Third Quarter 2008 Results
Cadence reported third quarter 2008 revenue of $232 million, compared to revenue of $401 million reported for the same period in 2007. On a GAAP basis, Cadence recognized a net loss of $169 million, or $(0.67) per share on a diluted basis, in the third quarter of 2008, compared to net income of $73 million, or $0.24 per share on a diluted basis in the same period in 2007.
In addition to using GAAP results in evaluating Cadence's business, management believes it is useful to measure results using a non-GAAP measure of net income or net loss, which excludes, as applicable, amortization of intangible assets, stock-based compensation expense, in-process research and development charges, certain termination and legal costs, costs related to Cadence's withdrawn proposal to acquire Mentor Graphics Corporation and losses on the sale of Mentor Graphics Corporation shares, integration and acquisition-related costs, gains or losses and expenses or credits related to non-qualified deferred compensation plan assets, executive severance payments, restructuring charges and credits, losses on extinguishment of debt, equity in losses (income) from investments and write-down of investments. Non-GAAP net income or net loss is adjusted by the amount of additional taxes or tax benefit that the company would accrue if it used non-GAAP results instead of GAAP results to calculate the company's tax liability. See "GAAP to non-GAAP Reconciliation" below for further information on the non-GAAP measure.
Using this non-GAAP measure, net loss in the third quarter of 2008 was $23 million, or $(0.09) per share on a diluted basis, as compared to net income of $97 million, or $0.33 per share on a diluted basis, in the same period in 2007.
"Over the past two months, the Interim Office of the Chief Executive has been working closely with the management team, and taking aggressive steps to better position the company today and in the future. We remain focused on leveraging the company's many strengths, including our market leadership position, our innovative, cutting-edge technology and our long-standing customer relationships. We believe strongly that Cadence's highly ratable business model and improved cost structure form a solid foundation for enhanced operating and financial performance and long-term growth," said Lip-Bu Tan, Interim Vice Chairman of the Board of Directors and member of the Interim Office of the Chief Executive.
"We are focused on delivering compelling and innovative technology to our customers. As part of this, in November, we restructured our R&D organization into two teams, each led by an experienced industry veteran and supported by some of the best and brightest minds in our field. We expect the new R&D team structure will deliver greater product synergy and tighter integration as we leverage our leadership positions to grow our business. We are also pleased with the quality and breadth of our technology portfolio, which provides our customers with an attractive consolidation option as they seek to optimize their own productivity and efficiency," said Charlie Huang, Senior Vice President and member and chief of staff of the Interim Office of the Chief Executive.
"As we continue to manage through the global economic downturn, we are pleased that our transition to the new ratable mix is on track. During the quarter, we implemented a significant cost reduction program to refocus the company, improve our operational execution and financial performance and bring our expense base and operating structure in-line with our outlook," added Kevin S. Palatnik, Senior Vice President and Chief Financial Officer and member of the Interim Office of the Chief Executive. "We remain focused on improving efficiency and productivity, while continuing to invest in areas that enhance our competitive position and growth."
Results of Accounting Investigation
As announced on October 22, 2008, Cadence will be restating its quarterly financial statements for the periods ending March 29, 2008 and June 28, 2008. Cadence will adjust $24.8 million of product revenue recognized in the first quarter of 2008 and $12.0 million of product revenue recognized in the second quarter of 2008. This revenue will be instead realized over the term of the relevant arrangement. The results of the Audit Committee's investigation into the restatement issues are summarized below.
During the first quarter of 2008, Cadence executed a term license arrangement with a customer and, during the third quarter of 2008, Cadence executed a subscription license arrangement with the same customer. As part of its regular quarterly review process for the third quarter, Cadence identified certain factors that, when evaluated together, indicated that the software arrangements executed with this customer both in the first quarter and in the third quarter were negotiated in contemplation of one another. Accordingly, Cadence determined that the term license arrangement executed during the first quarter and the subscription license arrangement executed during the third quarter 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.
Consistent with good corporate governance practices, the Audit Committee of Cadence's Board of Directors, with the assistance of special counsel and other advisors, conducted an investigation of the events that led to the restatement of the Company's financial results. Upon completion of the investigation, the Audit Committee concluded that the circumstances that led to the restatement were not the result of illegal conduct on the part of any of Cadence's directors, officers, or other employees. However, as a result of the investigation, the Company has identified a material weakness relating to the insufficient design and ineffective operation of certain internal controls over the recognition of revenue from term license agreements. The Company has taken and will continue to take actions to remediate the deficiencies identified as promptly as practicable.
As part of the remediation efforts that Cadence has begun implementing in response to the identified material weakness, Cadence reexamined a transaction that occurred during the second quarter of 2008 in which it concurrently cancelled a subscription arrangement and executed both a term license arrangement and hardware arrangement with a customer. Specifically, Cadence determined that, despite the cancellation of the subscription arrangement, the customer did not intend to substantively cancel its right to access future new technology because at the time the subscription license was cancelled the customer intended to re-establish its right to access future new technology at a later time. Accordingly, Cadence has determined that $12.0 million of revenue originally recognized in the second quarter of 2008 relating to the term license and hardware arrangement should be recognized ratably over the term of the arrangement, consistent with the way in which revenue was recognized on the cancelled subscription arrangement.
Lip-Bu Tan, Interim Vice Chairman and member of the Interim Office of the Chief Executive, said, "Cadence is committed to accurate and transparent financial reporting. The Audit Committee of our Board of Directors conducted a thorough investigation and we are pleased to put this matter behind us and focus our efforts on executing our business strategy."
The effect of the restatement on certain line items in Cadence's financial statements for the quarter ended March 29, 2008, the quarter ended June 28, 2008 and the six months ended June 28, 2008 is as set forth in the chart below. The effects set forth below take into account the $24.8 million and $12.0 million of revenue respectively discussed above, product revenue of $8.4 million recognized in the second quarter of 2008 that should have been recognized in the first quarter of 2008, as previously disclosed in Cadence's Form 10-Q for the period ended June 28, 2008, other immaterial adjustments to costs and expenses and the tax effect of the restatement adjustments.
Quarter Ended Quarter Ended Six Months Ended March 29, 2008 June 28, 2008 June 28, 2008 ------------------ ------------------ ------------------ As As As Previously As Previously As Previously As Reported Restated Reported Restated Reported Restated -------- -------- -------- -------- -------- -------- (In thousands, except per share data) Total revenue $287,189 $270,750 $329,478 $308,041 $616,667 $578,791 Total costs and expenses $314,192 $314,192 $310,092 $307,485 $624,284 $621,677 Income (loss) from operations $(27,003) $(43,442) $ 19,386 $ 556 $ (7,617) $(42,886) Provision (benefit) for income taxes $ (5,488) $(11,451) $ 9,760 $ 12,720 $ 4,272 $ 1,269 Net income (loss) $(18,747) $(29,223) $ 4,996 $(16,794) $(13,751) $(46,017) Diluted net income (loss) per share $ (0.07) $ (0.11) $ 0.02 $ (0.07) $ (0.05) $ (0.18)