CADENCE DESIGN SYSTEMS INC (CDNS) FY 2022 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K and with Part I, Item 1A, “Risk Factors.” Please refer to the cautionary language at the beginning of Part I of this Annual Report on Form 10-K regarding forward-looking statements.

Business Overview

We enable our customers to develop electronic products. Our products and services are designed to give our customers a competitive edge in their development of ICs, SoCs, and increasingly sophisticated electronic devices and systems. Our products and services do this by optimizing performance, minimizing power consumption, shortening the time to bring our customers’ products to market, improving engineering productivity and reducing their design, development and manufacturing costs. We offer software, hardware, services and reusable IC design blocks, which are commonly referred to as IP.

Our strategy, which we call Intelligent System Design, is to provide the technology necessary for our customers to develop electronic products across a variety of vertical markets including consumer, hyperscale computing, 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 EDA. Today, our offerings include and extend beyond EDA.

We group our products into categories related to major design activities:

•Custom IC Design and Simulation;

•Digital IC Design and Signoff;

•Functional Verification;

•IP; and

•System Design and Analysis.

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During fiscal 2021, we continued to execute our Intelligent System Design strategy with our announcement of the next generation of hardware-software products in our Functional Verification product category, which consists of the integrated Palladium Z2 emulation and Protium X2 prototyping systems, to accelerate hardware debug and software validation. We also completed our acquisitions of Belgium-based NUMECA, a leader in computational fluid dynamics (“CFD”), and Pointwise Inc, a leading provider of CFD Meshing technology. The addition of these technologies and talent broadens our System Design and Analysis portfolio and expertise. These acquisitions increased expenses, including amortization of acquired intangible assets, more than revenue during fiscal 2021.

For additional information about our products, see the discussion in Item 1, “Business,” under the heading “Products and Product Strategy.”

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.”

During the second quarter of fiscal 2021, we offered a voluntary retirement program to eligible employees in the United States. This program resulted in a one-time charge for voluntary termination and post-employment benefits of $26.8 million. As of January 1, 2022, liabilities related to the voluntary retirement program were $17.5 million and were included in accounts payable and accrued liabilities and other long-term liabilities on our consolidated balance sheet. We expect to make cash payments to settle these liabilities through fiscal 2023, including $17.0 million that is expected to be paid in the next twelve months.

COVID-19 Impact

In March 2020, the World Health Organization declared the outbreak of COVID-19 a pandemic. The effects of the ongoing global pandemic have been widespread and have resulted in authorities implementing numerous measures to contain the virus, including travel bans and restrictions, quarantines, shelter-in-place orders and business limitations and shutdowns. We are unable to accurately predict the full impact that COVID-19 will have on our results of operations, financial condition, liquidity and cash flows due to numerous uncertainties, including the duration and severity of the pandemic and containment measures and the distribution, acceptance and effectiveness of vaccines. Our efforts to comply with these containment measures have impacted our day-to-day operations and could disrupt our business and operations, as well as that of our key customers, suppliers (including contract manufacturers) and other counterparties, for an indefinite period of time. To support the health and well-being of our employees, customers, partners and communities, a vast majority of our employees are still working remotely as of January 1, 2022. However, we have begun a limited pilot program for employees to begin voluntarily returning to work in certain jurisdictions with lower rates of new COVID-19 cases and higher vaccination rates.

Since its inception, the COVID-19 pandemic has caused some volatility in our delivery timing for our hardware and IP products to certain customers. Many of our customers’ employees are working remotely, and, in some cases, we have experienced delivery lead times that are longer than normal because of delays in getting access to customer sites to complete our deliveries. In other cases, the amount of our hardware and IP products that we have been able to deliver has been greater than we originally anticipated at the beginning of the respective period. Despite the challenges the COVID-19 pandemic has posed to our operations, it did not have a material, adverse impact on our results of operations, financial condition, liquidity or cash flows during fiscal 2021. We will continue to evaluate the nature and extent of the impact of COVID-19 on our business. See Part I, Item 1A, “Risk Factors” for additional information on the impact of COVID-19 on our business.

Results of Operations

The discussion of our fiscal 2021 consolidated results of operations include year-over-year comparisons to fiscal 2020 for revenue, cost of revenue, operating expenses, operating margin, other non-operating expenses, income taxes and cash flows. For a discussion of the fiscal 2020 changes compared to fiscal 2019, see the discussion in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended January 2, 2021, filed on February 22, 2021.

Our fiscal years are 52- or 53-week periods ending on the Saturday closest to December 31. Fiscal 2021 was a 52-week fiscal year, compared to 2020, which was a 53-week fiscal year. The additional week in fiscal 2020 resulted in additional revenue of approximately $45 million and additional expense, including stock-based compensation and amortization of acquired intangibles, of approximately $35 million.

Results of operations for fiscal 2021, as compared to fiscal 2020, reflect the following:

•revenue growth that exceeded the growth of our costs and expenses;

•increased product and maintenance revenue, primarily from growth in our software and hardware product offerings;

•continued investment in research and development activities focused on expanding and enhancing our product portfolio; and

•higher selling costs, including additional investment in technical sales support in response to our customers’ increasing technological requirements.

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Revenue

We primarily generate revenue from licensing our software and IP, selling or leasing our emulation and prototyping hardware technology, providing maintenance for our software, hardware and IP, providing engineering services and earning royalties generated from the use of our IP. The timing of our revenue is significantly affected by the mix of software, hardware and IP products generating revenue in any given period and whether the revenue is recognized over time or at a point in time, upon completion of delivery.

In any fiscal year, we expect that between 85% and 90% of our annual revenue will be characterized as recurring revenue. Revenue characterized as recurring includes revenue recognized over time from our software arrangements, services, royalties, maintenance on IP licenses and hardware, and operating leases of hardware and revenue recognized at varying points in time over the term of our IP Access Agreements that include non-cancellable commitments from customers.

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.

Revenue by Year

The following table shows our revenue for fiscal 2021 and 2020 and the change in revenue between years:

Product and maintenance revenue increased during fiscal 2021, as compared to fiscal 2020, primarily because of increased revenue from each of our five product categories. This growth is driven by our customers investing in new, complex designs for their products including electronic systems for consumer, hyperscale computing, 5G communications, automotive, aerospace and defense, industrial and healthcare.

Services revenue increased during fiscal 2021, as compared to fiscal 2020, primarily due to the timing of performance obligations being fulfilled for certain customer contracts during fiscal 2021. Services revenue may fluctuate from period to period based on the timing of fulfillment of our services and IP performance obligations.

No one customer accounted for 10% or more of total revenue during fiscal 2021 or 2020.

Revenue by Product Category

The following table shows the percentage of product and related maintenance revenue contributed by each of our five product categories and services during fiscal 2021 and 2020:

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.

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Revenue by Geography

The increase in revenue in the United States and Other Asia during fiscal 2021, as compared to fiscal 2020, was attributable to growth in revenue from each of our five product categories.

The decrease in revenue in China during fiscal 2021, as compared to fiscal 2020, was due to higher-than-typical volume in China during fiscal 2020. During fiscal 2020, we experienced an increase in demand for our emulation and prototyping hardware and IP product offerings from our customers in China that resulted in a larger percentage of total revenue coming from that geography.

The increase in revenue in Europe, Middle East and Africa during fiscal 2021, as compared to fiscal 2020, was attributable to growth in revenue from System Design and Analysis, Digital IC Design and Custom IC Design product offerings.

Revenue by Geography as a Percent of Total Revenue

Most of our revenue is transacted in the United States dollar. However, certain revenue transactions are denominated in foreign currencies. For an additional description of how changes in foreign exchange rates affect our consolidated financial statements, see the discussion under Item 7A, “Quantitative and Qualitative Disclosures About Market Risk – Foreign Currency Risk.”

Cost of Revenue

The following table shows cost of revenue as a percentage of related revenue for fiscal 2021 and 2020:

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Cost of Product and Maintenance

Cost of product and maintenance includes costs associated with the sale and lease of our emulation and prototyping hardware and licensing of our software and IP products, certain employee salary and benefits and other employee-related costs, cost of our customer support services, amortization of technology-related and maintenance-related acquired intangibles, costs of technical documentation and royalties payable to third-party vendors. Cost of product and maintenance depends primarily on our hardware product sales in any given period, but is also affected by employee salary and benefits and other employee-related costs, reserves for inventory, and the timing and extent to which we acquire intangible assets, license third-party technology or IP, and sell our products that include such acquired or licensed technology or IP.

A summary of cost of product and maintenance for fiscal 2021 and 2020 is as follows:

Product and maintenance-related costs decreased during fiscal 2021, when compared to fiscal 2020, due to the following:

Costs associated with our emulation and prototyping hardware products include components, assembly, testing, applicable reserves and overhead. These costs make our cost of emulation and prototyping hardware products higher, as a percentage of revenue, than our cost of software and IP products. The decrease in emulation and prototyping hardware costs during fiscal 2021, as compared to fiscal 2020, was primarily due to the mix of products generating revenue and a decrease in charges related to previous generations of our emulation hardware.

Amortization of acquired intangibles included in cost of product and maintenance increased during fiscal 2021, as compared to fiscal 2020, primarily due to technology-related intangible assets acquired with our acquisitions of NUMECA and Pointwise during the first half of fiscal 2021 and in-process technology being placed into service during the second quarter of fiscal 2020. This increase was partially offset by certain technology-related intangible assets becoming fully amortized during fiscal 2021 and during fiscal 2020.

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 merit cycle, stock-based compensation, restructuring and other employment separation activities (such as the voluntary retirement program), foreign exchange rate movements, volatility in variable compensation programs that are driven by operating results and charitable donations.

Many of our operating expenses are transacted in various foreign currencies. We recognize lower expenses in periods when the United States dollar strengthens in value against other currencies and we recognize higher expenses when the United States dollar weakens against other currencies. For an additional description of how changes in foreign exchange rates affect our consolidated financial statements, see the discussion in Item 7A, “Quantitative and Qualitative Disclosures About Market Risk – Foreign Currency Risk.”

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Our operating expenses for fiscal 2021 and 2020 were as follows:

Our operating expenses, as a percentage of total revenue, for fiscal 2021 and 2020 were as follows:

Marketing and Sales

The changes in marketing and sales expense were due to the following:

Salary, benefits and other employee-related costs included in marketing and sales increased during fiscal 2021, as compared to fiscal 2020, primarily due to additional headcount from hiring and acquisitions and increased variable compensation. This increase was partially offset by reduced home office-related expenses associated with the transition to a remote work environment during fiscal 2020 due to the COVID-19 pandemic.

Research and Development

The changes in research and development expense were due to the following:

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Salary, benefits and other employee-related costs included in research and development expense increased during fiscal 2021, as compared to fiscal 2020, due primarily to additional headcount from hiring and acquisitions as we continue to expand and enhance our product portfolio. This increase was partially offset by reduced home office-related expenses associated with the transition to a remote work environment during fiscal 2020 due to the COVID-19 pandemic.

General and Administrative

The changes in general and administrative expense were due to the following:

The increase in contributions to non-profit organizations is the result of our continued commitment to support charitable initiatives. During the fourth quarter of fiscal 2021, we launched the Cadence Giving Foundation, a stand-alone, non-profit organization that was established to partner with other charitable initiatives to give back to the communities where we live and work. The Cadence Giving Foundation will also support critical needs in areas such as diversity, equity and inclusion, environmental sustainability and STEM education.

Salary, benefits and other employee-related costs included in general and administrative expense increased during fiscal 2021, as compared to fiscal 2020, due primarily to additional headcount from hiring and acquisitions.

Amortization of Acquired Intangibles

Amortization of acquired intangibles consists primarily of amortization of customer relationships, acquired backlog, trade names, trademarks and patents. Amortization in any given period depends primarily on the timing and extent to which we acquire intangible assets.

Amortization of acquired intangibles increased during fiscal 2021, as compared to fiscal 2020, primarily due to intangibles assets acquired from Pointwise and Numeca during fiscal 2021.

Restructuring

We have initiated restructuring plans in recent years, most recently in fiscal 2020, to better align our resources with our business strategy. Because the restructuring charges and related benefits are derived from management’s estimates made during the formulation of the restructuring plans, based on then-currently available information, our restructuring plans may not achieve the benefits anticipated on the timetable or at the level contemplated. Additional actions, including further restructuring of our operations, may be required in the future. For additional information about our restructuring plans, see Note 16 in the notes to consolidated financial statements.

Operating margin

Operating margin represents income from operations as a percentage of total revenue. Our operating margin for fiscal 2021 and 2020 was as follows:

Operating margin increased during fiscal 2021, as compared to fiscal 2020, primarily because revenue growth in each of our five product categories exceeded growth in operating expenses.

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Interest Expense

Interest expense for fiscal 2021 and 2020 was comprised of the following:

Interest expense decreased during fiscal 2021, as compared to fiscal 2020, primarily due to a decrease in outstanding borrowing under our revolving credit facility. During the first quarter of fiscal 2020, we had outstanding borrowings of $350 million under our revolving credit facility as a precautionary measure to provide additional liquidity in light of global economic uncertainty that was present at that time. All outstanding borrowings under our revolving credit facility were repaid in the fourth quarter of fiscal 2020. For an additional description of our debt arrangements, including our revolving credit facility, see Note 3 in the notes to consolidated financial statements.

Income Taxes

The following table presents the provision for income taxes and the effective tax rate for fiscal 2021 and 2020:

Our provision for fiscal 2021 was primarily attributable to federal, state and foreign income taxes on our fiscal 2021 income, partially offset by the tax benefit of $22.1 million related to our foreign-derived intangible income, and the tax benefit of $64.3 million related to stock-based compensation that vested or was exercised during the period. We also recognized a tax benefit of $10.5 million related to the release of the valuation allowance on our Massachusetts R&D tax credits because we expect to utilize these tax credits prior to expiration based on strong current earnings and future taxable income projections.

Our provision for fiscal 2020 was primarily attributable to federal, state and foreign income taxes on our fiscal 2020 income, partially offset by the tax benefit of $22.2 million related to the partial release of the valuation allowance on our California R&D tax credit deferred tax assets and the tax benefit of $60.1 million related to stock-based compensation that vested or was exercised during fiscal 2020.

The United States enacted the Tax Cuts and Jobs Act in December 2017 that 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 must capitalize and amortize R&D costs over five years for domestic research and 15 years for international research rather than expensing these costs as incurred. If the United States doesn’t repeal or defer the effective date of the law in the future, then 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 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, changes in valuation allowance and changes in tax law. A significant amount of our foreign earnings is generated by our subsidiaries organized in Ireland and Hungary. Our future effective tax rates may be adversely affected if our earnings were to be lower in countries where we have lower statutory tax rates. We currently expect that our fiscal 2022 effective tax rate will be approximately 25%. 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.” For further discussion regarding our income taxes, see Note 8 in the notes to consolidated financial statements.

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Liquidity and Capital Resources

Cash and Cash Equivalents

As of January 1, 2022, our principal sources of liquidity consisted of $1,088.9 million of cash and cash equivalents as compared to $928.4 million as of January 2, 2021.

Our primary sources of cash and cash equivalents during fiscal 2021 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 and cash equivalents during fiscal 2021 were payments related to salaries and benefits, operating expenses, repurchases of our common stock, payments for business combinations, net of cash acquired, payments for income taxes, purchases of inventory, payment of employee taxes on vesting of restricted stock and purchases of property, plant and equipment.

Approximately 55% of our cash and cash equivalents were held by our foreign subsidiaries as of January 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.

Net Working Capital

Net working capital is comprised of current assets less current liabilities, as shown on our consolidated balance sheets. The increase in our net working capital as of January 1, 2022, as compared to January 2, 2021, is primarily due to improved results from operations, the timing of cash receipts from customers and disbursements made to vendors.

Cash Flows from Operating Activities

Cash flows from operating activities during fiscal 2021 and 2020 were as follows:

Cash flows from operating activities include net income, adjusted for certain non-cash items, as well as changes in the balances of certain assets and liabilities. Our cash flows from operating activities are significantly influenced by business levels and the payment terms set forth in our customer agreements. The increase in cash flows from operating activities during fiscal 2021, as compared to fiscal 2020, 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

Cash flows used for investing activities during fiscal 2021 and 2020 were as follows:

Cash used for investing activities during fiscal 2021 and fiscal 2020, consisted primarily of cash paid in business combinations, net of cash acquired, and payments for purchases of property, plant and equipment. We expect to continue our investing activities, including purchasing property, plant and equipment, purchasing intangible assets, business combinations, purchasing software licenses, and making strategic investments.

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Cash Flows from Financing Activities

Cash flows used for financing activities during fiscal 2021 and 2020 were as follows:

The increase in cash used for financing activities during fiscal 2021, as compared to fiscal 2020, was primarily due to an increase in payments for repurchases of our common stock.

Other Factors Affecting Liquidity and Capital Resources

Stock Repurchase Program

As of the end of fiscal 2020, approximately $739 million remained available under the previously announced authorization to repurchase shares of our common stock. In August 2021, 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 January 1, 2022, approximately $1.1 billion remained available to repurchase shares of our common stock. See Part II, Item 5, “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” for additional information.

Revolving Credit Facility

On June 30, 2021, we terminated our then-existing revolving credit facility, dated January 30, 2017, and 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 (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 January 1, 2022, there were no 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. We received net proceeds of $342.4 million from the issuance of the 2024 Notes, net of a discount of $1.4 million and issuance costs of $6.2 million. Interest is payable in cash semi-annually. The 2024 Notes are unsecured and rank equal in right of payment to all of our existing and future senior indebtedness. As of January 1, 2022, we were in compliance with all covenants associated with the 2024 Notes.

For additional information relating to our debt arrangements, see Note 3 in the notes to consolidated financial statements.

Other Liquidity Requirements

A summary of other capital and liquidity requirements as of January 1, 2022 is as follows:

_________________

(1)    This table includes future payments under leases that had commenced as of January 1, 2022 as well as leases that had been signed but not yet commenced as of January 1, 2022.

(2)    Included in other long-term contractual obligations are long-term income tax liabilities of $23.1 million related to unrecognized tax benefits. The remaining portion of other long-term contractual obligations is primarily liabilities associated with defined benefit retirement plans and acquisitions.

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We expect that current cash and cash equivalent balances, 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.

Off-Balance Sheet Arrangements

As of January 1, 2022, we did not have any significant off-balance sheet arrangements that are reasonably likely to have a material current or future effect on our operating results or financial condition.

Critical Accounting Estimates

In preparing our consolidated financial statements, we make assumptions, judgments and estimates that can have a significant impact on our revenue, operating income and net income, as well as on the value of certain assets and liabilities on our consolidated balance sheets. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. At least quarterly, we evaluate our assumptions, judgments and estimates, and make changes as deemed necessary.

We believe that the assumptions, judgments and estimates involved in the accounting for income taxes, revenue recognition and business combinations have the greatest potential impact on our consolidated financial statements; therefore, we consider these to be our critical accounting estimates. For information on our significant accounting policies, see Note 2 in the notes to consolidated financial statements.

Revenue Recognition

Our contracts with customers often include promises to transfer multiple software and/or IP licenses, hardware and services, including professional services, technical support services, and rights to unspecified updates to a customer. These contracts require us to apply judgment in identifying and evaluating any terms and conditions in contracts which may impact revenue recognition. Determining whether licenses and services are distinct performance obligations that should be accounted for separately, or not distinct and thus accounted for together, requires significant judgment. In some arrangements, such as most of our IP license arrangements, we have concluded that the licenses and associated services are distinct from each other. In other arrangements, like our time-based software arrangements, the licenses and certain services are not distinct from each other. Our time-based software arrangements include multiple software licenses and updates to the licensed software products, as well as technical support, and we have concluded that these promised goods and services are a single, combined performance obligation.

Judgment is required to determine the stand-alone selling prices (“SSPs”) for each distinct performance obligation. We rarely license or sell products on a standalone basis, so we are required to estimate the SSP for each performance obligation. In instances where the SSP is not directly observable because we do not sell the license, product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual performance obligations due to the stratification of those items by classes of customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region of the customer in determining the SSP.

Revenue is recognized over time for our combined performance obligations that include software licenses, updates, and technical support as well as for maintenance and professional services that are separate performance obligations. For our professional services, revenue is recognized over time, generally using costs incurred or hours expended to measure progress. Judgment is required in estimating project status and the costs necessary to complete projects. A number of internal and external factors can affect these estimates, including labor rates, utilization and efficiency variances and specification and testing requirement changes. For our other performance obligations recognized over time, revenue is generally recognized using a time-based measure of progress reflecting generally consistent efforts to satisfy those performance obligations throughout the arrangement term.

If a group of agreements are so closely related that they are, in effect, part of a single arrangement, such agreements are deemed to be one arrangement for revenue recognition purposes. We exercise significant judgment to evaluate the relevant facts and circumstances in determining whether the separate agreements should be accounted for separately or as, in substance, a single arrangement. Our judgments about whether a group of contracts comprise a single arrangement can affect the allocation of consideration to the distinct performance obligations, which could have an effect on results of operations for the periods involved.

We are required to estimate the total consideration expected to be received from contracts with customers. In some circumstances, the consideration expected to be received is variable based on the specific terms of the contract or based on our expectations of the term of the contract. Generally, we have not experienced significant returns or refunds to customers. These estimates require significant judgment and the change in these estimates could have an effect on our results of operations during the periods involved.

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Accounting for Income Taxes

We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in evaluating and estimating our provision for these taxes. There are many transactions that occur during the ordinary course of business for which the ultimate tax determination is uncertain. Our provision for income taxes could be adversely affected by our earnings being lower than anticipated in countries where we have lower statutory rates and higher than anticipated in countries where we have higher statutory rates, losses incurred in jurisdictions for which we are not able to realize the related tax benefit, changes in foreign currency exchange rates, entry into new businesses and geographies and changes to our existing businesses, acquisitions and investments, changes in our deferred tax assets and liabilities including changes in our assessment of valuation allowances, changes in the relevant tax laws or interpretations of these tax laws, and developments in current and future tax examinations.

We only recognize the tax benefit of an income tax position if we judge that it is more likely than not that the tax position will be sustained, solely on its technical merits, in a tax audit including resolution of any related appeals or litigation processes. To make this judgment, we must interpret complex and sometimes ambiguous tax laws, regulations and administrative practices. If we judge that an income tax position meets this recognition threshold, then we must measure the amount of the tax benefit to be recognized by estimating the largest amount of tax benefit that has a greater than 50% cumulative probability of being realized upon settlement with a taxing authority that has full knowledge of all of the relevant facts. It is inherently difficult and subjective to estimate such amounts, as this requires us to determine the probability of various possible settlement outcomes. We must reevaluate our income tax positions on a quarterly basis to consider factors such as changes in facts or circumstances, changes in tax law, effectively settled issues under audit, the lapse of applicable statute of limitations, and new audit activity. Such a change in recognition or measurement would result in recognition of a tax benefit or an additional charge to the tax provision. For a more detailed description of our unrecognized tax benefits, see Note 8 in the notes to consolidated financial statements.

During fiscal 2019, we completed intercompany transfers of certain intangible property rights to our Irish subsidiary, which resulted in the establishment of a deferred tax asset and the recognition of an income tax benefit of $575.6 million. To determine the value of the deferred tax asset, we were required to make significant estimates in determining the fair value of the transferred IP rights. These estimates included, but are not limited to, the income and cash flows that the IP rights are expected to generate in the future, the appropriate discount rate to apply to the income and cash flow projections, and the useful lives of the IP rights. These estimates are inherently uncertain and unpredictable, and if different estimates were used, it would impact the fair value of the IP rights and the related value of the deferred tax asset and the income tax benefit recognized in fiscal 2019 and in future periods when the deferred tax asset is realized. In addition, we reviewed the need to establish a valuation allowance on the deferred tax asset of $575.6 million by evaluating whether there is a greater than 50% likelihood that some portion or all of the deferred tax asset will not be realized. To make this judgment, we must make significant estimates and predictions of the amount and category of future taxable income from various sources and weigh all available positive and negative evidence about these possible sources of taxable income. We give greater weight to evidence that can be objectively verified. Based on our evaluation and weighting of the positive and negative evidence, we concluded that it is greater than 50% likely that the deferred tax asset of $575.6 million will be realized in future periods and that a valuation allowance was not currently required. If, in the future, we evaluate that this deferred tax asset is not likely to be realized, an increase in the related valuation allowance could result in a material income tax expense in the period such a determination is made.

Business Combinations

When we acquire businesses, we allocate the purchase price to the acquired tangible assets and assumed liabilities, including deferred revenue, liabilities associated with the fair value of contingent consideration and acquired identifiable intangible assets. Any residual purchase price is recorded as goodwill. The allocation of the purchase price requires us to make significant estimates in determining the fair values of these acquired assets and assumed liabilities, especially with respect to intangible assets and goodwill. These estimates are based on information obtained from management of the acquired companies, our assessment of this information, and historical experience. These estimates can include, but are not limited to, the cash flows that an acquired business is expected to generate in the future, the cash flows that specific assets acquired with that business are expected to generate in the future, the appropriate weighted average cost of capital, and the cost savings expected to be derived from acquiring an asset. These estimates are inherently uncertain and unpredictable, and if different estimates were used, the purchase price for the acquisition could be allocated to the acquired assets and assumed liabilities differently from the allocation that we have made to the acquired assets and assumed liabilities. In addition, unanticipated events and circumstances may occur that may affect the accuracy or validity of such estimates, and if such events occur, we may be required to adjust the value allocated to acquired assets or assumed liabilities.

We also make significant judgments and estimates when we assign useful lives to the definite-lived intangible assets identified as part of our acquisitions. These estimates are inherently uncertain and if we used different estimates, the useful life over which we amortize intangible assets would be different. In addition, unanticipated events and circumstances may occur that may impact the useful life assigned to our intangible assets, which would impact our amortization of intangible assets expense and our results of operations.

During fiscal 2021, we acquired intangible assets of $88.9 million with our acquisition of NUMECA and Pointwise. The fair value of the definite-lived intangible assets acquired with these acquisitions was determined using variations of the income approach.

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For acquired existing technology, the fair value was determined by applying the relief-from-royalty method. This method is based on the application of a royalty rate to forecasted revenue to quantify the benefit of owning the intangible asset rather than paying a royalty for use of the asset. To estimate royalty savings over time, we projected revenue from the acquired existing technology over the estimated remaining life of the technology, including the effect of assumed technological obsolescence, before applying an assumed royalty rate. For NUMECA, we assumed technological obsolescence at a rate of 6.7% annually, before applying an assumed royalty rate of 22%. For Pointwise, we assumed technological obsolescence at a rate of 10.0% annually, before applying an assumed royalty rate of 25%. The present value of after-tax royalty savings were determined using discount rates ranging from 10.5% to 12.0%.

The fair value for acquired agreements and relationships was determined by using the multi-period excess earnings method. This method reflects the present value of the projected cash flows that are expected to be generated from existing customers, less charges representing the contribution of other assets to those cash flows. Projected income from existing customer relationships considered a customer retention rate of 95% for both NUMECA and Pointwise. The present value of operating cash flows from existing customers was determined using discount rates ranging from 10.5% to 12.0%.

We believe that our estimates and assumptions related to the fair value of its acquired intangible assets are reasonable, but significant judgment is involved.

New Accounting Standards

For additional information about the adoption of new accounting standards, see Note 2 in the notes to consolidated financial statements.

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