<PAGE>
================================================================================
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 October 3, 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 November 7, 1998, there were 221,828,768 shares of the registrant's Common
Stock, $0.01 par value outstanding.
================================================================================
<PAGE>
CADENCE DESIGN SYSTEMS, INC.
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1.
Financial Statements:
Condensed Consolidated Balance Sheets:
October 3, 1998 and January 3, 1998.................... 3
Condensed Consolidated Statements of Income:
Three and Nine Months Ended October 3, 1998
and September 27, 199.................................. 4
Condensed Consolidated Statements of Cash Flows:
Nine Months Ended October 3, 1998 and
September 27, 1997..................................... 5
Notes to Condensed Consolidated Financial Statements.... 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.......... 14
Item 3. Quantitative and Qualitative Disclosures About
Market Risk............................................ 32
PART II. OTHER INFORMATION
Item 1. Legal Proceedings....................................... 35
Item 5. Other Information....................................... 36
Item 6. Exhibits and Reports on Form 8-K........................ 36
Signatures........................................................... 37
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CADENCE DESIGN SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
October 3, January 3,
1998 1998
------------------ ------------------
ASSETS (Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents ....................................................... $ 207,727 $ 207,024
Short-term investments .......................................................... 38,231 97,180
Receivables, net ................................................................ 236,866 205,006
Prepaid expenses and other ...................................................... 86,582 99,849
------------------ ------------------
Total current assets ........................................................ 569,406 609,059
Property, plant, and equipment, net .................................................. 248,019 197,421
Software development costs, net ...................................................... 13,548 15,068
Acquired intangibles, net ............................................................ 295,224 10,117
Installment contract receivables ..................................................... 95,269 61,326
Other non-current assets ............................................................. 160,866 130,859
------------------ ------------------
$ 1,382,332 $ 1,023,850
================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt ............................................... $ 1,105 $ 794
Accounts payable and accrued liabilities ........................................ 161,831 156,426
Payable to Ambit shareholders.................................................... 252,990 - -
Income taxes payable ............................................................ 35,480 5,161
Deferred revenue ................................................................ 109,431 106,414
------------------ ------------------
Total current liabilities ................................................... 560,837 268,795
------------------ ------------------
Long-term liabilities:
Long-term debt .................................................................. 1,461 1,599
Deferred income taxes............................................................ 61,180 - -
Minority interest liability ..................................................... 325 121
Other long-term liabilities ..................................................... 30,167 26,238
------------------ ------------------
Total long-term liabilities ................................................. 93,133 27,958
------------------ ------------------
Stockholders' equity:
Preferred stock ................................................................. - - - -
Common stock and capital in excess of par value ................................. 626,602 502,602
Treasury stock at cost (9,644 and 6,739 shares, respectively) ................... (205,781) (97,285)
Retained earnings ............................................................... 315,010 328,934
Accumulated other comprehensive loss ............................................ (7,469) (7,154)
------------------ ------------------
Total stockholders' equity .................................................. 728,362 727,097
------------------ ------------------
$ 1,382,332 $ 1,023,850
================== ==================
</TABLE>
The accompanying notes are an integral part
of these condensed consolidated financial statements.
3
<PAGE>
CADENCE DESIGN SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------------------------- --------------------------------------
October 3, September 27, October 3, September 27,
1998 1997 1998 1997
----------------- ------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
Revenue:
Product .................................. $ 173,269 $ 135,480 $ 489,865 $ 361,320
Services ................................ 67,704 40,355 184,733 113,723
Maintenance .............................. 67,634 59,031 196,020 168,314
------------------ ------------------ ------------------ ------------------
Total revenue ......................... 308,607 234,866 870,618 643,357
------------------ ------------------ ------------------ ------------------
Costs and expenses:
Cost of product .......................... 14,782 10,760 38,168 29,344
Cost of services ......................... 49,482 28,520 137,084 80,582
Cost of maintenance ...................... 12,338 7,039 32,869 19,423
Amortization of acquired intangibles...... 2,856 493 6,029 1,417
Marketing and sales ...................... 76,052 63,261 216,663 183,306
Research and development ................. 44,854 35,927 129,522 104,350
General and administrative ............... 16,660 14,251 49,484 42,010
Unusual items ............................ 158,033 - - 218,890 34,114
------------------ ------------------ ------------------ ------------------
Total costs and expenses .............. 375,057 160,251 828,709 494,546
------------------ ------------------ ------------------ ------------------
Income (loss) from operations ...... (66,450) 74,615 41,909 148,811
Other income, net ............................ 1,328 4,386 6,523 22,988
------------------ ------------------ ------------------ ------------------
Income (loss) before provision for
income taxes .................... (65,122) 79,001 48,432 171,799
Provision for income taxes ................... 13,555 23,700 62,356 52,296
------------------ ------------------ ------------------ ------------------
Net income (loss) .................. $ (78,677) $ 55,301 $ (13,924) $ 119,503
================= ================== ================== ==================
Basic net income (loss) per share ............ $ (0.37) $ 0.27 $ (0.07) $ 0.63
================= ================== ================== ==================
Diluted net income (loss) per share .......... $ (0.37) $ 0.24 $ (0.07) $ 0.56
================= ================== ================== ==================
Weighted average common shares outstanding .. 212,292 204,168 211,505 190,432
================= ================== ================== ==================
Weighted average common and potential
common shares outstanding -- assuming
dilution ................................ 212,292 231,627 211,505 214,971
================= ================== ================== ==================
</TABLE>
The accompanying notes are an integral part
of these condensed consolidated financial statements.
4
<PAGE>
CADENCE DESIGN SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
--------------------------------------
October 3, September 27,
1998 1997
------------------ ------------------
<S> <C> <C>
Cash and Cash Equivalents at Beginning of Period $ 207,024 $ 289,118
------------------ ------------------
Cash Flows from Operating Activities:
Net income (loss) ................................................................ (13,924) 119,503
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization ................................................. 67,434 42,315
Deferred income taxes ......................................................... 37,067 (13,401)
Write-off of equipment and other assets, net .................................. 3,903 1,267
Write-off of in-process technology ............................................ 194,100 4,860
Other long-term liabilities and minority interest expense ..................... 3,533 4,980
Gain on sale of subsidiary stock .............................................. - - (13,061)
Changes in operating assets and liabilities, net of effect of acquired and
disposed businesses:
Receivables................................................................. (23,432) (14,396)
Prepaid expenses and other ................................................. 24,220 (9,954)
Installment contract receivables ........................................... (33,943) - -
Accrued liabilities and payables ........................................... (19,199) 33,953
Income taxes payable ....................................................... 85,761 56,155
Deferred revenue ........................................................... 1,222 (9,694)
------------------ ------------------
Net cash provided by operating activities .............................. 326,742 202,527
------------------ ------------------
Cash Flows from Investing Activities:
Maturities of short-term investments--held-to-maturity ........................... 48,802 19,600
Purchases of short-term investments--held-to-maturity ............................ (35,852) (67,688)
Maturities of short-term investments--available-for-sale ......................... 537,552 - -
Purchases of short-term investments--available-for-sale .......................... (491,553) (6,747)
Purchases of property, plant, and equipment ...................................... (84,395) (62,341)
Capitalization of software development costs ..................................... (17,316) (11,077)
Increase in acquired intangibles and other assets ............................... (92,896) (43,713)
Net proceeds from sale of subsidiary stock ....................................... - - 18,582
Effect of deconsolidation on cash ................................................ - - (25,118)
Purchase of businesses, net of acquired cash ..................................... (100,134) 34,988
Sale of put warrants ............................................................. 14,812 5,688
Purchase of call options ......................................................... (14,812) (5,688)
------------------ ------------------
Net cash used for investing activities ................................. (235,792) (143,514)
------------------ ------------------
Cash Flows from Financing Activities:
Principal payments on capital lease obligations and long-term debt ............... (699) (21,742)
Sale of common stock ............................................................. 60,949 43,576
Purchases of treasury stock ...................................................... (150,035) (33,138)
------------------ ------------------
Net cash used for financing activities ................................. (89,785) (11,304)
------------------ ------------------
Effect of exchange rate changes on cash .............................................. (462) (4,270)
------------------ ------------------
Increase in Cash and Cash Equivalents ................................................ 703 43,439
------------------ ------------------
Cash and Cash Equivalents at End of Period ........................................... $ 207,727 $ 332,557
================== ==================
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
<PAGE>
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 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 and nine months ended September 27, 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
condensed consolidated financial statements were not restated and the results of
CCT were only recorded in the Company's condensed 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
<PAGE>
<TABLE>
<CAPTION>
Nine Months
Ended
September 27,
1997
---------------
(In Thousands)
Revenue
- -------
<S> <C>
Cadence $632,881
CCT 10,476
--------
Combined and $643,357
restated ========
Net Income (Loss)
- -----------------
Cadence $120,869
CCT (1,366)
--------
Combined and $119,503
restated ========
</TABLE>
In September 1998, the Company acquired Ambit Design Systems, Inc. (Ambit)
and Bell Labs' Integrated Circuit Design Automation Group of Lucent
Technologies, Inc. (BLDA). 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 $214.4 million and $42.7 million for
Ambit and BLDA, respectively, was charged to expense in the quarter ended
October 3, 1998 and the estimated fair value of the 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 periods in which the acquisitions were
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 increase goodwill and intangible assets by similar
amounts.
The effect of these adjustments on the previously reported condensed
consolidated financial statements follows:
<TABLE>
<CAPTION>
For the Three Months Ended For the Nine Months Ended
October 3, 1998 October 3, 1998
------------------------ ------------------------
As Reported As Restated As Reported As Restated
----------- ----------- ----------- -----------
(In thousands)
<S> <C> <C> <C> <C>
Cost of product.............. $ 15,614 $ 14,782 $ 40,325 $ 38,168
Cost of services............. $ 50,061 $ 49,482 $ 138,066 $137,084
Amortization of acquired $ - - $ 2,856 $ - - $ 6,029
intangibles.................
Unusual items................ $ 278,333 $158,033 $ 364,290 $218,890
Total costs and expenses..... $ 493,912 $375,057 $ 971,219 $828,709
Provision for income taxes... $ 8,785 $ 13,555 $ 57,776 $ 62,356
Net loss..................... $(192,762) $(78,677) $(151,854) $(13,924)
Basic net loss per share..... $ (0.91) $ (0.37) $ (0.72) $ (0.07)
Diluted net loss per share... $ (0.91) $ (0.37) $ (0.72) $ (0.07)
</TABLE>
7
<PAGE>
<TABLE>
<CAPTION>
As of October 3, 1998
-------------------------
As Reported As Restated
----------- -----------
(In thousands)
<S> <C> <C>
Acquired intangibles, net............ $ 91,154 $295,224
Other non-current assets............. $165,826 $160,866
Deferred income taxes................ $ - - - $ 61,180
Retained earnings.................... $177,080 $315,010
</TABLE>
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 September 1998, the Company acquired all of the outstanding stock of Ambit
Design Systems, Inc. (Ambit), a California corporation, for cash. The total
purchase price was $255.0 million, and the acquisition was accounted for as a
purchase. The results of operations of Ambit 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 seven years.
Management estimates that $106.5 million of the purchase price represents
acquired in-process technology that has not yet reached technological
feasibility and has no alternative future use. Accordingly, this amount was
immediately charged to expense in the consolidated statement of operations upon
consummation of the acquisition. The value assigned to acquired 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 acquired 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 acquired 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 connection with the acquisition, net assets acquired were as follows:
<TABLE>
<CAPTION>
(in thousands)
<S> <C>
Acquired intangibles, including in-process
technology.................................. $308,678
Property, plant, and equipment, net and other
non-current assets.......................... 8,833
Cash, receivables, and other current assets... 8,349
Current liabilities assumed................... (13,605)
Deferred income taxes......................... (57,765)
--------
Net assets acquired......................... $254,490
========
</TABLE>
8
<PAGE>
The following table represents unaudited consolidated pro forma financial
information as if the Company and Ambit had been combined as of the beginning of
the periods presented. The pro forma data are presented for illustrative
purposes only and are not necessarily indicative of the combined financial
position or results of operations of future periods or the results that actually
would have resulted had the Company and Ambit been a combined company during the
specified periods. The pro forma results include the effects of the
amortization of intangible assets and adjustments to the income tax provision.
The pro forma combined results exclude acquisition-related charges for acquired
in-process technology related to Ambit.
<TABLE>
<CAPTION>
Nine Months Ended
--------------------------
October 3, September 27,
1998 1997
------------ ------------
(In thousands, except per share amounts)
<S> <C> <C>
Revenue........................................ $881,434 $644,485
======== ========
Net income..................................... $ 73,724 $100,987
======== ========
Net income per common share:
Basic......................................... $ 0.35 $ 0.53
======== ========
Diluted....................................... $ 0.31 $ 0.47
======== ========
</TABLE>
In September 1998, the Company acquired Bell Labs' Integrated Circuit Design
Automation Group of Lucent Technologies Inc. (BLDA), for cash. The total
purchase price was $58.0 million, and the acquisition was accounted for as a
purchase. The results of operations of BLDA 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 $30.3 million of the purchase price represents
acquired 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 acquired 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 acquired 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 acquired 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 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
9
<PAGE>
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
acquired 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 acquired 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 acquired 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 acquired 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
acquired 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 acquired 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 acquired 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 acquired 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.
Comparative pro forma financial information has not been presented as the
results of operations of BLDA, EXD and Symbionics were not material to the
Company's condensed consolidated financial statements, either individually or in
the aggregate.
Comprehensive Income (Loss)
In 1997, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (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
10
<PAGE>
currency translation gains and losses and other unrealized gains and losses that
have been previously excluded from net income (loss) and reflected instead in
equity.
A summary of comprehensive income (loss) follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
-------------------------- ----------------------------
October 3, September 27, October 3, September 27,
1998 1997 1998 1997
------------- ----------- ------------- -------------
(In thousands)
<S> <C> <C> <C> <C>
Net income (loss)........ $(78,677) $55,301 $(13,924) $119,503
Translation income (loss) 1,830 393 (315) (2,364)
-------- ------- -------- --------
Comprehensive income $(76,847) $55,694 $(14,239) $117,139
(loss).................. ======== ======= ======== ========
</TABLE>
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 dilution calculation
consist of dilutive shares issuable upon the exercise of outstanding common
stock options, warrants, contingent issuances of common stock, and put warrants
computed using the treasury stock method. For the periods in which the Company
had losses, potential common shares from common stock options, warrants,
contingent issuances of common stock, and put warrants are excluded from the
computation of diluted net loss per share as their effects are antidilutive.
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:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
---------------------- ----------------------
October 3, September 27, October 3, September 27,
1998 1997 1998 1997
---------- ---------- ---------- ----------
(In thousands)
<S> <C> <C> <C> <C>
Weighted average common
shares used to
calculate basic net
income (loss) per share. 212,292 204,168 211,505 190,432
Options................. - - 27,253 - - 24,222
Warrants and other
contingent common
shares................. - - 206 - - 240
Puts.................... - - - - - - 77
------- ------- ------- -------
Weighted average common
and potential common
shares used to
calculate diluted net
income (loss) per share. 212,292 231,627 211,505 214,971
======= ======= ======= =======
</TABLE>
Had the Company recorded net income for the three and nine months ended
October 3, 1998, dilutive weighted outstanding options would have been 19.0
million and 22.5 million shares, respectively, and weighted outstanding warrants
and other dilutive contingent shares would have been 0.6 million and 0.4 million
shares, respectively.
11
<PAGE>
Repricing of Stock Options
In order to continue to attract and retain employees, the Board of Directors
authorized the repricing of options to purchase shares of common stock effective
as of the close of business on September 4, 1998 to the then fair market value
of $22.59 per share. Under the terms of the repricing, optionees were required
to extend their existing vesting schedules in exchange for the repriced options.
All repriced options maintained the same expiration terms. Approximately 3.7
million options were repriced under this program. The Board of Directors and
Executive Officers were excluded from the repricing.
Credit Facility
In October 1998, the Company entered into a senior unsecured credit facility
(the 1998 Facility) with a syndicate of banks which allows the Company to borrow
up to $355.0 million. The 1998 Facility is divided between a $177.5 million
three year revolving credit facility (the Three Year Facility) and a $177.5
million 364-day revolving credit facility convertible to a three year term loan
(the 364-Day Facility). The Three Year Facility expires September 29, 2001 and
the 364-Day Facility will either expire on September 29, 1999 and be converted
to a three year term loan with a maturity date of September 29, 2002 or, at the
option of the bank group, be renewed for an additional one year period. The
Company has the option to pay interest based on LIBOR plus a spread of between
0.50% and 1.00%, based on a pricing grid tied to a financial covenant or the
higher of the Federal Funds Rate plus 0.50% or the prime rate. In addition,
commitment fees are payable on the unutilized portions of the Three Year
Facility at rates between 0.18% and 0.30% based on a pricing grid tied to a
financial covenant and on the unutilized portion of the 364-Day Facility at a
fixed rate of 0.10%. The 1998 Facility contains certain financial and other
covenants. As of October 3, 1998, the Company had no outstanding borrowings
under the 1998 Facility.
In April 1996, the Company entered into a senior secured revolving credit
facility (the 1996 Facility) which allowed the Company to borrow up to $120.0
million through April 1999. As a result of the Company securing the 1998
Facility, the 1996 Facility was terminated in September 1998.
Financing
The Company has a customer finance program whereby it may transfer qualifying
accounts receivables to certain financing institutions on a non-recourse basis.
These transfers are recorded as sales and accounted for in accordance with SFAS
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities."
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
12
<PAGE>
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 October 3, 1998, there were 5.4 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
$20.88 to $35.14 per share. Additionally, during the 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 October 3, 1998, the
Company had 3.8 million call options outstanding at prices ranging from $21.13
to $35.39 per share. The put warrants and call options outstanding at October
3, 1998 are exercisable on various dates through November 1999 and the Company
has the contractual ability to settle the options prior to their maturity.
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 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 the put warrants 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 October 3, 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.
New Accounting Standards
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards requiring that every derivative instrument be recorded in
the balance sheet as either an asset or liability measured at its fair value.
It requires that changes in the derivative's fair value be recognized currently
in earnings unless specific hedge accounting criteria are met and that a company
must formally document, designate, and assess the effectiveness of transactions
that receive hedge accounting. SFAS No. 133 is effective for fiscal years
beginning after June 15, 1999 and cannot be applied retroactively. The Company
has not yet determined the impact SFAS No. 133 will have on its financial
position, results of operations, or cash flows.
In April 1998, the American Institute of Certified Public Accountants issued
SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained
for Internal Use." The Company anticipates that SOP 98-1 will not have a
material impact on its consolidated financial statements.
13
<PAGE>
Subsequent Events
In October 1998, the Company began to draw on its 364-Day Facility to fund the
acquisition of the outstanding shares of Ambit. As of November 7, 1998, the
Company had $125.0 million outstanding under the 1998 Facility.
In October 1998, the Company announced a restructuring for the fourth quarter
of 1998 with a related charge estimated at approximately $36.0 million. This
charge is required to cover expenses related to staff reductions of
approximately 560 employees and facilities and program streamlining.
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
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------------- -------------------------
October 3, September 27, October 3, September 27,
1998 1997 % Change 1998 1997 % Change
---------- ------------- --------- ---------- ------------- ---------
(In millions) (In millions)
<S> <C> <C> <C> <C> <C> <C>
Product..................... $173.3 $135.5 28% $489.9 $361.3 36%
Services.................... 67.7 40.4 68% 184.7 113.7 62%
Maintenance................. 67.6 59.0 15% 196.0 168.3 16%
------ ------ ------ ------
Total revenue.............. $308.6 $234.9 31% $870.6 $643.3 35%
====== ====== ====== ======
<CAPTION>
Sources of Revenue as a Percent of Total Revenue
<S> <C> <C> <C> <C>
Product..................... 56% 58% 56% 56%
Services.................... 22% 17% 21% 18%
Maintenance................. 22% 25% 23% 26%
</TABLE>
The increase in product revenue of $37.8 million and $128.6 million for the
three and nine month periods ended October 3, 1998, respectively, when compared
to the same periods of 1997, 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 $27.3 million and $71.0 million in the three and
nine month periods ended October 3, 1998, respectively, when compared to the
same periods 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 of $8.6 million and $27.7 million for the
three and nine month periods ended October 3, 1998, respectively, as compared to
the same periods of
14
<PAGE>
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 $150.2 million and $134.2
million, or 49% and 57% of total revenue, for the third quarters of 1998 and
1997, respectively. For the nine month period ended October 3, 1998, revenue
from international sources was $436.0 million, as compared to $339.3 million for
the same period of 1997, representing 50% and 53%, respectively, of total
revenue for each period. The increase in total revenue from international
sources in the third quarter of 1998, as compared to the same period of 1997,
was primarily attributable to revenue growth in Japan. Total revenue growth
from international sources for the third quarter of 1998, was partially offset
by a $9.1 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.
Cost of Revenue
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------------- -------------------------
October 3, September 27, October 3, September 27,
1998 1997 % Change 1998 1997 % Change
---- ---- --------- ---- --- ---------
(In millions) (In millions)
<S> <C> <C> <C> <C> <C> <C>
Product......... $14.8 $10.8 37% $ 38.2 $29.3 30%
Services........ $49.5 $28.5 74% $137.1 $80.6 70%
Maintenance..... $12.3 $ 7.0 75% $ 32.9 $19.4 69%
</TABLE>
Cost of Revenue as a Percent of Related Revenue
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Product......... 9% 8% 8% 8%
Services........ 73% 71% 74% 71%
Maintenance..... 18% 12% 17% 12%
</TABLE>
Cost of product revenue includes costs of production personnel, packaging and
documentation, royalties, and the amortization of capitalized software
development costs. Cost of product revenue increased by $4.0 million and $8.9
million for the three and nine month periods ended October 3, 1998,
respectively, as compared with the same periods of 1997, primarily due to higher
amortization costs associated with capitalized software development costs and an
increase in product royalty 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 by $21.0 million and $56.5
million for the three and nine month periods ended October 3, 1998,
respectively, as compared with the same periods of 1997, primarily due to the
addition of services professionals by the Company, through acquisitions and
increased hiring, and the continued investment in developing new services
offerings. Services gross margins have been and may continue to be adversely
affected by the cost of integrating new service professionals as well as the
Company's inability to fully utilize these resources. In addition, services
gross margins may continue to be adversely affected by the Company's inability
to achieve operating efficiencies with its resources when implementing 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 by $5.3 million and $13.5 million
for the three and nine month periods ended
15
<PAGE>
October 3, 1998, respectively, as compared with the same periods of 1997,
primarily due to additional costs associated with supporting a larger installed
base of products, including products acquired, additional costs to provide
higher support levels on a per customer basis, and establishing a new
centralized customer response center.
Amortization of Acquired Intangibles
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------------------------- ----------------------------------
October 3, September 27, October 3, September 27,
1998 1997 1998 1997
------------------- ---------------- ---------------- ----------------
(In millions) (In millions)
<S> <C> <C> <C> <C>
Amortization of acquired
intangibles............... $ 2.9 $ 0.5 $ 6.0 $ 1.4
</TABLE>
Amortization of acquired intangibles increased $2.4 million and $4.6 million
for the three and nine month periods ended October 3, 1998, respectively, as
compared with the same periods of 1997, primarily due to amortization associated
with Cadence's acquisitions of Ambit, BLDA, Symbionics, and EXD. Additional
information about these acquisitions can be found below under "Acquisitions and
In-Process Technology."
Operating Expenses
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------------- -------------------------
October 3, September 27, October 3, September 27,
1998 1997 % Change 1998 1997 % Change
---- ---- --------- ---- ---- ---------
(In millions) (In millions)
<S> <C> <C> <C> <C> <C> <C>
Marketing and sales........... $76.1 $63.3 20% $216.7 $183.3 18%
Research and development...... $44.9 $35.9 25% $129.5 $104.3 24%
General and administrative.... $16.7 $14.3 17% $ 49.5 $ 42.0 18%
<CAPTION>
Operating Expenses as a Percent of Total Revenue
<S> <C> <C> <C> <C>
Marketing and sales........... 25% 27% 25% 28%
Research and development...... 15% 15% 15% 16%
General and administrative.... 5% 6% 6% 7%
</TABLE>
The increase in marketing and sales expenses of $12.8 million in the third
quarter of 1998, as compared with the third quarter of 1997, was primarily the
result of an increase of $10.0 million in employee related expenses attributable
to increased headcount and commissions, as well as an increase in sales support
costs in Japan of $4.1 million. The increase in marketing and sales expenses in
the third quarter of 1998 was partially offset by a $1.9 million decrease
resulting from the weakening of certain foreign currencies, primarily the
Japanese yen, in relation to the U.S. dollar in the third quarter of 1998, as
compared with the third quarter of 1997. For the nine month period ended
October 3, 1998, as compared with the same period of 1997, the increase in
marketing and sales expenses of $33.4 million was primarily the result of an
increase of $25.0 million in employee related expenses attributable to increased
headcount and commissions, as well as an increase in sales support costs in
Japan of $6.5 million.
The Company's investment in research and development, prior to the reduction
for capitalization of software development costs, was $50.6 million and $40.2
million for the third quarters of 1998 and 1997, respectively, representing 16%
and 17% of total revenue, respectively. The increase in net research and
development expenses for the third quarter of $9.0 million was primarily
attributable to employee related costs of $3.9 million due to increased
headcount and facilities costs of $3.2 million. The Company capitalized $5.7
million and $4.3
16
<PAGE>
million of software development costs for the third quarters of 1998 and 1997,
respectively, which represented 11% of total research and development
expenditures made in each of those periods, resulting primarily from general
increases in new product development. The increase in net research and
development expenses of $25.2 million for the nine month period ended October 3,
1998, as compared with the same period of 1997, was primarily the result of an
increase of $16.1 million in employee related expenses attributable to increased
headcount, facilities costs of $9.8 million and management information systems
costs of $5.5 million, partially offset by an increase in the capitalization of
software development costs of $6.2 million. For the nine month periods ended
October 3, 1998 and September 27, 1997, the Company capitalized $17.3 million
and $11.1 million of software development costs, which represented 12% and 11%,
respectively, of total research and development expenditures made in each of
those periods. The increase resulted 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 by $2.4 million and $7.5
million for the three and nine month periods ended October 3, 1998,
respectively, as compared to the same periods of 1997. This was primarily
attributable to an increase in bad debt expense of $1.2 million and $3.1
million, consulting services fees of $0.7 million and $2.4 million, and employee
related expenses of $0.2 million and $1.9 million, for the three and nine month
periods ended October 3, 1998, respectively, as compared to the same periods of
1997.
Unusual Items
Described below are unusual items and restructuring charges during the three
months ended October 3, 1998. There were no unusual items in the three month
period ended September 27, 1997.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
--------------------------- --------------------------
October 3, September 27, October 3, September 27,
1998 1997 1998 1997
----------- ------------ ---------- ------------
(In millions) (In millions)
<S> <C> <C> <C> <C>
Write-off of acquired in-process technology... $137.2 $ - - $194.1 $ 4.9
Restructuring charges......................... 20.8 - - 24.8 29.2
------ ----- ------ -----
$158.0 $ - - $218.9 $34.1
====== ===== ====== =====
</TABLE>
Unusual items also include restructuring charges of $20.8 million for the
three month period ended October 3, 1998, for the reduction in personnel
associated with the integration of its services organization and the
consolidation of facilities. In connection with the restructuring activities,
the Company reduced its workforce by approximately 101 employees. The majority
of the restructuring charges will be utilized during 1998, with the exception of
facility costs which will be paid out through the year 2008, and some severance
costs and other restructuring charges to be paid during 1999.
Also included in unusual items for the nine month period ending October 3,
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 nine month period ended September 27, 1997
was a $29.2 million restructuring charge due to the Company's merger with High
Level Design Systems, Inc. and Cooper and Chyan Technology, Inc., its
reorganization into business units, and expenses to restructure the Company's
international business operations.
17
<PAGE>
During the nine months ended October 3, 1998, the Company made a number of
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 nine months ended
October 3, 1998, follows:
<TABLE>
<CAPTION>
Estimated
Cost to
In-Process Complete
Purchase Technology In-Process
Price Charge Technology
---------- ---------- ----------
(In millions)
<S> <C> <C> <C>
Ambit Design Systems, Inc.:
Buildgates synthesis................ $106.5 $15.0
------ -----
Total............................. $255.0 $106.5 $15.0
====== ====== =====
Bell Labs' Integrated Circuit
Design Automation Group:
Formal verification................. $ 14.0 $ 2.0
Physical extraction................. 16.3 3.0
------ -----
Total............................. $ 58.0 $ 30.3 $ 5.0
====== ====== =====
Excellent Design, Inc.:
Process libraries/intellectual $ 20.5 $ 4.0
property...........................
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
====== ====== =====
</TABLE>
Acquisitions and In-Process Technology
In September 1998, Cadence acquired all of the outstanding stock of Ambit, for
cash. Ambit was a leading developer of design automation technology used in
system-on-a-chip (SOC) design. The total purchase price was $255.0 million, and
the acquisition was accounted for as a purchase.
Upon consummation of the Ambit acquisition, Cadence immediately charged to
expense $106.5 million representing acquired 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 takes into account the
uncertainty surrounding the successful development of the purchased in-process
technology. The in-process technology is expected to be commercially viable in
1999. Expenditures to complete the in-process technology are expected to total
approximately $15.0 million. These estimates are subject to change, given the
uncertainties of the development process, and no assurance can be given that
deviations from these estimates will not occur. Additionally, these projects
will
18
<PAGE>
require maintenance research and development after they have reached a state of
technological and commercial feasibility.
At the time of its acquisition by Cadence, Ambit was working on several
significant research and development projects that were intended to provide the
next generation version of its existing product, Buildgates 2.2. The nature of
the efforts to complete the next generation version of Buildgates relate 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.
The Company expects Ambit's creation of a fundamentally new approach to
synthesis in deep submicron and in SOC to create an opportunity for additional
consulting services revenue.
In September 1998, Cadence acquired BLDA for cash. The total purchase price
was $58.0 million and the acquisition was accounted for as a purchase.
Upon consummation of the BLDA acquisition, Cadence immediately charged to
expense $30.3 million representing acquired 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 acquired 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 acquired in-process
technology. The in-process technology is expected to be commercially viable in
2000. Expenditures to complete these projects are expected to total
approximately $5.0 million. These estimates are subject to change, given the
uncertainties of the development process, and no assurance can be given that
deviations from these estimates will not occur. Additionally, these projects
will require maintenance research and development after they have reached a
state of technological and commercial feasibility.
BLDA's in-process research and development projects are related to its
Formalcheck and Clover technologies. BLDA has two major enhancements underway
for Formalcheck. This effort is expected to yield a revenue-generating product
by the year 2000. BLDA's research and development related to Clover involved
the design and development of new Design Rule Checking and Parasitic Extraction
tools, which are expected to substantially improve the performance and
functionality of the technology. This effort is expected to be complete by late
1999. The nature of the efforts to complete the next generation version of
Formalcheck and Clover relate 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 each of the 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 Ambit and BLDA,
which were used to value the acquired in-process technology, were based on
management's
19
<PAGE>
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 revenue from the acquired in-process product areas peak in
years 2003-2004 and decline rapidly in years 2005-2006 as other new products are
expected to enter the market. In addition, a portion of the anticipated revenue
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 $50.3 million and $23.2 million in connection with the Ambit and BLDA
acquisitions, respectively. There can be no assurances that these assumptions
will prove accurate, or that Cadence will realize the anticipated benefit of the
acquisitions. See "Factors That May Affect Future Results." The net cash flows
generated from the in-process technology are expected to reflect earnings before
interest, taxes and depreciation of approximately 38% to 49% for the sales
generated from in-process technology.
The discount of the net cash flows to their present value is based on the
weighted average cost of capital (WACC). The WACC calculation produces the
average required rate of return of an investment in an operating enterprise,
based on various required rates of return from investments in various areas of
the enterprise. The discount rates used to discount the net cash flows from the
business enterprise, specifically acquired in-process technology, were 28% and
25% for Ambit and BLDA, respectively. These discount rates reflect 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 negatively affected in future
periods. In addition, the value of other intangible assets acquired may become
impaired.
To date, Ambit's and BLDA's results have not differed significantly from the
forecast assumptions. Cadence's research and development expenditures since the
acquisitions have not differed materially from 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 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 acquired 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.
20
<PAGE>
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.
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
21
<PAGE>
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 WACC. The discount rates used to discount the net cash flows
from acquired 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 acquired 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 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, Net and Income Taxes
Other income, net of other expenses, decreased by $3.1 million for the three
month period ended October 3, 1998, as compared to the same period of 1997,
primarily due to a decrease in interest income of $2.1 million and a higher
interest expense of $0.6 million. For the nine month period ended October 3,
1998, other income, net of other expenses, decreased by $16.5 million, as
compared to the same period 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 and a decrease in interest income of $4.0 million.
The Company's estimated effective tax rate in the three and nine month periods
ended October 3, 1998 was 28.5%, excluding the effect of the write-offs of
acquired in-process technology of $137.2 million and $194.1 million in the first
and third quarters of 1998, respectively, which is not deductible for income tax
purposes. This compares to 30% for the same periods of the prior year. The
decrease in the effective rate was due to the difference in tax rates between
domestic and foreign operations.
22
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Year 2000 Update
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 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. As of February 1999, of the 60 business application systems
that had been identified, 54 had been modified or replaced and determined to be
Year 2000 ready. Recently, Cadence has identified additional areas requiring
Year 2000 assessment, remediation, and testing, specifically software interfaces
and applications used to interact with vendors, as well as applications that are
unique to the various international operations. Cadence expects that all
business critical applications shall be Year 2000 Compliant by the third quarter
of 1999.
In July 1998, Cadence established a cross functional Year 2000 Project
Team to identify and resolve all remaining Year 2000 readiness issues. The
primary remaining issues consist of assessing the Year 2000 impact for outside
vendors, customers, facilities and the remaining internal business systems that
are not yet assessed as Year 2000 compliant. Project plans have
23
<PAGE>
been developed and include the process of identifying and prioritizing critical
suppliers and customers at the direct interface level and communicating with
them about their plans and progress in addressing Year 2000 issues. Detailed
evaluations of the most critical third parties have been initiated. It is
expected that all Year 2000 project inventories will be completed by the end of
the second quarter of 1999. This effort is being followed by each business
function conducting a focused level of ranking and functional assessment of its
inventory to establish the methods and actions required to resolve any Year 2000
issues discovered. The assessment efforts are estimated to be completed by the
second quarter of 1999. The remediation (modification or replacement of existing
software or systems) efforts are expected to be completed by the third quarter
of 1999 and the testing phases of the Year 2000 Project Plans are expected to
take place throughout most of 1999 and estimated to be completed, for all
business critical items, by the fourth quarter of 1999. All remaining issues
(which are considered low priority or low risk to the business) are planned to
be addressed as time permits and could continue through the first half of 2000.
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.
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
24
<PAGE>
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.
The Year 2000 Project is expected to significantly reduce Cadence's level
of uncertainty regarding Year 2000 issues and, in particular, about the Year
2000 readiness of its material internal operations and external agents. In
addition, Cadence believes that the current Year 2000 activities surrounding
Cadence's software products and internal systems have significantly reduced the
risk of any interruption caused by any Year 2000 issues in these areas.
However, 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.
Single European Currency
On January 1, 1999, 11 member countries of the European Union will adopt
the Euro as their common legal currency and establish fixed conversion rates
between their sovereign currencies and the Euro. Transactions can be made in
either the sovereign currencies or the Euro until January 1, 2002, when the Euro
must be used exclusively. Currently, only electronic transactions may be
conducted using the Euro. Cadence believes that its internal systems and
financial institution vendors are capable of handling the Euro conversion and is
in the process of examining current marketing and pricing policies and
strategies that may be affected by conversion to the Euro. The cost of this
effort is not expected to materially hurt Cadence's results of operations or
financial condition. However, Cadence cannot assure you that all issues related
to the Euro conversion have been identified and that any additional issues would
not materially hurt Cadence's results of operations or financial condition. For
example, the conversion to the Euro may have competitive implications on
Cadence's pricing and marketing strategies and Cadence may be at risk to the
extent its principal European suppliers and customers are unable to deal
effectively with the impact of the Euro conversion. Cadence has not yet
completed its evaluation of the impact of the Euro conversion on its functional
currency designations.
New Accounting Standards
Effective January 4, 1998, the Company adopted 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.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards requiring that every derivative instrument be recorded on
the balance sheet as either an asset or liability measured at its fair value.
It requires that changes in the derivative's fair value be recognized currently
in earnings unless specific hedge accounting criteria are met. SFAS No.
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133 is effective for fiscal years beginning after June 15, 1999 and cannot be
applied retroactively. The Company has not yet determined the impact SFAS No.
133 will have on its financial position, results of operations, or cash flows.
In April 1998, the American Institute of Certified Public Accountants issued
SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained
for Internal Use." The Company anticipates that SOP 98-1 will not have a
material impact on its consolidated financial statements.
Liquidity and Capital Resources
At October 3, 1998, the Company's principal sources of liquidity consisted
of $246.0 million of cash, cash equivalents, and short-term investments,
compared to $304.2 million at January 3, 1998, and a new $355.0 million senior
unsecured credit facility. As of November 7, 1998, the Company had borrowings
of $125.0 million under the credit facility.
Cash generated from operating activities increased $124.2 million for the
nine months ended October 3, 1998, as compared to the nine months ended
September 27, 1997. The increase was due primarily to increases in net income
excluding unusual items and certain other non-cash charges, partially offset by
changes in the balances of operating assets and liabilities. An important
contributor to the increase was the Company's software financing program,
whereby interests in the Company's qualified accounts receivables are
transferred to third party financial institutions on a non-recourse basis in
exchange for cash.
At October 3, 1998, the Company had working capital of $8.6 million
compared with $340.3 million at January 3, 1998. Working capital reductions
were generated primarily by an increase in current liabilities, due primarily to
the $253.0 million payable to Ambit shareholders, and a decrease in cash and
short-term investments of $58.2 million. The decrease in cash was primarily due
to the repurchase of the Company's stock, capital expenditures, and
acquisitions, partially offset by cash generated from operations.
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 $294.7 million and $82.1
million of cash used for investing activities in the nine months ended October
3, 1998 and September 27, 1997, respectively. Also contributing to cash from
investing activities for the nine month period ended September 27, 1997, were
net proceeds related to the sale of IMS stock of $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 October 3, 1998 to
buy back 5.4 million shares of its common stock at an aggregate price of
approximately $144.0 million through November 1999.
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, disbursements to Ambit shareholders of
approximately $253.0 million, and the contemplated additions of property, plant,
and equipment of approximately $25.0 million.
26
<PAGE>
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 October 3, 1998, the Company had
contributed approximately $26 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 $355.0 million 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 to
successfully 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 revenue growth from this
source from the 1997 periods to the 1998 periods 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 electronics design and consulting markets. The EDA industry
continues to be characterized by falling prices, rapid technological change, and
new market entrants. The
27
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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.
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 electronics 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 electronics 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 supply and demand
volatility for labor 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 electronics 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
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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. Services gross
margins have been and may continue to be adversely affected by the cost of
integrating new service professionals as well as the Company's inability to
fully utilize these resources. In addition, services gross margins may continue
to be adversely affected by the Company's inability to achieve operating
efficiencies with its resources to implement a growing number of services
offerings.
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.
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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, tariffs and other trade barriers, and move to a single European
currency. 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. A
portion of the Company's international revenues are derived from Asia. Recent
economic uncertainty and related weakening of foreign currencies has had, and
may continue to have an adverse effect on the Company's revenues and operating
results. 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. The Company 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 Company'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 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 infringes 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
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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.
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
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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 October 3, 1998. All investments mature in one year
or less.
<TABLE>
<CAPTION>
Average
Carrying Interest
Value Rate
---------- ----------
<S> <C> <C>
(In millions)
Investment Securities:
Cash equivalents-fixed rate................... $ 31.2 5.18%
Short-term investments-fixed rate............. 36.1 5.75%
Short-term investments-variable rate.......... 2.0 5.60%
------
Total investment securities............... 69.3 5.49%
Cash equivalentsvariable rate................. 48.4 4.78%
------
Total interest bearing instruments........ $117.7 5.20%
======
</TABLE>
Foreign Currency Risk
The Company transacts business in various foreign currencies, primarily in
Japanese yen and certain European currencies. 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 foreign currency transaction gains and losses. 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, net, and thus are recognized in
income in advance of the actual foreign currency cash flows. As these forward
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contracts mature, the realized gains and losses are recorded and are included in
net income as a component of other income, net. 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 October 3, 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.
<TABLE>
<CAPTION>
Average
Notional Contract
Forward Contracts: Amount Rate
--------------- --------------
<S> <C> <C>
(In millions)
Japanese yen........................ $32.7 143.61
French francs....................... $(5.7) 5.93
Italian lira........................ $ 4.6 1,749.28
German deutschemarks................ $ 4.3 1.77
Canadian dollars.................... $(3.9) 1.52
</TABLE>
The unrealized gain (loss) on the outstanding forward contracts at October 3,
1998 was immaterial to the Company's consolidated financial statements. Due to
the short-term nature of the forward contracts, the fair value at October 3,
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.
* 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
33
<PAGE>
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 warrants 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 October 3, 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 November 1999.
<TABLE>
<CAPTION>
Estimated
1998 1999 Fair
Maturity Maturity Value
---------- ---------- ---------
(Shares and contract amounts in millions)
<S> <C> <C> <C>
Put Warrants:
Shares................................. 1.2 4.2
Weighted average strike price.......... $24.34 $27.22
Contract amount........................ $ 29.7 $114.3 $25.2
Call Options:
Shares................................. 0.9 2.9
Weighted average strike price.......... $24.47 $27.19
Contract amount........................ $ 20.8 $ 78.8 $ 8.8
</TABLE>
Interest Rate Swap Risk
The Company entered into a 4.8% fixed interest rate swap in connection with
its accounts receivable financing program to modify the interest rate
characteristics of the receivables sold to a certain financing institution on a
non-recourse basis. At October 3, 1998 the maturity distribution of the $26.0
million notional amount was in quarterly installments of approximately $2.0
million commencing in January 1999 and ending in October 2001. The estimated
fair value at October 3, 1998 was negligible.
34
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
From time to time the Company is involved in various disputes and
litigation matters which arise in the ordinary course of business. These
include disputes and lawsuits related to intellectual property, licensing,
contracts , 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 and stayed the counterclaim pending resolution of the
Company's complaint. The counterclaim remains stayed.
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. That petition was denied without comment by the United
States Supreme Court. On July 9, 1998, Cadence filed additional motions seeking
to enjoin further sale of Avant!'s Aquarius products on copyright and trade
secret grounds. The Court currently is considering those motions.
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. On July 9, 1998, the Company
35
<PAGE>
filed a motion requesting that the stay be lifted. The Court is currently
considering that motion. 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
Pursuant to a recent change to the proxy rules, unless a stockholder
who wishes to bring a matter before the stockholders at the Company's 1999
annual meeting of stockholders notifies the Company of such matter prior to
February 14, 1999, management will have discretionary authority to vote all
shares for which it has proxies in opposition to such matter.
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are filed herewith:
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Title
---------- -------------
<S> <C>
10.45* Revolving Credit Agreement, dated September 30, 1998, by and between
ABN-AMRO Bank and the Registrant.
10.46* Amendment, dated October 16, 1998, to the Revolving Credit Agreement, by
and between ABN-AMRO Bank and the Registrant (Exhibit 10.45).
10.47 Agreement and Plan of Reorganization, dated September 3, 1998, by and
among the Registrant, Ambit Design Systems, Inc., and Adirondack
Transaction Corp. (incorporated by reference to Exhibit 2.01 to the
September 30, 1998 Form 8-K).
27.01 Financial data schedule for the period ended October 3, 1998.
</TABLE>
* Previously Filed
(b) Reports on Form 8-K:
On July 21, 1998, the Registrant filed a Current Report on Form 8-K
reporting that the Company issued shares of common stock and the related
acquisition of Esperan Limited, a United Kingdom corporation.
On September 30, 1998, the Registrant filed a Current Report on Form
8-K reporting the Company's completion of the acquisition of Ambit Design
Systems, Inc.
On September 30, 1998, the Registrant filed a Current Report on Form
8-K reporting the Company's completion of the acquisition of certain assets
and liabilities of Bell Labs' Integrated Circuit Design Automation Group of
Lucent Technologies, Inc.
36
<PAGE>
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
37
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED OCTOBER 3, 1998 AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-02-1999
<PERIOD-START> JAN-04-1998
<PERIOD-END> OCT-03-1998
<CASH> 207,727
<SECURITIES> 38,231
<RECEIVABLES> 236,866
<ALLOWANCES> 13,725
<INVENTORY> 0
<CURRENT-ASSETS> 569,406
<PP&E> 248,019
<DEPRECIATION> 179,061
<TOTAL-ASSETS> 1,382,332
<CURRENT-LIABILITIES> 560,837
<BONDS> 0
0
0
<COMMON> 420,821
<OTHER-SE> 307,541
<TOTAL-LIABILITY-AND-EQUITY> 1,382,332
<SALES> 870,618
<TOTAL-REVENUES> 870,618
<CGS> 214,150
<TOTAL-COSTS> 214,150
<OTHER-EXPENSES> 614,559
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 900
<INCOME-PRETAX> 48,432
<INCOME-TAX> 62,356
<INCOME-CONTINUING> (13,924)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (13,924)
<EPS-PRIMARY> (0.07)
<EPS-DILUTED> (0.07)
</TABLE>
