Magma F3Q08 (Qtr End 12/31/07) Earnings Call Transcript

Magma (LAVA)

F3Q08 Earnings Call

January 31, 20085:00 pm ET

Executives

Milan G. Lazich - Vice President, Corporate Marketing

Rajeev Madhavan - Chairman and Chief Executive Officer

Roy E. Jewell - President and Chief Operating Officer

Peter S. Teshima - Corporate Vice President, Finance, and Chief Financial Officer

Analysts

Tim Fox - Deutsche Bank

Raj Seth - Cowen & Company

Rich Valera - Needham and Company

Presentation

Operator

Good day everyone and welcome to Magma’s Third Quarter Fiscal 2008 Earnings Call.  (Operator Instructions) And now, here is Magma’s Vice President of Corporate Marketing, Mr. Milan Lazich. 

Milan G. Lazich

Thank you.  Welcome to Magma’s third quarter earnings call hosted by Chairman and CEO Rajeev Madhavan, President and Chief Operating Officer Roy Jewell, and CFO Pete Teshima.  Our Q3 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 includes updated financial guidance.

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, including statements about our expected financial results, current and future products and plans, market share and competition, customer spending trends, market trends, and sources of future revenue.

These forward-looking statements represent our current judgment of business and operating conditions, but are subject to risks and uncertainties as actual results could differ materially from current expectations.  In addition to any risks we highlight during this call, other potential risk factors are discussed in today’s earnings press release and in our form 10-Q for the period ended September 30, 2007.  Magma undertakes no additional obligation to update these forward-looking statements.

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

Rajeev Madhavan

Good afternoon.  In our third quarter, we again put up great numbers.  Revenue was a record $55.7 million, the fourth straight quarter of record revenue, and profitability was also strong with both GAAP and non-GAAP EPS exceeding guidance.  And as we said in this afternoon’s earnings press release, we raised full year guidance for both revenue and earnings per share.

In terms of our product and technology plan, these are exciting times for Magma.  Our R&D teams have delivered new capabilities to serve our traditional markets and continue to roll out enhancements that increase our total available market. 

This week we announced Talus qDRC, the latest addition to our physical verification product line.  Talus qDRC extends the advantages of our verification technology by putting it where it should be: directly in the implementation flow.  Magma has always been about integration.  Now users of our Talus design flow can reduce design costs by addressing DRC problems during the implementation phase.  This unique in-the-flow gets you to manufacturing quickly.

In our traditional technology segment, synthesis, placement and routing, our developers continue to push the envelope.  We are making available today a new release of Talus with new capabilities targeting 45-nanometer chips.  Designs at 45-nanometer require that implementation tools to address complexity, extraction, power, design for manufacturing, and turnaround time.

With today’s release, Talus now provides the most comprehensive 45-nanometer routing rules support of any EDA vendor.  It offers advanced low-power clock implementation and further reduces turnaround time with multi-threaded and distributed processing. 

It also provides concurrent automatic setup and hold optimization across multiple corners and multiple modes to address complexity.  An improved correlation with sign-off tools delivers results with better accuracy.  This ongoing work is how Talus continues to set the standard for implementation and is the reason the market has embraced Talus.  Roy will go over examples of that ina minute.

Looking back at our third quarter, our product and R&D teams were very busy.  Now let’s look ahead.  Analog design tools have not kept up with Moore’s Law the same way digital design tools have. 

For example, it takes only two to three months to port a digital design to a new process node while in analog it can take more than a year.  Current analog design tools impose significant bottlenecks in verification and while Magma has revolutionized analog simulation with our breakthrough SPICE simulator, FineSim, the accuracy of analog extractors continue to bea big problem.

The capability of analog tools to cope with large mixed analog-digital designs has fallen behind Moore’s Law.  The concept of IP re-use which increases productivity in digital designs is nonexistent inthe analog world.  The EDA industry needs to provide analog designers with the ability to use their expertise ina rapid and highly productive fashion. 

You can bet we will soon have something to say about our solution to this problem.   Stay tuned: we will host our music conference, users’ conference, inSilicon Valley between February 27th and 28th, and you can expect major product announcements then.

Before we hear from Roy, I’d like to comment on one more topic, the economy and its impact on our industry and our customers.  We do not believe the economy is having a significant impact on our business.  Our customers continue to invest in Magma tools because they provide the most productivity. 

Magma grows by taking market share and does not rely on overall EDA industry growth.  We continue to provide new products that expand our total available market and as long as these products increase customer productivity, Magma will continue to take market share.

With that, let me turn the call over to Roy.

Roy E. Jewell

Thanks, Rajeev.  If I might follow Rajeev’s observations on the economy with a brief comment, another benefit of our model is our consistently strong investment in R&D.  Rajeev and I are adamant that we will continue to take market share only by delivering better products and to do that we must maintain our technology edge. 

Leading semiconductor companies increasingly turn to Magma’s newest products: our next generation Talus platform and implementation, FineSim and circuit simulation, and Quartz DRCLVS and physical verification to complete their most advanced chips.  Here area few recent examples.

First, in our stronghold segment of implementation, Magma products continue to do well.  We announced this week that NVIDIA standardized on Talus for implementation of 45-nanometer design.  Talus was chosen because it provides unique integrated features that directly address 45-nanometer design challenges and accelerate design optimization for better quality of results.  We view selection by NVIDIA as a strong endorsement of Talus as the leading next generation design platform.

Broadcom also evaluated Talus and determined that it delivered significant advances in runtime, power reduction, and timing closure.  Broadcom found that Talus Automated Floorplan Creation generated a smaller footprint without user intervention, a significant efficiency advantage.  Broadcom will use Talus for 65-nanometer chip development.

Another Talus victory came at PLX Technology.  PLX implemented their PCI-based switch family using Magma’s RTL-to-GDS solution and made a decision to deploy the Talus Implementation System to design teams worldwide. 

In place of route for high performance cores, Renesas used Magma’s visible design products to create a new SoC for car navigation systems.  Renesas relied on Magma’s software to shorten their development schedule to deliver complex high performance chips at reasonable costs.

And Sigma Design is adopting Talus as part of a full suite of Magma products.  This multi-year agreement includes Talus Design and Talus Vortex for implementation, Quartz DRC and Quartz LVS for physical verification, and FineSim SPICE for circuit simulation.  Once again, the reason for this decision was Magma’s ability to provide the automation, integration, accuracy, and performance to meet their costs and time-to-market requirements.

And finally, Qualcomm recently used Magma to tape out 65-nanometer and 45-nanometer SoCs focusing on area, power, and time to market reduction.  I’d like to add that Rajeev and I are very pleased to have key Qualcomm technologists participating in our user conference committees worldwide.

Magma is a leader in wireless chip design because of our superiority and low power implementation.  In fact yesterday, we announced availability of an integrated low power IC implementation reference flow for UMCs advanced 65-nanometer process.  This 65-nanometer low power flow enables designers to address low-power nanometer design considerations during implementation and within a single environment.

Now moving on to circuit simulation, AMD selected FineSim SPICE as their circuit simulator of choice for critical analog IP.  AMD made the decision after FineSim SPICE delivered better accuracy and up to 15 times faster runtimes at AMDs existing circuit stimulation product during a detailed evaluation. 

FineSim’s technology edge has enabled it to rapidly take share from Synopsis and Cadence’s legacy products.  Ina physical verification, Quartz DRC run sets for qualified by TSMC for their 45-nanometer process.  These run sets and Talus qDRC now provide designers with a complete integrated implementation and verification solution that shortens time-to-market and improves manufacture ability of designs targeted for TSMCs advanced processors.

It’s clear that our R&D investments have positioned us well in both traditional and new segments.  Our customers want to take advantage of the competitive edge Magma provides and we continue our growth only by making them successful.

One quick point before I turn it over to Pete.  Saeid Ghafouri is stepping down as our Head of Sales but will continue as an advisor to Rajeev and me.  We want to think him for five-plus years of service that contributed much to Magma success.

Now here is Pete with the Q3 financials.

Peter S. Teshima

Thank you, Roy, and good afternoon everyone.  After we cover quarter three results, I’ll review our updated guidance, which is inthe financial data supplement on our website.  Unless specifically noted, all references to expenses, margins, and other financials are on a non-GAAP basis.

Revenue for quarter three was $55.7 million, above the top of our guidance range of $53-55 million and another record for the company.  This was up 23.6% from the year ago quarter and up from quarter two’s revenue of $53.5 million. 

In quarter three, 82% of revenue came from backlog-related transactions and 18% came from upfront orders completed inthe quarter, an improvement over the 76% of revenue from backlog-related transactions in quarter two.  To put this in context, our backlog contribution to revenue has averaged about 85% over the last four quarters, consistent with our steady state target of 85 to 90%.

Quarter three spending for R&D, sales and marketing, and G&A totaled $39.8 million or 71% of revenue.  Operating income for quarter three was $9.5 million or 17% of revenue, which exceeded our guidance range of 14.5% to 16.5% and compared to $7.9 million or 15% of revenue in quarter two.  Tax expense for quarter three was $2.5 million or 25% of pre-tax income.  This compared to $2.3 million or 25% of pre-tax income in quarter two.

Quarter three’s diluted non-GAAP EPS was $0.16 per share, above the top of our guidance range of $0.13 to $0.15 per share, and an increase over quarter two’s $0.15 per share.  On a GAAP basis, EPS was a loss of $0.14 per share, which was better than our guidance of a loss in the range of $0.21 to $0.19. 

Non-GAAP to GAAP adjustments accounted for approximately $0.30 per share on a diluted basis.  We ended quarter three with total cash and investments, including restricted cash, of $69.7 million, an increase of $15.2 million from $54.5 million atthe end of quarter two. Now, worth noting is that, atthe end of quarter three, we had a positive net cash position of $6.2 million, defined as cash and investments less debt, which for us is principally the remaining balance on our convert. 

Accounts receivable was $28.1 million for quarter three compared to $36.3 million for quarter two.  DSO for quarter three was 45 days compared to 61 days in quarter two and we do not factor our receivables.  Headcount atthe end of quarter three was 974.  That’s up from 930 atthe end of quarter two.  In conclusion, our third quarter financial performance met or exceeded all guidance.

For the fourth quarter ending April 6, guidance is as follows.  Revenue in quarter four is expected to bein the range of $56 million to $58 million.  Non-GAAP operating margin is expected to bein the range of 16% to 18% for quarter four. 

Tax rate is expected to be 25% of non-GAAP pre-tax income.  Non-GAAP EPS is expected to be inthe range of $0.15 to $0.17 per share.  Diluted shares outstanding are forecast to be inthe range of 48.5 million to 49.5 million shares for quarter four.

We are also updating our full year guidance for fiscal 2008 ending April 6, the revenue, operating margin, and EPS.

Revenue for fiscal 2008 is now expected to bein the range of $215 million to $217 million, representing growth inthe range of 21% to 22% over fiscal 2007.  This is an increase from our previous guidance that revenue would growin the range of 17% to 20%. 

Non-GAAP operating margin for fiscal 2008 is now expected to be inthe range of 15% to 16%.  This guidance increases the lower end of our previous guidance, which projected that non-GAAP operating margin would be inthe range of 13% to 16%.

Non-GAAP EPS for fiscal 2008 is now expected to bein the range of $0.56 to $0.58 per share.  This represents an increase from our previous guidance that non-GAAP EPS would bein the range of $0.50 to $0.52 per share.  Fourth quarter and fiscal 2008 full-year guidance are available in the financial data supplement on our web site.

Now we will provide full year guidance for fiscal 2009 during our fourth quarter earnings call in April, but at this time I can give you preliminary fiscal 2009 guidance for revenue and expenses.

Similar to the preliminary guidance we offered at this time last year for fiscal 2008, we expect fiscal 2009 revenue will increase in the range of 12% to 15% over our expected full-year revenue for fiscal 2008.  We expect non-GAAP operating expenses to increase in the range of 10% to 12% for fiscal 2009.  As you can see, we expect a solid top line growth rate and we expect the bottom line to grow even faster.

And finally, we are announcing today that Magma will change its fiscal year, essentially shifting our fiscal calendar one month later.  This change will have no impact on our current fiscal year which will end April 6, 2008.  Our fiscal 2009 will begin May 5th, 2008 and end on May 3rd, 2009.  As a result of this change, we will have a four-week transition period between fiscal 2008 and fiscal 2009 beginning April 7th, 2008 and concluding May 4th, 2008.

Now we’ll take your questions.

Question-and-Answer Session

Operator

(Operator Instructions)  We’ll go first today to Tim Fox - Deutsche Bank.

Tim Fox - Deutsche Bank

First question is, just digging ina little bit on the NVIDIA announcements, obviously a very solid endorsement of the technology.  When vendors say that a company has standardized, one has to dig into that a little bit further and could you just talk a little about how we can gauge how material this deal is for you?  It’s obviously for 45-nanometer, but at NVIDIA how big of an implementation would that be for 45-nanometer and are you seeing any possible backward adoption into 65-nanometer?

Roy E. Jewell

Basically, to give you the scope of this, our understanding is they have standardized on the Magma flow from Netlist to GDSII for 45-nanometer, and, on top of that, there has been some transition to 65-nanometer designs to our flow also.  For us it’s a very major announcement because NVIDIA does leading edge designs, probably some of the most difficult inthe industry, and it’s a validation that our technology’s applicable for really the broad cross-section of leading edge designs in this business.

Rajeev Madhavan

Tim, I just want to add one thing.  As you remember, we had a similar endorsement from them on our Quartz DRC product early on, which is a 90-nanometer.  So everything below that 90, 65 and 45, Quartz DRC is the solution that they use for physical verification.  So this is a very big endorsement for us in that we have taken that from a physical verification to now and physical implementation too as well into that account.

Tim Fox - Deutsche Bank

Okay, and secondly around Quartz DRC.  Can you talk a little bit about whether the new Automator rule DAC solution you have has helped in increased sales pipeline, closing deals, and could you just talk a little bit about how, if it’s helped at all, maybe quantify where that growth may go this year?

Roy E. Jewell

Number one, I’ll say it’s been a great asset removing the barriers to adoption versus the market leader in this business from Mentor Graphics.  The part I’ll say is that relative to our pipeline right now and Quartz DRC, it is by far the largest we have seen in at least the last two years.  And a lot of that is that we have been able to start engaging more people because the labor required to do these new DACs is quite reduced.

Rajeev Madhavan

So Tim, within a week of starting any engagement, the rolls are up in running and qualified and, given a golden rule DAC with our competition, a golden rule DAC with our tool is available within a week which is significant.  That would bethe amount of engagements we can take.

Tim Fox - Deutsche Bank

Where is Saeid going and what are your plans for replacing him?

Roy E. Jewell

Tim, as I think it’s pretty clear inthe market, I have been intimately involved inthe sales process in this company and I think you’ve meta number of our regional VPs that we have, which all of them are very senior guys that have, I guess, the ability to run an organization like this themselves. 

Relative to where Saeid is going right now, I don’t know.  I don’t want to talk about what his plans are.  I know that hehas had a desire to move back into a CEO role at some other company and I wouldn’t be surprised if I saw him pop up somewhere inthe near future.

Tim Fox - Deutsche Bank

And just lastly, Pete, why the shift in the fiscal year?

Peter S. Teshima

You know it makes sense for our industry, which might be why Synopsis and Mentor already made this change.  The schedule we’re adopting really hasa positive impact in terms of closing the business for each of the four quarters.  Let me give an example. 

The holiday season currently falls inthe last month of our third quarter making access to customers difficult.  So, with this change, December will become the mid-month of the quarter and we can close atthe end of January, thereby alleviating this sort of timing conflict.  So that’s one example.

Rajeev Madhavan

Another example, the Design Automation Conference, which is in June, which also used to fall atthe end of our quarter and today, I mean with this change, it will not.  So, it helps us alleviate the fact that a lot of events that we need to participate in unfortunately used to land atthe end of the quarter.

Operator

And we’ll take our next question from Raj Seth - Cowen & Company.

Raj Seth - Cowen & Company

But, Rajeev, obviously there is a lot of angst in the market.  Given what Cadence suggested last night, they are seeing in terms of pricing dramatically shifting inthe short term, etc.  I did hear your commentary about the economy, but I wonder if you can talk you or Roy, a little bit more about whether or not you’re seeing any of what I’m sure you heard they said last night?  And if you can just provide a little bit more color on that topic?

Roy E. Jewell

I guess we’re selling to different people, because we’re not seeing clearly any macroeconomic impact on our business today.  We lived through the 2001-2002 downturns inthe semiconductor industry where cost control paramount and I think uncertainty relative to where the semiconductor companies’ businesses was going was maximized. 

Of course, people are still prudent in how they spend money, but we don’t see any diminished interest in our products.  We don’t see any overly conservative approaches to making acquisitions of our tools and, quite frankly, the price compression that they were talking about, especially inthe digital space, there hasn’t been any change.  I really don’t know who they’re talking to.

Rajeev Madhavan

Just on the economy, I mean the factors, I mean we may be addressing a different set of customers because our consumer products is what drives Magma’s adoption which drives 50% of the semi industry today.  I mean, for example, the wireless phones is where we have prevalent use and even though the wireless industry, it has continued to grow, and the fact is the phones will do more and more and are getting more and more smart.  They’ll need more and more design tools and productivity. 

So, if you look atthe wireless phones inthe world today a large percentage of them are designed using Magma and that’s our biggest value proposition today.  So we don’t see the economic issues that have been reported so far.

Raj Seth - Cowen & Company

Roy, I read your remarks, but you talked about AMD as a new customer for FineSim in the last couple of quarters.  You’ve added a bunch of memory manufacturers, SanDisk, Micron, a bunch of others.  Can you talk a little bit about where you are you think in that adoption cycle, what your pipeline looks like, and sort of what the outlook is for FineSim at this point?

Roy E. Jewell

I think I had mentioned before that what we are seeing with FineSim, it’s the fastest growing product this company has ever introduced.  It includes Blast Fusion.  It opened up new markets for us.  You mentioned a number of memory manufacturers. 

And now what we are starting to see is a lot more adoption in FineSim SPICE both for analog IP development as well as just traditional analog applications both domestically and now we are starting see engagements in both AsiaPac as well as Europe.  So, I don’t want to give you any specific numbers right now, but it will be a meaningful part of our bookings for this year and a meaningful part of our revenue going forward.

Operator

We’ll go next to Rich Valera - Needham and Company.

Rich Valera - Needham and Company

Just looking at your preliminary fiscal ‘09 guidance, I notice in fiscal ‘08 it looks like you have grown revenue about 22% with roughly 8% expense growth and you’re guiding for fiscal ‘09 12-15% top line growth and 10% to 12% expense growth.  So just wondering why there isn’t more leverage there in fiscal ‘09 and why the expenses are growing faster, but sort of the revenue growth rate is substantially lower than fiscal ‘08.

Roy E. Jewell

First off, as we indicated, Rich, this is preliminary and we have not yet completed our formal planning process.  We arein that process now.  We’ll complete it before the end of our fiscal year, but at this point it’s the same level of revenue growth we guided to atthe beginning of 2008.  And this far ahead of the New Year, it’s a reasonable baseline to start with. 

And also keep inmind that, atthe high end of the rate, it’s still about double the growth in EDA in general.  Soall in all, it’s preliminary and it’s what we’re comfortable with at this time.  We’ll have a better idea at the end of quarter four.

There is a message here and that message is that fundamentally we believe the prudent thing for us to do is to continue to invest inthe business, although I call it more on a tempered basis.  We are executing to a plan that combines a level of investment as well as steady up-margin increases through the year with an end goal of getting back to 20%, like we have consistently stated. 

Now keep in mind, our trailing fourth quarter OP margin trend has been 9%, 13%, 15% and now 17%.  And we said that we wanted to get to the mid- to high-teens by the end of the year and we are tracking that.  So, with a little massaging of those two preliminary guidance figures coming off a full year in 2008, that gets us to about 20% in 2009 and that range feels right for us right now.  And again, like I said before, we’ll have a better set of figures for you in our quarter four call.

Rajeev Madhavan

Rich, this is no different than our number was in 2008 when we gave the guidance for that year.  If you look at it, we increased the guidance in 2008 because of the fact that FineSim was kicking into high gear. 

We said that after the first quarter that new products were kicking in to gear and we increased guidance as a result of the comfort of those new products.  We have a lot of new products that needs to be announced as we’ve implied in our call today.  And at this juncture, we’re making the investments on those deals and we have to continue to make those investments next year.

Rich Valera - Needham and Company

In terms of the expense growth, is that kind of across the board both in sort of APPS and R&D, and are there any specific projects?  Like is this sort of maybe targeted at analog or custom?  Or is it just generally rolling out new products and growing?

Roy E. Jewell

Rich, I think you have insight in what we are doing.  A lot of growth you’ll be seeing this year will bein funding the field we need to now start reaping the returns on the custom analog products that Rajeev was hitting at during his presentation.  And it’s not going to be astronomical investment.  It will be adequate investment so we have the technical resources on the ground to deploy those products.  So that’s primary what it is.

Rich Valera - Needham and Company

So you expect to announce the sort of full suite of custom analog tools?  I don’t want to sort of preannounce you guys, but atthe music conference, what could we expect there again?

Rajeev Madhavan

I think you have to come to the music conference to see what we’re going to announce.  I’m not going to preannounce anything.

But, I think it’s fair to say that we enter a market when we see a rather big discontinuity and there was a significant amount of discontinuity that I talked about in extraction accuracy inIP re-use, etc. And so we are not going to get into the market with a fractionally better productivity. 

We have to make it; it’s much like what physical synthesis was for the entry of the company into a very congested place and route into the synthesis market.  So we are not just going up at a [inaudible] somebody by a me-too product.

Rich Valera - Needham and Company

All right and what’s the date of the conference, sorry?

Rajeev Madhavan

27th and 28th.

Operator

And gentlemen we have no further questions at this time.  I’d like to turn the call back over to Mr. Madhavan for any additional or closing remarks.

Rajeev Madhavan

Thank you for joining us today.  We will beat a couple of conferences next month:  the Deutsche Bank Small and Mid-Cap Conference on February 13^th, and the DA Davidson Electronic Systems Design Conference on February 21st.  And after that, we will hold our Music Silicon Valley Users Group Conference here inSilicon Valley on February 27 and 28.  We hope to see you in one of these events and we will speak with you again on our next quarterly call.  Good afternoon.

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