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Synopsys, Inc. (NASDAQ:SNPS)

F2Q08 Earnings Call

May 21, 2008 5:00 pm ET

Executives

Lisa L. Ewbank – Vice President of Investor Relations

Aart J. de Geus - Chairman and Chief Executive Officer

Brian M. Beattie - Chief Financial Officer

Analysts

Raj Seth – Cowen & Company

Rich Valera – Needham & Company

Sterling Auty – JP Morgan

Terence Whalen - Citigroup

Jay Vleeschhouwer – Merrill Lynch

Matthew Petkun – D. A. Davidson & Co.

Mahesh Sanganeria – RBC Capital Markets

Operator

Welcome to the Synopsys, Inc. earnings conference call for the second quarter fiscal year 2008. (Operator Instructions) At this time I would now like to turn the call over to Lisa Eubanks, Vice President of Investor Relations.

Lisa L. Ewbank

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 may make forecasts, targets and other forward-looking statements regarding the company and its financial results. While 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 the call, important factors that may affect our future results are described in our quarterly report on Form 10-Q for the first quarter of fiscal 2008 and in our earnings release for the second 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 second quarter earnings release and financial supplement. All of these items are currently available on our website at www.synopsys.com.

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

Aart J. de Geus

I am happy to report a very full quarter for Synopsys. The revenue came in at $325 million, at the high end of our guidance range while maintaining our uniquely predictable business model with over 90% time-based license revenue. We are expansive within our guidance range and delivered above-target non-GAAP earnings growth of 17%, or $0.41 per share.

We completed the acquisition of Synplicity, a strong technology leader in FPGA designs and hardware-based rapid prototyping. We feel this strengthens our product offerings yielding very strong business levels that support our growth expectations for 2008 and 2009. And we are raising revenue and earnings guidance for the rest of this year.

As may of you have asked us why we are seeing a better environment than our competitors, let me address for a moment the customer landscape.

Fundamentally, things have not changed much from last quarter. The overall economy has been soft bringing some uncertainty to the semiconductor industry. On the positive side, even if mitigated a bit by continued AFP pressure, demand for electronics continues to grow. The main profitability [inaudible] areas are in the memory market, where a number of companies battle for share based on price and capacity. For the rest of the semiconductor industry, we see a number of innovations actions aimed at giving companies larger share and increased competitiveness in market sub-segments. A clear example of this trend is the recently announced wireless joint venture between SC and XB.

For Synopsys, there is little change in our customers’ behavior, including timing and closure rates of contracts. And although we have seen some aggressive pricing attempts by competitors trying to make their quarter-end numbers, Synopsys has fared well. In this environment customers are searching for optimal EDA partners and closer collaboration. Our leading technology, comprehensive solutions, conservative business model, and strong field support make us a preferred candidate for broader and closer relationships.

Indeed, just this week we announced that yet another leading semiconductor company, Matsushita, maker of the Panasonic brand, has selected Synopsys to be the primary EDA supplier. Their decision is supported by an expanded license and collaboration spanning design, digital AMF verification and manufacturing. This agreement indicates a further step towards delivering better productivity through more integrated solutions to our top customers.

In summary, companies are understandably cautious in their spending. However, Synopsys is executing well and we continue to grow our business run rate. A key benefit of our ratable business model is its enhanced predictability, which means that we’re already well into the planning of 2009 and 2010.

While we will provide 2009 guidance after our fourth quarter I want to respond to your requests with some preliminary thoughts on next year. Based on our business currently running ahead of plan, the closure of the Synplicity acquisition, what we see out of a healthy pipeline of opportunities and steady organic growth, our objective for 2009 is to reach double-digit revenue growth again. In addition, we plan on continued operating margin expansion, supporting double-digit non-GAAP EPS growth in 2009.

With that backdrop, let me provide some product and technology highlights for the quarter. Across the board we’re doing well and feel momentum in many accounts. This momentum was visible at our Western U.S. User Group meeting in March with record attendance of over 2,000 engineers. The program highlighted a complete solution from system to manufacturing. As a result we saw a substantial increase in FND from system companies and foundries. Sessions on low power were the hottest, no pun intended, and was standing room only for our IP and manufacturing sessions.

One of the particularly well received perspectives has been the progress we’re making in use of multi-core multi-thread computation in our product. These new capabilities result in substantial speed-ups, such as a 2x performance booth and extraction, using dual cores. In our mixed signal verification we delivers 3x performance improvements to HSPICE on a single CPU and a further 2x on four cores.

We also pioneered a novel capability for concurrent mass physicists and mass data processing shaving off significant time in this crucial pre-manufacturing step.

Also in Q2 we launched Eclypse, our low power solution. Eclypse is a comprehensive suite of system level verification and its limitation technology together with IP, methodologies, and services. Built around UPF, the industry-standard unified power format, it is designed to make adoption of advanced low power techniques easier for both advanced- and broader-market customers.

In core EDA, both our digital and analog mixed signal solutions did very well. In Synopsys we introduced design copower graphical a great new extension to design copower that predicts and reduces downstream congestion in place and route. Customer feedback is excellent. They are reporting that congestion avoidance significantly improves design and productivity and scheduled predictability.

In physical design we are seeing a number of customers coming to Synopsys after having experienced challenges with insufficient or immature capabilities from others. In addition, we will soon introduce a brand new router, developed from the ground up that supports multi-core computation. At beta availability today, it significantly improves speed and quality of routing, while factoring very tough manufacturing challenges. Stay tuned for more details.

We are also seeing good progress on the analog mixed signal side. FT Microelectronics recently adopted our XA capability which combines SPICE accuracy with the speed of Fast5 for its advanced marked power technologies.

Additionally we announced the results of our collaboration with TFMC around a new modeling methodology for their 40-nanometer process that improves AMF stimulation while reducing memory use.

Our new custom design solution is on track for introduction later this year. It is already getting very positive feedback from our initial beta partners and sneak previews of the technology at our launch user group meeting in San Jose and Israel generated a great deal of interest.

Now let me turn to our adjacency systems and manufacturing, each group representing about 10% of our revenue. Looking at our entire product portfolio, IP is the one area this quarter that saw some short-term choppiness. This correlates with light results reported by other players in the IP space as well. We remain confident, however, in the importance and impact of this area and are continuing to invest in broadening our offering. Specifically we delivered the industry’s first certified USB 2.05, or mixed signal core, for 45-nanometer processes. The small area and low power consumption make this core ideal for high volume, mobile, and consumer applications.

IP continues to be a hot topic for semiconductor companies. Many of them are adopting commercially available IP while focusing their own development R&D on truly different shading IP blocks. iSilicons for example, which designs chips for communication networks and digital media selected Synopsys as its IP vendor of choice for protocols including USB, PCI express, and DVR.

We also completed virtual platform projects aimed at embedded software development for two major customers in the computing and consumer electronics demand.

In manufacturing, both our mask and TCAB solutions showed very good progress. In the mask area Proteus OPC was selected by two important customers. One large consumer electronics company chose us not only for their very advance 32 nanometer process but also to replace the incumbent of previous process nodes. After substantial competitive evaluation the other, a global leader in storage solutions, also chose Proteus.

In TCAB, Toshiba adopted Venturas for simulating manufacturing process such as etching to optimize complex device structures. As a result Toshiba is able to develop technologies faster, reduce costs, and improve yields.

Another interesting note is that for many emerging solar cell start-ups Synopsys’ TCAB is a promising optimization solution in the global quest for green power.

Finally, last week we closed our acquisition of Synplicity, which is very promising from at least four angles. One, we are being joined by a very capable technical team. Two, Synplicity is a clear leader in the directly adjacent FPGA design area. Three, Synplicity brings an opportunity to cross sell products to each other’s customer base. And last but certainly not least, Synplicity’s growing rapid prototyping business will allow us to put increased emphasis on the embedded software market segment.

We plan to rapidly integrate the company around the same operating margin as Synopsys. Synplicity will thus contribute positively to our EPS growth next year while simultaneously becoming central to our strategic systems thrust going forward.

In summary, Synopsys has momentum and expects continued strong financial execution for three key reasons. Our broad product portfolio and critical mass are enabling customers to focus on fewer, more leveraged vendor relationships. This year Synopsys will see the continuous roll out of compelling technology and exciting new products. And finally, our focus on EPS growth through expense management, revenue growth, and a uniquely predictable business model makes Synopsys a long-term, competitive, and stable partner.

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

Brian M. Beattie

In my comments today I will summarize our financial results for the quarter and provide you with our guidance, including the financial impact of our recent Synplicity acquisition. As a reminder, I will be discussing certain GAAP and non-GAAP measures of our financial performance. We have provided reconciliations in the press release and financial supplement posted on our website. In my discussions all of my comparisons will be year-over-year unless I specify otherwise.

Synopsys delivered solid second quarter results highlighted by very strong business levels, double-digit revenues and non-GAAP earnings growth and continued operating margin expansion. In addition, we repurchased $87 million worth of Synopsys shares and exited the quarter with more $800 million in cash, which of course is prior to the Synplicity acquisition that closed just last week.

Now let me provide some additional details on our financials. Total revenue increased 11%, to $324.6 million, at the high end of our target range with particular strength in Japan. From a product perspective, we continue to see broad-based demand for our solutions, our Galaxy design and discovery verification solutions, which make up our core EDA platform, each delivered revenue growth in a double-digit range during the quarter. One customer accounted for slightly more than 10% of our second quarter revenue.

Turning to expenses, we remain focused on cost and expense management. Total non-GAAP costs and expenses were $249.7 million and expected sequential increase due to the timing of quarterly expenses, including variable compensation and some hiring that shifted out of Q1 into Q2. For the quarter non-GAAP operating margin was 23.1% and we’re well on track to achieving our target operating margin for the year of 23%. We remain committed to driving to the mid- to high-20s in the coming years as we continue to focus on profitable revenue growth.

Turning now to earnings GAAP earnings per share were $0.27 with cost and expenses totaling $275 million. This included $12.4 million of amortization of intangible assets and $17.8 million of share-based compensation. Non-GAAP earnings per share increased 17% to $0.41, exceeding our target range. We achieved these strong results while continuing to make disciplined investments that position us very well to capitalize on the long-term opportunities we see for Synopsys.

Our non-GAAP tax rate was approximately 26% and came in at the low end of our guidance range. For the entire year we expect a non-GAAP tax rate of approximately 26%, which does not assume renewal of the R&D tax credit in the United States.

Given our predictable business model, revenue visibility remains strong and we continue to execute well on contract mix. Up front revenue was 4% of total, well within our target range of less than 10%. And as expected, greater than 90% of Q2 revenue came from beginning-of-quarter backlog.

Our ability to consistently deliver solid financial results illustrates the power of our highly time-based business model. 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 $50 million year-over-year to $817 million, which again is prior to the Synplicity acquisition. We generated $35 million in cash from operations during the quarter. We expect higher cash generation in the second half of our fiscal year, partially driven by the expected annual payment from a large customer in the third quarter.

We continue to target 2008 operating cash flow of approximately $325 million with free cash flow generation of $280 million. I would also like to comment that our cash balance is not exposed to auction rate securities and we are pleased with the high quality and conservative risk profile of our investment portfolio.

We purchased 3.8 million shares of Synopsys stock for $87 million and have approximately $260 million remaining on our current authorization. Diluted shares outstanding for the quarter were 145 million.

Q2 net accounts receivable totaled $172 million and we maintained industry-leading DSOs of 48 days, reflecting the high quality of our AR portfolio and the timing of invoices. Deferred revenue at the end of the quarter was $587 million and ended Q2 with approximately 5,300 employees.

As Aart highlighted, we are excited to have closed the acquisition of Synplicity last week. It was an all cash deal, valued at approximately $181 million, net of cash acquired. We expect the transaction to be slightly dilutive to our non-GAAP earnings in fiscal 2008 and accretive in fiscal 2009.

Although we’re still early in the planning process, I wanted to provide you with some preliminary thoughts underlying our FY2009 goals of reaching double-digit revenues and EPS growth, along with operating margin expansion.

Traditionally the way we think about our business is to limit expense growth to about half of revenue growth. Now as you model 2009, at this point, we believe that ratio would temporarily be in the 70%-75% range due to the near term revenue transition and integration of Synplicity.

Before I provide our third quarter and fiscal 2008 guidance, let me make some general comments. Our targets reflect an increase in our base Synopsys revenue and EPS guidance and also the addition of Synplicity. We expect Synplicity revenue to be modest in Q3 and slightly higher in Q4, primarily reflecting the purchase accounting haircut that was applied to deferred revenue.

Given the highly complimentary nature of the two companies’ products, our goal over time is to realize revenue synergies, including cross sell opportunities into the combined installed base. We also believe there are opportunities for expense synergies over time, such as IT integration and typical G&A efficiencies. Now, please keep in mind that we closed the transaction only a week ago so these assumptions may change as we complete the valuation work and the integration efforts.

It’s also important to note that to ensure minimum impact on customers; we have kept both their development and sales organizations virtually intact. Finally, even with the slight dilutive effect from the acquisition in 2008, we reiterate our original operating margin target of 23%.

Now moving on to guidance. For the third quarter of FY2008 our targets are: revenue between $335 million to $343 million; total GAAP cost and expenses between $290 million to $308 million, which includes approximately $17 million of share-based compensation expense; total non-GAAP cost and expenses between $260 million to $270 million; other income and expense between $0.0 million to $3 million; a non-GAAP tax rate between 26% to 27%; outstanding shares between 143 million to 148 million; GAAP earnings of $0.18 to $0.24 per share; and non-GAAP earnings of $0.38 to $0.40 per share. We expect greater than 90% of the quarter’s revenue to come from backlog.

Now our fiscal 2008 outlook. We are raising our revenue range with our new target between $1.325 billion to $1.340 billion, a growth rate of approximately 9.5% to 10.5%. At this time we anticipate that Synplicity will contribute approximate $20 million to $23 million in revenue. A non-GAAP tax rate of approximately 26%. Outstanding shares between 146 million to 149 million. GAAP earnings per share between $0.99 to $1.11, which includes the impact of approximately $65 million in share-based compensation expense. Non-GAAP earning per share of $1.60 to $1.64. We’ve increased the low end of our guidance range by $0.04 and the top end by $0.03, even taking into account the $0.02 to $0.03 dilution we expect from Synplicity. Cash flow from operations of approximately $325 million and as I mentioned earlier, we’re targeting a 23% non-GAAP operating margin for the full year.

As a reminder, our guidance excludes Synplicity operating revenues and expenses through May 14, as the acquisition closed on May 15.

In summary, we once again demonstrated solid financial execution. We’re performing well against our strategy while delivering top and bottom line growth. Our results illustrate continued momentum in our business and our proven ability to execute in a competitive environment.

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Raj Seth - Cowen & Company.

Raj Seth – Cowen & Company

Brian, you said $20 million to $23 million from Synplicity. Is most of that just purchase accounting or, they were running what, $17 million a quarter or something, or are you having to change the revenue recognition itself to get to your model? What’s going on there?

Brian M. Beattie

It’s clearly the haircut you get in purchase accounting related to the deferred revenues. And again, it’s a public company, you can see the amount of deferred revenues they had at the end of their first quarter, and to that it’s a very large haircut, based on purchase accounting rules. Somewhere in the 90% range of that is lost, so you basically start over again on the revenue basis.

Raj Seth – Cowen & Company

Right. And what kind of model were they running? Do you have to shut their model at all or not really?

Brian M. Beattie

Not really. It’s about 60% up front, about 40% ratable and, again, as we look at how we integrate those transactions with ours, it will be in that range we anticipate. But it may swing around again, based on how we do the transitions. But that’s the number we’ve built in for now.

Raj Seth – Cowen & Company

Aart, I think you may have mentioned implicitly in your comments, but from a bookings perspective, are bookings on plan, above plan? How have bookings been trending in this environment which you acknowledge at the edge is probably a little bit more uncertain than it has been?

Aart J. de Geus

Overall they are a bit above plan. I mentioned the fact that we felt that our business was a bit stronger than what we had planned for. I’m always fairly relaxed about the quarter-to-quarter situation but, in general, this year is unfolding quite well for us. And that gave us additional confidence that integrated with the forward-looking model that we have, we could already make some very good comments for 2009.

Raj Seth – Cowen & Company

You mentioned progress in the multi-core multi-thread applications you have coming. I’m just curious, at Nvedia’s last analyst meeting, they’ve been pushing very fine-grain GPU architectures in a number of applications and there were actually a couple of EDA startups talking about really big speed ups using these kinds of architectures.

I’m just curious what thoughts you have about how real or not real that is? Is that something you can do? Any thoughts there would be appreciated.

Aart J. de Geus

We actually have in-house a centralized effort to look at a broad set of architectures because many of these things are promising but they’re also fairly immature and there’s going to be a broad swap from essentially duplication of the standard processor cores, all the way to extremely fine grained a la NVIDIA, or [inaudible] certain type of that transaction.

And so we are engaged with NVIDIA, we are engaged with a number of others and it depends a little bit on which products, what is the most common thing, and it also depends a little bit on how supportable will this be going forward.

So I think we are at the beginning of a very exciting age which is the whole age of computing is changing. And that will open up doors for us. And having seen this coming we did focus the entire company to make sure that all our products have plans. As a matter of fact, starting last year and a lot this year, we are now rolling out practical implementation.

Operator

Your next question comes from Rich Valera - Needham & Company.

Rich Valera – Needham & Company

Aart, can you say if that assumes backlog, year-over-year backlog growth, heading into fiscal 2009? I assume it would but I just wanted to confirm that.

Aart J. de Geus

Well, we actually give out the backlog at the end of the year, so actually did not make any statements on backlog, which should neither be read as positive or negative. It’s just that we want to stick to that rule. Largely because we want to stay away from giving fine-grain detail on the bookings as we don’t want to be back in the situation of having to negotiate at the end of the quarter with customers on what they hear via Wall Street.

Having said that, clearly our backlog is one of the key assets that over time in aggregate tends to keep growing as we want to enter the next year complicitly with about 80% of revenue in hand. The next quarter is 90% in hand. And all in all we’re well on track with that.

Rich Valera – Needham & Company

Brian, can you say, will the affect of the loss of deferred revenue at Synplicity be largely over in 12 months? Is most of that a 12-month duration?

Brian M. Beattie

That’s right. It’s over a 12-month duration. So the rest of this year and a little bit into 2009.

Rich Valera – Needham & Company

Then we should see the full, natural run rate of Synplicity in the second half of next year?

Brian M. Beattie

Yes. That’s right.

Rich Valera – Needham & Company

And with respect to the Matsushita consolidation deal that you just announced, I would assume, but you didn’t really want to, that you’ve increased your run rate there? Is that a safe assumption, Aart?

Aart J. de Geus

Actually, I think I indirectly said exactly that. Yes. Not only did we increase the run rate but we also broadened the product portfolio utilization.

And Matsushita is an outstanding company. Many of you may remember that they were actually the first one that announced production 45-nanometer chip, which probably we were involved in. And so they have been a very good technology driver partner/user for a number of years and having them be in the category of preferred vendors for us is really terrific.

Rich Valera – Needham & Company

Did that booking happen after the end of the quarter?

Brian M. Beattie

No. It’s in Q2.

Operator

Your next question comes from Sterling Auty - JP Morgan.

Sterling Auty – JP Morgan

Brian, you gave us the inclusion of Synplicity for this year but as you get the deferred revenue write down back, what should we think about the inclusion for 2009?

Brian M. Beattie

Well, again, at this point, we’ve provided some very preliminary views on 2009 and that performance from Synplicity, as you heard both with partial haircut in the first part of the year and then full run rate in the second half, combined with run rate is where we anticipate reaching the double-digit revenue growth again for next year. So we’ve built that in. And of course, we just closed the deal last week, so as we complete both the integration work, really understand the full detail of all of the license transitions that we go through, the amount of outstanding deferred and so to go through in our valuation work, we will be able to give you more detail and we anticipate doing that at the end of the year.

Sterling Auty – JP Morgan

And this was the second quarter that deferred revenue actually declined sequentially. Can you give us an update on how we should think about that?

Brian M. Beattie

Yes, absolutely. Again, as everyone understands, deferred revenue only includes what we’ve invoiced but have not yet taken into the revenues in the quarter. And again, it will fluctuate quarter-to-quarter based on the timing of the contracts and the invoices. Now, in Q3 we expect our deferred revenues should again increase. Because of our annual in-advance payment from our most significant customer. That, if you recall, shifted from Q1 renewal date to a Q3 contract term. So each Q3 we would anticipate deferred revenues going up and we anticipate seeing that in this third quarter.

Sterling Auty – JP Morgan

And then on the cash flow, I believe that the last couple of quarters you actually talked about cash flow for the year being greater than $325 million and now you’re talking about it being approximately $325 million. I’m not sure if I’m just nit-picking, but is there something that you’re looking at a little bit differently in terms of cash flow generation for the year?

Brian M. Beattie

No, we’re really close to that original number. We’re saying about $325 million, which again, we view as being for the year. And it’s just actually now getting through the integration of a pretty significant acquisition to really understand the full cash flow impact. So we’ve got a little bit of room to maneuver. So we’re still committed on that $325 million level, for the year, which is a real strong cash flow from the operations.

Sterling Auty – JP Morgan

Can you describe for us the current year FX impact on revenue and expenses and what you’ve included in your outlook?

Brian M. Beattie

From a revenue perspective, the company is primarily denominated in U.S. dollars, except for our Japanese business. So on a revenue perspective you don’t see any significant impact. And even from the expense side of things, based on our hedging plans and the coverage that we provided ourselves, we see no material impact on expenses or EPS for the year. So we’re locked in for the year and do not anticipate any deterioration based on movement in the U.S. dollar.

Operator

Your next question comes from the line of Terence Whalen - Citigroup.

Terence Whalen – Citigroup

My question relates to the outlook for 2009 for operating expenses to grow above the expectation of half of revenue growth. Brian, I think you mentioned 70% to 80% of revenue growth, is that correct?

Brian M. Beattie

Yes. 50% to 75% which we see as a temporary impact, primarily related to the acquisition, right? The revenue growth is slower than the regular run rate was for that business for that business but the expenses you get immediately on day one. So again, recognize both the haircut on the revenue side, and again, as we integrate the models with ours, that’s how we help you in terms of planning the operating of the financial models, as we look forward. So just to give you an awareness that we see that ratio temporarily increasing for 2009.

Terence Whalen – Citigroup

And would that have been the regular below half of revenue growth, without the Synplicity acquisition?

Brian M. Beattie

It’s about that rate, that’s right. As we have been modeling out the year, given the visibility we have and our own target. And again, we remain committed to that operating margin expansion that you’ve seen us on for the past few years. We have about 300 basis point improvement in operating margin this year, and again forecast expanded operating margins again for 2009, and then ultimately reaching that mid- to high 20s over the next two years.

So, you can see us both managing that expenses in line with the anticipated revenue growth, which has relatively high predictability to both sides of that equation.

Terence Whalen – Citigroup

Related to the cash flow impact of Synplicity for this year. You maintained your $325 million guidance for fiscal 2008, before and after the acquisition. What’s the net cash flow effect of that acquisition?

Brian M. Beattie

Well, the net cost of the acquisition is $181 million, net of the cash incurred as the transaction happens. And then relative to the impact on 2008 from the Synplicity business unit as it stands, we really do not anticipate any deterioration of our cash flow. It’s about a wash for this year as we look at both the revenue projections, collections, and expense run rate that we’ll see.

Terence Whalen – Citigroup

Aart, it seems like this marks the fourth major account consolidation in about as many quarters. While looking at the competitors we haven’t the same level of account traction. What, speaking for yourself, what do you attribute this string of customer traction and customer [inaudible] that you’ve alluded to? Is it technology position? Is it a benefit of having gone to the subscription model? Is it the current economic environment at customers? Could you maybe add some detail there?

Aart J. de Geus

Sure. I think there are two of the three that you mentioned that are most important. Technology advantage and economic model. The technology advantage is increasingly clear as you move to smaller geometries and dramatically more complex chips. And in very simple terms, if you glue together even best-in-class tools you increasingly get worst-in-class results. And so a more and more integrated flow is an absolute necessity to finish the chips and finish them on schedule. And so from that perspective there’s a big advantage of teaming up with somebody you can trust for that.

I would add to that technical angle that the very support model is also important, meaning that we have very strong fields teams that are now increasingly involved in the finishing of chips with our customers and it’s just a substantial risk reduction mechanism for them.

Now, on the other side of the equation it is very clear that the semiconductor industry, overall, is looking for efficiency and you can see that on how they structure their businesses more towards a focus on certain market segments. Well, that famous efficiency can be driven by being much less haphazard on how they spend their money on a variety of tools. And so, simply put, they get much more bang for their buck by teaming up and so we have had the economy pushing us but the technology is really the justification.

Operator

Your next question comes from Jay Vleeschhouwer - Merrill Lynch.

Jay Vleeschhouwer – Merrill Lynch

Aart, I would like to explore the Synplicity transaction with the following question. Do you regard Synplicity as being more than a medium size or routine technology filler acquisition and perhaps something more impactful, and if so, does it have a natural opportunity to be a nine-figure business for you where, even after 14 years and it’s own acquisitions it really wasn’t much more than a mid-eight figure business. Is there a significant subtle tens of millions of dollar up side opportunity here from what you’re getting there?

Secondly, Brian, could you elaborate on the Japan up side in the quarter. It was an unusually large increase which was not correlated to any sequential change in your upfront revenues so there must have been some larger amounts, some non-linearity coming out of backlog related to your Japan business, it would seem.

Aart J. de Geus

Okay, Jay, first to the Synplicity situation. Simply put, the answer is absolutely yes. I mean that. I see multiple opportunities coming with Synplicity. Let me start with the obvious one, which is, they are in a market segment that is completely adjacent, FPGA. And in all fairness has been somewhat stodgy over the last few years. However, if you look at FPGAs you can see that they are very rapidly adopting the most advanced design nodes, while a number of the designs are languishing behind the older nodes.

That’s another way of saying that FPGAs could well become more attractive for a set of customers, and they become even more attractive if you add to the FPGAs the Synopsys IP position and some of our verification tools. So that’s one reason.

The second reason and I think that’s one that ultimately ties even more to your comment, is the fact that Synplicity has built a very interesting rapid prototyping verification business. And it is very interesting because it touches this interaction between hardware and software and we have felt for quite a while that over time the embedded software was going to become more and more of a nightmare from a productivity and predictability point of view. And that if we can add some value there, we should be able to build that business.

And so, as Brian said, we just closed the transaction a few days ago. And so the time line is still quite a bit open, but fundamentally I support all of your comments whole-heartedly.

Brian M. Beattie

And maybe I’ll pick up your second point, Jay, on the Japanese business. It was extremely strong in the second quarter for us. And we named some of the wins in the quarter so far, but it was extremely strong for us.

The other advantage we had with that is both the annual fiscal years, for most Japanese companies, ends in February. So we were able to close many of the deals in Japan earlier than towards the end of the quarter, therefore, with our ratable revenue model we were able to get almost three full months of revenue from that. So that really helped our business pick up.

And secondly, when you look back at the business of Japan, our trailing four-quarter revenue is about a 10% run rate. So, again, that’s in line with our overall revenue growth. But, again, Q2 is the big year end and great results that were put up.

Jay Vleeschhouwer – Merrill Lynch

Just a shorter-term question. First, could you comment at all on what you’re seeing in terms of unscheduled or termed business? If there is anything meaningful going on there and we often speak about platform or multi-product deals, but are you seeing any changes at all in demand for large singe-product deals? Anything of that kind?

Aart J. de Geus

We’re looking at each slightly puzzled because I think fundamentally there’s nothing that stands out from that perspective. On the other hand, there’s no question that the notion of platform is becoming more and more important from my earlier comment which is that integrated complete solutions is what customers are looking for. So you can call it platform, you can also call it just more comprehensive transactions. But we are definitely growing on the basis of customers saying the overall offering of Synopsys stands out well.

Jay Vleeschhouwer – Merrill Lynch

You mentioned a new router. Could you help us understand how you foresee the adoption or migration of that, particularly in the context of earlier router initiatives from 6-8 years ago?

Aart J. de Geus

Well, we have not formally introduced the product yet so I want to be a little cautious about exactly how we position it in the context of our products. But clearly I think we have been able to continue a strong push of XG evolution in the last few years. And one is I think in addition to that is that we are using multi-core. Now, much more routinely I would say.

The fact that the router is already in beta, the results are excellent. But as a matter of fact even one of our customers decided to use it for production. So, they have a high degree of confidence. I believe it may even be mentioned in the Matsushita press release. So this thing is well on track.

Operator

Your next question comes from Matt Petkun - D. A. Davidson & Co.

Matthew Petkun – D. A. Davidson & Co.

Aart, could you comment a little bit about what’s going on in your DSM part of the business. And specifically, it looks like you have really been trying to build out your tool set around the TCAB product offering. Are you relying less on the assets you acquired from HPL on the test chip methodology for DSM?

Aart J. de Geus

All of your comments are correct. We are clearly focusing on those areas in the DSM, or manufacturing side that have been most successful. And the TCABs offering is of increasingly broad interest at a number of places. In the development of new technologies, in the development of new [inaudible] modules, transistors, and the manufacturing itself and then I think some of the cool applications, literally, are clearly those things that new materials use for solar cells, power devices, illuminations, and things like that. So I think there’s going to be a lot of creativity in the world and on these topics and our capability I think will be central to developing that.

On the test chip side, we have focused mostly on the yield management aspect that we got from HPL as being the one that is more rewarding for us. But so we continue to tune the operating a little bit as a function of where we see traction.

Matthew Petkun – D. A. Davidson & Co.

Brian, I think you mentioned that you bought back $87 million of Synopsys shares this quarter. How many actual shares did you buy back or what was the average price?

Brian M. Beattie

Year to date we’ve repurchased 7.2 million for $170 million. I think that’s averaging at about a $24.00 range. Just averaging it out. That’s again, more than we did all of last year, as well, at this same point in town. I think the average price in the second quarter was about $23.00 and it was 3.8 million shares.

Matthew Petkun – D. A. Davidson & Co.

Brian, another caller asked about the change in deferred and I understand in general that it’s going to decline in certain quarters, but I’m more interested in the more graphic change in the long term deferred and what I should be reading into that.

Brian M. Beattie

You’re saying from the perspective of Synplicity’s deferred revenues?

Matthew Petkun – D. A. Davidson & Co.

No. The long-term portion of your deferred revenues. Fell from $80 million to $65 million, so it was down $14 million, whereas just the traditional deferred, it was down less.

Brian M. Beattie

Right. Your up front deferred over the next year is in the short term and beyond one year is there. So really what happens is your contracts that mature, they roll into the next short-term perspective. So, I feel like that’s the one that you watch the most. And again, the movement between the two accounts, in general, for all of deferred revenues is really not that material. As I say, it’s really based on the timing of the annual renewals for these contracts and, as I say, that combined number is going to go up pretty significantly in the third quarter.

Operator

Your next question comes from Mahesh Sanganeria - RBC Capital Markets.

Mahesh Sanganeria – RBC Capital Markets

What would you say one can expect to be the incremental revenue [inaudible] $70 million dollar run rate?

Aart J. de Geus

Maybe going a little bit sideways onto Jay’s comments and question. Already next year, the contribution of Synplicity and Synopsys will be fully integrated and so we do not plan at all to follow that company in that fashion. So from an incremental point of view it’s going to be a little bit difficult to say. We have clearly said that we will be delivering double-digit revenue at least that is our plan for next year.

What is clear, though, is that we want to rethink how to look at Synplicity from the perspective of can we cross sell between our respective customer bases, how can we take advantage of the new position in FPGA with some of our other products, and most interestingly, what can we do to accelerate the system side of that business.

So I think we’re surrounded by opportunities and how we will prioritize them is a function of precisely the planning that has started about this week.

Mahesh Sanganeria – RBC Capital Markets

Could you give some broad outline on what are some of the specific incremental products that you are focusing on?

Aart J. de Geus

You mean from Synplicity?

Mahesh Sanganeria – RBC Capital Markets

Yes.

Aart J. de Geus

Well, they fundamentally have two major product lines. One is the product line that is addressing the synthesis in the creation of FPGAs. And therefore be head toward [inaudible] Excel as their main silicone partners. And so there are a lot of opportunities to broaden that relationship because Synopsys also has a strong collection of IP blocks and as the FPGAs become more complex a number of these IP blocks could reside very well on FPGAs. So there’s a lot of opportunity there.

The other key product line is really the one that is aimed at helping embedded software development by creating rapid prototypes of a design before the design is actually manufactured so that the software people can start developing this. And so that’s a product line called Confirm and really helps in the verification of all this. And so there, as well, I think we have a lot of opportunities to accelerate adoption because the old Synopsys field team, of course has a lot of customers that greatly benefit from these capabilities.

Mahesh Sanganeria – RBC Capital Markets

In the tradition product area could you point out some specific areas where you folks are reducing the run rate?

Aart J. de Geus

I mentioned earlier that increasingly our customers actually tend to buy a broad collection of our tools because the tools work really well together. And so what we can see is that the run rate of our customers with the vast majority of the large deals we do, are increasing. And this has always been a high importance when you have a ratable business model because you essentially would like to increase the commitment of the customer steadily as he commits for the next three years. And the vast majority of our deals are exactly around that time frame.

And so for this quarter and last quarter we have done particularly well in that direction and that has been one of the ingredients where we’re saying that in addition to the Synplicity acquisition we have organic growth and we see that not only were we able to increase our guidance for this year but also give you a sneak preview for next year given the number of people that were worried that the market was not doing well for us. I think we’re doing very well.

Mahesh Sanganeria – RBC Capital Markets

Is it fair to say that were one to suppose the contribution of Synplicity to Synopsys for fiscal 2009 one would have considered a mid [inaudible].

Aart J. de Geus

Well, clearly the addition of Synplicity improved things. We are actually tacking on pretty good growth given the overall outlook in the market and the uncertainty. We’ll see exactly how much we do by the time we deliver and we’ll give you much more detailed guidance at the end of the year. But fundamentally we do see a healthy situation and feel that we have quite a bit of momentum. And so we decided to share with you some of the outlook because a combination of organic growth plus Synplicity I think bodes well for Synopsys.

And a little side note. You probably heard in our comments that we’re also committed to move Synplicity rapidly to the same ops margin target as we have set for Synopsys. And that we will continue to grow the ops margin. So all in all we are sticking to our plans and I think we are delivering well.

Aart J. de Geus

We thank you for your attendance. As usual, Brian and I will be available after the call and thank you very much for your support.

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Source: Synopsys, Inc. F2Q08 (Qtr End 04/30/08) Earnings Call Transcript
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