OREANDA-NEWS. Fitch Ratings has affirmed the ratings for Cadence Design Systems, Inc. (Cadence), including the Long-Term Issuer Default Rating (IDR) at 'BBB+'. The Rating Outlook is Stable. The ratings affect $600 million of debt, including the $250 million revolving credit facility (RCF). A full list of current ratings follows at the end of this release.

KEY RATING DRIVERS

The ratings and Outlook reflect Fitch's expectations for solid operating results within the context of a challenging demand environment. System design enablement, digital and signoff, as well as intellectual property (IP) businesses should continue growing, driven by increased design complexity and shortened new product introduction (NPI) cycles and resulting in Fitch's expectations for more than 7% revenue growth for 2015 and low- to mid-single digit revenue growth over the intermediate-term.

Fitch expects profit margins will strengthen, due to operating leverage and a richer sales mix, including rapidly growing IP sales. Fitch expects operating EBITDA to remain in the high-20s over the intermediate-term, up from a Fitch estimated mid-20s in each of the last three years.

As a result, annual free cash flow could exceed the upper end of Fitch's previously forecasted range of $200 million to $400 million through the semiconductor cycle. Free Cash Flow (FCF) was $341 million for the latest-12-months (LTM) ended Oct. 3, 2015, up 28% from the comparable prior year period, while FCF margins expanded to 20% from 17% over the same periods.

Fitch expects financial policies will remain conservative, despite the company's authorization to buy back $1.2 billion of common stock by the end of 2016 ($1.1 billion remains available for repurchase as of Oct. 3, 2015). Fitch expects Cadence will fund stock buybacks with a mixture of domestic cash and domestic FCF (estimated at roughly half of total FCF), as well as potential debt issuance. Fitch assumes Cadence would slow or suspend share repurchases for meaningful acquisitions.

Fitch expects credit protection measures to remain strong for the rating with total leverage (total debt to operating EBITDA) below 2x, even were Cadence to replace the $350 million of convertible notes the company repaid at maturity on June 1, 2015. For the LTM ended Oct. 3, 2015, Fitch estimates total leverage was 0.65x, down from 1.7x for 2014. Fitch expects interest coverage (Operating EBITDA to gross interest expense) will remain remain above 10x and was nearly 15x for the LTM ended Oct. 3, 2015.

The ratings are supported by:
--Cadence's share leadership in the Electronic Design Automation (EDA) industry, with the leading position in Analog and a top three player in Verification, printed circuit board (PCB) & Packaging, and Digital & Signoff. Fitch believes NPI as a result of increasing R&D, recent acquisitions of new technologies, and ongoing trends in the semiconductor industry with regards to outsourcing design IP will allow Cadence to gain share in the Digital market;
--High switching costs, mission critical function in enabling semiconductor companies to remain competitive, and growing secular trends favoring design outsourcing support long-term partnerships with customers;
--Subscription-based model enables highly recurring revenue with a +99% renewal rate, supporting high revenue visibility;
--A highly diversified customer base, with only one customer representing slightly over 5% of revenue. Fitch also believes an increasing proportion of revenue derived from systems companies will drive further diversification.

Ratings concerns center on Fitch's expectations for:
--Meaningfully lower market share positioning in Digital, a key market in which its largest competitor dominates. Fitch believes this may shift over time as Cadence wins designs in new higher-end technologies. Additionally, Fitch believes Mentor Graphics' focus outside of Digital may drive share-gain opportunities for Cadence;
--Significant R&D investment requirements in maintaining technology leadership within the EDA industry that will constitute nearly $600 million (roughly 35% of revenues), which is in-line with the broader industry and provides barriers to new entrants;
--Substantial key man risk, given the CEO's significant network within the semiconductor industry, as well as increasing connections in the electronics systems industry;
--The company's relatively small revenue base, although FCF margin are strong for the rating category.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
--More than 7% revenue growth in 2015 and low- to mid-single digit growth beyond 2015, driven by increased complexity and shorter NPI cycles;
--Operating EBITDA margin in the high 20s from operating leverage and a richer sales mix;
--Some debt used to finance the company's $1.2 billion stock buyback program by the end of 2016;
--Management will slow or suspend share repurchases for a meaningful acquisition.

RATING SENSITIVITIES

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 total debt to operating EBITDA above 2x.

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

LIQUIDITY

Cadence's liquidity was solid as of Oct. 3, 2015 and supported by:

--Approximately $711 million of cash and equivalents, of which roughly two-thirds was located outside the U.S.;
--An undrawn $250 million senior unsecured RCF expiring Sept. 19, 2019.

Fitch's expectation for $200 million to $400 million of annual FCF through the semiconductor cycle also supports liquidity.

Total debt was $350 million as of Oct. 3, 2015, consisting solely of $350 million of 4.375% senior notes due Oct. 15, 2024.

FULL LIST OF RATING ACTIONS

Fitch affirms the following:

Cadence Design Systems, Inc.

--Issuer Default Rating (IDR) at 'BBB+';
--Senior unsecured RCF at 'BBB+;
--Senior unsecured notes at 'BBB+'.