Mentor Graphics Management Discusses Q2 2014 Results - Earnings Call Transcript

Aug.22.13 | About: Mentor Graphics (MENT)

Mentor Graphics (NASDAQ:MENT)

Q2 2014 Earnings Call

August 22, 2013 5:00 pm ET

Executives

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

Walden C. Rhines - Chairman and Chief Executive Officer

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

Analysts

Monika Garg - Pacific Crest Securities, Inc., Research Division

Krish Sankar - BofA Merrill Lynch, Research Division

Zachary R. Ajzenman - Griffin Securities, Inc., Research Division

Richard Valera - Needham & Company, LLC, Research Division

Saket Kalia - JP Morgan Chase & Co, Research Division

Jay Vleeschhouwer - Griffin Securities, Inc., Research Division

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Mentor Graphics Second Quarter Earnings Call. [Operator Instructions] I would now like to turn the conference over to our host, Mr. Joe Reinhart. Please go ahead.

Joseph L. Reinhart

Yes. Thank you very much, operator, and good afternoon, everyone. Welcome to Mentor Graphics Fiscal Second Quarter 2014 Conference Call. I am Joe Reinhart, Vice President of Investor Relations and Corporate Development. This afternoon, Walden Rhines, the 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 risks and uncertainties that could cause actual results to vary. In addition to factors noted later, these risk factors can be found in our most recent 10-K, 10-Q and annual report. 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 Graphics website. Wally?

Walden C. Rhines

Thanks, Joe. Well, fiscal Q2 bookings and revenue were all-time records for a second quarter for Mentor Graphics. The requirement for new capabilities for 20-, 14- and 10-nanometer technology was the principal driving force affecting both the Calibre family and Veloce Emulation. As a result, bookings grew 70% overall compared to last year. And Mentor achieved a 20% growth in non-GAAP earnings and 32% increase in GAAP earnings on a 5% growth in revenue to $253 million. Planned ramp-up of 2014 in 10-nanometer technologies requires both design and manufacturing groups to deal with double and triple patterning, FinFET, reliability, thermal and stress effects, and 3D stacking, as well as preparations for extreme ultraviolet, or EUV, which are all capabilities that played little or no role before 20-nanometers. This demands new types of software and more software licenses for previously existing capabilities.

The average annual run rate of the renewals in our 10 largest contracts increased 90% this quarter. Even the companies that are not at the leading edge of technology are adopting design for manufacturing, including reliability verification. We added 20 new logos or completely different companies this quarter to the list of more than 1,250 companies that have already purchased Calibre.

As design rules shrink, functional complexity increases. More and more design groups are moving to emulation as the only effective way to do full-chip debug and verification. Since full-chip verification increasingly requires emulation, design groups are adopting it at the beginning of a major design and using it for building blocks, as well as for full-chip verification and for hardware/software co-design.

Of the top 5 emulation bookings this quarter, 4 of the companies have never purchased emulation from Mentor Graphics before and 3 of those are top 20 semiconductor companies. Among emulation orders received in the second quarter was a greater than $5 million emulation order from a customer who had never used emulation of any type in the past. Current emulation evaluations in progress or installation expansions include 3 of the top 10 semiconductor companies in the world.

Overall, our emulation bookings in the first half of this year totaled almost as much as our total emulation revenue for all of last year. There are 3 major capabilities that make Mentor's Veloce Emulation unique: first, the ability to accelerate both the testbench and the verification of the design itself; second, the ability to have more than 100 software developers simultaneously developing embedded software on the same emulator; and third, a very broad capability to use virtual stimulus to test the design in addition to traditional in-circuit emulation techniques. This virtual stimulus capability allows users to program the test they want to run, eliminating the need to plug in expensive packet generator hardware, for example, and providing the increased flexibility of being programmable. With this approach, users can choose from a wide range of standard protocols, like Ethernet or USB, PCI Express and many more, and vary the number and character of tests all through an easily programmable interface. Demand for emulation and for advanced Calibre capabilities has produced an 85% growth in bookings in the first half of this year compared to last year. That's a faster start to the year than expected and it reinforces our outlook for a successful year of growth. Greg?

Gregory K. Hinckley

Thanks, Wally. The second quarter of 2014 was a quarter of records for Mentor Graphics: Q2 records for bookings, for revenue, for book-to-bill, for non-GAAP operating margin and earnings per share. Revenues were up 5% to $253 million and $8 million ahead of guidance. Gross margin non-GAAP was 82.7%, 1 point better than last year and almost 2 points better than guidance. Operating margin non-GAAP was 15.9%, 1.8 points better than last year and 4.7 points better than guidance. Non-GAAP earnings per share was $0.26, 18% ahead of last year and over 50% ahead of guidance.

The second quarter for fiscal year 2014 was the 18th, and I repeat, 18th consecutive quarter for which we exceeded our non-GAAP guidance. On incremental revenues of $12.4 million, we delivered $6.3 million of incremental non-GAAP operating income. This 50% of incremental revenue demonstrates our continuous and rigorous attention to operating expense control.

During the quarter, we retired 1 million shares or $20 million of stock and paid a $5 million dividend.

Now, for more financial detail. Bookings were up 70% to an all-time second quarter record with product up 80% and services down 40%. Design-to-Silicon and Scalable Verification, our 2 largest product categories, more than doubled. Design-to-Silicon was up 140%, and Scalable Verification up 160% to second quarter all-time records.

As Wally said, the movement to 20-nanometer and below in FinFET design is driving the need for more and more physical and functional verification software and hardware for chip companies. To date, even chip companies with less than $100 million of revenues are candidates for advanced emulation solutions.

Integrated System Design was down 30% as our larger renewals are scheduled for later this and next year. New and emerging was down 20% despite healthy Calypto and automotive bookings.

By geography, bookings were up 160% in the Americas and 90% in Pac Rim. Japan, which was strong in the first quarter, followed that with a 20% decline in the second quarter. In Japan, American EDA companies have historically concentrated on the semiconductor industry, which is currently troubled in that region. Consistent with Mentor Graphics' overall breadth, we have focused more attention on the Japanese system and automotive businesses, which we think promise us great potential.

Europe was down 30%, primarily as a result of a large transaction in the second quarter of last year. Bookings, paced by our success in emulation, were 50% perpetual, 45% term and 5% subscription, compared to 20%, 65% and 15% last year. Top 10 company -- customers were 80% of bookings, well ahead of our typical 45% to 50% -- 55% with 2 greater than 10% of total. Weighted average growth in annualized run rate of our largest contract renewals was 90%, driven by successful campaigns among foundry, IP and automotive accounts. Average deal length was 3.4 years, up from 3.0 years as 50% of our top 10 renewals this quarter were with large system accounts.

Revenue mix by geography was 40% North America, 20% Europe, 35% Pac Rim and 5% Japan. Service and support was up 2% as reported and up 5% when adjusted for the unfavorable effect of the yen. Repeating what I said last quarter, Mentor is structurally long the yen and consequently faces headwinds when the yen depreciates. Depreciation of the yen was unfavorable to revenue by about $3.5 million.

Leading indicators improved from last quarter. New customer accounts were down in the Americas, but up strongly in Europe and Japan and up meaningfully in booking value. Consulting was weak, but in part because of a difficult compare. Support declines dropped and the average value of the top 10 contracts was well up. Emulation boomed. Non-GAAP gross margin was up 1 point to 82.7%, driven by a more favorable mix, more software revenue and less emulation, as well as meaningfully higher margin on both service and support. Non-GAAP operating expense was up $6.5 million or 4%. Currency, including the Indian rupee, the British pound and the yen, were favorable to expense by about $1.5 million.

Approximately 40% of worldwide Mentor Graphics' expense is incurred in foreign currencies. A 1% weakening in these currencies favorably affects Mentor expense by about $800,000. Headcount increased 6% to 5,100, with about 40% of that due to acquisitions.

Other income and expense was a $3.9 million expense, essentially interest expense net of interest income. Special charges were $3.9 million, largely resulting from litigation. During the second quarter of fiscal 2014, we reclassified certain litigation expenses to special charges. The effect of this reclassification is shown in the unaudited reconciliation of non-GAAP adjustment schedule presented on Page 10 of the press release. This reclassification results in a $0.01 increase in non-GAAP earnings per share in the first quarter of this year, a $0.01 increase for both the first and second quarters of last year, and a $0.02 increase in earnings per share for all of fiscal year '13.

Our non-GAAP tax provision remained at 17%. Cash -- now on to the balance sheet -- cash equivalents and short-term investments increased $8 million sequentially to $214 million at quarter end. Operating cash flow for the quarter was a $23 million inflow compared to a $28 million inflow last year. Trade accounts receivable was $95 million, down $31 million sequentially. Short-term unbilled receivables were $271 million, up $29 million sequentially.

Trade DSOs were 34 days, a decrease of 16 days from last quarter and a decrease of 3 days from the second quarter last year. Total DSOs were 130 days, a decrease of 16 days from last quarter and an increase of 2 days from last year. The quality of receivables remains excellent with no receivables net of reserves greater than 60 days outstanding.

Factored receivables were $1 million in the quarter compared to $9 million last year and $1 million last -- $9 million last quarter and $1 million last year. Capital expenditures were $9 million for the quarter compared with $4 million last quarter and $11 million last year. Depreciation of property, plant and equipment was $8 million for the quarter, down $1 million from last quarter and equal to last year.

Now on to guidance. Our strong start to fiscal 2014 continued in the second quarter with record Design-to-Silicon and Scalable Verification bookings, record revenue and record operating margins. Emulation bookings were exceptional, a record in the second quarter. Emulation production is doubling and we are accelerating deliveries versus the original schedules established early in the second quarter. For the third quarter of fiscal 2014, we are forecasting revenue of approximately $260 million and non-GAAP earnings per share of about $0.19. The third quarter is expected to approximately double the amount of emulation revenues compared to the quarter just finished.

At the half, we're just over 40% of our revenue target. We still have 150% of what we've achieved year-to-date ahead of us. Frankly, it feels early to raise revenue targets. On the other hand, our ongoing efforts to wring out efficiencies are continuing to yield results. Gross margin is 1 point better than we expected this year due to improvements in emulation costs and yields and service expenses. As a result, for the year ending January 31, 2014, we are maintaining the revenue forecast of approximately $1.155 billion. We are taking the year-to-date margin improvement to our P&L guidance for the year and raising the non-GAAP EPS by $0.04 to about $1.59. Cash flow from operations for the year is unchanged at approximately $165 million. Wally?

Walden C. Rhines

Thanks, Greg. In today's press release, we announced a quarterly dividend of $0.045 per share payable on September 30 to shareholders of record on September 10, 2013. The Board of Directors also increased the share repurchase authorization. Under the increased authorization, $100 million is now available for share repurchase.

In summary, record-breaking bookings and revenue in the second quarter provide significant momentum, thanks largely to the customer need for tools to address emerging design challenges at 20-nanometers and below. Emulation is becoming the cornerstone for functional verification and embedded software development. Mentor is realizing the benefit of investing in these technologies over many years. Now let's take some questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from the line of Monika Garg with Pacific Crest Securities.

Monika Garg - Pacific Crest Securities, Inc., Research Division

I think first question is on the Q3 guidance. The revenue for Q3 guidance is higher than Q2, but EPS guidance is substantially lower. Is it mainly due to the emulation business? And if you can just walk through the math in that?

Gregory K. Hinckley

Yes, absolutely, Monika. We're expecting to -- about double our emulation shipments in the third quarter. And as a first approximation, the margin -- gross margin on software is about double that on hardware.

Monika Garg - Pacific Crest Securities, Inc., Research Division

And then the second question on the emulators. You've seen significant growth in this segment. Maybe you can talk about the growth you expect in this business for next some years, maybe next 2 years? And also, if you can talk about the customer segmentation in the emulators, like how much percent do you think are system companies now starting to use emulators and how many are kind of systemic [ph] companies?

Walden C. Rhines

Okay. This is Wally. So the emulation market has grown about a 25% compound average growth rate over the last 3 years and is dramatically greater than the overall EDA industry growth rate. And we would expect it to continue to be greater into the future. Now if you look at the history of EDA design tools, going back a long way, you find that every time there's a major change in EDA methodology, it's followed by an extended period of EDA revenue growth as that new methodology spreads to a broader base of customers. So we expect this to be true for emulation, just like it would be for any other major methodology discontinuity. And Veloce2 is an outstanding product to take advantage of that transition. And so the results you're seeing are impressive to us, as well, I hope, to our shareholders. Now your other question on the mix. Numerically, the system companies have clearly increased as a percent of total customers. Some of those are system companies that are checking out chips in larger systems, if they change a single chip in a multichip system. Some of those are doing system-level verification and embedded software development. And right now, the current mix of customer revenue is running about 75-25 IC to system, but I would expect that balance to move more and more toward system over time.

Monika Garg - Pacific Crest Securities, Inc., Research Division

That's helpful. And maybe you can talk about as you move to advanced geometrics, do you think mostly all the designs will need emulators for validation?

Walden C. Rhines

Interesting question. The answer is no. Not all designs will, at least in the near term, but over time, increasingly more and more designs will. And the reason is simply the practicality of just how much simulation you can do and how much the simulation performance increases over time. As we move from uniprocessor to multi-core, we haven't gotten a linear increase in the performance of simulators, so that's provided some gap for emulation. But now that people at the leading edge have moved to emulation, they've discovered a wide variety of other capabilities, including embedded software verification, that has driven the popularity of emulation up. And so I think you'll find that people doing system chips that use embedded software will very broadly adopt emulation. And then others will adopt it more gradually depending on how far they are from the leading edge.

Monika Garg - Pacific Crest Securities, Inc., Research Division

And just a last one for me. You are seeing significant growth in the emulator business. Now Cadence has talked about release of their new Palladium emulator over the next few months. Could you maybe talk about -- or if you think this could impact your emulation market?

Walden C. Rhines

Well, of course, all the major EDA competitors have emulation products. And the good thing is this market is growing so fast, it appears that all of us are profiting from it. Of course, we always have new technology in development, but I'd point out that Veloce2 is the newest of the emulation architectures on the market. It was introduced only a little over a year ago, so it's a very new technology and able to compete very effectively in the open market against whatever competition is put up against it.

Operator

Next we go to the line of Krish Sankar with Bank of America Merrill Lynch.

Krish Sankar - BofA Merrill Lynch, Research Division

Wally, I had a few of them, one on emulation. Can you tell us where do you think your market share is today or where you think it's going to be end of this year and where was it a year ago?

Walden C. Rhines

The problem is that, that's a multi-variable problem. We are certainly growing very, very rapidly. As I highlighted, year-to-date, our bookings are almost as much as our revenue last year. And so normally, I would say that we're going to gain an enormous amount of market share. But if the market is so hot that it's possible that others will grow at a rapid rate as well, so hard to predict what our end position will be, but we'll certainly be one of the leaders, if not the leader, in emulation revenue by the end of the year.

Krish Sankar - BofA Merrill Lynch, Research Division

Got it. That's helpful. One other thing, if you look at the core EDA business, share gain or share losses take a while to manifest. How easy or how difficult is it to gain share with a new product on the emulation side if these are more hardware-related?

Walden C. Rhines

Yes, good question. So, as you know, there's lots of inertia in established and deployed design tools. Engineers in general want to keep using what they're using unless it becomes totally inadequate to do the job. What causes change in EDA is when there's a distinct change in methodology and a whole new kind of design tool is adopted. That happened last decade when resolution enhancement was introduced and all of a sudden, something that was 0 revenue became over $200 million over the decade. Well emulation is sort of in that category. While it's been around for 40 years, it really didn't hit the mainstream until the leading-edge technologies found -- or the customers using leading-edge technologies found that they had to use it, not that it was just nice to use. And so that's the discontinuity that allows you to grow without taking market share from others or to grow by introducing a new generation of technology while things are changing very rapidly, and we're benefiting from that.

Krish Sankar - BofA Merrill Lynch, Research Division

Got it. All right. And then a final question from my side. Yourself and the other EDA players have all spoken about all these design challenges, complexity, FinFET. Is there any way you can quantify the increase in design cost through going from a 28-nanometer to a 20-nanometer planar geometry and then going from planar to 16- or 14-FinFET geometry. Is there any way to quantify the design cost increase?

Walden C. Rhines

There are ways to do it in the sense that they -- it always requires more design verification, more complexity, use of more tools in moving to any new generation. In terms of what it costs the developer, I think the numbers become exaggerated because when people develop a platform for design, it's fairly expensive. And then they'll do 5 or 10 derivatives off of that design and those are much less expensive. So when you look at the average cost, it has gone up. The -- but the actual cost of the software -- of the hardware design itself has increased at a fairly slow rate over the last decade in the range of 5% to 10% a year. And what's really soared is the cost of embedded software development to go with those chips, which is why Mentor has placed so much emphasis on the embedded software business.

Operator

And next we go to the line of Jay Vleeschhouwer with Griffin Securities.

Zachary R. Ajzenman - Griffin Securities, Inc., Research Division

This is Zack Ajzenman for Jay. We have a few questions. First, how feasible is that your backlog at the end of fiscal year '14 might return to about the record levels at the end of FY '12? Or if not, then perhaps by the end of FY '15?

Gregory K. Hinckley

It's feasible, Zack.

Zachary R. Ajzenman - Griffin Securities, Inc., Research Division

Okay. In terms of achieving fourth quarter revenues, could you foresee Design-to-Silicon bookings more than doubling year-over-year in that quarter and therefore more than doubling for the year, thus exceeding the FY '12 DTS booking?

Gregory K. Hinckley

We're not prepared to go down to that level of detail. And we have in the past -- there's just too many variables. We've had a really strong first half of the year. We've got a big presence. I'm talking about in Design-to-Silicon. We've got a big presence in the Calibre software for the foundries. And as the foundries move from one node to another node that it requires more and more software, we saw some of the benefit of that in the first quarter. We saw some more of that in the second quarter. Most of our foundry customers have gone through that play for now. And I think that what we're going to see in the second half of the year is more importance among our large integrated system design customers, particularly mil-aero.

Zachary R. Ajzenman - Griffin Securities, Inc., Research Division

Okay. Your highest market share by region is in Europe. What do you see as the opportunities to gain even further share or the risk to your share there?

Walden C. Rhines

So, Zack, the European users of EDA software tend to be much more system-oriented than the U.S. So while we do have a good, strong base of our software sales to semiconductor companies in Europe, the real strength is in the major systems companies, telecom-derived or automotive and others. And Europe really is a leader in automotive capability for electronics. So we see a big opportunity as the systems part of our business grows dramatically, but we expect we can sustain and grow the more traditional semiconductor part as well.

Gregory K. Hinckley

We're unique, Zack, within the EDA industry in that about 50% of our sales go to system companies. And as Wally pointed out, system companies have a uniquely strong place in the electronics industry in Europe.

Zachary R. Ajzenman - Griffin Securities, Inc., Research Division

Great. Last question, could you update us on the status or viability of your R&D operations in Egypt?

Gregory K. Hinckley

Yes. So it's a big site for us. We have approximately 400 people in Egypt. So far the political unrest in Egypt has had no impact upon our global business. The staff have been able and enthusiastic about working from their homes. We see -- and we were encouraging them to work from their homes. We see no near-term impact upon our customers anywhere. And obviously, our thoughts are with the people of Egypt and their safety. All of our employees are safe.

Operator

And next we go to the line of Rich Valera with Needham & Company.

Richard Valera - Needham & Company, LLC, Research Division

Question on emulation strength this year. It sounds like you have had bookings in the first half roughly equivalent to your revenue from last year. I'm kind of assuming you don't expect to double your revenue year-over-year, but I'm wondering if you'd give any bracket maybe of where you expect your revenue this year versus last year to be. Could it be up 50% or better? Just any rough gauge would be quite helpful.

Gregory K. Hinckley

We entered the year, Rich, thinking that we might have our business increase by as much as 50%. Our business is now much stronger than that and our outlook into the third and fourth quarter is we're forecasting continued booking strength. We now have the challenge of making so many emulators and we're making good progress on that. We -- from when we entered the second quarter to exit it, we doubled our rate of production, and we expect further advances in the third quarter.

Richard Valera - Needham & Company, LLC, Research Division

That's great. Could you give any comparison maybe of your second half bookings pipeline relative to your first half actuals for bookings? Is it roughly comparable or any feel there?

Gregory K. Hinckley

Second half of the year is always much stronger than the first half. I don't have any details.

Richard Valera - Needham & Company, LLC, Research Division

Okay. Even after that exceptional first half?

Gregory K. Hinckley

Yes, yes.

Richard Valera - Needham & Company, LLC, Research Division

Okay, okay, very impressive. Now in response to a question -- I believe the question was on Design-to-Silicon and you referenced a stronger second half, I believe you said with your mil-aero customers. Now was that in Design-to-Silicon or was that actually in your Integrated System Design business? I was a little confused on...

Gregory K. Hinckley

I introduced that by saying the second half would be stronger in Integrated System Design and that's our mil-aero customers.

Richard Valera - Needham & Company, LLC, Research Division

Okay. So back to that original question, I mean, how do you see the second half for Design-to-Silicon or Calibre? Sounds like you had some really nice foundry renewals in the first half and maybe you're not expecting them to repeat, but in general, how do you see Calibre or Design-to-Silicon in the back half?

Gregory K. Hinckley

What we've seen is pretty significant growth in all of our renewals year-to-date. We just have fewer opportunities in the second half than we had in the first half. I think we're going to see a lot more systems business in the second half than we saw in the first half. And then I think as we go into next year, where once again, we'll see Design-to-Silicon becoming more important in our mix of business.

Richard Valera - Needham & Company, LLC, Research Division

Great, that's helpful. And then with the new and emerging category, you mentioned a couple of areas of strength, but obviously, it was still down fairly meaningfully. What's going on there? Kind of what's weak and do you expect that to kind of rebound in the second half?

Gregory K. Hinckley

So we've got 3 categories that are in new and emerging. There's the Calypto, which is the C Synthesis. It had a strong quarter. We have our automotive business and we had a strong quarter. What is -- it's kind of quirky. It's really a difficult compare. Last year, we had a significant amount of compliance business within our embedded software business activity. The RTOS is challenged periodically by people who use the software with not promptly paying for it. And last year, we caught up on some of that and we ended up booking more strongly.

Richard Valera - Needham & Company, LLC, Research Division

So kind of a -- bit of a difficult kind of strange comparison on the RTOS...

Gregory K. Hinckley

Yes, yes. There's nothing fundamental. Our embedded software business seems to be going well.

Richard Valera - Needham & Company, LLC, Research Division

That's quite helpful. And I presume AUTOSAR is within that auto you talked about in new and emerging? I just wondered how the AUTOSARs business was going.

Gregory K. Hinckley

That's a terrific business. The worldwide -- the global automotive industry is rapidly migrating from other standards to AUTOSAR standards. The suppliers to that particular segment are capacity-limited. We have lots of opportunities. We think it's going to be a very good year for us.

Operator

[Operator Instructions] Next we go to the line of Saket Kalia with JPMorgan.

Saket Kalia - JP Morgan Chase & Co, Research Division

I guess, first, Greg, can you just talk about the higher run rate on renewals? 90% is a very impressive number, well ahead of your average. Did some -- maybe some of the larger deals that you had in the quarter positively impact that?

Gregory K. Hinckley

Oh, absolutely. We said that the top 10 deals in the quarter represented 80% of our entire bookings. And I think we booked something like 1,200 transactions in the quarter, so to have 10 equal 80% of entire bookings. We also said that 2 of them were in excess of 10% of total, which is pretty clear that they would have to be in order to get 10 equal to 80%, but -- so we had 2 very large contracts.

Saket Kalia - JP Morgan Chase & Co, Research Division

Got it. And then I think you hit on this in some earlier questions, but it seems like you had a couple of fixed renewals in Calibre. Can you just speak to whether some of those were the larger renewals, I think, from Calibre RET a couple of years ago?

Gregory K. Hinckley

Each time -- we've experienced, as the foundries have gone from node to node, major node to major node, that they need significantly more Calibre software. Some of it's RET. Some of it's physical verification. Some of it's Design for Manufacturability. Some of it's design for yield. We've got a broad portfolio of Calibre applications, all of which are particularly suitable for foundries. And it is a much expanded portfolio times many more licenses.

Saket Kalia - JP Morgan Chase & Co, Research Division

Okay, okay. And I guess as a follow-up to that, would you say that the major foundries are up to date on their versions of Calibre given where geometries are right now?

Gregory K. Hinckley

I think that's fair to say for this year. Next year is another story.

Saket Kalia - JP Morgan Chase & Co, Research Division

Okay. And then a question just on fourth quarter revenue, just based on the unchanged revenue guidance. Fourth quarter is still expected to be up quite a bit more than usual. And it sounds like you're accelerating deliveries on emulators. So can you just talk about the mix of software and hardware in the fourth quarter qualitatively?

Gregory K. Hinckley

No.

Saket Kalia - JP Morgan Chase & Co, Research Division

Okay. Would you say that...

Gregory K. Hinckley

That was a short answer.

Saket Kalia - JP Morgan Chase & Co, Research Division

Well, I guess, it seems like hardware is going to be up. I think the comment before was double third quarter versus second quarter, but is it going to be up sequentially in the fourth quarter?

Gregory K. Hinckley

I can only assume, yes.

Saket Kalia - JP Morgan Chase & Co, Research Division

Okay, okay. And then just moving down the income statement a little bit. You guys have done such a good job controlling expenses. And as we kind of think about the long-term profitability of the business, how should we sort of think about natural growth in expenses to support your level of revenue growth?

Gregory K. Hinckley

I think that we can continue at low single digits as long as we're in somewhere the mid-single digits in terms of growth. If we can accelerate our growth, we're likely to accelerate the -- our expenses, but we keep the expenses in line with what our expectations of revenue growth.

Operator

We do have a follow-up question from the line of Jay Vleeschhouwer with Griffin Securities.

Jay Vleeschhouwer - Griffin Securities, Inc., Research Division

Could you update us on your DFT business? You seemed to have some good upside there 2 quarters ago. Could DFT emulate emulation with more sustained growth in upside?

Walden C. Rhines

I didn't get the last part about emulation.

Gregory K. Hinckley

Can DFT emulate emulation with more...

Walden C. Rhines

Oh, excuse me, okay. Yes, DFT is -- has been having a run that's been going on for years now. It's driven by new products and new customers and the ramp-up continues. It's been setting records pretty much every year the last 3 years. The momentum really picked up during the last decade as the world moved to compression and Mentor introduced that technology. But in the last 2 years, we've introduced 3 more very significant technologies, one of which we believe is groundbreaking. And so I would expect that we see no limit ahead to the growth for design for test.

Operator

There are no additional questions at this time. Please continue.

Joseph L. Reinhart

Ladies and gentlemen, thank you for joining us this afternoon for this call. If you have follow-up questions, Greg and I will be available. The best way to reach us is by calling Monte Koller at (503) 685-1462, and she will make sure that we get back to you in a timely fashion. Operator, if you could please provide the replay information for the listeners. And thank you very much.

Operator

Yes. Ladies and gentlemen, this conference will be available for replay today after 5 p.m. And you may access the AT&T TeleConference Replay System at any time by dialing 1 (800) 475-6701, and enter the access code 300403. International participants may dial (320) 365-3844. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive TeleConference. You may now disconnect.

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Mentor Graphics (MENT): Q2 EPS of $0.26 beats by $0.10. Revenue of $253.2M beats by $8.3M. (PR)