Cadence Q2 10-Q Report : Between The Lines

Following up on my post last week on Cadence’s Q2 earnings call, here are my “between the lines” observations of Cadence’s Q2 10-Q report:

“Our recent announcement of the proposed acquisition of Mentor Graphics Corporation, or Mentor Graphics, has caused some customers to demand more flexibility in accessing new technology.”

Translation: When the large EDA vendors negotiate a multi-year deal with their customers, the deal will include “remix” rights allowing the customer to periodically alter his license mix (e.g. trade in simulator seats for synthesis seats). Typically, “new technology”, i.e. tools not yet available at the time of the deal, are excluded or are available only at some premium vs. existing technology. Evidently, Cadence customers are asking for the ability to remix in technology that might be acquired from Mentor. This is slowing things down and may have caused some deals to slip out.

To enable us to keep our focus on the value of our technologywe are moving to a license mix thatwill result in increased ratable revenue for us.” (Note: You can go to the 10-Q report for the full sentence, but the key part is shown above.)

Translation: EDA vendors that are publicly traded, like Cadence, need to hit their quarterly revenue estimates, or they are punished, as we saw last week. Since customers know this, they often defer purchases until the end of the EDA vendor’s fiscal quarter or year, resulting in the “hockey stick” effect (i.e. the graph of orders over time looks like a hockey stick with the big increase at the end of the quarter). By waiting until an EDA vendor is desperate to “make it’s numbers”, they can negotiate the best price. In order to be less dependent on the quarter end business, Cadence is increasing to a 90% ratable model. In this way, most of Cadence’s revenue will be determined by backlog orders, so they won’t need to heavily discount to hit their numbers.

“In order to provide our customers with the desired flexibility, our license mix will change to a higher proportion of licenses that require ratable revenue recognition which will result in a decrease in our expected revenue for the second half of fiscal year 2008.”

Translation: Instead of recognizing 100% revenue when the order is received (or the license is shipped) as for a perpetual license, the revenue for a subscription license is recognized “ratably” over the term of the license.  For instance, if the subscription license is for 24 months, then 1/24 of the revenue is recognized each month. So, in the upcoming quarters, Cadence will have reduced revenue due to the fact that the revenue is deferred out over the term on the subscription licenses. The nice part for Cadence is that they can attribute the decline in revenue over the next few quarters to the change in license mix.  This will be partly true, but they can also obscure poor orders performance since they do not report orders to the investment community, only revenue and backlog (as far as I know).

“To offset some of the impact of our expected decrease in revenue, we have implemented cost savings initiatives, including reducing headcount, decreasing employee bonuses and reducing other discretionary spending.”

Translation: I’ve heard that Cadence has already instituted 3 shutdowns this year, July 4th week, Thanksgiving week, and Christmas to New Years. Incentive bonuses usually accrue in Q4, so that will help later this year. I have not heard of any headcount reductions since last week, but maybe someone else has.

Hope that helps.

harry the ASIC guy

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