Cadence Design Systems, Inc. — Q2 2010 Form 10-Q
Business context and reporting period. The unaudited quarter ended July 3, 2010; comparable periods ended July 4, 2009. Cadence develops electronic design automation software and hardware, and provides maintenance and engineering services. Results are affected by customers’ design-project spending, contract-renewal timing, license mix and payment terms.
Financial performance and liquidity
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Revenue | $227.1M | $209.9M | $449.0M | $416.2M |
| Operating income (loss) | $5.2M | $(53.8)M | $(0.1)M | $(102.2)M |
| Net income (loss) | $48.6M | $(74.4)M | $36.8M | $(137.6)M |
| Diluted EPS | $0.18 | $(0.29) | $0.14 | $(0.54) |
- Revenue and margins: Q2 revenue rose 8.2% year over year. Product revenue increased to $117.1M and maintenance to $84.7M; services declined to $25.3M. Calculated gross margin was approximately 82.8% and operating margin approximately 2.3% in Q2. For the first six months, gross margin was approximately 82.7%; operating margin was approximately breakeven.
- Profit quality: Q2 net income included a $54.5M income-tax benefit. The filing attributes this chiefly to a $66.7M release of deferred-tax valuation allowance following Denali acquisition accounting; this release did not increase cash. Q2 had a $5.9M pretax loss.
- Cash flow: Six-month operating cash flow was $95.7M, versus $3.0M a year earlier. Investing used $265.6M, mainly including $254.0M net cash paid for acquisitions; financing provided $76.5M. Cash and equivalents declined $93.5M to $475.6M.
- Liquidity: Cash, equivalents and short-term investments totaled $478.5M at July 3. Net working capital was $321.0M, down $131.8M from January 2. Management expected existing liquidity and operating cash flows to meet requirements for at least 12 months.
- Debt: Outstanding convertible-note principal was approximately $650.2M: $350M of 2.625% cash-convertible notes due 2015, and $150M each of 1.375% notes due 2011 and 1.500% notes due 2013, plus $0.2M of 2023 notes. Carrying value of convertible notes on the balance sheet was $541.8M. The company issued the 2015 notes and used proceeds in part to repurchase $200M principal of older notes and buy back 6.5M shares for $40M. It forecast about $20.9M interest expense for the remainder of fiscal 2010.
Changes, outlook and key risks
- Improved year-over-year results reflected higher revenue, reduced operating costs and lower bad-debt expense. Q2 G&A fell to $17.1M from $34.2M; the company cited a $10.2M reserve release from collections and a $20.6M year-over-year decrease in bad-debt expense. Management expected G&A to rise in the second half, as it did not expect similar reserve releases.
- Cadence acquired Denali Software in June for $296.8M cash, adding design IP and system-on-chip verification capabilities. It expected Denali to add more cost than revenue during the rest of 2010; R&D and acquired-intangible amortization were expected to increase. Up to $12.6M of deferred Denali payments depend on specified employee-retention conditions.
- Approximately 90% of executed-order value was ratable in both the current and comparison periods. Management said semiconductor industry growth was projected to be moderate in 2010, while EDA spending could grow more slowly. No specific full-year revenue or earnings guidance was provided.
- Tax uncertainty is material: the IRS proposed deficiencies of approximately $318M for 2000–2002 and $60.7M for 2003–2005; Cadence disputes the assessments and was pursuing appeals. The IRS was also examining 2006–2008 returns. Timing and ultimate amounts remain uncertain.
- Shareholder securities and derivative lawsuits were stayed for mediation planned for August 2010. Management said it could not predict outcomes but did not believe current matters would materially adversely affect financial position, liquidity or results.
- Other stated risks include cyclical customer demand, customer payment delays or defaults, long and late-quarter sales cycles, competitive and technology changes, acquisition integration, currency exposure, debt-service obligations and potentially material tax outcomes. The filing reported effective disclosure controls and no material quarter-over-quarter change in internal control over financial reporting.
Important facts for investors to verify
- How much of reported earnings depends on the non-cash $66.7M valuation-allowance release, and how results perform excluding that benefit.
- Whether operating cash generation persists as acquisition spending, customer collections and deferred-revenue balances change.
- Denali’s post-acquisition revenue contribution, integration costs and the realization of expected strategic benefits.
- Debt maturities, interest expense, conversion and hedge/warrant terms, and the potential effect of the notes on cash needs and share dilution.
- Developments in IRS examinations and shareholder litigation, including any changes to estimated exposure or required payments.