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Mentor Graphics Announces Record Fourth Quarter

WILSONVILLE, Ore., Jan. 26, 2006 - Mentor Graphics Corporation (Nasdaq: MENT) today announced record fourth quarter revenue of $221.3 million, up 3% from the prior fourth quarter. Diluted earnings per share were $.19 on a GAAP basis and $.42 on a non-GAAP basis. Bookings were up more than 5% from the fourth quarter of 2004.

"We were pleased to see continued growth in bookings in the fourth quarter of 2005, especially considering the tough comparison to last year's fourth quarter growth of more than 35%," said Walden C. Rhines, chairman and CEO of Mentor Graphics. "Renewals showed strong growth, with contract values up nearly 30% over prior contract levels. Mentor's book-to-bill ratio was positive for the year, and the fourth quarter was the highest quarterly book-to-bill ratio since 1996."

Three of the four major product categories set new quarterly and annual bookings records. Compared to the fourth quarter of 2004, bookings grew 50% in Integrated Systems Design, 15% in IC Design to Silicon and 20% in New and Emerging.

Mentor's new Questa™ verification platform, launched in May, saw rapid customer adoption with over a thousand seats installed by the fourth quarter. TestKompress® bookings more than doubled during the year, while automotive products grew 40%. Strength in FPGA-related products like synthesis and I/O Designer™ helped provide increased bookings in the Integrated Systems Design product category. Calibre® resolution enhancement technology continued to expand with annual bookings growth of 25%. Calibre Design-for-Manufacturing (DFM) bookings grew 1000% over 2004 and materially improved fourth quarter 2005 results.

Two new Calibre DFM products and the company's automotive solution were launched during the fourth quarter of 2005 and performed well. YieldAssist™ had more than $1 million in bookings, while Calibre OPCverify™ had $5 million in bookings. Mentor's automotive solution was adopted at Shanghai Motors, one of the largest manufacturers of automobiles in the world. The resulting orders were the largest Mentor Graphics has ever received from China.

North America and Europe both saw strength in the quarter with bookings up 20% over the fourth quarter of 2004. Japan was weaker with bookings down 35%, while the Pacific Rim bookings dropped 5% over the year ago levels.

Split of revenue by geography was 45% North America, 35% Europe, 10% Japan, and 10% Pacific Rim.

"During the quarter, we examined several opportunities for savings to fuel our investment in high growth opportunities like Calibre Design-for-Manufacturing, Electronic System Level (ESL) tools, and automotive," said Gregory K. Hinckley, president of Mentor Graphics. "As a result of this review, we took steps which will conclude in the first quarter to reduce cost and headcount in our Intellectual Property business."

Special charges of $4.2 million were restructuring related.

Guidance

Based upon selective cost reduction programs, the company is raising non-GAAP earnings per share guidance for the full year 2006.

For the first quarter of 2006, the company expects revenue of approximately $170 million, a GAAP loss per share of $.06 and approximately breakeven non-GAAP earnings per share.

For full year 2006, Mentor Graphics expects revenue of about $755 million, GAAP earnings per share of $.18 and non-GAAP earnings per share of approximately $.55.

Discussion of Non-GAAP Financial Measures
Mentor Graphics management evaluates and makes operating decisions using various performance measures. In addition to our GAAP results, we also consider adjusted net income (loss), which we refer to as non-GAAP net income (loss). This measure is generally based on the revenues of our product, maintenance and services business operations and the costs of those operations, such as cost of revenue, research and development, sales and marketing and general and administrative expenses, that management considers in evaluating our ongoing core operating performance. Non-GAAP net income (loss) consists of net income (loss) excluding amortization of intangible assets, merger and acquisition charges, special charges, equity plan-related compensation expenses and charges and gains which management does not consider reflective of our core operating business. Intangible assets consist primarily of purchased technology, backlog, trade names, customer relationships, employment agreements and stock options issued in connection with acquisitions. Merger and acquisition charges represent in-process research and development charges related to products in development that had not reached technological feasibility at the time of acquisition. Special charges consist of post-acquisition restructuring costs including severance and benefits, excess facilities and asset-related charges, and also include strategic reallocations or reductions of personnel resources. For purposes of comparability across other periods and against other companies in our industry, non-GAAP net income (loss) is adjusted by the amount of additional taxes or tax benefit that the company would accrue using a normalized effective tax rate applied to the non-GAAP results. In addition, during the twelve months ended December 31, 2005, a $4.75 million purchase of technology that had not yet reached technological feasibility, a $957 thousand gain on the sale of a building and an $800 thousand gain on investment earnout income were excluded as management does not consider these transactions a part of its core operating performance. During the twelve months ended December 31, 2004, investment earnout and holdback income of $1,403 thousand were also excluded.

Non-GAAP net income (loss) is a supplemental measure of our performance that is not required by, or presented in accordance with, GAAP. Moreover, it should not be considered as an alternative to net income, operating income or any other performance measure derived in accordance with GAAP, or as an alternative to cash flow from operating activities or as a measure of our liquidity. We present non-GAAP net income (loss) because we consider it an important supplemental measure of our performance.

Management excludes from its non-GAAP net income (loss) certain recurring items to facilitate its review of the comparability of the company's core operating performance on a period to period basis because such items are not related to the company's on going core operating performance as viewed by management. Management uses this view of its operating performance for purposes of comparison with its business plan and individual operating budgets and allocation of resources. Additionally, when evaluating potential acquisitions, management excludes the items described above from its consideration of target performance and valuation. More specifically management adjusts for the excluded items for the following reasons:

  • Amortization charges for our intangible assets are inconsistent in amount and frequency and are significantly impacted by the timing and magnitude of the company's acquisition transactions. We therefore consider our operating results without these charges when evaluating our core performance. Generally, the most significant impact to inter-period comparability of the company's net income (loss) is in the first twelve months following the acquisition.

  • Special charges are primarily severance related and are due to the company's reallocation or reduction of personnel resources driven by modifications of business strategy or business emphasis and by assimilation of acquired businesses. These costs are originated based on the particular facts and circumstances of business decisions and can vary in size. Special charges also include excess facility and asset-related restructuring charges. These charges are not specifically included in the company's annual operating plan and related budget due to the rapidly changing technology and competitive environment in our industry. We therefore exclude them when evaluating our managers' performance internally.

  • Merger and acquisition charges are in- process R&D charges, which are largely disregarded as acquisition decisions are made and which often result in charges that vary significantly in size and amount. Management excludes these charges when evaluating the impact of an acquisition transaction and our ongoing performance.

  • Equity-plan related compensation expenses are non-cash expenses that are inconsistent in amount and frequency from period to period that depend on the timing of the grant of stock options and varying levels of participation in the company's stock purchase plan. We therefore exclude these charges for purposes of evaluating our core performance as well as with respect to evaluating any potential acquisition.

  • Income tax expense (benefit) is adjusted by the amount of additional tax expense or benefit that we would accrue if we used non-GAAP results instead of GAAP results in the calculation of our tax liability, taking into consideration the company's long-term tax structure. We use a normalized effective tax rate of 17%, which reflects the weighted average tax rate applicable under the various tax jurisdictions in which the company operates. This non-GAAP tax rate is subject to change as the geographic business mix and statutory tax rates and their effect on the weighted average tax rate differ over time. Our GAAP tax rate for the twelve months ended December 31, 2005 is 63%. This tax rate was substantially impacted by our pre-tax income for the year being near break-even, which exacerbates the effect of certain mandatory payments in some jurisdictions on our overall tax rate. Our adjustment for tax related items in 2005 applies this normalized rate to our non-GAAP pre-tax income, and thereby reduces the unusually large provision for taxes reflected in our GAAP results. Our adjustment for tax-related items in 2004 primarily reflects the elimination of the additional tax charge associated with a one-time inter-company tax dividend of $120 million, in addition to the tax impact of other previously described non-GAAP adjustments.

Non-GAAP net income (loss) also facilitates comparison with other companies in our industry, which use similar financial measures to supplement their GAAP results. However, non-GAAP net income (loss) has limitations as an analytical tool, and you should not consider this measure in isolation or as a substitute for analysis of our results as reported under GAAP. In the future the company expects to continue to incur expenses similar to the non-GAAP adjustments described above and exclusion of these items in our non-GAAP presentation should not be construed as an inference that these costs are unusual, infrequent or non-recurring. Some of the limitations in relying on non-GAAP net income (loss) are:

  • Amortization of intangibles, though not directly affecting our current cash position, represent the loss in value as the technology in our industry evolves, is advanced or is replaced over time. The expense associated with this loss in value is not included in the non-GAAP net income (loss) presentation and therefore does not reflect the full economic effect of the ongoing cost of maintaining our current technological position in our competitive industry, which is addressed through our research and development program.


  • The company regularly engages in acquisition and assimilation activities as part of its ongoing business and therefore we will continue to experience special charges and merger and acquisition charges on a regular basis. These costs also directly impact available funds of the company.

  • The company's stock option and stock purchase plans are important components of our incentive compensation arrangements and will be reflected as expenses in our GAAP results for the foreseeable future under FAS 123(R).

  • The company's income tax expense (benefit) will be ultimately based on its GAAP taxable income and actual tax rates in effect, which may differ significantly from the 17% rate assumed in our non-GAAP presentation.

  • Other companies, including other companies in our industry, may calculate non-GAAP net income (loss) differently than we do, limiting its usefulness as a comparative measure.

About Mentor Graphics
Mentor Graphics Corporation (Nasdaq: MENT) is a world leader in electronic hardware and software design solutions, providing products, consulting services and award-winning support for the world's most successful electronics and semiconductor companies. Established in 1981, the company reported revenues over the last 12 months of about $700 million and employs approximately 4,000 people worldwide. Corporate headquarters are located at 8005 S.W. Boeckman Road, Wilsonville, Oregon 97070-7777. World Wide Web site: http://www.mentor.com/.

TestKompress is a registered trademark and Questa, I/O Designer, Calibre OPCverify and YieldAssist are trademarks of Mentor Graphics Corporation.

Statements in this press release regarding the company's guidance for future periods constitute "forward-looking" statements based on current expectations within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company or industry results to be materially different from any results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: (i) the company's ability to successfully offer products and services that compete in the highly competitive EDA industry including the risk that the company's technology, products or inventory become obsolete; (ii) reductions in spending on EDA tools by the company's customers due to cyclical downturns or initiatives to increase profitability, (iii) discounting of products and services by competitors, which could force the company to lower its prices or offer other more favorable terms to customers (iv) changes in accounting or reporting rules or interpretations, limitations on repatriation of earnings, licensing and intellectual property rights protection; (v) changes in tax laws, regulations or enforcement practices where the company does business; (vi) effects of the increasing volatility of foreign currency fluctuations on the company's business and operating results; (vii) effects of unanticipated shifts in product mix on gross margin and unanticipated shifts in geographic mix on the overall tax rate, (viii) effects of customer seasonal purchasing patterns and the timing of significant orders may negatively or positively impact the company's quarterly results of operations, (ix) the company's ability to successfully integrate and manage its acquisitions, all as may be discussed in more detail under the heading "Factors That May Affect Future Results and Financial Condition" in the company's most recent Form 10-K or Form 10-Q. Given these uncertainties, prospective investors are cautioned not to place undue reliance on such forward-looking statements. In addition, statements regarding guidance do not reflect potential impacts of mergers or acquisitions that have not been announced or closed as of the time the statements are made. Mentor Graphics disclaims any obligation to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements to reflect future events or developments.

The company is currently in discussions with its external auditors on an emerging accounting issue related to Financial Accounting Standard No. 133 "Accounting for Derivative Instruments and Hedging Activities." The company hedges future cash flows in certain jurisdictions where it has long or short positions in key foreign currencies, namely the Japanese Yen, the Euro and the British Pound Sterling. The fair value of the related hedge instruments as of December 31, 2005 is a net unrealized gain. If the conclusion related to this emerging issue is different than our current position, the impact on our financial results for 2005 is expected to be in the range of neutral to a positive 3 cents per share. A conclusion on this matter is expected in the next week.

MENTOR GRAPHICS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except earnings per share data - Unaudited)

Three Months Ended
December 31,
Twelve Months Ended
December 31,

2005

2004

2005

2004

Revenues:

System and software

$ 145,837

$ 140,127

$ 410,264

$ 422,672

Service and support

75,433

74,822

294,985

288,284

Total revenues

221,270

214,949

705,249

710,956

Cost of revenues:

System and software

5,305

4,839

18,034

16,639

Service and support

21,196

20,800

81,039

80,294

Amortization of purchased technology

3,150

2,982

11,639

10,624

Total cost of revenues

29,651

28,621

110,712

107,557

Gross margin

191,619

186,328

594,537

603,399

Operating expenses:

Research and development

53,610

54,594

212,676

202,289

Marketing and selling

77,319

76,126

274,946

267,181

General and administration

19,491

18,825

76,834

74,255

Amortization of intangible assets

1,080

1,098

4,233

3,586

Special charges

4,248

4,843

6,777

9,213

Merger and acquisition related charges

-

50

750

7,700

Total operating expenses

155,748

155,536

576,216

564,224

Operating income

35,871

30,792

18,321

39,175

Other income, net

6,197

2,689

16,798

8,388

Interest expense

(7,366)

(4,838)

(23,496)

(18,619)

Income before income taxes

34,702

28,643

11,623

28,944

Income tax expense

19,287

12,829

7,278

49,494

Net income (loss)

$15,415

$15,814

$ 4,345

$ (20,550)

Net income (loss) per share:

Basic

$0.19

$0.21

$ 0.06

$ (0.28)

Diluted

$0.19

$0.20

$ 0.05

$ (0.28)

Weighted average number of shares outstanding:

Basic

79,202

76,354

78,633

72,381

Diluted

80,144

78,426

80,133

72,381

MENTOR GRAPHICS CORPORATION
RECONCILIATION OF GAAP TO NON-GAAP CONSOLIDATED STATEMENTS
OF OPERATIONS

(In thousands, except earnings per share data-Unaudited)

Three Months Ended December 31, 2005

GAAP

Adjustments

Non-GAAP

Revenues:

System and software

$ 145,837

$ -

$ 145,837

Service and support

75,433

-

75,433

Total revenues

221,270

-

221,270

Cost of revenues:

System and software

5,305

-

5,305

Service and support

21,196

-

21,196

Amortization of purchased technology

3,150

(3,150)

(1)

-

Total cost of revenues

29,651

(3,150)

26,501

Gross margin

191,619

3,150

194,769

Gross margin percentage

86.6%

88.0%

Operating expenses:

Research and development

53,610

-

53,610

Marketing and selling

77,319

-

77,319

General and administration

19,491

-

19,491

Amortization of intangible assets

1,080

(1,080)

(2)

-

Special charges

4,248

(4,248)

(3)

-

Total operating expenses

155,748

(5,328)

150,420

Operating income

35,871

8,478

44,349

Other income, net

6,197

(331)

(4)

5,866

Interest expense

(7,366)

-

(7,366)

Income before income taxes

34,702

8,147

42,849

Income tax expense

19,287

(12,003)

(5)

7,284

Net income

$ 15,415

$ 20,150

$ 35,565

Net income per share:

Basic

$ 0.19

$ 0.45

Diluted

$ 0.19

$ 0.42

Weighted average number of
shares outstanding:

Basic

79,202

79,202

Diluted

80,144

12,070

(6)

92,214

(1) Amortization of purchased technology acquired in 17 separate acquisition transactions, three of which were completed in the twelve months ended December 31, 2005. Purchased technology is amortized over two to five years.
(2) Amortization of other identified intangible assets including trade names, employment agreements and customer relationships acquired in 11 separate acquisition transactions, four of which were completed in the last twelve months. Other identified intangible assets are amortized over two to five years.
(3) Special charges consist of costs incurred related to the discontinuation of a product line in the fourth quarter of 2005. The total costs of this product line discontinuation were $2,290 which include (i) $1,151 of severance benefits, notice pay, and outplacement services related to employee rebalances, (ii) $936 for the abandonment of excess leased facility space, and (iii) $203 for other costs related to the discontinued product line. In addition, special charges include (i) $1,242 incurred for severance benefits, notice pay and outplacement services related to employee rebalances, (ii) $551 for the abandonment of excess leased facilities space in North America, (iii) $165 for other costs incurred to restructure the organization.
(4) Investment earnout payment received related to a sale of stock in 2003.
(5) Non-GAAP income tax expense adjustment is based upon the assumption of a normalized effective rate of 17% on non-GAAP income before income taxes.
(6) Dilutive shares related to the company's convertible debt as required by EITF 04-8. In calculating non-GAAP diluted net income per share, $3,069, representing the after-tax interest and amortization on the company's convertible debt, is added back to non-GAAP net income.

MENTOR GRAPHICS CORPORATION
RECONCILIATION OF GAAP TO NON-GAAP CONSOLIDATED
STATEMENTS OF OPERATIONS
(In thousands, except earnings per share data-Unaudited)

Three Months Ended December 31, 2004

GAAP

Adjustments

Non-GAAP

Revenues:

System and software

$ 140,127

$ -

$ 140,127

Service and support

74,822

-

74,822

Total revenues

214,949

-

214,949

Cost of revenues:

System and software

4,839

-

4,839

Service and support

20,800

-

20,800

Amortization of purchased technology

2,982

(2,982)

(1)

-

Total cost of revenues

28,621

(2,982)

25,639

Gross margin

186,328

2,982

189,310

Gross margin percentage

86.7%

88.1%

Operating expenses:

Research and development

54,594

-

54,594

Marketing and selling

76,126

-

76,126

General and administration

18,825

-

18,825

Amortization of intangible assets

1,098

(1,098)

(2)

-

Special charges

4,843

(4,843)

(3)

-

Merger and acquisition related charges

50

(50)

(4)

-

Total operating expenses

155,536

(5,991)

149,545

Operating income

30,792

8,973

39,765

Other income, net

2,689

(658)

(5)

2,031

Interest expense

(4,838)

-

(4,838)

Income before income taxes

28,643

8,315



36,958

Income tax expense

12,829

(6,546)

(6)

6,283

Net income

$ 15,814

$ 14,861

$ 30,675

Net income per share:

Basic

$ 0.21

$ 0.40

Diluted

$ 0.20

$ 0.38

Weighted average number of shares outstanding:

Basic

76,354

76,354

Diluted

78,426

12,099

(7 )

90,525

(1) Amortization of purchased technology acquired in 13 separate acquisition transactions, five of which were completed in the twelve months ended December 31, 2004. Purchased technology is amortized over two to five years.
(2) Amortization of other identified intangible assets including trade names, employment agreements, customer relationships and deferred compensation acquired in six separate acquisition transactions, three of which were completed in the last twelve months. Other identified intangible assets are amortized over two to five years.
(3) Special charges primarily consist of $3,658 in costs incurred for employee rebalances, which included severance benefits, notice pay and outplacement services, partially offset by a $52 net reversal related to the decision to utilize space that was previously abandoned. In addition, the company incurred $1,237 in costs related to additional funding for a defined benefit pension plan liability the company acquired as a result of an acquisition in 1999.
(4) Merger and acquisition related charges consist of an in-process R&D charge related to the acquisition of VeSys.
(5) Investment earnout and holdback payments received related to a sale of stock in 2003.
(6) Non-GAAP income tax expense adjustment is based upon the assumption of a normalized effective rate of 17% on non-GAAP income before income taxes.
(7) Dilutive shares related to the company's convertible debt as required by EITF 04-8. In calculating non-GAAP diluted net income per share, $3,682, representing the after-tax interest and amortization on the company's convertible debt, is added back to non-GAAP net income.

MENTOR GRAPHICS CORPORATION
RECONCILIATION OF GAAP TO NON-GAAP CONSOLIDATED STATEMENTS
OF OPERATIONS
(In thousands, except earnings per share data-Unaudited)

Twelve Months Ended December 31, 2005

GAAP

Adjustments



Non-GAAP

Revenues:

System and software

$ 410,264

$ -

$ 410,264

Service and support

294,985

-

294,985

Total revenues

705,249

-

705,249

Cost of revenues:

System and software

18,034

-

18,034

Service and support

81,039

-

81,039

Amortization of purchased technology

11,639

(11,639)

(1)

-

Total cost of revenues

110,712

(11,639)

99,073

Gross margin

594,537

11,639

606,176

Gross margin percentage

84.3%

86.0%

Operating expenses:

Research and development

212,676

(4,750)

(2)

207,926

Marketing and selling

274,946

-

274,946

General and administration

76,834

-

76,834

Amortization of intangible assets

4,233

(4,233)

(3)

-

Special charges

6,777

(6,777)

(4)

-

Merger and acquisition related charges

750

(750)

(5)

-

Total operating expenses

576,216

(16,510)

559,706

Operating income

18,321

28,149

46,470

Other income, net

16,798

(1,757)

(6)

15,041

Interest expense

(23,496)

-

(23,496)

Income before income taxes

11,623

26,392

38,015

Income tax expense

7,278

(815)

(7)

6,463

Net loss

$ 4,345

$ 27,207

$ 31,552

Net income per share:

Basic

$ 0.06

$ 0.40

Diluted

$ 0.05

$ 0.39

Weighted average number of shares outstanding:

Basic

78,633

78,633

Diluted

80,133

80,133

(1) Amortization of purchased technology acquired in 17 separate acquisition transactions, three of which were completed in the twelve months ended December 31, 2005. Purchased technology is amortized over two to five years.
(2) A charge of $4,750 for a purchase of technology that had not reached technological feasibility. This technology will be the basis for a new offering in the Calibre product family which is expected to be introduced in 2006.
(3) Amortization of other identified intangible assets including trade names, employment agreements, customer relationships and deferred compensation acquired in 11 separate acquisition transactions, four of which were completed in the last twelve months. Other identified intangible assets are amortized over two to five years.
(4) Special charges consist of costs incurred related to the discontinuation of a product line in the fourth quarter of 2005. The total costs of this product line discontinuation were $2,290 which include (i) $1,151 of severance benefits, notice pay, and outplacement services related to employee rebalances, (ii) $936 for the abandonment of excess leased facility space, and (iii) $203 for other costs related to the discontinued product line. In addition, special charges consist of (i) $4,005 of costs incurred for employee rebalances in other areas of the company, which included severance benefits, notice pay and outplacement services, (ii) $642 for charges for the abandonment of excess leased facilities space in North America, (iii) $390 in other costs incurred to restructure the organization, and (iv) a $550 reversal of previously recorded non-cancellable lease payments related to a facility in North America due to an increase in the expected sublease income.
(5) Merger and acquisition related charges consist of in-process R&D charges related to the acquisitions of Volcano Communications Technologies AB and Aptix Corporation.
(6) Investment earnout payment of $800 received related to a sale of stock in 2003 and a $957 gain on sale of a building in the first quarter of 2005.
(7) Non-GAAP income tax expense adjustment is based upon the assumption of a normalized effective rate of 17% on non-GAAP income before income taxes.

MENTOR GRAPHICS CORPORATION
RECONCILIATION OF GAAP TO NON-GAAP CONSOLIDATED STATEMENTS
OF OPERATIONS

(In thousands, except earnings per share data-Unaudited)

Twelve Months Ended December 31, 2004

GAAP

Adjustments



Non-GAAP

Revenues:

System and software

$ 422,672

$ -

$ 422,672

Service and support

288,284

-

288,284

Total revenues

710,956

-

710,956

Cost of revenues:

System and software

16,639

-

16,639

Service and support

80,294

-

80,294

Amortization of purchased technology

10,624

(10,624)

(1)

-

Total cost of revenues

107,557

(10,624)

96,933

Gross margin

603,399

10,624

614,023

Gross margin percentage

84.9%

86.4%

Operating expenses:

Research and development

202,289

-

202,289

Marketing and selling

267,181

-

267,181

General and administration

74,255

-

74,255

Amortization of intangible assets

3,586

(3,586)

(2)

-

Special charges

9,213

(9,213)

(3)

-

Merger and acquisition related charges

7,700

(7,700) -

(4)

-

Total operating expenses

564,224

(20,499)

543,725

Operating income

39,175

31,123

70,298

Other income, net

8,388

(1,403)

(5)

6,985

Interest expense

(18,619)

-

(18,619)

Income before income taxes

28,944

29,720

58,664

Income tax expense

49,494

(39,521)

(6)

9,973

Net income (loss)

$ (20,550)

$ 69,241

$ 48,691

Net income (loss) per share:

Basic

$ (0.28)

$ 0.67

Diluted

$ (0.28)

$ 0.65

Weighted average number of shares outstanding:

Basic

72,381

72,381

Diluted

72,381

75,397

(1) Amortization of purchased technology acquired in 13 separate acquisition transactions, five of which were completed in the twelve months ended December 31, 2004. Purchased technology is amortized over two to five years.
(2) Amortization of other identified intangible assets including trade names, employment agreements, customer relationships and deferred compensation acquired in seven separate acquisition transactions, three of which were completed in the last twelve months. Other identified intangible assets are amortized over two to five years.
(3) Special charges consist of (i) $1,946 in adjustments primarily related to previously recorded non-cancelable lease payments related to a facility in North America as a result of a reduction in the estimated expected sublease income, (ii) $5,655 in costs incurred for employee rebalances, which included severance benefits, notice pay and outplacement services, and (iii) $1,612 which primarily represents costs related to additional funding for a defined benefit pension plan liability the company acquired as a result of an acquisition in 1999.
(4) Merger and acquisition related charges consist of an in-process R&D charge related to the acquisitions of 0-In, Palmchip, Project Technology and VeSys.
(5) Investment earnout and holdback payments received related to a sale of stock in 2003.
(6) Non-GAAP income tax expense adjustment is based upon the assumption of a normalized effective rate of 17% on non-GAAP income before income taxes.

MENTOR GRAPHICS CORPORATION
RECONCILIATION OF GAAP TO NON-GAAP GUIDANCE
DILUTED NET EARNINGS PER SHARE
(Unaudited)



Q1 2006

2006

Diluted GAAP net earnings per share

$ (0.06)

$ 0.18

Amortization of purchased technology (1)

0.03

0.13

Amortization of intangible assets (2)

0.01

0.05

Estimated impact of stock compensation expense (3)

0.03

0.12

Shares used in calculation of net earnings per share (4)

0.01

-

Income tax adjustment (5)

(0.02)

0.07

Diluted non-GAAP net earnings per share

$0.00

$ 0.55

(1) Excludes amortization of purchased technology acquired in 20 separate acquisition transactions. Purchased technology is amortized over two to five years. The guidance for Q1 2006 and 2006 do not assume any new acquisition transactions.
(2) Excludes amortization of other identified intangible assets including trade names, employment agreements and customer relationships acquired in 11 separate acquisition transactions. Other identified intangible assets are amortized over two to five years. The guidance for Q1 2006 and 2006 do not assume any new acquisition transactions.
(3) Excludes the expense related to stock options and employee stock purchase plans as required with the adoption of FAS 123R, effective Q1 2006.
(4) Shares used in the calculation of diluted GAAP net earnings per share are expected to be the same as shares used in the calculation of diluted non-GAAP earnings per share except when the Company reports a GAAP loss and a non-GAAP income, or GAAP income and a non-GAAP loss. For Q1 2006 guidance, basic shares outstanding are used for diluted GAAP earnings per share and diluted shares outstanding are used for diluted non-GAAP earnings per share.
(5) Non-GAAP income tax expense adjustment is based upon the assumption of a normalized effective rate of 17% on non-GAAP income (loss) before income taxes.



MENTOR GRAPHICS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands - Unaudited)
As of December 31, 2005
As of December 31, 2004 (1)

Assets

Current assets:

Cash, cash equivalents and short-term investments

$ 114,410

$ 94,287

Trade accounts receivable, net

101,593

116,858

Term receivables, short-term

133,273

125,832

Prepaid expenses and other

30,778

28,457

Deferred income taxes

13,127

8,351

Total current assets

393,181

373,785

Property, plant and equipment, net

81,374

91,224

Term receivables, long-term

131,676

139,146

Intangibles, net

381,125

374,144

Other assets

34,631

34,336

Total assets

$ 1,021,987

$ 1,012,635

Liabilities and Stockholders' Equity

Current liabilities:

Short-term borrowings

$ 11,858

$ 9,632

Accounts payable

15,268

18,037

Income taxes payable

38,278

26,027

Accrued payroll and related liabilities

73,405

81,709

Accrued liabilities

29,363

37,098

Deferred revenue

106,453

103,336

Total current liabilities

274,625

275,839

Long-term notes payable

282,188

283,983

Other long-term liabilities

16,825

19,098

Total liabilities

573,638

578,920

Stockholders' equity:

Common stock

381,962

363,455

Deferred compensation

-

(508)

Retained earnings

44,062

39,717

Accumulated other comprehensive income

22,325

31,051

Total stockholders' equity

448,349

433,715

Total liabilities and stockholders' equity

$ 1,021,987

$ 1,012,635

(1) Certain reclassifications have been made for 2004 to conform with the 2005 presentation.

MENTOR GRAPHICS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands - Unaudited)

Three Months Ended
December 31,
Twelve Months Ended
December 31,

2005

2004(1)

2005

2004(1)

Operating Cash Flows:

Net income (loss)

$ 15,415

$ 15,814

$ 4,345

$ (20,550)

Depreciation and amortization

10,941

11,442

44,069

43, 720

Other adjustments to reconcile operating cash

$ (9,915)

$ 18,475

$ (12,349)

$ 52,585

Changes in working capital

1,197

(42,310)

8,191

(35,173)

Net cash provided by operating activities

17,638

3,421

44,256

40,582

Net cash used in investing activities

(7,866)

(10,609)

(55,279)

(60,898)

Net cash provided by (used in) financing activities

5,082

(668)

18,918

19,347

Effect of exchange rate changes on cash and cash equivalents

778

601

(1,158)

552

Net change in cash and cash equivalents

15,632

(7,255)

6,737

(417)

Cash and cash equivalents at beginning of period

59,021

75,171

67,916

68,333

Cash and cash equivalents at end of period, excluding short-term investments

$ 74,653

$ 67,916

$ 74,653

$ 67,916


(1) Certain reclassifications have been made for 2004 to conform with the 2005 presentation.

MENTOR GRAPHICS CORPORATION
SUPPLEMENTAL FINANCIAL AND OTHER INFORMATION

(In thousands, except for days sales outstanding -Unaudited)

Three Months Ended
December 31,
Twelve Months Ended
December 31,

2005

2004

2005

2004

Geographic Revenue:

Americas

$ 100,653

$ 90,336

$ 304,554

$ 306,911

45%

42%

43%

43%

Europe

$ 74,431

$ 64,660

$ 215,047

$ 199,417

34%

30%

31%

28%

Japan

$ 20,227

$ 32,617

$ 99,301

$ 131,107

9%

15%

14%

19%

Pac Rim

$ 25,959

$ 27,336

$ 86,347

$ 73,521

Other Data:

12%

13%

12%

10%

Capital expenditures

$ 8,584

$ 7,590

$ 25,843

$ 24,423

Days sales outstanding

96

102

-

-