Fitch Rates Cadence Design Systems' $350MM of Senior Notes 'BBB+'

CHICAGO--()--Fitch Ratings has assigned a 'BBB+' rating to Cadence Design Systems, Inc.'s (Cadence) $350 million senior notes offering. The Rating Outlook is Stable. A full list of current ratings follows at the end of this release.

The ratings affect $933 million of total debt including the company's senior notes offering and $250 million revolving credit facility.

Cadence will use net proceeds from the senior notes issuance for general corporate purposes, including debt repayment, working capital, capital spending or acquisitions.

KEY RATING DRIVERS

The ratings and Outlook reflect Cadence's:

--Share leadership in each of its key end markets, supported by high switching costs (resulting in subscription renewal rates of 99%) and a strong technology portfolio. Recent acquisitions, including Jasper Design Automation, Inc. (Jasper), have strengthened Cadence's system design strategy.

--Mission critical technology enabling customers' technology platform and product evolution. Cadence's electronic design automation (EDA) software and verification capabilities are critical to semiconductor and, increasingly, electronic systems companies facing intensified semiconductor technology and system design challenges, increased system on a chip (SoC) development costs and time to market pressures.

--Revenue and free cash flow (FCF) that is recurring in nature, driven by the company's subscription model. Cadence's highly diversified customer base, with no customer representing more than 5% of total revenues adds to a high degree of operating visibility and lower cyclicality.

--Conservative financial policies, supported by strong FCF margin and expectations for FCF-to-total debt ranging from 50% to 100% through the semiconductor cycle.

Rating concerns include:

--Significant research and development (R&D) investments required to maintain technology leadership. R&D will represent more than 35% of revenues and exceed $500 million annually. However, the high R&D intensity strengthens the sustainability of Cadence's market positions and could enable share gains in certain markets over time, as competitors reduce R&D investment levels.

--Expectations for intensified competitive pricing in hardware and printed circuit board and packaging markets to constrain meaningful profitability expansion. Fitch believes hardware product refreshes could offset current pricing pressures in hardware, which represents 10% of total revenues.

--Meaningful key man risk, given the strength of the CEO's network within the semiconductor industry. However, Fitch views this network as a meaningful competitive advantage, positioning Cadence for market share expansion.

Fitch anticipates focus revenues at Cadence will grow in the low-to-mid single digits over the longer term, consistent with the EDA industry. Secular industry growth is supported by increasing semiconductor design complexity, time-to-market pressures, and increased semiconductor content in end markets such as automotive, industrial, and the internet of things.

The company's top line will be less cyclical than the broader semiconductor industry, as R&D spending remains critical for semiconductor companies to maintain Moore's Law and electronics systems companies increasingly outsource product design elements.

Fitch expects operating EBITDA margins to remain in the mid-20s through the intermediate term, driven by higher gross margins associated with digital designs for electronic systems providers, a growing IP portfolio, and cost reduction efforts associated with the integration of Jasper. Fitch believes higher R&D spending will partially offset profitability expansion.

Fitch expects Cadence's credit metrics will remain strong for the rating. Fitch estimates total debt to operating EBITDA was 1.2x for the latest 12 months (LTM) ended June 28, 2014 and expects total leverage to remain below 2x over the longer term. Fitch expects FCF to total debt will range from 0.5x-1.0x through the cycle.

Fitch expects annual FCF generation of $200 million to $400 million through the semiconductor cycle, driven by the company's recurring revenue model, profitability expansion from cost reduction initiatives and low capital intensity. Fitch expects a net cash position through the cycle, although a substantial portion of cash will be overseas.

RATING SENSITIVITIES

Positive rating action is unlikely, given the company's comparatively smaller revenue and FCF base.

Negative rating actions could result from:

--Structurally lower revenue from material share losses resulting in Fitch's expectations for sustained FCF below $200 million.

--Lower base line operating profitability from increasing price competition or a shifting product mix resulting in Fitch's expectations for sustained debt/EBITDA above 2x.

Fitch believes excess cash and FCF will be used for a combination of acquisitions and share repurchases. Fitch expects acquisitions will be smaller tuck-in deals to support growth in the evolving IP market and Cadence's intensified push into digital design technologies. Cadence recently announced an increase in the rate of repurchase under a share repurchase program authorizing $300 million of stock buybacks through 2015.

Pro forma for the Sept. 19, 2014 amendment to the credit facility, Cadence's liquidity was solid as of June 28, 2014, and supported by:

--Approximately $557 million of cash and equivalents and $98 million in short-term investments.

--$150 million of availability under a $250 million senior unsecured credit facility expiring September 2019.

Liquidity is further supported by Fitch's expectations for $200 million to $400 million of annual FCF through the semiconductor cycle.

Total debt was $433 million as of June 28, 2014 and consisted of:

--$100 million drawn under the $250 million credit facility; and

--$333 million of 2.625% senior notes due June 2015.

Fitch currently rates Cadence as follows:

--Issuer Default Rating (IDR) 'BBB+';

--Senior unsecured notes 'BBB+'.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=891874

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Contacts

Fitch Ratings
Primary Analyst
Jason Pompeii, +1-312-368-3210
Senior Director
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
John M. Witt, CFA, +1-212-908-0673
Senior Director
or
Committee Chairperson
Peter Molica, +1-212-908-0288
Senior Director
or
Media Relations
Brian Bertsch, New York, +1-212-908-0549
brian.bertsch@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Jason Pompeii, +1-312-368-3210
Senior Director
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
John M. Witt, CFA, +1-212-908-0673
Senior Director
or
Committee Chairperson
Peter Molica, +1-212-908-0288
Senior Director
or
Media Relations
Brian Bertsch, New York, +1-212-908-0549
brian.bertsch@fitchratings.com