CADENCE DESIGN SYSTEMS INC quarterly report, Q1 FY2011

Cadence Design Systems, Inc. — Q1 2011 Form 10-Q

Business context and period. Cadence develops electronic design automation software, hardware and design intellectual property, and provides maintenance and engineering services. This unaudited quarter covered the three months ended April 2, 2011; comparisons are with the three months ended April 3, 2010.

Financial results and liquidity

Metric	Q1 2011	Q1 2010	Change
Revenue	$266.1 million	$221.9 million	+$44.2 million; about 20%
Operating income (loss)	$17.5 million	$(5.3) million	Improved
Net income (loss)	$6.3 million	$(11.8) million	Improved
Diluted earnings (loss) per share	$0.02	$(0.04)	Improved
Cash from operating activities	$56.4 million	$46.7 million	+$9.7 million

Revenue comprised product $141.8 million, services $27.8 million and maintenance $96.5 million. Product revenue grew $39.0 million year over year; services and maintenance also increased.
Calculated operating margin was approximately 6.6%, compared with approximately negative 2.4% in Q1 2010. Calculated gross margin, based on reported revenue less product, services and maintenance costs, was approximately 83.0%, versus 82.6%.
Cash and cash equivalents were $612.2 million and short-term investments $10.9 million at April 2. Together, these totaled $623.1 million, up $53.0 million from January 1. Net working capital was $249.0 million, up $67.1 million.
Investing activities used $4.2 million; financing activities provided $3.4 million. Cash and cash equivalents increased $54.8 million during the quarter to $612.2 million.
Outstanding debt had $644.7 million principal: $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 and are expected to be repaid in cash.

Material changes versus the prior period

Revenue growth reflected contract-renewal timing, revenue from prior bookings as the company shifted toward ratable licenses, higher hardware sales, and the 2010 Denali acquisition.
Cadence adopted new revenue-recognition standards prospectively in fiscal 2011 for arrangements containing hardware and software. For arrangements entered into from January 2, 2011, the company said revenue would have been $5.2 million lower under the prior rules.
Operating expenses increased $12.0 million, mainly from higher employee-related costs and Denali-related research and development. Research and development rose $11.9 million; marketing and sales rose $3.6 million; general and administrative expense fell $3.5 million.
Interest expense increased $3.6 million to $11.0 million, primarily because of the 2015 notes issued in June 2010. Other income, net declined to $4.5 million from $6.0 million, including gains from investment sales of $2.6 million in 2011 versus $4.5 million in 2010.

Outlook, risks and unusual items

Management expected modest semiconductor-industry growth for the remainder of 2011 and believed EDA spending might also grow modestly. It gave no specific revenue or earnings guidance in the provided filing text.
Management expected existing cash, short-term investments and operating cash flows to meet working-capital, capital and liquidity needs for at least the next 12 months. It estimated a fiscal 2011 annual effective tax rate of approximately 27%, subject to uncertainty and tax settlements.
Approximately 90% of bookings in both comparison quarters were of a recurring or ratable nature. Cadence said its ongoing license mix and modest customer-spending growth could make significant revenue increases difficult.
The company disclosed a disputed IRS proposed tax deficiency of $60.7 million for tax years 2003–2005; the matter remained under appeal, and the IRS was examining 2006–2009 returns. Cadence said the ultimate outcome and possible payment range could not be estimated clearly.
Restructuring accruals totaled $8.5 million at April 2, including severance and estimated lease losses; lease losses could reach $8.7 million. Cadence expected substantially all 2010-plan termination benefits to be paid by fiscal year-end and cautioned that estimates and anticipated savings could change.
Cadence reported settlements of securities and derivative litigation subject to documentation and court approval. The filing describes a $38.0 million securities settlement, with about $22.2 million expected from insurers, and elsewhere describes total settlement costs of $40.0 million, with $24.2 million expected from insurers and $15.8 million from Cadence. The differing totals reflect the filing’s separate descriptions; verify the final approved amounts and allocation.
After quarter-end, Cadence sold securities for approximately $8.0 million net proceeds and expected to recognize an approximately $8.0 million gain in Q2 2011. It had recorded $8.4 million of related unrealized gains in accumulated other comprehensive income at quarter-end.
Key risks include cyclical semiconductor and electronics markets, customer concentration and payment risk, lengthy sales cycles, technology and competitive pressures, foreign-exchange exposure, reliance on a sole supplier for certain hardware components, tax uncertainty, and substantial convertible-note obligations. The 2015 notes were not convertible as of April 2, but management noted the stock price had recently been near or above the conversion trigger.

Most important facts for investors to verify

How much of the reported revenue increase came from the new revenue-recognition standards, hardware sales, Denali and renewal timing; the company quantified the accounting-standard effect as $5.2 million versus prior rules.
Whether revenue growth and operating profitability persist given the ratable-license mix, modest EDA-spending outlook and higher R&D spending.
Final court-approved litigation settlement amounts, insurer contributions and Cadence’s cash obligation.
Developments in the IRS dispute and examinations, restructuring estimates, and any associated cash or earnings effects.
Cash availability for the $150.0 million 2011-note maturity and the potential liquidity and working-capital effects if other convertible notes become convertible.