Cadence Design Systems, Inc. — Q3 2013 Form 10-Q
Business context and period. Cadence develops electronic design automation software, intellectual property (IP), hardware, maintenance and engineering services. This unaudited filing covers the three and nine months ended September 28, 2013; comparisons are with the periods ended September 29, 2012. Amounts below are in U.S. dollars.
Financial results and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | $366.6m | $338.5m | $1,083.4m | $980.8m |
| Operating income | $47.9m | $59.4m | $151.2m | $155.4m |
| Net income | $38.5m | $58.6m | $126.5m | $126.1m |
| Diluted EPS | $0.13 | $0.21 | $0.43 | $0.45 |
| Operating margin | 13.1% | 17.6% | 14.0% | 15.8% |
| Gross margin* | 86.4% | 84.9% | 87.0% | 85.0% |
Revenue mix and drivers. Product and maintenance revenue rose 10% to $341.6m in Q3 and 13% to $1,007.9m year to date. Services revenue declined 12% to $25.0m in Q3 and 13% to $75.5m year to date, primarily as design-services engineers were redeployed to internal R&D and presales. Management attributed product and maintenance growth to higher business levels, revenue from prior-period bookings and acquisitions. No customer represented 10% or more of revenue.
Cash flow and liquidity. Nine-month operating cash flow was $248.4m, versus $220.1m. Investing activities used $417.1m, including $392.8m net cash paid for acquisitions; financing activities provided $77.4m. Cash and cash equivalents were $620.4m, and short-term investments were $96.0m, totaling $716.4m at September 28, down from $827.1m at year-end 2012. Net working capital was negative $23.5m, compared with positive $174.0m at year-end, mainly reflecting acquisition spending, $50.0m of net revolver borrowing and current classification of convertible notes.
Debt. Principal debt was $544.6m; carrying value was $513.8m. This included $144.5m principal of 1.5% convertible notes due December 15, 2013, $350.0m of 2.625% notes due June 2015, and $50.0m drawn on a $250.0m revolving facility. The 2013 notes mature in December. The 2015 notes were convertible for the following quarter under their stock-price condition; holders could require up to $350m cash principal payment if they converted. Management said it did not anticipate conversion and expected available cash, operating cash flow and revolver capacity to cover obligations. The company reported compliance with revolver covenants and $200m of undrawn capacity.
Material changes and unusual items
- Revenue grew, but operating income fell 19% in Q3 and 3% year to date as operating expenses rose 18% and 16%, respectively. Higher employee costs from acquisitions, hiring and variable compensation contributed; R&D increased 20% in Q3 and 19% year to date.
- Q3 net income fell 34% year over year. Year-to-date net income was nearly flat despite revenue growth. The nine-month tax provision included a $33.7m benefit from releasing a prior-business-combination uncertain tax position and related interest and penalties, plus a $5.9m research-credit benefit. Management estimated a fiscal 2013 effective tax rate of approximately 7%.
- Cadence acquired Tensilica in April and Cosmic Circuits in May 2013, and completed other smaller transactions. The acquisitions increased goodwill and acquired intangibles; management expected acquisition-related increases in operating expenses to exceed incremental revenue for the remainder of fiscal 2013, partly because acquired deferred revenue was adjusted to fair value.
- Japan revenue declined 22% in Q3 and 14% year to date; management expected lower Japan revenue for the remainder of fiscal 2013 versus the comparable 2012 period. Foreign-exchange movements, particularly in the yen, may affect reported results.
- Foreign-currency translation reduced nine-month comprehensive income by $23.3m. The filing reports no significant warranty or indemnification losses and describes ordinary-course legal matters without a clear quantified exposure.
Outlook, risks and controls
Management expected revenue from operations, existing liquidity and available revolver capacity to meet working-capital and other capital needs for at least the next 12 months, including the 2013 notes maturity. It expected operating expenses, R&D costs, acquired-intangible amortization and product-and-maintenance costs to rise during the remainder of fiscal 2013, principally due to acquisitions and hiring. These are management expectations, not quantified revenue or earnings guidance.
Key risks include cyclicality and uncertain spending in semiconductor and electronics markets; rapid technology change and competitive pressure; dependence on customer design-project starts and hardware delivery timing; sole-source hardware components; acquisition integration and contingent payments; foreign-exchange exposure; customer concentration in receivables; and debt conversion, maturity and covenant risks. Approximately 55% of cash, cash equivalents and short-term investments were held by foreign subsidiaries, with some earnings intended to remain permanently reinvested. Management concluded disclosure controls were effective as of September 28, 2013; no material change in internal control over financial reporting was reported for the quarter.
Investor verification points
- Track cash generation and liquidity after the December 2013 notes maturity and assess any conversion of the 2015 notes, including the possible cash principal requirement.
- Assess whether acquisition-driven revenue growth offsets rising operating expenses, amortization and integration costs.
- Monitor Japan demand, customer design activity, bookings mix and hardware deliveries, which affect revenue timing.
- Review the sustainability of the low reported tax rate and the effects of tax-position releases and foreign earnings reinvestment.
- Evaluate acquisition-related contingent payments, acquired intangible valuations and the concentration of receivables, including one customer at 13% of receivables.
*Gross margin is calculated as revenue less cost of product and maintenance and cost of services, divided by revenue.