Magma Design Automation (LAVA) 10-Q 2008 Q2 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

FORM 10-Q

 

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

For the quarterly period ended September 30, 2007

OR

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

For the Transition Period from ______ to ________ .

Commission File No.: 0-33213

 

MAGMA DESIGN AUTOMATION, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware	77-0454924
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification Number)

1650 Technology Drive
San Jose, California 95110

(Address of Principal Executive Offices)

Telephone: (408) 565-7500

(Registrant’s Telephone Number, Including Area Code)

 

Indicate by check mark whether the registrant (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for at least the past 90 days. Yesx NOo

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

Large Accelerated Filero	Accelerated Filerx	Non-accelerated Filero

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso NOx

On November 1, 2007, 41,378,236 shares of Registrant’s Common Stock, $.0001 par value were outstanding.

MAGMA DESIGN AUTOMATION, INC.
  
FORM 10-Q
QUARTERLY PERIOD ENDED SEPTEMBER 30, 2007

INDEX

	Page
Part I: Financial Information		3
Item 1: Financial Statements (unaudited)		3
Condensed Consolidated Balance Sheets at September 30, 2007 and April 1, 2007		3
Condensed Consolidated Statements of Operations for the Three and Six Months Ended September 30, 2007 and October 1, 2006		4
Condensed Consolidated Statements of Cash Flows for the Six Months Ended September 30, 2007 and October 1, 2006		5
Notes to Condensed Consolidated Financial Statements		6
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of   Operations		22
Item 3: Quantitative and Qualitative Disclosures About Market Risk		37
Item 4: Controls and Procedures		38
Part II: Other Information		39
Item 1: Legal Proceedings		39
Item 1A: Risk Factors		40
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds		56
Item 4: Submission of Matters to a Vote of Security Holders		56
Item 6: Exhibits		57
Signatures		58
Exhibit Index		59

1

PART I: FINANCIAL INFORMATION

Item 1. Financial Statements

MAGMA DESIGN AUTOMATION, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands)
(Unaudited)

	September 30, 2007			April 1, 2007
ASSETS
Current assets:
Cash and cash equivalents	$	45,914		$	45,338
Restricted cash		261			4,997
Short-term investments		8,300			10,700
Accounts receivable, net		36,335			41,086
Prepaid expenses and other current assets		6,337			4,126
Total current assets		97,147			106,247
Property and equipment, net		16,357			17,866
Intangibles, net		47,762			56,874
Goodwill		54,301			48,499
Restricted cash		—			4,700
Deferred tax assets		6,901			—
Other assets		5,486			5,460
Total assets	$	227,954		$	239,646
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	4,419		$	7,442
Accrued expenses		26,233			53,254
Deferred revenue		27,635			28,417
Convertible notes, current		15,216			—
Total current liabilities		73,503			89,113
Convertible notes, long-term, net of debt discount of $1,755 and $2,078 at September 30, 2007 and April 1, 2007, respectively		48,184			63,077
Line of credit		—			3,000
Long-term tax liabilities		11,590			—
Other long-term liabilities		2,292			1,689
Total liabilities		135,569			156,879
Commitments and contingencies (Note 11)
Stockholders’ equity:
Common stock		4			4
Additional paid-in capital		338,890			310,825
Accumulated deficit		(216,124	)		(197,808	)
Treasury stock		(28,517	)		(29,162	)
Accumulated other comprehensive loss		(1,868	)		(1,092	)
Total stockholders’ equity		92,385			82,767
Total liabilities and stockholders’ equity		227,954			239,646

 
 
See accompanying notes to unaudited condensed consolidated financial statements.

3

MAGMA DESIGN AUTOMATION, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Data)
(Unaudited)

	Three Months Ended						Six Months Ended
	September 30, 2007			October 1, 2006			September 30, 2007			October 1, 2006
Revenue:
Licenses	$	35,637		$	24,035		$	67,626		$	47,154
Bundled licenses and services		9,217			10,824			18,874			22,245
Services		8,639			7,103			17,158			13,522
Total revenue		53,493			41,962			103,658			82,921
Cost of revenue:
Licenses		4,603			5,663			9,927			10,992
Bundled licenses and services		2,117			3,356			4,541			6,839
Services		5,254			4,192			10,100			7,946
Total cost of revenue		11,974			13,211			24,568			25,777
Gross profit		41,519			28,751			79,090			57,144
Operating expenses:
Research and development		18,355			15,608			37,025			31,057
Sales and marketing		18,645			14,567			35,547			28,414
General and administrative		7,533			8,211			15,867			20,006
Amortization of intangible assets		2,039			2,922			4,066			5,812
In-process research and development		656			—			656			—
Restructuring charges		—			—			291			—
Total operating expenses		47,228			41,308			93,452			85,289
Operating loss		(5,709	)		(12,557	)		(14,362	)		(28,145	)
Other income (expense):
Interest income		489			671			948			1,558
Interest expense		(599	)		(133	)		(1,256	)		(308	)
Gain on extinguishment of debt		—			—			—			4,809
Other income (expense), net		796			(493	)		69			(599	)
Other income (expense), net		686			45			(239	)		5,460
Net loss before income taxes		(5,023	)		(12,512	)		(14,601	)		(22,685	)
Provision (benefit) for income taxes		1,372			(91	)		3,063			770
Net loss before cumulative effect of change in accounting principle		(6,395	)		(12,421	)		(17,664	)		(23,455	)
Cumulative effect of change in accounting principle		—			—			—			321
Net loss	$	(6,395	)	$	(12,421	)	$	(17,664	)	$	(23,134	)
Net loss per common share before cumulative effect of change in accounting principle, basic and diluted	$	(0.16	)	$	(0.34	)	$	(0.45	)	$	(0.65	)
Net loss per common share, basic and diluted	$	(0.16	)	$	(0.34	)	$	(0.45	)	$	(0.64	)
Shares used in calculation, basic and diluted		39,919			36,140			39,383			35,900

 
 
See accompanying notes to unaudited condensed consolidated financial statements.

4

MAGMA DESIGN AUTOMATION, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)

	Six Months Ended
	September 30, 2007			October 1, 2006
Cash flows from operating activities:
Net loss	$	(17,664	)	$	(23,134	)
Adjustments to reconcile net loss to net cash used in operating activities:
Cumulative effect of change in accounting principle		—			(321	)
Depreciation and amortization		5,163			5,149
Amortization of intangible assets		15,428			20,548
In-process research and development		656			—
Provision for (recovery from) doubtful accounts		(55	)		41
Amortization of debt discount and debt issuance costs		574			249
Loss on strategic equity investments		380			308
Gain on extinguishment of debt		—			(4,809	)
Stock-based compensation		10,042			9,013
Income tax benefit associated with exercise of stock options and debt issuance costs		21			—
Other non-cash items		1			3
Change in operating assets and liabilities, net of effect of acquisitions:
Accounts receivable		4,017			538
Prepaid expenses and other assets		(2,161	)		(1,076	)
Accounts payable		(1,883	)		942
Accrued expenses		(18,206	)		(5,667	)
Deferred revenue		(887	)		5,494
Long-term tax liabilities		1,067			—
Other long-term liabilities		38			(109	)
Net cash provided by (used in) operating activities		(3,469	)		7,169
Cash flows from investing activities:
Purchase of intangible assets		(6,994	)		(6,793	)
Purchase of property and equipment		(3,991	)		(1,504	)
Purchase of short-term investments		(14,693	)		(9,292	)
Proceeds from sale and maturities of short-term investments		17,100			34,010
Purchase of strategic equity investments		(1,275	)		(900	)
Restricted cash		4,850			—
Net cash provided by (used in) investing activities		(5,003	)		15,521
Cash flows from financing activities:
Proceeds from issuance of common stock, net		13,633			3,579
Repurchase of convertible notes		—			(35,000	)
Repayment of lease obligation		(1,114	)		(601	)
Repayment of line of credit		(3,000	)		—
Retirement of restricted stock		(394	)		(329	)
Other financing activities		(83	)		—
Net cash provided by (used in) financing activities		9,042			(32,351	)
Effect of foreign currency translation on cash and cash equivalents		6			(337	)
Net increase (decrease) in cash and cash equivalents		576			(9,998	)
Cash and cash equivalents at beginning of period		45,338			58,550
Cash and cash equivalents at end of period	$	45,914		$	48,552
Supplemental disclosure:
Non-cash investing and financing activities:
Deferred stock-based compensation	$	—		$	514
Issuance of common stock in connection with asset purchase	$	5,258		$	4,411
Purchase of fixed assets under capital leases	$	1,975		$	1,596
Common stock received from termination of hedge and warrants in connection with repurchase of convertible notes	$	—		$	102

 
 
See accompanying notes to unaudited condensed consolidated financial statements.

5

MAGMA DESIGN AUTOMATION, INC.
  
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1. Basis of Presentation

The interim unaudited condensed consolidated financial statements included herein have been prepared by Magma Design Automation, Inc. (“Magma” or “the Company”), pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”). Certain information and note disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted, pursuant to these rules and regulations. However, management believes that the disclosures are adequate to ensure that the information presented is not misleading. The interim unaudited condensed consolidated financial statements reflect, in the opinion of management, all adjustments necessary (consisting only of normal recurring adjustments) to present a fair statement of results for the interim periods presented. The operating results for any interim period are not necessarily indicative of the results that may be expected for the entire fiscal year ending April 6, 2008. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Company’s Form 10-K for the year ended April 1, 2007, as filed with the SEC on June 6, 2007. The accompanying unaudited condensed consolidated balance sheet at April 1, 2007 is derived from audited consolidated financial statements at that date.

Preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America 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. Management periodically evaluates such estimates and assumptions for continued reasonableness. Appropriate adjustments, if any, to the estimates used are made prospectively based upon such periodic evaluation. Actual results could differ from those estimates.

Principles of Consolidation

The consolidated financial statements of Magma include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated. Accounts denominated in foreign-currency have been translated from their functional currency to the U.S. dollar.

Reclassifications

Certain amounts in the prior year financial statements have been reclassified to conform to the current year presentation. Specifically, the Company modified its revenue and cost of revenue presentation in its unaudited condensed consolidated statements of operations and, accordingly, the related amounts reported in the unaudited condensed consolidated statements of operations for the fiscal 2007 periods have been reclassified to conform to the current period presentation.

Fiscal Year End

The Company has a 52-53 week fiscal year ending on the first Sunday subsequent to March 31. The Company’s fiscal years consist of four quarters of 13 weeks each except for each fifth or sixth fiscal year, which includes one quarter with 14 weeks. All references to years or quarters in these notes to consolidated financial statements represent fiscal years or fiscal quarters, respectively, unless otherwise noted.

Recently Issued Accounting Pronouncements

In June 2007, the Financial Accounting Standards Board (“FASB”) ratified a consensus opinion reached by the Emerging Issues Task Force (“EITF”) on EITF Issue 07-3, “Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities.” The guidance in EITF 07-3 requires the Company to defer and capitalize nonrefundable advance payments made for goods or services to be used in research and development activities until the goods have been delivered or the related services have been performed. If the goods are no longer expected to be delivered nor the services expected to be performed, the Company would be required to expense the related capitalized advance payments. The consensus in EITF 07-3 is effective for fiscal years, and interim periods within those fiscal years,

6

MAGMA DESIGN AUTOMATION, INC.
  
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1. Basis of Presentation  – (continued)

beginning after December 15, 2007 and is to be applied prospectively to new contracts entered into on or after December 15, 2007. Early adoption is not permitted. Retrospective application of EITF 07-3 is also not permitted. The Company intends to adopt EITF 07-3 effective January 1, 2008 and does not expect that the adoption of EITF 07-3 will have a material impact on its consolidated financial position or results of operations.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies only to other accounting pronouncements that require or permit fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The Company is in the process of evaluating the impact of the adoption of this statement on its consolidated financial position or results of operations.

In February 2007, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company is in the process of evaluating the impact of the adoption of this statement on its consolidated financial position or results of operations.

Note 2. Stock-Based Compensation

On April 3, 2006, the Company adopted the provisions of SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”) which requires the fair value recognition of share-based payment arrangements. The stock-based compensation recognized in the unaudited condensed consolidated statements of operations was as follows (in thousands):

	Three Months Ended				Six Months Ended
	September 30, 2007		October 1, 2006		September 30, 2007		October 1, 2006
Cost of revenue	$	439	$	344	$	868	$	686
Research and development expense		1,947		1,593		3,879		3,607
Sales and marketing expense		1,293		983		2,515		2,253
General and administrative expense		1,384		1,200		2,780		2,467
Total stock-based compensation expense	$	5,063	$	4,120	$	10,042	$	9,013

7

MAGMA DESIGN AUTOMATION, INC.
  
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 2. Stock-Based Compensation  – (continued)

The Company has adopted several stock incentive plans providing stock-based awards to employees, directors, advisors and consultants, including stock options, restricted stock and restricted stock units. The Company also has an Employee Stock Purchase Plan (“ESPP”), which enables employees to purchase shares of the Company’s common stock. Stock-based compensation expense by type of award was as follows (in thousands):

	Three Months Ended				Six Months Ended
	September 30, 2007		October 1, 2006		September 30, 2007		October 1, 2006
Stock options	$	2,681	$	2,723	$	5,516	$	5,746
Restricted stock and restricted stock units		1,508		851		3,091		2,000
Employee stock purchase plan		874		546		1,435		1,267
Total stock-based compensation expense	$	5,063	$	4,120	$	10,042	$	9,013

The Company uses the Black-Scholes option pricing model to determine the fair value of its stock options and ESPP awards. The Black-Scholes option pricing model incorporates various highly subjective assumptions including expected future stock price volatility and expected terms of instruments. The Company established the expected term for employee options and awards, as well as forfeiture rates, based on the historical settlement experience, while giving consideration to vesting schedules and to options that have life cycles less than the contractual terms. Assumptions for option exercises and pre-vesting terminations of options were stratified for employee groups with sufficiently distinct behavior patterns. Expected future stock price volatility was developed based on the average of the Company’s historical weekly stock price volatility and average implied volatility. The risk-free interest rate for the period within the expected life of the option is based on the yield of United States Treasury notes at the time of grant. The expected dividend yield used in the calculation is zero as the Company has not historically paid dividends.

The weighted average assumptions used in the Black-Scholes model and the weighted average grant date fair value per share were as follows:

	Three Months Ended						Six Months Ended
	September 30, 2007			October 1, 2006			September 30, 2007			October 1, 2006
Stock options:
Expected life (years)		4.04			3.96			4.17			4.16
Volatility		41	%		51	%		39 - 41	%		50 - 51	%
Risk-free interest rate		4.13 - 4.90	%		4.61 - 4.92	%		4.13 - 4.91	%		4.61 - 5.15	%
Expected dividend yield		0	%		0	%		0	%		0	%
Weighted average grant date fair value	$	5.37		$	3.69		$	4.92		$	3.56
ESPP awards:
Expected life (years)		1.13			1.13			1.13			1.13
Volatility		39	%		51	%		39 - 41	%		50 - 51	%
Risk-free interest rate		4.80	%		5.10	%		4.80 - 4.91	%		5.10 - 5.11	%
Expected dividend yield.		0	%		0	%		0	%		0	%
Weighted average grant date fair value	$	4.99		$	2.64		$	4.54		$	2.65

8

MAGMA DESIGN AUTOMATION, INC.
  
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 2. Stock-Based Compensation  – (continued)

As of September 30, 2007, there was approximately $19.7 million and $4.8 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to stock option grants and ESPP awards, which will be recognized over the remaining weighted average vesting period of approximately 2.44 years and 1.00 year, respectively.

The cost of restricted stock and restricted stock unit awards is determined using the fair value of the Company’s common stock on the date of the grant, and compensation expense is recognized over the vesting period, which is generally two to four years. As of September 30, 2007, there was approximately $5.3 million and $1.0 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to restricted stock and restricted stock unit awards, respectively, which will be recognized over the remaining weighted average vesting period of approximately 1.32 years and 1.80 years, respectively.

Note 3. Basic and Diluted Net Income (Loss) Per Share

The Company computes net income (loss) per share in accordance with SFAS No. 128, “Earnings per Share”. Basic net income (loss) per share is computed by dividing net income attributable to common stockholders (numerator) by the weighted average number of common shares outstanding (denominator) during the period. Diluted net income per share gives effect to all dilutive potential common shares outstanding during the period including stock options and redeemable convertible subordinated notes using the if-converted method.

For the three and six months ended September 30, 2007 and October 1, 2006, all potential common shares outstanding during the period were excluded from the computation of diluted net loss per share as their effect was anti-dilutive. Such shares included the following (in thousands, except per share data):

	Three and Six Months Ended
	September 30, 2007		October 1, 2006
Shares of common stock issuable upon conversion of convertible notes		3,995		2,850
Shares of common stock issuable under stock option plans outstanding		12,425		11,111
Weighted average exercise price of shares issuable under stock option plans	$	10.52	$	9.89

Note 4. Accumulated Deficit

The changes in accumulated deficit for the three and six months ended September 30, 2007 were as follows (in thousands):

	Three Months Ended September 30, 2007			Six Months Ended September 30, 2007
Balance at beginning of period	$	(209,669	)	$	(197,808	)
Net loss		(6,395	)		(17,664	)
Charges related to treasury stock reissuance		(60	)		(150	)
Effect of FIN 48 adoption		—			(502	)
Balance at September 30, 2007	$	(216,124	)	$	(216,124	)

9

MAGMA DESIGN AUTOMATION, INC.
  
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 5. Comprehensive Income (Loss)

Comprehensive income (loss) includes net loss, unrealized gain (loss) on investments and foreign currency translation adjustments as follows (in thousands):

	Three Months Ended						Six Months Ended
	September 30, 2007			October 1, 2006			September 30, 2007			October 1, 2006
Net loss	$	(6,395	)	$	(12,421	)	$	(17,664	)	$	(23,134	)
Unrealized gain (loss) on available-for-sale investments		5			(35	)		7			22
Foreign currency translation adjustments		(1,125	)		143			(783	)		(53	)
Comprehensive loss	$	(7,515	)	$	(12,313	)	$	(18,440	)	$	(23,165	)

Components of accumulated other comprehensive loss was as follows (in thousands):

	September 30, 2007			April 1, 2007
Unrealized loss on available-for-sale investments	$	—		$	(7	)
Foreign currency translation adjustments		(1,868	)		(1,085	)
Accumulated other comprehensive loss	$	(1,868	)	$	(1,092	)

Note 6. Acquisitions

Business Combination

Rio Design Automation, Inc. (“Rio”)

On September 19, 2007, the Company acquired the remaining 82% ownership interest of Rio (“82% step acquisition”) which it did not already own. Rio is an emerging electronic design automation (“EDA”) software company that provides package-aware chip design software. Rio’s software allows designers to analyze and optimize integrated circuit design within the context of the package and electronic system, further expanding the Company’s product offering.

The purchase price for the 82% step acquisition totaled $4.9 million, which consisted of $602,000 in cash, approximately 287,300 shares of the Company’s common stock valued at $3.9 million, and transaction costs of $369,000. The valuation of the Company’s common stock issued in connection with the acquisition was based on the average closing price per share of the stock for the ten days before the signing date of the definitive merger agreement. The Company held back approximately 46,900 shares of Magma common stock valued at $638,000 to secure certain indemnification obligations of Rio that may arise for a 12-month period from the date of the acquisition. The results of operations of Rio have been included in the Company’s results of operations since the acquisition date. Pro forma information has not been provided as the effects of the acquisition do not materially change the Company’s results of operations.

The 82% step acquisition was accounted for as a business combination in accordance with SFAS No. 141, “Business Combinations.” The purchase price was allocated to the assets acquired and liabilities assumed based on their respective fair values. The excess of the purchase price over the estimated fair value of the net assets acquired was allocated to goodwill. The goodwill totaling $3.1 million is not expected to be deductible for income tax purposes. Prior to the acquisition, Magma’s existing investment in Rio was accounted for under the equity method since the Company had significant influence on Rio’s operating or financial decisions. The value of the existing investment in Rio was based on the carrying value of approximately $220,000 as of September 19, 2007, and was allocated to the book value of the assets and liabilities previously owned. This resulted in the recognition of goodwill totaling $395,000 which is attributable to the

10

MAGMA DESIGN AUTOMATION, INC.
  
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 6. Acquisitions  – (continued)

original 18% ownership in Rio and was included in other assets on the Company’s consolidated balance sheets prior to September 19, 2007. The goodwill is not expected to be deductible for income tax purposes.

A summary of the purchase price allocation pertaining to the Rio acquisition as of September 19, 2007 and the amortization periods of the intangible assets acquired is as follows (in thousands):

	18% Existing Investment at Book Value		82% Step Acquisition at Fair Value		Total
Allocation of purchase price:
Assets acquired:
Current assets	$	12	$	24	$	36
Property, plant and equipment		11		—		11
Intangible assets
Developed technology		—		819		819
Customer relationship or base		—		1,065		1,065
In-process research and development		—		656		656
Goodwill		395		3,088		3,483
Total assets acquired		418		5,652		6,070
Liabilities assumed:
Current liabilities		198		774		972
Net assets acquired	$	220	$	4,878	$	5,098
Amortization period of intangibles (in years)
Developed technology				5
Customer relationship or base				7 – 8

The value assigned to developed technology was based upon future discounted cash flows related to the existing products’ projected income streams using a discount rate of 17%. The Company believes these rates were appropriate given the business risks inherent in marketing and selling these products. Factors considered in estimating the discounted cash flows to be derived from the existing technology include risks related to the characteristics and applications of the technology, existing and future markets and an assessment of the age of the technology within its life span. The cash flows generated by customer relationship or base were valued using discount rates ranging from 19% to 20%.

The $656,000 portion of the purchase price allocated to in process research and development (“IPR&D”) was recognized as a charge to operating expenses on the acquisition date. The in-process technology acquired from Rio is at a stage of development that requires further research and development to determine technical feasibility and commercial viability and they have no future alternative use. The valuation method used to value IPR&D is a form of discounted cash flow method commonly known as the excess earnings method. This approach is a widely recognized appraisal method and is commonly used to value technology assets. The value of the in-process technology is the sum of the discounted expected future cash flows attributable to the in-process technology, taking into consideration the costs to complete the products utilizing this technology, utilization of pre-existing technology, the risks related to the characteristics and applications of the technology, existing and future markets and the technological risk associated with completing the development of the technology. The cash flow derived from the in-process technology was discounted at a rate of 21%. The Company believes the rate used was appropriate given the risks associated with the technology for which

11

MAGMA DESIGN AUTOMATION, INC.
  
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 6. Acquisitions  – (continued)

commercial feasibility had not been established and there was no alternative use. The percentage of completion for in-process technology project acquired was 32%, and was an average of the percentage of completion based on costs and time. The cost-based percentage of completion was determined by identifying the total expenses incurred to date for the project as a ratio of the total expenses expected to be incurred to bring the project to technical and commercial feasibility. The time-based percentage of completion was determined by identifying the elapsed time invested in the project as a ratio of the total time required to bring the project to technical and commercial feasibility. Schedules were based on management’s estimate of tasks completed and the tasks to be completed to bring the project to technical and commercial feasibility. The in-process technology projects currently are expected to be completed during the fourth quarter of fiscal year 2009.

Development of in-process technology remains a substantial risk to the Company due to a variety of factors including the remaining effort to achieve technical feasibility, rapidly changing customer requirements and competitive threats from other companies and technologies. Additionally, the value of other intangible assets acquired may become impaired. The value of the in-process research and development, as well as the value of other intangible assets, was estimated by the management with the assistance of an independent appraisal firm, based on input from the Company and the acquired company’s management, using valuation methods that are in accordance with the generally accepted accounting principles.

Asset Purchase

On April 13, 2007, the Company acquired certain assets from a privately-held developer of EDA technology. Pursuant to the asset purchase agreement, the Company paid total consideration of $200,000 in cash. Based on management’s estimates and appraisal, the $200,000 consideration was allocated to patents and intellectual property, which was included in the intangible asset balance on the Company’s consolidated balance sheet as of September 30, 2007, and is being amortized over the estimated economic life of three years.

Acquisition-related Earnouts

For a number of Magma’s acquisitions, the asset purchase or merger agreements, as applicable, included an earnout provision under which the Company may pay contingent consideration in cash and/or stock based on the achievement of certain technology or financial milestones as outlined in the respective asset purchase or merger agreement.

For the six months ended September 30, 2007, the Company recorded $4.1 million of intangible assets and $2.8 million of goodwill resulting from contingent consideration that was paid or became payable to stockholders of acquired companies as follows (in thousands):

	Cash		Common Stock Value
Goodwill:
ACAD Corporation	$	2,806	$	—
Intangible assets:
Mojave, Inc		1,353		1,352
Other		1,400		—
Total earnout consideration	$	5,559	$	1,352

12

MAGMA DESIGN AUTOMATION, INC.
  
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 7. Goodwill and Intangible Assets

The following table summarizes the components of goodwill, intangible assets and related accumulated amortization balances as of September 30, 2007 and April 1, 2007 (dollars in thousands):

	Weighted Average Life (Months)		September 30, 2007							April 1, 2007
			Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Goodwill			$	54,301	$	—		$	54,301	$	48,499	$	—		$	48,499
Intangible assets:
Developed technology		40	$	108,389	$	(75,432	)	$	32,957	$	104,464	$	(64,229	)	$	40,235
Licensed technology		39		40,093		(31,981	)		8,112		39,093		(29,667	)		9,426
Customer relationship or base		42		4,375		(1,985	)		2,390		3,310		(1,631	)		1,679
Patents		58		13,015		(9,900	)		3,115		12,690		(8,615	)		4,075
Acquired customer contracts		25		1,390		(1,090	)		300		1,390		(1,069	)		321
Assembled workforce		45		1,252		(1,099	)		153		1,252		(976	)		276
No shop right		24		100		(100	)		—		100		(100	)		—
Non-competition agreements		22		500		(239	)		261		500		(156	)		344
Trademark		20		900		(426	)		474		900		(382	)		518
Total			$	170,014	$	(122,252	)	$	47,762	$	163,699	$	(106,825	)	$	56,874

In addition to the transactions discussed in Note 6 — “Acquisitions,” during the six months ended September 30, 2007, the Company reduced its goodwill by $0.4 million, reflecting purchase price adjustments related to an acquisition for tax benefits recognized on acquired net operating loss carryforwards.

The Company has included the amortization expense on intangible assets that relate to products sold in cost of revenue, while the remaining amortization is shown as a separate line item on the Company’s consolidated statement of operations. The amortization expense related to intangible assets was as follows (in thousands):

	Three Months Ended				Six Months Ended
	September 30, 2007		October 1, 2006		September 30, 2007		October 1, 2006
Amortization of intangible assets included in:
Cost of revenuelicenses	$	4,089	$	5,584	$	9,301	$	10,738
Cost of revenue – bundled licenses and services		838		1,986		2,060		3,998
Operating expenses		2,039		2,922		4,067		5,812
Total	$	6,966	$	10,492	$	15,428	$	20,548

13

MAGMA DESIGN AUTOMATION, INC.
  
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 7. Goodwill and Intangible Assets  – (continued)

The expected future annual amortization expense of intangible assets is as follows (in thousands):

Fiscal Year	Estimated Amortization Expense
2008 (remaining six months)	$	14,166
2009		23,853
2010		4,930
2011		2,673
2012		1,267
Thereafter		873
Total expected future amortization	$	47,762

Note 8. Convertible Notes, Current and Long-Term

Current: Zero Coupon Convertible Subordinated Notes due 2008 (the “2008 Notes”)

On May 22, 2003, the Company completed an offering of $150.0 million principal amount of the 2008 Notes due May 15, 2008 to qualified buyers pursuant to Rule 144A under the Securities Act of 1933, as amended, resulting in net proceeds to the Company of approximately $145.1 million. The 2008 Notes do not bear coupon interest and were initially convertible into shares of the Company’s common stock at a conversion price of $22.86 per share, for an aggregate of 6,561,680 shares. The 2008 Notes are subordinated to the Company’s existing and future senior indebtedness and effectively subordinated to all indebtedness and other liabilities of the Company’s subsidiaries. The Company paid approximately $4.5 million in transaction fees to the underwriters of the offering and approximately $0.4 million in other debt issuance costs. The Company is amortizing the transaction fees and issuance costs over the life of the 2008 Notes using the effective interest method.

In order to minimize the dilutive effect from the issuance of the 2008 Notes, the Company undertook the following additional transactions concurrent with the issuance of the Notes:

• The Company repurchased approximately 1.1 million shares of its common stock at a price of $18.00 per share, or approximately $20.0 million, from one of the initial purchasers of the 2008 Notes, and those shares were retired as of May 30, 2003.

• The Company and Credit Suisse First Boston International (“CSFB International”) entered into convertible bond hedge and warrant transactions with respect to the Company’s common stock, the exposure for which is held by CSFB International. Under the convertible bond hedge arrangement, CSFB International agreed to sell to the Company, for $22.86 per share, up to 6,561,680 shares of Magma common stock to cover the Company’s obligation to issue shares upon conversion of the Notes. In addition, the Company issued CSFB International a warrant to purchase up to 6,561,680 shares of common stock for a purchase price of $31.50 per share. Purchases and sales under this arrangement may be made only upon expiration of the 2008 Notes or their earlier conversion (to the extent thereof). Both transactions may be settled at the Company’s option either in cash or net shares, and will expire on the earlier of a conversion event or the maturity of the convertible debt on May 15, 2008. The transactions are expected to reduce the potential dilution from conversion of the 2008 Notes.

The net cost of $20.3 million incurred in connection with these arrangements, which consisted of the $56.2 million cost of the convertible bond hedge, offset in part by the $35.9 million proceeds from the issuance of the warrant, was presented in stockholder’s equity as a reduction of additional paid-in-capital, in accordance with the guidance in Emerging Issues Task Force Issue No. 00-19,

14

MAGMA DESIGN AUTOMATION, INC.
  
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 8. Convertible Notes, Current and Long-Term  – (continued)

“Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.” If the contracts are ultimately settled in a manner that results in the Company delivering or receiving cash, the amount of cash paid or received should be reported as a reduction of, or an addition to, stockholders’ equity. The shares issuable under these arrangements were excluded from the calculation of earnings per share as their effect was anti-dilutive.

In May 2005, the Company repurchased, in privately negotiated transactions, in an aggregate principal amount of $44.5 million (or approximately 29.7% of the total) of the 2008 Notes at an average discount to face value of approximately 22%. The Company spent approximately $34.8 million on the repurchase. The repurchase left approximately $105.5 million principal amount of the 2008 Notes outstanding. In addition, a portion of the hedge and warrant transactions was terminated in connection with the repurchase. In fiscal 2006, the Company recorded a gain of $9.7 million on the repurchase of the 2008 Notes, which was partially offset by the write-off of $0.9 million of deferred financing costs associated with the 2008 Notes. The net proceeds of $140,000 from the termination of a portion of the hedge and warrant were charged to additional paid-in capital.

In May 2006, the Company repurchased, in privately negotiated transactions, in an aggregate principal amount of $40.3 million (or approximately 38.2% of the remaining principal) of the 2008 Notes at an average discount to face value of approximately 13%. The Company spent approximately $35.0 million on the repurchases. The repurchase left approximately $65.2 million principal amount of the 2008 Notes outstanding. In addition, a portion of the hedge and warrant transactions was terminated in connection with the repurchase. In the first quarter of fiscal 2007, the Company recorded a gain of $5.3 million on the repurchase, which was partially offset by the write-off of $0.5 million of deferred financing costs associated with the 2008 Notes. The Company received 14,467 shares of Magma common stock, valued at approximately $102,000, as settlement for termination of a portion of the hedge and warrant in connection with the repurchase. The amount was charged to additional paid-in-capital.

In March 2007, the Company exchanged, in privately negotiated transactions, an aggregate principal amount of $49.9 million (or approximately 76.7% of the remaining principal) of the 2008 Notes for a new series of 2% convertible senior notes due May 2010. The exchange left approximately $15.2 million principal amount of the 2008 Notes outstanding. In the fourth quarter of fiscal 2007, the Company recorded a gain of $2.1 million on the exchange, which was partially offset by the write-off of $0.4 million of deferred financing costs associated with the 2008 Notes. Please see below under “Long-Term: 2% Convertible Senior Notes due 2010” for further discussion of the exchange. In addition, a portion of the hedge and warrant was terminated in connection with the exchange. The net proceeds of $88,000 from the termination of a portion of the hedge and warrant were charged to additional paid-in capital.

The $15.2 million principal amount of the 2008 Notes was included in current liabilities on the Company’s unaudited condensed balance sheets as of September 30, 2007, as the 2008 Notes became payable within one year. Similarly, the related $55,000 unamortized balance of transaction fees and debt issuance costs was included in current assets on the Company’s unaudited condensed balance sheets as of September 30, 2007. The shares issuable on the conversion of the 2008 Notes are included in “fully diluted shares outstanding” under the if-converted method of accounting for purposes of calculating diluted earnings per share.

Long-Term: 2% Convertible Senior Notes due 2010 (the “2010 Notes”)

In March 2007, the Company exchanged, in privately negotiated transactions, an aggregate principal amount of $49.9 million of the 2008 Notes for an equal aggregate principal amount of the 2010 Notes. The 2010 Notes mature on May 15, 2010 and bear interest at 2% per annum, with interest payable on May 15 and November 15 of each year, commencing May 15, 2007. The 2010 Notes are unsecured senior indebtedness of Magma, which rank senior in right of payment to the 2008 Notes and junior in right of payment to Magma’s revolving line of credit facility. In addition, after May 20, 2009, the Company will have the option to redeem

15

MAGMA DESIGN AUTOMATION, INC.
  
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 8. Convertible Notes, Current and Long-Term  – (continued)

the 2010 Notes for cash in an amount equal to 100% of the aggregate outstanding principal amount at the time of such redemption. The 2010 Notes also contain a net share settlement provision which allows the Company, at its option, in lieu of delivery of some or all of the shares of common stock otherwise issuable upon conversion of the 2010 Notes, to pay holders of the 2010 Notes in cash for all or a portion of the principal amount of the converted 2010 Notes and any amounts in excess of the principal amount which are due.

The 2010 Notes will be convertible upon the occurrence of certain conditions into shares of Magma common stock at an initial conversion price of $15.00 per share, which is equivalent to an initial conversion rate of approximately 66 shares per $1,000 principal amount of 2010 Notes. The conversion price and the conversion rate will adjust automatically upon certain dilution events. The 2010 Notes are convertible into shares of Magma common stock on or prior to maturity at the option of the holders upon the occurrence of certain change of control events. Conversions under these circumstances require Magma to pay a premium make-whole amount whereby the conversion rate on the 2010 Notes may be increased by up to 22 shares. The premium make-whole amount shall be paid in shares of common stock upon any such automatic conversion, subject to Magma’s option for net share settlement.

The 2010 Notes shall also be convertible at the option of the holders at such time as: (i) the closing price of Magma common stock exceeds 150% of the conversion price of the 2010 Notes, initially $15.00, for 20 out of 30 consecutive trading days; (ii) the trading price per $1,000 principal amount of 2010 Notes is less than 98% of the product of (x) the average price of common stock for each day during any five consecutive trading day period and (y) the conversion rate per $1,000 principal amount of 2010 Notes; (iii) Magma distributes to all holders of common stock rights or warrants entitling them to purchase additional shares of common stock at less than the closing price of common stock on March 5, 2007; (iv) Magma distributes to all holders of common stock any form of dividend which has a per share value exceeding 7.5% of the price of the common stock on the day prior to such date of distribution; (v) the period beginning 60 days prior to May 15, 2010; (vi) there has been a designated change of control of Magma; or (vii) the 2010 Notes have been called for redemption by Magma. Any such conversions shall not entitle the holders of the 2010 Notes to any premium make-whole payment by Magma.

The exchange offer was treated as an extinguishment of the 2008 Notes in accordance with EITF 96-19, “Debtors Accounting for a Modification or Exchange of Debt Instruments,” as amended by EITF 06-6, “Debtor’s Accounting for a Modification (or Exchange) of Convertible Debt Instruments.” The exchange resulted in a gain of $2.1 million on extinguishment of debt, which was partially offset by the write-off of $0.4 million of deferred financing costs associated with the 2008 Notes. The Company initially recorded the 2010 Notes at fair value of $47.8 million, net of the debt discount of $2.1 million. The debt discount is being amortized to interest expenses over the term of the 2010 Notes. As of September 30, 2007, debt discount balance related to the 2010 Notes was $1.8 million.

The $1.3 million of underwriting and legal fees related to the 2010 Notes offering was capitalized upon issuance and is being amortized over the term of the 2010 Notes using the effective interest method. As of September 30, 2007, the unamortized balance of debt issuance costs related to the 2010 Notes was approximately $1.1 million. The shares issuable on the conversion of the 2010 Notes are included in “fully diluted shares outstanding” under the if-converted method of accounting for purposes of calculating diluted earnings per share.

Note 9. Line of Credit

In July 2007, the Company established a $10.0 million unsecured revolving line of credit facility with Wells Fargo Bank, N.A. This credit facility, which replaces the $5.0 million revolving line of credit facility previously established in November 2006, is available through July 2012 and bears an interest rate equal to the bank’s prime rate less 1.20% or LIBOR plus 1.00%. The Company is required to make interest only

16

MAGMA DESIGN AUTOMATION, INC.
  
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 9. Line of Credit  – (continued)

payments monthly and the outstanding principal amount plus all accrued but unpaid interest is payable in full at the expiration of the credit facility. As of September 30, 2007, the Company had no borrowings outstanding under the facility.

The credit facility requires that the Company maintain certain financial conditions and pay fees of 0.125% per year on the unused amount of the facility. As of September 30, 2007, the Company was in compliance with the financial conditions. In addition, the credit facility allows letters of credit to be issued on behalf of the Company, provided that the aggregate outstanding amount of the letters of credit shall not exceed the available amount for borrowing under the credit facility. In connection with the establishment of the credit facility, the Company repaid the $3.0 million outstanding borrowing under the prior $5.0 million credit facility. Letters of credit under the prior credit facility were transferred to the new $10.0 million credit facility. As of September 30, 2007, two letters of credit totaling $1.7 million were outstanding and the Company had a borrowing base availability of $8.3 million under the facility. Since the new credit facility is unsecured, the Company is no longer required to maintain restricted cash balances relating to the letters of credit under the facility.

Note 10. Restructuring Charges

During the first quarter of fiscal year 2008, the Company recorded restructuring charges of $0.3 million for costs related to termination of 21 employees resulting from the Company’s realignment to current business conditions. As of September 30, 2007, all of these termination costs had been paid and the Company had not planned to incur additional costs related to this business realignment.

Note 11. Contingencies

The Company is subject to certain legal proceedings described below and from time to time, it is also involved in other disputes that arise in the ordinary course of business. The number and significance of these litigation proceedings and disputes are increasing as the Company’s business expands and grows larger. Any claims against the Company, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and result in the diversion of significant operational resources. As a result, these litigation proceedings and disputes could harm the Company’s business and have an adverse effect on its consolidated financial statements. However, the results of any litigation or dispute are inherently uncertain and, at this time, no estimate could be made of the loss or range of loss, if any, from these litigation matters and disputes. Accordingly, the Company has not recorded any liabilities relating to these contingencies as of September 30, 2007. Litigation settlement and legal fees are expensed in the period in which they are incurred.

On June 13, 2005, a putative shareholder class action lawsuit captionedThe Cornelia I. Crowell GST Trust vs. Magma Design Automation, Inc., Rajeev Madhavan, Gregory C. Walker and Roy E. Jewell., No. C 05 02394, was filed in U.S. District Court, Northern District of California. The complaint alleges that defendants failed to disclose information regarding the risk of the Company’s infringing intellectual property rights of Synopsys, Inc., in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and prays for unspecified damages. In March 2006, defendants filed a motion to dismiss the consolidated amended complaint. Plaintiff filed a further amended complaint in June 2006, which defendants again moved to dismiss. Defendants’ motion was granted in part and denied in part by an order dated August 18, 2006, which dismissed claims against two of the individual defendants. The case is now proceeding on the remaining claims and is scheduled for trial on December 3, 2008. This case was also discussed in the Company’s Annual Report on Form 10-K for the fiscal year ended April 1, 2007.

On July 26, 2005, a putative derivative complaint captionedSusan Willis v. Magma Design Automation, Inc. et al., No. 1-05-CV-045834, was filed in the Superior Court of the State of California for the County of Santa Clara. The Complaint seeks unspecified damages purportedly on behalf of the Company for alleged

17

MAGMA DESIGN AUTOMATION, INC.
  
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 11. Contingencies  – (continued)

breaches of fiduciary duties by various directors and officers, as well as for alleged violations of insider trading laws by executives during a period between October 23, 2002 and April 12, 2005. Defendants have demurred to the Complaint, and the action has been stayed pending further developments in the putative shareholder class action referenced above. This case was also discussed in the Company’s Annual Report on Form 10-K for the fiscal year ended April 1, 2007.

Narpat Bhandari v. Magma Design Automation, Inc.Cadence Design Systems, Inc., Dynalith Systems, Inc., Altera Corp., Mentor Graphics Corp. and Aldec, Inc., Case No. 6:06-CV-480, United States District Court, Eastern District of Texas, Tyler Division. On November 8, 2006, a complaint was filed alleging that the Company and several other named defendants infringe United States Patent No. 5,663,900. The complaint identifies the Company’s FineSim software, and other unidentified devices or programs, as the products accused of infringement. The Company and the other Defendants moved to dismiss the complaint on the basis that the only named plaintiff, Bhandari, does not own the ’900 Patent. On May 11, 2007, the Court issued a Memorandum Opinion and Order granting the motion to dismiss and dismissed the case without prejudice. This case was also discussed in the Company’s Annual Report on Form 10-K for the fiscal year ended April 1, 2007.

Cadence Design Systems, Inc., Magma Design Automation, Inc., Altera Corp., and Mentor Graphics Corp. v. Narpat Bhandari and Vanguard Systems, Inc., Case No. C 07-00823, United States District Court, Northern District of California, San Francisco Division. The Company and the other named plaintiffs filed a complaint for declaratory judgment on February 8, 2007, which the Company amended on March 27, 2007. The amended complaint for declaratory judgment asserts five claims for relief: (1) declaratory judgment of non-infringement of the ’900 Patent; (2) declaratory judgment of invalidity of the ’900 Patent; (3) lack of ownership of the ’900 Patent; (4) the ’900 Patent is unenforceable due to laches; and (5) declaratory judgment that the doctrine of unclean hands bars enforcement of the ’900 Patent. The Company and the other Plaintiffs contend that LSI Logic is a joint owner of the ’900 Patent, and the Company has obtained a license from LSI. On April 6, 2007, Defendants Narpat Bhandari and Vanguard Systems, Inc. answered the amended complaint and filed a counterclaim of patent infringement of the ’900 Patent. As in the Texas Action, the claim for patent infringement against us identified our FineSim software, and other unidentified devices or programs, as the products accused of infringement. The counterclaim seeks unspecified monetary damages, pre- and post-judgment interest, attorneys’ fees, and costs. The Court conducted a case management conference on May 21, 2007, and issued a case management order on May 23, 2007, approving Plaintiffs’ and Defendants’ proposal to bifurcate the issue of LSI’s ownership from all other remaining issues and stay activities relating to validity, enforceability, infringement, and damages until after a bench trial to resolve the ownership issue. The Court scheduled the bench trial on the sole issue of ownership of the ’900 Patent to begin on October 9, 2007. On July 27, 2007, the Company and the other Plaintiffs filed a motion for summary judgment requesting judgment in favor of the Plaintiffs on the grounds that LSI is a co-owner of the ’900 Patent. Plaintiffs’ motion was fully briefed and was scheduled for oral argument before the Court on September 27, 2007, the same day that the Court had previously scheduled a pre-trial conference. The Court, however, had to cancel the hearing, and in a September 28, 2007 Order, the Court vacated the summary judgment hearing date, the pre-trial conference date, and the bench trial date. The Court stated that it would decide the summary judgment motion on the papers. The Court has not yet issued any further orders. The Company intends to vigorously defend against the claims asserted by Bhandari and Vanguard Systems. However, the results of any litigation are inherently uncertain, and the Company can not assure that it will be able to successfully defend against the claims of Bhandari and Vanguard Systems. The Company is currently unable to assess the extent of damages and/or other relief, if any, that could be awarded to Bhandari and Vanguard Systems. This case was also discussed in the Company’s Annual Report on Form 10-K for the fiscal year ended April 1, 2007.

18

MAGMA DESIGN AUTOMATION, INC.
  
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 11. Contingencies  – (continued)

Indemnification Obligations

The Company enters into standard license agreements in the ordinary course of business. Pursuant to these agreements, the Company agrees to indemnify its customers for losses suffered or incurred by them as a result of any patent, copyright, or other intellectual property infringement claim by any third party with respect to the Company’s products. These indemnification obligations have perpetual terms. The Company’s normal business practice is to limit the maximum amount of indemnification to the amount received from the customer. On occasion, the maximum amount of indemnification the Company may be required to provide may exceed the amount received from the customer. The Company estimates the fair value of its indemnification obligations to be insignificant, based upon its historical experience concerning product and patent infringement claims. Accordingly, the Company has no liabilities recorded for indemnification under these agreements as of September 30, 2007.

The Company has agreements whereby its officers and directors are indemnified for certain events or occurrences while the officer or director is, or was, serving at the Company’s request in such capacity. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has directors’ and officers’ liability insurance that reduces its exposure and enables the Company to recover portions of future amounts paid. As a result of the Company’s insurance coverage, the Company believes the estimated fair value of these indemnification agreements is minimal. Accordingly, no liabilities have been recorded for these agreements as of September 30, 2007.

In connection with certain of the Company’s recent business acquisitions, it has also agreed to assume, or cause the Company’s subsidiaries to assume, the indemnification obligations of those companies to their respective officers and directors. No liabilities have been recorded for these agreements as of September 30, 2007.

Warranties

The Company offers certain customers a warranty that its products will conform to the documentation provided with the products. To date, there have been no payments or material costs incurred related to fulfilling these warranty obligations. Accordingly, the Company has no liabilities recorded for these warranties as of September 30, 2007. The Company assesses the need for a warranty accrual on a quarterly basis, and there can be no guarantee that a warranty accrual will not become necessary in the future.

Note 12. Segment Information

The Company has adopted the provisions of SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” which requires the reporting of segment information using the “management approach.” Under this approach, operating segments are identified in substantially the same manner as they are reported internally and used by the Company’s chief operating decision maker (“CODM”) for purposes of evaluating performance and allocating resources. Based on this approach, the Company has one reportable segment as the CODM reviews financial information on a basis consistent with that presented in the unaudited condensed consolidated financial statements.

19

MAGMA DESIGN AUTOMATION, INC.
  
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 12. Segment Information  – (continued)

Revenue from North America, Europe, Japan and the Asia Pacific region, which includes India, South Korea, Taiwan, Hong Kong and the People’s Republic of China, was as follows (in thousands, except for percentages shown):

	Three Months Ended				Six Months Ended
	September 30, 2007		October 1, 2006		September 30, 2007		October 1, 2006
North America*	$	31,610	$	24,241	$	56,053	$	52,601
Europe		4,106		5,848		14,864		10,386
Japan		14,601		9,542		21,268		12,798
Asia-Pacific (excluding Japan)		3,176		2,331		11,473		7,136
	$	53,493	$	41,962	$	103,658	$	82,921

	Three Months Ended						Six Months Ended
	September 30, 2007			October 1, 2006			September 30, 2007			October 1, 2006
North America*.		59	%		58	%		54	%		63	%
Europe		8			14			14			13
Japan		27			23			21			15
Asia-Pacific (excluding Japan)		6			5			11			9
		100	%		100	%		100	%		100	%

* Substantially all of the Company’s North America revenue related to the United States for all periods presented.

One customer accounted for more than 10% of the Company’s total revenue in the three and six months ended September 30, 2007 and in the six months ended October 1, 2006. Two customers each accounted for more than 10% of the Company’s total revenue in the three months ended October 1, 2006.

Substantially all of the Company’s long-lived assets are located in the United States.

Note 13. Income Taxes

On April 2, 2007, the Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109” (“FIN 48”). Under FIN 48, companies are required to apply the “more likely than not” threshold to the recognition and derecognition of tax positions. FIN 48 also provides guidance on the measurement of tax positions, balance sheet classification, interest and penalties, accounting in interim periods, disclosure and transition. As a result of the implementation of FIN 48, the Company recognized a $0.5 million increase to liabilities for uncertain tax positions, which was accounted for as an adjustment to the April 2, 2007 balance of accumulated deficit.

Upon adoption of FIN 48, the Company also recognized additional long-term income tax assets of $6.9 million and additional long-term income tax liabilities of $6.9 million to present the unrecognized tax benefits as gross amounts on its unaudited condensed consolidated balance sheets. In addition, the Company reclassified $3.0 million of income tax liabilities from current to long-term liabilities as the payment of cash is not anticipated within the next twelve months.

As of April 2, 2007, the Company had approximately $10.4 million of total gross unrecognized tax benefits, of which $3.5 million, if recognized, would favorably affect its effective tax rate in future periods and $1.6 million, if recognized, would result in a credit to additional paid-in capital. The Company currently

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MAGMA DESIGN AUTOMATION, INC.
  
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 13. Income Taxes  – (continued)

has a full valuation allowance against its U.S. net deferred tax assets which would impact the timing of the effective tax rate benefit should any of these uncertain tax positions be favorably settled in the future.

Upon adoption of FIN 48, the Company adopted an accounting policy to classify interest and penalties on unrecognized tax benefits as income tax expense. For years prior to adoption of FIN 48, the Company also reported interest and penalties on unrecognized tax benefits as income tax expense. As of April 2, 2007, the total amount of accrued interest and penalties was $248,000.

The Company is subject to income taxes in the United States and in numerous foreign jurisdictions and, in the ordinary course of business, there are many transactions and calculations where the ultimate tax determination is uncertain. The statute of limitations for adjustments to the Company’s historic tax obligations will vary from jurisdiction to jurisdiction. The tax years 2001 to 2006 remain open to examination by the major tax jurisdictions to which the Company is subject. At September 30, 2007, the Company does not anticipate that its total unrecognized tax benefits will significantly change due to any settlement of examination or expiration of statute of limitation within the next twelve months.

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

This Management’s Discussion and Analysis of Financial Condition and Results of Operations section should be read in conjunction with “Selected Consolidated Financial Data” and our condensed consolidated financial statements and results appearing elsewhere in this report. Throughout this section, we make forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. You can often identify these and other forward-looking statements by terms such as “becoming,” “may,” “will,” “should,” “predicts,” “potential,” “continue,” “anticipates,” “believes,” “estimates,” “seeks,” “expects,” “plans,” “intends,” or comparable terminology. These forward-looking statements include, but are not limited to, our expectations about revenue and various operating expenses. Although we believe that the expectations reflected in these forward-looking statements are reasonable, and we have based these expectations on our beliefs and assumptions, such expectations may prove to be incorrect. Our actual results of operations and financial performance could differ significantly from those expressed in or implied by our forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to: competition in the EDA market; Magma’s ability to integrate acquired businesses and technologies; potentially higher-than-anticipated costs of litigation; potentially higher-than-anticipated costs of compliance with regulatory requirements, including those relating to internal control over financial reporting; any delay of customer orders or failure of customers to renew licenses; adoption of products by customers; weaker-than-anticipated sales of Magma’s products and services; weakness in the semiconductor or electronic systems industries; the ability to manage expanding operations; the ability to attract and retain the key management and technical personnel needed to operate Magma successfully; the ability to continue to deliver competitive products to customers; and changes in accounting rules. We do not intend to, and we do not undertake any additional obligation to update these forward-looking statements after the date of this report to reflect actual results or future events or circumstances.

Overview

Magma Design Automation provides EDA software products and related services. Our software enables chip designers to reduce the time it takes to design and produce complex integrated circuits used in the communications, computing, consumer electronics, networking and semiconductor industries. Our products are used in all major phases of the chip development cycle, from initial design through physical implementation. Our focus is on software used to design the most technologically advanced integrated circuits, specifically those with minimum feature sizes of 0.13 micron and smaller.

As an EDA software provider, we generate substantially all our revenue from the semiconductor and electronics industries. Our customers typically fund purchases of our software and services out of their research and development (“R&D”) budgets. As a result, our revenue is heavily influenced by our customers’ long-term business outlook and willingness to invest in new chip designs.

The semiconductor industry is highly volatile and cost-sensitive. Our customers focus on controlling costs and reducing risk, lowering R&D expenditures, decreasing the number of design starts, purchasing from fewer suppliers, and requiring more favorable pricing and payment terms from suppliers. In addition, intense competition among suppliers of EDA products has resulted in pricing pressure on EDA products.

To support our customers, we have focused on providing the most technologically advanced products to address each step in the integrated circuit design process, as well as integrating these products into broad platforms, and expanding our product offerings. Our goal is to be the EDA technology supplier of choice for our customers as they pursue longer-term, broader and more flexible relationships with fewer suppliers.

During the second quarter of fiscal 2008, we achieved quarterly revenue of $53.5 million, which increased by 7% from the preceding quarter and increased by 27% from the same quarter in fiscal 2007. License sales for the second quarter of fiscal 2008 accounted for approximately 67% of total revenue, compared to 64% in the preceding quarter and 57% in the same quarter in the prior year.

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Critical Accounting Policies and Estimates

In preparing our financial statements, we make estimates, assumptions and judgments that can have a significant impact on our revenue, operating income or loss and net income or loss, as well as on the value of certain assets and liabilities on our balance sheet. We believe that the estimates, assumptions and judgments involved in the accounting policies described below have the most significant potential impact on our financial statements, so we consider these to be our critical accounting policies. We consider the following accounting policies related to revenue recognition, stock-based compensation, allowance for doubtful accounts, strategic investments, asset purchases and business combinations, valuation of long-lived assets and income taxes to be our most critical policies due to the estimation processes involved in each.

Revenue Recognition

We recognize revenue in accordance with Statement of Position (“SOP”) 97-2, as modified by SOP 98-9, which generally requires revenue earned on software arrangements involving multiple elements (such as software products, upgrades, enhancements, maintenance, installation and training) to be allocated to each element based on the relative fair values of the elements. The fair value of an element must be based on evidence that is specific to us. If evidence of fair value does not exist for each element of a license arrangement and maintenance is the only undelivered element, then all revenue for the license arrangement is recognized over the term of the agreement. If evidence of fair value does exist for the elements that have not been delivered, but does not exist for one or more delivered elements, then revenue is recognized using the residual method, under which recognition of revenue for the undelivered elements is deferred and the residual license fee is recognized as revenue immediately.

Our revenue recognition policy is detailed in Note 1 of the Notes to Consolidated Financial Statements on Form 10-K for the year ended April 1, 2007. Management has made significant judgments related to revenue recognition. Specifically, in connection with each transaction involving our products (referred to as an “arrangement” in the accounting literature) we must evaluate whether our fee is “fixed or determinable” and we must assess whether “collectibility is probable.” These judgments are discussed below.

The fee is fixed or determinable. With respect to each arrangement, we must make a judgment as to whether the arrangement fee is fixed or determinable. If the fee is fixed or determinable, then revenue is recognized upon delivery of software (assuming other revenue recognition criteria are met). If the fee is not fixed or determinable, then the revenue recognized in each period (subject to application of other revenue recognition criteria) will be the lesser of the aggregate of amounts due and payable or the amount of the arrangement fee that would have been recognized if the fees were being recognized ratably.

Except in cases where we grant extended payment terms to a specific customer, we have determined that our fees are fixed or determinable at the inception of our arrangements based on the following:

• The fee our customers pay for our products is negotiated at the outset of an arrangement and is generally based on the specific volume of products to be delivered; and

• Our license fees are not a function of variable-pricing mechanisms such as the number of units distributed or copied by the customer or the expected number of users of the product delivered.

In order for an arrangement to be considered fixed or determinable, 100% of the arrangement fee must be due within one year or less from the order date. We have a history of collecting fees on such arrangements according to contractual terms. Arrangements with payment terms extending beyond 12 months are considered not to be fixed or determinable.

Collectibility is probable. In order to recognize revenue, we must make a judgment about the collectibility of the arrangement fee. Our judgment of the collectibility is applied on a customer-by-customer basis pursuant to our credit review policy. We typically sell to customers for which there is a history of successful collection. New customers are subjected to a credit review process, which evaluates the customers’ financial positions and ability to pay. If it is determined from the outset of an arrangement that collectibility is not probable based upon our credit review process, revenue is recognized on a cash receipts basis (as each payment is collected).

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Licenses Revenue and Bundled Licenses and Services Revenue

We derive license revenue primarily from licenses of our design and implementation software and, to a much lesser extent, from licenses of our analysis and verification products. We license our products under time-based and perpetual licenses.

We recognize license revenue after the execution of a license agreement and the delivery of the product to the customer, provided that there are no uncertainties surrounding the product acceptance, fees are fixed or determinable, collection is probable and there are no remaining obligations other than maintenance. For licenses where we have vendor-specific objective evidence (“VSOE”) of fair value for maintenance, we recognize license revenue using the residual method. For these licenses, license revenue is recognized in the period in which the license agreement is executed assuming all other revenue recognition criteria are met. For licenses where we have no VSOE of fair value for maintenance, we recognize license revenue ratably over the maintenance period, or if extended payment terms exist, based on the amounts due and payable.

For transactions in which we bundle maintenance for the entire license term into a time-based license agreement, no VSOE of fair value exists for each element of the arrangement. For these agreements, where the only undelivered element is maintenance, we recognize revenue ratably over the contract term. If an arrangement involves extended payment terms — that is, where payment for less than 100% of the license, services and initial post contract support is due within one year of the contract date — we recognize revenue to the extent of the lesser of the portion of the amount due and payable or the ratable portion of the entire fee. We classify the revenue recognized from these transactions separately as bundled licenses and services revenue in our consolidated statements of operations.

For our perpetual licenses and some time-based license arrangements, we unbundle maintenance by including maintenance for up to the first period of the license term, with maintenance thereafter renewable by the customer at the substantive rates stated in their agreements with us. In these unbundled licenses, the aggregate renewal period is greater than or equal to the initial maintenance period. The stated rate for maintenance renewal in these contracts is VSOE of the fair value of maintenance in both our unbundled time-based and perpetual licenses. Where the only undelivered element is maintenance, we recognize license revenue using the residual method. If an arrangement involves extended payment terms, revenue recognized using the residual method is limited to amounts due and payable.

If we were to change any of these assumptions or judgments, it could cause a material increase or decrease in the amount of revenue that we report in a particular period. Amounts invoiced relating to arrangements where revenue cannot be recognized are reflected on our balance sheet as deferred revenue and recognized over time as the applicable revenue recognition criteria are satisfied.

Services Revenue

We derive services revenue primarily from consulting and training for our software products and from maintenance fees for our products. Most of our license agreements include maintenance, generally for a one-year period, renewable annually. Services revenue from maintenance arrangements is recognized on a straight-line basis over the maintenance term. Because we have VSOE of fair value for consulting and training services, revenue is recognized as these services are performed or completed. Our consulting and training services are generally not essential to the functionality of the software. Our products are fully functional upon delivery of the product. Additional factors considered in determining whether the revenue should be accounted for separately include, but are not limited to: degree of risk, availability of services from other vendors, timing of payments and impact of milestones or acceptance criteria on our ability to recognize the software license fee.

Stock-based Compensation

Effective April 3, 2006, we adopted SFAS No. 123 (revised 2004), “Share-Based Payment” using the modified prospective transition method. Under SFAS 123R, stock-based compensation expense is measured at the grant date, based on the fair value of the award, and is recognized as expense, net of estimated forfeitures, over the vesting period of the award.

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Determining the fair value of stock-based awards at the grant date requires the input of various highly subjective assumptions, including expected future stock price volatility, expected term of instruments and expected forfeiture rates. We established the expected term for employee options and awards, as well as forfeiture rates, based on the historical settlement experience, while giving consideration to vesting schedules and to options that have estimated life cycles less than the contractual terms. Assumptions for option exercises and pre-vesting terminations of options were stratified for employee groups with sufficiently distinct behavior patterns. Expected future stock price volatility was developed based on the average of our historical weekly stock price volatility and average implied volatility. These input factors are subjective and are determined using management’s judgment. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially affected.

Unbilled Accounts Receivable

Unbilled accounts receivable represent revenue that has been recognized in advance of being invoiced to the customer. In all cases, the revenue and unbilled receivables are for contracts which are non-cancelable, in which there are no contingencies and where the customer has taken delivery of both the software and the encryption key required to operate the software. We typically generate invoices 45 days in advance of contractual due dates, and we invoice the entire amount of the unbilled accounts receivable within one year from the contract inception.

Allowances for Doubtful Accounts

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We regularly review the adequacy of our accounts receivable allowance after considering the size of the accounts receivable balance, each customer’s expected ability to pay and our collection history with each customer. We review significant invoices that are past due to determine if an allowance is appropriate using the factors described above. We also monitor our accounts receivable for concentration in any one customer, industry or geographic region.

As of September 30, 2007, two of our customers each accounted for more than 10% of total receivables. The allowance for doubtful accounts represents our best estimate, but changes in circumstances relating to accounts receivable may result in a requirement for additional allowances in the future. If actual losses are significantly greater than the allowance we have established, that would increase our general and administrative expenses and reported net loss. Conversely, if actual credit losses are significantly less than our allowance, this would decrease our general and administrative expenses and our reported net income would increase.

Accounting for Asset Purchases and Business Combinations

We are required to allocate the purchase price of acquired assets and business combinations to the tangible and intangible assets acquired, liabilities assumed, as well as in-process research and development based on their estimated fair values. Such a valuation requires management to make significant estimates and assumptions, especially with respect to intangible assets.

Critical estimates in valuing certain of the intangible assets include but are not limited to: future expected cash flows from license sales, maintenance agreements, consulting contracts, customer contracts, acquired workforce and acquired developed technologies and patents; expected costs to develop the in-process research and development into commercially viable products and estimated cash flows from the projects when completed; the acquired company’s brand awareness and market position, as well as assumptions about the period of time the acquired brand will continue to be used in the combined company’s product portfolio; and discount rates. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. Assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur.

Other estimates associated with the accounting for business combinations may change as additional information becomes available regarding the assets acquired and liabilities assumed resulting in changes in the purchase price allocation.

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Goodwill Impairment

SFAS No. 142, “Goodwill and Other Intangible Assets,” requires that goodwill be tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis and between annual tests in certain circumstances. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of the reporting units. We have determined that we have one reporting unit (see Note 12 to the unaudited condensed consolidated financial statements). Significant judgments required to estimate the fair value of reporting units include estimating future cash flows, determining appropriate discount rates and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value for the reporting units. Any impairment losses recorded in the future could have a material adverse impact on our financial condition and results of operations.

Valuation of Intangibles and Long-lived Assets

SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” requires that we record an impairment charge on finite-lived intangibles or long-lived assets to be held and used when we determine that the carrying value of intangible assets and long-lived assets may not be recoverable. If one or more indicators of impairment exist, we will measure any impairment of intangibles or long-lived assets based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our business model. Our estimates of cash flows require significant judgment based on our historical results and anticipated results and are subject to many factors.

Income Taxes

We account for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes.” Significant judgment is required in determining our provision for income taxes. In the ordinary course of business, there are many transactions and calculations where the ultimate tax outcome is uncertain. The amount of income taxes we pay could be subject to audits by federal, state, and foreign tax authorities, which could result in proposed assessments. Although we believe that our estimates are reasonable, no assurance can be given that the final outcome of these tax matters will not be different than that which is reflected in our historical income tax provisions.

We assess the likelihood that our net deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not likely, we establish a valuation allowance. We consider all available positive and negative evidence including our past operating results, the existence of cumulative losses in the most recent fiscal years, future taxable income, and ongoing prudent and feasible tax planning strategies in assessing the amount of the valuation allowance. We will continue to evaluate the realizability of the deferred tax assets on a quarterly basis. Future reversals or increases to our valuation allowance could have a significant impact on our future earnings.

On April 2, 2007, we adopted FIN 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109.” Under FIN 48, we are required to apply the “more likely than not” threshold to the recognition and derecognition of tax positions. FIN 48 also provides guidance on the measurement of tax positions, balance sheet classification, interest and penalties, accounting in interim periods, disclosure and transition. As a result of the implementation of FIN 48, we recognized a $0.5 million increase to liabilities for uncertain tax positions, which was accounted for as an adjustment to the April 2, 2007 balance of accumulated deficit. At April 2, 2007, we had approximately $10.4 million of gross unrecognized tax benefits, $3.5 million of which, if recognized, would favorably affect our effective tax rate in future periods.

Strategic Investments in Privately-held Companies

Our strategic equity investments consist of preferred stock and convertible notes that are convertible into preferred or common stock of several privately-held companies. The carrying value of our portfolio of strategic equity investments in non-marketable equity securities (privately-held companies) and convertible notes totaled $2.5 million at September 30, 2007. Our ability to recover our investments in private, non-marketable equity securities and convertible notes and to earn a return on these investments is primarily dependent on how successfully these companies are able to execute on their business plans and how well their products are accepted, as well as their ability to obtain additional capital funding to continue operations.

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Under our accounting policy, the carrying value of a non-marketable investment is the amount paid for the investment unless it has been determined to be other than temporarily impaired, in which case we write the investment down to its estimated fair value. For equity investments where our ownership interest is between 20% to 50%, or where we have significant influence on the investee’s operating or financial decisions, we record our share of net equity income (loss) of the investee based on our proportionate ownership. During the second quarter of fiscal 2008, with the purchase of the remaining 82% ownership of one of our equity investments, Rio Design Automation, Inc. (“Rio”), we ceased accounting for our investment in Rio under the equity method and began accounting for our 100% ownership on a consolidated basis. The equity investment balance of $220,000 on the acquisition date was reclassified from other assets and was allocated to the book value of the previously owned assets and liabilities on our consolidated balance sheets.

We review all of our investments periodically for impairment; however, for non-marketable equity securities, the fair value analysis requires significant judgment. This analysis includes assessment of each investee’s financial condition, the business outlook for its products and technology, its projected results and cash flows, the likelihood of obtaining subsequent rounds of financing and the impact of any relevant contractual equity preferences held by us or others. If an investee obtains additional funding at a valuation lower than our carrying amount, we presume that the investment is other than temporarily impaired, unless specific facts and circumstances indicate otherwise, such as when we hold contractual rights that give us a preference over the rights of other investors. As the equity markets have experienced volatility over the past few years, we have experienced substantial impairments in our portfolio of non-marketable equity securities. If certain equity market conditions do not improve, as companies within our portfolio attempt to raise additional funds, the funds may not be available to them, or they may receive lower valuations, with more onerous investment terms than in previous financings, and the investments will likely become impaired. However, we are not able to determine at the present time which specific investments are likely to be impaired in the future, or the extent or timing of individual impairments. We recorded impairment charges related to these non-marketable equity investments of $0.2 million and $0.4 million, respectively, for the three and six months ended September 30, 2007. Similarly, we recorded impairment charges related to these non-marketable equity investments of $0.2 million and $0.3 million, respectively, for the three and six months ended October 1, 2006.

Results of Operations

Revenue

Revenue is comprised of licenses revenue, bundled licenses and services revenue, and services revenue. Licenses revenue consists of fees for time-based or perpetual licenses of our software products. Bundled licenses and services revenue consists of fees for software licenses and post-contract customer support (“PCS”), where we do not have VSOE of fair value of PCS. Services revenue consists of fees for services, such as customer training, consulting and PCS associated with unbundled license arrangements. We recognize revenue based on the specific terms and conditions of the license contracts with our customer for our products and services as described in detail above in our “Critical Accounting Policies and Estimates.” For management reporting and analysis purposes we classify our revenue into the following four categories:

• Ratable

• Due & Payable

• Cash Receipts

• Up-Front/Perpetual or Time-Based

We classify our license arrangements as either bundled or unbundled. Bundled license contracts include maintenance with the license fee and do not include optional maintenance periods. Unbundled license contracts have separate maintenance fees and include optional maintenance periods.

We use this classification of license revenue to provide greater insight into the reporting and monitoring of trends in the components of our revenue and to assist us in managing our business. It is important to note that the characterization of an individual contract may change over time. For example, a contract originally characterized as Ratable may be redefined as Cash Receipts if that customer has difficulty in making payments in a timely fashion. In cases where a contract has been re-characterized for management reporting purposes,

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prior periods are not restated to reflect that change. The following table shows the breakdown of license revenue by category as defined for management reporting and analysis purposes (in thousands, except for percentage data):

	September 30, 2007		% of Revenue			October 1, 2006		% of Revenue
Revenue category:
Three Months Ended:
License and bundled licenses and services revenue
Ratable	$	10,133		19	%	$	4,037		10	%
Due & Payable		20,060		38	%		16,058		38	%
Cash Receipts		1,633		3	%		2,114		5	%
Up-Front*		13,028		24	%		12,650		30	%
		44,854		84	%		34,859		83	%
Services revenue		8,639		16	%		7,103		17	%
Total Revenue	$	53,493		100	%	$	41,962		100	%
Six Months Ended:
License and bundled licenses and services revenue
Ratable	$	20,539		20	%	$	8,942		11	%
Due & Payable		40,329		39	%		33,257		41	%
Cash Receipts		3,188		3	%		4,451		5	%
Up-Front**		22,444		21	%		22,749		27	%
		86,500		83	%		69,399		84	%
Services revenue		17,158		17	%		13,522		16	%
Total Revenue	$	103,658		100	%	$	82,921		100	%

* Included $12,753 or 24% of revenue from new contracts for the quarter ended September 30, 2007, and $9,644 or 23% of revenue from new contracts for the quarter ended October 1, 2006.

** Included $19,822 or 19% of revenue from new contracts for the six months ended September 30, 2007, and $19,743 or 24% of revenue from new contracts for the six months ended October 1, 2006.

Ratable. For bundled time-based licenses, we recognize license revenue ratably over the contract term, or as customer payments become due and payable, if less. The revenue for these bundled arrangements for both license and maintenance is classified as bundled licenses and services revenue in our statements of operations. For unbundled time-based licenses with a term of less than 15 months, we recognize license revenue ratably over the license term. For management reporting and analysis purposes, we refer to both these types of licenses generally as “Ratable” and we generally refer to all time-based licenses recognized on a ratable basis as “Long-Term,” independent of the actual length of term of the license.

We classify unbundled perpetual or time-based licenses with a term of fifteen months or greater based on the payment term structure, as “Due and Payable,” “Cash Receipts” or “Up-Front”:

Due and Payable/Time-Based licenses with long-term payments. For unbundled time-based licenses where the payment terms extend greater than one year from the arrangement effective date, we recognize license revenue on a due and payable basis and we recognize maintenance and services revenue ratably over the maintenance term. For management reporting and analysis purposes, we refer to this type of license generally as “Due and Payable/Long-Term Time-Based Licenses.”

Cash Receipts. We recognize revenue from customers who have not met our predetermined credit criteria on a cash receipts basis to the extent that revenue has otherwise been earned. Such customers generally order short-term time based licenses or separate annual maintenance. We recognize license revenue as we receive cash payments from these customers. Maintenance is recognized ratably over the maintenance term as we

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received cash payments from these customers. For management reporting and analysis purposes, we refer to this type of license revenue as “Cash Receipts.”

Up-Front/Perpetual license or Time-Based licenses with short-term payments. For unbundled time-based and perpetual licenses, we recognize license revenue upon shipment if the payment terms require the customer to pay 100% of the license fee and the initial period of PCS within one year from the agreement date and payments are generally linear. We recognize maintenance revenue ratably over the maintenance term. In all of these cases, the contracts are non-cancelable, and the customer has taken delivery of both the software and the encryption key required to operate the software. For management reporting and analysis purposes, we refer to this type of license generally as “Up-Front,” where the license is either perpetual or time-based.

Our license revenue in any given quarter depends upon the mix and volume of perpetual or short-term licenses ordered during the quarter and the amount of long-term ratable or due and payable, and cash receipts license revenue recognized during the quarter. In general, we refer to license revenue recognized from perpetual or time-based licenses during the quarter as “Up-Front” revenue, for management reporting and analysis purposes. All other types of revenue are generally referred to as revenue from backlog. We set our revenue targets for any given period based, in part, upon an assumption that we will achieve a certain level of orders and a certain mix of short-term licenses. The precise mix of orders fluctuates substantially from period to period and affects the revenue we recognize in the period. If we achieve our target level of total orders but are unable to achieve our target license mix, we may not meet our revenue targets (if we have more-than-expected long-term licenses) or may exceed them (if we have more-than-expected short-term or perpetual licenses). If we achieve the target license mix but the overall level of orders is below the target level, then we may not meet our revenue targets as described in the risk factors in Part II, Item 1A of this Form 10-Q.

Revenue, Cost of Revenue and Gross Profit

The table below sets forth the fluctuations in revenue, cost of revenue and gross profit data for the three and six months ended September 30, 2007 and October 1, 2006 (in thousands, except for percentage data):

	September 30, 2007		% of Revenue			October 1, 2006		% of Revenue			Dollar Change			% Change
Three Months Ended:
Revenue:
Licenses	$	35,637		67	%	$	24,035		57	%	$	11,602			48	%
Bundled licenses and services		9,217		17	%		10,824		26	%		(1,607	)		(15	)%
Services		8,639		16	%		7,103		17	%		1,536			22	%
Total revenue		53,493		100	%		41,962		100	%		11,531			27	%
Cost of revenue:
Licenses		4,603		8	%		5,663		14	%		(1,060	)		(19	)%
Bundled licenses and services		2,117		4	%		3,356		8	%		(1,239	)		(37	)%
Services		5,254		10	%		4,192		10	%		1,062			25	%
Total cost of revenue		11,974		22	%		13,211		32	%		(1,237	)		(9	)%
Gross profit	$	41,519		78	%	$	28,751		68	%	$	12,768			44	%
Six Months Ended:
Revenue:
Licenses	$	67,626		65	%	$	47,154		57	%	$	20,472			43	%
Bundled licenses and services		18,874		18	%		22,245		27	%		(3,371	)		(15	)%
Services		17,158		17	%		13,522		16	%		3,636			27	%
Total revenue		103,658		100	%		82,921		100	%		20,737			25	%
Cost of revenue:
Licenses		9,927		10	%		10,992		13	%		(1,065	)		(10	)%
Bundled licenses and services		4,541		4	%		6,839		8	%		(2,298	)		(34	)%
Services		10,100		10	%		7,946		10	%		2,154			27	%
Total cost of revenue		24,568		24	%		25,777		31	%		(1,209	)		(5	)%
Gross profit	$	79,090		76	%	$	57,144		69	%	$	21,946			38	%

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We market our products and related services to customers in four geographic regions: North America, Europe (consisting of Europe, the Middle East and Africa), Japan, and Asia-Pacific. Internationally, we market our products and services primarily through our subsidiaries and various distributors. Revenue is attributed to geographic areas based on the country in which the customer is domiciled. The table below sets forth geographic distribution of revenue data for the three and six months ended September 30, 2007 and October 1, 2006 (in thousands, except for percentage data):

	September 30, 2007		% of Revenue			October 1, 2006		% of Revenue			Dollar Change			% Change
Three Months Ended:
Domestic	$	31,610		59	%	$	24,241		58	%	$	7,369			30	%
International:
Europe		4,106		8	%		5,848		14	%		(1,742	)		(30	)%
Japan		14,601		27	%		9,542		23	%		5,059			53	%
Asia-Pacific (excluding Japan)		3,176		6	%		2,331		5	%		845			36	%
Total International		21,883		41	%		17,721		42	%		4,162			23	%
Total revenue	$	53,493		100	%	$	41,962		100	%	$	11,531			27	%
Six Months Ended:
Domestic	$	56,053		54	%	$	52,601		63	%	$	3,452			7	%
International:
Europe.		14,864		14	%		10,386		13	%		4,478			43	%
Japan		21,268		21	%		12,798		15	%		8,470			66	%
Asia-Pacific (excluding Japan)		11,473		11	%		7,136		9	%		4,337			61	%
Total International		47,605		46	%		30,320		37	%		17,285			57	%
Total revenue	$	103,658		100	%	$	82,921		100	%	$	20,737			25	%

Revenue

• Revenue for the three and six months ended September 30, 2007 was $53.5 million and $103.7 million, up 27% and 25%, respectively, from the same periods in the prior year.

• Licenses revenue increased by 48% and 43%, respectively, in the three and six months ended September 30, 2007 compared to the same periods in the prior year primarily due to large orders executed during the fiscal 2008 periods in all regions. These orders came from new and existing customers who extended license periods and added license capacity due to the continued proliferation of existing and new Magma products among their design group designers. We do not factor any of our receivables to obtain revenue. One customer accounted for greater than 10% of the revenue for the three and six months ended September 30, 2007. Licenses revenue increased as a percentage of total revenue in the three and six months ended September 30, 2007 compared to the same periods in the prior year.

• Bundled licenses and services revenue decreased by 15% in both the three and six months ended September 30, 2007 compared to the same periods in the prior year primarily driven by a shift of new orders from a few of the Company’s customers to the unbundled licensed revenue category. Bundled licenses and services revenue decreased in all regions except Asia-Pacific. Bundled licenses and services revenue orders came from existing customers who extended license periods and added license capacity due to the continued proliferation of existing and new Magma products among their design group designers. Bundled licenses and services revenue decreased as a percentage of total revenue in the three and six months ended September 30, 2007 compared to the same periods in the prior year.

• Services revenue increased by 22% and 27%, respectively, in the three and six months ended September 30, 2007 compared to the same periods in the prior year. This was due to a $0.9 million and a $2.2 million, respectively, increase in maintenance revenue in the three and six months ended September 30, 2007 compared to the same periods in the prior year, and due to a $0.6 million and a

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$1.5 million, respectively, increase in services and training revenue in the three and six months ended September 30, 2007 compared to the same periods in the prior year. The increase in maintenance and service revenues was primarily due to our growth in customer base. Services revenue as a percentage of total revenue remained approximately the same in the three and six months ended September 30, 2007 compared to the same periods in the prior year.

• Domestic revenueincreased by 30% and 7%, respectively, in the three and six months ended September 30, 2007 compared to the same periods in the prior year primarily due to an increase in licenses revenue from existing customers of $7.0 million and $2.2 million, respectively, and an increase in maintenance and services revenue of $0.5 million and $1.3 million, respectively, in the three and six months ended September 30, 2007 compared to the same periods in the prior year. Domestic revenue as a percentage of total revenue remained approximately the same in the three months ended September 30, 2007 compared to the same period in the prior year, and decreased by 9% in the six months ended September 30, 2007 compared to the same period in the prior year.

• International revenue increased by 23% in the three months ended September 30, 2007 compared to the same periods in the prior year primarily due to an increase in purchases from new and existing customers in Asia-Pacific and Japan, partially offset by a decrease in purchases from new and existing customers in Europe. International revenue increased by 57% in the six months ended September 30, 2007 compared to the same period in the prior year due to increased sales to new and existing customers in all three international regions.

Cost of Revenue

• Cost of licenses revenue primarily consists of amortization of acquired developed technology and other intangible assets, software maintenance costs, royalties and allocated outside sales representative expenses. Cost of licenses revenue decreased by 19% and 10%, respectively, in the three and six months ended September 30, 2007 compared to the same periods in the prior year. Amortization charges related to existing intangible assets decreased in the three and six months ended September 30, 2007 compared to the same periods in the prior year due primarily to several acquired technology licenses which were fully amortized during the fiscal 2008 periods. The decreases were partially offset by increases in amortization charges related to intangible assets acquired subsequent to the first or second quarter of fiscal 2007 and decreases in costs allocated to cost of bundled licenses and services revenue in the three and six months ended September 30, 2007 compared to the same periods in the prior year.

• Cost of bundled licenses and services revenue primarily consists of allocation of costs from cost of licenses and services. Cost of bundled licenses and services revenue decreased in the three and six months ended September 30, 2007 compared to the same periods in the prior year primarily due to decreases in bundled licenses and services revenue in fiscal 2008 compared to fiscal 2007.

• Cost of services revenue primarily consists of personnel and related costs to provide product support, training and consulting services. Cost of services revenue also includes stock-based compensation expenses, asset depreciation and allocated outside sales representative expenses. Cost of services revenue increased in the three and six months ended September 30, 2007 compared to the same periods in the prior year primarily due to increases in payroll related costs and stock-based compensation expenses for application engineers that corresponded to higher consulting and maintenance activities in fiscal 2008 compared to fiscal 2007.

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Operating Expenses

The table below sets forth operating expense data for the three and six months ended September 30, 2007 and October 1, 2006 (in thousands, except for percentage data):

	September 30, 2007		% of Revenue			October 1, 2006		% of Revenue			Dollar Change			% Change
Three Months Ended:
Operating expenses:
Research and development	$	18,355		34	%	$	15,608		37	%	$	2,747			18	%
Sales and marketing		18,645		35	%		14,567		35	%		4,078			28	%
General and administrative		7,533		14	%		8,211		19	%		(678	)		(8	)%
Amortization of intangible assets		2,039		4	%		2,922		7	%		(883	)		(30	)%
In-process research and development		656		1	%		—					656			100	%
Total operating expenses	$	47,228		88	%	$	41,308		98	%	$	5,920			14	%

	September 30, 2007		% of Revenue			October 1, 2006		% of Revenue			Dollar Change			% Change
Six Months Ended:
Operating expenses:
Research and development	$	37,025		36	%	$	31,057		37	%	$	5,968			19	%
Sales and marketing		35,547		34	%		28,414		34	%		7,133			25	%
General and administrative		15,867		15	%		20,006		24	%		(4,139	)		(21	)%
Amortization of intangible assets		4,066		4	%		5,812		7	%		(1,746	)		(30	)%
In-process research and development		656		1	%		—					656			100	%
Restructuring charge		291		0	%		—					291			100	%
Total operating expenses	$	93,452		90	%	$	85,289		103	%	$	8,163			10	%

• Research and development expense increased by 18% and 19%, respectively, in the three and six months ended September 30, 2007 compared to the same periods in the prior year. The increase was due to increases in payroll related expenses of $1.3 million and $3.2 million, respectively, higher allocated common expenses, such as information technology and facility related expenses, of $1.0 million and $1.8 million, respectively, and increases in other individually insignificant items such as stock-based compensation, professional fees and travel expenses in the three and six months ended September 30, 2007 compared to the same periods in the prior year. The increase in payroll related expenses was primarily due to increases in the number of employees and annual salary increases. At the end of the second quarter of fiscal 2008, the number of our research and development employees increased by 39% through direct hiring and acquisitions compared to the same fiscal 2007 period. We expect our quarterly research and development expenses in each of the remaining two quarters of fiscal 2008 to increase moderately but to decrease as a percentage of total revenue. Moderate growth in the number of our research and development employees will be the primary factor driving up both fixed and variable compensation levels.

• Sales and marketing expense increased by 28% and 25%, respectively, in the three and six months ended September 30, 2007 compared to the same periods in the prior year primarily due to an increase in payroll related expenses of $2.8 million and $4.9 million, respectively, an increase in commission expense of $0.9 million and $1.2 million, respectively, and an increase in travel expense of $0.4 million and $0.9 million, respectively, in the three and six months ended September 30, 2007 compared to the same periods in the prior year. The remainder of the fluctuation in sales and marketing expense was accounted for by other individually insignificant items. The increases in payroll related charges were primarily due to increases in the number of employees and annual salary increases. At the end of the second quarter of fiscal 2008, the number of employees in sales and marketing increased by 27% over the comparable fiscal 2007 period primarily due to growth in

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the number of application engineer employees. We expect marketing expense in each of the remaining two quarters of fiscal 2008 to increase moderately but to decrease as a percentage of total revenue. Moderate growth in the number of our sales and marketing employees will be the primary factor driving up both fixed and variable compensation levels.

• General and administrative expense decreased by 8% and 21%, respectively, in the three and six months ended September 30, 2007 compared to the same periods in the prior year primarily due to a decrease of $1.2 million and $5.4 million, respectively, in legal fees related to patent litigation with Synopsys and an increase of $1.7 million and $2.8 million, respectively, in allocated cost to other functional areas due to higher common expenses in the three and six months ended September 30, 2007 compared to the same periods in the prior year. The decreases were partially offset by increases in office and facility related expenses of $1.0 million and $1.7 million, respectively, payroll related expenses of $0.7 million and $1.1 million, respectively, and other professional fees of $0.2 million and $0.4 million, respectively, in the three and six months ended September 30, 2007 compared to the same periods in the prior year. We expect that our quarterly general and administrative expenses in each of the remaining two quarters of fiscal 2008 will remain at levels comparable to those in the first half of fiscal 2008 and will decrease as a percentage of total revenue.

• Amortization of intangible assets decreased by 30% in both the three and six months ended September 30, 2007 compared to the same periods in the prior year primarily due to several existing developed technologies and patents have been fully amortized during the fiscal 2008 periods.

• In-process research and development of $0.7 million in the second quarter of fiscal 2008 consisted of a charge recorded in connection with our acquisition of Rio in September 2007. The charges were recorded based on management’s final purchase price allocation and were related to acquired technologies for which commercial feasibility had not been established and had no alternative future uses. We expect to bring Rio’s in-process products to completion during the fourth quarter of fiscal 2009.

• Restructuring charges of $0.3 million in the first quarter of fiscal 2008 represented employee termination charges resulting from our realignment to current business conditions. No such charge was incurred in fiscal 2007.

Other Items

The table below sets forth other data for the three and six months ended September 30, 2007 and October 1, 2006 (in thousands, except for percentage data):

	September 30, 2007			% of Revenue			October 1, 2006			% of Revenue			Dollar Change			% Change
Three Months Ended:
Other income (expense), net:
Interest income	$	489			1	%	$	671			2	%	$	(182	)		(27	)%
Interest expense		(599	)		(1	)%		(133	)		(0	)%		(466	)		350	%
Other income (expense), net		796			(1	)%		(493	)		(1	)%		1,289
Total other income (expense), net	$	686			0	%	$	45			0	%	$	641
Provision (benefit) from income taxes	$	1,372			3	%	$	(91	)		0	%	$	1,463
Six Months Ended:
Other income (expense), net:
Interest income	$	948			1	%	$	1,558			2	%	$	(610	)		(39	)%
Interest expense.		(1,256	)		(1	)%		(308	)		(0	)%		(948	)		(308	)%
Gain on extinguishment of debt		—						4,809			6	%		(4,809	)
Other income (expense), net		69			0	%		(599	)		(1	)%		668
Total other income (expense), net	$	(239	)		0	%	$	5,460			7	%	$	(5,699	)
Provision for income taxes	$	3,063			3	%	$	770			1	%	$	2,293			298	%

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• Interest income decreased in the three and six months ended September 30, 2007 compared to the same periods in the prior year primarily due to our lower cash and investments balance resulting from our use of cash in operations, to acquire intangible assets and to repurchase a portion of our 2008 Notes. The decrease was partially offset by higher interest rates on our cash and investments balance during the period.

• Interest expense increased in the three and six months ended September 30, 2007 compared to the same periods in the prior year primarily due to an addition of $0.4 million and $0.8 million, respectively, expense related to debt discount amortization and the 2% interest payment on the 2010 Notes. The 2010 Notes offering was completed in the fourth quarter of fiscal 2007. The remainder of the fluctuation in interest expense was accounted for by other individually insignificant items, such as amortization of debt issuance costs related to the 2008 and 2010 Notes, and interest expenses on the line of credit and capital leases.

• Gain on extinguishment of debt in the first quarter of fiscal 2007 consisted primarily of a $4.8 million gain on repurchases of a portion of the 2008 Notes.

• Other income, net increased in the three and six months ended September 30, 2007 compared to the same periods in the prior year primarily due to a $0.7 million and $1.3 million, respectively, change in foreign exchange gain/loss in fiscal 2008 periods. The changes in foreign exchange gain/loss were primarily caused by favorable exchange rate fluctuations between the U.S. Dollar and the Japanese Yen.

• Provision for income taxes increased by $1.5 million and $2.3 million, respectively, in the three and six months ended September 30, 2007 compared to the same periods in the prior year. The increase was primarily due to an increase in tax provisions for taxes in foreign tax jurisdictions and for federal and state taxes on income from our business operations. The income tax expenses for the discrete items for the three and six months ended September 30, 2007 was immaterial. The income tax expense of $1.3 million and $3.0 million, respectively, for the three and six months ended September 30, 2007 consisted primarily of federal, state, and foreign taxes provided for the income from our business operations. We recorded a tax benefit in the second quarter of fiscal 2007 to reflect the adjustment to the federal and state taxes provided in the prior quarter for certain discrete items, such as gain on the repurchase of the convertible bonds, impairment of certain equity investments, and cumulative effect of the change in accounting principle due to the change in our forecasts and other estimates. Our effective tax rates vary from the U.S. statutory rate primarily due to changes in our valuation allowance, state taxes, foreign income taxed at other than U.S. rates, stock compensation expense, research and development credits and foreign withholding taxes. We are in a net deferred tax asset position, for which a full valuation allowance has been recorded. We will continue to provide a valuation allowance on our net deferred tax assets until it becomes more likely than not that the deferred tax assets will be realizable. We will continue to evaluate the realizability of the deferred tax assets on a quarterly basis.

In the event of a future change in ownership, as defined under federal and state tax laws, our net operating loss and tax credit carryforwards may be subject to an annual limitation. The annual limitations may result in an increase to our current income tax provision and/or the expiration of the net operating loss and tax credit carryforwards before realization.

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Liquidity and Capital Resources

The table below sets forth certain cash flow data as of September 30, 2007 and April 1, 2007, and for the six months ended September 30, 2007 and October 1, 2006 (in thousands):

	September 30, 2007		April 1, 2007
Cash, cash equivalents and short-term investments	$	54,214	$	56,038

For the Six Months Ended:	September 30, 2007			October 1, 2006
Net cash provided by (used in) operating activities	$	(3,469	)	$	7,169
Net cash provided by (used in) investing activities	$	(5,003	)	$	15,521
Net cash provided by (used in) financing activities	$	9,042		$	(32,351	)

Our cash, cash equivalents and short-term investments, excluding restricted cash, were approximately $54.2 million on September 30, 2007, a decrease of $1.8 million or 3% from April 1, 2007. The decrease primarily reflected cash used in operations, which included the payments related to the Synopsys litigation settlement, legal fees and annual employee bonuses, cash for purchases of intangible assets and capital investments, and cash for repayment of the $3.0 million borrowing under the line of credit facility. These decreases were partially offset by proceeds from sale of short-term investments, issuance of common stock and releases of restricted cash. At September 30, 2007, our investment portfolio consisted of auction rate securities which provide liquidity at par every 28 days with underlying longer-term maturities.

We hold our cash and cash equivalents in the United States and in foreign accounts, primarily in the Netherlands and Japan. As of September 30, 2007, we held an aggregate of $28.1 million in cash and cash equivalents in the United States and an aggregate of $17.8 million in foreign accounts.

Net Cash Provided by (used in) Operating Activities

We generated $20.0 million of cash from operating activities in the second quarter of fiscal 2008 and used $23.4 million of cash in operating activities in the first quarter of fiscal 2008. Net cash used in operating activities increased by $10.6 million in the six months ended September 30, 2007 compared to the same period in the prior year. The increase was primarily due to a $15.4 million increase in payments on accounts payable and accrued liabilities balances, and a $12.5 million increase in costs and expenses. These decreases in cash flow were partially offset by a $17.7 million increase in cash from customers in the fiscal 2008 period. The increase in cash from customers was primarily due to growth in revenue and strong cash collection in the fiscal 2008 period. The decrease in accrued liabilities balances in the six months ended September 30, 2007 was primarily due to payment of $12.5 million on the Synopsys litigation settlement, legal fees and annual employee bonuses.

Net Cash Provided by (used in) Investing Activities

Net cash used in investing activities increased by $20.5 million in the six months ended September 30, 2007 compared to the same period in the prior year. The increase was primarily due to a $22.3 million decrease in net proceeds from sales of short-term investments and a $2.5 million increase in purchases of property and equipment, partially offset by an increase of $4.9 million cash from releases of restricted cash. In connection with the establishment of the $10.0 million credit facility, we are no longer required to maintain restricted cash balances relating to the $1.7 million letters of credit and to the $3.0 million borrowing under the prior credit facility which was paid off in the second quarter of fiscal 2008. We expect to make capital expenditures of approximately $3.5 million during the remainder of fiscal 2008. These capital expenditures will be used to support selling, marketing and product development activities. We will use capital lease financing as well as our cash and cash equivalents to fund these purchases. In addition, we may make earnout payments related to prior acquisitions and acquire additional technologies and strategic equity investments in the future using our cash and cash equivalents.

Net Cash Provided by (used in) Financing Activities

Net cash provided by financing activities increased by $41.4 million in the six months ended September 30, 2007 compared to the same period in the prior year. The increase was primarily due to a $10.0 million

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increase in cash received from the exercise of stock options and shares purchased under the employee stock purchase plan. In addition, we used $35.0 million to repurchase a portion of our 2008 Notes in the first quarter of fiscal 2007. The increases were partially offset by a $3.0 million repayment of the outstanding borrowing under our line of credit facility and a $0.5 million increase in payments of capital lease obligations in the six months ended September 30, 2007.

Capital Resources

We believe that our existing cash and cash equivalents will be sufficient to repay the 2008 Notes of $15.2 million which is due in May 2008 and to meet our anticipated operating and working capital expenditure requirements in the ordinary course of business for at least the next 12 months. If we require additional capital resources to grow our business internally or to acquire complementary technologies and businesses at any time in the future, we may use cash or need to sell additional equity or debt securities. The sale of additional equity or convertible debt securities may result in more dilution to our existing stockholders. Financing arrangements may not be available to us, or may not be available in amounts or on terms acceptable to us.

In July 2007, we established a $10.0 million unsecured revolving line of credit facility with Wells Fargo Bank, N.A. This credit facility, which replaces the $5.0 million revolving line of credit facility previously established in November 2006, is available through July 2012 and bears an interest rate equal to the bank’s prime rate less 1.20% or LIBOR plus 1.00%. We are required to make interest only payments monthly and the outstanding principal amount plus all accrued but unpaid interest is payable in full at the expiration of the credit facility. The credit facility requires that we maintain certain financial conditions and pay fees of 0.125% per year on the unused amount of the facility. In addition, the credit facility allows letters of credit to be issued on our behalf, provided that the aggregate outstanding amount of the letters of credit shall not exceed the available amount for borrowing under the credit facility. Letters of credit under the prior facility were transferred to the new $10.0 million credit facility. As of September 30, 2007, two letters of credit totaling $1.7 million were outstanding and we had a borrowing base availability of $8.3M under the credit facility. Since the new credit facility is unsecured, we are no longer required to maintain restricted cash balances relating to the letters of credit under the credit facility.

Contractual Obligations

As of September 30, 2007, other than the repayment of $3.0 million borrowing under our line of credit facility, there were no material changes in our reported payments due under contractual obligations as of April 1, 2007. Our principal contractual obligations consisted of operating lease commitments, with an aggregated future amount of $18.2 million through fiscal 2013 for office facilities, repayments of the convertible notes of $15.2 million due in May 2008 and $49.9 million due in May 2010. Although we have no material commitments for capital expenditures, we anticipate a substantial increase in our capital expenditures and lease commitments with our anticipated growth in operations, infrastructure, and personnel. In addition, we have other obligations for goods and services entered into in the normal course of business. These obligations, however, either are not enforceable or legally binding or are subject to change based on our business decisions.

Our acquisition agreements related to certain business combination and asset purchase transactions obligate us to pay certain contingent cash consideration based on meeting certain financial or project milestones and continued employment of certain employees. The total amount of cash contingent consideration that could be paid under our acquisition agreements, assuming all contingencies are met, was $40.0 million as of September 30, 2007. These contingent consideration obligations are not expected to affect our estimate that our existing cash and cash equivalents will be sufficient to repay the 2008 Notes of $15.2 million which is due in May 2008 and to meet our anticipated operating and working capital expenditure requirements in the ordinary course of business for at least the next 12 months.

Income Taxes

As of September 30, 2007, our unrecognized tax benefits amounted to $11.6 million and were included in our long-term tax liabilities on our unaudited condensed balance sheets. We are not able to estimate the amount or timing of any cash payments required to settle these liabilities, however we do not anticipate the settlement of the liabilities will require payment of cash within the next twelve months and do not believe that the ultimate settlement of these obligations will materially affect our liquidity.

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Off-balance Sheet Arrangements

As of September 30, 2007, we did not have any significant “off-balance-sheet arrangements,” as defined in Item 303(a)(4)(ii) of Regulation S-K.

Indemnification Obligations

We enter into standard license agreements in the ordinary course of business. Pursuant to these agreements, we agree to indemnify our customers for losses suffered or incurred by them as a result of any patent, copyright, or other intellectual property infringement claim by any third party with respect to our products. These indemnification obligations have perpetual terms. Our normal business practice is to limit the maximum amount of indemnification to the amount received from the customer. On occasion, the maximum amount of indemnification we may be required to make may exceed its normal business practices. We estimate the fair value of our indemnification obligations as insignificant, based on our historical experience concerning product and patent infringement claims. Accordingly, we have no liabilities recorded for indemnification under these agreements as of September 30, 2007.

We have agreements whereby our officers and directors are indemnified for certain events or occurrences while the officer or director is, or was, serving at our request in such capacity. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we retain directors and officers insurance that reduces our exposure and enables us to recover portions of future amounts paid. As a result of our insurance coverage, we believe the estimated fair value of these indemnification agreements is minimal. Accordingly, no liabilities have been recorded for these agreements as of September 30, 2007.

In connection with certain of our recent business acquisitions, we have also agreed to assume, or cause our subsidiaries to assume, the indemnification obligations of those companies to their respective officers and directors. No liabilities have been recorded for these agreements as of September 30, 2007.

Warranties

We warrant to our customers that our products will conform to the documentation provided. To date, there have been no payments or material costs incurred related to fulfilling these warranty obligations. Accordingly, we have no liabilities recorded for these warranties as of September 30, 2007. We assess the need for a warranty accrual on a quarterly basis, and there can be no guarantee that a warranty accrual will not become necessary in the future.

Item 3. Quantitative and Qualitative Disclosures About Markert Risk

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. The primary objective of our investment activities is to preserve principal while maximizing yields without significantly increasing risk. This is accomplished by investing in widely diversified short-term and long-term investments, consisting primarily of investment grade securities. As of September 30, 2007, a hypothetical 100 basis point increase in interest rates would result in approximately a $4,000 decline in the fair value of our cash equivalents and short-term investments.

The fair value of our fixed rate long-term debt is sensitive to interest rate changes. Interest rate changes would result in increases or decreases in the fair value of our debt, due to differences between market interest rates and rates in effect at the inception of our debt obligation. Changes in the fair value of our fixed rate debt have no impact on our cash flows or consolidated financial statements.

Credit Risk

We completed an offering on May 22, 2003 of $150.0 million principal amount of the 2008 Notes. Concurrent with the issuance of the 2008 Notes, we entered into convertible bond hedge and warrant transactions with respect to our common stock, the exposure for which is held by Credit Suisse First Boston International. Both the bond hedge and warrant transactions may be settled at our option either in cash or net shares and expire on May 15, 2008. The transactions are expected to reduce the potential dilution from conversion of the 2008 Notes. Subject to the movement in the share price of our common stock, we could be

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exposed to credit risk in the settlement of these options in our favor. Based on a review of the possible net settlements and the credit strength of Credit Suisse First Boston International and its affiliates, we believe that we do not have a material exposure to credit risk arising from these option transactions.

In May 2005 and May 2006, we repurchased $$44.5 million and $40.3 million, respectively, face value of our 2008 Notes for $34.8 million and $35.0 million, respectively. In doing so, we liquidated investments that generated a realized loss of approximately $0.7 million related to the May 2005 repurchases. There were no significant losses realized in connection with the May 2006 repurchases. Certain portions of the hedge and warrant transactions entered into by us in 2003 were terminated in connection with the repurchases. We believe that it was in the best interests of the stockholders to reduce the balance sheet debt despite the one-time loss resulting from the liquidation of marketable securities.

Foreign Currency Exchange Rate Risk

A majority of our revenue, expense, and capital purchasing activities are transacted in U.S. dollars. However, we transact some portions of our business in various foreign currencies, primarily related to a portion of revenue in Japan and operating expenses in Europe, Japan and Asia-Pacific. Accordingly, we are subject to exposure from adverse movements in foreign currency exchange rates. As of September 30, 2007, we had approximately $11.2 million of cash and money market funds in foreign currencies. As of that date, we had not utilized hedging instruments in connection with our currency exposures. Subsequently, in the third quarter of fiscal 2008, we entered into financial instruments to mitigate the effects of our currency exposure risk going forward.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures were effective.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control or to our knowledge, in other factors that could significantly affect our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

We are subject to certain legal proceedings described below and from time to time, we are also involved in other disputes that arise in the ordinary course of business. The number and significance of these litigation proceedings and disputes are increasing as our business expands and we grow larger. Any claims against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and result in the diversion of significant operational resources. As a result, these litigation proceedings and disputes could harm our business and have an adverse effect on our consolidated financial statements. However, the results of any litigation or dispute are inherently uncertain and, at this time, no estimate could be made of the loss or range of loss, if any, from these litigation matters and disputes. Accordingly, we have not recorded any liabilities relating to these contingencies as of September 30, 2007. Litigation settlement and legal fees are expensed in the period in which they are incurred.

On June 13, 2005, a putative shareholder class action lawsuit captionedThe Cornelia I. Crowell GST Trust vs. Magma Design Automation, Inc., Rajeev Madhavan, Gregory C. Walker and Roy E. Jewell., No. C 05 02394, was filed in U.S. District Court, Northern District of California. The complaint alleges that defendants failed to disclose information regarding the risk of Magma infringing intellectual property rights of Synopsys, Inc., in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and prays for unspecified damages. In March 2006, defendants filed a motion to dismiss the consolidated amended complaint. Plaintiff filed a further amended complaint in June 2006, which defendants again moved to dismiss. Defendants’ motion was granted in part and denied in part by an order dated August 18, 2006, which dismissed claims against two of the individual defendants. The case is now proceeding on the remaining claims and is scheduled for trial on December 3, 2008. This case was also discussed in our Annual Report on Form 10-K for the fiscal year ended April 1, 2007.

On July 26, 2005, a putative derivative complaint captionedSusan Willis v. Magma Design Automation, Inc. et al., No. 1-05-CV-045834, was filed in the Superior Court of the State of California for the County of Santa Clara. The Complaint seeks unspecified damages purportedly on behalf of us for alleged breaches of fiduciary duties by various directors and officers, as well as for alleged violations of insider trading laws by executives during a period between October 23, 2002 and April 12, 2005. Defendants have demurred to the Complaint, and the action has been stayed pending further developments in the putative shareholder class action referenced above. This case was also discussed in our Annual Report on Form 10-K for the fiscal year ended April 1, 2007.

Narpat Bhandari v. Magma Design Automation, Inc. Cadence Design Systems, Inc., Dynalith Systems, Inc., Altera Corp., Mentor Graphics Corp. and Aldec, Inc., Case No. 6:06-CV-480, United States District Court, Eastern District of Texas, Tyler Division. On November 8, 2006, a complaint was filed alleging that we and several other named defendants infringe United States Patent No. 5,663,900. The complaint identifies our FineSim software, and other unidentified devices or programs, as the products accused of infringement. We and the other Defendants moved to dismiss the complaint on the basis that the only named plaintiff, Bhandari, does not own the ‘900 Patent. On May 11, 2007, the Court issued a Memorandum Opinion and Order granting the motion to dismiss and dismissed the case without prejudice. This case was also discussed in our Annual Report on Form 10-K for the fiscal year ended April 1, 2007.

Cadence Design Systems, Inc., Magma Design Automation, Inc., Altera Corp., and Mentor Graphics Corp. v. Narpat Bhandari and Vanguard Systems, Inc., Case No. C 07-00823, United States District Court, Northern District of California, San Francisco Division. Magma and the other named plaintiffs filed a complaint for declaratory judgment on February 8, 2007, which we amended on March 27, 2007. The amended complaint for declaratory judgment asserts five claims for relief: (1) declaratory judgment of non-infringement of the ‘900 Patent; (2) declaratory judgment of invalidity of the ‘900 Patent; (3) lack of ownership of the ‘900 Patent; (4) the ‘900 Patent is unenforceable due to laches; and (5) declaratory judgment that the doctrine of unclean hands bars enforcement of the ‘900 Patent. We and the other Plaintiffs contend that LSI Logic is a joint owner of the ‘900 Patent, and we have obtained a license from LSI. On April 6, 2007, Defendants Narpat Bhandari and Vanguard Systems, Inc. answered the amended complaint and filed a counterclaim of patent infringement of the ‘900 Patent. As in the Texas Action, the claim for patent infringement against us

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identified our FineSim software, and other unidentified devices or programs, as the products accused of infringement. The counterclaim seeks unspecified monetary damages, pre- and post-judgment interest, attorneys’ fees, and costs. The Court conducted a case management conference on May 21, 2007, and issued a case management order on May 23, 2007, approving Plaintiffs’ and Defendants’ proposal to bifurcate the issue of LSI’s ownership from all other remaining issues and stay activities relating to validity, enforceability, infringement, and damages until after a bench trial to resolve the ownership issue. The Court scheduled the bench trial on the sole issue of ownership of the ‘900 Patent to begin on October 9, 2007. On July 27, 2007, Magma and the other Plaintiffs filed a motion for summary judgment requesting judgment in favor of the Plaintiffs on the grounds that LSI is a co-owner of the ‘900 Patent. Plaintiffs’ motion was fully briefed and was scheduled for oral argument before the Court on September 27, 2007, the same day that the Court had previously scheduled a pre-trial conference. The Court, however, had to cancel the hearing, and in a September 28, 2007 Order, the Court vacated the summary judgment hearing date, the pre-trial conference date, and the bench trial date. The Court stated that it would decide the summary judgment motion on the papers. The Court has not yet issued any further orders. We intend to vigorously defend against the claims asserted by Bhandari and Vanguard Systems. However, the results of any litigation are inherently uncertain, and we can not assure that we will be able to successfully defend against the claims of Bhandari and Vanguard Systems. We are currently unable to assess the extent of damages and/or other relief, if any, that could be awarded to Bhandari and Vanguard Systems. This case was also discussed in our Annual Report on Form 10-K for the fiscal year ended April 1, 2007.

Item 1A. Risk Factors

A restated description of the risk factors associated with our business is set forth below. This description includes any material changes to and supersedes the description of the risk factors associated with our business previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended April 1, 2007.

Our business faces many risks. The risks described below may not be the only risks we face. Additional risks that we do not yet know of or that we currently think are immaterial may also impair our business operations. If any of the events or circumstances described in the following risk factors actually occur, our business, financial condition or results of operations could suffer, and the trading price of our common stock could decline.

Our limited operating history makes it difficult to evaluate our business and prospects.

We were incorporated in April 1997 and introduced our first major software product, Blast Fusion, in April 1999. We have a limited history of generating revenue from our software products, and the revenue and income potential of our business and market is still unproven. As a result of our short operating history, we have limited financial data that can be used to evaluate our business. We have only been profitable in fiscal 2003 and fiscal 2004. Our software products represent a new approach to the challenges presented in the electronic design automation market, which to date has been dominated by established companies with longer operating histories. Key markets within the electronic design automation industry may fail to adopt our proprietary technologies and use our software products. Any evaluation of our business and our prospects must be considered in light of our limited operating history and the risks and uncertainties often encountered by relatively young companies.

We have a history of losses, except for fiscal 2003 and fiscal 2004, and had an accumulated deficit of approximately $216.1 million as of September 30, 2007. If we continue to incur losses, the trading price of our stock would likely decline.

We had an accumulated deficit of approximately $216.1 million as of September 30, 2007. Except for fiscal 2003 and fiscal 2004, we incurred losses in all other fiscal years. If we continue to incur losses, or if we fail to achieve profitability at levels expected by securities analysts or investors, the market price of our common stock is likely to decline. If we continue to incur losses, we may not be able to maintain or increase our number of employees or our investment in capital equipment, sales, marketing, and research and development programs. Further, we may not be able to continue to operate.

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Our quarterly results are difficult to predict, and if we fail to reach certain quarterly financial expectations, our stock price is likely to decline.

Our quarterly revenue and operating results fluctuate from quarter to quarter and are difficult to predict. It is likely that our operating results in some periods will be below investor expectations. If this happens, the market price of our common stock is likely to decline. Fluctuations in our future quarterly operating results may be caused by many factors, including:

• size and timing of customer orders, which are received unevenly and unpredictably throughout a fiscal year;

• the mix of products licensed and types of license agreements;

• our ability to recognize revenue in a given quarter;

• higher than anticipated costs in connection with litigation;

• timing of customer license payments;

• the relative mix of time-based licenses bundled with maintenance, unbundled time-based license agreements and perpetual license agreements, each of which has different revenue recognition practices;

• size and timing of revenue recognized in advance of actual customer billings and customers with graduated payment schedules which may result in higher accounts receivable balances and days sales outstanding (“DSO”);

• the relative mix of our license and services revenue;

• our ability to win new customers and retain existing customers;

• changes in our pricing and discounting practices and licensing terms and those of our competitors;

• changes in the level of our operating expenses, including general compensation levels as well as increases in incentive compensation payments that may be associated with future revenue growth;

• variability in stock-based compensation charges related to our option exchange program;

• changes in the interpretation of the authoritative literature under which we recognize revenue;

• the timing of product releases or upgrades by us or our competitors; and

• the integration, by us or our competitors, of newly-developed or acquired products.

We have faced lawsuits brought by Synopsys, Inc. related to patent infringement and other claims, and we may face additional intellectual property infringement claims or other litigation. Lawsuits can be costly to defend, can take the time of our management and employees away from day-to-day operations, and could result in our losing important rights and paying significant damages.

Synopsys previously filed various suits, including an action for patent infringement, against us. In addition, a putative shareholder class action lawsuit and a putative derivative lawsuit have been filed against us. All claims brought against us by Synopsys have been fully resolved by a settlement and a license under the asserted patents, although other similar litigation involving Synopsys or other parties may follow (subject, in the case of Synopsys, to the terms of the settlement agreement with Synopsys pursuant to which we and Synopsys agreed not to initiate future patent litigation against each other for a period of two years commencing on March 29, 2007 provided certain terms are met). In the future Synopsys or other parties may assert intellectual property infringement claims against us or our customers (subject, in the case of Synopsys, to the terms of our settlement agreement with Synopsys). We may have acquired or may in the future acquire software as a result of our acquisitions, and we could be subject to claims that such software infringes the intellectual property rights of third parties. We also license technology from certain third parties and could be subject to claims if the software which we license is deemed to infringe the rights of others. In addition, we

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are often involved in or threatened with commercial litigation unrelated to intellectual property infringement claims such as labor litigation and contract claims, and we may acquire companies that are actively engaged in such litigation.

Our products may be found to infringe intellectual property rights of third parties, including third-party patents. In addition, many of our contracts contain provisions in which we agree to indemnify our customers from third-party intellectual property infringement claims that are brought against them based on their use of our products. Also, we may be unaware of filed patent applications that relate to our software products. We believe that the patent portfolios of our competitors generally are far larger than ours. This disparity between our patent portfolio and the patent portfolios of our competitors may increase the risk that they may sue us for patent infringement and may limit our ability to counterclaim for patent infringement or settle through patent cross-licenses.

The outcome of intellectual property litigation and other types of litigation could result in our loss of critical proprietary rights and unexpected operating costs and substantial monetary damages. Intellectual property litigation and other types of litigation are expensive and time-consuming and could divert our management’s attention from our business. If there is a successful claim against us for infringement, we may be ordered to pay substantial monetary damages (including punitive damages), we may also be prevented from distributing all or some of our products, and we may also be required to develop non-infringing technology or enter into royalty or license agreements, which may not be available on acceptable terms, if at all. Our failure to develop non-infringing technologies or license the proprietary rights on a timely basis would harm our business.

Publicly announced developments in our litigation matters may cause our stock price to decline sharply and suddenly. Other factors may reduce the market price of our common stock, and we are subject to ongoing risks of securities class action litigation related to volatility in the market price for our common stocks.

We may not be successful in defending some or all claims that may be brought against us. Regardless of the outcome, litigation can result in substantial expense and could divert the efforts of our management and technical personnel from our business. In addition, the ultimate resolution of the lawsuits could have a material adverse effect on our financial position, results of operations and cash flows, and harm our ability to execute our business plan.

The price of our common stock may fluctuate significantly, which may make it difficult for our stockholders to resell our stock at attractive prices.

Our common stock trades on the Nasdaq Global Market under the symbol “LAVA”. There have been previous quarters in which we have experienced shortfalls in revenue and earnings from levels expected by securities analysts and investors, which have had an immediate and significant adverse effect on the trading price of our common stock. Furthermore, the price of our common stock has fluctuated significantly in light of the recent litigation with Synopsys.

In March, 2007, we completed exchanges, whereby certain holders of approximately $49.9 million in aggregate principal amount of our Zero Coupon Convertible Subordinated Notes due May 15, 2008 (the “2008 Notes”) agreed to exchange their 2008 Notes for an equal aggregate principal amount of 2% Convertible Senior Notes due May 15, 2010 (the “2010 Notes”). The 2010 Notes were initially convertible into 3,329,267 shares of our common stock. Approximately $15.2 million aggregate principal amount of the 2008 Notes remain outstanding, which is convertible into 664,916 shares of our common stock. Upon the occurrence of certain triggering events, the number of shares of our common stock that are issuable upon conversion of the 2010 Notes may be increased by up to an additional 1,098,658 shares of our common stock. Sales of a substantial number of shares of our common stock in the public market following this note exchange, or any conversion of the 2010 Notes into shares of our common stock or the perception that such sales may occur, could cause the market price of our common stock to decline and could increase the fluctuations in our stock price.

The market price of our stock is subject to significant fluctuations in response to the risk factors set forth in this Item 1A., many of which are beyond our control. Such fluctuations, as well as economic conditions generally, may adversely affect the market price of our common stock.

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In addition, the stock market in recent years has experienced extreme price and trading volume fluctuations that often have been unrelated or disproportionate to the operating performance of individual companies. These broad market fluctuations may adversely affect the price of our common stock, regardless of our operating performance. Recent problems with the financial system, such as problems involving banks as well as the mortgage markets, might increase such market fluctuations.

We may not be able to hire and/or retain the number of qualified personnel required for our business, particularly engineering personnel, which would harm the development and sales of our products and limit our ability to grow.

Competition in our industry for senior management, technical, sales, marketing and other key personnel is intense. If we are unable to retain our existing personnel, or attract and train additional qualified personnel, our growth may be limited due to a lack of capacity to develop and market our products.

In particular, we continue to experience difficulty in hiring and retaining skilled engineers with appropriate qualifications to support our growth strategy. Our success depends on our ability to identify, hire, train and retain qualified engineering personnel with experience in integrated circuit design. Specifically, we need to continue to attract and retain field application engineers to work with our direct sales force to qualify new sales opportunities technically and perform design work to demonstrate our products’ capabilities to customers during the benchmark evaluation process. Competition for qualified engineers is intense, particularly in the Silicon Valley area where our headquarters is located.

Furthermore, in light of our adopting SFAS 123R in the first quarter of our fiscal year 2007, we changed our employee compensation practices, and those changes could make it harder for us to retain existing employees and attract qualified candidates. If we lose the services of a significant number of our employees and/or if we cannot hire additional employees of the same caliber, we will be unable to increase our sales or implement or maintain our growth strategy.

Our success is highly dependent on the technical, sales, marketing and managerial contributions of key individuals who we may be unable to recruit and retain.

We depend on our senior executives and certain key research and development and sales and marketing personnel, who are critical to our business. We do not have long-term employment agreements with our key employees, and we do not maintain any key person life insurance policies. Furthermore, our larger competitors may be able to offer more generous compensation packages to executives and key employees, and therefore we risk losing key personnel to those competitors. If we lose the services of any of our key personnel, our product development processes and sales efforts could be slowed. We may also incur increased operating expenses and be required to divert the attention of our senior executives to search for their replacements. The integration of new executives or new personnel could disrupt our ongoing operations.

Customer payment defaults may cause us to be unable to recognize revenue from backlog, and changes in the type of orders comprising backlog could affect the proportion of revenue recognized from backlog each quarter, which could have a material adverse effect on our financial condition and results of operations.

A portion of our revenue backlog is variable based on volume of usage of our products by the customers or includes specific future deliverables or is recognized in revenue on a cash receipts basis. Our management has estimated variable usage based on customers’ forecasts, but there can be no assurance that these estimates will be realized. In addition, it is possible that customers from whom we expect to derive revenue from backlog will default and as a result we may not be able to recognize expected revenue from backlog. If a customer defaults and fails to pay amounts owed, or if the level of defaults increases, our bad debt expense is likely to increase. Any material payment default by our customers could have a material adverse effect on our financial condition and results of operations.

Our lengthy and unpredictable sales cycle, and the large size of some orders, make it difficult for us to forecast revenue and increase the magnitude of quarterly fluctuations, which could harm our stock price.

Customers for our software products typically commit significant resources to evaluate available software. The complexity of our products requires us to spend substantial time and effort to assist potential customers in evaluating our software and in benchmarking our products against those of our competitors. As the complexity

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of the products we sell increases, we expect our sales cycle to lengthen. In addition, potential customers may be limited in their current spending by existing time-based licenses with their legacy vendors. In these cases, customers delay a significant new commitment to our software until the term of the existing license has expired. Also, because our products require our customers to invest significant time and incur significant costs, we must target those individuals within our customers’ organizations who are able to make these decisions on behalf of their companies. These individuals tend to be senior management in an organization, typically at the vice president level. We may face difficulty identifying and establishing contact with such individuals. Even after those individuals decide to purchase our products, the negotiation and documentation processes can be lengthy and could lead the decision-maker to reconsider the purchase. Our sales cycle typically ranges between three and nine months, but can be longer. Any delay in completing sales in a particular quarter could cause our operating results to fall below expectations. Furthermore, technological changes, litigation risk or other competitive factors could cause some customers to shorten the terms of their licenses significantly, and such shorter terms could in turn have an impact on our total results for orders for this fiscal year. In addition, the precise mix of orders is subject to substantial fluctuation in any given quarter or multiple quarter periods, and the actual mix of licenses sold affects the revenue we recognize in the period. Even if we achieve the target level of total orders, we may not meet our revenue targets if we are unable to achieve our target license mix. In particular, we may fall short of our revenue targets if we deliver more long-term or ratable licenses than expected, or we may exceed our revenue targets if we deliver more short-term licenses than expected.

We may be unable to make payments to satisfy our indemnification obligations.

We enter into standard license agreements in the ordinary course of business. Pursuant to these agreements, we agree to indemnify certain of our customers for losses suffered or incurred by them as a result of any patent, copyright, or other intellectual property infringement claim by any third party with respect to our products. These indemnification obligations have perpetual terms. Our normal business practice is to limit the maximum amount of indemnification to the amount received from the customer. On occasion, the maximum amount of indemnification we may be required to make may exceed our normal business practices. We estimate that the fair value of our indemnification obligations is insignificant, based upon our historical experience concerning product and patent infringement claims. Accordingly, we have no liabilities recorded for indemnification under these agreements. If an indemnification event were to occur, we might not have enough funds to pay our indemnification obligations. Further, any material indemnification payment could have a material adverse effect on our financial condition and the results of our operations.

We have entered into certain indemnification agreements whereby certain of our officers and directors are indemnified for certain events or occurrences while the officer or director is, or was, serving at our request in such capacity. Additionally, in connection with certain of our recent business acquisitions, we agreed to assume, or cause our subsidiaries to assume, indemnification obligations to the officers and directors of the acquired companies. While we have directors and officers insurance that reduces our exposure and enables us to recover a portion of any future amounts paid pursuant to our indemnification obligations to our officers and directors, the maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited. However, as a result of our directors and officers insurance coverage, and our belief that our estimated potential exposure to our officers and directors for indemnification liabilities is minimal, no liabilities have been recorded for these agreements as of September 30, 2007. Therefore, if an indemnification event were to occur, we might not have enough funds to pay our indemnification obligations. Further, any material indemnification payment could have a material adverse effect on our financial condition and the results of our operations.

We rely on a small number of customers for a significant portion of our revenue, and our revenue could decline due to delays of customer orders or the failure of existing customers to renew licenses or if we are unable to maintain or develop relationships with current or potential customers.

Our business depends on sales to a small number of customers. For the six months ended September 30, 2007, we had one customer that accounted for more than 10% of our revenue, and our top three customers together accounted for approximately 26% of our revenue.

We expect that we will continue to depend upon a relatively small number of customers for a substantial portion of our revenue for the foreseeable future. If we fail to sell sufficient quantities of our products and

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services to one or more customers in any particular period, or if a large customer reduces purchases of our products or services, defers orders, or fails to renew licenses, our business and operating results could be harmed.

Most of our customers license our software under time-based licensing agreements, with terms that typically range from 15 months to 48 months. Most of our license agreements automatically expire at the end of the term unless the customer renews the license with us or purchases a perpetual license. If our customers do not renew their licenses, we may not be able to maintain our current revenue or may not generate additional revenue. Some of our license agreements allow customers to terminate an agreement prior to its expiration under limited circumstances — for example, if our products do not meet specified performance requirements or goals. If these agreements are terminated prior to expiration or we are unable to collect under these agreements, our revenue may decline.

Some contracts with extended payment terms provide for payments which are weighted toward the latter part of the contract term. Accordingly, for bundled agreements, as the payment terms are extended, the revenue from these contracts is not recognized evenly over the contract term, but is recognized as the lesser of the cumulative amounts due and payable or ratably. For unbundled agreements, as the payment terms are extended, the revenue from these contracts is recognized as amounts become due and payable. Revenue recognized under these arrangements will be higher in the latter part of the contract term, which potentially puts our future revenue recognition at greater risk of the customer’s continued credit-worthiness. In addition, some of our customers have extended payment terms, which creates additional credit risk.

We compete against companies that hold a large share of the EDA market and competition is increasing among EDA vendors as customers tightly control their EDA spending and use fewer vendors to meet their needs. If we cannot compete successfully, we will not gain market share and our revenue could decline.

We currently compete with companies that hold dominant shares in the electronic design automation market, such as Cadence, Synopsys and Mentor. Each of these companies has a longer operating history and significantly greater financial, technical and marketing resources than we do, as well as greater name recognition and a larger installed customer base. Our competitors are better able to offer aggressive discounts on their products, a practice they often employ. Competition and corresponding pricing pressures among EDA vendors or other factors might be causing or might cause in the future the overall market for EDA products to have low growth rates, remain relatively flat or even decrease in terms of overall dollars. Our competitors offer a more comprehensive range of products than we do; for example, we do not offer logic simulation which can sometimes be an impediment to our winning a particular customer order. In addition, our industry has traditionally viewed acquisitions as an effective strategy for growth in products and market share and our competitors’ greater cash resources and higher market capitalization may give them a relative advantage over us in acquiring companies with promising new chip design products or companies that may be too large for us to acquire without a strain on our resources and liquidity.

Competition in the EDA market has increased as customers rationalized their EDA spending by using products from fewer EDA vendors. Continued consolidation in the electronic design automation market could intensify this trend. Also, many of our competitors, such as Cadence, Synopsys and Mentor, have established relationships with our current and potential customers and can devote substantial resources aimed at preventing us from establishing or enhancing our customer relationships. Competitive pressures may prevent us from obtaining new customers and gaining market share, may require us to reduce the price of products and services or cause us to lose existing customers, which could harm our business. To execute our business strategy successfully, we must continue our efforts to increase our sales worldwide. If we fail to do so in a timely manner or at all, we may not be able to gain market share and our business and operating results could suffer.

Also, a variety of small companies continue to emerge, developing and introducing new products which may compete with our products. Any of these companies could become a significant competitor in the future. We also compete with the internal chip design automation development groups of our existing and potential customers. Therefore, these customers may not require, or may be reluctant to purchase, products offered by independent vendors.

Our competitors may develop or acquire new products or technologies that have the potential to replace our existing or new product offerings. The introduction of these new or additional products by competitors

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may either cause potential customers to defer purchases of our products or cause potential customers to decide against purchasing our products. If we fail to compete successfully, we will not gain market share, or our market share may decrease, and our business may fail.

We may not be successful in integrating the operations of acquired companies and acquired technology.

We expect to continuously evaluate the possibility of accelerating our growth through acquisitions, as is customary in the electronic design automation industry. Achieving the anticipated benefits of past and possible future acquisitions will depend in part upon whether we can integrate the operations, products and technology of acquired companies with our operations, products and technology in a timely and cost-effective manner. The process of integrating acquired companies and acquired technology is complex, expensive and time consuming, and may cause an interruption of, or loss of momentum in, the product development and sales activities and operations of both companies. In addition, the earnout arrangements we use, and expect to continue to use, to consummate some of our acquisitions, pursuant to which we agreed to pay additional amounts of contingent consideration based on the achievement of certain revenue, bookings or product development milestones, can sometimes complicate integration efforts. We cannot be sure that any part or all of the integration will be accomplished on a timely basis, or at all. Assimilating previously acquired companies such as Rio Design Automation, Inc., Knights Technology, Inc. (“Knights”), ACAD Corporation (“ACAD”), Mojave, Silicon Metrics Corporation, or any other companies we have acquired or may seek to acquire in the future, involves a number of other risks, including, but not limited to:

• adverse effects on existing customer relationships, such as cancellation of orders or the loss of key customers;

• difficulties in integrating or retaining key employees of the acquired company;

• the risk that earnouts based on revenue will prove difficult to administer due to the complexities of revenue recognition accounting;

• the risk that actions incentivized by earnout provisions will ultimately prove not to be in our best interest if our interests may change over time;

• difficulties in integrating the operations of the acquired company, such as information technology resources, manufacturing processes, and financial and operational data;

• difficulties in integrating the technologies of the acquired company into our products;

• diversion of our management’s attention;

• potential incompatibility of business cultures;

• potential dilution to existing stockholders if we incur debt or issue equity securities to finance acquisitions; and

• additional expenses associated with the amortization of intangible assets.

Our operating results may be harmed if our customers do not adopt, or are slow to adopt, 65-nanometer and 45-nanometer design geometries on a large scale.

Our customers are currently working on a range of design geometries, including without limitation 45-nanometer, 65-nanometer and 90-nanometer designs. We continue to work toward developing and enhancing our product line in anticipation of increased customer demand for 65-nanometer and 45-nanometer design geometries. Notwithstanding our efforts to support 65-nanometer and 45-nanometer design geometries, customers may fail to adopt these geometries on a large scale and we may be unable to convince our customers to purchase our related software products. Accordingly, any revenues we receive from enhancements to our products or acquired technologies may be less than the development or acquisition costs. If customers fail to adopt 65-nanometer and 45-nanometer design geometries on a large scale, our operating results may be harmed. In addition, if customers are not able successfully to generate profits as they adopt smaller geometries, demand for our products may be adversely affected, and our operating results may be harmed.

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Our operating results will be harmed if chip designers do not adopt Blast Fusion, Talus, FineSim, the Quartz family of products or our other current and future products.

Blast Fusion has accounted for the largest portion of our revenue since our inception and we believe that revenue from Blast Fusion, Talus, FineSim, and the Quartz family of products will account for most of our revenue for the foreseeable future. In addition, we have dedicated significant resources to developing and marketing Talus and other products. We must gain market penetration of Blast Fusion, Talus, FineSim, the Quartz family of products and other products in order to achieve our growth strategy and financial success. Moreover, if integrated circuit designers do not continue to adopt Blast Fusion, Talus, FineSim, the Quartz family of products or our other current and future products, our operating results will be significantly harmed.

In the event that the changes we made to our organizational structure in fiscal 2006 result in ineffective interoperability between our products or ineffective collaboration among our employees, then our operating results may be harmed.

We changed our organizational structure in fiscal 2006 to establish major business units that are responsible for our various products. If this new organizational structure results in ineffective interoperability between our products or ineffective collaboration among our employees, then our operating results may be harmed. For example, if this new organizational structure is not successful, we could experience delays in new product development that could cause us to lose customer orders and thereby could harm our operating results.

If the industries into which we sell our products experience a recession or other cyclical effects affecting our customers’ research and development budgets, our revenue would be likely to decline.

Demand for our products is driven by new integrated circuit design projects. The demand from semiconductor and systems companies is uncertain and difficult to predict. Slower growth in the semiconductor and systems industries, a reduced number of design starts, reduction of electronic design automation budgets or consolidation among our customers would harm our business and financial condition.

The primary customers for our products are companies in the communications, computing, consumer electronics, networking and semiconductor industries. Any significant downturn in our customers’ markets or in general economic conditions that results in the cutback of research and development budgets or the delay of software purchases would likely result in lower demand for our products and services and could harm our business. The continuing threat of terrorist attacks in the United States, the ongoing events in Afghanistan, Iraq, Iran, the Middle East and North Korea, recent problems with the financial system, such as problems involving banks as well as the mortgage markets and other worldwide events have increased uncertainty in the United States economy. If the economy declines as a result of this economic, political and social turmoil, existing customers may delay their implementation of our software products and prospective customers may decide not to adopt our software products, either of which could negatively impact our business and operating results.

The electronics industry has historically been subject to seasonal and cyclical fluctuations in demand for its products, and this trend may continue in the future. These industry downturns have been and may continue to be characterized by diminished product demand, excess manufacturing capacity and subsequent erosion of average selling prices. Any such seasonal or cyclical industry downturns could harm our operating results.

Difficulties in developing and achieving market acceptance of new products and delays in planned release dates of our software products and upgrades may harm our business.

To succeed, we will need to develop innovative new products. We may not have the financial resources necessary to fund all required future innovations. Expanding into new technologies or extending our product line into areas we have not previously addressed may be more costly or difficult than we presently anticipate. Also, any revenue that we receive from enhancements or new generations of our proprietary software products may be less than the costs that we incur to develop those technologies and products. If we fail to develop and market new products in a timely manner, or if new products do not meet performance features as marketed, our reputation and our business could suffer.

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Our costs of customer engagement and support are high, so our gross margin may decrease if we incur higher-than-expected costs associated with providing support services in the future or if we reduce our prices.

Because of the complexity of our products, we typically incur high field application engineering support costs to engage new customers and assist them in their evaluations of our products. If we fail to manage our customer engagement and support costs, our operating results could suffer. In addition, our gross margin may decrease if we are unable to manage support costs associated with the services revenue we generate or if we reduce prices in response to competitive pressure.

Product defects could cause us to lose customers and revenue, or to incur unexpected expenses.

Our products depend on complex software, which we either developed internally or acquired or licensed from third parties. Our customers may use our products with other companies’ products, which also contain complex software. If our software does not meet our customers’ performance requirements or meet the performance features as marketed, our customer relationships may suffer. Also, a limited number of our contracts include specified ongoing performance criteria. If our products fail to meet these criteria, it may lead to termination of these agreements and loss of future revenue. Complex software often contains errors. Any failure or poor performance of our software or the third-party software with which it is integrated could result in:

• delayed market acceptance of our software products;

• delays in product shipments;

• unexpected expenses and diversion of resources to identify the source of errors or to correct errors;

• damage to our reputation;

• delayed or lost revenue; and

• product liability claims.

Our product functions are often critical to our customers, especially because of the resources our customers expend on the design and fabrication of integrated circuits. Many of our licensing agreements contain provisions to provide a limited warranty. In addition, some of our licensing agreements provide the customer with a right of refund for the license fees if we are unable to correct errors reported during the warranty period. If our contractual limitations are unenforceable in a particular jurisdiction or if we are exposed to claims that are not covered by insurance, a successful claim could harm our business. We currently carry insurance coverage and limits that we believe are consistent with similarly situated companies within the EDA industry, however, our insurance coverage may prove insufficient to protect against any claims that we experience.

Because much of our business is international, we are exposed to risks inherent to doing business internationally that could harm our business. We also intend to expand our international operations. If our revenue from this expansion does not exceed the expenses associated with this expansion, our business and operating results could suffer.

For the six months ended September 30, 2007, we generated 46% of our total revenue from sales outside North America, compared to 32% in fiscal 2007 and 33% for fiscal 2006. While most of our international sales to date have been denominated in U.S. dollars, our international operating expenses have been denominated in foreign currencies. As a result, a decrease in the value of the U.S. dollar relative to the foreign currencies could increase the relative costs of our overseas operations, which could reduce our operating margins.

As we expand our international operations, we will need to maintain sales offices in Europe, the Middle East, and the Asia Pacific region. If our revenue from international operations does not exceed the expense of establishing and maintaining our international operations, our business could suffer. Additional risks we face in conducting business internationally include:

• difficulties and costs of staffing and managing international operations across different geographic areas;

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• changes in currency exchange rates and controls;

• uncertainty regarding tax and regulatory requirements in multiple jurisdictions;

• the possible lack of financial and political stability in foreign countries, preventing overseas sales growth;

• current events in North Korea, Iran, Iraq and the Middle East;

• the effects of terrorist attacks in the United States;

• recent problems with the financial system, such as problems involving banks as well as the mortgage markets; and

• any related conflicts or similar events worldwide.

Future changes in accounting standards, specifically changes affecting revenue recognition, could cause unexpected adverse revenue fluctuations for us.

Future changes in accounting standards or interpretations thereof, specifically those changes affecting software revenue recognition, could require us to change our methods of revenue recognition. These changes could result in deferral of revenue recognized in current periods to subsequent periods or in accelerated recognition of deferred revenue to current periods, each of which could cause shortfalls in meeting the expectations of investors and securities analysts. Our stock price could decline as a result of any shortfall. Implementation of internal controls reporting and attestation requirements, as further described below, will continue to impose additional financial and administrative obligations on us and may continue to cause us to incur substantial implementation costs from third party consultants, which could adversely affect our results.

Changes in laws and regulations that affect the governance of public companies have increased our operating expenses and will continue to do so.

Recently enacted changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and the listing requirements for the Nasdaq Global Market have imposed duties on us and on our executives, directors, attorneys and independent registered public accounting firms. In order to comply with these new rules, we have hired additional personnel and use additional outside legal, accounting and advisory services, all of which have increased and may further increase our operating expenses over time. In particular, we have incurred and will continue to incur additional administrative expenses relating to the implementation of Section 404 of the Sarbanes-Oxley Act (“Section 404”), which requires that we implement and maintain an effective system of internal controls and annual certification of our compliance by our independent auditor. For example, we have incurred significant expenses and will continue to incur expenses in connection with the implementation, documentation and continued testing of our internal control systems. Management time associated with these compliance efforts necessarily reduces time available for other operating activities, which could adversely affect operating results. For the years ended April 1, 2007, April 2, 2006 and March 31, 2005, our independent registered public accounting firms have certified that we were in compliance with the provision of Section 404 relating to effective internal control over financial reporting; however, our internal control obligations are ongoing and subject to continued review and testing. If we are unable to maintain full and timely compliance with these and other regulatory requirements, we could be required to incur additional costs, expend additional management time on remedial efforts and make related public disclosures that could adversely affect our stock price and result in securities litigation. Further, a failure to comply with Section 404 could cause us to delay filing our public reports, potentially resulting in de-listing by the Nasdaq Global Market and penalties or other adverse consequences under our existing contractual arrangements. In particular, pursuant to the indenture for the 2010 Notes, if we fail to file our annual or quarterly reports in accordance with the terms of that indenture, or if we do not comply with certain provisions of the Trust Indenture Act specified in the indenture, after the passage of certain periods of time at the election of a certain minimum number of holders of the 2010 Notes, we may be in default under the indenture unless we pay a fee equal to 1% per annum of the aggregate principal amounts of the 2010 Notes, or the extension fee, to extend the default date. Even if we pay the applicable extension fee, we will eventually be in default for these filing failures if sufficient time passes and we have not made the applicable filing.

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The effectiveness of disclosure controls is inherently limited.

We do not expect that our disclosure controls and procedures, or our internal control over financial reporting, will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system objectives will be met. The design of a control system must also reflect applicable resource constraints, and the benefits of controls must be considered relative to their costs. As a result of these inherent limitations, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. Failure of the control systems to prevent error or fraud could materially adversely impact our financial results and our business.

Forecasting our tax rates is complex and subject to uncertainty

Our management must make significant assumptions, judgments and estimates to determine our current provision for income taxes, deferred tax assets and liabilities, and any valuation allowance that may be recorded against our deferred tax assets. These assumptions, judgments and estimates are difficult to make due to their complexity, and the relevant tax law is often changing.

Our future effective tax rates could be adversely affected by the following:

• an increase in expenses that are not deductible for tax purposes, including stock-based compensation and write-offs of acquired in-process research and development;

• changes in the valuation of our deferred tax assets and liabilities;

• future changes in ownership that may limit realization of certain assets;

• changes in forecasts of pre-tax profits and losses by jurisdiction used to estimate tax expense by jurisdiction;

• assessment of additional taxes as a result of federal, state, or foreign tax examinations; or

• changes in tax laws or interpretations of such tax laws.

Our success will depend on our ability to keep pace with the rapidly evolving technology standards of the semiconductor industry. If we are unable to keep pace with these evolving technology standards, our products could be rendered obsolete, which would cause our operating results to decline.

The semiconductor industry has made significant technological advances. In particular, recent advances in deep sub-micron technology have required electronic design automation companies to develop or acquire new products and enhance existing products continuously. The evolving nature of our industry could render our existing products and services obsolete. Our success will depend, in part, on our ability to:

• enhance our existing products and services;

• develop and introduce new products and services on a timely and cost-effective basis that will keep pace with technological developments and evolving industry standards;

• address the increasingly sophisticated needs of our customers; and

• acquire other companies that have complementary or innovative products.

If we are unable, for technical, legal, financial or other reasons, to respond in a timely manner to changing market conditions or customer requirements, our business and operating results could be seriously harmed.

If we fail to offer and maintain competitive equity compensation packages for our employees, or if our stock price declines materially for a protracted period of time, we might have difficulty retaining our employees and our business may be harmed.

In today’s competitive technology industry, employment decisions of highly skilled personnel are influenced by equity compensation packages, which offer incentives above traditional compensation only where there is a consistent, long-term upward trend over time of a company’s stock price. Our stock price declined significantly for several years due to market conditions and had recently been negatively affected by uncertainty surrounding the outcome of our litigation with Synopsys, Inc. discussed above.

In August 2005, we implemented a stock option exchange program (the “Exchange Program”) allowing non-executive employees holding options to purchase our common stock at exercise prices greater than or

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equal to $10.50 to exchange those options for a smaller number of new options at an exercise price equal to $9.20, the fair market value on the date of grant. If this exercise price of $9.20 per share or the terms of the Exchange Program are not satisfactory to employees who participate in the Exchange Program, our ability to retain employees could be affected.

If our stock price declines in the future due to market conditions, investors’ perceptions of the technology industry or managerial or performance problems, we may be forced to grant additional options to retain employees. This in turn could result in:

• immediate and substantial dilution to investors resulting from the grant of additional options necessary to retain employees; and

• compensation charges against us, which would negatively impact our operating results.

In addition, the new accounting requirements for employee stock options discussed below has adversely affected our option grant practices and may affect our ability to recruit and retain employees.

Due to changes in the accounting treatment for employee stock options, we have changed our employee compensation practices, and our reported results of operations have been and will likely continue to be adversely affected.

Until April 2, 2006, we accounted for the issuance of employee stock options under principles that do not require us to record compensation expense for options granted at fair market value. In December 2004, the FASB issued SFAS 123R, “Share-Based Payment,” which eliminates the ability to account for share-based compensation transactions using APB 25, and generally requires instead that such transactions be accounted for using a fair-value based method. Under SFAS 123R, companies are required to recognize an expense for compensation cost related to share-based payment arrangements including stock options and employee stock purchase plans. We adopted the new rules in the first quarter of our fiscal year 2007. This change in accounting treatment has resulted and will continue to result in significant additional compensation expense compared to prior periods and has adversely affected and will likely continue to adversely affect our reported results of operations and hinder our ability to achieve profitability. We are continuing to assess the full impact of the adoption of SFAS 123R on our business practices and, as part of that assessment, have changed our employee compensation practices by, for example, issuing more restricted stock and fewer stock options. These changes could make it harder for us to retain existing employees and attract qualified candidates.

If our sales force compensation arrangements are not designed effectively, we may lose sales personnel and resources.

Designing an effective incentive compensation structure for our sales force is critical to our success. We have experimented, and continue to experiment, with different systems of sales force compensation. If our incentives are not well designed, we may experience reduced revenue generation, and we may also lose the services of our more productive sales personnel, either of which would reduce our revenue or potential revenue.

Fluctuations in our growth place a strain on our management systems and resources, and if we fail to manage the pace of our growth, our business could be harmed.

Periods of growth followed by efforts to realign costs when revenue growth is slower than anticipated have placed a strain on our management, administrative and financial resources. For example, in the first quarter of fiscal 2008, we decreased our workforce by 21 employees. Over time we have significantly expanded our operations in the United States and internationally, and we plan to continue to expand the geographic scope of our operations. To pace the growth of our operations with the growth in our revenue, we must continue to improve administrative, financial and operations systems, procedures and controls. Failure to improve our internal procedures and controls could hinder our efforts to manage our growth adequately, disrupt operations, lead to deficiencies in our internal controls and financial reporting and otherwise harm our business.

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If chip designers and manufacturers do not integrate our software into existing design flows, or if other software companies do not cooperate in working with us to interface our products with their design flows, demand for our products may decrease.

To implement our business strategy successfully, we must provide products that interface with the software of other electronic design automation software companies. Our competitors may not support efforts by us or by our customers to integrate our products into their existing design flows. We must develop cooperative relationships with competitors so that they will work with us to integrate our software into customers’ design flow. Currently, our software is designed to interface with the existing software of Cadence, Synopsys and others. If we are unable to convince customers to adopt our software products instead of those of competitors (including competitors offering a broader set of products), or if we are unable to convince other software companies to work with us to interface our software to meet the demands of chip designers and manufacturers, our business and operating results will suffer.

We may not obtain sufficient patent protection, which could harm our competitive position and increase our expenses.

Our success and ability to compete depends to a significant degree upon the protection of our software and other proprietary technology. We currently have a number of issued patents in the United States, but this number is relatively small in relation to our competitors.

These legal protections afford only limited protection for our technology. In addition, rights that may be granted under any patent application that may issue in the future may not provide competitive advantages to us. Further, patent protection in foreign jurisdictions where we may need this protection may be limited or unavailable. It is possible that:

• our pending U.S. and non-U.S. patents may not be issued;

• competitors may design around our present or future issued patents or may develop competing non-infringing technologies;

• present and future issued patents may not be sufficiently broad to protect our proprietary rights; and

• present and future issued patents could be successfully challenged for validity and enforceability.

We believe the patent portfolios of our competitors are far larger than ours, and this may increase the risk that they may sue us for patent infringement and may limit our ability to counterclaim for patent infringement or settle through patent cross-licenses.

We rely on trademark, copyright and trade secret laws and contractual restrictions to protect our proprietary rights, and if these rights are not sufficiently protected, it could harm our ability to compete and generate income.

To establish and protect our proprietary rights, we rely on a combination of trademark, copyright and trade secret laws, and contractual restrictions, such as confidentiality agreements and licenses. Our ability to compete and grow our business could suffer if these rights are not adequately protected. We seek to protect our source code for our software, documentation and other written materials under trade secret and copyright laws. We license our software pursuant to agreements, which impose certain restrictions on the licensee’s ability to utilize the software. We also seek to avoid disclosure of our intellectual property by requiring employees and consultants with access to our proprietary information to execute confidentiality agreements. Our proprietary rights may not be adequately protected because:

• laws and contractual restrictions in U.S. and foreign jurisdictions may not prevent misappropriation of our technologies or deter others from developing similar technologies;

• competitors may independently develop similar technologies and software;

• for some of our trademarks, federal U.S. trademark protection may be unavailable to us;

• our trademarks might not be protected or protectable in some foreign jurisdictions;

• the validity and scope of our U.S. and foreign trademarks could be successfully challenged; and

• policing unauthorized use of our products and trademarks is difficult, expensive and time-consuming, and we may be unable to determine the extent of this unauthorized use.

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The laws of some countries in which we market our products may offer little or no protection of our proprietary technologies. Reverse engineering, unauthorized copying or other misappropriation of our proprietary technologies could enable third parties to benefit from our technologies without paying us for them, which would harm our competitive position and market share.

Our directors, executive officers and principal stockholders own a substantial portion of our common stock and as a result of this concentration of ownership may be able to elect most of our directors and delay or prevent a change in control of Magma.

Our directors, executive officers and stockholders who currently own over 5% of our common stock beneficially own a substantial portion of our outstanding common stock. These stockholders, in a combined vote, will be able to influence significantly all matters requiring stockholder approval. For example, they may be able to elect most of our directors, delay or prevent a transaction in which stockholders might receive a premium over the market price for their shares or prevent changes in control or management.

We may need additional capital in the future, but there is no assurance that funds would be available on acceptable terms.

In the future we may need to raise additional capital in order to achieve growth or other business objectives. This financing may not be available in sufficient amounts or on terms acceptable to us and may be dilutive to existing stockholders. If adequate funds are not available or are not available on acceptable terms, our ability to expand, develop or enhance services or products, or respond to competitive pressures would be limited.

Our certificate of incorporation, bylaws and Delaware corporate law contain anti-takeover provisions which could delay or prevent a change in control even if the change in control would be beneficial to our stockholders. We could also adopt a stockholder rights plan, which could also delay or prevent a change in control.

Delaware law, as well as our certificate of incorporation and bylaws, contain anti-takeover provisions that could delay or prevent a change in control of our company, even if the change of control would be beneficial to the stockholders. These provisions could lower the price that future investors might be willing to pay for shares of our common stock. These anti-takeover provisions:

• authorize our Board of Directors to create and issue, without prior stockholder approval, preferred stock that can be issued increasing the number of outstanding shares and deter or prevent a takeover attempt;

• prohibit stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our stockholders;

• establish a classified Board of Directors requiring that not all members of the board be elected at one time;

• prohibit cumulative voting in the election of directors, which would otherwise allow less than a majority of stockholders to elect director candidates;

• limit the ability of stockholders to call special meetings of stockholders; and

• require advance notice requirements for nominations for election to the Board of Directors and proposals that can be acted upon by stockholders at stockholder meetings.

In addition, Section 203 of the Delaware General Corporation Law and the terms of our stock option plans may discourage, delay or prevent a change in control of our company. That section generally prohibits a Delaware corporation from engaging in a business combination with an interested stockholder for three years after the date the stockholder became an interested stockholder. Also, our stock option plans include change-in-control provisions that allow us to grant options or stock purchase rights that will become vested immediately upon a change in control of us.

Our board of directors also has the power to adopt a stockholder rights plan, which could delay or prevent a change in control of us even if the change in control is generally beneficial to our stockholders. These plans, sometimes called “poison pills,” are sometimes criticized by institutional investors or their advisors and

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could affect our rating by such investors or advisors. If our board were to adopt such a plan it might have the effect of reducing the price that new investors are willing to pay for shares of our common stock.

We are subject to risks associated with changes in foreign currency exchange rates.

We transact some portions of our business in various foreign currencies. Accordingly, we are subject to exposure from adverse movements in foreign currency exchange rates. This exposure is primarily related to a portion of revenue in Japan and operating expenses in Europe, Japan and Asia-Pacific, which are denominated in the respective local currencies. As of September 30, 2007, we had approximately $11.2 million of cash and money market funds in foreign currencies. As of that date, we had not utilized hedging instruments in connection with our currency exposures. Subsequently, in the third quarter of fiscal 2008, we entered into financial instruments to mitigate the effects of our currency exposure risk going forward. While we assess the need to utilize financial instruments to hedge currency exposures on an ongoing basis, our assessments may prove incorrect.

The convertible notes we issued in May 2003 and the convertible notes we issued in March 2007 are debt obligations that must be repaid in cash in May 2008 and May 2010, respectively, if they are not redeemed or converted into shares of our common stock at an earlier date, which is unlikely to occur if the price of our common stock does not exceed the conversion price.

In May 2003, we issued $150.0 million principal amount of the 2008 Notes. In May 2005, we repurchased, in privately negotiated transactions, $44.5 million face amount (or approximately 29.7% of the total) of the 2008 Notes at an average discount to face value of approximately 22%. In addition, in May 2006, we repurchased another $40.3 million face amount (approximately 38.2% of the remaining principal) of the 2008 Notes at an average discount to face value of approximately 13%. We spent an aggregate of approximately $34.8 million and $35.0 million, respectively, on the repurchases in May 2005 and May 2006. In March 2007, we exchanged, in privately negotiated transactions, an aggregate principal amount of $49.9 million of the 2008 Notes for an equal aggregate principal amount of the 2010 Notes. We will be required to repay the $15.2 million remaining principal amount of the 2008 Notes in full in May 2008 and the $49.9 million principal amount of the 2010 Notes in full in May 2010, unless the holders of those notes elect to convert them into shares of our common stock before the repayment dates or these notes are otherwise redeemed. The conversion price, subject to adjustment in certain circumstances, is $15.00 for the 2010 Notes and $22.86 for the 2008 Notes. If the price of our common stock does not rise above the applicable conversion price, conversion of the notes is unlikely and we would be required to repay the principal amounts of the notes in cash. There have been previous quarters in which we have experienced shortfalls in revenue and earnings from levels expected by securities analysts and investors, which have had an immediate and significant adverse effect on the trading price of our common stock. In addition, the stock market in recent years has experienced extreme price and trading volume fluctuations that often have been unrelated or disproportionate to the operating performance of individual companies. These broad market fluctuations may adversely affect the price of our stock, regardless of our operating performance. Because the notes are convertible into shares of our common stock, volatility or depressed prices for our common stock could have a similar effect on the trading price of the notes.

We may have insufficient cash flow to meet our debt service obligations, including payments due on our convertible notes.

We will be required to generate cash sufficient to conduct our business operations and pay our indebtedness and other liabilities, including all amounts, both principal and interest, due on our outstanding 2008 Notes and 2010 Notes. The aggregate outstanding principal amount of these notes was $15.2 million and $49.9 million, respectively, at April 1, 2007. The 2010 Notes bear interest at 2% per annum, with interest payable on May 15 and November 15 of each year, commencing on May 15, 2007. We may not be able to cover our anticipated debt service obligations from our cash flow. This may materially hinder our ability to make payments on the 2008 Notes and the 2010 Notes. Our ability to meet our future debt service obligations will depend upon our future performance, which will be subject to financial, business and other factors affecting our operations, many of which are beyond our control. Accordingly, we cannot assure that we will be able to make required principal and interest payments on the 2008 Notes and the 2010 Notes when due.

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The conversion of our outstanding convertible notes would result in dilution to our current stockholders.

We currently have outstanding 2008 Notes in the principal amount of $15.2 million and 2010 Notes in the principal amount of $49.9 million. The 2008 Notes are convertible into shares of our common stock at a conversion price of $22.86 per share, subject to adjustment. The 2010 Notes are convertible into shares of our common stock at a conversion price of $15.00 per share, subject to adjustment. At current conversion prices, an aggregate of approximately 3,995,000 shares of our common stock would be issued upon the conversion of all outstanding notes at these exchange rates, which would dilute the voting power and ownership percentage of our existing stockholders.

Hedging transactions and other transactions may affect the value of our common stock and our convertible notes.

We entered into hedging arrangements with Credit Suisse First Boston International at the time we issued the 2008 Notes, with the objective of reducing the potential dilutive effect of issuing common stock upon conversion of the notes. Although at the time of our May 2005 and May 2006 repurchases and our March 2007 exchanges of the 2008 Notes portions of the hedging arrangements were retired, the remaining portions of these hedging arrangements are likely to have caused Credit Suisse First Boston International and others to take positions in our common stock in secondary market transactions or to enter into derivative transactions at or after the sale of the notes. Any market participants entering into hedging arrangements are likely to modify their hedge positions from time to time prior to conversion or maturity of the notes by purchasing and selling shares of our common stock or other securities, which may increase the volatility and reduce the market price of our common stock.

We may be unable to meet the requirements under the indentures to purchase our 2008 Notes and 2010 Notes upon a change in control.

Upon a change in control, which is defined in the indentures relating to the 2008 Notes and 2010 Notes to include some cash acquisitions and private company mergers, note holders may require us to purchase all or a portion of the notes they hold. If a change in control were to occur, we might not have enough funds to pay the purchase price for all tendered notes. Future credit agreements or other agreements relating to our indebtedness might prohibit the redemption or repurchase of the notes and provide that a change in control constitutes an event of default. If a change in control occurs at a time when we are prohibited from purchasing the notes, we could seek the consent of our lenders to purchase the notes or could attempt to refinance this debt. If we do not obtain a consent, we could not purchase the notes. Our failure to purchase tendered notes would constitute an event of default under the indenture, which might constitute a default under the terms of our other debt. In such circumstances, or if a change in control would constitute an event of default under our senior indebtedness, the subordination provisions of the indenture would possibly limit or prohibit payments to note holders. Our obligation to offer to purchase the notes upon a change in control would not necessarily afford note holders protection in the event of a highly leveraged transaction, reorganization, merger or similar transaction involving us.

Failure to obtain export licenses could harm our business by preventing us from transferring our technology outside of the United States.

We are required to comply with U.S. Department of Commerce regulations when shipping our software products and/or transferring our technology outside of the United States or to certain foreign nationals. We believe we have complied with applicable export regulations, however, these regulations are subject to change, and future difficulties in obtaining export licenses for current, future developed and acquired products and technology, or any failure (if any) by us to comply with such requirements in the past, could harm our business, financial conditions and operating results.

Our business operations may be adversely affected in the event of an earthquake or other natural disaster.

Our corporate headquarters and much of our research and development operations are located in San Jose, California, in California’s Silicon Valley region, which is an area known for its seismic activity. An earthquake, fire or other significant natural disaster could have a material adverse impact on our business, financial condition and/or operating results.

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

Recent Sales of Unregistered Securities

During the second quarter of fiscal 2008, on September 19, 2007, we acquired the remaining 82% ownership interest in Rio Design Automation, Inc. which we did not already own, pursuant to a definitive merger agreement signed on September 7, 2007. In connection with the purchase of the 82% ownership interest in Rio, we will issue approximately 287,300 shares of common stock, of which approximately 46,900 shares will be held back to secure certain indemnification obligations of Rio that may arise for a 12-month period from the date of the acquisition. The issuance of our common stock was exempt from the registration requirements of the Securities Act of 1933, as amended, pursuant to Section 4(2) thereof and Regulation D promulgated thereunder based upon representations that we obtained from the Rio stockholders which confirmed that each Rio stockholder receiving our common stock was an “accredited investor” as such term is defined in Rule 501(a) of Regulation D.

Purchases of Equity Securities by the Issuer

The following table shows repurchases of shares of our common stock in the second quarter of fiscal 2008:

Period	Total Number of Shares Purchased*		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs
July 2 – July 31, 2007		16,540	$	0.0001		0		N/A
August 1 – August 31, 2007		42,464	$	12.60		0		N/A
September 1 – September 30, 2007		3,472	$	0.0001		0		N/A
Total		62,476	$	8.56		0		N/A

* Includes 36,792 shares repurchased at a weighted average price of $14.54 based on the fair market values on the repurchase dates, in order to satisfy tax withholding obligations associated with the vesting of restricted shares. The remaining shares that were repurchased represented forfeitures of restricted stock as a result of employee terminations.

Item 4. Submission of Matters to a Vote of Security Holders

At Magma’s annual meeting of stockholders, held on August 29, 2007, the following matters were considered and voted upon:

Proposal 1. To elect two Class III directors, to hold office until the 2010 annual meeting of stockholders. The votes for such nominees were as follows:

Nominee	For		Against		Withheld		Abstentions		Broker Non-Votes
Rajeev Madhavan		35,302,548		—		833,935		—		—
Kevin C. Eichler		35,232,556		—		903,927		—		—

At the annual meeting, Rajeev Madhavan and Kevin C. Eichler were elected to serve as Class III directors until the 2010 annual meeting of stockholders, or until their successors have been elected by the stockholders or appointed by the Board of Directors pursuant to the Company’s bylaws.

The Class I directors are Roy E. Jewell and Thomas M. Rohrs, and the Class II directors are Timothy J. Ng, Chester J. Silvestri, and Susumu Kohyama, and their term of office as directors continued after the meeting.

Proposal 2. To ratify the appointment of Grant Thornton LLP as our independent accountants for the fiscal year ending April 6, 2008. The votes for such proposal were as follows:

For	Against		Withheld		Abstentions		Broker Non-Votes
35,914,585		96,291		—		125,607		—

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Item 6. Exhibits

The following documents are filed as Exhibits to this report:

		Incorporated by Reference
Exhibit Number	Exhibit Description	Form	File No.	Exhibit	Filing Date	Filed Herewith
2.1	Agreement and Plan of Reorganization, dated February 23, 2004, by and among the Registrant, Motorcar Acquisition Corp., Auto Acquisition Corp., Mojave, Inc. and Vivek Raghavan, as Representative	8-K	000-33213	2.1	May 14, 2004
3.1	Amended and Restated Certificate of Incorporation	10-K	000-33213	3.1	June 28, 2002
3.2	Certificate of Correction to the Amended and Restated Certificate of Incorporation	10-K	000-33213	3.2	June 28, 2002
3.3	Amended and Restated Bylaws	10-K	000-33213	3.3	June 28, 2002
4.1	Amended and Restated Investors’ Rights Agreement dated July 31, 2001, by and among the Registrant and the parties that are signatories thereto	10-K	000-33213	4.2	June 28, 2002
4.2	Form of Common Stock Certificate	S-1/A	333-60838	4.1	November 15, 2001
4.3	Indenture, dated as of May 22, 2003, between the Registrant and U.S. Bank National Association, as Trustee (including form of Zero Coupon Convertible Subordinated Note due May 15, 2008)	10-K	0-33213	4.3	June 20, 2003
4.4	Form of Indenture, dated March 5, 2007, by and between Magma Design Automation, Inc. and U.S. Bank National Association, as Trustee (including form of 2.00% Convertible Senior Note due May 15, 2010)	8-K	000-33213	10.3	March 5, 2007
4.5	Registration Rights Agreement, dated as of May 22, 2003, between the Registrant, Credit Suisse First Boston LLC and UBS Warburg LLC	10-K	0-33213	4.4	June 20, 2003
4.6	Form of Registration Rights Agreement, dated March 5, 2007, by and between Magma Design Automation, Inc. and certain other party thereto	8-K	000-33213	10.2	March 5, 2007
4.7	Form of Supplemental Indenture, dated March 15, 2007, by and between Magma Design Automation, Inc. and U.S. Bank National Association, as Trustee (form of note is the same as the form of 2.00% Convertible Senior Note due May 15, 2010 and included in Exhibit 4.4)	8-K	000-33213	10.3	March 16, 2007
4.8	Form of Registration Rights Agreement Amendment, dated March 15, 2007, by and between Magma Design Automation, Inc. and certain other parties thereto	8-K	000-33213	10.2	March 16, 2007
31.1	Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer					X
31.2	Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer					X
32.1	Certification of Chief Executive Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002					X
32.2	Certification of Chief Financial Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002					X

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Magma Design Automation, Inc.

Dated: November 8, 2007 By /s/ Peter S. Teshima

Peter S. Teshima,
Corporate Vice President — Finance and
Chief Financial Officer
(Principal Financial Officer and Duly Authorized Signatory)

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EXHIBIT INDEX
TO
MAGMA DESIGN AUTOMATION, INC.
  
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2007

		Incorporated by Reference
Exhibit Number	Exhibit Description	Form	File No.	Exhibit	Filing Date	Filed Herewith
2.1	Agreement and Plan of Reorganization, dated February 23, 2004, by and among the Registrant, Motorcar Acquisition Corp., Auto Acquisition Corp., Mojave, Inc. and Vivek Raghavan, as Representative	8-K	000-33213	2.1	May 14, 2004
3.1	Amended and Restated Certificate of Incorporation	10-K	000-33213	3.1	June 28, 2002
3.2	Certificate of Correction to the Amended and Restated Certificate of Incorporation	10-K	000-33213	3.2	June 28, 2002
3.3	Amended and Restated Bylaws	10-K	000-33213	3.3	June 28, 2002
4.1	Amended and Restated Investors’ Rights Agreement dated July 31, 2001, by and among the Registrant and the parties that are signatories thereto	10-K	000-33213	4.2	June 28, 2002
4.2	Form of Common Stock Certificate	S-1/A	333-60838	4.1	November 15, 2001
4.3	Indenture, dated as of May 22, 2003, between the Registrant and U.S. Bank National Association, as Trustee (including form of Zero Coupon Convertible Subordinated Note due May 15, 2008)	10-K	0-33213	4.3	June 20, 2003
4.4	Form of Indenture, dated March 5, 2007, by and between Magma Design Automation, Inc. and U.S. Bank National Association, as Trustee (including form of 2.00% Convertible Senior Note due May 15, 2010)	8-K	000-33213	10.3	March 5, 2007
4.5	Registration Rights Agreement, dated as of May 22, 2003, between the Registrant, Credit Suisse First Boston LLC and UBS Warburg LLC	10-K	0-33213	4.4	June 20, 2003
4.6	Form of Registration Rights Agreement, dated March 5, 2007, by and between Magma Design Automation, Inc. and certain other party thereto	8-K	000-33213	10.2	March 5, 2007
4.7	Form of Supplemental Indenture, dated March 15, 2007, by and between Magma Design Automation, Inc. and U.S. Bank National Association, as Trustee (form of note is the same as the form of 2.00% Convertible Senior Note due May 15, 2010 and included in Exhibit 4.4)	8-K	000-33213	10.3	March 16, 2007
4.8	Form of Registration Rights Agreement Amendment, dated March 15, 2007, by and between Magma Design Automation, Inc. and certain other parties thereto	8-K	000-33213	10.2	March 16, 2007
31.1	Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer					X
31.2	Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer					X
32.1	Certification of Chief Executive Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002					X
32.2	Certification of Chief Financial Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002					X

59