CADENCE DESIGN SYSTEMS INC annual report, FY2014

Cadence Design Systems, Inc. — FY 2014 Form 10-K

Reporting period: Fiscal year ended January 3, 2015 (53 weeks; FY 2013 had 52 weeks). The filing also reports fourth-quarter results. Cadence develops electronic design automation software, emulation and prototyping hardware, design and verification IP, maintenance, and engineering services for semiconductor and electronics customers.

Financial performance

Metric	FY 2014	FY 2013	Change
Revenue	$1,580.9 million	$1,460.1 million	+8%
Operating income	$206.6 million	$189.0 million	+9%
Operating margin	13.1%	12.9%	+0.2 percentage points
Net income	$158.9 million	$164.2 million	-3%
Diluted EPS	$0.52	$0.56	-7%
Cash from operations	$316.7 million	$367.6 million	-$50.9 million

Product and maintenance revenue increased 9% to $1,479.2 million; services revenue was essentially flat at $101.8 million. Approximately 90% of revenue was recurring in nature.
Approximate gross margin was 85.9%, versus 86.3% in FY 2013. Product and maintenance costs rose 18%, partly reflecting lower emulation-hardware margins, inventory reserves, and higher amortization of acquired intangibles.
Research and development expense increased 13% to $603.0 million; total operating expenses rose 8% to $1,116.3 million.
Fourth-quarter revenue was $423.1 million, net income $65.0 million, and diluted EPS $0.21, versus $376.7 million, $37.7 million, and $0.13 in fourth-quarter FY 2013. The extra fiscal week contributed approximately $15 million of FY 2014 revenue, recognized in Q4.
Cash, cash equivalents, and short-term investments totaled $1,022.6 million at year-end, up from $633.0 million. Net working capital was $458.6 million, versus $72.9 million.
Outstanding debt had approximately $700 million principal value ($691.2 million carrying value): $350 million of 2.625% convertible notes due June 2015 and $350 million of 4.375% senior notes due October 2024. The $250 million revolving facility was undrawn; capacity could increase to $400 million subject to lender commitments.

Material changes and notable items

Revenue growth reflected higher business levels, acquisitions, and the additional fiscal week. Asia revenue grew 25%; Japan revenue fell 12%, primarily due to yen depreciation and difficult customer conditions.
Operating income improved, but net income declined. FY 2014 included a 12.2% effective tax rate and an $8.1 million research-credit tax benefit; FY 2013 had tax benefits that make the year-over-year net-income comparison less representative of underlying operations.
Operating cash flow fell mainly because of customer-receipt timing, working-capital needs, restructuring and early-retirement payments, and higher net cash taxes. Investing used $198.0 million, including $167.1 million for acquisitions; financing provided $289.0 million, substantially reflecting the 2024 notes issuance.
Cadence issued the $350 million 2024 notes and amended its revolving credit facility. It repurchased $100.1 million of shares in FY 2014. No cash dividends have been paid, and the company does not plan to pay them in the foreseeable future.
Acquisitions included Jasper Design Automation; acquisition activity increased goodwill and acquired intangible assets. Expected amortization of acquired intangibles rises to approximately $64.2 million in FY 2015.

Outlook, risks, and contingencies

The filing gives no specific FY 2015 revenue or earnings guidance. Management expects operating expenses to increase, citing hiring and a full year of costs for personnel added in FY 2014; it also expects the FY 2015 effective tax rate to exceed FY 2014’s.
Management expected approximately $1.2 billion, or about 70% of FY 2015 revenue, to come from arrangements already in backlog at year-end. Total backlog was approximately $2.1 billion, versus $1.9 billion a year earlier. Backlog is not a guarantee of revenue or timing.
Management expected available cash, operating cash flow, 2024-note proceeds, and revolver access to cover operating needs and obligations, including the 2015 notes, for at least 12 months. Approximately 45% of cash and investments was held outside the United States; repatriating indefinitely reinvested foreign earnings could trigger additional taxes.
Approximately $53.9 million principal value of 2015 notes had been tendered for conversion by February 19, 2015. The notes mature in June 2015; associated hedges are intended to offset conversion value above principal, while warrants with a $10.78 strike could dilute shareholders as they expire in 2015.
Key risks include semiconductor-industry cyclicality and dependence on customers’ new design projects; intense competition and technology change; sole-source hardware components; foreign-exchange exposure; acquisition integration; cybersecurity and IP litigation; and substantial debt and restrictive covenants. Ordinary-course legal matters are disclosed, but the filing does not provide a clear quantified aggregate exposure.
Restructuring charges were $10.3 million in FY 2014, and a voluntary early-retirement program generated approximately $9.7 million of operating expense. No significant off-balance-sheet arrangements were reported. Management and the auditor reported effective internal controls; the auditor issued an unqualified opinion on the financial statements.

Important facts for investors to verify

Whether recurring bookings, backlog conversion, and customer demand support FY 2015 growth, and how much of reported growth reflects the extra week or acquisitions.
The cash requirement and final settlement of the June 2015 convertible notes, hedge-counterparty performance, and resulting warrant dilution.
Cash available for U.S. obligations after considering the foreign-held balance, repatriation taxes, debt service, and share repurchases.
Whether emulation-hardware margins stabilize and whether acquisition integration and acquired-intangible amortization meet expectations.
The effect of the expected higher FY 2015 tax rate and increased operating expenses on earnings and cash generation.