Synopsys, Inc. (SNPS) Q2 2006 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you very much for standing by, and good afternoon. Welcome to the Synopsys Inc. Earnings Conference Call for the Second Quarter Fiscal Year 2006. [Operator Instructions]. With that being said, let’s get right to the Q2 agenda and here with our opening remarks is Vice President of Investor Relations Ms. Lisa Ewbank. Please go ahead, ma’am.

Thank you, Brad. 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 predictions, estimates and other forward-looking statements regarding the company. While these statements represent our best current judgment about future performance and events, the company’s actual performance is subject to significant risk 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 quarterly report on Form 10-Q for Q1 and in our Q2 Fiscal Year 2006 Earnings Release. 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 Q2 earnings release and financial supplements. Our earnings release, financial supplement and quarterly report on Form 10-Q are all currently available on our website www.synopsys.com. With that I would like to turn the conference over to Aart de Geus.

Good afternoon and thank you for joining us. The second quarter was yet another very solid quarter. For the fourth quarter in a row, business came in notably above all targets and our technology continues to demonstrate strong momentum. This outstanding performance was driven by all our product groups but especially implementation, analog and digital verification, and design for manufacturing. We also executed very well against our financial goals meeting or exceeding all our targets and making good progress on our operating margin. Let me begin with some financial highlights. Revenue was $274.8 million, 12% growth year-over-year and exceeding our guidance range. Non-GAAP earnings were $0.17 per share at the high end of our target range. Non-GAAP operating margin was 12.9%, which is excellent progress towards our original ‘06 annual target of 12% to 13% in our stated ‘07 objective of 20% plus. We continued to have one of the most predictable license models in the entire software industry and we are entering Q3 with more than 90% of our revenue targets already in hand. Given the very solid results of the first half and the predictability of our numbers, we are raising fiscal ‘06 guidance for revenue, operating margin and earnings. Brian will go over those numbers in a moment. First let me update you on the business, starting with the overall environment. Based on many recent discussions I have had with customers around the world, the semiconductor landscape appears stronger than three to six months ago. Across the globe, our customers are more positive about their business outlook and volume continued to grow. We have even seen the issue of manufacturing capacity begin to crop up, which in turn enhances the value of our solutions to improve yields. The move to 90nm and 65nm design is in full swing. Meanwhile consumer applications continued to require lower power and more on-chip integration. All these trends bode well for Synopsys. Customer interest in our technology has accelerated as our new products delivered tangible benefits, especially IC Compiler, System level based verification and design for manufacturing. As an example, attendance at our user group meetings worldwide from San Jose to Israel to Europe to India next week has increased notably in the last year. In addition, more than 500 engineers participated in our recent Design for Yield Seminar where we showcased the many yield improvement features in IC Compiler. Since the beginning of the year, a number of major customers have standardized on Synopsys. The benefits of our complete integrated flows are making a visible impact. Earlier in the year, a very large consumer electronics company consolidated on Synopsys’ implementation and application to enable their move to 65nm. Second, Micronas, a world leader in high-definition TV chip selected Synopsys as its preferred vendor for its digital design flow. Third, a top global fables semiconductor company chose Synopsys as its main EDA provider to help them move aggressively to 65nm. In Q2, Cypress Semiconductor was available to reduce its total design time by as much as five weeks using our Galaxy Implementation. Cypress is consolidating its digital design flows and methodologies on our platform. Also in the quarter, Agere announced that it standardized on both the Galaxy and Discovery platforms for digital design. Agere chose Synopsys as its primary supplier because of our technology strength and our ability to help them meet their complex design requirements. They will work with us to increase their use of our design for manufacturing tools as well. Let me now provide some specific technology highlights from the quarter. First, our Galaxy Implementation Platform was again strong and came in above target. IC Compiler continues to deliver impressive results for customers, 8% to 10% better timing area and power at 40% to 50% faster time to resolve. To-date, multiple take offs have been completed including a multi-core DSP for telecom application at Agere and an ultra-low power version of ST's most advanced nomadic multi-media processor. As IC Compiler has quickly gained momentum, it is already featured in four important reference flows. As just one example, STARC, the influential consortium of Japan’s major semiconductor manufacturers adopted IC Compiler in Q2 for its STARCAD-21 production flow. A number of evaluations on IC Compiler jumped markedly in Q2 for both current PC-Astro users and a dozen brand new logos. For competitive reasons we don’t disclose product specific counts, but I can tell you that our installed base more than doubled in Q2. The large number of IC Compiler evaluations and adoption is fully utilizing our present field capacity. In synthesis, Design Compiler won nine out of ten technical benchmarks in Q2. Our new topographical features are delivering substantial gains in layout, correlation and performance. Company such as NVIDIA are deploying this technology because of its productivity gains, fewer design iterations, and faster time to market results. As we predicted, designs of 65nm are ramping a bit faster than most others had anticipated. In a survey of designers at last month’s Silicon Valley Synopsys Users Group meeting representing the majority of North American semiconductor companies, 19% of designs were already targeted at 65nm, a big jump from last year; 45% of designs were aimed at 90nm. At this time, we are tracking (inaudible) active 65nm design, an increase of almost 19% over the last quarter. Tapeouts continued to grow rapidly with 71 completed to date, an increase of more than 30% sequentially. The majority of those tapeouts use Synopsys’ Physical Implementation tool. Now to manufacturing where we have another solid quarter. Customers recognized both the broad scope of our solution and the rapid progress we are making towards creating a bridge between design and manufacturing. Our unique position is making the difference in our technical and business engagement. No one else has the necessary technology in both manufacturing and design to develop a fully integrated design to manufacturing solution. Driven by the requirements of 65nm and 45nm design, Proteus mask synthesis continues to excel. The majority of 65nm fabs use Proteus today. Sony adopted our Phase-Shift Masking technology or PSM to enhance manufacturability of its high performance chip at 65nm and beyond. Hercules Physical Verification was selected for 32nm design project during the quarter. Our yield management solution is generating a lot of customer interests. Those are the standalone product and as part of the (audio gap) Platform. One of the top global fabless companies just adopted our solution to facilitate more rapid yield diagnosis and yield improvement. Stay tuned for more products announcements in this area as we move through the year. Moving on to Discovery, our verification platform, we had another very strong quarter for digital and an outstanding quarter for analog mixed signal. The combination of insatiable, customer demands for faster verification and our differentiated technology draws our strong results. The momentum continue with recent adoptions like companies such as Agere and SG. During the quarter, we announced the first ever complete system (inaudible) flow supported by Discovery for verification, Galaxy for implementation, and a strong collection of verification IP. On the analog-mixed signal verification side, Synopsys continues to be the clear choice with products that cover the spectrum from very high accuracy to very high speed. A great example comes from a large communications chip company that reduced its verification time for 65nm mixed-signal design from 17 hours to just one hour with NanoSim. In addition, a major Japanese company has standardized on HSIM for verification of their mixed-signal design. Now to IP and services, our customers moved to larger, more complex chips, successful IP reuse greatly improved their productivity. Utilization of commercial IP is becoming commonplace and Synopsys’ ability to provide complete and most importantly, the highest quality IP solution puts us in a great position to grow this business. Second quarter represented the best ever bookings quarter for DesignWare with particular strength in our newest mixed-signal core. In system level design, we just announced the acquisition of Virtio, a creator of virtual platforms for embedded software development. This technology will gradually extend our customer base to include software development engineer. They will be able to begin code development much earlier then with prior methods thereby accelerating hardware and software development. In services, our team continues to be very highly (inaudible) on some of the most advanced designs in the world. After completing several projects for 65nm, we have already started our first design at 45nm. There is strong evidence that leading edge services project continued to drive Synopsis through adoption. In March, we told you about our new Pilot Design environment. It provides a ready-to-use optimized design flow as well as a way to systematically measure and improve productivity. There has been a lot of interest as you can imagine by both mainstream and leading edge designers. One major fabless company after an initial engagement at one side is exploring how to deploy Pilot company-wide. While we do not expect Pilot to contribute materially this year, we are excited about the long-term possibility. I do have one personnel transition to report. Vicki Andrews, our head of sales will be leaving the company next month to spend time with her family. I would like to take this opportunity to thank Vicki for her great contribution to Synopsis. She leaves behind a strong team and we plan to appoint her successor within the next several months. In conclusion, we continue to execute very well in all key respects. Business was notably higher than target, our strong technology continues to expand adoptions by customers around the world, and we executed well on our financial goals. I am pleased to turn the call over to Brian for the financial update and guidance.

Thank you, Aart. Let me start with an update on my first 100 days. As you recall, my priorities during the first few months were to get a good handle on the financials and the expectations going forward, analyze the operations of company and to focus on cost management. During these 100 days, I had found a widespread commitment to improving operating margins and earnings power. We have already identified and implemented actions that we expect will drive improvement in our operating margin from 7% in 2005 to our original 12% to 13% target this year and to 20% plus in 2007. Furthermore, we have the most stable and predictable revenue model in the industry as well as the strong balance sheet and cash flow. These allow us to make the right long-term decisions to help us grow our business. We are working (audio gap) to drive the business forward by focusing on topline growth and increasing cash flows. In short, I have been very happy with the results I have seen so far, and would have an excellent foundation for further progress. Now to the quarter’s excellent result. As a reminder, I will be discussing certain GAAP and non-GAAP financial measures. We have provided a full reconciliation in the press release and financial supplements posted on our website. Total revenue for the quarter was $274.8 million, a 12% increase year over year and the sixth straight quarter of revenue growth. This exceeded the high-end of our target range. Our revenue mix remains stable with licenses at 86% on services, which includes maintenance and consulting at 14%. About 90% of Q2 revenue came from beginning of quarter backlog. Just over 9% of Q2 revenue was upfront, slightly higher than anticipated due to a one-time license of phase-shift masking intellectual property. From a products perspective, 75% of revenue came from our core Galaxy Design and Discovery Verification solution, 20% came from our IT and manufacturing businesses and 5% came from professional services. Geographically, Japan and North America were the strongest in the quarter in terms of orders. Revenue distribution reflected a very strong business in Japan, which came in at 18% of revenue. North America was 54%, Europe was 15%, and Asia-Pacific came in at 13% of revenue. One customer accounted for more than 10% of revenue in the second quarter. GAAP range for the quarter were $0.04 per share with cost and expenses totaling $267 million. GAAP results include $13.6 million of amortization of intangible assets and $13.8 million of stock based compensation expenses in compliance with FAS 123(R). Non-GAAP earnings per share of $0.17 were at the high-end of our guidance range, non-GAAP operating margin was 12.9%. Second quarter non-GAAP costs and expenses were $239 million, an expected increase of 7% sequentially. This increase was driven primarily by Q1 expense benefits that were non-recurring and timing related. As you may recall from last quarter, these benefits included greater than anticipated employee vacation and shifting out of hiring. Q2 expenses were also affected by increased variable compensation due to the strong quarter. Other income net for the quarter was approximately $1 million. The non-GAAP tax rate was 33%, slightly higher than last quarter due to a state audit accrual. We still estimate the annual tax rate at 31% for the year. We continued to execute well on contract mix, 92% of product orders in the quarter were booked as time-based licenses with 8% as upfront. The average length of our renewable customer license commitments remained healthy at 3.2 year. Turning now to cash, operating cash flow was $27 million in Q2. Capital expenditures were $16 million. Cash and short-term investments increased $20 million to $535 million. We also repurchased about 800,000 shares of our stock during the quarter for $18 million at an average price of $21.57. We have approximately $338 million left on our authorization and we will continue to evaluate the best use of cash each quarter, including company operations, investments and stock repurchases. Q2 net accounts receivable totaled $138 million, an expected increases from last quarter driven by seasonal billing. CFO’s were 46 days, up from last quarter as expected and within our historic range. Deferred revenue at the end of the quarter was $520 million, a slight increase sequentially. Headcount totaled 531 full-time employees at the end of Q2, a slight increase sequentially due to continued additions and lower cost geographies. And as Aart mentioned, we just announced the acquisition of Virtio, a small developer of virtual platform for embedded software development. It was an all-cash deal valued at up to $50 million depending on the ultimate level of earn out. Now I would like to give you a brief update on the progress we are making on improving the company’s operations and cost structure. As I mentioned at our Investor Day in March, we are committed to improving our earnings power through a combination of topline growth and expense control. On the expense control side, we are well on the way towards making concrete changes throughout the company starting with infrastructure. For example, we are concentrating hiring in lower cost geographies. We are also beginning to institute changes that will streamline our systems and processes in both infrastructure, and sales, and marketing. In R&D, in addition to the workforce globalization, we are evaluating quality and product development processes to identify cost-effective improvements. All of us are committed to topline growth and expense control to drive our long-term earnings power. Now looking forward to Q3 in fiscal 2006; in general, we expect revenue to grow 8½% to 10% in 2006. We expect that costs and expenses will be up approximately 2.5% over 2005, slightly higher than anticipated due primarily to very strong business in the first half of the year, as well the impact of the Virtio acquisition. We expect Virtio to have a small dilutive impact on its first two quarters, but be roughly neutral to earnings for the first full year. At this point, R&D expenses are expected to increase sequentially in Q3 and Q4. Sales and marketing expenses are expected to be about flat in Q3 and up sequentially in Q4 to reflect the end-of-the-year commission, the G&A declining sequentially through the rest of the year. For the Q3, our targets then are; revenue between $270 and $278 million, total GAAP costs and expenses between $261 million and $274 million, which includes approximately $70 million of stock compensation expense, total non-GAAP costs and expenses between $232 million and $242 million, other income and expense between zero to $4 million, our non-GAAP fact rate of 30%, outstanding shares between 144 and 150 million, GAAP earnings of $0.02 to $0.07 per share, and non-GAAP earnings about $0.17 to $0.20 per share. We expect more than 90% of the quarter’s revenue to come from backlog. For the full year, we are increasing our revenue, operating margin and earnings target. Revenue between $1.075 billion and $1.090 billion, on non-GAAP tax rate of 31%, outstanding shares between 144 and 150 million, GAAP earnings per share between $0.08 and $0.17, which includes the impact of approximately 66 million in stock-based compensation expense, and non-GAAP earnings per share between $0.68 and $0.74. This implies a non-GAAP operating margin of 12.5% to 13.5%, an increase from our previous target range. We expect to continue to see cash flow from operations to be greater than $175 million and over the next four quarters, we expect approximately $930 million of our beginning of quarter backlog to turn into revenue. More than 90% of our revenue for the remainder of fiscal ‘06 is already committed. In summary, I am pleased at our excellent execution this quarter and look forward to the rest of the year. With that I’ll turn it over to the operator for questions.

Indeed. Well, thank you very much Mr. de Geus, Mr. Beattie for your time in that overview today, we do appreciate that. [Operator Instructions]. And first in queue, we go to the line of Harlan Sur with Morgan Stanley, please go ahead sir.

Thank you, and good afternoon. With respect to your Asia-Pac revenues declined for second quarter in a row, here in April. Just your thoughts in the business activities there and do you expect to return to growth soon?

Well, in general our Asia-Pac business is actually quite. And so, how revenue gets synchronized is a little bit of function of how the deals came in, what were the deals from the -- and it can vary from greatly from quarter to quarter. Having just been there literally -- what was it, two weeks ago, I can tell you that there is actually a lot of activity specifically in China and I also know that business -- some of the very large boundaries -- not just in Taiwan, are very strong.

Okay, great. Thanks. Then, you talk about the 65nm project in your services business and I think last quarter you said that you had three in the pipeline. I am just wondering what are the issues or problems these customers are facing as they transition to this technology in mode?

Well there are very clear issues. Fundamentally, there are three; one is, at 65nm you have a lot of functionality therefore, verification is just a very, very large task. Secondly, at 65nm power is the toughest optimization criterion to meet while you simultaneously try to get to the speed and power is not just dynamic power but also leakage power. And third, as you move down towards the geometries -- now watching out for yield issues is essential and we have already today in our tools, quite a number of techniques to optimize full yield as we move even beyond 65 variations are going to become more important.

Okay and then one last question to you on IC Compiler. I know you talked about doubling of the installed base, can you just give us a rough idea of how many tapeouts your customers have completed using IC Compiler?

Well, I think we communicated the ones that we have authorization to communicate. People are still very reluctant to communicate where they are exactly with 65nm because they view it as quite competitive. We’ve had multiple tapeouts at this point in time, and so we are well versed in it and we are actually already moving to the next smaller geometry.

Okay, and then last question for you Brian, on the accounts receivable, DSO’s jumped at about 17 days sequentially. Again, can you just help us understand that and were you to expect DSO’s to trend going forward?

Yeah, we had the 29 days in Q1 and then it went to 45 and when you look at the trend over the last eight quarters with us, we have been ranging -- really 29 was an absolute low, so this is really in line with our typical flows on receivables. It also just reflects an increase in our business activity in Q2 as well. So you know, we are in good shape, almost anything over 90 days appropriate for business against it and a big focus on cash and we will continue to drive it the range of 30 to 45 days, I think.

Okay, all right. Thank you.

You are welcome.

Thank you very much Mr. Sur. Next, representing Needham & Company we go the line Rich Valera, please go ahead, sir. Rich Valera - Needham & Company: Thank you. Aart, in your comments you had talked about I think the overall semi-environment being stronger than it was three to six months ago, can you just talk about your confidence level like the overall EDA market will actually grow this year based on the stronger semi-environment?

Well you know, it’s difficult to see exactly what the others guys are going to do. We certainly feel that we are in a good position at this point in time by virtue of the technology that we have to offer, and by virtue of the fact that it’s almost like the race on technology is picking up again. You know, in many ways after the ’01 downturn people focus so much on costs for a while, and then that’s gradually shifted back into, “Well, how do you differentiate on products,” and now it feels like people are really racing for this technologies with more integration, we have more complex IT et cetera. All in all, I think the large EDA vendors have done okay, recently, and I think we just had a very good quarter. Rich Valera - Needham & Company: And Brian, the size of that base shift and can you give us any more granularity on that?

The customers really wouldn’t like us to disclose the amount of that particular transaction, but it was one-time. And you know, the range we have always identified as to be the 10% of the less of the quarter coming in, in terms of upfront revenue, so that pots us up to just over 9% and you know, we anticipate being less than that for the rest of the year. Rich Valera - Needham & Company: Okay, that’s helpful. With respect to Vicki leaving, Aart, do you have any sense here -- plan to with someone internally, or do you actually plan to engage in a search to look outside as well?

Well you know, I think we need to work that out internally before we communicate that externally, but it is true that we have a very good team and right now we are already on Q3, so that’s where I would like to see them focus. Rich Valera - Needham & Company: Great. Just one final one, Brian, on Virtio, I just wanted to clarify, I think you said 50 million was the total potential. Can you say how much of that is upfront versus earn out, in over what period of time that earn out might be over?

Yeah, just to clarify the number, it’s 15 -- Rich Valera - Needham & Company: Okay, thanks.

It’s $15 million and we have several million at the end of that over -- end of this -- roughly a one year period to determine what our final payments will be and we will start looking at that. The deal closed yesterday and we will start accounting for that here in Q3. Rich Valera - Needham & Company: Great, thanks very much guys.

You are welcome.

Okay, and thank you very much Mr. Valera. And our next question then, we go to the line of Jay Vleeschhower representing Merrill Lynch, please go ahead sir. Jay Vleeschhower - Merrill Lynch: Thanks, good afternoon. Aart, I would like to ask as well about IC Compiler. When you consider the results to-date into one of your production last year, are you seeing that in absolute or proportionate terms IC Compiler is growing within your overall pools with customers, but perhaps of the pool, DC or anything else might be perhaps declining in value, so that there is relatively little net increase in the total size of the pool, the run rates even with IC Compilers gaining momentum?

Well you know, we have obviously very complex pools where we have many tools. In general IC Compilers, I would say are right on track where we thought it would be in the anticipation of replacing PC-Astro to the tune of about 80% in three years. I believe that right now our engagements of IC Compilers versus PC-Astro are ruining about 4:1. And so that tells you immediately that’s only our field support audio gap) shifted there and you know, a hidden positive is that -- one of the reasons we have been able to shift well is that PC-Astro is doing very well as a product, and so that helps in terms of supporting them, but it’s very clear that the shift to IC compiler is moving.

Have you seen any examples where customer or customers has done a complete replacement thus far or migration from PC-Astro?

No, they typically -- well gradual, typically they start with one block and multiple blocks and then gradually a complete chip, and so we are now in the migration from multiple blocks to complete chip.

And with respect to the sales management change, it’s been quite a number of years I think five or more since you have a meaningful change like this in sales management. Whether it’s someone internal or external that you have put in this position, do you anticipate this as an opportunity maybe to make some kind of orientation or structural changes at all in sales, in terms of how you approach or manage global accounts, the field, pricing, product packaging, any of that sort of thing?

Well you know, whenever there is any management change anywhere in the company always look at the question of all the things that we could do definitely or is it the good time to ask the question if one would like to shift things. It is clear that the relationship with the global accounts is very important and very complex because these are large deals and they will continue to get a lot of attention. The other thing is that our selling is gradually moving more and more towards much more complete solution, and I think the good news is that Vicki prepared her team extremely well for an understanding of that, and in many ways I think we are well positioned by the way we do business today. Change is always an opportunity to change things that you wouldn’t do any more the same way five, six years ago and accelerate others.

Just a couple of last ones, you have highlighted in your comments to your strength in Japan again as you had in the previous calls since the summer, I assume that’s because we are now pretty much in the heart of the renewals of the Japan deals you did three years or so ago, so those names are now coming up in order. But again the typical run rate question, are you in fact seeing with those Japan deals which perhaps include any (inaudible) and the rest, are you in fact seeing meaningful increases upon the renewal?

Well, typically when I refer to strength, that’s exactly what I mean is the opportunity to grow the business. Obviously, sometimes there are ways of renewal, and whenever renewal come in -- and it’s always thankful that things went well, at the same time the objective is to grow the run rate with the company’s and in general I think Japan has been doing very well for us.

And in last, Brian, is there a measurable benefit benchmark from the new geographic disbursement of R&D? I mean, can you give us what the difference is perhaps over the last year from having made this headcount shift?

Yeah, I think you’ll see that as -- we indicated it at our Investor Day as well that we are leading in the industry relative to getting some top people in some of the lower cost geographies, and anticipate that by the end of this year about 29% of our employee base will be located in those geographies. We are staying this year a reduction in our average cost per employee and of course, that is one of the key deliverables to driving our operating margins and being able to increase our targets for this year to 12.5% to 13.5% and then to this 20% plus in ‘07.

Thank you.

You are welcome.

And thank you very much, Mr. Vleeschhower. Next representing Cowen & Company, we go to the line of Raj Seth, please go ahead sir. Raj Seth - Cowen & Co.: Hi, thanks very much. Aart, on IC Compilers, you mentioned a lot of ongoing evaluations. I am curious how audio gap) there’s probably not a uniformly length of time that it takes, but how long does these typically take at least those first within your existing customer bay?

Well, the question is to always be triggered by what is the thing that makes them start. Typically it’s a few months and the starting point has to be the moment where they actually have a major (audio gap) ready to go out to play some roles. And so you know, there might be blocks readily available or they may be -- one needs to be waiting until that train arrives. Once one or more blocks (audio gap) things move up. Secondly, within the organization typically, there is one place where it starts. People do a block, then do a chip and then it’s scraped through the divisions, and so we have already a number of larger companies that are now completely committed to strutting to all of their division’s schedule. It typically takes -- I would say, 12 to 18 months. Raj Seth - Cowen & Co.: Okay. You also mentioned some new logos, I think in the evaluation process. At this point in IC Compiler, are you generally, mostly focused on your current installed base? Are you beginning and feeling pull for evaluations in accounts where there has been competitive solutions as the incumbent solution? When do you think that starts happening if it isn’t yet?

Actually, a very good question because initially, invariably you start in your existing accounts because that not only reduces your own support cost, it is also accounts that you can work with as new product stabilizers. At this point in time, we have entered the phase where we are into accounts that before we were not in, we are a competitor was doing the (inaudible). That’s a good very sign because I think in once we are in, things will expand naturally and the new ones that’s clearly new opportunity space for us. Raj Seth - Cowen & Co.: One last one if I might, as you talked a little bit about some of the phase-shift products. When Numerical, do you still license that technology they did it on a royalty basis, rate based royalties with folks like UMC and some others, are you still licensing that technology in that way? And are royalty meaningful in your financial results now or no?

Typically, there is only a small portion that’s part of the royalty equation, and yes we have some customers that do that. You know, we have swiftly learned the lesson that people love royalties for small volume. And so, it’s essentially pushing a rope with most of the customers and therefore we work mostly on our licensing bases, which makes a much better relationship with our customers. Raj Seth - Cowen & Co.: Great. Thank you, Aart.

You are welcome.

And thank you very much, Mr. Seth. Our next in queue is Dennis Wassung representing Canaccord Adams, please go ahead. Dennis Wassung - Canaccord Adams: Thank you. Actually, quick first follow on the phase-shift question, if you look at the design and manufacturing area in your revenue with 10% to 12% percent this quarter, up from 10, I think it was 10 in the last year and a half or so, are you seeing a -- I guess did you expect to see that percentage to keep moving higher or was that really kind of a one-time effect of this phase-shift deal you did in the quarter?

You know, there is some variability from quarter to quarter and so something like the phase-shifts deals can be fairly big blimp in a given quarter. In general though, it is clear that the whole connection down to silicon with the FM connection and its actually fairly broad, it extends into our implementation tools as well. We will grow in importance because a lot of the practical problems reside there. And so I would not be surprised even if it’s not necessarily from quarter to quarter all the time that gradually the DFM contribution to our company will increase, it’s one of the growth area for us. Dennis Wassung - Canaccord Adams: And you talked about Proteus as well on the call, and a lot of -- the fact that 65nm is moving the Proteus, has that been -- I guess, steadily growing due to revenue for the company and I guess, can you quantify that at all and also on the (inaudible) side, is that something that you see as a growth market? I know it’s sort of an off and on, we’ve heard about the phase-shifting piece, but is that something that’s picking more I guess, more acceptance in the industry at this point?

Well, you just change your words a little bit. It’s not so much that Proteus is moving to 65nm, it’s that 65nm is moving into much more volume production. And yeah, in many ways we have to prepare Proteus already a long time ago, to make sure that it was completely ready and set it and optimize for these technologies, and now that the volume is increasing, the need for more copies increases with it. And so in that sense, it is well placed in the present needs set. I would say an aggregate -- all of DFM is doing very well for us, and as much as one can look at individual products, we have very much followed a strategy that tells how do you actually provide what increasingly is a complete DFM platform that ultimately has one objective; yield. Dennis Wassung - Canaccord Adams: Okay, great. A couple of quick ones here, I guess first up on the operating margins targeted, you talked about 20% plus in fiscal ‘07, is that your target for the full fiscal year or is that to achieve it at some time during the year?

While we’ve been extremely consistent and said that it would be the second, we have also been consistent to say that it’s not limited to 20 percent, it could be higher but our commitment has been that we would arrive at 20% during the year. Dennis Wassung - Canaccord Adams: Okay, great and I guess the last question, more of a macro question and I guess, environment question. Any changes in the pricing environments and you talked about the fact that you’ve finally come up to the customers and typically -- customers in general think (inaudible) in their markets volumes as well. Are you seeing that as any sort of expansion in their EDA budgets at this point or we do kind of fix with the vendor consolidation seeing just more money per Synopsys at these accounts? How would you kind of couch that, at this point?

It’s a little bit of both because we did know this up, there was actually a little bit more pricing pressure this quarter. At the same time, we also see I think that some of the budgets are growing and because we are seeing both, I think that is good for us. My suspicion is that some folks are getting a little bit more nervous about being around at the table when the deal is closed and as customers tend to focus on fewer suppliers and that’s what’s pushing the pricing a little bit. At the same time, we absolutely see a desire to grow the number of copies that customers have and that’s a good time for us. Dennis Wassung - Canaccord Adams: Great, thanks Aart.

You are welcome.

Our next question, we go to the line of Mahesh Songenalia representing RBC Capital Markets. Please go ahead sir. Mahesh Songenalia - RBC Capital Markets : Yes, I am calling for Stuart Muter. I’d like to go back to the question on the DFM. When I had looked at or talked to people that most DFM applications are OPC and TSM, is that a meaningful adoption for CMP? I know you mentioned that in your TSMC press release and also how about other more involved applications of the DFM like process variability -- process variability into design, I see -- elaborate on that, the adoption of that goals?

Sure well, yeah, actually one of the larger categories you did not mentioned that -- to be mentioned first, the TCAD -- and that has been a very good business for us and at least for us connected to TCAD is also the test chip business that helps calibrate what comes out of the manufacturing back into a variety of the tools. In regard to CMP that is a fairly narrow niche today that we will add capabilities gradually in our tools as they become necessary at the different geometries. Already today in our implementation tools we have techniques that compensate for what’s called some of the dishing problems due to CMP. So we are well connected to that, but we are looking really as a long collection of many, many techniques that all have to come together in a flow that ultimately either yield good yields or not and our objective clearly is to connect those things well together. Mahesh Songenalia - RBC Capital Markets : Is that CMP solution you have -- is it more tangible than just having designed kind of that you had it on the middle line or is it -- how does -- what I don’t understand is how is it that different from doing your modeling and coming up with design rules --

May be we should take this question offline because it can go very deep technically. Very quickly, I would make two comments though, one is that some of the dishing issues can have profound impact on the stability of chips. In other words if you don’t compensate for them your chips just don’t work -- period. Secondly, some of those techniques affect the timing because the capacitance on the chip are not what you expected them to be. So these are just two aspects to it, but there are many-many more, and so if we can help at some point of time giving a little bit broader background we can put you in contact with the GM that is in charge of that and that’s handled the modeling and the optimization. Mahesh Songenalia - RBC Capital Markets : That will be great. I have a different question, how should we look at year over year growth in sort of aside -- looking at the last two quarters it’s I would say trending down from ’05 -- ’06 over ’05, is that going to be the trend going forward?

You know, well on the services, firstly its actually quite a bit variability quarter to quarter because of whenever the milestones are reached you know, whenever projects are finished. Secondly, we have purposely not grown the service business very much as we are driving the profitability of the company and services is not at the higher end of what we do. However, it’s very important and that’s really has helped pioneer and drive forward some of the new technologies. So its the business that is essential but not growing very rapidly, so I think you know flattish is probably the best prediction here.

Yeah, maybe I could add some on this -- on the numbers related to that. What you have to look at in the ’06 is really the completion of the model transition where maintenance is typically included in our time based license activity compared to several years back when the upfront and the maintenance fees was separated out. So this is a pretty consistent level and to add to what I said, we are (inaudible) our service team be pretty busy these days and work in a lot of new activity. Mahesh Songenalia - RBC Capital Markets : Thanks a lot.

You are welcome. Mahesh Songenalia - RBC Capital Markets : And next we go to the line of Rohit Pandey, representing HSBC Securities. Please go ahead, sir.

Thank you, Aart or Brian, when I actually look at the TBL line on the income statement, that revenue from TBL declined slightly, less than $2 million though, but -- but I am trying understand why should this line go down? Brian Beattie: Yeah, it’s a -- we identify back in Q1 that there was one payment that was in the area of $4 million to $5 million, which we consider a due and payable accounts, so revenues recognized when the amount of billings are due and that was $4 million to $5 million. If you look over a trend period, that trend is continuing to go up and also if you exclude that from Q1, you can see a really nice progression from, you know Q3, Q4 and then to Q1 and Q2. So we are seeing an nice progression, but there is just the one time transaction identifying Q1, which was categorized as a TBL license appropriately.

And so about a $4 million -- $5 million transaction in Q1, which was not a three year transaction, but was a TBL? Brian Beattie, Chief Financial Officer: It was a TBL, but they -- they don’t have it very often, its really one where a payment stream is negotiated with the customer and because they extend beyond the one year period, that revenue is recognized when the cash is payable and that was $4 million to $5 million in Q1 of this one customer.

Okay, and then when I look at revenue from backlog for the next two or quarters, that number has gone up from $890 million to about $930 million from Q1 to Q2, so an improvement of about $40 million. So the visibility has gone up, but this $40 million, is it driven by better bookings in this quarter or is it driven by more amortization coming in from the extra quarter, now you have -- now that you are already at Q2 so one more quarter for amortization? Aart J. de Geus: Yeah, I think again we continue to have the most predictable visibility to our revenue streams going forward, its a very significant number. As you saw we have also more than 90% of Q3 revenue completed and also more than 90% of the rest of the year -- the next six months fully completed as well. So the extra visibility is something we have continued to build and it was a -- it was a good quarter, I mean our bookings are strong, the business is strong for the quarter and allowed us to build up that. That backlog is going be profiled over the next four quarters.

But what drove it more? Was it that $40 million increase -- was it driven more by bookings in the current -- in the reported quarter, or because you have one more –- I mean because you reporting ahead -- another four quarters of backlog?

Yeah, its -- its really about, it’s just the strong -- a strong quarter that continues to build and takes a new accounts -- the new business already been contracted for the next 12 months that’s already been factored in. So a very good nice strong growth.

Okay, and how big was the team acquired -- how many people?

I think -- more like 35, yeah.

35?

Yeah

And again, remind me where are they based?

They are based here in Silicon Valley and (inaudible) I believe and partially and -- and Great Britain.

Okay.

There’s a small group in Texas too.

Okay, so that would offset somewhat your move to the -- geometries?

I think well not too well across geometries but maybe geographies. Well, you know, we are in all of these locations with the exception of (inaudible) so the move to smaller -- to lower cost geometries -- the lower cost geographies is a gradual one and we use every attrition as an opportunity to sort of revisit, should we replace at the same place or if we can move, and we’re very conscious to want make sure that we maintain a very effective continuation of product developing, business picture etc., but it is very gradual.

How big do you estimate this ESL market to be and what are the growth you are kind of starting to see in this segment?

Well, one of the reasons that we’ve been fairly low key about this is that we want to spend a lot more time looking at this entire market. You know, ESL has been such an unexplained word and so misused by so many parties in the past to set expectations that were either close to zero or close to infinite, that -- it’s just not a very useful way to define things. Maybe the best way to present it that is we’ve always said that our move towards system design would be through the building blocks of IP where we have a strong position. We are gradually -- with the IP comes more and more embedded software, with the collections of IP comes more and more the need for platforms to tied it together and well this year there is really an opportunity to move from our IP collections, to our verification IP, to now system IP and that is I think a very elegant way to start touching the embedded software developers.

On the expenses, this one is for Brian. The original goal was to keep the expenses flat. Now that you expect them to go up some -- about 2.5% for this year so what are the basic operational challenges you are facing when you try to lower the cost further down, like you know, I mean you have done a good job in controlling expenses, but it’s a little higher than what you thought it would be originally. So, what are the fundamental problems you are facing there?

Yeah, well I would say first of all, recognizing that our business is growing now in the baseline of guidance at 8.5% to 10% and that as you see a growth of approximately 2.5% in spending, that’s basically a 4:1. So it’s -- you know minimize the spending while you can really drive through the revenue in the higher level of business. So what we are seeing in the rest of the year is number one, our compensation for overachieving the plans in both booking revenue and earnings, of course it has to be taken into account as it go through the rest of the year. We have a small increase there now associated with the Virtio acquisition that we closed yesterday, really mostly driven towards higher specific spending and at the same time the course continue to lower the ongoing cost. So it’s just something -- basically you call a direct cost, they grow with the incremental level of business and again we’ve now been able to increase our operating margin as we just did from 12% to 13% now to the range of 12.5% to 13.5% for this year. So getting closer to the target that we’ve been establishing for next year as well.

Thank you very much Mr. Pandey. [Operator Instructions]. Next representing Deutsche Bank we go to the line of Tim Fox, please go ahead.

Thank you, good afternoon. First question, Aart, you had some very nice growth in the discovery platform and the DFM, but the Galaxy growth had been in kind of a low-single digits here for a couple of quarters. When do you anticipate you will start to see some year-over-year growth in the Galaxy platform and you know, where can we see that for the full year?

Well, I think that if there is a growth opportunity it would be more towards in the second half or early next year as some of the products that we have rolled out do better and better. Revenue varies quite a bit from quarter to quarter, so I wouldn’t be able to say that its systematic. The other thing is you know the position in Galaxy helps our DFM position, the DFM position helps our Galaxy position, and so in that sense as much as we report in these major categories we ourselves always question ourselves if it’s the right thing to do given that you know there are quite a number of interdependencies. Nonetheless I think you know the core of the business is now very solid, and I think with the markets up and technology strong we should be able to do well.

Okay, and the second question is around backlog growth, you talked in the beginning of the year about your intention to grow backlog for the full year and given the three quarters that you reported here with bookings ahead of plan, I’m wondering if you could comment on whether you still do intend to grow backlog for the full year and whether you are willing to quantify that at this point?

So the answer is yes to the first which is, yes we are continuing to be every much on target in growing backlog and what we’ve said is that we would give you the backlog numbers at the end of each fiscal year as being the most meaningful and -- but so far I think we are very well on track and now the reason we are raising guidance on a variety metrics is because things have become much more solids rather than less.

Very good, that’s all I have, thank you.

Thank you, Tim.

And thank you very much sir, and next we go to the line of Matthew Petkun with D. A. Davidson & Co, please go ahead. Matthew Petkun - D. A. Davidson & Co: Hi, thank you for taking my call and of course most of my questions had been answered. I’m curious actually on the Virtio acquisition, you guys sort of had a chance to try before you buy having, I believe integrated that product suite with your Discovery platform last year, how many customers do you have currently working with Virtio and you know kind of what are your expectation for growth in that business for the next couple of years?

There are a number very important, very large customers working with Virtio, and you’re absolutely right, we had the opportunity to try it out so to speak or to be close to it and saw the impact. I think Virtio at this point had communicated already that they were doing business with CI and Freescale, but of those companies of course have very, very strong broad system on chip platforms that benefit greatly from this type of technology. And so it is precisely because we saw the impact and we knew that this was a very good team that we felt this would be a very good addition, and the complimentarity with our existing system tools and our IP I think is really remarkable. So from that perspective -- this is actually, for right still a small announcement but I think has the potential to be very important as we move now much more in to this general system or in better software arena. Matthew Petkun - D. A. Davidson & Co: Okay, and then others have sort of asked the question in a variety of ways, but the bulk of your DFM business came from OPC, what’s going with the integration of HPL and how do you see the market for really yield enhancement -- you know, starting to unfold and do you get customers coming out to you for that -- you know technology or is it more still about just you know, getting the design done on the chip?

Yeah, first -- and different people give different titles to their CEO, not always correctly but we still put TCAT in the general arena of design for manufacturing although it’s really much more -- you know tools for manufacturing. Presently, we have other products that share the factoring products cap that had gone very well. And third, on the HPL acquisition, that is moving along very nicely because it’s connecting to so many things that we do, and as a matter of fact we are already working with some key fables semiconductors vendors to see if we can help them connect better to their foundries and thus first diagnose and then improve their yield. So this is all part of a very simple to safe strategy which is, how do you close the loop on yield, in practice of course there are many pieces, but so far all the pieces appear to be right in place. Matthew Petkun - D. A. Davidson & Co: Okay. Maybe the more direct question is, you are working with those customers in regards to HPL, but have you figured out how to get paid for that?

The answer is yes. Matthew Petkun - D. A. Davidson & Co: Okay, great thank you so much, nice quarter.

Thank you.

And thank you Mr. Petkun. We go to the line now with Mr. Colio representing J. P. Morgan. Please go ahead.

Hi, guys I will make my question quick here -- two specifically. First on the guidance, correct me if I’m wrong, but to seems like the Q3 guidance as well as the four years seems to imply a roughly flat Q4 and I just wanted some more color on that. Second question was, just another clarification on the PSM customer that you had, was that indeed the 10% customer as well? That’s all I have.

On the second question, the answer is no. That was not a 10% customer. In terms of flatness for the year, we have raised the overall number a little bit -- you know quarter to quarter things can vary quite a little bit. We do feel that the first half was stronger than originally planned, therefore we feel more solid about projecting the ending, but the variability on Q4 invariably tends to be fairly large, therefore we are going to careful on how we set the target and we will do at next quarter.

Okay, thank you.

You are most welcome.

And thank you very much Mr. Colio, well with then Mr. de Geus, Mr. Beattie, I’m going to turn the call back to you, there are no further question.

Well, thank you very much for participating today, as usual Lisa, Brian, and myself will be available after the call, and I think we are looking back on a strong quarter and looking forward to a very solid outlook, thank you.

And Ladies and Gentlemen, Mr. de Geus is making today’s conference available for digitized replay, its for two full weeks starting at 5:30pm Pacific Daylight Time May 17th all the way through 11:59 pm May 31st. To access AT&T’s Executive Replay Service, please dial 800-475-6701. At the voice prompt enter today conference ID of 827525. And that does conclude our Earnings Report for this Second Quarter, thank you very much for your participation, as well as for using AT&T’s Executive Teleconference Service. You may now disconnect.