Last November Mentor reported its third quarter fiscal 2012 revenue and showed a nice increase both when compared with the same period the previous year and as compared with the previous quarter. If this trend continues Mentor is on track to break the $1 billion revenue mark for its 2012 fiscal year.

The Good News

Mentor is still under pressure by its major outside investor to cut spending, but it looks like it is making progress in this area. By moving Catapult to Calypto Mentor has lowered its overhead and given to Calypto the responsibility of managing development and marketing costs.

For reporting purposes Mentor divides the company in four operating groups: Integrated Systems Design, IC Design to Silicon, Scalable verification, and New and Emerging.
Ry Schwark was good enough to explain to me the products' breakdown into the aforementioned revenue groups, since I could not figure it out from the corporate structure. Ry wrote that: "Integrated System Design segment includes all of our PCB tools, including boardstation, expedition, and PADS. Our Valor products, and our FPGA synthesis tools.
IC Design to silicon includes all Calibre, both physical verification and RET and DFM, our custom IC tools, and our DFT tools.
Scalable verification includes our emulation products, our simulation products (Questa and Modelsim), our formal verification products, our HW/SW co-verification, our analog-mixed signal products and design creation tools.
New and emerging includes our transportation products, cabling and wire harness, in-vehicle networking and our embedded systems products."

The following analysis benefited significantly from help from Jay Vleeschhouwer of Griffin Securities who for years has been the most consistent analyst of the EDA industry.

The Design to Silicon group continues to be the highest contributor to Mentor's revenue. Calibre maintains its long standing position as the leading tool for design to manufacturing applications. The group posted results that are significantly better than the corresponding period a year ago, and almost doubled the revenue of the previous quarter.

The next contribution came from the Scalable Verification group followed very closely by the Integrated System Design (ISD) group. Logically this group should also include wire harness and cabling, which instead belongs in the New and Emerging products category. If logic were followed than the ISD group would be the second largest contributor to the company's revenue.

It seems that the New and Emerging group is really a market segment group aimed mainly at automotive applications.

What is interesting to me is that Ry did not explicitly include Mentor's embedded software products in any of the groups, yet the company has been active in this market for many years, and lately has issued press releases that indicate significant activity in this market segment. Given the importance of software in present day systems, this particular group of products is likely to increase Mentor's revenue in the quarters to come.

The Not So Good News

If there is one negative aspect to be found in Mentor's fiscal report is that 38% of the quarter revenue are attributable to Service Revenue which almost always have much higher cost of sales than software tools. This sector contributed a little over $96 million in the quarter and the level has been quite steady from quarter to quarter for the entire 2012 fiscal year.

Another possible negative item is that between May and July of 2011 Mentor was offered the opportunity to merge with Magma under the auspices of a "private equity firm" (controlled by Icahn I assume) and declined citing products overlap. I can certainly understand the emotional energy involved in the decision, but I think this is a very short term win for Mentor.

The problem is that although it is true that there would have been some products overlap, Magma's products have proven more competitive against Synopsys than Mentor's, with the obvious exception of Calibre. By purchasing Magma in spite of their own overlap Synopsys will not only dispose of a competitor that was showing the ability to take market shares away from the company, but also isolate Calibre in the market. Thus the opportunity to leverage Calibre to sell more products from the Design to Silicon group will be diminished, and Synopsys will gain a development team that could really challenge Calibre technical leadership.

It is not the first time that Mentor declines to join with Magma, and this missed opportunity will force Mentor to spend more development funds to strengthen the other products in the Design to Silicon group in order to defend its market not only from Synopsys but from Cadence as well. Will Mentor end up acquiring Oasys?