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Synopsys Inc. (NASDAQ:SNPS)

F4Q07 Earnings Call

December 6, 2007 5:00 pm ET

Executives

Lisa Ewbank - IR

Aart De Geus - Chairman of the Board, Chief ExecutiveOfficer

Brian Beattie, Chief Financial Officer

Analysts

Analyst for Harlan Sur - Morgan Stanley

Raj Seth - Cowen & Co.

Terence Whalen - Citi Investment Research

Jay Vleeschhouwer - Merrill Lynch

Matt Petkun – DA Davidson

Rich Valera - Needham

Sterling Auty - JP Morgan

Operator

Ladies and gentlemen, thank you for standing by and welcometo the Synopsys Inc. earnings conference call for the fourth quarter and fiscalyear 2007. (Operator Instructions) Atthis time, I would like to turn the conference over to Lisa Ewbank, VicePresident of Investor Relations. Please go ahead.

Lisa Ewbank

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 may make forecasts, targetsand other forward-looking statements regarding the company and its financialresults. While these statements represent our best current judgment aboutfuture results and performance as of today, the company's actual results andperformance are subject to significant risks and uncertainties that could causeactual results to differ materially from those that may be projected.

In addition to any risks that we highlight during this call,important factors that may affect our future results are described in our annualreport on Form 10-K for fiscal 2006; our recent quarterly report on Form 10-Q;and in our earnings release for the fourth quarter and full year issued earliertoday.

In addition, all financial information to be discussed onthis conference call, as well as the reconciliation of the non-GAAP financialmeasures to their most directly comparable GAAP financial measures, can befound in our fourth quarter and full year earnings release and financialsupplement. All of these items are currently available on our website at www.Synopsys.com.

With that, I will turn the call over to Aart de Geus.

Aart De Geus

Good afternoon. I'm happy to report a strong Q4, a strongfiscal '07, and a strong outlook for 2008. Three realities account for our excellent results and confidence in ouroutlook:

First, exceptional financial execution and visibility.

Second, impressive technology strength and a substantialpipeline of new products and capabilities for 2008.

Third, the favorable customer landscape for Synopsys, withincreased commitments to our comprehensive solutions.

Let me begin with our financial results. In Q4 and fiscal2007 we achieved the highest level of business in Synopsys history. We eithermet or exceeded all of our goals in terms of strong revenue and earnings growth;a substantial increase in ops margin; and excellent cash flow.

Specifically, we delivered non-GAAP earnings per share of$0.40 for the quarter and $1.37 for the year, substantially above the target communicated at the beginning of FY07.

With Q4 revenues of $315 million, we grew our business 11%for the year to more than $1.2 billion, also above our target. We delivered thatrevenue while adhering to our uniquely predictable business model with over 90%time-based licenses.

Through disciplined expense control and a focus onefficiency, we improved ops margin over last year from 14% to 20%; again, aheadof our targets. We grew our backlog to $2.5 billion, cementing our confidencein the outlook for '08 with over 80% of revenue in hand for the coming year;over 90% for the coming quarter; and already substantial visibility into 2009and 2010.

Based on our results, our outstanding backlog and ourpromising technology pipeline, we expect strong results for 2008 as well. In'08 we expect to grow revenue 7.5% to 8.5% while rigorously adhering to ourratable business model. We plan to expand operating margin an additional 300basis points to 23%, and we expect very solid earnings growth.

Let's take a look at the context in which we offer thisguidance. In spite of the turmoil in the financial markets, our customer'senvironments remained relatively steady. The consumer segment continues todrive growth in unit volume and the quest for more functionality is far fromover.

Differentiation through design is increasingly mission critical,boding well for EDA and for Synopsys in particular. Our best users are rapidlyadopting 65 and 45 nanometer silicon nodes, with 65 nanometer becoming muchmore broadly used and 45 nanometer tape-outs accelerating. At the same time,mainstream users wring more capabilities out of mature and cost effective 90,130, and even 180 nanometer nodes.

From a design perspective, three drivers clearly stand out.The rates for more functions on chips; low power end yield and the mostencompassing technical challenges, and productivity and predictability ofschedules as the top execution concerns. With our comprehensive technologyfoundation, Synopsis is uniquely positioned to meet these needs.

One especially notable growth element for us this year wasthe substantial increase in our territory business. These are start-ups to mid-sizedcompanies served by a local geographic team. As you recall, about a year ago weinstituted a strategy to better address this user segment by:

(a) providing a combination of easy to adopt solutionsincluding tools, IP, and services;

(b) introducing new products targeted at their specificneeds; and

(c) increasing our marketing and sales focus to betterunderstand and penetrate the segment.

The results so far are extremely encouraging. With furthertuning, we are poised to accelerate our progress with these customers in 2008.

From a business perspective, every product group came insignificantly over plan for both the quarter and the full year. In core EDA, which grew 9% for the year, wehad many successes. In physical implementation, IC Compiler continues to serveas the mainstay for the most advanced designs in the world.

Our overall transition is right on track. The number of tape-outsis growing massively and IC Compiler is helping to solve some of the mostdifficult technology challenges in the world. In fact, the first ever 45 nanometerconsumer chip in volume production was designed using IC Compiler.

Our synthesis and sign-off tools extended their technologyleads, especially with our unique topographical capabilities resulting in solidnumbers for the year. In verification, both digital and analog mixed-signal itvery well. Digital verificationdelivered outstanding results, substantially outpacing market growth for theyear. In Q3, we executed the ArchPro acquisition, adding a new dimension of lowpower verification to our simulation offering.

On the AMS side, our new XA technology combined the accuracyof SPICE with the speed of FastSPICE. This went into limited availability inSeptember and is already enjoying solid acceptance by customers. In Q4, weexpanded our analog mixed signal verification position by acquiring SandworkDesign, a leader in AMS analysis and debugging products.

Moving on to our design for manufacturing adjacency, wedelivered very good results as well. In Q4, we had several high profilecompetitive wins including a large global semiconductor company who adopted ouroptical proximity correction over its incumbent solution for 45 nanometerproduction.

Complementing our individual product successes, we are rapidlyintegrating the design for manufacturing flow as well. Following on the heels ofour first integration, PrimeYield, in Q4 we completed yet another key piece: thelinking of Odyssey, our yield management solution, with Design [for test].

We hada very strong year in IP and systems as well. We greatly tuned our IPdevelopments and technology coding processes, providing a very responsive and cost-efficientoffering for our customers, while maintaining the high-quality IP they havecome to expect. We demonstrated our design process discipline through our30-day integration of the DDR assets of MOSAID acquired last quarter. In fact,we've already had our first orders for the DDR cores.

Looking forward to 2008, we have a substantial pipeline ofnew products and capabilities with first deliveries on track for this December.Overall, we expect significant new technology advances throughout ourportfolio, focused primarily on speed and productivity.

With run support of parallel processing throughout our digitalflow, from synthesis to physical design through sign-off. Parallel processingenables significant speed improvements by taking advantage of the multipleprocessors now available in compute servers.

In physical design, we are shipping completely integratedfloor-planning capability, two to three times faster performance and brand newunmatched DFM capabilities for 65 nanometer and below. We will take sign off tothe next level, with 2x performance improvements and subtle but significant manufacturingchecks. We plan rapid advances in verification with expanded, low-powercapability and a new solution targeted for the broader market.

In our analog/mixed-signal flow, we will introduce a broadset of parallel processing capabilities as well. But even more importantly, we willintroduce our brand new, custom design solution. This long awaited set ofcapabilities will substantially complete our company product offering andincrease our total addressable market.

In DFM, we also plan to introduce a new tape-out flow. Thisflow intends to significantly speed up turnaround time for fabs by integratingall three lines of DFM -- lithography, TCAD and yield management. We'll alsolaunch the integration of our mask synthesis and mask data press solutions,allowing customers to do both in the time it now takes to do OBC alone. Finally in IP, we will further expand ourproduct line with new, in-house developed products for USB 3.0, wireless USB,DDR, PCI Express 2.0, and SATA.

In conjunction with our support technology pipeline, let metalk about an even more compelling aspect of our corporate strength. Pushed bytechnical and economic challenges, customers are increasingly partnering withus to increase their design differentiation and decrease their costs and schedulerisks. Years ago, we anticipated that customer productivity would be greatlyaffected not only by tool quality but also by the needs for much moreintegrated solutions from concept to volume production.

So we focused on assembling a complete design system,including the links to IP and manufacturing. While every customer has uniqueneeds and its own transformational timeline, the power of increasedcollaboration has become obvious. This year we made excellent progress withsome of the leading semiconductor companies in the world. Last quarter, wecommunicated that we had moved several important long-term relationships to thenext level of collaboration, including Intel, who selected Synopsys as itsprimary EDA supplier.

Last month, we announced that Renesas, another the world'stop ten semiconductor companies, chose Synopsys as its leading EDA supplier.With Renesas, technology collaboration on design and manufacturing efficiency issupported by increased use of our products and increased run rate.

As mentioned earlier, we also saw particularly positivemovement in the territories. A growing number of the smaller companies areusing Synopsys as the anchor to their design methodology with very goodresults. We believe that the segmentation initiatives towards more mainstream,easy to use products are paying off and we will continue our focus onbroadening our market opportunity.

To conclude, we had an outstanding 2007. We are looking at2008 and beyond with confidence based on three perspectives: a strong abilityto execute financially, supported by a unique business model with excellentbacklog; a comprehensive technology platform with a strong product pipeline;and an expanding set of collaborative and committed customer relationships.

With that, I will turn the call over to Brian Beattie, ourCFO.

Brian Beattie

Thank you, Aart and good afternoon, everyone. In my commentstoday, I will summarize our financial results for the quarter and fiscal yearand provide guidance for 2008. As a reminder, I will be discussing certain GAAPand non-GAAP measures of our financial performance. We have provided areconciliation of our GAAP to non-GAAP results in the press release and thefinancial supplement posted on our website. In my discussions, all of my comparisonswill be year over year unless I specify otherwise.

Synopsys delivered excellent fourth quarter and full fiscalyear results, executing well on many fronts. In fact, our strong performanceand momentum throughout the year enabled us to meet or exceed all of ouroriginal 2007 targets.

As Aart mentioned, Q4 revenues increased 11% to $315.2million and annual revenues also grew 11% to $1.212 billion. Business wasstrong across all product lines and geographies, reflecting the highest orders yearin Synopsys history, with total backlog growing to an industry-leading $2.5billion. This of course includes the benefit of a large Q3 customer agreement.However, even excluding this transaction, business was very robust. Onecustomer accounted for slightly more than 10% of Q4 and fiscal year revenue.

Turning to expenses, Q4 non-GAAP costs and expenses declinedsequentially to $246.2 million as the variable compensation impact of anexcellent Q4 and full year was offset by overall expense control. For the full year,we achieved our total annual expense target of a very modest 3% increase,inclusive of our extra week of spending in Q1.

GAAP expenses were $277.4 million, which included $1.1million of in-process R&D; $12.7 million of amortization of intangibleassets; and $15.3 million of share-based compensation. For the year, GAAPexpenses also increased just 3%.

I'm very pleased with the progress we've made on controllingexpenses. We've outsourced and offshored certain processes, shifted ouremployee base by approximately one-third in lower-cost geographies, and arefocused on streamlining our business processes. Of course, we are not done.

Even as we invest in technology development, including theadvances we'll introduce in 2008, we plan to keep expense growth to about halfof revenue growth to reach our margin expansion targets. In 2008, we'll focuson several expense control initiatives including:

  • Reengineering across our lead to collect process to maximize efficiency.
  • Continued focus on hiring in lower-cost geographies.
  • A reduction in CapEx spending by about 10% as we centralized IT resource management.

As the result of both revenue growth and expense control, Q4non-GAAP operating margin increased to 22% for fiscal 2007 and we exceeded ourmargin commitment by achieving 20% for the full year. We expect non-GAAPoperating margin to increase approximately 300 basis points in 2008 as wecontinue to move towards our next target of mid to high 20s.

Turning now to earnings, GAAP earnings per share were $0.27for the quarter and $0.87 for the year, both up substantially from a year ago.Non-GAAP earnings per share were $0.40 for Q4 and $1.37 for the year, bothrepresenting increases of approximately 80% over the same periods of last year.

Our non-GAAP tax rate was 21.4% for the quarter. Better thanour guidance range, due primarily to geographical business mix and higher thanexpected tax credits. For the year, we reduced our tax rate to 24% from 32%last year through the optimization of our international operations and lastyear's reenactment of the R&D tax credit.

Our revenue visibility remains strong. Upfront revenue was6%, well within our target range of less than 10%. Additionally, the amount ofbacklog that turns into revenue over the next year is already greater than 80%of our 2008 revenue target.

The average length of our renewable customer licensecommitments for the quarter was approximately three years, consistent withhistorical trends. For FY07, it was approximately three-and-a-half years,primarily due to one large, long-term contract. This metric will continue tofluctuate depending on the mix of contract signed, but we believe it shouldremain in the three-year range.

We continue to have the most predictable revenue model inour industry and we believe in all of software. It allows us to focus on thelong-term strength of the business and on growing and deepening our customerrelationships and we believe this is beneficial to our customers and ourshareholders alike.

Now turning to our key cash and balance sheet items. Cashand short-term investments increased $190 million sequentially to $984 milliondue to strong operating cash flow of $173 million. For the year, operating cashflow doubled to $433 million, driven by very solid collections and two paymentsmade by one very large customer.

Capital expenditures were $8 million in the quarter and $45million for the year, down 8% from last year.

Now as you know from our previous disclosures, we have beeninvolved in a material tax dispute with the IRS for the years 2000 and 2001associated with the establishment of our Irish subsidiary. Today we are happyto report that we have reached a tentative settlement with the appeals divisionthat would resolve this dispute. The settlement is subject to further reviewand approval within the government, which we will expect to take several moremonths, but as of today, we believe that settlement is likely. We reiteratethat if the settlement becomes final, we are adequately reserved for this item.

Now while this discussion was ongoing, we repurchasedapproximately 0.5 million shares of our stock in the quarter for 11 million.For the full fiscal year, we spent $152 million repurchasing approximately 5.7million shares, buying back approximately 60% more shares than we grantedduring the year. We considered Q4 buyback activity an anomaly and expect toreturn to our more aggressive pattern of buybacks, subject of course to ourongoing review of uses of cash. We have $430 million remaining on our currentauthorization.

In Q4, net accounts receivable totaled $124 million and DSOsdeclined 25 days sequentially to an industry-leading 36 days, reflecting the highquality of our accounts receivable portfolio and the timing of invoices.Deferred revenue at the end of the quarter was $643 million.

At the end of the year, we had approximately 5,200employees, a slight sequential increase due to our recent acquisitions. Now letme address our first quarter and fiscal 2008 guidance and then provide someadditional comments on our expected quarterly profile throughout the year.

For the first quarter of FY08, our targets are:

  • Revenue between $308 million and $316 million.
  • Total GAAP costs and expenses between $262 million and $278 million, which includes approximately $17 million of share-based compensation expense.
  • Total non-GAAP costs and expenses between $236 million and $246 million.
  • Other income and expense between $3 million and $6 million.
  • A non-GAAP tax rate between 27% and 28%.
  • Outstanding shares between 146 million and 151 million.
  • GAAP earnings of $0.20 to $0.28 per share and non-GAAP earnings of $0.37 to $0.39 per share.
  • We expect greater than 90% of the quarter's revenue to come from backlog.

For fiscal 2008:

  • We expect revenue between $1.3 billion and $1.315 billion, a growth rate of approximately 7.5% to 8.5%. We plan to limit total non-GAAP expense growth to about half of revenue growth.
  • A non-GAAP tax rate of between 27% and 28%, which does not assume renewal of the R&D tax credit.
  • Outstanding shares between 146 million and 151 million.
  • GAAP earnings per share of between $0.94 and $1.11, which includes the impact of approximately $73 million in share-based compensation expense.
  • Non-GAAP earnings per share of $1.54 to $1.60.
  • Cash flow from operations of greater than $325 million.
  • We are targeting a 23% non-GAAP operating margin for the full year.

In addition, we are repeating our commitments to achieve ournext non-GAAP operating margin in the mid to high 20s over the next severalyears. We plan to get there by making the appropriate level of investment backto the business to drive sustainable, long-term growth while at the same timecontrolling expenses.

Finally, let me provide some comments on our 2008 expenseprofile to help you as you model your quarterly estimates. While revenue wasquite predictable, the timing of expenses is more variable. As a result, weexpect Q1 expenses to be lower than the rest of the year, reflectinganticipated timing of deals.

For the balance of the year, we expect the expense profileto be more typical with Q2 and Q3 moderately below a traditional higher Q4.

In summary, we are very pleased with our exceptional fourthquarter and fiscal 2007 results. We leave 2007 in excellent financial condition.Our balance sheet has never been stronger. Our commitment to revenue growth andmargin improvement is unwavering and we look forward to another year of solidbusiness execution in 2008.

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

Question-and-AnswerSession

Operator

Your first question comes from Harlan Sur - Morgan Stanley.

Analyst for HarlanSur - Morgan Stanley

In regard to the demand environment, I think the last couple of weeks or so therehas been some concern about customer sentiment in terms of their spend on EDAtools. Could you give a little bit more color on that, if you’re seeing anykind of slowdown? Thank you.

Aart De Geus

Sure. We are not seeing any slowdown. Obviously with all thenoise in the financial market, there are a lot of questions of what are theimpacts of that on our market? First Iwould observe that there has been very little impact on the technology market,maybe with the exception of some software in the financial circles.

But having recently talked to about 20 CEOs in a room aboutwhat they were seeing, not a single one of the technologies saw any realslowdown and everybody else is reading the newspapers as well. I don’t want to say that we won’t be affectedby it, but only as far as what Synopsys can see we, I think, are doing verywell.

Operator

Your next question comes from Raj Seth - Cowen & Co.

Raj Seth - Cowen& Co.

Brian, can you talk a little bit about what your strategy iswith regard to buybacks? I know, I probably harped on this too much in the past,but you have now got $1 billion on the balance sheet and you are guiding for $300million more in cash from operations. How do you think about buybacks? Iacknowledge the comment you made about Q4, but how should we think about thepace of buybacks going forward at these kinds of price levels?

Brian Beattie

We always look at our cash balances and looking at the appropriatelevel of where we invest, whether that is internal growth, M&A or stockbuybacks. We’ve generated a very good amount of buyback activity this year with$152 million and we bought back 5.7 million shares and did pretty well for thefull year, but we were a little slower in the fourth quarter. Obviously whilewe’re negotiating that very significant IRS settlement we felt we shouldn’t bein the market; as a result of that weindicated we would be back to our more aggressive pattern now that we’ve madethis announcement relative to the IRS settlement.

We see it as an important part, but again, we will alwaysbalance between the appropriate uses of that cash and do the appropriate levelsgoing forward.

Raj Seth - Cowen& Co.

Brian, with this level of cash sort of $1 billion againgoing to $1.3 billion, how much do you need to run this business? There is nota lot out there that is sizeable for you to buy. What are you waiting for, is thequestion?

Brian Beattie

Well, we do continue to look and clearly in this financialenvironment having close to $1 billion in cash is very, very strong and allowsus a lot of dry gun powder to put our strategy into effect without having todepend on the external credit markets. Ireally believe that we are at the strongest financial position we’ve been onour balance sheet.

All that being said, we have been very aggressive and in manyyears buying back twice as many shares as we grant and we continue to look atthat as a pretty good use of cash, but you always have to balance that withexternal opportunities that we really focus on.

Raj Seth - Cowen& Co.

Aart, you mentioned that you have a lot of technology comingin ’08 and you touched on a custom flow. Can you talk a little bit more aboutthe strategy there? Do you go heads-up against Virtuoso or how should we thinkabout what you have coming?

Aart De Geus

Obviously the custom implementation side has always been --or for a long time been the singular hole in our product offering. Being able tofill that is really a fantastic step forward because it completes theinstruments needed for broader strategy.

Having said that, obviously there is at least one very, verystrong player on the market and frontal attacks are never wise. I would like tohighlight the fact that on the analog mixed signal side, on the custom sidefrom a verification point of view, Synopsys actually is very, very strong. Sofrom that perspective, we can clearly roll out the new product in conjunctionwith the position that we already have. I think it will be going quite well forus.

Raj Seth - Cowen& Co.

Is this something we should expect in the first half?

Aart De Geus

We are a little reticent to give more detail here, giventhat typically we announce these type of products mainly aimed at ourcustomers. So you will certainly hear more about it in the first half.

Operator

Your next question comes from Terence Whalen - CitiInvestment Research.

Terence Whalen - CitiInvestment Research

My first question relates to some of the larger accountconsolidations that you have had recently with Intel in the third quarter,Renesas in the fourth. I think you mentioned one other. It appears based onyour expense guidance that we are not expecting another one in the firstquarter but we could have others in fiscal ‘08.

Can you rewind a couple of quarters and explain why theseconsolidations have begun to occur? What are the factors that are reallydriving the wins? It seems like the acceleration in your business in regard toaccount consolidations has occurred while it has dropped off in some of yourcompetitors.

I was wondering if you could make observations and commenton that?

Aart De Geus

My first observation is account consolidation is somethingthat happens gradually, over time, but is invariably driven by two things: technologyneeds and economic needs; invariably,the two play well together.

On the technology side, we have said for a while thatcomplexity is growing much more rapidly than Moore’s Law, because when you do achip design it’s not only having many more transistors, if the interactionbetween power and timing and signal integrity and yield all play togethermaking it much more difficult for people to solve things. Therefore, anincreasingly integrated solution has a much, much better chance of getting goodchips in a predictable time flow.

On the economic side, you have clearly seen that there hasbeen a massive change in the semiconductor industry in terms of theirinvestments as playing for the next technology node development has become veryexpensive, and therefore either you see consortia or you see people deciding toteam up with foundries. Economics are starting to play a big role in looking athow people move forward.

That brings me to the third point which is I think ourstrength. We have seen this coming for a number of years, we have prepared forit by having a complete design flow that is state of the art that takes into accountall of these solutions; is well connected to the IP flow; it is well connectedto the DFM realities and when we are talking about collaboration, it isactually bringing it about with customers, helping them in the transition andhelping them essentially improve their ROI both very quickly in the short term,but also substantially in long term. That is what will drive the selection ofpreferred vendors.

Terence Whalen - CitiInvestment Research

If I could touch on the recapitalization issue that wasspoken about previous to my question, you have $1 billion cash. You are generatingover $300 million. Also, you are now in the third or fourth year of this steadythree-year model. So clearly, you have tested the model change out, have madeobservations, are more mature into this. You’re growing at a consistent rate.

What’s your thought not only on returning the cash withbuyback, but also on a dividend potentially, given that you can generate a 4% yieldwith less than 50% of your free cash flow each year? Thanks.

Brian Beattie

Terence, as I was saying in the previous response, we will lookat all of the alternatives, recognizing how we can leverage our cost of capitalto a higher return going forward. To this point, our buyback and our return toshareholders has been very aggressive, basically about twice as many shares wegrant each year to improve the EPS and have a very solid contribution to bothEPS and obviously to the price of the stock.

In addition, we are generating a significant amount of cashand continue to focus on that as we go forward with good collections from ourcustomers, a very solid DSO metric on those receivables and obviously thequality of the product is working well and customers are paying on time; Ithink reflective of very good relationships that way.

Then we do look at where we can use that cash. I believe at this point relative to dividends,most technology companies that are continuing to grow and pushing the levels weare looking at are not really focused on just returning to the shareholders butleveraging that capital into higher returns than our cost to capital into ourmarkets, into the adjacencies of our IP, DSM businesses and other areas that wecan continue to drive synergies in operations revenues and our products thatwill ultimately return a far greater amount to our shareholders than simply adividend.

Operator

Your next question comes from Jay Vleeschhouwer - MerrillLynch.

Jay Vleeschhouwer -Merrill Lynch

Aart, I would like to ask about some of the assumptionsbehind the ‘08 outlook, starting first with your geographic perspective. Youhad a good year-over-year comparison in Asia Pacific outside of Japan;that’s been the fastest growing market regionally for EDA for many, many years.The question is, would you expect to be able to maintain a disproportionategrowth in Asia Pac?

In addition, you referred to some of the structural changesthat have occurred in the semiconductor market. How do you see thatspecifically within Europe and Japan,which have already been both concentrated regions anyway in terms of a relativelysmall number of large customers?

Aart De Geus

That’s a lot of questions, Jay, because what you’re reallylooking at is the question of how does the overall global semiconductorindustry develop over time? I share the perspective that Asia Pac has grownrapidly and will continue to grow rapidly. At the same time, when I look at theworldwide revenue distribution by region for the last three years, I do seechange but the change is relatively minor. The reason for that is becauseutilization is going up rapidly in Asia Pac, but there are a number of globalcompanies where the buying patterns may still be centralized at their headquarters,which typically for the large companies tend to be the U.S. The revenue itself is an interesting but notquite sufficient indicator of what’s happening in practice in the field.

Secondly, you asked specifically about regions such as Europeand others. We do see that there are changes there as well. As you know FC, NXPand Infineon all three essentially have gone towards the path that I would say isfab light, not fabless. What we are also seeing is an increased number of startups in Europe and specifically in Israel.And so these things sort of come a little bit in waves, and I think we bothmore sensitized and much better equipped to deal with them with having now a muchbroader product portfolio.

Overall, I think it is sort of a pathway towards a morecomplete solution, where the solution includes the words “be prepared to serveglobally”.

Jay Vleeschhouwer -Merrill Lynch

In terms of some other metrics that you are thinking aboutfor ‘08, do you expect to be able to continue to drive higher run rates withmany, if not most, of your customers? Do you think your run rate expansiontrack record in ‘08 can be what you’ve seen in the last year or more,particularly since you’ve been trying to measure and compensate on run ratesmore than you have in the past?

Aart De Geus

That is definitely the plan. It has to be the plan becausenotwithstanding the fact that we do see new start-ups, the reality is that thevast majority of the revenue always will come from companies that are well-established.Therefore, we need to increase our footprint going forward.

You are also alluding to the fact that our compensation hasbecome more induced by looking at run rate growth and that actually has beenquite effective. One needs to be careful to not go overboard there, but at thesame time I think we have seen very good progress in being able to articulatemore value.

Lastly, because the solution will be complete as we deliverthe custom capabilities, we can now really leverage our position into both theadjacencies and specifically the new business in IP has been very, very strongand I think will increase substantially in the coming year again.

Jay Vleeschhouwer -Merrill Lynch

Just a couple more. On your installed base, other than ICCompiler, for which products, if any over the last year or so have you seen themost significant increases in the base in terms of the number of licenses? Ifthere is some way you can measure that as a capacity indicator; or conversely,have there been any products where the installed base of usage might have beenin decline, notwithstanding the general trend in run rates overall?

Aart De Geus

The set of tools where we have seen an increased base isactually quite substantial. Clearly, the leads are in the verification side,VCF; we have also had growth in the things that touch the lithography, and thatis directly linked to just the amount of work that has to be done there.

Interestingly, Design Compiler has done very well, thetopographical capabilities are really helping substantially in increasing thepredictability of design. You mentionedIC Compiler has now surpassed Astro and you may recall that a number of yearsago we predicted that we would be on a good ramp, and we are on a good ramp.

Now these products tend to pull with them others, but Ithink I mentioned some of the key anchor points.

Jay Vleeschhouwer -Merrill Lynch

Brian, you or Aart referred to the strength in yourterritorials business. Does that necessarily correlate to marginal increases inyour upfront business? It looked like your upfront business was quite strong inQ4 at around $20 million in sales. Does that correlate to the strength interritorials and would that continue into ’08.

Brian Beattie

No, it really doesn’t relate to the specific regions. Themodel is consistently applied throughout all of the product lines and all ofthe geographies and 6% is our upfront levels relative to the revenue, and it isvery consistent and well within our target range of being less than 10%. Soseeing as we’ve already got more than 90% of 2008 already completed for ourfirst quarter and more than 80% of the year already booked, it really isreflective of a very, very strong ratable business model.

Jay Vleeschhouwer -Merrill Lynch

Thank you.

Operator

Your next question comes from Matt Petkun – DA Davidson.

Matt Petkun – DADavidson

Aart, I might have missed this because I snuck out of theoffice for a second, but could you give the commentary about tape-outs? I thinkon the last call you said you would no longer be discussing 65 nanometer, it isso mainstream now, so I was wondering if you gave that data?

Aart De Geus

Actually, I did not. Let me give it you now. We sort ofcoerced the team to count one more time. So for 65 nanometer, we have a totalactive design number of 551, with a tape-out count of 307. The tape-out countis substantially up from where it was just three months ago.

For 45 nanometer designs, we have a total active design of109 and a tape-out count of 26, also substantially up. This will be the lasttime that we report 65; passing 500 is just too much work to really audit allof this work.

Matt Petkun – DADavidson

Aart, given that metric, I am wondering what you’re thinkingjust in terms of 65-nanometer design activity next year? More specifically,what I’m looking at is new fab construction. Obviously it’s impossible tocompletely correlate what’s going on from a capacity perspective in theindustry relative to the design part of the industry. Still, if you look at thefoundries, a small portion of their revenues today come from 65 nanometers. Doyou think that your opportunity at 65 now is obviously you have a lot of designsthere, but is there still room for growth in IC Compiler for 65 nanometers nextyear or is next year really about 45 nanometer design activity?

Aart De Geus

No, I think there is substantial opportunity for growth of65. As a matter of fact, I think that much of design is going to now migraterapidly to 65 as the mainstream, including for some smaller companies andincluding for many companies that are sort of jumping over the 90-nanometerpoint. Those folks actually do need some handholding, which as you can imagine,we are happy to provide.

Having said that, the most advanced designs are allmigrating to 45 given that there is a natural delay between design andmanufacturing capacity needed. I can say though that having talked recently tosome of the top foundries, they are starting to layer in now more capacity for65 and I think certainly in the second half of ‘08 we will see that happening.

Matt Petkun – DADavidson

Aart, if you could comment a little bit more specifically onwhat’s going on in the design for manufacturing realm, and not just in the capsand the design rule checking part of the business for you, but more specificallywhat you are seeing in terms of process aware design, what you have beeninvesting in with TCAD and with your HPL acquisition.

Are those going to be assets that you start to really seemonetization in ‘08 or is that really something that needs to be longer term inyour mind?

Aart De Geus

My first observation is those are assets that we areactually making very good money with right now. That doesn’t mean that all ofthe DFM problems are killer problems because our design tools are very capableof proactively avoiding them.

I would say that overall it is becoming now much more urgentand much more important to have strong technology between 65 and 45, and thatwe are now rapidly going to see that the tolerances, the variability, theissues around sizes on these designs compared to the actual size of the designis so large that the DFM connection will become a rapidly strong differentiatorfor our offering.

The very fact that I emphasized a little bit the effortsthat we have put in integrating and aligning all of these capabilities makes ita good indicator of where our future will be, which is to provide a completesolution. As a matter of fact, we see the statistical needs already ramping up.

Matt Petkun – DADavidson

Is a standard subscription model the right revenue model fora world where your tools may be delivering a lot of value to a few number ofchips at 32 nanometers and beyond?

Aart De Geus

That’sa very good question. Let me parse it out into two dimensions. One is the wholedimension of revenue accounting, steady business model, financialpredictability and so on. We are absolutely strong believers that thebusiness model that we are on, that it took us a number of years to get to, isa very good business model because it is the very model that right now allowsus to look into ‘08 and as a matter of fact ‘09 and ’10 with a high degree of confidenceand thus make very proactive judgments as to where we want to invest, how wewant to run our business.

Having said that, the very fact that we are entering theopportunities space of providing much more complete solutions that we have amuch more complete product portfolio, I think gives us an opportunity to nowwork with our customers and look at touching their fab budgets, touching theirIT budgets and rethinking how we should grow our business. But the fact thatgrowth is on our minds should not be a surprise.

Matt Petkun – DADavidson

But, you would hope to tap those fab budgets with licenserevenue or maybe a different model?

Aart De Geus

This is precisely where our creativity and thinking has togo into right now. Given that we are looking at many of these opportunities,let me hold back a little bit as to what we want to do specifically; but havingsaid that, we are clearly looking at ‘08 as a great opportunity year for us tothink through how do we evolve the engagement model with the customer to takeadvantage of the fact that they really need us and we need them to worktogether. That is an opportunity I think to look at how we want to grow ourbusiness going forward.

Operator

Your next question comes from Rich Valera - Needham.

Rich Valera - Needham

Brian, I was wondering if you could give us any sense of thesize of your settlements in the IRS issue? I think the original claim againstyou guys was somewhere in the $400 million range. I wonder if you could tell uswhat you currently have reserved on you balance sheet against this and any morecolor in terms of what you actually expect the settlement amount to be?

Brian Beattie

We are not really in a position at this point to disclosethe ultimate settlement because we are not there yet. The normal process isthat once you reach this tentative settlement with the IRS Appeals Divisionthat is then in turn put to a normal review of the Joint Committee on Taxationof the U.S. Congress. So, that’s the one that we are saying it may take severalmore months to have it finally resolved, but we have reiterated that theaccrual that we put in place, the provision for that liability is fullysatisfactory and therefore when we finally receive that signed document in acouple of months we’ll be able to make any adjustments that are required.

So at this point, I am confident it’s going to get approved.The original amount, just to clarify the number of it, is an assessment, a $477million assessment against the company and again reiterating that it is now inour range of the accrual we already made for the company and that will flowthrough when we get the final signature.

Rich Valera - Needham

Can you tell us what that accrual is?

Brian Beattie

Not really. We don’t give out the specifics of each of theaccruals like that and really prefer at this point until it’s signed to releasethat when we get the final signature, because it could move around perhaps andwe just don’t want to send the wrong expectations here. But we are fullyaccrued at the appropriate level and we will keep you posted as we get the finalsettlement signed.

Rich Valera - Needham

Would you expect that number to be in your K?

Brian Beattie

No, until it is signed the rules are officially from anaccounting perspective that until you have the final signed document, you havean ultimate agreement signed, you are not in a position to release any of thoseaccruals and to disclose even the tentative settlement because it’s notfinally, finally signed yet. It just allows us to protect our position going insubject to this final Congressional U.S. Tax Sub Committee to approve that.

Rich Valera - Needham

Aart, just in the SPICE and FastSPICE area you mentioned youhave a product, I think you called it XA,that is relatively new and was seeing good traction. Is this a multithreaded product and essentially in responseto Magma’s FineSim Pro or is there something else coming out on your end that isa multithreaded response to that?

Aart De Geus

No, no. We have had multithreaded capabilities in quite anumber of our tools; this is one of them that takes advantage of that. Actually,it’s a capability that has been in development for quite a while, it wasintroduced – I forget exactly which month, I think maybe September officiallyor so. We have quite a number of users already. Speeding up things in thatdomain is a never-ending quest but we’ve made fantastic progress and thecustomer reception is outstanding.

Rich Valera - Needham

Can you give any sense of if you have had any sort ofcompetitive situations since that tool has been out there? There are some claimson their end of some pretty substantial performance deltas relative to existingtools which presumably were yours. I am just wondering if you have any sense ofhow much that tool has improved relative to the old tool?

Aart De Geus

Well in all of these domains there are constant competitivebattles and you have to really defend your turf or attack on the basis of yourstrength. As a company we are probably on the conservative side in making bold predictions,but fundamentally we’ve done very well and actually have won a number ofaccounts. We feel very good about our technology, but it is a competitiveenvironment and there are multiple players there.

Rich Valera - Needham

Aart, you have observed over the last several years that thelong-term growth rate of the semiconductor industry has been trending downfirst towards low double-digits and it seemed like it is trending towardssingle-digit now. Where do you see the long-term growth rate of semiconductorrevenue? In that context, where do you see the long-term growth rate of EDAgoing forward?

Aart De Geus

If I may just put it slightly differently, I have not been apredictor of the trends going down. I have been arguing that we had a secularchange right after 2001 and that before that the semiconductor market wasessentially living a little bit beyond its means, and so was most of high-tech,by the way. If we look at the actual curve, you see that in ‘01 there was amassive correction on ‘00, and after that of course the market came somewhatback.

Today I would think that the semiconductor market is growingif you want to be broad, between 6% and 9% and of course from year to yearthere will be fluctuations and you can see that the fluctuations are a littlebit less large than they used to be in the ‘90s and ‘80s. I think that’sfundamentally because there is much more capacity available, thereforefluctuations around individual products don’t trigger much supply demand onbalance.

But going forward, I think the market will continue to grow atabout that rate and one of the encouraging signs of course is that no matterwhat happens to the global economy there is no question that electronics andspecifically consumer electronics is going to keep growing massively in terms ofdemand, because they are so many people that are joining the mainstream of buyers.That will continue, in my opinion, for quite a number of years.

Operator

We do have five minutes remaining in the conference. Yournext question comes from Sterling Auty - JP Morgan.

Sterling Auty - JPMorgan

As you look at the margins in 2008, I am curious how much ofthat is being helped by the fact that 2007 was such a big bookings year, do youactually end up getting a little bit of a boost from some of the variable salesexpenses? Where else are you going to get the additional leverage from in 2008for the margin target?

Aart De Geus

Well, there is no question that you always have to slightlyweld a double-edged sword, which is if you do really, really well in bookingsyou have to pay commissions and you have to pay bonuses to everybody, whichcomes out of the expense line. That is never quite an easy dance as we try topredict this. Having said that, I will take higher bookings any day versus nothaving to pay the expenses; that’s obviously clear.

Going forward, you have heard us now talk about operatingmargin improvement for at least two or three years. I do believe that withinthe company we have a much more systematic discipline from an attitude point ofview and processes from a management perspective to keep doing that.

Our intent for ‘08 is to grow 300 basis points and that isreally our top constraint. Our top objective is obviously the top line revenuegrowth and then the longer-term objective is really to make sure that we cansustain growth in ‘09 and ‘10.

Much of our own focus and compensation is to put in place orto have in place an orders process that looks at a multi-year set ofarrangements and I think we have become quite proficient at that.

Sterling Auty - JPMorgan

Given several of the very large contracts that you closedthis past fiscal year, how should we think about the backlog as it migrates throughto 2008? In other words, can you still grow backlog year on year next year, oris it just to tough of a comparison?

Aart De Geus

I think it is a tricky comparison no matter what becauseit’s always a function of a few very, very large deals that when once you getthem obviously backlog goes up and then for the next typically average threeyears, they roll off gradually.

Secondly, the timing of those or indeed the length of thedeals if it is beyond three years would impact that.

Having said that, I think almost more important from yourperspective should be our confidence in coming into a given year with a strongcoverage because that is really what’s giving us the ability to predict theshort and medium term well, thus reducing substantially the financial risk.

Secondly, it allows us to tune carefully how we grow thecompany and take maximum advantage that we have. So obviously growing backlog,whichever it is, be it the three months, the 12 months or the overall backlogis all good. The short-term backlog is really what determines the financialsecurity of the company.

Sterling Auty - JPMorgan

Last question would be on cash collection. On some of thoselarge deals that you did this past fiscal year, how much of that has alreadybeen collected or what were the collection terms? Are they annual over the lifeof the contract? I am just trying to get a sense as to how that will contributeto cash flow in this fiscal year?

Brian Beattie

We factored in obviously to the forecast for ‘08 cash thepayments; receipts are always just about the timing, does it fall into ‘07 or doesit move into 2008? With the performance and focus we had on DSOs coming in at36 days was great. We almost doubled our cash to $433 million in ‘07 and thenour estimates for 2008 take into account that there were two payments from a prettysignificant customer that did come in, were both invoiced and collected in2007. So that obviously doesn’t follow and replicate itself again in 2008. itis all factored into our guidance on cash.

Sterling Auty - JPMorgan

I would assume that is factored into the guidance, so thetwo payments came in early; what’s left? Are all the big collections on the bigcontracts already done, or is there more left?

Brian Beattie

There is clearly more left. That’s what we factored into ourcash forecast for 2008, to be over $325 million of operating cash flow for nextyear, all of those ongoing payments, including annual payments from thesecustomers continue to come in 2008.

Aart De Geus

With that, if you don’t mind, let me close off the call. Wehave passed our one hour allotment. We really appreciate your time, and ofcourse your support over this past year. ‘07 in many, many ways was a very,very strong year but clearly the most important aspect of the strength of ‘07is the confidence it gives us for ‘08.

I hope that we delivered well against your expectations and arelooking forward to a strong ‘08. Thank you very much.

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Source: Synopsys F4Q07 (Qtr End 10/31/07) Earnings Call Transcript

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