CADENCE DESIGN SYSTEMS INC quarterly report, Q1 FY2016

Cadence Design Systems, Inc. — Q1 2016 Form 10-Q

Reporting period: Three months ended April 2, 2016; comparable period ended April 4, 2015. Cadence develops electronic design automation software, emulation and prototyping hardware, intellectual property, maintenance and engineering services. Amounts below are in U.S. dollars.

Financial performance and liquidity

Metric	Q1 2016	Q1 2015	Change
Revenue	$447.9 million	$411.4 million	+9%
Operating income	$58.0 million	$49.3 million	+18%
Net income	$50.6 million	$36.3 million	+40%
Diluted EPS	$0.17	$0.12	Up $0.05
Cash from operations	$83.2 million	$46.7 million	+$36.5 million

Product and maintenance revenue was $411.7 million, up 7%; services revenue was $36.1 million, up 30%. Management attributed growth primarily to increased business levels; services also benefited from revenue recognized upon completion of a customer contract.
Gross profit was approximately $385.8 million, or 86.1% of revenue, compared with approximately $350.8 million, or 85.3%, in the prior-year quarter. Operating margin was 13.0%, versus 12.0%; net margin was 11.3%, versus 8.8%.
Research and development expense rose 10% to $179.9 million, reflecting continued investment. A new restructuring plan added $14.4 million of charges, primarily severance, compared with $4.4 million of restructuring and other charges in Q1 2015.
Interest expense declined to $5.4 million from $11.8 million, primarily reflecting the absence of costs associated with the 2015 Notes in the prior-year period.
At April 2, cash and cash equivalents were $810.4 million and short-term investments were $96.3 million. Net working capital was $584.3 million. Cash, cash equivalents and short-term investments exceeded reported debt carrying value by approximately $213.9 million.
Total debt carrying value was $692.9 million: $300 million principal under a new term loan, $350 million principal of 2024 Notes, and $50 million drawn on the revolving facility. The filing reports compliance with debt covenants. Approximately 55% of cash, cash equivalents and short-term investments was held by foreign subsidiaries.
Cash used in investing activities was $13.9 million, including $12.1 million of property and equipment purchases. Financing provided $118.4 million, including $350 million of term-loan and revolver proceeds, partly offset by $240 million of share repurchases.

Material changes and unusual items

Cadence borrowed $300 million under a three-year term loan and drew $50 million on its revolving facility during the quarter. The term-loan proceeds were for general corporate purposes, including share repurchases.
The company repurchased 11.6 million shares for $240 million, versus 2.0 million shares for $36.8 million in Q1 2015. Approximately $719.9 million remained authorized at quarter-end.
Cadence early adopted new stock-based compensation accounting guidance. It recorded an approximately $7.8 million reduction to opening accumulated deficit and recognized stock-award tax effects in income tax expense.
The Q1 effective tax rate was 12.0%, compared with 14.3%. The quarter included stated tax benefits relating to vested or settled stock awards and tax-credit valuation allowances, partly offset by a non-U.S. tax-audit settlement. Management estimated an approximately 18% annual effective tax rate for fiscal 2016, excluding specified uncertain items.
On April 8, 2016, after quarter-end, Cadence agreed to acquire Rocketick Technologies, a developer of multicore parallel simulation software. Closing was subject to conditions, including regulatory approval. A trust benefiting the CEO’s children held less than 2% of Rocketick; the CEO recused himself from the board’s valuation and transaction deliberations, and a financial advisor provided a fairness opinion.

Outlook, risks and contingencies

Management expected existing liquidity, operating cash generation and revolver availability to meet working-capital and other liquidity needs, including acquisitions and repurchases, for at least the next 12 months. It expected to execute the repurchase program through fiscal 2016, subject to business, market and other conditions; the program may be changed or discontinued.
Management described customer spending and bookings as sensitive to global economic conditions and semiconductor and electronics industry cycles. Revenue timing can vary with hardware and IP deliveries; much software revenue is recognized over time. The filing provides no specific revenue or earnings guidance.
Key disclosed risks include technology change and competition, customer project delays or consolidation, hardware supplier concentration and delivery disruption, foreign-exchange and interest-rate exposure, tax uncertainty, acquisition integration, cybersecurity, intellectual-property claims and substantial indebtedness. Variable-rate borrowings expose the company to higher interest expense.
Cadence described ordinary-course litigation and indemnification matters but did not provide a clear quantified estimate of potential losses. It reported no significant warranty or indemnification losses in the periods presented.
Management concluded disclosure controls were effective as of April 2, 2016; it reported no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

Whether product, maintenance and services demand—and especially hardware and IP delivery timing—supports continued revenue growth.
How continued R&D investment, stock-based compensation and restructuring costs affect operating margins and cash generation.
Debt levels, variable-rate exposure, covenant headroom and the use of debt and cash to fund buybacks or acquisitions.
The annual tax-rate outlook and the effects of stock-award tax accounting, tax audits and foreign earnings policies.
Rocketick acquisition terms, completion conditions, related-party safeguards and any subsequent financial impact.
Potential effects of industry cyclicality, customer concentration, foreign exchange, suppliers, litigation and other disclosed risks.