Cadence Design Systems, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Financial statements are unaudited. Comparisons are with the three and nine months ended October 1, 2016. Amounts below are in U.S. dollars; financial amounts are in millions unless stated otherwise.
Business context
Cadence provides electronic-design automation software, hardware, services and reusable design IP. It reports as one operating segment. Management attributed growth primarily to software and IP, particularly in Asia, partly offset by lower emulation and prototyping hardware revenue. Approximately 90% of revenue is recognized over time.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $485.4 | $446.2 | $1,441.3 | $1,347.1 |
| Operating income | $80.4 | $66.8 | $242.7 | $191.8 |
| Operating margin | 16.6% | 15.0% | 16.8% | 14.2% |
| Net income | $81.2 | $64.7 | $218.5 | $164.6 |
| Diluted EPS | $0.29 | $0.23 | $0.78 | $0.56 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $343.9 | $248.0 |
Q3 revenue increased 9%; product and maintenance revenue rose 9% to $451.2 million and services revenue rose 11% to $34.2 million. For the nine months, product and maintenance grew 8% to $1,346.5 million, while services declined 5% to $94.8 million. Gross margin, calculated from reported revenue less product and services costs, was approximately 88.8% in Q3 and 87.7% for the nine-month period, compared with 87.3% and 86.6%, respectively, in the prior-year periods.
Cash and cash equivalents plus short-term investments were $682.4 million at September 30, 2017, up from $468.3 million at December 31, 2016. Net working capital was $411.0 million, versus $116.5 million. Nine-month investing cash flow was negative $30.7 million and financing cash flow was negative $109.5 million. The filing attributes improved operating cash flow primarily to customer-receipt and vendor-payment timing and improved profitability.
Debt carrying value was $644.1 million, representing $650 million principal: a $300 million term loan due January 2019 and $350 million of 4.375% notes due October 2024. The revolving credit facility had no borrowings at quarter-end; its stated capacity was $350 million, with potential increases subject to lender commitments. Cadence reported compliance with debt covenants.
Material changes and unusual items
- Nine-month revenue increased 7%, operating income 27% and net income 33% year over year. Diluted weighted-average shares fell to 279.6 million from 295.4 million.
- R&D expense increased 8% in Q3 and 8% for the nine months; management cited hiring, acquisitions and higher stock-based compensation. Total nine-month stock-based compensation was $94.0 million.
- Q3 other income, net, was $12.4 million and included a $9.1 million gain on the sale of a non-marketable investment. The nine-month income tax rate was 8.2%, including $28.0 million in tax benefits related to vested or exercised stock awards.
- Cadence repurchased $50.0 million of shares during the nine months, with $475.0 million remaining under its $525.0 million authorization at September 30. The 2016 restructuring plans generated $2.8 million in credits during the nine months; remaining restructuring liabilities were $3.7 million.
Outlook, risks and contingencies
- Management estimated an approximately 11% effective tax rate for fiscal 2017, excluding certain items it said could not be reliably anticipated. It expected R&D expense and stock-based compensation to increase during the remainder of fiscal 2017 compared with fiscal 2016.
- Management expected existing liquidity, operating cash flows and available revolver capacity to meet working-capital and other requirements, including acquisitions and repurchases, for at least the next 12 months.
- Cadence expected Topic 606 adoption in Q1 2018 using the cumulative catch-up method. Management anticipated a small retained-earnings adjustment for some opening backlog and slightly lower 2018 revenue than under the prior standard; it expected the revenue mix to remain approximately 90% recognized over time. Estimates and contract-specific effects remained under evaluation.
- The company cited risks from semiconductor-industry cycles and customer design spending, technology changes and competition, hardware delivery and sole-supplier dependencies, foreign exchange, customer concentration or payment delays, cybersecurity, and substantial debt. Approximately 73% of cash, cash equivalents and short-term investments were held by foreign subsidiaries, which could make U.S. funding or repatriation more complex.
- Tax examinations were ongoing in Germany, India, Israel and South Korea; the timing and outcome were uncertain. Ordinary-course litigation and other contingencies were disclosed, but the filing did not provide a clear aggregate loss estimate. Management said disclosure controls were effective and reported no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether software and IP growth continues to offset lower emulation and prototyping hardware revenue, and whether services revenue stabilizes.
- How operating cash flow and working capital evolve, including the effect of customer collections and vendor-payment timing.
- The location and accessibility of cash, the $300 million term-loan maturity in 2019, and compliance with debt covenants and repurchase restrictions.
- The actual effects of Topic 606 adoption on opening retained earnings, backlog and reported revenue, and subsequent tax-rate outcomes.
- Developments in tax examinations, foreign-exchange exposure, supplier and hardware-delivery risks, and any material litigation or contingency updates.