CADENCE DESIGN SYSTEMS INC - 10-Q filing on 2014-07-21

Debt

6 Months Ended

Jun. 28, 2014

Cadence’s outstanding debt as of June 28, 2014 and December 28, 2013 was as follows:



	June 28, 2014							December 28, 2013
	(In thousands)
	Principal		Unamortized Discount			Carrying Value		Principal		Unamortized Discount			Carrying Value
2015 Notes	$	350,000	$	(16,667	)	$	333,333	$	350,000	$	(25,174	)	$	324,826
Revolving credit facility	100,000		—			100,000		—		—			—
Total outstanding debt	$	450,000	$	(16,667	)	$	433,333	$	350,000	$	(25,174	)	$	324,826

2015 Notes

In June 2010, Cadence issued $350.0 million principal amount of 2.625% Cash Convertible Senior Notes Due 2015, or the 2015 Notes. At maturity, the holders of the 2015 Notes will be entitled to receive the principal amount of the 2015 Notes plus accrued interest. The 2015 Notes are convertible into cash prior to maturity upon the occurrence of certain conditions described in the table below. To the extent that the 2015 Notes are convertible prior to maturity and a holder of the 2015 Notes elects to convert its notes prior to maturity, that note holder will be entitled to receive cash equal to the principal amount of the notes plus any additional conversion value as described in the table below under the heading “Conversion feature.”

Cadence entered into hedge transactions, or the 2015 Notes Hedges, in connection with the issuance of the 2015 Notes. The purpose of the 2015 Notes Hedges was to limit Cadence’s exposure to the additional cash payments above the principal amount of the 2015 Notes that may be due to the holders. As a result of the 2015 Notes Hedges, Cadence’s maximum expected cash exposure upon conversion of the 2015 Notes is the $350.0 million principal balance of the notes and accrued interest. In June 2010, Cadence also sold warrants in separate transactions, or the 2015 Warrants. As a result of the 2015 Warrants, Cadence will experience dilution to its diluted earnings per share if its average closing stock price exceeds $10.78 for any fiscal quarter. To the extent that Cadence’s stock price exceeds $10.78 at expiration of the 2015 Warrants, Cadence will issue shares to net settle the 2015 Warrants.

A summary of key terms of the 2015 Notes is as follows:



		2015 Notes
		(In thousands, except percentages and per share amounts)

Outstanding principal maturity value – at June 28, 2014		$350,000

Contractual interest rate		2.625%

Contractual maturity date		June 1, 2015

Initial conversion rate		132.5205 shares of common stock per $1,000 principal amount of notes, which is equivalent to a conversion price of approximately $7.55 per share of Cadence common stock.

Conversion feature (in addition to principal amount payable in cash)		Cash to the extent Cadence’s stock price exceeds approximately $7.55 per share, calculated based on the applicable conversion rate multiplied by the volume weighted average price of Cadence common stock over a specified period.

Early conversion conditions (or the Early Conversion Conditions)		• Closing stock price greater than $9.81 for at least 20 of the last 30 trading days in a fiscal quarter (convertible only for subsequent quarter); • Specified corporate transactions; or • Note trading price falls below a calculated minimum.

Conversion immediately preceding maturity		From March 1, 2015 until the second trading day immediately preceding the maturity date, holders may convert their 2015 Notes at any time into cash as described above under “Conversion feature.”

Redemption at Cadence’s option prior to maturity		None.

Fundamental change put right		Upon certain fundamental corporate changes prior to maturity, the 2015 Note holders could require Cadence to repurchase their notes for cash equal to the principal amount of the notes plus accrued interest.

Make-whole premium		Upon certain fundamental changes prior to maturity, if Cadence’s stock price were between $6.16 and $40.00 per share at that time, the holders of the notes would be entitled to an increase to the conversion rate. This is referred to as a “make-whole premium.”

Financial covenants		None.

Impact of Early Conversion Conditions on Financial Statements

The 2015 Notes mature on June 1, 2015 and therefore are classified as a current liability as of June 28, 2014. The 2015 Notes are convertible into cash from June 29, 2014 through September 27, 2014 because Cadence’s closing stock price exceeded $9.81 for at least 20 days in the 30-day period prior to June 28, 2014.

If the note holders elect to convert their 2015 Notes prior to maturity, any unamortized discount and transaction fees will be expensed at the time of conversion. If the entire outstanding principal amount had been converted on June 28, 2014, Cadence would have recorded an expense of $19.0 million associated with the conversion, comprised of $16.7 million of unamortized debt discount and $2.3 million of unamortized transaction fees.

As of June 28, 2014, the if-converted value of the 2015 Notes to the note holders of approximately $804.3 million exceeded the principal amount of $350.0 million. The fair value of the 2015 Notes was $807.7 million as of June 28, 2014 and $654.1 million as of December 28, 2013. The 2015 Notes currently trade at a premium to the if-converted value of the notes.

2015 Notes Embedded Conversion Derivative

The conversion feature of the 2015 Notes, or the 2015 Notes Embedded Conversion Derivative, requires bifurcation from the 2015 Notes and is accounted for as a derivative liability. The fair value of the 2015 Notes Embedded Conversion Derivative at the time of issuance of the 2015 Notes was $76.6 million and was recorded as original debt discount for purposes of accounting for the debt component of the 2015 Notes. This discount is amortized as interest expense using the effective interest method over the term of the 2015 Notes. The 2015 Notes Embedded Conversion Derivative is carried on the condensed consolidated balance sheet at its estimated fair value. The fair value was $455.8 million as of June 28, 2014 and $306.8 million as of December 28, 2013.

2015 Notes Hedges

The 2015 Notes Hedges expire on June 1, 2015 and must be settled in cash. The aggregate cost of the 2015 Notes Hedges was $76.6 million. The 2015 Notes Hedges are accounted for as derivative assets and are carried on the condensed consolidated balance sheet at their estimated fair value. The 2015 Notes Hedges fair value was $455.8 million as of June 28, 2014 and $306.8 million as of December 28, 2013. The 2015 Notes Embedded Conversion Derivative liability and the 2015 Notes Hedges asset are adjusted to fair value each reporting period and unrealized gains and losses are reflected in the condensed consolidated income statements. The 2015 Notes Embedded Conversion Derivative and the 2015 Notes Hedges are designed to have similar fair values. Accordingly, the changes in the fair values of these instruments offset during the three and six months ended June 28, 2014 and June 29, 2013 and did not have a net impact on the condensed consolidated income statements for the respective periods.

The classification of the 2015 Notes Embedded Conversion Derivative liability and the 2015 Notes Hedges asset as current on the condensed consolidated balance sheet corresponds with the classification of the 2015 Notes.

2015 Warrants

In June 2010, Cadence sold the 2015 Warrants in separate transactions for the purchase of up to approximately 46.4 million shares of Cadence’s common stock at a strike price of $10.78 per share, for total proceeds of $37.5 million, which was recorded as an increase in stockholders’ equity. The 2015 Warrants expire on various dates from September 2015 through December 2015 and must be settled in net shares of Cadence’s common stock. Upon expiration of the 2015 Warrants, Cadence will issue shares of common stock to the purchasers of the 2015 Warrants that represent the value by which the price of the common stock exceeds the strike price stipulated within the particular warrant agreement.

The effective interest rate and components of interest expense of the 2015 Notes for the three and six months ended June 28, 2014 and June 29, 2013 were as follows:



	Three Months Ended						Six Months Ended
	June 28, 2014			June 29, 2013			June 28, 2014			June 29, 2013
	(In thousands, except percentages)
Effective interest rate	8.1		%	8.1		%	8.1		%	8.1		%
Contractual interest expense	$	2,289		$	2,289		$	4,578		$	4,578
Amortization of debt discount	$	4,275		$	3,951		$	8,507		$	7,861

Revolving Credit Facility

In December 2012, Cadence entered into a five-year senior secured revolving credit facility with a group of lenders led by Bank of America, N.A., as administrative agent. The credit facility provides for borrowings up to $250.0 million, with the right to request increased capacity up to an additional $150.0 million upon the receipt of lender commitments, for total maximum borrowings of $400.0 million.

Any outstanding loans drawn under the credit facility are due at maturity on December 12, 2017. Outstanding amounts may be paid at any time prior to maturity. The facility is secured by certain accounts receivable and certain equity interests in Cadence’s subsidiaries.

Interest accrues on borrowings under the credit facility at either LIBOR plus a margin between 1.25% and 2.0% per annum or at a base rate plus a margin between 0.25% and 1.0% per annum. The interest rate applied to borrowings is determined by Cadence’s consolidated leverage ratio as specified by the credit facility agreement. Interest is payable quarterly. A commitment fee ranging from 0.20% to 0.35% is assessed on the daily average undrawn portion of revolving commitments. As of June 28, 2014, the interest rate applied to outstanding borrowings under the credit facility was 1.40%.

The credit facility contains customary negative covenants that, among other things, restrict Cadence’s ability to incur additional indebtedness, grant liens, make certain investments (including acquisitions), dispose of certain assets and make certain payments, including share repurchases and dividends. In addition, the credit facility contains financial covenants that require Cadence to maintain a leverage ratio not to exceed 3 to 1, and a minimum interest coverage ratio of 3 to 1.

As of June 28, 2014 and December 28, 2013, Cadence had outstanding borrowings under the credit facility of $100.0 million and $0, respectively, and was in compliance with all financial covenants.