UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

FORM 10-Q/A

Amendment No. 1

 

 

 

Commission file number 0-15867

 

 

 

 

CADENCE DESIGN SYSTEMS, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

 

 

(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     

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes          No  X   

 

On June 28, 2008, 260,256,338 shares of the registrant’s common stock, $0.01 par value, were outstanding.

 

Amendment No. 1 to the Quarterly Report on Form 10-Q
For the Quarterly Period Ended June 28, 2008
EXPLANATORY NOTE

 

Overview

 

Cadence Design Systems, Inc., or Cadence, is filing this Amendment No. 1 to its Quarterly Report on Form 10-Q for the quarter ended June 28, 2008, initially filed with the Securities and Exchange Commission, or the SEC, on July 29, 2008, to restate its unaudited Condensed Consolidated Financial Statements as of and for the three and six months ended June 28, 2008. This restatement corrects revenue recognition for one arrangement under which $24.8 million of Product revenue was recognized during the six months ended June 28, 2008 and $1.0 million of Maintenance revenue was recognized during the three and six months ended June 28, 2008, but should be recognized during the term of the arrangement, beginning in the fourth quarter of 2008.

 

In connection with this arrangement, Cadence entered into an agreement to sell $18.0 million of the receivable to a financing institution, and Cadence received the cash for this receivable sale during the three months ended June 28, 2008. Cadence has restated its Condensed Consolidated Statement of Cash Flows for the six months ended June 28, 2008 to reflect this cash receipt as Cash flows from financing activities and its Condensed Consolidated Balance Sheet as of June 28, 2008 to reflect the amount due to the financing institution as a liability.

 

This restatement also corrects revenue recognition for one arrangement identified during Cadence’s remediation efforts described in Item 4 — Controls and Procedures under which $12.0 million of Product revenue was recognized during the three and six months ended June 28, 2008, but should be recognized during the term of the arrangement, beginning in the third quarter of 2008.

 

Since Cadence is restating its Quarterly Report on Form 10-Q for the quarter ended June 28, 2008 for these two revenue arrangements, Cadence has also recorded two other Product revenue adjustments, in the aggregate amount of $8.4 million, that were previously disclosed in Cadence’s Quarterly Report on Form 10-Q for the quarter ended June 28, 2008, initially filed with the SEC on July 29, 2008. In addition, Cadence has recorded an adjustment to reduce Cost of product by $2.5 million for a hardware arrangement during the three and six months ended June 28, 2008. See Note 2 to the accompanying unaudited Condensed Consolidated Financial Statements for additional information.

 

As a result of these adjustments, certain other line items in our unaudited Condensed Consolidated Financial Statements were also adjusted.

 

Effects of Restatement

 

This Amendment No. 1 to the Quarterly Report on Form 10-Q/A restates the Quarterly Report on Form 10-Q for the quarter ended June 28, 2008 in its entirety. However, Cadence has not modified nor updated disclosures presented in the Quarterly Report on Form 10-Q for the quarter ended June 28, 2008, except as required to reflect the effects of the matters discussed above. Accordingly, this Amendment No. 1 to the Quarterly Report on Form 10-Q/A does not reflect events occurring after the filing of the Quarterly Report on Form 10-Q for the quarter ended June 28, 2008, initially filed with the SEC on July 29, 2008, or modify or update those disclosures affected by subsequent events or discoveries. Therefore, this Amendment No. 1 to the Quarterly Report on Form 10-Q/A should be read in conjunction with Cadence’s Annual Report on Form 10-K for the period ended December 29, 2007 and Cadence’s Quarterly Report on Form 10-Q for the quarter ended September 27, 2008.

 

Cadence has amended, to the extent relevant, the following items, which were impacted by the adjustments described above:

 

Part I

 

Item 1 — Financial Statements — Cadence has added Note 2 to explain the restatement and corrected the financial statements and footnotes to reflect the restatement described in this Explanatory Note.

 

Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Cadence has added an introductory paragraph summarizing the effect of the restatement and has corrected the relevant sections to reflect the restatement.

Item 4 — Controls and Procedures — Cadence has reevaluated its internal controls and procedures and included remediation steps to address a material weakness.

 

Part II

 

Item 1A — Risk Factors — Cadence has corrected revenue-related percentages to reflect the change in revenue in international locations as revised in its restated Condensed Consolidated Financial Statements.

 

In addition, in accordance with applicable SEC rules, this Amendment No. 1 to the Quarterly Report on Form 10-Q/A includes currently-dated certifications from our Member and Chief of Staff of the Office of the Chief Executive, who is performing functions similar to a Principal Executive Officer, and Principal Financial Officer in Exhibits 31.01, 31.02, 32.01 and 32.02.

CADENCE DESIGN SYSTEMS, INC.
INDEX

 

 

 

 

CADENCE DESIGN SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)

 

ASSETS

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

CADENCE DESIGN SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)

 

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

CADENCE DESIGN SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

CADENCE DESIGN SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

 

The Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q/A have been prepared by Cadence Design Systems, Inc., or Cadence, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission, or the SEC. 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, Cadence believes that the disclosures contained in this Quarterly Report on Form 10-Q/A comply with the requirements of Section 13(a) of the Securities Exchange Act of 1934, as amended, for a Quarterly Report on Form 10-Q/A and are adequate to make the information presented not misleading. These Condensed Consolidated Financial Statements are meant to be, and should be, read in conjunction with the Consolidated Financial Statements and the Notes thereto included in Cadence’s Annual Report on Form 10-K for the fiscal year ended December 29, 2007.

 

The unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q/A reflect all adjustments (which include only normal, recurring adjustments and those items discussed in these Notes) 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.

 

Preparation of the 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.

 

In September 2006, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standard, or SFAS, No. 157, “Fair Value Measurements,” which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS No. 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued FASB Staff Position, or FSP, FAS No. 157-2, “Effective Date of FASB Statement No. 157,” which delayed the effective date of SFAS No. 157 to fiscal years beginning after November 15, 2008 and interim periods within those fiscal years for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Cadence adopted SFAS No. 157 for fiscal 2008, except as it applies to those non-financial assets and non-financial liabilities as described in FSP FAS No. 157-2, and it did not have a material impact on its consolidated financial position, results of operations or cash flows. See Note 4 for information and related disclosures regarding Cadence’s fair value measurements.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” Under SFAS No. 159, companies may elect to measure certain financial instruments and certain other items at fair value. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. Cadence adopted SFAS No. 159 for fiscal 2008. However Cadence did not elect to apply the fair value option to any financial instruments or other items upon adoption of SFAS No. 159 or during the six months ended June 28, 2008. Therefore, the adoption of SFAS No. 159 did not impact Cadence’s consolidated financial position, results of operations or cash flows.

 

Subsequent to the filing of Cadence’s Quarterly Report on Form 10-Q for the quarter ended June 28, 2008, initially filed with the SEC on July 29, 2008, Cadence concluded that, based on a review of two arrangements in which revenue was recognized during this period, Cadence would restate its Condensed Consolidated Financial Statements for the three and six months ended June 28, 2008, as discussed in more detail below.

 

 

As part of its regular quarterly review process for the three months ended September 27, 2008, Cadence identified certain factors that, when evaluated together, indicated that the software arrangements executed with this customer both in the three months ended March 29, 2008 and the three months ended September 27, 2008 were negotiated in contemplation of one another. Accordingly, based on Technical Practice Aid, or TPA, 5100.39, “Software Revenue Recognition for Multiple-Element Arrangements,” Cadence determined that the term license arrangement executed during the three months ended March 29, 2008 and the subscription license arrangement executed during the three months ended September 27, 2008 collectively represented a multiple element arrangement. Because the subscription arrangement provides the customer with the right to use unspecified additional software products that become commercially available during the term of the arrangement, Cadence determined that the revenue relating to this multiple element arrangement should be recognized during the term of the arrangement, beginning in the fourth quarter of 2008. Accordingly, because no revenue should have been recognized during the three and six months ended June 28, 2008 in connection with this multiple element arrangement, Maintenance revenue was reduced by $1.0 million during the three and six months ended June 28, 2008 and Product revenue was decreased by $24.8 million during the six months ended June 28, 2008. Receivables, net was reduced by $6.9 million, as this was the outstanding balance relating to this transaction as of June 28, 2008, and Current portion of deferred revenue was increased by $1.0 million as a result of reducing Maintenance revenue.

 

In connection with this arrangement, Cadence entered into an agreement to sell $18.0 million of the accounts receivable to a financing institution, and Cadence received the cash for this receivable sale during the three months ended June 28, 2008. Because the sold receivable is considered part of the subscription license arrangement, the transaction was no longer deemed a true sale in accordance with SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” Accordingly, Cadence recorded a liability of $18.0 million due to the financing institution in its Condensed Consolidated Balance Sheet as of June 28, 2008, $1.5 million of which is a Current liability. The cash received from the financing institution of $18.0 million is included as a Cash flow from financing activities in the Condensed Consolidated Statement of Cash Flows for the six months ended June 28, 2008.

 

 

As a result of reversing $12.0 million of product revenue that was previously recognized, Cadence also increased Current portion of deferred revenue by $3.0 million, increased Long-term portion of deferred revenue by $9.0 million and increased Inventories by $0.1 million as of June 28, 2008, and decreased Cost of product by $0.1 million for the three and six months ended June 28, 2008.

 

 

 

The following table outlines the effects of the restatement adjustments on Cadence’s Condensed Consolidated Statement of Operations for the three months ended June 28, 2008:

 

The following table outlines the effects of the restatement adjustments on Cadence’s Condensed Consolidated Statement of Operations for the six months ended June 28, 2008:

 

The following table outlines the effects of the restatement adjustments on Cadence’s Condensed Consolidated Balance Sheet as of June 28, 2008:

 

The following table outlines the effects of the restatement adjustments on Cadence’s Condensed Consolidated Statement of Cash Flows for the six months ended June 28, 2008:

 

 

 

Cadence has equity incentive plans that provide for the grant to employees of stock-based awards, including stock options, restricted stock awards and restricted stock units. Restricted stock awards and restricted stock units are referred to as restricted stock in this Quarterly Report on Form 10-Q/A. In addition, the 1995 Directors Stock Option Plan, or 1995 Directors Plan, provides for the automatic grant of stock options to non-employee members of Cadence’s Board of Directors. Cadence also has an employee stock purchase plan, or ESPP, which enables employees to purchase shares of Cadence common stock.

 

Stock-based compensation expense and the related income tax benefit recognized under SFAS No. 123R, “Share-Based Payment” in the Condensed Consolidated Statements of Operations in connection with stock options, restricted stock and the ESPP for the three and six months ended June 28, 2008 and June 30, 2007 were as follows:

 

 

Stock Options

 

The exercise price of each stock option granted under Cadence’s employee equity incentive plans is equal to or greater than the market price of Cadence’s common stock on the date of grant. Generally, option grants vest over four years, expire no later than ten years from the grant date and are subject to the employee’s continuing service to Cadence. The options granted under the 1995 Directors Plan vest one year from the date of grant. Options assumed in connection with acquisitions generally have exercise prices that differ from the fair value of Cadence’s common stock on the date of acquisition and such options generally continue to vest under their original vesting schedules and expire on the original dates stated in the acquired company’s option agreements. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model. The weighted average grant date fair value of options granted and the weighted average assumptions used in the model for the three and six months ended June 28, 2008 and June 30, 2007 were as follows:

 

The computation of the expected volatility assumption used in the Black-Scholes pricing model for new grants is based on implied volatility. When establishing the expected life assumption, Cadence reviews annual historical employee exercise behavior with respect to option grants having similar vesting periods. The risk-free interest rate for the period within the expected term of the option is based on the yield of United States Treasury notes in effect at the time of grant. Cadence has not historically paid dividends; thus the expected dividend yield used in the calculation is zero.

 

Restricted Stock and Stock Bonuses

 

The cost of restricted stock is determined using the fair value of Cadence’s common stock on the date of the grant, and compensation expense is recognized over the vesting period. The weighted average grant date fair values of restricted stock granted during the three and six months ended June 28, 2008 and June 30, 2007 were as follows:

 

 

Generally, restricted stock vests over four years and is subject to the employee’s continuing service to Cadence. Cadence issues some of its restricted stock with performance-based vesting. The terms of these restricted stock grants are consistent with grants of restricted stock described above, with the exception that the shares vest not upon the mere passage of time, but upon the attainment of certain predetermined performance goals. Cadence estimates the most likely outcome of such performance goals and recognizes the related stock-based compensation expense at each period. The amount of stock-based compensation expense recognized in any one period can vary based on the attainment or estimated attainment of the various performance goals. If such performance goals are not met, no compensation expense is recognized and any previously recognized compensation expense is reversed. Stock-based compensation expense related to these performance-based restricted stock grants for the three and six months ended June 28, 2008 and June 30, 2007 was as follows:

 

 

Liability-based Awards

 

Cadence maintains a performance-based bonus plan under which payments may be made in Cadence’s common stock. Each period, Cadence estimates the most likely outcome of predetermined performance goals and recognizes any related stock-based compensation expense. The amount of stock-based compensation expense recognized in any one period can vary based on the attainment or estimated attainment of the various performance goals. If such performance goals are not met, no compensation expense is recognized and any previously recognized compensation expense is reversed. The dollar amount earned under this bonus plan is based on the achievement of the performance goals, and the number of shares to be issued under the plan is based on the average stock price for three days preceding the grant date. Stock issued under the performance-based bonus plan vests immediately. During the six months ended June 28, 2008, Cadence agreed to make the period’s payment of $2.7 million in cash. Under the terms of this performance-based bonus plan, future payments are to be made in stock. Stock-based

compensation expense related to these performance-based bonus plans and the shares issued for the three and six months ended June 28, 2008 and June 30, 2007 were as follows:

 

 

Employee Stock Purchase Plan

 

Under the ESPP, substantially all employees may purchase Cadence’s common stock at a price equal to 85% of the lower of the fair market value at the beginning of the applicable offering period or at the end of each applicable purchase period, in an amount up to 12% of their annual base earnings plus bonuses, subject to a limit in any calendar year of $25,000 worth of common stock. The duration of each offering period under the ESPP is six months. New offerings begin on each February 1st and August 1st of each year and the purchase dates under the ESPP are January 31st and July 31st of each year.

 

Shares of Cadence’s common stock issued under the ESPP for the three and six months ended June 28, 2008 and June 30, 2007 were as follows:

 

 

Compensation expense is calculated using the fair value of the employees’ purchase rights under the Black-Scholes option pricing model. The weighted average grant date fair value of purchase rights granted under the ESPP and the weighted average assumptions used in the model for the three and six months ended June 28, 2008 and June 30, 2007 were as follows:

 

 

The computation of the expected volatility assumption used in the Black-Scholes pricing model for purchase rights is based on implied volatility. The expected life assumption is based on the average exercise date for the purchase periods in each offering period. The risk-free interest rate for the period within the expected life of the purchase right is based on the yield of United States Treasury notes in effect at the time of grant. Cadence has not historically paid dividends; thus the expected dividend yield used in the calculation is zero.

 

Fair Value of Financial Instruments

 

On a quarterly basis, Cadence measures at fair value certain financial assets and liabilities, including cash equivalents, available-for-sale securities, time deposits, trading securities held in Cadence’s Nonqualified Deferred Compensation Plans, or NQDCs, and foreign exchange contracts. SFAS No. 157 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect Cadence’s market assumptions. These two types of inputs have created the following fair-value hierarchy:

 

 

This hierarchy requires Cadence to minimize the use of unobservable inputs and to use observable market data, if available, when determining fair value. The fair value of these financial assets and liabilities was determined using the following levels of inputs as of June 28, 2008:

 

 

Marketable Securities

 

Cadence considers all of its investments in marketable securities as available-for-sale. Available-for-sale securities are stated at fair value, with the unrealized gains and losses presented net of tax and reported as a separate component of Stockholders’ equity. Realized gains and losses are determined using the specific identification method. Gains are recognized when realized and are recorded in the Condensed Consolidated Statements of Operations as Other income (expense), net. Losses are recognized as realized or when Cadence has determined that an other-than-temporary decline in fair value has occurred.

 

It is Cadence’s policy to review the fair value of these marketable securities on a regular basis to determine whether its investments in these companies are other-than-temporarily impaired. This evaluation includes, but is not limited to, reviewing each company’s cash position, financing needs, earnings or revenue outlook, operational performance, management or ownership changes and competition. If Cadence believes the carrying value of an investment is in excess of its fair value, and this difference is other-than-temporary, it is Cadence’s policy to write down the investment to reduce its carrying value to fair value.

The following table summarizes Cadence’s available-for-sale marketable securities as of June 28, 2008 and December 29, 2007:

 

 

The following table summarizes the fair value and gross unrealized losses related to available-for-sale securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of June 28, 2008:

 

 

During the six months ended June 28, 2008, Cadence determined that one of its available-for-sale securities was other-than-temporarily impaired based on the severity and the duration of the impairment and Cadence wrote down the investment by $5.4 million. This impairment is included in Other income (expense), net in the Condensed Consolidated Statement of Operations for the six months ended June 28, 2008. Cadence did not recognize an other-than-temporary impairment of available-for-sale securities during the three months ended June 28, 2008 or during the three and six months ended June 30, 2007.

 

Cost Method Investments

 

Investments accounted for by Cadence under the cost method of accounting are carried at historical cost and Cadence periodically evaluates the fair value of each investment to determine if an other-than-temporary decline in value has occurred. Cadence recorded write-downs due to other-than-temporary declines in value of non-marketable securities carried on the cost basis of $2.9 million for the three and six months ended June 28, 2008 and $0.6 million for the three and six months ended June 30, 2007. These write-downs are included in Other income (expense), net, in the Condensed Consolidated Statement of Operations.

 

 

1.375% Convertible Senior Notes Due 2011 and 1.500% Convertible Senior Notes Due 2013

 

In December 2006, Cadence issued $250.0 million principal amount of 1.375% Convertible Senior Notes Due 2011, or the 2011 Notes, and $250.0 million of 1.500% Convertible Senior Notes Due 2013, or the 2013 Notes, and collectively, the Convertible Senior Notes, to three initial purchasers in a private placement pursuant to Section 4(2) of the Securities Act for resale to qualified institutional buyers pursuant to SEC Rule 144A. Cadence received net proceeds of approximately $487.0 million after transaction fees of approximately $13.0 million, including $12.0 million of underwriting discounts. A portion of the net proceeds totaling $228.5 million was used to purchase $189.6 million principal amount of Cadence’s Zero Coupon Zero Yield Senior Convertible Notes Due 2023, or the 2023 Notes.

 

Holders may convert their Convertible Senior Notes prior to maturity upon the occurrence of one of the following events:

 

 

On and after November 2, 2011, in the case of the 2011 Notes, and November 1, 2013, in the case of the 2013 Notes, until the close of business on the scheduled trading day immediately preceding the maturity date, holders may convert their Convertible Senior Notes at any time, regardless of the foregoing circumstances. Cadence may not redeem the Convertible Senior Notes prior to maturity.

 

The initial conversion rate for the Convertible Senior Notes is 47.2813 shares of Cadence common stock per $1,000 principal amount of Convertible Senior Notes, equivalent to a conversion price of approximately $21.15 per share of Cadence common stock. Upon conversion, a holder will receive the sum of the daily settlement amounts, calculated on a proportionate basis for each day, during a specified observation period following the conversion date. The daily settlement amount during each date of the observation period consists of:

 

 

In addition, if a fundamental change occurs prior to maturity, the conversion rate will increase by an additional amount of up to $8.27 per share, for a holder that elects to convert its Convertible Senior Notes in connection with such fundamental change, which amount will be paid entirely in cash. A fundamental change is any transaction or event (whether by means of an exchange offer, liquidation, tender offer, consolidation, merger, combination, reclassification, recapitalization or otherwise) in which more than 50% of Cadence’s common stock is exchanged for, converted into, acquired for or constitutes solely the right to receive, consideration. No fundamental change will have occurred if at least 90% of the consideration received consists of shares of common stock, or depositary receipts representing such shares, that are:

 

 

As of June 28, 2008, none of the conditions allowing the holders of the Convertible Senior Notes to convert had been met.

 

Cadence evaluated the embedded conversion option in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” and concluded that the embedded conversion option contained within the Convertible Senior Notes should not be accounted for separately because the conversion option is indexed to Cadence’s common stock and is classified as stockholders’ equity. Furthermore, Cadence evaluated the terms of the Convertible Senior Notes for a beneficial conversion feature in accordance with Emerging Issues Task Force, or EITF, No. 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios” and EITF No. 00-27, “Application of Issue 98-5 to Certain Convertible Instruments” and concluded there was no beneficial conversion feature at the commitment date based on the conversion rate of the Convertible Senior Notes relative to the commitment date stock price.

 

Interest on the Convertible Senior Notes began accruing in December 2006 and is payable semi-annually each December 15th and June 15th.

 

Concurrently with the issuance of the Convertible Senior Notes, Cadence entered into hedge transactions with various parties whereby Cadence has the option to purchase up to 23.6 million shares of Cadence’s common stock at a price of $21.15 per share, subject to adjustment. These options expire on December 15, 2011, in the case of the 2011 Notes, and December 15, 2013, in the case of the 2013 Notes, and must be settled in net shares. The aggregate cost of these hedge transactions was $119.8 million and has been recorded as a reduction to Stockholders’ equity in accordance with EITF No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.” The estimated fair value of the hedges acquired in connection with the issuance of the Convertible Senior Notes was $29.4 million as of June 28, 2008. Subsequent changes in the fair value of these hedges will not be recognized as long as the instruments remain classified as equity.

In separate transactions, Cadence also sold warrants to various parties for the purchase of up to 23.6 million shares of Cadence’s common stock at a price of $31.50 per share in a private placement pursuant to Section 4(2) of the Securities Act. The warrants expire on various dates from February 2012 through April 2012 in the case of the 2011 Notes, and February 2014 through April 2014 in the case of the 2013 Notes, and must be settled in net shares. Cadence received $39.4 million in cash proceeds from the sale of these warrants, which has been recorded as a reduction to Stockholders’ equity in accordance with EITF No. 00-19. The estimated fair value of the warrants sold in connection with the issuance of the Convertible Senior Notes was $12.7 million as of June 28, 2008. Subsequent changes in the fair value of these warrants will not be recognized as long as the instruments remain classified as equity. The warrants will be included in diluted earnings per share, or EPS, to the extent the impact is considered dilutive.

 

Zero Coupon Zero Yield Senior Convertible Notes Due 2023

 

In August 2003, Cadence issued $420.0 million principal amount of its 2023 Notes to two initial purchasers in a private placement pursuant to Section 4(2) of the Securities Act for resale to qualified institutional buyers pursuant to SEC Rule 144A. Cadence received net proceeds of $406.4 million after transaction fees of $13.6 million that were recorded in Other long-term assets and are being amortized to interest expense using the straight-line method over five years, which is the duration of the first redemption period. The 2023 Notes were issued by Cadence at par and bear no interest. The 2023 Notes are convertible into Cadence common stock initially at a conversion price of $15.65 per share, which would result in an aggregate of 26.8 million shares issued upon conversion, subject to adjustment upon the occurrence of specified events. In connection with the issuance of the Convertible Senior Notes in December 2006, Cadence repurchased $189.6 million principal amount of the 2023 Notes, reducing the aggregate number of shares to be issued upon conversion to 14.7 million.

 

Cadence may redeem for cash all or any part of the 2023 Notes on or after August 15, 2008 for 100.00% of the principal amount, except for the 2023 Notes that the holders require Cadence to repurchase on the repurchase dates described below. The holders of the 2023 Notes may require Cadence to repurchase for cash all or any portion of their 2023 Notes on August 15, 2008 for 100.25% of the principal amount, on August 15, 2013 for 100.00% of the principal amount or on August 15, 2018 for 100.00% of the principal amount, by providing to the paying agent a written repurchase notice. On July 16, 2008, Cadence filed a Tender Offer Statement on Schedule TO with the SEC and made available to the holders of the 2023 Notes, through the Depository Trust Company, documents specifying the terms, conditions and procedures for requiring Cadence to repurchase the 2023 Notes on August 15, 2008 for 100.25% of the principal amount. Because the holders of the 2023 Notes can require Cadence to repurchase for cash all or any portion of the 2023 Notes on August 15, 2008, the 2023 Notes are classified as a Current liability in Cadence’s Condensed Consolidated Balance Sheets as of June 28, 2008 and December 29, 2007.

 

Each $1,000 of principal of the 2023 Notes will initially be convertible into 63.8790 shares of Cadence common stock, subject to adjustment upon the occurrence of specified events. Holders of the 2023 Notes may convert their 2023 Notes prior to maturity only if:

 

 

In the event of a fundamental change in Cadence’s corporate ownership or structure, the holders may require Cadence to repurchase all or any portion of their 2023 Notes for 100.00% of the principal amount. Upon a fundamental change in Cadence’s corporate ownership or structure, in certain circumstances Cadence may choose to pay the repurchase price in cash, shares of Cadence common stock or a combination of cash and shares of Cadence common stock. As of June 28, 2008, none of the conditions allowing the holders of the 2023 Notes to convert had been met.

 

Cadence evaluated the embedded conversion option in accordance with SFAS No. 133 and concluded that the embedded conversion option contained within the 2023 Notes should not be accounted for separately because the conversion option is indexed to Cadence’s common stock and is classified as stockholders’ equity. Furthermore,

Cadence evaluated the terms of the 2023 Notes for a beneficial conversion feature in accordance with EITF No. 98-5 and EITF No. 00-27 and concluded there was no beneficial conversion feature at the commitment date based on the conversion rate of the 2023 Notes relative to the commitment date stock price.

 

In connection with the issuance of the Convertible Senior Notes in December 2006, a portion of the proceeds were used to purchase in the open market the 2023 Notes with a principal balance of $189.6 million and for a total purchase price of $228.5 million. In connection with this purchase, Cadence incurred expenses of $40.8 million for the early extinguishment of debt. The loss on early extinguishment of debt included the call premium on the purchased 2023 Notes and the write-off of a portion of the unamortized deferred debt issuance costs.

 

Concurrently with the issuance of the 2023 Notes, Cadence entered into hedge transactions with a financial institution whereby Cadence originally acquired options to purchase up to 26.8 million shares of Cadence common stock at a price of $15.65 per share. These options expire on August 15, 2008 and must be settled in net shares. The cost of the hedge transactions to Cadence was $134.6 million. In connection with the purchase of a portion of the 2023 Notes in December 2006, Cadence also sold 12.1 million of the hedges that were originally purchased in connection with the 2023 Notes and received proceeds of $55.9 million.

 

In addition, Cadence sold warrants for its common stock to a financial institution for the purchase of up to 26.8 million shares of Cadence common stock at a price of $23.08 per share. All of the warrants expired out of the money on various dates from February 2008 through May 2008 and no settlement was required. Cadence received $56.4 million in cash proceeds from the sale of these warrants. In connection with the purchase of a portion of the 2023 Notes in December 2006, Cadence also purchased 12.1 million of the warrants for its common stock that were originally issued in connection with the 2023 Notes at a cost of $10.2 million.

 

The costs incurred in connection with the hedge transaction and the proceeds from the sale of the warrants are included as a net reduction in Common stock and capital in excess of par in the accompanying Condensed Consolidated Balance Sheets as of June 28, 2008 and December 29, 2007, in accordance with the guidance in EITF No. 00-19. Additionally, the cost to purchase a portion of the warrants and the proceeds received from selling a portion of the notes hedges during December 2006 have also been recorded to stockholders equity. As of June 28, 2008, the estimated fair value of the remaining hedges acquired in connection with the issuance of the 2023 Notes was zero. Subsequent changes in the fair value of these hedge transactions will not be recognized as long as the instruments remain classified as equity.

 

 

Goodwill

 

In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” Cadence conducts an annual impairment analysis of goodwill. The most recent analysis was completed during the third quarter of 2007, at which time Cadence determined that no indicators of impairment existed. For purposes of SFAS No. 142, Cadence operates under one reporting unit. Cadence’s annual impairment review process compares the fair value of its reporting unit to its carrying value, including the goodwill related to the reporting unit. To determine the reporting unit’s fair value, Cadence utilized the market valuation approach in the most recent evaluation.

 

The changes in the carrying amount of goodwill for the six months ended June 28, 2008 were as follows:

 

Acquired Intangibles, net

 

Acquired intangibles with finite lives as of June 28, 2008 were as follows:

 

 

During the six months ended June 28, 2008, Cadence acquired intangible assets of $8.6 million, including $0.6 million allocated to acquired in-process technology related to Cadence’s acquisition of Chip Estimate Corporation. The acquired in-process technology was immediately expensed because technological feasibility had not been established and no future alternative use existed.

 

Acquired intangibles with finite lives as of December 29, 2007 were as follows:

 

 

Amortization of acquired intangibles for the three and six months ended June 28, 2008 and June 30, 2007 was as follows:

 

 

Amortization of costs from existing technology is included in Cost of product and Cost of services. Amortization of costs from acquired maintenance contracts is included in Cost of maintenance.

Estimated amortization expense for the following fiscal years and thereafter is as follows:

 

 

 

Legal Proceedings

 

From time to time, Cadence is involved in various disputes and litigation matters that arise in the ordinary course of business. These include disputes and lawsuits related to intellectual property, mergers and acquisitions, licensing, contracts, distribution arrangements and employee relations matters. At least quarterly, Cadence reviews the status of each significant matter and assesses its potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount or the range of loss can be estimated, Cadence accrues a liability for the estimated loss in accordance with SFAS No. 5, “Accounting for Contingencies.” Legal proceedings are subject to uncertainties, and the outcomes are difficult to predict. Because of such uncertainties, accruals are based only on the best information available at the time. As additional information becomes available, Cadence reassesses the potential liability related to pending claims and litigation matters and may revise estimates.

 

On May 30, 2007, Ahmed Higazi, a former Cadence employee, filed suit against Cadence in the United States District Court for the Northern District of California alleging that Cadence improperly classified him and a class of other Cadence information technology employees as exempt from overtime pay. The suit alleges claims for unpaid overtime under the federal Fair Labor Standards Act and California law, waiting-time penalties under the California Labor Code, failure to provide proper earnings statements under California law, failure to provide meal periods and rest breaks as required by California law, unfair business practices under California Business & Professions Code section 17200, and unpaid 401(k) Plan contributions in violation of the Employee Retirement Income Security Act. On June 20, 2007, Cadence answered the plaintiff’s complaint, denying its material allegations and raising a number of affirmative defenses, and on December 19, 2007, Cadence filed an amended answer. A period of discovery conducted by both sides then ensued, and was followed in January 2008 by a private mediation of the case. At the mediation, the parties were successful in resolving their respective differences, and entered into a settlement agreement without contesting the merits of the claims or admitting liability. On July 7, 2008, the court approved the settlement agreement and Cadence paid the settlement amount shortly thereafter. Cadence accrued for this settlement in its Condensed Consolidated Balance Sheets as of June 28, 2008 and December 29, 2007.

 

While the outcome of disputes and litigation matters cannot be predicted with any certainty, management does not believe that the outcome of any current matters will have a material adverse effect on Cadence’s consolidated financial position, liquidity or results of operations.

 

Income Taxes

 

The Internal Revenue Service, or IRS, and other tax authorities regularly examine Cadence’s income tax returns. In July 2006, the IRS completed its field examination of Cadence’s federal income tax returns for the tax years 2000 through 2002 and issued a Revenue Agent’s Report, or RAR, in which the IRS proposed to assess an aggregate tax deficiency for the three-year period of approximately $324.0 million. In November 2006, the IRS revised the proposed aggregate tax deficiency for the three-year period to be approximately $318.0 million. The IRS is contesting Cadence’s qualification for deferred recognition of certain proceeds received from restitution and settlement in connection with litigation during the period. The proposed tax deficiency for this item is approximately $152.0 million. The remaining proposed tax deficiency of approximately $166.0 million is primarily related

to proposed adjustments to Cadence’s transfer pricing arrangements with its foreign subsidiaries and to Cadence’s deductions for foreign trade income. The IRS took similar positions with respect to Cadence’s transfer pricing arrangements in the prior examination period and may make similar claims against Cadence’s transfer pricing arrangements in future examinations. Cadence has filed a timely protest with the IRS and will seek resolution of the issues through the Appeals Office of the IRS, or the Appeals Office.

 

Cadence believes that the proposed IRS adjustments are inconsistent with applicable tax laws and Cadence is vigorously challenging these proposed adjustments. The RAR is not a final Statutory Notice of Deficiency, but the IRS imposes interest on the proposed deficiencies until the matters are resolved. Interest is compounded daily at rates that are published and adjusted quarterly by the IRS and have been between 4% and 10% since 2001. The IRS is currently examining Cadence’s federal income tax returns for the tax years 2003 through 2005.

 

Other Contingencies

 

Cadence provides its customers with a warranty on sales of hardware products for a 90-day period. These warranties are accounted for in accordance with SFAS No. 5. To date, Cadence has not incurred any significant costs related to warranty obligations.

 

Cadence’s product license and services agreements include a limited indemnification provision for claims from third parties relating to Cadence’s intellectual property. Such indemnification provisions are accounted for in accordance with SFAS No. 5. The indemnification is generally limited to the amount paid by the customer. To date, claims under such indemnification provisions have not been significant.

 

 

Basic net income (loss) per share is computed by dividing net income (loss), the numerator, by the weighted average number of shares of common stock outstanding, less unvested restricted stock grants, the denominator, during the period. Diluted net income per share gives effect to equity instruments considered to be potential common shares, if dilutive, computed using the treasury stock method of accounting. In periods in which a net loss is recorded, potentially dilutive equity instruments would decrease the loss per share and therefore are not added to the weighted average shares outstanding.

 

Cadence accounts for the effect of its 2023 Notes in the diluted net income per share calculation using the if-converted method of accounting. Under that method, the 2023 Notes are assumed to be converted to shares (weighted for the number of days outstanding in the period) at a conversion price of $15.65, and amortization of transaction fees, net of taxes, related to the 2023 Notes is added back to net income.

 

EITF No. 04-08, “Accounting Issues Related to Certain Features of Contingently Convertible Debt and the Effect on Diluted Earnings per Share,” requires Cadence to include in diluted earnings per share the shares of Cadence’s common stock into which the 1.375% Convertible Senior Notes Due 2011 and the 1.500% Convertible Senior Notes Due 2013, together, the Convertible Senior Notes, may be converted. However, since the Convertible Senior Notes meet the qualification of an Instrument C under EITF No. 90-19, “Convertible Bonds with Issuer Option to Settle for Cash Upon Conversion,” and because cash will be paid for the principal amount of the obligation upon conversion, the only shares that will be considered for inclusion in diluted net income per share are those relating to the excess of the conversion premium over the principal amount, using the “if-converted” method of accounting.

The calculations for basic and diluted net income (loss) per share for the three and six months ended June 28, 2008 and June 30, 2007 were as follows:

 

 

The following table presents the potential shares of Cadence’s common stock outstanding for the three and six months ended June 28, 2008 and June 30, 2007 that were not included in the computation of diluted net income (loss) per share because the effect of including these shares would have been anti-dilutive:

 

 

In December 2006, Cadence’s Board of Directors authorized a program to repurchase shares of Cadence’s common stock in the open market with a value of up to $500.0 million in the aggregate that was completed during the six months ended June 28, 2008. In February 2008, Cadence’s Board of Directors authorized a new program to repurchase shares of Cadence’s common stock in the open market with a value of up to $500.0 million in the aggregate.

 

The shares repurchased under Cadence’s stock repurchase programs during the three and six months ended June 28, 2008 and June 30, 2007 were as follows: