UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

FORM 10-Q

 

 

 

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 November 29, 2008, 256,278,936 shares of the registrant’s common stock, $0.01 par value, were outstanding.

 

EXPLANATORY NOTE

 

On December 11, 2008, Cadence Design Systems, Inc., or Cadence, restated its unaudited Condensed Consolidated Financial Statements as of and for the three months ended March 29, 2008 and as of and for the three and six months ended June 28, 2008. The restatement corrected revenue recognition with respect to an arrangement in which $24.8 million of Product revenue was recognized in the first quarter of 2008 and $1.0 million of Maintenance revenue was recognized in the second quarter of 2008, but should be recognized during the term of the arrangement, beginning in the fourth quarter of 2008. The restatement also corrected revenue recognition with respect to an arrangement in which $12.0 million of Product revenue was recognized in the second quarter of 2008, but should be recognized during the term of the arrangement, beginning in the third quarter of 2008. In addition, Cadence made two other Product revenue adjustments that were previously disclosed in Cadence’s Quarterly Report on Form 10-Q for the quarter ended June 28, 2008, initially filed with the Securities and Exchange Commission, or SEC, on July 29, 2008, and one other previously determined immaterial adjustment. See Note 2 of Cadence’s Amendment No. 1 to Form 10-Q/A for the quarters ended March 29, 2008 and June 28, 2008. In addition to this Form 10-Q, Cadence is concurrently filing Amendment No. 1 to Form 10-Q/A for the quarters ended March 29, 2008 and June 28, 2008.

CADENCE DESIGN SYSTEMS, INC.
INDEX

 

 

 

CADENCE DESIGN SYSTEMS, INC.

 

 

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

 

 

The Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q 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 comply with the requirements of Section 13(a) of the Securities Exchange Act of 1934, as amended, or the Exchange Act, for a Quarterly Report on Form 10-Q 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. Cadence’s fiscal year end is the Saturday closest to December 31. Fiscal 2007 was a 52-week year and fiscal 2008 will be a 53-week year ending on January 3, 2009.

 

The unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q 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 3 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 nine months ended September 27, 2008. Therefore, the adoption of SFAS No. 159 did not impact Cadence’s consolidated financial position, results of operations or cash flows.

 

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. 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 nine months ended September 27, 2008 and September 29, 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 nine months ended September 27, 2008 and September 29, 2007 were as follows:

 

 

Cadence did not grant any stock options during the three months ended September 27, 2008. 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 nine months ended September 27, 2008 and September 29, 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.

 

During the three months ended September 27, 2008, Cadence modified the performance goals related to its performance-based restricted stock awards. On the modification date, Cadence evaluated the likelihood of achievement of both the original performance goals and the modified performance goals. For the performance-based restricted stock awards in which the original performance goal was unlikely to be achieved, Cadence reversed the previously recorded stock-based compensation expense of $6.5 million, calculated the fair value of the restricted stock award on the modification date, and will record the stock-based compensation expense to the extent that the modified performance goals are expected to be achieved over the remaining weighted average requisite service period of 1.0 years. The fair value of the modified performance-based restricted stock awards was $6.2 million, or $7.34 per share. For the performance-based restricted stock awards in which both the original performance goal and the modified performance goal were determined to be likely to be achieved, the original grant date fair value will continue to be recorded as stock-based compensation expense as if no modification had occurred.

 

As noted in Note 16 below, certain executive officers resigned from their positions at Cadence in October 2008. Pursuant to the resignations and the terms of the respective employment agreements of these executive officers, the performance-based restricted shares have either been forfeited or will vest subject to the terms of those agreements. Cadence will record additional stock-based compensation expense during the three months ending January 3, 2009 relating to the accelerated vesting, which will be offset by the reversal of previously recorded stock-based compensation expense relating to the performance-based awards that were forfeited.

 

Stock-based compensation expense (credits) related to the performance-based restricted stock grants for the three and nine months ended September 27, 2008 and September 29, 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 three months ended September 27, 2008, Cadence agreed to make the period’s payment of $2.9 million in cash. During the nine months ended September 27, 2008, Cadence agreed to make both of the period’s payments totaling $5.6 million in cash. Under the terms of this performance-based bonus plan, future payments may be made in cash or stock. Stock-based compensation expense related to these performance-based bonus plans and the shares issued for the three and nine months ended September 27, 2008 and September 29, 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 1^st and August 1^st of each year and the purchase dates under the ESPP are January 31^st and July 31^st of each year.

 

Shares of Cadence’s common stock issued under the ESPP for the three and nine months ended September 27, 2008 and September 29, 2007 were as follows:

 

 

Stock-based 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 nine months ended September 27, 2008 and September 29, 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 September 27, 2008:

 

 

 

Available-for-sale Securities

 

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 available-for-sale 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 securities as of September 27, 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 September 27, 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 $2.4 million during the three months ended September 27, 2008 and $7.8 million during the nine months ended September 27, 2008. This impairment is included in Other income (expense), net in the Condensed Consolidated Statement of Operations. Cadence did not recognize an other-than-temporary impairment of available-for-sale securities during the three or nine months ended September 29, 2007.

 

Net recognized gains (losses) from the sale of available-for-sale securities for the three and nine months ended September 27, 2008 and September 29, 2007 were as follows:

 

 

During the nine months ended September 27, 2008, Cadence purchased approximately 4.3 million shares of Mentor Graphics Corporation, or Mentor Graphics, common stock in connection with its proposed acquisition of Mentor Graphics. Subsequent to the announcement of Cadence’s withdrawal of the proposed acquisition of Mentor Graphics and during the three months ended September 27, 2008, Cadence sold its entire equity interest in Mentor Graphics at a loss of $9.4 million.

 

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 did not record write-downs due to other-than-temporary declines in value of non-marketable securities for the three months ended September 27, 2008, but did record $2.0 million for the three months ended September 29, 2007. 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 nine months ended September 27, 2008 and $2.6 million for the nine months ended September 29, 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 of 1933, as amended, or the Securities Act, for resale to qualified institutional buyers pursuant to SEC Rule 144A of the Securities Act, or 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 and provided that Cadence’s stock price is greater than $18.00 per share, 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 September 27, 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 $11.7 million as of September 27, 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 $5.2 million as of September 27, 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 were amortized to interest expense using the straight-line method over five years. In connection with the issuance of the Convertible Senior Notes in December 2006, Cadence repurchased $189.6 million principal amount of the 2023 Notes, and in August 2008, Cadence repurchased $230.2 million principal amount of the 2023 Notes upon the election of the holders of the 2023 Notes and pursuant to the terms of the 2023 Notes, for a total consideration of $230.8 million, reducing the outstanding 2023 Note balance to $0.2 million as of September 27, 2008. Concurrently with the issuance of the 2023 Notes, Cadence entered into hedge and warrant transactions, all of which expired during the nine months ended September 27, 2008 and no settlement was required.

 

 

Earnings of Foreign Subsidiaries

 

During the three months ended September 27, 2008, Cadence repatriated $200.0 million of earnings from a foreign subsidiary, earnings which had previously been considered to be indefinitely reinvested outside the United States and for which deferred taxes had not been previously provided. Cadence currently expects that an additional $117.9 million of previously untaxed earnings from foreign subsidiaries will not be indefinitely reinvested outside

of the United States. As a result, Cadence has accrued a tax expense of $71.0 million during the three and nine months ended September 27, 2008 to provide for the potential U.S., state and foreign income taxes on these repatriations. Cadence intends to indefinitely reinvest the remainder of its undistributed earnings of its foreign subsidiaries, which Cadence estimates to be $29.0 million for the year ending January 3, 2009, to meet both the working capital and long-term capital needs of its subsidiaries and of Cadence.

 

Internal Revenue Service Examinations

 

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.

 

Unrecognized Tax Benefits

 

During the nine months ended September 27, 2008, Cadence recognized a $7.9 million decrease in the net liabilities for unrecognized tax benefits based on new information received during the period, which Cadence accounted for as a $7.9 million increase in the balance of Common stock and capital in excess of par value.

 

Cadence believes that it is reasonably possible that the total amounts of unrecognized tax benefits for its transfer pricing arrangements with its foreign subsidiaries could significantly increase or decrease during the fiscal year ending January 3, 2009 if the Appeals Office develops new settlement guidelines that change Cadence’s measurement of the tax benefits to be recognized upon effective settlement with the IRS. Because of the uncertain impact of any potential settlement guidelines, Cadence cannot currently provide an estimate of the range of the reasonably possible change.

 

Cadence also believes that it is reasonably possible that the total amounts of unrecognized tax benefits related to the value of stock options included in its cost sharing arrangements with its foreign subsidiaries could significantly increase or decrease during the fiscal year ending January 3, 2009 based on the outcome of the IRS appeal of Xilinx, Inc. v. Commissioner, which is before the U.S. Court of Appeals for the Ninth Circuit. Cadence believes that the range of reasonably possible change is an increase in unrecognized tax benefits of $6.4 million to a decrease of unrecognized tax benefit of $1.6 million.

 

 

During the three months ended September 27, 2008, Cadence determined that it would initiate a plan of restructuring intended to decrease costs by reducing its workforce throughout the company, and that the expenses associated with that reduction were both probable and estimable. Cadence recorded Restructuring and other charges of approximately $48.1 million during the three months ended September 27, 2008, which included estimated severance payments, severance-related benefits and costs for outplacement services for at least 625 employees. Cadence expects to record an additional $17.0 million to $22.0 million in restructuring costs during the three

months ending January 3, 2009 related to other aspects of this restructuring that were not probable as of September 27, 2008, or that should be recorded as the expense is incurred. Cadence accounted for the termination and benefits charges associated with this Restructuring in accordance with SFAS No. 112, “Employers’ Accounting for Postemployment Benefits — An Amendment of FASB Statements No. 5 and 43.”

 

As of September 27, 2008, Cadence had not made any payments in connection with this restructuring plan, and the entire $48.1 million is included in Accounts payable and accrued liabilities in its Condensed Consolidated Balance Sheet. Due to varying regulations in the jurisdictions and countries in which Cadence operates, Cadence expects substantially all termination benefits to be paid by January 2, 2010.

 

In connection with this restructuring initiative, Cadence has recorded estimated provisions for severance payments, severance-related benefits and outplacement costs. Cadence regularly evaluates the adequacy of its restructuring accrual, and adjusts the balance based on changes in estimates and assumptions. Cadence may incur future charges for changes in estimates related to amounts previously recorded and for additional activities under this restructuring.

 

 

Goodwill

 

In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” Cadence conducts a goodwill impairment analysis annually and as necessary if changes in facts and circumstances indicate that the fair value of Cadence’s reporting unit may be less than its carrying amount. Cadence’s goodwill impairment test consists of the two steps required by SFAS No. 142. The first step requires that Cadence compare the estimated fair value of its single reporting unit to the carrying value of the reporting unit’s net assets, including goodwill. If the fair value of the reporting unit is greater than the carrying value of its net assets, goodwill is not considered to be impaired and no further testing is required. If the fair value of the reporting unit is less than the carrying value of its net assets, Cadence would be required to complete the second step of the test by analyzing the fair value of its goodwill. If the carrying value of the goodwill exceeds its fair value, an impairment charge is recorded.

 

To determine the reporting unit’s fair value, Cadence uses a combination of the income and market valuation approaches. In determining its overall conclusion of reporting unit fair value, Cadence considers the estimated values derived from both the income and market valuation approaches and weighs the values from each approach equally.

 

The income approach provides an estimate of fair value based on discounted expected future cash flows. These expected future cash flows are based on Cadence’s estimated market segment growth rates, assumed market segment share growth rates, estimated costs and appropriate discount rates based on the reporting unit’s weighted average cost of capital. Cadence’s estimates of market segment growth, market segment share growth and costs are based on historical data, various internal estimates and a variety of external sources, and are developed as part of Cadence’s routine long-range planning process.

 

The market approach provides an estimate of the fair value of Cadence’s one reporting unit using various price or market multiples applied to the reporting unit’s operating results and then applying an appropriate control premium. The control premium is determined by considering control premiums offered as part of acquisitions in both Cadence’s market segment and comparable market segments.

 

The most recent goodwill impairment analysis was completed during the three months ended September 27, 2008, and Cadence determined that no indicators of impairment existed as of September 27, 2008. However, subsequent to September 27, 2008, Cadence observed possible impairment indicators including a further deterioration in the market in which Cadence operates and a decrease in its market capitalization. As such, Cadence determined indicators exist subsequent to September 27, 2008 that indicate that the fair value of Cadence’s reporting unit may be less than its carrying amount. Accordingly, Cadence will complete an interim goodwill impairment test during the three months ending January 3, 2009. If the fair value of the reporting unit is determined to be less than its carrying value, Cadence will complete step two of the goodwill impairment test by evaluating the fair value of its goodwill as required by SFAS No. 142 and record an impairment charge, if necessary.

The changes in the carrying amount of goodwill for the nine months ended September 27, 2008 were as follows:

 

 

Acquired Intangibles, net

 

Acquired intangibles with finite lives as of September 27, 2008 were as follows:

 

 

During the nine months ended September 27, 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. During the nine months ended September 27, 2008, Cadence made cash payments of $13.4 million for previously completed business combinations and acquisitions of intangibles, $5.5 million for business combinations completed during the nine months ended September 27, 2008 and $1.7 million for earnouts related to previously completed business combinations that were earned during the nine months ended September 27, 2008.

 

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

 

Amortization of acquired intangibles for the three and nine months ended September 27, 2008 and September 29, 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.

 

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.

 

See also Note 16 — Subsequent Events.

 

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 typically 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 nine months ended September 27, 2008 and September 29, 2007 were as follows:

 

The following table presents the potential shares of Cadence’s common stock outstanding for the three and nine months ended September 27, 2008 and September 29, 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:

 

 

 

As of September 27, 2008, Cadence’s Board of Directors had authorized the following programs to repurchase shares of Cadence’s common stock in the open market:

 

 

The shares repurchased under Cadence’s stock repurchase programs during the three and nine months ended September 27, 2008 and September 29, 2007 were as follows:

 

 

The changes in retained earnings for the three and nine months ended September 27, 2008 were as follows:

 

 

 

Cadence records a gain or loss on re-issuance of treasury stock based on the total proceeds received in the transaction. Gains on the re-issuance of treasury stock are recorded as a component of Capital in excess of par in Stockholders’ Equity. Losses on the re-issuance of treasury stock are recorded as a component of Capital in excess of par to the extent that there are gains to offset the losses. If there are no treasury stock gains in Capital in excess of par, the losses upon re-issuance of treasury stock are recorded as a component of Retained earnings in Stockholders’ Equity. Cadence recorded losses on the re-issuance of treasury stock as a component of Retained earnings of $35.2 million and $79.1 million during the three and nine months ended September 27, 2008, respectively.

 

 

Other comprehensive income (loss) includes foreign currency translation gains and losses and unrealized gains and losses on available-for-sale marketable securities, net of related tax effects. These items have been excluded from net income (loss) and are reflected instead in Stockholders’ Equity.

 

Cadence’s comprehensive income (loss) for the three and nine months ended September 27, 2008 and September 29, 2007 was as follows:

 

 

Cadence’s Other income (expense), net, for the three and nine months ended September 27, 2008 and September 29, 2007 was as follows:

 

 

 

The supplemental cash flow information for the nine months ended September 27, 2008 and September 29, 2007 is as follows:

 

 

Cadence adopted FASB Interpretation, or FIN, No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109,” on December 31, 2006, the first day of fiscal 2007. The cumulative effect of adopting FIN No. 48 was reported as an adjustment to the opening balance of retained earnings (or other appropriate components of equity or net assets) in the Condensed Consolidated Balance Sheet, which amounts were non-cash items in Cadence’s Statement of Cash Flows for the nine months ended September 29, 2007.

 

SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” requires disclosures of certain information regarding operating segments, products and services, geographic areas of operation and major customers. SFAS No. 131 reporting is based upon the “management approach”: how management organizes the company’s operating segments for which separate financial information is (i) available and (ii) evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Cadence’s chief operating decision maker is its President and Chief Executive Officer or an authorized person or persons performing functions similar to a principal executive officer, or PEO.

 

Cadence’s PEO reviews Cadence’s consolidated results within one segment. In making operating decisions, the PEO primarily considers consolidated financial information, accompanied by disaggregated information about revenues by geographic region.

 

Outside the United States, Cadence markets and supports its products and services primarily through its subsidiaries. Revenue is attributed to geography based on the country in which the product is used or services are delivered. Long-lived assets are attributed to geography based on the country where the assets are located.

 

The following table presents a summary of revenue by geography:

 

 

No one customer accounted for 10% or more of total revenue for the three months ended September 27, 2008 and one customer accounted for 14% of total revenue during the three months ended September 29, 2007. No one customer accounted for 10% or more of total revenue during the nine months ended September 27, 2008 or during the nine months ended September 29, 2007.

 

As of September 27, 2008, one customer accounted for 12%, one customer accounted for 11% and one customer accounted for 10% of Cadence’s Receivables, net and Installment contract receivables. As of December 29, 2007, one customer accounted for 11% and one customer accounted for 10% of Cadence’s Receivables, net and Installment contract receivables.

The following table presents a summary of long-lived assets by geography: