Commentary: EDA Industry Update May 2006 -- What did the Last Quarter Bring?

On April 6, 2006, the EDA Consortium's Market Statistics Service (MSS) announced that total EDA industry revenue for Q4 of 2005 was $1,253 million versus $1,191 million in the fourth quarter of 2004, an increase of 5%.

During Q4 2005, CAE accounted for 43% of the total revenue, IC Design and Verification for 28%, PCB and MCM for 7%, Semiconductor IP for 17% and Services for 5.5%.

During Q4 of 2005, North America accounted for 45% of total revenue, Europe for 22%, Japan for 20% and ROW for 12.5%.

Walden C. Rhines, chairman of the EDA Consortium and chairman and CEO of Mentor Graphics Corporation "The EDA industry continued to strengthen in the fourth quarter. Revenues were up in all regions and most product lines."

For the year 2005 CAE accounted for 42% of the total EDA market, IC Design & Verification 26%, PCB + MCM 7.5%, Semiconductor IP 18% and Services 6%.

The EDA Consortium is the international association of companies that provide tools and services that enable engineers to create the world's electronic products. EDA is the critical technology used to design electronics for the communications, computer, space technology, medical and industrial equipment and consumer electronics markets among others.

Economic & Geopolitical Factors

Frequent readers of the authors' Commentaries will recall our quarterly discussions of economic and geopolitical factors that we believe have been causing high-anxiety in high technology industries in the United States and elsewhere around the world. We have often noted that, after eight years of an improving technology environment, the last five years have moved the country in the wrong direction.

These last five years have resulted in far more than a baker's dozen enervating political and economic factors here in the US: (1) unremitting extravagance and unwarranted tax cuts in the face of the shift from US federal budget surplus to deep deficit, (2) the definite long-term trend of a rich-get-richer, poor-get-poorer US income distribution, (3) sluggish net job growth below the requirements of US population increases, (4) a net US disadvantage in globalization, (5) weakened US environmental stewardship and deteriorating US infrastructure, (6) the ballooning real and psychic costs of war, in lives and treasure, (7) reduced worldwide and domestic admiration for US leadership, with an astonishing lack of accountability, (8) the weaker US dollar, (9) elevated energy, oil & gas prices, (10) a deteriorated domestic NASDAQ market that has never returned to 2001 levels, (11) ongoing corporate fraud, (12) indictments and criminal investigations in both the White House and Congress, (13) double-digit rises in the cost of US health care and ongoing increases in the number of US uninsured, (14) stunning US federal incompetence (cronyism, disaster relief, Medicare drug plan, nation building, ), (15) reduced US civil liberties and personal privacy, (16) unrelenting illegal immigration, and (17) record US trade deficits growing each year, requiring the US to borrow billions of dollars every week from abroad.

Alas, recent developments have not improved the situation.

Let's just consider Items (1) and (2) above. Worsening inflation in the US continues to steal US consumers' purchasing power and mocks the stagnant multi-year flatness of US workers' compensation. The Fed is so worried about inflation in the US, that for the 16th time in two years it raised interest rates, this time to 5% on May 10, 2006. Yet average Americans must react to their own paychecks and benefits, weighed against highly-volatile costs, like housing (higher mortgage rates), health care (Item (13) above) and gasoline (Item (9) above). For all but the wealthiest Americans, the latter volatile costs have outpaced paychecks since 2001.

Then inflation news got worse a few days later. On May 16, the government reported that wholesale prices jumped 0.9% in April, the most in seven months. Then the Labor Department reported on May 17 that the consumer price index swelled 0.6% in April, topping all forecasts. More importantly, the "core CPI" without food and energy also gained 0.3%.

Although the "recovery" from the 2001 recession is now nearly four and a half years old, the average wage in the US has nevertheless lost ground to inflation since 2001. So despite big statistics such as, "The US Gross Domestic Product advanced at a 4.8% pace in the January-to-March 2006 quarter, marking a rebound from the feeble 1.7% rate in the final quarter of 2005", we simultaneously realize that people's wages are not keeping up with inflation. No wonder the president's polls (see Item (7) above) are now at their lowest level of his tenure (31% approval = to his Daddy's lowest number, with some other fresh polls now at 29%). Some 69% of the people polled now say the nation is off track. Op-Ed columnist Thomas L. Friedman made this comment in the May 17 New York Times, "Those polls can't possibly be accurate. I mean, really, ask yourself: How could there still be 29% percent of the people who approve of this presidency?"

Well, at least the government is acting to get that ballooning federal deficit under control! (Item (1) again!). What's that you say? Congress agreed on May 12 to a five-year, $70 billion tax package that would extend deep cuts to US tax rates on dividends and capital gains, effectively locking in all the president's first-term tax cuts through the end of the decade? And Bush said he signed it enthusiastically once it reached his desk on May 17, 2006?

"We have a train wreck waiting to happen," said C. Clint Stretch, director of tax policy at the accounting giant Deloitte & Touche. "You cannot grow your way out of these (federal) deficits," said Senate Budget Committee Chairman Judd Gregg (R- NH).

Oh well, everyone benefits from tax cuts, what the heck! What's that you say? Most Americans will not benefit? Most of the cuts go to a tiny minority of wealthy Americans? Yep, the Center on Budget and Policy Priorities says the average middle- income household will get a $20 cut, while those making more than $1 million a year will get nearly $42,000. (See the red bars of the graph below to learn who benefits).

As Molly Ivins of the Creator's Syndicate said on May 18, "The $70 billion tax cut is part of a continuing right-wing fantasy going back to the Laffer Curve (circa 1981). Of course, clinging to demonstrably false economic precepts is understandable when you (stand to) benefit from them, but at some point reality does intervene."

Oh by the way, the latest tax cut bill also commits an estimated $53 billion through the middle of the 21st century to help those same high earners shift their existing savings into tax shelters. This foreshadows big federal deficits far into the future.

Let's turn to enervating Item (3) above. Alas, the pace of adding new US jobs continues lukewarm at best (see graph below). California's economy posted a net loss of 2,600 payroll jobs in April. Even after the recession of 2001 ended, with the millions of jobs lost in the US in 2001, 2002, and 2003, it took till part-way into 2005 before a single net new job was added in the US, the slowest post-recession jobs' recovery by far since WW II. Over the last year, the monthly job additions are still tepid, compared to the eight-year period of 1993-2000, when 230,000 jobs were added on average every month for 96 months! That's like an NBA star averaging a "triple-double" every year for 8 straight years!

Outsourcing of US jobs continues unabated (Item (4) above). While outsourcing to Asia still tops the list (India, China, Philippines, Singapore and Malaysia), lately Eastern European countries such as Bulgaria, Romania, Slovakia and the Czech Republic are getting into the act, shifting work from both the US and Western Europe. A low-cost, highly educated workforce, combined with solid infrastructure, economic and political stability, geographic proximity and fewer security concerns are just some of the factors helping Eastern Europe. For example, Bulgaria's educational system ranks fifth in the world and 11th in mathematics, with one of the highest numbers of information technology-certified professionals per capita. General Motors, Capital One, Ford Motor Co. and Lockheed Martin, have already outsourced information technology work to Bulgaria. In early 2006, Hewlett-Packard announced plans to open a global delivery service center in the Bulgarian capital to provide remote infrastructure management assistance to HP clientele in Europe, the Middle East and Africa. Expected to be fully operational next year, the center will employ about 1,000 Bulgarians, primarily multilingual engineers and programmers. Outsourced jobs in Bulgaria provide average base salaries of about $373 per month, well above the Bulgarian average monthly salary of $190.

Another sure sign of worsening US economic trouble is the recent surge in gold prices and other precious metals. The price of gold rose to a fresh 25-year high on May 10, 2006 as investors sought a safe haven amid a weakening US dollar (item (8) above) and worries over the administration's most-recent sword-rattling confrontation this time with Iran. Historically, gold is considered a truly desperate refuge against serious currency weakness, inflation and financial instability. Gold is trading now at levels not seen since the Reagan era. Many investors are now turning to gold; they don't think US inflation is under control, because the US economy is now much more leveraged (i.e. debt-ridden) than it has been in the past (items (1) and (17) above).

During the week of May 15-19, China slightly loosened the tether that binds the Chinese yuan to the US dollar. A stronger yuan implies a weaker dollar, as does the general strengthening so far in 2006 of the euro and the yen (see Item (8) above). But unless the falling US dollar is paired with reductions in the US federal budget deficit, more harm than good is done due to rising interest rates. That's because the foreign investors who finance the administration's "borrow as you go" budget (see Item (1) above) are likely to demand higher returns to invest in a depreciating US dollar. To keep interest rates in check as the US dollar falls, the administration tries to use smoke & mirrors to persuade investors not to believe what they see: a US dollar that is declining even as the US does nothing to curb its federal borrowing.

Meanwhile, the US housing market continues to slow. On May 16, 2006, the Commerce Department said US housing starts nationwide dropped 7% to 1.85 million in April, down for the third straight month, as rising mortgage rates showed signs of tempering demand. In the San Francisco Bay Area, home sales tumbled to their lowest level in five years in April as a chill continued to creep through the region's housing market. The Nasdaq Composite closed at its weakest level of the year on May 16, 2006. Then Wall Street skidded even lower on May 17, when the Dow Jones industrial average suffered its biggest one-day loss in three years, and the Nasdaq composite index turned negative for 2006. The Dow and Nasdaq lost another 77 and 15 points, respectively, on May 18. Then on May 22, the Nasdaq fell 21 points to 2,173, its weakest close in 6 and a half months.

The Nasdaq has really never recovered since 2001, despite claims of the "robust US economy" by administration spokesmen. It's still more than 15% below its level of January 21, 2001, just to choose a date (Item (10) above). The Nasdaq also remains 57% below its high water mark historically.

Of course, anyone who drives in the US has experienced the outrageous rise in gasoline prices in the US, exacerbated by the needless US conflicts with Iran and Iraq (items (6) and (9) above). Worse, Californians now pay 48 cents more for each gallon of regular than other Americans do, with the state's average reaching $3.37 on May 10, 2006. But the price of gasoline is way up across the US.

The latest New York Times/CBS News poll in mid-May showed that 63% of respondents had cut back on their driving because of the gas price increase, and 56% had cut back on other household spending. No wonder the University of Michigan's consumer-sentiment index for May 2006 plummeted 8.4 points to 79!

Meanwhile, big oil continues its grotesque march to record profits as it has for the last five years. Exxon recently reported first-quarter 2006 net income of $8.4 billion on sales of $89 billion. Chevron reported Q106 net income of $4 billion on sales of $54 billion. Oil execs always point out that the companies' profit margins are "only" in the 9% range, only "slightly higher" than the US corporate average. Of course they never mention to the public, except when touting their stock to their shareholders, that oil companies sport a return on capital employed more than double the average return on capital employed for all US industrial companies. In 2005, Exxon's ROCE was 31%. Collectively, the five largest oil companies (Exxon, Chevron, ConocoPhillips, Shell and BP) enjoyed an average ROCE of nearly 27% percent in 2005. Why not use some of this largess to build more refineries?

Crude oil -- gasoline's main ingredient -- has traded for more than $60 per barrel for most of 2006, reaching as high as $75.17 in April. Yet oil company profits have soared by a far greater percentage. Perversely, rising gas prices may also be shoring up crude prices. Although the cost of crude usually helps determine gasoline prices, and not the other way around, the two sometimes support each other, with each barrel of oil becoming more valuable as gas prices rise.

No wonder the administration wants to keep the vice president's 2001 energy policy conference an ongoing secret!

And talk about "unintended consequences." Due to the higher prices for fossil fuels, the US nuclear power industry now believes it has its best chance in years to come back to life and overcome skeptics to build new nuclear plants. Apparently the US nuclear industry already has as many as 20 nuclear plants planned across the country, worth upwards of $60 billion. Of course, the industry has a spotty past record at best of opening nuclear plants on time and on budget. And one other small consideration -- what to do with the nation's pesky radioactive waste -- a question that has dogged the US nuclear industry for decades.

Since the "peak" of the world's oil supply has probably already occurred, "big oil" also ought to be plowing most of its profits into developing and perfecting renewable energy sources, rather than focusing on exploiting the dwindling world oil supply. And the US government should insist on it, along with promoting conservation. In recent days, US Senate Democrats introduced new energy legislation to cut US oil consumption significantly by 2020 by boosting sales of alternative fuels, providing incentives for purchases of hybrid vehicles and researching next-generation energy technologies. It would create a national renewable portfolio standard for electric power requiring 10% of all electricity to come from renewable sources by 2020.

This "Clean Energy Development for a Growing Economy (EDGE) Act" is drafted around five core principles:

    * Transforming American's vehicles and infrastructure
    * Protecting American consumers and businesses
    * Leveling the playing field for clean energy technologies
    * Real government leadership for clean and secure energy
    * Diversifying American energy sources, investing in the future

Senator Maria Cantwell (D-WA), the lead sponsor of the bill stated, "It's time that we simply stop talking about energy independence and start running with a plan that also makes America more secure and more economically competitive." Senator Pete Domenic (R-NM), Chair of the Senate Energy Committee, criticized the plan for its "absence of any effort to increase American energy supply."

Well, at least corporate fraud is starting to taper off, especially in high-tech (Item (11) above). What's that you say? Boeing just agreed on May 15, 2006 to pay $615 million to end a probe into alleged defense contracting scandals. A former high- level manager at Cisco Systems Inc. in San Jose CA, accused of insider trading for allegedly tipping off his two brothers to pending acquisitions, reached a settlement with SEC regulators on May 16, 2006. Hundreds of thousands of dollars in fines were levied. The Cisco manager apparently learned of five impending acquisitions and shared the information with his younger brothers before it was publicly released. The younger brothers bought shares in the targeted companies and sold them after Cisco announced the deals, reaping $400,000 in illegal profits. On May 18, Abbott Laboratories was accused of vastly inflating prices of its drugs as part of a fraudulent billing scheme alleged to have cost government health programs more than $175 million over 10 years. The lawsuit is the latest in a series of whistleblower claims against drug manufacturers. Settlements in other cases have totaled more than $3.1 billion in recent years.

Former Enron chiefs Kenneth Lay and Jeffrey Skilling were convicted on May 25 of conspiracy to commit securities and wire fraud. The verdict put the blame for the 2001 demise of the high-profile energy trader, once the nation's seventh-largest company, squarely on its top two executives. It came in the sixth day of deliberations following a federal criminal trial that finally got underway after 4 years lasted nearly four months. Enron founder Ken Lay and former Chief Executive Jeff Skilling defrauded investors by concealing Enron's shaky finances while selling millions in company stock. The Enron defense attorney Daniel Petrocelli gave a worrisome quote at trial, "If Skilling and Lay weren't just using common, legal business practices, we might as well put every CEO in jail." Oh boy. Occurring early in the current administration's first term, Enron's bankruptcy was the biggest in US history at the time. It raised the curtain on a "pageant" of corporate greed led by the likes of Tyco's Dennis Kozlowski, and WorldCom's Bernard Ebbers, just to name two more notorious cases.

Meanwhile, some 17 public companies nationwide (many high tech) have been identified by the Securities & Exchange Commission as at risk for having backdated stock options, according to a report released May 19, 2006 by the Center for Financial Research and Analysis. Regulators are investigating whether companies broke securities and tax laws by backdating stock-option grants to coincide with the lowest possible price, thereby illegally maximizing the amount of money executives can make in exercising options. Another 3 companies were added to the list on May 22. If federal prosecutors find that executives illegally backdated grants so that the "strike" prices on their options were artificially low, those executives -- or board members who approved the practice -- could be charged with criminal fraud, an attorney said. "This has become the issue du jour for the SEC and federal prosecutors," said the securities lawyer, who spoke on condition of anonymity.

Finally, three makers of computer memory chips just agreed on May 12, 2006 to pay $161 million to settle a class action lawsuit accusing them of conspiring to hike prices. Apparently, all three semiconductor companies have pleaded guilty to felony price-fixing charges in federal court as part of an antitrust case that has netted more than $731 million in fines.

Hmmm - guess corporate fraud continues after all -

Well, at least Congress is getting a handle on the president's authorization of warrantless domestic wiretapping, which sidestepped the lawful albeit secret court set up by the 1978 Foreign Intelligence Surveillance Act (FISA) you know, the story that leaked to the public in December 2005 (Item (15) above). What's that you say? There's more? On May 11, 2006, USA Today disclosed the apparent existence of an even more massive domestic intelligence-gathering program? Approved by the president, the effort seemingly began in secret soon after the 9/11 terrorist attacks. Since then, the National Security Agency is said to have been collecting call records on tens of millions of personal and business telephone calls made in the United States. Apparently, Qwest, the nation's fourth-largest phone company, was the only one of four telephone companies that rebuffed US government requests for the company's calling records, because of "a disinclination on the part of the authorities to use any legal process." The three other big phone AT&T, BellSouth and may have secretly complied with the National Security Agency to build a vast database of calling records, without warrants, to increase NSA surveillance capabilities. A few days later, Verizon Communications Inc. and BellSouth Corp. began denying key points of the USA Today story. The denials leave open the possibility that the NSA directed its requests to long-distance companies, or that call data was collected by other means. The NSA program is so classified that the American people may never know the truth. We also learned recently that a little-known US government spy agency that analyzes imagery taken from the skies has been spending significantly more time watching US soil (The National Geospatial-Intelligence Agency).

Worse, Americans who raise legitimate questions about secret and/or warrantless invasions of privacy find their patriotism impugned. Hey, FISA is neither quaint nor irrelevant; it's the law! And anyhow, under FISA, the government can eavesdrop for 72 hours before seeking a warrant (which is almost always granted). So why do it illegally?

Rather than accept blame itself for the illegal surveillance, the administration is seeking to prosecute the journalists who reported it! Attorney General Alberto R. Gonzales raised the possibility on May 21, 2006 that New York Times reporters could be prosecuted for publishing the existence of the warrantless surveillance in December 2005.

Meanwhile, the Department of Homeland Security is late on releasing to Congress reports on 118 security plans for mass transit, rail, aviation, ports and borders. One late report assesses the impact on travelers' privacy and civil liberties from the Transportation Security Administration's proposed Secure Flight program, which would pre-screen passengers by computer. That report was due March 13, 2004. Another late report focuses on threats from international air cargo; it was due June 15, 2005. Congress also wanted an update on the criteria to be used to consolidate names on the terrorist watch list; that report was due in June 2005.

We need to recall the words of Benjamin Franklin, "Those who can give up essential liberty to obtain a little temporary safety deserve neither liberty nor safety." This line is frequently quoted these days by Richard Ben-Veniste, a member of the 9/11 Commission. You remember the 9/11 Commission: the distinguished bipartisan panel that the administration stonewalled for months until the 9/11 families intervened? The 9/11 Commission finally issued its full report in July 2004; its report became a best-seller. Among its 41 recommendations to the administration was to set up a civil liberties board as a watchdog to oversee privacy and civil rights compliance within the executive branch. And then 17 months later in December 2005, the 9/11 Commission issued a public report card on the government's response to the entire 41 recommendations. The average grade assigned to the government -- was a "D".

Update on Item (3) -- Sluggish net job growth below the requirements of US population increases:

On June 2, 2006, the Labor Department released the latest US job numbers. It turns out that May.s lackluster results further confirmed the downward trend discussed in the foregoing paragraphs on Economic and Geopolitical Factors . Payrolls only increased by a measly 75,000 in May, well below the 174,000 expected by economists. Worse, the latest revisions also reduced job gains previously stated in the past two months -- by some 37,000. April's payroll gains were revised lower to a subpar 126,000 from 138,000 initially reported. See the graph below that shows the unmistakable downward slope of net US job creation for the past four months:

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