CADENCE DESIGN SYSTEMS INC (CDNS) FY 2023 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 and with Part I, Item 1A, “Risk Factors.” Please refer to the cautionary language at the beginning of Part I of this Annual Report regarding forward-looking statements.

Business Overview

Cadence is a leading pioneer in electronic system design software and IP, building upon more than 35 years of computational software expertise. Since our inception, we have been at the forefront of technology innovation, solving highly complex challenges in the semiconductor and electronic systems industries. We are a global company that provides computational software, special-purpose computational hardware, IP and services to multiple vertical sectors including automotive, AI, aerospace and defense, high-performance and mobile computing, hyperscalers, wireless communications, IIoT and medical equipment.

Our strategy allows us to deliver essential computational software, hardware and IP that our customers use to turn their design concepts into reality. Our customers include many of the world's most innovative companies that design and build highly sophisticated semiconductor and electronic systems found in products used in everyday life. Our Intelligent System Design strategy allows us to quickly adapt to our customers' dynamic design requirements. Our products and services enable our customers to develop complex and innovative semiconductor and electronic systems, so demand for our technology and expertise is driven by increasing complexity and our customers’ need to invest in new designs and products that are highly differentiated. Historically, the industry that provided the tools used by IC engineers was referred to as Electronic Design Automation (“EDA”). Today, our offerings include and extend beyond EDA.

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

•Custom IC Design and Simulation;

•Digital IC Design and Signoff;

•Functional Verification;

•IP; and

•System Design and Analysis.

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

Consistent with our Intelligent System Design strategy, we completed several acquisitions since the beginning of fiscal 2023 that we believe enhance our talent, our technology portfolio and our ability to pursue attractive opportunities in the markets we serve. During fiscal 2023, these acquisitions increased expenses, including amortization of acquired intangible assets, more than revenue.

Management uses certain performance indicators to manage our business, including revenue, certain elements of operating expenses and cash flow from operations, and we describe these items further below under the headings “Results of Operations” and “Liquidity and Capital Resources.”

Fiscal Year End

Historically, our fiscal years were 52- or 53-week periods ending on the Saturday closest to December 31. During fiscal 2022, our Board of Directors approved a change in our fiscal year end from the Saturday closest to December 31 of each year to December 31 of each year. The fiscal year change became effective beginning with our fiscal year 2023, which began on January 1, 2023. Fiscal year 2022, which is included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for comparative purposes, represents a 52-week period.

Our first three fiscal quarters end on March 31, June 30, and September 30. No transition report was required in connection with this change.

Macroeconomic and Geopolitical Environment

Because we operate globally, our business is subject to the effects of expanded trade control laws and regulations, geopolitical conflict in and around Ukraine, the Middle East, and other areas of the world, volatility in foreign currency exchange rates relative to the U.S. dollar and the rise in interest rates.

We have been impacted by the continued expansion of trade control laws and regulations, including certain export control restrictions concerning advanced node IC production in China, the inclusion of additional Chinese technology companies on the Bureau of Industry and Security (“BIS”) “Entity List” and regulations governing the sale of certain technologies. Based on our current assessments, we expect the impact of these expanded trade control laws and regulations on our business to be limited.

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We also continuously monitor geopolitical conflicts around the world and their effects on our business. During the first half of fiscal 2022, due to the ongoing conflict between Russia and Ukraine and the corresponding sanctions imposed by the United States and other countries, we terminated our operations in Russia. The termination of our operations in Russia has not materially limited our ability to develop or support our products and has not had a material impact on our results of operations, financial condition, liquidity or cash flows. We do not have operations or employees in Ukraine.

More recently, the conflict in the Middle East has had an impact on our employees and our customers in that region of the world. Our assessment of the potential impact that this conflict could have on our business and our operations is ongoing.

While our business model provides some resilience against these factors, we will continue to monitor the direct and indirect impacts of these or similar circumstances on our business and financial results. For additional information on the potential impact of macroeconomic conditions on our business, see Part I, Item 1A, “Risk Factors.”

Results of Operations

The discussion of our fiscal 2023 consolidated results of operations includes year-over-year comparisons to fiscal 2022 for revenue, cost of revenue, operating expenses, operating margin, other non-operating expenses, income taxes and cash flows. For a discussion of the fiscal 2022 changes compared to fiscal 2021, see the discussion in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, filed with the SEC on February 13, 2023.

Results of operations for fiscal 2023, as compared to fiscal 2022, reflect the following:

•Increased revenue in each of our five product categories, primarily driven by growth in revenue from our software and emulation and prototyping hardware offerings;

•Continued investment in research and development activities and technical sales support;

•Incremental costs resulting from integration of acquired businesses; and

•Gains from our investments in equity securities.

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 and cloud 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, whether the revenue is recognized over time, or recognized at a point in time upon completion of delivery.

Recurring revenue includes revenue recognized over time from our software arrangements, services, royalties, maintenance on IP licenses and hardware, and operating leases of hardware. Recurring revenue also includes revenue recognized at varying points in time over the term of other arrangements with non-cancelable commitments, whereby the customer commits to a fixed dollar amount over a specified period of time that can be used to purchase from a list of products or services.

The remainder of our revenue is recognized at a point in time and is characterized as up-front revenue. Up-front revenue is primarily generated by our sales of emulation and prototyping hardware and individual IP licenses. The percentage of our recurring and up-front revenue and fluctuations in revenue within our geographies are impacted by delivery of hardware and IP products to our customers in any single fiscal period.

The following table shows the percentage of our revenue that is classified as recurring or up-front for fiscal 2023 and 2022:

Up-front revenue as a percentage of total revenue increased during fiscal 2023, as compared to fiscal 2022, primarily due to growth in our emulation and prototyping hardware offerings. This growth was driven by increased production capacity during fiscal 2023 to address demand for our emulation and prototyping hardware offerings.

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While the percentage of revenue characterized as recurring compared to revenue characterized as up-front may vary between fiscal quarters, the overall mix of revenue was relatively consistent over the course of twelve consecutive months during both fiscal 2023 and fiscal 2022. The following table shows the percentage of recurring revenue for the twelve-month periods ended concurrently with our five most recent fiscal quarters:

Revenue by Year

The following table shows our revenue for fiscal 2023 and 2022 and the change in revenue between years:

Product and maintenance revenue increased during fiscal 2023, as compared to fiscal 2022, primarily due to increased demand across our five product categories. This growth was driven by our customers investing in new, complex designs for their products that included the design of electronic systems for consumer, hyperscale computing, mobile, 5G communications, automotive, aerospace and defense, industrial and healthcare.

Services revenue increased during fiscal 2023, as compared to fiscal 2022, primarily due to increased revenue from our Cadence-managed cloud-based offerings, including our computational molecular modeling and simulation solution associated with our acquisition of OpenEye. 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 2023 or 2022.

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 2023 and 2022:

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

Revenue in each of the six geographies presented in the table above increased during fiscal 2023, as compared to fiscal 2022, primarily due to increased revenue from our software offerings, resulting from our customers’ continued investment in new, complex designs for their products. Also, during fiscal 2023, as compared to fiscal 2022, revenue growth from our emulation and prototyping hardware offerings contributed to the growth experienced in each geography, except the United States. This growth was driven by increased production capacity during fiscal 2023 to address continued demand from our customers.

Revenue by Geography as a Percent of Total Revenue

Most of our revenue is transacted in the U.S. 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 2023 and 2022:

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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 assets, technology or IP.

A summary of cost of product and maintenance for fiscal 2023 and 2022 is as follows:

Product and maintenance-related costs increased during fiscal 2023, when compared to fiscal 2022, 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 increase in emulation and prototyping hardware costs during fiscal 2023, as compared to fiscal 2022, was primarily due to increased revenue from emulation and prototyping hardware products.

Amortization of acquired intangibles included in cost of product and maintenance may fluctuate from period to period depending on the timing of newly acquired assets relative to assets becoming fully amortized in any given period.

Cost of Services

Cost of services primarily includes employee salary, benefits and other employee-related costs to perform work on revenue-generating projects and costs to maintain the infrastructure necessary to manage a services organization. Cost of services may fluctuate from period to period based on our utilization of design services engineers on revenue-generating projects rather than internal development projects.

Operating Expenses

Our operating expenses include marketing and sales, research and development, and general and administrative expenses. Factors that tend to cause our operating expenses to fluctuate include changes in the number of employees due to hiring and acquisitions, our annual mid-year promotion and pay raise cycle, stock-based compensation, foreign exchange rate movements, acquisition-related costs, 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 U.S. dollar strengthens in value against other currencies, and we recognize higher expenses when the U.S. 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 2023 and 2022 were as follows:

Our operating expenses, as a percentage of total revenue, for fiscal 2023 and 2022 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 and stock-based compensation included in marketing and sales expense increased during fiscal 2023, as compared to fiscal 2022, primarily due to our continued investment in attracting and retaining talent dedicated to technical sales support, including additional headcount from the acquisitions completed in both fiscal 2022 and fiscal 2023. Facilities and other infrastructure costs included in marketing and sales expense increased during fiscal 2023, as compared to fiscal 2022, primarily due to our growing workforce. Costs related to marketing programs and events, travel and sales meetings increased during fiscal 2023, as compared to fiscal 2022, primarily due to an increased number of in-person meetings and events. We expect to continue attracting and retaining talent dedicated to technical sales support through hiring and acquisitions.

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Research and Development

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

Salary, benefits and other employee-related costs and stock-based compensation included in research and development expense increased during fiscal 2023, as compared to fiscal 2022, primarily due to our continued investment in attracting and retaining talent for research and development activities, including additional headcount from the acquisitions completed in both fiscal 2022 and fiscal 2023. Facilities and other infrastructure costs increased during fiscal 2023, as compared to fiscal 2022, primarily due to an increase in costs associated with our acquisitions and our growing work force. We expect to continue attracting and retaining talent dedicated to research and development activities through hiring and acquisitions.

General and Administrative

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

Salary, benefits and other employee-related costs and stock-based compensation included in general and administrative expense increased during fiscal 2023, as compared to fiscal 2022, primarily due to additional headcount. Also, during fiscal 2023, as compared to fiscal 2022, we experienced an increase in foreign service tax, primarily because we did not benefit from any foreign service tax refunds as we did during fiscal 2022.

During fiscal 2023, as compared to fiscal 2022, contributions to non-profit organizations decreased, primarily due to the timing of our periodic contributions to support charitable initiatives, including the Cadence Giving Foundation. Also, during fiscal 2023, as compared to fiscal 2022, we experienced a decrease in legal fees and related costs primarily due to non-recurring legal services and legal matters that were active during fiscal 2022 and are now resolved.

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.

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Amortization of acquired intangibles decreased during fiscal 2023, as compared to fiscal 2022, primarily due to certain intangible assets becoming fully amortized, partially offset by amortization from intangible assets acquired with our fiscal 2023 and fiscal 2022 acquisitions.

Restructuring and Other Charges

We have initiated restructuring plans in recent years, most recently in fiscal 2023, 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 11 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 2023 and 2022 was as follows:

Operating margin increased during fiscal 2023, as compared to fiscal 2022, primarily because revenue growth in each of our five product categories exceeded growth in operating expenses.

Interest Expense

Interest expense for fiscal 2023 and 2022 was comprised of the following:

Interest expense increased during fiscal 2023, as compared to fiscal 2022, primarily due to the fact that borrowings under our 2025 Term Loan were outstanding for the full year during fiscal 2023, and only a partial year during fiscal 2022. For an additional description of our debt arrangements, including our 2025 Term Loan, see Note 5 in the notes to consolidated financial statements.

Other Income (Expense), Net

Other income (expense), net consists primarily of interest earned on cash, cash equivalents and investments in debt securities, realized and unrealized gains and losses from our investments in equity securities of other companies and foreign exchange gains and losses. Other income (expense), net increased during fiscal 2023, as compared to fiscal 2022, primarily due to unrealized gains from our investments in equity securities of publicly held companies and increased interest earned from deposits. For additional information about other income (expense), net, see Note 12 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 2023 and 2022:

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The United States enacted the Tax Cuts and Jobs Act in December 2017, which requires companies to capitalize all of their R&D costs, including software development costs, incurred in tax years beginning after December 31, 2021. Beginning in fiscal 2022, we began capitalizing and amortizing R&D costs over five years for domestic research and fifteen years for international research rather than expensing these costs as incurred. As a result, our fiscal 2023 and 2022 effective tax rates and our cash tax payments increased significantly as compared to fiscal 2021. We also recognized increases to our deferred tax assets as we begin to capitalize domestic research costs.

Our provision for income taxes for fiscal 2023 was primarily attributable to federal, state and foreign income taxes on our fiscal 2023 income, partially offset by the tax benefit of $54.0 million related to stock-based compensation that vested or was exercised during the period. We also recognized a tax benefit of $24.8 million due to the recognition of previously unrecognized federal tax benefits from the expiration of the applicable statute of limitations and a tax benefit of $14.0 million primarily related to a change in R&D expenses that were capitalized in fiscal 2022.

Our provision for income taxes for fiscal 2022 was primarily attributable to federal, state and foreign income taxes on our fiscal 2022 income, partially offset by the tax benefit of $42.1 million related to stock-based compensation that vested or was exercised during the period. We also recognized a tax benefit of $68.7 million related to the release of the valuation allowance on our California R&D tax credits because we expect to utilize these tax credits based on strong current earnings and future taxable income projections.

In 2021, the OECD announced Pillar Two Model Rules which call for the taxation of large multinational corporations, such as Cadence, at a minimum rate of 15%. Many non-U.S. tax jurisdictions have either recently enacted legislation to adopt certain components of the Pillar Two Model Rules beginning in 2024 (including the European Union Member States such as Ireland and Hungary) with the adoption of additional components in later years or announced their plans to enact legislation in future years. We are continuing to evaluate the impacts of enacted legislation and pending legislation to enact Pillar Two Model Rules in the non-U.S. tax jurisdictions in which we operate.

Our future effective tax rates may also be materially impacted by tax amounts associated with our foreign earnings at rates different from the United States federal statutory rate, research credits, the tax impact of stock-based compensation, accounting for uncertain tax positions, business combinations, closure of statutes of limitations or settlement of tax audits and changes in tax law. A significant amount of our foreign earnings is generated by our subsidiaries organized in Ireland and Hungary. Our future effective tax rates may be adversely affected if our earnings were to be lower in countries where we have lower statutory tax rates. We currently expect that our fiscal 2024 effective tax rate will be approximately 23.0%. We expect that our quarterly effective tax rates will vary from our fiscal 2024 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.

Liquidity and Capital Resources

Cash and Cash Equivalents

As of December 31, 2023, our principal sources of liquidity consisted of $1,008.2 million of cash and cash equivalents as compared to $882.3 million as of December 31, 2022.

Our primary sources of cash and cash equivalents during fiscal 2023 were cash generated from operations, proceeds from the issuance of common stock resulting from stock purchases under our employee stock purchase plan and stock options exercised during the year, proceeds from the sale of investments, and proceeds from our revolving credit facility.

Our primary uses of cash and cash equivalents during fiscal 2023 were payments related to employee salaries and benefits, operating expenses, repurchases of our common stock, purchases of inventory, payments for income taxes, cash paid for acquired businesses, payments on our revolving credit facility, purchases of investments, payment of employee taxes on vesting of restricted stock and purchases of property, plant and equipment.

Approximately 55% of our cash and cash equivalents was held by our foreign subsidiaries as of December 31, 2023. Our cash and cash equivalents held by our foreign subsidiaries may vary from period to period due to the timing of collections and repatriation of foreign earnings. We expect that current cash and cash equivalent balances and cash flows that are generated from operations and financing activities will be sufficient to meet the needs of our domestic and international operating activities and other capital and liquidity requirements, including acquisitions, investments and share repurchases, for at least the next 12 months and thereafter for the foreseeable future.

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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 December 31, 2023, as compared to December 31, 2022, is primarily due to the timing of cash receipts from customers and disbursements made for operating and financing activities, offset by our 2024 Notes being classified as current liabilities as of December 31, 2023.

Cash Flows from Operating Activities

Cash flows from operating activities during fiscal 2023 and 2022 were as follows:

Cash flows provided by 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 2023, as compared to fiscal 2022, was primarily due to improved results from operations, the timing of cash receipts from customers and the timing of cash disbursements.

Cash Flows Used for Investing Activities

Cash flows used for investing activities during fiscal 2023 and 2022 were as follows:

Cash used for investing activities decreased during fiscal 2023, as compared to fiscal 2022, primarily due to a decrease in cash used for business combinations, partially offset by an increase in cash used for investments in equity and debt securities. We expect to continue our investing activities, including purchasing property, plant and equipment, purchasing intangible assets, acquiring other companies and businesses, and making investments.

Cash Flows Used for Financing Activities

Cash flows used for financing activities during fiscal 2023 and 2022 were as follows:

Cash used for financing activities increased during fiscal 2023, as compared to fiscal 2022, primarily due to a decrease in proceeds from debt, partially offset by a decrease in payments for repurchases of our common stock.

Other Factors Affecting Liquidity and Capital Resources

Stock Repurchase Program

In August 2023, our Board of Directors increased the prior authorization to repurchase shares of our common stock by authorizing an additional $1.0 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 December 31, 2023, approximately $1.4 billion of the share repurchase authorization 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 on share repurchases.

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Revolving Credit Facility

In June 2021, we entered into a five-year senior unsecured revolving credit facility with a group of lenders led by Bank of America, N.A., as administrative agent, as amended in September 2022 (the “2021 Credit Facility”). The 2021 Credit Facility provides for borrowings up to $700.0 million, with the right to request increased capacity up to an additional $350.0 million upon receipt of lender commitments, for total maximum borrowings of $1.05 billion. The 2021 Credit Facility expires on June 30, 2026. Any outstanding loans drawn under the 2021 Credit Facility are due at maturity on June 30, 2026, subject to an option to extend the maturity date. Outstanding borrowings may be repaid at any time prior to maturity. Interest rates associated with the 2021 Credit Facility are variable, so interest expense is impacted by changes in the interest rates, particularly for periods when there are outstanding borrowings under the revolving credit facility. Interest is payable quarterly. As of December 31, 2023, 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 (the “2024 Notes”). We received net proceeds of $342.4 million from the issuance of the 2024 Notes, net of a discount of $1.4 million and issuance costs of $6.2 million. Interest is payable in cash semi-annually. The 2024 Notes are unsecured and rank equal in right of payment to all of our existing and future senior indebtedness. As of December 31, 2023, the net balance of the 2024 Notes of $349.3 million was classified as a current liability on our consolidated balance sheet.

2025 Term Loan

In September 2022, we entered into a $300.0 million three-year senior non-amortizing term loan facility due on September 7, 2025, with a group of lenders led by Bank of America, N.A., as administrative agent (the “2025 Term Loan”). The 2025 Term Loan is unsecured and ranks equal in right of payment to all of our unsecured indebtedness. Interest rates associated with the 2025 Term Loan are variable, so interest expense is impacted by changes in interest rates. Interest is payable quarterly. As of December 31, 2023, we were in compliance with all financial covenants associated with the 2025 Term Loan.

For additional information relating to our debt arrangements, see Note 5 in the notes to consolidated financial statements.

Other Liquidity Requirements

A summary of other capital and liquidity requirements as of December 31, 2023, is as follows:

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(1)    Contractual interest payments on our variable rate indebtedness were calculated based on outstanding borrowings and the weighted average interest rates as of December 31, 2023.

(2)    Included in other long-term contractual obligations are long-term income tax liabilities of $38.6 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.

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, payments on our 2024 Notes and share repurchases for at least the next 12 months and thereafter for the foreseeable future.

As of December 31, 2023, 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.

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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 revenue recognition, the accounting for income taxes 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.

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.

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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.

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 2023, we acquired intangible assets of $41.0 million. The fair value of the intangible assets acquired was determined using variations of the income approach that utilizes unobservable inputs classified as Level 3 measurements.

For existing technology, the fair value was determined by applying the relief-from-royalty method. This method is based on the application of a royalty rate to forecasted revenue to quantify the benefit of owning the intangible asset rather than paying a royalty for use of the asset. To estimate royalty savings over time, we projected revenue from 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. We assumed technological obsolescence at rates between 10% and 13% annually, before applying an assumed royalty rate between 25% and 30%.

For agreements and relationships, the fair value 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 was determined using customer retention rates between 70% and 90%. The present value of operating cash flows from existing customers was determined using discount rates between 12% and 15%.

We believe that our estimates and assumptions related to the fair value of our 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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