Cadence Design Systems, Inc. — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended October 1, 2011; comparisons are with periods ended October 2, 2010. Financial statements are unaudited. Cadence develops electronic-design-automation software, hardware and design IP, with maintenance and engineering services.
Key financial results
Amounts below are in millions, except per-share data. Fiscal Q3 and nine-month periods are shown against the comparable 2010 periods.
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $292.5 | $237.9 | $841.8 | $686.9 |
| Operating income (loss) | $32.2 | $(3.1) | $74.7 | $(3.2) |
| Operating margin | 11.0% | (1.3%) | 8.9% | (0.5%) |
| Net income | $28.1 | $126.8 | $61.3 | $163.6 |
| Diluted EPS | $0.10 | $0.48 | $0.23 | $0.62 |
| Cash from operations | — | — | $178.2 | $142.1 |
- Revenue mix: Q3 product revenue was $164.0 million, services $29.1 million and maintenance $99.4 million. Nine-month amounts were $463.7 million, $86.4 million and $291.7 million, respectively.
- Margins and expenses: Gross margin was approximately 83.0% in Q3 and 82.6% for the nine months, versus 83.3% and 82.9% in 2010. Operating expenses were $207.1 million in Q3 and $607.7 million for nine months; R&D was $103.2 million and $303.7 million, respectively.
- Cash and liquidity: Cash and cash equivalents were $696.1 million at October 1, with $3.0 million of short-term investments; combined liquidity was $699.1 million, up $129.0 million from January 1. Net working capital was $308.9 million, up $127.0 million.
- Cash flows: Nine-month investing cash outflow was $48.0 million, including $44.1 million net cash paid for acquisitions and $17.7 million of capital expenditures. Financing provided $7.1 million. Cash increased $138.7 million to $696.1 million.
- Debt: Convertible-note principal totaled approximately $644.7 million; net carrying liability was approximately $569.5 million. The $150.0 million principal of the 2011 Notes matures December 15, 2011. The $350.0 million 2015 Notes bear 2.625% stated interest and mature in June 2015.
- Other financial items: Q3 and nine-month 2011 net income included other income of $7.2 million and $20.1 million, respectively, including gains on investment sales. The 2010 comparisons benefited from unusually large tax benefits of $143.2 million in Q3 and $192.7 million for nine months, primarily from IRS settlements and deferred-tax valuation-allowance releases.
Material changes versus 2010
- Revenue increased 22.9% in Q3 and 22.5% for nine months. Management attributed growth to revenue from prior bookings amid a shift toward ratable licenses and shorter average contract duration, higher hardware sales and leases, and the Denali acquisition.
- Operating results improved from losses to profits, while net income declined because 2010 included exceptional tax benefits. In 2011, the tax provision was $0.5 million for Q3 and $0.9 million for nine months.
- Operating cash flow rose $36.1 million for nine months. Management attributed the increase principally to changes in operating assets and liabilities, which more than offset lower net income after noncash items.
- Cash used for investing fell substantially from 2010, chiefly because 2010 included the Denali acquisition. Cadence acquired businesses in 2011 for a combined purchase price of $49.3 million.
- Cadence adopted new revenue-recognition standards prospectively in fiscal 2011 for arrangements with hardware and software elements. For affected 2011 arrangements, reported revenue was $9.0 million higher for Q3 and $11.1 million higher year to date than it would have been under the prior standards.
Outlook, risks and contingencies
- Management outlook: Management expected semiconductor-industry revenue in 2011 to be similar to 2010 and described customers as cautious, while anticipating that EDA spending might grow modestly. It estimated a fiscal 2011 effective tax rate of approximately 8% and said cash, investments and operating cash flow should meet liquidity needs for at least the next 12 months.
- Debt and liquidity risks: Cadence expected to pay the 2011 Notes at maturity with cash on hand. If the $9.81 stock-price conversion condition for the 2015 Notes is met in a future quarter, the notes may be classified as current; a conversion could adversely affect liquidity. The 2015 Notes were not convertible as of October 1. Approximately 60% of cash and investments were held by foreign subsidiaries, with certain foreign earnings intended to remain permanently reinvested.
- Business risks: Results depend on customers’ design-project activity and spending, which management linked to a cautious semiconductor and electronics environment. Other disclosed risks include long sales cycles, license-renewal and product-competitiveness risks, customer payment delays, foreign-exchange exposure, reliance on a sole supplier for certain hardware components, and competition and acquisition-integration risks.
- Legal matters: A securities class-action settlement totaled $38.0 million, including $22.2 million from insurers; Cadence had paid its $15.8 million settlement share plus interest into the fund. Court approval remained pending. A separate derivative-litigation settlement included proposed attorneys’ fees of approximately $1.8 million, expected to be covered by insurers if approved.
- Acquisition and restructuring commitments: Potential contingent payments tied to prior acquisitions could total up to $30.7 million over 55 months if performance conditions are met. Restructuring accruals were $5.6 million; estimated maximum lease losses could reach $8.3 million.
- Tax matters: The IRS was examining federal returns for 2006–2009. Cadence said unrecognized tax benefits related to that examination could decrease by $20–$30 million if a resolution were reached; timing and outcome were uncertain.
- Unusual accounting and investment items: The 2015 Notes embedded conversion derivative and related hedge asset were each valued at $179.7 million. They were designed to have similar fair values, so their fair-value changes had no net income effect in the periods presented. Goodwill impairment testing found no impairment.
- Controls: Management concluded disclosure controls were effective as of October 1, 2011; no material change in internal control over financial reporting was reported for the quarter.
Important facts for investors to verify
- Whether Cadence funded the $150.0 million 2011 Notes maturity and how subsequent debt maturities affect liquidity.
- Whether the 2015 Notes conversion condition was met in a later quarter, and the associated cash, classification and dilution implications of the notes, hedges and warrants.
- How revenue growth and operating performance develop apart from the timing effects of ratable licensing, hardware sales and the new revenue-recognition rules.
- The status and final costs of the securities and derivative litigation settlements, including court approval and insurance coverage.
- The outcome of the IRS examination, the estimated annual tax rate, and whether foreign cash can be accessed without additional tax cost.
- Whether semiconductor and customer spending, collections, acquisition-related contingent payments and restructuring costs track management’s expectations.