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Magma Design Automation Inc. (NASDAQ:LAVA)

F2Q2011 Earnings Call Transcript

December 2, 2010 5:00 pm ET

Executives

Milan Lazich – VP, Corporate Marketing

Rajeev Madhavan – Chairman and CEO

Roy Jewell - President and COO

Pete Teshima – Corporate VP, Finance and CFO

Analysts

Richard Valera – Needham & Company

Tom Diffely – D.A. Davidson

Operator

Welcome to Magma's second quarter fiscal 2011 earnings call. All lines have been placed on mute and we ask that all participants turn off wireless communication devices to prevent background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator instructions) Now, here is Magma's Vice President of Corporate Marketing, Milan Lazich. Sir?

Milan Lazich

Good afternoon, and welcome to Magma’s fiscal 2011 second quarter earnings call, hosted by Chairman and CEO, Rajeev Madhavan; President and Chief Operating Officer, Roy Jewell; and CFO, Pete Teshima. Our Q2 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. Unless otherwise noted, all references today to expenses, margins and other financials are on a non-GAAP basis.

Please note that during our call, including the question-and-answer period, we make forward-looking statements within the meaning of the Safe Harbor provisions 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 10-Q for the fiscal quarter ended August 1, 2010 to Magma’s subsequent and future filings with the Securities and Exchange Commission and to cautionary statements in today’s earnings press release regarding forward-looking statements. Magma undertakes no 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. I’m happy to report that we exceeded all guidance targets for our second quarter. Revenue was $33.9 million, and we delivered non-GAAP earnings per share of $0.07 and non-GAAP operating margin of 16%. And for the seventh straight quarter we had positive cash flow. Magma is enjoying solid momentum in technology, market adoption, and financial performance, and recent developments indicate this will continue.

Let me tell you about two product announcements and a milestone partnership. This morning we announced two new products; Talus 1.2, the latest version of our industry-best Talus Vortex implementation platform, and Talus Vortex FX, a new product that is the first and only IC implementation solution to fully utilize distributed computing for place and route.

These releases extend our technology leadership in place-and-route technology with capabilities required as our leading-edge customers migrate to designs at 28-nanometer and smaller geometries. Creating chips at such small nodes requires designers to comprehend crosstalk, advanced on-chip variation, and multi-mode multi-corner variation.

Talus 1.2 borrows advanced algorithms from our next generation static timing analysis and extraction products, Tekton and QCP, and comprehends all three of these effects simultaneously during implementation. It delivers 1.0 million to 1.5 million cells, that’s as many as 4 million to 6 million logic gates, in 24 hours while simultaneously analyzing for all three effects.

This is at least 25% better than one of our major competitors in this space and 400% better than the other. Talus 1.2 also has the capacity to handle blocks of up to 4 million cells without any partitioning, an important factor as the average complexity of designs keeps moving up. Those are great advantages for any designer, but Talus Vortex FX takes it even further.

Talus Vortex FX, based on our Distributed Smart Sync technology, implements designs up to three times faster than Talus 1.2 and enables designers to implement multi-million cell designs flat at a rate of up to 2 million to 5 million cells per day. And this is with crosstalk avoidance, advanced on-chip variation, and multi-mode multi-corner analysis, all enabled.

Using Talus Vortex FX can substantially improve the productivity of engineers working at 28-nanometer and below. By now you’re probably thinking, “Okay, why does this matter?” It matters because our customers are on an increasingly faster treadmill. Expectations for electronic products continue to escalate. I myself moved to the iPad for much of my day-to-day use, and I usually go through two to three cell phones a year as new capabilities come along. I know I’m not alone in this. Tablets, many of them using integrated CDMA-GSM chips, are expected to sell more than 50 million units in 2011.

If design sizes grow at the current pace, especially with the migration to 28-nanometer technologies getting 3X productivity allows engineers to deliver 3X the number of gates they would otherwise be able to do. Hence the driver for Talus 1.2 and Talus Vortex FX. These two products will offer significant increases to productivity, and therefore profitability for our customers. Talus 1.2 and Talus Vortex FX offer designers more than just a ramping of the productivity curve. They deliver a wholesale shift to a new curve so they can cope with accelerating consumer demands that consumer products do more, do it faster, and do it anywhere.

The second major piece of news surrounding Magma is our partnership with Applied Materials, which closed during our second quarter. Under this agreement, Applied Materials is working with Magma’s Fab Analysis business unit to develop and co-market a full end-to-end solution for process qualification and yield improvement for advanced nodes.

This will incorporate advanced Applied Materials – Applied Materials Design-Based Binning engine with the CAD-based capabilities of Magma’s failure analysis products. This unique partnership not only represents a business opportunity for Magma, but also confirms our belief that customers would benefit from a tighter integration between design software and semiconductor manufacturing.

With that, I will turn the call over to Roy.

Roy Jewell

Thanks, Rajeev. Magma products continue to penetrate all key market segments. Not only does our growing list of customers include most of the world’s top semiconductor companies, such as Qualcomm, but it also includes companies such as Boeing, which uses Magma software to develop products unique to a particular industry application.

Overall, we added a number of new logos to our customer list in Q2; five for digital implementation, five in circuit simulation, two for analog implementation, three for library characterization, and three for physical verification. Also during the quarter, we took business from competitive incumbents at 12 accounts. One such win was Galaxy Computer System of China, maker of the world’s most powerful supercomputer.

Yesterday we announced a tape-out using Magma products for an application domain new for Magma, touch sensors. Melfas, a leader in capacitive-sensing touch input solutions, uses both Talus and FineSim. Melfas uses the Talus platform, including Talus RTL, Talus Vortex and Talus Power Pro, and FineSim SPICE to implement two of its next-generation touch sensor chips, which feature ARM Cortex processors.

Another highlight of the quarter was an expanded relationship with IDT, which has been a long time user of Talus for digital implementation and FineSim for transistor-level circuit simulation. In Q2, we expanded the scope of our partnership with IDT to include the full range of Magma products, including Titan for analog implementation and Talus Vortex FX for digital implementation.

As Rajeev mentioned earlier, Talus Vortex FX uses Magma’s proprietary Distributed Smart Sync technology for the dramatically improved designer productivity. We continue to see share gains in the key technology segments of circuit simulation, analog/mixed-signal, and physical verification.

While companies such as NVIDIA have experienced two times throughput improvement in the current production versions of Talus, we are confident that with today’s announcements of highly differentiated technology in Talus 1.2 and Talus Vortex FX, we will accelerate growth in our core digital implementation segment even further.

At Magma, we have always been focused on making our customers successful, and a big part of that is working closely with our foundry partners. TSMC recently recognized Magma with awards for qualification of 28-nanometer extraction and 28-nanometer routing in our Talus Vortex place-and-route tool.

This follows TSMC’s August announcement that Magma’s Quartz was used for physical verification and our Talus was used for routing on a 28-nanometer Product Qualification Vehicle test chip. Of particular note is the fact that Magma was the only EDA vendor recognized by TSMC for both routing and physical verification.

We announced Tuesday that Toshiba deployed FineSim for sign-off simulation. As you know, Toshiba is one of the leading providers of flash memory products and uses FineSim Pro with native distributed computing for NAND flash memory development. One of the reasons Toshiba cited for choosing FineSim was the ability to use a single tool when assessing tradeoffs between performance and accuracy. This is particularly imperative in Toshiba’s efforts to be first to market with highly reliable products.

Overall, FineSim continues to show strong growth and market adoption, as we have acquired several new logos in the analog and mixed-signal market segments. In memory, FineSim is now being used in four out of five of the leading DRAM suppliers and five of the top six flash memory providers. As we expand our presence in the analog/mixed-signal space, Titan continues its momentum. Along with 15 customer logos so far, 11 of the top 25 semiconductor companies are actively using or evaluating Titan.

In library characterization, SiliconSmart continues to do very well. Q2 was our best quarter for SiliconSmart IP characterization product line. We added three new logos in the wireless, analog/mixed-signal, and transportation segments. One of these is a US-based company among the world’s top-20, which intends to use SiliconSmart for cell, I/O and memory characterization, and which selected SiliconSmart after it demonstrated superior speed, accuracy and ease of use against competitive commercial offerings and internal solutions.

In physical verification, Quartz continued to add new customers, specifically those actively designing in the TSMC 40-nanometer and 28-nanometer domains. We added three new customer logos in Q2. Rajeev discussed our joint work with Applied Materials. In another fab analysis success from Q2, we also won yield management and CAD navigation business at the newest fab venture in the semiconductor business, Global Foundries’ Fab 8.

So before I wrap up, let me emphasize that Q2 continued Magma’s market penetration in all key technology segments. And finally, we have five customers doing production low-power and high-performance designs at 28 and 32-nanometer, ahead of our competitors.

Now I’ll turn the call over to Pete.

Pete Teshima

Thanks, Roy. Good afternoon, everyone. After we cover quarter-two results, I’ll review our updated guidance, which is in the Financial Data Supplement on our website. Unless otherwise noted, all references to expenses, margins and other financials are on a non-GAAP basis.

Revenue for quarter-two was $33.9 million, better than our guidance range of $33.0 million to $33.5 million. This compares to revenue in the year-ago quarter of $29.7 million and to quarter-one’s revenue of $32.6 million. In quarter-two, the percentage of revenue from backlog-related transactions was again greater than 90%. Quarter-two spending for R&D, sales & marketing, and G&A totaled $24.7 million, or 73% of revenue.

Operating income for quarter-two was $5.6 million, or 16% of revenue. This exceeded our guidance range of 13.5% to 14.0%% of revenue, was an increase from quarter-one’s operating income of $4.1 million, or 13% of revenue, and is consistent with our expectation to return to a 20% operating margin during fiscal 2012.

We had a tax expense for quarter-two of approximately $105,000 compared to a tax expense of approximately $320,000 in quarter-one. Quarter-two’s diluted non-GAAP EPS was $0.07 per share, better than our guidance range of $0.05 to $0.06 per share, and compared to quarter-one’s EPS of $0.05 per share.

In quarter-two, we were cash flow positive on both an operating and free cash flow basis and generated $2.7 million in cash from operations. Over the trailing four quarters, Magma generated a total of $10.5 million in cash from operations and has generated cash in each of the last seven quarters. We ended quarter-two with total cash and investments, including restricted cash, of $42.9 million compared to $33.3 million at the end of quarter-one.

Accounts receivable was $16.6 million for quarter-two compared to $12.4 million for quarter-one. DSO for quarter-two was 44 days compared to 34 days in quarter-one, and we do not factor our receivables.

A brief update on our convertible debt. At the end of quarter-one, Magma had total convertible debt of $23.9 million, all due in May of 2014. During quarter-two, note-holders converted the bulk of that total, and at the end of quarter-two, only $3.3 million in convertible debt remained, all of which is due in May of 2014. We finished quarter-two with 667 employees compared to 661 at the end of quarter-one.

Now here is our guidance for the third quarter ending January 30, 2011. Revenue in quarter-three is expected to be in the range of $34.0 million to $34.5 million. Non-GAAP operating margin is expected to be in the range of 16.5% to 17.0%. Non-GAAP tax expense is expected to be in the range of $300,000 to $400,000. Non-GAAP EPS is expected to be in the range of $0.06 to $0.07. Diluted shares outstanding are expected to be in the range of 71.0 million to 71.5 million shares, including the as-if-converted shares of the outstanding 2014 convertible bonds.

Also at this time, we are making the following adjustments to full-year guidance for fiscal 2011, ending May 1, 2011. Revenue in fiscal 2011 is now expected to be in the range of $134 million to $136 million, an increase from the prior range of $132 million to $135 million. Non-GAAP operating margin is now expected to be in the range of 14.5% to 15.5%, an increase from the prior range of 14% to 15%. Non-GAAP EPS is now expected to be in the range of $0.25 to $0.26 per share, an increase from the prior range of $0.24 to $0.25 per share. Guidance for the third quarter and fiscal 2011 is in the Financial Data Supplement on our website.

Now we’ll open it up for your questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from Richard Valera with Needham & Company.

Richard Valera – Needham & Company

Thanks. Good afternoon, gentlemen. I was wondering if, Roy and/or Rajeev, you can just comment on the macro picture, what you are seeing out there. It seems like in general EDA has a bit of a tail wind now, at least for the last couple of quarters. Just wondering what you guys are seeing from a macro perspective. Hello?

Rajeev Madhavan

Can you hear me?

Richard Valera – Needham & Company

Could you guys hear me?

Rajeev Madhavan

Yes.

Richard Valera – Needham & Company

I couldn’t hear you. I’m not sure if you’re – are you responding?

Roy Jewell

Rich, this is Roy.

Richard Valera – Needham & Company

Okay.

Roy Jewell

The overall macro environment in terms of EDA spending, I think, is – we think, is maintaining a pretty steady pace right now. And we’ve seen people come back with budgets. They are still very sensitive in terms of spending money. But if you differentiated technology, especially ones that impact productivity, they will consider you. On the customer side, I think you’re seeing some seasonality in their business, maybe a little softness right now as people determine where their inventories are going into the holiday season. But overall, I still see a very strong semiconductor industry out there.

Richard Valera – Needham & Company

Great. And with respect to your guys’ bookings, it looks like you maintained your prior bookings target of $160 million to $170 million for the year. And I think in prior calls you’ve talked about some potential swing factors that might drive upside there. I think Talus 1.2 was a possible swing factor as well as maybe, I think, Titan. Just wondering how you feel about where you are with respect to plan on bookings for the year and what are some of the possible swing factors there.

Rajeev Madhavan

The swing factor is certainly the Talus thing where 1.2 and FX, which has just gone out. We have a tremendous amount of activity now. I mean, as this was the first quarter, we have added one or two customers that we have added in a few quarters in digital. The last quarter was the first time we added five, as we just started showing the 1.2 and 1.2 FX to close some of those businesses. So we haven’t taken that into account in realizing our bookings now because we are sort of just delivering to that. We just delivered Talus FX, but the impact of that will be known for us next quarter. We have a huge pipeline of Talus engagements now underway. As you realize, when FineSim had gotten such a substantial differentiation, a lot of our sales force was leading into a lot of accounts with FineSim. In the last couple of weeks, we are now leading back in with digital. There is a lot of activity that we are leading with. Just today morning a couple of customer meetings that I took, both have translated into engagements based on what the tool can do by explaining the message. So we clearly are getting a lot of traction. We just need to see a little more progress, which would be before we update that range essentially.

Richard Valera – Needham & Company

Sure. That’s quite helpful. And then with respect to Titan, Roy, you mentioned – it sounds like 11 of the top-25 semi companies are now using or evaluating Titan. Can you further clarify, of those 11, how many are actual users at this point versus evaluating?

Roy Jewell

Most of them are at some stage of either adoption or in terms of getting it budgeted. But we work with a number of people, and as you know, we have a differentiated approach on analog. We’re not trying to go head-to-head with the incumbents and layout editing or schematic entry. We’re really positioning our product for analog optimization. And in Japan and in the US, we’re seeing dramatic results coming out of the –

Rajeev Madhavan

Yes. Our results – Rich, we are getting somewhere in the range of 40% to 50% power reduction, 30% in the area reduction in analog circuitry. Our results are just tremendous. We’ve gotten the first few deals where it’s like $0.25 million, $0.5 million, et cetera, in some of these top-11 – in the top-25 11. We expect most of them to translate into real big businesses in the fourth quarter. That’s what our sales guys are tipping them for. So we clearly are seeing evaluation results where we are differentiating on – I mean, it’s fair to say today in any analog circuit we could walk in, take our Titan analog optimization, and we can give you 30% to 50% power reduction and about the same amount of area reduction. So this is a significant boost in terms of the productivity for the customers that we are now displaying in benchmarks repeatedly.

Richard Valera – Needham & Company

Sure. And I guess in terms of the integration or interfacing with existing analog design environments, what’s the level of seamlessness, I guess, if you will, at this point between your product and sort of the incumbent analog solutions?

Rajeev Madhavan

Our strategy, as Roy said, is to go with the differentiation technology. So, any of the differentiated point tools are integrated within the existing incumbent platforms. We provide integrations to that. But having said that, most of the customers who adopted within a quarter or two quarters are coming to the conclusion why are we doing so much in manual and layout and in schematic, and they would just come into the tool from their existing environment, optimize, do the layout and everything and then go back once just to do a few things. So we basically are – we provide the layout editing and schematic editing, but the way we are showing our technology is the point tools are incorporated within incumbent tools, the differentiation is certainly the value that the point tools like analog optimization brings. We provide the other tools, and as more of these automation becomes adopted, people will realize you need to do less of the manual layout editing and less of the manual schematic editing that people do.

Roy Jewell

Rich, I’ll make a bold comment. The interfaces to the legacy tools out there have not been an issue at all in the adoption of this plan.

Richard Valera – Needham & Company

Okay. That’s a helpful comment, Roy. Thank you. And one final one on the product side, could you in any way add some color around the revenue opportunity for you with this Applied Materials partnership? Is there any way you could frame that out, or is it completely dependent on sort of ultimate customer take-up or –? Anything you could say around that would be helpful.

Roy Jewell

Well, what I’ll say is we’re doing joint development today, and we probably won’t ship products under this agreement until the end of our fiscal year. So right now it’s probably premature to make any estimates on what the real bookings impact is.

Richard Valera – Needham & Company

Okay. Fair enough on that. And one final one for Pete. Your other income now that you’ve retired the vast majority of your debt, should we see that essentially a less negative number going forward? I mean, how should we think about that line?

Pete Teshima

Rich, for modeling purposes, we’ve got modeled in about $650,000 a quarter. It’s true that the converted balance has come down, but we also have our credit facility, which we’ve been able to increase. So that’s going to take up some of it, but it is coming down pretty significantly.

Richard Valera – Needham & Company

Okay. That’s helpful. That’s it for me, gentlemen. Thank you.

Pete Teshima

Thanks, Rich.

Operator

Our next question comes from Tom Diffely with D.A. Davidson.

Tom Diffely – D.A. Davidson

Yes. Good afternoon. Just quickly on the last point, you said negative $650,000 per quarter?

Pete Teshima

That’s right, for quarters three and four.

Tom Diffely – D.A. Davidson

Okay. All right. And then I guess another follow-up on the Applied Materials. Is that for a pure product? Is that product consulting combination?

Roy Jewell

No. It is pure product, and they are using our CAD tools integrated into their metrology equipment, and the products would be sold through the Applied Materials channel.

Tom Diffely – D.A. Davidson

Okay. And then I guess on the industry side, if you look out the next few quarters, do you think most of your growth will be coming from share gains then in this new product acceptance versus the industry growth?

Rajeev Madhavan

I mean, obviously in circuit simulation, our growth is happening at the cost of some or the other. I mean – so we are taking market share in circuit simulation, period. In digital, with the new growth opportunities that we have, we will be taking market share, but in reality, this FX tool is creating a class of differentiated tools where no one else really plays in it. No one else can actually distribute it on a form of computers and scale their algorithms appropriately. No one can do it. So we have a little bit of a delta in that. We have a tool 1.2, which is better than – significantly better than some of them, and we basically can actually go in with the delta. So there, there will be some which will be taking market share and some which will be a class of SOCs being placed and routed where we can actually play a very unique value differentiation. And those chips are just evolving and getting done with all these chips that go into iPads and things like that, that we need to go in and get more active pushing this differentiated technology.

Tom Diffely – D.A. Davidson

Okay. It sounds like – we're hearing though that the industry itself is doing well enough, most companies should actually just get a nice lift on the overall industry. And so it seemed that would be an adder for you as well as these new markets and share shifts.

Rajeev Madhavan

Absolutely. I mean, any growth in the market, we love it. Yes.

Tom Diffely – D.A. Davidson

Okay. And then couple of, I guess, more basic questions here. Pete, maybe you could talk a little bit about the share repurchases during the quarter and plans there on a broader base.

Pete Teshima

Sure, Tom. In quarter-one, we went back – we went out and we bought about 630,000 shares. That’s quarter-one. We didn’t buy anything back in quarter-two, and the reason why we didn’t buy back is because we were focused on the conversation of the outstanding notes. So we were pretty successful there. Now going forward, it is our intent to continue to repurchase on a quarterly basis in the near future. So we’re going to continue on that program.

Tom Diffely – D.A. Davidson

Okay. And then what is your share count – your basic share count at this point?

Pete Teshima

Basic share count is about 59 million – I'm sorry, 63 million. Diluted share count, I would term that as being fully diluted share count, including the as-if-converted shares, is 69.6 million.

Tom Diffely – D.A. Davidson

Okay. All right. And is there any reason that we would expect kind of the cash flow generation you had for the last few quarters not to continue?

Pete Teshima

Not at all. It’s my expectation to continue to have and experience positive cash flow going forward.

Tom Diffely – D.A. Davidson

Okay. And then just last question, what are you seeing on the pricing front for your established products?

Rajeev Madhavan

For pricing on digital, this is unique that Vortex FX gives us a differentiation. With Talus 1.2, yes, our other place-and-route tool vendors and we are differentiated, and yes, the pricing will be what is dictated by the competitive pressures as well. On FX, we are not. We are in a unique category. I want to repeat that to you. I mean, in the history of Magma, we’ve had that once before where we had two products in digital; one at a very high capacity and one at a capacity which beats the others. And that’s the situation we are in. So at the high-end spectrum, we’re not going to be seeing much pressure. On the low-end spectrum, we will certainly be under whatever competitive pressure. Having said that, in the last couple of quarters, I’ve seen better behaviors certainly from all the other EDA vendors. All of us seem to be getting better at controlling and making sure that that was not free to be given away. So I think that behavior has certainly improved, and I look forward to seeing it continue to improve.

Tom Diffely – D.A. Davidson

Okay. That’s encouraging. All right. Well, thank you very much.

Operator

I would now like to turn the conference back over to Rajeev Madhavan for closing remarks.

Rajeev Madhavan

Thank you for joining us today. We will be in New York for Needham’s Annual Growth Conference on January 11 and hope to see many of you there. And we, of course, will look forward to speaking with you on our next quarterly call. Good afternoon and thank you.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program. You may now disconnect. Everyone, have a great day.

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