Cadence Design Systems, Inc. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 29, 2014; comparable period ended March 30, 2013. Amounts below are in U.S. dollars; financial statement figures are in millions unless noted.
Business context
Cadence develops electronic design automation software, emulation hardware, semiconductor design and verification intellectual property, and related services. It reports as one operating segment. Revenue depends substantially on customers’ new design projects and spending in semiconductor and electronics markets. Management seeks a revenue mix of approximately 90% recurring, while hardware sales are generally recognized upon delivery.
Financial performance and liquidity
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Total revenue | $378.6 | $354.3 | +7% |
| Product and maintenance revenue | $357.4 | $328.3 | +9% |
| Services revenue | $21.2 | $26.0 | -18% |
| Income from operations | $42.3 | $58.1 | -27% |
| Operating margin | 11.2% | 16.4% | -5.2 percentage points |
| Net income | $33.1 | $78.6 | -58% |
| Diluted EPS | $0.11 | $0.27 | -59% |
| Operating cash flow | $28.1 | $75.3 | -$47.2 |
- Product and maintenance costs rose 42% to $42.2 million; related cost was 12% of revenue versus 9% a year earlier. Services cost was 70% of services revenue versus 71%.
- Operating expenses increased 12% to $273.5 million, including research and development of $146.5 million (+18%) and marketing and sales of $98.3 million (+9%). The filing attributes much of the increase to acquired and newly hired employees and higher stock-based compensation.
- Q1 2013 net income benefited from a $33.7 million release of an uncertain tax position and a $5.9 million retroactive research-credit benefit. Q1 2014 had a $5.4 million tax provision. Thus, the earnings decline reflects both lower operating income and the unusually favorable prior-year tax comparison.
- Cash, cash equivalents and short-term investments totaled $629.8 million at March 29, 2014, versus $633.0 million at December 28, 2013. Net working capital was $105.0 million, up $32.1 million. Cash and cash equivalents alone were $532.8 million.
- Investing activities used $34.2 million, including $27.4 million net cash paid for acquisitions. Financing activities used $0.1 million; Cadence repurchased $12.5 million of shares during the quarter. Cash at quarter-end was $532.8 million, down $3.5 million from year-end.
- Debt principal was $350 million under 2.625% convertible notes due June 1, 2015; the carrying value was $329.1 million after unamortized discount. No revolving credit facility borrowings were outstanding; the facility provides $250 million of capacity. Cash, cash equivalents and short-term investments exceeded notes principal by approximately $279.8 million, before considering other obligations and cash location.
Material changes and management commentary
- Revenue growth reflected higher business levels, revenue recognized from prior-period bookings, and contribution from fiscal 2013 acquisitions. Asia revenue rose 28%, while Japan fell 16%; management cited Japanese customer business conditions and expected Japan revenue to be lower in fiscal 2014 than in fiscal 2013.
- Emulation hardware costs rose with higher sales volume, and management reported lower hardware margins amid intensifying competition. It expected lower hardware margins for the remainder of fiscal 2014 than in the comparable 2013 period.
- Operating cash flow fell mainly because of customer-receipt timing, working-capital needs, restructuring payments, and higher net cash taxes. Management expected to pay a further $7.2 million for prior restructuring activities after quarter-end.
- Approximately 83% of cash, cash equivalents and short-term investments were held by foreign subsidiaries; certain foreign earnings are intended to remain permanently reinvested. Management stated that available liquidity, operating cash flows and the credit facility should cover working capital and other needs for at least the next 12 months.
Outlook, transactions and risks
- Management estimated a fiscal 2014 annual effective tax rate of approximately 20%, excluding certain stock-compensation effects, potential acquisitions and other items. Expiration of the federal research tax credit was expected to increase the estimated annual rate by 3 percentage points.
- Management expected operating expenses and acquired-intangible amortization to rise during the remainder of fiscal 2014, reflecting acquisitions and added personnel.
- The $350 million notes became convertible for cash from March 30 through June 28, 2014 after the stock-price conversion condition was met. Holders had not elected conversion as of March 29; management did not anticipate conversion in that window. If converted, principal and accrued interest could become payable earlier than maturity. The note hedge is intended to offset conversion-value payments above principal, but depends on counterparties performing. Warrants with a $10.78 strike may dilute shareholders if the stock price exceeds that level.
- On April 18, 2014, Cadence agreed to acquire Jasper Design Automation for approximately $170 million in cash, subject to conditions including regulatory approval. Jasper had approximately $24 million of cash, cash equivalents and short-term investments at December 31, 2013.
- Other disclosed risks include cyclical customer demand and long sales cycles; technology change and competition; hardware supplier concentration and delivery risk; integration and realization of acquisition benefits; foreign exchange and international operations; customer payment risk; intellectual-property disputes; and market, credit and interest-rate risks. Cadence reported ordinary-course disputes and litigation but provided no clear quantified aggregate exposure.
- Cash-flow sensitivity: a 1 percentage-point rise in market interest rates was estimated to reduce the fair value of marketable debt securities by approximately $0.8 million. The company reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether revenue growth persists and how much is recurring versus hardware or other revenue recognized upon delivery.
- Whether hardware margins, operating expenses and operating cash flow develop in line with management’s expectations.
- The outcome and cash funding of the Jasper acquisition, and whether acquired businesses deliver expected revenue and synergies.
- Whether holders convert the 2015 notes, the company’s ability to fund repayment, and the performance and dilution effects of associated hedges and warrants.
- The actual fiscal 2014 tax rate, particularly the effect of the expired research credit and any changes in foreign earnings or tax positions.
- Japan demand, foreign-currency exposure, concentration of cash held abroad, and the company’s ability to access domestic liquidity if needed.
- Potential developments in litigation, contingent acquisition payments of up to $11.8 million, and remaining restructuring cash payments.