Bob,
I also enjoyed the story and agree it would make a good documentary.
Following is a bit more forward looking.
Enjoy,
Ian.
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Cadence Design Systems Inc.
September 2, 1999
TALES OF THE TAPE: Cadence's Bitter Pill Might Heal Co.
By Maria V. Georgianis
NEW YORK (Dow Jones)--The bitter pill that Cadence Design Systems Inc. (CDN) swallowed earlier this year by changing how it sells software in order to make its revenue more predictable may be just what the doctor ordered.
But people are divided about how quickly its depressed stock will recover.
In addition to the revenue and earnings declines that its new software-sales policies unleashed, Cadence faces more challenges to defend its turf from rivals and new entrants in the chip-design software market.
And it's still is trying to create a stable corporate culture two years after the resignation of legendary Chief Executive Officer Joe Costello, said Gary Smith, an analyst with market research firm Dataquest Inc.
However, prospects of heightened spending for Cadence's type of products and progress in its transition to subscription sales could move the stock north to 20 a share in 12 months, according to BancBoston Robertson Stephens analyst Arnab Chanda.
The stock has been trading near its 52-week low of 9 3/16 set Aug. 11 and at a five-year valuation low, before Chanda upgraded it to a buy from long-term attractive Tuesday. The stock closed Wednesday at 13 1/2.
When the stock was below 12, "it looked enticing to upgrade it on a 'too cheap' basis," said Credit Suisse First Boston analyst Erach Desai. But Desai said he wants to wait to see clear signs of a turnaround before recommending it.
The stock may see a catalyst in the fourth quarter with "potentially stronger bookings momentum and the adoption of newer products," the analyst said.
Over the long-term, Wall Street is giving Cadence the benefit of the doubt.
"They are likely to remain a major factor in the EDA industry," said Merrill Lynch & Co. analyst Jay Vleeschhouwer. "They have a substantial installed base and set of technology and reach into the marketplace."
Chip-Design Software Industry More Competitive
Cadence is a leader in the $2.6 billion market for electronic-design automation, or EDA, software, used to create the integrated circuits and electronics in telephones, computers and other devices. It held a 27.5% share last year - at least 10 percentage points ahead of its nearest rival Synopsys Inc. (SNPS). The company isn't likely to drop out of first place and is "technically stronger than they've been for a long time," Smith said.
Still, the company has been losing ground to Synopsys, Avant Inc. (AVNT) and Mentor Graphics Inc. (MENT) in their respective EDA segments and is no longer dominant in those areas like it was in the early 1990s, he said.
And in Cadence's stronghold of physical-design software, there's more competition emerging from well-regarded upstarts such as Magma Design Automation and Monterey Design Systems, and from Synopsys as well.
The EDA industry is growing at about a annual 15% rate, but it can accelerate to 20% or greater as customers begin buying software to design systems-on-a-chip and chips at 0.18 micron or smaller in size, said Cadence Chief Executive Ray Bingham.
"The story is more about the growth that's coming than the growth that's currently happening," he said. Less than 20% of chip designs currently, for example, are being attempted at 0.18 micron or smaller, Bingham noted.
"Over the next two or three years there will be a rapid rate of adoption (of new software)," he said. Cadence has been shipping software for these new design requirements and is expected to pick up the pace over the next few quarters.
"The products that will be released in Q4 and the first half of next year are on schedule and generating excitement about industry analysts and customers alike," Bingham said.
Despite the market's growth, Cadence's emphasis on subscription sales is depressing revenue. That's because in subscriptions, Cadence places sales on its books on an evenly divided basis over the length of the contract. In other types of sales, the company accounts for most of the software revenue upfront.
Software revenue comparisons will be difficult for a while because the reported revenue will be contrasted to quarters with few subscription sales. Cadence doesn't expect year-over-year software revenue growth until 2000's second quarter.
Wall Street expects Cadence's 1999 revenue is be at least 15% below 1998's $1.32 billion and for 2000 revenue to be about flat with 1998.
Prior Type Of Software Contract Saturated Mkt
Last year, the company's total revenue rose by 33%, or more than double the total market's growth. Cadence boosted its revenue by promoting three-year software contracts that were deeply discounted.
It ended up saturating its market because the contracts were longer than customers' product-design cycles required. That ended up costing Cadence sales because it lowered incentives for customers to buy more.
"We grew our product business faster than what was sustainable," Bingham said.
These three-year contracts were coming during a tough time for the chip sector. Customers needed enticements to buy, and Cadence made it easier by allowing them to pay for the software gradually and by financing deals.
At the same time, Cadence immediately counted the product it sold under these three-year contracts as revenue, even though the software was paid for over three years. The impact was near-term revenue growth was overstated, analysts said.
Cadence reassessed the situation and began emphasizing subscription licenses. When it reported its second quarter last month, Cadence said 1999 earnings would be worse than already lowered estimate because of its shift to subscriptions. Earnings had previously been reduced because of weakness in services and product sales.
The consensus 1999 earnings view is 30 cents per share, and the 2000 view is 36 cents, according to First Call/Thomson Financial. In 1998, the company reported $1.18.
Making Progress With Subscription Bookings
Cadence has been making progress on transitioning its products bookings towards subscriptions, said BancBoston's Chanda, citing that as a reason he upgraded the stock.
By the end of this quarter, Cadence has told analysts that it should generate at least 30% of its bookings from subscription licenses, up from 10% in the second quarter. By the first quarter of 2000, Cadence is likely to have one quarter's worth of bookings from subscriptions, Chanda said.
Cadence plans to disclose how much product backlog it is building when it reports its third-quarter results on Oct. 19.
The chip-design software sector as a whole has been experimenting with different ways of selling software. Generally, companies have been moving to shorter contracts that suit customers' faster chip-design cycles.
Companies have been trying to lessen their reliance on so-called perpetual sales that give a customer a "99-year" right to use the software. These contracts lower the incentive for customers to upgrade the product until their existing software costs are depreciated, said Merrill's Vleeschhouwer.
Under subscriptions, which act like rentals, there is no depreciation and thus more of an incentive to stay current with the quickly changing software, he said.
Cadence hopes to generate one-third of its revenue from subscriptions, another third from a new two-year contract, and the final third from perpetual sales. It hopes to convert customers who signed three-year contracts to subscription sales, as these contracts expire next year.
Other chip-design software companies already have gone through this transition. When Synopsys began transitioning to subscription sales two years ago, it's growth had initially slowed and the stock struggled, said Credit Suisse's Desai.
Even if Cadence's sales last year had risen at a more "normal" rate of growth, or between 15% to 20%, it's still likely that this year's revenue may have decelerated, Vleeschhouwer said, noting that Cadence has need to upgrade its products.
Now, Cadence is technically competitive with its rivals, said Dataquest's Smith "If they can stabilize and pull their sales force back together,' he said, "those guys are sharp enough to full the holes to start the growth up again."
- By Maria V. Georgianis;
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