Synopsys, Inc. (SNPS) Q3 2011 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you very much for standing by, and welcome to the Synopsys Earnings Conference Call for the Third Quarter of Fiscal Year 2011. [Operator Instructions] As a reminder, today's conference is being recorded. And at this time, I would like to turn the conference over to Lisa Ewbank, Vice President of Investor Relations. Please go ahead, ma'am.

Thank you, Dave. Good afternoon, everyone. On the call today are Aart de Geus, Chairman and CEO of Synopsys; and Brian Beattie, Chief Financial Officer. During the course of this conference call, Synopsys will discuss forecasts and targets, and will make other forward-looking statements regarding the company and its financial results. While these statements represent our best current judgment about future results and performance as of today, our actual results and performance are subject to many risks and uncertainties that could cause actual result to differ materially from what we expect. 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 the quarter ended April 30, 2011, and in our earnings release for the third quarter of fiscal year 2011 issued earlier today. In addition, all financial information to be discussed on this conference call, the reconciliation of the non-GAAP financial measures to their most directly comparable GAAP financial measures, and supplemental financial information, can be found in the current report on Form 8-K that we filed today, our third quarter earnings release and our financial supplement. All of these items are currently available on our website at www.synopsys.com. With that, I'll turn the call over to Aart de Geus.

Good afternoon. I'm happy to report that we had an excellent Q3. Combined with strong results in the first half and a solid outlook for Q4, we're confident that we will exit fiscal 2011 with a great deal of strength. Financially, in the quarter, we delivered revenue of $387 million and non-GAAP earnings per share of $0.46. Our orders for the year have been strong and the run rate of the business grew nicely this quarter. We are increasing our revenue, EPS and cash flow guidance for the year, and expect to deliver double-digit growth for both top and bottom line. Now before commenting on our products and results, let me give you some color on the customer landscape. Notwithstanding the global economic worries and the high volatility in the stock market, design activity continues unabated in pursuit of 3 markets: Mobile devices, the cloud infrastructure and smart everything. In the mobile market, semiconductor companies are grappling with the technical challenge of increasing speed without increasing power. These highly competitive customers are racing to meet market windows, while, of course, also aiming at the lowest possible production costs. The cloud is a system of massive data centers running very high-performance servers, offloading compute and storage-intensive tap for the portable devices. The technical need here is symmetric: decrease power while delivering the highest possible performance. The rest of the electronics industry, be it in the automotive, industrial or consumer segment, is seeing significant growth in silicon content through an explosion of embedded smart everything chip. To give a sense of proportion, of the top 50 electronic design software spenders in the world, 36 are mobile providers and 9 are providers of cloud hardware. We are the largest supplier in almost every case. In Asia Pacific, which dominates in the development of…

Well, thank you, Aart, and good afternoon, everyone. In my comments today, I will summarize our financial results for the quarter and provide you with our guidance for Q4 and the full year. As a reminder, I'll be discussing certain GAAP and non-GAAP measures of our financial performance. We have provided reconciliations in the press release and the financial supplement, which is posted on our website. In my discussions, all of my comparisons will be year-over-year, unless I specify otherwise. Synopsys delivered a great quarter, meeting or exceeding all of the quarterly financial targets that we provided in May. Q3 financial results were highlighted by strong orders, double-digit growth in both revenue and non-GAAP earnings, and considerable free cash flow generation. Additionally, we are raising our full-year outlook for revenue, non-GAAP earnings and operating cash flow. Total revenue was $387 million, an increase of 15% and slightly above our target range. Our IP and systems products continued their momentum and achieved double-digit revenue growth in Q3 and the trailing 4 quarters. One customer accounted for slightly more than 10% of third quarter revenue. Turning to expenses. Total GAAP costs and expenses were $329 million, which included $17 million of amortization of intangible assets and $13.5 million of stock-based compensation. Total non-GAAP costs and expenses were $301 million, an expected year-over-year increase due mainly to our acquisitions, along with the timing of quarterly expenses such as the variable compensation impact that resulted from strong orders in the first 3 quarters of the year. Non-GAAP operating margin was about 22% for Q3 and about 22.5% for the first 3 quarters of the year, as we worked through the integration of a number of 2010 acquisitions. Turning now to earnings, GAAP earnings per share were $0.35. Non-GAAP earnings per share increased 18% to…

[Operator Instructions] Our first question will come from the line of Richard Valera with Needham & Company. Richard Valera - Needham & Company, LLC: Aart, I'm sure you don't want to talk about the fiscal '12 guidance right now, but I'm wondering if you could just refresh us on how you characterize the different pieces of -- the growth rates of the different pieces of your business. Before, you know you have 80% that I think you call core EDA. I think you have said that has roughly a mid-single digit long-term growth rate and then you've got 20% in the IPN system, which, I think, you've characterized as maybe 15% or so. If you could just sort of refresh us on those and tell us if you think those rates sort of still apply?

I don't think there's much to refresh, you just gave the answer, roughly. We are in low- to mid-single digits for the core EDA. We said double digits for the IP and systems area, and then there are a variety of other smaller components that have their own growth rate. But fundamentally, for the year, we entered the year with expectations setting of high-single digits. We are exiting the year doing quite a bit better than that. And in general, I think we feel that the portfolio is strengthened because some of the high growth components are now a bigger percentage of our overall revenue. And so in that sense, I think we're heading in the right direction. Richard Valera - Needham & Company, LLC: And based on your comments, it doesn't sound like you're seeing any adverse impact from some of the macro headwinds, if you will, out there. But just, if you could give us maybe a little more color on sort of what you're seeing from your customers in terms of EDA spending despite some of the obvious sort of negative headlines in certain semiconductor areas, if you will.

Well, of course, our customers read the newspapers, too. And so they -- on one hand share the concern. On the other hand, they also share the rates forward towards being very competitive in areas of high growth. And no matter how what happens to the economy, I think electronics will outperform the economy just because the demand for, especially the mobile devices, the many Internet interaction capabilities is very, very high. I think one of the other reasons that we are probably feeling, actually, very good market results is that even if there were any challenges in the overall market, we are definitely a very, very safe bet for customers because we provide complete solutions. We can help them streamline their expenses while staying extremely competitive. So whichever scenario ultimate plays out, and far for me to be able to tell which one it is, I think we are in a very good position. Richard Valera - Needham & Company, LLC: Great. And could you just talk about what you're seeing in terms of pricing? I think for years, we've seen pretty significant price pressure within EDA. Recently, we've actually heard some talk of prices actually going up in certain instances. I'm just wondering if you could give any color on what you're seeing from a pricing perspective?

Well, it's certainly encouraging to hear a number of people actively speaking about pricing as being an important component to do well in our market. As you know, I think we've been quite disciplined for now a long time. We have a business model that has extremely high degree of linearity and we manage the contracts within, all in all, a fairly tight window, which is typically around 3 years or so. And so that stability gives us an opportunity to be quite watchful about the overall terms. But on top of that, in the last few years, we have step-by-step put a bit more emphasis on how to improve the contract. And the fact that we hear from, obviously, in our industry that they're heading in the same direction is very encouraging. Richard Valera - Needham & Company, LLC: Great. And one final one, if I could just -- with respect to your operating margins. I think this year, you had some pressure from the integration of numerous acquisitions, especially Virage. And I think you've been investing pretty aggressively developing some new IP. Is there any reason to think some of those pressures wouldn't abate at least somewhat as we move into next year and maybe see some upward move on the operating margin on a year-to-year basis?

Well, so I think you understand the overall picture quite well. You're correct that actually more than just this year, even in the previous year, we did put a high degree of emphasis during the downturn to continue to invest both in technology and in serving the customers. The acquisitions bring with them, as you know, a revenue haircut and then a number of cost of integration, and also on our companies that have a lower ops margin than what we have. We have managed to mostly absorb that but definitely the ops margin has been at the lower end of what we normally would manage towards. Going forward, without making a hard commitment at this point in time, given that the guidance will be really done at the end of the fourth quarter, we are looking at the fact that it's possible to put a little bit more emphasis on the ops margin towards the positive. And so I think at this point in time, I would say there should not be any negative surprises by the time we give you guidance.

Next we'll hear from the line of Raj Seth with Cowen and Company.

Aart, if I could just to follow up a little bit on a couple of Richard's questions vis-a-vis ambitions for 2012. It sounds like the revenue line, especially given a higher mix of IP, et cetera, you feel pretty good about. It sounds like -- from your previous answer, that we shouldn't expect anything negative on the operating margin side. In terms of your own R&D intensity, et cetera, in this business, given all the shift, is there, in fact, an opportunity to move, do you think, overtime? Not looking for any short-term commitment but operating margin significantly up beyond the -- getting back some of the pressure that some of the acquisitions cost? I mean, you're running sort of 23-ish, 22%. Can you move that back into the mid-20s, even upper 20s? How do you think about that just generally?

Well, we have been on record for now a long period of time, saying that the longer-term ambition was towards the mid-20s. And we certainly would only say that if we thought that actually was not only possible but desirable. And as you well know, there's always a tension pair between, on one hand, having no end to wanting to do more investments, on the other hand, also wanting to have higher profitability as it generates the cash with potential M&A. And the M&A is mostly important to actually broaden our TAM. And we are step-by-step doing that and actually see some of the positive effects of that very strategy of the last 3, 4 years. And so in general, I do agree with the tenor of your question, and I don't want to turn this entire earnings release into the guessing for guidance for next year. But if there's one more comment coming out of, not only this quarter but really the sum of the year so far is, we're building a very solid backlog that allows us, again, to enter the next year with a high degree of confidence. And once you have that, it allows you to focus on some of the other financial variables. And we do want to put a high degree of emphasis on the P&L profile of the company to generate more shareholder value.

Would it be reaching too far to take that as an ambition beyond high single-digit earnings growth in the next year or is that stretching?

The notion of standing on thin ice and going further and further applies to this discussion. Let's keep the -- both the strategy discussion will be at the September meeting and then the hard guidance should be complete by the end of our fiscal year. But I think, in general, we are thinking about the company, both of course, in terms of technology, investment, but also, in terms of the financial management that we want to apply more systematically. And there are many opportunities to see how we can tune to make the company even stronger.

One follow-up if I might, just on capital structure and cash. You're generating, you have probably one of the most visible models around semiconductors. You've talked about some of the attributes that give you that visibility, vis-à-vis the model, et cetera. You're generating tons of cash. I think you have somewhere around $7 of cash. Can you just talk about the trade-offs as you see them, between buybacks, maybe even dividends and a model like this? Where are you in the thinking around capital structure, please?

Yes, Raj, why don't I grab that one. The performance of our company is really strong again this year on cash flows, we've highlighted with our targets over $400 million. When you look at the structure of the business, we now have $340 million in the U.S. and the rest of our -- just over $1 billion of cash offshore. So again, we look very carefully at the blend of where that cash resides. And then, we've laid out pretty clearly that we're focused on growth, we're focused on M&A as a key ingredient of that growth, in addition to our organic growth, and we committed to keep our share count roughly flat. And again you can see a very strong impact on our buyback program this year, with spending $335 million of U.S. cash on that buyback to take our share count down, even a little bit actually this year, compared to where we were from the prior quarter and over last year. So those are the top 2 priorities. And at this point, we don't have dividends on the table as long as the company continues to grow, both the top line and the bottom line.

Next we'll hear from the line of Sterling Auty with JPMorgan. Sterling Auty - JP Morgan Chase & Co: Within the comment about strong orders for the quarter, can you give us a sense that relative to your own expectation were there any one or two areas that really stood out?

Well, in many ways, the areas that stand out is precisely what makes up the company. IP, again, did very well. We had a number of other individual products that really stand out by particular technical strengths, such as the whole physical domain. We have a number of products that we introduced in the last couple of years that are going well. IC Validator is a good example. And so it is all in all, relatively balanced, but it fits very well, I think, the make-up story that we have told you, are then exactly the facts of the growth rates that we see. In general, we were -- I don't think that we were surprised. I think we executed very well on all the transactions that came up. And I think mostly it is because we have very good relationships with the customers right now. And in many situations that -- they're involved in really, really sophisticated designs, and now that's good for us. Sterling Auty - JP Morgan Chase & Co: Okay. And then, Aart. Can you give us a little bit more color, It wasn't completely clear about the agreements that you have in place with ARM, and exactly how that's going to -- how are you going to monetize that relationship over the next couple of years?

Well, we are, of course, in different businesses. Their main business is in the processor business, where they are doing extremely well. We provide many of the things around that, be it some of the I/O, IP blocks, but mostly a large number of tools and especially, the tools support with their key customers. And one needs to understand what happens really at those most advanced customers that are typically in the mobile field. They are driving extremely hard on the cores of the processors and all the IP around that to be as high-performance as possible, and as low power as possible. And there's really a race among them. And so by being well aligned and having access to some of the IP from ARM in time and with the right support, we can actually make their cores shine in the hands of their customers. And so we have, I would say, probably, 1/2 of our worldwide support is dedicated to that type of task in the broad sense, embedding these cores in very complex chips. In addition, ARM has access for quite a number of years to our tools and hopefully, they can say the positive things about the quality and capabilities of our tools, it certainly helps them drive the state-of-the-art. Sterling Auty - JP Morgan Chase & Co: And then last question. Brian, can you give us a sense given the strong orders, what did that do in terms of the variable expense in the sales and marketing line, in other words, how much higher was the sales and marketing than maybe you would have expected when you originally gave guidance?

Well, it is up over what we had originally anticipated for Q3, as both the bookings for this year and the outlook for bookings for the rest of the year came in higher than what we had anticipated. So as we look at the overall expenses, we're within the range, we're at the top end of that as we came through. So we managed to control the expenses within what we'd anticipated. But again, just reiterating, very strong bookings year, has come in stronger each sequential quarter, as far as performance again, against our anticipation. And again that was the biggest driver of our cash flow as well as we look at that from last quarter to this quarter. So nice diversity of accounts, high volumes, collections earlier than what we had planned on a historical basis, and very good performance in that. But we just had to manage those expenses all within our expectations.

Next we'll hear from the line of Paul Thomas with Bank of America.

One of your competitors went out of their way recently to highlight some competitive displacements at 2 top 10 semi customers. I know historically, there's a lot of back and forth amongst the competitors in this space. But this was the first time we heard a dollar figure of $10 million or more in annual revenue from these couple of agreements. So I wanted to ask you guys directly about it. Have there been any significant losses for Synopsys at any of the top 10 customers recently or is Synopsys market share stable and growing?

You know we have not seen any, and our market share feels very stable and growing and as much as $10 million is a great number, we do $1.5 billion, and so it doesn't -- it was not visible to us. And the reality is many of the very large customers have brought set of customer tool arrangements, sorry, and so frankly, we don't know what they're talking about.

Okay, fair enough. On the average contract life, you've talked about the long term 3-year average, but you've been below that for several quarters. Now just wondering are you still getting sort of inter-contract renewals that are being down a little bit? Or is this a little more active management to get shorter contracts? Or is there anything going on, sort of near term that's going to go away later on to get that back to 3 years? Or how should we be thinking about that?

Sorry for interrupting you. I think in general, from our perspective, the contracts are sort of staying the same. At any point in time, the reality is one rarely goes to the end of a contract then renews for 3 years. And the way this works in practice is, more often than not is, after a year or so, the customer wants some additional tools or some different configuration. And then one tends to renew and re-up for the next 3 years. That is the most common situation. During the massive downturn, we saw that some of the people waited a bit longer, mostly because they didn't want to make any additional commitments from where they were. We are not seeing that recently. From quarter-to-quarter, there can be big changes, because it's a discrete number of contracts. You're right, I think in the last 3 quarters that it was a little bit below 3 years. We are of course, ask ourselves the question, the same question. But we have not really found any special line or reason to be either concerned or elated about.

And maybe just to add to that, Paul, we're at 2.7 years, last quarter 2.8 years, then 2.5 years the previous quarter. So we are seeing a little bit down from the 3.0 years average. But we still feel that 3.0s the target level -- is 2.9 years. So a couple of points, we believe in the full transparency and be able to demonstrate what it is. We say 3.0 years is the way to go. And the other really important part of that, is the inherent run rate of those deals when they come through, and we're very happy with the run rates, the annual revenue increases that we've seen on each of those contracts, and that's also very positive.

Okay, that's very helpful, thank you. And maybe following up on the buyback question from earlier. So you did mention too in your prepared remarks that your share counts stepped down a little bit more, I guess, than normal quarter-over-quarter. And so if there's -- is there anything to read into that? And you guys getting a little more aggressive on buybacks or is that just kind of an anomaly with the stock compensation not chewing up to that in the short term?

Well, that's a good question. But again, we remain committed to keeping our share count roughly flat. And we exercise against a program we put in place that looks at the source of cash and how we can best apply it. And then as we went through the year, we exercised against our plan in the most recent quarter and the amount of exercises that came through towards the end of the quarter as the stock price had come down a little bit, came in less than anticipated. So we executed on our buyback the amount of exercises came in a little bit lighter based on the price. And we ended up in the lowest net stock position we've had in the last 2 years. So very, very good position to be in.

Next we'll hear from the line of Tom Diffely with D.A. Davidson. Thomas Diffely - D.A. Davidson & Co.: Maybe another cash flow question. Of the $400 million that you're projecting for this year are there any unusual or one-time items in there? Or is this the level you'd expect from this new revenue and earnings level?

Yes. We wanted to highlight that when we looked at the 3-year average of our operating cash flow, it came in at $354 million. We are looking at a $400 million. And as you know, cash flow forecasting can be lumpy from year-to-year. The increase in our guidance from last year -- from last quarter, I should say, even from the beginning of the quarter, really all came as a result of increased collections. We had record levels of collections, reflecting a very strong business in our third quarter. We saw that both the level of bookings we anticipated came in higher volume-wise, as well as came in earlier in the year, and that again gives the opportunity for us to collect cash with the new negotiated terms that are put in place. So again, very happy with the amount of cash based on the bookings, but kind of highlighting that our average over the last 3 years have been about $350 million. So just to say, this is our, it's our, one of our record levels of performance, but it's hard to forecast, and it can be lumpy going forward. Thomas Diffely - D.A. Davidson & Co.: Okay. And then also you talked about 1/3 onshore, 2/3 offshore. What's the split for the, I guess the cash flow run rate at this point?

Oh, it's about 1/2 and 1/2, generating 1/2 of our cash in the U.S. and the other 1/2 outside of the country, based on where this comes through based on our current mix of profitability by region. Thomas Diffely - D.A. Davidson & Co.: Okay. And has there been any changes in the laws as far as bringing cash back to the U.S.?

No, not yet. We're following the developments in Washington very closely. There have been a number of proposals on improved tax rates or repatriation, we're watching that really, really closely and support any initiative that does allow us to do that, and to bring back cash at more favorable rates. Thomas Diffely - D.A. Davidson & Co.: All right. Then switching gears a bit. Aart, when you look at the memory space, and going down to 2x nodes and talk about the vertical demand, and all this tech stuff, does this increase CDA intensity to offer memory or is it still pretty small or pretty low compared to logic?

It increases it. Every step to the next node down just brings a boat load of physics, if I can call it like that. And you may have heard about the very fact that Intel announced that they are betting on FinFETs. Think of FinFETs as transistors that instead of being flat, are vertical. And so it's a little bit like high-rise transistors, so to speak. Well, in order to build those things, the physics are extremely tricky, they're very thin, and it requires a lot of simulation. We are very well positioned with that because Synopsys is the prime provider of so-called TCADs, Technology Computer Aided Design, and TCAD in the last few years has had the breakthrough that it can now simulate 3 dimensions. Well, perfect timing because transistors are now 3 dimension. Well, the transition technology of course, is driven mostly by memory FPGA and processor people, because they are the leading edge of technology. And so the trend that you're highlighting, which is the smaller and smaller devices in Moore's Law, absolutely demands more TCAD, more extraction, more simulation, more sophisticated building of libraries and memories. And by the way also more sophisticated investments in IP blocks, and that serves us well again because our IP blocks will become of higher and higher value as they are more and more difficult to build. So we're lovers of Moore's Law, what can I say? Thomas Diffely - D.A. Davidson & Co.: So do you view this as just kind of a continuation of the Moore's Law you've been on for 15 years or so, or is this, is there more of a step function now because of this move to the vertical transistor?

The funky thing with Moore's Law is because it’s an exponential, it feels like every 5 years there's a step function because it's not just a little bit harder, it's a lot harder. At the same time, Moore's Law is certainly alive for now 45 or 50 years. And we can see today another decade, predicting beyond that is always a little haphazard. But for right now, we see people working at sub-10 microns, sort of, nanometers, sorry, not microns, nanometers. And these are extremely small devices and the hunger for more transistors will continue. So I think there's a lot of work to be done, and we're at the heart of that. Thomas Diffely - D.A. Davidson & Co.: And then finally, when you look at your business and you have 90% going into the quarter. Of that remaining 10%, is there some way to characterize the makeup of it? Is the difference in there the other 90%?

Yes, it is. And the reason it is, is because IP tends to be a higher percentage of that because in many situations the IP is a shorter duration cell or in the number of cases also just an up-front cell. So that is -- that tends to fill the last 10%. And then of course, we also have a number of services, and there the services, essentially, are being accounted for upon delivery of certain milestones. And so as much as -- on one hand, it's great to have 90% going into the quarter, it's not like there's no work to be done. But having such a strong percentage in hand, of course, gives the degree of stability that's good for the company.

Next, we will go to the line of Mahesh Sanganeria of RBC Capital Markets.

Aart, I would like to revisit that capital structure question. I mean, here we have -- it seems like the world is falling apart, but you are doing great, your bookings are up, your cash flows is great. And so what stops you from putting some leverage on the balance sheet? I mean, we have equipment companies which are so volatile, but even the equipment companies are putting some leverage on their balance sheets. So I don't understand why you would not consider that very seriously.

Nothing stops us from doing that. And as a matter of fact, we are extremely conscious of the fact that the interest rates have become very better and better. And so from the overall strength of the company, obviously, we can take on debt. That also only make sense if there is a good return to be had on that debt. And far from me to say that there will be or will not be, but it is also clear that if there is more of a downturn, having a strong position has a high degree of value, and we certainly have learned a lot of things from the last downturn. But again, I don't want to be quoted or so I think there is going to be a downturn. There are many questions and uncertainty, and in that landscape we are solid. If the market continues as it is today, our business will continue to grow well on its own volition. But in any case, we are very proactively considering all of these options all the time. Thank you.

Okay. That's helpful, and one more question on the 28-nanometer. How would you characterize the design starts and adoption of 28-nanometer right now, compared to 40-nanometer at a similar stage?

Actually all in all, it's not dissimilar. We put 28 and 32 in the same bucket because technically they mostly are. And we've seen, for example, in the last quarter, the design tapeouts moved to 173 from 134 in the previous quarter. So we track these things quite carefully. And all in all, we are following sort of a 2.5 to 3 years cycle from 1 node sets to the next. So I think 28 is only, where all of the advanced design that's going to go to market in the next 18 months is being done. There are a number of people working at 20 and 22 already, so that's the next wave -- that's much of our deep technology emphasis is on, and then I said there are people already below that. But 28 is the node that all of the foundries are completely focusing on, as we speak.

And just one more follow-up on that. It seems like some of the comments from TSMC, that process technology is relatively better, compared to 40-nanometer, they have much better yield at 28-nanometer, but it seems like that it's taking longer to close the design or product qualified. So can you give your viewpoint as to what's happening? Why is TSMC seeing some push outs in terms of product qualification when your process technology is quite ready?

Well, I think in general, TSMC specifically, has put a high degree of emphasis and hard work on 28-nanometer, and I think they've done very well with that. At the same time, it is also clear that when you go to these smaller and smaller geometries, the tolerances of the technology become larger versus the size of the device. Well those very tolerances reflect themself directly inside of the design. And so what we have now clearly demonstrated, is that yield is about, I would say, 1/2 to 2/3 the results of design technology and about 1/2 to 1/3 the result of actually, manufacturing prowess. Well that's a very important statement because that says that the design community needs to become much more yield sensitive. Now if you compare that to let's say 10 years ago, where most people did designs and then they would send it to the fab and the fab would execute it and end of story. Well today, you have to really tune your design for yields optimization. And actually we have some very exciting tools that are doing well one is called, Yield Explorer that allows our users, the design community to find yield issues much more rapidly. Because there's one more component, it's not just the absolute number of how good is the yield, it is how good is the yield over time. Meaning when you start in a new node, it tends to be not so great and then you tune and tune, and tune, both on the fab side as well as on the design side, and then the yields moves up. That's called the yield ramp. And so the faster you ramp, the faster your chips become cheaper. And so it's in that context that Yield Explorer is doing very well. And actually, just in the last couple of days, I've had interactions with foundries that are optimizing and where Yield Explorer has been able to find some, essentially, bad situations in the design that immediately helped the resulting yield. So I think it's an opportunity for us, the design world and the manufacturing world are no longer disconnected.

Can you assign some kind of incremental opportunity you might have or the industry might have from this systematic yield issues or the design related to yield issue? I know that this was talked about long time ago, that was DFM, and now we don't hear that word that much. But I'm sure the problem was a lot more severe. Is that an area of growth? You talked about that, but is there a dollar amount you can think about for this segment?

Well, we don't break out individual tools, but there's no question that the whole area that touches manufacturing for us, is actually of significant size. And the reason for that is because it contains things such as, the yield optimization techniques that I described, but also described -- contains the optical proximity corrections and there are 2. There's a whole new discontinuity in physics happening, the TCADs, that I mentioned earlier, which has gone 3-dimensional. And so the overall manufacturing tools TAM is probably around $500 million or so, and we must be doing, out the top of my head, I would say $175 million or something along those lines. So it's an area -- it's only that will remain very solid or potentially, growing a bit better than the core EDA.

[Operator Instructions] We will next go to the line of Jay Vleeschhouwer with Griffin Securities.

First, I'd like to ask a couple of interrelated financial questions. In the third quarter, your deferred revenue on the cash flow statement was about $122 million, which was an unusually large amount now as versus that $77 million in the third quarter the year ago. I don't know it's always tricky to compare one quarter versus another in EDA. But would that increase be a rough proxy for your level of bookings increase year-over-year? In addition, in 2010, you increased your backlog by $100 million, not counting the effect of acquisitions which were another $100 million. Would it be fair to say that in fiscal '11, you should be able to increase your year end backlog versus last year by at least another $100 million or so? Then a couple of follow-ups.

Okay. So the first answer is, no. It's not related to any specific customer activity. But just overall, that deferred revenues grew on our ability to invoice our customers, and of course, it does grow very traditionally in the third quarter. It grows compared to the prior quarter, based on the profile of our ability to invoice our customers in cases of annually, in advance, or even quarterly, in advance. It's a very typical program for us to see to a growth. This year was even stronger which relates to general bookings increase and generally, abilities to invoice customers based on terms and conditions that we have negotiated. So it's very strong and does give confidence as we move forward in the year. It is a factor that we do look at for managing cash flows, and it gives us a visibility into the amount that we've invoiced and that then therefore, has very high probability on collections from that point on. As far as the backlog, we did not comment at the beginning of the year of what the backlog would do for the year. We did commit each year that we will disclose the amount of backlog at the end of this year, which would be effectively in a earnings call schedule at the very end of November. And we'll give the numbers then at that point. So again, focus more on the run rate improvement, and not just on the absolute gross dollar values of the bookings, because those do move around an awful lot.

For Aart, a couple of product and market questions. First, at the Design Automation Conference in June. The detailed Intel's architecture group gave a pretty interesting talk on the importance of the necessary transformation in EDA, as they put it. They were talking specifically, for example, about the need to optimize across all of systems software and silicon together. The question is, setting IP aside for the moment, how well do think Synopsys is positioned to meet those kinds of needs, particularly, at the systems level? Then one last one after that.

Okay. I think Gadi Singer gave the presentation and he is tasked of course to try to look at division that Intel has 4 more encompassing design development flow. And there's no question that for a lot of products, the system angle is becoming much, much more important. Now I don't want to give the impression that many people are looking at a completely integrated system to silicon flow, because there just too many tasks and they already specialize. In the systems area though, we have made substantial investments over the last number of years, and they range from tools that are IP algorithmic, architectural level at the very high end, and the companies that used to invest a lot in those were the high end communication company. We have a number of tools that are focused on the virtual prototyping, in other words, built a model of the hardware before the hardware exists. And in that context, we acquired a number of companies, and we have just released a product that integrates much of their efforts. We have some efforts at high-level synthesis. We have a number of efforts in the prototyping based on FPGAs, which is also the benefit that it can be connected directly to analog/mixed-signal boards, for example. So we have a lot going, is the bottom line. And at the same time, I think that this is just the beginning of a field that is still evolving quite a bit. I would add one more component though, which is that in that whole system thinking, one should also look at IP. Because in many ways, IP has 2 faces. And let me take memory blocks as an example. You can think of a memory block as a set of transistors that have been really, really polished physically to be optimally dense. Well, that's the low end of memory. You can also think of it as a -- almost a software device that can store ones and zeroes, well that's the system's perspective. And the fact that we have a very strong IP position, helps us again, in looking at the whole system area. So I think we are by far in a way in the strongest position of all the players, at the same time, it is still very, very much a beginning market.

All right. Lastly, along the lines of some of the earlier questions about where your growth will come from. Synopsys already has the highest share in IC implementation, almost certainly the plurality of the market. And of course, you still lead in synthesis and that category has been doing better over the last year, and you still have very high share in simulation and analysis. So the question is, in what other areas might you look again enough share in the 2 [indiscernible] categories, that there would be a material impact on your run rates and total revenue?

Well, there are a couple of specific areas where we do not have a high share, and so physical verification would be a good example of that, the entire custom domain. We do not have all that much share in the implementation side, and so these are areas that we can grow into. Secondly, the overall EDA market, or EDA plus-plus is actually quite a bit larger than Synopsys. So the share battles will continue, and it's a competitive market. And so our ambition should be to do better and better. At the same time, we have been quite explicit that we want to use the strong position we have to use at least some of the capital strength that we have to broaden the TAM. And you have seen our IP story expand substantially. we have at least one nice little example in the optical area where we made an investment last year that is turning out to work extremely well, and so there are many opportunities, the demand for new capability is unstoppable at this point in time. I think we have arrived at the end of the hour. And so we'd like to thank you for attending the conference call. Hopefully, the takeaway is that we have very good results for the quarter, a strong outlook for the year and are very much looking forward to see a number of you, if not all, at the September analyst meeting. Thank you for your time.

Thank you very much. And ladies and gentlemen, that concludes our conference today. We appreciate your participation and you're using the AT&T Executive TeleConference. And you may now disconnect.