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Magma Design Automation, Inc. (NASDAQ:LAVA)

F4Q09 Earnings Call

May 27, 2009 5:00 pm ET

Executives

Milan Lazich – Vice President, Corporate Marketing

Rajeev Madhavan – Chairman and Chief Executive Officer

Roy Jewell – President and Chief Operating Officer

Pete Teshima – Vice President Finance and Chief Financial Officer

Analysts

Raj Seth – Cowen and Company

Rich Valera – Needham & Company

Sterling Auty – JP Morgan

Operator

Welcome to Magma’s fourth quarter fiscal 2009 conference call. (Operator Instructions) Now here is Magma’s Vice President of Corporate Marketing, Milan Lazich. Please go ahead, sir.

Milan Lazich

Thank you. Welcome to Magma’s fiscal 2009 fourth quarter earnings call hosted by Chairman and CEO, Rajeev Madhavan; President and Chief Operating Officer, Roy Jewell and CFO, Pete Teshima. Our Q4 earnings release is on Magma’s website and includes a reconciliation of non-GAAP results to GAAP results. The financial data supplement in our website’s Investor Relations section also includes a reconciliation of non-GAAP results to GAAP results as well as updated financial guidance.

Please note that during our call including the question-and-answer period we make forward-looking statements within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995 and that actual results may differ materially from expectations. For information on factors that could cause a difference in our results please refer to our form 10Q for the period ended February 1, 2009 to Magma’s subsequent and future filings with the Securities and Exchange Commission and to the cautionary statements related to forward-looking statements in today’s earnings press release. Magma undertakes no additional obligation to update these forward-looking statements.

With that let me turn the call over to Rajeev Madhavan.

Rajeev Madhavan

Thank you Milan. Good afternoon everyone. Magma put up good numbers in the fourth quarter with revenue above our guidance range at $34.1 million and as expected we reached our target revenue model with a greater than 90/10 revenue mix. EPS and operating margin were also better than our guidance and we reestablished positive cash flow in the quarter generating $5.5 million.

You have seen several recent key technology announcements from us and I would like to review them and discuss how they position us to take market share this year. First, in design implementation the new version of Talus we announced today gives us what we consider our best technology edge ever in design implementation. Talus was created to target advanced process nodes and is presently ready for 28 nanometer designs, a segment we expect to gain increasing commercial significance as demand increases for applications such as notebooks, handhelds, consumer electronics and embedded applications.

The silicon content for each of those markets is predicted to reach $10 billion by 2011 and with Talus 1.1 we are well positioned for this opportunity. Talus 1.1’s router is fast but frankly that is not what customers care about. What they care about is how fast they can get their tape-outs done. Talus is the fastest design closure solution available. It delivers the fastest timing, area and power closure on the largest and toughest designs thanks to Talus Core, the new Talus concurrent optimization routing engine.

This approach delivers concurrent routing and optimization, an industry first. Unlike other routing systems that focus only on layout oriented factors such as design for manufacturing or design rule checking, Magma’s unified data model enables Talus core to do concurrent optimization during routing providing the fastest overall design closure.

Talus 1.1 also includes advanced support for low power design with Talus Power Pro. Talus was the first RTL to GDSII flow to support both the Unified Power Format and the Common Power Format. The UPF and CPF formats enable customers to manage and drive their power constraints throughout the flow. Talus Power Pro works within the Talus flow to reduce both leakage and dynamic power and with Talus design it performs low-power optimization during synthesis.

Our other major technology announcement of the last quarter was the new release of Quartz DRC/LVS. With this release these products deliver better performance than any physical verification product up to 3-10x faster than competitive products while being plug compatible with legacy rule decks. Quartz can be used seamlessly within a design implementation flow to eliminate iterations and cut up to two weeks from a chip’s tape-out cycle and certification from the world’s major foundries makes adopting Quartz DRC/LVS easy. They drop right into your flow.

Magma products continue our progress in other key markets analog, mixed signal, circuit simulation and characterization. In analog, Titan ADX delivers circuit optimization, layout optimization, analog floor planning, analysis and accuracy using an embedded analysis engine. It enables circuit optimization for a given process technology in a matter of hours without lengthy SPICE runs and streamlined analog design optimization and porting.

In circuit simulation, FineSim continues its momentum. Magma provides the only solution that is scalable on multiple CPU’s in a distributed computing environment. Others will say they can use threaded machines but such an approach limits the number of CPU’s and hence scaling; problems we don’t have.

In library characterization, Silicon Smart’s built in enhanced analysis engine cuts runtime on full-standard cell libraries to just an hour using multiple CPU’s. With the adoption by the market-leading suppliers of physical libraries we have now achieved market leadership in this segment.

Summing up, in Q4 we hit our financial performance goals including positive cash flow and the milestones reached by our product development teams have reestablished our technology leadership. We are positioned for leadership in key segments.

Now here’s Roy.

Roy Jewell

Thanks, Rajeev. I would like to highlight achievements in Q4 and fiscal 2009 and then outline performance indicators we expect to focus on in fiscal 2010. Even though overall revenue was down from fiscal 2008 we had significant renewal orders from many of our major customers. They recognized their need to maintain a technology edge and rely on Magma for that. As a result, a majority of the most advanced tape-outs were completed using Magma.

Rajeev spoke of the enhancements in the latest release of Talus. Today we announced that NVIDIA adopted Talus 1.1 specifically citing overall usability. The improvements in runtime, timing convergence and ECO routing that improved throughput and quality of results and as a result we added three new customer logos using Talus 1.1.

In analog we have had wins at major customers. A few weeks ago Panasonic adopted Titan ADX for analog circuit optimization for a production flow. The reasons were simple. Titan ADX could identify the optimal circuit architecture for best performance before circuit design begins thereby avoiding design iterations and shortening time to market. Panasonic said Titan ADX enables their designers to obtain optimized results over multiple process conditions in a few days where previous approaches would have taken weeks.

In circuit simulation we won a number of new logos also and increased market penetration with FineSim SPICE and FineSim Pro. For example, Panasonic adopted FineSim SPICE for its significant speedup compared to a legacy SPICE simulator. Because of order of magnitude faster simulation, designers can simulate much larger circuits than was practical before and TSMC certified FineSim SPICE for its SPICE Tool Qualification Program.

Rajeev mentioned the enhancements in the latest release of our Quartz DRC and Quartz LVS physical verification products. As many of you know we face deployment barriers with these products but results with the latest release indicate we have eliminated those barriers. To illustrate, a new customer adopted Quartz DRC after it took only five days to benchmark and integrate it into their design flow.

Furthermore, PDF Solutions used Quartz DRC to develop a characterization vehicle test chip for a leading semiconductor manufacturer citing Quartz’s ability to address complex design rules for leading edge process technologies and its fast runtime.

Fiscal 2009 had its ups and downs but we made a lot of progress in key product areas this year. Key performance indicators to look for in fiscal 2010 are: New logos in design implementation as Talus propagation accelerates, building momentum with FineSim and Quartz DRC/LVS and continued success in analog and mixed signal with further adoption of the FineSim public Titan platform.

Now let me turn the call over to Pete.

Pete Teshima

Good afternoon everyone. After we cover quarter four results I will review our updated guidance which is in the financial data supplement on our website. Unless otherwise noted during this call all references to expenses, margins and other financials are on a non-GAAP basis.

Highlights of our quarter four financial performance included being cash flow positive on both an operating and free cash flow basis. Cash from operations was greater than $5.5 million and we grew cash and investments on the balance sheet by approximately $4 million to a total of $60 million.

Revenue for quarter four was $34.1 million, above our guidance range of $33-34 million. This compares to revenue in the year-ago quarter of $55 million and was an increase from quarter three’s revenue of $30.7 million.

In quarter four the percentage of revenue from backlog related transactions was greater than 90%. For fiscal 2009 revenue was $147 million, within our guidance range of $145-147 million. This compares to fiscal 2008 revenue of $214.4 million. Backlog at the end of the year was greater than $292 million. This represents a decline from the backlog at the end of fiscal 2008 which was reported at greater than $390 million.

Two factors contributed to this decline. First, in this current economic climate EDA customers exercised greater caution in their purchase decisions particularly toward the end of calendar 2008. Second, over the past year customers renewed for shorter periods, often 1-2 years instead of the 3-4 year contracts more common in past years. Backlog will be reported in our form 10K in mid July.

Q4 spending for R&D, sales and marketing and G&A totaled $26.5 million or 78% of revenue. Operating income for quarter four was $2.9 million or 8% of revenue. This was better than our guidance range of 2-4% of revenue and compared to quarter three’s operating loss of $3.3 million or minus 11% of revenue.

For fiscal 2009, operating margin was minus 4% compared to 15% for fiscal 2008. Tax benefit for quarter four was $1.2 million compared to a tax expense of $534,000 in quarter three. Quarter four’s diluted non-GAAP EPS was $0.07 per share better than our guidance range of $0.01 to $0.03 per share and was an improvement from quarter three’s loss of $0.09 per share. On a GAAP basis, EPS was a loss of $0.19 per share better than our guidance of a loss in the range of $0.39 per share to $0.37.

Non-GAAP to GAAP adjustments for quarter four accounted for approximately $0.26 per share on a diluted basis. For fiscal 2009, our non-GAAP EPS was a loss of $0.15 compared to fiscal 2008’s non-GAAP EPS of $0.58. Non-GAAP to GAAP adjustments for fiscal 2009 accounted for approximately $2.69 per share on a diluted basis.

As I mentioned in my introduction, we were cash flow positive on both an operating and free cash flow basis. We ended quarter four with total cash and investments, including restricted cash of $60 million, compared to $55.6 million at the end of quarter three. Accounts receivable was $26.6 million for quarter four compared to $39.4 million for quarter three. DSO for quarter four was 70 days compared to 115 days in quarter three and we do not factor our receivables.

Before we leave the balance sheet I would like to mention the Form S4 we filed with the SEC last week as we intend to offer holders of our outstanding 2% convertible notes due in May of 2010 the right to exchange those notes for 8% convertible notes due in 2014. The purpose of this exchange offer is to improve our liquidity and financial position. The registration statement has not yet become effective and the timing and success of the proposed exchange are subject to a number of risks and uncertainties. We are not able to take questions relating to the proposed exchange offer due to the regulatory restrictions and direct you to the Form S4 for further information.

We finished quarter four with 732 employees. This compares to 900 at the end of quarter three.

Here is our guidance for the first quarter ending August 2, 2009. Revenue in quarter one is expected to be in the range of $27.5-28.5 million. Non-GAAP operating margin is expected to be in the range of 3-5%. Non-GAAP taxes are expected to be $400,000 to $500,000. Non-GAAP EPS is expected to be in the range of $0.00 to $0.01 per share. Diluted shares outstanding are expected to be in the range of 47.5-48.5 million shares.

Now here is our guidance for fiscal 2010 ending May 2, 2010. Revenue in fiscal 2010 is expected to be in the range of $120-125 million. Non-GAAP operating margin is expected to be in the range of 3-5%. Non-GAAP EPS is expected to be in the range of $0.01 to $0.03 per share. Diluted shares outstanding are expected to be in the range of 48-50 million shares.

We don’t provide formal guidance on cash flow but we expect to be cash flow positive on a quarterly basis throughout fiscal 2010. Guidance for the first quarter and fiscal 2010 is in the financial data supplement on our website.

Now let’s take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Raj Seth – Cowen and Company.

Raj Seth – Cowen and Company

Pete can you talk a little bit about why you expect such a sequential drop in revenues as you move into Q1? As it relates to your annual guidance you are talking about $0.01 to $0.03 for the whole year, $0.01 in Q1. Are you just being conservative there? It strikes me if you do a [center] two in the first quarter that seems a bit conservative. I would love to hear your perspective.

Pete Teshima

In terms of our quarter one numbers, for us seasonally it is the lowest quarter so we are just staying consistent with that in terms of why it decreases from quarter four down in quarter one. Relative to your question on the EPS and where EPS falls out for the whole year, I have to tell you given the macro economic environment as we currently see it visibility is really tough. I would say we are being prudent and we are being conservative but I think that is the way we want to be to position the company right now.

Raj Seth – Cowen and Company

This doesn’t make any comment given your model a lot of what you do I would imagine in the next fiscal year is dependent on the amount of bookings you had this year which were obviously low. What is your view on bookings and tell me what is the best way to think about this because you did I think $140 million, forgive me as I don’t have the numbers in front of me, last year. You talked about $100 million drop in backlog which suggests somewhere in the order of $50 million in bookings this last year. I understand that bookings by themselves can be a little bit misleading given the term has reduced somewhat from whatever it was, the three plus year average. How do you think about bookings into the next fiscal year?

Pete Teshima

What I am expecting or what I would expect is for bookings to be in excess of say $120 million. As I mentioned before, these are pretty abnormal times. It is difficult to predict. What I can say and what I do know is we have a healthier renewal portfolio this year and an even better one in fiscal 2011.

Raj Seth – Cowen and Company

That $120 million in bookings, what would be the average duration that is predicated on? Is that a 2-year average number? Again, how do I think about that?

Pete Teshima

I would say it is less than three years.

Raj Seth – Cowen and Company

You talked about NVIDIA adopting and maybe there was a press release…I haven’t seen it yet, but adopting Talus. They also several weeks ago talked about Synopsis and DRC. What are they using Talus for because they have a number of different suppliers? Is the Synopsis announcement the other day, how does that relate to what I have always thought of as one of your original DRC customers who has had some pretty public, positive commentary in the past about Magma. Is that a switch or how do I read that?

Rajeev Madhavan

First of all, on the DRC side there is no switch. We have always had two vendors and we continue to have two vendors. We have predominately used the [diton] micron geometries. We continue to provide the fastest physical verification flow on that account and it continues to be used in most of the [inaudible] chips. With respect to Talus we had early deployment of Talus versus 1.1. We have taken most of these most complex chips and take out the 40 nanometer chips that are being done today. A lot of them are being done with the Talus 1.1 design flow. We pretty much have flow into the back-end side of the physical design side of the flow on that account.

Raj Seth – Cowen and Company

So just primarily sort of routing and optimization?

Rajeev Madhavan

That’s right. We continue to be used and very aggressively used on the DRC. They use us on pretty much every chip in the 40 nanometer. They are using us as [inaudible] DRC base.

Raj Seth – Cowen and Company

In the past you have talked about the fact that at least in your view this was a very low growth industry and your opportunity was driven entirely by share gains opportunity. Where is it that you expect especially in the context of probably a smaller channel than before given the cuts you had to make, where is it that you expect to take share to drive incremental growth? What is your perspective on sort of the environment now a little bit and where the real opportunity is for you as you move forward?

Rajeev Madhavan

Two things. With respect to channel, the actual number of sales people has actually gone up with any of these lay offs and cuts we have done. We have actually increased the number of quota carrying sales people on the ground over the last one year. We have actually seen an increase in our sales force in that particular side of things. With respect to the number of AE’s, what we expect our 1.1 to do is basically with 1.0 as we had earlier talked about we had usability issues. Magma is known for being out of the box and providing the best quality results. Now with 1.1 we can do that.

The out of the box is beating anybody’s best results. That means we can actually save a lot of application engineering support on a lot of accounts which gives us the usability to go and focus on a lot of new accounts. So, internally we are now driving a new logo campaign. I think Roy talked about it that Talus 1.1 last quarter generated three new logos. This is very new for us in the fact that we had a lot of usability issues and could not go after new logos. We are increasing the number of logos. We have a [tolerated] campaign now where we are going to be increasing the number of benchmarks at a lot of different accounts.

We have currently ongoing three. This quarter we are hoping to increase that to anywhere in the range of 5-15 new engagements in a given quarter given the usability of the tool.

Roy Jewell

I think the important thing you have to think about especially in our flagship product area, as you know we have always been the guys focusing primarily on the leading edge. The first guys in any process to establish a [beach head] and maintain that position as the more mainstream pulls into that node. With what Rajeev is talking about, the out of the box usability it gives us the opportunity to really focus on more of the mainstream designs also. Yes, regionally we have done extremely well in the U.S. I think we have done less well in places like Japan and Taiwan and China. I think those are areas where we see an opportunity for growth. We still look at the overall placement in back end spaces. We think it is pretty much divided up 1/3, 1/3, 1/3. So there is still a lot of opportunity for us to gain market share.

Raj Seth – Cowen and Company

Of the bookings you suggested, how much of those bookings would come from the Core, and I include Talus in that? How much would come from some of the new analog products?

Roy Jewell

I would say the Core is probably 60% or something like that. On the analog side we are expecting to see bookings type activity in the second half of our fiscal 2010 and revenue in the following year. That is going to be a smaller portion.

Operator

The next question comes from Rich Valera – Needham & Company.

Rich Valera – Needham & Company

I just wanted to re-address the bookings question that Raj had started on. It does look like you did about $50 million in bookings which is kind of a stunning number in the context of your historical numbers of around $200 million for several years and even a disappointing $185 last year. I am just trying to understand; of the decrease in bookings you attributed part of it to duration and part of it to a weaker environment. Can you give us a rough split of how much of each contributed to that and/or if you know a duration rated backlog number for each of the years? What was your average duration in 2008 versus 2009?

Pete Teshima

I don’t have the actual duration detail you are referring to. Given as I mentioned on our previous calls, we did expect a lower backlog given what we are experiencing out there in terms of customer caution, the general theme of cash preservation, expense control and just the shorter deal lengths which I mentioned previously, all tied to the macro economic situation. Also that we have seen this shift from the traditional length to much shorter duration.

This does have, as you know, a negative impact on the backlog but it doesn’t impact the revenue and cash. Customers are just purchasing what they need to preserve cash and reduce those expenses and to weather out these economic times. I believe this issue is pretty much shared within the industry. I am still expecting for us to have positive cash flow and positive operating margins for 2010. Those two reasons that you mentioned were the principal reasons. I just don’t have a split in a nice tidy package for you.

Rich Valera – Needham & Company

How about average I guess run rate, if you will, in your renewals? That has historically been a big focus of media companies in general. Can you say what you experienced in terms of renewal run rates this year? You mentioned in your remarks you did have several significant renewals. Could you talk about how those run rates trended?

Pete Teshima

They were not as high as before, right? So they were down a little bit but the duration was key in that metric. The shortened duration.

Rich Valera – Needham & Company

So you are saying the duration had a bigger impact than the decrease in the run rate?

Pete Teshima

I would say so.

Rich Valera – Needham & Company

When you look out at your renewals for this year, the $120 million you are talking about in bookings what is your assumption on renewal run rates?

Pete Teshima

That they be very close to what we experienced in the past and just over time we would expect the durations to increase from what we were experiencing over the last 6-9 months.

Rich Valera – Needham & Company

I am a little confused. So you are not expecting any real decrease in run rate in the renewals that you are going to be implementing this year?

Pete Teshima

We are expecting them to pick back up, right? We are expecting the general economic condition to not get any worse than it is right now. Hopefully by the end of the year it can get a little bit better.

Rich Valera – Needham & Company

I don’t know if this is going to count as a question about your exchange offer, but I just want to confirm. You gave a share count for your guidance for fiscal 2010. That doesn’t assume a successful exchange I am assuming because if that were to happen and you were to be profitable I would think your share count could increase pretty significantly.

Pete Teshima

True. You are right.

Operator

The next question comes from Sterling Auty – JP Morgan.

Sterling Auty – JP Morgan

I just wanted to follow-up on the one point, I missed it. When you talked about the performance in Talus you mentioned I believe that the performance out of the box was better than what is already out there. Did you actually mention have you had actual bench marks? Obviously the multi-mode, multi-corner and some of the other things that over the last year that have been critical, so is there actual bench marks you can point to as you are going to customers about that performance especially in some of those new key areas?

Rajeev Madhavan

Absolutely. Nobody inclusive of any customer with whom we have already done press releases on are counted as [inaudible]. Last quarter as Roy point out we had three new logos. All three were contested by all 3-4 players. At least three participated in benchmarks. In some cases four participated in bench marks. I want to very simply put it to you. We not only have multi-mode, multi-corner, all the features we talk about. We have them in an automated, integrated, out of the box fashion. We don’t have 20 different pieces that need to be done up and down. We have out of the box. We can beat these guys here. This is the same leadership that Magma had back when fusion had come out a year and a half later that we have. So we have done significant amount of benchmarking. The last three benchmarks in the last one quarter have been excellent. The quarter before that we had improved. The last quarter we still had to provide some AE support. By the end of the quarter we had things out of the box without AE, just growing our nodes and the tool has been running will produce very good results out of the box and beat anybody else pretty handsomely. So we feel very bullish right now.

Sterling Auty – JP Morgan

Can you give us an update in terms of the structure on the field force in terms of the AE’s versus the quota reps, etc.? Kind of the process you have been working through?

Roy Jewell

As I think you and I discussed before one of the things we are working as we become I think more profitable in our engagement and one of the areas we have always been extremely aggressive on is the number of support people we put out in the field to support any particular customer. Rajeev didn’t mention this as much but in addition to providing I think a better capability to customers in terms of the new Talus release is a very significant objective for us was to really improve usability so we didn’t require as many people supporting the product on any account. It makes the customer much more self-sufficient with the product. We still end up with today we probably have got on the order of between 4-5 application engineers per sales guy but you should know that is down probably 30-40% from where we were.

We will continue to try and rationalize that number. One thing we want to do is continue to increase the number of sales guys in the field just so we can increase the top line because I believe even in times like this you don’t save yourself for prosperity. You have to grow yourself out of the current market environment.

One thing I also want to make a comment on is in terms of the market environment, Pete was talking about backlog. We definitely saw, and I think I have concurred with my peers at other companies; the last two quarters of 2008 were very, very blind as an industry. I think it was because our customers were very blind. We are definitely seeing an up tick in our visibility in the most recent quarter and pipelines are growing. People actually know where their business is going and they know where their budgets are. I think we are going to be growing our field commensurate as those opportunities continue to increase.

Operator

That does conclude our question-and-answer session. At this time I would like to turn the conference back over to Mr. Madhavan for any closing remarks.

Rajeev Madhavan

Thank you. Before we end the call let me recap the major objectives we achieved in our fourth quarter. We returned to profitability, we returned to positive cash flow generating $5.5 million in our fourth quarter. With Talus 1.1 we have reestablished our technology leadership and innovation. Thank you all for joining us today. Roy and Pete will speak tomorrow at the Cowen and Co. conference in New York. Hope to see some of you there and have an opportunity to speak with you on our next quarterly call. Good afternoon. Thank you all.

Operator

That does conclude today’s conference. Thank you for your participation.

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