Summary of Significant Accounting Policies (Policies)

12 Months Ended

Dec. 29, 2018

Principles of Consolidation and Basis of Presentation

The consolidated financial statements include the accounts of Cadence and its subsidiaries after elimination of intercompany accounts and transactions. All consolidated subsidiaries are wholly owned by Cadence. Certain prior period balances have been reclassified to conform to the current period presentation.

Cadence’s fiscal years are 52- or 53-week periods ending on the Saturday closest to December 31. Fiscal 2017, 2016 and 2015 were each 52-week fiscal years.

Use of Estimates

Preparation of the consolidated financial statements in conformity with United States generally accepted accounting principles 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 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 29, 2018 and the consolidated income statements for fiscal 2018 were prepared using accounting standards that were different than those in effect for fiscal 2017 and fiscal 2016. Therefore, the consolidated balance sheets as of December 29, 2018 are not directly comparable to the consolidated balance sheets as of December 30, 2017, nor are the results of operations for fiscal 2018 comparable to the results of operations for fiscal 2017 and fiscal 2016.

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 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 were 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 unbilled 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 was 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 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.

Notwithstanding the shift from recognizing revenue under Topic 605 to doing so under Topic 606, Cadence continues to recognize revenue over time for its time-based software arrangements, which generate a majority of total revenue. 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 coterminous 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 are now recognized upon delivery under Topic 606, as opposed to over time under Topic 605, because the requirement to have VSOE for undelivered elements under prior GAAP is eliminated under Topic 606. Certain perpetual software licenses are now 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.

More judgments and estimates are required under Topic 606 than were required under Topic 605. Due to the complexity of certain contracts, the actual revenue recognition treatment required under Topic 606 for the Company’s arrangements may be dependent on contract-specific terms and may vary in some instances.

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

The following table summarizes the effects of adopting Topic 606 on Cadence’s consolidated balance sheet as of December 29, 2018:



	As reported under Topic 606			Adjustments			Balances under Prior GAAP
	(In thousands)
Receivables, net	$	297,082		$	(12,099	)	$	284,983
Prepaid expenses and other	92,550			(10,055		)	82,495
Long-term receivables	5,972			(623		)	5,349
Other assets	371,231			(17,013		)	354,218
Accounts payable and accrued liabilities*	256,526			(17,438		)	239,088
Current portion of deferred revenue	352,456			45,119			397,575
Long-term portion of deferred revenue	48,718			17,637			66,355
Retained earnings	772,709			(86,120		)	686,589
Accumulated other comprehensive loss	(24,780		)	1,012			(23,768		)

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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 consolidated income statement for fiscal 2018:



	As reported under Topic 606		Adjustments			Balances under Prior GAAP
	(In thousands, except per share amounts)
Product and maintenance revenue	$	1,997,887	$	1,031		$	1,998,918
Services revenue	140,135		6,643			146,778
Cost of product and maintenance	173,011		571			173,582
Marketing and sales expense	439,669		3,947			443,616
Provision for income taxes	30,613		(2,364		)	28,249
Net income	345,777		5,520			351,297
Net income per share - basic	1.26		0.02			1.28
Net income per share - diluted	1.23		0.02			1.25

Cadence’s net cash provided by operating activities for fiscal 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 consolidated statement of cash flows for fiscal 2018:



	As reported under Topic 606			Adjustments			Balances under Prior GAAP
	(In thousands)
Net income	$	345,777		$	5,520		$	351,297
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred income taxes	(11,676		)	(2,213		)	(13,889		)
Changes in operating assets and liabilities:
Receivables	(87,083		)	(28,226		)	(115,309		)
Prepaid expenses and other	(19,622		)	5,968			(13,654		)
Other assets	(16,077		)	3,461			(12,616		)
Accounts payable and accrued liabilities	1,553			10,100			11,653
Deferred revenue	100,696			5,390			106,086

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.

Prior to the adoption of the updated standard, Cadence’s investment in marketable equity securities was classified as available-for-sale, and changes in the fair value of the underlying securities were reported in accumulated other comprehensive loss in the consolidated balance sheets. The new standard eliminated the available-for-sale classification for equity securities and requires changes in the fair value of Cadence’s investment to be recognized through net income for fiscal 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.

Cadence’s non-marketable investments in equity securities consist of investments in privately-held companies and are presented as other assets in the 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. For additional information regarding Cadence’s investments in equity securities, see Note 7 to the consolidated financial statements.

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 consolidated financial statements or the related disclosures.

Cumulative Effect Adjustments to 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	345,777
Balance, December 29, 2018	$	772,709

New Accounting Standards Not Yet Adopted

Leases

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842),” requiring, among other things, the recognition of lease liabilities and corresponding right-of-use assets on the balance sheet by lessees for all leases with a term longer than 12 months. The new standard is effective for Cadence in the first quarter of fiscal 2019. A modified retrospective approach is required, applying the new standard to leases existing as of the date of initial application. An entity may choose to apply the standard as of either its effective date or the beginning of the earliest comparative period presented in the financial statements. Cadence adopted the new standard on December 30, 2018, the first day of fiscal 2019, and used the effective date as the date of initial application. Consequently, financial information will not be updated and the disclosures required under the new standard will not be provided for dates and periods prior to the first quarter of fiscal 2019. Cadence elected certain practical expedients permitted under the transition guidance within the new standard, which among other things, allowed Cadence to carry forward its prior conclusions about lease identification and classification.

Cadence estimates the key change upon adoption of the standard will result in balance sheet recognition of additional lease assets and lease liabilities ranging from $75 to $85 million as of December 30, 2018, which is based on the present value of committed lease payments. Cadence does not expect the adoption of the new standard to have a material impact on the recognition, measurement or presentation of lease expenses within its consolidated income statements, consolidated statements of comprehensive income or consolidated statements of cash flows.

The new standard also provides updated guidance for lessor accounting; however, Cadence does not expect the new standard to have a material effect on its consolidated financial statements for arrangements in which it is the lessor.

Foreign Operations

Cadence transacts business in various foreign currencies. The United States dollar is the functional currency of Cadence’s consolidated entities operating in the United States and certain of its consolidated subsidiaries operating outside the United States. The functional currency for Cadence’s other consolidated entities operating outside of the United States is generally the country’s local currency.

Cadence translates the financial statements of consolidated entities whose functional currency is not the United States dollar into United States dollars. Cadence translates assets and liabilities at the exchange rate in effect as of the financial statement date and translates income statement accounts using an average exchange rate for the period. Cadence includes adjustments from translating assets and liabilities into United States dollars, and the effect of exchange rate changes on intercompany transactions of a long-term investment nature in stockholders’ equity as a component of accumulated other comprehensive income. Cadence reports gains and losses from foreign exchange rate changes related to intercompany receivables and payables that are not of a long-term investment nature, as well as gains and losses from foreign currency transactions of a monetary nature in other income, net, in the consolidated income statements.

Concentrations of Credit Risk

Financial instruments, including derivative financial instruments, that may potentially subject Cadence to concentrations of credit risk, consist principally of cash and cash equivalents, accounts receivable, investments and forward contracts. Credit exposure related to Cadence’s foreign currency forward contracts is limited to the realized and unrealized gains on these contracts.

Cash and Cash Equivalents

Cadence considers all highly liquid investments with original maturities of three months or less on the date of purchase to be cash equivalents. Book overdraft balances are recorded in accounts payable and accrued liabilities in the consolidated balance sheets and are reported as a component of cash flows from financing activities in the consolidated statement of cash flows.

Receivables

Cadence’s receivables, net includes invoiced accounts receivable and the current portion of unbilled receivables. Unbilled receivables represent amounts Cadence has recorded as revenue for which payments from a customer are due over time and Cadence has an unconditional right to the payment. Cadence’s accounts receivable and unbilled receivables were initially recorded at the transaction value. Cadence’s long-term receivables balance includes receivable balances to be invoiced more than one year after each balance sheet date.

Allowance for Doubtful Accounts

Allowances for Doubtful Accounts

Each fiscal quarter, Cadence assesses its ability to collect outstanding receivables, and provides allowances for a portion of its receivables when collection is not probable. Cadence analyzes the creditworthiness of its customers, historical experience, changes in customer demand and the overall economic climate in the industries that Cadence serves. Provisions are made based upon a specific review of customer receivables and are recorded in operating expenses.

Inventories

Inventories are stated at the lower of cost or net realizable value. Cadence’s inventories include high technology parts and components for complex emulation and prototyping hardware systems. These parts and components are specialized in nature and may be subject to rapid technological obsolescence. While Cadence has programs to minimize the required inventories on hand and considers technological obsolescence when estimating required reserves to reduce recorded amounts to market values, it is reasonably possible that such estimates could change in the near term. Cadence’s policy is to reserve for inventory in excess of 12-month demand or for other known obsolescence or realization issues.

Property, Plant and Equipment

Property, plant and equipment is stated at historical cost. Depreciation and amortization are generally provided over the estimated useful lives, using the straight-line method, as follows:



Computer equipment and related software	2-7 years
Buildings	25-32 years
Leasehold improvements	Shorter of the lease term or the estimated useful life
Building improvements and land improvements	Estimated useful life up to 32 years
Furniture and fixtures	3-5 years
Equipment	3-5 years

Cadence capitalizes certain costs of software developed for internal use. Capitalization of software developed for internal use begins at the application development phase of the project. Amortization begins when the computer software is substantially complete and ready for its intended use. Amortization is recorded on a straight-line basis over the estimated useful life. Cadence capitalized costs of software developed for internal use of $3.6 million, $2.2 million, and $3.5 million during fiscal 2018, 2017 and 2016, respectively.

Cadence recorded depreciation and amortization expense of $60.4 million, $52.9 million and $52.7 million during fiscal 2018, 2017 and 2016, respectively, for property, plant and equipment.

Software Development Costs

Software development costs are capitalized beginning when a product’s technological feasibility has been established by completion of a working model of the product and amortization begins when a product is available for general release to customers. The period between the achievement of technological feasibility and the general release of Cadence’s products has typically been of short duration. Costs incurred during fiscal 2018, 2017 and 2016 were not material.

Commissions Expense, Policy [Policy Text Block]

Deferred Sales Commissions

Cadence records an asset for the incremental costs of obtaining a contract with a customer, including direct sales commissions that are earned upon execution of the contract. Cadence uses the portfolio method to recognize the amortization expense related to these capitalized costs related to initial contracts and renewals and such expense is recognized over a period associated with the revenue of the related portfolio, which is generally two to three years for Cadence’s software arrangements and upon delivery for its hardware and IP arrangements. Incremental costs related to initial contracts and renewals are amortized over the period of the arrangement in each case because Cadence pays the same commission rate for both new contracts and renewals. Deferred sales commissions are tested for impairment on an ongoing basis when events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment is recognized to the extent that the amount of deferred sales commission exceeds the remaining expected gross margin (remaining revenue less remaining direct costs) on the goods and services to which the deferred sales commission relates. Total capitalized costs as of December 29, 2018 were $31.2 million and are included in other assets in Cadence’s consolidated balance sheet. Amortization of these assets during fiscal 2018 was $26.5 million and is included in sales and marketing expense in Cadence’s consolidated income statement.

Goodwill

Cadence conducts a goodwill impairment analysis annually and as necessary if changes in facts and circumstances indicate that the fair value of Cadence’s single reporting unit may be less than its carrying amount. Cadence’s goodwill impairment test consists of two steps. The first step requires that Cadence compare the estimated fair value of its single reporting unit to the carrying value of the reporting unit’s net assets, including goodwill. If the fair value of the reporting unit is greater than the carrying value of its net assets, goodwill is not considered to be impaired and no further testing is required. If the fair value of the reporting unit is less than the carrying value of its net assets, Cadence would be required to complete the second step of the test by analyzing the fair value of its goodwill. If the carrying value of the goodwill exceeds its fair value, an impairment charge is recorded.

Long-lived Assets, Including Acquired Intangibles

Long-Lived Assets, Including Acquired Intangibles

Cadence’s long-lived assets consist of property, plant and equipment and acquired intangibles. Acquired intangibles with definite lives are amortized on a straight-line basis over the estimated economic life of the underlying products and technologies, which range from two to fourteen years. Acquired intangibles with indefinite lives, or in-process technology, consists of projects that had not reached technological feasibility by the date of acquisition. Upon completion of the project, the assets are amortized over their estimated useful lives. If the project is abandoned rather than completed, the asset is written off. In-process technology is tested for impairment annually and as necessary if changes in facts and circumstances indicate that the assets might be impaired.

Cadence reviews its long-lived assets, including acquired intangibles, for impairment whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset or asset group may not be recoverable. Recoverability of an asset or asset group is measured by comparison of its carrying amount to the expected future undiscounted cash flows that the asset or asset group is expected to generate. If it is determined that the carrying amount of an asset group is not recoverable, an impairment loss is recorded in the amount by which the carrying amount of the asset or asset group exceeds its fair value.

Investments in Equity Securities

Cadence’s investments in marketable equity securities are carried at fair value as a component of prepaid expenses and other in the consolidated balance sheets. Cadence records realized and unrealized holding gains or losses as part of other income, net in the consolidated income statements.

Cadence’s non-marketable investments include its investments in privately-held companies. These investments are initially recorded at cost and are included in other assets in the consolidated balance sheets. Cadence accounts for these investments using the measurement alternative when the fair value of the investment is not readily determinable and Cadence does not have the ability to exercise significant influence or the equity method of accounting when it is determined that Cadence has the ability to exercise significant influence. For investments accounted for using the equity method of accounting, Cadence records its proportionate share of the investee’s income or loss, net of the effects of any basis differences, to other income, net on a one-quarter lag in Cadence’s consolidated income statements.

Cadence reviews its non-marketable investments on a regular basis to determine whether its investments in these companies are other-than-temporarily impaired. Cadence considers investee financial performance and other information received from the investee companies, as well as any other available estimates of the fair value of the investee companies in its review. If Cadence determines the carrying value of an investment exceeds its fair value, and that difference is other than temporary, Cadence writes down the value of the investment to its fair value. Cadence records investment write-downs in other income, net, in the consolidated income statements.

Derivative Financial Instruments

Cadence enters into foreign currency forward exchange contracts with financial institutions to protect against currency exchange risks associated with existing assets and liabilities. A foreign currency forward exchange contract acts as a hedge by increasing in value when underlying assets decrease in value or underlying liabilities increase in value due to changes in foreign exchange rates. Conversely, a foreign currency forward exchange contract decreases in value when underlying assets increase in value or underlying liabilities decrease in value due to changes in foreign exchange rates. The forward contracts are not designated as accounting hedges and, therefore, the unrealized gains and losses are recognized in other income, net, in advance of the actual foreign currency cash flows. The fair value of these forward contracts is recorded in accrued liabilities or in other current assets. These forward contracts generally have maturities of 90 days or less.

Nonqualified Deferred Compensation Trust

Executive officers, senior management and members of Cadence’s Board of Directors may elect to defer compensation payable to them under Cadence’s Nonqualified Deferred Compensation Plan (“NQDC”). Deferred compensation payments are held in investment accounts and the values of the accounts are adjusted each quarter based on the fair value of the investments held in the NQDC.

The selected investments held in the NQDC accounts are carried at fair value, with the unrealized gains and losses recognized in the consolidated income statements as other income, net. These securities are classified in other assets in the consolidated balance sheets because they are not available for Cadence’s use in its operations.

Cadence’s obligation with respect to the NQDC trust is recorded in other long-term liabilities on the consolidated balance sheets. Increases and decreases in the NQDC trust liability are recorded as compensation expense in the consolidated income statements.

Treasury Stock

Cadence generally issues shares related to its stock-based compensation plans from shares held in treasury. When treasury stock is reissued at an amount higher than its cost, the difference is recorded as a component of capital in excess of par in the consolidated statements of stockholders’ equity. When treasury stock is reissued at an amount lower than its cost, the difference is recorded as a component of capital in excess of par to the extent that gains exist to offset the losses. If there are no accumulated treasury stock gains in capital in excess of par, the losses upon reissuance of treasury stock are recorded as a component of retained earnings in the consolidated statements of stockholders’ equity. There were no losses recorded by Cadence on the reissuance of treasury stock during fiscal 2018, 2017 or 2016.

Revenue Recognition

Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration to which Cadence expects to be entitled in exchange for promised goods or services. Cadence’s performance obligations are satisfied either over time or at a point in time. Revenue from performance obligations that transferred to customers over time accounted for approximately 90% of Cadence’s total revenue for the fiscal year ended December 29, 2018.

Product and maintenance revenue includes Cadence’s licenses of time-based and perpetual software, sales of emulation hardware, licenses of per-use IP, and the related maintenance on these licenses and sales.

Service revenue includes revenue received for performing engineering services (which are generally not related to the functionality of other licensed products), customized IP on a fixed fee basis, and sales from cloud-based solutions that provide customers with software and services over a period of time.

Cadence enters into contracts that can include various combinations of licenses, products and services, some of which are distinct and are accounted for as separate performance obligations. For contracts with multiple performance obligations, Cadence allocates the transaction price of the contract to each performance obligation, generally on a relative basis using its standalone selling price. The stated contract value is generally the transaction price to be allocated to the separate performance obligations. Revenue is recognized net of any taxes collected from customers that are subsequently remitted to governmental authorities.

Software Revenue Recognition

Cadence’s time-based license arrangements grant customers the right to access and use all of the licensed products at the outset of an arrangement and updates are generally made available throughout the entire term of the arrangement, which is generally two to three years. Cadence’s updates provide continued access to evolving technology as customers’ designs migrate to more advanced nodes and as our customers’ technological requirements evolve. In addition, certain time-based license arrangements include remix rights and unspecified additional products that become commercially available during the term of the agreement. Payments are generally received in equal or near equal installments over the term of the agreement.

Multiple software licenses, related updates, and technical support in these time-based arrangements constitute a single, combined performance obligation and revenue is recognized over the term of the license, commencing upon the later of the effective date of the arrangement or transfer of the software license. Remix rights are not an additional promised good or service in the contract, and where unspecified additional software product rights are part of the contract with the customer, such rights are accounted for as part of the single performance obligation that includes the licenses, updates, and technical support because such rights are provided for the same period of time and have the same time-based pattern of transfer to the customer.

Hardware Revenue Recognition

Cadence generally has two performance obligations in arrangements involving the sale or lease of hardware products. The first performance obligation is to transfer the hardware product (which includes software integral to the functionality of the hardware product). The second performance obligation is to provide maintenance on hardware and its embedded software, which includes rights to technical support, hardware repairs and software updates that are all provided over the same term and have the same time-based pattern of transfer to the customer. The transaction price allocated to the hardware product is generally recognized as revenue at the time of delivery because the customer obtains control of the product at that point in time. Cadence has concluded that control generally transfers at that point in time because the customer has title to the hardware, physical possession, and a present obligation to pay for the hardware. The transaction price allocated to maintenance is recognized as revenue ratably over the maintenance term. Payments for hardware contracts are generally received upon delivery of the hardware product. Shipping and handling costs are considered fulfillment costs and are included in cost of product and maintenance in Cadence’s consolidated income statements.

IP Revenue Recognition

Cadence generally licenses IP under nonexclusive license agreements that provide usage rights for specific designs. In addition, for certain of Cadence’s IP license agreements, royalties are collected as customers ship their own products that incorporate Cadence IP. These arrangements generally have two performance obligations — transferring the licensed IP and associated maintenance, which includes rights to technical support and software updates that are all provided over the maintenance term and have a time-based pattern of transfer to the customer. Revenue allocated to the IP license is recognized at a point in time upon the later of the delivery of the IP or the beginning of the license period and revenue allocated to the maintenance is recognized over the maintenance term. Royalties are recognized as revenue in the quarter in which the applicable Cadence customer ships its products that incorporate Cadence IP. Payments for IP contracts are generally received upon delivery of the IP. Cadence customizes certain IP and revenue related to this customization is recognized as services revenue as described below.

Services Revenue Recognition

Revenue from service contracts is recognized over time, generally using costs incurred or hours expended to measure progress. Cadence has a history of accurately 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. Payments for services are generally due upon milestones in the contract or upon consumption of the hourly resources.

Revenue Net of Taxes Collected

The stated contract value is generally the transaction price to be allocated to the separate performance obligations. Revenue is recognized net of any taxes collected from customers that are subsequently remitted to governmental authorities.

Shipping and Handling Cost

Shipping and handling costs are considered fulfillment costs and are included in cost of product and maintenance in Cadence’s consolidated income statements.

Stock-Based Compensation

Cadence recognizes the cost of awards of equity instruments granted to employees in exchange for their services as stock-based compensation expense. Stock-based compensation expense is measured at the grant date based on the value of the award and is recognized as expense over the requisite service period, which is typically the vesting period. Cadence recognizes stock-based compensation expense on the straight-line method for awards that only contain a service condition and on the graded-vesting method for awards that contain both a service and performance condition. Cadence recognizes the impact of forfeitures on stock-based compensation expense as they occur.

The fair value of stock options and purchase rights issued under Cadence’s Employee Stock Purchase Plan (“ESPP”) are calculated using the Black-Scholes option pricing model. The computation of the expected volatility assumption used for new awards is based on implied volatility when the remaining maturities of the underlying traded options are at least one year. When the remaining maturities of the underlying traded options are less than one year, expected volatility is based on a weighting of historical and implied volatilities. When determining the expected term, Cadence reviews historical employee exercise behavior from options having similar vesting periods. The risk-free interest rate for the period within the expected term of the option is based on the yield of United States Treasury notes for the comparable term in effect at the time of grant. The expected dividend yield used in the calculation is zero because Cadence has not historically paid and currently does not expect to pay dividends in the foreseeable future.

Advertising

Cadence expenses the costs of advertising as incurred. Total advertising expense, including marketing programs and events, was $7.6 million, $7.4 million and $8.4 million during fiscal 2018, 2017 and 2016, respectively, and is included in marketing and sales in the consolidated income statements.

Restructuring Charges

Cadence records personnel-related restructuring charges with termination benefits when the costs are both probable and estimable. Cadence records personnel-related restructuring charges with non-customary termination benefits when the plan has been communicated to the affected employees. Cadence records facilities-related restructuring charges in the period in which the affected facilities are vacated. In connection with facilities-related restructuring plans, Cadence has made a number of estimates and assumptions related to losses on excess facilities that have been vacated or consolidated, particularly the timing of subleases and sublease terms. Closure and space reduction costs included in the restructuring charges include payments required under leases less any applicable estimated sublease income after the facilities are abandoned, lease buyout costs and certain contractual costs to maintain facilities during the period after abandonment.

Cadence records estimated provisions for termination benefits and outplacement costs along with other personnel-related restructuring costs, long-term asset impairments related to abandoned assets and other costs associated with the restructuring plan. Cadence regularly evaluates the adequacy of its lease loss accruals and severance and related benefits accruals, and adjusts the balances based on actual costs incurred or changes in estimates and assumptions. Subsequent adjustments to restructuring accruals are classified in restructuring and other charges in the consolidated income statements.

Accounting for Income Taxes

Cadence accounts for the effect of income taxes in its consolidated financial statements using the asset and liability method. This process involves estimating actual current tax liabilities together with assessing carryforwards and temporary differences resulting from differing treatment of items, such as depreciation, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, measured using enacted tax rates expected to apply to taxable income in the years when those temporary differences are expected to be recovered or settled.

Cadence then records a valuation allowance to reduce the deferred tax assets to the amount that Cadence believes is more likely than not to be realized based on its judgment of all available positive and negative evidence. The weight given to the potential effect of negative and positive evidence is commensurate with the extent to which the strength of the evidence can be objectively verified. This assessment, which is completed on a taxing jurisdiction basis, takes into account a number of types of evidence, including the following:


•	The nature and history of current or cumulative financial reporting income or losses;


•	Sources of future taxable income;


•	The anticipated reversal or expiration dates of the deferred tax assets; and


•	Tax planning strategies.

Cadence takes a two-step approach to recognizing and measuring the financial statement benefit of uncertain tax positions. The first step is to evaluate the tax position for recognition by determining whether the weight of available evidence indicates that it is more likely than not that the tax position will be sustained on audit, including resolution of any related appeals or litigation processes. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement of the audit. Cadence classifies interest and penalties on unrecognized tax benefits as income tax expense or benefit.

For additional discussion of income taxes, see Note 6 in the notes to the consolidated financial statements.

Fair Value of Financial Instruments

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


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


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


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

This hierarchy requires Cadence to minimize the use of unobservable inputs and to use observable market data, if available, when determining fair value. Cadence recognizes transfers between levels of the hierarchy based on the fair values of the respective financial instruments at the end of the reporting period in which the transfer occurred.

Contingencies

At least quarterly, Cadence reviews the status of each significant matter and assesses its potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount or the range of loss can be estimated, Cadence accrues a liability for the estimated loss. Legal proceedings are subject to uncertainties, and the outcomes are difficult to predict. Because of such uncertainties, accruals are based on Cadence’s judgments using the best information available at the time. As additional information becomes available, Cadence reassesses the potential liability related to pending claims and litigation matters and may revise estimates.