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Synopsys Inc. (NASDAQ:SNPS)

F1Q08 (Qtr End 01/31/08) Earnings Call

February 20, 2008 5:00 pm ET

Executives

Lisa Ewbank - VP IR

Aart de Geus - Chairman and CEO

Brian Beattie - CFO

Analysts

Harlan Sur - Morgan Stanley

Raj Seth - Cowen and Company

Jay Vleeschhouwer - Merrill Lynch

Matt Petkun - D.A. Davidson & Company

Rich Valera - Needham & Company

Sterling Auty - JPMorgan

Tim Fox - Deutsche Bank

Operator

Ladies and gentlemen, thank you for standing by. And welcome to the Synopsys Incorporated Earnings Call for first quarter and fiscal year 2008. At this time, all lines are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions)

Today's call will last one hour. Five minutes prior to the end of the call, I'll announce the time remaining on the conference. As a reminder, today's conference is being recorded. At this time, I would like to turn the conference over to Lisa Ewbank, Vice President of Investor Relations. Please go ahead.

Lisa Ewbank

Thank you. 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 discuss forecasts, targets, and other forward-looking statements regarding the company and its financial results. These statements represent our best current judgment about future results and performance as of today.

The company's actual results and performance are subject to significant risks and uncertainties that could cause actual 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 annual report on Form 10-K for fiscal 2007 and in our earnings release for the first quarter, issued earlier today.

In addition, all financial information to be discussed on this conference call, as well as the reconciliation of the non-GAAP financial measures to their most directly comparable GAAP financial measures, can be found in our first quarter earnings release and financial supplement. All of these items are currently available on our website at www.synopsys.com.

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

Aart de Geus

Good afternoon. I'm pleased to report another good quarter for Synopsys. We met our target and are confirming yearly guidance. In Q1, we delivered solid on-track progress towards our continued '08 objective of 7.5 to 8.5 top line growth; 300 basis point of ops margin improvement, rollout of substantial new and enhanced technology and deepening customer relationship through collaboration on viable productivity improvement.

Specifically, this quarter we achieved non-GAAP earnings per share of $0.44, more than 40% year-over-year growth. Revenue came in at $350 million at the high end of our target range. With more than 90% time based license revenue, we stuck firmly to our uniquely predictable business model.

Our disciplined ops margin improvement progressed quite well with Q1 coming in at 25.6%. This puts us solidly on track towards our annual goal of 23%. Finally, we shift major new product releases in December with a large number of key enhancements and new capabilities. Overall, we exit the first quarter with all year solidly on track, in terms of revenue, earnings, cash flow, ops margin and technology.

Before moving to some product highlights, let me characterize the customer environment and how we see little behavioral change. Although the uncertainty in the macro environment may have intensified, it isn't new. And while they have shifted in internal investment decision, they haven't changed the R&D side of the semiconductor market.

For the last few years, volume growth and cost sensitivity have been the driving forces for most of our customers against the backdrop of continued technology complexity. They focused on two things, differentiation for variant markets and productivity improvements for everything out.

Synopsys is very well positioned for exactly the situation. For a number of years, we followed a systematic strategy. First, continue to deliver best-in-class tools across the vast majority of our portfolio and lead in the adoption of new technology notes. Second, build a comprehensive portfolio of core EDA tools. This year, we will be completing that goal with the addition of analog implementation capability. Third, assemble and link these tools into coherent design verification platforms aimed at end-to-end design productivity and predictability.

Fourth, build technical and collaboration links to manufacturing that will assure performance, power and yield. Fifth, build a bridge to the growing space of software and system design to the high quality IP block and virtual prototyping capability. And finally, grow sophisticated global support and service structure to engage customers on the most challenging design. As a number of semiconductor companies now shift some of their internal investments from manufacturing to design, we expect our R&D spending for our solutions to stay healthy.

We also anticipate that customers will continue to streamline the number of vendors they have, and consider a higher level of relationships with select companies such as Synopsys. As a result, we project that EDA will grow and we will gain market share in 2008, all under our very stable business model. With that backdrop, let me provide some product and technology highlights for the quarter.

In core EDA, we made excellent progress both in adoption and use of our software. We also shifted significant enhancement and additions of our Galaxy Design and Discovery Verification Platforms. For example, our Matsushita, the global consumer electronic company behind the Panasonic brand, used our Galaxy Flow, including IC Complier, to design the world's first 45-nanometer consumer chip in production.

Matsushita achieved a smaller die size and just as importantly, lower power consumption using Galaxy. TSMC has notified us that IC Compiler is the first place in our system to be truly qualified for TSMC's 45-nanometer process. During the quarter, we also delivered to customers a major Galaxy Platform upgrade, which includes expanded capabilities in design compilers, fully integrated hierarchical design planning, faster performance in IC Compiler and a significant upgrade of PrimeTime yielding [technical difficulty] performance and lower memory consumption.

Still to come in 2008 will be several other notable advances throughout our portfolio, focused mainly on speed and productivity. These include advances that take our high-end low power solutions to the broader market. Specifically in digital design; in 2008, we will introduce advances such as two-to-three times faster performance and brand new unmatched DFM capabilities for 65-nanometer and below.

In digital verification, we are continuing to grow off an outstanding 2007, when where we greatly expanded our position in this segment of the market. The integration of ArchPro has increased our differentiation in terms of low power solutions. And we plan to introduce additional related capability during the year, specifically aimed at the mainstream market.

In Analog/Mixed-Signal Verification, our new XA Technology, which combines accuracy of SPICE with the speed of FastSPICE is demonstrating very good customer success in its early availability. For example, iC-Haus, which manufactures chips for industrial, automotive and medical application, switched to XA after being able to reduce their simulation time from 6 hours to just minutes, while experiencing superior accuracy.

New product advances to be introduced during the rest of the year will include a broad set of parallel processing capabilities. As mentioned earlier, this year, we'll introduce a Synopsys analog implementation solution. Although we have not yet formally announced the products, I can report that in Q1, we move from alpha to beta test and that the stability of the product has positively surprised our beta partners. This capability will increase Synopsys's pan, but it also removes competitive challenge as we complete our core EDA portfolio.

Let me move on to design from manufacturing an emerging market segment still in its early stages. As you have heard from my earlier comments, we consider our links into manufacturing unique and essential in helping customers achieve their yield goals. Our strategy is to take full advantage of both the growth potential of this segment and the differentiation it confers to our core EDA offering.

In Q1, we delivered the first phase of a new integrated mask synthesis and mask data prep solution, which dramatically reduces lithography turnaround time. Developed in collaboration with TSMC, this so called PCX capability has already been successfully tested at TSMC.

Looking forward, we are also working on a new tape outflow that significantly speeds turnaround time for fabs by integrating Lithography, TCAT and Yield Management. Looking up to the system side of the design spectrum, we have made excellent progress there as well increasingly customers are realizing the economic benefits of commercial IP reuse versus building all blocks themselves.

Excluding memory companies 17 of our top 20 customers now buying our IP. This quarter, we entered the most advanced end of the IP market with our first 45 nanometer analog mixed-signal customer. In addition, our newly acquired DDR products are doing very well. In these fast growing standards, we have already seen excellent customer interest and purchases.

Our pipeline through the year features new in-house developed products for virtually all titles from USB, PCI Express, SATA and DDR. Our other thrust in the systems area, virtual platforms is also doing well. Virtual platforms creates models of hardware long before the chip is actually available, thus enabling software development up to six months earlier than with traditional methods. This quarter for example, a key phone architecture firm purchased our virtual platform solution to accelerate their software development.

Closing off on the product, Q1 saw excellent progress in delivering new performance and capability to our users and we are excited about our robust technology pipeline in 2008. To conclude, Q1 was a very good start to 2008 and we are confident in our ability to deliver strong results throughout the year.

We remain committed to growing our profitability, while adhering to our predictable business model. We had a comprehensive technology platform with a strong product pipeline and we are benefiting from an expanding set of collaborative and committed customer relationships.

With that, I'll turn the call over to Brian Beattie, our CFO.

Brian Beattie

Well, thank you Aart and good afternoon everyone. In my comments today, I'll summarize our financial results for the quarter and provide with you with our guidance. As a reminder, I'll be discussing certain GAAP and non-GAAP measures of our financial performance. We have provided a reconciliation of our GAAP to non-GAAP results in the press release and the financial supplement posted on our website.

In my discussions, all of my comparisons will be year-over-year, unless I specify otherwise. Well we also remind you that last year's Q1 comparable results include an extra physical week of revenues and expenses and events that occurs every seven years.

Synopsys reported another very good quarter demonstrating the strength and predictability of our time-based business model. Q1 financial results were highlighted by solid revenue growth across all products and geographies resulting in substantial operating margin and earnings expansion. Additionally, we repurchased approximately $83 million worth of Synopsys shares during the quarter.

And once again, we showed robust increases across our key revenue and profitability metrics. Total revenue increased 5% to $315.5 million at the high end of our target range, driven by our continued execution against our strategy. Normalizing for the extra week in 2007, revenue grew by 13% one customer accounted for slightly more than 10% of our Q1 revenue.

Turning to expenses, we continue to execute very well. Total non-GAAP expenses decreased 5% to $235 million, primarily due to the extra physical week in the year over quarter that I mentioned earlier. Expenses also came in slightly below our planned target range, driven primarily by some seasonal shifting out of hiring and other employee expenses. For the balance of the year, we expect to return to more typical expense profile with Q2 and Q3 progressing towards the traditionally higher Q4. And we continue to target expense growth at about half a revenue growth for all of 2008.

The net effect of our solid top line growth and excellent delivery in expense management was 25.6% non-GAAP operating margin, a year-over-year increase of nearly 800 basis points. So, we are off to a tremendous start towards achieving our operating margin target of 23% for all of fiscal 2008 and we are committed to drive into the mid to high 20s over the next several years. We try to get there by making the appropriate level of investment back into the business to maintain our technology leadership and to drive sustainable long-term growth, while at the same time controlling expenses.

Turning now to earnings, GAAP earnings per share were $0.31, with costs and expenses totaling $262 million. This included $11.6 million of amortization of intangible assets and $15.6 million of share-based compensation. Non-GAAP earnings per share increased more than 40% to $0.44 in the quarter.

Our non-GAAP tax rate was approximately 25%, below our guidance primarily due to certain one-time tax benefits. For the entire year, we now expect the tax rate between 26% and 27%, which does not assume renewal of the R&D tax credit in the United States.

Given our very predictable business models, revenue visibility remains strong. Upfront revenue was 4% of total revenue, well within our target range of less than 10%. And as expected, greater than 90% of Q1 revenue came from beginning of quarter backlog. We are strong believers that our highly ratable business model is the right financial architecture for Synopsys and our customers.

We put ourselves in the unique position of looking not only at 2008, but also into 2009 and 2010 with confidence. This will allow us to make a very proactive judgment as to where we want to invest and how we want to run our business and this is a great place to be in any environment. The average length of our renewable customer license commitments for the quarter was again, approximately three years.

Now turning to our cash and balance sheet items. Cash and short-term investments increased $181 million year-over-year to $860 million and as expected there was an operating cash outflow of $51 million in the quarter. Operating cash was affected by a recent agreement with an existing large customer that resulted in the shift of their annual payments from the first to the third quarter along with the timing of our seasonal incentive compensation cycles. We are confident that we'll achieve our fiscal 2008 operating cash flow target of greater than $325 million.

Capital expenditures were $10 million in the quarter and we expect to reduce annual CapEx by about 10% over last year. We returned to a more aggressive pattern of buybacks this quarter. We purchased 3.4 million shares of Synopsys stock for $83 million and we have $347 million remaining on our current authorization.

Q1 net accounts receivable totaled $142 million and we maintain industry leading DSOs of 41 days reflecting the high quality of our AR portfolio and the timing of invoices. As you know, we do not factor our receivables. Deferred revenue at the end of the quarter was $609 million. We ended Q1 with approximately 5,200 employees basically flat to our fourth quarter headcount.

And now addressing our guidance. For the second quarter of FY08, our targets are revenue between $317 million and $325 million. Total GAAP cost and expenses between $269 million and $283 million, which includes approximately $17 million of share based compensation expense.

Total non-GAAP cost and expenses between $242 million and $252 million. Other income and expense between $0 and $4 million, a non-GAAP tax rate between 26% and 27%, outstanding shares between $145 million and $150 million. GAAP earnings of $0.22 to $0.26 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.

Now our fiscal 2008 outlook. We reiterate that 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 between 26% and 27%. Outstanding shares between $145 million and $150 million. GAAP earnings per share between $1.03 and $1.12, which includes the impact of approximately $66 million in share based compensation expense and non-GAAP earnings per share of $1.56 to $1.61.

We have increased the low end of our guidance range by $0.02 and then top end by $0.01 as a benefit from a lower tax rate is offset by slightly lower other income and expense items due to interest rate declines. Cash flow from operations is greater than $325 million. And as I mentioned earlier we are targeting a 23% non-GAAP operating margin for the full year.

In summary, we are very pleased with our Q1 financial performance. We continue to execute against our strategy while delivering strong growth and profitability and hope to continue that momentum throughout 2008.

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

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from the line of Harlan Sur with Morgan Stanley. Please go ahead.

Harlan Sur - Morgan Stanley

Thank you and good afternoon and nice execution on the quarter. Aart I think you probably expected this question. But one of your major competitors did cite weakness at the very end of their December quarter. I guess the question to you is did the team at Synopsys see any significant changes in terms of new closure rates or aggressive pricing negotiations at the end of your January quarter, relative to prior quarters and as the customer pipeline in the first half of this year changed relative to your view of that let say three months even six months ago?

Aart de Geus

The answer is no and no and obviously we make sure that check with our sales force to see if there was any change in both the pipeline or how we execute it and the answer was no in both cases. Now, we read the newspapers as well and we can see that everybody is reading a lot of newspapers, but as for as it pertains to our domain. I don't expect actually very big changes because a number of our customers already shifting their investment for manufacturing into design. They have to differentiate in design, EDA is absolutely central to that and if you have strong technology that can help them with that, I think here in a good position and we are that.

Harlan Sur - Morgan Stanley

And to follow-up on that, there has been a lot of reference recently to semiconductor R&D spending trends in '08 not by you, but by others and I think it is getting more difficult to use R&D as a proxy for EDA tool spend given the moves by the IDMs to more sounds like business model, but I think what everyone is trying to get at, is what is the level of design activity and product development by your customers and is that slowing relative to what you saw in 2007 or is that actually accelerating here in '08?

Aart de Geus

First, I agree with your observation. There are so many moving parts right now that, a number of people have a tough time figuring out where this all lead. Let me start first with the designs. We do not see any major change in design starts period. We said all along that we see two phenomena. One is that the number of silicon nodes that stay alive has been growing, meaning that some of the older nodes are being pushed harder for performance in order to take advantage of the costs.

On the other side of the spectrum, the most advanced node continue to be designed in at a feverish pace, and we are now seeing the move to 45 and even 32 being very, very active with the most advanced designers. So, from that perspective I think that the spending with the tools will continue.

Harlan Sur - Morgan Stanley

Okay, great. One last question, from me just a longer-term question. So, you talked a lot about your penetration and your competitiveness on litho-related tools and mask data prep and, so as we think about the 32-nanometer node and the move to double-patterning by your customers. Do you think is going to drive faster growth for your litho solutions?

Aart de Geus

I'd say yes, and no. Yes, definitely in the sense that the complexity of what needs to be done there just demands more compute power and more capability. I am a little careful with just jumping to the conclusion that every node drives more volume, partially because those people live with budget too and they don't change all that rapidly. But in general the most advanced technologies are to our advantage because that sort of where we as a company live.

Harlan Sur - Morgan Stanley

Okay. One last question for Brian, I noticed you're not giving us the same level of transparency on the product revenue segmentation, you no longer breaking out implementation and verification segments, any reasons for that?

Brian Beattie

Well, we I think we're telegraphing our metrics that we're going to continue to disclose to everybody in. We saw a trend over the last few years it's just more and more sales as the pool of core EDA tools. So, there will be a budget set aside there would be performance expectations and achieving that through both our verification and our upfront tools are the focus. So, it's really selling as a pool and therefore we put them there in that set that's how we're representing it.

Harlan Sur - Morgan Stanley

Okay, thank you.

Brian Beattie

They both did really well in the quarter though as a composite of the business tool.

Harlan Sur - Morgan Stanley

Okay, great. Thank you very much.

Operator

And our next question comes from the line of Raj Seth, Cowen and Company. Please go ahead.

Raj Seth - Cowen and Company

Hi, thank you. Just a follow-up a little bit on the previous question. If hypothetically what I heard was targets haven't changed, you haven't seen any big shift in pricing etcetera. But if hypothetically booking started to weaken how do you think about managing the business? Are you -- I think you once told me that you had a hard line around operating margin targets and everything else was variable?

Are you still thinking about the business that way if you saw in subsequent quarter's weakness in bookings, which wouldn't appear in revenues for a while? Would you begin to take early action to preserve margins and expenses, how do you think that?

Brian Beattie

Sure. Well, let me first remove the anxiety around the, if. We did not see bookings weaken. But as a matter of fact I think that I'd be reluctant to communicate to you that we had a strong quarter if under the covers we felt very differently. Having said that, if we did see any change I think that we'd pay a great deal of attention at the bottom line.

But we're doing that no matter what. And so that's becomes only part of how we manage the company and maybe the best way to put that in numbers is to say, hey, we don't want to grow the expenses at more than about half of the revenue. And so, if revenue overtime were to become weaker we'd definitely pay even more attention to the expenses.

Raj Seth - Cowen and Company

Great thank you that's helpful. And just a quick one for Brian, any update on the tax settlement you talked about last quarter sort of what the amount is etcetera?

Brian Beattie

Yeah. The progress we've made is that the tentative settlement with the IRS has moved to Joint Committee of U.S. Congress as we anticipated. And relative to what the timing of getting that final sign-off it typically takes several months to get approved. And so, we've been informed. It's been sent in and it still will be a couple months to -- two to three months probably to get it resolved.

Raj Seth - Cowen and Company

Right, thanks. That's all I have. Nice quarter.

Brian Beattie

Thanks.

Aart de Geus

Thank you.

Operator

And next we've the line of Jay Vleeschhouwer with Merrill Lynch. Please go ahead.

Jay Vleeschhouwer - Merrill Lynch

Thanks. Good afternoon. I'd like to ask a question on the addressable market remaining for digital in particular. Do you have anyway of gauging how much or how many of the design infrastructure and upgrade decisions have been made specifically for 65 and 45 how would you characterize it in terms of remaining available runway for those kinds of decisions and commitments for designing to those nodes?

And then secondly for either you or for Brian in terms of resource commitments and spending, could you go into little bit more detail on how you are portioning R&D specifically how much remaining ongoing spending is being done to complete legacy tool development even any remaining development pertaining to incorporating the Avanti technology I know that's quite a while back, but if there any work still going on there and how much is been a portion to wholly new efforts?

Aart de Geus

Okay. Well, let's talk with the changes to 65 and 45. We have reported to you over time -- sort of the evolution of 90, 65, 45, now 32 and when we talk about those people invariably is probably at a set of about top 20 customers that mean the block of that, because those are the people that move who lay ahead of the pack.

And as a matter of fact, as I mentioned earlier the pack is sort of spreading out. So, at times given that we live so much in the advanced technology, I'm surprised myself when I talk to a customer, who is agonizing about the move from 130 to 90 and thinking how can we help these people because that is by now old technology from our perspective, but it is still very new for them.

And so I think that there is a fairly big mainstream group of people that still needs to move, and will be moving over the coming couple of years because certainly 65-nanometer is very stable now and have a lot of benefits for people that want to add more functionality on their chips.

Regarding the R&D expense allocation, the majority of our products are evolving continually. Is anything left in terms of integration of Avanti and Synopsys interesting, you asked the question because just a few days ago I mentioned to somebody I don't even recall now who is from Avanti and who is from Synopsys. And so in that sense I think that integration is entirely complete, but many of the products that we have are now intersection product that's where most of the investment goes, the rest is just some remedial fixing.

Jay Vleeschhouwer - Merrill Lynch

Okay. Backlog and preferred revenue question, Brian can you elaborate on the sequentially decline of deferred from Q4, which was substantially larger than we saw from fourth quarter to first quarters in the preceding two years was that tied into the cash payment you mentioned earlier that you took in third quarter from Intel in lieu of the current quarter or was there something else going on in terms of replenishing deferred in the current quarter?

Brian Beattie

We wouldn't mentioned customers by name, but yes there was a large contract signed in the third quarter of last year, more deferred revenues increased and then they would decline sequentially until not in the third quarter of 2008 when it would then increase again with the invoicing we take that into the receivables and then work that down throughout the year based on the annual payments. So, you got it exactly right.

Jay Vleeschhouwer - Merrill Lynch

Okay. And then finally do you think you can rebuild backlog or grow backlog for the year as a whole? In other words, will you have a positive book-to-bill for the year as a whole?

Aart de Geus

We don't disclose book-to-bill. We don't disclose our backlog until the end of the year and so we have not changed that. That's all in all we are well on track on the business so that we were thinking to do and just to clarify -- when we look at how we structure our business right now, we put equal weight on the present year revenue as well as on the growth of backlog for the subsequent year and even two years further down, all the way to compensation of the top people being linked to that. And that is largely in order to make sure that we stay on a good growth trajectory, while managing the business in a fashion that has stability and a high degree of transparency.

Jay Vleeschhouwer - Merrill Lynch

Thanks, Aart.

Aart de Geus

You're welcome.

Operator

And our next question comes from the line of Matt Petkun with D.A. Davidson & Company. Please go ahead.

Matt Petkun - D.A. Davidson & Company

Hi, good afternoon. Aart I was wondering given the changing landscape and the fact that it appears that you guys have the upper hand from an equity valuation standpoint as well as the balance sheet standpoint relative to your peers. Would it be reasonable to expect increased M&A activity for you guys this year?

Aart De Geus

Well, as you probably all know we never comment on M&A. We've done M&A in the past and when the opportunity is right, we're certainly always open. At this point and time, I think that the characterization of 2008 is going to be very much a year, where strong technology and good execution makes all the difference because as much as I do not see the financial behavior of our customers change the whole world right now is somewhat nervous about the economic status.

Therefore buyers become discerning. And what that means is, they make sure that the companies they spend their money with will be around for long time, it will be solid and will give them actually the differentiation that they need in these times. And so, from that perspective I think our number one focus has to be absolutely on stellar execution and I guess so far so good.

Matt Petkun - D.A. Davidson & Company

Okay. And then you mentioned the integrated litho product that you're talking about that would include TCAT, Yield Management amongst everything's. Will that be a post DRC product or would you integrate that with what you're doing in DRC as well?

Aart De Geus

It is definitely post DRC. Although it is very clear that increasingly all of these things are becoming gradually more integrated. And you may recall from my preamble that I said sort of a precedent that first you need to have good tools then they need to really start to talk well together and then it becomes more and more of an integrated platform.

But all of these things ultimately are aimed at the same thing which is on one hand, how do you maximize performance and minimize power in other words, the attributes that differentiate a chip. And on the other hand, how do you get the best productivity and predictability out of the whole flow.

And that frankly impact the economics. And we're seeing that by integrating well a number of the backend stuffs, we can have major impact on the turnaround time in the fab and that of course has very positive impact on their customers.

Matt Petkun - D.A. Davidson & Company

Okay. And then just finally will future analog revenues obviously they will be small to begin with, but will that be encapsulated in your core EDA revenue bucket or will you make as a new bucket for that one?

Aart De Geus

No, you're right. They will be in the core EDA and we've said all along that we consider it's both an opportunity to grow in a sub segment that we were not in before. But just as importantly it's a result, what I consider a critical strategic hold that we've for long, long time that allows us now to be much more competitive in our market overall. And simultaneously go to customers and provide them truly full solution.

Matt Petkun - D.A. Davidson & Company

Okay. Thanks for taking my questions.

Aart De Geus

You're welcome Matt.

Operator

Thank you. And our next question comes from the line of Rich Valera with Needham & Company. Please go ahead.

Rich Valera - Needham & Company

Thank you. Good evening. Last week at the EDC DO forum I think a projection was put forth for EDA growth in 2008 of 2%. And I know you didn't give create that forecast, but just wondering where you stand relative to that forecast if you're willing to sort of comment on how you see EDA growth this year?

Brian Beattie

You are correct. I did not want to come forth with a prediction for EDA because we've obviously seen that the impact of revenue models has the great impact of how you make these forecast and we can stand behind a very solid and visible forecast of 7.5% to 8.5% for this year for us because we actually mostly know what is going to be, and that is a very different situation than if you are a company that is much more dependent of the ups and downs of having a front or if you have a very different revenue recognition model. And so having been there many years ago I know how difficult it is to predict your future and therefore, we are very cautious with predicting EDA. Overall I think the healthy market then it will continue to grow somewhat at least.

Rich Valera - Needham & Company

I guess we thinking of it more in terms of bookings growth, rather than understanding some revenue model changes will clearly put some pressure on the industry revenue, but do you see the industry growing and sort of a booking basis or however you want to look at it sort of factoring out the obvious revenue compression from that model shift?

Aart de Geus

Well, if I may send the note of caution how people over interpret bookings, you obviously can greatly mislead yourself and others depending on the length of the deals that you make. And then think of it as booking growth when in reality it is essentially taking out years.

And so we have been very careful with that as well, having learned from the past and so booking's growth is actually a very tricky indicator. I understand that there is some value to that our own sense is that we continually watch the run rate growth with our customers and that is internally absolutely the single thing that we pay most attention to because that is pretty decent predictor of future revenue growth.

Rich Valera - Needham & Company

And I'd like just to follow-up on that, one last point. Would you feel comfortable, it sounds like you're planning certainly to be building your run rate throughout this year and as you enter into fiscal '09 that you will have a higher run rate in fiscal '09. Is that a fair statement?

Aart de Geus

That's a very fair statement. That is absolutely what we are, not only planning, but managing the company towards.

Rich Valera - Needham & Company

Great and just one quick one for you, Brian, I missed the actual number of shares you bought back this quarter?

Brian Beattie

We bought back 3.4 million shares for $83 million in the first quarter overall.

Rich Valera - Needham & Company

Great, that is very helpful. Thank you.

Operator

And our next question comes from line of Sterling Auty with JPMorgan. Please go ahead.

Sterling Auty - JPMorgan

Yeah, thanks. Can I actually get clarification on the last kind of, Aart you said that you're managing the business to be at a higher run rate next year, meaning you expect faster revenue growth next year, what -- I didn't understand the comment?

Aart de Geus

Let me clarify without say going into '09 guidance, which we do at the end of the year. What I meant to say it wasn't clear is that we are running our business with two fundamental objectives. The first one that you all know well about is to keep improving gradually the ops margin, and we do that by roughly speaking, making sure that expenses are at about half or less of the revenue growth.

The second one is I meant to say that we expect that revenue in '09 will be larger than in '08 and in '08 we did give guidance of revenue growth of 7.5% to 8.5%. But given that much of our focus in the bookings and the run rate with the customer is aimed at building backlog for '09 and '10. That is why I'm saying that our objective and our plan is, entirely aimed at growing the revenue of the company.

Sterling Auty - JPMorgan

Okay, great. Thanks. And then in terms of -- you made the comment that in this type of year its execution and better technology that's going to win the day. You mentioned a large number of different areas in terms of new product introductions etcetera. But from your point of view what are the couple of real keys that are going to drive the bookings execution or the bookings with your customers this year. Is it going through the inflexion on IC Compiler or what are the two or three key areas that we should really be watching as the year unfold?

Aart de Geus

Actually, I think that all, the product advances, which we've many. Many are very much focused on speed, capacity etcetera all have one fundamental objective at this point and time, which is the productivity and the success rate of our customers. And unfortunately the word productivity is a much more nebulous term for which there is not a very sharp definition or easy set of metrics. But is the set of measures that has the biggest economic impacts on our customers.

And so I expect that a lot of the growth will come from customers that gradually say hey, I want to go much more with Synopsys because there is a much better chance of getting my chips out on time with the performance and the power characteristics that I'm looking for. Now on the margin, obviously, there are some areas that may grow a little bit faster than others. But from a big picture point of view that is really how we're managing the company.

Sterling Auty - JPMorgan

And then last question to Brain. In terms of the sales and marketing expenses in the quarter, how much of the variation versus last quarter should we think about in terms of some of the variable expenses like commissions related to bookings in the quarter and how of it is other factors and including seasonality?

Brian Beattie

Yeah. I'm just comparing here in terms of the expenses Q4 to Q1 of '08 came down about $7 million. So, primarily that's related to shifting out of some of our expenses in terms of bringing on new headcount. It did not happen in the quarter. We also retained on some of the travel expenses for the quarter. Some of the contractor usage all that was light and as a result we're able to come in less than our plan and really drive up that margin number for the quarter.

So, a lot of that is shifted out relative to any headcount relatively we got factored in from sales or marketing and of course as you know there is a proportionate allocation of commission expense to the level of activity as it comes in. So, it's all lined up in our guidance for the year or so where we expected to come in.

Sterling Auty - JPMorgan

Thank you.

Operator

(Operator Instructions) We've a question from line of Tim Fox with Deutsche Bank. Please go ahead.

Tim Fox - Deutsche Bank

Thanks. Good afternoon. Aart, just a couple of questions around DFM, you mentioned the focus there was around growth of the segment as well as differentiation of your flows utilizing some of the DFM technology. I was just curious more so around the growth and the fact that in many cases you're selling different value proportion to the fab then you maybe to the designer themselves. I'm wondering, how do you actually get the value of all these new TCAT/Yield/Litho technologies. How do you actually get the value out of the customer if you are selling to different people and are you considering any different kind of licensing models to actually extract that value that you're rolling into your flows?

Aart de Geus

It's a very good question because there is no question that it's sort of almost like building a bridge on two sides of the river. And in many ways the ultimate value is how well, can you help both set of customers get the chip through with high yield. Don't forget that on the foundry side, if you don't have yield, you don't get any money either. And of course if you don't do good job on the design side, you are essentially dead and so our job is to sort of build that bridge more and more and initially we definitely sold very independently on both sides of it.

Increasingly now, we are going to see that the learning's of the manufacturing side get translated directly into our tools and some of those can be recently upstream such as directly into the place en route, in order to minimize some of the yield issues or make it more manufacturable and my suspicion is that as number of customers become less and less involve themselves in manufacturing that they will almost use us as a substitute to help them guarantee the quality of that bridge and so I view it as much as an area of opportunity to grow as well as an investment area that solidifies the entire rest of our offering.

Tim Fox - Deutsche Bank

Okay that's helpful. And then on the other end of the design spectrum in around systems you mentioned virtual platforms starting to add a little bit more meaningfully to the business just one and if you can characterize, who is buying the virtual platforms, is that a market that you see as reasonable size growth over time or just more a niche that will fill some gap in the system level design area?

Aart de Geus

Okay. I think the jury is out, but the promise is interesting and just to clarify for those that may not be familiar what this is, what virtual prototyping is, is a capability to build a model of chip in electronic system before that system or chip is available. And using that model you can now start developing and checking out the software is going to run on them. Well as you can imagine with many, many product the software content is becoming very, very large as a matter of fact becoming increasingly one of the key bottlenecks.

And so if you can start earlier with that you have a big benefit. So, why is that not a slam dunk? Well, it is not a slam dunk because you actually need to develop the model that is something that requires some skill, and you need to have a strategy whereby your chips are going to be used in multiple situations.

So, that the models are usable and we are starting to see now both of the people providing the chips, as well as interestingly our new buyers coming from the system side. Those that are going to use the chips and I expect that the virtual prototyping or variations on it increasingly are going to become almost a little bit the hand-off or the spec between those two parties. And so from that perspective, the last few quarters have been actually pretty positive.

Tim Fox - Deutsche Bank

Very good, thank you.

Aart de Geus

You're welcome.

Operator

And we have a follow-up question from the line of Sterling Auty with JPMorgan. Please go ahead, sir.

Sterling Auty - JPMorgan

Yeah, thanks. Brian, coming back to the third quarter last year you still kind of given off the model beginning at the quarter backlog that would flow into revenue over the next four quarters. Is that still a metric that you can give us?

Brian Beattie

We are giving a lot visibility through are knowing that we entered the year with more than 80% of 2008 revenues in hand, with entering each quarter with more than 90% of the quarter booked and again we reconfirmed that top line revenue guidance.

So, given that one quarter through with very strong performance, you obviously concede that we've got a lot higher visibility going in. So, we are finding that the quarterly variations relative to the bookings as we did see last year can not be that significant to the business. So not really indicative of the level of activity, just due to the rotating nature and timing of when the contracts get renewed.

So, again we continue to focus on the total year deliverables and continue to provide very good visibility in each quarter.

And then as you know we give the actual backlog number at the end of the quarter, which in turn provides the level of booking activity. And again we'll give total year guidance at the end of 2008 relative to 2009. And I'd add as well to the metrics about this ongoing focus on multiyear business deliverables is that, that is built in again to compensation levels in the company. So, it's not just optimizing one year but a multiyear agreement, multiyear commitment with customers and multiyear return for investors.

Sterling Auty - JPMorgan

And one other question, in terms of with Cadence and their EDA Card been out there for a little bit now. Are any customers coming to you and asking for different types of structures or different types of arrangements that gives them additional flexibility to takedown more seats on a temporary basis to kind of mere that and if so, how you're handling it?

Aart de Geus

Well customers have always asked for more flexibility and at times we joke that the word flexibility just means lower pricing. Now, there are mechanisms for that. We've quite a number of models that allow people to take up more software under the right circumstances. We should not be confused with how one actually recognizes revenue, which is a whole different story. And there we should be very clear that our model remains one of well over 90% is ratable and so that's a whole different aspect of how all of these mechanism work.

Having said that, there is no question that we should work with the customers to optimize the impact of our software on their success because at the end of the day is those sort of the customers that are more successful with our software will be a returning customers.

Sterling Auty - JPMorgan

All right, thank you.

Aart de Geus

You're welcome.

Operator

There are no further questions in queue at this time. Please go ahead with any closing remarks.

Aart De Geus

Well, at this time, I'd like to thank you for the time you spent with us. I think we had a very good quarter and we well launched into the year. And as usual Brian and I are available after the call. Have a good afternoon.

Operator

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Source: Synopsys F1Q08 (Qtr End 01/31/08) Earnings Call Transcript
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