Cadence Design Systems, Inc. — Q3 2014 Form 10-Q
Business context and period. Unaudited results for the three and nine months ended September 27, 2014, compared with the periods ended September 28, 2013. Cadence develops electronic design automation software, emulation hardware, design and verification IP, maintenance, and engineering services for semiconductor and electronics customers. Revenue depends substantially on customers’ new design projects.
Financial results and liquidity
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $400.5 million | $366.6 million | $1,157.8 million | $1,083.4 million |
| Operating income | $54.0 million | $47.9 million | $131.9 million | $151.2 million |
| Net income | $37.5 million | $38.5 million | $93.9 million | $126.5 million |
| Diluted EPS | $0.12 | $0.13 | $0.31 | $0.43 |
| Operating cash flow | Not separately stated | Not separately stated | $184.7 million | $248.4 million |
- Q3 revenue grew 9%; product and maintenance revenue rose 10% to $374.1 million, while services revenue increased 5% to $26.4 million. Nine-month revenue grew 7%, with product and maintenance up 8% and services down 5%.
- Operating margin was approximately 13.5% in Q3 versus 13.1% a year earlier; nine-month operating margin was approximately 11.4% versus 14.0%. Net margin was approximately 9.4% and 10.5% for Q3, and 8.1% and 11.7% for the respective nine-month periods.
- Nine-month cash from operations fell $63.7 million, primarily reflecting changes in operating assets and liabilities, timing of customer receipts, working capital, restructuring and retirement-program payments, and higher net tax payments. Capital spending was $28.0 million.
- At September 27, cash and cash equivalents were $500.5 million and short-term investments $95.0 million, totaling $595.5 million. Net working capital was $55.6 million, down from $72.9 million at December 28, 2013. Approximately 68% of cash, cash equivalents and short-term investments was held by foreign subsidiaries.
- Debt included $350.0 million principal of 2.625% convertible notes due June 1, 2015, carried at $337.7 million net of discount. No revolver borrowings were outstanding; the amended facility provides $250 million of capacity, with possible increases subject to lender commitments. The notes’ hedge asset and embedded derivative liability were each valued at $452.5 million and designed to offset in fair-value changes.
Changes, outlook and notable items
- Higher product and maintenance revenue reflected stronger business levels, revenue recognized from prior bookings and acquisition contributions. Asia revenue increased 23% in both Q3 and the nine-month period; Japan revenue declined 6% in Q3 and 11% year to date. Management expected Japan revenue for fiscal 2014 to be below fiscal 2013.
- Operating costs increased with emulation hardware volume, acquisition-related intangible amortization, hiring, compensation and stock-based compensation. Q3 included $11.0 million of restructuring and other charges, including severance and asset impairment; the nine-month total was $11.4 million. A voluntary early retirement program generated $9.7 million of expense year to date.
- Management expected fiscal 2014 gross margins on emulation hardware to be lower than fiscal 2013 because of increased competition; amortization and total operating expenses were also expected to rise for the rest of fiscal 2014, partly offset by restructuring savings. Management estimated a fiscal 2014 effective tax rate of approximately 18%; the expired federal research tax credit was estimated to increase the annual rate by 3 percentage points.
- Management said existing liquidity, operating cash flows, proceeds from the 2024 notes and revolver availability should cover working capital, capital needs and 2015-note maturity or conversion for at least 12 months. It did not anticipate significant early conversions, although the 2015 notes were convertible into cash from September 28, 2014 through January 3, 2015; conversion could require up to $350 million plus accrued interest. Related hedges are intended to limit additional conversion-value cash exposure, while warrants may dilute shareholders if the stock price exceeds $10.78.
- On October 9, 2014, after quarter-end, Cadence issued $350 million of 4.375% senior notes due 2024, receiving estimated net proceeds of $342.4 million. Management expected interest expense to rise following the issuance. The credit facility was amended in September, including removal of security and extension to September 2019.
- Cadence acquired Jasper Design Automation in June for $139.5 million of cash consideration after specified adjustments, and completed two other acquisitions for $27.5 million cash consideration after acquired cash. Purchase allocations remained subject to measurement-period adjustments. A customer represented approximately 15% of receivables at quarter-end; no customer represented 10% or more of revenue.
- Principal risks include semiconductor-industry cyclicality and uncertain customer design spending; competition and hardware margin pressure; sole-source hardware-component supply; foreign exchange and international operations; acquisition integration; product and technology execution; litigation and IP claims; and leverage, note-conversion, covenant and liquidity risks. Cadence reported no significant warranty or indemnification losses in the periods presented. Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether revenue growth and customer bookings persist, particularly given Japan’s weakness and the reliance on new customer design projects.
- Whether operating profitability and cash generation recover as revenue grows, including the effects of hardware competition, acquisition amortization, restructuring and working-capital movements.
- The amount and timing of any 2015-note conversions or repayment, and the performance and counterparty exposure of the associated hedges and warrants.
- Use of the 2024-note proceeds, resulting interest burden and compliance with credit-facility covenants.
- Integration and final purchase accounting for Jasper and other acquisitions, including expected benefits, contingent employee payments and any further restructuring costs.
- Tax-rate assumptions, foreign-cash availability and exposure to foreign exchange, customer concentration, litigation and other contingencies; the filing does not quantify a specific material legal loss.