CIMdata PLM Industry Summary Online Archive

26 February 2009

Financial News

Mentor Graphics Reports Fiscal Fourth Quarter Results

Mentor Graphics Corporation announced fiscal fourth quarter revenues of $242.6 million, non-GAAP earnings per share of $.35, and GAAP earnings per share of $.33. For full fiscal 2009, the company reported revenues of $789.1 million, non-GAAP earnings per share of $.20, and a GAAP loss per share of $.97.

“Large accounts fared well in the quarter, with modest growth in the company’s top ten renewal contracts. This strength was significantly offset, however, by weakness in smaller transactions,” said Walden C. Rhines, chairman and CEO of Mentor Graphics. “For the year, our diversity of product line and breadth of served markets, as well as growth in newer product segments, helped sustain the business. In particular, automotive and design for manufacturing both showed solid growth for the year. Looking forward, we see the opportunity to take advantage of this period of weakness to help customers consolidate on Mentor’s leading design platforms.”

During the quarter, the company launched an expansion of capacity to 512 million gates for its Veloce® emulation product line, now double the capacity of competitive offerings. The company qualified its Olympus-SoC™ place-and-route solution for Taiwan Semiconductor Manufacturing Company’s (TSMC) 40nm processes in record time, winning an award from TSMC for the speed of its qualification.

The company extended its leadership in electronic system level (ESL) design by acquiring the high level synthesis assets of Agility Design Solutions as well as with its announcement of a scalable design methodology with its Vista™ design tools based on the new 2.0 transaction level modeling standard. In functional verification, the company announced the availability of an open source solution that allows users of the industry standard open verification methodology (OVM) to incorporate their legacy verification methodology manual (VMM) code. The company also launched Capital® Architect, an extension to its cabling product line, which helps automotive manufacturers and their suppliers develop lighter and more cost-effective electrical distribution systems in vehicles. In analog simulation, the company released a multiprocessor version of its ELDO® simulator that can increase the speed of circuit simulation by 3 to 10 times.

“Given the environment, the company has further strengthened its existing cost control efforts with new reductions in compensation and travel, targeted personnel reductions and strict hiring limits. We will continue to assess our cost envelope as the year unfolds,” said Gregory K. Hinckley, president of Mentor Graphics. “Our relatively strong balance sheet will also allow us to consider opportunities this market is presenting.”

Guidance

For fiscal first quarter 2010 ending April 30, 2009, the company expects revenues of $200 to $210 million, non-GAAP earnings per share between $.05 and $.10, and a GAAP loss per share between $.08 and $.13.

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 and other identified intangible assets, in-process research and development, special charges, equity plan-related compensation expenses and charges, debt issuance costs, equity in losses of unconsolidated entities, impairment of long-lived assets, and impairment of cost method investments which management does not consider reflective of our core operating business.

Purchased and other identified 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 Statement of Financial Accounting Standards 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 we would accrue using a normalized effective tax rate applied to the non-GAAP results.

During the year ended January 31, 2008, we excluded $1.1 million of interest expense attributable to net retirement premiums and write-offs of debt issuance costs. The amounts were expensed in connection with the refinancing or repurchase of certain convertible debt. The amounts were excluded as management does not consider these transactions a part of its core operating performance. There were no debt repurchases during the year ended January 31, 2009.

During the year ended January 31, 2009, we excluded $1.4 million of equity in losses of unconsolidated entities. The amounts represent our equity in the losses of a common stock investment accounted for under the equity method. The amounts were excluded as management does not consider these transactions a part of its core operating performance. We had no equity in unconsolidated entities during the year ended January 31, 2008.

During the year ended January 31, 2009, we excluded $4.6 million of charges related to the impairment of long-lived assets. The amounts represent the write-off of fixed assets and purchased technology associated with our emulation division. The amounts were excluded as management does not consider the impairment part of its core operating performance. We had no impairment of long-lived assets during the year ended January 31, 2008.

During the year ended January 31, 2009, we excluded $3.5 million for the impairment of cost method investments. The amounts represent the full write-off of two cost method investments. The amounts were excluded as management does not consider these transactions part of its core operating performance. We had no impairment of cost method investments during the year ended January 31, 2008.

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 our non-GAAP measures certain recurring items to facilitate its review of the comparability of our core operating performance on a period-to-period basis because such items are not related to our 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 our operating performance for purposes of comparison with our 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 and other identified intangible assets are inconsistent in amount and frequency and are significantly impacted by the timing and magnitude of our 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 our net income (loss) is in the first twelve months following an acquisition.

•  Special charges are primarily severance related and are due to our 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. In fiscal 2009 fees incurred in response to the unsolicited bid by Cadence Design Systems were included as a special charge. These charges are not specifically included in our 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, since 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 equity plan-related 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 equity plan-related 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.

•  Impairment of long-lived assets can occur whenever events or changes in circumstances indicate that assets’ carrying amount may not be recoverable. These charges are inconsistent in amount and frequency. We therefore consider our operating results without these charges when evaluating our core performance.

•  Impairment of cost method investments can occur when the fair value of the investment is less than its cost. This can occur when there is a significant deterioration in the investee’s earnings performance, significant adverse changes in the general market conditions of the industry in which the investee operates, or indications that the investee may no longer be able to conduct business. These charges are inconsistent in amount and frequency. We therefore consider our operating results without these charges when evaluating our core performance.

•  Equity in losses of unconsolidated subsidiaries represents the net income (losses) in an investment accounted for under the equity method. The carrying amount of our investment is adjusted for our share of earnings or losses of the investee. We do not influence or control the results of operations for this investment. We therefore consider our results without the charge when 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 our 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 we operate. 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 year ended January 31, 2009 is (14)%, which considers tax expense on our international operations. The GAAP tax rate considers certain mandatory and other non-scalable tax costs which may adversely or beneficially affect our tax rate depending upon our 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 therefore should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. In the future we expect 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.

•  We regularly engage in acquisition and assimilation activities as part of our ongoing business and therefore we will continue to experience special charges on a regular basis. These costs also directly impact our available funds.

•  Our 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.

•  Impairment of long-lived assets occurs when events or circumstances indicate that the value of the asset may not be recoverable. The impaired assets may still be in use in our current operations, however, and the expense associated with the asset impairment may not reflect the full economic effect of the ongoing cost of maintaining the associated assets. We will continue to evaluate the fair value of our assets and investments and will record impairment charges when appropriate.

•  Our income tax expense (benefit) will be ultimately based on our 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.

Please visit http://www.mentor.com/company/investor_relations/news/2009_q4_fy/upload/Q4FY09-earnings_pdf.cfm for the unabridged press release with financial tables.

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