Magma Design Automation (LAVA) 10-Q 2009 Q3 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 February 1, 2009

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)

1650 Technology Drive

San Jose, California 95110

(Address of principal executive offices)

Telephone: (408) 565-7500

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for at least the past 90 days.    Yes  x    No  ¨

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

Large Accelerated Filer  ¨	Accelerated Filer  x	Non-accelerated Filer  ¨	Smaller reporting company  ¨
		(Do not check if a smaller reporting company)

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 March 2, 2009, 46,868,230 shares of Registrant’s Common Stock, $.0001 par value were outstanding.

MAGMA DESIGN AUTOMATION, INC.

FORM 10-Q

QUARTERLY PERIOD ENDED FEBRUARY 1, 2009

INDEX

		Page
Part I: Financial Information		3
Item 1:	Financial Statements (unaudited)	3
	Condensed Consolidated Balance Sheets at February 1, 2009 and April 6, 2008	3
	Condensed Consolidated Statements of Operations for the Three and Nine Months Ended February  1, 2009 and January 6, 2008	4
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended February 1, 2009 and January 6, 2008	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
Item 3:	Quantitative and Qualitative Disclosures About Market Risk	39
Item 4:	Controls and Procedures	40
Part II: Other Information		40
Item 1:	Legal Proceedings	40
Item 1A:	Risk Factors	41
Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds	57
Item 6:	Exhibits	58
Signatures		59
Exhibit Index		60

2

PART 1: FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

MAGMA DESIGN AUTOMATION, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

(unaudited)

	February 1, 2009			April 6, 2008
ASSETS
Current assets:
Cash and cash equivalents	$	29,221		$	46,970
Restricted cash		8,660			—
Short-term investments		—			3,000
Accounts receivable, net		39,380			38,310
Prepaid expenses and other current assets		3,735			5,244
Total current assets		80,996			93,524
Property and equipment, net		12,842			15,553
Intangible assets, net		18,877			40,436
Goodwill		6,629			64,877
Long-term investments		—			17,538
Long-term investments, pledged as collateral for secured credit line		17,739			—
Other assets		5,853			5,467
Total assets	$	142,936		$	237,395
LIABILITIES AND STOCKHOLDERS EQUITY
Current liabilities:
Accounts payable	$	2,559		$	3,971
Accrued expenses		19,937			27,788
Secured credit line		12,494			—
Revolving note, current portion		13,000			—
Current portion of other long-term liabilities		2,868			2,078
Deferred revenue		40,978			25,254
Convertible notes		—			15,216
Total current liabilities		91,836			74,307
Convertible notes, net of debt discount of $886 and $1,421 at February 1, 2009 and April 6, 2008, respectively		49,054			48,518
Long-term tax liabilities, less current portion		6,043			4,968
Other long-term liabilities		3,080			2,374
Total liabilities		150,013			130,167
Commitments and contingencies (Note 14)
Stockholders equity:
Common stock		5			5
Additional paid-in capital		395,562			374,183
Accumulated deficit		(363,999	)		(229,479	)
Treasury stock at cost		(32,615	)		(32,697	)
Accumulated other comprehensive loss		(6,030	)		(4,784	)
Total stockholders equity (deficit)		(7,077	)		107,228
Total liabilities and stockholders equity	$	142,936		$	237,395

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						Nine Months Ended
	February 1, 2009			January 6, 2008			February 1, 2009			January 6, 2008
Revenue:
Licenses	$	13,086		$	35,615		$	58,924		$	103,241
Bundled licenses and services		8,248			11,283			25,664			30,157
Services		9,353			8,849			28,299			26,007
Total revenue		30,687			55,747			112,887			159,405
Cost of revenue:
Licenses		4,463			4,362			14,231			14,289
Bundled licenses and services		3,032			2,504			7,897			7,045
Services		4,377			5,274			14,427			15,374
Total cost of revenue		11,872			12,140			36,555			36,708
Gross profit		18,815			43,607			76,332			122,697
Operating expenses:
Research and development		15,297			19,513			54,476			56,538
Sales and marketing		12,658			17,833			44,935			53,380
General and administrative		5,469			8,570			19,165			24,437
Impairment of goodwill		60,089			—			60,089			—
Amortization of intangible assets		378			2,242			2,660			6,308
In-process research and development		—			—			—			656
Restructuring charge		3,286			—			8,612			291
Total operating expenses		97,177			48,158			189,937			141,610
Operating loss		(78,362	)		(4,551	)		(113,605	)		(18,913	)
Other income (expense):
Interest income		142			562			522			1,510
Interest and amortization of debt discount expense		(692	)		(618	)		(2,005	)		(1,874	)
Valuation gain (loss), net		1,068			—			(611	)		—
Other income (expense), net		(207	)		(18	)		401			51
Other income (expense), net		311			(74	)		(1,693	)		(313	)
Net loss before income taxes		(78,051	)		(4,625	)		(115,298	)		(19,226	)
Provision for (benefit from) income taxes		(629	)		1,318			2,941			4,381
Net loss	$	(77,422	)	$	(5,943	)	$	(118,239	)	$	(23,607	)
Net loss per share basic and diluted	$	(1.71	)	$	(0.14	)	$	(2.68	)	$	(0.59	)
Shares used in calculation basic and diluted		45,215			41,025			44,165			39,990

See accompanying notes to unaudited condensed consolidated financial statements.

4

MAGMA DESIGN AUTOMATION, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Nine Months Ended
	February 1, 2009			January 6, 2008
Cash flows from operating activities:
Net loss	$	(118,239	)	$	(23,607	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization		6,537			7,588
Amortization of intangible assets		21,224			22,933
In-process research and development		—			656
Provision for (recovery from) doubtful accounts		1,628			186
Amortization of debt discount and debt issuance costs		793			877
Loss on auction rate securities		3,078			—
Gain on purchased put option		(2,466	)		—
Loss on strategic equity investments		179			437
Stock-based compensation		14,855			14,921
Tax benefits associated with exercise of stock options and debt issuance costs		—			27
Impairment of goodwill		60,089			—
Other non-cash items		(62	)		49
Changes in operating assets and liabilities, net of effect of acquisitions:
Accounts receivable		(11,823	)		10,770
Prepaid expenses and other assets		2,415			(862	)
Accounts payable		(697	)		(1,919	)
Accrued expenses		(4,646	)		(18,470	)
Deferred revenue		15,333			(4,580	)
Other long-term liabilities		798			1,630
Net cash flows (used in) provided by operating activities		(11,004	)		10,636
Cash flows from investing activities:
Cash paid for business and asset acquisitions, net of cash acquired		(4,211	)		(8,702	)
Purchase of property and equipment		(124	)		(6,037	)
Purchase of available-for-sale investments		—			(32,697	)
Proceeds from maturities and sales of available-for-sale investments		5,000			25,700
Purchase of strategic investments		(1,801	)		(1,275	)
Restricted cash		(8,660	)		4,850
Net cash flows (used in) investing activities		(9,796	)		(18,161	)
Cash flows from financing activities:
Proceeds from issuance of common stock, net		2,892			18,896
Retirement of restricted stock		(1,139	)		—
Proceeds from revolving note		13,000			—
Proceeds from secured credit line		12,550			—
Repayment of lease obligations		(1,922	)		(1,704	)
Repayment of convertible notes		(15,216	)		—
Repayment of line of credit		—			(3,000	)
Net cash provided by financing activities		10,165			14,192
Effect of foreign currency translation changes on cash and cash equivalents		227			29
Net change in cash and cash equivalents		(10,408	)		6,696
Cash and cash equivalents, beginning of period		39,629			45,338
Cash and cash equivalents, end of period	$	29,221		$	52,034
Supplemental disclosure of cash flow information:
Non-cash investing and financing activities:
Purchase of equipment under capital leases	$	2,393		$	2,039
Purchase of software under installment payment agreement	$	909		$	—
Issuance of common stock in connection with acquisitions	$	739		$	5,638

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 May 3, 2009. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Company’s Form 10-K for the year ended April 6, 2008, as filed with the SEC on June 16, 2008. The accompanying unaudited condensed consolidated balance sheet at April 6, 2008 is derived from audited consolidated financial statements at that date.

Preparation of condensed 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 condensed 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.

Fiscal Year End

The Company has a 52-53 week fiscal year. Prior to fiscal 2009, the fiscal year ended on the first Sunday subsequent to March 31. On January 28, 2008, the Board of Directors approved a change of fiscal year from a fiscal year ending on the first Sunday subsequent to March 31 to a fiscal year ending on the first Sunday subsequent to April 30 (except for any given year in which April 30 is a Sunday, in which case the fiscal year will end on April 30), starting with fiscal 2009.

The Company’s fiscal years consist of four quarters of 13 weeks except for each fifth or sixth fiscal year, which includes one quarter with 14 weeks. The Company’s fiscal year 2012 consists of 53 weeks and the second quarter of fiscal 2012 includes 14 weeks. The result of the additional week is not expected to have a material impact on the Company’s consolidated financial position or results of operations. All references to years or quarters in these notes to condensed consolidated financial statements represent fiscal years or fiscal quarters, respectively, unless otherwise noted.

Information for the transition period from April 7, 2008 to May 4, 2008 was included in the Company’s Form 10-Q for the quarter ended August 3, 2008, which was filed with the SEC on September 12, 2008. The separate audited financial statements required for the transition period will be included in the Company’s annual report on Form 10-K for the fiscal year ending May 3, 2009.

References in this Form 10-Q to the third quarter and first nine months of fiscal 2009 represent the three and nine months ended February 1, 2009. References in this Form 10–Q to the third quarter and first nine months of fiscal 2008 represent the three and nine months ended January 6, 2008. We have not submitted financial information for the three and nine months ended February 3, 2008 in this Form 10–Q because the information is not practical or cost beneficial to prepare. We believe that the third quarter and first nine months of fiscal 2008 provides a meaningful comparison to the third quarter and first nine months of fiscal 2009. The three and nine months ended February 1, 2009 had the same number of weeks as the three and nine months ended January 6, 2008. We do not believe that there are any significant factors, seasonal or otherwise, that would impact the comparability of information or trends if results for the three and nine months ended February 3, 2008 were presented in lieu of results for the three and nine month ended January 6, 2008.

Principles of Consolidation

The condensed 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.

6

Reclassifications

Certain prior period amounts have been reclassified to conform to current classifications. A new caption, current portion of other long-term liabilities has been added to the condensed consolidated balance sheets. As part of this, certain prior period amounts were reclassified from accrued expenses into current portion of other long-term liabilities. These reclassifications did not change the previously reported net loss, net change in cash and cash equivalents or stockholders’ equity.

Accounting Corrections

As a part of the Company’s implementation of new automated controls in internal controls over financial reporting in the first quarter of fiscal 2009, the Company identified certain amounts in deferred revenue recorded after events occurred which required the recognition of revenue or the reduction of goodwill. The error resulted from amounts not recognized once final revenue recognition criteria were met; amounts not recognized within the write-down of an investment in a former customer; and amounts not adjusted to goodwill as part of the fair value adjustment to acquired deferred revenue within 12 months subsequent to acquisition.

The Company concluded the effect of the error was not material to any of the affected years and recorded the correction in the first quarter of fiscal 2009 as an increase in revenue and other income of $0.9 million and $0.2 million, respectively, and a decrease in goodwill and deferred revenue of $0.7 million and $1.8 million, respectively. As a result, the Company’s operating loss was decreased by $0.9 million and net loss was decreased by $1.1 million, or $0.02 per basic and diluted share, for the nine months ended February 1, 2009.

While preparing the second quarter of fiscal 2009 tax provision, the Company determined the previously reported $6.9 million deferred tax assets recorded upon adoption of FASB Interpretation Number 48 (“FIN 48”) should have been reported net with long-term tax liabilities. Management determined that this classification was not material to previously issued interim and annual financial statements as it was limited to a balance sheet reclassification and did not affect the statements of operations or cash flows. The Company has reported net long term tax liabilities in the condensed consolidated balance sheet at April 6, 2008 in conformity with the presentation at February 1, 2009.

Adoption of New Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measures (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value. SFAS 157 became effective for the Company on April 7, 2008.

SFAS 157 requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three levels:

Level 1: Quoted market prices in active markets for identical assets or liabilities.

Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data.

Level 3: Unobservable inputs that are not corroborated by market data.

In February 2008, the FASB issued FASB Staff Position (“FSP”) FAS No. 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13 (“FSP FAS 157-1”). FSP FAS 157-1 provides a scope exception from SFAS 157 for the evaluation criteria on lease classification and capital lease measurement under SFAS No. 13, Accounting for Leases (“SFAS 13”) and other related accounting pronouncements. Accordingly, the Company did not apply the provisions of SFAS 157 in determining the classification of and accounting for leases.

In February 2008, the FASB issued FSP FAS No. 157-2, Effective Date of FASB Statement No. 157 (“FSP FAS 157-2”) which delays the effective date of SFAS 157 to fiscal years beginning after November 15, 2008 for certain nonfinancial assets and nonfinancial liabilities. FSP FAS 157-2 will become effective for the Company on May 4, 2009. The Company is in the process of evaluating the impact of applying FSP FAS 157-2 to nonfinancial assets and liabilities measured on a nonrecurring basis. Examples of items to which the deferral would apply include, but are not limited to:

• reporting units measured at fair value in the first step of a goodwill impairment test as described in SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS 142”), and nonfinancial assets and nonfinancial liabilities measured at fair value in the SFAS 142 goodwill impairment test, if applicable;

7

• indefinite-lived intangible assets measured at fair value for impairment assessment under SFAS 142, and nonfinancial long-lived assets (asset groups) measured at fair value for an impairment assessment under SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS 144”); and

• nonfinancial liabilities for exit or disposal activities initially measured at fair value under SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities (“SFAS 146”).

As a result of the issuance of FSP FAS 157-2, the Company did not apply the provisions of SFAS 157 to the nonfinancial assets and nonfinancial liabilities within the scope of FSP FAS 157-2.

In October 2008, the FASB issued FSP FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active (“FSP FAS 157-3”). FSP FAS 157-3 clarifies the application of SFAS 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. FSP FAS 157-3 is effective October 10, 2008, and for prior periods for which financial statements have not been issued.

The adoption of SFAS 157 did not materially affect the Company’s consolidated financial position or results of operations.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115 (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value, with changes in fair value recognized in earnings each reporting period. The election, called the fair value option, will enable entities to achieve an offset accounting effect for changes in fair value of certain related assets and liabilities without having to apply complex hedge accounting provisions. SFAS 159 is effective as of the beginning of the Company’s 2009 fiscal year. The Company did not elect the fair value option for any assets or liabilities at the beginning of its 2009 fiscal year. The Company did elect the fair value option for an asset in the second quarter of fiscal 2009 (see Note 3.)

In June 2007, the FASB ratified a consensus opinion reached by the Emerging Issues Task Force (“EITF”) on EITF Issue 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities (“EITF 07-3”). The guidance in EITF 07-3 requires the Company to defer and capitalize nonrefundable advance payments made for goods or services to be used in research and development activities until the goods have been delivered or the related services have been performed. If the goods are no longer expected to be delivered nor the services expected to be performed, the Company would be required to expense the related capitalized advance payments. EITF 07-3 became effective for the Company on April 4, 2008 and had no material impact on its consolidated financial position or results of operations.

Recently Issued Accounting Pronouncements

In December 2007, the FASB issued SFAS 141R,Business Combinations (“SFAS 141R”) which amends SFAS 141 and provides revised guidance for recognizing and measuring identifiable assets and goodwill acquired, liabilities assumed, and any non-controlling interest in the acquiree. It also provides disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of the business combination. It is effective for fiscal years beginning on or after December 15, 2008 and will be applied prospectively. The impact of the adoption of SFAS No. 141(R) will depend on the nature and extent of our business combinations occurring on or after the beginning of fiscal 2010.

In April 2008, the FASB issued FSP FAS 142-3, Determination of the Useful Life of Intangible Assets (“FSP FAS 142-3”) which amends the factors that must be considered in developing renewal or extension assumptions used to determine the useful life over which to amortize the cost of a recognized intangible asset under SFAS 142. FSP FAS 142-3 requires an entity to consider its own assumptions about renewal or extension of the term of the arrangement, consistent with its expected use of the asset. FSP FAS 142-3 also requires the Company to disclose the weighted-average period prior to the next renewal or extension for each major intangible asset class, the accounting policy for the treatment of costs incurred to renew or extend the term of a recognized intangible assets and for intangible assets renewed or extended during the period, if the Company will capitalize renewal or extension costs, the costs incurred to renew or extend the asset and the weighted-average period prior to the next renewal or extension for each major intangible asset class. FSP FAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The Company is currently evaluating the impact of the adoption of this statement on its consolidated financial position or results of operations. The guidance for determining the useful life of a recognized intangible asset in this FSP shall be applied prospectively to intangible assets acquired after the effective date. The disclosure requirements shall be applied prospectively to all intangible assets recognized as of, and subsequent to, the effective date. Early adoption is prohibited.

8

In May 2008, the FASB issued Staff Position No. 14-1,Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)(“FSP 14-1”) Accounting Principles Board. FSP 14-1 clarifies that convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) are not addressed by paragraph 12 of Accounting Principles Board Opinion No. 14,Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants. FSP 14-1 will require the issuer of convertible debt instruments with cash settlement features to separately account for the liability and equity components of the instrument. The debt will be recognized at the present value of its cash flows discounted using the issuer’s nonconvertible debt borrowing rate at the time of issuance. The equity component will be recognized as the difference between the proceeds from the issuance of the note and the fair value of the liability. FSP 14-1 will also require an accretion as interest expense of the resultant debt discount over the expected life of the debt. The transition guidance requires retrospective application to all periods presented, and does not grandfather existing instruments. The guidance will be effective for fiscal years beginning after December 15, 2008, and interim periods within those years. As such, we will adopt FSP 14-1 in the first quarter of fiscal year 2010. The Company is currently evaluating the impact of the adoption of this statement on its consolidated financial position or results of operations.

In June 2008, the FASB issued FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (“FSP EITF 03-6-1”). FSP EITF 03-6-1 addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share (“EPS”) under the two-class method. FSP EITF 03-6-1 clarifies that all outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends participate in undistributed earnings with common shareholders and are considered to be participating securities. As such, the issuing entity is required to apply the two-class method of computing basic and diluted EPS. FSP EITF 03-6-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The Company is currently evaluating the impact of the adoption of this standard on its consolidated financial position or results of operations. Upon adoption, the Company is required to retrospectively adjust its earnings per share data (including any amounts related to interim periods, summaries of earnings and selected financial data) to conform with the provisions in this FSP. Early application of this FSP is prohibited.

In November 2008, the FASB issued FSP EITF 08-6,Equity Method Investment Accounting Considerations (“FSP EITF 08-6) to clarify accounting and impairment considerations involving equity method investments after the effective date of both SFAS 141R,Business Combinations, and SFAS 160,Noncontrolling Interests in Consolidated Financial Statements. FSP EITF 08-6 includes the Task Force’s conclusions on how an equity method investor should (1) initially measure its equity method investment, (2) account for impairment charges recorded by its investee, and (3) account for shares issued by the investee. FSP EITF 08-6 is effective for fiscal years beginning on or after December 15, 2008. The Company does not anticipate the adoption of FSP EITF 08-6 will have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

In November 2008, the FASB issued FSP EITF 08-7,Accounting for Defensive Intangible Assets(“FSP EITF 08-7”) to clarify how to account for defensive intangible assets subsequent to initial measurement. This issue applies to acquired intangible assets, except for those used in research and development activities that an entity does not intend to actively use but intends to hold to prevent others from using. FSP EITF 08-7 requires that intangible assets within the scope of FSP EITF 08-7 be accounted for as separate units of accounting and assigned useful lives reflecting the period over which they diminish in fair value. FSP EITF 08-7 is effective for intangible assets acquired on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company does not anticipate the adoption of FSP EITF 08-6 will have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

With the exception of the discussion above, there have been no recent accounting pronouncements or changes in accounting pronouncements during the three and nine months ended February 1, 2009, as compared to the recent accounting pronouncements described in our Annual Report on Form 10-K for the fiscal year ended April 6, 2008, that are of significance or potential significance to us.

Note 2. Liquidity

Cash and cash equivalents available for use aggregated a total of $29.2 million at February 1, 2009. Since fiscal 2004 the Company has not achieved profitability. Since inception, the Company has incurred aggregate consolidated net losses of $364.0 million, and expects to continue to incur net losses for the foreseeable future. In addition, the Company has experienced a significant decline in revenues during the current fiscal year and the Company does not currently have the cash or third party financing in place to repay the $49.9 million due on its 2% convertible notes maturing May 2010 (see Note 10). Given the current adverse economic conditions generally, and in the semiconductor industry in particular, the credit market crisis and our own liquidity position, we have increased our focus on cash management and identifying and taking actions to sustain and enhance our liquidity position. These actions include further operational expense reduction initiatives and re-timing or eliminating certain capital spending or research and development projects. In addition, we are exploring opportunities to restructure our debt, including through the issuance of new debt or equity securities. In the event that these efforts do not generate adequate additional liquidity, we may not have sufficient cash to fund our working capital requirements, capital investments, debt service and operations during the next twelve months and may not have sufficient cash for the repayment of the $49.9 million in bond debt maturing in May 2010. However the Company believes that its current cash and cash equivalents will be sufficient to fund its cash needs for at least the next 12 months.

9

In recent years, the Company has funded its operations primarily from operating cash flows and through the issuance of convertible debt and equity securities. In the first quarter of fiscal 2009, the Company began implementing cost reduction measures which continued into the third quarter of fiscal 2009 and are planned to continue through the end of fiscal 2009. In total, the Company expects overall operating expenses to be reduced approximately 15% compared to fiscal 2008. Additionally, the Company has taken action to obtain liquidity from the Company’s $18.4 million in auction rate securities (“ARS”), which have been illiquid for most of 2008. The Company entered into a settlement agreement with UBS Financial Services, Inc. (“UBS”) which allows the Company to recover the par value of the ARS on or about June 30, 2010 (see Note 3). Concurrently, the Company entered into a “no net cost” secured line of credit with UBS offered as part of the total settlement agreement (see Note 12). This secured line of credit provided the Company with cash of $12.5 million until the ARS can be sold back to UBS at par value in 2010.

The Company’s ability to fund its cash needs over the short and long term will depend on its ability to generate cash from operations, which is subject to general economic and financial market conditions, competitive and other factors. It could be difficult to obtain additional financing on favorable terms, or at all, due to the Company’s financial condition, and current credit market conditions may make external financing difficult to obtain. Any external credit financing that we are able to obtain will likely contain terms that are not as favorable as our historical financings. The Company may try to obtain additional financing by means which could dilute the Company’s existing shareholders. If the Company cannot raise needed funds on acceptable terms, or at all, it may not be able to develop or enhance the Company’s products, respond to competitive pressures or grow its business, or the Company may be required to undertake further expense reduction measures in addition to the $8.6 million in restructuring costs incurred in the current year to date. The Company is in the process of evaluating the need for additional restructuring activities in conjunction with the FY 2009 Restructuring Plan. The Company estimates additional restructuring costs to be in the range of $2.0 to $3.0 million in the fourth quarter of fiscal 2009. Any of these factors could have a materially adverse impact on the Company’s financial position and results of operations.

Note 3. Fair Value Option

During the second quarter of fiscal 2009, the Company elected fair value accounting for the purchased put option recorded in connection with the ARS settlement agreement signed with UBS (see Note 4). This election was made in order to mitigate volatility in earnings caused by accounting for the purchased put option and underlying ARS under different methods. The election of fair value led to a $1.4 million and $2.5 million gain for the three and nine months ended February 1, 2009, respectively, included in “Valuation gain (loss), net” with the purchased put option asset recorded in long-term investments pledged as collateral for the secured credit line.

Note 4. Fair Value of Financial Instruments

In the first quarter of fiscal 2009, the Company adopted the provisions of SFAS 157. Although the adoption of SFAS 157 did not materially impact its financial condition, results of operations, or cash flow, the Company is now required to provide additional disclosures as part of its financial statements.

SFAS 157 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

10

The Company’s assets measured at fair value on a recurring basis subject to the disclosure requirements of SFAS 157 at February 1, 2009, were as follows (in thousands):

	Balance at February 1, 2009		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobserved Inputs (Level 3)
Cash equivalents:
Money market funds	$	—	$	—	$	—	$	—
Long-term investments, pledged as collateral for secured credit line:
Auction rate securities		15,273		—		—		15,273
Purchased put option		2,466		—		—		2,466
Total long-term investments, pledged		17,739		—		—		17,739
Total assets measured at fair value	$	17,739	$	—	$	—	$	17,739
Accrued expenses:
Foreign currency forward contract		70		—		70		—
Total liabilities measured at fair value	$	70	$	—	$	70	$	—

The following table is a reconciliation of financial assets measured at fair value using significant unobservable inputs (Level 3) during the three and nine months ended February 1, 2009 (in thousands):

	Three Months Ended February 1, 2009			Nine Months Ended February 1, 2009
Beginning balance	$	16,671		$	—
Net transfers into Level 3		—			17,347
Net purchases, sales, issuances and settlements		—			—
Losses on auction rate securities		(322	)		(2,074	)
Acquisition of purchased put option		—			1,076
Gain on put option		1,390			1,390
Balance at February 1, 2009	$	17,739		$	17,739

Long-term investments on the condensed consolidated balance sheets consist of (i) ARS that are AAA rated and are secured by pools of student loans guaranteed by state regulated higher education agencies and reinsured by the U.S. Department of Education, and (ii) the UBS purchased put option. Historically, liquidity for investors in ARS was provided via an auction process that reset the applicable interest rate generally every 28 days, allowing investors to either roll over their investments or sell them at par. Beginning in fourth quarter of fiscal 2008, there was insufficient demand for these types of investments during the auctions and, as a result, these securities are not currently liquid.

In October 2008, the Company entered into an agreement with UBS which provides the Company with Auction Rate Securities Rights (“Rights”) to sell its ARS at par value to UBS at any time during the period June 30, 2010 through July 2, 2012. These Rights are a separate freestanding instrument accounted for separately from the ARS, and are registered, nontransferable securities accounted for as a purchased put option initially recorded at fair value (see Note 3). Under the Rights agreement, UBS may, at its discretion, sell the ARS at any time through July 2, 2012 without prior notice to the Company and must pay the Company par value for the ARS within one day of the sale transaction settlement. Additionally, UBS offered a “no net cost” loan to the Company up to 75% of the market value of the ARS as determined by UBS until June 30, 2010 (see Note 12) and the Company agreed to release UBS from certain potential claims related to the collateralized ARSs in certain specified circumstances. Due to the Company entering into this agreement with UBS and enabling UBS to sell the ARS at any time, the ARS previously reported as available-for-sale have been transferred to trading securities and are classified as long-term investments pledged as collateral for secured credit line as of February 1, 2009.

As of February 1, 2009, there was insufficient observable market information available to determine the fair value of the Company’s ARS. Prior to November 2, 2008, the Company estimated Level 3 fair values for these securities based on the investment bank’s valuations. The investment bank valued student loan ARSs as floating rate notes with three pricing inputs: the coupon, the current discount margin or spread, and the maturity. The coupon was generally assumed to equal the maximum rate allowed under the terms of the instrument, the current discount margin was based on an assessment of observable yields on instruments bearing comparable risks, and the maturity was based on an assessment of the terms of the underlying instrument and the potential for restructuring the ARS. The primary unobservable input to the valuation was the maturity assumption which was set at five years for the majority of ARS instruments. Through January 6, 2008, the ARS were valued at par value due to the frequent resets that historically occurred through the auction process.

11

As of November 2, 2008, the Company engaged a third party valuation service to model Level 3 fair value using an income approach. The Company reviewed the methodologies employed by the third party models. This included a review of all relevant data inputs and the appropriateness of key model assumptions.

The pricing assumptions for the ARS included the coupon rate, the estimated time to liquidity, current market rates for publicly traded corporate debt of similar credit rating and an adjustment for lack of liquidity. The coupon rate was assumed to equal the stated maximum auction rate being received, which is determined based on the applicable 91-day U.S. Treasury rate plus 1.20% premium according to provisions outlined in each security’s agreement. The estimated time to liquidity was 3.7 years based on (i) expectations from industry brokers for liquidity in the market and (ii) the period over which UBS and other broker-dealers that had issued ARS have agreed to redeem certain ARS at par value.

The purchased put option gives the Company the right to sell the ARS to UBS for a price equal to par value during the period June 30, 2010 to July 2, 2012, providing liquidity for the ARS sooner than the originally estimated 3.7 years. As the Company plans to exercise the purchased put option on or around June 30, 2010, the value of the purchased put option lies in (i) the ability to sell the securities thereby creating liquidity approximately 1.5 years before the ARS market is expected to become liquid and (ii) the avoidance of receiving below-market coupon rate while the security is illiquid and auctions are failing. The fair value of the purchased put option represents the difference between the ARS with an estimated time to liquidity of 3.5 years and the ARS with an estimated time to liquidity of 1.5 years as the purchased put option allows for the acceleration of liquidity and the avoidance of a below-market coupon rate over the two year time period.

Based on the Level 3 valuation and the transfer of the ARS from the available-for-sale category to the trading category, the Company has recorded a loss of $1.9 million in net loss for the fiscal second quarter ended November 2, 2008 and transferred an accumulated loss of $0.9 million from other comprehensive loss to other expense.

During the fiscal third quarter, the Company recorded a loss of $0.3 million on the ARS due to the third quarter valuation. In addition, the Company recorded a gain due to the increase in the valuation of the put option of $1.4 million.

A total net gain of $1.1 million was reported in the valuation gain (loss) in the condensed consolidated statement of operations for the three months ended February 1, 2009, and $(0.6) million was reported as a loss in the valuation gain (loss) in the condensed consolidated statement of operations for the nine months ended February 1, 2009.

Note 5. Basic and Diluted Net Income (Loss) Per Share

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

For the three and nine months ended February 1, 2009 and January 6, 2008 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				Nine Months Ended
	February 1, 2009		January 6, 2008		February 1, 2009		January 6, 2008
Shares of common stock issuable upon conversion of convertible notes		3,329		3,995		3,356		3,995
Shares of common stock issuable under stock option plans outstanding		8,148		12,117		8,148		12,117
Weighted average exercise price per share issuable under stock option plans	$	8.29	$	10.67	$	8.29	$	10.67

12

Note 6. Accumulated Deficit

The changes in accumulated deficit for the three and nine months ended February 1, 2009 were as follows (in thousands):

	Three Months Ended February 1, 2009			Nine Months Ended February 1, 2009
Balance at beginning of period	$	(286,576	)	$	(245,756	)
Net loss		(77,422	)		(118,239	)
Charges related to treasury stock reissuance		—			(4	)
Balance at February 1, 2009	$	(363,999	)	$	(363,999	)

Note 7. Comprehensive Loss

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

	Three Months Ended						Nine Months Ended
	February 1, 2009			January 6, 2008			February 1, 2009			January 6, 2008
Net loss	$	(77,422	)	$	(5,943	)	$	(118,239	)	$	(23,607	)
Unrealized gain on available-for-sale investments		—			—			1,003			—
Foreign currency translation adjustments		(648	)		(1,243	)		(2,236	)		(2,019	)
Comprehensive loss	$	(78,070	)	$	(7,186	)	$	(119,472	)	$	(25,626	)

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

	February 1, 2009			April 6, 2008
Unrealized loss on available-for-sale investments	$	—		$	(812	)
Foreign currency translation adjustments		(6,030	)		(3,972	)
Accumulated other comprehensive loss	$	(6,030	)	$	(4,784	)

Note 8. Acquisitions

Acquisition-related earnouts

For a number of Magma’s previously completed acquisitions, the Company agreed to pay contingent consideration in cash and/or stock to former stockholders of the acquired companies based on the acquired business’ achievement of certain technology or financial milestones as set forth in the respective acquisition agreements.

For the nine months ended February 1, 2009 the Company recorded $1.5 million of intangible assets and $2.5 million of goodwill resulting from contingent consideration that was paid or became payable to stockholders of acquired companies as follows (in thousands):

	Cash		Common Stock Value
Goodwill:
Sabio Labs	$	2,448	$	—
Intangible assets:
Mojave		750		741
Other		2		—
Total earnout consideration	$	3,200	$	741

Restricted cash for Sabio Labs, Inc.

Pursuant to the agreement to acquire Sabio Labs, Inc. (“Sabio”) and cash consideration held back to secure certain indemnification obligations that may arise for a 15-month period from the date of acquisition, the Company has classified $1.3 million of cash and cash equivalents as restricted cash. The Sabio indemnification period ends in May 2009.

13

Note 9. Goodwill and Intangible Assets

The following table summarizes the components of goodwill, intangible assets and related accumulated amortization balances as of February 1, 2009 and April 6, 2008 (dollars in thousands):

	Weighted	February 1, 2009										April 6, 2008
	Average Life (months)	Gross Carrying Amount		Goodwill Impairment			Accumulated Amortization			Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Goodwill		$	66,718	$	(60,089	)	$	—		$	6,629	$	64,877	$	—		$	64,877
Other intangible assets:
Developed technology	43	$	115,097				$	(104,541	)	$	10,556	$	113,609	$	(85,759	)	$	27,850
Licensed technology	40		41,699					(36,800	)		4,899		41,097		(34,503	)		6,594
Customer relationship or base	70		5,575					(3,209	)		2,366		5,575		(2,429	)		3,146
Patents	57		13,015					(12,749	)		266		13,015		(11,205	)		1,810
Acquired customer contracts	33		1,390					(1,090	)		300		1,390		(1,090	)		300
Assembled workforce	45		1,252					(1,243	)		9		1,252		(1,221	)		31
No shop right	24		100					(100	)		—		100		(100	)		—
Non-competition agreements	36		600					(475	)		125		600		(325	)		275
Trademark	67		900					(544	)		356		900		(470	)		430
Total		$	179,628	$	—		$	(160,751	)	$	18,877	$	177,538	$	(137,102	)	$	40,436

In addition to the transactions discussed in Note 8 — “Acquisitions,” during the nine months ended February 1, 2009, the Company increased its goodwill by $0.1 million, reflecting purchase price adjustments related to acquired net tangible assets.

We account for goodwill and other intangible assets in accordance with SFAS 142. In accordance with SFAS 142 goodwill is reviewed annually or whenever events or circumstances occur which indicate that goodwill might be impaired. SFAS 142 provides for a two-step approach to determining whether and by how much goodwill has been impaired. The first step requires a comparison of the fair value of the Company (reporting unit) to its net book value. If the fair value is greater, then no impairment is deemed to have occurred. If the fair value is less, then the second step must be performed to determine the amount, if any, of actual impairment. The process of evaluating the potential impairment of goodwill is highly subjective and requires significant judgment. In estimating the fair value of the Company, the Company made estimates and judgments about future revenues and cash flows for its reporting unit. To determine the fair value, the Company’s review process includes the income method and is based on a discounted future cash flow approach that uses estimates including the following for the reporting unit: revenue, based on assumed market growth rates and its assumed market share; estimated costs; and appropriate discount rates based on the particular business’s weighted average cost of capital. The Company’s estimates of market segment growth, market segment share and costs are based on historical data, various internal estimates and certain external sources, and are based on assumptions that are consistent with the plans and estimates it uses to manage the underlying business. The Company’s business consists of both established and emerging technologies and its forecasts for emerging technologies are based upon internal estimates and external sources rather than historical information. The Company also considered its market capitalization on the date of its impairment test in determining the fair value of its business. The Company completed the first step analysis during the second fiscal quarter and determined that the fair value of its reporting unit was in excess of the net book value on that date.

In accordance with SFAS 142, the Company conducts an annual goodwill impairment test at December 31. Accordingly the Company conducted this test during the third quarter and concluded that events had occurred and circumstances had changed during the third quarter of fiscal 2009 which showed the existence of impairment indicators including a significant decline in the Company’s stock price and continued deterioration in the EDA software products market and the related impact on revenue forecasts of the Company. Consistent with the Company’s approach in its annual impairment testing, in assessing the fair value of the reporting unit, the Company considered both the market approach and income approach. Under the market approach, the fair value of the reporting unit is based on quoted market prices and the number of shares outstanding of the Company’s common stock. Under the income approach, the fair value of the reporting unit is based on the present value of estimated future cash flows. At December 31, 2008, the Company determined that the fair value of its reporting unit was less than the net book value of the net assets of the reporting unit and accordingly, the Company performed step two of the impairment test.

In step two of the impairment test, the Company determined the implied fair value of the goodwill and compared it to the carrying value of the goodwill. With the assistance of a third party valuation firm, the Company allocated the fair value of the reporting unit to all of its assets and liabilities as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the price paid to acquire the reporting unit. The excess of the fair value of the reporting unit over the amount assigned to its assets and liabilities is the implied fair value of goodwill. The Company’s step two analysis resulted in a reduction in fair value of goodwill and the Company therefore recognized an impairment charge of $60.1 million in the third quarter of fiscal 2009.

The Company’s intangible assets include acquired intangibles, excluding goodwill. Acquired intangibles with definite lives are amortized on a straight-line basis over the remaining estimated economic life of the underlying products and technologies (original lives assigned are one to six years). The Company reviews its long-lived assets for impairment in accordance with SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets. For assets to be held and used, the Company initiates its review whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. Recoverability of an asset is measured by comparison of its carrying amount to the

14

expected future undiscounted cash flows that the asset is expected to generate. If it is determined that an asset is not recoverable, an impairment loss is recorded in the amount by which the carrying amount of the asset exceeds its fair value. Based on the Company’s review, no impairment is indicated.

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

	Three Months Ended				Nine Months Ended
	February 1, 2009		January 6, 2008		February 1, 2009		January 6, 2008
Amortization of intangible assets included in:
Cost of revenue-licenses	$	4,252	$	4,211	$	13,708	$	13,512
Cost of revenue-bundled licenses and services		2,117		1,053		4,856		3,113
Operating expenses		378		2,242		2,660		6,308
Total	$	6,747	$	7,506	$	21,224	$	22,933

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

Fiscal Year	Estimated Amortization Expense
2009 (remaining three months)	$	6,687
2010		5,007
2011		3,935
2012		1,885
2013		956
2014		265
Thereafter		142
Total expected future amortization	$	18,877

Expected future annual amortization expense of intangible assets for the remaining three months of fiscal 2009 includes $5.2 million relating to the intangible assets acquired from Mojave. The Mojave intangible assets will be fully amortized by the end of fiscal 2009.

Note 10. Convertible Notes, Current and Long-Term

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

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

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

In May 2006, the Company repurchased, in privately negotiated transactions, an aggregate principal amount of $40.3 million (or approximately 38.2% of the remaining principal) of the 2008 Notes at an average discount to face value of approximately 13%. The Company spent approximately $35.0 million on the repurchases. The repurchase left approximately $65.2 million principal amount of the 2008 Notes outstanding. In addition, a portion of the hedge and warrant transactions was terminated in connection with the repurchase. In the first quarter of fiscal 2007, the Company recorded a gain of $5.3

15

million on the repurchase, which was partially offset by the write-off of $0.5 million of deferred financing costs associated with the 2008 Notes. The Company received 14,467 shares of Magma common stock, valued at approximately $102,000, as settlement for termination of a portion of the hedge and warrant in connection with the repurchase. The amount was charged to additional paid-in-capital.

In March 2007, the Company exchanged, in privately negotiated transactions, an aggregate principal amount of $49.9 million (or approximately 76.7% of the remaining principal) of the 2008 Notes for a new series of 2% convertible senior notes due May 2010. The exchange left approximately $15.2 million principal amount of the 2008 Notes outstanding. In the fourth quarter of fiscal 2007, the Company recorded a gain of $2.1 million on the exchange, which was partially offset by the write-off of $0.4 million of deferred financing costs associated with the 2008 Notes. Please see below under “Long-Term 2% Convertible Senior Notes due 2010” for further discussion of the exchange. In addition, a portion of the hedge and warrant was terminated in connection with the exchange. The net proceeds of $88,000 from the termination of a portion of the hedge and warrant were charged to additional paid-in capital. The $15.2 million remaining principal amount of the 2008 Notes and the related $10,000 of unamortized balance of transaction fees and debt issuance costs were included in current liabilities on the Company’s consolidated balance sheets as of April 6, 2008.

In May 2008, the Company repaid the $15.2 million in remaining principal amount of its 2008 Notes. In connection with the repayment, the remaining portion of the hedge and warrant expired.

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

In March 2007, the Company exchanged, in privately negotiated transactions, an aggregate principal amount of $49.9 million of the 2008 Notes for an equal aggregate principal amount of the 2010 Notes. The 2010 Notes mature on May 15, 2010 and bear interest at 2% per annum, with interest payable on May 15 and November 15 of each year, commencing May 15, 2007. The 2010 Notes are unsecured senior indebtedness of Magma, which rank senior in right of payment to the 2008 Notes and junior in right of payment to Magma’s revolving line of credit facility. In addition, after May 20, 2009, the Company will have the option to redeem the 2010 Notes for cash in an amount equal to 100% of the aggregate outstanding principal amount at the time of such redemption. The 2010 Notes also contain a net share settlement provision which allows the Company, at its option, in lieu of delivery of some or all of the shares of common stock otherwise issuable upon conversion of the 2010 Notes, to pay holders of the 2010 Notes in cash for all or a portion of the principal amount of the converted 2010 Notes and any amounts in excess of the principal amount which are due.

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

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

The exchange offer was treated as an extinguishment of the 2008 Notes in accordance with EITF 96-19, Debtors Accounting for a Modification or Exchange of Debt Instruments, as amended by EITF 06-6, Debtor’s Accounting for a Modification (or Exchange) of Convertible Debt Instruments. The exchange resulted in a gain of $2.1 million on extinguishment of debt, which was partially offset by the write-off of $0.4 million of deferred financing costs associated with the 2008 Notes. The Company initially recorded the 2010 Notes at fair value of $47.8 million, net of the debt discount of $2.1 million. The debt discount is being amortized to interest expenses over the term of the 2010 Notes. As of February 1, 2009, debt discount balance related to the 2010 Notes was $0.9 million.

The $1.3 million of underwriting and legal fees related to the 2010 Notes offering was capitalized upon issuance and is being amortized over the term of the 2010 Notes using the effective interest method. As of February 1, 2009, the unamortized balance of debt issuance costs related to the 2010 Notes was approximately $0.6 million.

16

The shares issuable on the conversion of the 2010 Notes are included in “fully diluted shares outstanding” under the if-converted method of accounting for purposes of calculating diluted earnings per share, if the result is dilutive.

Note 11. Revolving note

In July 2007, the Company entered into a revolving line of credit facility with Wells Fargo Bank, N.A (the “Credit Facility”). The Credit Facility, as amended, provided for a $10.0 million (amended temporarily to $15.0 million from May 31, 2008 to October 31, 2008) revolving secured credit line through July 2010, bears an interest rate equal to the bank’s prime rate or LIBOR plus 2.5% at management’s election, required the Company to maintain certain financial conditions and pay fees of 0.125% per year on the unused amount of the Credit Facility. The Company was required to make interest only payments monthly and the outstanding principal amount plus all accrued but unpaid interest was payable in full at the expiration of the Credit Facility. The Credit Facility allowed for letters of credit to be issued on behalf of the Company, provided that the aggregate outstanding amount of the letters of credit would not exceed the total amount available for borrowing under the credit facility.

On May 31, 2008, the Company entered into the Second Amendment to the Credit Facility (“Second Amendment”). Pursuant to the Second Amendment, the Credit Facility was temporarily amended to increase the total amount available for borrowing to $15.0 million until August 31, 2008, at which time the total amount available for borrowing reverted back to $10.0 million and any borrowings in excess of $10.0 million were due and payable.

On September 26, 2008, the Company entered into the Third Amendment to the Credit Facility (“Third Amendment”). Pursuant to the Third Amendment, the temporary increase in the total amount for borrowing of $15.0 million was extended from August 31, 2008 to October 31, 2008, at which time the total amount available for borrowing reverted back to $10.0 million and any borrowings in excess of $10.0 million were due and payable.

Effective as of October 31, 2008, the Company entered into a new secured revolving line of credit facility with (the “New Credit Facility”) Wells Fargo Bank, N.A. (“Wells Fargo”), which replaced the then existing $10.0 million Credit Facility. The New Credit Facility provides for an increase in the total facility and the aggregate commitments thereunder up to $15.0 million. The New Credit Facility expires on December 31, 2009 and shall be used by the Company first, to refinance the existing Credit Facility, and second, to finance working capital and letters of credit, not to exceed $2.5 million, requirements. The New Credit Facility is secured by collateral that includes first priority interests in all the Company’s accounts receivable, intangible assets, inventory and equipment.

Outstanding borrowings and letter of credit liabilities under the New Credit Facility shall not exceed the lesser of $15.0 million or 80% of the Company’s eligible accounts receivable plus an additional amount not to exceed $3.0 million. The New Credit Facility bears an annual interest rate equal to the bank’s prime rate plus 2.5% or LIBOR plus 2.5%, at management’s election, on outstanding borrowings. The New Credit Facility requires the Company to maintain certain financial conditions and to pay fees of 0.125% per annum on the unused amount of the New Credit Facility and 2.0% per annum for each letter of credit issued. The Company is required to pay interest and fees monthly with the outstanding principal amount plus all accrued but unpaid interest and fees payable in full at the expiration of the New Credit Facility.

Pursuant to the New Credit Facility, the Company has pledged to grant to Wells Fargo a security interest in deposits equal to the amount of outstanding borrowings and letters of credit outstanding in excess of the maximum allowable. As of February 1, 2009, the Company had outstanding borrowings of $13.0 million and two letters of credit totaling $1.7 million under the New Credit Facility. The maximum borrowing available under the New Credit Facility at February 1, 2009 was $7.3 million; therefore the Company has classified $7.4 million of cash and cash equivalents as restricted cash in connection with the New Credit Facility.

The New Credit Facility requires that the Company maintain certain financial conditions. The Company has obtained a waiver for noncompliance with certain financial covenants as of February 1, 2009.

Note 12. Secured Credit Line

In October 2008, the Company obtained a line of credit with UBS in conjunction with the ARS settlement agreement (see Note 3). The line of credit is due on demand and allows for borrowings of up to 75% of the market value of the ARS, as determined by UBS, pledged as collateral for the line of credit. As of February 1, 2009, UBS determined the ARS market value to be $16.3 million. Prior to January 22, 2009 advances under this agreement bear interest at LIBOR plus 1.0% with interest payments payable monthly. All interest, dividends, distributions, premiums, other income and payments received into the ARS investment account at UBS will be automatically transferred to UBS as payments on the line of credit. Additionally, proceeds from any liquidation, redemption, sale or other disposition of all or part of the ARS will be automatically transferred to UBS as payments. If these payments are insufficient to pay all accrued interest by the monthly due date, then UBS will either require the Company to make additional interest payments or, at UBS’ discretion, capitalize unpaid interest as an additional advance. UBS’ intent is to cause the interest rate payable by the Company to be equal to the weighted average interest or dividend rate payable to the Company on the ARS pledged as collateral. Upon cancellation of the line of credit, the Company will be reimbursed for any amount paid in interest on the line of credit that exceeds the income on the ARS.

17

Effective January 22, 2009, the line of credit converted to a 100% Loan-to-Par Value No Net Cost loan program. Under this program the interest rate will be based on the lesser of either the weighted average ARS coupon rate or the published UBS Bank rate. This new rate applies to existing outstanding balances and new advances.

Advances on this line of credit may be used to fund working capital requirements, capital expenditures or other general corporate purposes, except that they may not be used to purchase, trade or carry any securities or to repay debt incurred to purchase, trade or carry any securities.

There was $12.5 million outstanding on this line of credit at February 1, 2009, which is the maximum available borrowing.

Note 13. Restructuring charges

In May 2008, the Company initiated a restructuring plan (“FY 2009 Restructuring Plan”) designed to improve its cost structure and to align better its resources and improve operating efficiencies.

During the first quarter of fiscal 2009, the Company recorded $2.0 million in pre-tax restructuring charges associated with the termination of 71 employees and costs related to expatriate relocation. During the second quarter of fiscal 2009, the Company recorded an additional $0.1 million in pre-tax restructuring charges associated with the first quarter of fiscal 2009 actions.

On October 1, 2008, the Company announced additional restructuring actions under the FY 2009 Restructuring Plan. These additional actions included the termination of 76 employees and the closing of certain offices. The Company recorded $3.2 million in pre-tax restructuring charges in the second quarter of fiscal 2009 related to the October 2008 actions.

On February 5, 2009 the Company announced further restructuring actions under the FY 2009 Restructuring Plan. These additional actions included the termination of approximately 160 employees and the closing of two sales and support offices in North America and one in Europe, and plans to consolidate its Beijing, China operations into a single facility, and its Shanghai, China operations into a single facility. The Company recorded $3.3 million in pretax restructuring charges in the third quarter of fiscal 2009 related to these actions.

In total, the Company recorded restructuring charges of $3.3 million and $8.6 million, respectively, during the three and nine months ended February 1, 2009 in connection with the FY 2009 Restructuring Plan. These costs relate to severance, expatriate relocation, facilities consolidation and termination, and other costs related to the restructuring.

The Company is in the process of evaluating the need for additional restructuring activities in conjunction with the FY 2009 Restructuring Plan. The Company estimates these costs to be in the range of $2.0 to $3.0 million for the fourth quarter of fiscal 2009.

The cash payments associated with the net restructuring liability are expected to be paid through fiscal 2010. The restructuring liability activity was as follows (in thousands):

	Severance			Relocation			Facilities and Other			Net Liability
Balance at April 6, 2008	$	—		$	—		$	—		$	—
Restructuring provision		—			—			—			—
Cash payments		—			—			—			—
Balance at May 4, 2008		—			—			—			—
Restructuring provision		1,583			418			19			2,020
Cash payments		(1,433	)		—			(19	)		(1,452	)
Balance at August 3, 2008		150			418			—			568
Restructuring provision		3,064			—			243			3,307
Cash payments		(2,050	)		(125	)		(36	)		(2,211	)
Balance at November 2, 2008		1,164			293			207			1,664
Restructuring provision		2,771			—			515			3,286
Cash payments		(744	)		(35	)		(107	)		(886	)
Balance at February 1, 2009	$	3,191		$	258		$	615		$	4,064

18

During the first quarter of fiscal 2008, the Company recorded restructuring charges of $0.3 million for costs related to termination of 21 employees resulting from the Company’s realignment to current business conditions. As of April 6, 2008, all of these termination costs had been paid and the Company had not planned to incur additional costs related to this business realignment.

Note 14. Contingencies

The Company is subject to certain legal proceedings described below and from time to time, it is also involved in other disputes that arise in the ordinary course of business. The number and significance of these litigation proceedings and disputes may increase as the Company’s size changes. Any claims against the Company, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and result in the diversion of significant operational resources. As a result, these litigation proceedings and disputes could harm the Company’s business and have an adverse effect on its consolidated financial statements. However, the results of any litigation or dispute are inherently uncertain and, at this time, no estimate could be made of the loss or range of loss, if any, from such litigation matters and disputes unless they are or are close to being settled. Liabilities are recorded when a loss is probable and the amount can be reasonably estimated. Accordingly, the Company recorded a liability of $1.1 million in fiscal year 2008 to cover legal settlement exposure related to the shareholder class action lawsuit and the derivative complaint, as described below, and has not recorded any liabilities related to other contingencies. In accordance with the proposed shareholder class action lawsuit settlement agreement, the Company deposited into escrow $1.0 million in June 2008, which $1.0 million has been classified as a reduction of the previously recorded liability. However, any estimates of losses or any such recording of legal settlement exposure is not a guarantee that there will be any court approval of any settlement, and there is no assurance that there will be any final, court approved settlement. In accordance with the derivative complaint settlement agreement, the Company deposited into escrow $0.1 million in September 2008, which $0.1 million was classified as a reduction of the previously recorded liability. The court granted final approval of the derivative complaint settlement agreement in October 2008. No accrued legal settlement liabilities remain on the condensed consolidated balance sheet as of February 1, 2009. Litigation settlement and legal fees are expensed in the period in which they are incurred.

On June 13, 2005, a putative shareholder class action lawsuit captioned The Cornelia I. Crowell GST Trust vs. Magma Design Automation, Inc., Rajeev Madhavan, Gregory C. Walker and Roy E. Jewell., No. C 05 02394, was filed in U.S. District Court, Northern District of California. The complaint alleges that defendants failed to disclose information regarding the risk of Magma infringing intellectual property rights of Synopsys, Inc., in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and prays for unspecified damages. In March 2006, defendants filed a motion to dismiss the consolidated amended complaint. Plaintiff filed a further amended complaint in June 2006, which defendants again moved to dismiss. Defendants’ motion was granted in part and denied in part by an order dated August 18, 2006, which dismissed claims against two of the individual defendants. On November 30, 2007, the parties agreed to a settlement. The court granted preliminary approval of the settlement on July 7, 2008. On December 5, 2008, the court held a hearing on final approval of the settlement and requested that plaintiff submit additional information, including information on claims by class members. The court will rule on final approval after review of plaintiff’s submissions. There is no assurance that the court will grant final approval of the settlement.

On July 26, 2005, a putative derivative complaint captioned Susan Willis v. Magma Design Automation, Inc. et al., No. 1-05-CV-045834, was filed in the Superior Court of the State of California for the County of Santa Clara. The Complaint seeks unspecified damages purportedly on behalf of us for alleged breaches of fiduciary duties by various directors and officers, as well as for alleged violations of insider trading laws by executives during a period between October 23, 2002 and April 12, 2005. Defendants have demurred to the Complaint, and the action has been stayed pending further developments in the putative shareholder class action referenced above. On January 8, 2008, the parties reached an agreement in principle with respect to certain aspects of settlement of the case and agreed upon the remaining terms of the settlement on February 21, 2008. The court granted preliminary approval of the settlement on August 4, 2008, and granted final approval of the settlement on October 3, 2008.

Indemnification Obligations

The Company enters into standard license agreements in the ordinary course of business. Pursuant to these agreements, the Company agrees to indemnify its customers for losses suffered or incurred by them as a result of any patent, copyright, or other intellectual property infringement claim by any third party with respect to the Company’s products. These indemnification obligations have perpetual terms. The Company’s normal business practice is to limit the maximum amount of indemnification to the amount received from the customer. On occasion, the maximum amount of indemnification the Company may be required to provide may exceed the amount received from the customer. The Company estimates the fair value of its indemnification obligations to be insignificant, based upon its historical experience concerning product and patent infringement claims. Accordingly, the Company has no liabilities recorded for indemnification under these agreements as of February 1, 2009.

19

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 February 1, 2009.

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. No liabilities have been recorded for these agreements as of February 1, 2009.

Warranties

The Company offers certain customers a warranty that its products will conform to the documentation provided with the products. To date, there have been no payments or material costs incurred related to fulfilling these warranty obligations. Accordingly, the Company has no liabilities recorded for these warranties as of February 1, 2009. The Company assesses the need for a warranty accrual on a quarterly basis, and there can be no guarantee that a warranty accrual will not become necessary in the future.

Note 15. Stock-Based Compensation

The stock-based compensation recognized in the condensed consolidated statements of operations was as follows (in thousands):

	Three Months Ended				Nine Months Ended
	February 1, 2009		January 6, 2008		February 1, 2009		January 6, 2008
Cost of revenue	$	433	$	409	$	1,210	$	1,277
Research and development expense		1,942		1,813		5,883		5,692
Sales and marketing expense		1,229		1,256		4,115		3,771
General and administrative expense		1,221		1,401		3,647		4,181
Total stock-based compensation expense	$	4,825	$	4,879	$	14,855	$	14,921

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

	Three Months Ended				Nine Months Ended
	February 1, 2009		January 6, 2008		February 1, 2009		January 6, 2008
Stock options	$	1,699	$	2,562	$	5,309	$	8,078
Restricted stock and restricted stock units		2,361		1,481		7,103		4,572
Employee stock purchase plan		765		836		2,443		2,271
Total stock-based compensation expense	$	4,825	$	4,879	$	14,855	$	14,921

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

20

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

	Three Months Ended						Nine Months Ended
	February 1, 2009			January 6, 2008			February 1, 2009			January 6, 2008
Stock options:
Expected life (years)		3.66 - 4.00			4.06			3.66 - 4.02			4.04 - 4.31
Volatility		77	%		42	%		73	%		39% - 42	%
Risk-free interest rate		1.13% - 1.79	%		3.26% - 4.06	%		1.13% - 3.56	%		3.26% - 4.91	%
Expected dividend yield		0	%		0	%		—			0	%
Weighted average grant date fair value	$	0.58		$	5.17		$	0.92		$	4.94
ESPP awards:
Expected life (years)		1.13			1.13			1.13			1.13
Volatility		77	%		42	%		45% - 77	%		39% - 42	%
Risk-free interest rate		0.87	%		3.88	%		0.87% - 2.25	%		3.88% - 4.91	%
Expected dividend yield		0	%		0	%		0	%		0	%
Weighted average grant date fair value	$	1.70		$	5.04		$	1.53		$	4.59

As of February 1, 2009, there was approximately $12.1 million and $6.1 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to stock option grants and ESPP awards, respectively, which will be recognized over the remaining weighted average vesting period of approximately 3.09 years and 1.83 years, respectively.

The cost of restricted stock and restricted stock unit awards is determined using the fair value of the Company’s common stock on the date of the grant, and compensation expense is recognized over the vesting period, which is generally one to four years.

In November 2008, the Company filed a Tender Offer Statement on Schedule TO with the Securities Exchange Commission relating to an offer by the Company to exchange (the “Exchange Offer”) certain options to purchase up to an aggregate of 6,223,830 shares of the Company’s Common Stock, whether vested or unvested, that were granted with an exercise price per share above $4.00. These eligible options could be exchanged for Restricted Stock Units (“RSUs”) upon the terms and subject to the conditions set forth in the Exchange Offer. The Company’s executive officers, members of the Company’s board of directors, and the Company’s consultants were not eligible to participate in the Exchange Offer.

The Exchange Offer permitted eligible option holders to exchange eligible underwater options for a lesser number of RSUs. The exchange ratio was determined based on the pricing of the original option. The new RSUs have vesting terms based on the individual option holder’s service history with the Company.

Options to purchase 5,374,016 shares of the Company’s common stock at an average exercise price of $9.92 per share were exchanged for 1,813,303 RSU shares. The option exercise prices ranged from $4.34 to $25.85 per share. The RSUs were issued on December 18, 2008 when the market price and the fair value was $0.98 per share of common stock. There is no exercise price for the RSUs. As of December 18, 2008, there was unamortized expense of $5.2 million remaining on the cancelled and unvested option shares.

With the assistance of a third party actuarial firm, the Company determined incremental value of the RSUs to be $1.4 million; therefore the total expense to be amortized over the vesting period of the RSUs is $6.6 million, or $3.66 per share.

As of February 1, 2009, there was approximately $0.6 million and $11.5 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to restricted stock and restricted stock unit awards, respectively, which will be recognized over the remaining weighted average vesting period of approximately 0.3 years and 1.8 years, respectively.

Note 16. Income Taxes

Provision for (benefit from) income taxes was $(0.6) million and $2.9 million for the three and nine months ended February 1, 2009, respectively, and $1.3 million and $4.4 million, respectively, for the three and nine months ended January 6, 2008.

In July 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS 109 and prescribes a recognition threshold and measurement attributes for financial statement disclosure of tax positions taken or expected to be taken on a tax return. Under FIN 48, the impact of an uncertain income tax position on the income tax return must be recognized as the largest amount that is more-likely-than-not not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of not being sustained. Additionally, FIN 48 provides guidance on de-recognition, classification, interest

21

and penalties, accounting in interim periods, disclosure and transition. The Company adopted the provisions of FIN 48 on April 2, 2007, the beginning of its fiscal 2008. For the period ended February 1, 2009, the Company had approximately $12.5 million of total gross unrecognized tax benefits, of which $10.9 million, if recognized, would favorably affect its effective tax rate in future periods and $1.6 million, if recognized, would result in a credit to additional paid-in capital.

The Company’s fiscal 2009 effective tax rate differs from the combined federal and state statutory rate primarily due to changes in its US valuation allowance, state taxes, goodwill impairment, foreign income taxed at other than U.S. rates, stock compensation expense, research and development credits and foreign withholding taxes.

Note 17. Segment Information

The Company has adopted the provisions of SFAS 131, Disclosures about Segments of an Enterprise and Related Information, which requires the reporting of segment information using the “management approach.” Under this approach, operating segments are identified in substantially the same manner as they are reported internally and used by the Company’s chief operating decision maker (“CODM”) for purposes of evaluating performance and allocating resources. Based on this approach, the Company has one reportable segment as the CODM reviews financial information on a basis consistent with that presented in the consolidated financial statements.

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

	Three Months Ended						Nine Months Ended
	February 1, 2009			January 6, 2008			February 1, 2009			January 6, 2008
North America*	$	20,866		$	37,024		$	65,241		$	93,080
Europe		3,849			6,498			22,447			21,364
Japan		2,651			6,981			14,384			28,245
Asia-Pacific (excluding Japan)		3,321			5,244			10,815			16,716
	$	30,687		$	55,747		$	112,887		$	159,405
	Three Months Ended						Nine Months Ended
	February 1, 2009			January 6, 2008			February 1, 2009			January 6, 2008
North America*		68	%		66	%		58	%		58	%
Europe		12	%		12	%		20	%		13	%
Japan		9	%		13	%		12	%		18	%
Asia-Pacific (excluding Japan)		11	%		9	%		10	%		11	%
		100	%		100	%		100	%		100	%

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

For the three and nine months ended February 1, 2009 and for the three and nine months ended January 6, 2008, the Company had no significant customers, representing 10% or more of total revenue.

22

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Management’s Discussion and Analysis of Financial Condition and Results of Operations section should be read in conjunction with our condensed consolidated financial statements and results appearing elsewhere in this Quarterly Report on Form 10-Q and with Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Company’s Annual Report on Form 10-K for the fiscal year ended April 6, 2008. Throughout this section, we make forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. 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. These forward-looking statements are made in reliance upon the safe harbor provision of The Private Securities Litigation Reform Act of 1995. 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 the risks discussed in this Quarterly Report on Form 10-Q under the caption “Risk Factors” as well as the following factors: competition in the EDA market; weakness in the semiconductor or electronic systems industries; Magma’s lengthy and unpredictable sales cycle; Magma’s substantial amount of indebtedness; difficulty in predicting quarterly results; an inability to generate sufficient operating cash flows; market acceptance of existing and new products; potentially higher-than-anticipated costs of litigation; the ability to attract and retain the key management and technical personnel needed to operate Magma successfully; risk of customer payment defaults; Magma’s ability to make payments to satisfy its indemnification obligations; Magma’s ability to maintain or develop relationships with current or potential customers; financial market conditions that may impede access to or increase the cost of financing operations and investments; debt arrangements that may subject Magma to restrictive covenants which could limit its ability to operate its business; Magma’s ability to integrate acquired businesses and technologies; a potential failure of customers to adopt, or to adopt at a sufficiently fast rate, 65-nanometer and smaller design geometries on a large scale; 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; weaker-than-anticipated sales of Magma’s products and services; the ability to continue to deliver competitive products to customers; changes in accounting rules; and the ability to manage expanding operations and restructurings of operations. We do not intend to, and we do not undertake any additional obligation to update these forward-looking statements after the date of this report to reflect actual results or future events or circumstances.

Change in Fiscal Year End

Prior to fiscal 2009, we had a 52-53 week fiscal year ending on the first Sunday subsequent to March 31. On January 28, 2008, our Board of Directors approved a change of fiscal year from a fiscal year ending on the first Sunday subsequent to March 31 to a fiscal year ending on the Sunday subsequent to April 30 (except for any given year in which April 30 is a Sunday, in which case the fiscal year will end on April 30), starting with fiscal 2009. Our 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.

The Company’s 2009 fiscal year began on May 5, 2008 and will end on May 3, 2009, resulting in a one-month transition period that began on April 7, 2008 and ended May 4, 2008. Information for the transition period from April 7 to May 4, 2008 was included in our Form 10-Q for the quarter ended August 3, 2008, which was filed with the SEC on September 12, 2008. The separate audited financial statements required for the transition period will be included in the Company’s annual report on Form 10-K for the fiscal year ending May 3, 2009.

References in this Form 10-Q to the third quarter and first nine months of fiscal 2009 represent the three and nine months ended February 1, 2009. References in this Form 10–Q to the third quarter and first nine months of fiscal 2008 represent the three and nine months ended January 6, 2008. We have not submitted financial information for the three and nine months ended February 3, 2008 in this Form 10–Q because the information is not practical or cost beneficial to prepare. We believe that the third quarter and first nine months of fiscal 2008 provides a meaningful comparison to the third quarter and first nine months of fiscal 2009. The three and nine months ended February 1, 2009 had the same number of weeks as the three and nine months ended January 6, 2008. We do not believe that there are any significant factors, seasonal or otherwise, that would impact the comparability of information or trends if results for the three and nine months ended February 3, 2008 were presented in lieu of results for the three and six month ended January 6, 2008.

23

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 technologically advanced integrated circuits, specifically those with feature sizes of 0.13-micron and smaller.

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

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

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

During the third quarter of fiscal 2009, we recognized quarterly revenue of $30.7 million, which decreased 16% from the preceding quarter and 45% from the third quarter of fiscal 2008. Licenses revenue for the third quarter of fiscal 2009 accounted for approximately 65% of total revenue, and 80% in the third quarter of the prior year.

Global Markets

Recent market and economic conditions have been unprecedented and challenging with tighter credit conditions and slower growth through the third quarter of fiscal 2009. For the nine month period ended February 1, 2009, continued concerns about the global financial and banking system, systemic impact of inflation (or deflation), energy costs, geopolitical issues, the availability and cost of credit, the U.S. mortgage market and a declining real estate market in the U.S. have contributed to increased market volatility and diminished expectations for the global economy generally. These concerns, combined with volatile oil prices, declining business and consumer confidence and increased unemployment have recently contributed to volatility of unprecedented levels. In particular, the semiconductor industry continues to be materially adversely affected by the macroeconomic environment.

As a result of these market conditions, the availability and cost of credit has been and may continue to be adversely affected by illiquid credit markets and wider credit spreads. Concern about the stability of the financial markets has led many lenders and institutional investors to reduce, and in some cases, cease to provide funding to borrowers. Continued turbulence in the U.S. and global markets and economies may adversely affect our liquidity and financial condition, and the liquidity and financial condition of our customers. If these market conditions continue, they may limit our ability to access the capital markets to meet liquidity needs, resulting in an adverse effect on our financial condition and results of operations.

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, fair value of financial instruments, strategic investments, asset purchases and business combinations, valuation of long-lived assets and income taxes to be our most critical policies due to the estimation processes involved in each.

Revenue recognition

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

24

Our revenue recognition policy is detailed in Note 1 to the Consolidated Financial Statements on Form 10-K for the year ended April 6, 2008. 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 “collectability 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 is recognized when customer installments are due and payable.

In order for an arrangement to be considered to have fixed or determinable fees, 100% of the license, services and initial post contract support fee is to be paid 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 twelve months are considered not to be fixed or determinable.

Collectability is probable. In order to recognize revenue, we must make a judgment about the collectability of the arrangement fee. Our judgment of the collectability 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 collectability is not probable based upon our credit review process, revenue is recognized on a cash receipts basis (as each payment is collected).

Licenses revenue and bundled licenses and services revenue

We derive license revenue primarily from licenses of our design and implementation software and, to a lesser extent, from licenses of our analysis and verification products. We license our products under time-based and perpetual licenses whereby license revenue is recognized 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 perpetual licenses and unbundled time-based license arrangements, where maintenance is included for the first period of the license term, with maintenance thereafter renewable by the customer at the substantive rates stated in their agreements with us, the stated rate for maintenance renewal is vendor-specific objective evidence (“VSOE”) of the fair value of maintenance in these arrangements. For these arrangements license revenue is recognized using the residual method in the period in which the license agreement is executed assuming all other revenue recognition criteria are met. Where an arrangement involves extended payment terms, revenue recognized using the residual method is limited to amounts due and payable.

For transactions that include bundled maintenance for the entire license term we have no VSOE of fair value of maintenance. Therefore, we recognize license revenue ratably over the maintenance period. If an arrangement involves extended payment terms—that is, where payment for less than 100% of the arrangement fee is due within one year of the contract date—we recognize revenue to the extent of the lesser of the amount due and payable or the ratable portion. We classify the revenue recognized from these transactions separately as bundled licenses and services revenue in our consolidated statements of operations.

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

Services revenue

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

25

Stock-based compensation

Stock-based compensation expense is measured at the grant date, based on the fair value of the award, and is recognized as expense, net of estimated forfeitures, over the vesting period of the award.

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

Unbilled accounts receivable

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

Allowances for doubtful accounts

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

As of February 1, 2009, three of our customers each accounted for more than 10% of total receivables. The allowance for doubtful accounts represents our best estimate, but changes in circumstances relating to accounts receivable may result in a requirement for additional allowances in the future. If actual losses are significantly greater than the allowance we have established, that would increase our sales and marketing expenses and reported net loss. Conversely, if actual credit losses are significantly less than our allowance, this would decrease our sales and marketing expenses and our reported net income would increase.

Fair value option

In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115 (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value, with changes in fair value recognized in earnings each reporting period. The election, called the fair value option, enables entities to achieve an offset accounting effect for changes in fair value of certain related assets and liabilities without having to apply complex hedge accounting provisions.

We adopted SFAS 159 in the first quarter of fiscal 2009. Our adoption of SFAS 159 permits us to elect to carry certain financial instruments at fair value with corresponding changes in fair value reported in the results of operations. The election to carry an instrument at fair value is made at the individual contract level and can be made only at origination or inception of the instrument, or upon the occurrence of an event that results in a new basis of accounting. Our election is on a prospective basis and is irrevocable.

During the second quarter of fiscal 2009, we elected fair value accounting for the purchased put option recorded in connection with the settlement agreement signed with UBS Financial Services, Inc. (“UBS”). This election was made in order to mitigate volatility in earnings caused by accounting for the purchased put option and underlying auction rate securities (“ARS”) under different methods. The initial election of fair value led to a $1.1 million gain included in “Other income (expense), net” with the purchased put option asset recorded in long-term investments for the three months ended November 2, 2008.

26

During the third fiscal quarter, the Company recorded a loss of $0.3 million on the ARS due to the third quarter valuation. In addition, the Company recorded a gain due to the increase in the valuation of the put option by $1.4 million.

Total net gain on the put option and the ARS of $1.1 million was reported in valuation gain (loss) in the condensed consolidated statement of operations for the three months ended February 1, 2009, and $(0.6) million was reported as a loss in other income (expense) in the condensed consolidated statement of operations for the nine months ended February 1, 2009.

Cash equivalent, short-term investments and long-term investments

We account for our investments in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. These investments are typically classified as available-for-sale, and are recorded on the balance sheet at fair market value as of the balance sheet date, with gains or losses considered to be temporary in nature reported as a component of other comprehensive income (loss) within the stockholders’ equity on our condensed consolidated balance sheets. As of February 1, 2009, investments in ARS have been classified as trading, and are recorded on the balance sheet at fair market value as of the balance sheet date, with gains or losses recorded as other income or expense on our condensed consolidated statement of operations.

In the first quarter of fiscal 2009, we adopted the provisions of SFAS No. 157, Fair Value Measurements (“SFAS 157.”) SFAS 157 defines fair value and establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

Long-term investments on the condensed consolidated balance sheets consist of ARS that are AAA rated and are secured by pools of student loans guaranteed by state regulated higher education agencies and reinsured by the U.S. Department of Education and the UBS purchased put option. Historically, liquidity for investors in ARS was provided via an auction process that reset the applicable interest rate generally every 28 days, allowing investors to either roll over their investments or sell them at par. Beginning in fourth quarter of fiscal 2008, there was insufficient demand for these types of investments during the auctions and, as a result, these securities are not currently liquid.

In October 2008, we entered into an agreement with UBS which provides us with Auction Rate Securities Rights (“Rights”) to sell our ARS at par value to UBS at any time during the period June 30, 2010 through July 2, 2012. These Rights are a separate freestanding instrument accounted for separately from the ARS, and are registered, nontransferable securities accounted for as a purchased put option initially recorded at fair value. Under the Rights agreement, UBS may, at its discretion, sell the ARS at any time through July 2, 2012 without prior notice to us and must pay us par value for the ARS within one day of the sale transaction settlement. Additionally, UBS offered a “no net cost” loan to us up to 75% of the market value of the ARS as determined by UBS until June 30, 2010. Due to our entering into this agreement with UBS and enabling UBS to sell the ARS at any time, the ARS previously reported as available-for-sale have been transferred to trading securities.

As of February 1, 2009, there was insufficient observable market information available to determine the fair value of our ARS. Prior to November 2, 2008, we estimated Level 3 fair values for these securities based on the investment bank’s valuations. The investment bank valued student loan ARSs as floating rate notes with three pricing inputs: the coupon, the current discount margin or spread, and the maturity. The coupon was generally assumed to equal the maximum rate allowed under the terms of the instrument, the current discount margin was based on an assessment of observable yields on instruments bearing comparable risks, and the maturity was based on an assessment of the terms of the underlying instrument and the potential for restructuring the ARS. The primary unobservable input to the valuation was the maturity assumption which was set at five years for the majority of ARS instruments. Through January 6, 2008, the ARS were valued at par value due to the frequent resets that historically occurred through the auction process.

As of November 2, 2008, we engaged a third party valuation service to model Level 3 fair value using an income approach. We reviewed the methodologies employed by the third party models. This included a review of all relevant data inputs and the appropriateness of key model assumptions.

The pricing assumptions for the ARS included the coupon rate, the estimated time to liquidity, current market rates for publicly traded corporate debt of similar credit rating and an adjustment for lack of liquidity. The coupon rate was assumed to equal the stated maximum auction rate being received, which is determined based on the applicable 91-day U.S. Treasury rate plus 1.20% premium according to provisions outlined in each security’s agreement. The estimated time to liquidity was 3.7 years based on (i) expectations from industry brokers for liquidity in the market and (ii) the period over which UBS and other broker-dealers that had issued ARS have agreed to redeem certain ARS at par value.

27

The purchased put option gives us the right to sell the ARS to UBS for a price equal to par value during the period June 30, 2010 to July 2, 2012, providing liquidity for the ARS sooner than the originally estimated 3.7 years. As we plan to exercise the purchased put option on or around June 30, 2010, the value of the purchased put option lies in (i) the ability to sell the securities thereby creating liquidity approximately 1.5 years before the ARS market is expected to become liquid and (ii) the avoidance of receiving below-market coupon rate while the security is illiquid and auctions are failing. The fair value of the purchased put option represents the difference between the ARS with an estimated time to liquidity of 3.5 years and the ARS with an estimated time to liquidity of 1.5 years as the purchased put option allows for the acceleration of liquidity and the avoidance of a below-market coupon rate over the two year time period.

Based on the Level 3 valuation and the transfer of the ARS from the available-for-sale category to the trading category, we recorded an other-than-temporary loss of $2.8 million in valuation gain (loss), net in the second quarter of 2009 including the transfer of accumulated temporary losses of $0.9 million from other comprehensive loss previously recorded as a component of stockholder equity. Total other-than-temporary impairment loss of $0.3 million and $3.1 million was reported in the valuation gain (loss), net in the condensed consolidated statement of operations for the three and nine months ended February 1, 2009, respectively.

Accounting for asset purchases and business combinations

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

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

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

Goodwill impairment

SFAS No. 142, Goodwill and Other Intangible Assets, requires that goodwill be tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis and between annual tests in certain circumstances. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of the reporting units. We have determined that we have one reporting unit (see Note 13 to the Company’s Form 10-K for the year ended April 6, 2008`). Significant judgments required to estimate the fair value of reporting units include estimating future cash flows, determining appropriate discount rates and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value for the reporting units. Any impairment losses recorded in the future could have a material adverse impact on our financial condition and results of operations.

SFAS 142 provides for a two-step approach to determining whether and by how much goodwill has been impaired. The first step requires a comparison of the fair value of the Company (reporting unit) to its net book value. If the fair value is greater, then no impairment is deemed to have occurred. If the fair value is less, then the second step must be performed to determine the amount, if any, of actual impairment. To determine the fair value, the Company’s review process includes the income method and is based on a discounted future cash flow approach that uses estimates including the following for the reporting unit: revenue, based on assumed market growth rates and its assumed market share; estimated costs; and appropriate discount rates based on the particular business’s weighted average cost of capital. The Company’s estimates of market segment growth, market segment share and costs are based on historical data, various internal estimates and certain external sources, and are based on assumptions that are consistent with the plans and estimates it uses to manage the underlying business. The Company’s business consists of both established and emerging technologies and its forecasts for emerging technologies are based upon internal estimates and external sources rather than historical information. The Company also considered its market capitalization on the dates of its impairment tests in determining the fair value of the respective business. The Company completed the first step analysis during the second fiscal quarter and determined that the fair value of its reporting units was in excess of the net book value on that date.

28

The Company conducts an annual goodwill impairment test at December 31. Accordingly the Company conducted this test during the third quarter and concluded that events had occurred and circumstances had changed during the third fiscal quarter of 2008 which showed the existence of impairment indicators including a significant decline in the Company’s stock price and continued deterioration in the EDA software products market and the related impact on revenue forecasts of the Company. Consistent with the Company’s approach in its annual impairment testing, in assessing the fair value of the reporting unit, the Company considered both the market approach and income approach. Under the market approach, the fair value of the reporting unit is based on quoted market prices and the number of shares outstanding of the Company’s common stock. Under the income approach, the fair value of the reporting unit is based on the present value of estimated future cash flows. At December 31, 2008, the Company determined that the fair value of its reporting units was less than the net book value of the net assets of the reporting unit and accordingly, the Company performed step two of the impairment test.

In step two of the impairment test, the Company determined the implied fair value of the goodwill and compared it to the carrying value of the goodwill. With the assistance of a third party valuation firm, the Company allocated the fair value of the reporting unit to all of its assets and liabilities as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the price paid to acquire the reporting unit. The excess of the fair value of the reporting unit over the amount assigned to its assets and liabilities is the implied fair value of goodwill. The Company’s step two analysis resulted in a reduction in fair value of goodwill, and therefore, the Company recognized an impairment charge of $60.1 million in the third quarter of fiscal 2009.

Valuation of intangibles and long-lived assets

The Company’s intangible assets include acquired intangibles, excluding goodwill. Acquired intangibles with definite lives are amortized on a straight-line basis over the remaining estimated economic life of the underlying products and technologies (original lives assigned are one to six years). The Company reviews its long-lived assets for impairment in accordance with SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets. For assets to be held and used, the Company initiates its review whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. Recoverability of an asset is measured by comparison of its carrying amount to the expected future undiscounted cash flows that the asset is expected to generate. If it is determined that an asset is not recoverable, an impairment loss is recorded in the amount by which the carrying amount of the asset exceeds its fair value. Based on the Company’s review, no impairment is indicated.

Income taxes

We account for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. Significant judgment is required in determining our provision for income taxes. In the ordinary course of business, there are many transactions and calculations where the ultimate tax outcome is uncertain. The amount of income taxes we pay could be subject to audits by federal, state, and foreign tax authorities, which could result in proposed assessments. Although we believe that our estimates are reasonable, no assurance can be given that the final outcome of these tax matters will not be different from what was 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 the recovery is not likely, we establish a valuation allowance. We consider all available positive and negative evidence including our past operating results, the existence of cumulative losses in the most recent fiscal years, future taxable income, and ongoing prudent and feasible tax planning strategies in assessing the amount of the valuation allowance. We will continue to evaluate the realizability of the deferred tax assets on a quarterly basis. Future reversals or increases to our valuation allowance could have a significant impact on our future earnings.

Strategic investments in privately-held companies

Our strategic equity investments consist of preferred stock and convertible notes that are convertible into preferred or common stock of several privately-held companies. The carrying value of our portfolio of strategic equity investments totaled $3.4 million at February 1, 2009. Our ability to recover our investments in private, non-marketable equity securities and convertible notes and to earn a return on these investments is primarily dependent on how successfully these companies are able to execute on their business plans and how well their products are accepted, as well as their ability to obtain additional capital funding to continue operations.

Under our accounting policy, the carrying value of a non-marketable investment is the amount paid for the investment unless it has been determined to be other than temporarily impaired, in which case we write the investment down to its estimated fair value. For equity investments where our ownership interest is between 20% to 50%, or where we have significant influence on the investee’s operating or financial decisions, we record our share of net equity income (loss) of the investee based on our proportionate ownership.

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

29

rounds of financing and the impact of any relevant contractual equity preferences held by us or others. If an investee obtains additional funding at a valuation lower than our carrying amount, we presume that the investment is other than temporarily impaired, unless specific facts and circumstances indicate otherwise, such as when we hold contractual rights that give us a preference over the rights of other investors. As the equity markets have experienced volatility over the past few years, we have experienced substantial impairments in our portfolio of non-marketable equity securities. If certain equity market conditions do not improve, as companies within our portfolio attempt to raise additional funds, the funds may not be available to them, or they may receive lower valuations, with more onerous investment terms than in previous financings, and the investments will likely become impaired. However, we are not able to determine at the present time which specific investments are likely to be impaired in the future, or the extent or timing of individual impairments. We recorded impairment charges related to these non-marketable equity investments of $0.1 million and $0.4 million, respectively, for the three and nine months ended February 1, 2009. Similarly, we recorded impairment charges related to these non-marketable equity investments of $0.1 million and $0.5 million, respectively, for the three and nine months ended January 6, 2008.

Results of Operations

Revenue

Revenue is comprised of licenses revenue, bundled licenses and services revenue, and services revenue. Licenses revenue consists of fees for time-based or perpetual licenses of our software products. Bundled licenses and services revenue consists of fees for software licenses and post-contract customer support (“PCS”) where we do not have VSOE of fair value of PCS. Services revenue consists of fees for services, such as customer training, consulting and PCS associated with licenses where we have established VSOE to account for services separately. 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 under the caption “Critical Accounting Policies and Estimates.”

In our financial statements, 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. The Company offers various contractual terms to its customers in designing license agreements to accommodate customer preferences, which are unrelated to product performance and service requirements, order volume, or pricing. The contractual terms that result in the recognition of bundled licenses and services revenue are subject to customer preferences and have historically been inconsistently elected by customers. Moreover, revenue from existing long term contracts frequently shifts between revenue categories, with no change in the aggregate revenues recognized from such contracts. In light of the foregoing, the Company has concluded that changes in results of the bundled licenses and services revenue category generally do not indicate a material trend in the Company’s historical or future performance and therefore are not discussed below.

For management reporting and analysis purposes we classify our revenue as either licenses or services. Bundled licenses and services are divided into their component parts based on internal analysis and industry data, and included with either licenses or services for management analysis.

Licenses revenue is divided into the following categories:

• Ratable

• Due & Payable

• Up-Front

• Cash Receipts

Services revenue is analyzed separately from the licenses revenue portion.

We use these classifications of 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. 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’s discussion and analysis purposes, prior periods are not restated to reflect that change.

RatableFor bundled time-based licenses, we recognize license revenue ratably over the contract term, or as customer payments become due and payable, if less. In our statements of operations the revenue for these bundled arrangements for both license and service is classified as bundled licenses and services. For management reporting and analysis purposes we separate the licenses portion from the services portion based on internal analysis and industry data. For unbundled time-based licenses, we recognize license revenue ratably over the license term. We refer to these 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.

Due & Payable 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. For management reporting and analysis purposes, we refer to this type of license generally as “Due & Payable.”

30

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

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

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

Revenue, cost of revenue and gross profit

The table below sets forth the fluctuations in revenue, cost of revenue and gross profit data by category as defined for management reporting and analysis purposes for the three and nine months ended February 1, 2009 and January 6, 2008 (in thousands, except for percentage data):

Three Months Ended:	February 1, 2009		% of Revenue		January 6, 2008		% of Revenue		Dollar Change			% Change
Revenue
Licenses revenue
Ratable	$	6,909	23	%	$	9,659	17	%		(2,750	)	(28	)%
Due & Payable		4,767	16	%		19,424	35	%		(14,657	)	(75	)%
Up-Front*		5,547	18	%		13,694	25	%		(8,147	)	(59	)%
Cash Receipts		2,684	9	%		1,922	3	%		762		40	%
Total Licenses revenue		19,907	65	%		44,699	80	%		(24,792	)	(55	)%
Services revenue		10,780	35	%		11,048	20	%		(268	)	(2	)%
Total Revenue		30,687	100	%		55,747	100	%		(25,060	)	(45	)%
Cost of revenue:
Licenses		6,685	22	%		5,452	10	%		1,233		23	%
Services		5,187	17	%		6,688	12	%		(1,501	)	(22	)%
Total cost of sales		11,872	39	%		12,140	22	%		(268	)	(2	)%
Gross profit	$	18,815	61	%	$	43,607	78	%	$	(24,792	)	(57	)%

31

Nine Months Ended:	February 1, 2009		% of Revenue		January 6, 2008		% of Revenue		Dollar Change			% Change
Revenue
License revenue
Ratable	$	22,165	20	%	$	26,271	16	%		(4,106	)	(16	)%
Due & Payable		30,611	27	%		59,860	38	%		(29,249	)	(49	)%
Up-Front**		21,797	19	%		36,137	23	%		(14,340	)	(40	)%
Cash Receipts		5,343	5	%		5,101	3	%		242		5	%
Total Licenses revenue		79,916	71	%		127,369	80	%		(47,453	)	(37	)%
Services revenue		32,971	29	%		32,036	20	%		935		3	%
Total Revenue		112,887	100	%		159,405	100	%		(46,518	)	(29	)%
Cost of revenue:
Licenses		19,384	17	%		17,590	11	%		1,794		10	%
Services		17,171	15	%		19,118	12	%		(1,947	)	(10	)%
Total cost of sales		36,555	32	%		36,708	23	%		(153	)	—
Gross profit	$	76,332	68	%	$	122,697	77	%	$	(46,365	)	(38	)%

* Included $4,047 or 13% of total revenue from new contracts for the quarter ended February 1, 2009 and $10,279 or 18% of total revenue from new contracts for the quarter ended January 6, 2008.

** Included $12,832 or 11% of total revenue from new contracts for the nine months ended February 1, 2009 and $30,101 or 19% of total revenue from new contracts for the nine months ended January 6, 2008.

We market our products and related services to customers in four geographic regions: North America, Europe (including Europe, the Middle East and Africa), Japan, and Asia-Pacific (including India, South Korea, Taiwan, Hong Kong and the People’s Republic of China). Internationally, we market our products and services primarily through our subsidiaries and various distributors. Revenue is attributed to geographic areas based on the country in which the customer is domiciled. The table below sets forth geographic distribution of revenue data for the three and nine months ended February 1, 2009 and January 6, 2008 (in thousands, except for percentage data):

Three Months Ended:	February 1, 2009		% of Revenue		January 6, 2008		% of Revenue		Dollar Change			% Change
Domestic	$	20,866	68	%	$	37,024	66	%	$	(16,158	)	(44	)%
International:
Europe		3,849	12	%		6,498	12	%		(2,649	)	(41	)%
Japan		2,651	9	%		6,981	13	%		(4,330	)	(62	)%
Asia-Pacific (excluding Japan)		3,321	11	%		5,244	9	%		(1,923	)	(37	)%
Total international		9,821	32	%		18,723	34	%		(8,902	)	(48	)%
Total revenue	$	30,687	100	%	$	55,747	100	%	$	(25,060	)	(45	)%
Nine Months Ended:	February 1, 2009		% of Revenue		January 6, 2008		% of Revenue		Dollar Change			% Change
Domestic	$	65,241	58	%	$	93,080	58	%	$	(27,839	)	(30	)%
International:
Europe		22,447	20	%		21,364	13	%		1,083		5	%
Japan		14,384	12	%		28,245	18	%		(13,861	)	(49	)%
Asia-Pacific (excluding Japan)		10,815	10	%		16,716	11	%		(5,901	)	(35	)%
Total international		47,646	42	%		66,325	42	%		(18,679	)	(28	)%
Total revenue	$	112,887	100	%	$	159,405	100	%	$	(46,518	)	(29	)%

Revenue

• Revenue for the three and nine months ended February 1, 2009 was $30.7 million and $112.9 million, down 45% and 29%, respectively, from the three and nine months ended January 6, 2008.

• Licenses revenue decreased by 55% and 37%, respectively, in the three and nine months ended February 1, 2009 compared to the three and nine months ended January 6, 2008. Licenses revenue as a percentage of total revenue decreased by 15% and 9% respectively, in the three and nine months ended February 1, 2009 compared to the three and nine months ended January 6, 2008. The decrease in licenses revenue is a primarily the result of a sharp downturn in the semiconductor and systems industries, a reduced number of design starts, a reduction of electronic design automation budgets and customers experiencing continued end market softness in demand and reduced visibility in forecasting their business.

32

Ratable revenue decreased $2.8 million and $4.1 million for the three and nine months ended February 1, 2009 compared to the three and nine months ended January 6, 2008. The Company analyzed the purchasing trends of its key customers, those that make up 70% or more of total revenue. We believe this decrease is primarily a result of delayed and reduced orders from key customers experiencing continued end market softness in demand and reduced visibility in forecasting their business. This decrease was partially offset as a result of the Company’s intent to increase the portion of revenue based on backlog to 90% or more of total revenue and thereby reducing up-front revenue to 10% or below, which resulted in ratable revenue increasing from 17% to 23% and 16% to 20% as a percentage of total licenses revenue for the three and nine months ended February 1, 2009 compared to the three and nine months ended January 6, 2008, respectively.

Due & Payable revenue decreased $14.7 million and $29.2 million for the three and nine months ended February 1, 2009 compared to the three and nine months ended January 6, 2008, a decrease of 75% and 49% respectively. The Company analyzed the purchasing trends of its key customers, those that make up 70% or more of total revenue. We believe this decrease is primarily a result of delayed and reduced orders from key customers experiencing continued end market softness in demand and reduced visibility in forecasting their business. The decrease was also attributed to the Company’s intent to increase the portion of revenue based on backlog to 90% or more of total revenue and thereby reducing up-front revenue to 10% or below.

Up-Front revenue decreased $8.1 million and $14.3 million for the three and nine months ended February 1, 2009 compared to the three and nine months ended January 6, 2008 a decrease of 59% and 40% respectively. The Company analyzed the purchasing trends of its key customers, those that make up 70% or more of total revenue. We believe this decrease is primarily a result of delayed and reduced orders from key customers experiencing continued end market softness in demand and reduced visibility in forecasting their business. The decrease was also attributed to the Company’s intent to increase the portion of revenue based on backlog to 90% or more of total revenue and thereby reducing up-front revenue to 10% or below.

Cash Receipts revenue increased during the three and nine months ended February 1, 2009 by $0.8 million and $0.2 million respectively compared to the three and nine months ended January 6, 2008. This increase is the result of five significant customers being changed to revenue recognition on cash receipts.

• Services revenue decreased by 2% in the three months ended February 1, 2009 compared to the three months ended January 6, 2008. During the nine months ended February 1, 2009, services revenue increased 3% compared to the nine months ended January 6, 2008. Services revenue as a percentage of total revenue increased by 15% and 9%, respectively, in the three and nine months ended February 1, 2009 compared to the three and nine months ended January 6, 2008. We believe the 2% decrease during the third quarter of fiscal 2009 is primarily the result of timing of customers’ purchases of services, although customers are delaying licenses purchases in response to end market softness in the demand, they are continuing to purchase maintenance contracts and other services to support their activities.

• Domestic revenue decreased 44% and 30%, respectively, in the three and nine months ended February 1, 2009 compared to the three and nine months ended January 6, 2008. The decreases in domestic revenues were generally proportionate to the decreases in total revenues during the periods and were primarily due to delayed and reduced orders from key customers experiencing continued end market softness in demand and reduced visibility in forecasting their business. Domestic revenue as a percentage of total revenue increased by 2% in the three months ended February 1, 2009 compared to the three months ended January 6, 2008 and was a consistent 58% of total revenue in the nine months ended February 1, 2009 and January 6, 2008.

• International revenue decreased by 48% and 28%, respectively, in the three and nine months ended February 1, 2009 compared to the three and nine months ended January 6, 2008. The decreases in international revenues were generally proportionate to the decreases in total revenues during the periods and were primarily due to delayed and reduced orders from key customers experiencing continued end market softness in demand and reduced visibility in forecasting their business. International revenue as a percentage of total revenue decreased 2% in the three months ended February 1, 2009 compared to the three months ended January 6, 2008 and was consistent at 42% of total revenue in the nine months ended February 1, 2009 and January 6, 2008.

No individual customer accounted for greater than 10% of total revenue for the three and nine months ended February 1, 2009, or the three and nine months ended January 6, 2008.

Cost of Revenue

• Cost of licenses revenue primarily consists of amortization of acquired developed technology and other intangible assets which are fixed in nature and variable expenses such as royalties and allocated outside sales representative expenses. Cost of licenses revenue increased by $1.2 million or 23% and $1.8 million or 10%, in the three and nine months ended February 1, 2009, respectively, compared to the three and nine months ended January 6, 2008. Amortization charges related to acquired developed technology and intangible assets increased in the three and nine months ended February 1, 2009 by $1.1 million and $2.0 million, respectively, compared to the three and nine months ended January 6, 2008 due primarily to the increased value of intangible assets from acquisitions and contingent acquisition earnouts.

33

• Cost of services revenue primarily consists of personnel and related costs to provide product support, training and consulting services. Cost of services revenue also includes stock-based compensation expenses, asset depreciation and allocated outside sales representative expenses. Cost of services revenue decreased by $1.5 million or 22% and $1.9 million or 10% in the three and nine months ended February 1, 2009 compared to the three and nine months ended January 6, 2008. The changes were primarily due to a decrease in payroll related costs of $1.6 million and $2.0 million resulting from staff reductions as a result of the FY 2009 Restructuring Plan.

Operating expenses

The table below sets forth operating expense data for the three and nine months ended February 1, 2009 and January 6, 2008 (in thousands, except for percentage data):

Three Months Ended:	February 1, 2009		% of Revenue		January 6, 2008		% of Revenue		Dollar Change			% Change
Operating Expenses
Research and development	$	15,297	50	%	$	19,513	35	%	$	(4,216	)	(22	)%
Sales and marketing		12,658	42	%		17,833	32	%		(5,175	)	(29	)%
General and administrative		5,469	19	%		8,570	15	%		(3,101	)	(36	)%
Impairment of Goodwill		60,089	196	%		—	—			60,089		N/A
Amortization of intangible assets		378	1	%		2,242	4	%		(1,864	)	(83	)%
In-process research and development		—	—			—	—			—		N/A
Restructuring charge		3,286	11	%		—	—			3,286		N/A
Total operating expenses	$	97,177	319	%	$	48,158	86	%	$	49,019		102	%
Nine Months Ended:	February 1, 2009		% of Revenue		January 6, 2008		% of Revenue		Dollar Change			% Change
Operating Expenses
Research and development	$	54,476	48	%	$	56,538	35	%	$	(2,062	)	(4	)%
Sales and marketing		44,935	40	%		53,380	33	%		(8,445	)	(16	)%
General and administrative		19,165	17	%		24,437	15	%		(5,272	)	(22	)%
Impairment of Goodwill		60,089	53	%		—	—			60,089		N/A
Amortization of intangible assets		2,660	2	%		6,308	4	%		(3,648	)	(58	)%
In-process research and development		—	—			656	—			(656	)	(100	)%
Restructuring charge		8,612	8	%		291	—			8,321		2859	%
Total operating expenses	$	189,937	168	%	$	141,610	87	%	$	48,327		34	%

• Research and development expense decreased by $4.2 million and $2.1 million, respectively, in the three and nine months ended February 1, 2009 compared to the three and nine months ended January 6, 2008. The decrease in the three months ended February 1, 2009 was primarily attributable to a decrease in compensation expense of $1.5 million due to salary reductions implemented during the quarter, a decrease in related benefits costs of $0.6 million as a result of the lower salaries, and a Company shut-down in December 2008. The decrease was also attributable to a decrease in bonus expense of $1.7 million and decreased software maintenance costs of $0.3 million due to the costs being fully amortized. The decrease in the nine months ended February 1, 2009 was primarily attributable to a decrease in bonus expense of $3.5 million and a $0.5 million decrease in benefit costs. These decreases were partially offset by an increase in compensation costs of $1.2 million as a result of salary increases in the first quarter of fiscal 2009 and 17% higher average headcount for the nine months ended February 1, 2009 as a result of the Sabio acquisition and expansion in China and India, compared to the nine months ended January 6, 2008.

• Sales and marketing expense decreased by $5.2 million and $8.4 million, respectively, in the three and nine months ended February 1, 2009 compared to the three and nine months ended January 6, 2008. For the three months ended February 1, 2009, the decrease was primarily attributed to a decrease in compensation and related benefit costs of $4.0 million as a result of a 13% average headcount reduction implemented during the quarter and a Company shut-down in December 2008, a decrease in commission expense of $1.1 million due to lower bookings, a decrease in bonus expense of $0.8 million, decreased facilities and information technology expense of $0.6 million due to lower spending and closed offices, and a decrease in travel and entertainment of expense $0.7 million due to lower spending on reduced sales. The decrease in nine months ended February 1, 2009 was primarily attributed to a decrease in compensation and related benefit costs of $2.8 million as a result a 3% average headcount reduction and a Company shut-down in December 2008, a decrease in commission expense of $3.3 million due to lower bookings during the period, a decrease in bonus expense of $1.7 million, decreased travel and entertainment of $1.1 million, and decreased consultant expense of $0.8 million. These decreases were offset in part by an increase in bad debt expense of $1.4 million as a result of more customers facing deteriorating economic conditions.

• General and administrative expense decreased by $3.1 million and $5.3 million, respectively, in the three and nine months ended February 1, 2009 compared to the three and nine months ended January 6, 2008. The decrease during the three months ended February 1, 2009 is primarily the result of a decrease in legal expense of $1.2 million due to the settlement of

34

litigation; a decrease in compensation and related benefit costs of $0.9 million as a result of a 17% lower average headcount, salary reductions implemented during the quarter and a Company shut-down in December 2008; a decrease in bonus expense of $0.5 million; and a decrease in travel and entertainment of $0.2 million. The decrease for the nine months ended February 1, 2009 was primarily attributable to a decrease in compensation costs of $1.1 million in salary reductions and a decrease in the related benefits of $0.5 million; a decrease in bonus expense of $1.2 million and a decrease in non-cash compensation of $0.5 million; a decrease in legal expense of $1.8 million due to the settlement of litigation; and decrease in depreciation expense of $1.0 million as a result of assets being fully depreciated in prior periods. These decreases were partially offset by an increase in consulting expense of $0.7 million and an increase in facilities expense of $0.5 million from higher rent and common area charges in the new San Jose facility.

• Amortization of intangible assets decreased by 83% and 58%, respectively, in the three and nine months ended February 1, 2009 compared to the three and nine months ended January 6, 2008 primarily due to several existing technologies and patents having been fully amortized during fiscal 2008.

• Impairment of goodwill.The Company recognized an impairment charge of $60.1 million in the third quarter of fiscal 2009. See“Critical Accounting Policies and Estimates - Goodwill impairment” discussion in item 2 above.

• Restructuring charges of $3.3 million and $8.6 million, respectively, in the three and nine months ended February 1, 2009 represented employee termination expenses, expatriate relocation charges and facilities consolidations and closures costs resulting from our continued realignment to current business conditions. A similar charge of $0.3 million was incurred in the first quarter of fiscal 2008.

During the first quarter of fiscal 2009, the Company recorded $2.0 million in pre-tax restructuring charges associated with the termination of 71 employees and costs related to expatriate relocation. During the second quarter of fiscal 2009, the Company recorded an additional $0.1 million in pre-tax restructuring charges associated with the first quarter of fiscal 2009 actions. In the second quarter, the Company announced additional restructuring actions under the FY 2009 Restructuring Plan. These additional actions included the termination of 76 employees and the closing of certain offices. The Company recorded $3.2 million of pre-tax restructuring charges in the second quarter of fiscal 2009 related to these additional second quarter actions.

On February 5, 2009 the Company announced further restructuring actions under the FY 2009 Restructuring Plan. These additional actions included the termination of approximately 160 employees and the closing of two sales and support offices in North America and one in Europe, and plans to consolidate its Beijing, China, operations into a single facility and its Shanghai, China, operations into a single facility. The Company recorded $3.3 million in pretax restructuring charges in the third quarter of fiscal 2009 related to these actions.

The Company is in the process of evaluating the need for additional restructuring activities in conjunction with the FY 2009 Restructuring Plan. The Company estimates these costs to be in the range of $2.0 to $3.0 million in the fourth quarter of fiscal 2009.

Other items

The table below sets forth other data for the three and nine months ended February 1, 2009 and January 6, 2008 (in thousands, except for percentage data):

Three Months Ended:	February 1, 2009			% of Revenue		January 6, 2008			% of Revenue		Dollar Change			% Change
Operating income, net
Interest income	$	142		—		$	562		1	%	$	(420	)	(75	)%
Interest and amortization of debt discount expense		(692	)	(2	)%		(618	)	(1	)%		(74	)	12	%
Valuation gain (loss), net		1,067					—					1,067		N/A
Other income (expense), net		(206	)	(1	)%		(18	)	—			(188	)	1044	%
Total other income (expense), net	$	311		(3	)%	$	(74	)	—		$	385		(520	)%
Provision for (benefit from) income taxes	$	(629	)	2	%	$	1,318		(2	)%	$	(1,947	)	(148	)%

35

Nine Months Ended:	February 1, 2009			% of Revenue		January 6, 2008			% of Revenue		Dollar Change			% Change
Operating income, net
Interest income	$	522		—		$	1,510		1	%	$	(988	)	(65	)%
Interest and amortization of debt discount expense		(2,005	)	(2	)%		(1,874	)	(1	)%		(131	)	7	%
Valuation gain (loss), net		(611	)	(1	)%		—		—			(611	)	N/A
Other income (expense), net		401		—			51		—			350		686	%
Total other expense, net	$	(1,693	)	(3	)%	$	(313	)	—		$	(1,380	)	441	%
Provision for (benefit from) income taxes	$	2,941		(3	)%	$	4,381		(3	)%	$	(1,440	)	(33	)%

• Interest income decreased $0.4 million and $1.0 million, respectively, in the three and nine months ended February 1, 2009 compared to the three and nine months ended January 6, 2008 primarily due to lower average cash and investments balances resulting from our use of cash in operations, the acquisition of intangible assets and the payment of the balance of our outstanding 2008 Notes.

• Interest expense decreased $0.1 million in both the three and nine months ended February 1, 2009 compared to the three and nine months ended January 6, 2008, primarily due to reduced indebtedness of $15.2 million resulting from the repayment of the 2008 Notes partially offset by revolving note borrowings of $13.0 million and the secured credit line borrowings of $12.6 million. The remainder of the fluctuation in interest expense was accounted for by other individually insignificant items, such as amortization of debt issuance costs related to the 2008 and 2010 Notes and interest expenses on capital leases.

• Valuation gain (loss), net The Company recognized a net gain of $1.1 million and a net loss of $0.6 million in the three months ended February 1, 2009 and the nine months ended February 1, 2009, respectively. See“Fair value option” discussion in item 2 above.

• Other income (expense), net decreased by $0.2 million in the three months ended February 1, 2009 compared to the three months ended January 6, 2008 and increased by $0.3 million in the nine months ended February 1, 2009 compared to the nine months ended January 6, 2008. The decrease for the three months ended February 1, 2009 is primarily due to a foreign exchange loss of $0.1 million. The increase of $0.4 million for the nine months ended February 1, 2009 is primarily due to a foreign exchange gain of $0.6 million.

Starting in fiscal 2008, we entered into foreign currency forward contracts to mitigate exposure in movements between the U.S. dollar and Japanese Yen. The derivatives do not qualify for hedge accounting treatment under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. We recognize the gain and loss on foreign currency forward contracts in the same period as the remeasurement loss and gain of the related foreign currency-denominated exposures.

• Provision for (benefit from) income taxes was $(0.6) million and $2.9 million for the three and nine months ended February 1, 2009, respectively, and $1.3 million and $4.4 million, respectively, for the three and nine months ended January 6, 2008. The effective tax rate for fiscal 2009 was approximately 0.1% and (2.5%) for the three months and nine months ended February 1, 2009, respectively. Our fiscal 2009 effective tax rate differs from the combined federal and state statutory rate primarily due to changes in our US valuation allowance, state taxes, goodwill impairment, foreign income taxed at other than U.S. rates, stock compensation expense, research and development credits and foreign withholding taxes.

We are subject to income taxes in the United States and in numerous foreign jurisdictions and, in the ordinary course of business, there are many transactions and calculations where the ultimate tax determination is uncertain. The statute of limitations for adjustments to our historic tax obligations will vary from jurisdiction to jurisdiction. The tax years 2002 to 2007 remain open to examination by the major tax jurisdictions where we operate. At February 1, 2009, we do not anticipate that our total unrecognized tax benefits will significantly change due to any settlement of examination or expiration of statute of limitation within the next twelve months. In addition, we do not believe that the ultimate settlement of these obligations will materially affect our liquidity.

36

Liquidity and Capital Resources

The table below sets forth certain cash, cash equivalents and short-term investments as of February 1, 2009 and April 6, 2008, and cash flow data for the nine months ended February 1, 2009 and January 6, 2008 (in thousands):

	February 1, 2009			April 6, 2008
Cash and cash equivalents	$	29,221		$	49,970
For nine months ended:	February 1, 2009			January 6, 2008
Net cash flows (used in) provided by operating activities	$	(11,004	)	$	10,636
Net cash flows (used in) investing activities	$	(9,796	)	$	(18,161	)
Net cash provided by financing activities	$	10,165		$	14,192

Our cash and cash equivalents were approximately $29.2 million on February 1, 2009, a decrease of $20.7 million or 42% from April 6, 2008, the end of fiscal 2008. The decrease primarily reflected cash used in operations, cash used for purchases of intangible assets, strategic investments and the funding of restricted cash, and cash used for the repayment of $15.2 million of the 2008 Notes and capital leases. These decreases were partially offset by $25.6 million of borrowings on our revolving note and secured credit line and net proceeds of $0.9 million from the issuance of common stock.

We hold our cash and cash equivalents in the United States and in foreign accounts, primarily in Japan, the Netherlands and India. As of February 1, 2009, we held an aggregate of $25.6 million in cash and cash equivalents in the United States and an aggregate of $3.6 million in foreign accounts.

Net cash used in operating activities

Net cash used in operating activities decreased by $21.6 million in the nine months ended February 1, 2009 compared to nine months ended January 6, 2008 due to a decrease in cash from customers of $47.8 million, partially offset by a decrease in cost and expenses of $8.4 million, a decrease of $15.0 million in payments on accounts payable and accrued liabilities balances, and a decrease of $3.2 million in payments on prepaid and other assets. The aggregate balance of accounts payable and accrued liabilities decreased by $1.2 million and $13.8 million, respectively, in the nine months ended February 1, 2009 and January 6, 2008. The decrease in accrued liabilities in the nine months ended February 1, 2009 was primarily due to a reduction in annual employee bonus accrual. The decrease in accrued liabilities in the nine months ended January 6, 2008 was primarily due to payments on the Synopsys litigation settlement, legal fees and annual employee bonuses. The decrease in cash from customers was primarily due to lower revenue; the decrease in costs and expenses was primarily due Company’s cost reduction initiatives resulting in lower expenses in sales and marketing of $8.4 million, lower research and development of $2.1 million, and general and administrative expense of $5.3 million, partially offset by an increase of $8.3 million of restructuring expense.

Net cash used in investing activities

Net cash used in investing activities for the nine months ended February 1, 2009 compared to the nine months ended January 6, 2008 decreased by $8.4 million. The change was primarily the result of cash paid for business and asset acquisitions, net of cash acquired decreased $4.5 million; purchases of property and equipment were $0.1 million cash during the 2009 period compared to $6.0 million during the 2008 period, a decrease of $5.9 million. The Company did not purchase any available-for-sale investments in year to date fiscal 2009, but used $32.7 million to purchase available-for-sale investments in the first nine months fiscal 2008. These decreases in the use of cash were offset by a decrease in proceeds from maturities and sales of available-for-sale investments which decreased by $20.7 million and an increase in restricted cash during the nine months ended February 1, 2009 compared to the nine months ended January 6, 2008 as a result of an increase in the use of cash of $13.5 million, an increase of $8.6 million related to the revolving note and acquisition earnouts in fiscal 2009 and a release of $4.9 million restricted cash in fiscal 2008.

Net cash provided by financing activities

Net cash provided by financing activities for the nine months ended February 1, 2009 decreased $4.0 million compared to the nine months ended January 6, 2008. For the nine months ended February 1, 2009, net cash from the issuance of common stock decreased $16.0 million compared to the nine months ended January 6, 2008. In addition the Company repaid $15.2 million of convertible notes during fiscal 2009. These uses of cash were partially offset by proceeds from the revolving note of $13.0 million and proceeds from secured credit line of $12.6 million during the nine months ended February 1, 2009.

Capital resources

Cash and cash equivalents available for use aggregated a total of $29.2 million at February 1, 2009. Since fiscal 2004 the Company has not achieved profitability. Since inception, the Company has incurred aggregate

37

consolidated net losses of approximately $364.0, and expects to continue to incur net losses for the foreseeable future. In addition, the Company has experienced a significant decline in revenues during the current fiscal year and the Company does not currently have the financing in place to pay the $49.9 million in bond debt maturing May 2010. Given the current adverse economic conditions generally, and in the semiconductor industry in particular, the credit market crisis and our own liquidity position, we have increased our focus on cash management and identifying and taking actions to sustain and enhance our liquidity position. These actions include further operational expense reduction initiatives and re-timing or eliminating certain capital spending or research and development projects. In addition, we are exploring opportunities to restructure our debt, including through the issuance of new debt or equity securities. In the event that these efforts do not generate adequate additional liquidity, we may not have sufficient cash for our working capital requirements, capital investments, debt service and operations during the next twelve months and may not have sufficient cash for the repayment of the $49.9 million in bond debt maturing in May 2010. However the Company believes that its current cash and cash equivalents will be sufficient to fund its cash needs for at least the next 12 months.

The Company’s ability to fund its cash needs over the short and long term will also depend on its ability to generate cash from operations, which is subject to general economic and financial market conditions, competitive and other factors. It could be difficult to obtain additional financing on favorable terms, or at all, due to the Company’s financial condition, and current credit market conditions may make external financing difficult to obtain. Any external credit financing that we are able to obtain will likely contain terms that are not as favorable to us as historical financings. The Company may try to obtain additional financing by means which could dilute the Company’s existing shareholders which dilution would likely be material in light of the recent significant decline in the Company’s market capitalization. If the Company cannot raise needed funds on acceptable terms, or at all, it may not be able to develop or enhance the Company’s products, respond to competitive pressures or grow its business, or the Company may be required to undertake further expense reduction measures in addition to the $8.6 million in restructuring costs incurred in the current year to date. The Company is in the process of evaluating the need for additional restructuring activities in conjunction with the FY 2009 Restructuring Plan. The Company estimates additional restructuring costs to be in the range of $2.0 to $3.0 million in the fourth quarter of fiscal 2009. Any of these factors could have a materially adverse impact on the Company’s financial position and results of operations. For a complete discussion of the risks facing our business, including our liquidity, please see Part II, Item 1A “Risk Factors.”

In recent years, the Company has funded its operations primarily through operating cash flows and through the issuance of convertible debt and equity securities. In the first quarter of fiscal 2009, the Company began implementing cost reduction measures which continued into the third quarter of fiscal 2009 and are planned to continue through the end of fiscal 2009. In total, the Company expects overall operating expenses to be reduced approximately 15% compared to fiscal 2008. Additionally, the Company has taken action to receive liquidity from the Company’s $18.4 million in auction rate securities (“ARS”), which have been illiquid for most of 2008. The Company entered into a settlement agreement with UBS Financial Services, Inc. (“UBS”) which allows the Company to recover the par value of the ARS on or about June 30, 2010 (see Note 3). Concurrently, the Company entered into a “no net cost” secured line of credit with UBS offered as part of the total settlement agreement (see Note 12). This secured line of credit provided the Company with cash of $12.5 million until the ARS can be sold back to UBS at par value in 2010.

Effective as of October 31, 2008, we entered into a new secured revolving line of credit facility (the “New Credit Facility”) with Wells Fargo Bank, N.A. (“Wells Fargo”), which replaced our existing $10.0 million credit facility. The New Credit Facility provides for an increase in the total facility and the aggregate commitments available up to $15.0 million. The New Credit Facility expires on December 31, 2009 and was used first to refinance the previous credit facility, with the balance available to finance working capital and letters of credit, not to exceed $2.5 million. The New Credit Facility is secured by collateral that includes first priority interests in all the Company’s accounts receivable, intangible assets, inventory and equipment.

Outstanding borrowings and letter of credit liabilities under the New Credit Facility cannot exceed the greater of $15.0 million or 80% of our eligible accounts receivable plus an additional amount not to exceed $3.0 million. The New Credit Facility bears an annual interest rate equal to the bank’s prime rate plus 2.5% or LIBOR plus 2.5%, at management’s election, on outstanding borrowings. The New Credit Facility requires us to maintain certain financial conditions and to pay fees of 0.125% per annum on the unused amount of the New Credit Facility and 2.0% per annum for each letter of credit issued. We are required to pay interest and fees monthly with the outstanding principal amount plus all accrued but unpaid interest and fees payable in full at the expiration of the New Credit Facility.

Pursuant to the New Credit Facility, we have pledged to grant to Wells Fargo a security interest in deposits equal to the amount of outstanding borrowings and letters of credit outstanding in excess of the maximum allowable. As of February 1, 2009, we had outstanding borrowings of $13.0 million and two letters of credit totaling $1.7 million under the New Credit Facility. The maximum borrowing available under the new Credit Facility at February 1, 2009 was $7.3 million; therefore we have classified $7.4 million of cash and cash equivalents as restricted cash.

The New Credit Facility requires that the Company maintain certain financial conditions. The Company has obtained a waiver for noncompliance with certain financial covenants as of February 1, 2009.

38

Contractual obligations

As of February 1, 2009, our principal contractual obligations consisted of operating lease commitments, with an aggregate future amount of $12.5 million through fiscal 2013 for office facilities, repayments of the revolving notes of $13.0 million due December 31, 2009, repayment of the convertible notes of $49.9 million due in May 2010, capital lease obligations for computer equipment and purchase obligations. We have no material commitments for capital expenditures. In addition, we have other obligations for goods and services entered into in the normal course of business. These obligations, however, either are not legally binding or are subject to change based on our business decisions.

Our acquisition agreements related to certain business combination and asset purchase transactions obligate us to pay certain contingent cash consideration based on meeting certain financial or project milestones and continued employment of certain employees. The total amount of cash contingent consideration that could be paid under our acquisition agreements, assuming all contingencies are met, was $39.9 million as of February 1, 2009 and will be paid through the third quarter of fiscal 2010. Based on past performance and expected future performance, we do not anticipate any material future payments on these acquisition contingencies.

Income taxes

As of February 1, 2009, the Company recorded unrecognized tax benefits of $12.5 million of which $5.6 million were included in our long-term tax liabilities on our unaudited condensed consolidated balance sheets. We are not able to estimate the amount or timing of any cash payments required to settle these liabilities; however we do not anticipate the settlement of the liabilities will require payment of cash within the next twelve months.

Off-balance Sheet Arrangements

As of February 1, 2009, 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 our normal business practices. We estimate the fair value of our indemnification obligations as insignificant, based on our historical experience concerning product and patent infringement claims. Accordingly, we have no liabilities recorded for indemnification under these agreements as of February 1, 2009.

We have agreements whereby our officers and directors are indemnified for certain events or occurrences while the officer or director is, or was, serving at our request in such capacity. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we retain directors and officers insurance that reduces our exposure and enables us to recover portions of amounts paid. As a result of our insurance coverage, we believe the estimated fair value of these indemnification agreements is minimal. Accordingly, no liabilities have been recorded for these agreements as of February 1, 2009.

In connection with certain of our recent business acquisitions, we have also agreed to assume, or cause our subsidiaries to assume, the indemnification obligations of those companies to their respective officers and directors. No liabilities have been recorded for these agreements as of February 1, 2009.

Warranties

We warrant to our customers that our products will conform to the documentation provided. To date, there have been no payments or material costs incurred related to fulfilling these warranty obligations. Accordingly, we have no liabilities recorded for these warranties as of February 1, 2009. 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 February 1, 2009, a hypothetical 100 basis point increase in interest rates would not result in material impact on the fair value of our cash equivalents and short-term investments.

39

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

Starting with the fourth quarter of fiscal 2008, the $18.4 million of auction rate securities we held failed at auction and have continued to fail at auction due to sell orders exceeding buy orders. As of February 1, 2009, we have written down our auction rate securities from their par value of $18.4 million to the estimated fair value of approximately $16.3 million. The $3.1 million decline in market value was recorded to other expense of $2.8 million and $0.3 million during the quarters ended November 2, 2008 and February 1, 2009, respectively, in conjunction with our decision to reclassify the auction rate securities from the available-for-sale category to the trading category. In addition, we entered into a settlement agreement with UBS whereby we have the option to sell the auction rate securities at par value to UBS between June 30, 2010 and July 1, 2012. As part of the settlement with UBS, we have entered into a “no net cost” secured line of credit agreement with UBS. The secured line of credit allowed us to borrow up to 75% of the market value of the auction rate securities as determined by UBS, which totaled $12.6 million. This $12.6 million borrowing afforded us additional cash liquidity until we exercise our option to sell at par value, expected to be on or about June 30, 2010.

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 February 1, 2009, we had approximately $3.6 million of cash and money market funds in foreign currencies. During the third quarter of fiscal 2008, we entered into foreign currency forward contracts to mitigate exposure in movements between the U.S. Dollar and Japanese Yen. The derivatives do not qualify for hedge accounting treatment under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. We recognize the gain and loss on foreign currency forward contracts in the same period as the remeasurement loss and gain of the related foreign currency-denominated exposures. In the three months ended February 1, 2009, net foreign exchange loss of $0.1 million and in the nine months ended February 1, 2009, net foreign exchange gains of $0.6 million were included in “Other Income (Expense), Net” in our condensed consolidated statements of operations.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

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

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

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the third quarter of fiscal 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company is subject to certain legal proceedings described below and from time to time, it is also involved in other disputes that arise in the ordinary course of business. The number and significance of these litigation proceedings and disputes may increase as the Company’s size changes. Any claims against the Company, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and result in the diversion of significant operational resources. As a result, these litigation proceedings and disputes could harm the Company’s business

40

and have an adverse effect on its consolidated financial statements. However, the results of any litigation or dispute are inherently uncertain and, at this time, no estimate could be made of the loss or range of loss, if any, from such litigation matters and disputes unless they are or are close to being settled. Liabilities are recorded when a loss is probable and the amount can be reasonably estimated. Accordingly, the Company recorded a liability of $1.1 million in fiscal year 2008 to cover legal settlement exposure related to the shareholder class action lawsuit and the derivative complaint, as described below, and has not recorded any liabilities related to other contingencies. In accordance with the proposed shareholder class action lawsuit settlement agreement, the Company deposited into escrow $1.0 million in June 2008, which $1.0 million has been classified as a reduction of the previously recorded liability. However, any estimates of losses or any such recording of legal settlement exposure is not a guarantee that there will be any court approval of any settlement, and there is no assurance that there will be any final, court approved settlement. In accordance with the derivative complaint settlement agreement, the Company deposited into escrow $0.1 million in September 2008, which $0.1 million was classified as a reduction of the previously recorded liability. The court granted final approval of the derivative complaint settlement agreement in October 2008. No accrued legal settlement liabilities remain on the condensed consolidated balance sheet as of February 1, 2009. Litigation settlement and legal fees are expensed in the period in which they are incurred.

On June 13, 2005, a putative shareholder class action lawsuit captioned The Cornelia I. Crowell GST Trust vs. Magma Design Automation, Inc., Rajeev Madhavan, Gregory C. Walker and Roy E. Jewell., No. C 05 02394, was filed in U.S. District Court, Northern District of California. The complaint alleges that defendants failed to disclose information regarding the risk of Magma infringing intellectual property rights of Synopsys, Inc., in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and prays for unspecified damages. In March 2006, defendants filed a motion to dismiss the consolidated amended complaint. Plaintiff filed a further amended complaint in June 2006, which defendants again moved to dismiss. Defendants’ motion was granted in part and denied in part by an order dated August 18, 2006, which dismissed claims against two of the individual defendants. On November 30, 2007, the parties agreed to a settlement. The court granted preliminary approval of the settlement on July 7, 2008. On December 5, 2008, the court held a hearing on final approval of the settlement and requested that plaintiff submit additional information, including information on claims by class members. The court will rule on final approval after review of plaintiff’s submissions. There is no assurance that the court will grant final approval of the settlement.

On July 26, 2005, a putative derivative complaint captioned Susan Willis v. Magma Design Automation, Inc. et al., No. 1-05-CV-045834, was filed in the Superior Court of the State of California for the County of Santa Clara. The Complaint seeks unspecified damages purportedly on behalf of us for alleged breaches of fiduciary duties by various directors and officers, as well as for alleged violations of insider trading laws by executives during a period between October 23, 2002 and April 12, 2005. Defendants have demurred to the Complaint, and the action has been stayed pending further developments in the putative shareholder class action referenced above. On January 8, 2008, the parties reached an agreement in principle with respect to certain aspects of settlement of the case and agreed upon the remaining terms of the settlement on February 21, 2008. The court granted preliminary approval of the settlement on August 4, 2008, and granted final approval of the settlement on October 3, 2008.

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 6, 2008 and our Quarterly Report on Form 10-Q for the fiscal quarter ended November 2, 2008.

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

We have a substantial amount of, and continue to incur, indebtedness which could adversely affect our financial position.

We currently have and will continue to have for the foreseeable future, a substantial amount of indebtedness. Our indebtedness has increased over time and may increase in the future. As of February 1, 2009, we had an aggregate principal amount of approximately $80.0 million in outstanding debt. If cash flow from operations is not sufficient to meet working capital needs and capital requirements, we may need to incur additional indebtedness. Our indebtedness will require us to use a substantial portion of our cash flows from operations to make debt service payments.

In addition, our substantial indebtedness may:

• make it difficult for us to satisfy our financial obligations;

• limit our ability to use our cash flows, use our available financings to the fullest extent possible, or obtain additional financing for future working capital, capital expenditures, acquisitions or other general corporate purposes;

• limit our flexibility to plan for, or react to, changes in our business and industry;

41

• place us at a competitive disadvantage compared to our less leveraged competitors;

• increase our vulnerability to the impact of adverse economic and industry conditions; and

• cause our business to go into bankruptcy or cause our business to fail.

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

In May 2003, we issued $150.0 million principal amount of the Zero Coupon Convertible Subordinated Notes due May 15, 2008 (the “2008 Notes”). In May 2005, we repurchased, in privately negotiated transactions, $44.5 million face amount (or approximately 29.7% of the total) of the 2008 Notes at an average discount to face value of approximately 22%. In addition, in May 2006, we repurchased another $40.3 million face amount (approximately 38.2% of the remaining principal) of the 2008 Notes at an average discount to face value of approximately 13%. We spent an aggregate of approximately $34.8 million and $35.0 million, respectively, on the repurchases in May 2005 and May 2006. In March 2007, we exchanged, in privately negotiated transactions, an aggregate principal amount of $49.9 million of the 2008 Notes for an equal aggregate principal amount of the 2010 Notes. We repaid the $15.2 million remaining principal amount of the 2008 Notes in full in May 2008 and we will be required to repay the $49.9 million principal amount of the 2010 Notes in full in May 2010 unless the holders of those notes elect to convert them into shares of our common stock before the repayment dates or these notes are otherwise redeemed. The conversion price is $15.00 for the 2010 Notes, subject to adjustment in certain circumstances. If the price of our common stock does not rise above the applicable conversion price, conversion of the notes is unlikely and we would be required to repay the principal amounts of the notes in cash.

If we cannot generate sufficient operating cash flows or alternatively obtain external financing, our business and financial condition may be materially adversely affected, and our business may fail.

As of February 1, 2009, we held cash and cash equivalents, excluding restricted cash, of $29.2 million. Our long-term investments consist of auction rate securities, auctions for which have not occurred since February 2008 and a purchased put option.

We have experienced a decrease in revenues during fiscal 2009 and, if adverse semiconductor industry or general economic conditions persist or worsen, we could experience further decreases in revenues. In the second quarter of fiscal 2009, we increased cost cutting activities, including: reducing the number of employees, reducing capital spending, cutting research and development projects and reducing administrative expenses. In the third quarter of fiscal 2009, we further increased cost cutting activities, including a reduction of the number of employees, the closing of some offices, and the consolidation of some other offices. Some cost cutting activities may require initial cost outlays before the cost reductions are realized. We cannot assure you that we will be able to achieve anticipated expense reductions. If our revenues continue to decrease, or if our expense reduction efforts are unsuccessful, our operating results and business may be materially adversely affected, and our business may fail.

In addition, the $49.9 million in principal amounts outstanding on our 2% Convertible Senior Notes (the “2010 Notes”) will become payable in May 15, 2010. We will be required to generate cash sufficient to conduct our business operations and pay our indebtedness and other liabilities, including all amounts, both principal and interest, due on our outstanding 2010 Notes. The 2010 Notes have an aggregate outstanding principal amount of $49.9 million and bear interest at 2% per annum, with interest payable on May 15 and November 15 of each year, commencing on May 15, 2007. We may not be able to cover our anticipated debt service obligations from our cash flow. This may materially hinder our ability to make payments on the 2010 Notes. Our ability to meet our future debt service obligations will depend upon our future performance, which will be subject to financial, business and other factors affecting our operations, many of which are beyond our control. Accordingly, we cannot assure that we will be able to make required principal and interest payments on the 2010 Notes when due in the absence of additional sources of equity or debt financing.

We intend to assess and try to access private and public sources of external financing, including debt and equity, to repay our indebtedness. Such financing may not be available when needed or, if available, may not be available on satisfactory terms. We also may, from time to time, redeem, tender for, or repurchase our securities in the open market or in privately negotiated transactions depending upon availability of our cash resources, market conditions and other factors. Moreover, the availability of funds under our existing $15.0 million revolving credit facility may be adversely affected by our financial condition, results of operations and incurrence or maintenance of additional debt, and we may be required to designate additional amounts of restricted cash. Finally, any equity financing may not be desirable because of resulting dilution to our stockholders, which may be significant in light of the recent declines in our common stock and the size of our market capitalization compared to our outstanding debt. Our inability to obtain needed financing or to generate sufficient cash from operations would materially adversely affect our business and financial condition and could cause our business to fail.

42

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

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

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

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

Our competitors may develop or acquire new products or technologies that have the potential to replace our existing or new product offerings. The introduction of these new or additional products by competitors may either cause potential customers to defer purchases of our products or cause potential customers to decide against purchasing our products. If we fail to compete successfully, we will not gain market share, or our market share may decrease, and our business may fail.

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

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. A continued sharp downturn (such as that currently being experienced in the semiconductor and systems industries), a reduced number of design starts, a reduction of electronic design automation budgets or consolidation among our customers would accelerate the decrease in revenues we have experienced during fiscal 2009 and would harm our business and financial condition.

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

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

43

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

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

We have a history of losses, except for fiscal 2003 and fiscal 2004, and had an accumulated deficit of approximately $364.0 million as of February 1, 2009. If we continue to incur losses, the trading price of our stock would likely decline.

We had an accumulated deficit of approximately $364.0 million as of February 1, 2009. Except for fiscal 2003 and fiscal 2004, we incurred losses in all other fiscal years since our incorporation in 1997. If we continue to incur losses, or if we fail to achieve profitability at levels expected by securities analysts or investors, the market price of our common stock is likely to decline. If we continue to incur losses, we may not be able to maintain or increase our number of employees or our investment in capital equipment, sales, marketing, and research and development programs. Further, we may not be able to continue to operate.

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

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

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

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

• our ability to recognize revenue in a given quarter;

• higher-than-anticipated costs in connection with litigation;

• timing of customer license payments;

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

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

• the relative mix of our license and services revenue;

44

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

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

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

• 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 or businesses.

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

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

We have faced lawsuits 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.

We have faced lawsuits related to patent infringement and other claims in the past. For example, Synopsys previously filed various suits, including actions for patent infringement, against us. In addition, a putative shareholder class action lawsuit and a putative derivative lawsuit were filed against us. All claims brought against us by Synopsys have been fully resolved by a settlement and a license under the asserted patents, although other similar litigation involving Synopsys or other parties may follow (subject, in the case of Synopsys, to the terms of the settlement agreement with Synopsys pursuant to which we and Synopsys agreed not to initiate future patent litigation against each other for a period of two years commencing on March 29, 2007 provided certain terms are met). In the future 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. We also license technology from certain third parties and could be subject to claims if the software which we license is deemed to infringe the rights of others. In addition, we are often involved in or threatened with commercial litigation unrelated to intellectual property infringement claims such as labor litigation and contract claims, and we may acquire companies that are actively engaged in such litigation.

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

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

45

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

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

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

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

In addition, the stock market in recent years, and particularly in the last year, 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 have in the past and may in the future adversely affect the price of our common stock, regardless of our operating performance. Recent problems with the financial system, such as problems involving banks as well as the mortgage markets, might increase such market fluctuations.

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

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

In particular, we may 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 may need to continue to attract and retain field application engineers to work with our direct sales force to qualify new sales opportunities technically and perform design work to demonstrate our products’ capabilities to customers during the benchmark evaluation process. Competition for qualified engineers is intense, particularly in the Silicon Valley area where our headquarters are located.

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

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

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

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

A portion of our revenue backlog is variable based on volume of usage of our products by the customers or includes specific future deliverables or is recognized in revenue on a cash receipts basis. Our management has estimated variable usage based on customers’ forecasts, but there can be no assurance that these estimates will be realized. In addition, it is

46

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.

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

We enter into standard license agreements in the ordinary course of business. Pursuant to these agreements, we agree to indemnify certain of our customers for losses suffered or incurred by them as a result of any patent, copyright, or other intellectual property infringement claim by any third party with respect to our products. These indemnification obligations have perpetual terms. Our normal business practice is to limit the maximum amount of indemnification to the amount received from the customer. On occasion, the maximum amount of indemnification we may be required to make may exceed our normal business practices. We estimate that the fair value of our indemnification obligations are insignificant, based upon our historical experience concerning product and patent infringement claims. Accordingly, we have no liabilities recorded for indemnification under these agreements as of February 1, 2009. If an indemnification event were to occur, we might not have enough funds to pay our indemnification obligations. Further, any material indemnification payment could have a material adverse effect on our financial condition and the results of our operations.

We have entered into certain indemnification agreements whereby certain of our officers and directors are indemnified for certain events or occurrences while the officer or director is, or was, serving at our request in such capacity. Additionally, in connection with certain of our recent business acquisitions, we agreed to assume, or cause our subsidiaries to assume, indemnification obligations to the officers and directors of the acquired companies. While we have directors and officers insurance that reduces our exposure and enables us to recover a portion of any future amounts paid pursuant to our indemnification obligations to our officers and directors, the maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited. However, as a result of our directors and officers insurance coverage and our belief that our estimated potential exposure to our officers and directors for indemnification liabilities is minimal, no liabilities have been recorded for these agreements as of February 1, 2009. Therefore, if an indemnification event were to occur, we might not have enough funds to pay our indemnification obligations. Further, any material indemnification payment could have a material adverse effect on our financial condition and the results of our operations.

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

Our business depends on sales to a small number of customers. Although no customer accounted for more than 10% of our revenue for the nine months ended February 1, 2009, we expect that we will generally 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, defaults on its payment obligations to us, or fails to renew licenses, our business and operating results could be harmed.

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

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

Financial market conditions may impede access to or increase the cost of financing operations and investments.

The volatility and disruption in the capital and credit markets has reached unprecedented levels in recent months. These changes in U.S. and global financial and equity markets, including market disruptions and tightening of the credit markets, may make it more difficult for us to obtain financing for our operations or investments or increase the cost of obtaining financing.

47

We are currently party to and may enter into debt arrangements in the future, each of which may subject us to restrictive covenants which could limit our ability to operate our business.

We are party to a $15.0 million senior secured revolving credit facility that imposes various restrictions and covenants on us that limit our ability to acquire or merge into other entities, sell substantial portions of our assets and grant security interests in our assets. In the future, we may incur additional indebtedness through arrangements such as credit agreements or term loans that may also impose similar restrictions and covenants. These restrictions and covenants limit, and any future covenants and restrictions may limit our ability to respond to market conditions, to make capital investments or to take advantage of business opportunities. Any debt arrangements we enter into may require us to make regular interest payments, which would adversely affect our results of operations.

We cannot assure you that in the future we will be able to satisfy or comply with the provisions, covenants, financial tests and ratios of our debt instruments, which can be affected by events beyond our control. If we fail to satisfy or comply with such provisions, covenants, financial tests and ratios, or if we disagree with our lenders about whether or not we are in compliance, we cannot assure you that we will be able to obtain waivers for any failures to comply with our financial covenants or any other terms of the debt instruments. We also may not be able to obtain amendments which will prevent a failure to comply in the future. A breach of any of the provisions, covenants, financial tests or ratios under our debt instruments could result in a default under the applicable agreement, which in turn could accelerate the timing of our repayment obligations such that our indebtedness becomes immediately due and payable and could trigger cross-defaults under our other debt instruments, any of which would materially adversely affect us.

Our investments in marketable debt securities are subject to risks which may cause losses and affect the liquidity of these investments.

Our marketable securities portfolio is invested in auction rate securities which were structured to provide liquidity through an auction process that reset the applicable interest rate generally every 28 days. Starting with the fourth quarter of fiscal 2008, the $18.4 million auction rate securities held by us failed at auction and have continued to fail at auction due to sell orders exceeding buy orders. These auctions had historically provided a liquid market for these securities. All of the auction rate securities that failed are AAA rated and are secured by pools of student loans guaranteed by state regulated higher education agencies and reinsured by the U.S. Department of Education. However, the liquidity and fair value of these investments have been impacted primarily by the uncertainty of the credit markets. Given these circumstances and the lack of liquidity, we have classified all of our auction rate securities as long-term investments. In October 2008, we entered into a settlement agreement with UBS which provided us with an option to sell the auction rate securities held by us back to UBS at par value beginning June 30, 2010 until July 2, 2012 and with an offer to provide “no net cost” loans to us up to 75% of the market value of the auction rate securities. We intend to exercise our option and sell the auction rate securities back at par on or about June 30, 2010. In the meantime, we entered into a “no net cost” secured line of credit with UBS for $12.6 million, which provides cash liquidity to us until June 30, 2010.

If UBS fails to meet its obligation to buy back the auction rate securities at par value, if a certain concentration of the underlying reference portfolios default, if the issuing agent fails to make the required interest payments, or if the credit ratings on the underlying reference portfolios deteriorate significantly, we may be required to further adjust the carrying value of these investments, which could materially affect our results of operations and financial condition.

Acquisitions are an important element of our strategy. We may not find suitable acquisition candidates and we may not be successful in integrating the operations of acquired companies and acquired technology.

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

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

48

• adverse effects on existing licensor or supplier relationships, such as termination of certain license agreements;

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

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

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

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

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

• diversion of our management’s attention;

• potential incompatibility of business cultures;

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

• additional expenses associated with the amortization of intangible assets.

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

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

In the event that the changes we made to our organizational structure in fiscal 2006 and in fiscal 2008 and the restructuring plan that we initiated in May 2008 result in ineffective interoperability between our products or ineffective collaboration among our employees, then our operating results may be harmed.

We changed our organizational structure in fiscal 2006 to establish major business units that are responsible for our various products, and we made some additional changes to our organizational structure in fiscal 2008. In addition, we initiated a restructuring plan in May 2008. If this organizational structure or restructuring plan results in ineffective interoperability between our products or ineffective collaboration among our employees, then our operating results may be harmed. For example, if this organizational structure or restructuring plan is not successful, we could experience delays in new product development that could cause us to lose customer orders and thereby could harm our operating results.

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

49

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

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

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

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

• delayed market acceptance of our software products;

• delays in product shipments;

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

• damage to our reputation;

• delayed or lost revenue; and

• product liability claims.

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

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

In fiscal 2008, we generated 40% of our total revenue from sales outside North America, compared to 32% in fiscal 2007 and 33% in fiscal 2006. While most of our international sales to date have been denominated in U.S. dollars, our international operating expenses have been denominated in foreign currencies. As a result, a decrease in the value of the U.S. dollar relative to the foreign currencies could increase the relative costs of our overseas operations, which could reduce our operating margins.

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

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

• changes in currency exchange rates and controls;

• uncertainty regarding tax and regulatory requirements in multiple jurisdictions;

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

• current events in North Korea, Iran, Iraq, the Middle East, and other parts of the world;

• the effects of terrorist attacks in the United States;

50

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

• any related conflicts or similar events worldwide.

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

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

We have incurred and will continue to incur significant costs as a result of being a public company.

As a public company, we incur significant legal, accounting and other expenses. In addition, the Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the Securities and Exchange Commission and the Nasdaq Stock Market, required changes in the corporate governance practices of public companies, which increased our legal and financial compliance costs. In particular, we have incurred and will continue to incur administrative expenses relating to compliance with 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. In addition, we incur other costs associated with our public company reporting requirements.

We are required to evaluate our internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002 and any adverse results from such evaluation could result in a loss of investor confidence in our financial reports and have an adverse effect on our stock price.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”), we are required to report on, and our independent registered public accounting firm is to attest to, the effectiveness of our internal control over financial reporting. Our assessment of the effectiveness of our internal control over financial reporting must include disclosure of any material weaknesses in our internal control over financial reporting identified by management. We have an ongoing program to perform the system and process evaluation and testing necessary to comply with these requirements. Effective internal controls are necessary for us to provide reliable financial reports. If we cannot provide reliable financial reports, there could be an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our financial statements, which ultimately could negatively impact our stock price.

In addition, we must continue to monitor and assess our internal control over financial reporting because a failure to comply with Section 404 could cause us to delay filing our public reports, potentially resulting in de-listing by the Nasdaq Stock Market and penalties or other adverse consequences under our existing contractual arrangements. In particular, pursuant to the indenture for the 2010 Notes, if we fail to file our annual or quarterly reports in accordance with the terms of that indenture, or if we do not comply with certain provisions of the Trust Indenture Act specified in the indenture, after the passage of certain periods of time at the election of a certain minimum number of holders of the 2010 Notes, we may be in default under the indenture unless we pay a fee equal to 1% per annum of the aggregate principal amounts of the 2010 Notes, or the extension fee, to extend the default date. Even if we pay the applicable extension fee, we will eventually be in default for these filing failures if sufficient time passes and we have not made the applicable filing.

The effectiveness of disclosure controls is inherently limited.

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

51

Forecasting our tax rates is complex and subject to uncertainty.

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

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

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

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

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

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

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

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

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

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

• enhance our existing products and services;

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

• address the increasingly sophisticated needs of our customers; and

• acquire other companies that have complementary or innovative products.

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

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

If the salaries of our employees are not competitive or satisfactory to the employees, we may have difficulty in retaining our employees and our business may be harmed. In addition, in today’s competitive technology industry, employment decisions of highly skilled personnel are influenced by equity compensation packages, which offer incentives above traditional compensation only where there is a consistent, long-term upward trend over time of a company’s stock price. Our stock price has declined significantly for many years due to market conditions and had until recently been negatively affected by uncertainty surrounding the outcome of our litigation with Synopsys, Inc. discussed above. In addition, our stock price has declined significantly in light of our financial results for fiscal year 2008 (including our backlog as of April 6, 2008, which backlog is described in Item 1 of our Annual Report for the fiscal year ended April 6, 2008) as well as our outlook for fiscal year 2009 and in light of our recent financial results.

As a result, many of our outstanding stock options have exercise prices per share that are currently above the trading price per share of our common stock. Even though we recently exchanged certain stock options of employees for restricted stock units as a means to try to retain employees, such exchange might not be sufficient to retain employees. Therefore, we may be forced to grant additional options or other equity to retain employees. This in turn could result in:

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

52

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

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

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. Over time we have significantly expanded our operations in the United States and internationally, and we plan, over the long term, to continue to expand the geographic scope of our operations. However, in the first quarter of fiscal 2008, we decreased our workforce by 21 employees; and in May 2008, we initiated a restructuring plan for which we have incurred restructuring charges of just over $8.6 million so far in fiscal 2009 primarily for employee termination costs. In addition, it is likely that we will continue to restructure our company and to incur additional associated expenses for the remainder of fiscal year 2009. To pace the growth of our operations with the growth in our revenue, we must continue to improve administrative, financial and operations systems, procedures and controls. Failure to improve our internal procedures and controls could hinder our efforts to manage our growth adequately, disrupt operations, lead to expenses associated with restructurings, lead to deficiencies in our internal controls and financial reporting and otherwise 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 efforts by us or by our customers to integrate our products into their existing design flows. We must develop cooperative relationships with competitors so that they will work with us to integrate our software into customers’ design flow. Currently, our software is designed to interface with the existing software of Cadence, Synopsys and others. If we are unable to persuade customers to adopt our software products instead of those of competitors (including competitors offering a broader set of products), or if we are unable to persuade other software companies to work with us to interface our software to meet the demands of chip designers and manufacturers, our business and operating results will suffer.

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

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

53

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

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

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

• competitors may independently develop similar technologies and software;

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

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

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

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

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

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

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

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

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

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

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

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

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

54

• 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.

Our board of directors also has the power to adopt a stockholder rights plan, which could delay or prevent a change in control of us even if the change in control is generally beneficial to our stockholders. These plans, sometimes called “poison pills,” are sometimes criticized by institutional investors or their advisors and could affect our rating by such investors or advisors. If our board were to adopt such a plan it might have the effect of reducing the price that new investors are willing to pay for shares of our common stock.

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

We transact some portions of our business in various foreign currencies. Accordingly, we are subject to exposure from adverse movements in foreign currency exchange rates. This exposure is primarily related to a portion of revenue in Japan and operating expenses in Europe, Japan and Asia-Pacific, which are denominated in the respective local currencies. As of February 1, 2009, we had approximately $3.6 million of cash and money market funds in foreign currencies. During the third quarter of fiscal 2008, we started entering into foreign exchange forward contracts to mitigate the effects of our currency exposure risk for foreign currency transactions in Japanese Yen. While we assess the need to utilize financial instruments to hedge currency exposures on an ongoing basis, our assessments may prove incorrect. Therefore, movements in exchange rates could negatively impact our business operating results and financial condition.

The conversion of our outstanding convertible notes would result in dilution to our current stockholders, and there may be additional dilution to our current stockholders upon achievement of various milestones pursuant to our mergers and acquisitions.

The terms of the 2010 Notes permit the holders to convert the 2010 Notes into shares of our common stock. The 2010 Notes are convertible into shares of our common stock at an initial conversion price of $15.00 per share, which would result in an aggregate of approximately 3.3 million shares of our common stock being issued upon conversion, subject to adjustment. Upon the occurrence of certain triggering events, approximately 1.1 million additional shares of our common stock may be issued upon conversion of the 2010 Notes. The conversion of some or all of the 2010 Notes will dilute the voting power and ownership interest of our existing stockholders. Sales in the public market of a substantial number of shares of our common stock issuable upon conversion of the 2010 Notes, or the perception that such sales may occur, could cause the market price of our common stock to decline and could increase the fluctuations in our stock price. In addition, there may be additional dilution to our current stockholders upon achievement of various milestones pursuant to our mergers and acquisitions, and such dilution would also dilute the voting power and ownership interest of our existing stockholders and could cause the market price of our common stock to decline and could increase the fluctuations in our stock price.

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

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

55

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

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

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

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

56

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Recent Sales of Unregistered Securities

None.

Purchases of Equity Securities by the Issuer

The following table shows repurchases of shares of our common stock in the third quarter of fiscal 2009:

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
November 3 - November 30, 2008	14,869	$	2.86	—	N/A
December 1 - December 31, 2008	868	$	0.0001	—	N/A
January 1 - January 31, 2009	375	$	0.0001	—	N/A
	16,112	$	—	—	N/A

* Includes 14,869 shares repurchased at a weighted average price of $2.86 based on the fair market values on the repurchase dates, in order to satisfy tax withholding obligations associated with the vesting of restricted shares. The remaining shares that were repurchased represented forfeitures of restricted stock as a result of employee terminations.

57

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
10.1	Separation Agreement and Mutual Release between Magma Design Automation, Inc. (“Magma”) and Saeid Ghafouri (with an Effective Date as of March 29, 2008)					X
10.2	Consulting Services Agreement between Magma and Saeid Ghafouri (with an Effective Date as of May 2, 2008)					X
10.3	Form of Tier 1 Magma Design Automation Employment and Severance Agreement (between Magma and the following executive officers: Rajeev Madhavan, Roy E. Jewell, Bruce Eastman, and Peter S. Teshima)					X
10.4	Form of Tier 2 Magma Design Automation Employment and Severance Agreement (between Magma and the following executive officer: David H. Stanley					X
10.5	Form of Indemnification Agreement (between Magma and the following directors and executive officers: Kevin C. Eichler, Thomas M. Rohrs, Chester J. Silvestri, Timothy Ng, Susumu Kohyama, Rajeev Madhavan, Roy E. Jewell, Bruce Eastman, Peter S. Teshima, and David H. Stanley)					X
10.6	Separation Agreement and Mutual Release between Magma and David Stanley (with an effective date as of February 13, 2009)					X
10.7†	Revolving Line of Credit Note, Security Agreement - Specific Rights to Payment, and Credit Agreement (between Magma and Wells Fargo Bank, National Association) (with an effective date as of October 31, 2008)					X
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

† Confidential treatment has been requested for certain portions of this exhibit.

58

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: March 12, 2009	/S/    PETER S. TESHIMA
	Peter S. Teshima Corporate Vice President—Finance and Chief Financial Officer (Principal Financial Officer and Duly Authorized Signatory)

59

EXHIBIT INDEX

TO

MAGMA DESIGN AUTOMATION, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTER ENDED FEBRUARY 1, 2009

Exhibit Number	Exhibit Description	Incorporated by Reference				Filed Herewith
		Form	File No.	Exhibit	Filing Date
10.1	Separation Agreement and Mutual Release between Magma Design Automation, Inc. (“Magma”) and Saeid Ghafouri (with an Effective Date as of March 29, 2008)					X
10.2	Consulting Services Agreement between Magma and Saeid Ghafouri (with an Effective Date as of May 2, 2008)					X
10.3	Form of Tier 1 Magma Design Automation Employment and Severance Agreement (between Magma and the following executive officers: Rajeev Madhavan, Roy E. Jewell, Bruce Eastman, and Peter S. Teshima)					X
10.4	Form of Tier 2 Magma Design Automation Employment and Severance Agreement (between Magma and the following executive officer: David H. Stanley					X
10.5	Form of Indemnification Agreement (between Magma and the following directors and executive officers: Kevin C. Eichler, Thomas M. Rohrs, Chester J. Silvestri, Timothy Ng, Susumu Kohyama, Rajeev Madhavan, Roy E. Jewell, Bruce Eastman, Peter S. Teshima, and David H. Stanley)					X
10.6	Separation Agreement and Mutual Release between Magma and David Stanley (with an effective date as of February 13, 2009)					X
10.7†	Revolving Line of Credit Note, Security Agreement - Specific Rights to Payment, and Credit Agreement (between Magma and Wells Fargo Bank, National Association) (with an effective date as of October 31, 2008)					X
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

† Confidential treatment has been requested for certain portions of this exhibit.

60