Mentor Graphics (MENT)

Business Trends

In the United States (U.S.) and abroad, recent market and economic conditions have been unprecedented in the recent past and challenging, with tighter credit conditions, increased market volatility, diminished expectations for the U.S. and global economies, and increased market uncertainty and instability in both U.S. and international capital and credit markets. These conditions, combined with generally declining business and consumer confidence and increased unemployment, have contributed to volatility of unprecedented levels.

As a result of these market conditions, the cost and availability of credit has been and may continue to be adversely affected by illiquid credit markets and wider credit spreads. Many lenders and institutional investors reduced, and in some cases, ceased to provide, funding to borrowers due to the absence of a securitization market and concerns about the stability of the markets generally and the strength of the counterparties specifically. Continued turbulence in the U.S. and international markets and economies may adversely affect our liquidity and financial condition, and the liquidity and financial condition of our customers. If these market conditions continue, they may limit our ability, and the ability of our customers, to access the capital markets to meet liquidity needs and timely refinance maturing liabilities, resulting in an adverse effect on our financial condition and results of operations.

The semiconductor industry experienced a bounce back from the major reductions in supply chain inventories in the fourth quarter of fiscal 2009, with foundries reporting a recovery in loadings. However, bankruptcies and credit problems are increasingly evident and had an effect on our revenues during the first quarter of fiscal 2010.

The semiconductor industry is particularly vulnerable in this economy as several of the largest companies lack the balance sheet strength that they historically carried into recessions. Consistent with our revenue recognition policy, when individual customer credit worthiness declines to a level where we do not consider collectability probable, we convert new transactions from up-front revenue recognition to cash-based revenue recognition and we may be required to modify the payment terms to meet the customer’s ability to pay. Our top ten accounts make up approximately 40% of our receivables, including both short and long term balances, and we have not experienced and do not presently expect collection issues with these customers. Net of reserves, we have no receivables greater than 60 days past due, and continue to experience no difficulty in factoring our receivables.

Bad debt expense recorded for the first quarter of fiscal 2010 was not material. However, we do have exposures within our receivables portfolio to some of the larger semiconductor companies with weak credit ratings. These receivables balances do not represent a material portion of our portfolio but could have a material effect on earnings in any given quarter, should additional allowances for doubtful accounts be necessary.

We rely on smaller dollar contracts for a material portion of our business. During fiscal 2009 we experienced a decline in these transactions, which we believe contributed to a decline in our revenue for fiscal 2009. For the first quarter of fiscal 2010 we continued to see a reduced contribution from these accounts and the timing of recovery is not known.

We noted a decline in service and support revenues in the first quarter of fiscal 2010. A multi-quarter increase or decrease in service and support revenue can be an early indicator that our business is either strengthening or weakening. Our experience is that customers will scale back on the purchase of outsourcing services in times of economic decline or weakness.

Bookings during the first three months of fiscal 2010 improved by 25% compared to the first three months of fiscal 2009. Bookings are the value of executed orders during a period for which revenue has been or will be recognized within six months for products and within twelve months for professional services and training. The ten largest transactions for the three months ended April 30, 2009 accounted for approximately 60% of total system and software bookings compared to 45% for the three months ended April 30, 2008. The number of new customers during the three months ended April 30, 2009, excluding PADS (our ready to use printed circuit board design tools) and new customer relationships arising out of our acquisition of Flomerics Group Plc. (Flomerics) was down 55% from the levels experienced during the three months ended April 30, 2008.