Cadence Design Systems, Inc. — Q2 2011 Form 10-Q
Reporting period: Fiscal quarter and six months ended July 2, 2011; comparisons are to periods ended July 3, 2010. Amounts below are in millions, except per-share data and percentages.
Business context
Cadence develops electronic-design-automation software, hardware and design intellectual property, and provides maintenance and engineering services. Demand is tied to customers’ new design projects and investment in semiconductor and electronics products. The company reports as one operating segment.
Financial performance and liquidity
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Revenue | $283.3 | $227.1 | $549.4 | $449.0 |
| Operating income (loss) | $25.0 | $5.2 | $42.5 | $(0.1) |
| Net income | $26.9 | $48.6 | $33.2 | $36.8 |
| Diluted EPS | $0.10 | $0.18 | $0.12 | $0.14 |
| Operating cash flow | Six-month figure: $125.8 | Prior-year six-month figure: $95.7 |
- Q2 revenue rose 24.8% year over year; six-month revenue rose 22.4%. Product revenue was the largest contributor to growth, increasing to $157.9 million for Q2 from $117.1 million.
- Approximate gross margin was 81.8% in Q2 2011 versus 82.8% in Q2 2010; approximate operating margin improved to 8.8% from 2.3%. Six-month operating margin was approximately 7.7%, versus approximately breakeven a year earlier.
- Q2 net income fell despite higher operating income, principally because Q2 2010 included a $54.5 million income-tax benefit, largely associated with a $66.7 million release of deferred-tax valuation allowance related to the Denali acquisition. Q2 2011 included a $4.3 million tax benefit.
- Other income was $8.4 million in Q2 and $12.9 million for six months, including an $8.0 million gain on marketable securities sales; six-month other income also included a $2.7 million gain on an equity-method investment sale.
- Cash and short-term investments totaled $668.6 million at July 2, 2011, up $98.5 million from January 1. Net working capital was negative $19.1 million, down $201.0 million, primarily because the 2015 Notes became convertible and were classified as current; the related hedge asset and derivative liability each increased current balances by $222.1 million.
- Six-month investing cash use was $22.4 million, including $11.3 million of property and equipment purchases and $22.9 million paid for acquisitions, net of cash acquired. Financing cash flow provided $1.1 million. Management expected cash, short-term investments and operating cash flows to cover needs for at least 12 months.
- Outstanding debt principal was approximately $644.7 million: $350.0 million of 2015 Notes, $150.0 million of 2011 Notes, $144.5 million of 2013 Notes and $0.2 million of 2023 Notes. The $150.0 million 2011 Notes mature December 15, 2011.
Material changes and management commentary
- Management attributed revenue growth to renewal timing, more revenue recognized from prior bookings amid a shift toward ratable licenses and shorter average contract duration, increased hardware sales and leases, and the Denali acquisition. Services revenue also benefited from customer cash collections and higher staff utilization.
- More than 90% of bookings in both current and comparable periods were of a recurring, ratable-revenue type. Management’s stated target mix was approximately 90% ratable bookings and 10% upfront revenue.
- Cadence adopted new revenue-recognition standards prospectively in fiscal 2011 for arrangements involving hardware and software. Under the prior standards, Q2 revenue would have been $3.1 million higher and six-month revenue $2.1 million lower than reported.
- Higher hardware sales contributed to a sharp increase in product costs: Q2 cost of product rose to $20.1 million from $7.1 million. Management expected hardware revenue and costs to remain above historical levels for the rest of fiscal 2011, but to decline from the levels experienced in the reported quarter and half-year.
- Management described semiconductor-industry growth and expected EDA spending to be modest for the remainder of 2011. The filing does not provide a specific revenue or earnings forecast; management estimated a fiscal 2011 effective tax rate of approximately 10%, subject to sensitivity in its estimates.
Risks, contingencies and unusual items
- The 2015 Notes met a stock-price conversion trigger and were convertible for cash at holders’ option from July 2 through October 1, 2011. Conversion could require cash payment of up to the $350.0 million principal; management did not anticipate conversion during that window but stated it had sufficient liquidity. The conversion status would be reassessed at quarter-end October 1.
- The $38.0 million securities-litigation settlement was subject to court approval. Cadence paid $16.4 million into the settlement fund; insurers paid the remaining $15.5 million after quarter-end. A separate derivative-litigation settlement, including approximately $1.8 million in attorneys’ fees expected to be insurer-funded, was also subject to court approval.
- Restructuring accruals were $7.5 million, including $6.7 million of estimated lease losses. Lease-loss estimates could rise to $10.0 million and depend on rental rates and subleasing. Cadence had paid $83.1 million for 2008–2010 restructuring activities and expected another $3.5 million of payments.
- Acquisition-related contingent payments could total up to $27.2 million over the next 58 months if performance conditions are met; up to $19.8 million could be expensed. A 2011 acquisition added $14.2 million of goodwill and $13.2 million of intangible assets.
- The IRS effectively settled disputed 2003–2005 tax positions, but the IRS was examining 2006–2009 returns. Additional tax assessments could materially affect future results or cash flows.
- Key business risks include cyclicality and modest expected industry growth, customer renewal and payment risk, long sales cycles, competition and technology change, foreign-exchange exposure, reliance on a sole supplier for certain hardware components, acquisition integration, litigation and substantial debt. Management reported disclosure controls were effective and no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether holders converted the 2015 Notes during the July 2–October 1, 2011 window, and the resulting cash and liquidity impact.
- Repayment or refinancing of the $150.0 million 2011 Notes due December 15, 2011.
- Whether the litigation settlements received court approval and whether insurer payments covered the expected amounts.
- Whether revenue growth, bookings mix and customer renewals continued, particularly as hardware revenue and costs were expected to decline from Q2 levels.
- Actual tax rate and any developments in the IRS examination of 2006–2009 returns.
- Collections and credit quality of receivables, restructuring lease-loss estimates, and any acquisition-related contingent payments.