Cadence Design Systems, Inc. — Q2 2014 Form 10-Q
Business context and period: Cadence supplies electronic design automation software, emulation hardware, design and verification IP, maintenance, and engineering services. This unaudited report covers the quarter and six months ended June 28, 2014; comparisons are to the periods ended June 29, 2013. Results are not necessarily indicative of full-year performance.
Financial performance
Amounts below are in millions of dollars except per-share data and percentages.
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | $378.8 | $362.5 | $757.3 | $716.7 |
| Operating income | $35.5 | $45.1 | $77.8 | $103.3 |
| Net income | $23.3 | $9.4 | $56.3 | $88.0 |
| Diluted EPS | $0.08 | $0.03 | $0.19 | $0.30 |
| Operating margin | 9.4% | 12.5% | 10.3% | 14.4% |
| Net margin | 6.1% | 2.6% | 7.4% | 12.3% |
| Operating cash flow | — | $97.0 | $150.2 |
Q2 product and maintenance revenue rose 5% to $354.5 million; services revenue was nearly flat at $24.3 million. For the first half, product and maintenance revenue increased 7% to $711.8 million while services revenue declined 10% to $45.5 million. Reported operating margins above are calculated from filing figures.
- First-half operating cash flow declined $53.2 million year over year, which management attributed mainly to customer receipt timing, working-capital needs, restructuring payments, and higher net cash taxes.
- Cash and cash equivalents were $557.4 million; short-term investments were $97.9 million, for combined liquidity of $655.3 million, up from $633.0 million at year-end. Investing cash use was $180.5 million, including $163.7 million for acquisitions; financing provided $100.0 million.
- Net working capital fell to $6.7 million from $72.9 million, largely reflecting the new $100 million revolver borrowing and classification of the convertible notes as current.
- Debt principal totaled $450 million: $350 million of 2.625% convertible notes due June 1, 2015 and $100 million drawn on a $250 million revolving facility. The notes’ carrying value was $333.3 million, net of discount. Cadence reported compliance with credit-facility covenants.
Material changes and unusual items
- Revenue increased 4% in Q2 and 6% in the first half, primarily due to higher business levels, revenue recognized from prior-period bookings, and acquisitions. Asia revenue grew 19% in Q2 and 23% for the half; Japan revenue fell 11% and 14%, respectively.
- Operating income declined despite revenue growth: first-half operating expenses rose 9%, including increased research and development spending, employee costs, stock-based compensation, acquisition-related amortization, and a voluntary early-retirement program. The program generated approximately $9.3 million of operating expense in Q2 and the first half.
- Q2 net income improved year over year partly because the prior-year quarter included a higher tax provision. First-half 2013 tax results included a $33.7 million benefit from releasing an uncertain tax position and a $5.9 million benefit from retroactive enactment of a federal research credit; these items make the year-over-year first-half earnings comparison less comparable.
- Cadence acquired Jasper Design Automation on June 13, 2014, for stated cash consideration of $139.5 million after specified adjustments and cash held at closing. The acquisition added formal-analysis technology; purchase-price allocation remained preliminary. Two other first-half acquisitions involved $27.5 million of cash consideration after acquired cash.
Outlook, risks and contingencies
- Management estimated a fiscal 2014 effective tax rate of approximately 19%, excluding certain items it could not anticipate. It expected the expired federal research credit to increase the estimated annual rate by 3%.
- Management expected lower Japan revenue in fiscal 2014 than in fiscal 2013, lower emulation-hardware gross margins due to competition, and higher operating expenses and acquired-intangible amortization during the remainder of fiscal 2014. It also expected U.S. cash, cash equivalents, and short-term investments to remain above $150 million for the rest of the fiscal year.
- Management said existing liquidity, operating cash generation, and available revolver capacity should meet working-capital and other requirements, including acquisitions and repurchases, for at least 12 months. Approximately 84% of cash, equivalents, and short-term investments were held by foreign subsidiaries; repatriation of permanently reinvested earnings could trigger additional taxes.
- The 2015 notes were convertible for June 29–September 27, 2014 following satisfaction of a stock-price condition. A conversion could require cash payment of up to $350 million plus accrued interest; the related hedges are intended to offset conversion-value payments above principal. Warrants may dilute shareholders if the stock price exceeds $10.78. Management did not anticipate significant early conversions.
- Cadence spent $25.0 million repurchasing shares in the first half and said it expected to repurchase up to $100 million in fiscal 2014. The filing also describes acquisition-related contingent payments of up to $11.8 million over 22 months and expected post-quarter restructuring and retirement-program payments.
- The FASB’s new revenue-recognition standard was scheduled to become effective for Cadence in fiscal 2017; the company was evaluating its impact. Key risks include semiconductor-industry cyclicality, customer design spending and payment timing, competition and pricing, hardware supplier concentration, acquisition integration, foreign exchange, and intellectual-property disputes. The filing describes ordinary-course litigation but provides no clear quantified exposure for specific matters.
Important facts for investors to verify
- Whether the 2015 notes convert, and how the cash settlement and hedge counterparties affect liquidity.
- Whether operating cash flow recovers from the first-half decline and how much reflects timing versus underlying changes.
- Whether Japan weakness and emulation-hardware competition continue to pressure revenue and gross margins.
- Whether Jasper and other acquisitions deliver expected benefits, and whether preliminary purchase accounting or contingent payments change.
- Whether the estimated 19% tax rate, foreign cash availability, and repurchase plans remain consistent with reported results and liquidity.