Cadence Design Systems, Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 28, 2019; comparative periods ended September 29, 2018. Cadence provides software, hardware, services and design IP for electronic systems and semiconductor development. Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions where shown.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $579.6M | $532.5M | $1,736.8M | $1,568.2M |
| Operating income | $120.8M | $103.6M | $382.9M | $282.5M |
| Net income | $101.5M | $99.3M | $329.3M | $247.4M |
| Diluted EPS | $0.36 | $0.35 | $1.17 | $0.88 |
| Operating margin, approximately | 20.8% | 19.5% | 22.0% | 18.0% |
- Q3 revenue rose 9% year over year; product and maintenance revenue increased 11% to $548.1M, while services revenue fell 16% to $31.5M. Nine-month revenue rose 11%.
- Q3 operating income grew 17%; nine-month operating income grew 36%. Q3 net income grew only 2%, alongside a higher income-tax provision of $15.2M versus $0.2M a year earlier. Nine-month effective tax rate was 11.8%, versus 7.6%.
- Research and development expense was $240.5M in Q3 and $700.6M for nine months; marketing and sales expense was $121.4M and $354.4M, respectively. Management cited hiring and continued investment in R&D and technical sales support.
- Nine-month operating cash flow was $570.3M, up from $472.9M. Investing used $78.6M and financing used $357.0M. Cash increased by $121.9M from year-end to $655.2M.
- At September 28, cash and cash equivalents were $655.2M; current assets were $1,049.9M and current liabilities $619.0M. Net working capital was $431.0M. About 58% of cash was held by foreign subsidiaries.
- Debt carrying value was $345.8M, consisting of $350.0M principal of 4.375% senior notes due 2024; no revolving-credit borrowings were outstanding. The $350M revolving facility expires in January 2022, and the company reported compliance with its covenants.
Material changes and operating context
- Management attributed revenue growth to customer investment in complex designs, including machine learning, 5G, aerospace and defense, automotive and cloud data-center applications, with growth across geographies. IP revenue increased, primarily from Tensilica IP.
- China revenue increased year over year, but U.S. Department of Commerce Entity List restrictions prevented support or maintenance for certain customers. Management expected China revenue in the second half of fiscal 2019 to be lower than in the first half.
- The company repurchased $231.1M of stock during the first nine months of 2019; $444M remained under the February 2019 $500M authorization.
- Deferred revenue was $392.1M. Contracted but unsatisfied performance obligations were approximately $3.0B, including $212.1M of non-cancellable IP Access Agreement commitments; the company expected to recognize about 60% of the other contracted obligations over the next 12 months.
- Adoption of the new lease standard added approximately $80M of lease assets and liabilities at adoption. At quarter-end, operating lease liabilities were $118.2M.
Outlook, risks and unusual items
- Management expected 85%–90% of fiscal 2019 revenue to come from arrangements characterized as recurring. It also expected marketing and sales and R&D expenses to increase during the remainder of fiscal 2019, primarily due to hiring and compensation.
- Management stated that cash, operating cash generation and available revolver capacity were expected to meet working-capital and other capital and liquidity needs, including acquisitions and repurchases, for at least the next 12 months.
- In October 2019, Cadence began an internal realignment of its international operating structure that may significantly increase foreign deferred tax assets. The analysis was incomplete, and the financial impact was not yet estimable; the company expected to record the impact in Q4 2019.
- Key risks include semiconductor and electronics-industry cyclicality, customer design-spending uncertainty, export restrictions and Entity List exposure, competition and technology shifts, foreign-exchange and tax-rate variability, and dependence on hardware suppliers. International revenue represented approximately 59% of nine-month revenue.
- Ordinary-course litigation and other contingencies were disclosed, but the filing did not provide a clear quantified potential loss. No significant warranty or IP-indemnification losses were reported for the periods presented. Prior restructuring estimates generated a $1.2M credit in the first nine months.
Important facts for investors to verify
- Whether Entity List restrictions or broader U.S.-China trade measures further affect China sales, customer support and collections.
- Whether revenue growth and the large remaining-performance-obligation balance convert to recognized revenue as expected, including the impact of hardware and IP delivery timing.
- The Q4 accounting and tax impact of the international operating-structure realignment.
- Whether rising R&D and sales investment supports growth without eroding margins, and how the effective tax rate evolves after unusually favorable stock-compensation tax benefits.
- Cash location and accessibility, ongoing repurchase pace, and compliance with debt covenants as capital needs and business conditions change.