filings.toolsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K and with Part I, Item 1A, “Risk Factors.” Please refer to the cautionary language at the beginning of Part I of this Annual Report on Form 10-K regarding forward-looking statements.
Business Overview
We enable our customers to develop electronic products. Our products and services are designed to give our customers a competitive edge in their development of ICs, SoCs, and increasingly sophisticated electronic devices and systems. Our products and services do this by optimizing performance, minimizing power consumption, shortening the time to bring our customers’ products to market, improving engineering productivity and reducing their design, development and manufacturing costs. We offer software, hardware, services and reusable IC design blocks, which are commonly referred to as IP.
Our strategy, which we call Intelligent System Design™, is to provide the technology necessary for our customers to develop electronic products across a variety of vertical markets including consumer, hyperscale computing, 5G communications, automotive, aerospace and defense, industrial and healthcare. Our products and services enable our customers to develop complex and innovative electronic products, so demand for our technology is driven by our customers’ investment in new designs and products. Historically, the industry that provided the tools used by IC engineers was referred to as EDA. Today, our offerings include and extend beyond EDA.
We group our products into categories related to major design activities:
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Custom IC Design and Simulation;
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Digital IC Design and Signoff;
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Functional Verification;
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IP; and
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System Design and Analysis.
For additional information about our products, see the discussion in Item 1, “Business,” under the heading “Products and Product Strategy.”
During the first quarter of fiscal 2020, we completed our acquisitions of AWR and Integrand. The aggregate cash consideration for these acquisitions of approximately $196 million was allocated to the assets acquired and liabilities assumed based on their respective estimated fair values on the respective acquisition dates. These acquisitions enhance our technology portfolio to address growing radio frequency design activity, driven by expanding use of 5G communications. These acquisitions increased expenses, including amortization of acquired intangible assets, more than revenue during fiscal 2020.
During the first quarter of fiscal 2021, we entered into a definitive agreement to acquire all of the outstanding equity of Belgium-based NUMECA, a leader in CFD, mesh generation, multi-physics simulation and optimization. The addition of NUMECA’s technologies and talent supports our Intelligent System Design™ strategy. The acquisition is expected to close in the first quarter of fiscal 2021, subject to customary closing conditions.
Management uses certain performance indicators to manage our business, including revenue, certain elements of operating expenses and cash flow from operations, and we describe these items further below under the headings “Results of Operations” and “Liquidity and Capital Resources.”
COVID-19 Impact
In March 2020, the World Health Organization declared the outbreak of COVID-19 a pandemic, which continues to spread throughout the U.S. and the world and has resulted in authorities implementing numerous measures to contain the virus, including travel bans and restrictions, quarantines, shelter-in-place orders, and business limitations and shutdowns. We are unable to accurately predict the full impact that COVID-19 will have on our results of operations, financial condition, liquidity and cash flows due to numerous uncertainties, including the duration and severity of the pandemic and containment measures. Our compliance with these containment measures has impacted our day-to-day operations and could disrupt our business and operations, as well as that of our key customers, suppliers (including contract manufacturers) and other counterparties, for an indefinite period of time. To support the health and well-being of our employees, customers, partners and communities, a vast majority of our employees are still working remotely as of February 22, 2021.
The COVID-19 pandemic has caused some volatility in our usual delivery timing for our hardware and IP products to certain customers. Many of our customers' employees are working remotely, and, in some cases, we have experienced delivery lead times that are longer than normal because of delays in getting access to customer sites to complete our deliveries. In other cases, the amount of our hardware and IP products that we have been able to deliver has been greater than we originally anticipated at the beginning of the respective period. We have also received numerous COVID-19 pandemic-related requests from our customers to allow them to delay their payments to us, while we continue to provide services to these customers. Despite the challenges the COVID-19 pandemic has posed to our operations, it did not have material adverse impact on our results of operations, financial condition, liquidity or cash flows during fiscal 2020. We will continue to evaluate the nature and extent of the impact of COVID-19 on our business. See Part I, Item 1A, “Risk Factors” for additional information on the impact of COVID-19.
Results of Operations
The discussion of our fiscal 2020 consolidated results of operations include year-over-year comparisons to fiscal 2019 for revenue, cost of revenue, operating expenses, operating margin, other non-operating expenses, income taxes and cash flows. For a discussion of the fiscal 2019 changes compared to fiscal 2018, see the discussion in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 28, 2019, filed on February 24, 2020.
Our fiscal years are 52- or 53-week periods ending on the Saturday closest to December 31. Fiscal 2020 was a 53-week year, compared to 2019 and 2018, which were each 52-week fiscal years. The additional week in fiscal 2020 resulted in additional revenue of approximately $45 million and additional expense, including stock-based compensation and amortization of acquired intangibles, of approximately $35 million.
Results of operations for fiscal 2020, as compared to fiscal 2019, reflect the following:
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increased product and maintenance revenue, resulting from growth in software, IP and hardware, particularly in China and the United States;
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higher selling costs, including additional investment in technical sales support in response to our customers’ increasing technological requirements;
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continued investment in research and development activities focused on expanding and enhancing our product portfolio;
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decreased operating expenses for travel, meetings and events due to various measures implemented to contain COVID-19;
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a 3 percentage point increase in operating margin driven primarily by revenue growth and temporary decreases in certain operating expenses due to the COVID-19 pandemic; and
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changes in our provision (benefit) for income taxes due to a non-cash tax benefit resulting from intercompany transfers of certain intangible property rights to our Irish subsidiary during fiscal 2019.
Revenue
We primarily generate revenue from licensing our software and IP, selling or leasing our emulation and prototyping hardware technology, providing maintenance for our software, hardware and IP, providing engineering services and earning royalties generated from the use of our IP. The timing of our revenue is significantly affected by the mix of software, hardware and IP products generating revenue in any given period and whether the revenue is recognized over time or at a point in time, upon completion of delivery.
In any fiscal year, we expect that between 85% and 90% of our annual revenue will be characterized as recurring revenue. Revenue characterized as recurring includes revenue recognized over time from our software arrangements, services, royalties, maintenance on IP licenses and hardware, and operating leases of hardware and revenue recognized at varying points in time over the term of our IP Access Agreements.
The remainder of our revenue is characterized as up-front revenue. Up-front revenue is primarily generated by our sales of emulation and prototyping hardware and individual IP licenses. The percentage of our recurring and up-front revenue may be impacted by delivery of hardware and IP products to our customers in any single fiscal period.
Revenue by Year
The following table shows our revenue for fiscal 2020 and 2019 and the change in revenue between years:
| Change | |||||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | 2020 vs. 2019 | |||||||||||||||||||||||||||||||||||||||
| (In millions, except percentages) | |||||||||||||||||||||||||||||||||||||||||
| Product and maintenance | $ | 2,536.6 | $ | 2,204.6 | $ | 332.0 | 15 | % | |||||||||||||||||||||||||||||||||
| Services | 146.3 | 131.7 | 14.6 | 11 | % | ||||||||||||||||||||||||||||||||||||
| Total revenue | $ | 2,682.9 | $ | 2,336.3 | $ | 346.6 | 15 | % |
Product and maintenance revenue increased during fiscal 2020, as compared to fiscal 2019, primarily because of increased investments by our customers in new, complex designs for their products that include the design of electronic systems for consumer, hyperscale computing, 5G communications, automotive, aerospace and defense, industrial and healthcare. Services revenue may fluctuate from period to period based on the timing of fulfillment of our services and IP performance obligations.
No one customer accounted for 10% or more of total revenue during fiscal 2020 or 2019.
Revenue by Product Category
The following table shows the percentage of product and related maintenance revenue contributed by each of our five product categories and services during fiscal 2020 and 2019:
| 2020 | 2019 | ||||||||||||||||
| Custom IC Design and Simulation | 25 | % | 25 | % | |||||||||||||
| Digital IC Design and Signoff | 29 | % | 30 | % | |||||||||||||
| Functional Verification, including Emulation and Prototyping Hardware | 22 | % | 23 | % | |||||||||||||
| IP | 14 | % | 13 | % | |||||||||||||
| System Design and Analysis | 10 | % | 9 | % | |||||||||||||
| Total | 100 | % | 100 | % |
Revenue by product category fluctuates from period to period based on demand for our products and services, our available resources and our ability to deliver and support them. Certain of our licensing arrangements allow customers the ability to remix among software products. Additionally, we have arrangements with customers that include a combination of our products, with the actual product selection and number of licensed users to be determined at a later date. For these arrangements, we estimate the allocation of the revenue to product categories based upon the expected usage of our products. The actual usage of our products by these customers may differ and, if that proves to be the case, the revenue allocation in the table above would differ.
Revenue by Geography
| Change | |||||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | 2020 vs. 2019 | |||||||||||||||||||||||||||||||||||||||
| (In millions, except percentages) | |||||||||||||||||||||||||||||||||||||||||
| United States | $ | 1,096.3 | $ | 982.4 | $ | 113.9 | 12 | % | |||||||||||||||||||||||||||||||||
| Other Americas | 43.6 | 43.5 | 0.1 | — | % | ||||||||||||||||||||||||||||||||||||
| China | 406.6 | 241.5 | 165.1 | 68 | % | ||||||||||||||||||||||||||||||||||||
| Other Asia | 487.4 | 459.0 | 28.4 | 6 | % | ||||||||||||||||||||||||||||||||||||
| Europe, Middle East and Africa | 469.8 | 433.3 | 36.5 | 8 | % | ||||||||||||||||||||||||||||||||||||
| Japan | 179.2 | 176.6 | 2.6 | 1 | % | ||||||||||||||||||||||||||||||||||||
| Total revenue | $ | 2,682.9 | $ | 2,336.3 | $ | 346.6 | 15 | % |
Revenue in the United States increased during fiscal 2020, as compared to fiscal 2019, primarily due to an increase in revenue for software and IP offerings.
Revenue in China increased during fiscal 2020, as compared to fiscal 2019,due to increased demand from many of our customers in China. We experienced an increase in demand in the first half of fiscal 2020 that resulted in approximately 13% of our total revenue being generated from customers in China, as compared to approximately 11% during the first half of fiscal 2019. This was followed by an additional increase in demand in the second half of fiscal 2020 that resulted in approximately 17% of our revenue being generated from customers in China, as compared to approximately 10% during the second half of fiscal 2019. During fiscal 2021, we expect revenue from our customers in China to be consistent, as a percentage of total revenue, with the first half of fiscal 2020.
Beginning in the second quarter of fiscal 2019, we have not been able to deliver maintenance or support for certain customers in China due to the U.S. Department of Commerce’s designation of these customers to the “Entity List.” We expect these restrictions and new or expanded trade restrictions to continue to impact revenue from certain customers in China.
For the primary factors contributing to the change in revenue for other geographies during fiscal 2020, as compared to fiscal 2019, see the general description under “Revenue by Year” and “Revenue by Product Category” above.
Revenue by Geography as a Percent of Total Revenue
| 2020 | 2019 | ||||||||||||||||
| United States | 41 | % | 42 | % | |||||||||||||
| Other Americas | 1 | % | 2 | % | |||||||||||||
| China | 15 | % | 10 | % | |||||||||||||
| Other Asia | 18 | % | 20 | % | |||||||||||||
| Europe, Middle East and Africa | 18 | % | 18 | % | |||||||||||||
| Japan | 7 | % | 8 | % | |||||||||||||
| Total | 100 | % | 100 | % |
Most of our revenue is transacted in the United States dollar. However, certain revenue transactions are denominated in foreign currencies. For an additional description of how changes in foreign exchange rates affect our consolidated financial statements, see the discussion under Item 7A, “Quantitative and Qualitative Disclosures About Market Risk – Foreign Currency Risk.”
Cost of Revenue
| Change | |||||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | 2020 vs. 2019 | |||||||||||||||||||||||||||||||||||||||
| (In millions, except percentages) | |||||||||||||||||||||||||||||||||||||||||
| Cost of product and maintenance | $ | 231.0 | $ | 189.1 | $ | 41.9 | 22 | % | |||||||||||||||||||||||||||||||||
| Cost of services | 74.5 | 77.2 | (2.7) | (3) | % | ||||||||||||||||||||||||||||||||||||
| Total cost of revenue | $ | 305.5 | $ | 266.3 | $ | 39.2 | 15 | % |
The following table shows cost of revenue as a percentage of related revenue for fiscal 2020 and 2019:
| 2020 | 2019 | ||||||||||||||||
| Cost of product and maintenance | 9 | % | 9 | % | |||||||||||||
| Cost of services | 51 | % | 59 | % |
Cost of Product and Maintenance
Cost of product and maintenance includes costs associated with the sale and lease of our emulation and prototyping hardware and licensing of our software and IP products, certain employee salary and benefits and other employee-related costs, cost of our customer support services, amortization of technology-related and maintenance-related acquired intangibles, costs of technical documentation and royalties payable to third-party vendors. Cost of product and maintenance depends primarily on our hardware product sales in any given period, but is also affected by employee salary and benefits and other employee-related costs, reserves for inventory, and the timing and extent to which we acquire intangible assets, license third-party technology or IP, and sell our products that include such acquired or licensed technology or IP.
A summary of cost of product and maintenance for fiscal 2020 and 2019 is as follows:
| Change | |||||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | 2020 vs. 2019 | |||||||||||||||||||||||||||||||||||||||
| (In millions, except percentages) | |||||||||||||||||||||||||||||||||||||||||
| Product and maintenance-related costs | $ | 184.8 | $ | 148.1 | $ | 36.7 | 25 | % | |||||||||||||||||||||||||||||||||
| Amortization of acquired intangibles | 46.2 | 41.0 | 5.2 | 13 | % | ||||||||||||||||||||||||||||||||||||
| Total cost of product and maintenance | $ | 231.0 | $ | 189.1 | $ | 41.9 | 22 | % |
Product and maintenance-related costs increased during fiscal 2020, when compared to fiscal 2019, due to the following:
| Change | |||||||||||
| 2020 vs. 2019 | |||||||||||
| (In millions) | |||||||||||
| Emulation and prototyping hardware costs | 34.1 | ||||||||||
| Professional services | 2.5 | ||||||||||
| Salary, benefits and other employee-related costs | 1.8 | ||||||||||
| Other items | (1.7) | ||||||||||
| Total change in product and maintenance-related costs | $ | 36.7 |
Costs associated with our emulation and prototyping hardware products include components, assembly, testing, applicable reserves and overhead. These costs make our cost of emulation and prototyping hardware products higher, as a percentage of revenue, than our cost of software and IP products. The increase in emulation and prototyping hardware costs during fiscal 2020, as compared to fiscal 2019, was primarily due to increased demand for our emulation and prototyping hardware, increased reserves for inventory, and the mix of products generating revenue.
Amortization of acquired intangibles included in cost of product and maintenance increased by $9.4 million during fiscal 2020, as compared to fiscal 2019, due to technology-related intangible assets acquired from AWR and Integrand during fiscal 2020 and in-process technology being placed into service during fiscal 2020 and 2019. This increase was partially offset by certain technology-related intangible assets becoming fully amortized during fiscal 2020 and 2019.
Cost of Services
Cost of services primarily includes employee salary, benefits and other employee-related costs to perform work on revenue-generating projects and costs to maintain the infrastructure necessary to manage a services organization. Cost of services may fluctuate from period to period based on our utilization of design services engineers on revenue-generating projects rather than internal development projects. Despite an increase in services revenue, cost of services decreased during fiscal 2020, as compared to fiscal 2019, due to a higher margin on the mix of services arrangements in fiscal 2020, compared to fiscal 2019, and temporary savings due to the COVID pandemic.
Operating Expenses
Our operating expenses include marketing and sales, research and development, and general and administrative expenses. Factors that tend to cause our operating expenses to fluctuate include changes in the number of employees due to hiring and acquisitions, stock-based compensation, restructuring activities, foreign exchange rate movements, and the impact of our variable compensation programs that are driven by operating results. During fiscal 2020 we experienced decreased operating expenses for travel, meetings and events due to various measures implemented to contain COVID-19.
Many of our operating expenses are transacted in various foreign currencies. We recognize lower expenses in periods when the United States dollar strengthens in value against other currencies and we recognize higher expenses when the United States dollar weakens against other currencies. For an additional description of how changes in foreign exchange rates affect our consolidated financial statements, see the discussion in Item 7A, “Quantitative and Qualitative Disclosures About Market Risk – Foreign Currency Risk.”
Our operating expenses for fiscal 2020 and 2019 were as follows:
| Change | |||||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | 2020 vs. 2019 | |||||||||||||||||||||||||||||||||||||||
| (In millions, except percentages) | |||||||||||||||||||||||||||||||||||||||||
| Marketing and sales | $ | 516.5 | $ | 481.7 | $ | 34.8 | 7 | % | |||||||||||||||||||||||||||||||||
| Research and development | 1,033.7 | 935.9 | 97.8 | 10 | % | ||||||||||||||||||||||||||||||||||||
| General and administrative | 154.4 | 139.8 | 14.6 | 10 | % | ||||||||||||||||||||||||||||||||||||
| Total operating expenses | $ | 1,704.6 | $ | 1,557.4 | $ | 147.2 | 9 | % |
Our operating expenses, as a percentage of total revenue, for fiscal 2020 and 2019 were as follows:
| 2020 | 2019 | ||||||||||||||||
| Marketing and sales | 19 | % | 21 | % | |||||||||||||
| Research and development | 39 | % | 40 | % | |||||||||||||
| General and administrative | 6 | % | 6 | % | |||||||||||||
| Total operating expenses | 64 | % | 67 | % |
Marketing and Sales
The changes in marketing and sales expense were due to the following:
| Change | |||||||||||
| 2020 vs. 2019 | |||||||||||
| (In millions) | |||||||||||
| Salary, benefits and other employee-related costs | $ | 41.7 | |||||||||
| Stock-based compensation | 3.0 | ||||||||||
| Home office-related expenses | 2.0 | ||||||||||
| Travel and sales meetings | (13.0) | ||||||||||
| Other items | 1.1 | ||||||||||
| Total change in marketing and sales expense | $ | 34.8 |
Salary, benefits and other employee-related costs included in marketing and sales increased during fiscal 2020, as compared to fiscal 2019, salary, benefits and other employee-related costs included in marketing and sales expense increased due primarily to additional headcount from hiring and acquisitions and variable compensation as we continue to invest in technical sales support in response to our customers’ increasing technological requirements. This increase was partially offset by reduced costs for marketing events and travel due to COVID-19.
Research and Development
The changes in research and development expense were due to the following:
| Change | |||||||||||
| 2020 vs. 2019 | |||||||||||
| (In millions) | |||||||||||
| Salary, benefits and other employee-related costs | 95.7 | ||||||||||
| Stock-based compensation | 10.3 | ||||||||||
| Product development costs | 3.7 | ||||||||||
| Home office-related expenses | 5.3 | ||||||||||
| Facilities and other infrastructure costs | (2.2) | ||||||||||
| Professional services | (2.8) | ||||||||||
| Travel | (11.8) | ||||||||||
| Other items | (0.4) | ||||||||||
| Total change in research and development expense | $ | 97.8 |
Salary, benefits and other employee-related costs included in research and development expense increased during fiscal 2020, as compared to fiscal 2019, due primarily to additional headcount from hiring and acquisitions and variable compensation as we continue to expand and enhance our product portfolio. This increase was partially offset by reduced costs for travel due to COVID-19.
General and Administrative
The changes in general and administrative expense were due to the following:
| Change | |||||||||||
| 2020 vs. 2019 | |||||||||||
| (In millions) | |||||||||||
| Salary, benefits and other employee-related costs | $ | 6.5 | |||||||||
| Facilities and other infrastructure costs | 2.6 | ||||||||||
| University endowment | 2.0 | ||||||||||
| Stock-based compensation | 2.0 | ||||||||||
| Other items | 1.5 | ||||||||||
| Total change in general and administrative expense | $ | 14.6 |
Salary, benefits and other employee-related costs included in general and administrative expense increased during fiscal 2020, as compared to fiscal 2019, due primarily to an increase in variable compensation and additional headcount from hiring.
Amortization of Acquired Intangibles
Amortization of acquired intangibles consists primarily of amortization of customer relationships, acquired backlog, trade names, trademarks and patents. Amortization in any given period depends primarily the timing and extent to which we acquire intangible assets.
| Change | |||||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | 2020 vs. 2019 | |||||||||||||||||||||||||||||||||||||||
| (In millions, except percentages) | |||||||||||||||||||||||||||||||||||||||||
| Amortization of acquired intangibles | $ | 18.0 | $ | 12.1 | $ | 5.9 | 49 | % |
Amortization of acquired intangibles increased by $7.3 million during fiscal 2020, as compared to fiscal 2019, due to intangibles assets acquired from AWR and Integrand during fiscal 2020. This increase was partially offset by certain intangible assets becoming fully amortized during fiscal 2020 and 2019.
Restructuring and Other Charges
We have initiated restructuring plans in recent years to better align our resources with our business strategy. Because the restructuring charges and related benefits are derived from management’s estimates made during the formulation of the restructuring plans, based on then-currently available information, our restructuring plans may not achieve the benefits anticipated on the timetable or at the level contemplated. Additional actions, including further restructuring of our operations, may be required in the future.
The following table presents restructuring and other charges, net for our restructuring plans:
| 2020 | 2019 | ||||||||||||||||
| (In millions) | |||||||||||||||||
| Severance and benefits | $ | 7.5 | $ | 8.6 | |||||||||||||
| Excess facilities | 1.7 | — | |||||||||||||||
| Total | $ | 9.2 | $ | 8.6 |
For an additional description of our restructuring plans, see Note 13 in the notes to consolidated financial statements.
Operating margin
Operating margin represents income from operations as a percentage of total revenue. Our operating margin for fiscal 2020 and 2019 was as follows:
| 2020 | 2019 | ||||||||||||||||
| Operating margin | 24 | % | 21 | % |
Operating margin increased during fiscal, 2020, as compared to fiscal 2019, because revenue growth exceeded the growth of our costs and expenses. During fiscal 2021, we expect growth in operating margin will be more moderate due to an increase in costs and expenses associated with acquisitions, including increased amortization of intangibles. We also expect an increase in expenses related to travel, meetings and events if measures implemented to contain COVID-19 are lifted.
Interest Expense
Interest expense for fiscal 2020 and 2019 was comprised of the following:
| 2020 | 2019 | ||||||||||||||||
| (In millions) | |||||||||||||||||
| Contractual cash interest expense: | |||||||||||||||||
| 2024 Notes | $ | 15.5 | $ | 15.3 | |||||||||||||
| Revolving credit facility | 4.4 | 2.4 | |||||||||||||||
| Amortization of debt discount: | |||||||||||||||||
| 2024 Notes | 0.8 | 0.7 | |||||||||||||||
| Other | — | 0.4 | |||||||||||||||
| Total interest expense | $ | 20.7 | $ | 18.8 |
Interest expense increased during fiscal 2020, as compared to fiscal 2019, due to borrowings of $350 million under our revolving credit facility during the first quarter of fiscal 2020 as a precautionary measure to provide additional liquidity in light of global economic uncertainty. All outstanding borrowings under our revolving credit facility were repaid in the fourth quarter of fiscal 2020. For an additional description of our debt arrangements, including our revolving credit facility, see Note 3 in the notes to consolidated financial statements.
Income Taxes
The following table presents the provision (benefit) for income taxes and the effective tax rate for fiscal 2020 and 2019:
| 2020 | 2019 | ||||||||||||||||
| (In millions, except percentages) | |||||||||||||||||
| Provision (benefit) for income taxes | $ | 42.1 | $ | (510.0) | |||||||||||||
| Effective tax rate | 6.7 | % | (106.5) | % |
In June 2020, the State of California enacted legislation that, for a three-year period beginning in fiscal 2020, will limit our utilization of California research and development tax credits to $5 million annually and will suspend the use of California net operating loss deductions. We accounted for the effects of the California tax law change and we recognized a tax benefit of approximately $22.2 million due to a partial release of the valuation allowance on our California research and development tax credit deferred tax assets as a result of certain tax elections made in our 2019 California tax return.
Our provision for fiscal 2020 was primarily attributable to federal, state and foreign income taxes on our fiscal 2020 income, partially offset by the tax benefit of $22.2 million related to the partial release of the valuation allowance on our California research and development tax credit deferred tax assets and the tax benefit of $60.1 million related to stock-based compensation that vested or was exercised during fiscal 2020.
During fiscal 2019, we completed intercompany transfers of certain intangible property rights to our Irish subsidiary, which resulted in the establishment of a net deferred tax asset and the recognition of an income tax benefit of $575.6 million. We expected to realize the deferred tax asset in future periods and did not provide for a valuation allowance.
This income tax benefit was partially offset by the federal, state and foreign income taxes on our fiscal 2019 income. We also recognized $36.8 million of tax benefit related to stock-based compensation that vested or was exercised during the year.
Our future effective tax rates may be materially impacted by tax amounts associated with our foreign earnings at rates different from the United States federal statutory rate, research credits, the tax impact of stock-based compensation, accounting for uncertain tax positions, business combinations, closure of statutes of limitations or settlement of tax audits, changes in valuation allowance and changes in tax law. A significant amount of our foreign earnings is generated by our subsidiaries organized in Ireland and Hungary. Our future effective tax rates may be adversely affected if our earnings were to be lower in countries where we have lower statutory tax rates. We currently expect that our fiscal 2021 effective tax rate will be approximately 14%. We expect that our quarterly effective tax rates will vary from our fiscal 2021 effective tax rate as a result of recognizing the income tax effects of stock-based awards in the quarterly periods that the awards vest or are settled and other items that we cannot anticipate. For additional discussion about how our effective tax rate could be affected by various risks, see Part I, Item 1A, “Risk Factors.” For further discussion regarding our income taxes, see Note 6 in the notes to consolidated financial statements.
Liquidity and Capital Resources
| As of | Change | ||||||||||||||||||||||||||||
| January 2, 2021 | December 28, 2019 | 2020 vs. 2019 | |||||||||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||||||||
| Cash and cash equivalents | $ | 928.4 | $ | 705.2 | $ | 223.2 | |||||||||||||||||||||||
| Net working capital | 681.8 | 497.0 | 184.8 |
Cash and Cash Equivalents
As of January 2, 2021, our principal sources of liquidity consisted of $928.4 million of cash and cash equivalents as compared to $705.2 million as of December 28, 2019.
Our primary sources of cash and cash equivalents during fiscal 2020 were cash generated from operations, proceeds from borrowings under our revolving credit facility, proceeds from the exercise of stock options and proceeds from stock purchases under our employee stock purchase plan.
Our primary uses of cash and cash equivalents during fiscal 2020 were payments related to salaries and benefits, operating expenses, repurchases of our common stock, payments on our revolving credit facility, payments for business combinations, net of cash acquired, and purchases of property, plant and equipment.
Approximately 61% of our cash and cash equivalents were held by our foreign subsidiaries as of January 2, 2021. Our cash and cash equivalents held by our foreign subsidiaries may vary from period to period due to the timing of collections and repatriation of foreign earnings. We expect that current cash and cash equivalent balances, cash flows that are generated from operations and cash borrowings available under our revolving credit facility will be sufficient to meet our domestic and international working capital needs, and other capital and liquidity requirements, including acquisitions and share repurchases for at least the next 12 months.
Net Working Capital
Net working capital is comprised of current assets less current liabilities, as shown on our consolidated balance sheets. The increase in our net working capital as of January 2, 2021, as compared to December 28, 2019, is primarily due to improved results from operations, the timing of cash receipts from customers and disbursements made to vendors.
Cash Flows from Operating Activities
Cash flows from operating activities during fiscal 2020 and 2019 were as follows:
| Change | |||||||||||||||||||||||||||||
| 2020 | 2019 | 2020 vs. 2019 | |||||||||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||||||||
| Cash provided by operating activities | $ | 904.9 | $ | 729.6 | $ | 175.3 |
Cash flows from operating activities include net income, adjusted for certain non-cash items, as well as changes in the balances of certain assets and liabilities. Our cash flows from operating activities are significantly influenced by business levels and the payment terms set forth in our customer agreements. The increase in cash flows from operating activities during fiscal 2020, as compared to fiscal 2019, was primarily due to the improved results from operations and timing of cash receipts from customers and disbursements made to vendors.
Cash Flows from Investing Activities
Cash flows used for investing activities during fiscal 2020 and 2019 were as follows:
| Change | |||||||||||||||||||||||||||||
| 2020 | 2019 | 2020 vs. 2019 | |||||||||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||||||||
| Cash used for investing activities | $ | (292.2) | $ | (105.7) | $ | (186.5) |
The increase in cash used for investing activities during fiscal 2020, as compared to fiscal 2019, was primarily due to an increase in cash paid in business combinations, net of cash acquired, and an increase in purchases of property, plant and equipment. These increases were partially offset by a decrease in payments to acquire equity instruments of other entities. We expect to continue our investing activities, including purchasing property, plant and equipment, purchasing intangible assets, business combinations, purchasing software licenses, and making strategic investments.
Cash Flows from Financing Activities
Cash flows used for financing activities during fiscal 2020 and 2019 were as follows:
| Change | |||||||||||||||||||||||||||||
| 2020 | 2019 | 2020 vs. 2019 | |||||||||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||||||||
| Cash used for financing activities | $ | (415.3) | $ | (443.9) | $ | 28.6 |
The decrease in cash used for financing activities during fiscal 2020, as compared to fiscal 2019, was primarily due to a decrease in net cash paid for debt arrangements, partially offset by an increase in payments for repurchases of our common stock.
Other Factors Affecting Liquidity and Capital Resources
Stock Repurchase Program
At the end of fiscal 2019, approximately $369 million remained available under our previously announced authorization to repurchase shares of our common stock. In July 2020, Cadence’s Board of Directors increased the previously announced authorization to repurchase shares of Cadence common stock by an additional $750 million. The actual timing and amount of repurchases are subject to business and market conditions, corporate and regulatory requirements, stock price, acquisition opportunities and other factors. As of January 2, 2021, approximately $739 million remained available to repurchase shares of Cadence common stock. See Part II, Item 5, “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” for additional information.
Revolving Credit Facility
Our senior unsecured revolving credit facility provides for borrowings up to $350.0 million, with the right to request increased capacity up to an additional $250.0 million upon the receipt of lender commitments, for total maximum borrowings of $600.0 million. The credit facility expires on January 28, 2022 and currently has no subsidiary guarantors. Any outstanding loans drawn under the credit facility are due at maturity on January 28, 2022. Outstanding borrowings may be paid at any time prior to maturity. As of January 2, 2021, there were no borrowings outstanding under our revolving credit facility, and we were in compliance with all financial covenants associated with the revolving credit facility.
2024 Notes
In October 2014, we issued $350.0 million aggregate principal amount of 4.375% Senior Notes due October 15, 2024. We received net proceeds of $342.4 million from the issuance of the 2024 Notes, net of a discount of $1.4 million and issuance costs of $6.2 million. Interest is payable in cash semi-annually. The 2024 Notes are unsecured and rank equal in right of payment to all of our existing and future senior indebtedness. As of January 2, 2021, we were in compliance with all covenants associated with the 2024 Notes.
For additional information relating to our debt arrangements, see Note 3 in the notes to consolidated financial statements.
Contractual Obligations
A summary of our contractual obligations as of January 2, 2021 is as follows:
| Payments Due by Period | |||||||||||||||||||||||||||||
| Total | Less Than 1 Year | 1-3 Years | 3-5 Years | More Than 5 Years | |||||||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||||||||
| Operating lease obligations(1) | $ | 173.5 | $ | 38.4 | $ | 51.9 | $ | 35.6 | $ | 47.6 | |||||||||||||||||||
| Purchase obligations | 46.8 | 36.3 | 8.7 | 1.3 | 0.5 | ||||||||||||||||||||||||
| Long-term debt | 350.0 | — | — | 350.0 | — | ||||||||||||||||||||||||
| Contractual interest payments | 61.8 | 15.8 | 30.7 | 15.3 | — | ||||||||||||||||||||||||
| Current income tax payable | 7.8 | 7.8 | |||||||||||||||||||||||||||
| Other long-term contractual obligations (2) | 40.4 | — | 19.8 | 4.0 | 16.6 | ||||||||||||||||||||||||
| Total | $ | 680.3 | $ | 98.3 | $ | 111.1 | $ | 406.2 | $ | 64.7 |
(1) This table includes future payments under leases that had commenced as of January 2, 2021 as well as leases that had been signed but not yet commenced as of January 2, 2021.
(2) Included in other long-term contractual obligations are long-term income tax liabilities of $17.6 million related to unrecognized tax benefits. Of the $17.6 million, we estimate $16.3 million will be paid or settled within 1 to 3 years, $1.2 million within 3 to 5 years and $0.1 million in more than 5 years. The remaining portion of other long-term contractual obligations is primarily liabilities associated with defined benefit retirement plans and acquisitions.
Off-Balance Sheet Arrangements
As of January 2, 2021, we did not have any significant off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
Critical Accounting Estimates
In preparing our consolidated financial statements, we make assumptions, judgments and estimates that can have a significant impact on our revenue, operating income and net income, as well as on the value of certain assets and liabilities on our consolidated balance sheets. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. At least quarterly, we evaluate our assumptions, judgments and estimates, and make changes as deemed necessary.
We believe that the assumptions, judgments and estimates involved in the accounting for income taxes, revenue recognition and business combinations have the greatest potential impact on our consolidated financial statements; therefore, we consider these to be our critical accounting estimates. For information on our significant accounting policies, see Note 2 in the notes to consolidated financial statements.
Revenue Recognition
Our contracts with customers often include promises to transfer multiple software and/or IP licenses, hardware and services, including professional services, technical support services, and rights to unspecified updates to a customer. These contracts require us to apply judgement in identifying and evaluating any terms and conditions in contracts which may impact revenue recognition. Determining whether licenses and services are distinct performance obligations that should be accounted for separately, or not distinct and thus accounted for together, requires significant judgment. In some arrangements, such as most of our IP license arrangements, we have concluded that the licenses and associated services are distinct from each other. In other arrangements, like our time-based software arrangements, the licenses and certain services are not distinct from each other. Our time-based software arrangements include multiple software licenses and updates to the licensed software products, as well as technical support, and we have concluded that these promised goods and services are a single, combined performance obligation.
Judgment is required to determine the stand-alone selling prices (“SSPs”) for each distinct performance obligation. We rarely license or sell products on a standalone basis, so we are required to estimate the SSP for each performance obligation. In instances where the SSP is not directly observable because we do not sell the license, product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual performance obligations due to the stratification of those items by classes of customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region of the customer in determining the SSP.
Revenue is recognized over time for our combined performance obligations that include software licenses, updates, and technical support as well as for maintenance and professional services that are separate performance obligations. For our professional services, revenue is recognized over time, generally using costs incurred or hours expended to measure progress. Judgment is required in estimating project status and the costs necessary to complete projects. A number of internal and external factors can affect these estimates, including labor rates, utilization and efficiency variances and specification and testing requirement changes. For our other performance obligations recognized over time, revenue is generally recognized using a time-based measure of progress reflecting generally consistent efforts to satisfy those performance obligations throughout the arrangement term.
If a group of agreements are so closely related that they are, in effect, part of a single arrangement, such agreements are deemed to be one arrangement for revenue recognition purposes. We exercise significant judgment to evaluate the relevant facts and circumstances in determining whether the separate agreements should be accounted for separately or as, in substance, a single arrangement. Our judgments about whether a group of contracts comprise a single arrangement can affect the allocation of consideration to the distinct performance obligations, which could have an effect on results of operations for the periods involved.
We are required to estimate the total consideration expected to be received from contracts with customers. In some circumstances, the consideration expected to be received is variable based on the specific terms of the contract or based on our expectations of the term of the contract. Generally, we have not experienced significant returns or refunds to customers. These estimates require significant judgment and the change in these estimates could have an effect on our results of operations during the periods involved.
Accounting for Income Taxes
We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in evaluating and estimating our provision for these taxes. There are many transactions that occur during the ordinary course of business for which the ultimate tax determination is uncertain. Our provision for income taxes could be adversely affected by our earnings being lower than anticipated in countries where we have lower statutory rates and higher than anticipated in countries where we have higher statutory rates, losses incurred in jurisdictions for which we are not able to realize the related tax benefit, changes in foreign currency exchange rates, entry into new businesses and geographies and changes to our existing businesses, acquisitions and investments, changes in our deferred tax assets and liabilities including changes in our assessment of valuation allowances, changes in the relevant tax laws or interpretations of these tax laws, and developments in current and future tax examinations.
We only recognize the tax benefit of an income tax position if we judge that it is more likely than not that the tax position will be sustained, solely on its technical merits, in a tax audit including resolution of any related appeals or litigation processes. To make this judgment, we must interpret complex and sometimes ambiguous tax laws, regulations and administrative practices. If we judge that an income tax position meets this recognition threshold, then we must measure the amount of the tax benefit to be recognized by estimating the largest amount of tax benefit that has a greater than 50% cumulative probability of being realized upon settlement with a taxing authority that has full knowledge of all of the relevant facts. It is inherently difficult and subjective to estimate such amounts, as this requires us to determine the probability of various possible settlement outcomes. We must reevaluate our income tax positions on a quarterly basis to consider factors such as changes in facts or circumstances, changes in tax law, effectively settled issues under audit, the lapse of applicable statute of limitations, and new audit activity. Such a change in recognition or measurement would result in recognition of a tax benefit or an additional charge to the tax provision. For a more detailed description of our unrecognized tax benefits, see Note 6 in the notes to consolidated financial statements.
During fiscal 2019, we completed intercompany transfers of certain intangible property rights to our Irish subsidiary, which resulted in the establishment of a deferred tax asset and the recognition of an income tax benefit of $575.6 million. To determine the value of the deferred tax asset, we were required to make significant estimates in determining the fair value of the transferred IP rights. These estimates included, but are not limited to, the income and cash flows that the IP rights are expected to generate in the future, the appropriate discount rate to apply to the income and cash flow projections, and the useful lives of the IP rights. These estimates are inherently uncertain and unpredictable, and if different estimates were used, it would impact the fair value of the IP rights and the related value of the deferred tax asset and the income tax benefit recognized in fiscal 2019 and in future periods when the deferred tax asset is realized. In addition, we reviewed the need to establish a valuation allowance on the deferred tax asset of $575.6 million by evaluating whether there is a greater than 50% likelihood that some portion or all of the deferred tax asset will not be realized. To make this judgment, we must make significant estimates and predictions of the amount and category of future taxable income from various sources and weigh all available positive and negative evidence about these possible sources of taxable income. We give greater weight to evidence that can be objectively verified. Based on our evaluation and weighting of the positive and negative evidence, we concluded that it is greater than 50% likely that the deferred tax asset of $575.6 million will be realized in future periods and that a valuation allowance was not currently required. If, in the future, we evaluate that this deferred tax asset is not likely to be realized, an increase in the related valuation allowance could result in a material income tax expense in the period such a determination is made.
Business Combinations
When we acquire businesses, we allocate the purchase price to the acquired tangible assets and assumed liabilities, including deferred revenue, liabilities associated with the fair value of contingent consideration and acquired identifiable intangible assets. Any residual purchase price is recorded as goodwill. The allocation of the purchase price requires us to make significant estimates in determining the fair values of these acquired assets and assumed liabilities, especially with respect to intangible assets and goodwill. These estimates are based on information obtained from management of the acquired companies, our assessment of this information, and historical experience. These estimates can include, but are not limited to, the cash flows that an acquired business is expected to generate in the future, the cash flows that specific assets acquired with that business are expected to generate in the future, the appropriate weighted-average cost of capital, and the cost savings expected to be derived from acquiring an asset. These estimates are inherently uncertain and unpredictable, and if different estimates were used, the purchase price for the acquisition could be allocated to the acquired assets and assumed liabilities differently from the allocation that we have made to the acquired assets and assumed liabilities. In addition, unanticipated events and circumstances may occur that may affect the accuracy or validity of such estimates, and if such events occur, we may be required to adjust the value allocated to acquired assets or assumed liabilities.
We also make significant judgments and estimates when we assign useful lives to the definite-lived intangible assets identified as part of our acquisitions. These estimates are inherently uncertain and if we used different estimates, the useful life over which we amortize intangible assets would be different. In addition, unanticipated events and circumstances may occur that may impact the useful life assigned to our intangible assets, which would impact our amortization of intangible assets expense and our results of operations.
During the first quarter of fiscal 2020, we acquired intangible assets of $101.3 million with our acquisition of AWR and Integrand. The fair value of the definite-lived intangible assets acquired with these acquisitions was determined using variations of the income approach.
For existing technology, the fair value was determined by applying the relief-from-royalty method. This method is based on the application of a royalty rate to forecasted revenue to quantify the benefit of owning the intangible asset rather than paying a royalty for use of the asset. To estimate royalty savings over time, we projected revenue from existing technology over the estimated remaining life of the technology, including the effect of technological obsolescence which was estimated at rate between 5% and 7.5% annually, before applying an assumed royalty rate of 20%. The present value of after-tax royalty savings were determined using discount rates ranging from 10% to 11.5%.
The fair value for customer contracts and related relationships was determined by using the multi-period excess earnings method. This method reflects the present value of the projected cash flows that are expected to be generated from existing customers, less charges representing the contribution of other assets to those cash flows. Projected income from existing customer relationships considered customer retention rates ranging between 85% and 95%. The present value of operating cash flows from existing customer was determined using discount rates 10% and 11.5%.
We also assumed obligations related to deferred revenue of $6.9 million during the first quarter of fiscal 2020 with our acquisition of AWR. The fair value of these obligations was estimated using the cost build-up approach. The cost build-up approach determines fair value using estimates of the costs required to fulfill the contracted obligations plus an assumed profit margin, which approximates the amount that AWR would be required to pay a third party to assume the obligation.
Cadence believes that its estimates and assumptions related to the fair value of its acquired intangible assets and deferred revenue obligations are reasonable, but significant judgment is involved.
New Accounting Standards
For additional information about the adoption of new accounting standards, see Note 2 in the notes to consolidated financial statements.
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