CIMdata PLM Industry Summary Online Archive

23 August 2007

Financial News

Mentor Graphics Reports Second Quarter Results

Mentor Graphics Corporation announced second quarter revenue of $205.7 million, up 15% over the prior second quarter. On a GAAP basis, earnings were $.03 per share, up from a loss of $.01 in the year ago second quarter, despite $4.1 million of in-process R&D charges related to the Sierra Design Automation acquisition. On a non-GAAP basis, earnings were $.15 per share, up from $.09 a year ago. These results incorporate the change in the fiscal year with the second quarter running from May 1 to July 31.

"During the quarter, we saw strength across all of our system related product lines," said Walden C. Rhines, chairman and CEO of Mentor Graphics. "In addition to strength in more traditional systems design segments like FPGA and printed circuit board design, we also saw significant strength in automotive design and electronic system level (ESL) products."

Compared to the prior year second quarter, Integrated Systems Design bookings grew 35%, New and Emerging bookings grew 5%, while Scalable Verification was down 5% and IC Design to Silicon was down 25%. IC Design to Silicon is expected to strengthen notably in the second half, based on a strong renewal pipeline.

Automotive networking wins during the quarter included a major Tier 1 parts supplier, further sales to the Ford family of customers and suppliers, and a major Chinese OEM.

During the quarter, the company acquired Sierra Design Automation, a leading provider of high-performance place and route solutions. Sierra's flagship product, Olympus-SOCT, provides the next-generation place and route system that concurrently addresses variations in lithography, process corners and operating modes allowing designers to simultaneously solve for large numbers of variables to achieve an optimal design quickly.

"We continue to see strength in our customer base with total new customers up for the quarter and average contract values up sharply," said Gregory K. Hinckley, president of Mentor Graphics. "With our excellent first-half results, as well as our visibility into our second half business, we are confident in our outlook for fiscal 2008 and 2009."

Year on year, bookings for Europe were up 30%, Pacific Rim was flat, North America was down 15%, and Japan was down 30%.

Guidance

•  For the third quarter, the company expects revenue of approximately $200 million, GAAP earnings per share of about $.02, and non-GAAP earnings per share of about $.10.

•  For the full fiscal year 2008, the company expects revenue of approximately $860 million, GAAP earnings per share of about $.55 and non-GAAP earnings per share of approximately $1.02.

•  Preliminary guidance for Fiscal 2009 is for revenues of $920 million, GAAP earnings per share of about $.78 and non-GAAP earnings per share of approximately $1.22.

Discussion of Non-GAAP Financial Measures

Mentor Graphics management evaluates and makes operating decisions using various performance measures. In addition to our GAAP results, we also consider adjusted gross margin, operating margin and net income (loss), which we refer to as non-GAAP gross margin, operating margin and net income (loss), respectively. These non-GAAP measures are derived from the revenues of our product, maintenance and services business operations and the costs directly related to the generation of those revenues, such as cost of revenue, research and development, sales and marketing and general and administrative expenses, that management considers in evaluating our ongoing core operating performance. These non-GAAP measures exclude amortization of purchased intangible assets, in-process research and development, special charges, equity plan-related compensation expenses and charges and gains which management does not consider reflective of our core operating business.

Purchased intangible assets consist primarily of purchased technology, backlog, trade names, customer relationships and employment agreements. In-process research and development charges represent products in development that had not reached technological feasibility at the time of acquisition. Special charges consist of post-acquisition rebalance costs including severance and benefits, excess facilities and asset-related charges, and also include strategic reallocations or reductions of personnel resources. Equity plan-related compensation expenses represent the fair value of all share-based payments to employees, including grants of employee stock options, as required under SFAS No. 123 (revised 2004), "Share-Based Payment" (SFAS 123R). For purposes of comparability across other periods and against other companies in our industry, non-GAAP net income (loss) is adjusted by the amount of additional taxes or tax benefit that the company would accrue using a normalized effective tax rate applied to the non-GAAP results.

During the six months ended July 31, 2007 and June 30, 2006, $164 thousand and $5.9 million, respectively of interest expense attributable to net retirement premiums and write-offs of debt issuance costs related to the refinancing or repurchase of certain convertible debt was excluded as management does not consider these transactions a part of its core operating performance.

In certain instances our GAAP results of operations may not be profitable when our corresponding non-GAAP results are profitable or vice versa. The number of shares on which our non-GAAP EPS is calculated may therefore differ from the GAAP presentation due to the anti-dilutive effect of stock options in a loss situation.

Non-GAAP gross margin, operating margin and net income (loss) are supplemental measures of our performance that are not required by, or presented in accordance with, GAAP. Moreover, they should not be considered as an alternative to any performance measure derived in accordance with GAAP, or as an alternative to cash flow from operating activities as a measure of our liquidity. We present non-GAAP gross margin, operating margin and net income (loss) because we consider them to be important supplemental measures of our operating performance and profitability trends, and because we believe they give investors useful information on period-to-period performance as evaluated by management.

Management excludes from its non-GAAP measures certain recurring items to facilitate its review of the comparability of the company's core operating performance on a period-to-period basis because such items are not related to the company's ongoing core operating performance as viewed by management. Management considers our core operating performance to be that which can be affected by our managers in any particular period through their management of the resources that affect our underlying revenue and profit generating operations during that period. Management uses this view of its operating performance for purposes of comparison with its business plan and individual operating budgets and allocation of resources. Additionally, when evaluating potential acquisitions, management excludes the items described above from its consideration of target performance and valuation. More specifically management adjusts for the excluded items for the following reasons:

•  Amortization charges for our purchased intangible assets are inconsistent in amount and frequency and are significantly impacted by the timing and magnitude of the company's acquisition transactions. We therefore consider our operating results without these charges when evaluating our core performance. Generally, the most significant impact to inter-period comparability of the company's net income (loss) is in the first twelve months following the acquisition.

•  Special charges are primarily severance related and are due to the company's reallocation or reduction of personnel resources driven by modifications of business strategy or business emphasis and by assimilation of acquired businesses. These costs are originated based on the particular facts and circumstances of business decisions and can vary in size. Special charges also include excess facility and asset-related restructuring charges. These charges are not specifically included in the company's annual operating plan and related budget due to the rapidly changing technology and competitive environment in our industry. We therefore exclude them when evaluating our managers' performance internally.

•  In-process research and development charges are largely disregarded as acquisition decisions are made, as they often result in charges that vary significantly in size and amount. Management excludes these charges when evaluating the impact of an acquisition transaction and our ongoing performance.

•  Management supplementally considers performance without the impact of stock-based compensation charges and believes this information is useful to investors to compare our performance to the performance of other companies in our industry who present non-GAAP results adjusted to exclude stock compensation expense. We view stock-based compensation as a key element of our employee retention and long-term incentives, not as an expense that should be an element of evaluating core operations in any given period. We therefore exclude these charges for purposes of evaluating our core performance.

•  Income tax expense (benefit) is adjusted by the amount of additional tax expense or benefit that we would accrue if we used non-GAAP results instead of GAAP results in the calculation of our tax liability, taking into consideration the company's long-term tax structure. We use a normalized effective tax rate of 17%, which reflects the weighted average tax rate applicable under the various tax jurisdictions in which the company operates. This non-GAAP weighted average tax rate is subject to change over time for various reasons, including changes in the geographic business mix and changes in statutory tax rates. Our GAAP tax rate for the six months ended July 31, 2007 is 42% after consideration of discrete items. Without discrete items of $780 thousand, our GAAP tax rate is 25%. Inclusive of discrete items, our full fiscal year 2008 GAAP tax rate is projected to be 30%. The GAAP tax rate considers certain mandatory and other non-scalable tax costs which may adversely or beneficially affect the Company's tax rate depending upon the Company's level of profitability.

Non-GAAP net income (loss) also facilitates comparison with other companies in our industry, which use similar financial measures to supplement their GAAP results. However, non-GAAP net income (loss) has limitations as an analytical tool, and you should not consider this measure in isolation or as a substitute for analysis of our results as reported under GAAP. In the future the company expects to continue to incur expenses similar to the non-GAAP adjustments described above and exclusion of these items in our non-GAAP presentation should not be construed as an inference that these costs are unusual, infrequent or non-recurring. Some of the limitations in relying on non-GAAP net income (loss) are:

•  Amortization of purchased intangibles, though not directly affecting our current cash position, represents the loss in value as the technology in our industry evolves, is advanced or is replaced over time. The expense associated with this loss in value is not included in the non-GAAP net income (loss) presentation and therefore does not reflect the full economic effect of the ongoing cost of maintaining our current technological position in our competitive industry, which is addressed through our research and development program.

•  The company regularly engages in acquisition and assimilation activities as part of its ongoing business and therefore we will continue to experience special charges and merger and acquisition charges on a regular basis. These costs also directly impact available funds of the company.

•  The company's stock option and stock purchase plans are important components of our incentive compensation arrangements and will be reflected as expenses in our GAAP results for the foreseeable future under SFAS 123R.

•  The company's income tax expense (benefit) will be ultimately based on its GAAP taxable income and actual tax rates in effect, which often differ significantly from the 17% rate assumed in our non-GAAP presentation.

•  Other companies, including other companies in our industry, may calculate non-GAAP net income (loss) differently than we do, limiting its usefulness as a comparative measure.

For more complete financials, please access http://www.mentor.com/company/investor_relations/news/2008_q2_fy/1123232_1.pdf .

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