Cadence Design Systems, Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 26, 2020. Unaudited results; amounts below are in millions except per-share data. Cadence provides software, hardware, services and IP used to design electronic systems and semiconductors.
Financial performance
| Metric | Q3 2020 | Q3 2019 | First nine months 2020 | First nine months 2019 |
|---|---|---|---|---|
| Revenue | $666.6 (+15%) | $579.6 | $1,923.0 (+11%) | $1,736.8 |
| Operating income | $169.3 | $120.8 | $460.6 | $382.9 |
| Operating margin | 25.4% | 20.8% | 23.9% | 22.0% |
| Net income | $161.6 | $101.5 | $416.9 | $329.3 |
| Diluted EPS | $0.58 | $0.36 | $1.49 | $1.17 |
| Operating cash flow | Not presented quarterly | Not presented quarterly | $769.4 | $570.3 |
Revenue growth was driven primarily by product and maintenance, including hardware, IP and software; services revenue also increased. Cost of product and maintenance rose 55% in Q3, mainly with increased hardware deliveries and inventory reserves. Calculated gross margin was approximately 87.7% in Q3 versus 89.5% a year earlier, reflecting the higher hardware-related cost mix. Management cited lower travel, events and professional-services costs related to COVID-19, partly offset by higher headcount and R&D investment.
Cash flow and liquidity: Nine-month investing cash use was $261.3, including $197.6 for acquisitions and $63.7 for property and equipment. Financing provided $85.9, including $350.0 of revolving-credit borrowings, offset in part by $250.0 of share repurchases and employee tax withholding payments. Cash and equivalents were $1,306.6 at quarter-end, up from $705.2 at fiscal year-end 2019; net working capital was $618.6.
Debt: Total debt carrying value was $696.6, comprising $350.0 outstanding under the revolving credit facility and $346.6 on the 2024 Notes. The revolver rate was 1.50%; the notes carry a 4.375% coupon and mature in October 2024. Cadence reported compliance with debt covenants.
Material changes and notable items
- Revenue rose 15% in Q3 and 11% year to date. China revenue increased 96% in Q3 and 48% year to date; management attributed this to higher-than-expected hardware and IP activity.
- AWR and Integrand were acquired in Q1 for approximately $195.6 net cash consideration. Cadence recorded $101.3 of acquired definite-lived intangibles and $119.4 of goodwill. Management said the acquisitions were expected to add more expense than revenue through the remainder of fiscal 2020.
- Cash from operations increased by $199.1 year to date, primarily due to timing of customer receipts and vendor payments; deferred revenue increased to $561.6 from $428.9 at year-end 2019.
- Debt increased after the company drew the full $350.0 available under its revolver in Q1 as a precautionary COVID-19 liquidity measure. Cash exceeded debt by approximately $610.0 at quarter-end, using reported cash and debt carrying value.
- Q3 income tax provision was $4.1 versus $15.2 a year earlier. Results included an approximately $19.0 discrete tax benefit from a partial release of a California R&D tax-credit valuation allowance. The company also reported tax benefits from vested or exercised stock awards.
- The board added $750 of share-repurchase authorization in July. Approximately $869 remained available at quarter-end; nine-month repurchases cost $250.0.
Outlook, commentary and risks
- Cadence expected its fiscal 2020 effective tax rate to be approximately 9%. It did not provide a specific revenue or earnings forecast in the supplied filing text.
- Management said 85%–90% of annual revenue is typically recurring. Contracted but unsatisfied performance obligations were approximately $3.8 billion; excluding non-cancellable IP Access Agreement commitments, about 55% was expected to be recognized over the next 12 months.
- Management expected elevated China hardware and IP activity to continue into the middle of Q4 2020, while warning that U.S. Entity List and other trade restrictions limit service and delivery to certain customers and may further affect China business.
- The company expected existing cash and operating cash flows to cover working capital and other liquidity requirements for at least 12 months. Approximately 38% of cash was held by foreign subsidiaries.
- COVID-19 created uncertainty around customer demand, collections, hardware delivery and installation, employee operations, and access to customer and laboratory sites. The company had reduced revenue for certain contracts where customers requested payment delays and expected collectible amounts were uncertain.
- Other risks include hardware and IP delivery timing, reliance on limited hardware suppliers, semiconductor-industry cyclicality, foreign-exchange and interest-rate movements, acquisition integration, competition, and litigation. The revolver expires January 2022 and has variable-rate exposure.
Investor facts to verify
- Whether China’s exceptional hardware and IP demand is sustainable, and the financial effect of export restrictions and Entity List limitations.
- How much of the $3.8 billion performance-obligation balance converts to revenue, and the timing and collectability of customer payments.
- Hardware mix, inventory reserves and delivery/install delays, which affected product costs and reported gross margin.
- Acquisition contribution to revenue and expenses, integration progress, and future employee-related contingent payments.
- Cash availability by jurisdiction, debt repayment capacity, and variable-rate exposure under the revolver.
- The extent to which the Q3 tax benefit and stock-based compensation tax benefits affect comparability of reported earnings and the expected full-year tax rate.