-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Ro7KrhFuSm8pFJHRur31217jKnmG9T/63CS0qLsdlc86D6Kk6avey584xjmxRn0c KPT/A+esZ7alXBxREDK8FQ== 0000898430-99-001441.txt : 19990405 0000898430-99-001441.hdr.sgml : 19990405 ACCESSION NUMBER: 0000898430-99-001441 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980404 FILED AS OF DATE: 19990402 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CADENCE DESIGN SYSTEMS INC CENTRAL INDEX KEY: 0000813672 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 770148231 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: SEC FILE NUMBER: 001-10606 FILM NUMBER: 99586676 BUSINESS ADDRESS: STREET 1: 2655 SEELY ROAD BLDG 5 CITY: SAN JOSE STATE: CA ZIP: 95134 BUSINESS PHONE: 4089431234 MAIL ADDRESS: STREET 1: 555 RIVER OAKS PARKWAY CITY: SAN JOSE STATE: CA ZIP: 95134 FORMER COMPANY: FORMER CONFORMED NAME: ECAD INC /DE/ DATE OF NAME CHANGE: 19880609 10-Q/A 1 FORM 10-Q/A, AMENDMENT ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ______________________ FORM 10-Q/A (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended April 4, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission file number 1-10606 ______________________ CADENCE DESIGN SYSTEMS, INC. (Exact name of registrant as specified in its charter) ______________________ Delaware 77-0148231 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 2655 Seely Avenue, Building 5, San Jose, California 95134 (Address of principal executive offices) (Zip Code) (408) 943-1234 Registrant's telephone number, including area code ______________________ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --------- --------- At May 8, 1998, there were 212,052,011 shares of the registrant's Common Stock, $0.01 par value outstanding. ================================================================================ CADENCE DESIGN SYSTEMS, INC. INDEX
Page ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements: Condensed Consolidated Balance Sheets: April 4, 1998 and January 3, 1998.................................................. 3 Condensed Consolidated Statements of Operations: Three Months Ended April 4, 1998 and March 29, 1997................................ 4 Condensed Consolidated Statements of Cash Flows: Three Months Ended April 4, 1998 and March 29, 1997................................ 5 Notes to Condensed Consolidated Financial Statements................................. 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.............................................................. 11 Item 3. Quantitative and Qualitative Disclosures About Market Risk........................... 22 PART II. OTHER INFORMATION Item 1. Legal Proceedings.................................................................... 25 Item 5. Other Information.................................................................... 25 Item 6. Exhibits and Reports on Form 8-K..................................................... 26 Signatures ..................................................................................... 27
2 PART I. FINANCIAL INFORMATION Item 1. Financial Statements CADENCE DESIGN SYSTEMS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands)
ASSETS April 4, January 3, 1998 1998 ------------------ ------------------ (Unaudited) Current assets: Cash and cash equivalents........................................................... $ 179,215 $ 207,024 Short-term investments.............................................................. 113,258 97,180 Receivables, net.................................................................... 203,222 205,006 Prepaid expenses and other.......................................................... 75,715 99,849 ---------- ---------- Total current assets............................................................. 571,410 609,059 Property, plant, and equipment, net.................................................... 218,070 197,421 Software development costs, net........................................................ 14,563 15,068 Acquired intangibles, net.............................................................. 55,949 10,117 Other non-current assets............................................................... 199,129 192,185 ---------- ---------- $1,059,121 $1,023,850 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term debt................................................... $ 695 $ 794 Accounts payable and accrued liabilities............................................ 126,898 156,426 Income taxes payable................................................................ 2,874 5,161 Deferred revenue.................................................................... 117,033 106,414 ---------- ---------- Total current liabilities........................................................ 247,500 268,795 ---------- ---------- Long-term liabilities: Long-term debt...................................................................... 759 1,599 Deferred income taxes............................................................... 3,795 - - - - Minority interest liability......................................................... 281 121 Other long-term liabilities......................................................... 31,477 26,238 ---------- ---------- Total long-term liabilities...................................................... 36,312 27,958 ---------- ---------- Stockholders' equity: Preferred stock..................................................................... - - - - - - - - Common stock and capital in excess of par value..................................... 561,090 502,602 Treasury stock at cost (6,367 and 6,739 shares, respectively)....................... (105,996) (97,285) Retained earnings................................................................... 328,575 328,934 Accumulated other comprehensive loss................................................ (8,360) (7,154) ---------- ---------- Total stockholders' equity....................................................... 775,309 727,097 ---------- ---------- $1,059,121 $1,023,850 ========== ==========
The accompanying notes are an integral part of these condensed consolidated financial statements. 3 CADENCE DESIGN SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts) (Unaudited)
Three Months Ended ------------------------------------- April 4, March 29, 1998 1997 ------------------ ----------------- Revenue: Product................................................................................ $154,049 $107,956 Services............................................................................... 52,302 33,753 Maintenance............................................................................ 63,872 54,577 -------- -------- Total revenue........................................................................ 270,223 196,286 -------- -------- Costs and expenses: Cost of product........................................................................ 11,844 8,868 Cost of services....................................................................... 39,601 24,194 Cost of maintenance.................................................................... 10,343 6,494 Amortization of acquired intangibles................................................... 546 431 Marketing and sales.................................................................... 69,245 59,012 Research and development............................................................... 41,707 33,325 General and administrative............................................................. 16,521 13,243 Unusual items.......................................................................... 60,857 11,748 -------- -------- Total costs and expenses............................................................. 250,664 157,315 -------- -------- Income from operations............................................................. 19,559 38,971 Other income, net....................................................................... 2,619 15,181 -------- -------- Income before provision for income taxes........................................... 22,178 54,152 Provision for income taxes.............................................................. 22,537 17,142 -------- -------- Net income (loss).................................................................. $ (359) $ 37,010 ======== ======== Basic net income (loss) per share....................................................... $- - - - $ 0.19 ======== ======== Diluted net income (loss) per share..................................................... $- - - - $ 0.16 ======== ======== Weighted average common shares outstanding.............................................. 210,014 198,275 ======== ======== Weighted average common and potential common shares outstanding assuming dilution....... 210,014 224,737 ======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements. 4 CADENCE DESIGN SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited)
Three Months Ended -------------------------------------- April 4, March 29, 1998 1997 ------------------ ------------------ Cash and Cash Equivalents at Beginning of Period $ 207,024 $289,118 --------- -------- Cash Flows from Operating Activities: Net income (loss)...................................................................... (359) 37,010 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization........................................................ 18,854 13,787 Deferred income taxes................................................................ 3,961 (905) Write-offs of equipment and other assets, net........................................ 903 (2,074) Write-off of in-process technology.................................................... 56,900 4,860 Change in other long-term liabilities and minority interest expense.................. 4,817 (12,421) Gain on sale of subsidiary stock..................................................... - - - - (13,061) Changes in operating assets and liabilities, net of effect of acquired and disposed businesses: Accounts receivable................................................................ 7,714 25,251 Prepaid expenses and other......................................................... 23,390 1,502 Installment contract receivables................................................... (4,126) - - - - Accrued liabilities and payables................................................... (43,632) 1,880 Income taxes payable............................................................... 23,649 11,209 Deferred revenue................................................................... 10,543 (4,551) --------- -------- Net cash provided by operating activities........................................ 102,614 62,487 --------- -------- Cash Flows from Investing Activities: Maturities of short-term investments held-to-maturity.................................. 24,180 - - - - Purchases of short-term investments held-to-maturity................................... (23,258) (12,028) Maturities of short-term investments available-for-sale................................ 189,150 - - - - Purchases of short-term investments available-for-sale................................. (206,150) (4,970) Purchases of property, plant, and equipment............................................ (30,890) (24,590) Capitalization of software development costs........................................... (5,453) (3,259) Increase in acquired intangibles and other assets...................................... (15,024) (2,076) Net proceeds from sale of subsidiary stock............................................. - - - - 18,582 Effect of deconsolidation on cash...................................................... - - - - (9,536) Purchase of businesses, net of acquired cash........................................... (51,313) - - - - Sale of put warrants................................................................... - - - - 2,443 Purchase of call options............................................................... - - - - (2,443) --------- -------- Net cash used for investing activities........................................... (118,758) (37,877) --------- -------- Cash Flows from Financing Activities: Principal payments on capital lease obligations and long-term debt..................... (879) (1,592) Increase in leases and other debt...................................................... - - - - 794 Sale of common stock................................................................... 23,559 18,956 Purchases of treasury stock............................................................ (33,010) (10,603) --------- -------- Net cash provided by (used for) financing activities............................. (10,330) 7,555 --------- -------- Effect of exchange rate changes on cash................................................. (1,335) (1,791) --------- -------- Increase (decrease) in Cash and Cash Equivalents........................................ (27,809) 30,374 --------- -------- Cash and Cash Equivalents at End of Period.............................................. $ 179,215 $319,492 ========= ========
The accompanying notes are an integral part of these condensed consolidated financial statements. 5 CADENCE DESIGN SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Basis of Presentation The condensed consolidated financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's annual report on Form 10-K for the fiscal year ended January 3, 1998. The unaudited condensed consolidated financial statements included herein reflect all adjustments (which include only normal, recurring adjustments) that are, in the opinion of management, necessary to state fairly the results for the periods presented. The results for such periods are not necessarily indicative of the results to be expected for the full fiscal year. The preparation of condensed consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain amounts in the condensed consolidated financial statements as of January 3, 1998 and for the three months ended March 29, 1997, have been reclassified to conform with the 1998 presentation. Restatement of Financial Statements In May 1997, the Company merged with Cooper & Chyan Technology, Inc. (CCT), whose software products are used to design sophisticated integrated circuits and high-speed printed circuit boards. The merger was accounted for using the pooling of interest method of accounting. At the time of this transaction, the Company believed that the operations of CCT were not material to the Company's consolidated operations and financial position. Therefore, prior-period consolidated financial statements were not restated and the results of CCT were only recorded in the Company's consolidated financial statements prospectively from the date of acquisition. Following discussions with the staff of the Securities and Exchange Commission, Cadence has restated all prior period financial statements as if the merger took place at the beginning of such periods, in accordance with required pooling of interests accounting disclosures. Reconciliation of the current condensed consolidated financial statements and previously reported information is presented below: 6
Three Months Ended -------------------------------- March 29, 1997 -------------------------------- (In thousands) Revenue - ------- Cadence $187,548 CCT 8,738 -------- Combined and restated $196,286 ======== Net Income (Loss) - ----------------- Cadence $ 37,122 CCT (112) -------- Combined and restated $ 37,010 ========
In March 1998, the Company acquired Excellent Design, Inc. (EXD) and in February 1998, the Company acquired Symbionics Group Limited (Symbionics). The acquisitions were accounted for as business combinations using the purchase method of accounting. The estimated fair value of the in-process technology (IPR&D), of $42.0 million and $40.0 million for EXD and Symbionics, respectively, was charged to expense in the quarter ended April 4, 1998 (the period in which the acquisition was consummated). Subsequent to the Securities and Exchange Commission's letter to the AICPA, dated September 9, 1998, regarding its views on IPR&D, the Company had discussions with the staff of the Securities and Exchange Commission and revised the purchase price allocations and restated its financial statements. As a result, the Company has made adjustments to decrease the amounts previously expensed as IPR&D in 1998 and to increase goodwill and intangible assets by similar amounts. The effect of these adjustments on the previously reported condensed consolidated financial statements follows:
For the Three Months Ended April 4, 1998 ------------------------- As Reported As Restated ----------- ------------ (In thousands) Cost of product................................ $ 12,337 $ 11,844 Cost of services............................... $ 39,654 $ 39,601 Amortization of acquired intangibles........... $- - - - $ 546 Unusual items.................................. $ 85,957 $ 60,857 Total costs and expenses....................... $275,764 $250,664 Provision for income taxes..................... $ 22,537 $ 22,537 Net loss....................................... $(25,459) $ (359) Basic net loss per share....................... $ (0.12) $- - - - Diluted net loss per share..................... $ (0.12) $- - - -
7
As of April 4, 1998 ------------------------------------------------ As Reported As Restated ----------------------- ----------------------- (In thousands) Acquired intangibles, net....................................... $ 27,054 $ 55,949 Deferred income taxes........................................... $- - - - $ 3,795 Retained earnings............................................... $303,475 $328,575
Revenue Recognition Effective January 4, 1998, the Company adopted Statement of Position (SOP) 97-2, "Software Revenue Recognition." SOP 97-2 provides guidance on applying generally accepted accounting principles in recognizing revenue on software transactions. The adoption of SOP 97-2 did not have a material impact on the Company's consolidated financial position or results of operations. Acquisitions In March 1998, the Company acquired all of the outstanding stock of Excellent Design, Inc. (EXD), a Japanese corporation, for cash. The total purchase price was $40.9 million, and the acquisition was accounted for as a purchase. The results of operations of EXD and the estimated fair value of the assets acquired and liabilities assumed are included in the Company's financial statements from the date of acquisition. Intangibles arising from the acquisition are being amortized on a straight-line basis over five years. Management estimates that $28.4 million of the purchase price represents purchased in-process technology that has not yet reached technological feasibility and has no alternative future use. Accordingly, this amount was immediately expensed in the consolidated statements of operations upon consummation of the acquisition. The value assigned to purchased in-process technology was determined by identifying research projects in areas for which technological feasibility has not been established. The value was determined by estimating the costs to develop the purchased in-process technology into commercially viable products, estimating the resulting net cash flows from such projects, and discounting the net cash flows back to their present value. The discount rate includes a factor that takes into account the uncertainty surrounding the successful development of the purchased in-process technology. If these projects are not successfully developed, future revenue and profitability of the Company may be adversely affected. Additionally, the value of other intangible assets acquired may become impaired. In February 1998, the Company acquired all of the outstanding stock of Symbionics Group Limited (Symbionics), a U.K. corporation, for approximately 1.0 million shares of the Company's common stock and $21.3 million of cash. The total purchase price was $46.1 million, and the acquisition was accounted for as a purchase. The results of operations of Symbionics and the estimated fair value of the assets acquired and liabilities assumed are included in the Company's financial statements from the date of acquisition. Intangibles arising from the acquisition are being amortized on a straight-line basis over five years. Management estimates that $28.5 million of the purchase price represents purchased in-process technology that has not yet reached technological feasibility and has no alternative future use. Accordingly, this amount was immediately expensed in the consolidated statements of operations upon consummation of the acquisition. The value assigned to purchased in-process technology was determined by identifying research projects in areas for which technological feasibility has not been established. The value was determined by estimating the costs to develop the purchased in-process technology into commercially viable products, estimating the resulting net cash flows from such projects, and discounting the net cash flows back to their present value. The discount rate includes a factor that takes into account the uncertainty surrounding the successful development of the purchased in-process technology. If these projects are not successfully developed, future revenue and profitability of the Company may be adversely affected. Additionally, the value of other intangible assets acquired may become impaired. 8 Comprehensive Income (Loss) In 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income," which was adopted by the Company in the first quarter of 1998. SFAS No. 130 requires companies to report a new, additional measure of income on the income statement or to create a new financial statement that has the new measure of income on it. "Comprehensive income" includes foreign currency translation gains and losses and other unrealized gains and losses that have been previously excluded from net income and reflected instead in equity. A summary of comprehensive income (loss) follows:
April 4, 1998 March 29, 1997 --------------- ---------------- (In thousands) Net income (loss)........................ $ (359) $37,010 Translation loss......................... (1,206) (3,839) ------- ------- Comprehensive income (loss).............. $(1,565) $33,171 ======= =======
Net Income (Loss) Per Share Basic net income (loss) per share is calculated by dividing net income (loss) by the weighted average shares of common stock outstanding during the period, and for diluted net income (loss) per share, net income (loss) is divided by the weighted average shares of common stock outstanding and potential common shares during the period. Potential common shares included in the diluted calculation consist of dilutive shares issuable upon the exercise of outstanding common stock options, warrants, and put warrants computed using the treasury stock method. For periods in which the Company had losses, potential common shares from common stock options, warrants, and put warrants are excluded from the computation of diluted net loss per share as their effect is antidilutive. 9 The following is a reconciliation of the weighted average common shares used to calculate basic net income (loss) per share to the weighted average common and potential common shares used to calculate diluted net income (loss) per share:
April 4, 1998 March 29, 1997 --------------- ---------------- (In thousands) Weighted average common shares used to calculate basic net income (loss) per share.............................. 210,014 198,275 Options........................................................ - - - - 26,140 Warrants and other contingent shares........................... - - - - 322 ------- ------- Weighted average common and potential common shares used to calculate diluted net income (loss) per share.......... 210,014 224,737 ======= =======
Had the Company recorded net income in the first quarter of 1998, dilutive weighted outstanding options would have been 24.7 million shares and weighted outstanding warrants and other dilutive contingent shares would have been 0.2 million shares. Contingencies Refer to Part II, Item 1 for a description of legal proceedings. Put Warrants and Call Options The Company has authorized two seasoned systematic stock repurchase programs under which the Company repurchases common stock to satisfy estimated requirements for shares to be issued under its Employee Stock Purchase Plan (ESPP) and the 1997 Nonstatutory Stock Option Plan (the 1997 Plan), respectively. Share repurchases are intended to cover the Company's expected reissuances under the ESPP and the 1997 Plan for the next 12 months and 24 months, respectively. As part of its authorized repurchase programs, the Company has sold put warrants through private placements. At April 4, 1998, there were 4.8 million put warrants outstanding which entitle the holder to sell one share of common stock to the Company on a specified date and at a specified price ranging from $23.29 to $24.34 per share. Additionally, during this same period, the Company purchased call options that entitle the Company to buy one share of common stock at a specified price to satisfy anticipated stock repurchase requirements under the Company's systematic stock repurchase programs. At April 4, 1998, the Company had 3.4 million call options outstanding at prices ranging from $23.42 to $24.47 per share. The put warrants and call options outstanding at April 4, 1998 are exercisable on various dates through February 26, 1999 and the Company can elect to exercise the options prior to their expiration. If exercised, the Company has the right to settle the put warrants with stock equal to the difference between the exercise price and the fair value at the date of exercise. Settlement of the put warrants with stock could cause the Company to issue a substantial number of shares, depending on the exercise price of the put warrants and the per share fair value of the Company's common stock at the time of exercise. In addition, settlement of put warrants in stock could lead to the disposition by put warrant holders of shares of the Company's common stock that such holders may have accumulated in anticipation of the exercise of the put warrants or call options, which may adversely affect the price of the Company's common stock. At April 4, 1998, the Company had the ability to settle these put warrants with stock and, therefore, no amount was classified out of stockholders' equity in the condensed consolidated balance sheets. 10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Except for the historical information contained herein, the following discussion contains forward-looking statements based on current expectations that involve certain risks and uncertainties. The Company's actual results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below in "Factors That May Affect Future Results" and "Liquidity and Capital Resources." Results of Operations Revenue
April 4, 1998 March 29, 1997 % Change --------------- ---------------- ---------- (In millions) Product..................... $154.0 $108.0 43% Services.................... 52.3 33.7 55% Maintenance................. 63.9 54.6 17% ------ ------ Total revenue............. $270.2 $196.3 38% ====== ====== Sources of Revenue as a Percent of Total Revenue Product...................... 57% 55% Services..................... 19% 17% Maintenance.................. 24% 28%
In the first quarter of 1998, product revenue increased $46.0 million or 43%, as compared to the first quarter of 1997. The increase in product revenue for the first quarter of 1998 was attributable primarily to increased demand for products used by customers to develop integrated circuits (ICs) and deep submicron designs, including design entry tools, custom layout tools, analog design tools, automatic place-and-route tools, and verification tools. Services revenue increased $18.6 million or 55% in the first quarter of 1998, when compared to the first quarter of 1997. The increase in services revenue was primarily the result of increased demand for the Company's services offerings throughout the world. The increase in maintenance revenue for the quarter ended April 4, 1998, as compared to the quarter ended March 29, 1997, was attributable primarily to an increase in the Company's installed base of products and the sale of higher priced maintenance contracts which on average require higher support levels. Revenue from international sources was approximately $117.0 million and $99.6 million or 43% and 51% of total revenue for the first quarters of 1998 and 1997, respectively. The increase in total revenue from international sources in the first quarter of 1998, as compared to the first quarter of 1997, was attributable to overall revenue growth partially offset by a $3.7 million negative impact on revenue as a result of the weakening of certain foreign currencies, primarily the Japanese yen, in relation to the U.S. dollar. The decrease in revenue from international sources as a percentage of total revenue for the first quarter of 1998, as compared with the first quarter of 1997, was due to domestic revenue growing at a faster rate than international revenue. Domestic revenue was approximately $153.2 million and $96.7 million for the first quarters of 1998 and 1997, respectively, representing an increase of 50% from 1997 to 1998. The increase in domestic revenue was attributable to increased sales volume for products and services. 11
Cost of Revenue April 4, 1998 March 29, 1997 % Change --------------- ---------------- ---------- (In millions) Product................ $11.8 $ 8.9 34% Services............... $39.6 $24.2 64% Maintenance............ $10.3 $ 6.5 59% Cost of Revenue as a Percent of Related Revenue Product................. 8% 8% Services................ 76% 72% Maintenance............. 16% 12%
Cost of product revenue includes costs of production personnel, packaging and documentation, and the amortization of capitalized software development costs. Cost of products increased for the first quarter of 1998, as compared with the first quarter of 1997, primarily due to higher amortization costs associated with software development costs. Cost of services revenue includes personnel and related costs associated with providing services to customers and the infrastructure to manage a services organization, as well as costs to recruit, develop, and retain services professionals. Cost of services revenue increased in total dollars due to the continued investment in developing new services offerings and the addition of services professionals by the Company, primarily through acquisitions and increased hiring. Services gross margins have been and may continue to be adversely affected by the Company's inability to fully utilize its services resources and achieve operating efficiencies with its services resources. In addition, services gross margins have been adversely affected by the cost of integrating new services professionals and a growing number of services offerings. Cost of maintenance revenue includes the cost of customer services such as hot-line and on-site support and the production cost of the maintenance renewal process. Cost of maintenance revenue increased in total dollars and as a percent of associated revenues primarily due to additional costs associated with supporting a larger installed base of products and additional costs to provide higher support levels to customers. Amortization of Acquired Intangibles
April 4, March 29, 1998 1997 --------------------- --------------------- (In millions) Amortization of acquired intangibles...................... $ 0.5 $ 0.4
Amortization of acquired intangibles increased $0.1 million for the three month period ended April 4, 1998, as compared with the same period of 1997, primarily due to amortization associated with Cadence's acquisitions in 1997. Additional information about these acquisitions can be found below under "Acquisitions and In-Process Technology." 12
Operating Expenses April 4, 1998 March 29, 1997 % Change --------------- ---------------- ---------- (In millions) Marketing and sales............. $69.2 $59.0 17% Research and development........ $41.7 $33.3 25% General and administrative...... $16.5 $13.2 25% Expenses as a Percent of Total Revenue Marketing and sales.............. 26% 30% Research and development......... 15% 17% General and administrative....... 6% 7%
The increase in marketing and sales expenses in the first quarter of 1998, as compared to the same period of the prior year, was primarily the result of an increase of $6.2 million in employee related expenses attributable to increased headcount, commissions, and sales incentives, as well as an increase in sales support costs in Japan of $2.9 million. The increase in marketing and sales expenses in the first quarter of 1998 was partially offset by a $1.7 million decrease resulting from the weakening of certain foreign currencies in relation to the U.S. dollar in the first quarter of 1998, as compared to the same period of the prior year. The Company's investment in research and development, prior to the reduction for capitalization of software development costs, was $47.2 million and $36.5 million for the first quarters of 1998 and 1997, respectively, representing 17% and 19% of total revenue, respectively. The increase in net research and development expenses was primarily attributable to employee related costs due to increased headcount of $5.5 million, facility costs of $3.4 million, and management information systems costs of $1.7 million. The Company capitalized $5.5 million and $3.2 million of software development costs for the first quarters of 1998 and 1997, respectively, which represented 12% and 9%, respectively, of total research and development expenditures made in each of those periods, resulting primarily from general increases in new product development. In any given period, the amount of capitalized software development costs may vary depending on the exact nature of the development performed. General and administrative expenses increased in the first quarter of 1998, as compared to the same period of the prior year, primarily as a result of an increase in consulting services fees for information services of $1.5 million and employee related expenses of $1.5 million. Unusual Items Described below are unusual items and restructuring charges during the three months ended April 4, 1998 and March 29 1997.
Three Months Ended --------------------------------------- April 4, March 29, 1998 1997 --------------------- ---------------- (In millions) Write-off of acquired in-process technology................. $56.9 $ 4.9 Restructuring charges....................................... 4.0 6.8 ----- ----- $60.9 $11.7 ===== =====
13 Included in unusual items for the three month period ended April 4, 1998 were restructuring charges of $4.0 million related to the Company's international business operations and its information technology support services contract. Included in unusual items for the three month period ended March 29, 1997 was a $4.8 million restructuring charge related to restructuring plans primarily aimed at reducing costs after the Company acquired High Level Design Systems, Inc. and $2.0 million of expenses to restructure the Company's international business operations. During the three months ended April 4, 1998, the Company made two purchase acquisitions. The consolidated financial statements include the operating results of each business from the date of acquisition. A summary of purchase acquisitions and values assigned to acquired in-process technology and projected costs to complete the ongoing development for the three months ended April 4, 1998, follows:
Estimated Cost to In-Process Complete Purchase Technology In-Process Price Charge Technology ----------- ------------ ------------ (In millions) Excellent Design, Inc.: Process libraries/intellectual property............... $20.5 $4.0 Process specific tools................................ 7.9 3.0 ----- ---- Total............................................... $40.9 $28.4 $7.0 ===== ===== ==== Symbionics Group Limited: Digital television.................................... $13.2 $2.5 Wireless communications............................... 15.3 3.5 ----- ---- Total............................................... $46.1 $28.5 $6.0 ===== ===== ====
Acquisitions and In-Process Technology In March 1998, Cadence acquired all of the outstanding stock of EXD for cash. The total purchase price was $40.9 million, and the acquisition was accounted for as a purchase. Upon consummation of the EXD acquisition, Cadence immediately charged to expense $28.4 million representing purchased in-process technology that had not yet reached technological feasibility and had no alternative future use. The value was determined by estimating the costs to develop the purchased in-process technology into commercially viable products, estimating the resulting net cash flows from such projects and discounting the net cash flows back to their present value. The discount rate included a factor that took into account the uncertainty surrounding the successful development of the purchased in-process technology. The in-process projects were expected to be commercially viable on dates ranging from the end of 1998 through the year 2000. Expenditures to complete these projects are expected to total approximately $7.0 million. At the time of its acquisition by Cadence, EXD was working on several significant research and development projects that, if successful, would represent the introduction of new products and technologies to meet tomorrow's market needs. These efforts included the development of new tools for library generation, delay calculation, memory compilation and semiconductor intellectual property technology. These new technologies were intended to be fully supportive of deep submicron design functions, which were a critical market requirement. The nature of the efforts required to complete the research and development projects relate, to varying degrees, to the completion of all planning, designing, prototyping, verification and testing activities that are necessary to establish that the proposed technologies meet their design specifications including functional, technical and economic performance requirements. 14 In February 1998, Cadence acquired all of the outstanding stock of Symbionics for approximately 1.0 million shares of Cadence's common stock and $21.3 million of cash. The total purchase price was $46.1 million, and the acquisition was accounted for as a purchase. Upon consummation of the Symbionics acquisition, Cadence immediately charged to expense $28.5 million representing purchased in-process technology that had not yet reached technological feasibility and had no alternative future use. The value was determined by estimating the costs to develop the purchased in-process technology into commercially viable products, estimating the resulting net cash flows from such projects and discounting the net cash flows back to their present value. The discount rate includes a factor that took into account the uncertainty surrounding the successful development of the purchased in-process technology. The in-process projects were expected to be commercially viable on dates ranging from the end of 1998 through the year 2000. Expenditures to complete these projects are expected to total approximately $6.0 million. At the time of its acquisition by Cadence, Symbionics was working on several significant research and development projects that, if successful, would meet future market needs. These efforts involve digital television, wireless home networking, cellular roaming and digital voice technologies, which were intended to insure the long-term success and survival of the organization. The nature of the efforts required to complete the research and development projects relate, to varying degrees, to the completion of all planning, designing, prototyping, verification and testing activities that are necessary to establish that the proposed technologies meet their design specifications including functional, technical and economic performance requirements. As evidenced by their continued support for these projects, management believes Cadence is well positioned to successfully complete the remaining major research and development programs. However, there is risk associated with the completion of the projects and there is no assurance that each will meet with either technological or commercial success. The net cash flows resulting from the projects underway at EXD and Symbionics, which were used to value the purchased in-process technology, were based on management's estimates of revenues, cost of revenues, research and development costs, selling, general and administrative costs, and income taxes from such projects. The revenue projections are based on the potential market size that the projects are addressing, Cadence's ability to gain market acceptance in these segments, and the life cycle of in-process technology. Estimated total revenues from the purchased in-process product areas peak in years 2001-2002 and decline rapidly thereafter as other new products are expected to enter the market. In addition, a portion of the anticipated revenues has been attributed to enhancements of the base technology under development, and has been excluded from net cash flow calculations. Existing technology was valued at $9.1 million and $6.0 million related to the EXD and Symbionics acquisitions, respectively. There can be no assurances that these assumptions will prove accurate, or that Cadence will realize the anticipated benefit of the acquisitions. The net cash flows generated from the in-process technology are expected to reflect earnings before interest and taxes are estimated to be approximately 31% to 39% for the sales generated from EXD's and Symbionics' in-process technology. The discount applied to the net cash flows to calculate their present value was based on the weighted average cost of capital (WACC). The discount rates used to discount the net cash flows from purchased in-process technology range from 22% to 30% for EXD and Symbionics. The discount rates are sometimes higher than the WACC due to the inherent uncertainties in the estimates, including the uncertainty surrounding the successful development of the purchased in-process technology, the useful life of such technology, the profitability levels of such technology, if any, and the uncertainty of technological advances, all of which are unknown at this time. If these projects are not successfully developed, Cadence's business, operating results and financial condition may be adversely affected in future periods. In addition, the value of other intangible assets acquired may become impaired. To date, EXD's and Symbionics' results have not differed significantly from the forecast assumptions. Cadence's research and development expenditures since the acquisitions have not differed materially from 15 expectations. The risks associated with the research and development are still considered high, and no assurance can be made that upcoming products will meet market expectations. In 1997, Cadence wrote off $4.9 million of acquired in-process technology associated with its acquisition of Synthesia AB. These costs reflected in- process technology that had not reached technological feasibility and, in management's opinion, had no probable alternative future use. Other Income (Expense), net and Income Taxes Other income (expense), net decreased in the first quarter of 1998, as compared to the first quarter of 1997, primarily due to the $13.1 million gain on the sale of Integrated Measurement Systems, Inc. (IMS) stock recorded in the first quarter of 1997. Additionally, interest income decreased in the first quarter of 1998 due to a lower average balance of invested cash and lower interest rates. The Company's estimated effective tax rate in the first quarter of 1998 was 28.5%, excluding the effect of the write-off of acquired in-process technology of $56.9 million, which is not deductible for income tax purposes. This compares to 30% for the same period of the prior year. The decrease in the effective rate is due to the difference in tax rates between domestic and foreign operations. New Accounting Standards Effective January 4, 1998, the Company adopted Statement of Position (SOP) 97-2, "Software Revenue Recognition." SOP 97-2 provides guidance on applying generally accepted accounting principles in recognizing revenue on software transactions. The adoption of SOP 97-2 did not have a material impact on the Company's consolidated financial position or results of operations. Liquidity and Capital Resources At April 4, 1998, the Company's principal sources of liquidity consisted of $292.5 million of cash and short-term investments, compared to $304.2 million at January 3, 1998, and a $110.0 million senior secured revolving credit facility. As of May 8, 1998, the Company had no borrowings under the revolving line of credit. Cash generated from operating activities increased $40.1 million for the first quarter of 1998, as compared to the first quarter of 1997. The increase was due primarily to increases in net income excluding unusual items and other non-cash charges, partially offset by changes in the balances of operating assets and liabilities. At April 4, 1998, the Company had working capital of $323.9 million compared with $340.3 million at January 3, 1998. Working capital increases were driven primarily by a decrease in accounts payable and accrued liabilities of $29.5 million. Working capital reductions were generated by a decrease in cash and short-term investments of $11.7 million, a decrease in prepaid expenses and other of $24.1 million, and an increase in deferred revenues of $10.6 million. The decrease in cash was primarily due to the repurchase of the Company's stock, capital expenditures, and acquisitions. In addition to its short-term investments, the Company's primary investing activities were acquisitions, purchases of property and equipment, purchases of software, intangibles, and other assets, and the capitalization of software development costs that in the aggregate represented $102.7 million and $29.9 million of cash used for investing activities in the first quarters of 1998 and 1997, respectively. Additionally, net proceeds related to the sale of IMS stock contributed $18.6 million, which was partially offset by the loss to the Company of IMS cash of $9.5 million due to deconsolidation. As part of its authorized stock repurchase programs, the Company has sold put warrants and purchased call options through private placements. The Company has a maximum potential obligation related to put warrants at April 4, 1998 to buy back 4.8 million shares of its common stock at an aggregate price of approximately $114.2 million. 16 Anticipated cash requirements for the remainder of 1998 include the purchase of treasury stock through the exercise of call options for the Company's stock repurchase programs and the contemplated additions of property, plant, and equipment of approximately $70.0 million. As part of its overall investment strategy, the Company has committed to invest $50.0 million in a venture capital partnership as a limited partner over the next three to four years. As of April 4, 1998, the Company had contributed approximately $22.2 million, which is reflected in other non-current assets in the accompanying condensed consolidated balance sheets, net of operating losses. The Company anticipates that current cash and short-term investment balances, cash flows from operations, and the $110.0 million revolving credit facility will be sufficient to meet its working capital requirements on a short- and long-term basis. Factors That May Affect Future Results Rapid Technological Change; Dependence on New Products The EDA industry and the commercial electronic design and consulting industry in which the Company competes are subject to rapid technological developments, evolving industry standards, changes in customer requirements, and frequent new product introductions and enhancements. As a result, the Company's future revenues and operating results will depend on its ability to develop or acquire new products and enhance its existing products and processes on a timely basis to keep pace with innovations in technology and to support a range of changing computer software, hardware platforms, and customer preferences. Changes in manufacturing technology may render the Company's software tools obsolete. There can be no assurance that the Company will be able successfully to develop new products to address new customer requirements and technological changes, or that such products will achieve market acceptance. Lack of market acceptance or significant delays in product development could result in a loss of competitiveness of the Company's products, with a resulting loss of revenues. Fluctuations in Quarterly Results of Operations The Company's operating expenses are partially based on its expectations regarding future revenue. Since expenses are usually committed in advance of revenues, and because only a small portion of expenses vary with revenue, the Company's consolidated results of operations may be disproportionately impacted by lower than expected revenue. Factors that may affect operating results include, among other things: (i) the timing and introduction of new products; (ii) the mix of products and services sold; (iii) the timing of significant orders from and shipments to or implementations for customers; (iv) product and services pricing and discounts; (v) the timing of completion of acquisitions; and (vi) general economic conditions. In addition, the Company's focus on providing services is relatively recent, and therefore quarter to quarter comparisons may not be meaningful. For example, the percentage revenue growth from this source from 1996 to 1997 may not be indicative of future growth. Although the Company's revenues are not generally seasonal in nature, the Company has experienced, and may continue to experience, decreases in first quarter revenue compared with the preceding fourth quarter, which is believed to result primarily from the budgeting and expenditure cycles of the Company's customers. Highly Competitive Market The Company operates in the highly competitive EDA industry and in the emerging commercial electronic design and consulting markets. The EDA industry continues to be characterized by falling prices, rapid technological change, and new market entrants. The Company's success is dependent upon its ability to develop innovative, cost competitive EDA software products and take them to market in a timely manner. The Company competes with a number of companies, including Avant! Corporation, Mentor Graphics Corp., Synopsys, Inc., and Zuken- Redac. The Company also experiences competition from manufacturers of electronic devices that have developed and/or have the capability to develop their own EDA software. Some of these companies may have substantially greater financial, marketing, and technological resources than the Company. 17 The EDA industry has relatively low barriers to entry, and, therefore, the number of the Company's actual and potential competitors is significant. A potential competitor that possesses the necessary knowledge of electronic circuit and systems design, production, and operations could develop competitive EDA tools using a moderately priced computer workstation and take such tools to market quickly. There can be no assurance that development of competitive products will not result in a shift of customer preferences away from the Company's products, resulting in a significant decrease in the sales of the Company's comparable products. In addition, there can be no assurance that the Company will successfully identify new product opportunities, develop and take new products to market in a timely manner and achieve market acceptance of its products. Failure to do so may have a material adverse effect on the Company's business, operating results and financial condition. In the electronic design and consulting markets, the Company competes with numerous EDA and other consulting companies. This emerging market represents the outsourcing of an activity by electronics manufacturers that has traditionally been performed in house, and is thus subject to the customers' "make versus buy" decisions. As a result, the Company's services business must also compete with the internal design capabilities of manufacturers of electronic devices, many of which have substantially greater financial, marketing, and technological resources than the Company. Therefore, the Company's ability to obtain such business is dependent upon its ability to offer better strategic concepts and technical solutions, competitive prices, a quicker response or a combination of these factors. There can be no assurance the Company will be able to effectively compete in this area, and any failure to compete in the electronic design and consulting market may have a material adverse effect on the Company's business, operating results, and financial condition. The electronic design and consulting service businesses have relatively low barriers to entry and, therefore, EDA and other electronics companies and management consulting firms have entered and may continue to enter into this market. The pricing model for services is susceptible to labor supply and demand as well as the Company's continuing ability to provide competitive time- to-market benefits to its customers. Some of the Company's current and potential competitors in the electronic design and consulting services businesses may have substantially greater financial, marketing, and technological resources than the Company. There can be no assurance that the Company will be able to compete successfully in these businesses, and any failure to compete in this business may have a material adverse effect on the Company's business, operating results, and financial condition. Risk of Services Business The Company has recently increased its focus on offering electronics design and consulting services. The market for such services in the electronics design area is relatively new and evolving rapidly. In order to increase revenues and sustain operating results from the Company's services business, the Company must continue to gain market acceptance for its professional services, which will depend substantially on its ability to offer better strategic concepts and technical solutions, competitive prices, a timely response or a combination of these factors. Failure to successfully operate its services business would have a material adverse effect on the Company's business, operating results, and financial condition. The Company's professional services contracts generally reflect a high amount of revenue per order. The loss of individual orders, therefore, could have a significant impact on the revenue and operating results of the Company. The timing of revenue from the Company's services business is also difficult to predict because of the length and variability of the sales and implementation cycles. In addition, a substantial portion of the Company's revenues from services are earned pursuant to fixed price contracts. Variances in costs associated with those contracts could have a material adverse effect on the Company's business, operating results, and financial condition. The professional services business is labor-intensive. Accordingly, the ability to expand its services business is dependent on its ability to hire and retain adequate professional services personnel. The market for professional services personnel is highly competitive. In general, the high component of salaries in the cost structure of the professional services business results in lower gross margins than in the Company's software business. 18 Risks Associated with Mergers and Acquisitions The Company has been involved, and may in the future be involved, in a number of merger and acquisition transactions. These transactions have been motivated by many factors, including the desire to obtain new technologies, the desire to expand and enhance the Company's product and services lines and the desire to attract personnel. Growth through acquisition has several identifiable risks, including risks related to integration of the previously distinct businesses into a single unit, the substantial management time devoted to such activities, undisclosed liabilities, the failure to realize anticipated benefits (such as cost savings and synergies) and issues related to product transition (such as distribution, engineering and customer support). Realization of any of these risks in connection with an acquisition by the Company could have a material adverse effect on the Company's business, operating results, and financial condition. Dependence on Key Personnel The Company is dependent upon the efforts and abilities of its senior management, its research and development staff and a number of other key management, sales, support, technical, and services personnel. The Company has recently increased its focus on offering professional services to its customers, the growth of which is directly dependent on the attraction and retention of personnel. The market for highly skilled employees is intensely competitive. To the extent that the Company is not able to attract, retain, train, and motivate highly skilled employees, directly or through acquisition, who are able to provide EDA and other design services that satisfy customer's expectations, the Company's business, operating results, and financial condition could be materially adversely affected. Risks of International Operations The Company expects that international revenues will continue to account for a significant portion of its total revenues. The Company's international operations involve a number of risks normally associated with such operations including, among others, adoption and expansion of government trade restrictions, volatile foreign exchange rates, currency conversion risks, limitations on repatriation of earnings, reduced protection of intellectual property rights, the impact of possible recessionary environments in economies outside the U.S., longer receivables collection periods and greater difficulty in accounts receivable collection, difficulties in managing foreign operations, political and economic instability, unexpected changes in regulatory requirements and tariffs and other trade barriers. In addition, political or economic conditions in a specific country or region, government spending factors and natural disasters could have a material adverse impact on the Company's future international business as well as the Company's international operations. Currency exchange fluctuations in countries in which the Company conducts business could also materially adversely affect the Company's business, operating results, and financial condition. The Company enters into forward contracts to hedge the short-term impact of foreign currency fluctuations. Although the Company attempts to reduce the impact of foreign currency fluctuations, significant exchange rate movements may have a material adverse impact on the Company's consolidated results of operations. Dependence on Proprietary Technology; Risks of Infringement The Company's success is dependent, in part, upon its proprietary technology. The Company generally relies upon patents, copyrights, trademarks, and trade secret laws to establish and maintain its proprietary rights in its technology and products. Cadence has a program to file applications for and obtain patents in the United States and in selected foreign countries where a potential market for the Cadence's products exists. The Company has been issued a number of patents; other patent applications are currently pending. There can be no assurance that any of these patents will not be challenged, invalidated or circumvented or that any rights granted thereunder will provide competitive advantages to the Company. In addition, there can be no assurance that patents will be issued from pending applications, or that claims allowed on any future patents will be sufficiently broad to protect the Company's technology. In addition, the laws of some foreign countries may not permit the protection of the Company's proprietary rights to the same extent as do the laws of the United States. Although the Company believes the protection afforded by its patents, patent applications, copyrights and trademarks has value, the rapidly changing technology in the EDA industry makes the Company's future success dependent primarily on the 19 innovative skills, technological expertise, and management abilities of its employees rather than on patent, copyright, and trademark protection. Because of the existence of a large number of patents in the EDA industry and the rapid rate of issuance of new patents, it is not economically practicable to determine in advance whether a product or any of its components infringe patent rights of others. From time to time, the Company receives notices from or is sued by third parties regarding patent or other intellectual property claims or is called upon to defend or indemnify a customer against such a claim of a third party. If infringement is alleged, the Company believes that, based upon industry practice, any necessary license or rights under such patents may be obtained on terms that would not have a material adverse effect on the Company's business, operating results, and financial condition. Nevertheless, there can be no assurance that the necessary licenses would be available on acceptable terms, or at all, or that the Company would prevail in any such challenge. Many of the Company's products are designed to include software or other intellectual property licensed from third parties, and it may be necessary in the future to seek or renew licenses relating to various aspects of its products. The inability to obtain certain licenses or other rights or to obtain such licenses or rights on favorable terms, or the need to engage in litigation could have a material adverse effect on the Company's business, operating results, and financial condition. Risk of Failure to Obtain Export Licenses The Company is required to comply with the regulations of the United States Department of Commerce with respect to the shipment of its products and other technologies outside the United States to certain countries and certain end users. Although to date, the Company has not encountered any material difficulty in complying with these regulations, any difficulty in such compliance in the future could have an adverse effect on the Company's business, operating results, and financial condition. Risks of Business Interruption The Company's operations are dependent on its ability to protect its computer equipment and the information stored in its databases against damage by fire, natural disaster, power loss, telecommunications failures, unauthorized intrusion, and other catastrophic events. The Company believes it has taken prudent measures to reduce the risk of interruption in its operations. However, there can be no assurance that these measures will be sufficient. Any damage or failure that causes interruptions in the Company's operations could have a material adverse effect on its business, operating results, and financial condition. Implementation of New Systems The Company is currently in the process of transitioning to new computer software for its financial, accounting, project system accounting, and order management information systems. The successful implementation of these new systems is crucial to the efficient operation of the Company's business. There can be no assurance that the Company will implement its new systems in an efficient and timely manner or that the new systems will be adequate to support the Company's operations. Problems with installation or initial operation of the new systems could cause substantial management difficulties in operations planning, financial reporting, and management and thus could have a material adverse effect on the Company's business, operating results, financial condition, and results of operations. Year 2000 Compliance The Year 2000 computer issue creates risks for Cadence, the full extent and scope of which have not yet been fully assessed. In the event that internal products and systems, or those products and systems provided by, or utilized by third parties, do not correctly recognize and process date data information beyond the year 1999, it could have a material adverse effect on Cadence's business, operating results and financial condition. To address Year 2000 issues, Cadence initiated a program designed to address the most critical Year 2000 items that would affect Cadence's products, its worldwide business systems and the operations of the following 20 functions: research and development, finance, sales, manufacturing and human resources. Assessment and remediation efforts regarding these critical items are proceeding in parallel. Cadence is also creating a plan to work with critical suppliers and customers to determine that such suppliers' and customers' operations and the products and services they provide are Year 2000 capable or to monitor their progress towards Year 2000 capability. Cadence has commenced work on contingency plans to address potential problems with its internal systems or with suppliers, customers and other third parties. In 1997, Cadence commenced a program to inventory, assess, remediate and test the Year 2000 capability of its products. As a result of those efforts, Cadence believes that the most current release of Cadence's software products, as set forth in the Year 2000 Software Compliance List (available on Cadence's web site), are Year 2000 Compliant. Cadence defines the term "Year 2000 Compliant" to mean that the software will not: (A) cease to perform due solely to a change in date to or after January 1, 2000, nor (B) generate incorrect or ambiguous data or results with respect to same-century and/or multi-century formulas, functions, date values and date data interfaces. Cadence does not believe that customers are using a significant amount of products that are not determined to be Year 2000 Compliant. Cadence continues to further validate current products, as well as new products, products acquired through acquisitions, such as Ambit and BLDA, and releases through testing and code reviews. All Cadence Year 2000 activities concerning Cadence's products are expected to be completed by October 1999. In 1995, Cadence also commenced a worldwide business systems replacement project with systems that use programs primarily from SAP America, Inc. (SAP), PeopleSoft, Inc. (PeopleSoft), and Siebel Systems, Inc. (Siebel). The new systems are expected to make approximately 70% of Cadence's business computer systems Year 2000 Compliant. In addition, during September 1997, Cadence commenced an investigation of the condition of Year 2000 readiness for all of its other internal business applications. This effort began with an inventory to identify current business applications, an evaluation of their Year 2000 readiness status and development of plans for remediation and testing of all discovered issues. It is estimated that the 1999 budget for Year 2000 related costs to resolve remaining readiness issues will be approximately $13.0 million. The costs of implementing the SAP, PeopleSoft and Siebel business application systems are not included in these cost estimates. The total cost associated with required modifications to become Year 2000 compliant is not expected to have a material adverse effect on Cadence's business, operating results and financial condition. Cadence's current estimates of the amount of time and costs necessary to implement and test its systems are based on the facts and circumstances existing at this time. The estimates were derived utilizing multiple assumptions of future events including the continued availability of certain resources, implementation success and other factors. New developments may occur that could affect Cadence's estimates for Year 2000 compliance. These developments include, but are not limited to: (a) the availability and cost of personnel trained in this area, (b) the ability to locate and correct all relevant computer code and equipment, and (c) the planning and modification success needed to achieve full implementation. Readers are cautioned that the foregoing discussion regarding Year 2000 Update contains forward-looking statements based on current expectations that involve risks and uncertainties and should be considered in conjunction with the following. The failure to correct a material Year 2000 problem could result in an interruption in, or a failure of, certain normal business activities or operations of Cadence. Such failures could materially and adversely affect Cadence's business, operating results and financial condition. Due in large part to the uncertainty of the Year 2000 readiness of third-party suppliers and customers, as well as the lack of remediation and testing for the remaining internal business systems which are not yet assessed as Year 2000 Compliant, Cadence is currently unable to determine whether the consequences of Year 2000 issues will have a material impact on Cadence's business, operating results or financial condition. Cadence's risks associated with non-information technology systems and embedded systems are generally limited to systems that typically involve environmental control systems, interruptible power systems, elevator systems and security systems. Cadence feels confident that through its research, testing, and corrective actions, the realized risks from embedded systems will be low. 21 The reasonably likely worst case scenario of a Year 2000 problem for all of Cadence's material systems is that Cadence's operations could be disrupted for a few days before the problem could be identified and remediated. The reasonably likely worst case scenario associated with Cadence products for a Year 2000 problem is that a customer project could be delayed for a short period of time before the problem can be identified and remediated by Cadence's support process. Because of the small amount of software code that could be involved, it is anticipated that problems will be remediated within 5 business days from when the problem is recreated by Cadence's support organization. Cadence uses contract terms to limit indirect damages that may be incurred by customers, although no assurance can be given that such terms are enforceable. Because of uncertainties with Year 2000 issues, Cadence is currently unable to determine whether and to what extent the Year 2000 problem will harm its business, operating results or financial condition. Volatility of Stock Price Due to the foregoing, as well as other factors, past financial performance should not be considered an indicator of future performance. In addition, the Company's participation in a highly dynamic industry often results in significant volatility of the Company's common stock price. Factors such as fluctuations in revenues or operating results, including failure to meet expectations of securities analysts, announcements of technological innovations or new products by the Company or its competitors, or developments in or disputes regarding patents and proprietary rights could have a significant adverse effect on the trading price of the Company's common stock in any given period. Moreover, the stock market has from time to time experienced extreme price and volume fluctuations, which have particularly affected the market for technology companies, and which have often been unrelated to the operating performance of such companies. These broad market fluctuations, as well as general economic, political, and market conditions may adversely affect the market price of the Company's common stock. Item 3. Quantitative and Qualitative Disclosures About Market Risk Disclosures about Market Risk Interest Rate Risk The Company's exposure to market risk for changes in interest rates relates primarily to the Company's investment portfolio. The Company places its investments with high credit quality issuers and, by policy, limits the amount of credit exposure to any one issuer. As stated in its policy, the Company is averse to principal loss and seeks to preserve its invested funds by limiting default risk, market risk, and reinvestment risk. The Company mitigates default risk by investing in only high credit quality securities that it believes to be low risk and by positioning its portfolio to respond appropriately to a significant reduction in a credit rating of any investment issuer or guarantor. The portfolio includes only marketable securities with active secondary or resale markets to ensure portfolio liquidity. The table below presents the carrying value and related weighted average interest rates for the Company's investment portfolio. The carrying value approximates fair value at April 4, 1998. All investments mature in one year or less.
Carrying Average Value Interest Rate ------------------ ------------------- (In millions) Investment Securities: Cash equivalents - fixed rate.................... $117.7 5.60% Short-term investments - fixed rate.............. 45.2 5.63% Short-term investments - variable rate........... 68.0 5.72% ------ Total investment securities.................... 230.9 5.64% Cash equivalents - variable rate................. 16.4 5.02% ------ Total interest bearing instruments............. $247.3 5.60% ======
22 Foreign Currency Risk The Company transacts business in various foreign currencies, primarily in Japan, emerging market countries in Asia, and certain European countries. The Company has established a foreign currency hedging program, utilizing foreign currency forward exchange contracts (forward contracts) to hedge certain foreign currency transaction exposures in Japan, Canada, Asia, and certain European countries. Under this program, increases or decreases in the Company's foreign currency transactions are partially offset by gains and losses on the forward contracts, so as to mitigate the possibility of short-term earnings volatility. The Company does not use forward contracts for trading purposes. All outstanding forward contracts at the end of a period are marked-to-market with unrealized gains and losses included in other income (expense), and thus are recognized in income in advance of the actual foreign currency cash flows. As these forward contracts mature, the realized gains and losses are recorded and are included in net income as a component of other income (expense). The Company's ultimate realized gain or loss with respect to currency fluctuations will depend on the currency exchange rates and other factors in effect as the contracts mature. The table below provides information as of April 4, 1998 about the Company's material forward contracts. The information is provided in U.S. dollar equivalent amounts. The table presents the notional amounts (at contract exchange rates) and the weighted average contractual foreign currency exchange rates. These forward contracts mature in less than thirty days.
Average Notional Contract Forward Contracts: Amount Rate ------------- -------- (In millions) Japanese yen........................ $14.1 125.96 British pound sterling.............. $17.3 0.60 German deutschemarks................ $ 3.3 1.82 Hong Kong dollars................... $ 1.2 7.75 Swedish krona....................... $(1.1) 7.93 Singapore dollars................... $ 1.8 1.61 Italian lira........................ $ 2.2 1,789.88
The unrealized gain (loss) on the outstanding forward contracts at April 4, 1998 was immaterial to the Company's consolidated financial statements. Due to the short-term nature of the forward contracts, the fair value at April 4, 1998 was negligible. The realized gain (loss) on these contracts as they matured was not material to the consolidated operations of the Company. Equity Price Risk As part of its authorized repurchase program, Cadence has sold put warrants through private placements. Additionally, Cadence has purchased call options that entitle Cadence to buy on a specified day one share of common stock at a specified price to satisfy anticipated stock repurchase requirements under Cadence's seasoned systematic repurchase programs. Cadence repurchases shares of its common stock under stock repurchase programs in order to make sure it has enough shares for issuance under its Employee Stock Purchase Plan, its 1997 Stock Option Plan and for other corporate purposes. This may result in sales of a large number of shares and consequent decline in the market price of Cadence common stock. As part of these repurchase programs, Cadence has purchased and will purchase call options or has sold and will sell put warrants. * Call options allow Cadence to buy shares of its stock on a specified day at a specified price. If the market price of the stock is greater than the exercise price of a call option, Cadence will typically exercise the option and receive shares of stock. If the market price of the stock is less than the exercise price of a call option, Cadence typically will not exercise the option. 23 * Call option issuers may accumulate a substantial number of shares of Cadence common stock in anticipation of Cadence's exercising its call option and may dispose of these shares if and when Cadence fails to exercise its call option. This could cause the market price of Cadence common stock to fall. * Put warrants allow the holder to sell to Cadence shares of Cadence common stock on a specified day at a specified price. Cadence has the right to settle the put warrants with shares of Cadence common stock valued at the difference between the exercise price and the fair value of the stock at the date of exercise. * Depending on the exercise price of the put warrant and the market price of the stock at the time of exercise, settlement of the put warrants with stock could cause Cadence to issue a substantial number of shares to the holder of the put warrants. The holder may sell these shares in the market, which could cause the price of Cadence common stock to fall. * Put warrant holders may accumulate a substantial number of shares of stock in anticipation of exercising their put warrants and may dispose of these shares if and when they exercise their put warrants and Cadence issues shares in settlement of their put warrants. This could also cause the market price of Cadence common stock to fall. The table below provides information at April 4, 1998 about the Company's put warrants and call options. The table presents the contract amounts and the weighted average strike prices. The put warrants and call options expire at various dates through February 26, 1999.
1998 1999 Estimated Maturity Maturity Fair Value ------------- ------------- ------------- (Shares and contract amounts in millions) Put Warrants: Shares................................. 3.5 1.3 Weighted average strike price.......... $24.00 $24.20 Contract amount........................ $ 83.9 $ 30.3 $ 2.0 Call Options: Shares................................. 2.6 0.8 Weighted average strike price.......... $24.11 $24.45 Contract amount........................ $ 61.5 $ 20.8 $47.5
24 PART II OTHER INFORMATION Item 1. Legal Proceedings From time to time the Company is involved in various disputes and litigation matters which arises in the ordinary course of business. These include disputes and lawsuits related to intellectual property, licensing, contract law, distribution arrangements, and employee relations matters. The Company filed a complaint in the United States District Court for the Northern District of California on December 6, 1995 against Avant! Corporation (Avant!) and certain of its employees for misappropriation of trade secrets, copyright infringement, conspiracy, and other illegalities. On January 16, 1996, Avant! filed various counterclaims against the Company and the Company's former President and Chief Executive Officer, and with leave of the court, on January 29, 1998 filed a second amended counterclaim. The second amended counterclaim alleges, inter alia, that the Company and its former President and Chief Executive Officer had cooperated with the Santa Clara County District Attorney and initiated and pursued its complaint against Avant! for anticompetitive reasons, engaged in wrongful activity in an attempt to manipulate Avant!'s stock price and utilized certain pricing policies and other acts to unfairly compete against Avant! in the marketplace. The second amended counterclaim also alleges that certain Company insiders engaged in illegal insider trading with respect to Avant!'s stock. The Company and its former President and Chief Executive Officer believe that each has meritorious defenses to Avant!'s claims, and each intends to defend such action vigorously. By an order dated July 13, 1996, the court bifurcated Avant!'s counterclaim from the Company's complaint. On April 19, 1996, the Company filed a motion seeking a preliminary injunction to prevent further use of Cadence copyrighted code and trade secrets by Avant!. On March 18, 1997, the District Court issued an order in which it granted in part and denied in part that motion. On September 23, 1997, the United States Court of Appeals for the Ninth Circuit reversed the District Court's decision and directed the District Court (a) to issue an order enjoining the sale of Avant!'s ArcCell products and (b) to determine whether Avant!'s Aquarius software infringes Cadence's code and, if so, to enter an order enjoining the sale of that software. In an order issued on December 19, 1997, as modified on January 26, 1998, the district court entered an injunction barring any further infringement of Cadence's copyrights in Design Framework II software, or selling, licensing, or copying such product derived from Design Framework II, including but not limited to, Avant!'s ArcCell products. On February 19, 1998, Avant! Filed a petition for writ of certiorai to the United States Supreme Court, requesting a review of the Ninth Circuit Court's decision. On April 17, 1998, the Company filed its opposition to Avant!'s Petition with the Supreme Court. By an order dated July 22, 1997, the District Court stayed most activity in the case pending in that Court and ordered Avant! to post a $5.0 million bond, in light of criminal proceedings pending against Avant! and several of its executives. The District Court has not yet set a trial date. The Company intends to pursue its claim vigorously. Management believes that the ultimate resolution of the disputes and litigation matters discussed above will not have a material adverse impact on the Company's financial position or results of operations. Item 5. Other Information In February 1998, the Company issued 1,013,108 shares of its common stock, $0.01 par value per share, to the stockholders of Symbionics Group Limited (Symbionics), a U.K. corporation, in connection with the Company's acquisition of 100% of the outstanding stock of Symbionics. The Company's primary purpose in acquiring the Symbionics shares was the acquisition of Symbionic's product development and design services for integration into the Company's services offerings. In December 1997, the Company issued an additional 12,796 shares of its common stock, $0.01 par value per share, to the former stockholders of Synthesia AB, a Swedish limited liability company (Synthesia), subject to certain rights of indemnification and setoff under the agreement of acquisition pursuant to which the Synthesia 25 shares were acquired in February 1997. The Company's primary purpose in acquiring the Synthesia shares was the acquisition of Synthesia's behavioral synthesis technology for integration into the Company's product offerings. Item 6. Exhibits and Reports on Form 8-K (a) The following exhibits are filed herewith: Exhibit Number Exhibit Title ------- ------------- 27.01 Financial data schedule for the period ended April 4, 1998. (b) Reports on Form 8-K: None. 26 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CADENCE DESIGN SYSTEMS, INC. (Registrant) DATE: April 1, 1999 By: /s/ John R. Harding ------------------- ------------------------------------- JOHN R. HARDING President and Chief Executive Officer DATE: April 1, 1999 By: /s/ H. Raymond Bingham ------------------- ------------------------------------- H. RAYMOND BINGHAM Executive Vice President and Chief Financial Officer 27 EX-27.01 2 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q FOR THE QUARTERLY PERIOD ENDED APRIL 4, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS JAN-02-1999 JAN-04-1998 APR-04-1998 179,215 113,258 203,222 18,580 0 571,410 218,070 153,078 1,059,121 247,500 0 0 0 455,094 320,215 1,059,121 270,223 270,223 62,334 62,334 188,330 0 426 22,178 22,537 (359) 0 0 0 (359) 0.00 0.00
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