Synopsys F3Q07 (Qtr End 7/31/07) Earnings Call Transcript

| About: Synopsys, Inc. (SNPS)
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Synopsys, Inc. (NASDAQ:SNPS) F3Q07 Earnings Call August 22, 2007 5:00 PM ET

Wall Street Breakfast


Lisa Ewbank - Vice President, Investor Relations

Aart J. de Geus - Chairman of the Board, Chief Executive Officer

Brian M. Beattie - Chief Financial Officer


Harlan Sur - Morgan Stanley

Matt Petkun - D.A. Davidson & Company

Jay Vleeschhouwer - Merrill Lynch

Terence R. Whalen - Citigroup

Mahesh Sanganeria - RBC Capital Markets

Richard Valera - Needham & Company

Dennis Wassung - Canaccord Adams


Ladies and gentlemen, thank you for standing by and welcome to the Synopsys earnings conference call for the third quarter fiscal year 2007. (Operator Instructions) At this time, I would like to turn the conference over to Lisa Ewbank, Vice President of Investor Relations. Please go ahead.

Lisa Ewbank

Thank you. Good afternoon, everyone. With us today are Aart de Geus, Chairman and CEO of Synopsys; and Brian Beattie, Chief Financial Officer. During the course of this conference call, Synopsys may 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 during this call, important factors that may affect our future results are described in our annual report on Form 10-K for fiscal 2006, our recent quarterly reports on Form 10-Q, and in our earnings release for the third quarter.

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 third quarter earnings release and financial supplement. All of these items are currently available on our website at

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

Aart J. de Geus

Good afternoon. I’m happy to report that Synopsys again produced a very strong quarter. Excellent business execution brought us strong revenue and earnings growth, as well as solid cash flow. Our robust technology was rewarded by increased customer momentum and our focus on marketing strategy is making visible progress.

Let me begin with the main financial highlights. In Q3, we delivered excellent earnings growth with non-GAAP earnings of $0.32 per share, a 50% increase over the same period last year. Revenue in the quarter grew 10% year over year to $304 million. From an orders perspective, we had by far the largest quarter ever with a book-to-bill of well over 2.

We managed costs well. Non-GAAP expenses were within our expected range of $247 million. For the year, we are well on track to deliver on our operating margin objective of 20%. Going forward, we remain committed to a target in the mid to high 20s over the coming years.

Let me now briefly comment on the overall semiconductor landscape. In Q3, the environment did not change significantly from the previous period. Memory pricing is clearly strained, although overall semiconductor demand continues to grow unabated.

A number of companies are reassessing their manufacturing options, including the possibility of sharing capacity and technology developments. The move to smaller geometries meanwhile is not slowing down. In fact, one of our customers has already announced a 45-nanometer consumer chip that has moved from design to production shipments.

Needless to say, the technical challenges of 65 and 45-nanometer design are substantial. There are hundreds of millions of transistors, laying out the physical design for optimal timing and low power, minimizing the physical effects on yield, all under severe schedule constraints on an [upward] path.

However, these challenges play to Synopsys' strength of advanced technology, complete solution, and sophisticated support. As a result, during Q3 we moved several important long-term relationships to the next level of collaboration. The most visible of these is with Intel. After a substantial set of evaluations, Intel selected Synopsys as its primary EDA supplier.

This comprehensive agreement expands our relationships, not just in terms of commercial duration, run-rate and product utilization, but also in terms of wide-reaching technical collaboration with what is arguably the most advanced semiconductor technology company in the world.

It is important to note that our business was strong this quarter, even excluding Intel. A number of other leading companies, including some we have worked closely with for years, are expanding their relationships with us to redefine the technology landscape and sharpen their differentiation.

One example is a broad agreement with a semiconductor ecosystem leader, which features both a larger commercial relationship and a collaboration to bring advanced solutions to our mutual customers.

This brings me to some product highlights for the quarter. Over the years, we have pulled together an increasingly integrated and broad complement of capabilities. Today, I would like to highlight one area where Synopsys is differentiated with a complete end-to-end solution -- low power.

At 65-nanometer and below, piecemeal solutions offered by many vendors just don’t work. Synopsys’ integrated offerings let customers achieve low power goals while also meeting their other objectives on schedule.

As one example, when ARM, the world’s largest semiconductor IP company, required a low power methodology for their CPU cores, they partnered with Synopsys. We jointly developed a low power methodology that was delivered to the design community at June’s design automation conference. Demand was so high that the publisher cut its release timeline in half and was actually selling preliminary copies.

Our low power expertise permeates both our Galaxy implementation and discovery verification platforms. While Synopsys’ synthesis has had embedded power optimization for well over a decade, more recently our IC Compiler has integrated the most advanced low power layout techniques with great success.

For example, IC Compiler helped NEC achieve 2X performance improvement and still meet a very tough power budget. Toshiba is standardizing on IC Compiler for its highly automated, multi-voltage, tightly integrated flow. Just to expand on IC Compiler for a moment, we have moved beyond the initial deployment phase well into proliferation. On both a business and technology basis, it is doing very well.

On the verification side, we continued our low power focus with the June acquisition of ArchPro, the industry leader in multi-voltage design verification and sign-off. With ArchPro, we are adding unique low-power differentiation to discovery.

Companies such as Renesas, for example, are already using this sophisticated technology in their most advanced multi-voltage designs.

The need for faster and faster verification continues with no end in sight. In both digital and analog mixed signal, Discovery is seeing great technical end-market success.

VCF is seeing important competitive wins and displacements and continues to grow very well. This momentum is driven by strong technology, leadership in SystemVerilog, and a complete, mature verification methodology that has been deployed worldwide, most recently in China.

In analog mixed signal, we also witnessed excellent technical end market progress. Specifically, the ability to trade up accuracy and performance in our AMS 2007 offering was especially well-received by our customers.

Now, to our design for manufacturing adjacency, which continues to show good results. This area has potential both for manufacturing and for the connection between design and manufacturing. The physics of ever-smaller geometry makes designing for acceptable yields an increasing challenge. Over the last five years, Synopsys has developed and acquired advanced technology in both design and manufacturing.

We have been integrating these two domains to enhance yield at 65-nanometer and especially at 45 and below. Our first integrated product was PrimeYield, which links manufacturing information into design. The result is an accurate simulation of complex lithography physical effects before the chips are actually built.

This integration brings customers potentially huge cost-savings by avoiding yield pitfalls. We are beginning to see PrimeYield momentum in both technology wins and adoption. In addition, it has already been qualified for TSMC’s reference flow 8.0.

Looking forward, we are continuing to integrate more steps along the design for manufacturing continuum. For example, we are presently integrating our optical proximity correction and mass data prep solutions. Excellent advancements in our core OCP engine are also bringing us competitive success.

We had two significant wins in Q3 against both a traditional competitor whom we displaced and also a technology win versus a newcomer.

Now to IP, which had another very strong quarter and is our fastest-growing adjacency. Having heavily invested in the quality processes to create a core sophisticated IP, we are now enjoying the fruits of those efforts as IP proliferation becomes much more mainstream.

Today, Synopsys is the recognized leader in connectivity IP, with both analog and digital cores for standards like USB and PCI express. During the quarter, we expanded our IP portfolio by acquiring the assets of MOSAID, a leader in DDR cores. Increasing our reach into this key interface standard expands our ability to offer customers a one-stop shop for high quality IP.

Let me focus for a moment on our go-to-market strategy to capture more value for what we provide. I am happy to report that we made good progress this quarter. As you’ll recall, in addition to serving customers with the most advanced, bleeding edge designs, we are focusing on better addressing the needs of customers who design at mature technology nodes of 130-nanometer and above.

Last quarter, we introduced our first new product, IC Compiler Express, targeted at these processes. This quarter, IC Compiler Express became generally available and already has several customers.

From the IP side, we are also broadening our offering beyond the most demanding users. In Q3, as part of our segmentation strategy, we introduced special edition design ware cores. These cores are preconfigured and pre-integrated IP for customers who need more mainstream solutions. They reduce the engineering efforts spent on integrating a digital and analog block together and reduce our support cost as well.

Going forward, we will apply the same product stratification to our verification offering. Today, we are viewed as the go-to company for the most advanced simulation and bug-finding needs and rightfully so. We plan to extend this expertise into the broader market as well. Stay tuned to this are in the quarters to come.

Before concluding, I would like to briefly address our outlook beyond 2007. With recent fluctuations in the financial markets, we appreciate that many of you are wondering about our 2008 outlook. We are completing our 2008 plans this quarter and will provide final guidance at our next earnings call. However, thanks to the visibility of our business model, we feel comfortable giving you some preliminary thoughts as an indication of confidence and strength going into the year.

Even with the end of our license model transition, and even without the extra week we had in 2007, we are comfortable with current Wall Street expectations of non-GAAP EPS growth of 16% to 19%, revenue growth of 7% to 8%, and assumptions of continued improvement in operating margin.

To wrap up, Q3 was all about excellent execution. We delivered strong earnings growth, record orders, solid cash flow, and we broadened some very important customer partnerships. We look forward to ending the year strongly and are well-positioned to continue to deliver good results into 2008.

With that, I will turn the call over to Brian who will provide more detail on the financials.

Brian M. Beattie

Thank you, Aart. Good afternoon, everyone. In my comments today, I will summarize our financial results for the quarter, provide you with an update on our stock repurchase program, and conclude with our guidance. As a reminder, I will be discussing certain GAAP and non-GAAP measures of our financial performance. We have provided a reconciliation of our GAAP to non-GAAP results in the press release and the financial supplement posted on our website.

In my discussions, all of my comparisons will be on a year-over-year basis, unless I specify otherwise.

We are very pleased that we’ve completed another strong quarter. We delivered double-digit growth in revenues and earnings per share and expanded our operating margins. We generated significant cash from operations, continued our stock repurchase program, and our balance sheet remains extremely healthy.

Let me now provide some additional detail on our financials. Total revenues increased 10% to $304.1 million, at the high-end of our target range. Business was robust across all the product lines and we continue to expect a book-to-bill greater than one for all of FY07. One customer accounted for slightly more than 10% of our Q3 revenues.

Turning to expenses, total non-GAAP expenses were within our planned range at $247.2 million for the quarter. As expected, operating expenses increased during the quarter due to timing of expenses, such as variable compensation, reflecting higher Q3 and annual business levels.

For the full year, we are maintaining our total annual expense target of a very modest 2% to 3% increase, inclusive of our extra week of spending this year.

We were pleased with our profitability during the quarter. Non-GAAP operating margins increased nearly 400 basis points to 18.7%, and as expected, dipped sequentially due to timing of expenses.

For the first three quarters of our fiscal year, we have achieved a non-GAAP operating margin of 19.4%. We are committed to achieving an operating margin of approximately 20% for all of fiscal 2007, driving to the mid to high 20s in the next several years. We plan to achieve these targets by growing revenue and continually improving the company’s operations and cost structure.

Turning now to earnings, GAAP earnings per share were $0.17, with cost and expenses totaling $281.1 million. This includes $12.2 million of amortization of intangible assets and $16.1 million of share-based compensation.

Non-GAAP earnings per share increased more than 50% to $0.32, exceeding our target range. We achieved these strong results even as we continued to invest in our marketing efforts and product innovation.

Our non-GAAP tax rate was 26% in Q3, down substantially from year-ago levels, primarily due to the continued optimization of our international operations and the reenactment of an R&D tax credit.

For modeling purposes, we think that a 28% non-GAAP tax rate is a reasonable estimate for FY08.

Turning now to bookings, we continue to execute well on contract mix. Greater than 95% of Q3 product orders were booked as rateable licenses, with less than 5% booked up front. A large long-term contract during the quarter brought the average length of our renewable customer license commitments to greater than four years. This metric will continue to fluctuate quarterly depending on the mix of contracts signed, but would typically be in the three-year range.

Turning now to cash and balance sheet items, cash and short-term investments increased $27 million sequentially to $794 million, due to strong operating cash flow of $116 million.

Capital expenditures were $12 million in the quarter. We continued to execute on our buy-back program and repurchased 2.2 million shares of Synopsys stock for $59 million.

During the first three quarters of the fiscal year, we have spent $141 million repurchasing approximately 5.3 million shares, and we have $441 million remaining on our current authorization.

Because of the timing of a large invoice at the end of the quarter, Q3 net accounts receivable increased to $204.8 million, and DSOs were slightly above our historical range at 61 days.

Deferred revenue at the end of the quarter was $635.4 million.

At the end of Q3, we had approximately 5,100 employees with a slight sequential increase due primarily to the acquisition of ArchPro.

Now, as Aart discussed, we closed two strategic acquisitions during the quarter. In June, we acquired ArchPro Design Automation for low power verification. It was an all-cash deal valued at $12.9 million. In July, we acquired the semiconductor IP assets of MOSAID Technologies, a developer and licensor of semiconductor IP. It was an all-cash deal valued at $15.3 million. These acquisitions are included in our guidance for the rest of FY07.

And now, addressing guidance for the fourth quarter of FY07, our targets are: revenue between $300 million and $310 million; total GAAP costs and expenses between $261 million and $277 million, which includes approximately $17 million of share-based compensation expense; total non-GAAP costs and expenses between $236 million and $246 million; other income and expense between $3 million and $6 million; a non-GAAP tax rate between 25% and 26%; outstanding shares between 146 million and 151 million; GAAP earnings of $0.18 to $0.26 per share, and non-GAAP earnings of $0.34 to $0.37 per share.

We expect greater than 90% of the quarter’s revenue to come from backlog.

For fiscal year 2007, we are again raising the low end of our revenue range with our new target between $1.195 billion and $1.205 billion, reflecting an annual increase of 9% to 10%; total non-GAAP expenses to be 2% to 3% higher than FY06; a non-GAAP tax rate of about 25%; outstanding shares between 146 million and 151 million; GAAP earnings per share between $0.78 and $0.86, which includes the impact of approximately $64 million in share-based compensation expense; non-GAAP earnings per share of $1.31 to $1.34 -- we’ve increased the low-end of our guidance range by $0.04 and the high-end by $0.01; operating margin of approximately 20%.

Over the next four quarters, we expect approximately $1.02 billion of our beginning of quarter backlog to turn to revenue. We are raising our cash flow from operations target to greater than $325 million.

In summary, we are very pleased with our third quarter financial results. We’ve expanded our profitability, increased cash from operations, and our strong balance sheet stands ready to support our future growth objectives. We’ll continue to focus on delivering shareholder returns by improving our capital structure, primarily driven by our stock buy-back program.

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

Question-and-Answer Session


(Operator Instructions) Our first question is from the line of Harlan Sur from Morgan Stanley. Please go ahead.

Harlan Sur - Morgan Stanley

Good afternoon. Nice execution on the July quarter. Aart, first question for you; in the memory market, both DRAM and NAND are really sort of the technology drivers now for the semiconductor industry from a manufacturing perspective. Clearly the adoption of memory, especially Flash in the consumer markets is driving a significant amount of growth going forward in this segment of the market space.

Can you just talk about how Synopsys is positioned to take advantage of these trends in memory? At a minimum, I would assume that it’s analog verification, DFN and IP. Am I missing anything?

Aart J. de Geus

Well, thanks for answering your own question. You got it right that the technologies where we have the most impact is clearly the verification side. Actually, interestingly enough, increasingly even some synthesis because with these very large memories, there’s more and more very, very sophisticated control logic that goes around it and so memory is far and away now from just being a bunch of transistors.

Having said that, if I my just quibble slightly with your opening, as much as memory is one of the technology drivers, the technology that is used for logic is quite a bit different than what is used in the memory domain. And of course, all of those are continuing going for smaller geometries but they do demand today a slightly different approach. And so for us, it is important to be well-connected to both the leaders on the logical side and the leaders on the memory side and I think we absolutely are.

Harlan Sur - Morgan Stanley

Okay, great. Thanks for that, and then another question for the team, if I look at the next four quarter backlog, it went up by about $50 million, obviously as a result I think of the larger deal that you signed in the July quarter, so I’m a little perplexed why the fourth quarter revenue outlook wouldn’t be going up at a minimum about $10 million to $13 million sequentially versus the July quarter. Maybe the team can help me understand that.

Aart J. de Geus

Sure. Well, part of the answer is that as new deals come in, you can’t assume that every deal gets renewed on the last day of its existence, meaning that the backlog can grow in the future without impacting necessarily the quarter that we are in presently or even the next one. These things really are extremely complex layering in of backlog.

Secondly, overall the run-rates with many of those companies goes, just goes steadily up, assuming that we do a good job driving them in that direction, and it is fairly rare that you would have enormous discontinuities unless you sort of layer in that whole new set of products.

Lastly, I am glad that you’re observing these numbers and at the same time always a little bit weary of over-interpreting a single quarter because there is a little bit of fluctuation and things are somewhat lumpy. But in aggregate over a long period of time, I think these are good long-term indicators.

Harlan Sur - Morgan Stanley

Okay, great. Thanks, Aart.


Next we go to the line of Matt Petkun from D.A. Davidson & Company. Please go ahead.

Matt Petkun - D.A. Davidson & Company

Thanks for taking my call. Just one real quick question for me, Aart; I noticed last week Cadence and Mentor are partnering on what they are calling an open SystemVerilog verification methodology. I’m wondering what your read is on that new methodology that they are purporting to be supporting and how that compares to the SystemVerilog that you guys have been supporting for some time.

Aart J. de Geus

Sure. The first comment is that these days, everything starts with the word open and so that’s not a surprise. What is interesting is that, not a surprise either, SystemVerilog has really moved forward very, very rapidly. You may recall that we introduced the notion of SystemVerilog about three-and-a-half years ago, initially to a great deal of skepticism. Today, I can tell you that a vast majority of the advanced users already are well entrenched. We have hundreds of users and I would think that Synopsys is way ahead on this ball game today.

Now, there are many reasons why we are ahead. Not only is it a good standard but it is also because of the technology that we have deployed behind it. And so, notwithstanding all the languages and standards and so on, at the end of the day, the raw strength of the tools really makes a difference. We have a broad set of partners, not just in the utilization side but also on the IP side around that. So I think we are doing very well with it.

Matt Petkun - D.A. Davidson & Company

Okay, and then just one other question for Brian; when we look at the operating margin expansion that you anticipate for fiscal ’08, do you see more synergy coming out of your R&D efforts or out of sales and marketing? And I assume that the big up-tick we saw in this most recent quarter was the result of that large deal in the sales and marketing line item.

Brian M. Beattie

Yes, that’s correct, Matt. The expense piece itself grew in the third quarter associated with the large transaction of business, both in the third quarter and for the total year. When we look ahead to some of the early discussions on 2008, we’d anticipate that expenses of course grow less than the rate of revenue, therefore contributing to margin growth in the year. And you know, we are working through the final details of that plan of next year but obviously we are committed to continued margin expansion for 2008, as well as our longer term targets in the mid to high 20 range.

Matt Petkun - D.A. Davidson & Company

Thank you.


Next we go to the line of Jay Vleeschhouwer with Merrill Lynch. Please go ahead.

Jay Vleeschhouwer - Merrill Lynch

Thanks. Brian, I would like to ask you about the duration of the contracts in the quarter. Obviously Intel took the average up significantly, presumably it was about a five-year deal. The question is, if it made sense to do a deal that long for that customer, would it make sense to do similarly long deals for other important customers as well?

Brian M. Beattie

Well, it makes sense. Of course, our focus is on the run-rate for the quarter as well, that we continue to expand our relationships with all these customers. And as Aart mentioned, getting deeper in terms of increased partnerships, working closely in terms of sharing growth with their business and us, so it’s all good directions. This particular agreement f course locking in a company the size of Intel without commenting specifically on the length of the contract agreement was that this is the right thing to do for Synopsys and for Intel at this point.

You know, different customers have different time horizons in mind. We typically expect our contract length is in that three-year range, so this is again expanding relationships during this quarter.

Jay Vleeschhouwer - Merrill Lynch

Aart, a two-fold question on technology; could you elaborate on the nature of the technology collaboration you will be doing with Intel? Synopsys has a history of working closely with different customers from time to time, Toshiba, for example, in the past, and other examples. Where specifically will you focus with Intel?

And then secondly otherwise, are there any products in the portfolio that are undergoing or would need to undergo any significant rewrites? Sooner or later, any product and software would need to through some rebuild. Is there anything of that kind that you foresee for Synopsys products?

Aart J. de Geus

We never comment on anything that we do with specific customers unless there has been a specific press release, and given the level of sophistication of Intel, that certainly applies to them as well.

Generically though, I can say that I foresee that with a number of customers, we are moving towards a closer and closer relationship for a variety of reasons, one of which is that the level of sophistication of the support we provide as a material impact on the success and differentiation in their utilization. Secondly, a number of our customers have very good insight as to some of the technology development that we can do together to actually accelerate our technology. And so I think that is sort of the general categories that these types of things fall under.

Now, regarding rewrite, most people don’t fully appreciate that in the vast majority of the cases we have an ongoing rewriting happening in our code, and there is very good reason for that, which is we actually deliver an enormous amount of innovation, but what is not always fully understood is that all of that innovation has to be 100% plus backward-compatible with 15 years of ways of doing chips. This is actually quite a unique set of requirements that we’ve been able to live up very, very well.

If I can take an example for that, our in that sense oldest or youngest product, depending on how you want to look at it, is the design compiler topographical, which has seen enormous progress in terms of understanding place and route capabilities in the synthesis and yet being in some ways a good old design compiler that you can trust and that works very well and that does all these things that it always used to do. And from a software development perspective, I can tell you it’s not an easy feat to do at times.

And so from the customer perspective, in general as much as they are interested by brand new features, they really hate discontinuities and I’ve always said revolutionary technology needs to be rolled out in evolutionary fashion.

Jay Vleeschhouwer - Merrill Lynch

Final question; could you comment, Aart, at all, any vertical market expectations you have, particularly going into ’08? Is there anything you see on the mobile side, the automotive side? Any other verticals that you think will become particularly incremental for you or the industry over the next year or two?

Aart J. de Geus

You know, I think that is almost the same as asking the question which vertical segments will do well, with or without us, because it is clear that some market segments have a lot more opportunity than others.

One of the things I would highlight is the tremendous importance of everything that touches the word video through the entire food chain. There’s no question that video does for baud rate, for storage, for even display and capture, the same as word MIPS did for processors 15 years ago, which is more is better.

If you see the many clips that people download just from YouTube, it’s just going to be a matter of time that that stuff needs to high definition. So those are the types of things that transcend a number of the key traditional verticals. One of the reasons we prefer to look at it almost from these technology requirement perspectives is because they become much more actionable than just saying here’s the memory segment. And as we alluded to earlier, even the memory segment is suddenly very, very interested in synthesis, so it’s not the good old memory segment from the past.

Jay Vleeschhouwer - Merrill Lynch

Thanks, Aart.


Next we go to the line of Terence Whalen with Citigroup. Please go ahead.

Terence R. Whalen - Citigroup

Thanks for taking the question and congratulations on the quarter. My first question, Aart, is a pretty straightforward one. You typically give active designs and cumulative tape-outs for 65 and 45, and I was wondering if I could get those.

Aart J. de Geus

Sure. Let’s look at 65-nanometer first. We are right now tracking 488 designs, and this is probably the last time that we track because once we pass 500, the amount of work that goes into having very good numbers is very difficult, so about 488 active designs, 241 tape-outs. Again, the majority with Synopsys physical tools.

Looking at 45-nanometer, we are tracking 73 active designs. That is up from 52 last quarter and 16 tape-outs, and we are also tracking already several 32-nanometer designs.

So fundamentally, the state-of-the-art leaders are moving forward unencumbered.

Terence R. Whalen - Citigroup

Great, and then secondly, Aart, I think you mentioned that intellectual property represents one of your higher growth adjacency opportunities. You’ve obviously had the recent acquisition there. I was wondering, does that comment reflect at all on the opportunity in design for manufacturer or do you think both offer similar growth potential looking into 2008?

Aart J. de Geus

Well, certainly looking back, if we look at the trailing 12-month revenue growth, you see about 23% to 24% for IP and 21% to 22% for DFM, so they are fairly similar. They are different in nature in that IP comes truly in sort of incremental building blocks, if I can call it that, and we certainly have a strong position, not just by virtue of the collection of things that we have but just as importantly by virtue of the process of be able to roll out high quality IP almost like a factory now. That took a long time to build.

On the DFM side, it’s a little different. There I think the game has already moved more towards the integration of extremely sophisticated techniques that all add up to how do you modify design to avoid challenges in the first place? And so in that sense, it is a little bit more technically like traditional, very, very sophisticated software but it is a new domain and we do expect very good growth. So right now, I would handicap ’08 as probably IP first, DFM second.

Terence R. Whalen - Citigroup

Okay, great, and one last one, if I could; I think Aart, in your opening statement, you mentioned that you are beginning to see visible progress from your marketing strategy. I was wondering if you could just drill down with a little more specificity. Are you referring to segmentation or low power? And that’s it for me, thanks.

Aart J. de Geus

Well, you know, I think this builds a little bit on Jay’s question, which is the sheer fact that we use the term segmentation at Synopsys is almost novel. But it is also clear that you can approach it from the traditional segments, such as memory, automotive, et cetera, and look at it in terms of how well are we doing with these players and how well are we moving forward.

You can approach it from a stratification in terms of need, and there we have made some progress because you saw, for example, IC Compiler Express be a different type of tool than the one that we’ve used for the advanced end. We’ve done the same for IP. We are going to do more on verification.

And then you can finally approach it more from a solution perspective and my focus on low power was chosen on purpose because it’s the single most important design constraint that’s actually hard to do when you add to it timing and schedule and test and other things.

So I think what I can report after about now I guess nine months of moving in this direction, that the vocabulary has set in and that we are starting to now look at the insight and turning them into action. And you saw the first results of that and I think that’s going to be ongoing from now on.

Terence R. Whalen - Citigroup

Thank you.


(Operator Instructions) Next we go to the line of Mahesh Sanganeria from RBC Capital Markets.

Mahesh Sanganeria - RBC Capital Markets

Thank you very much. Aart, I just want to drill down a little bit on the DFM, in terms of basically I see it’s a record number for Q3, and you are saying that is going to grow slower than IP, but is it expanding into the areas beyond just a little calculation, some of the variability in the processing, like CMP or other areas of processing? And hopefully your new position, new board membership gives you more insight into this kind of variability.

Aart J. de Geus

First, I am not sure that I said it would grow slower than IP. Maybe I just said that IP may grow faster than DFM. The reality is I don’t think that I can really tell much difference right now going forward because most of these areas are very promising. They just behave very differently.

Having said that, I think you are alluding correctly to the fact that within the general realm of DFM, different capabilities are sort of gradually coming online and gradually becoming important and we can absolutely see that things such as DMP and a few others are starting to sort of turn the corner in terms of being essential, amounting in between 65 and 45 or 55-nanometer, we see even some of those designs.

And there’s a slew of these capabilities that we have available and that suddenly are sort of hitting the interest meter of our customers. If I take another one that falls into that category is the notion of stress, where essentially certain structures inside of a transistor are under stress and therefore change their electrical characteristic. Well, that’s suddenly very important because that may impact substantially the timing of a circuit.

And so all of these things are sort of now suddenly becoming important but we have invested in them for a long time and we have connected many of those already in a flow that is truly could be viewed as a design for manufacturing flow.

So I think there’s a lot of opportunity there and we are encouraged by the need for the technology.

Mahesh Sanganeria - RBC Capital Markets

And the question of 65-nanometer adoption, I don’t have a good sense of that design, the number of designs and tape-outs. What does that convey in terms of what do you expect that for at this stage for 90-nanometer? If you can give a comparison and the other thing I want you to comment, if you could, is what we are hearing is that foundries are not, do not have a very good utilization at 65-nanometer as they expected, and the adoption in terms of [inaudible] has been slower. Any comment on that would be helpful.

Aart J. de Geus

Certainly. Well, you know, we are in the unfortunate situation that we literally now have multiple years of quarter-by-quarter data and to my own surprise, we saw about three or four quarters ago, that 90-nanometer tracked 130, 65 tracked 90, and 45 tracked 65 by virtually exactly two years, and the present numbers reflect that again.

So what that tells me is that the advanced guys, and that’s not the same as the lagging group, that the advanced guys are absolutely still competing on smaller geometries. By the way, that also explains why the foundries are not necessarily there yet because most of the advanced guys are or used to be, if I can call it that, IDMs where they drove the advanced technology and then executed it themselves.

I think that will change over time, as now the foundries are picking up more of the technology development and will be forced into moving a little bit faster and we definitely see a change there as well.

Mahesh Sanganeria - RBC Capital Markets

Thank you, and a couple of quick questions on the income statement. The other income, if you take out the non-recurring item, is close to $7 million. That is probably -- your run-rate of interest income is about $7 million, I’m guessing. You can correct me on that, and your guidance, you have been guiding $3 million to $6 million. Can you explain the disparity there in terms of guidance?

Brian M. Beattie

You’re right, Mahesh. What we’ve been looking at is the OI&E line is primarily representing our interest income, and actually with higher cash balances, by focusing on our operating cash flows, we’re able to drive that number higher and as a result, our interest income continues to grow.

We had $6 million in the second quarter. It went to $7 million in the third quarter. I think we are being a little cautious perhaps on the interest rate assumption for the fourth quarter, but that’s in the same range as what we’d expect to see this quarter.

Mahesh Sanganeria - RBC Capital Markets

And a quick one on the buy-back strategy; is it your long-term strategy is going to basically keep your share count flat or even going down slightly, the buy-back will be driven by that?

Brian M. Beattie

Yes, exactly. We’ve looked back over history the last three years and we continue to buy back more shares than what we had issued in terms of options, and then more recently in terms of RSUs.

We also continue to focus in 2007 on actually reducing the number of options and RSUs that we intend to issue by design, and therefore as a result continue to address reducing the number of shares outstanding.

The offset to that proactive program here is really focused on the fact that our share price continues to go up, and as a result, the dilutive impact of the additional share price is one of the offsets we are also trying to drive and get the absolute share count down on a fully diluted basis.

Mahesh Sanganeria - RBC Capital Markets

Okay, that’s very helpful. Thank you.


Next we go to the line of Richard Valera from Needham & Company. Please go ahead.

Richard Valera - Needham & Company

Thank you. Good evening. Aart, you had several notable success of IC Compiler in terms of customers that have adopted it, and yet it seems that the growth in the Galaxy area is still pretty modest year over year. Can you say if you are getting the value you expected to get from IC Compiler in terms of I believe it was around a 30%, 35% up-lift in list price, or was there anything else that is keeping that line from growing in terms of competitive or pricing pressures?

Aart J. de Geus

Sure. Well, the ratio in terms of the list prices is unchanged. I think one of the reasons we are starting to report a little bit more from the perspective of core EDA is because in so many cases, it is actually at times a little difficult to distinguish between Galaxy and Discovery.

In general, IC Compiler is doing very well for us and so the replacement of PC Astro is well on track. There is definitely pricing stress throughout the industry, just because a lot of competitors but even within that, I think we’ve done reasonably well. So if you look at core EDA growth, it’s about 8%. Maybe we have been a little too stringent on Galaxy but that’s just sort of the reality that we deal with right now.

Richard Valera - Needham & Company

Great, that’s helpful. Brian, could you just reiterate the initial fiscal 2008 guidance that you said? What were those ranges you had given out?

Brian M. Beattie

Yes, I clarified that it wasn’t specifically guidance for the year but we are really just commenting on the Wall Street expectations at this point. And what that reflects is that we said we are comfortable with the EPS growth that was forecast in the range of 16% to 19%; revenue growth of 7% to 8%; and also that the assumptions of the ops margin expansion was also in line.

Richard Valera - Needham & Company

Okay, that’s helpful. And understanding that everything is preliminary for fiscal ’08, in terms of what would drive that growth, would you care to comment on that at all, Aart? It sounds like it is probably the two adjacencies you’ve talked about, which are sort of faster growing. But would you give any color at all on what drives that 7% to 8% top line growth?

Aart J. de Geus

Sure. Again, with maybe reiterating the caveat that we did not want to be in a position of giving guidance. This is not guidance. The plan is not finished, therefore that was not the intent. The intent was to respond to the very fact that there’s so much fluctuation on Wall Street, people are just worried, is this a good or bad company, that we are actually a very solid company given the business model, and that’s why we can make these statements.

Having said that, going forward clearly we see multiple opportunities. We feel that actually our core EDA is quite strong and the fact that we have seen the benefit of many of the integrations now gradually become more and more visible to customers that before didn’t fully appreciate this, I think bodes well for our core EDA position.

Now, around those, clearly the adjacencies are not only doing well on their own but I think they are also strategically important in helping the core, or you could turn it around -- the core helps the adjacencies because the better we do in IP, the better we for our tools and vice versa.

And so we are actually quite positive about the opportunity space that we have and our comments going forward were almost exclusively based on the fact that the business model allowed us to already project that we would be well in tune with what, at a minimum, Wall Street is expecting.

Richard Valera - Needham & Company

That’s helpful. Thank you very much.


And our final question is from Dennis Wassung from Canaccord Adams. Please go ahead.

Dennis Wassung - Canaccord Adams

Thanks. Good afternoon. First question, another follow-up on the Intel contract and also you alluded to some other large contracts in the quarter. I’m just curious; as you look at these transactions and obviously they are larger in scope than the prior contracts, you talked about increasing your run-rate, I’m just wondering if you could comment as to how much of that increase that you are seeing at this point is increased usage of the same class of tools or basically higher seat counts, higher capacity versus how much, for Intel, for example, being the primary supplier there and expanding your relationship, are you really getting at the new categories of tools that you weren’t currently in at Intel? Namely, are you taking some share away from other people in the process?

Aart J. de Geus

Dennis, with the caveat that I don’t want to say anything more than what I said specifically about Intel, as we protect the privacy of all of our customers, we did say there that it was a broadening of pretty much every dimension, meaning the contracts in the various forms of sizes, the product utilization.

What is clear is that when we are looking at R&D collaboration, one of the reasons that we are very, very happy to work with Intel is because they are a phenomenally strong player from a silicon technology point of view.

As we see that increasingly, a number of semiconductor companies can no longer afford the development costs or the sophistication required to be on the leading edge, working closely in a technology relationship with the company that arguably is the most advanced one is something that if we do a good job, will be of very high value to both parties.

And I would not want to restrict at all that value to the existing tools, although there’s no question that on the existing tools, we have already found areas where we can do better than what we have, so it will accelerate our technology.

Talking a little bit more broadly, I think that these collaboration relationships will be important going forward and I believe that over the years, we have built a skill-set within Synopsys that knows how to manage this relatively small scale that we now can gradually go broader scale, and Intel is clearly a trailblazer with us in that.

Dennis Wassung - Canaccord Adams

Okay, and just a quick follow-up on the Intel side of it specifically, obviously Intel has been a very important customer for you for a number of years here, and likely the primary EDA supplier for Synopsys here, so is the real change or I guess difference in this agreement specifically, is that more the technology collaboration aspect of this that’s the key differentiator between this and former relationships or contracts with Intel?

Aart J. de Geus

I think there are many positive changes. The reason I like to highlight specifically the collaboration is because from a strategic point of view, I think it has the broadest ramifications, and it has ramifications between the two companies in terms of the value they get, the product evolution, their product utilization, et cetera. But it also has ramifications for other companies that will over time benefit from doing business with us because they can rest assured that we will stay very close to the leading edge of technology.

Dennis Wassung - Canaccord Adams

Okay, and last one for me on the manufacturing side, you alluded to the fact that you guys are integrating some of your OPC capabilities with the mass data prep technology. I’m just curious at this point, I know Synopsys has amassed a long list of manufacturing-related technologies, whether it’s TCAD or PrimeYield or the OPC stuff -- how much of your business at this point really is an integrated offering in that area, or is it more driven by point tool sales in some of these areas of manufacturing?

Aart J. de Geus

That’s a very good question because I think in many situations, customers use sort of all of our tools and so they are sort of applauding on the sidelines every time that we do better integration because the better integration initially does not change the nature of the tools -- it immediately has major impact on throughput.

In the medium term though, it does change gradually the nature of the tools because now they start to play off better off of each other. In the long-term, it’s even broader than that. It really brings a vision and an understanding of manufacturing into the design world and I think that is where it has to go, because if you don’t do that, it will be absolutely impossible to do layouts and expect high yield. There are just too many places where a small mistake gets multiplied by thousands and thousands of occurrences.

And so I think this integration is one of the key directions and it is sort of a little bit of a catch-all word for really a substantial evolution in an entire field, but it is simultaneously built on making sure that we have the best product as well.

Dennis Wassung - Canaccord Adams

Great. Thank you.

Aart J. de Geus

It sounds like we have arrived at the end of the quarter. We appreciate -- well, I guess we have arrived at the end of the quarter but also at the end of the earnings release. We appreciate the time you spent with us. We clearly are looking back on a very strong Q3 and have a good outlook on Q4 and even beyond that, and so we appreciate the time and as usual, Brian, Lisa and I are available after the call. Thank you very much.


Thank you. Ladies and gentlemen, this conference is available for replay after 5:30 p.m. Pacific Time today through September 5th at midnight. You may access the AT&T executive replay service at any time by dialing 1-800-475-6701 and enter the access code of 883145. International participants may dial 320-365-3844. Once again, those numbers are 1-800-475-6701 and 320-365-3844, with the access code of 883145, and it is available for replay after 5:30 p.m. Pacific Time today through September 5th at midnight.

That does conclude your conference for today. Thank you for your participation. You may now disconnect.

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