Magma Design Automation (LAVA) 10-Q 2007 Q1 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 July 2, 2006

or

¨ 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)

5460 Bayfront Plaza

Santa Clara, California 95054

(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.    Yes  x    No  ¨

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 Filer  ¨    Accelerated Filer  x    Non-accelerated Filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

On August 1, 2006, 37,004,613 shares of Registrant’s Common Stock, $.0001 par value were outstanding.

MAGMA DESIGN AUTOMATION, INC.

FORM 10-Q

QUARTERLY PERIOD ENDED JULY 2, 2006

INDEX

		Page
Part I: Financial Information		3
Item 1:	Financial Statements (unaudited)	3
	Condensed Consolidated Balance Sheets at July 2, 2006 and April 2, 2006	3
	Condensed Consolidated Statements of Operations for the Three Months Ended July 2, 2006 and July 3, 2005	4
	Condensed Consolidated Statements of Cash Flows for the Three Months Ended July 2, 2006 and July 3, 2005	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
Item 3:	Quantitative and Qualitative Disclosures About Market Risk	39
Item 4:	Controls and Procedures	40
Part II: Other Information		41
Item 1:	Legal Proceedings	41
Item 1A:	Risk Factors	46
Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds	61
Item 6:	Exhibits	62
Signatures		65
Exhibit Index		66

2

PART I: FINANCIAL INFORMATION

Item 1. Financial Statements.

MAGMA DESIGN AUTOMATION, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

(unaudited)

	July 2, 2006			April 2, 2006
ASSETS
Current assets:
Cash and cash equivalents	$	36,304		$	58,550
Restricted cash		3,793			58
Short-term investments		13,956			38,608
Accounts receivable, net		33,641			33,849
Prepaid expenses and other current assets		6,455			4,096
Total current assets		94,149			135,161
Property and equipment, net		19,582			20,062
Intangibles, net		72,983			75,735
Goodwill		43,469			43,985
Restricted cash		150			3,841
Other assets		5,249			5,280
Total assets	$	235,582		$	284,064
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	6,483		$	2,479
Accrued expenses		27,111			31,833
Deferred revenue		22,617			24,622
Total current liabilities		56,211			58,934
Convertible subordinated notes		65,155			105,500
Other long-term liabilities		2,692			5,727
Total liabilities		124,058			170,161
Commitments and contingencies (Note 8)
Stockholders’ equity:
Common stock		4			4
Additional paid-in capital		292,789			286,336
Deferred stock-based compensation		—			(2,020	)
Accumulated deficit		(147,294	)		(136,581	)
Treasury stock		(32,650	)		(32,650	)
Accumulated other comprehensive loss		(1,325	)		(1,186	)
Total stockholders’ equity		111,524			113,903
Total liabilities and stockholders’ equity	$	235,582		$	284,064

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
	July 2, 2006			July 3, 2005
Revenue:
Licenses	$	34,540		$	33,910
Services		6,419			4,922
Total revenue		40,959			38,832
Cost of revenue:
Licenses		7,408			4,414
Services		5,158			3,857
Total cost of revenue		12,566			8,271
Gross profit		28,393			30,561
Operating expenses:
Research and development		15,449			12,609
Sales and marketing		13,847			11,210
General and administrative		11,795			8,643
Amortization of intangible assets		2,890			3,588
Total operating expenses		43,981			36,050
Operating loss		(15,588	)		(5,489	)
Other income:
Interest income		887			660
Interest expense		(175	)		(208	)
Other income, net		4,703			7,450
Other income, net		5,415			7,902
Net (loss) income before income taxes		(10,173	)		2,413
Provision for income taxes		(861	)		(2,436	)
Net loss before cumulative effect of change in accounting principle		(11,034	)		(23	)
Cumulative effect of change in accounting principle		321			—
Net loss	$	(10,713	)	$	(23	)
Net loss per common share before cumulative effect of change in accounting principle, basic and diluted	$	(0.31	)	$	(0.00	)
Net loss per common share, basic and diluted	$	(0.30	)	$	(0.00	)
Shares used in calculation, basic and diluted		35,654			34,132

See accompanying notes to unaudited condensed consolidated financial statements.

4

MAGMA DESIGN AUTOMATION, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Three Months Ended
	July 2, 2006			July 3, 2005
Cash flows from operating activities:
Net loss	$	(10,713	)	$	(23	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Cumulative effect of change in accounting principle		(321	)		—
Depreciation and amortization		2,529			2,250
Amortization of intangible assets		10,055			7,752
Provision for (recovery from) doubtful accounts		17			(179	)
Amortization of debt issuance costs		144			199
Loss on strategic equity investments		155			390
Gain on repurchase of convertible notes, net of debt issuance cost write-off		(4,809	)		(8,781	)
Loss on sale of short-term investments		3			661
Stock-based compensation		4,893			1,672
Income tax benefit realized from gain on repurchase of convertible notes		—			701
Income tax benefit realized from debt issuance costs		—			21
Change in operating assets and liabilities, net of effect of acquisitions:
Accounts receivable		(16	)		(878	)
Prepaid expenses and other assets		(2,264	)		447
Accounts payable		4,408			(809	)
Accrued expenses		(7,088	)		1,890
Deferred revenue		(2,004	)		522
Other long-term liabilities		(51	)		(355	)
Net cash (used in) provided by operating activities		(5,062	)		5,480
Cash flows from investing activities:
Purchase of intangible assets		(5,990	)		(9,505	)
Purchase of property and equipment		(1,223	)		(366	)
Purchase of short-term investments		(29,960	)		(37,733	)
Proceeds from sale and maturities of short-term investments		54,666			109,096
Purchase of strategic equity investments		(900	)		—
Net cash provided by investing activities		16,593			61,492
Cash flows from financing activities:
Proceeds from issuance of common stock, net		1,499			1,841
Repurchase of common stock		—			(16,045	)
Repurchase of convertible notes, net		(35,000	)		(34,668	)
Repayment of lease obligation		(287	)		(131	)
Net cash used in financing activities		(33,788	)		(49,003	)
Effect of foreign currency translation on cash and cash equivalents		11			(46	)
Net (decrease) increase in cash and cash equivalents		(22,246	)		17,923
Cash and cash equivalents at beginning of period		58,550			20,622
Cash and cash equivalents at end of period	$	36,304		$	38,545
Supplemental disclosure:
Non-cash investing and financing activities:
Deferred stock-based compensation	$	514		$	(908	)
Issuance of common stock in connection with asset purchase	$	2,402		$	12,005
Issuance of common stock warrant in connection with intangible asset purchase	$	—		$	3,080
Purchase of fixed assets under capital leases	$	1,489		$	1,790
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 1, 2007. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Company’s Form 10-K for the year ended April 2, 2006, as filed with the SEC on June 15, 2006. The accompanying unaudited condensed consolidated balance sheet at April 2, 2006 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 with the current year presentation. Specifically, the Company has reclassified certain prior year amounts relating to stock-based compensation as detailed in the statements of operations and in Note 2.

Change in Fiscal Year End

On January 26, 2005, the Company’s Board of Directors approved a change in Magma’s fiscal year end from March 31 to a 52-53 week fiscal year ending on the first Sunday subsequent to March 31. After the fiscal year ended March 31, 2005, Magma’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. As a result of this change, the first quarter of Magma’s fiscal year 2006 included three additional days, the results of which were included in Magma’s Form 10-Q for that quarter.

Recently Issued Accounting Pronouncements

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (“FIN 48”).

6

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

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. The new guidance will be effective for the Company on April 2, 2007, beginning of its fiscal year 2008. The Company is currently evaluating the provisions in FIN 48, however, at the present time, it does not anticipate that the adoption of FIN 48 will have a material impact on its consolidated financial statements.

In May 2005, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS 154”). This new standard replaces APB Opinion No. 20, “Accounting Changes in Interim Financial Statements”, and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements”, and represents another step in the FASB’s goal to converge its standards with those issued by the International Accounting Standards Board (“IASB”). Among other changes, SFAS 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless it is impracticable. SFAS 154 also provides that (1) a change in method of depreciating or amortizing a long-lived nonfinancial asset be accounted for as a change in estimate (prospectively) that was effected by a change in accounting principle, and (2) correction of errors in previously issued financial statements should be termed a “restatement.” The new standard is effective for accounting changes and correction of errors made in fiscal years beginning after December 15, 2005. Early adoption of this standard is permitted for accounting changes and correction of errors made in fiscal years beginning after June 1, 2005. Management does not expect the adoption of SFAS 154 to have a material effect on the Company’s consolidated financial statements.

NOTE 2. STOCK-BASED COMPENSATION

Adoption of SFAS 123R

Effective April 3, 2006, the Company accounts for stock-based employee compensation arrangements under SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”) which supersedes the provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and requires the fair value recognition of share-based payment arrangements, including stock options, restricted stock, restricted stock units and the Employee Stock Purchase Plan (“ESPP”). Prior to April 3, 2006, the Company accounted for its stock based compensation plans using the intrinsic value method under the provisions of APB 25 and related guidance. The Company adopted SFAS 123R using the modified-prospective-transition method and accordingly prior periods have not been restated to reflect the impact of SFAS 123R. Under the modified-prospective-transition method, the results of operations include compensation costs of unvested options and awards granted prior to April 3, 2006, and options and awards granted subsequent to that date. Additionally, the Company elected to use the straight-line method to recognize its stock-based compensation expenses over the option and award’s vesting periods. For options and awards granted prior to adoption of SFAS 123R, the Company continues to record stock-based compensation expenses under the accelerated attribution method. As required by SFAS 123R, on April 3, 2006, the Company eliminated the unamortized deferred stock compensation of $2.0 million and reduced the Company’s additional paid-in capital by the same amount, which had been included in stockholders’ equity in the Company’s condensed consolidated balance sheet as of April 2, 2006.

Unlike APB 25, which allows adjustments to compensation costs for actual forfeitures, SFAS 123R requires the rate of forfeiture to be estimated and recorded during the option term. Accordingly, during the first quarter of fiscal 2007, the Company recorded a credit of $321,000, reflecting the cumulative effect of the change in accounting principle for forfeitures primarily related to unvested restricted stock that had previously been recognized as stock-based compensation expense without consideration of forfeitures. No income tax benefit related to the cumulative effect of the change in accounting for stock option forfeitures was recorded as the Company has provided full valuation allowance against its net deferred tax assets.

7

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

In March 2005, the Commission issued Staff Accounting Bulletin (“SAB”) No. 107, which provided supplemental implementation guidance for SFAS 123R. SAB 107 requires stock-based compensation to be classified in the same expense line items as cash compensation. Accordingly, the Company recorded stock-based compensation for the three months ended July 2, 2006 and reclassified stock-based compensation for the three months ended July 3, 2005 as follows (in thousands):

	Three Months Ended
	July 2, 2006		July 3, 2005
Cost of revenue	$	342	$	—
Research and development expense		2,013		1,634
Sales and marketing expense		1,271		8
General and administrative expense		1,267		30
Total stock-based compensation expense	$	4,893	$	1,672

The Company has not provided an income tax benefit for stock-based compensation expense for current and prior year periods, since it is more likely than not that the deferred tax assets associated with this expense will not be realized. To the extent the Company realizes the deferred tax assets associated with the stock-based compensation expense in the future, the income tax effects of such an event may be recognized at that time. Prior to the adoption of SFAS 123R, the Company presented all tax benefits for deductions resulting from the exercise of stock options as operating cash flows on its statement of cash flows. SFAS 123R requires the cash retained as a result of tax benefits for tax deductions in excess of the compensation expense recorded for those options to be classified as cash from financing activities. The Company recorded no excess tax benefits for the three months ended July 2, 2006.

The adoption of SFAS 123R had a material effect on the Company’s financial results since April 3, 2006. The Company’s operating loss for the three months ended July 2, 2006 increased by $3.4 million and net loss by $3.1 million than if the Company had continued to account for stock-based compensation under APB 25. Basic and diluted net loss per share for the three months ended July 2, 2006 was $0.09 higher than if the company had continued to account for stock-based compensation under APB 25. For the three months ended July 3, 2005, the Company recognized $1.7 million of stock-based compensation expense under the intrinsic value method.

Stock-based compensation expense by type of awards during the three months ended July 2, 2006 was as follows (in thousands):

	Three Months Ended July 2, 2006
Stock options	$	3,023
Restricted stock and restricted stock units		1,149
Employee stock purchase plan		721
Total stock-based compensation expense	$	4,893

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, which enables employees to purchase shares of the

8

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Company’s common stock. As of July 2, 2006, the Company had remaining 12.9 million and 3.1 million shares, respectively, of common stock authorized for issuance under its stock incentive plans and the ESPP.

Stock Options

Stock options are granted at the market price of the Company’s common stock on the date of grant under the Company’s stock incentive plans. Option grants vest over two to four years, expire no later than five or ten years from the grant date and are subject to the employee’s continuing service to the Company. The Company uses the Black-Scholes option pricing model to determine the fair value of its stock options, which is consistent with what was used for pro forma disclosures under SFAS 123, “Accounting for Stock-Based Compensation,” prior to the adoption of SFAS 123R. The Black-Scholes option pricing model was developed to estimate the fair value of short lived exchange-traded options that have no vesting restrictions and are fully transferable. In addition, the Black-Scholes option-pricing model incorporates various highly subjective assumptions including expected future stock price volatility and expected terms of instruments. The weighted average grant date fair value of options granted during the three months ended July 2, 2006 was $3.53. The weighted average assumptions used in the model for the three months ended July 2, 2006 were as follows:

	Three Months Ended July 2, 2006
Expected life (years)	4.20
Volatility	50%
Risk-free interest rate	4.90% - 5.15%
Expected dividend yield	0%

In refining estimates used in the adoption of SFAS 123R, the Company established the expected life assumption for employee options and awards, as well as expected forfeiture rates, based on the historical settlement experience, while giving consideration to vesting schedules and 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 volatility under SFAS 123R was developed based on the average 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.

A summary of the changes in stock options outstanding and exercisable under the Company’s stock incentive plans during the three months ended July 2, 2006 is as follows (in thousands, except per share amount):

	Number of Shares		Weighted Average Price per Share		Weighted Average Remaining Contractual Term (Years)	Aggregate Intrinsic Value
Options outstanding at April 2, 2006	8,979		$	10.64		$	2,940
Granted	2,153		$	7.77
Exercised	(1	)	$	6.08
Cancelled and forfeited	(324	)	$	14.13
Options outstanding at July 2, 2006	10,807		$	9.96	5.60	$	1,194
Exercisable at July 2, 2006	5,057		$	11.08	6.09	$	993

9

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

The total intrinsic value of options exercised during the three months ended July 2, 2006 and July 3, 2005 was $2,000 and $171,000, respectively. As of July 2, 2006, there was approximately $16.5 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to stock option grants, which will be recognized over the remaining weighted average vesting period of approximately 1.51 years.

Restricted Stock and Restricted Stock Units

Restricted stock and restricted stock units were granted to employees at par value under the Company’s stock incentive plans and Key Contributor Long-Term Incentive Plan, or assumed in connection with an acquisition. In general, restricted stock and restricted stock unit awards vest over two to four years and are subject to the employees’ continuing service to the Company. 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.

A summary of the changes in restricted stock outstanding during the three months ended July 2, 2006 is presented below (in thousands, except per share amount):

	Number of Shares		Weighted Average Grant Date Fair Value
Shares nonvested at April 2, 2006	389		$	11.87
Granted	352		$	7.14
Vested	(166	)	$	10.98
Forfeited	—		$	—
Shares nonvested at July 2, 2006	575		$	9.23

As of July 2, 2006, there was $3.3 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to restricted stock awards, which will be recognized over the remaining weighted average vesting period of approximately 1.67 years.

A summary of the changes in restricted stock units outstanding during the three months ended July 2, 2006 is presented below (in thousands, except per share amount):

	Number of Shares		Weighted Average Price per Share		Weighted Average Remaining Contractual Term (Years)	Aggregate Intrinsic Value
Shares nonvested at April 2, 2006	—		$	—
Granted	51		$	0.0001
Vested	—		$	—
Forfeited	(1	)	$	0.0001
Shares nonvested at July 2, 2006	50		$	0.0001	4.94	$	369

As of July 2, 2006, there was $0.3 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to restricted stock unit awards, which will be recognized over the remaining weighted average vesting period of approximately 1.75 years.

10

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

The total fair value of restricted stock and restricted stock units that were vested during the three months ended July 2, 2006 and July 3, 2005 was $1.8 million and $0, respectively.

Employee Stock Purchase Plan

The 2001 Employee Stock Purchase Plan (“2001 Purchase Plan”) provides for a series of overlapping offering periods with a duration of 24 months, with new offering periods beginning in February, May, August, and November of each year. The 2001 Purchase Plan allows employees to purchase common stock through payroll deductions of up to 15% of their eligible compensation. Such deductions will accumulate over a three-month accumulation period without interest. After such accumulation period, shares of common stock will be purchased at a price equal to 85% of the fair market value per share of common stock on either the first day preceding the offering period or the last date of the accumulation period, whichever is less. In the event that the fair market value on the last date of the accumulation period is lower than the fair market value at the beginning of the offering period, participants are automatically re-enrolled in a new 24- month offering period at the lower fair market value. During the quarter ended July 2, 2006, a total of 313,646 shares were issued under the 2001 Purchase Plan at an average price of $5.36 per share. As of July 2, 2006, a total of 3,056,332 shares of common stock remained available for issuance under the 2001 Purchase Plan.

Compensation expense for ESPP is calculated using the fair value of the employees’ purchase rights under the Black-Scholes option pricing model. The weighted average estimated grant date fair value of purchase rights granted under the ESPP during the three months ended July 2, 2006 was $2.64. The weighted average assumptions used in the model for the three months ended July 2, 2006 were as follows:

	Three Months Ended July 2, 2006
Expected life (years)	1.13
Volatility	50	%
Risk-free interest rate	4.97	%
Expected dividend yield	0	%

Expected volatility under SFAS 123R was developed based on the average of Magma’s historical weekly stock price volatility and average implied volatility. The expected life assumption is based on the average exercise date for the eight purchase periods in each 24-month offering period. The risk-free interest rate for the period within the expected life of the purchase right is based on the yield of United States Treasury notes in effect at the time of grant.

As of July 2, 2006, the Company had $1.9 million of total unrecognized compensation expense, net of estimated forfeitures, related to ESPP, which will be recognized over the remaining weighted average vesting period of 0.57 years.

Tax Effects of Stock-Based Compensation Awards

In November 2005, FASB issued Financial Statement Position (“FSP”), on SFAS No. 123R-3, “Transition Election Related to Accounting for Tax Effects of Stock-Based Payment Awards.” Effective upon issuance, FSP 123R-3 provides for an alternative transition method for calculating the tax effects of stock-based compensation pursuant to SFAS No. 123R. The alternative transition method provides simplified approaches to establish the beginning balance of a tax benefit pool comprised of the additional paid-in capital, or APIC, related to the tax effects of employee stock-based compensation, and to determine the subsequent impact on the APIC tax benefit

11

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

pool and the statement of cash flows of stock-based awards that were outstanding upon the adoption of SFAS No. 123R. Companies have one year from the later of the adoption of SFAS No. 123R or the effective date of the FSP to evaluate their transition alternatives and make a one-time election. Upon adoption of SFAS No. 123R, the Company elected to calculate its historical pool of windfall tax benefits using the “long-form method” provided in paragraph 81 of SFAS 123R, which resulted in an APIC windfall pool of tax benefits position.

Stock-Based Compensation for the Three Months Ended July 3, 2005

During the three months ended July 3, 2005, the Company accounted for its stock-based employee compensation arrangements in accordance with provisions of APB 25 and related guidance. The Company recognized in its Condensed Consolidated Statements of Operations $1.7 million of stock-based compensation expense primarily for the intrinsic value of restricted stock awarded during the three months ended July 3, 2005.

During the three months ended July 3, 2005, the Company complied with the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended. Had compensation cost for the Company’s stock-based compensation plan been determined using the Black-Scholes option pricing model at the grant date for awards granted in accordance with the provisions of SFAS 123, the Company’s net loss would have been the amounts indicated below (in thousands, except per share amount):

	Three Months Ended July 3, 2005
Net loss:
As reported	$	(23	)
Add: Stock-based employee compensation expense included in reported net loss		1,672
Deduct: Stock-based employee compensation expense determined under fair value method for all awards		(5,382	)
Pro forma	$	(3,733	)
Net loss per share, basic and diluted:
As reported	$	(0.00	)
Pro forma	$	(0.11	)

The weighted-average estimated fair value per share at the date of grant for options granted to employees and for share purchase rights granted under the employee stock purchase plans was as follows:

	Three Months Ended July 3, 2005
Stock options	$	3.16
Employee stock purchase plans	$	1.72

12

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

The fair value of options at the date of grant was estimated using the Black-Scholes option pricing model, with the following weighted-average assumptions:

	Three Months Ended July 3, 2005
Stock options:
Risk-free interest rate	3.78	%
Expected dividend yield	0	%
Volatility	55	%
Expected life (years)	3.13
Employee stock purchase plans:
Risk-free interest rate	3.65	%
Expected dividend yield	0	%
Volatility	64	%
Expected life (years)	0.25

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

The Company computes net income (loss) per share in accordance with SFAS 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 as-if-converted method.

For the three months ended July 2, 2006 and July 3, 2005, 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 Months Ended
	July 2, 2006		July 3, 2005
Shares of common stock upon full conversion of convertible subordinated notes		2,850		4,615
Shares of common stock issuable for all outstanding instruments under stock option plans		11,783		10,330
Weighted average price of shares issuable under stock option plans	$	9.62	$	14.63

13

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Note 4. Cash Equivalents and Investments

Cash equivalents and short-term investments are detailed as follows (in thousands):

	Cost		Unrealized Gains		Unrealized Losses			Estimated Fair Value
	(In Thousands)
July 2, 2006
Classified as current assets:
Cash	$	14,496	$	—	$	—		$	14,496
Money market funds		7,113		—		—			7,113
Commercial paper		14,709		—		(14	)		14,695
Auction rate preferred		13,950		—		—			13,950
Government agencies		7		—		(1	)		6
	$	50,275	$	—	$	(15	)	$	50,260
April 2, 2006
Classified as current assets:
Cash	$	13,167	$	—	$	—		$	13,167
Money market funds		4,899		—		—			4,899
Commercial paper		40,556		—		(72	)		40,484
Auction rate preferred		3,250		—		—			3,250
Government agencies		158		—		—			158
Auction rate certificates		35,200		—		—			35,200
	$	97,230	$	—	$	(72	)	$	97,158

As of July 2, 2006, the stated maturities of the Company’s current investments (including $21.8 million classified as cash equivalent investments in the table above) are $36.3 million within one year and $14.0 million after ten years.

As of July 2, 2006, all unrealized losses related to instruments with durations of less than twelve months. The gross unrealized losses on these investments were primarily due to interest rate fluctuations and market-price movements. The Company reviewed the investment portfolio and determined that the gross unrealized losses on these investments at July 2, 2006 were temporary in nature. The Company has the ability and intent to hold these investments until recovery of their carrying values. The Company also believes that it will be able to collect both principal and interest amounts due to the Company at maturity, given the high credit quality of these investments.

In May 2005, the Company liquidated certain investments to repurchase a portion of the convertible subordinated notes, resulting in a realized loss of approximately $0.7 million. There were no significant losses realized in connection with the convertible subordinated note repurchases in May 2006. See Note 7 for information regarding the repurchase of convertible subordinated notes.

Note 5. Asset Purchases

Technology Licenses

On May 3, 2006, the Company acquired a license to technology relating to electronic design automation from Stabie-Soft, Inc. The Company paid $2.5 million for the license and, subject to the completion and delivery of technology meeting certain milestones, may pay additional fees of $0.5 million.

14

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

On June 30, 2005, the Company acquired a technology license from International Business Machines Corporation (“IBM”) and extended the term of Magma’s patent license with IBM to 2010. Both arrangements cover IBM’s patents and significant technology with respect to the development of EDA tools and products that perform physical implementation. Included in intangible assets were license fees of $7.0 million and $3.1 million fair value of warrants to purchase 500,000 shares of Magma common stock at $4.73 per share.

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 three months ended July 2, 2006, the Company recorded $4.8 million, approximately half in cash and half in stock, of intangible assets resulting from contingent consideration that was paid or became payable to stockholders of Mojave, Inc.

Note 6. Goodwill and Intangible Assets

The following table summarizes the components of goodwill, intangible assets and related accumulated amortization balances as of July 2, 2006 and April 2, 2006 (in thousands):

	Weighted Average Life (months)	July 2, 2006							April 2, 2006
		Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Goodwill		$	43,469	$	—		$	43,469	$	43,985	$	—		$	43,985
Intangible assets:
Developed technology	44	$	93,995	$	(43,970	)	$	50,025	$	89,192	$	(37,824	)	$	51,368
Licensed technology	38		35,593		(20,804	)		14,789		33,093		(17,962	)		15,131
Customer relationship or base	60		2,310		(1,202	)		1,108		2,310		(1,086	)		1,224
Patents	58		12,690		(6,638	)		6,052		12,690		(5,934	)		6,756
Acquired customer contracts	32		1,090		(889	)		201		1,090		(782	)		308
Assembled workforce	45		1,235		(760	)		475		1,235		(675	)		560
No shop right	24		100		(100	)		—		100		(100	)		—
Non-competition agreements	36		300		(58	)		242		300		(33	)		267
Trademark	45		400		(309	)		91		400		(279	)		121
Total		$	147,713	$	(74,730	)	$	72,983	$	140,410	$	(64,675	)	$	75,735

During the three months ended July 2, 2006, the Company reduced its goodwill by $0.5 million, reflecting purchase price adjustments of an acquisition for tax benefits recognized on acquired net operating loss carryforwards.

For the three months ended July 2, 2006 and July 3, 2005 the amortization expense related to intangible assets was $10.1 million and $7.8 million, respectively, of which $7.2 million and $4.2 million, respectively, was

15

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

included in cost of revenue because it related to the products sold, while the remaining $2.9 million and $3.6 million, respectively, was shown as a separate line item on the Company’s unaudited condensed consolidated statement of operations for the respective periods.

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

Fiscal Year	Estimated Amortization Expense
2007 (remaining nine months)	$	30,347
2008		23,217
2009		16,746
2010		2,110
2011 and thereafter		563
Total expected future annual amortization	$	72,983

Note 7. Repurchase of Convertible Subordinated Notes

In May 2006, the Company repurchased, in privately negotiated transactions, $40.3 million face amount (or approximately 38.2 percent of the remaining principal) of the Company’s zero coupon convertible subordinated notes due May 2008 at an average discount to face value of approximately 13 percent. The Company spent approximately $35.0 million on the repurchases. The repurchase left approximately $65.2 million principal amount of convertible subordinated notes outstanding. In addition, a portion of the hedge and warrant transactions entered into by Magma in 2003 to limit potential dilution from conversion of the notes was terminated in connection with the repurchase. In the first quarter of fiscal 2007, the Company recorded a pre-tax 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 convertible subordinated 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 recorded against additional paid-in-capital.

In May 2005, the Company repurchased, in privately negotiated transactions, $44.5 million face amount (or approximately 29.7 percent of the total) of the Company’s zero coupon convertible subordinated notes due May 2008 at an average discount to face value of approximately 22 percent. The Company spent approximately $34.8 million on the repurchases. The repurchase left approximately $105.5 million principal amount of convertible subordinated 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 2006, the Company recorded a pre-tax gain of $8.8 million on the repurchase, which was partially offset by the write-off of $0.9 million of deferred financing costs associated with the convertible subordinated notes. The net proceeds of $140,000 from the termination of a portion of the hedge and warrant were recorded against additional paid-in capital.

Note 8. Contingencies

Synopsys, Inc. v. Magma Design Automation, Inc., Civil Action No. C04-03923, United States District Court, Northern District of California. In this action, filed September 17, 2004, Synopsys has sued the Company for alleged infringement of U.S. Patent Nos. 6,378,114 (“the ‘114 Patent”), 6,453,446 (“the ‘446 Patent”), and 6,725,438 (“the ‘438 Patent”). The patents-in-suit relate to methods for designing integrated circuits. The Complaint seeks unspecified monetary damages, injunctive relief, trebling of damages, fees and costs, and the imposition of a constructive trust for the benefit of Synopsys over any profits, revenues or other benefits

16

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

allegedly obtained by the Company as a result of its alleged infringement of the patents-in-suit. In addition to the below discussion, this case was also discussed in our Annual Report on Form 10-K for the fiscal year ended April 2, 2006.

On October 21, 2004, the Company filed its answer and counterclaims (“Answer”) to the Complaint. On November 10, 2004, Synopsys filed motions to strike and dismiss certain affirmative defenses and counterclaims in the Answer. On November 24, 2004 the Company filed an Amended Answer and Counterclaims (“Amended Answer”). By order dated November 29, 2004, the Court denied Synopsys’ motions as moot in light of the Amended Answer. On December 10, 2004, Synopsys moved to strike and dismiss certain affirmative defenses and counterclaims in the Amended Answer. By order dated January 20, 2005, the Court denied in part and granted in part Synopsys’ motion. In its pretrial preparation order dated January 21, 2005, the Court set forth a schedule for the case which, among other things, sets trial for April 24, 2006.

On February 3, 2005, Synopsys filed its Reply to the Amended Answer. On March 17, 2005, Synopsys filed a First Amended Complaint, which asserts seven causes of action against the Company and/or Lukas van Ginneken: (1) patent infringement (against both defendants), (2) breach of contract (against van Ginneken), (3) inducing breach of contract (against the Company), (4) fraud (against the Company), (5) conversion (against both defendants), (6) unjust enrichment/constructive trust (against both defendants), and (7) unfair competition (against both defendants). Synopsys seeks injunctive relief, declaratory relief, at least $100 million in damages, trebling of damages, punitive damages, fees and costs, and the imposition of a constructive trust for the benefit of Synopsys over any profits, revenues or other benefits allegedly obtained by the Company as a result of its alleged exploitation of the alleged inventions in the patents-in-suit. On April 1, 2005, the Company filed a motion to dismiss the third through seventh causes of action. This motion was granted in part and denied in part by order dated May 18, 2005.

On April 11, 2005, Synopsys voluntarily dismissed van Ginneken from the lawsuit without prejudice. Also on April 11, 2005, Synopsys filed against the Company a motion for partial summary judgment establishing unfair competition and a motion for partial summary judgment based on the doctrine of assignor estoppel.

On June 7, 2005, Synopsys filed a Second Amended Complaint that asserts six causes of action against the Company: (1) patent infringement, (2) inducing breach of contract/interference with contractual relations, (3) fraud, (4) conversion, (5) unjust enrichment/constructive trust/quasi-contract, and (6) unfair competition. Synopsys seeks injunctive relief, declaratory relief, at least $100 million in damages, trebling of damages, punitive damages, fees and costs, and the imposition of a constructive trust for the benefit of Synopsys over any profits, revenues or other benefits allegedly obtained by the Company as a result of its alleged exploitation of the alleged inventions in the patents-in-suit. On June 10, 2005, Magma moved for summary judgment as to the second through sixth causes of action in the Second Amended Complaint based on the applicable statutes of limitations. On June 21, 2005, the Company moved to dismiss the third cause of action alleging fraud in the Second Amended Complaint and moved to strike certain allegations in the Second Amended Complaint. The Court granted the Company’s motion to dismiss and strike by order dated July 15, 2005.

On July 1, 2005, the Court granted Synopsys’s motion for partial summary judgment regarding assignor estoppel, dismissing Magma’s affirmative defenses and counterclaim alleging the invalidity of the ‘114 Patent. On July 14, 2005, the Court vacated the hearings on Magma’s motion for summary judgment on the second through sixth causes of action in the Second Amended Complaint and Synopsys’s motion for partial summary judgment establishing unfair competition. The Court stated that it would reset the motions for hearing, if necessary, after the claims construction hearing scheduled for August 15, 2005.

17

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

On July 29, 2005, Synopsys moved to preliminarily enjoin the Company from abandoning or dedicating to the public the ‘446 Patent or the ‘438 Patent. Also on July 29, 2005, Synopsys moved for partial summary judgment seeking dismissal of certain counterclaims and defenses asserted by the Company on the grounds of estoppel by contract. On September 16, 2005, Synopsys filed a revised motion for preliminary injunction. On September 30, 2005, the Company filed its oppositions to Synopsys’s preliminary injunction motion and estoppel by contract motion.

On August 3, 2005, Synopsys filed a Third Amended Complaint that asserts six causes of action against the Company: (1) patent infringement, (2) inducing breach of contract/interference with contractual relations, (3) fraud, (4) conversion, (5) unjust enrichment/constructive trust/quasi-contract, and (6) unfair competition. Synopsys seeks injunctive relief, declaratory relief, at least $100 million in damages, trebling of damages, punitive damages, fees and costs, and the imposition of a constructive trust for the benefit of Synopsys over any profits, revenues or other benefits allegedly obtained by the Company as a result of its alleged exploitation of the alleged inventions in the patents-in-suit.

On August 30, 2005, the Court issued a temporary restraining order against the Company restraining and enjoining the Company from taking any steps in the United States Patent and Trademark Office to abandon, suspend or disclaim the ‘446 and ‘438 Patents, failing or refusing to pay the maintenance fees for the ‘446 and ‘438 Patents, or seeking reexamination of the ‘446 and ‘438 Patents. The temporary restraining order was scheduled to remain in effect until the hearing on Synopsys’s motion for a preliminary injunction that was scheduled for December 2, 2005. On December 1, 2005, the Court, vacated the hearing and granted Synopsys’s motion for preliminary injunction. The Court entered the preliminary injunction enjoining the Company from abandoning, dedicating to the public or seeking reexamination in the United States Patent and Trademark Office of the ‘446 Patent or the ‘438 Patent.

On September 2, 2005, the Company filed an Answer and Counterclaims to Synopsys’s Third Amended Complaint. In that pleading, the Company alleges,inter alia, that IBM is a joint owner of the patents-in-suit and that, as a result, the Company cannot be liable for infringement because (1) Synopsys lacks standing to assert the patents-in-suit against Magma, and (2) IBM has granted the Company a license under the patents-in-suit.

On October 14, 2005, the Court granted Synopsys’s request for permission to file an amended opposition to Magma’s motion for summary judgment on the second through sixth causes of action in the Second Amended Complaint. Synopsys filed its amended opposition on December 20, 2005, and the Company filed its reply on January 13, 2006. The motion was set for hearing on January 27, 2006, but the Court vacated the hearing date and took the matter under submission.

On October 19, 2005, the Court granted in part and denied in part Synopsys’s motion to strike certain affirmative defenses and to dismiss certain counterclaims in the Company’s Answer and Counterclaims to Synopsys’s Third Amended Complaint. The Court dismissed without leave to amend the Company’s counterclaims seeking correction of inventorship of the ‘446 and ‘438 Patents. The Court also struck without leave to amend the Company’s affirmative defenses of (1) invalidity of the ‘446 and ‘438 Patents based on failure to name all inventors, (2) unenforceability of the ‘446 and ‘438 patents due to inequitable conduct, and (3) unclean hands. The Court struck with leave to amend the Company’s affirmative defenses of invalidity of the ‘446 and ‘438 Patents based on 35 U.S.C. §§ 102, 103 and 112, as well as the Company’s affirmative defense that Synopsys is not the owner of any invention defined by the claims of the ‘446 and ‘438 Patents. On October 24, 2005, the Company filed a motion for summary judgment as to the first cause of action (for patent infringement) in Synopsys’s Third Amended Complaint on the grounds that IBM is an owner of all the

18

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

patents-in-suit. Also on October 24, 2005, Synopsys filed (1) a motion for partial summary judgment to dismiss the Company’s joint ownership defenses and counterclaims, and (2) a motion for partial summary judgment to dismiss allegations of co-ownership based on judicial and quasi-estoppel.

On November 2, 2005, the Company filed a motion for leave to file an amended answer and counterclaims to Synopsys’s Third Amended Complaint, requesting leave to amend the Company’s answer to add affirmative defenses of invalidity of the ‘446 and ‘438 Patents based on 35 U.S.C. §§ 102, 103 and 112. The Company’s motion was set for hearing on December 16, 2005, but the Court vacated the hearing date and took the matter under submission.

On November 8, 2005, Synopsys filed a motion for sanctions against the Company based on the Company’s assertion of non-infringement defenses and counterclaims in the litigation. The Company opposed the motion, which was set for hearing on December 16, 2005. The hearing was vacated and the motion was taken under submission by the Court.

On November 8, 2005, the Company filed a motion seeking leave to file a motion for reconsideration of the Court’s October 19, 2005 Order striking certain of the Company’s defenses without leave to amend. The Court granted the Company’s request on November 21, 2005. On December 9, 2005, the Company filed a motion for reconsideration of the Court’s October 19, 2005 Order striking the Company’s affirmative defense of unclean hands and for leave to amend the Company’s answer to assert an unclean hands defense. The motion was set for hearing on January 13, 2006, but the Court vacated the hearing and took the matter under submission.

On December 23, 2005, Synopsys filed a motion for partial summary judgment regarding the Company’s statute of limitations defense. The Company opposed the motion, which was set for hearing on January 27, 2006. The hearing was vacated and the motion taken under submission by the Court.

On December 29, 2005, the Company filed a notice of interlocutory appeal to the Court of Appeals for the Federal Circuit of the Court’s December 1, 2005, preliminary injunction against the Company. By agreement of the parties, Magma has dismissed the appeal.

On January 20, 2006, the Company filed a motion to bifurcate the trial into issues of patent ownership and all other issues. The parties subsequently stipulated to bifurcate the case with patent ownership to be tried first.

Fact and expert discovery relating to patent ownership have closed. By stipulation so-ordered on March 13, 2006, the parties have agreed to schedule any remaining discovery after the patent ownership trial is resolved.

By order dated March 30, 2006, the Court denied Magma’s motion for summary judgment regarding patent ownership, as well Synopsys’s motions (1) for partial summary judgment based on estoppel by contract, (2) for partial summary judgment to dismiss the Company’s joint ownership defenses and counterclaims, and (3) for partial summary judgment to dismiss allegations of co-ownership based on judicial and quasi-estoppel. The parties subsequently stipulated (a) that Magma would withdraw its claim to ownership of the ‘446 and ‘438 Patents on the basis that the “buckets” claims (i.e., Claims 17, 18, 31, and 32 of the ‘446 Patent and Claims 17 and 18 of the ‘438 Patent) were conceived by Magma engineers after Lukas van Ginneken left Synopsys and (b) that Synopsys would withdraw its assertion that Magma would be foreclosed from arguing that the inventions in the ‘446 and ‘438 Patents were reduced to practice after van Ginneken left Synopsys.

The ownership case was tried to the Court, without a jury, from April 24, 2006 through May 10, 2006. The parties’ opening post-trial briefs and findings of fact and conclusions of law were filed June 9, 2006. The parties’ reply post-trial briefs were filed June 30, 2006. The parties are currently awaiting the Court’s ruling.

19

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

On April 18, 2005, Synopsys, Inc. filed an action against the Company in Germany at the Landgericht München I (District Court in Munich) seeking to obtain ownership of the European patent application corresponding to the Company’s ‘446 Patent. The action has been stayed pending the outcome of the above-referenced Synopsys action filed in the United States. This action was also discussed in our Annual Report on Form 10-K for the fiscal year ended April 2, 2006.

On July 29, 2005, Synopsys, Inc. filed an action against the Company in Japan in Civil Department No. 40 of the Tokyo District Court seeking to obtain ownership of the Japanese patent application corresponding to the Company’s ‘446 Patent. The court has entered a defacto stay pending the outcome of the above-referenced Synopsys action filed in the United States. The Japanese Court held hearings on January 18, 2006, March 6, 2006 and July 11, 2006, and set a further hearing on October 23, 2006. This action was also discussed in our Annual Report on Form 10-K for the fiscal year ended April 2, 2006.

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 have again moved to dismiss. This lawsuit was also discussed in our Annual Report on Form 10-K for the fiscal year ended April 2, 2006.

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 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 lawsuit was also discussed in our Annual Report on Form 10-K for the fiscal year ended April 2, 2006.

On September 26, 2005, Synopsys, Inc. filed an action against the Company in the Superior Court of the State of California in and for the County of Santa Clara, entitledSynopsys, Inc. v. Magma Design Automation, Inc., et al., Case Number 105 CV 049638. Synopsys alleges that Magma committed unfair business practices by asserting defenses of non-infringement and invalidity to patent infringement allegations brought by Synopsys in the patent infringement action already pending against Magma in the Northern District of California. The Complaint seeks unspecified monetary damages, an unspecified restitutionary/disgorgement award, injunctive relief, fees and costs, and an accounting of all revenues and profits derived from licensing the technology at issue. On October 19, 2005, the Company removed the action to the United States District Court for the Northern District of California. On October 26, 2005, the Company moved to strike and dismiss the complaint. On October 27, 2005, the Court granted the Company’s motion to relate the removed action with the preexisting patent infringement action, and both actions are now assigned to Judge Maxine M. Chesney. The Court vacated the hearing on the Company’s motion to strike and dismiss the complaint and has taken the matter under submission. This action was also discussed in our Annual Report on Form 10-K for the fiscal year ended April 2, 2006.

On September 26, 2005, Synopsys, Inc. filed an action against the Company in Delaware federal court,Synopsys, Inc. v. Magma Design Automation, Inc., Civil Action No. 05-701. The Complaint alleges infringement

20

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

of U.S. Patent Nos. 6,434,733 (“the ‘733 Patent”), 6,766,501 (“the ’501 Patent”), and 6,192,508 (“the ‘508 Patent”). The patents-in-suit relate to methods for designing integrated circuits. The Complaint seeks unspecified monetary damages, injunctive relief, trebling of damages, fees and costs, and the imposition of a constructive trust for the benefit of Synopsys over any profits, revenues or other benefits allegedly obtained by the Company as a result of its alleged infringement of the patents-in-suit. In addition to the below discussion, this case was also discussed in our Annual Report on Form 10-K for the fiscal year ended April 2, 2006.

On October 19, 2005, the Company filed its answer and counterclaims (“Answer”) to Synopsys’s Complaint. The Answer asserts that the Company’s products do not infringe the patents-in-suit, that the patents-in-suit are unenforceable, and that the ‘733 Patent and the ‘501 Patent were fraudulently obtained by Synopsys and are therefore unenforceable. The Answer also asserts antitrust counterclaims based on Synopsys’s assertion of the ‘733 and ‘501 Patents, as well as claims for product disparagement and trade libel, statutory and common law unfair competition, and tortuous interference with business relations. The counterclaims seek treble damages and other equitable relief for Synopsys’s anticompetitive and tortuous conduct.

On October 25, 2005, the Company filed an Amended Answer, adding a counterclaim for infringement of U.S. Patent No. 6,505,328 (“the ‘328 Patent”). The ‘328 Patent relates to methods for designing integrated circuits. The Company seeks treble damages and an injunction against Synopsys for the sale and manufacture of products the Company alleges infringe the ‘328 Patent.

On November 22, 2005, Synopsys filed a motion to dismiss the Company’s antitrust and other commercial counterclaims. The Company opposed that motion on December 7, 2005. Synopsys filed its reply brief on December 14, 2005. The Court denied Synopsys’s motion on May 25, 2006.

On January 9, 2006, Synopsys filed a request for the United States Patent and Trademark Office to reexamine its ‘733 and ‘501 Patents in light of two prior art references that it had not previously disclosed to the Patent Office. On January 23, 2006, Synopsys filed a motion with the Delaware federal court to bifurcate and stay its claims for infringement of its ‘733 and ‘501 Patents and the Company’s counterclaims except for its claim for infringement of the ‘328 Patent, based in part on Synopsys’s having filed the request for patent reexamination. The Company’s opposition to that motion was filed on February 6, 2006. The Court denied Synopsys’s motion on May 25, 2006.

On March 24, 2006, the Company filed a motion for leave to file a Second Amended Answer and Counterclaims, to add counterclaims for infringement of U.S. Patent Nos. 6,519,745 (“the ‘745 Patent”), 6,931,610 (“the ‘610 Patent”), 6,854,093 (“the ‘093 Patent”), and 6,857,116 (“the ‘116 Patent”). All four patents relate to methods for designing integrated circuits. Synopsys opposed the motion on April 7, 2006. The Company filed its reply brief on April 14, 2006. The Court granted the Company’s motion on May 25, 2006.

On June 13, 2006, the parties held a conference with the Court at which, among other things, Synopsys requested that the trial be delayed until late 2007. The Court denied Synopsys’s request. Fact discovery is ongoing and is currently scheduled to close on January 12, 2007, and trial remains scheduled for June 11, 2007.

The Company intends to vigorously defend against all claims asserted by Synopsys and to fully enforce its rights against Synopsys. 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 Synopsys claims. A favorable outcome for Synopsys could have a material adverse effect on the Company’s financial position, results of operations or cash flows. The Company is currently unable to assess the extent of damages and/or other relief, if any, that could be awarded to Synopsys.

21

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

In addition to the above, from time to time, the Company is involved in disputes that arise in the ordinary course of business. The number and significance of these disputes is increasing as the Company’s business expands and it 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 disputes could harm the Company’s business, financial condition, results of operations or cash flows.

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 make may exceed its normal business practices. The Company estimates the fair value of its indemnification obligations as 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 July 2, 2006.

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 a directors’ and officers’ liability insurance policy that reduces its exposure and enables the Company to recover a portion of future amounts paid. As a result of the Company’s insurance policy 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 July 2, 2006.

In connection with certain of the Company’s recent business acquisitions, it has also agreed to assume, or cause Company subsidiaries to assume, the indemnification obligations of those companies to their respective officers and directors.

Warranties

The Company offers its 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 July 2, 2006. 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.

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MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Note 9. Comprehensive Income (Loss)

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

	Three Months Ended
	July 2, 2006			July 3, 2005
Net loss	$	(10,713	)	$	(23	)
Unrealized gain on available-for-sale investments		57			823
Foreign currency translation adjustments		(196	)		99
Comprehensive income (loss)	$	(10,852	)	$	899

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

	July 2, 2006			April 2, 2006
Unrealized loss on available-for-sale investments	$	(15	)	$	(72	)
Foreign currency translation adjustments		(1,310	)		(1,114	)
Accumulated other comprehensive loss	$	(1,325	)	$	(1,186	)

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MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Note 10. Segment Information

The Company 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 management for purposes of evaluating performance and allocating resources. Based on this approach, the Company has one reportable segment as management reviews financial information on a basis consistent with that presented in the unaudited condensed consolidated financial statements.

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

	Three Months Ended
	July 2, 2006			July 3, 2005
North America*	$	28,610		$	28,161
Europe		4,289			4,201
Japan		3,256			4,236
Asia-Pacific (excluding Japan)		4,804			2,234
	$	40,959		$	38,832
	Three Months Ended
	July 2, 2006			July 3, 2005
North America*		70	%		73	%
Europe		10			11
Japan		8			11
Asia-Pacific (excluding Japan)		12			5
		100	%		100	%

* Substantially all its North America revenue related to the United States for all periods presented.

Revenue attributable to significant customers, representing 10% or more of total revenue for at least one of the respective periods, is summarized as follows:

	Three Months Ended
	July 2, 2006		July 3, 2005
Customer A	11	%	32	%
Customer B	14	%	—

The Company has substantially all of its long-lived assets located in the United States.

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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 Operation 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; uncertain outcome of Synopsys 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. Magma undertakes no additional obligation to update these forward looking statements.

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 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 research and development (“R&D”) expenditures, decreasing on design starts through chip integration, 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 IC 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.

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Our accomplishments during the first quarter of fiscal 2007:

• We achieved quarterly revenue of $41.0 million during the first quarter of fiscal 2007, down 7% from the prior quarter and up 5% from the same quarter in fiscal 2006. License sales for the quarter ended July 2, 2006 accounted for approximately 84% of total revenue, compared to 86% in the prior quarter and 87% from the same quarter in the prior year.

• We continued to penetrate our market, and during the first quarter of fiscal 2007 we surpassed the 250-customers mark.

• We continued to develop new technology, as we introduced Talus, an all-new integrated circuit implementation product line that offers our users unequaled automation. With Talus and other products, we continue to offer the best products for delivering the best quality of results as defined by chip performance, area and manufacturability.

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, investments, asset purchases and business combinations, income taxes and valuation of long-lived assets 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 2, 2006. 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.

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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.

• 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).

License 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 of fair value (“VSOE,”) 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 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.

For our perpetual licenses and some time-based license arrangements, we unbundle maintenance by including maintenance for up to first year 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

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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 from the first quarter of fiscal 2007, we account for stock-based employee compensation arrangements under SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”) and no longer apply the intrinsic value method to recognize deferred compensation of fixed and variable awards. We adopted SFAS 123R using the modified-prospective-transition method, resulting in the inclusion in our operating results of compensation costs related to unvested options granted prior to April 3, 2006, and options granted subsequent to that date. Under the modified-prospective-transition method of SFAS 123R, prior periods were not restated for comparative purposes to reflect the impact of SFAS 123R.

Adoption of SFAS 123R had a material effect on the Company’s financial results since April 3, 2006, increasing total stock-based compensation expenses from $1.7 million for the three months ended July 3, 2005 using the intrinsic value method to $4.9 million for the three months ended July 2, 2006 using the SFAS 123R fair value method. We continue to evaluate the terms of our stock-based compensation arrangements to provide appropriate incentives to recruit and retain our employees. We expect our quarterly stock-based compensation expense in each of the remaining three quarters of fiscal 2007 to be consistent with the amount in the first quarter of fiscal 2007. In March 2005, the Commission issued Staff Accounting Bulletin (“SAB”) No. 107, which provided supplemental implementation guidance for SFAS 123R. SAB 107 requires stock-based compensation to be classified in the same expense line items as cash compensation as provided in Note 2 to the financial statements.

We use the Black-Scholes option pricing model to determine the fair value of stock options and employee stock purchase plan awards. The Black-Scholes option pricing model was developed for use in estimating the fair value of short lived exchange-traded options that have no vesting restrictions and were fully transferable. In addition, the Black-Scholes option-pricing model incorporates various highly subjective assumptions including expected future stock price volatility and expected term of instruments. In developing estimates used in the adoption of SFAS 123R, 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 prevesting terminations of options were stratified for employee groups with sufficiently distinct behavior patterns. Expected volatility under SFAS 123R was developed based on the average of Magma’s historical weekly stock price volatility and average implied volatility.

Additionally, SFAS 123R requires the rate of forfeiture to be estimated and recorded during the option term unlike previous accounting guidance which allowed adjustments to stock compensation when forfeitures occurred. Consequently, during the first quarter of 2007, we recorded a credit of $321,000 reflecting the cumulative effect of the change in accounting principle for forfeitures primarily related to unvested restricted stock that had previously been recognized as stock-based compensation expense without consideration of

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forfeitures. No income tax benefit related to the cumulative effect of the change in accounting for stock option forfeitures was recorded as the Company has provided full valuation allowance against its net deferred tax assets.

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, 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.

For the quarter ended July 3, 2005, one customer 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 these acquisitions may change as additional information becomes available regarding the assets acquired and liabilities assumed resulting in changes in the purchase price allocation.

Goodwill impairment

Statement of Financial Accounting Standards 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 unit, and determining the fair value of the reporting

29

unit. We have determined that we have one reporting unit (see Note 6 of the Notes to the Condensed Consolidated Financial Statements in this Form 10-Q). Significant judgments required to estimate the fair value of a reporting unit 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 unit. 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. Based on the existence of one or more indicators of impairment, we 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 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. The Company 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.

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. As of July 2, 2006, none of the notes have been converted. The carrying value of our portfolio of strategic equity investments in non-marketable equity securities (privately-held companies) totaled $2.8 million at July 2, 2006. Our ability to recover our investments in private, non-marketable equity securities 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.

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. 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,

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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 declined significantly over the past few years, we have experienced substantial impairments in our portfolio of non-marketable equity securities. If 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. At the present time, it is difficult to determine 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 during the first quarter of fiscal 2007 and 2006, respectively.

Results of Operations

Revenue

Revenue consists of licenses revenue and services revenue. License revenue consists of fees for time-based or perpetual licenses of our products. Services revenue consists of fees for services, such as post-contract customer support (“PCS”), customer training and consulting. 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

• “Turns or 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, 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 percent data):

		Three Months Ended
		July 2, 2006				July 3, 2005
		$ Amount		% of Revenue		$ Amount		% of Revenue
Revenue category:
License revenue
Ratable	Bundled and Unbundled	$	4,905	12	%	$	5,007	13	%
Due & Payable	Unbundled		17,199	42	%		13,593	35	%
Cash Receipts	Unbundled		2,337	6	%		1,876	5	%
Turns	Unbundled		10,099	25	%		13,434	34	%
Total license revenue			34,540	84	%		33,910	87	%
Services revenue			6,419	16	%		4,922	13	%
Total Revenue		$	40,959	100	%	$	38,832	100	%

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Bundled and Unbundled Licenses: 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 license revenue in our statement of operations. For unbundled time-based with a term of less than 15 months, we recognize license revenue ratably over the license term, or as customer payments become due and payable, if earlier. 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 “Perpetual”:

Unbundled Licenses: 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.”

Unbundled 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 after the customer has remitted payment. For management reporting and analysis purposes, we refer to this type of license revenue as “Cash Receipts.”

Unbundled Licenses: “Turns”/Perpetual License or Time-Based licenses with short-term payments.For unbundled time-based and perpetual licenses, we recognize license revenue upon shipment as long as 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 “Turns,” 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” or “turns” 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 below.

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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 months ended July 2, 2006 and July 3, 2005 (in thousands, except for percent data):

	July 2, 2006		% of Revenue		July 3, 2005		% of Revenue		Dollar Change			% Change
Three Months Ended:
Revenue:
Licenses	$	34,540	84	%	$	33,910	87	%	$	630		2	%
Services		6,419	16	%		4,922	13	%		1,497		30	%
Total revenue		40,959	100	%		38,832	100	%		2,127		5	%
Cost of revenue:
Licenses		7,408	18	%		4,414	11	%		2,994		68	%
Services		5,158	13	%		3,857	10	%		1,301		34	%
Total cost of revenue		12,566	31	%		8,271	21	%		4,295		52	%
Gross profit	$	28,393	69	%	$	30,561	79	%	$	(2,168	)	(1	)%

We market our products and related services to customers in four geographic regions: North America, Europe (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 months ended July 2, 2006 and July 3, 2005 (in thousands, except for percent data):

	July 2, 2006		% of Revenue		July 3, 2005		% of Revenue		Dollar Change			% Change
Three Months Ended:
Domestic	$	28,610	70	%	$	28,161	73	%	$	449		2	%
International:
Europe		4,289	10	%		4,201	11	%		88		2	%
Japan		3,256	8	%		4,236	11	%		(980	)	(23	)%
Asia-Pacific (excluding Japan)		4,804	12	%		2,234	5	%		2,570		115	%
Total International		12,349	30	%		10,671	27	%		1,678		16	%
Total revenue	$	40,959	100	%	$	38,832	100	%	$	2,127		5	%

Revenue

• Revenue for the first quarter of fiscal 2007 was $41.0 million, up 5% from the same quarter in the prior year.

• License revenue increased in the first quarter of fiscal 2007 compared to the same quarter in the prior year primarily due to large orders executed during the first quarter of fiscal 2007 in North America. These orders came from existing customers who extended license periods and added license capacity due to the continued proliferation of existing and new Magma products amongst their design group designers. Two customers each accounted for greater than 10% of revenue for the first quarter of fiscal 2007 compared to one customer for the same quarter in the prior year. License revenue decreased as a percentage of total revenue.

• Service revenue increased in the first quarter of fiscal 2007 compared to the same quarter in the prior year. This was due to a $0.9 million increase in revenue from consulting service and a $0.6 million increase in maintenance revenue. The increase in maintenance revenue was primarily due to our growth in customer base. Service revenue as a percentage of total revenue increased over the same quarter in the prior year.

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• Domestic revenueincreased in the first quarter of fiscal 2007 compared to the same quarter in the prior year primarily due to large customers in North America purchasing new technology products and additional license capacity. Domestic revenue as a percentage of total revenue decreased by 3 percent in the first quarter of fiscal 2007 compared to the same quarter in the prior year.

• International revenue increased in the first quarter of fiscal 2007 compared to the same quarter in the prior year primarily due to an increase in purchases by our existing customers in Asia-Pacific (excluding Japan) and to a lesser extent Europe which offset a decrease in revenues from Japanese customers. International revenue as a percentage of total revenue increased by 3 percent in the first quarter of fiscal 2007 compared to the same quarter in the prior year.

Cost of Revenue

• Cost of license revenue primarily consists of amortization of acquired developed technology and other intangible assets, software maintenance costs, royalties and allocated outside sale representative expenses. Cost of license revenue increased by $3.0 million in the first quarter of fiscal 2007 compared to the same quarter in the prior year. The increase was due to amortization charges related to intangible assets acquired subsequent to the first quarter of fiscal 2006 and to several existing acquired technology licenses, as the Company began recognizing revenue from such products that were based on these acquired technologies during the quarter. Amortization expenses on these existing technology assets were included in the operating expense for prior periods.

• Cost of service revenue primarily consists of personnel and related costs to provide product support, consulting services and training. Cost of service revenue also includes asset depreciation, allocated outside sale representative expenses and stock-based compensation expenses. Cost of service revenue increased by $1.3 million primarily due to increases in sales commission expenses and headcount. Additionally, stock-based compensation expense accounted for a $0.3 million increase.

Operating expenses

The table below sets forth operating expense data for the three months ended July 2, 2006 and July 3, 2005 (in thousands, except for percent data):

	July 2, 2006		% of Revenue		July 3, 2005		% of Revenue		Dollar Change			% Change
Three Months Ended:
Operating expenses:
Research and development	$	15,449	38	%	$	12,609	32	%	$	2,840		23	%
Sales and marketing		13,847	34	%		11,210	29	%		2,637		24	%
General and administrative		11,795	29	%		8,643	22	%		3,152		36	%
Amortization of intangible assets		2,890	7	%		3,588	9	%		(698	)	(19	)%
Total operating expenses	$	43,981	108	%	$	36,050	93	%	$	7,931		22	%

• Research and development expense increased in the first quarter of fiscal 2007 compared to the same quarter in the prior year. The increase was due to increases in payroll related expenses of $2.2 million, stock-based compensation charges of $0.4 million, and other individually insignificant items. The increase in payroll related expenses of $2.2 million was principally attributable to a $0.6 million increase in bonus expense, and, a $1.4 million increase in salaries and related expenses due to headcount increases and performance-based annual wage increases. Research and development engineering headcount increased by 22% over the comparable period. Stock-based compensation expense for the first quarter of fiscal 2007 was based on accounting guidance prescribed by SFAS 123R, while stock-based compensation expense for the first quarter of fiscal 2006 was based on the intrinsic value method. We expect our quarterly research and development expenses in each of the remaining three quarters of

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fiscal 2007 to increase moderately and will remain at the same percentage of sales as the first quarter of fiscal 2007. Growth of our research and development headcount growth will be the primary factor driving up both fixed and variable compensation levels.

• Sales and marketing expense increased in the first quarter of 2007 compared to the comparable prior fiscal year quarter due principally to compensation related charges of $2.4 million, of which stock-based compensation charges under SFAS 123R accounted for $1.3 million. The remaining increases in compensation related charges were primarily due to headcount and merit increments. Sales and marketing headcount increased by 18% over the comparable period primarily due to application engineer headcount growth. There were no material changes in our sales and marketing activities in the first quarter of fiscal 2007 compared to the same quarter in the prior year. We expect that our quarterly sales and marketing expenses in each of the remaining three quarters of fiscal 2007 to increase moderately compared with the amount in the first quarter of fiscal 2007, primarily as a function of increased variable compensation cost driven by headcount, bookings and revenue growth. We also expect marketing expense to increase in the second quarter of fiscal 2007 due to expense incurred for our annual industry tradeshow, the Design Automation Conference, or “DAC”.

• General and administrative expense increased in the first quarter of fiscal 2007 compared to the same quarter in the prior year. This was due to increases in stock-based compensation charges under SFAS 123R of $1.3 million, professional fees of $1.1 million, payroll related expenses of $0.3 million, asset depreciation of $0.3 million and bad debt expenses of $0.2 million. The increase in professional fees was primarily due to legal expenses related to patent litigation with Synopsys, Inc. and audit fees due to the change in our independent registered public accounting firm, partially offset by the absence of legal fees related to other law suits in the first quarter of fiscal 2007. The increase in bad debt expenses was due to an increase in customer nonpayments in the first quarter of fiscal 2007. We expect that our quarterly general and administrative expenses in each of the remaining three quarters of fiscal 2007 will decline moderately compared with the amount in the first quarter of fiscal 2007 as our general and administrative head count growth will be minimal, and legal expenses and professional services related to litigation may decrease slightly, variable compensation will grow moderately in line with headcount increases and compliance with the requirements of the Sarbanes-Oxley Act of 2002 will decline moderately from first quarter levels.

• Amortization of intangible assets decreased in the first quarter of fiscal 2007 compared to the same quarter in fiscal 2006 primarily due to the change in classification of amortization charges relating to developed technology from operating expenses to cost of license revenue as the Company began recognizing revenues from products based on the developed technology during the first quarter of fiscal 2007.

Other items

The table below sets forth other data for the three months ended July 2, 2006 and July 3, 2005 (in thousands, except for percent data):

	July 2, 2006			% of Revenue		July 3, 2005			% of Revenue		Dollar Change			% Change
Three Months Ended:
Other income, net:
Interest income	$	887		2	%	$	660		2	%	$	227		34	%
Interest expense		(175	)	0	%		(208	)	(1	)%		33		(16	)%
Other income, net		4,703		11	%		7,450		19	%		(2,747	)	37	%
Total other income, net	$	5,415		13	%	$	7,902		20	%	$	(2,487	)	31	%
Provision for income taxes	$	(861	)	(2	)%	$	(2,436	)	(6	)%	$	1,575		(65	)%

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• Interest income increased in the first quarter of fiscal 2007 compared to the same quarter in fiscal 2006 primarily due to higher interest rates on our cash and investments balance during the period, despite the use of cash to repurchase a portion of outstanding convertible subordinated notes.

• Interest expense primarily represents amortization of debt discount and issuance costs, which were recorded in connection with our convertible subordinated debt offering completed in May 2003. We wrote off $0.5 million of the unamortized debt issuance costs in connection with the portion of the convertible subordinated notes repurchased in May 2006, resulting in a decrease in amortization of debt issuance costs.

• Other income, net in the first quarter of fiscal 2007 consisted principally of a $4.8 million gain on repurchases of convertible subordinated notes. Other income, net in the first quarter of fiscal 2006 consisted principally of an $8.8 million gain on repurchases of convertible subordinated notes, offset by a $1.1 million loss on investments. The remaining fluctuation in other income, net relates primarily to changes in currency exchange rates.

• Provision for income taxes. The income tax expense of $0.9 million for the three months ended July 2, 2006 consisted primarily of federal and state taxes provided 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, as well as the federal, state, and foreign taxes provided for the income from our normal operations. Similarly, the income tax expense of $2.4 million for the three months ended July 3, 2005 consisted primarily of the tax provided for certain discrete items and the tax provided for income from our normal operations. The Company’s effective tax rates vary from the U.S. statutory rate primarily due to changes in its valuation allowance, state taxes, foreign income taxed at other than U.S. rates, stock compensation expense, in-process research and development, research and development credits, and foreign withholding taxes.

The Company is in a net deferred tax asset position, for which a full valuation allowance has been recorded. The Company will continue to provide a valuation allowance on its net deferred tax assets until it becomes more likely than not that the deferred tax assets will be realizable. The Company 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, the Company’s net operating loss and tax credit carryforwards may be subject to an annual limitation. The annual limitations may result in an increase to the Company’s current income tax provision and/or the expiration of the net operating loss and tax credit carryforwards before realization.

Liquidity and Capital Resources

The table below sets forth certain cash flow data as of July 2, 2006 and April 2, 2006, and for the three months ended July 2, 2006 and July 3, 2005 (in thousands):

	July 2, 2006		April 2, 2006
Cash, cash equivalents and short-term investments	$	50,260	$	97,158

For the three months ended:	July 2, 2006			July 3, 2005
Net cash (used in) provided by operating activities	$	(5,062	)	$	5,480
Net cash provided by investing activities	$	16,593		$	61,492
Net cash used in financing activities	$	(33,788	)	$	(49,003	)

Our cash, cash equivalents and short-term investments, excluding restricted cash, were approximately $50.3 million on July 2, 2006, a decrease of $46.9 million or 48% from April 2, 2006. The decrease primarily reflected the use of cash to repurchase a portion of outstanding convertible subordinated notes ($35.0 million), the purchase of intangible assets ($6.0 million), and funding of operations ($5.1 million).

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In May 2006, we repurchased, in privately negotiated transactions, $40.3 million face amount (or approximately 38.2 percent of the remaining principle) of these notes at an average discount to face value of approximately 13 percent. We spent an aggregate of approximately $35.0 million on the repurchase. The repurchase left approximately $65.2 million aggregate principal amount of convertible subordinated notes outstanding. At the same time we terminated a portion of a related hedging arrangement.

Net cash (used in) provided by operating activities

Net cash used in operating activities was $5.0 million in the first quarter of fiscal 2007 compared to net cash provided of $5.5 million in the same quarter in the prior year. Net cash used in operating activities in the first quarter of fiscal 2007 reflected approximately $7 million employees bonus payment which was absent in the same quarter of the prior year.

The decrease of $10.5 million was primarily due to a $5.5 million increase in cash costs and operating expenses, net of other income, and working capital requirements consuming $5.0 million. Working capital related to a $3.4 million usage in accounts payable and other liabilities and a $1.9 million usage in prepaid and other assets, slightly offset by a $0.3 million improvement from customer collections.

Net cash provided by investing activities

Net cash provided by investing activities was $16.6 million in the first quarter of fiscal 2007. We had net proceeds of $24.7 million from sales of marketable securities as we liquidated these investments to repurchase a portion of the convertible subordinated notes. Partially offsetting the cash inflow, we used a total of $6.9 million in cash to purchase a technology license and made earnout payments relating to prior asset purchases. In addition, we acquired property and equipment totaling $1.2 million in cash and $1.5 million through capital leases. We expect to make capital expenditures of approximately $7.8 million for the remainder of fiscal 2007. 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 and/or investments to fund these purchases. In addition, we may make additional strategic equity investments in the future using our cash, cash equivalents and/or investments.

Net cash provided by investing activities was $61.5 million in the first quarter of fiscal 2006. We had net proceeds of $71.4 million from maturities of short-term investments as we liquidated these investments to repurchase a portion of the convertible subordinated notes. Partially offsetting the cash inflow, we used a total of $9.5 million in cash to purchase a technology license and made earnout payments relating to prior asset purchases. In addition, we acquired property and equipment totaling $0.4 million in cash and $1.8 million through capital leases.

Net cash used in financing activities

Net cash used in financing activities was $33.8 million in the first quarter of fiscal 2007. We used $35.0 million to repurchase a portion of our convertible subordinated notes. The primary source of cash was $1.5 million in net cash received from the exercise of stock options and shares purchased under the employee stock purchase plan during the period. The remaining uses of $0.3 million related to payment of capital lease obligations.

Net cash used in financing activities was $49.0 million in the first quarter of fiscal 2006. We used $34.8 million to repurchase a portion of our convertible subordinated notes and received net proceeds of $140,000 from termination of the related portion of the bond hedge and warrant. In addition, we used $16.0 million to repurchase 2,000,000 shares of common stock on the open market, as authorized by the board of directors in April 2005, and made payments of $0.1 million on our capital leases. The primary source of cash was $1.8 million in cash received from the exercise of stock options and shares purchased under the employee stock purchase plan during the period.

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Capital resources

We believe that our existing cash and cash equivalents and short-term investments will be sufficient 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.

Our acquisition agreements related to certain business combination and asset purchase transactions obligate us to pay certain contingent cash compensation based on continued employment and meeting certain revenue or project milestones. Total cash contingent compensation that could be paid under our acquisition agreements assuming all contingencies are met is $46.5 million as of July 2, 2006.

Contractual obligations

As of July 2, 2006, our principal commitments consisted of operating leases, with an aggregated future amount of $12.3 million through fiscal 2011 for office facilities, and repayment of the convertible subordinated notes of $65.2 million due in fiscal 2009. During the three months ended July 2, 2006, other than the decrease of $40.3 million in the convertible subordinated notes, there were no material changes in our reported payments due under contractual obligations at April 2, 2006. 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.

Off-balance Sheet Arrangements

As of July 2, 2006, 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 its 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 July 2, 2006.

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 have a directors and officers insurance policy that reduces our exposure and enables us to recover a portion of future amounts paid. As a result of our insurance policy coverage, we believe the estimated fair value of these indemnification agreements is minimal. Accordingly, no liabilities have been recorded for these agreements as of July 2, 2006.

In connection with recent business acquisitions, we agreed to assume, or cause our subsidiaries to assume, indemnification obligations to the officers and directors of acquired companies.

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Warranties

We offer our customers a warranty that our 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, we have no liabilities recorded for these warranties as of July 2, 2006. 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 MARKET 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 July 2, 2006, a hypothetical 100 basis point increase in interest rates would result in approximately a $12,000 decline in the fair value of our available-for-sale securities.

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 convertible subordinated notes due May 15, 2008. Concurrent with the issuance of the convertible 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 notes. Subject to the movement in the share price of our common stock, we could be 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 2006 and May 2005, the Company repurchased $40.3 million and $44.5 million, respectively, face value of its convertible notes for $35.0 million and $34.8 million, respectively. In doing so, the Company liquidated investments that generated a realized loss of approximately $3,000 and $0.7 million, respectively, related to the repurchases. Certain portion of the hedge and warrant transactions entered into by Magma in 2003 were terminated in connection with the repurchases. The Company believes 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 July 2, 2006, we had no currency hedging contracts outstanding. We do not currently use financial instruments to hedge revenue and operating expenses denominated in foreign currencies. We assess the need to utilize financial instruments to hedge currency exposures on an ongoing basis.

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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 Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. However, our disclosure controls and procedures have been designed to meet, and management believes that they meet, reasonable assurance standards.

Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective to ensure that material information relating to us, including our consolidated subsidiaries, is made known to them by others within those entities, particularly during the period in which this Quarterly Report on Form 10-Q was being prepared. Although our principal executive officer and principal accounting officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report, we continue to enhance our controls by hiring qualified personnel in key functional areas, implementing a new computerized system to automate a number of procedures related to quarterly and year-end close processes, and creating procedures to address the impact of acquisitions on a timely basis.

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

Synopsys, Inc. v. Magma Design Automation, Inc., Civil Action No. C04-03923, United States District Court, Northern District of California. In this action, filed September 17, 2004, Synopsys has sued the Company for alleged infringement of U.S. Patent Nos. 6,378,114 (“the ‘114 Patent”), 6,453,446 (“the ‘446 Patent”), and 6,725,438 (“the ‘438 Patent”). The patents-in-suit relate to methods for designing integrated circuits. The Complaint seeks unspecified monetary damages, injunctive relief, trebling of damages, fees and costs, and the imposition of a constructive trust for the benefit of Synopsys over any profits, revenues or other benefits allegedly obtained by the Company as a result of its alleged infringement of the patents-in-suit. In addition to the below discussion, this case was also discussed in our Annual Report on Form 10-K for the fiscal year ended April 2, 2006.

On October 21, 2004, the Company filed its answer and counterclaims (“Answer”) to the Complaint. On November 10, 2004, Synopsys filed motions to strike and dismiss certain affirmative defenses and counterclaims in the Answer. On November 24, 2004 the Company filed an Amended Answer and Counterclaims (“Amended Answer”). By order dated November 29, 2004, the Court denied Synopsys’ motions as moot in light of the Amended Answer. On December 10, 2004, Synopsys moved to strike and dismiss certain affirmative defenses and counterclaims in the Amended Answer. By order dated January 20, 2005, the Court denied in part and granted in part Synopsys’ motion. In its pretrial preparation order dated January 21, 2005, the Court set forth a schedule for the case which, among other things, sets trial for April 24, 2006.

On February 3, 2005, Synopsys filed its Reply to the Amended Answer. On March 17, 2005, Synopsys filed a First Amended Complaint, which asserts seven causes of action against the Company and/or Lukas van Ginneken: (1) patent infringement (against both defendants), (2) breach of contract (against van Ginneken), (3) inducing breach of contract (against the Company), (4) fraud (against the Company), (5) conversion (against both defendants), (6) unjust enrichment/constructive trust (against both defendants), and (7) unfair competition (against both defendants). Synopsys seeks injunctive relief, declaratory relief, at least $100 million in damages, trebling of damages, punitive damages, fees and costs, and the imposition of a constructive trust for the benefit of Synopsys over any profits, revenues or other benefits allegedly obtained by the Company as a result of its alleged exploitation of the alleged inventions in the patents-in-suit. On April 1, 2005, the Company filed a motion to dismiss the third through seventh causes of action. This motion was granted in part and denied in part by order dated May 18, 2005.

On April 11, 2005, Synopsys voluntarily dismissed van Ginneken from the lawsuit without prejudice. Also on April 11, 2005, Synopsys filed against the Company a motion for partial summary judgment establishing unfair competition and a motion for partial summary judgment based on the doctrine of assignor estoppel.

On June 7, 2005, Synopsys filed a Second Amended Complaint that asserts six causes of action against the Company: (1) patent infringement, (2) inducing breach of contract/interference with contractual relations, (3) fraud, (4) conversion, (5) unjust enrichment/constructive trust/quasi-contract, and (6) unfair competition. Synopsys seeks injunctive relief, declaratory relief, at least $100 million in damages, trebling of damages, punitive damages, fees and costs, and the imposition of a constructive trust for the benefit of Synopsys over any profits, revenues or other benefits allegedly obtained by the Company as a result of its alleged exploitation of the alleged inventions in the patents-in-suit. On June 10, 2005, Magma moved for summary judgment as to the second through sixth causes of action in the Second Amended Complaint based on the applicable statutes of limitations. On June 21, 2005, the Company moved to dismiss the third cause of action alleging fraud in the Second Amended Complaint and moved to strike certain allegations in the Second Amended Complaint. The Court granted the Company’s motion to dismiss and strike by order dated July 15, 2005.

On July 1, 2005, the Court granted Synopsys’s motion for partial summary judgment regarding assignor estoppel, dismissing Magma’s affirmative defenses and counterclaim alleging the invalidity of the ‘114 Patent.

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On July 14, 2005, the Court vacated the hearings on Magma’s motion for summary judgment on the second through sixth causes of action in the Second Amended Complaint and Synopsys’s motion for partial summary judgment establishing unfair competition. The Court stated that it would reset the motions for hearing, if necessary, after the claims construction hearing scheduled for August 15, 2005.

On July 29, 2005, Synopsys moved to preliminarily enjoin the Company from abandoning or dedicating to the public the ‘446 Patent or the ‘438 Patent. Also on July 29, 2005, Synopsys moved for partial summary judgment seeking dismissal of certain counterclaims and defenses asserted by the Company on the grounds of estoppel by contract. On September 16, 2005, Synopsys filed a revised motion for preliminary injunction. On September 30, 2005, the Company filed its oppositions to Synopsys’s preliminary injunction motion and estoppel by contract motion.

On August 3, 2005, Synopsys filed a Third Amended Complaint that asserts six causes of action against the Company: (1) patent infringement, (2) inducing breach of contract/interference with contractual relations, (3) fraud, (4) conversion, (5) unjust enrichment/constructive trust/quasi-contract, and (6) unfair competition. Synopsys seeks injunctive relief, declaratory relief, at least $100 million in damages, trebling of damages, punitive damages, fees and costs, and the imposition of a constructive trust for the benefit of Synopsys over any profits, revenues or other benefits allegedly obtained by the Company as a result of its alleged exploitation of the alleged inventions in the patents-in-suit.

On August 30, 2005, the Court issued a temporary restraining order against the Company restraining and enjoining the Company from taking any steps in the United States Patent and Trademark Office to abandon, suspend or disclaim the ‘446 and ‘438 Patents, failing or refusing to pay the maintenance fees for the ‘446 and ‘438 Patents, or seeking reexamination of the ‘446 and ‘438 Patents. The temporary restraining order was scheduled to remain in effect until the hearing on Synopsys’s motion for a preliminary injunction that was scheduled for December 2, 2005. On December 1, 2005, the Court, vacated the hearing and granted Synopsys’s motion for preliminary injunction. The Court entered the preliminary injunction enjoining the Company from abandoning, dedicating to the public or seeking reexamination in the United States Patent and Trademark Office of the ‘446 Patent or the ‘438 Patent.

On September 2, 2005, the Company filed an Answer and Counterclaims to Synopsys’s Third Amended Complaint. In that pleading, the Company alleges,inter alia, that IBM is a joint owner of the patents-in-suit and that, as a result, the Company cannot be liable for infringement because (1) Synopsys lacks standing to assert the patents-in-suit against Magma, and (2) IBM has granted the Company a license under the patents-in-suit.

On October 14, 2005, the Court granted Synopsys’s request for permission to file an amended opposition to Magma’s motion for summary judgment on the second through sixth causes of action in the Second Amended Complaint. Synopsys filed its amended opposition on December 20, 2005, and the Company filed its reply on January 13, 2006. The motion was set for hearing on January 27, 2006, but the Court vacated the hearing date and took the matter under submission.

On October 19, 2005, the Court granted in part and denied in part Synopsys’s motion to strike certain affirmative defenses and to dismiss certain counterclaims in the Company’s Answer and Counterclaims to Synopsys’s Third Amended Complaint. The Court dismissed without leave to amend the Company’s counterclaims seeking correction of inventorship of the ‘446 and ‘438 Patents. The Court also struck without leave to amend the Company’s affirmative defenses of (1) invalidity of the ‘446 and ‘438 Patents based on failure to name all inventors, (2) unenforceability of the ‘446 and ‘438 patents due to inequitable conduct, and (3) unclean hands. The Court struck with leave to amend the Company’s affirmative defenses of invalidity of the ‘446 and ‘438 Patents based on 35 U.S.C. §§ 102, 103 and 112, as well as the Company’s affirmative defense that Synopsys is not the owner of any invention defined by the claims of the ‘446 and ‘438 Patents. On October 24, 2005, the Company filed a motion for summary judgment as to the first cause of action (for patent infringement) in Synopsys’s Third Amended Complaint on the grounds that IBM is an owner of all the

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patents-in-suit. Also on October 24, 2005, Synopsys filed (1) a motion for partial summary judgment to dismiss the Company’s joint ownership defenses and counterclaims, and (2) a motion for partial summary judgment to dismiss allegations of co-ownership based on judicial and quasi-estoppel.

On November 2, 2005, the Company filed a motion for leave to file an amended answer and counterclaims to Synopsys’s Third Amended Complaint, requesting leave to amend the Company’s answer to add affirmative defenses of invalidity of the ‘446 and ‘438 Patents based on 35 U.S.C. §§ 102, 103 and 112. The Company’s motion was set for hearing on December 16, 2005, but the Court vacated the hearing date and took the matter under submission.

On November 8, 2005, Synopsys filed a motion for sanctions against the Company based on the Company’s assertion of non-infringement defenses and counterclaims in the litigation. The Company opposed the motion, which was set for hearing on December 16, 2005. The hearing was vacated and the motion was taken under submission by the Court.

On November 8, 2005, the Company filed a motion seeking leave to file a motion for reconsideration of the Court’s October 19, 2005 Order striking certain of the Company’s defenses without leave to amend. The Court granted the Company’s request on November 21, 2005. On December 9, 2005, the Company filed a motion for reconsideration of the Court’s October 19, 2005 Order striking the Company’s affirmative defense of unclean hands and for leave to amend the Company’s answer to assert an unclean hands defense. The motion was set for hearing on January 13, 2006, but the Court vacated the hearing and took the matter under submission.

On December 23, 2005, Synopsys filed a motion for partial summary judgment regarding the Company’s statute of limitations defense. The Company opposed the motion, which was set for hearing on January 27, 2006. The hearing was vacated and the motion taken under submission by the Court.

On December 29, 2005, the Company filed a notice of interlocutory appeal to the Court of Appeals for the Federal Circuit of the Court’s December 1, 2005, preliminary injunction against the Company. By agreement of the parties, Magma has dismissed the appeal.

On January 20, 2006, the Company filed a motion to bifurcate the trial into issues of patent ownership and all other issues. The parties subsequently stipulated to bifurcate the case with patent ownership to be tried first.

Fact and expert discovery relating to patent ownership have closed. By stipulation so-ordered on March 13, 2006, the parties have agreed to schedule any remaining discovery after the patent ownership trial is resolved.

By order dated March 30, 2006, the Court denied Magma’s motion for summary judgment regarding patent ownership, as well Synopsys’s motions (1) for partial summary judgment based on estoppel by contract, (2) for partial summary judgment to dismiss the Company’s joint ownership defenses and counterclaims, and (3) for partial summary judgment to dismiss allegations of co-ownership based on judicial and quasi-estoppel. The parties subsequently stipulated (a) that Magma would withdraw its claim to ownership of the ‘446 and ‘438 Patents on the basis that the “buckets” claims (i.e., Claims 17, 18, 31, and 32 of the ‘446 Patent and Claims 17 and 18 of the ‘438 Patent) were conceived by Magma engineers after Lukas van Ginneken left Synopsys and (b) that Synopsys would withdraw its assertion that Magma would be foreclosed from arguing that the inventions in the ‘446 and ‘438 Patents were reduced to practice after van Ginneken left Synopsys.

The ownership case was tried to the Court, without a jury, from April 24, 2006 through May 10, 2006. The parties’ opening post-trial briefs and findings of fact and conclusions of law were filed June 9, 2006. The parties’ reply post-trial briefs were filed June 30, 2006. The parties are currently awaiting the Court’s ruling.

On April 18, 2005, Synopsys, Inc. filed an action against the Company in Germany at the Landgericht München I (District Court in Munich) seeking to obtain ownership of the European patent application

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corresponding to the Company’s ‘446 Patent. The action has been stayed pending the outcome of the above-referenced Synopsys action filed in the United States. This action was also discussed in our Annual Report on Form 10-K for the fiscal year ended April 2, 2006.

On July 29, 2005, Synopsys, Inc. filed an action against the Company in Japan in Civil Department No. 40 of the Tokyo District Court seeking to obtain ownership of the Japanese patent application corresponding to the Company’s ‘446 Patent. The court has entered a defacto stay pending the outcome of the above-referenced Synopsys action filed in the United States. The Japanese Court held hearings on January 18, 2006, March 6, 2006 and July 11, 2006, and set a further hearing on October 23, 2006. This action was also discussed in our Annual Report on Form 10-K for the fiscal year ended April 2, 2006.

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 have again moved to dismiss. This lawsuit was also discussed in our Annual Report on Form 10-K for the fiscal year ended April 2, 2006.

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 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 lawsuit was also discussed in our Annual Report on Form 10-K for the fiscal year ended April 2, 2006.

On September 26, 2005, Synopsys, Inc. filed an action against the Company in the Superior Court of the State of California in and for the County of Santa Clara, entitledSynopsys, Inc. v. Magma Design Automation, Inc., et al., Case Number 105 CV 049638. Synopsys alleges that Magma committed unfair business practices by asserting defenses of non-infringement and invalidity to patent infringement allegations brought by Synopsys in the patent infringement action already pending against Magma in the Northern District of California. The Complaint seeks unspecified monetary damages, an unspecified restitutionary/disgorgement award, injunctive relief, fees and costs, and an accounting of all revenues and profits derived from licensing the technology at issue. On October 19, 2005, the Company removed the action to the United States District Court for the Northern District of California. On October 26, 2005, the Company moved to strike and dismiss the complaint. On October 27, 2005, the Court granted the Company’s motion to relate the removed action with the preexisting patent infringement action, and both actions are now assigned to Judge Maxine M. Chesney. The Court vacated the hearing on the Company’s motion to strike and dismiss the complaint and has taken the matter under submission. This action was also discussed in our Annual Report on Form 10-K for the fiscal year ended April 2, 2006.

On September 26, 2005, Synopsys, Inc. filed an action against the Company in Delaware federal court,Synopsys, Inc. v. Magma Design Automation, Inc., Civil Action No. 05-701. The Complaint alleges infringement of U.S. Patent Nos. 6,434,733 (“the ‘733 Patent”), 6,766,501 (“the ’501 Patent”), and 6,192,508 (“the ‘508 Patent”). The patents-in-suit relate to methods for designing integrated circuits. The Complaint seeks unspecified monetary damages, injunctive relief, trebling of damages, fees and costs, and the imposition of a constructive trust for the benefit of Synopsys over any profits, revenues or other benefits allegedly obtained by the Company as a result of its alleged infringement of the patents-in-suit. In addition to the below discussion, this case was also discussed in our Annual Report on Form 10-K for the fiscal year ended April 2, 2006.

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On October 19, 2005, the Company filed its answer and counterclaims (“Answer”) to Synopsys’s Complaint. The Answer asserts that the Company’s products do not infringe the patents-in-suit, that the patents-in-suit are unenforceable, and that the ‘733 Patent and the ‘501 Patent were fraudulently obtained by Synopsys and are therefore unenforceable. The Answer also asserts antitrust counterclaims based on Synopsys’s assertion of the ‘733 and ‘501 Patents, as well as claims for product disparagement and trade libel, statutory and common law unfair competition, and tortuous interference with business relations. The counterclaims seek treble damages and other equitable relief for Synopsys’s anticompetitive and tortuous conduct.

On October 25, 2005, the Company filed an Amended Answer, adding a counterclaim for infringement of U.S. Patent No. 6,505,328 (“the ‘328 Patent”). The ‘328 Patent relates to methods for designing integrated circuits. The Company seeks treble damages and an injunction against Synopsys for the sale and manufacture of products the Company alleges infringe the ‘328 Patent.

On November 22, 2005, Synopsys filed a motion to dismiss the Company’s antitrust and other commercial counterclaims. The Company opposed that motion on December 7, 2005. Synopsys filed its reply brief on December 14, 2005. The Court denied Synopsys’s motion on May 25, 2006.

On January 9, 2006, Synopsys filed a request for the United States Patent and Trademark Office to reexamine its ‘733 and ‘501 Patents in light of two prior art references that it had not previously disclosed to the Patent Office. On January 23, 2006, Synopsys filed a motion with the Delaware federal court to bifurcate and stay its claims for infringement of its ‘733 and ‘501 Patents and the Company’s counterclaims except for its claim for infringement of the ‘328 Patent, based in part on Synopsys’s having filed the request for patent reexamination. The Company’s opposition to that motion was filed on February 6, 2006. The Court denied Synopsys’s motion on May 25, 2006.

On March 24, 2006, the Company filed a motion for leave to file a Second Amended Answer and Counterclaims, to add counterclaims for infringement of U.S. Patent Nos. 6,519,745 (“the ‘745 Patent”), 6,931,610 (“the ‘610 Patent”), 6,854,093 (“the ‘093 Patent”), and 6,857,116 (“the ‘116 Patent”). All four patents relate to methods for designing integrated circuits. Synopsys opposed the motion on April 7, 2006. The Company filed its reply brief on April 14, 2006. The Court granted the Company’s motion on May 25, 2006.

On June 13, 2006, the parties held a conference with the Court at which, among other things, Synopsys requested that the trial be delayed until late 2007. The Court denied Synopsys’s request. Fact discovery is ongoing and is currently scheduled to close on January 12, 2007, and trial remains scheduled for June 11, 2007.

The Company intends to vigorously defend against all claims asserted by Synopsys and to fully enforce its rights against Synopsys. 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 Synopsys claims. A favorable outcome for Synopsys could have a material adverse effect on the Company’s financial position, results of operations or cash flows. The Company is currently unable to assess the extent of damages and/or other relief, if any, that could be awarded to Synopsys.

In addition to the above, from time to time, the Company is involved in disputes that arise in the ordinary course of business. The number and significance of these disputes is increasing as the Company’s business expands and it 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 disputes could harm the Company’s business, financial condition, results of operations or cash flows.

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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 2, 2006.

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 risks 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 $147.3 million as of July 2, 2006; if we continue to incur losses, the trading price of our stock would be likely to decline.

We had an accumulated deficit of approximately $147.3 million as of July 2, 2006. 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 incur net 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, and we may not be able to continue to operate.

Our quarterly results are difficult to predict, and if we miss 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 with Synopsys, Inc.;

• 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;

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• 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 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 currently face 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, Inc. has filed various suits, including for patent infringement, against us (please see the discussion in Part II, Item 1, “Legal Proceedings.”) In addition, a putative shareholder class action lawsuit and a putative derivative lawsuit have been filed against us (please see the discussion in Part II, Item 1, “Legal Proceedings.”) Other related litigation may follow. In the future other parties may assert intellectual property infringement claims against us or our customers. 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. In addition, we 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 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.

The outcome of intellectual property litigation, such as the pending Synopsys litigation (discussed herein) and other types of litigation, could be, in the case of intellectual property litigation, our loss of critical proprietary rights and, in the case of intellectual property litigation and other types of litigation, unexpected operating costs and substantial monetary damages. Intellectual property litigation and other types of litigation are expensive and time-consuming and could divert management’s attention from our business. If there is a successful claim of infringement, we may be ordered to pay substantial monetary damages (including punitive damages), we may be prevented from distributing all or some of our products, and we may 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.

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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.

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 technically qualify new sales opportunities and perform design work to demonstrate our products’ capabilities to customers during the benchmark evaluation process. Competition for qualified engineers is intense, particularly in Silicon Valley where our headquarters is located.

Retaining our employees has become more challenging due to the decline in our stock price over the past several years. Many of the stock options held by our employees may have an exercise price that is significantly higher than the current trading price of our stock, and these “underwater” options do not serve their purpose as incentives for our employees to remain with Magma. Although, as discussed below, we have attempted to address this problem in part via a stock option exchange program that allowed eligible employees to exchange existing underwater options for options exercisable for a smaller number of shares at the price of $9.20 per share, we cannot guarantee that this program will satisfy our employees. In addition, the increased volatility of our stock price due to the pendency of, and developments in, the Synopsys litigation and the above-referenced shareholder litigation may affect employee morale. Furthermore, in light of our adopting SFAS 123R “Share-Based Payment” in the first quarter of our fiscal year 2007, we have 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, 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, and we may be unable to recruit and retain these personnel.

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 our new executives or any new personnel could disrupt our ongoing operations.

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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 and on investor expectations.

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. 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, makes it difficult for us to forecast revenue and increases 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 it against our competition. As the complexity of the products we sell increases, we expect the 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 a significant investment of time and cost by our customers, we must target those individuals within the customer’s organization 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 initial acceptance, the negotiation and documentation processes can be lengthy. 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 deals significantly, and such shorter terms of deals could in turn have an impact on our total results for orders for this fiscal year.

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 quarterly period ended July 2, 2006, we had two customers that each accounted for more than 10% of our revenue, and our top three customers together accounted for approximately 33% 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 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 vary 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.

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Some contracts with extended payment terms provide for payments which are weighted toward the later 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 later part of the contract term, which puts our revenue recognition in the future at greater risk of the customer’s continuing 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 electronic design automation 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 larger installed customer bases. 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, full-feature custom layout editing, analog or mixed signal implementation products, 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 buying companies with promising new chip design products or companies that may be too large for us to acquire without a strain on our resources.

Competition in the EDA market has increased as customers rationalized their EDA spending by using products from fewer EDA vendors and continued consolidation in the electronic design automation market could intensify this trend. Also, many of our competitors, including 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. 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 may cause potential customers to defer purchases of our products. If we fail to compete successfully, we will not gain market share 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

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acquired companies with our operations, products and technology in a timely and cost-effective manner. The process of integrating with 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 Silicon Metrics Corporation and Mojave, Inc., or any other companies we 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 an inability to retain 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 Magma’s best interest as its 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 management attention;

• potential incompatibility of business cultures;

• potential dilution to existing stockholders if we have to incur debt or issue equity securities to pay for any future 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 design geometries.

Many Magma customers are currently working on 90-nanometer designs. Magma continues to work toward developing and enhancing its product line in anticipation of increased customer demand for 65-nanometer (sub-90 nanometer) design geometries. Similarly, Magma has acquired Mojave personnel and technology to better address customers’ needs for designing and verifying semiconductors that are manufacturable with higher yield and performance, which is a key design parameter when moving to 65-nanometer geometries. Notwithstanding our efforts to support 65-nanometer geometries, customers may fail to adopt or may be slower to adopt 65-nanometer geometries 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 design geometries or are slow to adopt 65-nanometer design geometries, our operating results may be harmed. In addition, if customers are not able successfully to make profits as they adopt smaller geometries, demand for our products may be adversely affected, and our operating results may be harmed.

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

Blast Fusion has accounted for a significant majority of our revenue since our inception and we believe that revenue from Blast Fusion, Talus and related 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

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products. We must gain market penetration of Blast Fusion, Talus 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 or do not adopt Talus, our operating results will be significantly harmed. Furthermore, if there is a delay in the commercialization of Talus, our operating results may be significantly harmed.

We changed our organizational structure in fiscal 2006, and if this organizational structure does not successfully lead to effective interoperability between our products or effective collaboration among the applicable employees, then our operating results may be harmed.

We changed our organizational structure in fiscal 2006 such that we now have major business units that are responsible for our various products. If this organizational structure does not successfully lead to effective interoperability between our products or effective collaboration among the applicable employees, then our operating results may be harmed. For example, if this organizational structure is not successful, we could experience delays in new product development that could cause us to lose customer orders, which could harm our operating results.

If the industries into which we sell our products experience 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 continued 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. For example, the United States economy, including the semiconductor industry, experienced a slowdown starting in 2000, which negatively impacted and may continue to impact our business and operating results. While the semiconductor industry experienced a moderate recovery in recent years, our customers have remained cautious, and it is not yet clear when increased R&D spending will occur. The continuing threat of terrorist attacks in the United States, the ongoing events in Iraq and other worldwide events including those in the Middle East 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.

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 anticipated. Also, any revenue that we receive from enhancements or new generations of our proprietary software products may be less than the costs of development. 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, both internally developed and 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, which provides 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.

Much of our business is international, which exposes us 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.

We generated 28% of our total revenue from sales outside North America for Q1 fiscal 2007, compared to 33% for fiscal 2006 and 43% for fiscal 2005. 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.

The expansion of our international operations includes the maintenance of 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;

• on-going events in Iraq and the Middle East; and

• the effects of terrorist attacks in the United States and any related conflicts or similar events worldwide.

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

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 impose additional financial and administrative obligations on us and will 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 Stock Market have imposed new 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, 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 2, 2006 and March 31,2005, our independent registered public accounting firm 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.

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 Magma have been detected. Failure of the control systems to prevent error or fraud could materially adversely impact our financial results and our business.

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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, 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 continuously develop or acquire new products and enhance existing products. 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 stock option 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 stock option 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 has declined significantly over the past several years due to market conditions and has recently been negatively affected by uncertainty surrounding the outcome of our litigation with Synopsys, Inc. (discussed above under Part II, Item 1, “Legal Proceedings”).

On June 22, 2005, our stockholders approved a stock option exchange program (“Exchange Program”) allowing non-executive employees holding options to purchase our common stock at exercise prices greater than or equal to $10.50 to exchange those options for a smaller number of new options at an exercise price equal to fair market value on the date of grant. Magma implemented this Exchange Program, and the date of grant was

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August 22, 2005, at which date the closing trading price of our stock was $9.20 per share. Therefore, the exercise price for new options under this Exchange Program is $9.20 per share. 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, or, if our stock price remains below the grant price of $9.20, our ability to retain employees could be affected.

Many of the options held by our non-executive employees, including options issued in the Exchange Program, have an exercise price significantly above the current trading price of our stock; on April 2, 2006 approximately 78% of the options held by our non-executive employees were “underwater.”

If our stock price continues to decline in the future due to market conditions, investors’ perceptions of the technology industry or managerial or performance problems we might have, 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 has 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 were required to and did adopt 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 affect adversely 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 less 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 fiscal year 2005 we decreased our workforce by 23 employees. Over time we have significantly expanded our operations in the

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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 adequately manage our growth, disrupt operations, lead to deficiencies in our internal controls and financial reporting and ultimately harm our business.

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 our or our customers’ efforts 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 offering a broader set of products, or if we are unable to convince other software companies to work with us to interface our software with theirs 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 few 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

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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.

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 it, 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 this concentration of ownership may allow them to elect most of our directors and could 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 significantly influence 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 the Board of Directors without prior stockholder approval to create and issue 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;

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• 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.

The board of directors also has the power to adopt a stockholder rights plan, which could delay or prevent a change in control even if the change in control appeared to be beneficial to stockholders. These plans, sometimes called “poison pills,” are sometimes criticized by institutional investors or their advisors and could affect our rating by such investors or advisors. If the 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 operating expenses in the United Kingdom, Europe and Japan, which are denominated in the respective local currencies. As of July 2, 2006, we had no currency hedging contracts outstanding. We do not currently use financial instruments to hedge operating expenses denominated in Euro, British Pounds and Japanese Yen. We assess the need to utilize financial instruments to hedge currency exposures on an ongoing basis.

The convertible notes we issued in May 2003 are debt obligations that must be repaid in cash in May 2008 if they are not converted into 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 zero coupon convertible notes due May 2008. In May 2005, we repurchased, in privately negotiated transactions, $44.5 million face amount (or approximately 29.7 percent of the total) of these notes at an average discount to face value of approximately 22 percent. In addition, in May 2006, we repurchased another $40.3 million face amount (approximately 38.2 percent of the remaining principal) of these notes at an average discount to face value of approximately 13 percent. Magma spent an aggregate of approximately $34.8 million and $35.0 million, respectively, on the repurchases in May 2005 and May 2006. The repurchases leave approximately $65.2 million aggregate principal amount of convertible subordinated notes outstanding. We will be required to repay that principal amount in full in May 2008 unless the holders of those notes elect to convert them into our common stock before the repayment date. The conversion price of the notes is $22.86 per share. If the price of our common stock does not rise above that level, conversion of the notes is unlikely and we would be required to repay the principal amount 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.

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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 our convertible notes, with the objective of reducing the potential dilutive effect of issuing common stock upon conversion of the notes. At the time of our May 2005 and May 2006 repurchases of our zero coupon convertible notes, portions of the hedging arrangements were retired. 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 indenture to purchase our convertible notes upon a change in control.

Upon a change in control, which is defined in the indenture 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 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 Santa Clara, 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 first quarter of fiscal 2007, on April 3, 2006, we issued 513,601 shares of our common stock as part of the contingent consideration in connection with our acquisition of Mojave, Inc. pursuant to a definitive agreement signed on February 23, 2004. The contingent share consideration was based on Mojave’s achievement of certain technology milestones and product orders. We may issue additional contingent share consideration of up to $39.9 million based on additional product orders over the period ending March 31, 2009. These securities were issued in reliance upon the exemption from the registration requirements of the Securities Act of 1933 provided by Section 3(a)(10) thereof.

Issuer Purchases of Equity Securities

The following table shows repurchases of shares of our common stock in the first quarter of fiscal 2007:

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
April 3 – April 30, 2006	—	$	—	0	N/A
May 1 – May 31, 2006	41,175	$	7.12	0	N/A
June 1 – July 2, 2006	—	$	—	0	N/A
Total	41,175	$	7.12	0	N/A

* Includes 26,708 shares repurchased at $7.16, the fair market value on the repurchase date, in order to satisfy tax withholding obligations associated with the vesting of restricted shares. Also includes 14,467 shares repurchased at $7.03 in settlement for termination of a portion of the company’s hedge and warrant in connection with its convertible bond repurchase.

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ITEM 6. EXHIBITS

The following documents are filed as Exhibits to this report:

Exhibit Number	Exhibit Description	Incorporated by Reference				Filed Herewith
		Form	File No.	Exhibit	Filing Date
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
10.1#	Registrant’s 2001 Stock Incentive Plan, as amended	10-Q	000-33213	10.1	November 14, 2003
10.2	Form of Notice of Grant of Stock Options and Stock Option Agreement pursuant to Magma’s 2001 Stock Incentive Plan for U.S. Employees (other than Executive Officers)	10-Q	000-33213	10.1	November 14, 2005
10.3	Form Notice of Grant of Stock Options pursuant to Magma’s 2001 Stock Incentive Plan for Executive Officers	10-Q	000-33213	10.2	November 14, 2005
10.4	Form of Notice of Grant of Stock Options and Stock Option Agreement pursuant to Magma’s 2001 Stock Incentive Plan for Employees residing in countries other than the United States, China, Israel, Italy and the United Kingdom	10-Q	000-33213	10.3	November 14, 2005
10.5	Form of Notice of Grant of Stock Options and Stock Option Agreement pursuant to Magma’s 2001 Stock Incentive Plan for Employees residing in China, Israel, and Italy	10-Q	000-33213	10.4	November 14, 2005
10.6	Notice of Grant of Stock Options and Stock Option Agreement pursuant to Magma’s 2001 Stock Incentive Plan for Employees residing in the United Kingdom	10-Q	000-33213	10.5	November 14, 2005
10.7	Notice of Restricted Share Award and Restricted Share Agreement pursuant to Magma’s 2001 Stock Incentive Plan for non-Executive Employees	10-Q	000-33213	10.6	November 14, 2005

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Exhibit Number	Exhibit Description	Incorporated by Reference				Filed Herewith
		Form	File No.	Exhibit	Filing Date
10.8#	Notice of Restricted Share Award and Restricted Share Agreement pursuant to Magma’s 2001 Stock Incentive Plan for Executive Officers	10-Q	000-33213	10.7	November 14, 2005
10.9#	2005 Key Contributor Long-Term Incentive Plan	10-Q	000-33213	10.8	November 14, 2005
10.10#	Registrant’s 2001 Employee Stock Purchase Plan, as amended	S-8	333-112326	99.2	January 30, 2004
10.11#	Registrant’s 2004 Employment Inducement Award Plan, as amended	8-K	000-33213	10.1	January 30, 2006
10.12#	1998 Stock Incentive Plan	S-1	333-60838	10.4	May 14, 2001
10.13#	Form of Stock Option Agreement in connection with the Registrant’s 1998 Stock Incentive Plan	S-1/A	333-60838	10.10	August 14, 2001
10.14#	Form of Amendment to Stock Option Agreement in connection with the Registrant’s 1998 Stock Incentive Plan	S-1/A	333-60838	10.11	August 14, 2001
10.15#	1997 Stock Incentive Plan	S-1	333-60838	10.5	May 14, 2001
10.16#	Moscape, Inc. 1997 Incentive Stock Plan	S-1	333-60838	10.6	May 14, 2001
10.17	Agreement and Plan of Merger and Reorganization, dated as of October 16, 2003, among the Company, Silicon Metrics Corporation, Silicon Correlation, Inc., and Vess Johnson and Austin Ventures V, L.P., as Stockholder Agents	8-K	000-33213	2.1	October 31, 2003
10.18	Second Amended and Restated Agreement and Plan of Reorganization, dated July 7, 2000, between the Registrant, Magma Acquisition Corp. and Moscape, Inc.	S-1	333-60838	2.3	May 14, 2001
10.19#	Stock Option Agreement entered into between the Registrant and Rajeev Madhavan dated September 29, 2000	S-1/A	333-60838	10.8	August 14, 2001
10.20#	Stock Option agreement entered into between the Registrant and Rajeev Madhavan dated September 29, 2000	S-1/A	333-60838	10.9	August 14, 2001
10.21#	Stock Option Agreement entered into between the Registrant and Roy E. Jewell dated March 30, 2001	S-1/A	333-60838	10.13	August 14, 2001
10.22#	Form of Stock Option Agreement for agreements between the Registrant and Roy E. Jewell dated March 30, 2001	S-1/A	333-60838	10.14	August 14, 2001

63

Exhibit Number	Exhibit Description	Incorporated by Reference				Filed Herewith
		Form	File No.	Exhibit	Filing Date
10.23	Lease for corporate headquarters dated June 19, 2003, between Registrant and 3Com Corporation (assumed by Marvell Semiconductor from 3Com)	10-Q	000-33213	10.2	November 14, 2003
10.24#	Summary of Standard Director Compensation Arrangements for Non-Employee Directors	10-K	000-33213	10.24	June 15, 2006
10.25	Warrant Agreement	10-Q	000-33213	10.1	August 12, 2005
10.26	Form of Indemnification Agreement Between the Registrant and certain directors and officers	S-1	333-60838	10.1	May 14, 2001
10.27(a)#	Summary of Compensation Arrangement for Certain Executive Officers	10-K	000-33213	10.27(a)	June 15, 2006
10.27(b)#	Schedule of Certain Executive Officers for the Summary of Compensation Arrangement Set Forth in Exhibit 10.27(a)	10-K	000-33213	10.27(b)	June 15, 2006
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

# Indicates management contract or compensatory plan or arrangement.

64

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: August 10, 2006	By	/S/    PETER S. TESHIMA
		Peter S. Teshima, Senior Vice President—Finance and Chief Financial Officer (Principal Financial and Accounting Officer and Duly Authorized Signatory)

65

EXHIBIT INDEX

TO

MAGMA DESIGN AUTOMATION, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTER ENDED JULY 2, 2006

Exhibit Number	Exhibit Description	Incorporated by Reference				Filed Herewith
		Form	File No.	Exhibit	Filing Date
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
10.1#	Registrant’s 2001 Stock Incentive Plan, as amended	10-Q	000-33213	10.1	November 14, 2003
10.2	Form of Notice of Grant of Stock Options and Stock Option Agreement pursuant to Magma’s 2001 Stock Incentive Plan for U.S. Employees (other than Executive Officers)	10-Q	000-33213	10.1	November 14, 2005
10.3#	Form Notice of Grant of Stock Options pursuant to Magma’s 2001 Stock Incentive Plan for Executive Officers	10-Q	000-33213	10.2	November 14, 2005
10.4	Form of Notice of Grant of Stock Options and Stock Option Agreement pursuant to Magma’s 2001 Stock Incentive Plan for Employees residing in countries other than the United States, China, Israel, Italy and the United Kingdom	10-Q	000-33213	10.3	November 14, 2005
10.5	Form of Notice of Grant of Stock Options and Stock Option Agreement pursuant to Magma’s 2001 Stock Incentive Plan for Employees residing in China, Israel, and Italy	10-Q	000-33213	10.4	November 14, 2005

66

Exhibit Number	Exhibit Description	Incorporated by Reference				Filed Herewith
		Form	File No.	Exhibit	Filing Date
10.6	Notice of Grant of Stock Options and Stock Option Agreement pursuant to Magma’s 2001 Stock Incentive Plan for Employees residing in the United Kingdom	10-Q	000-33213	10.5	November 14, 2005
10.7	Notice of Restricted Share Award and Restricted Share Agreement pursuant to Magma’s 2001 Stock Incentive Plan for non-Executive Employees	10-Q	000-33213	10.6	November 14, 2005
10.8#	Notice of Restricted Share Award and Restricted Share Agreement pursuant to Magma’s 2001 Stock Incentive Plan for Executive Officers	10-Q	000-33213	10.7	November 14, 2005
10.9#	2005 Key Contributor Long-Term Incentive Plan	10-Q	000-33213	10.8	November 14, 2005
10.10#	Registrant’s 2001 Employee Stock Purchase Plan, as amended	S-8	333-112326	99.2	January 30, 2004
10.11#	Registrant’s 2004 Employment Inducement Award Plan, as amended	8-K	000-33213	10.1	January 30, 2006
10.12#	1998 Stock Incentive Plan	S-1	333-60838	10.4	May 14, 2001
10.13#	Form of Stock Option Agreement in connection with the Registrant’s 1998 Stock Incentive Plan	S-1/A	333-60838	10.10	August 14, 2001
10.14#	Form of Amendment to Stock Option Agreement in connection with the Registrant’s 1998 Stock Incentive Plan	S-1/A	333-60838	10.11	August 14, 2001
10.15#	1997 Stock Incentive Plan	S-1	333-60838	10.5	May 14, 2001
10.16#	Moscape, Inc. 1997 Incentive Stock Plan	S-1	333-60838	10.6	May 14, 2001
10.17	Agreement and Plan of Merger and Reorganization, dated as of October 16, 2003, among the Company, Silicon Metrics Corporation, Silicon Correlation, Inc., and Vess Johnson and Austin Ventures V, L.P., as Stockholder Agents	8-K	000-33213	2.1	October 31, 2003
10.18	Second Amended and Restated Agreement and Plan of Reorganization, dated July 7, 2000, between the Registrant, Magma Acquisition Corp. and Moscape, Inc.	S-1	333-60838	2.3	May 14, 2001
10.19#	Stock Option Agreement entered into between the Registrant and Rajeev Madhavan dated September 29, 2000	S-1/A	333-60838	10.8	August 14, 2001

67

Exhibit Number	Exhibit Description	Incorporated by Reference					Filed Herewith
		Form	File No.	Exhibit		Filing Date
10.20#	Stock Option agreement entered into between the Registrant and Rajeev Madhavan dated September 29, 2000	S-1/A	333-60838	10.9		August 14, 2001
10.21#	Stock Option Agreement entered into between the Registrant and Roy E. Jewell dated March 30, 2001	S-1/A	333-60838	10.13		August 14, 2001
10.22#	Form of Stock Option Agreement for agreements between the Registrant and Roy E. Jewell dated March 30, 2001	S-1/A	333-60838	10.14		August 14, 2001
10.23	Lease for corporate headquarters dated June 19, 2003, between Registrant and 3Com Corporation (assumed by Marvell Semiconductor from 3Com)	10-Q	000-33213	10.2		November 14, 2003
10.24#	Summary of Standard Director Compensation Arrangements for Non-Employee Directors	10-K	000-33213	10.24		June 15, 2006
10.25	Warrant Agreement	10-Q	000-33213	10.1		August 12, 2005
10.26	Form of Indemnification Agreement Between the Registrant and certain directors and officers	S-1	333-60838	10.1		May 14, 2001
10.27(a)#	Summary of Compensation Arrangement for Certain Executive Officers	10-K	000-33213	10.27	(a)	June 15, 2006
10.27(b)#	Schedule of Certain Executive Officers for the Summary of Compensation Arrangement Set Forth in Exhibit 10.27(a)	10-K	000-33213	10.27	(b)	June 15, 2006
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

# Indicates management contract or compensatory plan or arrangement.

68