Cadence Design Systems, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended July 1, 2017; comparisons are with the periods ended July 2, 2016. Amounts below are in millions of dollars except per-share data.
Business context and results
Cadence provides software, hardware, services and design IP that help customers develop electronic systems and integrated circuits. It reports as one operating segment. Management attributed growth mainly to software and IP, particularly in Asia, while noting lower emulation and prototyping hardware revenue.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $479.0 | $453.0 | $955.9 | $900.9 |
| Operating income | $82.7 | $66.9 | $162.3 | $124.9 |
| Net income | $69.1 | $49.3 | $137.4 | $99.9 |
| Diluted EPS | $0.25 | $0.17 | $0.49 | $0.33 |
| Operating margin | 17.3% | 14.8% | 17.0% | 13.9% |
Revenue increased 6% in both comparisons. Product and maintenance revenue rose 6% for the quarter and 8% year to date; six-month services revenue declined 12%, primarily because the prior-year period included revenue recognized upon completion of a customer contract. Derived gross margin was approximately 87.3% for Q2 and 87.2% year to date, versus 86.4% and 86.3%, respectively, in the comparable periods. Lower income-tax provisions contributed to net income growth: effective tax rates were 10.6% for Q2 and 9.3% year to date, compared with 22.7% and 17.6%.
Cash flow, balance sheet and debt
- Six-month operating cash flow was $254.6, up from $163.6; management cited improved profitability and the timing of customer receipts and vendor payments. Capital expenditures were $27.5; operating cash flow less capital expenditures was approximately $227.1.
- Cash, cash equivalents and short-term investments totaled $659.2 at July 1, up from $468.3 at December 31, 2016. Net working capital was $338.7, compared with $116.5.
- Debt carrying value was $643.9, comprising the $300.0 term loan due in 2019 and $350.0 of 4.375% notes due in 2024. No revolving-facility borrowings remained at quarter-end, after a $100.0 repayment during the first half. Cadence reported compliance with debt covenants.
- Approximately 65% of cash and short-term investments were held by foreign subsidiaries. The company said available liquidity, operating cash flow and revolving-credit capacity should meet needs for at least 12 months.
Changes, outlook and risks
- Asia revenue increased 18% in Q2 and 21% for the first half; U.S. revenue was nearly flat for Q2 and down 1% year to date.
- Research and development expense rose 7% in Q2 and 9% year to date as the company continued product investment. Management expected R&D expense and stock-based compensation to increase during the remainder of fiscal 2017.
- Management estimated a fiscal 2017 effective tax rate of approximately 12%, excluding stock-compensation tax effects, potential acquisitions and other items not reliably anticipated. This is an estimate, not revenue or earnings guidance.
- Cadence expected to adopt the new revenue standard in Q1 2018 using the cumulative catch-up method. It anticipated a slightly lower share of revenue recognized over time and a small portion of year-end backlog adjusted to retained earnings; contract-level effects remained under assessment. The new lease standard was expected to materially affect the balance sheet.
- The January 2017 authorization to repurchase up to $525.0 of shares remained entirely unused at July 1. The filing reports no cash-funded repurchases in the first half.
- Restructuring and other charges included a $2.8 credit in the first half from revised estimates under the 2016 plans; remaining restructuring liabilities were $6.7.
- Risks include cyclical semiconductor and electronics demand, competition and pricing pressure, product delivery and supplier dependencies, foreign-exchange exposure, tax examinations and the company’s debt obligations. Tax authorities were examining Cadence in Germany, India, Israel and South Korea; potential outcomes and amounts were not clearly quantified. Ordinary-course litigation and other contingencies were disclosed without a clear aggregate loss estimate.
Investor verification priorities
- Track software and IP growth, hardware deliveries, and the sustainability of Asia-led revenue gains.
- Assess the causes and durability of higher operating margins, including R&D investment, stock-based compensation and the unusually low effective tax rate.
- Review the fiscal 2017 tax-rate estimate and outcomes of tax examinations, including any liquidity impact from required deposits or repatriation.
- Monitor the revenue-standard transition, especially changes to timing of revenue recognition, backlog and retained earnings.
- Evaluate debt service, covenant headroom, foreign-held cash accessibility and any future use of the share-repurchase authorization.