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Cadence Design Systems, Inc. (NASDAQ:CDNS)

Q1 2008 Earnings Conference Call

April 23, 2008 at 5:00 pm ET

Executives

Jennifer Jordan - Corporate Vice President of Investor Relations

Mike Fister - President and Chief Executive Officer

Bill Porter - Executive Vice President and Chief Administrative Officer

Analysts

Mahesh Sanganeria

Richard Valera

Jay Vleeschhouwer

Terence Whalen

Mat Petkun

Sterling Auty

Tim Fox

Operator

Good afternoon. My name is Heather and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence’s First Quarter 2008 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator instructions). Thank you.

I would now like to turn the conference over to Ms. Jennifer Jordan, Corporate Vice President of Investor Relations for Cadence Design Systems. Please go ahead ma’am.

Jennifer Jordan - Corporate Vice President of Investor Relations

Thank you, Heather. Welcome to our Earnings Conference Call for the First Quarter of 2008. The webcast of this call can be accessed through our website www.cadence.com and will be archived for one week.

With me today are Mike Fister, President and CEO and Bill Porter, Executive Vice President and CAO.

Please note that today’s discussion will contain forward-looking statements and that our actual results may differ materially from those expectations. For information on the factors that could cause the difference in our results, please refer to our 10-K for the period ended December 29, 2007.

In addition to financial results prepared in accordance with generally accepted accounting principles or GAAP, we will also present certain non-GAAP financial measures today. Cadence management believes that in addition to using GAAP results in evaluating our business, it can be useful to measure results using certain non-GAAP financial measures. Please refer to our earnings press release for a discussion of non-GAAP measures and to both our earnings press release and our website for reconciliation to GAAP and non-GAAP financial measures used in today’s discussion.

Now here’s Mike Fister.

Michael Fister - President and Chief Executive Officer

Thanks Jennifer and good afternoon everyone. Revenue for the quarter is $287 million, non-GAAP earnings per share were $0.04. Our customers continue to face tremendous challenges due to the relentless demands of competing and a maturing semiconductor industry and the current economic uncertainty. This highlights what we discussed at Analyst Day. The customers were constantly trade-off conflicting technical and economic goals to deliver winning products to end users.

In these strategies to look at product development holistically and deliver the most complete and integrated solution that have material impact on our customers and businesses. We are committed to expanding into the adjacencies as system design and design for manufacturability because these areas are critical for helping customers maximize their overall productivity of the product development process.

For example is our focus on the design and design for manufacturability. We can demonstrate that the ability to model and take into consideration manufacturing effects within the design can save time to market and improve manufacturing output. For this reason, we saw increased customer interest in our Chip Optimizer, Litho Electrical and Litho Physical Analyzer and CMP Predictive products during the first quarter.

Improving productivity and helping customers meet their critical design challenges is also in our core business we deliver holistic solutions within and across platforms targeting four key areas. Functional verification, Mixed Signal design, Low Power design and design and advanced nodes.

During the first quarter, we acquired Chip Estimate Corporation, an innovative company which is developing industry’s first comprehensive solution for IT planning. With this capability, Cadence customers can perform what its analyses at the outset of the development project to actually gauge key factors like product cost, power dissipation and performance. Chip Estimate is one example of how we are looking beyond the EDA core to improve customer productivity.

Another is Cadence’s Encounter Conformal ECO Designer, a unique and automated capability to address the extreme pressure customers face to deliver on schedule while still achieving targets for product cost and quality. ECO stands for Engineering Change Order and unfortunately for designers these are all too common.

Late stage functional changes historically met the time consuming task had to be repeated to ensure that the impact have been completely comprehended. New capability we delivered in Q1 allows designers to automatically compare the old and new versions of the design, and then guide the implementation tools to minimally disrupt the original design, bringing badly needed automation and predictability to the ECO process and of course resulting in improved productivity, fast return to market and higher quality.

Relating to systems design, I have been out talking with customers about our [Sydney] Technology some of which is already in beta release and the response has been extremely positive. Customers are eager for help to reduce iterations between system specification and design implementation. Improved chip and design partitioning and manage and verify IP and embedded software.

The Sydney Technology builds naturally upon our strong position in functional verification. Customers are expanding their commitment to Cadence verification technology leveraging our solutions, debug capability and scalability to meet their verification demand. For example major Japanese Consumers Systems and Electronic company plans to increase it’s usage of [Virtuoso’s] simulation 40% over the course of this year.

At the same time momentum for Palladium emulation and extreme acceleration solutions continue. For instance AMCC, a leading provider of processor based network SoC chose Palladium for its advanced verification needs.

To further enhance our verification capability for releasing new technology to the Xtreme product line during the second quarter, which will allow customers to swap seamlessly between incisive simulation and Xtreme acceleration in a single cockpit creating outstanding performance capability for incisive accelerating simulation environments up to a 100X.

The demand in mixed signal designs plus additional stress on customers is bringing the digital and analog components of a chip design together is not a trivial task. We’ve released new turbo technology for the XL and GXL versions of Virtuoso's Spectre Circuit Simulator. These new technology targets the toughest analog in mixed signal designs which required detailed analysis of electrical effects and providing 10 to 20 times faster performance and cutting simulation time from days to hours.

Capability is part of our multi-mode simulation solution and enables customers to stay within the holistic Virtuoso environment. In fact we displaced the competition with Spectre at US Storage Systems and a semiconductor company during the first quarter and won the complete Virtuoso platform and a major Korean company’s LCD business.

The semiconductor industry is being called upon the to do its part to address climate change in the conserve natural resources by designing devices that consume less power and produce less heat. Industry momentum behind the common power format continues to grow. In March the Power Ford initiative published a low power methodology guide that contains user written examples from NEC, NXP, Fujitsu and ARC. Case studies from ARM TSMC and Freescale will be added to the guide next week. And Virage announced that their cell libraries now support the common power format.

Cadence low power solution optimizes power consumption across the entire digital design flow including functional verification. Including, enabling customers to build ships with as much as a 50% power savings, interest and adoption of the Cadence low power solution continues to increase.

For instance, Norwegian startup Energy Micro, it’s relying on our advanced verification solutions to aid and development of some of the world’s most energy efficient microprocessors. At the same time two large memory companies are relying on our low power verification, the capabilities to decrease over development time, which has placed the competitor Taiwanese fabless SoC platform and IP provider with the full Cadence low power solution including our digital design flow integrated with Cadence verification.

In the silicon package and board area, usage of Cadence system in package or SIP solutions among our IDM and fabless semiconductor companies is increasing. As they step up functional integration at the component level to provide more complete solutions to their end customers particularly in a highly competitive wireless handheld market. For example the use of Cadence RF solutions dramatically improved productivity at STMicroelectronics. The availability solutions to rapidly design, accurately simulate and reliably implement our SF Modules provided ST better confidence in a design of physical substrate.

Finally, I’m happy to announce the appointment of Bill Porter, as Chief Administrative Officer and Kevin Palatnik a 12 year veteran of Cadence, as Chief Financial Officer. He will be leveraging the talent for the team that report to him and focus on our growth strategy and Kevin is a natural leader who brings a proven track record of success along with the deep knowledge of our field operations, products and business strategy to his new role.

Now, I will let Bill take you through the detailed results.

Bill Porter - Executive Vice President and Chief Administrative Officer

Thanks Mike. Results for our key operating metrics for Q1 were; total revenue of $287 million; non-GAAP operating margin of 2%; operating cash flow of negative $19 million. GAAP earnings per share for Q1 was a net loss of $0.07 compared to net income of $0.15 in Q1 of 2007. Non-GAAP earnings per share for Q1, was $0.04 compared to $0.26 in Q1 of 2007.

Total revenue for the first quarter was $287 million, compared to $365 million in Q1 of 2007, down 21%. Product revenue was $156 million, maintenance revenue was $99 million and services revenue was $32 million.

Revenue mix by geography in Q1 was 40% for the Americas, 22% for Europe, 26% for Japan and 12% for Asia, one customer accounted for approximately 11% of total revenue.

For 2008 we expect weighted average contract life to be in the range of 3 to 4 years. Total cost and expenses on a non-GAAP basis for Q1 were $281 million compared to $277 million in Q1 of 2007. The non-GAAP operating margin for Q1 was 2%.

Order and headcount was approximately 5,100 down from 5,300 at year end 2007. Total DSOs for Q1 increased to 176 days from 111 days in Q4 of 2007 driven by lower revenue and fewer receivable sales. The quality of receivables remains high with less than 1% of receivables, 90 days pass due.

Operating cash flow for Q1 was a negative $19 million compared to a positive $19 million in the first quarter of 2007. Operating cash flow declined primarily because of lower receivable sales. As a result as expected in this environment, its taking longer to sell receivables. For example one receivable for $17 million sold late in Q1 funded two days after the quarter ended and will be included in our Q2 cash flow.

Capital expenditures for Q1 were $25 million. Cadence repurchased 19.8 million shares of stock in Q1 at a cost of $216 million, approximately $412 million remains under our current stock repurchase authorization. Cash and cash equivalents were $826 million at quarter end.

Now I will turn to our outlook for Q2 and the year. For Q2 we expect revenue to be in the range of 310 to $320 million. GAAP EPS should be in the range of $0.02 to $0.04 and non-GAAP EPS in the range of $0.13 to $0.15. For the year 2008 we expect revenue to be in the range of 1.49 to $1.54 billion, we expect backlog to grow to $2.1 billion at the end of 2008.

For 2008 we are targeting a 27% non-GAAP operating margin. GAAP EPS should be in the range of $0.64 to $0.72 and non-GAAP EPS in the range of a $1.14 to a $1.22. For the seasonal revenue pattern for the remainder of the year, we expect to generate 26% to 29% of revenues in Q3, and 31% to 34% of revenues in Q4. Other income for 2008 should be in the range of $15 million to $19 million.

For 2008, we expect to generate operating cash flow of at least $350 million. We expect DSOs to be approximately 125 days at the close of 2008. Capital expenditures for 2008 should be in the range of $17 million with an additional $37 million for work to complete our new engineering building.

Although the semiconductor environment remains challenging I am confident in our strategy, our technology has never been stronger and we are on track to achieve our operating targets for the year. On a personal note, I am excited about working with Mike and the Cadence team in my role as Chief Administrative Officer. As you can see from the press release Kevin Palatnik has exceptional qualifications for the CFO role. Having worked with Kevin for over a decade, I am confident in his ability to do an outstanding job as CFO.

Operator, we'll now take questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Mahesh Sanganeria.

Mahesh Sanganeria

Hi guys. This is Casey calling in place of Mahesh. Can you comment a little bit about the change in the macro environment if any since your last conference call?

Michael Fister

Hi, Casey, I had been to three of the four geographies in the last month and the business discussions always sort out customers around the environment. I don’t think there has been a big change, customers are still a little bit murky about what’s going to happen for second half that means there hasn't been anything positive, there isn’t been any big thing negative, and they are looking at for every dollar they can find in cost, and making those trade-offs that we talked about at Analysts day. So the good news is, there is not heck of lot worst, the bad news is that it's not a heck a lot better.

Mahesh Sanganeria

Okay. Could you comment a little bit about reason as to why is your second half weighted more heavily than is common?

Bill Porter

Yeah, Casey, this is Bill. I think we explained the same reason in January as when we looked at our year, we did expect a more difficult environment and it does take customers more time to make decisions in this environment and in many cases they can put off making purchasing decisions for six to nine months. And so that really hasn’t changed as Mike described in the environmentals. So, that’s how we plan the year. That’s how we see the year playing out. We’ve got a pipeline to deliver that business but it’s not without risk and we think we’ll be able to manage that risk.

Mahesh Sanganeria

Okay. And lastly, can you comment a little bit about the calculations that have gone into the upside to your ’08 EPS guidance compared to your previous guidance?

Bill Porter

I am sorry Casey, I didn’t quite get the question?

Mahesh Sanganeria

Your ’08 EPS, can you comment on that I mean do you see I am sorry for because of cost cutting as planned to do later in the year?

Bill Porter

Well the increase -- let me just comment on the increase in our outlook for the year and you saw that earnings for the year have gone up from our previous estimate by $0.03 and that’s really driven by our stock repurchase activity and so that’s what's giving us smaller share count, which is resulting in some improvement in the earnings. Not all of that share repurchase will come through and the reason is we have lower interest income as you examine our income statement. Part of that is because we had a very conservative cash portfolio that we made even more conservative based on what we see in the environment with lower interest rate. So, you will see a slight reduction in interest income more than offset by reduction in shares giving us some increase in EPS for the year.

Michael Fister

In terms of the cost cutting, we are continuously managing performance, do you see that reflected in the headcount. We don’t have any big mega actions plans, that doesn’t mean that we are not going to continue to keep doing streamlining we look for efficiencies across the business all the time, are largely sourced across many of the geographies not just to take advantage of cost but locality for our customers because they operate across all the geographies. Those all represent opportunities for us to drive our cost base and like I say we continuously mange that process.

Mahesh Sanganeria

Okay. Thank you.

Michael Fister

Sure.

Operator

Our next question comes from the line of Rich Valera.

Richard Valera

Thank you, good afternoon. This is a tough one, but I am just wondering if there’s since you guys are no longer giving percentage of ratable versus some upfront booking is there anything you can give us qualitatively to give us some confidence in the model as you progress through the year, any kind of color you can give us on that back half pipeline that should give us confidence that’s achievable. And to just sort of revisit that decision not to give the upfront versus ratable. it seems as you move to the back half, the fear will be that you could move to an exceptionally sort of upfront weighted model, which could allow you to achieve the numbers, but could essentially make things more volatile and potentially more risky as you move forward. Anyway, I was just wondering, if there is anything that sort of give us some comfort on the upfront anything qualitative you can say about that back half? Thanks.

Bill Porter

Sure Rich. I think the first thing, the reason just to reiterate bookings is really an annual measure for us. And we went to that for the specific reason but that’s I think how we should look at the business and we think that’s how you should look at the business. In terms of mix, I do expect a balance between what you would consider subscription in term business for the year. So, its going to be around 50/50 I believe. And then if we expect that to dramatically change we would let you know. But its really an annual view of the business and that’s what we expect to deliver during the year. And I think we’ve talked about how see the second half. So I don’t think there’s anything that I could add to that because we just talked about.

Michael Fister

Yeah qualitatively Rich the other thing I would add is, we don’t do customer engagements do something for a month from now or even a quarter from now. Most of the things are long tedious things that involve quarter's worth of work and large sales plans to target across the multitude of projects that go on in companies. And so as Bill described it earlier it’s a pipeline that we understand the breadth of that because we work on it for a long, long time. Many of these things can be competitive and so sometimes those aren’t even a secret and that’s what we use to plan the year, it's exquisite in its detail, it's targeted with the manpower and expertise that we have. I hope that some in some way the consistency that we demonstrated through the last years is just as consistent for us as we bridge this year and the fact that the year isn't as big as the last year’s just the details of the environment.

Richard Valera

Fair enough. As far as your stock buy back you were pretty aggressive in this last quarter. Can you give us any sense of how aggressive you might be in the relatively near-term your stock hasn’t moved a whole lot since then, I'm just wondering what your thoughts are on the continued stock buy back?

Michael Fister

Sure Rich. Well we do use our cash for two things, to expand the business and then when we see the opportunity to buy back stock. And so those are sort of the same things that we are going to look at it for 2008. We are opportunistic in each area, so I am not going to try to predict one or the other. And I think that’s just the best way to go forward but it will be used for both activities. I think as we’ve said in the past, the priority is always try to grow the business but then when there is value looking at you, you have to take advantage of it as we did in Q1.

Richard Valera

Right, just one final one if I could. With respect to receivables, the receivable sales, is your 350 million of cash flow from ops predicated on the market for receivable sales improving I mean, it sounds like its quite challenging right now and it would seems like if its maintained in this current level of challenge difficulty that it might be tough to achieve that number you know I am just wondering what your thoughts are on that Bill?

Bill Porter

Sure Rich. When we talked about the year in January we said we did expect a harder time selling receivables and so I think we factored that in. I estimated at that point is around $40 million to $50 million less and I think it still is taking a little longer but that was within the range that we had allowed. So, we gave ourselves a little bit of ability in case things were harder and so that’s factored into our 350. So, I believe we are going to hit the 350 in light of this current environment for receivables sales and it’s not always that like we actually have some opportunities to add some new partners to our program. So, we are continuing to do that and as usual capital will flow where there is an opportunity. So, I think there will be some opportunities there as things that maybe don’t have as much pressure on their balance sheets look to get into this business.

Richard Valera

Great. Thanks very much.

Michael Fister

Sure.

Operator

Our next question comes from the line of Jay Vleeschhouwer.

Jay Vleeschhouwer

Thanks, good afternoon. I would like to go back to the issue of what substantiates your particularly heavy fourth quarter outlook. And you mentioned for instance that customers can in some cases put decisions off by 6 to 9 months so does that mean in effect that you are expecting some contracts to come down to the wire of the expiration date in Q4 where otherwise they might have respond six or nine months earlier as we would typically see in an easier environment. In addition, you did have that more than 10% customer in the quarter, was that expected in the quarter and might you expect other similar large pieces of business over the next couple of quarters?

Michael Fister

Yeah, Jay some of these companies are the biggest companies in the world, some of them aren’t nearly that but they are aspired at the end. So sometimes the transactions are significant and there is going to be some other significant ones through the year you can count on that. I wouldn’t at this time forecast what percentage they are per quarter what this report does, as Bill does every quarter. As the time goes along, flexibility and time has always been a 6 to 12 months cycle, typically a customer engages about a year before the end of their contract with the first discussions they are going to be back into the quarter. It’s usually more advantageous for us the longer it goes because sooner or later they are forced to act on things and that’s a collaborative discussion that we have. When we plan the pipeline and like I say we do this with a lot of visibility in some excruciating detail, we took into account the time shift and I think you remember that that was lot of work done I said when we projected that this year was going to be harder for us as we were looking at that time flexibility or continuum. Its not a matter of if, its a matter of when. So, we tried to plan that the business is typically back ended into a quarter and our business is cyclic around the year and this year isn’t much different that way either.

Jay Vleeschhouwer

Could you comment on how you did with the EDA cards in the quarter either in terms of overall demand, consumption, repeat business if any and perhaps how that license mix looked for the cards?

Bill Porter

Sure, Jay and we continued to see very good pickup from the cards business, all of the same things that we talked about at the Analysts day continued into this year. We are seeing more customers trying the cards, we are seeing them continue to use the technology faster particularly with the gold cards and so I think that’s one of those dynamics that we expect will continue. And so, I think it is a competitive differentiator for us for example for the gold cards 46% of the customers are consuming faster than straight line another 27% as expected, and we are seeing similar in the platinum cards about 63% are using it as fast or faster. So, good usage of the cards and the levels I think are going to continue to creep up on us overtime as customers like that ability to have very flexible engagement and use that technology 24/7.

Michael Fister

We’ve already got some customers layering on multiple cards and this at the end of the year is Jay, when we really see the term on the first of the three year card so we can see what the re-operate is. Remember our belief is that as they use it faster they probably layer on more the next time and we modeled that at Analysts day in a couple of different ways so, it will be interesting to see and it is a data rich environment so we are absolutely methodical about collecting the trends and as Bill says it gives us a great engagement model to talk in a objective way with customers.

Jay Vleeschhouwer

Finally, you went through a catalogue of some of your products in the prepared remarks which I’d like to ask about in terms of your positioning by vertical market and geo, for instance how do you position yourself in terms of what appear to be the better or more incremental vertical market for the consumption of electronics for example automotive parts of consumer and other markets versus where you might have been positioned before. And similarly when we look at non-Japan and Asia, its been the fastest growing region for years in the industry albeit it’s a smallest, but your share over there is somewhat smaller than your share elsewhere and impacted sometimes by quite a bit as a percentage of EDA total spend in that part of the world. So what do you foresee in terms of improving your position in that faster growing part of the world?

Michael Fister

Well, I guess, what I would say is that in the pockets that are high and consumers have the pricing is tough for our customers or automotive -- in almost any category these days the mixed signal content is high, favors our analogue mixed signal incumbency and especially for something like wireless. As those companies try to do more integration on the dye and that’s obviously sometimes it’s a lot of analog with more digital and sometimes it’s reverse. It always saves as a holistic solution. And the way that we approached the verification in the last four years is absolutely thoughtful and down to the holistic element itself. And so I’m always very careful about what I say when I was talking in some of the prepared remarks about the construction and the integration of verification and the implementation that is a demonstration of the breadth dynamic of the company. And I see more and more companies valuing that. You see that people voting and consolidating elements like you know an XP and Hitachi were sighted last year and you see lots of other companies that were in discussion projecting exactly the same thing. We’ve never lost a consolidation opportunity that there were change was made never. And that’s a strong statement around incumbency and holistic.

The other thing I would say is Japan is up and that’s as a very forward-looking environment of a lot of systems companies, they are full of engineers you want to operator and abstraction above the physical implementation of a semiconductor that’s one of the reasons it’s high, it’s up and they are also very big participants as you know companies like Renesas, Hitachi, NEC across those vertical segments.

In China it’s a lot small numbers, I mean we have gained share in China, by my analysis I think even you could find up by going through the EDA consortium. Taiwan in particular is a place where we’ve called our testimonials of last two quarters and some of the fastest growing fabless companies are there. So, I’m a little bit allowed with your notion that we haven’t done much in the Asia-Pacific region, I think we’re doing great there, focused it’s a very interesting strong coupling to the foundries you know great foundry partners across the board. So, I’m pleased with what we were doing, and we will just have to see how fast that region becomes a mega force in the world. Right now the Americas are still extremely strong, Europe is on its own and Japan is on the rise especially in international list of consumption.

So, our long answer to I like what we have done, it’s consistent where we targeted, it’s consistent with the technology focuses and happy for spending the money.

Jay Vleeschhouwer

Thank you.

Operator

Our next question comes from the line of Terence Whalen.

Terence Whalen

Great, thanks for taking my question. This one is for Bill, Bill I think there is about $300 million of debt coming to you in August likely you will pay that with cash on hand, you are also generating some cash flow from operations, it is my question is once that's paid into we are going to be at a lower cash level, what’s the reasonable baseline operating cash level that you think about in the business?

Bill Porter

Well, Terence as you can see we should be able to generate enough cash during the years to more than offset the debt that's coming due. So, you could just expect that and our cash level should at least be where it is or higher and the thing that you know, we are not going to try to project as how we will use some of the cash as I described earlier either for growing the business and/or repurchasing stock.

Terence Whalen

Is there a baseline level of cash that you feel comfortable operating wise, and that I’m asking the question so, I can then ascertain what could be a buyback number potentially?

Bill Porter

I’m not going to try to project absolute number Terence, I think it’s one of those things that you know we can you know, you could see where our authorization is, you know, we have got another $400 million and we will use that as we seek that. But, I’m not going to try to beg a number at this stage for net cash.

Terence Whalen

Okay, fair enough. My second question relates to a comment made at Analyst Day about our operating margins you target 27% this year, and then I think at Analyst Day you took the first shot of talking about 2009 saying that you expect operating margin to return to 30%, I want to understand what sort of growth expectation is factored into that operating margin, reacceleration and I don’t think it’s characteristic that you talk about a year further out and why did you take the opportunity to do that at Analyst Day? Thanks.

Bill Porter

Well, as we were talking about the business we feel that it’s a little hard to get all of the specifics laid out in terms of what top line and expenses are but we did feel that we had enough confidence that we would go back to a 30% operating margins because that’s what our mentality is and that’s how we run the business. So, we looked and said, yep we might not get each of the elements with this far -- this much notice completely and accurately. But, I think we can to get the combination at a 30% margins because that’s essential as you know, we try to grow, our leverage in the business we grow expenses at half the rate we grow our top line and I think that’s what gets us back to the 30% operating margin. In addition, there is a couple of things they are just unique for 2007 as we talked about, and we have the additional week for the year that’s about 17 million and we also have seen the effect of foreign exchange, which is another thing in 2008. So, I think both of those are things that we would expect and would neutralize when we get to 2009.

Michael Fister

Yeah it’s a growth rate in the industry is relatively flat, there is some contention about that. More right size of business to be able to generate great operating results. We did it, as we got the 30%. If the thing resets you can’t hardly get all of that in one year, but over the year and plus period we can do it. That’s the core of the business at a minimum and as the capacity adjacencies kick in and we get better top line growth and this is going to trend up faster. But at a minimum we are going to run the core of the business to be an attractive financial machine, we proved and we can do it again.

Terence Whalen

Okay thanks, Mike. Can I ask just one last one then I will re-queue. You said average contract life this year will be 3 to 4 years. I assume that will be up slightly versus last year and can you just a talk a little bit about in general the trends you are seeing in -- in seeing higher contract duration and what’s driving that, you are driving that or the customer driving that. And then lastly as I think about rolling that forward in the renewal cycle, won't that create a sort of a gap in the -- when you'd normally expect a shorter order, renewal to come through? That’s its from me. Thank you?

Michael Fister

Sure Terence. I don’t expect that we are going to see anything necessarily creep a year-over-year. So just to comment on that assumption, we’ve seen a lot with the cards and again customers like in these kind of uncertain times the ability to use the technology a little longer, if they are going to be more frugal and how they are spending their money in utilizing projects. But, our experience has been that they are actually using it faster as I mentioned earlier in the statistics. So we allow them the extra contract length for the cards, but we expect that they are going to use them up in a shorter period of time. So I think it pretty much offsets.

Bill Porter

Yeah I mean all semiconductor designer that the three year term constant training to get into the half life of two process generations and unless that dramatically pushes out at least with the discipline we have, we'll stay in about that time. The cards make an automatic opportunity to be objective about that discussion with the customer. The contract life is driven by them and we try to creatively respond to it. And the discussion with the cards is very interesting, it says hey look, we’ve got, we are using this stuff faster already. So if I just need a little bit of extra time why not, and then okay so that's what gives you around the things to a little bit more than 3.5 years as we reported at Analyst Day. It's all about the usage of technology and that’s the beautiful thing about those, it's totally objective discussion and the project dynamics haven’t changed demonstrably and the fact that we can separate new technology from stuff is already locked in and differentiate those to allow us the further segment the things. So, I think that we understand very well and that’s what we did, we did the cards on purpose where we have construct the conversation with the customers on purpose and we’re reacting to the way that people want to buy the stuff, and that’s a slow moving change and as a changes I think were well positioned to react to that to corner value. I don’t know of everybody else is in that that position, but I am very confident that we are.

Operator

Our next question comes from the line of Mat Petkun.

Mat Petkun

Hi there just a follow on Terence’s question real quick, you are talking about deal lengths, is there any way that you can characterize the trends and may be average deal size because Bill I remember you talking about may be even a year ago as you were kind of conditioning the street to expect backlog growth that the average deal size would hopefully be getting smaller and then you would be trying to continuously trip on your customers rather than signing up individual large deals, has that happened?

Michael Fister

Sure and sure it does, it does by the number of cards when you have multiple cards engaged in the customer, you can do that and if you think about it its because in most of these companies they are not just one project companies, there is hundreds of projects sometimes in a company with different kinds of buying proclivity now the all buying old fashion, old school buying proclivity was one mega purchasing guy trying to arbitrate or amalgamate that across every project. And what the geo centricity, decentralization of some of the customers, sometimes even the approach they take, they want to have Greenfield experiments to be able to fore set down and see if they get better productivity in different spot. So, that’s some of the logic for it once again the mechanisms we have are that way and at the same time not everyone is totally condition themselves. Some of our customers still want to have one central purchasing guy trying to arbitrate as much of the thing as they can, they tend to be big companies and so you can get some very big transactions that go along. But its is the mix pool in when we concentrated on the geo -- geography accounts which we did 2, 2.5 years ago we grow our business there we have 100’s and 100’s of transactions with companies that are small I mean they just follow us in a million dollars and so that’s a beauty it gives us a little bit of you know growth dynamic outside as the big global, but the global companies that the traditional big semi conductor comes or still a huge attraction of the business.

Bill Porter

Hi, Mat this is Bill, I think that we were also seeing the cards facility customers buying in smaller pieces even within different divisions of larger companies and they can track it very well so I think that’s also enabling you know the strategy of trying to sell more in different time periods for customer when they want it.

Mat Petkun

Okay. And then Mike I think last call you mentioned some incremental pricing pressure especially on the digital side any update there, does that continue to be kind of you know the back drop with what you've provided guidance for this year?

Michael Fister

Well, we certainly factored it in, I think in our Analyst Day was the most concrete and we should ASP up lift across the segment in view and even and Bill stratified it across the concentrated global accounts in the broad geography accounts. At best -- at worst we were holding our own even in highly concentrated you know, big mega customers as a testimony to the segmentation of the product as well as the value of the integrated holistic solutions tax that become so talked about by us and now trying -- other people trying to emulate us. That said the tricky thing about digital is it’s a very wide berth of projects in a company someone does the hardest things in the world, and almost every company that I can think of almost without exception we do the hardest digital projects with them. And I think it’s a testimony to high end, in the low end projects the stuff is less challenging, they may be not be as challenged by frequency area or whatever it turns out to be, some of the incumbent processes are just fine, they are just good enough. Now, we can show better productivity across that whole thing so we should proliferate a waterfall down and that’s the question of time, and it knows a low end projects are those lower with the technologies just good enough that’s where the pricing pressure is really intense and that’s what why we are so pragmatic or objective about the conversion cycle there, what I would -- said before is absolutely true, someone is try to consolidate or change and is driven by productivity and gone and done and made the change we’ve always won those things across either both our mixed signal and digital technology gives me some confidence that we know what we are doing and that we are getting a value it’s one of the reasons power was a good focal point because it is a very objective conversation to have and I got three more of them right beyond power -- behind power that we were going to do. They have to do with virtualizing and managing the computing architecture and how it impinges into the physical implementation. We are already out there talking with customers about that, and that’s the mechanism that you can use to drive or derive value if not then it is, it’s just becomes a mine is better than yours and who is going to go cheapest and that’s there is no long term win in that for anybody.

Mat Petkun

Okay, then one really final question from me. You know, when I talked to investors there is a lot of misunderstanding and confusion and I think I’m confused as well. You had a 34% year-over-year declining your product revenues implying another 30% next quarter that’s not just end market related you know, we have seen a smattering of companies report and it’s been nowhere near that severe can you help us understand what else is it play in your year-over-year declines and product revenue?

Michael Fister

The total revenue is down 20% so, it’s just try to get that sizing. It really is about the timing that we described you know we did expect a more difficult environment, we are being more patient, we showed at Analysts Day a lot of the progress we’ve made with improving our run rate at the same time showing that we can, with segmentation, particularly in the geography accounts and hold for value and we were also I think realistic that in this environment customers will take more time. So, we factored all of that in to our outlook for the year and naturally what’s driving it’s a matter of when we close if we believe not if we close business and some of it's going to move out beyond this year and you know that’s what is really driving the decrease.

Bill Porter

I would say that there is two other things to think about, if you look at the services component of our business take it as a good news or bad news, I’m a helpful guy, I think that stability that has a percentage that’s what's driving some of your fractional computation that was very stable and that is an asset -- a differentiating asset. Companies need help and trying to use the method in a new way, deployed in a new way, we’ve got 400 experts that know a lot about design that we get paid for that’s why –that is very stable and I think it’s a great asset. We certainly use it to our differentiation in all the consolidation and customers value that. And so, on a quarter-by-quarter basis now I think you can really confuse yourself if you look at those things in isolation across the years since it’s a relatively small part of our business, it then equalizes itself.

The second thing that I would think about, I have seen speculation about market segment shares shift or loss, I made two strong statements about the consolidation that I’m standing by and I can tell you me and Kevin Bushby are out there everyday upfront in personal, we know where we were going, we have a loss market segment share across anywhere. Anywhere and so you know it will be very interesting to see what happens with the rest of the world as they go along and you guys try to integrate it. We can only talk about what we do but the precision that we try to do is to estimate that distribution in time across a year's boundary and I think it’s important to look across the years as opposed to any quarter especially with the cyclically of the business and the current macro economic effect on timing and buying cycles. And then see what happens and you know we’ll measure through the year and at the end of the year I’m sure quarter-by-quarter we will have a conversation about this but, you know we are thoughtful and pragmatic and objective about it and that’s the best we can be.

Mat Petkun

Okay thank you.

Bill Porter

Sure.

Operator

Our next question comes from the line of Sterling Auty.

Sterling Auty

Yeah thanks, hi guys. So first question is can you talk a little bit about what the decision factors were for Bill’s transition here to Chief Administrative Officer?

Michael Fister

Simple, we got great talent in the company, we’re continuously trying to take advantage of that so that we can drive bandwidth in other areas and the growth strategy of the company we’re perfectly timed to continue to not only think continue about that but execute on it. Kevin Palatnik as you get to me, he missed that Analysts Day so you know, he is a great guy, has been driving a lot of the financial machine for the last two years as a Controller and it gives Bill a lot more bandwidth to do that we can aggregate some of the other administrative functions that are going to help with those growth strategies and off we go, it doesn’t add anything to layer in it except for focus. And if you look at it on an annual cycle for performance review and evaluation it's perfectly timed with a spring this is when we do these kind of things in the last couple of weeks we also had another one of very talented guy named Jim Carey, Center General Counsel and Smith is off helping us some other stuff on the bandwidth side lot like Bill is. And we have structured and continued to structure the company at the top line management so that we can go and evolve it and grow it and that’s what all of us are doing.

Sterling Auty

Okay I’m the 10% customers, are you seeing or just a large deals in general, are you seeing any of these large deals being chopped up in doing smaller purchases now and just trying to breakup some of the purchasing?

Michael Fister

Sometimes, yeah Bill and I both commented on it in response to the previous questioning if someone can do that for value across the project to your geographic boundaries they will do it. Some companies are not structured to do that. Some companies want to operate in the historical way and will characterize it majority or not and they want to have one mega thing that they can do. In my time in the company these were very hard to try to get people to have multiple engagements and break those structures also they can pass the productivity difference. So, they can deploy more officially and the cards are very good mechanism to do that, but it’s not uniform across all customers.

Sterling Auty

Okay, and looking at the product group, the functional verification area in terms of performance there how much of that do you think is just kind of the macro environment where it is, how much of it do you think it as customer are focusing in other areas right now, how much of it might be from competitive dynamic?

Michael Fister

Well, I think the competitive dynamic for us is all positive, the timing is everything in these adventures. Verification is a top of mind for everybody. It is a automation around the physical and it started with back end where Cadence was very strong and in front end and we are -- our incumbency is growing is very well handled by computing and verification is still large amount of humans in that thing and in typical when I go around and talk to companies they grow that resource at a rate of three to four times of the rate they grow the physical implementation resource. So, after a while the wheels come off the machine and they value automation and so that’s why we lay that category out four years ago when I came in and we have grown it nicely. So, it’s top of mind for everybody, starts with you know, things in the incisive platform for simulation and we’ve grown very nicely to couple that with emulation all the Sydney technology we talked about before is just further complementing that and sometimes what it is sterling is that it is a little bit lumpy. People will execute on a program, the way, the best way they now have and then take the next one as the Greenfield opportunity to do that. And the product project node migration slowed where some of these things become longer to implement because the complexity of the device a building is longer. You see different lumpiness and when they adapt these new technologies but over time over a period of years verification is going to be just the biggest category alive and where you can be seamless with the implementation then you get fantastic predictability. We are seamless not only with the digital implementation but with the mixing of implementation, no one else in the world can do that and that’s the big asset for both and we call and describe it as pool across the product line and it happens. On a quarter by quarter basis it can be a little lumpy though.

Sterling Auty

Last question, can you give us an updated kind of view from your perspective on Magno's analog platform and patent platform and specifically how they are utilizing the Cadence Pcell technology?

Michael Fister

Well, I don’t know I guess I can few things come off of my mind on a mixed signal platform whether its analogue digital full custom memory, RF you know we have a tremendous asset in the incumbency of that technology that we have evolved is extremely complete, that thing I was going today in the prepared remarks about the spectra turbo is satisfying me. Because it’s all seamless and as I go around and talk to customers and I’m very into this, it’s growing that kind of productivity and the value the homogeneity makes. As I have gone around and talked to people I haven’t seen anything significant from any new entrants you know, now I’m not making fun of anybody I’m just reporting and we use that as a measure to make sure that what the technology we’re bringing to bear is relevant but you know we already projected out for years. So, it’s a -- it will be interesting to see what harms overtime. I like our position you know even in a niches like in the thin film display area and some of these other ones we have had you know, tiny niche targeting of some of our mix signals incumbency, we have done extremely well. So, you know I think the value that we have done -- we have done remember we considered and built it up over years over a dozen years there. The Pcells and skill code are another manifestation of that and some of our customers they have a million lines or millions of lines of that stuff that is very sticky for us. You know and so that’s what I would say about all that the Pcell technology is proprietary to us you know it’s well integrated into our tools that we will see what happens but, I have no plans to change at any time in the near future.

Sterling Auty

All right, thank you.

Operator

Our next question comes from the line of Tim Fox.

Tim Fox

Hi, thank you good afternoon. In difference to your comments about now looking at quarterly trends up I wanted to just ask about the Americas and I was just wondering generally is there fundamental shift in where design is being done one would think that might be part of the case but 40% of revenue is one of the lowest levels in my model anyway, 8 or 9 years can you comment at all whether there is anything particularly going on in Americas is just a sign of the macro environment here or is it more a shift in where designs being done and do you expect that to rebound on more with timing issue?

Michael Fister

We had an exceptionally good quarter across some of the other geographic regions as you saw and that some of the quarter by quarter lumpiness I characterize, I am sure Bill has a more colorful word. Some of it’s in macro environment here for sure, the cost pressure in the Americas is acute in most companies and certainly the biggest companies and even now an increasing number of smaller companies are geo operating outside of the United States, India and China are the two biggest areas, some emergence in South America, some emergence in places like Vietnam and we are tracking customer by customer you know their interest because a lot of our value is to operate locally with them, that’s why we have such big labor pools outside of United States as well. I always think the United States is going to be big participant, the homes, the historical size of the engineering teams in the United States is huge and they are highly experienced, so to replace that experience and grow it outside the United States is a tough thing for people to do. But that doesn’t stop them from trying to do that and in some respects there are also taking the availability of co locality with their customers because the systems integrators or developers are outside of the United States. There are huge Chinese companies or Japanese companies and such so I think that’s the logic of it I don’t think it signals any kind of a long term trend yet but this year it will be interesting and watch to see how the cost pressure in the Americas and strength of the dollar and all that kind of stuff factors into it.

Bill Porter

Yeah, Tim. This is Bill. I guess the only color I would add is I think the magnitude is driven somewhat by the timing of business you know in the first quarter its we’ve seen overtime more of our customers gradually going outside the US, I think that’s the trend has been on going but the drop you know to 40% I think a lot of that has to do with just timing I think that will over you know year, year pull itself back up.

Tim Fox

Okay good. That’s helpful. And second question was around the Virtuoso upgrade cycle, I was wondering if you could just give us some update about where that stands I mean it is a very promising upgrade cycle and I guess just wondering whether that’s actually meeting our expectations at this point if you can give us some qualitative numbers around what percentage of the base is upgraded at this point other you are getting the kind of ASP lift that you were looking for in and what’s the prospects for ’08 for this upgrade?

Michael Fister

Yeah the trends that we reported at Analysts Day still stand we are progressing with the technology you know that we’ve got several other kind of releases that are coming out through this year that are targeted is at either subsections of that big domain that, that Virtuoso does or making the conversation easier and we’re very well integrated across a huge number of companies trying it. The trend is very positive that way. That said not all companies are doing the most complicated things and so some of our old Virtuoso will be just fine for them. In that case there are let’s call the proliferation of new Virtuoso is take some time and that’s why we have such a long time constant for it to do it, but so far with what we have done –today and we obviously we’re tracking at very deeply we will look at broad company engagements the proliferation rates and the kind of feedback that we are getting, we’re doing just fine. There is definitely across the complexity of that universe features that are more useful to some companies and others that’s part of the life cycle, they have more features that people want that’s part of the life cycle and you know that’s what we are doing in all these [inaudible] lives and those kind of engagements with users. We targeted the people who are going to be challenging to start with on purpose that’s kind of the way we [inaudible] the thing and the collaborations are going just fine as far as I’m concerned.

Tim Fox

Great, and lastly, for me just one you mentioned major consolidation opportunities earlier on Mike I was just wondering given the environment we are operating in, do you think that there is an opportunity for more of these consolidation opportunities, are you tracking any meaningful ones at this point and do you have any of those embedded in your guidance for ’08?

Michael Fister

We certainly got them in the pipeline, some are more public than others and you might even hear about them through the customers. Since, I know things that I’m not sure testimonial for them I won’t -- I can’t just off the top of my head react to which ones are prominent this year or what the timing is that doesn’t mean that they are not, it just means that I don’t want to misplace any confidences that we have with our customers those are very dear to us. And I think that overtime and I don’t know what the time constant is but over the next years, all companies have to consider that, it's just logical for them to do that and then it’s across do they isolate to geography that they isolate the product line, some product lines move faster than others. And some customers we consolidate their consumer business but their automotive business is come in second tier and that‘s a practical thing, Tim. What happens is you want to de-risk it if you can apply those principles and part of your product line and get it perfected and you can waterfall them over the other parts of the businesses and so it’s complicated, but the breadth of the technology and the variety of the approaches that we have been engaged with customers, had been very engaging for those that have been outspoken about it and more constantly discussing that with the other ones doing and being small alike.

Tim Fox

Great, thank you both.

Michael Fister

Okay, well thanks for participating in the conference call. Unfortunately we run out of time. If you have any other questions, I hope that you will give Jennifer a call and she will arrange to get your question answered. And we will hope to see you at the next conference call. Operator, you can disconnect now. Thank you.

Operator

Thank you. This concludes our conference call for today. Thank you for participating on the Cadence First Quarter 2008 Earnings Call. You may now disconnect.

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Source: Cadence Design Systems, Inc. Q1 2008 Earnings Call Transcript
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