Mentor Graphics (MENT)

Q1 2013 Earnings Call

May 25, 2012 8:30 am ET

Executives

Joseph L. Reinhart - Vice President of Corporate Development and Investor Relations

Walden C. Rhines - Chairman of the Board and Chief Executive Officer

Gregory K. Hinckley - President, Chief Operating Officer, Chief Financial Officer and Executive Director

Analysts

Jay Vleeschhouwer - Griffin Securities, Inc., Research Division

Richard Valera - Needham & Company, LLC, Research Division

Thomas Yeh - BofA Merrill Lynch, Research Division

Thomas Diffely - D.A. Davidson & Co., Research Division

Saket Kalia - JP Morgan Chase & Co, Research Division

Presentation

Operator

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All right, ladies and gentlemen. Thank you for standing by. Welcome to the First Quarter Fiscal 2013 Earnings Release Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Mr. Joe Reinhart. Please go ahead.

Joseph L. Reinhart

Thank you, Larry. Good morning, everyone. Welcome to Mentor Graphics Fiscal First Quarter 2013 Conference Call. I am Joe Reinhart, Vice President of Investor Relations and Corporate Development. This morning, Walden Rhines, CEO and Chairman, will open with a discussion of key trends in our business. Gregory Hinckley, our President will then provide operational and financial highlights along with guidance. Wally and Greg will then take your questions.

As a reminder, this conference call contains forward-looking statements. While these statements reflect our best current judgment, they are subject to risk and uncertainties that could cause actual results to vary. In addition to the factors noted later, these risk factors can be found in our most recent 10-K, 10-Qs and annual reports. For a reconciliation from GAAP to non-GAAP measures used in this presentation, please refer to today's financial release. This information is available online at the Mentor website. Wally?

Walden C. Rhines

Thanks, Joe. Mentor got off to a fast start this year, substantially exceeding our non-GAAP earnings per share guidance of $0.25 with $0.30 of non-GAAP earnings per share on revenue of $248 million. This is an all-time revenue and non-GAAP earnings record for Q1.

As expected, bookings in Q1 decreased 30% compared to last year. Rapidly accelerating emulation and service bookings late in fiscal 2012 along with some early contract renewals combined to grow Mentors beginning backlog this year to over $200 million, about 3x its typical level. The current forecast supports the $1.1 billion revenue guidance of about 8% growth. We are raising earnings per share guidance for the year by the $0.05 that we exceeded first quarter guidance. This makes our annual earnings growth rate more than double our revenue growth rate.

While there were few major contract renewals this quarter, the increase in annualized run rates for the largest contract renewals that did occur increased 100%, the largest growth in renewal run rate since we began reporting this metric. This comes on top of an increased annualized run rate of the largest contract renewals that averaged 30% in the last fiscal year and 20% the year before. This growth is partly driven by increasing number of designers, but is affected more by the adoption of additional products, especially for the challenges of 28-nanometer chip design and the growing need for products to support embedded software and system design.

It's clear that the semiconductor industry transition to 28-nanometer family of technologies, which broadly includes 32-nanometer and 20-nanometer, is a much larger transition than we've experienced in recent history. Capital investment by silicon foundries, which had been flat for the previous decade at about $7 billion per year, doubled in 2010 to $14 billion, increased again in 2011 to $19 billion and is now projected to sustain this high level through 2012.

Capital spending forecasts for the 3 largest semiconductor companies have increased by almost 50% just since the beginning of this year. The world's 28-nanometer capable capacity now comprises almost 20% of total silicon area and production, and yet the silicon foundries are fully loaded with more 28-nanometer demand than they can handle.

As yields and throughput mature at 28 nanometers, this major wave of capital investment will provide plentiful foundry capacity at lower cost, stimulating a major wave of design activity. Cost-effective, high-yield 28-nanometer foundry capacity will not only drive increasing numbers of new designs, but it will also force redesigns of mature products to take advantage of the cost-reduction opportunity. This should impact overall spending on EDA for the industry, which typically increases in line with semiconductor R&D spending delayed by 1 year.

Semiconductor R&D spending increased 11% in calendar 2010, 6% in 2011 and is expected to increase 12% in 2012. If historical patterns continue, the strong EDA industry growth in 2011 should be followed by a good but lower rate of growth in 2012 and then acceleration in 2013.

Current guidance by the major EDA companies support this prediction, but it probably understates the significance of the 28-nanometer transition that's likely to increase semiconductor R&D funded design activity this year beyond the current forecast.

Now Mentor received some unique benefits from the 28-nanometer transition. First, the dramatic increase in physical verification and resolution enhancement complexity already drove 25% in growth in our design for silicon subflow last year, and even with a lack of major contract renewals in Q1, drove 30% growth into design for silicon bookings this quarter.

Second, industry consolidation of place and route has accelerated adoption of Mentor's Olympus place and route at several of our largest customers. But the largest impact has been in the adoption of emulation. As reported by Mentor, as well as others in the industry, emulation is undergoing a major acceleration in growth. The 28-nanometer transition means that Full-Chip Verification through simulation is no longer possible for leading-edge large chips.

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