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Cadence Design Systems (NASDAQ:CDNS)

Q3 2007 Earnings Call

October 24, 2007 5:00 pm ET

Executives

Jennifer Jordan - Corporate VP of IR

Mike Fister - President and CEO

Bill Porter - EVP and CFO

Analysts

Jay Vleeschhouwer - Merrill Lynch

Analyst for Harlan Sur – Morgan Stanley

Analyst for Mahesh Sanganeria - RBC Capital Markets

Terence Whalen – Citi Investment Research

Sterling Auty - JP Morgan

Benjamin Pappas – D.A. Davidson

Operator

Good afternoon.(Operator Instructions) I would now like to turn the call over to Jennifer Jordon, Corporate Vice President of Investor Relations for Cadence Design Systems. Thank you Miss Jordon, you may begin the conference.

Jennifer Jordon

Thank you Kathina. And welcome to our earnings conference call for the third quarter of 2007. The webcast of this call can be accessed through our website www.cadence.com and it will be archived for one week. With my today are Mike Fister, President and CEO and Bill Porter, Executive Vice President and CFO. 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 the results, please refer to our 10-K for the period ended December 30, 2006 and our 10-Q for the period ended June 30, 2007.

In Addition to the financial results prepared in accordance with generally accepted accounting principles or GAAP, we also present non-GAAP financial measures today. Cadence management believe 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. Please refer to our earnings press release for a discussion of non-GAAP measures and to both our earnings press release and our website for reconciliations of GAAP and non-GAAP financial measures used in today’s discussion. Mr. Fister.

Mike Fister

Once again Cadence delivered excellent results in the third quarter. Revenue was $401 million operating margin was 30% and cash flows was $89 million. Cadence continues to focus on aligning our technology solutions with our customer needs. As a result we deliver and receive more value which has strengthened our market segment share position. The fact that Cadence offers the industry’s most complete and robust technology with segmentation tailored to customer demand has contributed to our success. Customers are increasingly adopting our innovative end-solutions and leveraging our unique software distribution mechanisms.

For example, we introduced two years ago a form of technology delivery called an EDA card, which has proven increasingly popular with customers. The EDA card is a form of contract that enables customers to draw down product licenses from a self-serve real-time system, so they are better able to match their project license demand with purchase license capacity. Infrastructure for the EDA card is proprietary and provides us and our customers with an excellent visibility into their project needs and utilization. Customers also have the ability to draw down licenses of different time durations, each priced accordingly, until they exhaust their purchase capacity. Our initial experience has been that customers draw down the licenses faster with the EDA cards than with traditional contract cards. And just as this unique delivery system helps customers manage their most complex business productivity challenges, our innovative technology solutions help customers manage their most complex design challenges.

We examined our digital implementation platform end-to-end and delivered the Cadence low power solution. We are preserving power throughout the digital flow that is unmatched in the industry. This differentiation is fueling sales and accounting platforms both competitively and expansively into existing accounts. NEC America used our Encounter platform to implement the Arm11 MPCore – one of the world’s high performance low power processors. NEC achieved overall performance in timing performance and lower power. Advanced technologies Encounter GXL such as statistical static timing analysis and optimization allow the customers to accurately account for the effects of processor ability, in a leading edge 45 mm designs. Raincoast adopted this solution for SoC design including Encounter timing system GXL with the statistical static timing analysis.

During the third quarter, design physical was added to logic design team solution. Design physical gives logic teams access to interconnected information in their logic synthesis environment, dramatically improving physical predictability and increasing the quality and accuracy of high speed and low power design.

In customized IC we experienced continued momentum for the high end GXL versions of Virtuoso 6.1. A major North American communications company included 45 nanometer design using the new platform as a custom analog design for the Virtuoso 6.1. The speed, capacity and versatility of Virtuoso multi-mode simulation in handling the verification of complex design, showed several competitive wins during the period. For example, Neotech a leading Taiwanese designer of imbedded systems chose Virtuoso multi-mode simulation as his preferred solution. CDNLive! in Silicon Valley can provide additional insight into our strategy for manufacturability adjacency.

Our collaboration with and subsequent acquisition of Clear Shape extends Candence’s capability with design analysis and optimization solutions. Together these capabilities provide a design and implementation flow where what you design is what you get in terms of manufacturability and advanced process control. And in manufacturing sign-off the acquisition of Invarium gives us leading edge of optimal proximity correction. These kinds of technologies address the next generation of lithography challenges of 45 and 32 nanometers.

During the quarter we added over 100 million gates of palladium upgrades within existing accounts and booked palladium sales in a number of new accounts requiring system level verification. Customers are using our integrative software extensions or ISX with palladium for hardware/software co-verification and validation. And as projected we released a SoC functional verification kit, which provides a pre-built verification environment extending from the block to the system level, targeted especially for today’s futurist wireless and consumer designs.

It’s this type of leadership that’s compelled many of the largest semi-conductor companies in the world to deepen their relationship with us, making Cadence a primary design solutions partner. After exhaustive evaluation process NXP named Cadence its primary strategic partner for EDA technology. NXP has endorsed us as the low power chip design solutions leader and the only company with the depth and breadth to deliver for NXP the fully integrated front to back analog and digital solution they require. And like us, NXP shares an acute interest in developing solutions at the system level. I am excited we’ll also be working and investing together to develop new technologies for the next generation for electronic system level designs. Our consistent performance is a result of strong customer response to our technologies and to our strategic roadmap. And now I’ll let Bill speak to the financials.

Bill Porter

Thanks Mike. The results for the company’s key operating metrics for Q3 were total revenue of 9% year over year; non-GAAP operating margin of 30%, improving 200 basis points from Q3 of 2006; and operating cash flow of $89 million. GAAP earnings per share for Q3 were $0.24, compared to $0.14 in Q3 of 2006. Non-GAAP earnings per share for Q3 were $0.33 compared to $0.26 in Q3 of 2006, up 27% year over year. Total revenue for the third quarter was 401 million, compared to 366 million in Q3 of 2006. Product revenue was $274 million, maintenance revenue was 96 million and services revenue was $31 million. Revenue mix by geography in Q3 was 41% for North America, 25% for Europe, 22% for Japan and 12% for Asia. One customer accounted for 14% of revenue.

Estimated contract life on a dollar weighted average basis approached four years, driven primarily by one large customer. In the quarter approx 50% of our product business was represented by ratable licenses. This was lower than our historical rate, because of a higher mix of term contracts. Important factor which contributed to the higher level of term business in Q3 was the EDA card that Mike talked about. Cadence offers both term and subscription EDA card contracts. The volume of EDA card contracts has grown rapidly over the past several quarters and has reached 1 billion cumulatively. Based on a recent experience I expect the ratable mix for Q4 to be in the low fifties and for the year, in the low sixties.

Total cost and expenses on a non-GAAP basis for Q3 were $281 million compared to $280 million in Q2. Our non-GAAP operating margin in Q3 was 30% compared to 28% in Q3 of 2006. We are on target to achieve a 30% operating margin for the full year 2007. Quarter-end head count was approximately 5300.

Total DSOs in Q3 were 112 days compared to 93 days in Q3 of 2006. The higher DSOs are directly attributable to more term business for customers pay over time. We expect DSOs to be in the mid-nineties at year end. The quality of our receivables remain high with receivables ninety days past due less than 1%.

Operating cash flow for Q3 was $89 million compared to $60 million in the third quarter of 2006. For 2007, we expect to generate operating cash flow of approximately $450 million. Capital expenditures in Q3 were $19 million. For 2007, we expect normal capital expenditures of about $75 million, plus $21 million for work on the new engineering building.

Cadence repurchased $12 million shares of common stock at a cost of $251 million in Q3. Approximately $155 million remains under our current stock repurchase authorization.

Cash and cash equivalents were $936 million at quarter end.

Now I’ll turn to our outlook for Q4 in the year 2007: for Q4 we expect revenue to be in the range of $465 to $475 million. GAAP EPS should be in the range of $0.34 to $0.36 and non-GAAP EPS in the range of $0.45 to $0.47. For the year 2007, we expect revenue to be in the range of $1.622 billion to $1.632 billion. GAAP EPS should be in the range of $0.94 to $0.96 and non-GAAP EPS in the range of $1.34 to $1.36. Other income expense for 207 should be in the range of $40 to $45 million.

I expect that we will attain our primary operating metrics for the year of growing the top line, improving operating margin and increasing cash flow. Looking beyond this year, we should be able to grow the business profitably while expanding operating margins.

Operator, we’ll now take questions.

Question-and-Answer Session

Operator

Your first question comes from Jay Vleeschhouwer from Merrill Lynch.

Jay Vleeschhouwer - Merrill Lynch

Yes thanks. Bill I’d like to ask about a couple of assumptions behind your fourth quarter revenue outlook and your license outlook. First are you expecting as we’ve seen in the last five quarters a double digit percentage revenue customer, and secondly, for the year do you expect as you did expect before, to be able to grow back log by the end of the year.

Bill Porter

Sure Jay. Let me cover your second question first: I do expect that we will grow our backlog for the year. In terms of large customers, I think we have seen this year that we have had the ability to close large contracts as part of our business. I think we’ve gone and done a good job of that it’s the ability to have strong technology and to manage our pipeline and I do think that we have an ability to do that going forward, although I don’t want to project, you know how those things close in a particular quarter.

Jay Vleeschhouwer - Merrill Lynch

Alright, with respect to some of the customers you named, NXP was of course in the pipeline for the year; the difference this time with the renewal you were the primary media vendor already so what’s new about it; you also mentioned NEC America and you have been exposed to NEC Europe, so are you now suggesting that you’re broadening your exposure and share in NEC more globally?

Mike Fister

Absolutely and it’s a pleasure to have been a long-standing part of the supply dynamic to companies like NXP and I think as the press release indicates today and from what you can see we’ve definitely expanded our relationship front to back; it’s a tremendous vote of confidence in the product direction that we’re on. The companies like NEC see the value of low power and dynamic there and deploy it more broadly – those are market segment share gains as I said in my comments so I think a lot of the test of the metal is not just being part of the supply dynamic but a more and more integral partner, quote-unquote, with these companies and increasing our ability to help them across all of the pieces of the solution geocentrically and technologically.

Jay Vleeschhouwer - Merrill Lynch

Mike, in your remarks you referred to CDNLive! And the technologies you are working on there, but clearly you have acknowledged yourselves that you’re behind in DFM for example, it’s still a small percentage of your business; when do some of the things you do, based on internal technologies, Clear Shape and all the rest, really become more material; at what point do you run the risks of say just being too far behind your peers in this growing category?

Mike Fister

It’s a good question. As I mentioned in the first of the comments, a lot of our DFM is integrated into the design so that you do it right as opposed to added in later, OPC, or whatever the heck people try to do and to me is an historical artifact of the approach. Already in the GXL versions of Encounter and Virtuoso we have those technologies implicit in there. For the other elements of modeling, which is the ability to have the same model in the design and the manufacturing process, that’s where our collaboration and now acquisition of Clear Shape has amounted to impact for over a year. And consistently throughout next year, we’ll see those things kick in monetarily. For the most part now we’re in trial with very specific clients, who have very specific problems, and who we referred to in the last call about some memory companies – those are guys that are out already at 45 nanometers. To go back and do a bunch of DFM stuff at 130 that track’s already been laid. So a lot of that is a forward looking thing as people move aggressively into 65 nanometer production or certainly 45 nanometer production - I like our chances. You have to have the implementation flow to be able to marry with the manufacturing sign-off and manufacturability, and so far, I’m happy with our results with the customers that we’re in trial with.

Bill Porter

If I could add just a little color to that, with the correct-by-construction particularly in digital GXL in custom and Virtuoso in GXL, you will see additional strength in those two product lines as the result of our success with manufacturability. But we’re not going to be able to pull that out, so at the high end of our line, and I think we talked a little about this in the past, that’s going to be one of the ways that you’re going to see us outperform traditional growth in digital and in custom is because of the strength we’re going to bring from manufacturability up to the high end of our design capability. And in addition to just taking some market share there.

Jay Vleeschhouwer - Merrill Lynch

Alright, finally the duration of contracts on average went up about 1/4 which you attributed to one deal. You’ve pretty much always been at 3 years up until now so what was the requirement in this particular case that the customer wanted a longer deal which enlarged your average. Is this a spreading phenomenon after all, notwithstanding your previous statements that three years wasn’t necessarily in your interest or in the customers.

Bill Porter

I do think it is unique to the customer situation, but I think the one thing when you do have let’s say primary status with a customer and some cases they do want a little longer footprint so they can establish a degree of stability, but I do also think that as I think about this particular situation we still have the ability to increase our footprint there, albeit a longer contract because there’s additional value we can bring to the table which we will be able to grow our run rate at that customer over the term of that contract. SO we’re not done there, and I think that’s the thing that we are really trying to focus on both with our model that we’ve talked about with having our AMTs to work with customers and the way we’re trying to sell the new technology.

Mike Fister

Any time that we look at a contract that is longer than three year average that we’re approximately operating on the trick that we’re trying to do is not have you know a limitless access to technology going forward - that’s what’s unhealthy about the long, long, long contracts. And in this case, we can’t tell you a lot of the details but we do have a nice balance with the customer and also given them a lot of confidence in the kind of time line commitment they’re going to have to the technology base.

Jay Vleeschhouwer - Merrill Lynch

Thanks a lot.

Mike Fister

Sure.

Operator

Your next question comes from [analyst] with Morgan Stanley.

Analyst for Harlan Sur – Morgan Stanley

I’m calling for Harlan Sur. One question I had I’m just trying to get a read on the tone of your end-customers, you know we see some mix bag of results – some companies are struggling, their business kind of slowing down a bit whereas other companies are still doing well. I’m wondering if there’s any change in the general tone in your customer base when it comes to their planned R&D spending, especially going into 2008. Thank you.

Mike Fister

Think productivity. You know what I find and it comes from my past experience is a heightened focus on productivity. Some of that is to allow them to spend money in other places like hire more software people, but that’s not necessarily bad for us: they relay more intensely on the value of our automation and also one of the reasons why we pushed for strong adjacencies predicated on what we do with verification, and one of the examples I used was hardware/software co-verification at a big semi-conductor company. So productivity is also the thing that drives some of the consolidations because they can operate more efficiently, and that’s a training dynamic as much as anything else.

I think some people get over-focused on core spending going down – people spend a lot of money on things besides licensing technology, you got to train people and deal with errata and all those kinds of things so that’s what we’re responding to. The other two areas that we focus on are complexity management and time to market: the consumer cycle if you miss it, bad things happen, Christmas doesn’t wait and all those kinds of euphemisms, and so across those three and a focus on productivity will cover most of the customer universe, I see big companies and small companies alike.

Bill Porter

The only thing I would add to the caller is I do see, at least our experience with customers in Q3 is that they are holding onto their cash a little tighter, I think that’s just reflective of that kind of uncertainty you’re seeing in that customer base as well. And so that’s probably adding a day or so to receivables, but I think that being said, we’re also just watching R&D spending and at this stage I don’t think we’ve seen anything from customers that’s giving us any indication that they’re going to dramatically change their R&D spending patterns. And so I think we’re watching carefully and we’ll look at that in Q4 as we get ready to project what our business is for 2008.

Analyst for Harlan Sur – Morgan Stanley

Okay great, thank you very much.

Operator

Your next question comes from Mahesh Sanganeria with RBC Capital Market.

Analyst for Mahesh Sanganeria - RBC Capital Markets

Hi guys. I have a couple of questions for Mike and a few for Bill. Could you comment on the impact if any, of the change in the ratables both for this quarter and for the year?

Bill Porter

Sure, I think one of the things that we have seen is that particularly with our experience with the EDA cards, we have the ability to work with customers to give them some more flexibility to, as Mike said, match their design needs with their purchasing, to better align that, and given that we have worked on this model slowly over the last two years but it has really picked up speed for us in the last quarter and just by reference, we’ve seen our business with some of these term cards triple from Q2 to Q3, and that allows us to really expand our run rate with these customers, because the experience that we’re having is that customers because they have the flexibility of buying more when they need it are actually utilizing the technology at a rate that’s about 47% faster than under a traditional time based contract. And so what we see is the ability to increase our run rate and I think that is what’s going to drive the mix going forward. It’ll be unique to customers; we have some who still prefer to access new technology but we are seeing a trend of buying the strong technology as it’s delivered so I think we’re seeing the view that is reflecting more term EDA cards and that’s what is reflecting in my Q4 forecast for ratability.

Mike Fister

There’s always a discussion on access to future technology and consumption rates. The reason we got into this is to be able to have visibility into that; the contention with the purchasing element as opposed to the developers is how fast or if they constrain the ability for the engineers to take the technology and this is a great demonstrable of, sometimes it’s more valuable to give the guy some run way and let him go. And it’s consistent with almost anybody who’s a developer you know, so I think it’s a responsiveness to people wanting to spend the money in a way that they want to spend it and having very sophisticated mechanisms for them to do this; it’s very neat differentiating technology that we have in the computing systems to allow real-time access to it and measure the usage models, and not have a debate about it. I mean, it is a database discussion then with the customers then that is our benefit.

Analyst for Mahesh Sanganeria - RBC Capital Markets

As a quick follow-up, can you comment on any changes to your revenue predictability because of a decreased ratable model?

Bill Porter

Sure, K.C. You know, one of the questions that I have had in the past is, what do we expect to come out of backlog in 2007? That really hasn’t changed. I still expect that about two-thirds of our revenue for the year is coming out of backlog. That predictor of 2007 stays the same.

Now if our experience continues to be what it is in Q3 and Q4 and we are going to have about, let’s say 50% of our business coming from these term contracts, then of course the math will show that over time we are going to have 50% coming out of backlog versus what we are seeing today of about two-thirds.

That is a tradeoff that we are willing to make, because we can see the ability to increase our run rate with our customers, and it is something that we will factor into our pipeline; albeit the math would show that you don’t have that same predictability out of backlog, but we think it enhances our ability to sell more often to these customers. So I think we will get it back in terms of a richer pipeline over time.

Mike Fister

Absolutely. The one thing I would add to the debate for the value of the technology, anybody who goes out and does extremely, extremely long deals is, I think, diminishing the value. We've been very forthright to say we would like to demonstrate the value to our customers and I think we'll get some return on that. This is just an ever-increasing focus for us to try to do a good job at maximizing the value of the fantastic technology we deliver.

Analyst for Mahesh Sanganeria - RBC Capital Markets

I've got two quick questions on the balance sheet. Going forward, how should we view debt and also how should we view income from interest going forward?

Bill Porter

Sure. In terms of the debt on our balance sheet, as many of you know, our original convertible, a portion of that will be callable this summer. So the $230 million is now short term and you can see that in the classification. So you would expect that would be retired. I think we'll look at the trade-offs to adding additional leverage on the balance sheet. I've been asked that in the past and I think it makes sense for software companies and ones particularly that generate good cash flow to have reasonable leverage. We will look at the timing and the availability of the debt markets to do that. But I think we'll just watch that and see. Our inclination is a little more is better.

In terms of other interest and expense, I think I gave a forecast there that it is in the 40 to 45 for the year, so I think that's probably the best estimate we have right now and then again, we'll look at next year when we talk about that in January.

Operator

Your next question comes from Terence Whalen – Citi Investment Research.

Terence Whalen – Citi Investment Research

Great, thanks for taking my question. This one relates to cash flow and the $450 million target for this year for cash flow from operations. What amount of receivable sales in the fourth quarter is implied to hit that $450 million target?

Bill Porter

Terence, I think that's going to really depend on what cash that we're going to be able to get from customers in the fourth quarter. We don't have a specific target. It's really the mix of business that we get. We're feeling that we're about the same level we were last year, in terms of nine months and cash from operations. It's a little over $200 million plus. We expect to have a good cash flow quarter in Q4 that goes along with our history and you can expect that we will be selling some receivables. Those are things that the financial institutions value and we think it's something that we can get a good return on by using that cash in our business.

So I don't have a specific number for you, but it will be a reasonable amount of our normal cash from operations like it has been in the past.

Terence Whalen – Citi Investment Research

Another question related to the license mix. As you transition the business into next year, relying more on upfront versus ratable, do you expect the frequency or the concentration of 10% plus customers in a quarter to increase versus 2007?

Secondly, what changes are being made in terms of the approach based upon the salesforce perspective to customers with this model change and any other operational changes that go to the model change mix between ratable and upfront? Thanks.

Bill Porter

Terence, I don't know that we're going to see an increase in the number of large contracts. I think there's a certain number of large customers in the world, all of which I think we serve, and we work closely with those customers to meet their technology needs. I don't know that we're going to see anything dramatic in terms of a change there.

In terms of working with the salesforce, one of the things that we have and we alluded to earlier, is we have very good visibility into the consumption of the technology, as does the customer. That allows us to work very closely with the customer to help get them technology that they need when they need it. They appreciate it and it helps our salesforce help them. I think we all have better knowledge.

The other thing that I would just emphasize is this is a refinement of the use that we see of customers with contracts. I don't see this as any kind of a model change, just to be clear from my perspective.

Mike Fister

I'm out in front with Kevin a lot with the customers. What we do with the salesforce specifically is we use the techniques that we have to reinforce the value and opportunity for run rate continuous business with the customers. You can tell that by the testimonials that come quarter after quarter where you see like names over and over again and this is something that is a mindset with some of our field people, because a very old-fashioned mindset would have been “I got the contract and now I don't go back and look at it again for three more years.” No. There's business every quarter with expansion of the license usage that we have and/or new technology areas that are geocentric, because most of these big customers, as Bill says, are operating in all different places of the world and that's the refinement we've made that many people may talk about --that's what we do.

I think the team's doing a nice job there so far, and we've got some more that we can take that. That's why something like an EDA card is such a neat mechanism because it reinforces the mechanism that we use for our sales teams, our application engineering teams to have that conversation with all aspects of the customer.

Bill Porter

Your question is a good one. The salesforce works closely because they can assist the customer to utilize that technology faster. I think that's the one experience that we have now seen over the two years that we have slowly introduced and then got acceptance of using these cards is that customers are actually utilizing the technology, as I mentioned, 47% faster. So it allows the salesforce to work with them to get that new technology into those customers and to have additional selling opportunities and essentially grow our run rate.

Operator

Your next question comes from Sterling Auty - JP Morgan.

Sterling Auty - JP Morgan

I want to dig deeper into these EDA cards. If they're a term structure, that means they're locking into a specific product and a specific version that they can actually take down. That's correct, right?

Bill Porter

Sterling, they actually have a choice, so we offer both. With the ones that we have seen them adopting the fastest is the term-type card. That's correct. So it is locked in to a fixed price book.

Sterling Auty - JP Morgan

But you talked about that you've been able to give the customers the flexibility. What do you mean by giving them the flexibility then?

Mike Fister

What I mentioned, what they can do is they can draw the technology down faster. They pay more money to do that. It allows them to match a short-term capacity with a demand that they might have. They're basically making a trade-off of whether they have a long-term commitment or not. To me it's a little bit like renting a car. If you know you're going to have a car for a year you might do something different than if you're going to rent it by the week. You pay more to rent it by the week. You know, that works out really good for you when that's all the need you have.

Some of this is a little bit of the tension or the nominal conversation you have between the users of the technology and maybe even the purchasers of the technology. This is a real good, objective way to be able to have that discussion without constraining the access. The things have a fixed duration so they expire and in that respect they are really no different than a regular contract. So it is use it or lose it, and it works out good.

Bill Porter

Let me give you another example, Sterling, because it may help. Say a traditional contract the customer would license ten seats for three years. They would have those ten seats, they would use them for three years. If they get a card, they can start off with ten seats and then as they see a project need, they can increase that and start going to say 15 or 20 seats and generate more capacity and burn through those seats faster. Say at the end of two years, they have burned through that technology, used it when they needed it and now are coming back for some additional technology.

So that's a way that customers can utilize the technology faster to meet their needs.

Sterling Auty - JP Morgan

I guess I'm still a little bit confused. Are you saying that out of the ten seats per year and you're using up the number of chips that you've got and then you come back and purchase more versus if it's subscription you subscribe for ten seats you can only use ten seats at a time over the three years?

Bill Porter

Generally, yes. In my example, if they only had a contract that allowed them to get ten seats, that what their capacity would be.

Mike Fister

Another way to thing about it, this is a good way to have a different discussion about remix, historically people would have gone and tried to have an endless debate on an infinite amount of remix opportunity. Now you take that discussion out of play because people can buy the technology they want for a spontaneous demand. The design is nichy that way. You get going along the thing and you get close to a tape out and you decide you need a bunch of more licenses for some element, say seasonal integrity analysis. Historically, you might have been ultimately constrained so you say to the engineers work harder or fail. This gives them a very easy way to go and blip that technology up without having that debate and pay a little bit more for the pleasure or the privilege of being able to do that. We both are happy and off you go.

Sterling Auty - JP Morgan

What is the collection structure in terms of the payment under a term-based EDA card?

Bill Porter

The payment structures are very much like a traditional term contract, and of course, we incent the field to try to get more cash up front and we are continuing to look to do more of that. But essentially, it is payment over time or with incentives for our salesforce, as you know, they get commissioned when we get the cash, to more and more get that up front. But we allow both.

Sterling Auty - JP Morgan

But with a jump in DSOs, are you seeing that most of the customers are choosing to pay annually over three years or what is the experience that you're seeing with these?

Bill Porter

Well, I think the experience is about the same that we see with normal term contracts. I don't think we've seen anything significantly different so far.

Sterling Auty - JP Morgan

We saw that there's a jump up in long-term deferred. Can you give us a little bit more color there?

Bill Porter

I think as I've described in the past, that's just our ability in some cases to get cash ahead of when revenue is recognized. When you have increases in either short-term or long-term deferred, that's just about getting some of that cash before the revenue is recognized. I wouldn't try to make it much more, other than that.

Sterling Auty - JP Morgan

Mike, I am curious what you are seeing out there in the marketplace. It would seem to me that 2005/2006 you guys had a field day, I think, taking market share away from Mentor in the emulation space. I think now that the [Deloche] has been out there for a number of quarters, it seems to be gaining traction within the old, existing Mentor accounts. Are you finding that it's harder to win some of those accounts now?

Mike Fister

That's a good observation. Anybody will first try to farm their installed base and that was one of the reasons why I put in the prepared comments some of the momentum that we have around our emulator families. It is not just a one-hit wonder with us, we've got some great products across the acceleration, all the way up through the emulation.

We have a targeted program to go back and upgrade our base and are doing very well. We have seen some competitive momentum in market segment share shift as well, but it has not been totally the focus. I mean, we've got the next generation Palladium coming to debut next year. We've got a very nice potpourri of systems all the way from acceleration up through Palladium 3 and then the anticipation coming of the unified architecture.

So I like our progress. I don't think that we've lost anything that we didn't expect. We've been very targeted and the real value in the emulation for us isn't just in the functional logic simulation. It's in the software/hardware coverification. That's why I think that testimonial that I rattled off was indicative.

That is the strength of our total verification approach and story, aided with emulation as a neat piece of it. I think we have the most comprehensive offering and strategies that way and the stuff that we're doing with some of these leading edge customers reinforces that as a component of growth for our emulation capability.

Bill Porter

Sterling, I would just add that we are continuing to grow that piece of the business. It is growing for us year-over-year in both existing and new accounts.

Operator

Your next question comes from Benjamin Pappas – D.A. Davidson.

Benjamin Pappas – D.A. Davidson

You mentioned the relationship with NXP is expanding. Is it fair to assume then that the overall revenue run rate will increase on an annual basis?

Bill Porter

I did mention that I think as our relationship expanded, I do expect that we will, over time, increase our run rate as we deliver new capabilities to the customer.

Benjamin Pappas – D.A. Davidson

Fair enough. In the past, I know you used to mention percent of new bookings booked at subscription. Do you have that number again?

Bill Porter

I think what you're referring to is what I talked a little earlier about in terms of the percentage of our business that's ratable and in Q3, it was 50%.

Operator

This concludes our conference call for today. Thank you for participating on the Cadence third quarter 2007 earnings conference call.

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Source: Cadence Design Systems Q3 2007 Earnings Call Transcript
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