Edgar Filing: CADENCE DESIGN SYSTEMS INC

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

_____________________________________

FORM 10-Q

_____________________________________

(Mark One)



	x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 1, 2017



	¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 000-15867

_____________________________________

CADENCE DESIGN SYSTEMS, INC.

(Exact Name of Registrant as Specified in Its Charter)

_____________________________________



Delaware		00-0000000
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

2655 Seely Avenue, Building 5, San Jose, California		95134
(Address of Principal Executive Offices)		(Zip Code)

(408) 943-1234

Registrant’s Telephone Number, including Area Code

_____________________________________

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):



Large accelerated filer	x	Accelerated filer	o	Smaller reporting company	o

Non-accelerated filer	o	(Do not check if a smaller reporting company)		Emerging growth company	o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

On July 1, 2017, approximately 280,201,000 shares of the registrant’s common stock, $0.01 par value, were outstanding.

CADENCE DESIGN SYSTEMS, INC.

INDEX



		Page
PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements:

	Condensed Consolidated Balance Sheets: July 1, 2017 and December 31, 2016	1

	Condensed Consolidated Income Statements: Three and Six Months Ended July 1, 2017 and July 2, 2016	2

	Condensed Consolidated Statements of Comprehensive Income: Three and Six Months Ended July 1, 2017 and July 2, 2016	3

	Condensed Consolidated Statements of Cash Flows: Six Months Ended July 1, 2017 and July 2, 2016	4

	Notes to Condensed Consolidated Financial Statements	5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	28

Item 4.	Controls and Procedures	29

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings	31

Item 1A.	Risk Factors	31

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	45

Item 3.	Defaults Upon Senior Securities	46

Item 4.	Mine Safety Disclosures	46

Item 5.	Other Information	46

Item 6.	Exhibits	47

	Signatures	48

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

CADENCE DESIGN SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)



	As of
	July 1, 2017			December 31, 2016
ASSETS
Current assets:
Cash and cash equivalents	$	655,998		$	465,232
Short-term investments	3,229			3,057
Receivables, net	153,154			157,171
Inventories	31,894			39,475
Prepaid expenses and other	39,175			37,099
Total current assets	883,450			702,034
Property, plant and equipment, net of accumulated depreciation of $634,418 and $612,961, respectively	249,140			238,607
Goodwill	575,025			572,764
Acquired intangibles, net of accumulated amortization of $269,859 and $267,723, respectively	229,783			258,814
Long-term receivables	13,340			12,949
Other assets	316,961			311,740
Total assets	$	2,267,699		$	2,096,908
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Revolving credit facility	$	—		$	50,000
Accounts payable and accrued liabilities	222,216			239,496
Current portion of deferred revenue	322,509			296,066
Total current liabilities	544,725			585,562
Long-term liabilities:
Long-term portion of deferred revenue	60,158			66,769
Long-term debt	643,927			643,493
Other long-term liabilities	67,096			59,314
Total long-term liabilities	771,181			769,576
Commitments and contingencies (Note 10)
Stockholders’ equity:
Common stock and capital in excess of par value	1,848,719			1,820,081
Treasury stock, at cost	(1,156,626		)	(1,190,053		)
Retained earnings	274,288			136,902
Accumulated other comprehensive loss	(14,588		)	(25,160		)
Total stockholders’ equity	951,793			741,770
Total liabilities and stockholders’ equity	$	2,267,699		$	2,096,908

See notes to condensed consolidated financial statements.

CADENCE DESIGN SYSTEMS, INC.

CONDENSED CONSOLIDATED INCOME STATEMENTS

(In thousands, except per share amounts)

(Unaudited)



	Three Months Ended						Six Months Ended
	July 1, 2017			July 2, 2016			July 1, 2017			July 2, 2016
Revenue:
Product and maintenance	$	443,847		$	419,963		$	895,254		$	831,707
Services	35,154			33,058			60,658			69,176
Total revenue	479,001			453,021			955,912			900,883
Costs and expenses:
Cost of product and maintenance	38,829			42,960			82,546			87,141
Cost of services	22,003			18,823			40,078			36,696
Marketing and sales	103,897			101,110			207,244			200,310
Research and development	195,901			182,371			394,187			362,277
General and administrative	32,774			36,388			64,590			64,688
Amortization of acquired intangibles	3,836			4,537			7,692			10,317
Restructuring and other charges (credits)	(929		)	(74		)	(2,717		)	14,512
Total costs and expenses	396,311			386,115			793,620			775,941
Income from operations	82,690			66,906			162,292			124,942
Interest expense	(6,248		)	(5,896		)	(12,727		)	(11,253		)
Other income, net	924			2,842			1,983			7,605
Income before provision for income taxes	77,366			63,852			151,548			121,294
Provision for income taxes	8,239			14,517			14,162			21,397
Net income	$	69,127		$	49,335		$	137,386		$	99,897
Net income per share - basic	$	0.25		$	0.17		0.51			0.34
Net income per share - diluted	$	0.25		$	0.17		0.49			0.33
Weighted average common shares outstanding – basic	271,887			288,191			271,030			292,403
Weighted average common shares outstanding – diluted	279,526			295,201			278,631			299,318

See notes to condensed consolidated financial statements.

CADENCE DESIGN SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

(Unaudited)



	Three Months Ended						Six Months Ended
	July 1, 2017			July 2, 2016			July 1, 2017		July 2, 2016
Net income	$	69,127		$	49,335		$	137,386	$	99,897
Other comprehensive income, net of tax effects:
Foreign currency translation adjustments	7,866			(2,307		)	10,255		1,907
Changes in unrealized holding gains or losses on available-for-sale securities, net of reclassification adjustment for realized gains and losses	(218		)	(304		)	248		560
Changes in defined benefit plan liabilities	40			(109		)	69		(27		)
Total other comprehensive income (loss), net of tax effects	7,688			(2,720		)	10,572		2,440
Comprehensive income	$	76,815		$	46,615		$	147,958	$	102,337

See notes to condensed consolidated financial statements.

CADENCE DESIGN SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)



	Six Months Ended
	July 1, 2017			July 2, 2016
Cash and cash equivalents at beginning of period	$	465,232		$	616,686
Cash flows from operating activities:
Net income	137,386			99,897
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	58,304			62,759
Amortization of debt discount and fees	633			527
Stock-based compensation	57,918			49,988
Gain on investments, net	(2,083		)	(3,265		)
Deferred income taxes	4,813			10,252
Other non-cash items	2,157			750
Changes in operating assets and liabilities, net of effect of acquired businesses:
Receivables	6,342			(3,532		)
Inventories	2,535			(10,296		)
Prepaid expenses and other	(1,557		)	(8,690		)
Other assets	(8,790		)	(8,709		)
Accounts payable and accrued liabilities	(21,995		)	(14,012		)
Deferred revenue	18,733			(7,412		)
Other long-term liabilities	174			(4,700		)
Net cash provided by operating activities	254,570			163,557
Cash flows from investing activities:
Purchases of available-for-sale securities	—			(20,525		)
Proceeds from the sale of available-for-sale securities	189			55,168
Proceeds from the maturity of available-for-sale securities	—			26,115
Proceeds from the sale of long-term investments	—			2,583
Purchases of property, plant and equipment	(27,488		)	(28,287		)
Cash paid in business combinations and asset acquisitions, net of cash acquired	—			(41,627		)
Net cash used for investing activities	(27,299		)	(6,573		)
Cash flows from financing activities:
Proceeds from term loan	—			300,000
Proceeds from revolving credit facility	50,000			50,000
Payment on revolving credit facility	(100,000		)	—
Payment of debt issuance costs	(793		)	(622		)
Proceeds from issuance of common stock	29,967			36,296
Stock received for payment of employee taxes on vesting of restricted stock	(25,819		)	(17,490		)
Payments for repurchases of common stock	—			(480,100		)
Net cash used for financing activities	(46,645		)	(111,916		)
Effect of exchange rate changes on cash and cash equivalents	10,140			7,819
Increase in cash and cash equivalents	190,766			52,887
Cash and cash equivalents at end of period	$	655,998		$	669,573

Supplemental cash flow information:
Cash paid for interest	$	12,112		$	9,423
Cash paid for taxes, net	$	27,236		$	13,730

See notes to condensed consolidated financial statements.

CADENCE DESIGN SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1. BASIS OF PRESENTATION

The condensed consolidated financial statements included in this Quarterly Report on Form 10-Q have been prepared by Cadence Design Systems, Inc., or Cadence, without audit, pursuant to the rules and regulations of the United States Securities and Exchange Commission, or the SEC. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with United States generally accepted accounting principles, or U.S. GAAP, have been condensed or omitted pursuant to such rules and regulations. However, Cadence believes that the disclosures contained in this Quarterly Report on Form 10-Q comply with the requirements of Section 13(a) of the Securities Exchange Act of 1934, as amended, or the Exchange Act, for a Quarterly Report on Form 10-Q and are adequate to make the information presented not misleading. These condensed consolidated financial statements are meant to be, and should be, read in conjunction with the consolidated financial statements and the Notes thereto included in Cadence’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016. Certain prior period balances have been reclassified to conform to current period presentation.

The unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q reflect all adjustments (which include only normal, recurring adjustments and those items discussed in these Notes) that are, in the opinion of management, necessary to state fairly the results of operations, cash flows and financial position for the periods and dates presented. The results for such periods are not necessarily indicative of the results to be expected for the full fiscal year. Management has evaluated subsequent events through the issuance date of the unaudited condensed consolidated financial statements.

Use of Estimates

Preparation of the condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

NOTE 2. DEBT

Cadence’s outstanding debt as of July 1, 2017 and December 31, 2016 was as follows:



	July 1, 2017							December 31, 2016
	(In thousands)
	Principal		Unamortized Discount			Carrying Value		Principal		Unamortized Discount			Carrying Value
Revolving Credit Facility	$	—	$	—		$	—	$	50,000	$	—		$	50,000
2019 Term Loan	300,000		(330		)	299,670		300,000		(434		)	299,566
2024 Notes	350,000		(5,743		)	344,257		350,000		(6,073		)	343,927
Total outstanding debt	$	650,000	$	(6,073	)	$	643,927	$	700,000	$	(6,507	)	$	693,493

Revolving Credit Facility

On January 30, 2017, Cadence entered into a five-year senior unsecured revolving credit facility with a group of lenders led by JPMorgan Chase Bank, N.A., as administrative agent, which replaced Cadence’s existing revolving credit facility. The 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 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.

Interest accrues on borrowings under the credit facility at either LIBOR plus a margin between 1.25% and 1.875% per annum or at the base rate plus a margin between 0.25% and 0.875% per annum. Interest is payable quarterly. A commitment fee ranging from 0.15% to 0.30% is assessed on the daily average undrawn portion of revolving commitments.

The credit facility contains customary negative covenants that, among other things, restrict Cadence’s ability to incur additional indebtedness, grant liens, make certain investments (including acquisitions), dispose of certain assets and make certain payments, including share repurchases and dividends. In addition, the credit facility contains financial covenants that require Cadence to maintain a funded debt to EBITDA ratio not greater than 3.00 to 1, with a step up to 3.50 to 1 for one year following an acquisition by Cadence of at least $250.0 million that results in a pro forma leverage ratio between 2.75 to 1 and 3.25 to 1. As of July 1, 2017, Cadence was in compliance with all financial covenants associated with the revolving credit facility.

2019 Term Loan

In January 2016, Cadence entered into a $300.0 million three-year senior unsecured non-amortizing term loan facility due on January 28, 2019, or the 2019 Term Loan, with a group of lenders led by JPMorgan Chase Bank, N.A., as administrative agent. On January 30, 2017, Cadence amended the agreement for its 2019 Term Loan. The amendment modified the 2019 Term Loan covenants to make them consistent with the covenants in the revolving credit facility. The other material terms of the 2019 Term Loan remain unchanged.

Amounts outstanding under the 2019 Term Loan initially accrue interest at a rate equal to LIBOR plus a margin of 1.125% per annum, which may increase to a rate equal to LIBOR plus a margin of up to 1.875% per annum, depending on Cadence’s leverage ratio. As of July 1, 2017, the interest rate on Cadence’s 2019 Term Loan was 2.52%.

The 2019 Term Loan contains customary negative covenants that, among other things, restrict Cadence’s ability to incur additional indebtedness, grant liens, make certain investments (including acquisitions), dispose of certain assets and make certain payments, including share repurchases and dividends. In addition, the term loan agreement contains certain financial covenants that require Cadence to maintain a funded debt to EBITDA ratio not greater than 3.00 to 1, with a step-up to 3.50 to 1 for one year following an acquisition by Cadence of at least $250.0 million that results in a pro forma leverage ratio between 2.75 to 1 and 3.25 to 1. As of July 1, 2017, Cadence was in compliance with all financial covenants associated with the 2019 Term Loan.

2024 Notes

In October 2014, Cadence issued $350.0 million aggregate principal amount of 4.375% Senior Notes due October 15, 2024, or the 2024 Notes. Cadence 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. Both the discount and issuance costs are being amortized to interest expense over the term of the 2024 Notes using the effective interest method. Interest is payable in cash semi-annually in April and October. The 2024 Notes are unsecured and rank equal in right of payment to all of Cadence’s existing and future senior indebtedness.

Cadence may redeem the 2024 Notes, in whole or in part, at a redemption price equal to the greater of (a) 100% of the principal amount of the notes to be redeemed and (b) the sum of the present values of the remaining scheduled payments of principal and interest, plus any accrued and unpaid interest, as more particularly described in the indenture governing the 2024 Notes.

The indenture governing the 2024 Notes includes customary representations, warranties and restrictive covenants, including, but not limited to, restrictions on Cadence’s ability to grant liens on assets, enter into sale and lease-back transactions, or merge, consolidate or sell assets, and also includes customary events of default. As of July 1, 2017, Cadence was in compliance with all financial covenants associated with the 2024 Notes.

NOTE 3. CASH, CASH EQUIVALENTS AND INVESTMENTS

Cadence’s cash, cash equivalents and short-term investments at fair value as of July 1, 2017 and December 31, 2016 were as follows:



	As of
	July 1, 2017		December 31, 2016
	(In thousands)
Cash and cash equivalents	$	655,998	$	465,232
Short-term investments	3,229		3,057
Cash, cash equivalents and short-term investments	$	659,227	$	468,289

Cash and Cash Equivalents

Cadence considers all highly liquid investments with original maturities of three months or less on the date of purchase to be cash equivalents. The amortized cost of Cadence’s cash equivalents approximates fair value. The following table summarizes Cadence’s cash and cash equivalents at fair value as of July 1, 2017 and December 31, 2016:



	As of
	July 1, 2017		December 31, 2016
	(In thousands)
Cash and interest bearing deposits	$	208,108	$	227,508
Money market funds	447,890		237,724
Total cash and cash equivalents	$	655,998	$	465,232

Short-Term Investments

The following tables summarize Cadence’s short-term investments as of July 1, 2017 and December 31, 2016:



	As of July 1, 2017
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(In thousands)
Marketable equity securities	$	2,055	$	1,174	$	—	$	3,229



	As of December 31, 2016
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(In thousands)
Marketable equity securities	$	2,131	$	926	$	—	$	3,057

Realized gains and losses from the sale of marketable debt and equity securities are recorded in other income, net in the condensed consolidated income statements.

NOTE 4. RECEIVABLES, NET

Cadence’s current and long-term receivables balances as of July 1, 2017 and December 31, 2016 were as follows:



	As of
	July 1, 2017		December 31, 2016
	(In thousands)
Accounts receivable	$	84,383	$	85,554
Unbilled accounts receivable	68,771		71,617
Long-term receivables	13,340		12,949
Total receivables	166,494		170,120
Less allowance for doubtful accounts	—		—
Total receivables, net	$	166,494	$	170,120

Cadence’s customers are primarily concentrated within the semiconductor and electronics systems industries. As of July 1, 2017 and December 31, 2016, no one customer accounted for 10% or more of Cadence’s total receivables.

NOTE 5. GOODWILL AND ACQUIRED INTANGIBLES

Goodwill

The changes in the carrying amount of goodwill during the six months ended July 1, 2017 were as follows:



	Gross Carrying Amount
	(In thousands)
Balance as of December 31, 2016	$	572,764
Effect of foreign currency translation	2,261
Balance as of July 1, 2017	$	575,025

Acquired Intangibles, Net

Acquired intangibles as of July 1, 2017 were as follows, excluding intangibles that were fully amortized as of December 31, 2016:



	Gross Carrying Amount		Accumulated Amortization			Acquired Intangibles, Net
	(In thousands)
Existing technology	$	340,584	$	(179,507	)	$	161,077
Agreements and relationships	150,039		(83,753		)	66,286
Tradenames, trademarks and patents	9,019		(6,599		)	2,420
Total acquired intangibles	$	499,642	$	(269,859	)	$	229,783

Acquired intangibles as of December 31, 2016 were as follows, excluding intangibles that were fully amortized as of January 2, 2016:



	Gross Carrying Amount		Accumulated Amortization			Acquired Intangibles, Net
	(In thousands)
Existing technology	$	342,108	$	(160,178	)	$	181,930
Agreements and relationships	174,623		(100,778		)	73,845
Tradenames, trademarks and patents	9,806		(6,767		)	3,039
Total acquired intangibles	$	526,537	$	(267,723	)	$	258,814

Amortization expense from existing technology and maintenance agreements is included in cost of product and maintenance. Amortization of acquired intangibles for the three and six months ended July 1, 2017 and July 2, 2016 was as follows:



	Three Months Ended				Six Months Ended
	July 1, 2017		July 2, 2016		July 1, 2017		July 2, 2016
	(In thousands)
Cost of product and maintenance	$	10,868	$	10,546	$	21,446	$	21,209
Amortization of acquired intangibles	3,836		4,537		7,692		10,317
Total amortization of acquired intangibles	$	14,704	$	15,083	$	29,138	$	31,526

Estimated amortization expense for intangible assets with definite lives for the following five fiscal years and thereafter is as follows:



	(In thousands)
2017 – remaining period	$	27,231
2018	52,183
2019	45,185
2020	39,976
2021	35,484
Thereafter	29,724
Total estimated amortization expense	$	229,783

NOTE 6. STOCK-BASED COMPENSATION

Stock-based compensation expense is reflected in Cadence’s condensed consolidated income statements for the three and six months ended July 1, 2017 and July 2, 2016 as follows:



	Three Months Ended				Six Months Ended
	July 1, 2017		July 2, 2016		July 1, 2017		July 2, 2016
	(In thousands)
Cost of product and maintenance	$	491	$	447	$	1,020	$	911
Cost of services	717		653		1,478		1,334
Marketing and sales	6,237		5,305		12,245		10,841
Research and development	18,014		14,477		33,496		28,374
General and administrative	5,023		4,474		9,679		8,528
Total stock-based compensation expense	$	30,482	$	25,356	$	57,918	$	49,988

Cadence had total unrecognized compensation expense related to stock option and restricted stock grants of $176.0 million as of July 1, 2017, which will be recognized over the remaining vesting period. The remaining weighted-average vesting period of unvested awards is 2.0 years.

NOTE 7. RESTRUCTURING AND OTHER CHARGES

Cadence has initiated various restructuring plans, most recently in fiscal 2016, in an effort to better align its resources with its business strategy. These restructuring plans have primarily been comprised of severance payments and termination benefits related to headcount reductions, estimated lease losses related to facilities vacated under the restructuring plans and charges related to assets abandoned as part of the restructuring plans. During the six months ended July 1, 2017, Cadence revised certain estimates made in connection with its 2016 restructuring plans and recorded credits of approximately $2.8 million. As of July 1, 2017, total liabilities related to the 2016 restructuring plans were $6.7 million. Cadence expects to make cash payments for severance and related benefits for the 2016 restructuring plans through the first quarter of fiscal 2019.

The following table presents activity relating to Cadence’s restructuring plans during the six months ended July 1, 2017:



	Severance and Benefits			Excess Facilities			Total
	(In thousands)
Balance, December 31, 2016	$	24,402		$	58		$	24,460
Restructuring and other charges (credits):
2016 Restructuring Plans	(2,805		)	34			(2,771		)
Prior restructuring plans	2			52			54
Cash payments	(15,157		)	(141		)	(15,298		)
Effect of foreign currency translation	236			(3		)	233
Balance, July 1, 2017	$	6,678		$	—		$	6,678

The remaining liability for Cadence’s restructuring plans is recorded in the condensed consolidated balance sheet as follows:



	As of
	July 1, 2017
	(In thousands)
Accounts payable and accrued liabilities	$	6,209
Other long-term liabilities	469
Total liabilities	$	6,678

NOTE 8. NET INCOME PER SHARE

Basic net income per share is computed by dividing net income during the period by the weighted average number of shares of common stock outstanding during that period, less unvested restricted stock awards. Diluted net income per share is impacted by equity instruments considered to be potential common shares, if dilutive, computed using the treasury stock method of accounting.

The calculations for basic and diluted net income per share for the three and six months ended July 1, 2017 and July 2, 2016 are as follows:



	Three Months Ended				Six Months Ended
	July 1, 2017		July 2, 2016		July 1, 2017		July 2, 2016
	(In thousands, except per share amounts)
Net income	$	69,127	$	49,335	$	137,386	$	99,897
Weighted average common shares used to calculate basic net income per share	271,887		288,191		271,030		292,403
Stock-based awards	7,639		7,010		7,601		6,915
Weighted average common shares used to calculate diluted net income per share	279,526		295,201		278,631		299,318
Net income per share - basic	$	0.25	$	0.17	$	0.51	$	0.34
Net income per share - diluted	$	0.25	$	0.17	$	0.49	$	0.33

The following table presents shares of Cadence’s common stock outstanding for the three and six months ended July 1, 2017 and July 2, 2016 that were excluded from the computation of diluted net income per share because the effect of including these shares in the computation of diluted net income per share would have been anti-dilutive:



	Three Months Ended		Six Months Ended
	July 1, 2017	July 2, 2016	July 1, 2017	July 2, 2016
	(In thousands)
Long-term performance-based stock awards	225	1,141	229	888
Options to purchase shares of common stock	820	1,279	606	1,014
Non-vested shares of restricted stock	13	19	87	51
Total potential common shares excluded	1,058	2,439	922	1,953

NOTE 9. FAIR VALUE

Inputs to valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect Cadence’s market assumptions. These two types of inputs have created the following fair value hierarchy:


•	Level 1 – Quoted prices for identical instruments in active markets;


•	Level 2 – Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets; and


•	Level 3 – Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

This hierarchy requires Cadence to minimize the use of unobservable inputs and to use observable market data, if available, when determining fair value. Cadence recognizes transfers between levels of the hierarchy based on the fair values of the respective financial instruments at the end of the reporting period in which the transfer occurred. There were no transfers between levels of the fair value hierarchy during the six months ended July 1, 2017.

On a quarterly basis, Cadence measures at fair value certain financial assets and liabilities. The fair value of financial assets and liabilities was determined using the following levels of inputs as of July 1, 2017 and December 31, 2016:



	Fair Value Measurements as of July 1, 2017
	Total		Level 1		Level 2		Level 3
	(In thousands)
Assets
Cash equivalents:
Money market funds	$	447,890	$	447,890	$	—	$	—
Short-term investments:
Marketable equity securities	3,229		3,229		—		—
Trading securities held in Non-Qualified Deferred Compensation, or NQDC, trust	27,570		27,570		—		—
Foreign currency exchange contracts	934		—		934		—
Total Assets	$	479,623	$	478,689	$	934	$	—

As of July 1, 2017, Cadence did not have any financial liabilities requiring a recurring fair value measurement.




	Fair Value Measurements as of December 31, 2016
	Total		Level 1		Level 2		Level 3
	(In thousands)
Assets
Cash equivalents:
Money market funds	$	237,724	$	237,724	$	—	$	—
Short-term investments:
Marketable equity securities	3,057		3,057		—		—
Trading securities held in NQDC trust	26,622		26,622		—		—
Total Assets	$	267,403	$	267,403	$	—	$	—

	Total		Level 1		Level 2		Level 3
	(In thousands)
Liabilities
Foreign currency exchange contracts	$	2,653	$	—	$	2,653	$	—

NOTE 10. CONTINGENCIES

Legal Proceedings

From time to time, Cadence is involved in various disputes and litigation that arise in the ordinary course of business. These include disputes and lawsuits related to intellectual property, indemnification obligations, mergers and acquisitions, licensing, contracts, distribution arrangements and employee relations matters. At least quarterly, Cadence reviews the status of each significant matter and assesses its potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount or the range of loss can be estimated, Cadence accrues a liability for the estimated loss. Legal proceedings are subject to uncertainties, and the outcomes are difficult to predict. Because of such uncertainties, accruals are based on Cadence’s judgments using the best information available at the time. As additional information becomes available, Cadence reassesses the potential liability related to pending claims and litigation matters and may revise estimates.

Other Contingencies

Cadence provides its customers with a warranty on sales of hardware products, generally for a 90-day period. Cadence did not incur any significant costs related to warranty obligations during the three and six months ended July 1, 2017 and July 2, 2016.

Cadence’s product license and services agreements typically include a limited indemnification provision for claims from third parties relating to Cadence’s intellectual property. If the potential loss from any indemnification claim is considered probable and the amount or the range of loss can be estimated, Cadence accrues a liability for the estimated loss. The indemnification is generally limited to the amount paid by the customer. Cadence did not incur any significant losses from indemnification claims during the three and six months ended July 1, 2017 and July 2, 2016.

Non-Income Based Taxes

Cadence undergoes examination from time to time by U.S. and foreign authorities for non-income based taxes, such as payroll, sales, use, value-added, net worth or franchise, property, goods and services, consumption, import, stamp and excise taxes. Cadence is under examination by tax authorities in certain jurisdictions. If the potential loss from the examinations is considered probable and the amount or the range of loss can be estimated, Cadence accrues a liability for the estimated expense. Tax examinations and the related appeals processes are subject to uncertainties, and the outcomes are difficult to predict. Because of such uncertainties, accruals are based on Cadence’s judgments using the best information available at the time. As additional information becomes available, Cadence reassesses the potential losses related to the non-income based taxes and may revise estimates.

NOTE 11. OTHER COMPREHENSIVE LOSS

Cadence’s other comprehensive loss is comprised of foreign currency translation losses, changes in defined benefit plan liabilities, and changes in unrealized holding gains and losses on available-for-sale securities net of reclassifications for realized gains and losses, as presented in Cadence’s condensed consolidated statements of comprehensive income.

Accumulated other comprehensive loss was comprised of the following as of July 1, 2017 and December 31, 2016:



	As of
	July 1, 2017			December 31, 2016
	(In thousands)
Foreign currency translation loss	$	(12,115	)	$	(22,370	)
Changes in defined benefit plan liabilities	(3,647		)	(3,716		)
Unrealized holding gains on available-for-sale securities	1,174			926
Total accumulated other comprehensive loss	$	(14,588	)	$	(25,160	)

For the three and six months ended July 1, 2017 and July 2, 2016 there were no significant amounts reclassified from accumulated other comprehensive loss to net income.

NOTE 12. SEGMENT REPORTING

Segment reporting is based on the “management approach,” following the method that management organizes the company’s reportable segments for which separate financial information is made available to, and evaluated regularly by, the chief operating decision maker in allocating resources and in assessing performance. Cadence’s chief operating decision maker is its President and CEO, who reviews Cadence’s consolidated results as one operating segment. In making operating decisions, the CEO primarily considers consolidated financial information, accompanied by disaggregated information about revenues by geographic region.

Outside the United States, Cadence markets and supports its products and services primarily through its subsidiaries. Revenue is attributed to geography based upon the country in which the product is used or services are delivered. Long-lived assets are attributed to geography based on the country where the assets are located.

The following table presents a summary of revenue by geography for the three and six months ended July 1, 2017 and July 2, 2016:



	Three Months Ended				Six Months Ended
	July 1, 2017		July 2, 2016		July 1, 2017		July 2, 2016
	(In thousands)
Americas:
United States	$	206,742	$	206,416	$	412,177	$	416,438
Other Americas	10,056		7,196		17,811		16,437
Total Americas	216,798		213,612		429,988		432,875
Asia	131,395		111,032		253,818		210,211
Europe, Middle East and Africa	91,413		88,720		189,734		174,184
Japan	39,395		39,657		82,372		83,613
Total	$	479,001	$	453,021	$	955,912	$	900,883

The following table presents a summary of long-lived assets by geography as of July 1, 2017 and December 31, 2016:



	As of
	July 1, 2017		December 31, 2016
	(In thousands)
Americas:
United States	$	197,663	$	193,750
Other Americas	678		757
Total Americas	198,341		194,507
Asia	36,046		30,564
Europe, Middle East and Africa	14,063		12,692
Japan	690		844
Total	$	249,140	$	238,607

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, or this Quarterly Report, and in conjunction with our Annual Report on Form 10-K for the fiscal year ended December 31, 2016. 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 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, statements regarding our reliance on third parties and other statements using words such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “forecasts,” “intends,” “may,” “plans,” “projects,” “should,” “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 “Risk Factors,” “Results of Operations,” “Quantitative and Qualitative Disclosures About Market Risk,” and “Liquidity and Capital Resources” sections contained in this Quarterly Report, and the risks discussed in our other Securities Exchange Commission, or 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 undertake no obligation, to update these forward-looking statements.

Overview

We enable our customers to design electronic products. Our products and services are designed to give our customers a competitive edge in their development of electronic systems, integrated circuits, or ICs, electronic devices and increasingly sophisticated manufactured products, by optimizing performance, minimizing power consumption, shortening the time to bring their products to market 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, or IP.

System Design Enablement, or SDE, is our overall strategy to provide the technologies necessary for our customers to develop a complete and functional electronic product. Our SDE strategy enables us to address the growing trends of electronic systems companies developing their own ICs as part of their end product systems, as well as semiconductor companies delivering greater portions of the systems into which their IC products are integrated. Demand for our products is driven by our customers’ investment in new designs and products.

We combine our products and technologies into categories related to major design activities:


•	Functional Verification, including Emulation and Prototyping Hardware;


•	Digital IC Design and Signoff;


•	Custom IC Design;


•	System Interconnect and Analysis; and


•	IP.

For additional information about our products, see the discussion in Item 1, “Business,” under the heading “Products and Product Strategy,” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.

We have identified certain items that management uses as 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.”

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 condensed 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 on Form 10-K for the fiscal year ended December 31, 2016.

New Accounting Standards

Revenue Recognition

In May 2014, the FASB issued Accounting Standards Update, or ASU, 2014-09, “Revenue from Contracts with Customers (Topic 606),” which supersedes the revenue recognition requirements in “Revenue Recognition (Topic 605).” Under Topic 606, revenue is recognized when a customer obtains control of promised goods or services and is recognized in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. In addition, Topic 606 requires enhanced disclosures, including disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The FASB has recently issued several amendments to the standard, including clarification on accounting for licenses of intellectual property and identifying performance obligations. Topic 606 will be effective for us beginning with the first quarter of fiscal 2018.

While we continue to assess all potential impacts of Topic 606, we currently expect to continue to recognize revenue over time for our time-based software arrangements, which represents a significant percentage of our total revenue, because the multiple software licenses and related updates in our time-based arrangements constitute a single, combined performance obligation. The timing of revenue recognition for our hardware and professional services is expected to remain substantially unchanged.

We currently believe the adoption of Topic 606 will impact our accounting for multiple element arrangements, or MEAs, that combine many software-related deliverables, which may include multiple software contracts with varying terms, IP licenses, and/or service elements. In addition, we expect certain IP license agreements to be recognized up front under Topic 606, as opposed to over time under Topic 605. Topic 605 requires vendor-specific objective evidence, or VSOE, to recognize revenue separately for the different undelivered elements. We have not established VSOE under Topic 605, thus the revenue related to these agreements is generally recognized over time beginning with the delivery of the last specified deliverable and ending on the latest end date. Topic 606 requires us to separate the different elements through the use of stand-alone selling prices, or SSPs, and to recognize the revenue allocated to the different elements as if those elements had been sold on a standalone basis, either up front or over time. Currently, our revenue mix is such that approximately 90% of our revenue is recognized over time. Under Topic 606, we expect a slightly lower percentage of our revenue will be recognized over time.

More judgment and estimates will be required under Topic 606 than are required under Topic 605, including estimating the SSP for each performance obligation identified within our contracts. We are currently performing analyses to determine the SSP for each of the performance obligations that have been identified. We are currently calculating our SSPs based on our historical pricing practices. Due to the complexity of certain contracts, the actual revenue recognition treatment required under the new standard for these arrangements may be dependent on contract-specific terms and vary in some instances.

Topic 606 permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or modified retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the cumulative catch-up transition method). We currently anticipate adopting the standard using the cumulative catch-up transition method.

Under the cumulative catch-up transition method, we will evaluate each contract that is effective on the adoption date as if that contract had been accounted for under Topic 606 from contract inception. Some revenue related to the MEAs and IP arrangements noted above that would have been recognized in future periods under Topic 605 will be recast under Topic 606 as if the revenue had been recognized in prior periods. As this transition method requires that we not adjust historical reported revenue amounts, the revenue that would have been recognized under this method prior to the adoption date will be an adjustment to retained earnings and will not be recognized as revenue in future periods as previously planned. Because we expect that a slightly lower percentage of our revenue will be recognized over time under Topic 606, we expect to have a small percentage of our year-end backlog to be adjusted to retained earnings upon adoption.

Topic 606 also requires the deferral of incremental costs of obtaining a contract with a customer. This will require that we capitalize commission costs directly related to obtaining customer contracts, and we will amortize those costs over the life of the contract. Due to the broad scope and complexity associated with Topic 606, we are currently implementing systems and processes to assist in the adoption of this new accounting standard.

Financial Instruments

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities,” which will impact certain aspects of recognition, measurement, presentation and disclosure of financial instruments. The updated standard becomes effective for us in the first quarter of fiscal 2018. Upon the effective date of the new standard, all equity investments in unconsolidated entities, other than those accounted for using the equity method of accounting, will generally be measured at fair value with the changes in fair value recognized through earnings. There will no longer be an available-for-sale classification and therefore, the changes in the fair value of our marketable equity securities will no longer be reported in other comprehensive income (loss).

The updated standard also simplifies the impairment assessment of investments without readily determinable fair values by requiring a qualitative assessment of investments at each reporting period. The new guidance must be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the year of adoption. We do not anticipate that the adoption of this standard will have a significant impact on our consolidated financial statements or the related disclosures based on our current holdings of equity investments.

Leases

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842),” requiring, among other things, the recognition of lease liabilities and corresponding right-of-use assets on the balance sheet by lessees for certain lease arrangements that are classified as operating leases under the previous standard. While we are continuing to assess the potential impacts of the standard, we anticipate that the adoption of this standard will have a material impact on our consolidated balance sheets and may require changes to our systems and processes. We currently expect the most significant impact will be the recognition of right-of-use assets and lease liabilities for operating leases.

The updated standard becomes effective for us in the first quarter of fiscal 2019, with early adoption permitted, and requires the use of a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. We have not yet decided on the timing of adoption.

Income Tax

In October 2016, the FASB issued ASU 2016-16, “Income taxes (Topic 740): Intra-entity Transfers of Assets Other Than Inventory.” The new guidance requires the recognition of the income tax consequences of an intra-entity asset transfer when the transfer occurs. For intra-entity transfers of inventory, the income tax effects will continue to be deferred until the inventory has been sold to a third party. The new standard becomes effective for us in the first quarter of fiscal 2018. The new guidance must be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. We are currently evaluating the effects that the adoption of this guidance will have on our consolidated financial statements. We anticipate the potential for increased volatility in future effective tax rates from the adoption of this guidance.

Business Combinations

In January 2017, the FASB issued ASU 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business,” that revises the definition of a business as it relates to acquisitions, disposals, goodwill impairments and consolidations. The updated standard becomes effective for us in the first quarter of fiscal 2018, and early adoption is permitted. We are currently evaluating the effect of adopting the new standard.

Goodwill Impairment

In January 2017, the FASB issued ASU 2017-04, “Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment,” that eliminates “Step 2” from the goodwill impairment test. The new standard is effective for us in the first quarter of fiscal 2020, and early adoption is permitted. The new guidance must be applied on a prospective basis. We do not anticipate that the adoption of this standard will have a significant impact on our consolidated financial statements or the related disclosures.

Stock-based Compensation

In May 2017, the FASB issued ASU 2017-09, “Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting,” that provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The new standard is effective for us in the first quarter of fiscal 2018. The new guidance must be applied on a prospective basis. We do not anticipate that the adoption of this standard will have a significant impact on our consolidated financial statements or the related disclosures.

Results of Operations

Financial results for the three and six months ended July 1, 2017, as compared to the three and six months ended July 2, 2016, reflect the following:


•	increased product and maintenance revenue, because of the overall growth in our software and IP business, particularly in Asia; and


•	continued investment in research and development activities focused on creating and enhancing our products.

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 multiple periods or up front, upon completion of delivery.

Approximately 90% of our revenue is recognized over time, and the remainder of the resulting revenue is recognized up front, upon completion of delivery. Revenue recognized over time includes revenue from our time-based software arrangements, certain IP license arrangements where revenue is recognized over multiple periods, services, royalties from certain IP arrangements, maintenance on perpetual software licenses and hardware, and operating leases of hardware. Upfront revenue is primarily generated by our sales of emulation and prototyping hardware and perpetual software and certain IP licenses. Our ability to maintain this mix in any single fiscal period may be impacted primarily by delivery of hardware and IP products to our customers.

Revenue by Period

The following table shows our revenue for the three months ended July 1, 2017 and July 2, 2016 and the change in revenue between periods:



	Three Months Ended				Change
	July 1, 2017		July 2, 2016		Amount		Percentage
	(In millions, except percentages)
Product and maintenance	$	443.9	$	420.0	$	23.9	6	%
Services	35.1		33.0		2.1		6	%
Total revenue	$	479.0	$	453.0	$	26.0	6	%

The following table shows our revenue for the six months ended July 1, 2017 and July 2, 2016 and the change in revenue between periods:



	Six Months Ended				Change
	July 1, 2017		July 2, 2016		Amount			Percentage
	(In millions, except percentages)
Product and maintenance	$	895.2	$	831.7	$	63.5		8	%
Services	60.7		69.2		(8.5		)	(12	)%
Total revenue	$	955.9	$	900.9	$	55.0		6	%

Product and maintenance revenue may fluctuate from period to period and by geography based on demand for emulation hardware and IP offerings. Product and maintenance revenue increased during the three and six months ended July 1, 2017, as compared to the three and six months ended July 2, 2016, primarily because of growth in our software and IP business, partially offset by lower emulation and prototyping hardware revenue.

Services revenue may fluctuate from period to period based on demand for, and our available resources to fulfill, our services and IP offerings. The decrease in services revenue during the six months ended July 1, 2017, compared to the six months ended July 2, 2016, was primarily due to the timing of incremental revenue recognized during the six months ended July 2, 2016 from a customer agreement at the completion of the contract when all specified deliverables were made available.

No one customer accounted for 10% or more of total revenue during the three and six months ended July 1, 2017 or July 2, 2016.

Revenue by Product Group

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
	July 2, 2016		October 1, 2016		December 31, 2016		April 1, 2017		July 1, 2017
Functional Verification, including Emulation and Prototyping Hardware	27	%	24	%	25	%	23	%	23	%
Digital IC Design and Signoff	27	%	28	%	30	%	29	%	30	%
Custom IC Design	26	%	27	%	25	%	26	%	26	%
System Interconnect and Analysis	10	%	10	%	9	%	10	%	10	%
IP	10	%	11	%	11	%	12	%	11	%
Total	100	%	100	%	100	%	100	%	100	%

Revenue by product group fluctuates from period to period based on demand for, and our resources to fulfill, our services, emulation hardware and IP offerings. As described in Note 2 in the notes to consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016, 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 groups 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
	July 1, 2017		July 2, 2016		Amount			Percentage
	(In millions, except percentages)
United States	$	206.7	$	206.4	$	0.3		—	%
Other Americas	10.1		7.2		2.9			40	%
Asia	131.4		111.0		20.4			18	%
Europe, Middle East and Africa	91.4		88.7		2.7			3	%
Japan	39.4		39.7		(0.3		)	(1	)%
Total revenue	$	479.0	$	453.0	$	26.0		6	%



	Six Months Ended				Change
	July 1, 2017		July 2, 2016		Amount			Percentage
	(In millions, except percentages)
United States	$	412.2	$	416.5	$	(4.3	)	(1	)%
Other Americas	17.8		16.4		1.4			9	%
Asia	253.8		210.2		43.6			21	%
Europe, Middle East and Africa	189.7		174.2		15.5			9	%
Japan	82.4		83.6		(1.2		)	(1	)%
Total revenue	$	955.9	$	900.9	$	55.0		6	%

Revenue by geography fluctuates from period to period based on demand for, and our resources to fulfill, our services, emulation hardware and IP offerings.

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 condensed consolidated financial statements, see the discussion under Item 3, “Quantitative and Qualitative Disclosures About Market Risk – Foreign Currency Risk.”

Revenue by Geography as a Percent of Total Revenue



	Three Months Ended				Six Months Ended
	July 1, 2017		July 2, 2016		July 1, 2017		July 2, 2016
United States	43	%	45	%	43	%	46	%
Other Americas	2	%	2	%	2	%	2	%
Asia	28	%	24	%	26	%	24	%
Europe, Middle East and Africa	19	%	20	%	20	%	19	%
Japan	8	%	9	%	9	%	9	%
Total	100	%	100	%	100	%	100	%

Cost of Revenue



	Three Months Ended				Change
	July 1, 2017		July 2, 2016		Amount			Percentage
	(In millions, except percentages)
Cost of product and maintenance	$	38.8	$	43.0	$	(4.2	)	(10	)%
Cost of services	22.0		18.8		3.2			17	%



	Six Months Ended				Change
	July 1, 2017		July 2, 2016		Amount			Percentage
	(In millions, except percentages)
Cost of product and maintenance	$	82.5	$	87.1	$	(4.6	)	(5	)%
Cost of services	40.1		36.7		3.4			9	%

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. Costs associated with our emulation and prototyping hardware products include materials, assembly, testing, applicable reserves and overhead. These hardware manufacturing costs make our cost of emulation and prototyping hardware product higher, as a percentage of revenue, than our cost of software and IP products.

A summary of cost of product and maintenance is as follows:



	Three Months Ended				Change
	July 1, 2017		July 2, 2016		Amount			Percentage
	(In millions, except percentages)
Product and maintenance-related costs	$	27.9	$	32.5	$	(4.6	)	(14	)%
Amortization of acquired intangibles	10.9		10.5		0.4			4	%
Total cost of product and maintenance	$	38.8	$	43.0	$	(4.2	)	(10	)%



	Six Months Ended				Change
	July 1, 2017		July 2, 2016		Amount			Percentage
	(In millions, except percentages)
Product and maintenance-related costs	$	61.1	$	65.9	$	(4.8	)	(7	)%
Amortization of acquired intangibles	21.4		21.2		0.2			1	%
Total cost of product and maintenance	$	82.5	$	87.1	$	(4.6	)	(5	)%

Cost of product and maintenance depends primarily on our hardware product sales in any given period. Cost of product and maintenance is also affected by employee salary and benefits and other employee-related costs, as well as the timing and extent to which we acquire intangible assets, acquire or license third-parties’ intellectual property or technology and sell our products that include such acquired or licensed intellectual property or technology.

The changes in product and maintenance-related costs for the three and six months ended July 1, 2017, as compared to the three and six months ended July 2, 2016, were due to the following:



	Change
	Three Months Ended			Six Months Ended
	(In millions)
Emulation and prototyping hardware costs	$	(2.7	)	$	(1.8	)
Salary, benefits and other employee-related costs	(1.5		)	(2.9		)
Other items	(0.4		)	(0.1		)
Total change in product and maintenance-related costs	$	(4.6	)	$	(4.8	)

Emulation and prototyping hardware costs decreased during the three and six months ended July 1, 2017, as compared to the three and six months ended July 2, 2016, primarily due to lower emulation and prototyping hardware revenue, offset by an increase in charges for reserves on inventory. Gross margins on our hardware products will fluctuate based on product life cycle, product competition, product mix and pricing strategies.

Salary, benefits and other employee-related costs decreased during the three and six months ended July 1, 2017, as compared to the three and six months ended July 2, 2016, primarily due to a reduction in headcount.

Cost of Services

Cost of services primarily includes employee salary, benefits and other employee-related costs to perform work on revenue-generating projects, costs to maintain the infrastructure necessary to manage a services organization, and provisions for contract losses, if any. Cost of services will fluctuate from period to period based on our utilization of design services engineers on revenue-generating projects or on internal development projects.

Operating Expenses

Our operating expenses include marketing and sales, research and development and general and administrative expenses. Factors that cause our operating expenses to fluctuate include changes in the number of employees due to hiring and acquisitions, restructuring activities, foreign exchange rates, stock-based compensation and the impact of our variable compensation programs that are driven by overall operating results.

Salary, benefits and other employee-related costs and facilities and other infrastructure costs included in operating expenses increased during the three and six months ended July 1, 2017, as compared to the three and six months ended July 2, 2016, primarily due to an increase in headcount resulting from additional hiring and our 2016 acquisitions.

Stock-based compensation included in our operating expenses increased during the three and six months ended July 1, 2017, as compared to the three and six months ended July 2, 2016, primarily because successive increases in the price of our common stock have resulted in higher grant-date fair values for the mix of stock awards expensed in each period. We expect stock-based compensation included in operating expenses to increase during the remainder of fiscal 2017, as compared to fiscal 2016, due to higher grant-date fair values of stock awards vesting during fiscal 2017.

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 six months ended July 1, 2017 and July 2, 2016 were as follows:



	Three Months Ended				Change
	July 1, 2017		July 2, 2016		Amount			Percentage
	(In millions, except percentages)
Marketing and sales	$	103.9	$	101.1	$	2.8		3	%
Research and development	195.9		182.4		13.5			7	%
General and administrative	32.8		36.4		(3.6		)	(10	)%
Total operating expenses	$	332.6	$	319.9	$	12.7		4	%



	Six Months Ended				Change
	July 1, 2017		July 2, 2016		Amount			Percentage
	(In millions, except percentages)
Marketing and sales	$	207.2	$	200.3	$	6.9		3	%
Research and development	394.2		362.3		31.9			9	%
General and administrative	64.6		64.7		(0.1		)	—	%
Total operating expenses	$	666.0	$	627.3	$	38.7		6	%

Our operating expenses, as a percentage of total revenue, for the three and six months ended July 1, 2017 and July 2, 2016 were as follows:



	Three Months Ended				Six Months Ended
	July 1, 2017		July 2, 2016		July 1, 2017		July 2, 2016
Marketing and sales	22	%	22	%	22	%	22	%
Research and development	41	%	40	%	41	%	41	%
General and administrative	7	%	8	%	7	%	7	%
Total operating expenses	70	%	70	%	70	%	70	%

Marketing and Sales

The changes in marketing and sales expense for the three and six months ended July 1, 2017, as compared to the three and six months ended July 2, 2016, were due to the following:



	Change
	Three Months Ended			Six Months Ended
	(In millions)
Salary, benefits and other employee-related costs	$	1.8		$	4.9
Facilities and other infrastructure costs	1.4			1.5
Stock-based compensation	0.9			1.4
Other items	(1.3		)	(0.9		)
Total change in marketing and sales expense	$	2.8		$	6.9

Research and Development

The changes in research and development expense for the three and six months ended July 1, 2017, as compared to the three and six months ended July 2, 2016, were due to the following:



	Change
	Three Months Ended			Six Months Ended
	(In millions)
Salary, benefits and other employee-related costs	$	9.7		$	25.2
Stock-based compensation	3.5			5.1
Facilities and other infrastructure costs	2.4			4.2
Materials and other pre-production costs	(1.3		)	(1.8		)
Other items	(0.8		)	(0.8		)
Total change in research and development expense	$	13.5		$	31.9

We must invest significantly in product research and development to keep pace with the latest manufacturing technology. The demand for new IC manufacturing technology directly impacts the demand for our newest products and we must keep pace with our customers’ technical developments, satisfy industry standards and meet our customers’ increasingly demanding performance, productivity, quality and predictability requirements. Therefore, we expect research and development expense to increase during the remainder of fiscal 2017, as compared to fiscal 2016.

General and Administrative

The changes in general and administrative expense for the three and six months ended July 1, 2017, as compared to the three and six months ended July 2, 2016, were due to the following:



	Change
	Three Months Ended			Six Months Ended
	(In millions)
Acquisition-related costs	$	(5.0	)	$	(3.5	)
Salary, benefits and other employee-related costs	0.5			1.5
Stock-based compensation	0.5			1.2
Other items	0.4			0.7
Total change in general and administrative expense	$	(3.6	)	$	(0.1	)

Restructuring and Other Charges

We have initiated various 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. Demand for our products and services and, ultimately, our future financial performance, is difficult to predict with any degree of certainty. Accordingly, additional actions, including further restructuring of our operations, may be required in the future.

During the six months ended July 1, 2017, we revised certain estimates made in connection with the 2016 Restructuring Plans and recorded credits of approximately $2.8 million. For additional information about our restructuring plans, see Note 7 in the notes to condensed consolidated financial statements.

Interest Expense



	Three Months Ended				Six Months Ended
	July 1, 2017		July 2, 2016		July 1, 2017		July 2, 2016
	(In millions)
Contractual interest expense:
2019 Term Loan	$	1.9	$	1.4	$	3.7	$	2.4
2024 Notes	3.8		3.8		7.6		7.6
Revolving credit facility	0.2		0.4		0.6		0.6
Amortization of debt discount:
2019 Term Loan	0.1		0.1		0.2		0.1
2024 Notes	0.1		0.2		0.3		0.3
Other	0.1		—		0.3		0.3
Total interest expense	$	6.2	$	5.9	$	12.7	$	11.3

For an additional description of our debt arrangements, see Note 2 in the notes to condensed consolidated financial statements.

Income Taxes

The following table presents the provision for income taxes and the effective tax rate for the three and six months ended July 1, 2017 and July 2, 2016:



	Three Months Ended						Six Months Ended
	July 1, 2017			July 2, 2016			July 1, 2017			July 2, 2016
	(In millions, except percentages)
Provision for income taxes	$	8.2		$	14.5		$	14.2		$	21.4
Effective tax rate	10.6		%	22.7		%	9.3		%	17.6		%

Our provision for income taxes for the three and six months ended July 1, 2017 is primarily attributable to federal, state and foreign income taxes on our anticipated fiscal 2017 income partially, offset by tax benefits related to stock-based compensation. Our provision for income taxes for the three months and six months ended July 1, 2017 includes $6.1 million and $13.3 million of tax benefit related to stock-based compensation that vested or was exercised during the period.

Our foreign earnings are generally subject to lower statutory tax rates than our United States earnings. We estimate our annual effective tax rate for fiscal 2017 to be approximately 12.0%. Our estimate excludes tax effects of certain stock-based compensation, potential acquisitions, and other items that we cannot reliably anticipate.

Our provision for income taxes for the three and six months ended July 2, 2016 was primarily attributable to federal, state and foreign income taxes on our then-anticipated fiscal 2016 income, partially offset by tax benefits related to stock-based compensation. Our provision for income taxes for the three months and six months ended July 2, 2016 included $4.1 million and $7.8 million of tax benefit related to stock-based compensation that vested or was exercised during the period.

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, the tax impact of stock-based compensation, accounting for uncertain tax positions, business combinations, closure of statute 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 or if we were to repatriate certain foreign earnings on which United States taxes have not been previously accrued.

For further discussion regarding our income taxes, see Note 10 in the notes to consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.

Liquidity and Capital Resources



	As of
	July 1, 2017		December 31, 2016		Change
	(In millions)
Cash, cash equivalents and short-term investments	$	659.2	$	468.3	$	190.9
Net working capital	$	338.7	$	116.5	$	222.2

Cash, Cash Equivalents and Short-term Investments

As of July 1, 2017, our principal sources of liquidity consisted of $659.2 million of cash, cash equivalents and short-term investments, as compared to $468.3 million as of December 31, 2016.

Our primary sources of cash, cash equivalents and short-term investments during the six months ended July 1, 2017 were cash generated from operations, proceeds from the exercise of stock options and proceeds from stock purchases under our employee stock purchase plan.

Our primary uses of cash, cash equivalents and short-term investments during the six months ended July 1, 2017 were payments related to salaries and benefits, other employee-related costs and operating expenses, payment on our revolving credit facility, purchases of property, plant and equipment, and tax payments.

Approximately 65% of our cash, cash equivalents and short-term investments were held by our foreign subsidiaries as of July 1, 2017. Our intent is to indefinitely reinvest our earnings from certain foreign operations. We do not anticipate we will need to repatriate dividends from foreign operations that are indefinitely reinvested in order to fund our domestic operations. In the event that dividends from foreign operations that are currently indefinitely reinvested are needed to fund United States liquidity, we could be required to accrue and pay additional taxes in order to repatriate these funds. For further discussion regarding our income taxes see Note 10 in the notes to consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.

We expect that current cash, cash equivalents and short-term investment 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 condensed consolidated balance sheets. The increase in our net working capital as of July 1, 2017, as compared to December 31, 2016, is primarily due to a net increase in cash and cash equivalents generated from operations.

Cash Flows from Operating Activities



	Six Months Ended
	July 1, 2017		July 2, 2016		Change
	(In millions)
Cash provided by operating activities	$	254.6	$	163.6	$	91.0

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 for the six months ended July 1, 2017, as compared to the six months ended July 2, 2016, was primarily due to the timing of cash receipts from customers and disbursements made to vendors and improved profitability.

We expect that cash flows from operating activities will fluctuate in future periods due to a number of factors, including our operating results, the timing of our billings, collections and disbursements and tax payments.

Cash Flows from Investing Activities



	Six Months Ended
	July 1, 2017			July 2, 2016			Change
	(In millions)
Cash used for investing activities	$	(27.3	)	$	(6.6	)	$	(20.7	)

The increase in cash used for investing activities during the six months ended July 1, 2017, as compared to the six months ended July 2, 2016, was due to a decrease in net proceeds from our investment portfolio, partially offset by a decrease in cash used for business combinations and asset acquisitions because we did not complete any acquisitions during the six months ended July 1, 2017. We expect to continue our investing activities, including purchasing property, plant and equipment, purchasing intangible assets, business combinations, purchasing software licenses, and making long-term equity investments.

Cash Flows from Financing Activities



	Six Months Ended
	July 1, 2017			July 2, 2016			Change
	(In millions)
Cash used for financing activities	$	(46.6	)	$	(111.9	)	$	65.3

Cash used for financing activities decreased during the six months ended July 1, 2017, as compared to the six months ended July 2, 2016, primarily due to a decrease in payments made to repurchase common stock, partially offset by a decrease in proceeds from borrowings and an increase in payments on our revolving credit facility.

Other Factors Affecting Liquidity and Capital Resources

Stock Repurchase Program

In January 2017, our Board of Directors authorized the repurchase of shares of our common stock with a value of up to $525.0 million in the aggregate. The actual timing and amount of repurchases will be subject to business and market conditions, corporate and regulatory requirements, acquisition opportunities and other factors.

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 July 1, 2017, there were no borrowings outstanding under our revolving credit facility.

2019 Term Loan

In January 2016, we entered into a $300.0 million three-year senior unsecured non-amortizing term loan facility due on January 28, 2019, or the 2019 Term Loan, with a group of lenders led by JPMorgan Chase Bank, N.A., as administrative agent. The 2019 Term Loan is unsecured.

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. The proceeds from the 2024 Notes are available for general corporate purposes, which may include the retirement of debt, working capital, capital expenditures, acquisitions and strategic transactions.

For additional information relating to our debt arrangements, see Note 2 in the notes to condensed consolidated financial statements.

Tax Examinations

We are regularly subject to examinations by tax authorities in the U.S. and foreign jurisdictions, which may in some cases result in assessments for additional taxes. Cadence is under examination in certain jurisdictions by tax authorities, including Germany, India, Israel and Republic of Korea. In certain jurisdictions, we may be required to deposit the amount assessed by the tax authorities, including additional taxes, penalties or interest, prior to appealing such assessment even if the final assessment could be lower than the initial assessment. The timing of the resolution of the appeals cannot be estimated with certainty. Any requirement to deposit a material amount of cash for the tax assessments that we are appealing could reduce our cash flows, working capital and liquidity until the matter is resolved.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Foreign Currency Risk

A material portion of our revenue, expenses and business activities are transacted in the U.S. dollar. In certain foreign countries where we price our products and services in U.S. dollars, a decrease in value of the local currency relative to the U.S. dollar results in an increase in the prices for our products and services compared to those products of our competitors that are priced in local currency. This could result in our prices being uncompetitive in certain markets.

In certain countries where we may invoice customers in the local currency our revenues benefit from a weaker dollar and are adversely affected by a stronger dollar. The opposite impact occurs in countries where we record expenses in local currencies. In those cases, our costs and expenses benefit from a stronger dollar and are adversely affected by a weaker dollar. The fluctuations in our operating expenses outside the United States resulting from volatility in foreign exchange rates are not generally moderated by corresponding fluctuations in revenues from existing contracts.

We enter into foreign currency forward exchange contracts to protect against currency exchange risks associated with existing assets and liabilities. A foreign currency forward exchange contract acts as a hedge by increasing in value when underlying assets decrease in value or underlying liabilities increase in value due to changes in foreign exchange rates. Conversely, a foreign currency forward exchange contract decreases in value when underlying assets increase in value or underlying liabilities decrease in value due to changes in foreign exchange rates. These forward contracts are not designated as accounting hedges, so the unrealized gains and losses are recognized in other income, net, in advance of the actual foreign currency cash flows with the fair value of these forward contracts being recorded as accrued liabilities or other current assets.

We do not use forward contracts for trading purposes. Our forward contracts generally have maturities of 90 days or less. We enter into foreign currency forward exchange contracts based on estimated future asset and liability exposures, and the effectiveness of our hedging program depends on our ability to estimate these future asset and liability exposures. Recognized gains and losses with respect to our current hedging activities will ultimately depend on how accurately we are able to match the amount of foreign currency forward exchange contracts with actual underlying asset and liability exposures.

The following table provides information about our foreign currency forward exchange contracts as of July 1, 2017. The information is provided in United States dollar equivalent amounts. The table presents the notional amounts, at contract exchange rates, and the weighted average contractual foreign currency exchange rates expressed as units of the foreign currency per United States dollar, which in some cases may not be the market convention for quoting a particular currency. All of these forward contracts mature before or during August 2017.



	Notional Principal		Weighted Average Contract Rate
	(In millions)
Forward Contracts:
European Union euro	$	59.3	0.89
Japanese yen	50.0		110.69
Israeli shekel	25.5		3.52
Indian rupee	23.7		64.62
British pound	16.6		0.79
South Korean won	12.2		1,124.55
Chinese renminbi	7.2		6.81
Singapore dollar	5.2		1.38
Other	8.3		N/A