BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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. (“Cadence”) without audit, pursuant to the rules and regulations of the United States Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with United States generally accepted accounting principles (“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, (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 30, 2017.

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.

Comparability

Effective on the first day of fiscal 2018, Cadence adopted multiple new accounting standards. Prior periods were not retrospectively restated, so the consolidated balance sheet as of December 30, 2017 and the condensed consolidated income statements for the three and six months ended July 1, 2017 were prepared using accounting standards that were different than those in effect for the three and six months ended June 30, 2018. Therefore, the consolidated balance sheets as of June 30, 2018 and December 30, 2017 are not directly comparable, nor are the results of operations for the three and six months ended June 30, 2018 and July 1, 2017.

Recently Adopted Accounting Standards

Revenue from Contracts with Customers

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606),” which supersedes the revenue recognition requirements in “Revenue Recognition (Topic 605)” and Subtopic 985-605 “Software - Revenue Recognition.” Topic 605 and Subtopic 985-605 are collectively referred to as “Topic 605” or “prior GAAP.” Under Topic 606, revenue is recognized when a customer obtains control of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled 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 issued several amendments to the standard, including updates on accounting for licenses of intellectual property (“IP”) and identifying performance obligations.

Cadence adopted Topic 606 on the first day of fiscal 2018 using the modified retrospective transition method. Under this method, Cadence evaluated contracts that were in effect at the beginning of fiscal 2018 as if those contracts had been accounted for under Topic 606. Cadence did not evaluate individual modifications for those periods prior to the adoption date, but the aggregate effect of all modifications as of the adoption date and such effects are provided below. Under the modified retrospective transition approach, periods prior to the adoption date were not adjusted and continue to be reported in accordance with historical, pre-Topic 606 accounting. A cumulative catch up adjustment was recorded to beginning retained earnings to reflect the impact of all existing arrangements under Topic 606.

The most significant impacts of the adoption of Topic 606 are as follows:

•

At the adoption date, Cadence increased retained earnings by $85.4 million for uncompleted contracts for which revenue will not be recognized in future periods under Topic 606. This revenue would otherwise have been recognized in prior periods, so the beginning balance of receivables increased by $47.3 million, contract assets were established at $4.0 million, deferred revenue decreased by $57.4 million and accrued liabilities increased by $23.3 million;

•

Revenue generated under Topic 606 is expected to be slightly lower than revenue would have been under Topic 605 in fiscal 2018. This is the result of a combination of factors, including the elimination of deferred revenue that, under Topic 605, would have continued to be recognized into revenue in 2018 and beyond, as well as changes in the timing of revenue recognition as discussed below. The actual effects on revenue recognized for the first two quarters of fiscal 2018 are reported in the table below; and


•	Cadence capitalized $27.3 million of incremental sales commission costs at the adoption date directly related to obtaining customer contracts and is amortizing these costs over the life of the contract.

Cadence will continue to recognize revenue over time for its time-based software arrangements, which generate a majority of total revenue. However, the reason for the similar accounting treatment is different under Topic 606 than under Topic 605. Under Topic 605, Cadence could not establish vendor specific objective evidence (“VSOE”) for its undelivered elements and therefore was not able to separate its delivered software licenses from those undelivered elements, such as technical support and unspecified (when-and-if available) update rights. Topic 606 no longer requires separability of promised goods or services, such as software licenses, technical support, or unspecified update rights on the basis of VSOE. Rather, Topic 606 requires Cadence to identify the performance obligations in the contract — that is, those promised goods and services (or bundles of promised goods or services) that are distinct — and allocate the transaction price of the contract to those performance obligations on the basis of stand-alone selling prices (“SSPs”). The transaction price allocated to each performance obligation is then recognized either at a point in time or over time using an appropriate measure of progress. Under Topic 606, Cadence has concluded that its software licenses in time-based arrangements are not distinct from each other, or from its obligation to provide unspecified software updates to the licensed software throughout the license term, because the multiple software licenses represent inputs to a single, combined offering, and timely, relevant software updates are integral to maintaining the utility of the software licenses. Cadence will recognize revenue for the combined performance obligation, which also includes the co-terminus technical support provided to the customer, ratably over the term of the arrangement.

In contrast to the similar accounting result for time-based software arrangements, revenue related to certain IP licenses will now be recognized upon delivery under Topic 606, as opposed to over time under Topic 605, because the requirement to have VSOE for undelivered elements under current accounting standards is eliminated under Topic 606. Certain perpetual software licenses will now be recognized over time under Topic 606, as opposed to upon delivery under Topic 605, because these software licenses and the when-and-if available updates provided to the customer are accounted for together as one performance obligation and recognized over time.

The timing of revenue recognition for hardware and professional services is expected to remain substantially unchanged. Cadence’s overall mix of revenue recognized at a point in time versus over time is expected to remain relatively constant, with approximately 90% recognizable over time.

The following table summarizes the effects of adopting Topic 606 on Cadence’s condensed consolidated balance sheet as of June 30, 2018:



	As reported under Topic 606			Adjustments			Balances under Prior GAAP
	(In thousands)
Receivables, net	$	219,072		$	(19,328	)	$	199,744
Prepaid expenses and other	56,042			(7,597		)	48,445
Long-term receivables	4,740			1,073			5,813
Other assets	227,173			(11,766		)	215,407
Accounts payable and accrued liabilities*	243,158			(26,920		)	216,238
Current portion of deferred revenue	327,078			57,720			384,798
Long-term portion of deferred revenue	46,912			16,009			62,921
Retained earnings	574,966			(83,068		)	491,898
Accumulated other comprehensive loss	(13,172		)	(1,359		)	(14,531		)

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* Cadence has certain arrangements under which consideration is received from customers prior to identifying the specific goods or services to be delivered under the contract. Cadence records an accrued liability on a contract-by-contract basis at the end of each reporting period for cash consideration received.

The following table summarizes the effects of adopting Topic 606 on Cadence’s condensed consolidated income statement for the three months ended June 30, 2018:



	As reported under Topic 606		Adjustments			Balances under Prior GAAP
	(In thousands, except per share amounts)
Product and maintenance revenue	$	487,870	$	(4,616	)	$	483,254
Services revenue	30,521		1,336			31,857
Cost of product and maintenance	40,127		114			40,241
Marketing and sales expense	109,300		(1,166		)	108,134
Provision for income taxes	14,876		(151		)	14,725
Net income	75,149		(2,077		)	73,072
Net income per share - basic	0.27		—			0.27
Net income per share - diluted	0.27		(0.01		)	0.26

The following table summarizes the effects of adopting Topic 606 on Cadence’s condensed consolidated income statement for the six months ended June 30, 2018:



	As reported under Topic 606		Adjustments			Balances under Prior GAAP
	(In thousands, except per share amounts)
Product and maintenance revenue	$	968,479	$	1,564		$	970,043
Services revenue	67,225		3,300			70,525
Cost of product and maintenance	81,857		(137		)	81,720
Marketing and sales expense	218,448		(3,976		)	214,472
Provision for income taxes	20,160		406			20,566
Net income	148,034		8,571			156,605
Net income per share - basic	0.54		0.03			0.57
Net income per share - diluted	0.53		0.03			0.56

Cadence’s net cash provided by operating activities for the six months ended June 30, 2018 did not change due to the adoption of Topic 606. The following table summarizes the effects of adopting Topic 606 on the financial statement line items of Cadence’s condensed consolidated statement of cash flows for the six months ended June 30, 2018:



	As reported under Topic 606			Adjustments			Balances under Prior GAAP
	(In thousands)
Net income	$	148,034		$	8,571		$	156,605
Changes in operating assets and liabilities:
Receivables	(2,606		)	(27,473		)	(30,079		)
Prepaid expenses and other	13,294			4,446			17,740
Other assets	5,622			(3,214		)	2,408
Accounts payable and accrued liabilities	(11,832		)	1,307			(10,525		)
Deferred revenue	71,667			16,363			88,030

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.” Cadence adopted this standard on the first day of fiscal 2018, modifying its accounting and required disclosures for investments in equity securities, other than those accounted for using the equity method of accounting.

Cadence’s marketable investments in equity securities consist of investments in a publicly-held company and are presented as short-term investments in the condensed consolidated balance sheets. Prior to the adoption of the updated standard, these investments were classified as available-for-sale, and changes in the fair value of these investments were reported in accumulated other comprehensive loss in the condensed consolidated balance sheets. The new standard eliminated the available-for-sale classification for equity securities and requires changes in the fair value of these investments to be recognized through net income for the three and six months ended June 30, 2018 and each subsequent reporting period. Upon adoption, Cadence recorded a cumulative-effect adjustment to increase retained earnings in the amount of $2.6 million related to unrealized holding gains previously recorded in accumulated other comprehensive loss. In addition, Cadence recorded gains of $0.4 million and $1.4 million during the three and six months ended June 30, 2018, respectively, to other income in the condensed consolidated income statements for changes in the fair value of investments in marketable equity securities.

Cadence’s non-marketable investments in equity securities consist of investments in privately-held companies and are presented as other assets in the condensed consolidated balance sheets. Prior to the adoption of the updated standard, non-marketable investments that were not accounted for using the equity method of accounting were recorded at cost, less impairment. The new standard eliminated the cost method of accounting for investments in equity securities that do not have readily determinable fair values and permits the election of a measurement alternative that allows such securities to be recorded at cost, less impairment, if any, plus or minus changes resulting from observable price changes in market-based transactions for an identical or similar investment of the same issuer. Cadence adopted the provisions of the new standard applicable to its investments in equity securities without a readily determinable fair value on a prospective basis and elected the measurement alternative for non-marketable investments previously accounted for under the cost method of accounting. Gains and losses resulting from observable price changes or impairment will be recorded through net income in the period incurred. During the six months ended June 30, 2018, there were no observable price changes or impairments related to Cadence’s non-marketable investments in equity securities. Cadence’s non-marketable investments, including those accounting for using the equity method of accounting, had a carrying value of $3.1 million and $3.0 million as of June 30, 2018 and December 30, 2017, respectively.

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 rather than when the asset has been sold to a third party. 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. Cadence adopted the new standard on the first day of fiscal 2018 using the modified retrospective transition approach and recorded a cumulative-effect adjustment to decrease retained earnings in the amount of $8.3 million. The cumulative-effect adjustment includes the write-off of income tax consequences deferred from prior intra-entity transfers involving assets other than inventory and new deferred tax assets for amounts not recognized under U.S. GAAP. We anticipate the potential for increased volatility in future effective tax rates from the adoption of this guidance.

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. Cadence adopted the standard on the first day of fiscal 2018. The adoption of this standard did not impact Cadence’s condensed consolidated financial statements or the related disclosures.

Retained Earnings

The following table presents the cumulative effect adjustments, net of income tax effects, to beginning retained earnings for new accounting standards adopted by Cadence on the first day of fiscal 2018:



	Retained Earnings
	(In thousands)
Balance, December 30, 2017, as previously reported	$	341,003
Cumulative effect adjustment from the adoption of new accounting standards:
Revenue from Contracts with Customers (Topic 606)	91,640
Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities	2,638
Income taxes (Topic 740): Intra-entity Transfers of Assets Other Than Inventory	(8,349		)
Balance, December 30, 2017, as adjusted	426,932
Net Income	148,034
Balance, June 30, 2018	$	574,966