Cadence Design Systems Q3 2007 Earnings Call Transcript

| About: Cadence Design (CDNS)
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Cadence Design Systems (NASDAQ:CDNS) Q3 2007 Earnings Call October 24, 2007 5:00 PM ET

Executives

Jennifer Jordan - Corporate VP of IR

Mike Fister - President and CEO

Bill Porter - EVP and CFO

Analysts

Jay Vleeschhouwer - Merrill Lynch

Analyst for Harlan Sur – Morgan Stanley

Analyst for Mahesh Sanganeria - RBC Capital Markets

Terence Whalen – Citi Investment Research

Sterling Auty - JP Morgan

Benjamin Pappas – D.A. Davidson

Operator

Good afternoon.(Operator Instructions) I would now like toturn the call over to Jennifer Jordon, Corporate Vice President of InvestorRelations for Cadence Design Systems. Thank you Miss Jordon, you may begin theconference.

Jennifer Jordon

Thank you Kathina. And welcome to our earnings conferencecall for the third quarter of 2007. The webcast of this call can be accessedthrough our website www.cadence.com and it will be archived for one week. Withmy today are Mike Fister, President and CEO and Bill Porter, Executive VicePresident and CFO. Please note that today’s discussion will contain forwardlooking statements and that our actual results may differ materially from thoseexpectations.

For information on the factors that could cause a differencein the results, please refer to our 10-K for the period ended December 30, 2006 and our 10-Q forthe period ended June 30, 2007.

In Addition to the financial results prepared in accordancewith generally accepted accounting principles or GAAP, we also present non-GAAPfinancial measures today. Cadence management believe that in addition to usingGAAP results in evaluating our business, it can also be useful to measureresults using certain non-GAAP financial measures. Please refer to our earningspress release for a discussion of non-GAAP measures and to both our earningspress release and our website for reconciliations of GAAP and non-GAAPfinancial measures used in today’s discussion. Mr. Fister.

Mike Fister

Once again Cadence delivered excellent results in the thirdquarter. Revenue was $401 million operating margin was 30% and cash flows was$89 million. Cadence continues to focus on aligning our technology solutionswith our customer needs. As a result we deliver and receive more value whichhas strengthened our market segment share position. The fact that Cadenceoffers the industry’s most complete and robust technology with segmentationtailored to customer demand has contributed to our success. Customers are increasingly adopting ourinnovative end-solutions and leveraging our unique software distributionmechanisms.

For example, we introduced two years ago a form oftechnology delivery called an EDA card, which has proven increasingly popularwith customers. The EDA card is a form of contract that enables customers todraw down product licenses from a self-serve real-time system, so they arebetter able to match their project license demand with purchase licensecapacity. Infrastructure for the EDA card is proprietary and provides us andour customers with an excellent visibility into their project needs andutilization. Customers also have the ability to draw down licenses of differenttime durations, each priced accordingly, until they exhaust their purchasecapacity. Our initial experience has been that customers draw down the licensesfaster with the EDA cards than with traditional contract cards. And just as thisunique delivery system helps customers manage their most complex businessproductivity challenges, our innovative technology solutions help customersmanage their most complex design challenges.

We examined our digital implementation platform end-to-endand delivered the Cadence low power solution. We are preserving powerthroughout the digital flow that is unmatched in the industry. Thisdifferentiation is fueling sales and accounting platforms both competitivelyand expansively into existing accounts. NEC America used our Encounter platformto implement the Arm11 MPCore – one of the world’s high performance low powerprocessors. NEC achieved overall performance in timing performance and lowerpower. Advanced technologies Encounter GXL such as statistical static timinganalysis and optimization allow the customers to accurately account for theeffects of processor ability, in a leading edge 45 mm designs. Raincoastadopted this solution for SoC design including Encounter timing system GXL withthe statistical static timing analysis.

During the third quarter, design physical was added to logicdesign team solution. Design physical gives logic teams access tointerconnected information in their logic synthesis environment, dramaticallyimproving physical predictability and increasing the quality and accuracy ofhigh speed and low power design.

In customized IC we experienced continued momentum for thehigh end GXL versions of Virtuoso6.1. A major North Americancommunications company included 45 nanometer design using the new platform as acustom analog design for the Virtuoso 6.1. The speed, capacity and versatility of Virtuoso multi-mode simulation inhandling the verification of complex design, showed several competitive winsduring the period. For example, Neotech a leading Taiwanese designer ofimbedded systems chose Virtuoso multi-mode simulation as his preferredsolution. CDNLive! in Silicon Valleycan provide additional insight into our strategy for manufacturabilityadjacency.

Our collaboration with and subsequent acquisition ofClear Shape extends Candence’s capability with design analysis and optimizationsolutions. Together these capabilities provide a design and implementation flowwhere what you design is what you get in terms of manufacturability andadvanced process control. And in manufacturing sign-off the acquisition ofInvarium gives us leading edge of optimal proximity correction. These kinds oftechnologies address the next generation of lithography challenges of 45 and 32nanometers.

During the quarter we added over 100 million gatesof palladium upgrades within existing accounts and booked palladium sales in anumber of new accounts requiring system level verification. Customers are usingour integrative software extensions or ISX with palladium for hardware/softwareco-verification and validation. And as projected we released a SoC functionalverification kit, which provides a pre-built verification environment extendingfrom the block to the system level, targeted especially for today’s futuristwireless and consumer designs.

It’s this type of leadership that’s compelled manyof the largest semi-conductor companies in the world to deepen theirrelationship with us, making Cadence a primary design solutions partner. Afterexhaustive evaluation process NXP named Cadence its primary strategic partnerfor EDA technology. NXP has endorsed us as the low power chip design solutionsleader and the only company with the depth and breadth to deliver for NXP thefully integrated front to back analog and digital solution they require. Andlike us, NXP shares an acute interest in developing solutions at the systemlevel. I am excited we’ll also be working and investing together to develop newtechnologies for the next generation for electronic system level designs. Ourconsistent performance is a result of strong customer response to ourtechnologies and to our strategic roadmap. And now I’ll let Bill speak to the financials.

Bill Porter

Thanks Mike. The results for the company’s key operatingmetrics for Q3 were total revenue of 9% year over year; non-GAAP operatingmargin of 30%, improving 200 basis points from Q3 of 2006; and operating cashflow of $89 million. GAAP earnings per share for Q3 were $0.24, compared to$0.14 in Q3 of 2006. Non-GAAP earnings per share for Q3 were $0.33 compared to$0.26 in Q3 of 2006, up 27% year over year. Total revenue for the third quarterwas 401 million, compared to 366 million in Q3 of 2006. Product revenue was$274 million, maintenance revenue was 96 million and services revenue was $31million. Revenue mix by geography in Q3 was 41% for North America, 25% for Europe,22% for Japanand 12% for Asia.One customer accounted for 14% of revenue.

Estimated contract life on a dollar weighted averagebasis approached four years, driven primarily by one large customer. In thequarter approx 50% of our product business was represented by ratable licenses.This was lower than our historical rate, because of a higher mix of termcontracts. Important factor which contributed to the higher level of termbusiness in Q3 was the EDA card that Mike talked about. Cadence offers bothterm and subscription EDA card contracts. The volume of EDA card contracts hasgrown rapidly over the past several quarters and has reached 1 billioncumulatively. Based on a recent experience I expect the ratable mix for Q4 tobe in the low fifties and for the year, in the low sixties.

Total cost and expenses on a non-GAAP basis for Q3were $281 million compared to $280 million in Q2. Our non-GAAP operating marginin Q3 was 30% compared to 28% in Q3 of 2006. We are on target to achieve a 30%operating margin for the full year 2007. Quarter-end head count wasapproximately 5300.

Total DSOs in Q3 were 112 days compared to 93 daysin Q3 of 2006. The higher DSOs are directly attributable to more term businessfor customers pay over time. We expect DSOs to be in the mid-nineties at yearend. The quality of our receivables remain high with receivables ninety dayspast due less than 1%.

Operating cash flow for Q3 was $89 million comparedto $60 million in the third quarter of 2006. For 2007, we expect to generateoperating cash flow of approximately $450 million. Capital expenditures in Q3were $19 million. For 2007, we expect normal capital expenditures of about $75million, plus $21 million for work on the new engineering building.

Cadence repurchased $12 million shares of commonstock at a cost of $251 million in Q3. Approximately $155 million remains underour current stock repurchase authorization.

Cash and cash equivalents were $936 million atquarter end.

Now I’ll turn to our outlook for Q4 in the year2007: for Q4 we expect revenue to be in the range of $465 to $475 million. GAAPEPS should be in the range of $0.34 to $0.36 and non-GAAP EPS in the range of$0.45 to $0.47. For the year 2007, we expect revenue to be in the range of$1.622 billion to $1.632 billion. GAAP EPS should be in the range of $0.94 to$0.96 and non-GAAP EPS in the range of $1.34 to $1.36. Other income expense for207 should be in the range of $40 to $45 million.

I expect that we will attain our primary operatingmetrics for the year of growing the top line, improving operating margin andincreasing cash flow. Looking beyond this year, we should be able to grow thebusiness profitably while expanding operating margins.

Operator, we’ll now take questions.

Question-and-AnswerSession

Operator

Your first question comes from Jay Vleeschhouwer fromMerrill Lynch.

Jay Vleeschhouwer -Merrill Lynch

Yes thanks. Bill I’d like to ask about a couple ofassumptions behind your fourth quarter revenue outlook and your licenseoutlook. First are you expecting as we’ve seen in the last five quarters adouble digit percentage revenue customer, and secondly, for the year do youexpect as you did expect before, to be able to grow back log by the end of theyear.

Bill Porter

Sure Jay. Let me cover your second question first: I doexpect that we will grow our backlog for the year. In terms of large customers, I think we haveseen this year that we have had the ability to close large contracts as part ofour business. I think we’ve gone and done a good job of that it’s the abilityto have strong technology and to manage our pipeline and I do think that wehave an ability to do that going forward, although I don’t want to project, youknow how those things close in a particular quarter.

Jay Vleeschhouwer -Merrill Lynch

Alright, with respect to some of the customers you named,NXP was of course in the pipeline for the year; the difference this time withthe renewal you were the primary media vendor already so what’s new about it;you also mentioned NEC America and you have been exposed to NEC Europe, so areyou now suggesting that you’re broadening your exposure and share in NEC moreglobally?

Mike Fister

Absolutely and it’s a pleasure to have been a long-standingpart of the supply dynamic to companies like NXP and I think as the pressrelease indicates today and from what you can see we’ve definitely expanded ourrelationship front to back; it’s a tremendous vote of confidence in the productdirection that we’re on. The companieslike NEC see the value of low power and dynamic there and deploy it morebroadly – those are market segment share gains as I said in my comments so Ithink a lot of the test of the metal is not just being part of the supplydynamic but a more and more integral partner, quote-unquote, with thesecompanies and increasing our ability to help them across all of the pieces ofthe solution geocentrically and technologically.

Jay Vleeschhouwer -Merrill Lynch

Mike, in your remarks you referred to CDNLive! And thetechnologies you are working on there, but clearly you have acknowledged yourselvesthat you’re behind in DFM for example, it’s still a small percentage of yourbusiness; when do some of the things you do, based on internal technologies,Clear Shape and all the rest, really become more material; at what point do yourun the risks of say just being too far behind your peers in this growingcategory?

Mike Fister

It’s a good question. As I mentioned in the first of thecomments, a lot of our DFM is integrated into the design so that you do itright as opposed to added in later, OPC, or whatever the heck people try to doand to me is an historical artifact of the approach. Already in the GXL versions of Encounter andVirtuoso we have those technologies implicit in there. For the other elementsof modeling, which is the ability to have the same model in the design and themanufacturing process, that’s where our collaboration and now acquisition ofClear Shape has amounted to impact for over a year. And consistently throughoutnext year, we’ll see those things kick in monetarily. For the most part nowwe’re in trial with very specific clients, who have very specific problems, andwho we referred to in the last call about some memory companies – those areguys that are out already at 45 nanometers. To go back and do a bunch of DFMstuff at 130 that track’s already been laid. So a lot of that is a forwardlooking thing as people move aggressively into 65 nanometer production orcertainly 45 nanometer production - I like our chances. You have to have theimplementation flow to be able to marry with the manufacturing sign-off andmanufacturability, and so far, I’m happy with our results with the customersthat we’re in trial with.

Bill Porter

If I could add just a little color to that, with thecorrect-by-construction particularly in digital GXL in custom and Virtuoso inGXL, you will see additional strength in those two product lines as the resultof our success with manufacturability. But we’re not going to be able to pullthat out, so at the high end of our line, and I think we talked a little aboutthis in the past, that’s going to be one of the ways that you’re going to seeus outperform traditional growth in digital and in custom is because of thestrength we’re going to bring from manufacturability up to the high end of ourdesign capability. And in addition to just taking some market share there.

Jay Vleeschhouwer -Merrill Lynch

Alright, finally the duration of contracts on average wentup about 1/4 which you attributed to one deal. You’ve pretty much always been at 3 years up until now so what was therequirement in this particular case that the customer wanted a longer dealwhich enlarged your average. Is this a spreading phenomenon after all,notwithstanding your previous statements that three years wasn’t necessarily inyour interest or in the customers.

Bill Porter

I do think it is unique to the customer situation, but Ithink the one thing when you do have let’s say primary status with a customerand some cases they do want a little longer footprint so they can establish adegree of stability, but I do also think that as I think about this particularsituation we still have the ability to increase our footprint there, albeit alonger contract because there’s additional value we can bring to the tablewhich we will be able to grow our run rate at that customer over the term ofthat contract. SO we’re not done there, and I think that’s the thing that weare really trying to focus on both with our model that we’ve talked about withhaving our AMTs to work with customers and the way we’re trying to sell the newtechnology.

Mike Fister

Any time that we look at a contract that is longer thanthree year average that we’re approximately operating on the trick that we’retrying to do is not have you know a limitless access to technology goingforward - that’s what’s unhealthy about the long, long, long contracts. And inthis case, we can’t tell you a lot of the details but we do have a nice balancewith the customer and also given them a lot of confidence in the kind of timeline commitment they’re going to have to the technology base.

Jay Vleeschhouwer -Merrill Lynch

Thanks a lot.

Mike Fister

Sure.

Operator

Your next question comes from [analyst] with Morgan Stanley.

Analyst for HarlanSur – Morgan Stanley

I’m calling for Harlan Sur. One question I had I’m justtrying to get a read on the tone of your end-customers, you know we see somemix bag of results – some companies are struggling, their business kind ofslowing down a bit whereas other companies are still doing well. I’m wonderingif there’s any change in the general tone in your customer base when it comesto their planned R&D spending, especially going into 2008. Thank you.

Mike Fister

Think productivity. You know what I find and it comes from my past experience is aheightened focus on productivity. Some of that is to allow them to spend moneyin other places like hire more software people, but that’s not necessarily badfor us: they relay more intensely on the value of our automation and also oneof the reasons why we pushed for strong adjacencies predicated on what we dowith verification, and one of the examples I used was hardware/softwareco-verification at a big semi-conductor company. So productivity is also the thing that drivessome of the consolidations because they can operate more efficiently, andthat’s a training dynamic as much as anything else.

I think some people get over-focused on core spending goingdown – people spend a lot of money on things besides licensing technology, yougot to train people and deal with errata and all those kinds of things sothat’s what we’re responding to. The other two areas that we focus on arecomplexity management and time to market: the consumer cycle if you miss it,bad things happen, Christmas doesn’t wait and all those kinds of euphemisms,and so across those three and a focus on productivity will cover most of thecustomer universe, I see big companies and small companies alike.

Bill Porter

The only thing I would add to the caller is I do see, atleast our experience with customers in Q3 is that they are holding onto theircash a little tighter, I think that’s just reflective of that kind ofuncertainty you’re seeing in that customer base as well. And so that’s probablyadding a day or so to receivables, but I think that being said, we’re also justwatching R&D spending and at this stage I don’t think we’ve seen anythingfrom customers that’s giving us any indication that they’re going todramatically change their R&D spending patterns. And so I think we’rewatching carefully and we’ll look at that in Q4 as we get ready to project whatour business is for 2008.

Analyst for HarlanSur – Morgan Stanley

Okay great, thank you very much.

Operator

Your next question comes from Mahesh Sanganeria with RBCCapital Market.

Analyst for MaheshSanganeria - RBC Capital Markets

Hi guys. I have a couple of questions for Mike and a few forBill. Could you comment on the impact ifany, of the change in the ratables both for this quarter and for the year?

Bill Porter

Sure, I think one of the things that we have seen is thatparticularly with our experience with the EDA cards, we have the ability towork with customers to give them some more flexibility to, as Mike said, matchtheir design needs with their purchasing, to better align that, and given thatwe have worked on this model slowly over the last two years but it has reallypicked up speed for us in the last quarter and just by reference, we’ve seenour business with some of these term cards triple from Q2 to Q3, and thatallows us to really expand our run rate with these customers, because theexperience that we’re having is that customers because they have theflexibility of buying more when they need it are actually utilizing thetechnology at a rate that’s about 47% faster than under a traditional time basedcontract. And so what we see is the ability to increase our run rate and Ithink that is what’s going to drive the mix going forward. It’ll be unique to customers; we have somewho still prefer to access new technology but we are seeing a trend of buying thestrong technology as it’s delivered so I think we’re seeing the view that isreflecting more term EDA cards and that’s what is reflecting in my Q4 forecastfor ratability.

Mike Fister

There’s always a discussion on access to future technology andconsumption rates. The reason we gotinto this is to be able to have visibility into that; the contention with thepurchasing element as opposed to the developers is how fast or if theyconstrain the ability for the engineers to take the technology and this is agreat demonstrable of, sometimes it’s more valuable to give the guy some runway and let him go. And it’s consistent with almost anybody who’s a developeryou know, so I think it’s a responsiveness to people wanting to spend the moneyin a way that they want to spend it and having very sophisticated mechanismsfor them to do this; it’s very neat differentiating technology that we have inthe computing systems to allow real-time access to it and measure the usagemodels, and not have a debate about it. I mean, it is a database discussion then with the customers then that isour benefit.

Analyst for MaheshSanganeria - RBC Capital Markets

As a quick follow-up, can you comment on any changes to yourrevenue predictability because of a decreased ratable model?

Bill Porter

Sure, K.C. You know, one of the questions that I have had inthe past is, what do we expect to come out of backlog in 2007? That reallyhasn’t changed. I still expect that about two-thirds of our revenue for theyear is coming out of backlog. That predictor of 2007 stays the same.

Now if our experience continues to be what it is in Q3 andQ4 and we are going to have about, let’s say 50% of our business coming fromthese term contracts, then of course the math will show that over time we aregoing to have 50% coming out of backlog versus what we are seeing today ofabout two-thirds.

That is a tradeoff that we are willing to make, because wecan see the ability to increase our run rate with our customers, and it issomething that we will factor into our pipeline; albeit the math would showthat you don’t have that same predictability out of backlog, but we think itenhances our ability to sell more often to these customers. So I think we willget it back in terms of a richer pipeline over time.

Mike Fister

Absolutely. The one thing I would add to the debate for thevalue of the technology, anybody who goes out and does extremely, extremelylong deals is, I think, diminishing the value. We've been very forthright tosay we would like to demonstrate the value to our customers and I think we'llget some return on that. This is just an ever-increasing focus for us to try todo a good job at maximizing the value of the fantastic technology we deliver.

Analyst for MaheshSanganeria - RBC Capital Markets

I've got two quick questions on the balance sheet. Goingforward, how should we view debt and also how should we view income frominterest going forward?

Bill Porter

Sure. In terms of the debt on our balance sheet, as many ofyou know, our original convertible, a portion of that will be callable thissummer. So the $230 million is now short term and you can see that in theclassification. So you would expect that would be retired. I think we'll look at the trade-offs toadding additional leverage on the balance sheet. I've been asked that in thepast and I think it makes sense for software companies and ones particularlythat generate good cash flow to have reasonable leverage. We will look at thetiming and the availability of the debt markets to do that. But I think we'lljust watch that and see. Our inclination is a little more is better.

In terms of other interest and expense, I think I gave aforecast there that it is in the 40 to 45 for the year, so I think that'sprobably the best estimate we have right now and then again, we'll look at nextyear when we talk about that in January.

Operator

Your next question comes from Terence Whalen – CitiInvestment Research.

Terence Whalen – CitiInvestment Research

Great, thanks for taking my question. This one relates tocash flow and the $450 million target for this year for cash flow fromoperations. What amount of receivable sales in the fourth quarter is implied tohit that $450 million target?

Bill Porter

Terence, I think that's going to really depend on what cashthat we're going to be able to get from customers in the fourth quarter. Wedon't have a specific target. It's really the mix of business that we get.We're feeling that we're about the same level we were last year, in terms ofnine months and cash from operations. It's a little over $200 million plus. Weexpect to have a good cash flow quarter in Q4 that goes along with our historyand you can expect that we will be selling some receivables. Those are thingsthat the financial institutions value and we think it's something that we canget a good return on by using that cash in our business.

So I don't have a specific number for you, but it will be areasonable amount of our normal cash from operations like it has been in thepast.

Terence Whalen – CitiInvestment Research

Another question related to the license mix. As youtransition the business into next year, relying more on upfront versus ratable,do you expect the frequency or the concentration of 10% plus customers in aquarter to increase versus 2007?

Secondly, what changes are being made in terms of theapproach based upon the salesforce perspective to customers with this modelchange and any other operational changes that go to the model change mix betweenratable and upfront? Thanks.

Bill Porter

Terence, I don't know that we're going to see an increase inthe number of large contracts. I think there's a certain number of largecustomers in the world, all of which I think we serve, and we work closely withthose customers to meet their technology needs. I don't know that we're going to see anything dramatic in terms of achange there.

In terms of working with the salesforce, one of the thingsthat we have and we alluded to earlier, is we have very good visibility intothe consumption of the technology, as does the customer. That allows us to workvery closely with the customer to help get them technology that they need whenthey need it. They appreciate it and it helps our salesforce help them. I thinkwe all have better knowledge.

The other thing that I would just emphasize is this is arefinement of the use that we see of customers with contracts. I don't see thisas any kind of a model change, just to be clear from my perspective.

Mike Fister

I'm out in front with Kevin a lot with the customers. Whatwe do with the salesforce specifically is we use the techniques that we have toreinforce the value and opportunity for run rate continuous business with thecustomers. You can tell that by the testimonials that come quarter afterquarter where you see like names over and over again and this is something thatis a mindset with some of our field people, because a very old-fashionedmindset would have been “I got the contract and now I don't go back and look atit again for three more years.” No. There's business every quarter withexpansion of the license usage that we have and/or new technology areas thatare geocentric, because most of these big customers, as Bill says, areoperating in all different places of the world and that's the refinement we'vemade that many people may talk about --that's what we do.

I think the team's doing a nice job there so far, and we'vegot some more that we can take that. That's why something like an EDA card issuch a neat mechanism because it reinforces the mechanism that we use for oursales teams, our application engineering teams to have that conversation withall aspects of the customer.

Bill Porter

Your question is agood one. The salesforce works closely because they can assist the customer toutilize that technology faster. I thinkthat's the one experience that we have now seen over the two years that we haveslowly introduced and then got acceptance of using these cards is thatcustomers are actually utilizing the technology, as I mentioned, 47% faster. Soit allows the salesforce to work with them to get that new technology intothose customers and to have additional selling opportunities and essentiallygrow our run rate.

Operator

Your next questioncomes from Sterling Auty - JP Morgan.

Sterling Auty - JPMorgan

I want to dig deeper into these EDA cards. If they're a termstructure, that means they're locking into a specific product and a specificversion that they can actually take down. That's correct, right?

Bill Porter

Sterling, theyactually have a choice, so we offer both. With the ones that we have seen themadopting the fastest is the term-type card. That's correct. So it is locked into a fixed price book.

Sterling Auty - JPMorgan

But you talked aboutthat you've been able to give the customers the flexibility. What do you meanby giving them the flexibility then?

Mike Fister

What I mentioned,what they can do is they can draw the technology down faster. They pay moremoney to do that. It allows them to match a short-term capacity with a demandthat they might have. They're basically making a trade-off of whether they havea long-term commitment or not. To me it's a little bit like renting a car. Ifyou know you're going to have a car for a year you might do something differentthan if you're going to rent it by the week. You pay more to rent it by theweek. You know, that works out really good for you when that's all the need youhave.

Some of this is a little bit of the tension or the nominalconversation you have between the users of the technology and maybe even thepurchasers of the technology. This is a real good, objective way to be able tohave that discussion without constraining the access. The things have a fixedduration so they expire and in that respect they are really no different than aregular contract. So it is use it or lose it, and it works out good.

Bill Porter

Let me give you another example, Sterling,because it may help. Say a traditional contract the customer would license ten seatsfor three years. They would have those ten seats, they would use them for threeyears. If they get a card, they can start off with ten seats and then as theysee a project need, they can increase that and start going to say 15 or 20seats and generate more capacity and burn through those seats faster. Say atthe end of two years, they have burned through that technology, used it whenthey needed it and now are coming back for some additional technology.

So that's a way that customers can utilize the technologyfaster to meet their needs.

Sterling Auty - JPMorgan

I guess I'm still alittle bit confused. Are you saying that out of the ten seats per year and you're using up the number of chips thatyou've got and then you come back and purchase more versus if it's subscriptionyou subscribe for ten seats you can only use ten seats at a time over the threeyears?

Bill Porter

Generally, yes. In my example, if they only had a contractthat allowed them to get ten seats, that what their capacity would be.

Mike Fister

Another way to thing about it, this is a good way to have adifferent discussion about remix, historically people would have gone and triedto have an endless debate on an infinite amount of remix opportunity. Now youtake that discussion out of play because people can buy the technology theywant for a spontaneous demand. The design is nichy that way. You get goingalong the thing and you get close to a tape out and you decide you need a bunchof more licenses for some element, say seasonal integrity analysis.Historically, you might have been ultimately constrained so you say to theengineers work harder or fail. This gives them a very easy way to go and blipthat technology up without having that debate and pay a little bit more for thepleasure or the privilege of being able to do that. We both are happy and offyou go.

Sterling Auty - JPMorgan

What is thecollection structure in terms of the payment under a term-based EDA card?

Bill Porter

The payment structures are very much like a traditional termcontract, and of course, we incent the field to try to get more cash up frontand we are continuing to look to do more of that. But essentially, it is paymentover time or with incentives for our salesforce, as you know, they getcommissioned when we get the cash, to more and more get that up front. But weallow both.

Sterling Auty - JPMorgan

But with a jump in DSOs, are you seeing that most of thecustomers are choosing to pay annually over three years or what is theexperience that you're seeing with these?

Bill Porter

Well, I think the experience is about the same that we seewith normal term contracts. I don't think we've seen anything significantlydifferent so far.

Sterling Auty - JPMorgan

We saw that there's a jump up in long-term deferred. Can yougive us a little bit more color there?

Bill Porter

I think as I've described in the past, that's just ourability in some cases to get cash ahead of when revenue is recognized. When youhave increases in either short-term or long-term deferred, that's just aboutgetting some of that cash before the revenue is recognized. I wouldn't try tomake it much more, other than that.

Sterling Auty - JPMorgan

Mike, I am curious what you are seeing out there in themarketplace. It would seem to me that 2005/2006 you guys had a field day, Ithink, taking market share away from Mentorin the emulation space. I think now that the [Deloche] has been out there for anumber of quarters, it seems to be gaining traction within the old, existing Mentoraccounts. Are you finding that it's harder to win some of those accounts now?

Mike Fister

That's a good observation. Anybody will first try to farmtheir installed base and that was one ofthe reasons why I put in the prepared comments some of the momentum that wehave around our emulator families. It is not just a one-hit wonder with us,we've got some great products across the acceleration, all the way up throughthe emulation.

We have a targeted program to go back and upgrade our baseand are doing very well. We have seen some competitive momentum in marketsegment share shift as well, but it has not been totally the focus. I mean,we've got the next generation Palladium coming to debut next year. We've got avery nice potpourri of systems all the way from acceleration up throughPalladium 3 and then the anticipation coming of the unified architecture.

So I like our progress. I don't think that we've lostanything that we didn't expect. We've been very targeted and the real value inthe emulation for us isn't just in the functional logic simulation. It's in thesoftware/hardware coverification. That's why I think that testimonial that Irattled off was indicative.

That is the strength of our total verification approach andstory, aided with emulation as a neat piece of it. I think we have the mostcomprehensive offering and strategies that way and the stuff that we're doingwith some of these leading edge customers reinforces that as a component ofgrowth for our emulation capability.

Bill Porter

Sterling, Iwould just add that we are continuing to grow that piece of the business. It isgrowing for us year-over-year in both existing and new accounts.

Operator

Your next questioncomes from Benjamin Pappas – D.A. Davidson.

Benjamin Pappas –D.A. Davidson

You mentioned the relationship with NXP is expanding. Is itfair to assume then that the overall revenue run rate will increase on anannual basis?

Bill Porter

I did mention that I think as our relationship expanded, Ido expect that we will, over time, increase our run rate as we deliver newcapabilities to the customer.

Benjamin Pappas –D.A. Davidson

Fair enough. In the past, I know you used to mention percentof new bookings booked at subscription. Do you have that number again?

Bill Porter

I think what you're referring to is what I talked a littleearlier about in terms of the percentage of our business that's ratable and inQ3, it was 50%.

Operator

This concludes our conference call for today. Thank you forparticipating on the Cadence third quarter 2007 earnings conference call.

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