive Officer, President and Director

Analysts

Sterling Auty - JP Morgan Chase & Co

Paul Thomas - BofA Merrill Lynch

Thomas Diffely - D.A. Davidson & Co.

Jay Vleeschhouwer - Griffin Securities, Inc.

Richard Valera - Needham & Company, LLC

Operator

Good afternoon. My name is Kristen, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence Design Systems Second Quarter 2011 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Alan Lindstrom, Director of Investor Relations for Cadence Design Systems. Please go ahead.

Alan Lindstrom

Thank you, operator, and welcome to our earnings conference call for the second quarter of fiscal year 2011. The webcast of this call can be accessed through our website www.cadence.com and will be archived for 2 weeks. With us today are Lip-Bu Tan, President and CEO of Cadence, and Senior Vice President and CFO, Geoff Ribar.

Please note that today's discussion will contain forward-looking statements and that our actual results may differ materially from those expectations. For information on the factors that could cause a difference in our results, please refer to our Form 10-K for the period ended January 1, 2011, our 10-Q for the period ended April 2, 2011, the company's future filings with the Securities and Exchange Commission and the cautionary statements regarding forward-looking statements in the earnings press release issued today.

In addition to financial results prepared in accordance with generally accepted accounting principles, or GAAP, we will also use certain non-GAAP financial measures today. Cadence's management believes that in addition to using GAAP results in evaluating our business, it can also be useful to measure results using certain non-GAAP financial measures. Investors and potential investors are encouraged to review the reconciliation of non-GAAP financial measures with their most direct comparable GAAP financial results, which can be found in the Quarterly Earnings section of the Investor Relations portion of our website. A copy of today's press release dated July 28, 2011, for the quarter ended July 2, 2011, and related financial tables can also be found in the Investor Relations portion of our website at www.cadence.com. Now I'll turn the call over to Lip-Bu.

Lip-Bu Tan

Good afternoon, everyone, and thank you for joining us. I'm pleased to report that our strong momentum in Q1 continued into Q2. For the second quarter, revenue totaled $283 million, non-GAAP operating margin was 17%, and we generated $69 million of operating cash flow.

Demand for both our software and hardware products was strong, driving increased run rates on renewals. For example, 2 of the world's top 10 semiconductor companies significantly increased their usage of our digital products. Both of these transactions consist primarily of new business, and together, will provide more than $10 million of incremental annualized revenue. And now let me turn to the second quarter by highlighting each of the 3 businesses: System Realization, SoC Realization and Silicon Realization.

In Q2, we extended our position in System Realization with the launch of the System Development Suite. This new suite of products reduced system integration time by up to 50% by enabling hardware-software co-design within a common design environment.

It introduced 2 new platforms: the Virtual System Platform and Rapid Prototyping Platform. These are tightly integrated with the 2 established platforms, the Palladium XP Verification Computing Platform and our Incisive Verification Platform.

A number of leading customers and partners announced their adoption of the suite, including ARM, NVIDIA and Western Digital. NVIDIA, a user of Cadence emulation products for many years, deploy the broader Cadence System Development Suite with elements such as Rapid Prototyping Platform, offering immediate value.

Sales of our Palladium XP Verification Computing Platform, a key component of the System Development Suite, was strong again.

In Q2, Marvell purchased Palladium XP and will use it for future projects. We are also seeing new and growing global demand as HiSilicon, a China-based provider of ASIC and solutions for communication network and digital media, adopted Palladium XP to speed integration and time-to-market.

Now let me talk about our SoC Realization business. Cadence is the leader in Verification IP, or VIP. In Q2, we announced the availability of VIP for ARM new AMBA 4 protocol. This new VIP enables designers to verify the functionality of multiprocessor ARM Cortex-A15 designs, which are now being deployed in various mobile applications, including tablets and smartphones.

We also announced close collaboration with TSMC that will strengthen our design IP. This extends an already close relationships and ensures the availability of IP that has been validated at the foundry.

Next, I will highlight our Q2 Silicon Realization successes. As I said in the beginning, we significantly expanded our digital implementation position at 2 of the world's top 10 semiconductor companies as we displaced alternative suppliers. This illustrates the growing competitiveness of our end-to-end digital solution, especially for advanced node designs, where the optimization of power, performance and area is more complex than in previous generations.

We improve our digital flow with the acquisition of Azuro. This technology, when integrated into our end-to-end digital flow will enhance our customers' ability to optimize power, performance, area of the most complex designs.

We also acquired Altos Design Automations, whose tools enable fast, accurate characterizations of foundation IP, generating models used for SoC implementation. These models, when combined with our digital and custom analog flows, improve the quality of results by providing greater visibility into the effects of noise, timing and power at every phase of the design cycle.

Our customers tell me this a great acquisition for Cadence, and will significantly improve their implementation flows. In our Custom/Analog business, customer adoption of our Virtuoso 6.1 flow also continue to grow.

We displaced a competitor analog flow at a leading 4G IC customer. We also announced that Bosch has standardized on our Virtuoso 6.1 technology, gaining an approximately 25% advantage in productivity.

Finally, strong ecosystem partnerships are essential for the successful development and manufacturing of advanced SoC. I want to highlight key developments with several of our ecosystem partners this quarter. Samsung deployed the Cadence digital flow to tape out a test chip featuring an ARM processor at 20 nanometers. Cadence's Encounter-based digital flow was used to address the requirements of Samsung's advanced 20-nanometer process technology for the SOC.

A number of new Cadence technologies has also been included in the new TSMC Reference Flow 12.0, and Analog/Mixed Signal Reference Flow 2.0. These include system level design capabilities available through our new System Development Suite.

Cadence is currently also the only collaborating partner with TSMC to provide DFM service to their customers for TSMC 40-nanometer technology and below.

Let me conclude my remarks with the following thoughts. We continue to see good momentum in our business. This quarter, we took an important step in building up our System Realization strategy to facilitate hardware-software system integration with the release of the System Development Suite.

Key customers are selecting our digital solution for next-generation designs. The integration of our digital and custom analog solutions provides designers with powerful flow for mixed-signal SoC. We are investing in and strengthening our ecosystem partnerships.

Now, Geoff will review the financial results and provide our outlook.

Geoff Ribar

Thank you, Lip-Bu and good afternoon, everyone. Cadence posted strong financial results for Q2 and that we have good momentum going into Q3. I will review results for the second quarter and then present our outlook for Q3 and update you on 2011.

Total revenue for the second quarter was $283 million compared to $227 million for Q2 of 2010. Product revenue was $158 million, maintenance revenue was $96 million and services revenue was $29 million.

The revenue mix for the geographies was: 47% for the Americas; 20% for EMEA; 17% for Japan; and 16% for Asia. Total costs and expenses on a non-GAAP basis for Q2 were $235 million compared to $230 million for Q1 of 2011.

On balance, the sequential increase was primarily due to higher cost of product. Quarter-end headcount was approximately 4,600 employees, flat compared to Q1. Non-GAAP operating margin for Q2 was 17% compared to 11% for Q2 2010.

For Q2, we recorded GAAP net income per share of $0.10. Non-GAAP net income per share was $0.12. Operating cash flow for Q2 was $69 million. Total DSOs for Q2 decreased to 51 days, from 62 days in Q1. We have driven DSOs down from over 150 days at the end of Q1 2009. Our target DSO for the year is now 55 to 56 days.

Quality of receivables remained high, with less than 1% of receivables more than 90 days past due. Capital expenditures for Q2 were $6 million. Cash and cash equivalents were $665 million at quarter end. Approximately 1/3 of our cash is in the United States.

Over 90% of orders booked in Q2 were ratable including product maintenance and services. Weighted average contract life for Q2 was approximately 2.5 years.

As Lip-Bu mentioned, on a weighted-average basis, run rates on contract renewals in Q2 increased. I want to point out one item on our balance sheet that has changed this quarter. The contingent conversion feature of our 2015 convertible notes was triggered during Q2 as the price of Cadence's common stock traded above $9.81 for an extended period during the last month of the quarter. And as a result, the 2015 notes are now classified as a current liability. However, we do not expect the note holders to exercise their options to convert as the economic benefit of holding and trading notes significantly outweighs converting the notes.

Now let's address our outlook for the third quarter of 2011 and our update for fiscal 2011. We are increasing our 2011 outlook for bookings, revenue and operating cash flow due to strong Q2 results, the expectation of continued strong demand, and a positive impact of shorter contract lives on revenue.

For Q3 2011, we expect revenue to be in the range of $280 million to $290 million. We expect good revenue for the Cadence Verification Computing Platform in the second half through not as high as in the first half of the year when we were working through strong initial orders.

Q3 non-GAAP operating margin is expected to be in the range of 16% to 18%. Non-GAAP total costs and expenses are expected to increase modestly from Q2 levels due to the impact of recent acquisitions. GAAP EPS for the third quarter is expected to be in the range of $0.04 to $0.06. Non-GAAP EPS for Q3 is expected to be in the range of $0.11 to $0.13.

Now for our update on fiscal 2011 outlook. Bookings are now expected to be in a range of $1.115 billion to $1.145 billion, compared to the prior range of $1.08 billion to $1.112 billion. We expect weighted average contract life in a range of 2.5 to 2.9 years and we expect to book at least 90% of our orders for the year under ratable arrangements.

We now expect revenue to be in the range of $1.115 billion to $1.135 billion for 2011, compared to the prior range of $1.075 billion to $1.115 billion. Non-GAAP operating margin is expected to be in the range of 15% to 17% on an annual basis for 2011 compared to the prior range of 14% to 16%.

Non-GAAP. The other income and expense for 2011 is expected to be in the range of negative $19 million to negative $15 million. For 2011 we're assuming a non-GAAP tax rate of 26% and a weighted average shares outstanding of 270 million to 274 million shares.

GAAP EPS for 2011 is expected to be the range of $0.20 to $0.26, compared to the prior range of $0.11 to $0.19. Non-GAAP EPS is now expected in a range of $0.41 to $0.47 compared to the prior range of $0.36 to $0.44.

For 2011, we expect operating cash flow in a range of $230 million to $250 million compared to the prior expectation of $200 million to $220 million. We expect DSOs to be in a range of 55 to 65 days at year-end 2011. The prior range was 65 to 75 days. My long-term goal is to see DSOs approach 45 days.

Capital expenditures for 2011 are expected to be in the range of $30 million to $35 million. One final comment on guidance. Please remember that we expect lower hardware sales in the second half, and that we have better visibility with just 2 quarters remaining in the year.

So in summary, Cadence had a very good first half. While the macro uncertainty facing the global economy causes me some concern as we plan for the second half, demand for our products and services still looks strong. Our focus on value and deal quality continues to yield benefits in form of lower average contract life and increase in run rates on renewals.

I'm especially pleased that we are making consistent progress towards a long-term profitability goal of a non-GAAP operating margin in mid-20s. Operator, we will now take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question is from Paul Thomas with Bank of America Merrill Lynch.

Paul Thomas - BofA Merrill Lynch

Obviously, the numbers speak for themselves, but I guess if you contrast what you guys are seeing with the larger semi industry, it looks like there's more uncertainty on the customers' side versus you guys, now versus 6 months ago. Your run rates are increasing, but I just wanted to get your commentary on when you speak with customers, is there any sense of caution, more caution now than there was 3 months or 6 months ago, or is there a sense right now that the focus is really on getting the next generation of products ready, and they're really looking through any uncertainty in the second half of the year here?

Lip-Bu Tan

Yes, Paul this is Lip-Bu. Let me try to answer your questions. First of all, I think we all know that the macro environment [indiscernible] and unclearly, the second half a little bit soften. And then somewhat the result from the semiconductor company that are announcing the results have been mixed. But overall, I think from the feedback from our customer that design activity still remains strong. And engagement, the new model of engagement we have with the customer starting to bear fruit and that really engaged strategically with us on the next challenging product they have. Clearly, we see smartphone, tablets, server, area of strengths. PC, networking and some of the industrial and selective part of the automotive has been weakened. But overall, I think it's a very healthy, we see in terms of the design activity and our engagement with our customer continue to be strong. And then we look at some of our ecosystem partners like Foundry and now clearly, the Q3, a little bit correction, but they all indicate good pickup in Q4. So overall, I think the semiconductor trend we see is about 5%, 7% growth, but answer your question on the design side remain very strong.

Paul Thomas - BofA Merrill Lynch

Maybe just one more on emulation. I know no Geoff, you talked about hardware sales being down half over half. I guess when you look at 2009 to 2010, the EDAC data says 15% growth for emulation, and Q1 started off more like a 30% pace. Do you still think you'll be ahead of that 2009, 2010 15% growth rate this year? Or I guess any color you can give there would be helpful.

Lip-Bu Tan

Paul, this is Lip-Bu. Let me just touch on the high level and then Geoff can tell you more in detail. So overall, as you know, the Palladium XP, our verification platform is very, very needed and is essential for any complex chip design anything below 40-nanometer and time-to-market in terms of improvement finding the box earlier is a must-have and we are starting to see companies I mentioned, Marvell in the past, Broadcom, in the earlier earnings call. So there's a suite of company like NVIDIA have been a great partner for us. So anything complex-intensive design is a must-have. We continue to see strength in that. And Geoff?

Geoff Ribar

Yes. It's obviously a secular trend. Emulation is becoming more and more important, and we think we are doing very well in it. The reason the second half is down for us has to do with the manufacturing bubble that was created on initial orders for Palladium XP. We've now worked through that manufacturing bubble. Having said that, we don't guide specifically on hardware revenue and numbers, but we are of course, going to see growth year-over-year.

Operator

Your next question is from Sterling Auty with JPMorgan.

Sterling Auty - JP Morgan Chase & Co

I want to follow on with the commentary on the first set of questions. Given the mixed results that we've had in the semiconductor area, what's your sense in your conversations with them? How long would it have to go in terms of this kind of current sluggishness that they're in before some of the design trends and activities start to get reined in? Do you still feel like we've got at least a couple quarters through the back half of the year before we have to worry, or maybe I should put it this way, that there's runway in hope we get an uplift, so it carries them into 2012?

Lip-Bu Tan

I think first of all, it's very hard to generalize a way to answer your question, and I mentioned earlier, I think some of the customer we have engaged specifically in the smartphone, tablet and server has been very strong. And they are heavily engaging with us. And then some of the low MPC and networking, I think is – I see it as temporary. Some of the infrastructure delay, but I think one or two quarter, semi will be coming a back -- and there's no slowing down that the design for the next-generation design. So overall, I'm optimistic and from the design activity point of view, we do not see any slowdown.

Sterling Auty - JP Morgan Chase & Co

And then follow-up would be, since you've got the pattern on Palladium, second half versus the first half, what are the areas that you think will continue to power through? And you made a lot of commentary about the IP side of things, as well as the digital side. I didn't hear as much commentary on this call about the analog platform, so what should we be looking for in terms of what you think is going to be the strength in the back half of the year?

Lip-Bu Tan

Okay, so a couple of things. First of all, I think in this quarter, across our product line had been strong, and I think we'll continue the strength going forward for the second half. In terms of the growth area, first of all, let me touch on the digital side. Clearly, we mentioned about 2 of the top 10 semiconductor companies engaging with and now using us, have a nice incremental replacement for competitors. And then clearly with the 2 acquisitions we make, Azuro and Altos make us very competitive, especially in the advanced nodes for optimizing power performance in the area. So I think we continue to see strength in terms of the digital solution that we provide. In terms of the IP area, and I think I mentioned that the Denali continue to -- doing very, and especially in the memory modeling and then some of the critical storage management, and we announced wide I/O and DDR4. We have a very strong reception from the customer and we have been very focused on highly differentiating we call it interface or connectivity IP. And we are going to continue doing that, and we see strength on that. And then in terms of the analog side, and I think we continue to see the proliferations from our customers, and we don't see any meaningful competitors' position then. So I think we'll continue to do very well and then in the longer run, I think the EDA360 is really our vision and our strategy. We are laser-focused on that whole SoC realization and the System Realization and we have a lot of good traction there. In time I mentioned about the System Development Suite that we announced. We have received a lot of very positive customer feedback like ARM, NVIDIA, Western Digital and continue to expand the list. So clearly, the application-driven is a fast-growing sector. And then we continue to drive deal quality improvement, and so I think we'll continue to be optimistic, cautious/optimistic about the progress we are making.

Geoff Ribar

And I think just a couple of pieces, Sterling, of tactical, to back some of that up. The 2 top 10 semiconductors companies in the world will had over $10 million of annualized run rate. So that's obviously material to us. I think also the duration of our backlog has come down as the duration of our bookings have come down. And I think that's increased the quality of our backlog, increased the confidence in our future guidance.

Operator

Your next question is from Rich Valera with Needham & Company.

Richard Valera - Needham & Company, LLC

Kind of a follow-up on that. If you take the midpoints of your third quarter and full-year guidance, it would imply a revenue level in the fourth quarter of about $10 million higher than the second quarter, yet one would expect probably a significantly lower level of emulation business in that fourth quarter. So just wondering how we should think about the sustainability of that fourth quarter revenue run rate as you exit this year. It seems like it won't have any sort of unusually high level of emulation in it, so maybe we could sort of use that as a starting point as we think about next year in terms of implied sort of software run rate. Just want to know if you could comment on that.

Geoff Ribar

You're correct. Emulation is going to be down in the second half of the year, and we're making that up largely in software, right, and maintenance component to our business. We expect the Emulation business to be a good business next year, and we expect Q4 to be approximately where you just worked out. Having said that, we’re really not guiding 2012 yet.

Richard Valera - Needham & Company, LLC

Okay, fair enough. And also on emulation historically, emulation has been the most economically sensitive of the EDA products out there. I know you just had a great quarter from a revenue standpoint. Any signs at all of customers being more cautious with emulation purchases or outlook there?

Lip-Bu Tan

Yes, so I think Rich, first of all, I think you’re talking about the pattern I think Geoff mentioned to you, in terms of the customer engagement we have, we continue to see a lot of strength and a lot of engagement because time-to-market is so critical. Somewhat a complex design and some of the customer tell me that they really need it. It's a lifesaver and they would like to buy more of that. So I think we continue to see strength and with the industry development moving down below 40-nanometer and with the best of class and it's a must-have.

Geoff Ribar

I think on the other side, it also helps the productivity of our customers, right, and the amount of engineers and resources they need to use to get the design out the door.

Richard Valera - Needham & Company, LLC

So was it your feeling that maybe emulation is going to be more resilient this cycle, presuming where we may be heading into some sort of ebb in the cycle here than it was historically?

Lip-Bu Tan

Yes, so I think if you look closely into our Development Suite, it's really built around a whole emulations. And that's why you have the whole virtual co-design hardware and software and also the Rapid Prototyping, and that is a very good growth engine for us in terms of what we discuss with the customer, time-to-market, time for integrations and that are really critical for them especially in the SoC. And so I think it's not just looking at just pure hardware. We should look at the whole other software to drive productivity and time to integration, time-to-market and that is very critical to win in this marketplace.

Richard Valera - Needham & Company, LLC

And then just one final one, a bookkeeping one. I missed your updated bookings guidance, Geoff, if you could just give me that again please?

Geoff Ribar

Sure, it's $1.115 billion to $1.145 billion.

Operator

Your next question is coming from Tom Diffely with D.A. Davidson.

Thomas Diffely - D.A. Davidson & Co.

It sounds like you're seeing some strength across-the-board. I was curious though, at this point, are you seeing your big customers get even stronger? Is there a widening of the GAAP between your big and small customers?

Lip-Bu Tan

Absolutely. And that's why 2 years ago, I really focused on the top 40 customers. And clearly, for a start-up company, [indiscernible] are not backing as many and then secondly, some of – even the public company, if they don't have -- able to create a platform, it's become harder and harder to be a stand-alone company. So I think a couple of key platform company and I call it a winning company. We'll just have to continue increasing and we are making great progress, we mentioned about 2 of the top 20 in this quarter and then continue we’re going to make progress, and I think it's critical for our health of the company.

Thomas Diffely - D.A. Davidson & Co.

So this trend continues, does that have a negative impact on margins?

Lip-Bu Tan

No. We continue to drive the deal quality, and we continue to provide that shorter duration so that we are aligned with the design cycle with the customer. And so that we continue to drive value to provide to our customer, and we want to be there so that a trusted partner that they can count on us to provide the solution they need to time-to-market and then to win in the marketplace.

Thomas Diffely - D.A. Davidson & Co.

Okay. And then looking at margins in the second half of the year, if the emulation of the hardware component goes down, is that a boon for margins, at least in the near-term?

Geoff Ribar

Yes, obviously hardware margins are lower than software margins, but we also have some offsetting trends. We're going to have some increases related to higher commissions, related to higher bookings. So -- and we'll also have some incremental expenses related to the 2 acquisitions that we've done.

Thomas Diffely - D.A. Davidson & Co.

Okay. And Geoff, if you could also just dig in a little deeper on the notes and derivatives and what the structured mechanics are for that, that would -- what kind of scenarios do you see potentially happening over the next year or 2?

Geoff Ribar

So as you know, Tom, we moved the notes to current, the 2015s because we're traded over the essentially over the trigger price, if you want to look at it. We expect the note hedges to move in tandem. We expect the notes to be current as long as the share prices stays over that price. We don't expect the notes to be converted. They’re trading at a materially higher price in the market than conversion, materially higher price, so we don't expect the notes to be converted at all.

Thomas Diffely - D.A. Davidson & Co.

And what kind of stock price would you need before you thought it would be a possibility or likelihood?

Geoff Ribar

I don't think it's even the price of our stock that would allow the notes to be converted. They get a nice interest payment on it and until it becomes closer to 2015, it's really not an issue.

Operator

[Operator Instructions] Your next question is from the line of Jay Vleeschhouwer of Griffin Securities.

Jay Vleeschhouwer - Griffin Securities, Inc.

A couple of detailed questions first about the second quarter and then a couple of longer-term questions. So Geoff, first, when we look at your sequential change and cost of product, the increase there was about the same as the increase from Q4 to Q1. Was that predominantly driven by the cost of product for the hardware? And if so, does that mean that the hardware revenues increased by about as much sequentially in Q2 as they did in Q1?

Geoff Ribar

So the cost of product is largely hardware and the second question can't really answer because we don't give specific on revenue for hardware.

Jay Vleeschhouwer - Griffin Securities, Inc.

Okay. Was there anything unusual or nonrecurring in the maintenance number? It's usually not quite that strong in the second quarter, at least not compared to the first quarter. So is that just a function of how you apportion bookings, or was there something else going on in terms of one-time payments or something of that kind?

Geoff Ribar

Yes, Cadence used to have a history where in Q1 and Q3 maintenance would go up and then Q2 and Q4 maintenance would go down related to Japan. That's no longer the trend anymore. We're gradually getting away from that trend and getting more reasonable over a period of time. So don't expect to see that cyclical pattern going forward. Did that answer your question, Jay?

Jay Vleeschhouwer - Griffin Securities, Inc.

Well, not entirely. Is there something stemming from the way you apportion a fixed percentage of bookings each year?

Geoff Ribar

No, it's just that the swings that used to be caused by Japan aren't as relevant anymore. So there's no really other material changes as to how our, how we manage our maintenance.

Jay Vleeschhouwer - Griffin Securities, Inc.

Going for the longer-term, how are you thinking about the progression of bookings over the next number of years? For this year, you're looking for about $150 million to $200 million increase over last year but let's, for the moment, strip out the bookings for services and maintenance and just look at product bookings. You'll still be pretty considerably below your '05 through '07 levels of bookings just for product. And the question is, do you think you're going to need perhaps another couple of years to get back to where you were, adjusting for duration and that's one of the questions.

Geoff Ribar

So Jay, what we've said consistently about bookings and this applies to total bookings, right? We tend to look at total bookings, is that we expect '11 to be better than '10 and '12 to be better than '11, and this is related to the model change and also our normal renewal cycles. We haven't gotten much more specific beyond that. We've said that Q4 2012 will be essentially when we're fully converted on our model change and 2013 will be the first year where we're fully in our new model. And really can't comment on 2005 to 2007 or what's going to take to go forward. We're guiding that far out yet.

Jay Vleeschhouwer - Griffin Securities, Inc.

Sure. Question about duration. You're tending towards the low end of the range that you've given before of 2.5% to 2.9%. I guess the question is 2.5% necessarily a floor? Are they're already practical limitations to customers going even shorter than that, particularly your larger customers?

Lip-Bu Tan

So I think Jay, let me answer that question. So first of all, we try to be aligned with the customer in the design cycle. And we're the ones who give them too much and that give them too little that are nervous. I think it's kind of case-by-case with the customer. And then more important also, we want to have it a little bit shorter so that we can really introduce new technology, new product or new solution that we can provide to them and so that's kind of our strategy.

Jay Vleeschhouwer - Griffin Securities, Inc.

Okay, and then lastly, could you talk about how you see the progression of R&D spending for the balance of the year? It was kind of sideways in the second quarter. And related to that as well, what kind of investments do you think you need to make in services, in support of your overall IP strategy?

Lip-Bu Tan

Let me answer that and then Geoff can add on to that. So first of all, I think we feel comfortable with our R&D spending and we continue to drive our efficiency and also very focused and targeted in terms of the digital mixed-signal flow, IP and SoC and also the system level. And we drive some of the road map in terms of how to provide the best solution to the customer and that we also did acquisition: We acquired Azuro and acquired Altos. So will continue find the best solution, the best product we can continue to drive success with the customer and then listen to the customer. So I think between the R&D spending and then the acquisition, we feel comfortable with our directions.

Geoff Ribar

And specifically, from Q1 to Q2 on engineering spending it was relatively flat. Obviously, social security and FICO kind of rolled off as people made it over those limits. And second of all, there's was little bit more vacation taken. We expect those numbers to increase though in the second half of the year for the reason Lip-Bu gave.

Operator

There are currently no further questions. I'd like to turn the call back to Mr. Lip-Bu Tan for closing remarks.

Lip-Bu Tan

So in closing, Q2 was a great quarter for Cadence, and we have momentum going into the second half. We are introducing exciting new products like System Development Suite that expand our market. We are winning new business at important accounts on strength of our technology. We are making acquisition that matter to our customers. And our key operation metrics are all improving. Thank you everyone for calling in this afternoon. And we are looking forward to speaking with you soon and thank you again for joining us.

Operator

Thank you for participating in today's Cadence Design Systems Second Quarter 2011 Earnings Conference Call. You may now disconnect.

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