Cadence Design Systems, Inc. — Q3 2015 Form 10-Q
Business and period: Cadence develops electronic design automation software, emulation hardware, intellectual property and related services for semiconductor and electronics customers. This unaudited report covers the three and nine months ended October 3, 2015, compared with the periods ended September 27, 2014. Dollar figures below are in millions unless stated otherwise.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $433.8 | $400.5 | $1,261.0 | $1,157.8 |
| Operating income | $77.9 | $54.0 | $203.6 | $131.9 |
| Operating margin | 18.0% | 13.5% | 16.1% | 11.4% |
| Net income | $77.6 | $37.5 | $172.0 | $93.9 |
| Diluted EPS | $0.25 | $0.12 | $0.55 | $0.31 |
| Operating cash flow | Not separately reported for the quarter | $255.3 | $184.7 |
Revenue increased 8% in Q3 and 9% year to date. Product and maintenance revenue rose 6% and 7%, respectively; services revenue rose 40% and 33%. Management attributed growth principally to increased business levels and demand for services and IP. Gross margin, calculated from reported revenue and product, maintenance and services costs, was approximately 85.0% in Q3 (86.5% prior year) and 85.9% year to date (85.7% prior year).
Financial position and liquidity
- Cash, cash equivalents and short-term investments were $711.2 at October 3, down from $1,022.6 at January 3, 2015. Cash and cash equivalents were $616.1.
- Net working capital was $532.4, up from $458.6 at fiscal year-end. Current assets were $1,042.1 and current liabilities $509.6.
- Debt carried at $348.8, representing $350.0 principal of 4.375% senior notes due 2024. The $350.0 principal amount of 2.625% convertible notes due 2015 was settled or repaid during the period; the related hedge proceeds offset the additional conversion payments.
- No borrowings were outstanding under the $250.0 revolving credit facility (with potential capacity up to $400.0 subject to lender commitments); Cadence reported compliance with its financial covenants.
- Operating cash flow was $255.3. Investing activities used $34.5, while financing activities used $518.5, including $213.1 of share repurchases and payments related to the 2015 notes. Cash decreased by $316.1 over the nine-month period.
Changes, outlook and notable items
- Operating income and net income rose substantially year over year, with lower restructuring charges and higher revenue contributing to the improvement. Research and development expense increased 6% for the nine months as Cadence continued investing in product development and technical sales support.
- Q3 income taxes included a $13.8 benefit from settling a foreign subsidiary tax examination and releasing valuation allowance on tax credits. The company estimated a fiscal 2015 effective tax rate of approximately 10%; actual rates may vary.
- A 2015 restructuring plan generated $4.1 of charges for the nine months, primarily severance. Cash payments are expected to continue through Q4 fiscal 2016.
- Cadence said available liquidity, operating cash flows and borrowing capacity should cover working capital and other needs, including potential acquisitions and repurchases, for at least the next 12 months. It expected to execute its repurchase plan through fiscal 2016; timing and amounts may change.
- Management seeks a revenue mix of approximately 90% recurring, but reported no specific revenue or earnings guidance. Revenue timing can vary, particularly with emulation hardware deliveries and IP arrangements.
- Approximately 66% of cash, cash equivalents and short-term investments were held by foreign subsidiaries. Repatriating indefinitely reinvested foreign earnings could result in additional taxes. Japan revenue declined amid difficult customer conditions and yen depreciation; foreign exchange also affected results.
- Remaining 2015 warrants could dilute shareholders through December 2015. At October 3, 31.2 million warrants remained outstanding, with net share settlement dependent on the stock price relative to the $10.78 strike price.
- Key stated risks include uncertainty in semiconductor and electronics markets, customer project and spending decisions, competition and technology shifts, hardware supplier concentration, foreign exchange, customer concentration and payment risk, cybersecurity, litigation and debt obligations. The filing identifies ordinary-course legal matters but provides no clear quantified exposure. Management reported disclosure controls were effective and no material quarterly change in internal control over financial reporting.
Investor verification points
- Track whether revenue growth and services/IP demand persist, and how hardware deliveries affect revenue timing and margins.
- Assess the sustainability of cash generation and liquidity after the 2015 note settlement, substantial repurchases and planned repurchases.
- Monitor remaining warrant settlements and resulting share dilution, along with diluted EPS.
- Check the fiscal 2015 effective tax rate against management’s approximately 10% estimate and evaluate the one-time tax settlement benefit.
- Review foreign cash availability and potential repatriation taxes, Japan and broader currency exposure, and compliance with debt covenants.
- Monitor semiconductor customer spending, supply-chain execution for emulation hardware, and material developments in litigation or other contingencies.