Mentor Graphics: Here's What Worries Investors

Mentor Graphics reported its third quarter results on Wednesday which were roughly in-line with expectations. The supplier of electronic design automation tools reported that earned $0.28 per share in the quarter on revenue of $291 million. Wall Street analysts were looking for the company to earn $0.28 per share on revenue of $291.8 million. Mentor Graphics also provided guidance and expects to earn $0.47 per share in the fourth quarter on revenue of $336 million – well short of the $0.97 per share and $439.33 million analysts were looking for. Analysts at Wall Street firms were mostly unanimous in slashing their investment rating profiles.

Monika Garg of Pacific Crest downgraded Mentor Graphics to Sector Weight from Overweight while removing a $60 price target. According to Garg, Mentor Graphics' third quarter print that was "in line" with expectations but it was the company's guidance that is worrisome. Mentor Graphics cited delayed adoption of emulation, ongoing currency headwinds, and an impact from industry wide consolidation in reported its "meaningfully lower" guidance. Garg isn't buying the excuse and pointed out that Cadence released its new emulation tool in the quarter which led Mentor's customers to delay decisions around emulation. The company also cited its revenue was lower by $25 million year over year due to foreign exchange. "Assuming 50 percent less currency impact in FQ4 still leaves a $92 million shortfall," Garg argued. "Then assuming a $42 million adverse effect from emulation means core EDA sales could be down $50 million. Since Mentor recognizes 60% of revenue upfront, this would mean core EDA license revenue would be down close to $83 million, which is a significant license shortfall, in our view." Garg added that Mentor Graphics disclosed it didn't lose any customers, so the "magnitude of negative impact from consolidation is puzzling." The analyst added that further consolidation in the industry could continue "for some time" which "means more impact" on Mentor Graphics in the coming years. Finally, Garg lowered her fiscal 2016 and 2017 estimates "meaningfully." The analyst now expects the company to earn $1.40 per share in fiscal 2016 (down from a prior estimate of $1.90 per share) on revenue of $1.1808 billion (down from a previous $1.2854 billion). The following year, the company is expected to earn $1.58 per share (down from a previous $2.02 per share) on revenue of $1.2253 billion (down from a previous $1.3489 billion).

Shares of Mentor Graphics were cut to Sector Weight at Pacific Crest. Shares of Mentor Graphics were cut to Underweight at JPMorgan. Shares of Mentor Graphics were cut to Neutral from Buy at Bank of America.