CDNS

Cadence Design Systems, Inc. - 10-Q Summary

Business Context and Reporting Period

This Quarterly Report on Form 10-Q covers the period ended June 28, 2008. Cadence Design Systems, Inc. develops electronic design automation (EDA) software and hardware, licensing software, selling hardware, and providing maintenance and design services to IC manufacturers and electronics systems companies. The company operates as a single reporting unit.

Key Financial Metrics

Note: Debt consists of $250M 2011 Convertible Notes, $250M 2013 Convertible Notes, and $230.4M 2023 Convertible Notes.

Material Changes vs. Prior Period

• Revenue Decline: Total revenue decreased 16% year-over-year for the quarter and 18% for the six-month period. Product revenue dropped significantly (26% for the quarter, 30% for six months) due to a challenging economic environment, longer sales cycles, and a shift in license mix toward subscription models which defer revenue recognition.
• Profitability Shift: While the company reported a net income of $5.0 million for the quarter, it reported a net loss of $13.8 million for the six months ended June 28, 2008, compared to net income of $104.0 million in the prior year period. Operating income turned negative for the six-month period ($(7.6) million) from a positive $120.6 million previously.
• Expense Management: Operating expenses decreased 7% for the quarter and 4% for the six months, driven by reductions in salary, stock-based compensation, and travel costs, partially offset by increased facility costs.
• Investment Write-downs: The company recorded an $8.3 million write-down of investment securities (including a $5.4 million other-than-temporary impairment) during the six-month period.

Guidance, Outlook, and Risks

• Outlook: Management forecasts lower business levels for the remainder of 2008 due to the slowing macroeconomic environment and a strategic shift to a license mix that provides customers greater flexibility but results in increased ratable (deferred) revenue. The company expects to recognize a net loss for fiscal 2008.
• Proposed Acquisition: On May 2, 2008, Cadence proposed to acquire Mentor Graphics Corporation for approximately $1.6 billion. The offer was initially rejected but publicly announced in June 2008. Cadence expects to borrow in excess of $1.0 billion to finance the transaction if successful, though there are no assurances of completion.
• Liquidity and Debt: Holders of the Zero Coupon Zero Yield Senior Convertible Notes Due 2023 may require Cadence to repurchase the notes on August 15, 2008, for 100.25% of the principal amount. Cadence expects to use approximately $231.0 million to repurchase these notes if all holders elect to surrender them.
• Tax Contingency: The IRS has proposed an aggregate tax deficiency of approximately $318.0 million for tax years 2000-2002. Cadence is vigorously challenging these adjustments, which relate to transfer pricing and foreign trade income deductions.
• Accounting Changes: New accounting standards (FSP APB 14-1) effective in fiscal 2009 will require the recognition of additional non-cash interest expense related to convertible notes, which will adversely affect operating results and financial ratios.

Investor Verification Checklist

• 2023 Notes Repurchase: Verify the final amount of the 2023 Notes repurchased on August 15, 2008, and its impact on cash reserves.
• Mentor Graphics Acquisition: Monitor the status of the proposed $1.6 billion acquisition of Mentor Graphics and the availability of financing.
• Revenue Mix: Assess the long-term impact of the shift from perpetual/term licenses to subscription licenses on future revenue recognition and cash flow.
• IRS Dispute: Track the resolution of the $318 million proposed tax deficiency and potential interest accruals.
• Investment Portfolio: Review the valuation and impairment status of the company's equity investment portfolio given market volatility.