Why Is Cadence (CDNS) Down 8.9% Since Last Earnings Report?

It has been about a month since the last earnings report for Cadence Design Systems (CDNS). Shares have lost about 8.9% in that time frame, underperforming the S&P 500.

Will the recent negative trend continue leading up to its next earnings release, or is Cadence due for a breakout? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at its most recent earnings report in order to get a better handle on the important catalysts.

Cadence’s Q3 Results Ride on Robust Adoption of its Digital & Signoff, Custom & Analog, and IP Solutions

Cadence Design Systems delivered robust third-quarter 2018 results, wherein both the top and bottom lines outpaced the respective Zacks Consensus Estimate and also management’s guided ranges. Notably, the company adopted the new accounting standard rules of ASC 606 from the first quarter of fiscal 2018 and accordingly incorporated the same while reporting the third-quarter results.

Cadence delivered non-GAAP earnings of 49 cents per share for the third quarter, surpassing the Zacks Consensus Estimate by 8 cents. Management had predicted earnings between 40 cents and 42 cents. The figure surged 40% from the year-ago figure of 35 cents.

Under the old accounting standard revenues increased 8.4% year over year to almost $526 million. Under ASC 606, the company reported revenues of $532.5 million comfortably beating the Zacks Consensus Estimate of $518 million. Moreover, the top line was ahead of the high end of management’s expectation of $510-$520 million.

Robust adoption of the company’s digital and signoff, custom and analog, and IP solutions along with an ever expanding customer base drove year-over-year growth.

Quarter in Detail

Under ASC 606, Product & Maintenance revenues came in at approximately $495 million and accounted for almost 93% of total revenues. The figure was well ahead of Zacks Consensus Estimate of $487 million. Notably, as per old ASC 605, Product & Maintenance revenues effectively grew 8.5% year over year and came in at $489.5 million.

Under ASC 606, Services revenues of $37.5 million contributed 7% to total revenues, was ahead of the Zacks Consensus Estimate of $31.5 million. Per ASC 605, Services revenues effectively increased 6.7% and came in at $36.5 million.

Geographically, Americas, Asia, Europe, Middle East and Africa (EMEA) and Japan contributed 44%, 29%, 19% and 8%, respectively to the total revenues under the new accounting standard.

The company reported non-GAAP operating margin of 32% during the quarter.

Product-wise, Functional Verification, Digital IC & signoff, Custom IC design, Systems Interconnect & Analysis and IP, comprised 22%, 30%, 26%, 9% and 13% of the total revenues, respectively per ASC 606 standard.

IP segment witnessed strong quarter driven by robust adoption of the company’s PCIe and DDR products.

The company enhanced Tensilica solution with DNA 100 Processor, a deep neural-network based accelerator. The accelerator will improve efficiency and performance for emerging applications in drones, Intenet of Things (IoT), automotive sensor fusion, surveillance, among others.

Considering, System Design and Verification solutions, traction witnessed by Xcelium Parallel Simulator and Palladium Z1 drove revenues. Traction witnessed by Palladium Z1 on the back of strong demand for growing hardware capacity was notable. Further, two customers expanded Palladium Z1 installation in the quarter. Five new logos were also added in the quarter.

Cadence Verification Suite reported revenue growth of 9% on a year-over-year basis.

The management is also elated on the order strength in Palladium Cloud solution which offers cloud-based emulation capacity as per the customers’ demand.

In the Digital and Signoff space, the company added 19 new logos, with revenues growing 9% year-over-year. Cadence taped-out greater than twelve 7-nanometer (nm) designs in the quarter by leveraging Innovus. Management noted that around 50 customers have selected Innovus.

The company remains optimistic about it ongoing collaboration with Taiwan Semiconductor Manufacturing Company (TSM). Notably Cadence garnered four partner of the year awards at TSM’s Open Innovation Platform, comprising 5 nm design architcture collaboration.

Furthermore, Cadence collaborated with Microsoft Azure, Amazon Web Services (“AWS”) and Google Cloud platform to enable smooth design development of electronic systems and semiconductors. The management is elated with the sturdy pipeline of the company’s innovative cloud-ready solutions.

With Cadence Cloud, the company aims to offer a comprehensive cloud portfolio enabling the development of semiconductors and other electronic systems.

The considerable customer wins and repeat orders bolstered the top-line.

Cadence is focusing on providing end-to-end solutions, which rapidly reduces the time required to introduce a semiconductor product in the market.

The company is experiencing strong demand for its software – particularly verification and digital design products – from customers providing datacenter servers, networking products and smartphones.

The strong collaborations and smart product launches augur well for Cadence in the longer haul.

Balance Sheet & Cash Flow

The company ended the quarter with cash and cash equivalents & short-term investments of approximately $550 million compared with the previous quarter’s figure of $825.4 million. We may note that at the end of the quarter, around 25% of cash and short-term investments were in the United States.

Cadence’s long-term debt as on Sep 29, 2018, was $345.1 million compared with $344.9 million, as on Jun 30, 2018.

The company generated operating cash flow of almost $110 million in the quarter compared with previous quarter’s reported figure of $205.3 million.

The company repurchased shares worth approximately $50 million in the third quarter.

Guidance

For fourth-quarter 2018, Cadence expects total revenues under ASC 606 in the range of $545-$555 million and non-GAAP earnings in the range of 46-48 cents per share. Non-GAAP operating margin is anticipated to be in the range of 29-30%.

The company raised 2018 outlook expecting the third-quarter momentum to continue. Revenues are now projected in the range of $2.113-$2.123 billion, up from $2.07-$2.09 billion anticipated earlier. Non-GAAP earnings are now guided in the range of $1.80-$1.82 per share, raised from the previous band of $1.64-$1.70.

Further, non-GAAP operating margin for 2018 is expected at 29.5-30%. Previously, the company has predicted non-GAAP operating margin to come in at 28%.

Similarly, operating cash flow is anticipated in the range of $550-$580 million, instead of earlier prediction of $535-$565 million.

The company anticipates repurchasing shares worth approximately $75 million in the fourth quarter.

How Have Estimates Been Moving Since Then?

In the past month, investors have witnessed an upward trend in fresh estimates. The consensus estimate has shifted 17.81% due to these changes.

VGM Scores

Currently, Cadence has a nice Growth Score of B, a grade with the same score on the momentum front. However, the stock was allocated a grade of F on the value side, putting it in the lowest quintile for this investment strategy.

Overall, the stock has an aggregate VGM Score of C. If you aren't focused on one strategy, this score is the one you should be interested in.

Outlook

Estimates have been trending upward for the stock, and the magnitude of these revisions looks promising. It comes with little surprise Cadence has a Zacks Rank #1 (Strong Buy). We expect an above average return from the stock in the next few months.

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