Magma Design Automation (LAVA) 10-Q 2010 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended August 2, 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 (1) 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    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 September 8, 2009, 49,178,745 shares of the registrant’s Common Stock, $.0001 par value were outstanding.

MAGMA DESIGN AUTOMATION, INC.

FORM 10-Q

QUARTERLY PERIOD ENDED AUGUST 2, 2009

INDEX

		Page
Part I: Financial Information		3
Item 1:	Financial Statements (unaudited)	3
	Condensed Consolidated Balance Sheets at August 2, 2009 and May 3, 2009	3
	Condensed Consolidated Statements of Operations for the Three Months Ended August 2, 2009 and August 3, 2008	4
	Condensed Consolidated Statements of Cash Flows for the Three Months Ended August 2, 2009 and August 3, 2008	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22
Item 3:	Quantitative and Qualitative Disclosures About Market Risk	37
Item 4:	Controls and Procedures	38
Part II: Other Information		38
Item 1:	Legal Proceedings	38
Item 1A:	Risk Factors	38
Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds	52
Item 6:	Exhibits	53
Signatures		54
Exhibit Index		55

2

PART 1: FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

MAGMA DESIGN AUTOMATION, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

(unaudited)

	August 2, 2009			May 3, 2009 (as adjusted)
ASSETS
Current assets:
Cash and cash equivalents	$	36,812		$	32,888
Restricted cash		7,876			9,215
Short-term investments, pledged as collateral for secured credit line		18,010			—
Accounts receivable, net		11,320			26,635
Prepaid expenses and other current assets		5,764			5,443
Total current assets		79,782			74,181
Property and equipment, net		8,868			10,443
Intangible assets, net		10,772			12,170
Goodwill		6,672			6,666
Long-term investments, pledged as collateral for secured credit line		—			17,908
Other assets		6,190			5,665
Total assets	$	112,284		$	127,033
LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)
Current liabilities:
Accounts payable	$	1,595		$	1,212
Accrued expenses		9,462			15,353
Secured credit line		12,403			12,451
Revolving note		11,246			12,181
Current portion of other long-term liabilities		2,468			2,679
Deferred revenue		28,648			35,779
Convertible notes, net of debt discount of $1,798 at August 2, 2009		48,141			—
Total current liabilities		113,963			79,655
Convertible notes, net of debt discount of $2,340 at May 3, 2009		—			47,600
Long-term tax liabilities, less current portion		9,750			9,729
Other long-term liabilities		2,419			3,160
Total liabilities		126,132			140,144
Commitments and contingencies (Note 14)
Stockholders equity (deficit):
Common stock		5			5
Additional paid-in capital		408,724			405,342
Accumulated deficit		(384,802	)		(380,490	)
Treasury stock at cost		(32,615	)		(32,615	)
Accumulated other comprehensive loss		(5,160	)		(5,353	)
Total stockholders equity (deficit)		(13,848	)		(13,111	)
Total liabilities and stockholders equity	$	112,284		$	127,033

May 3, 2009 adjusted for adoption of FSP 14-1. See Footnote 1.

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
	August 2, 2009			August 3, 2008 (as adjusted)
Revenue:
Licenses	$	13,779		$	26,096
Bundled licenses and services		7,577			9,930
Services		7,485			9,716
Total revenue		28,841			45,742
Cost of revenue:
Licenses		701			4,809
Bundled licenses and services		976			2,519
Services		3,160			5,002
Total cost of revenue		4,837			12,330
Gross profit		24,004			33,412
Operating expenses:
Research and development		11,197			20,133
Sales and marketing		9,770			16,803
General and administrative		4,383			6,952
Amortization of intangible assets		305			1,444
Restructuring charge		703			2,020
Total operating expenses		26,358			47,352
Operating loss		(2,354	)		(13,940	)
Other income (expense):
Interest income		45			186
Interest and amortization of debt discount expense		(1,157	)		(984	)
Valuation gain (loss), net		151			—
Other expense, net		(601	)		(96	)
Other income (expense), net		(1,562	)		(894	)
Net loss before income taxes		(3,916	)		(14,834	)
Provision for income taxes		396			440
Net loss	$	(4,312	)	$	(15,274	)
Net loss per share basic and diluted	$	(0.09	)	$	(0.35	)
Shares used in calculation basic and diluted		47,863			43,385

August 3, 2008 adjusted for adoption of FSP 14-1. See Footnote 1.

See accompanying notes to unaudited condensed consolidated financial statements.

4

MAGMA DESIGN AUTOMATION, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Three Months Ended
	August 2, 2009			August 3, 2008 (as adjusted)
Cash flows from operating activities:
Net loss	$	(4,312	)	$	(15,274	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Cumulative effect of change in accounting principle		—			—
Depreciation		1,825			2,161
Amortization of intangible assets		1,415			7,397
Provision for doubtful accounts		79			152
Amortization of debt discount and debt issuance costs		637			629
Loss on auction rate securities		648			—
Gain on purchased put option		(800	)		—
Loss (gain) on strategic equity investments		147			(13	)
Stock-based compensation		3,181			5,374
Restructuring charges		339			—
Other non-cash items		(187	)		—
Changes in operating assets and liabilities, net of effect of acquisitions:
Accounts receivable		15,415			(4,014	)
Prepaid expenses and other assets		(1,085	)		1,034
Accounts payable		383			562
Accrued expenses		(4,738	)		(6,524	)
Deferred revenue		(7,052	)		1,687
Other long-term liabilities		(200	)		337
Net cash flows (used in) provided by operating activities		5,695			(6,492	)
Cash flows from investing activities:
Cash paid for business and asset acquisitions, net of cash acquired		(1,465	)		(2,764	)
Purchase of property and equipment		(65	)		(132	)
Proceeds from maturities and sale of available-for-sale investments		50			5,000
Repayment of secured credit line		(50	)		—
Purchase of strategic investments		—			(1,801	)
Restricted cash		1,339			(1,090	)
Net cash flows (used in) investing activities		(191	)		(787	)
Cash flows from financing activities:
Proceeds from issuance of common stock, net		518			338
Retirement of restricted stock		(316	)		(352	)
(Repayment of) proceeds from revolving note		(935	)		13,000
Repayment of lease obligations		(929	)		(436	)
Repayment of convertible notes		—			(15,216	)
Net cash (used in) financing activities		(1,662	)		(2,666	)
Effect of foreign currency translation changes on cash and cash equivalents		82			(10	)
Net change in cash and cash equivalents		3,924			(9,955	)
Cash and cash equivalents, beginning of period		32,888			39,629
Cash and cash equivalents, end of period	$	36,812		$	29,674
Supplemental disclosure of cash flow information:
Non-cash investing and financing activities:
Purchase of equipment under capital leases	$	—		$	1,068
Issuance of common stock in connection with acquisitions	$	—		$	540

August 3, 2008 adjusted for adoption of FSP 14-1. See Footnote 1.

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 2, 2010. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Company’s Form 10-K for the year ended May 3, 2009, as filed with the SEC on July 20, 2009. The accompanying unaudited condensed consolidated balance sheet at May 3, 2009 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.

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.

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.

Adoption of New Accounting Pronouncements

On May 4, 2009, the Company adopted FSP APB 14-1, which clarifies the accounting for convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement). FSP APB 14-1 specifies that issuers of such instruments should separately account for the liability and equity components in a manner that reflects the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP APB 14-1 requires retrospective application of its provisions. The Company has determined this new guidance affects its 2% Convertible Senior Notes issued in March 2007 and due March 2010 (the “2010 Notes”). Upon adoption of FSP APB 14-1, the Company, with the assistance of a third party valuation firm, estimated the fair value of the 2010 Notes as of the date of issuance to be $43.1 million, assuming a 7.5% non-convertible borrowing rate. The non-convertible borrowing rate was determined utilizing debt yields of publicly traded debt of comparable companies. The difference between the fair value and the net proceeds of the notes was $4.8 million. This amount was retrospectively recorded as additional debt discount and as an increase to additional paid-in capital as of the issuance date. The discount is being accreted to interest expense over the three-year period to the due date of the notes in 2010 resulting in an increase in non-cash interest expense in prior and future periods.

6

The carrying amounts of the 2010 Notes is as follows (in thousands):

	Balance at
	August 2, 2009			May 3, 2009
				As Reported			As Adjusted
Equity component of 2% Convertible Senior Notes net of issuance costs of $133 (additional paid-in capital)	$	4,628		$	—		$	4,628
Principal amount of 2% Convertible Senior Notes	$	49,939		$	49,939		$	49,939
Unamortized discount of 2% Convertible Senior Notes		(1,798	)		(718	)		(2,340	)
Unamortized issuance cost of 2% Convertible Senior Notes		(315	)		(452	)		(409	)
Liability component of 2% Convertible Senior Notes	$	47,826		$	48,769		$	47,190

The unamortized discount and issuance costs will be amortized through May 2010. Interest and amortization expense of the 2010 Notes recognized in the Consolidated Statements of Income are as follows (in thousands):

	Three Months Ended
	August 2, 2009			August 3, 2008
Cash interest expense recognized (2% coupon)	$	246		$	246
Non-cash interest expense recognized
Amortization of discount		542			535
Amortization of issuance costs		95			94
	$	883		$	875
Effective interest rate		7.1	%		7.0	%

The following table presents the effect of the retrospective application of FSP APB 14-1 made to the Company’s previously reported Consolidated Statement of Income for the three month period ended August 3, 2008 (in thousands):

	Three Months Ended August 3, 2008
	As Reported			As Adjusted
Operating loss	$	(13,940	)	$	(13,940	)
Other income (expense):
Interest income		186			186
Interest and amortization of debt discount expense		(621	)		(984	)
Other income (expense), net		(96	)		(96	)
Other income (expense), net		(531	)		(894	)
Net loss before income taxes		(14,471	)		(14,834	)
Provision for income taxes		439			440
Net loss	$	(14,910	)	$	(15,274	)
Net loss per share basic and diluted	$	(0.34	)	$	(0.35	)

The following table presents the effect of the retrospective application of FSP APB 14-1 made to the Company’s previously reported Consolidated Balance Sheet as of May 3, 2009 (in thousands):

	May 3, 2009
	As Reported			As Adjusted
Other assets	$	5,707		$	5,665
Total Assets	$	127,075		$	127,033
Convertible notes	$	49,221		$	47,600
Additional paid-in capital	$	400,713		$	405,342
Accumulated deficit	$	(377,440	)	$	(380,490	)
Total stockholders equity (deficit)	$	(14,690	)	$	(13,111	)
Total liabilities and stockholders equity	$	127,075		$	127,033

7

The following table presents the effect of the retrospective application of FSP APB 14-1 and related tax effects made to the Company’s previously reported Consolidated Statement of Cash Flows for the three months ended August 3, 2008 (in thousands):

	Three Months Ended August 3, 2008
	As Reported			As Adjusted
Net Loss	$	(14,910	)	$	(15,274	)
Amortization of debt discount and debt issuance costs	$	262		$	629
Net cash flows (used in) operating activities	$	(6,492	)	$	(6,492	)

As of August 2, 2009, the if-converted value of the 2010 Notes did not exceed their principal amount.

In May 2009, the FASB issued FAS 165,Subsequent Events (“FAS 165”), which establishes the general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, this Statement sets forth: (1) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, (2) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and (3) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. This Statement is effective for financial statements issued for interim or annual financial periods ending after June 15, 2009. The adoption of FAS 165 did not have a material impact on the Company’s consolidated financial statements.

In April 2009, the FASB issued FSP No. FAS 157-4,Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. FSP No. FAS 157-4 provides guidance on estimating fair value when the volume and level of activity for an asset or liability have significantly decreased and determining when a transaction is not orderly. FSP No. FAS 157-4 was effective for interim and annual periods ending after June 15, 2009. The adoption of FSP No. FAS 157-4 did not have a material impact on the Company’s consolidated financial statements (See Note 4, “Fair Value of Financial Instruments”).

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 was effective for fiscal years beginning on or after December 15, 2008 and is applied prospectively. The impact of the adoption of SFAS No. 141(R) will depend on the nature and extent of the Company’s business combinations occurring during or after fiscal 2010.

In April 2009, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) FAS 141R-1Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies (“FSP FAS 141R-1”). This FSP amends and clarifies Statement on Financial Accounting Standards (“SFAS”) No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”), to require that an acquirer recognize at fair value, at the acquisition date, an asset acquired or a liability assumed in a business combination that arises from a contingency if the acquisition-date fair value of that asset or liability can be determined during the measurement period. If the acquisition-date fair value of such an asset acquired or liability assumed cannot be determined, the acquirer should apply the provisions of SFAS 5,Accounting for Contingencies, to determine whether the contingency should be recognized at the acquisition date or after it. FSP FAS 141R-1 was effective for assets or liabilities arising from contingencies in business combinations for which the acquisition date is after the beginning of the first annual reporting period beginning after December 15, 2008. The impact of the adoption of FSP FAS 141R will depend on the nature and extent of the Company’s business combinations occurring during or after fiscal 2010.

In December 2007, the FASB issued SFAS No. 160,Noncontrolling Interests in Consolidated Financial Statements, an Amendment of Accounting Research Bulletin No 51 (“SFAS 160”). SFAS 160 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, changes in a parent’s ownership of a noncontrolling interest, calculation and disclosure of the consolidated net income attributable to the parent and the noncontrolling interest, changes in a parent’s ownership interest while the parent retains its controlling financial interest and fair value measurement of any retained noncontrolling equity investment. SFAS 160 was effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early implementation is prohibited. There are no parties that have a noncontrolling interest in any Magma subsidiaries; therefore the implementation of SFAS 160 did not have a material impact on its financial position and results of operations.

8

In March 2008, the FASB issued SFAS No. 161,Disclosures about Derivative Instruments and Hedging Activities — An Amendment of FASB Statement No. 133 (“SFAS 161”). SFAS 161 enhances required disclosures regarding derivatives and hedging activities. SFAS 161 was effective for fiscal years and interim periods beginning after November 15, 2008. The adoption of SFAS 161 did not have a material impact on the Company’s consolidated financial statements.

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 was effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. 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. The adoption of FSP FAS 142-3 did not have a material impact on the Company’s consolidated financial statements.

In June 2008, the FASB issued EITF 07-5,Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock. EITF 07-5 provides guidance in assessing whether an equity-linked financial instrument (or embedded feature) is indexed to an entity’s own stock for purposes of determining whether the appropriate accounting treatment falls under the scope of SFAS 133 and/or EITF 00-19,Accounting For Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock. EITF 07-5 is effective for the Company for fiscal 2010. The adoption of EITF 07-5 did not have a material impact on the Company’s consolidated financial statements.

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. 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. FSP EITF 03-6-1 was effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early application of this FSP is prohibited. The adoption of FSP EITF 03-6-1 did not have a material impact on the Company’s consolidated financial statements.

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 was effective for fiscal years beginning on or after December 15, 2008. The adoption of FSP EITF 08-6 did not have a material impact on the Company’s consolidated financial statements.

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 was effective for intangible assets acquired on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The adoption of FSP EITF 08-6 did not have a material impact on the Company’s consolidated financial statements.

In April 2009, the FASB issued (1) FSP FAS 115-2 and FSP FAS 124-2, which provides guidance on determining other-than-temporary impairments for debt securities; and (2) FSP FAS 107-1 and FSP APB 28-1, which provides additional fair value disclosures for financial instruments in interim periods. Each of these FSPs was effective for interim and annual periods ending after June 15, 2009. The adoption of these FSPs did not have a material impact on the Company’s consolidated financial statements.

9

Recently issued accounting pronouncements

In January 2009, the Securities and Exchange Commission issued Release No. 33-9002,Interactive Data to Improve Financial Reporting. The final rule requires companies to provide their financial statements and financial statement schedules to the Securities and Exchange Commission and on their corporate websites in interactive data format using the eXtensible Business Reporting Language (“XBRL”). The rule was adopted by the Securities and Exchange Commission to improve the ability of financial statement users to access and analyze financial data. The Securities and Exchange Commission adopted a phase-in schedule indicating when registrants must furnish interactive data. Under this schedule, the Company will be required to submit filings with financial statement information using XBRL commencing with its April 2, 2011 quarterly report on Form 10-Q. The Company is currently evaluating the impact of XBRL reporting on its financial reporting process.

In June 2009, the FASB issued SFAS No. 167,Amendments to FASB Interpretation No. 46(R) (“SFAS 167”), which modifies how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. SFAS 167 clarifies that the determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. SFAS 167 requires an ongoing reassessment of whether a company is the primary beneficiary of a variable interest entity. SFAS 167 also requires additional disclosures about a company’s involvement in variable interest entities and any significant changes in risk exposure due to that involvement. SFAS 167 is effective for fiscal years beginning after November 15, 2009 and is effective for the Company on May 3, 2010. The Company expects SFAS 167 may have an impact on the Company’s financial position and results of operations in future periods, but the nature and magnitude of the specific effects will depend upon the nature, terms and size of the transactions the Company consummates in the future.

In June 2009, the FASB approved SFAS No. 168,FASB Accounting Standards Codification (“Codification”) as the single source of authoritative nongovernmental U.S. GAAP which was launched on July 1, 2009. The Codification does not change current U.S. GAAP, but is intended to simplify user access to all authoritative U.S. GAAP by providing all the authoritative literature related to a particular topic in one place. All existing accounting standard documents will be superseded and all other accounting literature not included in the Codification will be considered nonauthoritative. The Codification is effective for interim and annual periods ending after September 15, 2009. The Codification is effective for the Company during our interim period ending September 26, 2009 and will not have an impact on the Company’s financial condition or results of operations. The Company is currently evaluating the impact to its financial reporting process of providing Codification references in its public filings.

Note 2. Liquidity

Cash and cash equivalents available for use aggregated a total of $36.8 million at August 2, 2009. For the first fiscal quarter of 2010, net cash flow provided by operations was $5.7 million.

As of the Company’s 2009 fiscal year end, the Company’s auditors issued an opinion raising substantial doubt about the Company’s ability to continue as a going concern. Since fiscal 2004 the Company has not achieved profitability. Since inception, the Company has incurred aggregate consolidated net losses of approximately $384.8 million, and may continue to incur net losses for the foreseeable future. In addition, the Company has experienced a significant decline in revenues during fiscal 2009 and the first quarter of 2010. As of the end fiscal 2009, the Company did not have the financing in place to pay the $49.9 million 2010 Notes maturing May 15, 2010.

As more fully described in Footnote 19 “Subsequent Events,” on September 11, 2009, the Company completed an exchange offer pursuant to which 2010 Notes in the aggregate principal amount of $26.7 million were exchanged for a new series of 6% Convertible Senior Notes due 2014 (“2014 Notes”). As a result of the exchange, approximately $23.2 million principal amount of the 2010 Notes remains outstanding. See Footnote 19 “Subsequent Events”

Given the current adverse economic conditions generally, and in the semiconductor industry in particular, the credit market crisis and the Company’s liquidity position, the Company has increased its focus on cash management and taken actions to sustain and enhance its liquidity position. These actions include operational expense reduction initiatives and re-timing or eliminating certain capital spending or research and development projects. As a result of these efforts and other factors, the Company generated positive cash flow of $5.7 million of cash from operations in the first quarter of fiscal 2010.

The Company’s ability to fund its cash needs over the short and long term will also depend on its ability to continue to generate cash from operations, which is subject to general economic and financial market conditions, competitive and other factors, and to maintain or replace its existing credit facility. 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 the Company is able to obtain will likely contain terms that are not as favorable to the Company as historical financings. The Company may try to obtain additional financing by means which could dilute the Company’s existing stockholders.

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The Company believes it will have sufficient capital resources to fund its working capital requirements and operations, capital investments, and debt service during the next twelve months, and to retire the remaining $23.2 million outstanding 2010 Notes at maturity. However any of these factors could have a materially adverse impact on the Company’s financial position and results of operations.

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 through the end of the first quarter of fiscal 2010. Additionally, the Company has taken action to obtain liquidity from the $18.3 million in auction rate securities (“ARS”), which have been illiquid since February 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 “Fair Value Option”). 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 “Secured Credit Line”). 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.

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 $0.2 million gain for the first quarter of fiscal 2010, 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. 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.

The Company’s assets measured at fair value on a recurring basis subject to the disclosure requirements of SFAS 157 at August 2, 2009, were as follows (in thousands):

	Balance at August 2, 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	$	—		$	—	$	—	$	—
Short-term investments, pledged as collateral for secured credit line:
Auction rate securities		16,925			—		—		16,925
Purchased put option		1,085			—		—		1,085
Total short-term investments, pledged		18,010			—		—		18,010
Total assets measured at fair value	$	18,010		$	—	$	—	$	18,010
Accrued expenses:
Foreign currency forward contract		(91	)		—		—		(91	)
Total liabilities measured at fair value	$	(91	)	$	—	$	—	$	(91	)

The following table is a reconciliation of financial assets measured at fair value using significant unobservable inputs (Level 3) during the three months ended August 2, 2009 (in thousands):

	Three Months Ended August 2, 2009
Beginning balance	$	17,908
Net sales and settlements		(50	)
Gain on auction rate securities		800
Losses on put option		(648	)
Balance at August 2, 2009	$	18,010

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Cash, cash equivalents, short-term and long-term investments are included in the consolidated balance sheets as follows (in thousands):

	Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
August 2, 2009
Cash and Cash Equivalents
Cash (U.S. and international)	$	36,812	$	—	$	—		$	36,812
Total cash and cash equivalents		36,812		—		—			36,812
Short-term investments:
Auction rate certificates		18,300		—		(290	)		18,010
Total cash and cash equivalents and short-term investments	$	55,112	$	—	$	(290	)	$	54,822
May 3, 2009
Cash and Cash Equivalents
Cash (U.S. and international)	$	32,888	$	—	$	—		$	32,888
Total cash and cash equivalents		32,888		—		—			32,888
Long-term investments:
Auction rate certificates		18,350		—		(442	)		17,908
Total cash and cash equivalents and long-term investments	$	51,238	$	—	$	(442	)	$	50,796

As of August 2, 2009, the stated maturities of the Company’s current investments classified as cash and cash equivalents and short term investments are $54.8 million within one year.

The unrealized losses for the first fiscal quarter ended August 2, 2009 were primarily associated with failed auction rate securities as discussed above. Gross realized losses from the sales of marketable securities were immaterial for all periods presented.

The notional fair value of outstanding forward exchange contracts was approximately $3.9 million and $5.5 million as of August 2, 2009 and May 3, 2009, respectively. The Company had realized losses of $0.2 million and $0.5 million on foreign currency forward exchange contracts for the first fiscal quarters ended August 2, 2009 and August 3, 2008, respectively. As of August 2, 2009, the Company recorded an unrealized loss of $0.1 million in other current liabilities, and a $0.1 million unrealized gain in other current assets as of May 3, 2009.

Short-term investments as of August 2, 2009 and long-term investments as of May 3, 2009 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 the 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 “Fair Value Option”). 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 “Secured Credit Line”) and the Company agreed to release UBS from certain potential claims related to the collateralized ARS 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 the secured credit line as of August 2, 2009.

As of August 2, 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 ARS 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

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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, 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 current estimated time to liquidity was 5.0 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 Rights are a form of purchased put option that 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 currently estimated 5.0 years. As the Company plans to exercise the Rights on or around June 30, 2010, the value of the Rights lies in (i) the ability to sell the securities thereby creating liquidity approximately 0.9 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 Rights represents the difference between the ARS with an estimated time to liquidity of 5.0 years and the ARS with an estimated time to liquidity of 0.9 years as the Rights allow 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 gain of $0.8 million and $0 in valuation gain (loss), net, in the first quarter of fiscal 2010 and 2009, respectively, including the transfer of accumulated temporary losses of $0 million and $0.9 million, respectively, from other comprehensive loss previously recorded as a component of stockholder’s equity. For the first quarter of fiscal 2010, total other-than-temporary impairment gain on ARS of $0.8 million was reported in the valuation gain (loss), net in the consolidated statement of operations. This gain was offset by losses related to the purchased put option of $0.6 million.

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 months ended August 2, 2009 and August 3, 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
	August 2, 2009		August 3, 2008
Shares of common stock issuable upon conversion of convertible notes		3,329		3,410
Shares of common stock issuable under stock option plans outstanding		9,012		12,198
Weighted average exercise price of shares issuable under stock option plans	$	6.74	$	10.58

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Note 6. Balance Sheet Components

Significant components of certain balance sheet items are as follows (in thousands):

	August 2, 2009			May 3, 2009
Accounts receivable, net:
Trade accounts receivable	$	10,531		$	23,946
Unbilled receivable		981			2,880
Gross accounts receivable		11,512			26,826
Allowance for doubtful accounts		(192	)		(191	)
Total accounts receivable	$	11,320		$	26,635
Accrued expenses:
Accrued sales commissions	$	948		$	1,548
Accrued bonuses		365			2,693
Other payroll and related accruals		4,726			5,244
Acquisition accrual		339			1,780
Income taxes payable		(866	)		(452	)
Restructuring accrual		1,284			1,426
Other		2,666			3,114
Total accrued expenses	$	9,462		$	15,353

Note 7. Comprehensive Loss

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

	August 2, 2009			May 3, 2009
Unrealized loss on available-for-sale investments	$	—		$	(2	)
Foreign currency translation adjustments		(5,160	)		(5,351	)
Accumulated other comprehensive loss	$	(5,160	)	$	(5,353	)

Note 8. Acquisitions

The Company did not make any acquisitions during the fiscal quarter ended August 2, 2009.

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 businesses’ achievement of certain technology or financial milestones. The following table summarizes the amounts of goodwill and intangible assets recorded by the Company for contingent consideration paid or payable to former stockholders of the acquired companies (in thousands):

	Three Months Ended August 2, 2009				Three Months Ended August 3, 2008
	Cash		Common Stock Value		Cash		Common Stock Value
Goodwill:
Sabio Labs, Inc	$	6	$	—	$	26	$	2,145
Total goodwill		6		—		26		2,145
Intangible assets:
Mojave		—		—		548		540
Other		17		—		—		—
Total intangible assets		17		—		548		540
Total earnout consideration	$	23	$	—	$	574	$	2,685

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Note 9. Goodwill and Intangible Assets

The following table summarizes the components of goodwill, other intangible assets and related accumulated amortization balances, which were recorded as a result of business combinations and asset purchases (dollars in thousands):

	Weighted	August 2, 2009										May 3, 2009
	Average Life (months)	Gross Carrying Amount		Goodwill Impairment			Accumulated Amortization			Net Carrying Amount		Gross Carrying Amount		Goodwill Impairment			Accumulated Amortization			Net Carrying Amount
Goodwill		$	66,761	$	(60,089	)	$	—		$	6,672	$	66,755	$	(60,089	)	$	—		$	6,666
Other intangible assets:
Developed technology	43	$	115,436				$	(111,447	)	$	3,989	$	115,436				$	(110,794	)	$	4,642
Licensed technology	40		41,716					(37,779	)		3,937		41,699					(37,291	)		4,408
Customer relationship or base	70		5,575					(3,543	)		2,032		5,575					(3,376	)		2,199
Patents	57		13,015					(12,896	)		119		13,015					(12,836	)		179
Acquired customer contracts	33		1,390					(1,090	)		300		1,390					(1,090	)		300
Assembled workforce	45		1,252					(1,245	)		7		1,252					(1,244	)		8
No shop right	24		100					(100	)		—		100					(100	)		—
Non-competition agreements	36		600					(525	)		75		600					(500	)		100
Trademark	67		900					(587	)		313		900					(566	)		334
Total		$	179,984	$	—		$	(169,212	)	$	10,772	$	179,967	$	—		$	(167,797	)	$	12,170

During the three months ended August 2, 2009, the Company increased its goodwill by $6,000, reflecting purchase price adjustments related to acquired net tangible assets.

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
	August 2, 2009		August 3, 2008
Amortization of intangible assets included in:
Cost of revenue-licenses	$	775	$	4,671
Cost of revenue-bundled licenses and services		335		1,282
Operating expenses		305		1,444
Total	$	1,415	$	7,397

As of August 2, 2009, the estimated future amortization expense of intangible assets in the table above is as follows (in thousands):

Fiscal Year	Estimated Amortization Expense
2010 (remaining nine months)	$	3,579
2011		3,943
2012		1,889
2013		956
2014 and thereafter		405
Total expected future amortization	$	10,772

Note 10. Convertible Notes, Current and Long-Term

The Company’s 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 convertible into shares of the Company’s common stock at an initial conversion price of $15.00 per share, for an aggregate of approximately 3.33 million shares. The 2010 Notes are unsecured senior indebtedness of Magma, which rank equally in right of payment to Magma’s Wells Fargo credit facility. The 2010 Notes are effectively subordinated in right of payment to the Wells Fargo credit facility to the extent of the security interest held by

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Wells Fargo Bank in the assets of the Company. The Company has 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 that requires the Company to deliver to a holder upon conversion of their 2010 Notes cash equal to the lesser of $1,000 and the conversion value of the 2010 Notes, and in the event that the conversion value is in excess of $1,000 upon conversion of the 2010 Notes, cash or common stock at the Company’s election. As more fully described in Footnote 1, “Basis of Presentation”Adoption of New Accounting Pronouncements, in May 2008, the FASB issued FSP 14-1 which clarifies the accounting for convertible debt instruments that may be settled in cash upon conversion. The Company has determined this new guidance affects its 2010 Notes. Retrospective adoption requires Magma to adjust its Consolidated Financial Statements for all prior periods presented, as a result the Company has adjusted its accounting for the 2010 Notes. As adjusted, the Company initially recorded the 2010 Notes at fair value of $43.1 million, net of the debt discount of $6.9 million. The debt discount is being amortized to interest expense over the term of the 2010 Notes. As of August 2, 2009, debt discount balance related to the 2010 Notes was $1.8 million.

The $1.3 million of underwriting and legal fees related to the 2010 Notes offering was capitalized upon issuance and is being amortized over the term of the 2010 Notes using the effective interest method. As of August 2, 2009, the unamortized balance of debt issuance costs related to the 2010 Notes was approximately $0.3 million. The shares issuable upon 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 unless they are determined to be anti-dilutive. For the three months ended August 2, 2009 and August 3, 2008 the shares were excluded from the computation of diluted net loss per share as their effect was anti-dilutive.

As more fully described in Footnote 19 “Subsequent Events”, on September 11, 2009 the Company completed an exchange offer pursuant to which 2010 Notes in the aggregate principal amount of $26.7 million were exchanged for new 2014 Notes. Holders of an aggregate principal amount of $26.7 million, or 53%, of the total $49.9 million principal outstanding of the 2010 Notes, accepted the exchange offer. As a result of the exchange, approximately $23.2 million principal amount of the 2010 Notes remains outstanding as of the date of the exchange.

Note 11. Revolving note

Effective as of October 31, 2008, the Company entered into a new secured revolving line of credit facility with Wells Fargo Bank, N.A. (the “New Credit Facility”), 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 will be used by the Company 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 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 agreed to grant to Wells Fargo Bank, N.A. a security interest in deposits equal to the amount of outstanding borrowings and letters of credit outstanding in excess of the maximum allowable.

Effective as of March 11, 2009, the Company entered into the First Amendment to the New Credit Facility (“New First Amendment”) with Wells Fargo Bank, N.A. which provides for two revolving lines of credit. The two revolving line of credit notes allow for a maximum borrowing of $7.5 million each and replace the existing $15.0 million line of credit facility. The New First Amendment expires on December 31, 2009, and is secured by collateral that includes a $7.5 million certificate of deposit and first priority interests in all the Company’s accounts receivable, intangible assets, inventory and equipment. The Company is required to make interest only payments monthly, and the outstanding principal amount plus all accrued but unpaid interest is payable in full at the expiration of the New Credit Facility.

Outstanding borrowings under the first note shall not exceed the lesser of $7.5 million or 80% of the Company’s eligible accounts receivable plus an additional amount not to exceed (i) $2.0 million up to and including May 3, 2009; and (ii) $1.0 million from May 4, 2009 up to and including August 2, 2009; and (iii) zero thereafter. The note bears an annual interest rate equal to a fluctuating rate of 3.5% above Wells Fargo’s prime rate or a fixed rate of 3.5% above LIBOR, at management’s election, on outstanding borrowings.

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Outstanding borrowings under the second note shall not exceed $7.5 million, including two existing letters of credit, which total $1.7 million. The note bears an annual interest rate equal to a fluctuating rate of 1.5% above Wells Fargo’s prime rate or a fixed rate of 1.5% above LIBOR, at management’s election, on outstanding borrowings.

As of August 2, 2009, the Company had aggregate outstanding borrowings of $11.2 million and two letters of credit totaling $1.7 million under the New First Amendment. The maximum borrowing available under the New First Amendment at August 2, 2009 was $15.0 million. The Company has classified the $7.5 million of collateralized certificate of deposit as restricted cash in connection with the New First Amendment.

On May 21, 2009, the Company entered into the Second Amendment to the New Credit Facility, which modified certain restrictive covenants in connection with the Company’s 2010 Note exchange.

The credit facility restricts the Company’s ability to pay dividends or make other distributions on its stock and requires that the Company maintain certain financial conditions. As of August 2, 2009, the Company was in compliance with the financial conditions.

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 August 2, 2009, UBS determined the ARS market value to be $16.1 million. Prior to January 22, 2009 advances under this agreement bore 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.

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 $12.4 million outstanding on this line of credit at August 2, 2009, the maximum amount available for borrowing was $12.6 million.

Note 13. Restructuring charges

In fiscal 2009, the Company initiated an additional 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 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. In the third quarter of fiscal 2009 the Company announced further actions including the termination of 164 employees and the closing of two sales and support offices in North America and one in Europe, consolidation of its Beijing, China operations into a single facility, and consolidation of its Shanghai, China operations into a single facility. During the fourth quarter of fiscal 2009, the Company incurred additional restructuring costs mainly due to the consolidation of part of its San Jose facility.

In total, the Company recorded restructuring charges of $10.7 million during fiscal 2009 in connection with the FY 2009 Restructuring Plan. These costs related to severance, expatriate relocation, facilities consolidation and termination, and other costs related to the restructuring.

During the first quarter of fiscal 2010, the Company recorded an additional restructuring charge of $0.7 million.

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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 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	)		(106	)		(885	)
Balance at February 1, 2009		3,191			258			615			4,064
Restructuring provision		318			(83	)		1,814			2,049
Cash payments		(3,134	)		(166	)		(631	)		(3,931	)
Balance at May 3, 2009		374			9			1,799			2,182
Restructuring provision		655			—			48			703
Cash payments		(663	)		—			(379	)		(1,042	)
Balance at August 2, 2009	$	366		$	9		$	1,468		$	1,843

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 legal 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 legal 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 August 2, 2009 or May 3, 2009. Litigation settlement and legal fees are expensed in the period in which they are incurred.

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 August 2, 2009.

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’

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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 August 2, 2009.

In connection with certain of the Company’s 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 August 2, 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 August 2, 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
	August 2, 2009		August 3, 2008
Cost of revenue	$	300	$	412
Research and development expense		1,133		2,070
Sales and marketing expense		935		1,639
General and administrative expense		813		1,253
Total stock-based compensation expense	$	3,181	$	5,374

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
	August 2, 2009		August 3, 2008
Stock options	$	731	$	2,123
Restricted stock and restricted stock units		1,599		2,416
Employee stock purchase plan		851		835
Total stock-based compensation expense	$	3,181	$	5,374

Stock Options and Employee Stock Purchase Plan

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.

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

	Three Months Ended
	August 2, 2009			August 3, 2008
Stock options:
Expected life (years)		3.94			4.02
Volatility		85	%		46	%
Risk-free interest rate		1.50% - 2.10	%		2.90% - 3.56	%
Expected dividend yield		0	%		0	%
Weighted average grant date fair value	$	0.92		$	2.66
ESPP awards:
Expected life (years)		1.13			1.13
Volatility		85	%		46	%
Risk-free interest rate		0.54	%		2.25	%
Expected dividend yield		0	%		0	%
Weighted average grant date fair value	$	0.74		$	2.80

As of August 2, 2009, there was approximately $5.8 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to stock option grants, which will be recognized over the remaining weighted average vesting period of approximately 2.33 years.

As of August 2, 2009, the Company had $5.0 million of total unrecognized compensation expense, net of estimated forfeitures, related to the ESPP, which will be recognized over the remaining weighted average vesting period of 1.58 years. Cash received from the purchase of shares under the ESPP was $0.5 million and $0.3 million during first quarter of fiscal 2010 and 2009, respectively.

Restricted Stock and Restricted Stock Units

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

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

As of August 2, 2009, the Company had $0.2 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to restricted stock awards, which will be recognized over the remaining weighted average vesting period of approximately 0.45 years.

As of August 2, 2009, there was $8.5 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to restricted stock unit awards, which will be recognized over the remaining weighted average vesting period of approximately 1.57 years.

Note 16. Income Taxes

Provision for income taxes was $0.4 million and $0.4 million for the three months ended August 2, 2009, and August 3, 2008, respectively.

For the fiscal quarter ended August 2, 2009, the Company had approximately $27.3 million of total gross unrecognized tax benefits, of which $9.5 million, if recognized, would favorably affect its effective tax rate in future periods and $1.6 million, if recognized, would result in a credit to additional paid-in capital. The remaining $16.2 million of unrecognized tax benefits, if recognized, would result in an increase in deferred tax assets. However, the Company currently has a full valuation allowance against its U.S. net deferred tax assets which would impact the timing of the effective tax rate benefit should any of such uncertain tax positions be favorably settled in the future.

The Company’s fiscal 2010 effective tax rate differs from the combined federal and state statutory rate primarily due to changes in its U.S. 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.

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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
	August 2, 2009			August 3, 2008
North America*	$	14,999		$	24,332
Europe		7,640			12,765
Japan		2,569			4,112
Asia-Pacific (excluding Japan)		3,633			4,533
	$	28,841		$	45,742
North America*		52	%		53	%
Europe		26	%		28	%
Japan		9	%		9	%
Asia-Pacific (excluding Japan)		13	%		10	%
		100	%		100	%

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

For the three months ended August 2, 2009, the Company had one customer representing 10% or more of total revenue (16% of total revenue). For the three months ended August 3, 2008, the Company had one customer representing 10% or more of total revenue (22% of total revenue).

Note 18. Related Party Transactions

In fiscal 2004, the Company began leasing a building for its corporate headquarters from one of its customers under a seven-year lease agreement, as amended in February 2007, which expires in 2010. Under the lease amendment, the Company vacated most of the building and is not obligated to make rent payments effective January 31, 2007. In each of the first quarters of fiscal 2010 and 2009, the Company recorded $0.2 million of rent expense related to this lease and recognized $1.7 million, and $0.6 million, respectively, in revenue from the sale of software licenses to this customer.

Note 19. Subsequent Events

The Company has evaluated subsequent events that have occurred through September 11, 2009, the date of financial statement issuance.

On September 11, 2009, the Company completed the exchange of approximately $26.7 million principal amount of its 2010 Notes for $26.7 million principal amount of newly issued 6% Convertible Senior Notes due 2014 (“2014 Notes”). The 2014 Notes bear interest at 6% per annum and are convertible into shares of the Company’s common stock at an initial conversion price of $1.80 per share, for an aggregate of approximately 14.8 million shares. The 2014 Notes are unsecured senior indebtedness and rank equally in right of payment to the Wells Fargo credit facility and the 2010 Notes. The 2014 Notes are effectively subordinated in right of payment to the Wells Fargo credit facility to the extent of the security interest held by Wells Fargo Bank in the assets of the Company.

The exchange offer will be treated as an extinguishment of approximately $26.7 million principal amount of the 2010 Notes in accordance with EITF 96-19 as amended by EITF 06-6. The exchange will result in a net gain or loss on extinguishment of debt in the second quarter of fiscal 2010. The Company will record the 2014 Notes at fair value. The 2014 Notes debt discount or premium, the difference between the 2014 Notes principal amount and fair value, and debt issuance costs of approximately $1.8 million, will be amortized over the term of the 2014 Notes using the effective interest method.

As of September 11, 2009, debt discount and unamortized debt issuance costs related to the $26.7 million principal amount of exchanged 2010 Notes were $0.8 million and $0.1 million, respectively. As of September 11, 2009, the Company has not determined the fair value of the 2014 Notes. The net gain or loss on extinguishment resulting from the exchange will be the difference between the fair value of the 2014 Notes and $25.7 million, the net book value of the exchanged 2010 Notes and the related debt issuance costs.

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

This Management’s Discussion and Analysis of Financial Condition and Results of Operations section should be read in conjunction with 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 May 3, 2009. 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: the substantial amount of our indebtedness, which could adversely affect our financial position; customer payment defaults, which may cause us to be unable to recognize revenue from backlog, and changes in the type of orders comprising backlog, which could affect the proportion of revenue recognized from backlog each quarter, both of which could have a material adverse effect on our financial condition and results of operations; competition in the EDA market; weaker-than-anticipated sales of Magma’s products and services; weakness in the semiconductor or electronic systems industries; 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; Magma’s lengthy and unpredictable sales cycle; 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; 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; 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; 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.

Overview

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

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

The semiconductor industry is highly volatile and cost-sensitive. Our customers focus on controlling costs and reducing risk, lowering R&D expenditures, cutting back on 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 IC design process, as well as integrating these products into broad platforms, and expanding our product offerings. Our goal is to be the EDA technology supplier of choice for our customers as they pursue longer-term, broader and more flexible relationships with fewer suppliers.

During the first quarter of fiscal 2010, we recognized quarterly revenue of $28.8 million, which decreased 37% from the first quarter of fiscal 2009. License sales for the first quarter of fiscal 2010 accounted for approximately 70% of total revenue, compared to 74% in the first quarter of the prior year.

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Global Markets

Recent market and economic conditions have been unprecedented and challenging with tighter credit conditions and slower growth through fiscal 2009 and the first quarter of fiscal 2010. 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 has adversely affected our liquidity and financial condition, and the liquidity and financial condition of our customers. If these market conditions continue, they may continue to 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, unbilled accounts receivable, allowances for doubtful accounts, fair value option, cash equivalents, short-term investments and long-term investments, asset purchases and business combinations, goodwill impairment, valuation of intangible and long-lived assets, income taxes and strategic investments in privately-held companies to be our most critical policies due to the estimation processes involved in each.

Revenue recognition

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

Our revenue recognition policy is detailed in Note 1 to the Consolidated Financial Statements on Form 10-K for the year ended May 3, 2009. 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).

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Licenses revenue and bundled licenses and services revenue

We derive license revenue primarily from licenses of our design and implementation software and, to a 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.

Stock-based compensation

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

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 represents 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.

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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 August 2, 2009, two of our customers each accounted for more than 10% of total receivables. The allowance for doubtful accounts represents our best estimate, but changes in circumstances relating to accounts receivable may result in a requirement for additional allowances in the future. If actual losses are significantly greater than the allowance we have established, that would increase our 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.

Total net gain on the put option and the ARS of $0.2 million was reported in valuation gain (loss) in the condensed consolidated statement of operations for the three months ended August 2, 2009.

Cash equivalents, 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 August 2, 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 statements 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.

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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 August 2, 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 August 2, 2009, 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 current estimated time to liquidity was 5.0 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 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 currently estimated 5.0 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 0.9 year 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 5.0 years and the ARS with an estimated time to liquidity of 0.9 year 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 gain of $0.8 million in valuation gain (loss), net in the consolidated statements of operations for the first quarter of fiscal 2010. This gain was offset by losses related to the purchased put option of $0.6 million.

Accounting for asset purchases and business combinations

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

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

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

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Goodwill impairment

SFAS No. 142, Goodwill and Other Intangible Assets, requires that goodwill be tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis and between annual tests in certain circumstances. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of the reporting units. We have determined that we have one reporting unit (see Note 13 to the Company’s Form 10-K for the year ended May 3, 2009). 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.

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.

We performed the step one analysis in the first quarter of fiscal 2010 and determined that the fair value of our reporting units was in excess of the net book value as of August 2, 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.

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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.

Deferred tax assets and liabilities result primarily from temporary timing differences between book and tax valuation of assets and liabilities as well as federal and state net operating loss and credit carryforwards. 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. As of August 2, 2009, we believe a valuation allowance against our U.S. net deferred tax assets is required. 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 $3.2 million at August 2, 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 can exercise 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 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 $0.2 million, respectively, for the three months ended August 2, 2009 and August 3, 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 Vendor Specific Objective Evidence (“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 consolidated 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. We offer various contractual terms to our customers in designing

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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, we have concluded that changes in results of the bundled licenses and services revenue category generally do not indicate a material trend in our 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 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.

Licenses revenue

Ratable.For bundled time-based licenses, we recognize license revenue ratably over the contract term, or as customer payments become due and payable, if less. 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. 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.”

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.”

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.

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Services revenue

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.

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 months ended August 2, 2009 and August 3, 2008 (in thousands, except for percentage data):

Three Months Ended:	August 2, 2009		% of Revenue		August 3, 2008		% of Revenue		Dollar Change			% Change
Revenue
Licenses revenue**
Ratable	$	7,119	25	%	$	8,229	18	%	$	(1,110	)	(13	)%
Due & Payable		10,053	35	%		12,428	27	%		(2,375	)	(19	)%
Up-Front*		850	3	%		11,674	26	%		(10,824	)	(93	)%
Cash Receipts		2,275	8	%		1,525	3	%		750		49	%
Total Licenses revenue		20,297	70	%		33,856	74	%		(13,559	)	(40	)%
Services revenue**		8,544	30	%		11,886	26	%		(3,342	)	(28	)%
Total Revenue		28,841	100	%		45,742	100	%		(16,901	)	(37	)%
Cost of Revenue
License		1,006	3	%		6,254	14	%		(5,248	)	(84	)%
Services		3,831	13	%		6,076	13	%		(2,245	)	(37	)%
Total cost of sales		4,837	17	%		12,330	27	%		(7,493	)	(61	)%
Gross Profit	$	24,004	83	%	$	33,412	73	%	$	(9,408	)	(28	)%

* Includes $0.8 million or 3% of total revenue from new contracts for the quarter ended August 2, 2009 and $4.2 million or 9% of total revenue from new contracts for the quarter ended August 3, 2008.

** Bundled licenses and services in the consolidated statement of operations consisted of $6,518 of license revenue and $1,059 of service revenue for the first quarter of fiscal 2010, and $7,760 of license revenue and $2,170 of service revenue for the first quarter of fiscal 2009.

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 months ended August 2, 2009 and August 3, 2008 (in thousands, except for percentage data):

Three Months Ended:	August 2, 2009		% of Revenue		August 3, 2008		% of Revenue		Dollar Change			% Change
Domestic	$	14,999	52	%	$	24,332	53	%	$	(9,333	)	(38	)%
International:
Europe		7,640	26	%		12,765	28	%		(5,125	)	(40	)%
Japan		2,569	9	%		4,112	9	%		(1,543	)	(38	)%
Asia-Pacific (excluding Japan)		3,633	13	%		4,533	10	%		(900	)	(20	)%
Total international		13,842	48	%		21,410	47	%		(7,568	)	(35	)%
Total revenue	$	28,841	100	%	$	45,742	100	%	$	(16,901	)	(37	)%

Revenue

Revenue for the first quarter of fiscal 2010 was $28.8 million, down 37% from the first quarter of fiscal 2009.

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Licenses revenue decreased by 40% in the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009. Licenses revenue as a percentage of total revenue decreased by 4% in the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009. We analyzed the license purchasing trends of our key customers, those that make up 70% or more of revenue, for the first quarter of fiscal 2010. The decrease in licenses revenue was primarily the result of a sharp downturn in the semiconductor and systems industries, a reduction of electronic design automation budgets and customers experiencing continued end market softness in demand and reduced visibility in forecasting their business, which caused customers to reduce spending.

• Ratable revenue decreased $1.1 million for the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009. The decrease in ratable revenue was partially offset as a result of our intent to increase the portion of revenue based on backlog to 90% or more of total revenue to reduce volatility and increase the predictability of our revenues, and thereby reduce due & payable and up-front revenues to 10% or less of total revenue, which resulted in ratable revenue increasing from 18% of total revenue in the first quarter of fiscal 2009 to 25% in the first quarter of fiscal 2010.

• Due & Payable revenue decreased $2.4 million for the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009, a decrease of 19%, andUp-Front revenue decreased $10.8 million in the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009, a decrease of 93%. These decreases were also attributable to our intent to reduce due and payable revenue and increase ratable revenue.

• Cash Receipts revenue increased during the first quarter of fiscal 2010 by $0.8 million compared to the first quarter of fiscal 2009. Additional customers have been classified as cash receipts customers. This increase is the result of the impact of a deterioration of economic conditions in the industry and with respect to some of our customers.

Services revenue, as a percent of total revenue, increased by 4% in the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009. We believe the 4% increase during the first quarter of fiscal 2010 was primarily the result of timing of customers’ purchases of services, as customers delayed licenses purchases in response to the end market softness in the demand, while continuing to purchase maintenance contracts and other services to support their ongoing activities.

Domestic revenue decreased 38% during the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009. The decreases in domestic revenues were generally proportionate to the decreases in total revenues during the period and were primarily due to decreased customer orders. Domestic revenue as a percentage of total revenue decreased by 1% during the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009.

International revenue decreased by 35% for the first quarter of fiscal 2010 compared the first quarter of fiscal 2009. The decreases in international revenues were generally proportionate to the decreases in total revenues during the periods and were primarily due to decreased customer orders. International revenue as a percentage of total revenue increased 1% during the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009.

One customer accounted for 10% or more of total revenue during the first quarter of fiscal 2010.

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 decreased by $5.2 million or 84% during the first quarter of fiscal 2010, compared to the first quarter of fiscal 2009. Amortization charges related to acquired developed technology and intangible assets decreased during the first quarter of fiscal 2010 by $4.8 million compared to the first quarter of fiscal 2009 primarily due to the full amortization of significant intangible assets from acquisitions, a decrease in contingent acquisition earnouts and due to the decrease in the deferred stock compensation expense of $0.1 million during the first quarter of fiscal 2010 as compared to the first quarter of fiscal 2009.

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 and asset depreciation.

Cost of services revenue decreased by $2.2 million for the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009. The change was primarily due to a net decrease of $2.1 million in the allocation of pre-sale costs (primarily application engineering costs) from sales and marketing costs which were a result of staff reductions under the fiscal 2009 restructuring plan.

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Operating expenses

The table below sets forth operating expense data for the three months ended August 2, 2009 and August 3, 2008 (in thousands, except for percentage data):

Three Months Ended:	August 2, 2009		% of Revenue		August 3, 2008		% of Revenue		Dollar Change			% Change
Operating Expenses
Research and development	$	11,197	39	%	$	20,133	44	%	$	(8,936	)	(44	)%
Sales and marketing		9,770	34	%		16,803	37	%		(7,033	)	(42	)%
General and administrative		4,383	15	%		6,952	15	%		(2,569	)	(37	)%
Amortization of intangible assets		305	1	%		1,444	3	%		(1,139	)	(79	)%
Restructuring charge		703	2	%		2,020	5	%		(1,317	)	(65	)%
Total operating expenses	$	26,358	91	%	$	47,352	104	%	$	(20,994	)	(44	)%

Research and development expensedecreased by $8.9 million in the first quarter of fiscal 2010 as compared to the first quarter of fiscal 2009 primarily due to a decrease in compensation expense of $4.7 million as a result of lower headcount and employee salary reductions implemented mid-year in fiscal 2009 and a decrease in related employee benefits of $1.0 million as a result of lower salaries and headcount. The decrease in research and development expense in the first quarter of fiscal 2010 was also attributable to a decrease in consulting expenses of $0.6 million, decrease in bonus expense of $0.2 million, decrease in software maintenance costs of $0.2 million due to the costs being fully amortized, decrease in travel related costs of $0.3 million due to cost cutting, decrease in the deferred stock compensation expense of $0.9 million and decrease of $0.9 million in the allocation of common expenses, such as information technology and facility related expenses.

Sales and marketing expensedecreased by $7.0 million in the first quarter of fiscal 2010 as compared to the first quarter of fiscal 2009 primarily due to a decrease in compensation expense of $4.2 million as a result of lower headcount and employee salary reductions implemented mid-year in fiscal 2009, and a decrease in related employee benefits of $1.2 million as a result of lower salaries and headcount. The decrease in sales and marketing expense in the first quarter of fiscal 2010 was also attributable to a decrease in marketing related expense of $0.5 million, a decrease in bonus expense of $0.1 million, a decrease in commission expense of $0.5 million due to decreased bookings, a decrease in travel and entertainment costs of $0.9 million due to lower spending on reduced sales, decrease in the deferred stock compensation expense of $0.7 million and a decrease in the allocation of common expenses, such as information technology and facility related expenses of $0.7 million. The decrease in sales and marketing expense was offset by a decrease in the allocation of pre-sale costs (primarily application engineering costs) to cost of services revenue of $2.1 million.

General and administrative expensedecreased by $2.6 million in the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009 primarily due to a decrease in compensation expense of $1.0 million as a result of lower headcount and employee salary reductions implemented mid-year in fiscal 2009. The decrease in general and administrative expense in the first quarter of fiscal 2010 was also the result of a decrease of $0.2 million in bad debt expense, decrease of $0.4 million in legal fees due to settlement of the patent litigation with Synopsys in the first quarter of fiscal 2009, a decrease of $0.4 million in stock-based compensation expense due to our option exchange program, a decrease of $0.2 million in travel and entertainment expense due to our cost reduction efforts, and a decrease of $0.2 million in consulting expenses.

Amortization of intangible assetsdecreased by 79% in the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009 primarily due to several existing developed technologies and patents having been fully amortized prior to or during the first quarter of fiscal 2010.

The intangible assets amortized include licensed technology, customer relationship or base, patents, customer contracts and trademarks that were identified in the purchase price allocation for each business combination and asset purchase transaction.

Restructuring chargesof $0.7 million in the first quarter of fiscal 2010 represented employee termination and facility consolidation and closure charges resulting from our realignment to current business objectives.

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Other items

The table below sets forth other data for the three months ended August 2, 2009 and August 3, 2008 (in thousands, except for percentage data):

Three Months Ended:	August 2, 2009			% of Revenue		August 3, 2008 (as adjusted)			% of Revenue		Dollar Change			% Change
Operating income, net
Interest income	$	45		—		$	186		—		$	(141	)	(76	)%
Interest and amortization of debt discount expense		(1,157	)	(4	)%		(984	)	(2	)%		(173	)	18	%
Other expense, net		(601	)	(2	)%		(96	)	—			(505	)	526	%
Total other income (expense), net	$	(1,713	)	(6	)%	$	(894	)	(2	)%	$	(819	)	92	%
Provision for income taxes	$	396		(1	)%	$	440		(1	)%	$	(44	)	(10	)%

August 3, 2008 adjusted for adoption of FSP 14-1. See Footnote 1 to the financial statements.

Interest incomedecreased by 76% in the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009 primarily due to the lower interest rates in the first quarter of fiscal 2010 on investments of cash in money market funds to maintain liquidity.

Interest expense primarily represents amortization of debt discount and issuance costs in connection with our 2010 Notes and our 2008 Notes and interest on our line of credit facility. Interest expense increased in the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009 primarily due to an additional $0.6 million expense related to debt discount amortization, a $0.2 million interest payment on the 2010 Notes, and a $0.2 million interest payment on the line of credit with Wells Fargo Bank. The remainder of the fluctuation in interest expense was accounted for by other individually insignificant items, such as amortization of debt issuance costs and interest expense on the capital leases.

Other income (expense), netincreased by $0.4 million in the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009 primarily due to a $0.5 million foreign exchange loss and a loss on equity investments of $0.1 million offset by a gain of $0.2 million in the fair value of the ARS investments in the first quarter of fiscal 2010.

During fiscal 2009, 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 first quarter of fiscal 2010 and the first quarter of fiscal 2009, net foreign exchange gain (loss) totaled $(0.2) million and $0.1 million, respectively and was included in other income (expense), net in our consolidated statements of operations.

Provision for (benefit from) income taxes.Our effective tax rate was 10% and 3%, in the first quarter of fiscal 2010 and 2009, respectively. Our effective tax rates vary from the U.S. statutory rate primarily due to changes in our U.S. valuation allowance, goodwill impairment, state taxes, foreign income taxed at other than U.S. rates, stock compensation expenses, research and development tax credits, and foreign withholding taxes for which no U.S. tax benefits were received due to our full U.S. valuation allowance. U.S. income tax expense was $0.4 million, and $0.4 million, in the first quarter of fiscal years 2010 and 2009, respectively. The income tax expense is comprised primarily of state and local taxes, income taxes in certain foreign jurisdictions, and foreign withholding taxes offset by federal refundable research and development tax credits.

We are in a net deferred tax asset position, for which a full valuation allowance has been recorded against our U.S. net deferred tax assets. We will continue to provide a valuation allowance against our U.S. net deferred tax assets until it becomes more likely than not that the deferred tax assets are realizable. We will continue to evaluate the realizability of the deferred tax assets on a quarterly basis.

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 August 2, 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 limitations within the next twelve months. In addition, we do not believe that the ultimate settlement of these obligations will materially affect our liquidity.

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Liquidity and Capital Resources

The table below sets forth certain cash, cash equivalents and short-term investments as of August 2, 2009 and May 3, 2009, and cash flow data for the three months ended August 2, 2009 and August 3, 2008 (in thousands):

	August 2, 2009			May 3, 2009
Cash, cash equivalents and short-term investments	$	54,822		$	32,888
	Three Months Ended
For three months ended:	August 2, 2009			August 3, 2008
Other long-term liabilities	$	(200	)	$	337
Restricted cash	$	1,339		$	(1,090	)

Our cash, cash equivalents and short term investments were approximately $54.8 million on August 2, 2009, an increase of $21.9 million or 67% from May 3, 2009, the end of fiscal 2009. The increase is primarily the result of $18.0 million in auction rate securities and purchased put options that were classified as long term investments at May 3, 2009 being classified as short term investments at August 2, 2009. In addition, cash provided by operations was $5.7 million. These increases were offset by cash used in investing activities of $0.2 million and cash used in financing activities of $1.7 million in the first quarter of fiscal 2010.

We hold our cash and cash equivalents in the United States and in foreign accounts, primarily in Japan, the Netherlands and India. As of August 2, 2009, we held an aggregate of $34.2 million in cash and cash equivalents in the United States and an aggregate of $2.6 million in foreign accounts.

Net cash provided by (used in) operating activities

Net cash provided by operating activities increased by $12.1 million in the three months ended August 2, 2009 compared to three months ended August 3, 2008 due to an increase in cash from customers of $8.4 million, a decrease in cash used in cost and expenses of $2.5 million, and a decrease of $1.6 million in payments on accounts payable and accrued liabilities balances, partially offset by an increase of $2.1 million in payments on prepaid and other assets. The aggregate balance of accounts payable and accrued liabilities decreased by $4.4 million and $5.9 million, respectively, in the three months ended August 2, 2009 and August 3, 2008. The decrease in accrued liabilities in the three months ended August 2, 2009 was primarily due to a reduction in annual employee bonus accrual and acquisition related accruals. The decrease in accrued liabilities in the three months ended August 3, 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 our cost reduction initiatives resulting in lower expenses in sales and marketing of $7.0 million, lower research and development of $8.9 million, general and administrative expense of $2.6 million and a decrease of $1.3 million of restructuring expense.

Net cash used in investing activities

Net cash used in investing activities for the three months ended August 2, 2009 compared to the three months ended August 3, 2008 decreased by $0.6 million. The change was primarily the result of cash paid for business and asset acquisitions, net of cash acquired decreasing by $1.3 million and a decrease in restricted cash during the three months ended August 2, 2009 compared to the three months ended August 3, 2008. We did not purchase any strategic investments in year to date fiscal 2010, but used $1.8 million to purchase strategic investments in the first three months fiscal 2009. These decreases in the use of cash were offset by a decrease in proceeds from maturities and sales of available-for-sale investments of $5.0 million. Purchases of property and equipment were $0.1 million cash during the first quarter of both fiscal 2010 and 2009.

Net cash used in financing activities

Net cash used in financing activities for the three months ended August 2, 2009 decreased $1.0 million compared to the three months ended August 3, 2008. For the three months ended August 2, 2009, net cash from the issuance of common stock increased $0.2 million compared to the three months ended August 3, 2008. In addition we repaid $15.3 million of convertible notes during fiscal 2009. Proceeds from the revolving note decreased $12.7 million in fiscal 2010 compared to fiscal 2009. Repayments of lease obligations increased $0.5 million. In addition, we used $1.2 million for repayments on the secured credit line. Retirement of restricted stock used $0.3 million cash during the first quarter of both fiscal 2010 and 2009.

Capital resources

Cash and cash equivalents available for use aggregated a total of $36.8 million at August 2, 2009. Since fiscal 2004 we have not achieved profitability.

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As of our 2009 fiscal year end, our auditors issued an opinion raising substantial doubt about our ability to continue as a going concern. Since inception, we have incurred aggregate consolidated net losses of approximately $384.8 million, and may continue to incur net losses for the foreseeable future. In addition, we experienced a significant decline in revenues during fiscal 2009 and the first quarter of fiscal 2010. As of the end of fiscal 2009, the Company did not have the financing in place to pay the $49.9 million 2010 Notes maturing May 15, 2010.

As more fully described in Footnote 19 “Subsequent Events,” on September 11, 2009, we completed an exchange offer pursuant to which 2010 Notes in the aggregate amount of $26.7 million were exchanged for a new series of 6% Convertible Senior Notes due 2014. As a result of the exchange, approximately $23.2 million principal amount of the 2010 Notes remains outstanding.

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 operational expense reduction initiatives and re-timing or eliminating certain capital spending or research and development projects. As a result of these efforts, and other factors, we generated positive cash flow of $5.7 million of cash from operations in the first quarter of fiscal 2010.

Our ability to fund our cash needs over the short and long term will also depend on our ability to continue to generate cash from operations, which is subject to general economic and financial market conditions, competition and other factors and to maintain or replace our existing credit facility. It could be difficult to obtain additional financing on favorable terms, or at all, due to our financial condition, and current credit market conditions may make external financing difficult to obtain. Any external credit financing that we are able to obtain may contain terms that are not as favorable to us as historical financings. We may try to obtain additional financing by means that could dilute our existing stockholders. We believe we will have sufficient capital resources to fund our working capital requirements and operations, capital investments, and debt service during the next twelve months, and to retire the remaining $23.2 million outstanding 2010 Notes at maturity. However any of these factors could have a materially adverse impact on our 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, we have funded our operations primarily through operating cash flows and through the issuance of convertible debt and equity securities. In the first quarter of fiscal 2009, we began implementing cost reduction measures which continued through the end of the first quarter of fiscal 2010. Additionally, we have taken action to receive liquidity from our $18.3 million in auction rate securities (“ARS”), which have been illiquid since February 2008. We entered into a settlement agreement with UBS Financial Services, Inc. (“UBS”) which allows us to recover the par value of the ARS on or about June 30, 2010 (see Note 2, “Liquidity”). Concurrently, we entered into a “no net cost” secured line of credit with UBS offered as part of the total settlement agreement (see Note 12 “Secured Credit Line”). This secured line of credit provided us with cash of $12.5 million until the ARS can be sold back to UBS at par value in 2010.

Revolving Line of Credit

Effective as of October 31, 2008, we entered into a new secured revolving line of credit facility with Wells Fargo Bank, N.A. (the “New Credit Facility”), which replaced our existing $10.0 million credit facility. The New Credit Facility provides for an increase in the total facility and 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 of our accounts receivable, intangible assets, inventory and equipment.

Effective as of March 11, 2009, we entered into the First Amendment to the New Credit Facility (“New First Amendment”) with Wells Fargo Bank, N.A. which provides for two revolving lines of credit. The two revolving line of credit notes allow for a maximum borrowing of $7.5 million each and replaced the $15.0 million line of credit facility. The New First Amendment expires on December 31, 2009, and is secured by collateral that includes a $7.5 million certificate of deposit and first priority interests in all of our accounts receivable, intangible assets, inventory and equipment. We are required to make interest only payments monthly and the outstanding principal amount plus all accrued but unpaid interest is payable in full at the expiration of the New Credit Facility.

Outstanding borrowings under the first note shall not exceed the lesser of $7.5 million or 80% of the Company’s eligible accounts receivable plus an additional amount not to exceed (i) $2.0 million up to and including May 3, 2009; (ii) $1.0 million from May 4, 2009 up to and including August 2, 2009; and (iii) zero thereafter. The note bears an annual interest rate equal to a fluctuating rate of 3.5% above Wells Fargo’s prime rate or a fixed rate of 3.5% above LIBOR, at management’s election, on outstanding borrowings.

Outstanding borrowings under the second note shall not exceed $7.5 million, including two existing letters of credit, which total $1.7 million. The note bears an annual interest rate equal to a fluctuating rate of 1.5% above Wells Fargo’s prime rate or a fixed rate of 1.5% above LIBOR, at management’s election, on outstanding borrowings.

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On May 21, 2009, we entered into the Second Amendment to the New Credit Facility, which modified certain restrictive covenants in connection with our 2010 Note exchange.

As of August 2, 2009, we had aggregate outstanding borrowings of $11.2 million and two letters of credit totaling $1.7 million under the New First Amendment. The maximum borrowing available under the New First Amendment at August 2, 2009 was $15.0 million. We have classified the $7.5 million of collateralized certificate of deposit as restricted cash in connection with the New First Amendment. We believe we will be able to extend the maturity of the New Credit Facility or replace it with a new facility prior to its expiration on December 31, 2009.

The credit facility restricts our ability to pay dividends or make other distributions on our stock and requires that we maintain certain financial conditions. As of August 2, 2009, we were in compliance with the financial conditions.

Convertible notes

On May 22, 2003, we issued $150.0 million principal amount of the 2008 Notes resulting in net proceeds of approximately $145.1 million. The 2008 Notes did not bear coupon interest and were convertible into shares of our common stock at an initial conversion price of $22.86 per share. Through March 2007, we paid $85.0 million in cash to repurchase $100.1 million in face amount of the 2008 Notes.

In March 2007, we exchanged an aggregate principal amount of $49.9 million (or approximately 76.7% of the remaining principal amount) of the 2008 Notes for an equal aggregate principal amount of the 2010 Notes. At the same time we terminated a corresponding portion of the hedging arrangements entered into with the initial purchaser in connection with the initial private placement of the 2008 Notes. The 2010 Notes bear interest at 2% per annum and are convertible into shares of our common stock at an initial conversion price of $15.00 per share, for an aggregate of approximately 3.33 million shares. The 2010 Notes are unsecured senior indebtedness of Magma, which rank equally in right of payment to our Wells Fargo credit facility. The 2010 Notes are effectively subordinated in right of payment to our Wells Fargo credit facility to the extent of the security interest held by Wells Fargo in such facility. We 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 that requires us to deliver to a holder upon conversion of their 2010 Notes cash equal to the lesser of $1,000 and the conversion value of the 2010 Notes, and in the event that the conversion value is in excess of $1,000 upon conversion of the 2010 Notes, cash or common stock at our election.

We repaid the $15.2 million principal amount of the 2008 Notes in May 2008. The remaining portion of the hedging arrangements expired at the same time. Approximately $49.9 million principal amount of the 2010 Notes remain due on May 15, 2010, unless the notes are redeemed before maturity or exchanged for New Notes pursuant to our proposed exchange offer.

As more fully described in Footnote 19 “Subsequent Events”, on September 11, 2009 the Company completed an exchange offer pursuant to which 2010 Notes in aggregate principal amount of $26.7 million were exchanged for a new series of 6% Convertible Senior Notes due 2014. As a result of the exchange, approximately $23.2 million principal amount of the 2010 Notes remains outstanding as of the date of the exchange.

Contractual obligations

As of August 2, 2009, our principal contractual obligations consisted of $53.8 million from fiscal 2010 through fiscal 2013 for office facilities, repayments of $23.2 million of the remaining principal of the 2010 Notes due in May 2010, and $7.0 million in capital lease obligations for computer equipment and purchase obligations. Although we have no material commitments for capital expenditures, we do not anticipate an increase in our capital expenditures and lease commitments with cost reduction plans that were initiated in fiscal 2009. Purchase obligations represent an estimate of all open purchase orders and contractual obligations in the normal course of business for which we have not received the goods or services as of August 2, 2009. Although open purchase orders are considered enforceable and legally binding, the terms generally allow us the option to cancel, reschedule and adjust our requirements based on our business needs prior to the delivery of goods or performance of services. In addition, we have other obligations for goods and services entered into in the normal course of business. These obligations, however, either are not enforceable or legally binding or are subject to change based on our business decisions.

Our acquisition agreements related to certain business combination and asset purchase transactions obligate us to pay certain contingent cash consideration based on meeting certain financial or project milestones and continued employment of certain employees. The total amount of cash contingent consideration that could be paid under our acquisition agreements, assuming all contingencies are met, was $7.9 million as of August 2, 2009. Subject to the uncertainties further described in “Capital resources” above, these contingent consideration obligations are not expected to affect our estimate that our existing cash and cash equivalents will be sufficient to meet our anticipated operating and working capital expenditure requirements in the ordinary course of business for at least the next 12 months.

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Income taxes

As of August 2, 2009 and May 3, 2009, we recorded unrecognized tax benefits of $27.3 million, and $27.1 million, respectively, of which $9.8 million and $9.7 million, respectively, are included in our long-term tax liabilities on our consolidated balance sheet. We are not able to estimate the amount or timing of any cash payments required to settle these liabilities; however, we do not anticipate the settlement of the liabilities will require payment of cash within the next twelve months and do not believe that the ultimate settlement of these obligations will materially affect our liquidity.

Off-balance Sheet Arrangements

As of August 2, 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 August 2, 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 August 2, 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 August 2, 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 August 2, 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 August 2, 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.

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

During the fourth quarter of fiscal 2008, the $18.4 million auction rate securities we held failed auction due to sell orders exceeding buy orders. 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

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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.

Based on the Level 3 valuation and the transfer of the ARS from the available-for-sale category to the trading category, an other-than-temporary gain of $0.8 million in valuation gain (loss), net in the first quarter of fiscal 2010 was reported in the consolidated statement of operations. Based on our ability to access our cash, cash equivalents and other short-term operating cash flows, we do not anticipate the current lack of liquidity on these investments to have a material impact on our financial condition or results of operations.

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 August 2, 2009, we had approximately $2.6 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 August 2, 2009, net foreign exchange loss of $0.4 million was 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 first quarter of fiscal 2010 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

We are subject to certain legal proceedings described below and from time to time, we are also involved in other disputes that arise in the ordinary course of business. The number and significance of these legal proceedings and disputes may increase as our size changes. Any claims against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and result in the diversion of significant operational resources. As a result, these legal proceedings and disputes could harm our 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. Litigation settlement and legal fees are expensed in the period in which they are incurred.

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 May 3, 2009.

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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 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 August 2, 2009, we had an aggregate principal amount of approximately $78.0 million in outstanding debt, $49.9 million of which was the 2010 Notes. On September 11, 2009 the Company completed a tender offer and registration to exchange its 2010 Notes for new 2014 Notes. As a result of the exchange, approximately $23.2 million principal amount of the 2010 Notes remains outstanding and approximately $26.7 million principal amount of newly issued 2014 Notes is outstanding. In addition, as of August 2, 2009 the Company had outstanding borrowings of $11.2 million and two letters of credit totaling $1.7 million under its revolving credit facility, which expires on December 31, 2009. If cash on hand and cash flow from operations are not sufficient to meet our working capital needs, capital requirements, and debt repayment obligations, we may need to incur additional indebtedness. Our outstanding indebtedness will also require us to use a substantial portion of our cash flow from operations to make debt service payments. If we do not increase our revenue, we could have difficulty making required payments on our indebtedness. If we are unable to generate sufficient cash flow or otherwise obtain funds necessary to make required payments, or if we fail to comply with the various requirements of our indebtedness, we would be in default, which would permit the holders of our indebtedness to accelerate the maturity of the indebtedness and could cause defaults under any indebtedness we may incur in the future. Any default under our indebtedness would have a material adverse effect on our business, operating results and financial condition.

In addition, our substantial indebtedness may:

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

• limit our ability to use our cash flow, 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;

• 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.

General economic conditions, industry cycles and financial, business and other factors affecting our operations, many of which are beyond our control, may affect our future performance, which may affect our ability to make principal and interest payments on our indebtedness. If we cannot generate sufficient cash flow from operations in the future to service our debt, we may, among other things:

• seek additional financing in the debt or equity markets, and the documentation governing any future financing may contain covenants that limit or restrict our strategic, operating or financing activities;

• attempt to refinance or restructure all or a portion of our indebtedness;

• attempt to sell selected assets;

• reduce or delay planned capital expenditures; or

• reduce or delay planned research and development expenditures.

These measures may not be successful, may not be sufficient to enable us to service our indebtedness and may harm our business and prospects. In addition, any financing, refinancing or sale of assets might not be available, or available on economically favorable terms.

The convertible notes we issued in March 2007 must be repaid in cash in May 2010, unless they are redeemed by us 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.

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On May 15, 2010, we will be required to repay in full the remaining $23.2 million principal amount outstanding on our 2010 Notes unless the holders of the remaining 2010 Notes elect to convert them into shares of our common stock before the repayment date, or the 2010 Notes are otherwise redeemed by us. The conversion price is $15.00 for the 2010 Notes, subject to adjustment in certain circumstances. On September 10, 2009, the last reported sale price of our common stock on the Nasdaq Global Market was $1.50 per share. If the price of our common stock does not rise above the applicable conversion price prior to maturity, conversion of the 2010 Notes is unlikely and we would be required to repay the principal amounts of the 2010 Notes in cash. In that event, we may not have enough cash to meet our repayment obligations and we would be in default under the 2010 Notes, which would have a material adverse effect on our business, operating results and financial condition.

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

As of August 2, 2009, we had cash and cash equivalents, excluding restricted cash, of $36.8 million. Our short-term investments of $18.0 million as of August 2, 2009, consisted of auction rate securities, for which auctions have not occurred since February 2008, and a purchased put option.

We have experienced a decrease in revenue during fiscal 2009 and the first quarter of fiscal 2010 and, if adverse semiconductor industry or general economic conditions persist or worsen, we could experience further decreases in revenue. In the second quarter of fiscal 2009, we increased cost cutting activities, including reducing the number of employees, capital spending, research and development projects and administrative expenses. In the third quarter of fiscal 2009, we further increased cost cutting activities, including reducing the number of employees, closing some offices and consolidating other offices. We cannot assure you that we will be able to achieve anticipated expense reductions or that we will not be required to make further cost reductions. Some cost cutting activities may require initial cost outlays before the cost reductions are realized. If our revenue continues 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 $23.2 million remaining principal amount outstanding on our 2010 Notes, after the effect of the September 11, 2009 note exchange, will become due and payable on 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, as they become due on the 2010 Notes. We may not generate sufficient cash flow from operations to cover our anticipated debt service obligations, including making payments on any outstanding notes or repaying any 2010 Notes that remain outstanding at maturity. 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. We believe we will have sufficient capital resources to fund our working capital requirements and operations, capital investments, and debt service during the next twelve months, and to retire the remaining $23.2 million outstanding 2010 Notes at maturity. However , we cannot assure you that we will be able to make required principal and interest payments on our notes when due in the absence of additional sources of equity or debt financing. If our customers believe that we are not financially sound, they may choose to stop doing business with us, which would materially adversely affect our business and financial condition.

We intend to assess and try to access private and public sources of external financing, including debt and equity, to repay our existing indebtedness. We are also currently exploring and may explore in the future sources of external financing in order to achieve growth or other business objectives. Such financing may not be available in sufficient amounts, when needed or on terms acceptable to us. In addition, any equity financing may not be desirable because of resulting dilution to our stockholders, which may be significant in light of the current trading price of our common stock and the size of our market capitalization compared to our outstanding debt. We also may, from time to time, redeem, tender for, exchange 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 two existing $7.5 million revolving lines of credit 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 up to an aggregate of $7.5 million. If we are unable to obtain needed financing or generate sufficient cash from operations, our ability to expand, develop or enhance our services or products, fund our working capital requirements or respond to competitive pressures would be limited, which would materially adversely affect our business and financial condition.

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 two $7.5 million senior secured revolving lines of credit that impose various restrictions and covenants on us that limit our ability to incur or guarantee indebtedness, make investments, declare dividends or make distributions, 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

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conditions, make capital investments or take advantage of business opportunities. Any debt arrangements we enter into may require us to make regular interest or principal 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 that 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 would become immediately due and payable and could trigger cross-defaults under our other debt instruments, any of which would materially adversely affect our business and financial condition.

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 over the past several 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.

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 customers or includes specific future deliverables or is recognized as revenue on a cash receipts basis. Management has estimated variable usage based on customers’ forecasts, but there can be no assurance that these estimates will be realized. In addition, it is possible that customers from whom we expect to derive revenue from backlog will default, and, as a result, we may not be able to recognize revenue from backlog as expected. At August 2, 2009, two customers each accounted for more than 10% of accounts receivable. 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 rely on a small number of customers for a significant portion of our revenue, and our revenue could decline if customers delay orders or fail 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 one customer accounted for 10% or more of our consolidated revenue for the first quarter of fiscal year 2010, 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. In addition, if our customers believe that we are not financially sound, they may choose to stop doing business with us, which would materially adversely affect our business and financial condition.

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.

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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 (“EDA”) 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 could cause 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 would likely 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 EDA market could intensify this trend. In addition, gaining market share in the EDA market can be difficult as it may take years for a customer to move from a competitor. 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 cause potential customers to defer purchases of our products or 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 in the complexity of integrated circuits, a reduction in our customers’ EDA budgets or consolidation among our customers would accelerate the decrease in revenue we have experienced during fiscal 2009 and the first quarter of fiscal 2010, 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. A continued 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, 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 and political 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.

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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 $384.8 million as of August 2, 2009. If we continue to incur losses, the trading price of our stock would likely decline and we may be forced to discontinue our operations altogether.

We had an accumulated deficit of approximately $384.8 million as of August 2, 2009. Except for fiscal 2003 and fiscal 2004, we incurred losses in all other fiscal years since our incorporation in 1997. As a result of our limited cash resources, outstanding debt and history of operating losses, our auditors have expressed in their report on our consolidated financial statements that there is doubt about our ability to continue as a going concern. 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 be forced to discontinue our operations entirely.

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;

• 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 requires 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”);

• changes in accounting rules and practices related to revenue recognition;

• the relative mix of our license and services revenue;

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

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

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

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

• 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.

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 stockholder 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. 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 against 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), be prevented from distributing all or some of our products, and 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 any required proprietary rights on a timely basis could harm our business.

Publicly announced developments in 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.

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 flow, and harm our ability to execute our business plan.

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

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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, or may face technical difficulties in adopting, these geometries on a large scale and we may be unable to persuade our customers to purchase our related software products. Accordingly, any revenue we receive from enhancements to our products or acquired technologies may be less than the development or acquisition costs. If customers fail to or delay the adoption of 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.

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.

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 EDA 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.

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.

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 EDA 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.

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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.

We may not be able to hire 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. If we lose the services of a significant number of our employees 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 whom 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 harmed. 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.

If we fail to offer and maintain competitive 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 compensation of our employees is not competitive or satisfactory to the employees, we may have difficulty in retaining our employees and our business may be harmed. In today’s competitive technology industry, employment decisions of highly skilled personnel are influenced by equity compensation packages. Our stock price has declined significantly for many years due to market

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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 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

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

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.

We have had to implement a series of restructuring efforts recently. In the event that these efforts result in ineffective interoperability between our products or ineffective collaboration among our employees, or we are unable to continue to manage the pace of our growth, our business could be harmed.

The recent global economic downturn has negatively affected the semiconductor industry and our business, and in response to these adverse conditions we have had to implement a series of restructuring efforts. In the first quarter of fiscal 2008, we decreased our workforce and incurred restructuring charges of $0.3 million. In addition, we initiated a restructuring plan in May 2008 for which we have incurred restructuring charges of $10.7 million in fiscal 2009, and $0.7 million in the first quarter of fiscal 2010, primarily for employee termination and facility closure costs. It is likely that we will continue to restructure our company and incur additional associated expenses during fiscal 2010. This reduction in force might harm operating results by making it more difficult for the reduced workforce to take advantage of business opportunities and reach revenue goals. Furthermore, if our 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, we could experience delays in new product development that could cause us to lose customer orders, which could harm our operating results. 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 additional expenses associated with restructurings, lead to deficiencies in our internal controls and financial reporting and otherwise harm our business.

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 August 2, 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

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agreements as of August 2, 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.

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 auction rate securities held by us at face value of $18.4 million as of August 2, 2009, 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 of 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. We also 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 EDA industry. The recent decline in the price of our common stock, our focus on cash management and our need to reduce our debt levels 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”), 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;

• 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;

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• 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.

Because much of our business is international, we are exposed to risks inherent in 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 the first quarter of fiscal 2010, we generated 48% of our total revenue from sales outside North America, compared to 47% in fiscal 2009.

To the extent that we expand our international operations, we may need to continue to maintain 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, the Middle East, and other parts of the world;

• the effects of terrorist attacks in the United States or against U.S. interests overseas;

• 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.

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

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 such foreign currencies could increase the relative costs of our overseas operations, which could reduce our operating margins. 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 August 2, 2009, we had approximately $2.6 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.

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.

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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.

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 Global 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 registered public accounting firm.

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 required 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 Global Market and penalties or other adverse consequences under our existing contractual arrangements. In particular, pursuant to the indenture for the 2010 Notes, if we fail to file our annual or quarterly reports in accordance with the terms of that indenture, or if we do not comply with certain provisions of the Trust Indenture Act specified in the indenture, after the passage of certain periods of time at the election of a certain minimum number of holders of the 2010 Notes, we may be in default under the indenture unless we pay a fee equal to 1% per annum of the aggregate principal amounts of the 2010 Notes, or the extension fee, to extend the default date. Even if we pay the applicable extension fee, we will eventually be in default for these filing failures if sufficient time passes and we have not made the applicable filing.

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.

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 for 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. Patents 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;

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• 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.

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

In addition to patents, we rely on a combination of trademark, copyright and trade secret laws, and contractual restrictions, such as confidentiality agreements and licenses, to establish and protect our proprietary rights. 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 for 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.

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. From January 1, 2008 until September 8, 2009, the closing price of our common stock has ranged from $0.71 to $12.30 per share.

The market price of our stock is subject to significant fluctuations in response to a number of factors, including the risk factors set forth in this prospectus, 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.

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Our certificate of incorporation and 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 in control would be beneficial to the stockholders. These provisions could lower the price that future investors might be willing to pay for shares of our common stock. These anti-takeover provisions:

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

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

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

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

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

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

Section 203 of the Delaware General Corporation Law and the terms of our stock option plans also may discourage, delay or prevent a change in control of our company. Section 203 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. 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.

There may be additional dilution to our current stockholders upon achievement of various milestones pursuant to our mergers and acquisitions.

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.

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.

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

Recent Sales of Unregistered Securities

None.

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Purchases of Equity Securities by the Issuer

The following table shows repurchases of shares of our common stock in the first quarter of fiscal 2010:

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
May 4 - May 31, 2009	10,758	$	1.7506	0	N/A
June 1 - June 30, 2009	4,409		0.0001	0	N/A
July 1 - August 2, 2009	—	$	—	0	N/A
	15,167	$	1.2417	0	N/A

* Includes 10,758 shares repurchased at prices ranging from $1.74 to $2.10 per share, the fair market values on the repurchase dates, in order to satisfy tax withholding obligations associated with the vesting of restricted shares. The remaining shares that were repurchased represented forfeitures of restricted stock as a result of employee terminations.

ITEM 6. EXHIBITS

The following documents are filed as Exhibits to this report:

Exhibit Number	Exhibit Description	Incorporated by Reference				Furnished Herewith	Filed Herewith
		Form	File No.	Exhibit	Filing Date
10.1	Second Amendment to Revolving Line of Credit Note, Security Agreement - Specific Rights to Payment, and Credit Agreement by and between the Registrant and Wells Fargo Bank, National Association (with an effective date as of May 21, 2009)	8-K	000-33213	10.1	May 29, 2009
31.1	Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer						X
31.2	Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer						X
32.1	Certification of Chief Executive Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002					X
32.2	Certification of Chief Financial Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002					X

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SIGNATURES

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

	MAGMA DESIGN AUTOMATION, INC.
Dated: September 11, 2009	/S/    PETER S. TESHIMA
	Peter S. Teshima
	Corporate Vice President—Finance and Chief Financial Officer
	(Principal Financial Officer and Duly Authorized Signatory)

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EXHIBIT INDEX

TO

MAGMA DESIGN AUTOMATION, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTER ENDED AUGUST 2, 2009

Exhibit Number	Exhibit Description	Incorporated by Reference				Furnished Herewith	Filed Herewith
		Form	File No.	Exhibit	Filing Date
10.1	Second Amendment to Revolving Line of Credit Note, Security Agreement - Specific Rights to Payment, and Credit Agreement by and between the Registrant and Wells Fargo Bank, National Association (with an effective date as of May 21, 2009)	8-K	000-33213	10.1	May 29, 2009
31.1	Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer						X
31.2	Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer						X
32.1	Certification of Chief Executive Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002					X
32.2	Certification of Chief Financial Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002					X

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