Cadence Design Systems, Inc. — Q3 2012 Form 10-Q
Reporting period: Three and nine months ended September 29, 2012; comparisons are against periods ended October 1, 2011. Cadence develops electronic-design-automation software, hardware and intellectual property, principally for semiconductor and electronics customers. Financial statements are unaudited.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Revenue | $338.5M | $292.5M | $980.8M | $841.8M |
| Operating income | $59.4M | $32.2M | $155.4M | $74.7M |
| Operating margin | 17.6% | 11.0% | 15.8% | 8.9% |
| Net income | $58.6M | $28.1M | $126.1M | $61.3M |
| Diluted EPS | $0.21 | $0.10 | $0.45 | $0.23 |
| Operating cash flow | Not separately provided | Not separately provided | $220.1M | $178.2M |
Q3 gross margin was approximately 84.8%, versus 83.0% a year earlier; nine-month gross margin was approximately 85.0%, versus 82.6%. Cash, cash equivalents and short-term investments totaled $744.9M at September 29, 2012, up from $604.6M at year-end 2011. Net working capital was $176.0M, compared with $48.6M.
For the first nine months, investing activities used $186.4M, including $64.3M paid at closing for the Sigrity acquisition and purchases of marketable securities; financing activities provided $18.1M. Total convertible-note principal was approximately $494.7M, with a reported net liability value of approximately $441.4M. The $350.0M principal 2015 Notes were classified as current because they were convertible during the following quarter; the $144.5M principal 2013 Notes were not then convertible.
Changes versus comparable periods
- Revenue grew 16% in Q3 and 17% for the nine months. Product revenue rose 32% and 33%, respectively; services were broadly flat, while maintenance revenue declined 6% and 4%.
- Management attributed growth mainly to higher annualized software-contract values, increased hardware sales and leases, and revenue recognized from prior-period bookings. Maintenance’s decline partly reflected shorter average software-license terms, which shifted revenue allocation toward product.
- Operating income and net income increased substantially. Operating expenses rose 8% in Q3 and 10% year to date, primarily reflecting added employees, Sigrity-related costs and higher variable compensation.
- Operating cash flow increased $41.9M year over year for the nine-month period, primarily on higher earnings, partly offset by changes in operating assets and liabilities.
Outlook, commentary and risks
- Management expected fiscal 2012’s annual effective tax rate to be approximately 9%, and expected existing liquidity plus operating cash flows to cover working-capital and other liquidity needs for at least 12 months.
- Management expected operating expenses to increase during the remainder of fiscal 2012 versus the comparable 2011 period, reflecting hiring and the Sigrity acquisition; it also expected research and development and acquired-intangible amortization to rise. Cost of services was expected to continue declining.
- The Q3 tax benefit was $8.0M, principally reflecting a $14.8M valuation-allowance release associated with Sigrity-acquired intangible assets, partly offset by foreign subsidiary tax expense. The nine-month tax provision was $9.5M. Cadence also reported a $35.1M increase in unrecognized tax benefits for prior-period positions, accompanied by a similar decrease in its deferred-tax-asset valuation allowance.
- Cadence acquired Sigrity on July 2 for $78.5M net of acquired cash; $14.2M of consideration was deferred and tied to employee retention. The acquisition added $39.7M of goodwill and $40.6M of acquired intangible assets.
- Management did not expect holders to convert the 2015 Notes during the then-current conversion window, but noted a significant conversion could materially reduce liquidity. The company said it expected to have sufficient liquidity to fund a conversion and to fund the 2013 Notes’ December 2013 maturity from cash and future operating cash flows.
- Key disclosed risks include semiconductor-sector cyclicality and customer design spending, competition and pricing pressure, long and variable sales cycles, foreign-exchange and investment-market exposure, customer payment delays, acquisition integration, intellectual-property litigation, cybersecurity, and potential cash demands from convertible notes. Approximately half of cash and cash equivalents was held by foreign subsidiaries; repatriation of permanently reinvested earnings could incur additional taxes.
- Cadence disclosed ordinary-course disputes and litigation but provided no clear quantified exposure. It reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether product-revenue growth, including hardware sales and the effect of Sigrity, is sustainable and how it affects margins.
- The timing and potential cash impact of 2015 Notes conversions, the 2013 Notes maturity, and dilution from outstanding warrants.
- Whether the approximately 9% full-year tax-rate estimate and deferred-tax-asset valuation assumptions remain appropriate.
- Customer bookings, renewals, collections and design-project spending, particularly amid semiconductor-industry and macroeconomic uncertainty.
- The integration and retention costs of Sigrity and potential future contingent acquisition payments, which could reach $18.8M in aggregate under specified performance conditions.