Research Analyst: Payal Jalan, M. Fin

February 12, 2010

Research Analyst: Payal Jalan, M. Fin.

Sr. Ed.: Ian Madsen, CFA; ; 1-800-767-3771, x9417

111 N. Canal Street, Suite 1101  Chicago, IL 60606

Cadence Design Systems, Inc.

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(CDNS – NASDAQ)

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$5.60*

Note: This report contains substantially new material. Subsequent reports will have new or revised material highlighted.

Reason for Report: 4Q09 and FY09 Earnings Update

Prev. Ed.: January 19, 2010; Coverage Dropped by One Broker (brokers’ material considered till January 15)

Brokers’ Recommendations: Positive: 50.0% (3 firms); Negative: 33.3% (2); Neutral: 16.7% (1) Prev. Ed.: 3; 2; 1

Brokers’ Target Price: $7.34 (↓ $0.10 from the last edition; 5 firms) Brokers’ Avg. Expected Return: 31.1%

*Note: Although dated February 12, 2010, share price and brokers’ material are as of February 8, 2010.

Note: A flash update was done on February 3, 2010 (4Q09 and FY09 Earnings Release)

Note: The tables below (Revenue, Margins, and Earnings per Share) contain less brokers’ material than the brokers’ material used in the Valuation table. The extra figures in the Valuation table come from reports that did not have accompanying spreadsheet models.

Portfolio Manager Executive Summary

Cadence Design Systems, Inc. (CDNS or the Company) is the world's leading diversified supplier of electronic design automation (EDA) software and services for semiconductor, computer, telecom, consumer electronics, and other electronics customers. The Company's products and services are managed in several business units: Functional Verification, Digital IC Design, Custom IC, DFM, System Interconnect, and Services.

Key factors for determining an investment strategy for CDNS are as follows:

• CDNS has been losing share to Synopsys and is struggling through the downturn in the semiconductor cycle.
• CDNS has substantial share of the mix-signal market as well as a solid position in verification and low-power digital implementation.
• Potential longer-term benefits from the Company's shift to a 90.0% subscription model.

Brokerage firms’ sentiment is tripartite with 50.0%of the firms being positive, 33.3% negative,and 16.7% beingneutral on the stock. Target prices range from a low of $5.00 to a high of $12.00, with an average of $7.34. On anaverage, the firms expect a return of 31.1% from the stock at the current price.

Bulls (Buy or equivalent outlook) – 3 firms or 50.0% – Target prices range from $7.50-$12.00. These firms remainencouraged by the Company’s fundamentals, topline growth expectations, market share lead in signals, and the largest installed base in the EDA industry. Firms expect growth to reaccelerate as IT spending is recovering and believe CDNS is well-positioned to capitalize from the situation. CDNS shares representan accretive investment opportunity forthe long-term investors atthe current level.

Bears (Negative or equivalent outlook) – 2 firms or 33.3% – Target prices range from $5.00-$5.70. The firms remain concerned about the Company’s weak revenue and booking guidance and expect no improvement until R&D spending of companies revives.

Cautious(Neutral or equivalent outlook) – 1firm or 16.7% –Target price provided is $6.50. The firm with a cautious stance states that CDNS possesses strong fundamentals, but will likely face challenges,given tepid demand trends in EDA; return to normalized margins/earnings at least three years away; and slow semiconductor R&D spending restricting bookings acceleration in the 1H10.

General Long-Term Outlook: The Company’s long-term growth is contingent upon an upturn in demand in the semiconductor cycle. The brokerage firms expect total revenue to decrease at a 3-year CAGR (’08-’11) of 2.8% and net income to decrease at a 3-year CAGR (’07-’10) of 59.5%.

February 12, 2010

Recent Events

On February 3, 2010, CDNS reported its4Q09 and FY09 financial results. Total revenue in 4Q09 was $220.0 million versus $227.0 million in 4Q08. On a GAAP basis, net income was $2.0 million, or $0.01 per diluted share versus a net loss of $1.63 billion, or ($6.55) per share in 4Q08. On a non-GAAP basis, net income in 4Q09 was $15.0 million, or $0.06 per share versus a net loss of $11.0 million, or ($0.04) per share in 4Q08.

In FY09, total revenue was $853.0 million versus $1.04 billion in FY08; GAAP net loss was $150.0 million, or ($0.58) per diluted share versus a net loss of $1.86 billion, or ($7.30) per diluted share; and non-GAAP net loss was $16.0 million, or ($0.06) per share, versus a net loss of $10.0 million, or ($0.04) per share in FY08.

Overview

The analysts identified the following factors for evaluating the investment merits of CDNS:

Key Positive Arguments / Key Negative Arguments

• CDNS invested heavily in verification and digital design products over the last few years.
• CDNS appears to have the lead in offering a broad array of complementary products for many key IC components, which shortened the time for marketing.
• CDNS has a strong financial position, with cash equivalents and short-term investments of $571.3 million.

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• Semiconductor R&D budgets have contracted in recent years and may continue reducing the amount spent on EDA software.
• CDNS faces competition from other EDA companies like Magma (LAVA), Synopsys (SNPS), and Mentor Corp. (MENT).
• The EDA industry faces pricing problems from direct discounting, extension of payment terms, and/or the lowered value of a deal.
• Dependency on cyclical chip and electronics industries might have an unfavorable revenue and earnings impact.
• CDNS made numerous acquisitions and faces many attendant integration and execution risks.

Based in San Jose, CA, Cadence Design Systems, Inc. (CDNS or the Company) offers electronic design automation (EDA) technologies and engineering services to electronics companies worldwide. Its software and hardware technology provides design and methodology services to accelerate and manage customers' electronic product development processes.

EDA is used to design and develop complex integrated circuits (ICs) and personal and commercial electronic systems, including semiconductors, computer systems and peripherals, telecommunications, mobile, automotive, consumer products, and other advanced electronics. The major product lines of CDNS include the Incisive Functional Verification Platform that verifies chip design parameters; Encounter Digital IC Design Platform that provides tools and methodologies for implementing chips; Virtuoso Custom Design Platform that helps in designing custom analog, radio frequency (RF), and mixed-signal ICs; and the Allegro System Interconnect Design Platform enabling collaborative design of interconnects across IC and PCB domains. The Design for Manufacturing (DFM) operation provides complete or partial turnkey contract design to the small/custom customers, and involves consulting, project services and/or complete turnkey services for verification acceleration, and system emulation. For more information, please visit

Note: CDNS’s Fiscal Year ends on December 31.

February 12, 2010

Revenue

Provided below is a summary of total revenue as compiled by Zacks Research Digest:

Revenue ($ M) / 4Q08A / 3Q09A / 4Q09A / 1Q10E / FY08A / FY09A / FY10E / FY11E
Digest Average / $227.2 / $216.1 / $220.3 / $215.0↑ / $1,038.7 / $852.6 / $882.5↓ / $954.0
Digest High / $227.3 / $216.1 / $220.3 / $215.0 / $1,039.0 / $852.6 / $884.0 / $963.0
Digest Low / $227.0 / $216.1 / $220.3 / $215.0 / $1,038.6 / $852.6 / $880.0 / $941.8
Y/Y % Growth / -50.4% / -7.0% / -3.1% / 4.2% / -35.7% / -17.9% / 3.5% / 8.1%
Q/Q % Growth / -2.2% / 2.9% / 1.9% / -2.4%
Company Guidance

According to the Digest model, total revenue in 4Q09was $220.3 million, down3.1% y/y andup 1.9% sequentially. Thequarter’s revenue was toward the high-end of the Company’s guided range of $215.0-$225.0 million. In FY09, total revenue was $852.6 million, down 17.9% y/y and toward the high-end of the Company’s guided range of $845.0-$855.0 million.

Booking in FY09 was $615.0 million (within the Company’s guidance range of $600.0-$625.0 million) with duration of 2.8 years. Mix of bookings continued at 90.0% ratable/10.0% upfront. Renewal run rates in 4Q09 were slightly positive, reflecting an improvement from 3Q09. Backlog exiting FY09 was roughly $1.6 billion.

From a geographical perspective, revenue mix in 4Q09 was 51.0% from America versus 43.0% in 3Q09, 24.0% from Europe versus 20.0% in 3Q09, 12.0% from Japan versus 23.0% in 3Q09, and 13.0% from Asia, versus 14.0% in 3Q09.

Revenue mix by product category in 4Q09 was 22.0% from Functional Verification, 22.0% from Digital IC Design, 28.0% from Custom IC Design, 7.0% from Design for Manufacturing, 11.0% from System Interconnect, and 10.0% from Services & Other versus 21.0%, 19.0%, 28.0%, 9.0%, 11.0%, and 12.0%, respectively in 3Q09.

Provided below is a summary of segment revenue as compiled by Zacks Research Digest:

Revenue ($ M) / 4Q08A / 3Q09A / 4Q09A / 1Q10E / FY08A / FY09A / FY10E / FY11E
Product Revenue / $94.2 / $96.9 / $114.5 / $99.0↓ / $516.7 / $400.7 / $415.0↑ / $474.0
Services / $34.8 / $26.7 / $22.9 / $28.0↑ / $133.4 / $106.6 / $115.0↑ / $119.6
Maintenance / $98.3 / $92.5 / $82.9 / $88.0↑ / $388.6 / $345.3 / $353.0↑ / $363.6
Total Revenue / $227.2 / $216.1 / $220.3 / $215.0↑ / $1,038.7 / $852.6 / $882.5↓ / $954.0

Provided below is a graphical representation of revenue segments:

Product Revenue (52.0% of 4Q09 total revenue): Total Product revenue in 4Q09 was $114.5 million, up 21.6% y/y and 18.2% sequentially. In FY09, product revenue was $400.7 million, down 22.5% y/y.

Services Revenue (10.2% of 4Q09 total revenue): Total Services revenue in 4Q09 was $22.9 million, down34.2% y/y and14.2% sequentially. In FY09, services revenue was $106.6 million, down 20.1% y/y.

Maintenance Revenue (37.6% of 4Q09 total revenue): Total Maintenance revenue in 4Q09 was $82.9million, down 15.7% y/y and 10.4% sequentially. In FY09, maintenance revenue was $345.3 million, down 11.1% y/y.

Outlook

For 1Q10, management expects total revenue to be in the range of $210.0-$220.0 million and for FY10 expects total revenue to be in the range of $865.0-$900.0 million (roughly 80.0% is expected to come frombeginning of the year backlog). For the seasonal revenue pattern in 2010, CDNS expects to generate 23.0% to 26.0% of annual revenue in 1Q10, the same range for 2Q10, 23.0% to 27.0% in 3Q10, and finally 24.0% to 28.0% in 4Q10.

For FY10, management expects the impact from financially distressed and bankrupt companies to decline from the levels experienced in FY09 and expects approximately $10.0 million of reserves taken in 2009 to reverse in 2010.

For FY10, management expects bookings growth to be between 26.0%-34.0% and anticipates order level and revenue to yield a book-to-bill of less than one. Bookings are expected to be in the range of $775.0-$825.0 million and weighted average contract life to be in the range of 2.6 to 3.0 years. The Company is modeling a 10.0% renewal run rate decrease for FY10.

One firm (J.P. Morgan) estimates over $1.0 billion of contract value to be renewed in 2010.

Please refer to the Zacks Research Digest spreadsheet of CDNS for detailed revenue estimates.

Margins

Provided below is a summary of margins as compiled by Zacks Research Digest:

Margins / 4Q08A / 3Q09A / 4Q09A / 1Q10E / FY08A / FY09A / FY10E / FY11E
Gross / 80.6% / 83.2% / 82.9% / 82.1%↑ / 82.0% / 81.8% / 82.1%↑ / 80.4%
Operating / -8.5% / 5.7% / 9.6% / 3.3%↑ / -2.9% / -2.1% / 4.7%↑ / 7.9%
Pre-tax / -8.1% / 4.8% / 8.4% / 2.6%↑ / -1.9% / -2.7% / 4.4%↑ / 7.5%
Net / -4.4% / 3.6% / 6.9% / 1.4%↑ / -1.0% / -1.8% / 3.0%↑ / 5.5%

According to the Digest model, gross profit in 4Q09was $182.6 million, down 0.3% y/yandup 1.5% sequentially. Gross margin was 82.9% versus 80.6% in 4Q08 and 83.2% in 3Q09. In FY09, gross profit was $697.5 million, down 18.1% y/y.

Operating expenses in 4Q09decreased both on a y/y and sequential basis. R&D expense (33.9% of 4Q09 total revenue) was $74.6 million, down 20.1% y/y and 8.9% sequentially. S&M expense (31.3% of 4Q09 total revenue) was $68.9 million, down 15.1% y/y and up 5.1% sequentially. G&A expense (8.2% of 4Q09 total revenue) was $18.1million, down 49.3% y/y and 30.1% sequentially. In FY09, R&D expense was $328.0 million; S&M expense was $274.6 million; and G&A expense was $112.9 million.

Operating income in 4Q09 was $21.1 million, up 209.3% y/yand71.5% sequentially. Operating margin was 9.6%versus (8.5%) in 4Q08 and 5.7% in 3Q09. In FY09, operating income was ($18.1) million, up 40.4% y/y.

Other income (expense) in 4Q09 was ($2.7) million versus ($10.3) million in 4Q08 and ($2.5) million in 3Q09. In FY09, other income (expense) was ($5.2) million, down 0.6% y/y.

Pre-tax income was $18.4 million in 4Q09, up 199.8% y/y and 76.7% sequentially and pre-tax margin was 8.4% in 4Q09versus (8.1%) in 4Q08 and 4.8% in 3Q09. In FY09, pre-tax income was ($23.3) million and margin was (2.7%). Effective tax rate in 4Q09 was 26.0%. Net margin in 4Q09 was 6.9% versus (4.4%) in 4Q08 and 3.6% in 3Q09 and in FY09 was (1.8%) versus (1.0%) in FY08.

Outlook

For 1Q10, management expects GAAP total costs and expenses to be in the range of $226.0-$231.0 million and non-GAAP total costs and expenses to be in the range of $210.0-$215.0 million. GAAP operating margin would be in the range of (6.0%)-(4.0%) and non-GAAP operating margin in the range of 2.0%-4.0%.

For FY10, GAAP operating margin is expected to be in the range of (3.0%)-(1.0%) and non-GAAP operating margin to be in the range of 4.0%-6.0%. GAAP total other income (expense) is expected to be in the range of ($32.0)-($30.0) million and non-GAAP to be in the range of ($10.0)-($8.0) million. CDNS reiterated its commitment to drive its operating margin toward 25.0% over the long-term.

As per the Digest model, COGS will likelyincrease by1.7% y/y in FY10 and 15.9% y/y in FY11;R&D expense will likelydecrease by 3.4% y/y in FY10andincrease by 1.3% y/y in FY11; S&M expense will likelyincrease by 0.6% y/y in FY10 anddecrease by 2.4% y/y in FY10; andG&A expense will likelydecrease by 18.3% in FY10 andincrease by 11.7% y/y in FY11. In comparison, revenue will likelyincrease by3.5% y/y in FY10 and 8.1% y/y in FY11.

Please refer to the Zacks Research Digest spreadsheet of CDNS for detailed margin estimates.

Earnings per Share

Provided below is a summary of EPS as compiled by Zacks Research Digest:

EPS / 4Q08A / 3Q09A / 4Q09A / 1Q10E / FY08A / FY09A / FY10E / FY11E
Zacks Consensus / ($0.02) / ($0.03) / $0.15
Digest High / ($0.04) / $0.03 / $0.06 / $0.02↑ / ($0.04) / ($0.06) / $0.12↑ / $0.24
Digest Low / ($0.04) / $0.03 / $0.06 / $0.01↑ / ($0.05) / ($0.07) / $0.09↑ / $0.15
Digest Average / ($0.04) / $0.03 / $0.06 / $0.01↑ / ($0.05) / ($0.07) / $0.11↑ / $0.21
Y/Y % Growth / -108.7% / 133.4% / 250.0% / 113.3% / -103.4% / -44.9% / 257.5% / 96.8%
Q/Q % Growth / 55.5% / 160.0% / 100.0% / -77.8%
Guidance Before FAS 123 / $0.00-$0.02 / $0.05-$0.15
GAAP Guidance / ($0.10)-($0.08) / ($0.29)-($0.19)

According to the Digest model, pro forma EPS in 4Q09 was$0.06 (same as reported by the Company), up 250.0% y/y and 100.0% sequentially. EPS improvement was primarily driven by continued cost controls. The quarter’s EPS was above the Company’s guidance range of $0.02-$0.04and the Street consensus of $0.03. In FY09, pro forma EPS was ($0.07), down 44.9% y/y and above the Company’s guidance range of ($0.10)-($0.08).

As reported by the Company, GAAP EPS in 4Q09 was $0.01 versus ($6.55) per share in 4Q08 and ($0.05) in 3Q09. Thequarter’s resultswere above the Company’s guidance range of ($0.08)-($0.06). 4Q09 GAAP EPS included amortization of acquired intangibles charge of $0.02; stock-based compensation expense of $0.04; non-qualified deferred compensation expenses of $0.01; restructuring and other charges (credits) of $0.05; amortization of debt discount of $0.02; benefit of $0.01 from gains and losses on non-qualified deferred compensation plan assets; and $0.08 of income tax benefits. In FY09, GAAP EPS was ($0.58) versus ($7.30) in FY08 and above the Company’s guidance range of ($0.66)-($0.64).

Outlook

For 1Q10, management expects GAAP net loss per diluted share to be in the range of ($0.10) to ($0.08). On a non-GAAP basis, GAAP net income per share is expected to be in the range of $0.00 to $0.02. GAAP EPS forecast includes amortization of acquired intangibles charge of $0.02; stock-based compensation expense of $0.04; amortization of debt discount of $0.02; and income tax effect of $0.02.

For FY10, GAAP net loss per diluted share is expected to be in the range of ($0.29) to ($0.19) and on a non-GAAP basis, net income per diluted share is expected to be in the range of $0.05 to $0.15. GAAP EPS forecast includes amortization of acquired intangibles charge of $0.04; stock-based compensation expense of $0.18; amortization of debt discount of $0.08; and income tax effect of $0.04.

The Digest average model forecasts EPS of $0.11 for FY10 and $0.21 for FY11,with ay/y increase of 257.5% in FY10 and 96.8% y/y in FY11.

Highlights from the EPS table are as follows:

• 2010 forecasts (4 analysts) range from $0.09 to $0.12; the average is $0.11.
• 2011 forecasts (3analysts) range from $0.15 to $0.24; the average is $0.21.

Following the 4Q09earnings release,three brokerage firms lowered their FY10 EPS estimates based on moderating margin improvement trajectory.

Please refer to the Zacks Research Digest spreadsheet of CDNS for detailed EPS estimates.

Target Price/Valuation

Of the sixfirms covering the stock, three gavepositive ratings, two firms gavenegative ratings, and one firm (Deutsche Bank) assigned a neutralrating. Target prices range from $5.00 (10.7% downside from the current price) (RBC Cap.) to $12.00 (114.3%upside from the current price) (J.P. Morgan), with an average of $7.34 (↓$0.10fromthe previous report, 31.1% upside from the current price). The firm with the lowest target price rated the stock Underperform and used 1.25x EV to CY10 salesto compute the target price, while the firm with the highest target price rated the stock Overweight, and used DCF analysis to value the stock.

Provided below is a summary of valuation/ratings as compiled by Zacks Digest:

Rating Distribution
Positive / 50.0%
Neutral / 16.7%
Negative / 33.3%
Digest High / $12.00
Digest Low / $5.00
Average Target Price / $7.34↓
No. of Brokers with Target Price/Total / 5/6

General risks to the target price, according to the firms, include economic slowdown, cyclical downturn in the semiconductor industry, increased revenue volatility, order slowdown, significant market share loss, delay in new product introduction, aggressive pricing by competitors, management attrition, inability to recruit or retain key employees, lawsuits, and patent litigation.

Metrics detailing current management effectiveness are as follow:

Metrics (TTM) / Company / Industry / S&P 500
Return on Assets (ROA) / -9.7%↑ / 1.0%↓ / 4.3%↑
Return on Investment (ROI) / -14.1%↑ / 1.3%↓ / 5.7%↑
Return on Equity (ROE) / -101.6%↑ / 2.8%↓ / 12.7%↑

CDNS’s ROA, ROI, and ROE of (9.7%), (14.1%), and (101.6%) are lower than the overall market averages (as measured by S&P 500) of 4.3%, 5.7%, and 12.7%, respectively.

Capital Structure/Solvency/Cash Flow/Governance/Other

Balance Sheet

Exiting 4Q09, cash and cash equivalents, and short-term investments were $571.3 million versus $575.4 million in 3Q09. Accounts receivable were $200.6 million versus $195.5 million in 3Q09. Days Sales Outstanding (DSO) for 4Q09 decreased to 106 days versus 108 days in 3Q09 and below the Company’s guidance range of 120-125 days. Inventories were $24.2 million versus $25.6 million in 3Q09.

On the liabilities side, total long-term liabilitieswere $904.3 million versus $912.8 million in 3Q09. 4Q09 total debt included $92.3 million of long-term deferred revenue and $436.0 million of convertible notes.

For FY10, management expects DSOs to be in the range of 80 to 90 days.

Cash Flow

Net cash flow from operating activitiesin 4Q09 was $0.9 million versus $21.7 million in 3Q09 and above the Company’s guidance range of ($10.0)-($5.0) million. Capital expenditure was approximately $10.8 million versus $8.2 million in 3Q09. In FY09, cash flow from operating activities was $25.6 million versus $70.3 million in FY08 and above the Company’s guidance of $15.0-$20.0 million. Capital expenditure was $41.3 million versus $97.3 million in FY08 and within the Company’s guidance range of $40.0-$45.0 million.

For 1Q10, management expects net cash flow from operating activities to be in the range of $45.0-$50.0 million and after severance payments in the amount of $14.0 million. Operating cash flow for 1Q10 is higher than the quarterly average for 2010, because of a one-time up front payment expected to be received in 1Q10 in the amount of approximately $20.0 million.

For FY10, management expects net cash flow from operating activities to be in the range of $125.0-$135.0 million and capital expenditure to be within $30.0-$40.0 million.

Others

On February 1, 2010, CDNS released Cadence® Encounter® Digital Implementation (EDI) System 9.1, a complete and integrated digital design, implementation, and verification environment for the development of large-scale, complex SoCs.

On February 1, 2010, CDNS announced that austriamicrosystems, a leading global designer and manufacturer of high-performance analog ICs for communications, industrial, medical and automotive applications and foundry services, has broadened its deployment of Cadence® technology.

On January 28, 2010, CDNS and Semiconductor Technology and Academic Research Center (STARC), the Japan semiconductor industry consortium, revealed an ongoing collaboration to leverage STARC’s regression suites to ensure the high quality of electronic design automation (EDA) software for advanced chip design.

February 12, 2010

Potentially Severe Problems

There are none other than those discussed in other sections of this report.

August 11, 2009