filings.toolsItem 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q (this “Quarterly Report”) and in conjunction with our Annual Report on Form 10-K for the fiscal year ended January 1, 2022 (our “Annual Report”). This Quarterly Report contains statements that are not historical in nature, are predictive, or that depend upon or refer to future events or conditions or contain other forward-looking statements. Statements including, but not limited to, statements regarding the extent and timing of future revenues and expenses and customer demand, statements regarding the deployment of our products and services, statements regarding our reliance on third parties, statements regarding the impact on our business of the COVID-19 pandemic and related public health measures or mandates, statements regarding the impact of government actions and other statements using words such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “forecasts,” “intends,” “may,” “plans,” “projects,” “should,” “targets,” “will” and “would,” and words of similar import and the negatives thereof, constitute forward-looking statements. These statements are predictions based upon our current expectations about future events. Actual results could vary materially as a result of certain factors, including, but not limited to, those expressed in these statements. We refer you to the “Results of Operations,” “Quantitative and Qualitative Disclosures About Market Risk,” and “Liquidity and Capital Resources” sections contained in this Quarterly Report, the "Risk Factors" section contained in our Annual Report for the fiscal year ended January 1, 2022, and the risks discussed in our other Securities and Exchange Commission (“SEC”) filings, which identify important risks and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements.
We urge you to consider these factors carefully in evaluating the forward-looking statements contained in this Quarterly Report. All subsequent written or oral forward-looking statements attributable to our company or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. The forward-looking statements included in this Quarterly Report are made only as of the date of this Quarterly Report. We do not intend, and disclaim any obligation, to update these forward-looking statements.
Business Overview
Cadence is a leader in electronic system design, building upon more than 30 years of computational software expertise. 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 integrated circuits (“ICs”), systems-on-chip (“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 intellectual property (“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, mobile, 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 Electronic Design Automation (“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.
Consistent with our Intelligent System Design strategy, in the third quarter of fiscal 2022, we completed our acquisitions of OpenEye Scientific Software, Inc. (“OpenEye”) and FFG Holdings Limited (“Future Facilities”). Both of these acquisitions are expected to add important new technologies and capabilities to our System Design and Analysis technology portfolio that we believe will enhance our ability to pursue attractive opportunities in the markets we serve. These acquisitions are expected to increase expenses, including amortization of acquired intangible assets, more than revenue for at least the remainder of fiscal 2022.
For additional information about our products, see the discussion in Item 1, “Business,” under the heading “Products and Product Strategy,” in our Annual Report for the fiscal year ended January 1, 2022.
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.”
Fiscal Year End
On September 7, 2022, our Board of Directors approved a change in our fiscal year end from the Saturday closest to December 31 of each year to December 31 of each year. Our fiscal quarters will end on March 31, June 30, and September 30. The fiscal year change is effective beginning with our 2023 fiscal year, which will begin on January 1, 2023.
COVID-19 Pandemic
Since its inception, the COVID-19 pandemic has posed a variety of challenges to our day-to-day operations. Despite these challenges, the pandemic has not had a material, adverse impact on our results of operations, financial condition, liquidity or cash flows. Going forward, and as the COVID-19 pandemic reaches endemic stages, the degree of impact on our business will depend on factors such as the duration and severity of the pandemic, the spread of new variants, actions taken by government authorities, and measures taken by our customers and suppliers.
While we are unable to accurately predict the full impact that COVID-19 and its continuing repercussions will have on our results of operations, financial condition, liquidity and cash flows, we have implemented policies and practices that have enabled us to support critical operations and execute our strategy. For example, to support the health and well-being of our employees, we currently have a large number of employees who operate in a hybrid work environment, choosing to alternate between working from home and working from our facilities. Because these and similar measures may not fully mitigate the direct and indirect impacts of the COVID-19 pandemic on our business, our management continues to actively monitor and respond to ongoing developments of the COVID-19 pandemic.
Russia-Ukraine Conflict
During the first half of fiscal 2022, due to the ongoing conflict between Russia and Ukraine and the corresponding sanctions imposed by the United States and other countries, we terminated our operations in Russia. The termination of our operations in Russia has not limited our ability to develop or support our products and has not had a material impact on our results of operations, financial condition, liquidity or cash flows. We do not have operations or employees in Ukraine. We will continue to monitor the future developments relative to this conflict and the potential impacts it could have on our employees and our ability to provide products and services to our global customer base.
Expansion of Trade Restrictions
On October 7, 2022, the Bureau of Industry and Security (“BIS”) of the U.S. Department of Commerce released broad changes in export control regulations, including new restrictions concerning advanced node IC production in China and the inclusion of additional Chinese technology companies on the BIS’s “Unverified List.” In addition, on October 14, 2022, a new rule went into effect imposing U.S. export controls on additional technologies, including electronic computer-aided design software specially designed for the development of ICs with Gate-All-Around Field-Effect Transistor (GAAFET) structure. Based on our current assessments, we expect the impact of these expanded trade restrictions on our business to be limited. We will continue to monitor for any further trade restrictions, other regulatory or policy changes by the U.S. or foreign governments and any actions in response. For additional information regarding risks related to international relations and changes in governmental regulations and policies, including existing restrictions imposed by the BIS, see Part I, Item 1A, “Risk Factors,” in our Annual Report.
Critical Accounting Estimates
In preparing our condensed 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.
For further information about our critical accounting estimates, see the discussion in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” under the heading “Critical Accounting Estimates” in our Annual Report.
New Accounting Standards
For additional information about the adoption of new accounting standards, see Note 1 in the notes to condensed consolidated financial statements.
Results of Operations
Financial results for the three and nine months ended October 1, 2022, as compared to the three and nine months ended October 2, 2021, reflect the following:
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revenue growth that exceeded the growth of our costs and expenses;
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increased revenue from software, IP and other arrangements where revenue is recognized over time;
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growth in revenue from emulation and prototyping hardware and IP where revenue is recognized up-front;
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continued investment in research and development activities and technical sales support; and
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increased provision for income taxes primarily due to changes to tax laws in the United States.
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.
Generally, between 85% and 90% of our annual revenue is characterized as recurring revenue. Recurring revenue includes revenue recognized over time from our software arrangements, services, royalties, maintenance on IP licenses and hardware, and operating leases of hardware. Recurring revenue also includes revenue recognized at varying points in time over the term of other arrangements with non-cancelable commitments, whereby the customer commits to a fixed dollar amount over a specified period of time that can be used to purchase from a list of products or services.
The remainder of our revenue is recognized at a point in time and 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 and fluctuations in revenue within our geographies are impacted by delivery of hardware and IP products to our customers in any single fiscal period.
The following table shows the percentage of our revenue that is classified as recurring or up-front for the three months ended October 1, 2022 and October 2, 2021:
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| October 1, 2022 | October 2, 2021 | October 1, 2022 | October 2, 2021 | ||||||||||||||||||||
| Revenue recognized over time | 81 | % | 86 | % | 82 | % | 84 | % | |||||||||||||||
| Revenue from arrangements with non-cancelable commitments | 3 | % | 3 | % | 2 | % | 3 | % | |||||||||||||||
| Recurring revenue | 84 | % | 89 | % | 84 | % | 87 | % | |||||||||||||||
| Up-front revenue | 16 | % | 11 | % | 16 | % | 13 | % | |||||||||||||||
| Total | 100 | % | 100 | % | 100 | % | 100 | % |
While the percentage of revenue characterized as recurring compared to revenue characterized as up-front may vary between fiscal quarters, the overall mix of revenue is relatively consistent on an annual basis or over the course of twelve consecutive months. The following table shows the percentage of recurring revenue for the twelve-month periods ending concurrently with our five most recent fiscal quarters:
| Trailing Twelve Months Ended | |||||||||||||||||||||||||||||
| October 1, 2022 | July 2, 2022 | April 2, 2022 | January 1, 2022 | October 2, 2021 | |||||||||||||||||||||||||
| Recurring revenue | 86 | % | 87 | % | 87 | % | 88 | % | 87 | % | |||||||||||||||||||
| Up-front revenue | 14 | % | 13 | % | 13 | % | 12 | % | 13 | % | |||||||||||||||||||
| Total | 100 | % | 100 | % | 100 | % | 100 | % | 100 | % |
Revenue by Period
The following table shows our revenue for the three months ended October 1, 2022 and October 2, 2021 and the change in revenue between periods:
| Three Months Ended | Change | ||||||||||||||||||||||
| October 1, 2022 | October 2, 2021 | Amount | Percentage | ||||||||||||||||||||
| (In millions, except percentages) | |||||||||||||||||||||||
| Product and maintenance | $ | 845.8 | $ | 706.2 | $ | 139.6 | 20 | % | |||||||||||||||
| Services | 56.8 | 44.7 | 12.1 | 27 | % | ||||||||||||||||||
| Total revenue | $ | 902.6 | $ | 750.9 | $ | 151.7 | 20 | % |
The following table shows our revenue for the nine months ended October 1, 2022 and October 2, 2021 and the change in revenue between periods:
| Nine Months Ended | Change | ||||||||||||||||||||||
| October 1, 2022 | October 2, 2021 | Amount | Percentage | ||||||||||||||||||||
| (In millions, except percentages) | |||||||||||||||||||||||
| Product and maintenance | $ | 2,494.3 | $ | 2,093.1 | $ | 401.2 | 19 | % | |||||||||||||||
| Services | 167.5 | 122.1 | 45.4 | 37 | % | ||||||||||||||||||
| Total revenue | $ | 2,661.8 | $ | 2,215.2 | $ | 446.6 | 20 | % |
Product and maintenance revenue increased during the three and nine months ended October 1, 2022, as compared to the three and nine months ended October 2, 2021, due to increased revenue in each of our five product categories. This growth was driven by our customers investing in new, complex designs for their products that include the design of electronic systems for consumer, hyperscale computing, mobile, 5G communications, automotive, aerospace and defense, industrial and healthcare.
Services revenue increased during the three and nine months ended October 1, 2022, as compared to the three and nine months ended October 2, 2021, primarily due to increased revenue from our custom IP offerings. Services revenue may fluctuate from period to period based on the timing of fulfillment of our services and IP performance obligations.
No single customer accounted for 10% or more of total revenue during the three and nine months ended October 1, 2022 or October 2, 2021.
Revenue by Product Category
The following table shows the percentage of revenue contributed by each of our five product categories and services for the past five consecutive quarters:
| Three Months Ended | |||||||||||||||||||||||||||||
| October 1, 2022 | July 2, 2022 | April 2, 2022 | January 1, 2022 | October 2, 2021 | |||||||||||||||||||||||||
| Custom IC Design and Simulation | 22 | % | 23 | % | 22 | % | 24 | % | 23 | % | |||||||||||||||||||
| Digital IC Design and Signoff | 29 | % | 27 | % | 27 | % | 29 | % | 29 | % | |||||||||||||||||||
| Functional Verification, including Emulation and Prototyping Hardware | 25 | % | 24 | % | 28 | % | 21 | % | 23 | % | |||||||||||||||||||
| IP | 12 | % | 14 | % | 13 | % | 14 | % | 14 | % | |||||||||||||||||||
| System Design and Analysis | 12 | % | 12 | % | 10 | % | 12 | % | 11 | % | |||||||||||||||||||
| Total | 100 | % | 100 | % | 100 | % | 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
| Three Months Ended | Change | ||||||||||||||||||||||
| October 1, 2022 | October 2, 2021 | Amount | Percentage | ||||||||||||||||||||
| (In millions, except percentages) | |||||||||||||||||||||||
| United States | $ | 392.2 | $ | 331.5 | $ | 60.7 | 18 | % | |||||||||||||||
| Other Americas | 15.2 | 11.5 | 3.7 | 32 | % | ||||||||||||||||||
| China | 148.3 | 98.3 | 50.0 | 51 | % | ||||||||||||||||||
| Other Asia | 156.3 | 136.3 | 20.0 | 15 | % | ||||||||||||||||||
| Europe, Middle East and Africa | 143.0 | 129.6 | 13.4 | 10 | % | ||||||||||||||||||
| Japan | 47.6 | 43.7 | 3.9 | 9 | % | ||||||||||||||||||
| Total revenue | $ | 902.6 | $ | 750.9 | $ | 151.7 | 20 | % |
The increase in revenue in the United States, China, Other Asia, and Europe, Middle East and Africa during the three months ended October 1, 2022, as compared to the three months ended October 2, 2021, was primarily due to increased revenue from our software and hardware offerings.
| Nine Months Ended | Change | ||||||||||||||||||||||
| October 1, 2022 | October 2, 2021 | Amount | Percentage | ||||||||||||||||||||
| (In millions, except percentages) | |||||||||||||||||||||||
| United States | $ | 1,174.7 | $ | 970.9 | $ | 203.8 | 21 | % | |||||||||||||||
| Other Americas | 39.0 | 31.4 | 7.6 | 24 | % | ||||||||||||||||||
| China | 401.5 | 287.4 | 114.1 | 40 | % | ||||||||||||||||||
| Other Asia | 466.9 | 404.5 | 62.4 | 15 | % | ||||||||||||||||||
| Europe, Middle East and Africa | 431.6 | 384.3 | 47.3 | 12 | % | ||||||||||||||||||
| Japan | 148.1 | 136.7 | 11.4 | 8 | % | ||||||||||||||||||
| Total revenue | $ | 2,661.8 | $ | 2,215.2 | $ | 446.6 | 20 | % |
The increase in revenue in the United States and China during the nine months ended October 1, 2022, as compared to the nine months ended October 2, 2021, was primarily due to increased revenue from our software, hardware and IP offerings. The increase in revenue in Other Asia and Europe, Middle East and Africa during the nine months ended October 1, 2022, as compared to the nine months ended October 2, 2021, was primarily due to increased revenue from our software and hardware offerings.
Revenue by Geography as a Percent of Total Revenue
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| October 1, 2022 | October 2, 2021 | October 1, 2022 | October 2, 2021 | ||||||||||||||||||||
| United States | 43 | % | 44 | % | 44 | % | 44 | % | |||||||||||||||
| Other Americas | 2 | % | 2 | % | 1 | % | 2 | % | |||||||||||||||
| China | 17 | % | 13 | % | 15 | % | 13 | % | |||||||||||||||
| Other Asia | 17 | % | 18 | % | 18 | % | 18 | % | |||||||||||||||
| Europe, Middle East and Africa | 16 | % | 17 | % | 16 | % | 17 | % | |||||||||||||||
| Japan | 5 | % | 6 | % | 6 | % | 6 | % | |||||||||||||||
| Total | 100 | % | 100 | % | 100 | % | 100 | % |
The substantial majority 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 condensed consolidated financial statements, see the discussion under Item 3, “Quantitative and Qualitative Disclosures About Market Risk – Foreign Currency Risk.”
Cost of Revenue
The following tables show our cost of revenue for the three and nine months ended October 1, 2022 and October 2, 2021 and the change in cost of revenue between periods:
| Three Months Ended | Change | ||||||||||||||||||||||
| October 1, 2022 | October 2, 2021 | Amount | Percentage | ||||||||||||||||||||
| (In millions, except percentages) | |||||||||||||||||||||||
| Cost of product and maintenance | $ | 62.4 | $ | 54.2 | $ | 8.2 | 15 | % | |||||||||||||||
| Cost of services | 25.2 | 22.4 | 2.8 | 13 | % |
| Nine Months Ended | Change | ||||||||||||||||||||||
| October 1, 2022 | October 2, 2021 | Amount | Percentage | ||||||||||||||||||||
| (In millions, except percentages) | |||||||||||||||||||||||
| Cost of product and maintenance | $ | 203.9 | $ | 174.9 | $ | 29.0 | 17 | % | |||||||||||||||
| Cost of services | 74.2 | 62.4 | 11.8 | 19 | % |
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 is as follows:
| Three Months Ended | Change | ||||||||||||||||||||||
| October 1, 2022 | October 2, 2021 | Amount | Percentage | ||||||||||||||||||||
| (In millions, except percentages) | |||||||||||||||||||||||
| Product and maintenance-related costs | $ | 53.5 | $ | 42.4 | $ | 11.1 | 26 | % | |||||||||||||||
| Amortization of acquired intangibles | 8.9 | 11.8 | (2.9) | (25) | % | ||||||||||||||||||
| Total cost of product and maintenance | $ | 62.4 | $ | 54.2 | $ | 8.2 | 15 | % |
| Nine Months Ended | Change | ||||||||||||||||||||||
| October 1, 2022 | October 2, 2021 | Amount | Percentage | ||||||||||||||||||||
| (In millions, except percentages) | |||||||||||||||||||||||
| Product and maintenance-related costs | $ | 173.0 | $ | 139.1 | $ | 33.9 | 24 | % | |||||||||||||||
| Amortization of acquired intangibles | 30.9 | 35.8 | (4.9) | (14) | % | ||||||||||||||||||
| Total cost of product and maintenance | $ | 203.9 | $ | 174.9 | $ | 29.0 | 17 | % |
The changes in product and maintenance-related costs for the three and nine months ended October 1, 2022, as compared to the three and nine months ended October 2, 2021, were due to the following:
| Change | |||||||||||
| Three Months Ended | Nine Months Ended | ||||||||||
| (In millions) | |||||||||||
| Emulation and prototyping hardware costs | $ | 10.3 | $ | 32.3 | |||||||
| Other items | 0.8 | 1.6 | |||||||||
| Total change in product and maintenance-related costs | $ | 11.1 | $ | 33.9 |
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. Emulation and prototyping hardware costs increased during the three and nine months ended October 1, 2022, as compared to the three and nine months ended October 2, 2021, primarily due to increased revenue from emulation and prototyping hardware products.
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.
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, our annual, mid-year promotion and pay raise cycle, stock-based compensation, restructuring and other employment separation activities (such as the voluntary retirement program we offered to certain employees during the second quarter of fiscal 2021), foreign exchange rate movements, acquisition-related costs, volatility in variable compensation programs that are driven by operating results, and charitable donations.
Stock-based compensation for the three and nine months ended October 1, 2022 increased, as compared to the three and nine months ended October 2, 2021, due to an increased number of grants under our equity incentive plans, including long-term market-based awards, to attract and retain talent.
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 condensed consolidated financial statements, see the discussion in Item 3, “Quantitative and Qualitative Disclosures About Market Risk – Foreign Currency Risk.”
Our operating expenses for the three and nine months ended October 1, 2022 and October 2, 2021 were as follows:
| Three Months Ended | Change | ||||||||||||||||||||||
| October 1, 2022 | October 2, 2021 | Amount | Percentage | ||||||||||||||||||||
| (In millions, except percentages) | |||||||||||||||||||||||
| Marketing and sales | $ | 152.9 | $ | 143.4 | $ | 9.5 | 7 | % | |||||||||||||||
| Research and development | 323.6 | 289.1 | 34.5 | 12 | % | ||||||||||||||||||
| General and administrative | 73.7 | 43.0 | 30.7 | 71 | % | ||||||||||||||||||
| Total operating expenses | $ | 550.2 | $ | 475.5 | $ | 74.7 | 16 | % |
| Nine Months Ended | Change | ||||||||||||||||||||||
| October 1, 2022 | October 2, 2021 | Amount | Percentage | ||||||||||||||||||||
| (In millions, except percentages) | |||||||||||||||||||||||
| Marketing and sales | $ | 432.4 | $ | 412.2 | $ | 20.2 | 5 | % | |||||||||||||||
| Research and development | 901.1 | 845.3 | 55.8 | 7 | % | ||||||||||||||||||
| General and administrative | 174.1 | 123.3 | 50.8 | 41 | % | ||||||||||||||||||
| Total operating expenses | $ | 1,507.6 | $ | 1,380.8 | $ | 126.8 | 9 | % |
Our operating expenses, as a percentage of total revenue, for the three and nine months ended October 1, 2022 and October 2, 2021 were as follows:
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| October 1, 2022 | October 2, 2021 | October 1, 2022 | October 2, 2021 | ||||||||||||||||||||
| Marketing and sales | 17 | % | 19 | % | 16 | % | 19 | % | |||||||||||||||
| Research and development | 36 | % | 40 | % | 34 | % | 39 | % | |||||||||||||||
| General and administrative | 8 | % | 6 | % | 7 | % | 6 | % | |||||||||||||||
| Total operating expenses | 61 | % | 65 | % | 57 | % | 64 | % |
Marketing and Sales
The increase in marketing and sales expense for the three and nine months ended October 1, 2022, as compared to the three and nine months ended October 2, 2021, was due to the following:
| Change | ||||||||||||||
| Three Months Ended | Nine Months Ended | |||||||||||||
| (In millions) | ||||||||||||||
| Salary, benefits and other employee-related costs | $ | 0.3 | $ | 9.7 | ||||||||||
| Stock-based compensation | 4.2 | 7.4 | ||||||||||||
| Marketing programs and events | 3.6 | 6.9 | ||||||||||||
| Travel and sales meetings | 1.3 | 1.9 | ||||||||||||
| Voluntary retirement program | — | (6.7) | ||||||||||||
| Other items | 0.1 | 1.0 | ||||||||||||
| Total change in marketing and sales expense | $ | 9.5 | $ | 20.2 |
Salary, benefits and other employee-related costs included in marketing and sales expense increased during the three and nine months ended October 1, 2022, as compared to the three and nine months ended October 2, 2021, primarily due to increased compensation costs related to additional headcount. Costs related to marketing programs and events increased during the three and nine months ended October 1, 2022, as compared to the three and nine months ended October 2, 2021, primarily due to an increased number of in-person meetings and events.
Research and Development
The increase in research and development expense for the three and nine months ended October 1, 2022, as compared to the three and nine months ended October 2, 2021, was due to the following:
| Change | |||||||||||
| Three Months Ended | Nine Months Ended | ||||||||||
| (In millions) | |||||||||||
| Salary, benefits and other employee-related costs | $ | 16.6 | $ | 34.5 | |||||||
| Stock-based compensation | 10.4 | 18.4 | |||||||||
| Facilities and other infrastructure costs | 3.4 | 7.7 | |||||||||
| Professional services | 2.6 | 7.0 | |||||||||
| Travel | 1.8 | 2.7 | |||||||||
| Voluntary retirement program | — | (14.7) | |||||||||
| Other items | (0.3) | 0.2 | |||||||||
| Total change in research and development expense | $ | 34.5 | $ | 55.8 |
Salary, benefits and other employee-related costs included in research and development expense increased during the three and nine months ended October 1, 2022, as compared to the three and nine months ended October 2, 2021, primarily due to increased compensation costs related to additional headcount from hiring.
General and Administrative
The increase in general and administrative expense for the three and nine months ended October 1, 2022, as compared to the three and nine months ended October 2, 2021, was due to the following:
| Change | |||||||||||
| Three Months Ended | Nine Months Ended | ||||||||||
| (In millions) | |||||||||||
| Contributions to non-profit organizations | $ | 22.0 | $ | 25.3 | |||||||
| Professional services | 4.9 | 16.0 | |||||||||
| Stock-based compensation | 5.8 | 15.1 | |||||||||
| Salary, benefits and other employee-related costs | 1.8 | 4.4 | |||||||||
| Voluntary retirement program | — | (2.6) | |||||||||
| Foreign service tax refund | (4.0) | (9.0) | |||||||||
| Other items | 0.2 | 1.6 | |||||||||
| Total change in general and administrative expense | $ | 30.7 | $ | 50.8 |
The increase in contributions to non-profit organizations during the three and nine months ended October 1, 2022, as compared to the three and nine months ended October 2, 2021, is the result of our continued commitment to support charitable initiatives, including the Cadence Giving Foundation. Professional services included in general and administrative expense increased during the three and nine months ended October 1, 2022, as compared to the three and nine months ended October 2, 2021, primarily due to an increase in acquisition-related professional services and legal fees and costs for other matters. Stock-based compensation included in general and administrative expense increased during the three and nine months ended October 1, 2022, as compared to the three and nine months ended October 2, 2021, primarily due to equity awards granted to executives.
Operating Margin
Operating margin represents income from operations as a percentage of total revenue. Our operating margin for the three and nine months ended October 1, 2022, and the three and nine months ended October 2, 2021 was as follows:
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| October 1, 2022 | October 2, 2021 | October 1, 2022 | October 2, 2021 | ||||||||||||||||||||
| Operating margin | 29 | % | 26 | % | 32 | % | 26 | % |
Generally, our operating margin during the second half of the fiscal year is impacted by incremental costs associated with our annual, mid-year promotion and pay raise cycle. Operating margin increased during the three and nine months ended October 1, 2022, as compared to the three and nine months ended October 2, 2021, primarily because revenue growth in each of our five product categories exceeded growth in cost of revenue and operating expense. For the remainder of fiscal 2022, we expect our operating margin to be impacted by the operating expenses from our acquisitions, including amortization of acquired intangibles, exceeding the revenue contributed from our acquisitions.
Interest Expense
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| October 1, 2022 | October 2, 2021 | October 1, 2022 | October 2, 2021 | ||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||
| Contractual interest expense: | |||||||||||||||||||||||
| 2024 Notes | 3.8 | 3.8 | $ | 11.4 | $ | 11.4 | |||||||||||||||||
| 2025 Term Loan | 0.9 | — | 0.9 | — | |||||||||||||||||||
| Revolving credit facility | 0.7 | 0.2 | 1.1 | 0.5 | |||||||||||||||||||
| Amortization of debt discount: | |||||||||||||||||||||||
| 2024 Notes | 0.2 | 0.2 | 0.6 | 0.6 | |||||||||||||||||||
| Other | (0.1) | — | (0.1) | 0.2 | |||||||||||||||||||
| Total interest expense | $ | 5.5 | $ | 4.2 | $ | 13.9 | $ | 12.7 |
Income Taxes
The following table presents the provision for income taxes and the effective tax rate for the three and nine months ended October 1, 2022 and October 2, 2021:
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| October 1, 2022 | October 2, 2021 | October 1, 2022 | October 2, 2021 | ||||||||||||||||||||
| (In millions, except percentages) | |||||||||||||||||||||||
| Provision for income taxes | $ | 66.0 | $ | 12.4 | $ | 226.3 | $ | 55.0 | |||||||||||||||
| Effective tax rate | 26.1 | % | 6.6 | % | 27.1 | % | 9.6 | % |
The United States enacted the Tax Cuts and Jobs Act in December 2017, which requires companies to capitalize all of their R&D costs, including software development costs, incurred in tax years beginning after December 31, 2021. Beginning in fiscal 2022, we began capitalizing and amortizing R&D costs over five years for domestic research and 15 years for international research rather than expensing these costs as incurred. As a result, we expect our fiscal 2022 effective tax rate and our cash tax payments to increase significantly as compared to fiscal 2021. We also expect to recognize increases to our deferred tax assets as we begin to capitalize domestic research costs.
Our provision for income taxes for the three and nine months ended October 1, 2022 was primarily attributable to federal, state and foreign income taxes on our anticipated fiscal 2022 income. We also recognized tax benefits of $18.0 million and $36.9 million related to stock-based compensation that vested or was exercised during each period. Our provision for income taxes for the three and nine months ended October 1, 2022, reflected the impact of the Tax Cuts and Jobs Act, which requires the capitalization and amortization of R&D costs incurred after December 31, 2021.
Our provision for income taxes for the three and nine months ended October 2, 2021 was primarily attributable to federal, state and foreign income taxes on our then anticipated fiscal 2021 income, partially offset by the tax benefit of $13.7 million for the three and nine months ended October 2, 2021 related to an increase in our foreign-derived intangible income, and tax benefits of $14.3 million and $59.1 million for the three and nine months ended October 2, 2021, respectively, related to stock-based compensation that vested or was exercised during the period.
We maintain valuation allowances on certain federal, state, and foreign deferred tax assets. While we believe our current valuation allowance is sufficient, we assess the need for an adjustment to the valuation allowance on a quarterly basis. The assessment is based on our estimates of future sources of taxable income in the jurisdictions in which we operate and the periods over which our deferred tax assets will be realizable. In the event we determine that we will be able to realize all or part of our net deferred tax assets in the future, the valuation allowance will be reversed in the period in which we make such determination. The release of a valuation allowance would result in an increase to our net deferred tax assets and a decrease to income tax expense in the period in which the release is recorded.
Our future effective tax rates may also 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 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 2022 effective tax rate will be approximately 28%. We expect that our quarterly effective tax rates will vary from our fiscal 2022 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,” in our Annual Report.
Liquidity and Capital Resources
| As of | |||||||||||||||||
| October 1, 2022 | January 1, 2022 | Change | |||||||||||||||
| (In millions) | |||||||||||||||||
| Cash and cash equivalents | $ | 1,026.1 | $ | 1,088.9 | $ | (62.8) | |||||||||||
| Net working capital | 413.5 | 744.5 | (331.0) |
Cash and Cash Equivalents
As of October 1, 2022, our principal sources of liquidity consisted of approximately $1.0 billion of cash and cash equivalents as compared to $1.1 billion as of January 1, 2022.
Our primary sources of cash and cash equivalents during the nine months ended October 1, 2022 were cash generated from operations, proceeds from our revolving credit facility, proceeds from our term loan and proceeds from the issuance of common stock resulting from stock purchases under our employee stock purchase plan and stock options exercised during the period.
Our primary uses of cash and cash equivalents during the nine months ended October 1, 2022 were payments related to employee salaries and benefits, operating expenses, repurchases of our common stock, cash paid for business combinations, payments on our revolving credit facility, payment of employee taxes on vesting of restricted stock, and purchases of property, plant and equipment.
Approximately 72% of our cash and cash equivalents were held by our foreign subsidiaries as of October 1, 2022. 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 and cash flows that are generated from operations and financing activities will be sufficient to meet the needs of our domestic and international operating activities and other capital and liquidity requirements, including acquisitions and share repurchases, for at least the next 12 months and thereafter for the foreseeable future.
Net Working Capital
Net working capital is comprised of current assets less current liabilities, as shown on our condensed consolidated balance sheets. The decrease in our net working capital as of October 1, 2022, as compared to January 1, 2022, is primarily due to our use of cash for investing and financing activities and the timing of cash receipts from customers and disbursements made to vendors.
Cash Flows from Operating Activities
| Nine Months Ended | |||||||||||||||||
| October 1, 2022 | October 2, 2021 | Change | |||||||||||||||
| (In millions) | |||||||||||||||||
| Cash provided by operating activities | $ | 978.3 | $ | 885.1 | $ | 93.2 |
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 provided by 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 for the nine months ended October 1, 2022, as compared to the nine months ended October 2, 2021, was primarily due to improved results from operations and timing of cash receipts from customers and disbursements made to vendors.
Cash Flows from Investing Activities
| Nine Months Ended | |||||||||||||||||
| October 1, 2022 | October 2, 2021 | Change | |||||||||||||||
| (In millions) | |||||||||||||||||
| Cash used for investing activities | $ | (674.5) | $ | (269.9) | $ | (404.6) |
Cash used for investing activities increased during the nine months ended October 1, 2022, as compared to the nine months ended October 2, 2021, primarily due to increases in payments for business combinations and purchases of property, plant and equipment. We expect to continue our investing activities, including purchasing property, plant and equipment, purchasing intangible assets, acquiring other companies and businesses, purchasing software licenses, and making strategic investments.
Cash Flows from Financing Activities
| Nine Months Ended | |||||||||||||||||
| October 1, 2022 | October 2, 2021 | Change | |||||||||||||||
| (In millions) | |||||||||||||||||
| Cash used for financing activities | $ | (299.9) | $ | (528.1) | $ | 228.2 |
Cash used for financing activities decreased during the nine months ended October 1, 2022, as compared to the nine months ended October 2, 2021, primarily due to an increase in proceeds from borrowings, partially offset by an increase in payments for repurchases of our common stock.
Other Factors Affecting Liquidity and Capital Resources
Stock Repurchase Program
In August 2022, our Board of Directors increased the prior authorization to repurchase shares of our common stock by authorizing an additional $1 billion. 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 October 1, 2022, approximately $1.4 billion of the share repurchase authorizations remained available to repurchase shares of our common stock. See Part II, Item 2, “Unregistered Sales of Equity Securities and Use of Proceeds” for additional information on share repurchases.
Revolving Credit Facility
In June 2021, we entered into a five-year senior unsecured revolving credit facility with a group of lenders led by Bank of America, N.A., as administrative agent, as amended in September 2022 (the “2021 Credit Facility”). The 2021 Credit Facility provides for borrowings up to $700.0 million, with the right to request increased capacity up to an additional $350.0 million upon receipt of lender commitments, for total maximum borrowings of $1.05 billion. The 2021 Credit Facility expires on June 30, 2026. Any outstanding loans drawn under the 2021 Credit Facility are due at maturity on June 30, 2026, subject to an option to extend the maturity date. Outstanding borrowings may be repaid at any time prior to maturity. As of October 1, 2022, there were $150.0 million of borrowings outstanding under the 2021 Credit Facility, and we were in compliance with all financial covenants associated with such credit facility.
2024 Notes
In October 2014, we issued $350.0 million aggregate principal amount of 4.375% Senior Notes due October 15, 2024 (the “2024 Notes”). 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 October 1, 2022, we were in compliance with all covenants associated with the 2024 Notes.
2025 Term Loan
In September 2022, we entered into a $300 million three-year senior non-amortizing term loan facility due on September 7, 2025 with a group of lenders led by Bank of America, N.A., as administrative agent (the “2025 Term Loan”). The 2025 Term Loan is unsecured and ranks equal in right of payment to all of our unsecured indebtedness. Proceeds from the 2025 Term Loan were used to fund our acquisition of OpenEye. As of October 1, 2022, we were in compliance with all financial covenants associated with the 2025 Term Loan.
For additional information relating to our debt arrangements, see Note 4 in the notes to condensed consolidated financial statements. For additional information relating to OpenEye and other acquisitions, see Note 5 in the notes to condensed consolidated financial statements.
Other Liquidity Requirements
During the nine months ended October 1, 2022, there were no material changes to our other liquidity requirements as reported in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report for the fiscal year ended January 1, 2022.
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