Commentary: Electronics IP Industry - A November 2008 Update

Fresh news broke on October 15, 2008, that the CEO of Cadence Mike Fister and four of his top executives had “resigned” from Cadence. Shares of the company, which had lost three quarters of their value over the last 12 months, immediately went down another 12% percent to $4.68 upon the news release October 15. (Cadence closed at $4.51 per share on Friday October 17, leaving a dismal market cap of $1.17 billion).

Combined with the deteriorating revenues, earnings, and stock price endured by Cadence in recent quarters, the failed takeover of Mentor earlier this year meant that top management changes at Cadence were arguably inevitable. It is said by EDA insiders that Mike Fister was already out interviewing other companies for a new position for the last several months. In addition to the aborted Mentor bid, Cadence's inability to sell itself to a private equity firm in 2007 and an expensive Cadence share buyback were also causes for Fister's resignation.

It can fairly be said that Cadence also made some poor product decisions during Fister's four-year reign. It did not focus on expansion into key areas such as system level design nor into FPGA markets. Cadence also cut back its involvement in EDAC and halted its appearances at the industry's main trade show, the Design Automation Conference. Finally, EDA industry analyst Gary Smith claims that Fister shifted the Cadence away from industry-standard two- or three-year product & service license contracts toward five-year agreements, enabling Cadence to book more revenue up front. The shift to longer contracts "insulated their actual earnings for three years. At the end of three years, the bubble popped," Smith asserts.

(Of course, Bush 43's current second economic recession didn't help Cadence either. Indeed, Mentor's market cap had deteriorated to only $761 million as of October 17, 2008, and even rival Synopsys' market cap had declined some, although it was still a very healthy $2.63 billion on October 17).

Collateral damage at Cadence: Some analysts are predicting that Cadence would soon be forced to lay off up to 1500 of its 5000 current employees. But Cadence might be able to postpone a layoff or at least mitigate its depth, because the October 15 resignations did eliminate some giant salaries. According to the Cadence proxy statement filed in March 2008 with the S.E.C., Fister's total compensation exceeded $13.5 million in 2007. Even if not increased since the filing, the total annual compensation of the five executives who resigned on the Ides of October 2008 was more than $26 million.

Cadence has not yet provided more details on possible layoffs, as this IP Commentary goes to press. Cadence may wait till a new management team is hired, installed and comfortable before announcing cost reduction moves.

In the meantime, the Cadence Board of Directors has formed an Interim Office of the Chief Executive to oversee the day-to-day running of the company's operations. The Interim Office of the Chief Executive includes: John B. Shoven, Ph.D., Chairman of the Board of Directors of Cadence, Lip-Bu Tan, Interim Vice Chairman of Cadence's Board, Kevin S. Palatnik, Senior Vice President and Chief Financial Officer and Charlie Huang, Senior Vice President - Business Development and Chief of Staff of the Interim Office of the Chief Executive.

Additional troubles:

Over and above the Cadence troubles outlined in the foregoing, the company announced still more problems on October 22, 2008 when it postponed its promised final Q3 financial results.

On October 22, Cadence announced that “it is reviewing, in conjunction with the company's independent accountants and legal advisors, the recognition of revenue related to customer contracts signed during the first quarter of 2008.” Apparently, some $24 million in revenue associated with those contracts was booked in the first quarter but should have been booked over the duration of the contracts starting in the second quarter. Should this prove to be the case, Cadence will have to restate both Q1 and Q2.

In postponing yesterday's Q3 earnings announcement, the company reiterated its earlier Q3 guidance from July 23, 2008: the company expects Q3 revenue to be in the range of $235 to $245 million; third quarter GAAP net loss per share to be in the range of $(0.27) to $(0.25); and non-GAAP net loss per share to be in the range of $(0.11) to $(0.09).

As early as the morning of October 23, 2008, Cadence shares had lost another $1.39 each, trading in the area of $2.88, or a downward plunge of 32% in the first few hours of the October 23rd day in New York.

Next, Cadence shares dropped to $2.70 each in after hours trading on Friday October 24, 2008, then further reducing Cadence's market cap to just north of $700 million ( On that same day, Mentor Graphics' market cap stood at $642 million, and Synopsys' was at $2.33 billion).

Also on October 24, a law firm called Finkelstein Thompson LLP (Washington, DC & San Francisco) announced it “was investigating Cadence Design Systems following the announcement that Cadence was indefinitely delaying its third-quarter earnings report and expected to restate its financial reports for the first half of 2008.”

On October 30, 2008 Dyer & Berens LLP announced that a class action has been commenced in the United States District Court for the Northern District of California on behalf of all purchasers of Cadence Design Systems, Inc. common stock during the period between April 23, 2008 and October 22, 2008. The case is entitled Hu v. Cadence Design Systems, Inc., Michael J. Fister, William Porter and Kevin S. Palatnik. The complaint charges Cadence and certain of its current and former officers with violations of the Securities Exchange Act of 1934.

Several other law firms are also entering the fray.

On November 5, 2008 Cadence announced the commencement of a restructuring program designed to “focus the company's strategy, streamline the business and improve operational execution and financial performance.” Once completed, the company expects to achieve annual operating expense savings of at least $150 million through a combination of workforce and other expense reductions.

The company expects to eliminate at least 625 full-time positions, representing 12% of its global employee base, plus a substantial number of contractors and consultants. Because of varying regulations in the jurisdictions and countries in which Cadence operates, workforce reductions will be realized over a period of time and are expected to be completed in the second half of fiscal 2009. Cadence expects to record a restructuring charge of approximately $65 million to $70 million pre-tax, $48 million of which will be recorded in the third quarter of 2008.

Several analysts fear that Cadence's November 5th cost cutting plan is not severe enough.

Cadence Shares closed trading in New York on November 6 at $3.98 a share, down more than 8% on the day. Cadence's Market Cap stood just north of $1 billion. (The Dow itself lost 443 points on the day, or 4.85%).

How did the Electronics IP G7 perform in the Third Quarter of 2008?

On the IP revenue front, Table 3 below reveals that the G7's combined Q3 revenue performance was $223 million, a mild increase of just over 2% from the $218 million in the third quarter of 2007, but down slightly sequentially. Three firms (CEVA, MIPS and Virage Logic) reported double digit year-over-year percentage growth. Rambus was the only decliner with a drop of almost 30%. On a sequential basis, MoSys was the revenue growth leader at almost 27%. Rambus and MIPS were the only decliners at -18% and -9%, respectively. The others had small single digit sequential percentage growth.

Figure 1 below provides a bar graph of each vendor's revenue for Q3 2007, Q2 2008, and Q3 2008 in sequence.

ARM continues to dominate with 60% relative market share. Rambus and MIPS come next with 13% and 12%, respectively. See Figure 2.

Relative to earnings, Table 4 reveals that G7 IP Providers suffered a combined Q3 2008 net loss of $15.1 million, compared to a slight combined net gain of $816 thousand in the third quarter of 2007 and compared to a combined net loss of $241 million in the second quarter of 2008. Only ARM ($22.2 million) and CEVA ($1.4 million) had net gains in the quarter. On a year-over-year basis Rambus had the largest earnings drop (-$21.4 million). MoSys was the only other IP vendors to have a drop (-$415K) in earnings. On a sequential basis all the firms had earnings growth, although the G7 total earnings were still in the red. Rambus and MIPS made significant improvement from losses in excess of $100 million in the prior quarter. In 2Q08 Rambus recorded a valuation allowance of $130.5 million against its net deferred tax assets. In the second quarter MIPS recorded $103.1 million impairment of goodwill and intangible assets.

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