Magma Design Automation (LAVA) 10-Q 2011 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 1, 2010

or

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

For the transition period from            to            .

Commission File No.: 0-33213

MAGMA DESIGN AUTOMATION, INC.

(Exact name of registrant as specified in its charter)

Delaware	77-0454924
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)

1650 Technology Drive,

San Jose, California 95110

(Address of principal executive offices)

Telephone: (408) 565-7500

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant 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  ¨    (Do not check if a smaller reporting company)	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 7, 2010, 59,510,245 shares of the registrant’s Common Stock, $.0001 par value were outstanding.

MAGMA DESIGN AUTOMATION, INC.

FORM 10-Q

QUARTERLY PERIOD ENDED AUGUST 1, 2010

INDEX

		Page
Part I: Financial Information		2
Item 1:	Financial Statements (unaudited)	2
	Condensed Consolidated Balance Sheets at August 1, 2010 and May 2, 2010	2
	Condensed Consolidated Statements of Operations for the Three Months Ended August  1, 2010 and August 2, 2009	3
	Condensed Consolidated Statements of Cash Flows for the Three Months Ended August  1, 2010 and August 2, 2009	4
	Notes to Condensed Consolidated Financial Statements	5
Item 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item 3:	Quantitative and Qualitative Disclosures About Market Risk	33
Item 4:	Controls and Procedures	34
Part II: Other Information		35
Item 1:	Legal Proceedings	35
Item 1A:	Risk Factors	35
Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds	49
Item 6:	Exhibits	50
Signatures		51
Exhibit Index		52

1

PART 1: FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

MAGMA DESIGN AUTOMATION, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

(unaudited)

	August 1, 2010			May 2, 2010
ASSETS
Current assets:
Cash and cash equivalents	$	33,060		$	57,518
Restricted cash		250			250
Short-term investments		—			16,837
Accounts receivable, net		12,409			17,401
Prepaid expenses and other current assets		3,871			4,472
Total current assets		49,590			96,478
Property and equipment, net		6,055			5,979
Intangible assets, net		6,713			7,487
Goodwill		7,097			7,093
Other assets		5,098			5,086
Total assets	$	74,553		$	122,123
LIABILITIES AND STOCKHOLDERS DEFICIT
Current liabilities:
Accounts payable	$	1,964		$	2,220
Accrued expenses		12,535			16,347
Secured credit line		—			11,162
Current portion of term debt		2,250			1,688
Current portion of other long-term liabilities		1,656			1,901
Deferred revenue		21,560			25,528
Convertible notes, net of debt discount of $44 at May 2, 2010		—			23,206
Total current liabilities		39,965			82,052
Convertible notes, net of debt premium of ($1,327) and ($1,574) at August 1, 2010 and May 2, 2010, respectively		25,266			28,263
Long-term portion of term debt		12,750			13,312
Long-term tax liabilities		1,856			1,856
Other long-term liabilities		767			922
Total liabilities		80,604			126,405
Commitments and contingencies (Note 13)
Stockholders deficit:
Common stock		6			6
Additional paid-in capital		418,360			417,131
Accumulated deficit		(387,082	)		(383,824	)
Treasury stock at cost		(32,615	)		(32,615	)
Accumulated other comprehensive loss		(4,720	)		(4,980	)
Total stockholders deficit		(6,051	)		(4,282	)
Total liabilities and stockholders deficit	$	74,553		$	122,123

See accompanying notes to unaudited condensed consolidated financial statements.

2

MAGMA DESIGN AUTOMATION, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

	Three Months Ended
	August 1, 2010			August 2, 2009
Revenue:
Licenses	$	18,127		$	13,779
Bundled licenses and services		7,778			7,577
Services		6,651			7,485
Total revenue		32,556			28,841
Cost of revenue:
Licenses		699			701
Bundled licenses and services		987			976
Services		3,056			3,160
Total cost of revenue		4,742			4,837
Gross profit		27,814			24,004
Operating expenses:
Research and development		12,259			11,197
Sales and marketing		10,567			9,770
General and administrative		4,690			4,383
Amortization of intangible assets		256			305
Restructuring charge		(14	)		703
Total operating expenses		27,758			26,358
Operating income (loss)		56			(2,354	)
Other income (expense):
Interest income		29			45
Interest and amortization of debt discount (premium)		(806	)		(1,157	)
Valuation gain, net		38			151
Loss on extinguishment of debt		(2,093	)		—
Other (expense), net		(151	)		(601	)
Other, net		(2,983	)		(1,562	)
Net loss before income taxes		(2,927	)		(3,916	)
Provision for income taxes		(331	)		(396	)
Net loss	$	(3,258	)	$	(4,312	)
Net loss per share, basic and diluted	$	(0.06	)	$	(0.09	)
Shares used in per share calculation, basic and diluted		52,563			47,863

See accompanying notes to unaudited condensed consolidated financial statements.

3

MAGMA DESIGN AUTOMATION, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Three Months Ended
	August 1, 2010			August 2, 2009
Cash flows from operating activities:
Net loss	$	(3,258	)	$	(4,312	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation		1,298			1,825
Amortization of intangible assets		1,081			1,415
Provision for doubtful accounts		148			79
Amortization of debt discount and debt issuance costs		354			637
Amortization of debt premium		(247	)		—
Loss on extinguishment of convertible notes due 2014		2,093			—
Loss on auction rate securities		—			649
Gain on purchased put option		(38	)		(800	)
Loss on strategic equity investments		34			147
Stock-based compensation		2,984			3,181
Restructuring charges		(1,867	)		339
Other non-cash items		53			(188	)
Changes in operating assets and liabilities:
Accounts receivable		5,101			15,415
Prepaid expenses and other assets		504			(1,085	)
Accounts payable		(256	)		383
Accrued expenses		(2,539	)		(4,738	)
Deferred revenue		(4,002	)		(7,052	)
Other long-term liabilities		(56	)		(200	)
Net cash provided by operating activities		1,387			5,695
Cash flows from investing activities:
Cash paid for business acquisitions		(596	)		(1,465	)
Purchase of property and equipment		(490	)		(65	)
Proceeds from maturities and sale of investments		16,875			50
Purchase of strategic investments		(275	)		(50	)
Restricted cash		—			1,339
Net cash provided by (used in) investing activities		15,514			(191	)
Cash flows from financing activities:
Repayment of lease obligations		(364	)		(929	)
Repayment of secured credit line		(11,162	)		—
Repayment of convertible notes due 2010		(23,250	)		—
Repurchase of convertible notes due 2014		(4,839	)		—
Proceeds from issuance of common stock, net		793			518
Repurchase of common stock for retirement		(1,960	)		—
Retirement of restricted stock		(578	)		(316	)
Proceeds from term debt		—			(935	)
Net cash used in financing activities		(41,360	)		(1,662	)
Effect of foreign currency translation changes on cash and cash equivalents		1			82
Net change in cash and cash equivalents		(24,458	)		3,924
Cash and cash equivalents, beginning of period		57,518			32,888
Cash and cash equivalents, end of period	$	33,060		$	36,812

See accompanying notes to unaudited condensed consolidated financial statements.

4

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Note 1.    Basis of Presentation

The accompanying 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”) for interim period financial reporting. 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 condensed consolidated financial statements reflect, in the opinion of management, all adjustments necessary to present a fair statement of results and financial position 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 1, 2011. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Company’s Form 10-K for the fiscal year ended May 2, 2010, as filed with the SEC on July 16, 2010. The accompanying unaudited condensed consolidated balance sheet at May 2, 2010 is derived from audited consolidated financial statements at that date.

Preparation of 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 financial statements and the reported amounts of revenue and expenses during the reporting period. Management periodically evaluates such estimates and assumptions for continued reasonableness. Appropriate adjustments, if any, to the estimates used are made prospectively based upon such periodic evaluation. Actual results could differ from those estimates.

Principles of Consolidation

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

Recently issued accounting pronouncements

In January 2009, the SEC 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 SEC and on their corporate websites in interactive data format using the eXtensible Business Reporting Language (“XBRL”). The rule was adopted by the SEC to improve the ability of financial statement users to access and analyze financial data. The SEC 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 quarterly report on Form 10-Q for the quarter ended July 31, 2011. The Company is currently evaluating the impact of XBRL reporting on its financial reporting process.

In October 2009, the FASB issued an amendment to ASC 605-25,Multiple Element Arrangements(“ASC 605-25”), which modifies how a company separates consideration in multiple-delivery arrangements. The amendment establishes a selling price hierarchy for determining the selling price of a deliverable. The amendment also clarifies the allocation of revenue is based on entity-specific assumptions rather than assumptions of a marketplace participant. The amendment also eliminates the residual method of allocating revenue and requires the use of the relative selling price method. This amendment to ASC 605-25 is effective for new revenue arrangements entered into or modified in fiscal years beginning after June 15, 2010. Early adoption is permitted. The Company does not enter into non-software revenue transactions. The adoption of this amendment is not expected to have a material impact on the Company’s consolidated financial statements.

In October 2009, the FASB issued an amendment to ASC 985-605,Software-Revenue Recognition (“ASC 985-605”), which modifies the accounting model for revenue arrangements that include both tangible products and software elements. This amendment to ASC 985-605 is effective for new revenue arrangements entered into or modified in fiscal years beginning after June 15, 2010. Early adoption is permitted. The Company does not sell products that include both tangible products and software elements, therefore this amendment will not impact the Company’s consolidated financial statements.

5

In April 2010, the FASB issued an amendment to ASC 605, Revenue Recognition (“ASC 605”), to provide guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. This amendment to ASC 605 is effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. Early adoption is permitted. The Company does not provide research or development for others and does not recognize revenue using the milestone method, therefore this amendment will not impact the Company’s consolidated financial statements.

Note 2.    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 Auction Rate Securities (“ARS”) settlement agreement signed with UBS Financial Services, Inc. (“UBS”) (see Note 3 “Fair Value of Financial Instruments”). 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. Fair value accounting led to a gain of $38,000 on the exercise of the purchased put option for the three months ended August 1, 2010, which is included in “Valuation gain, net” in the Company’s condensed consolidated statement of operations.

Note 3.    Fair Value of Financial Instruments

The Company measures fair value in accordance with ASC 820, Fair Value Measurements and Disclosures (“ASC 820”). ASC 820 requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three levels:

Level 1:	Quoted market prices in active markets for identical assets or liabilities.
Level 2:	Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets; and
Level 3:	Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

The following table summarizes the Company’s carrying values and market-based fair values of these financial instruments as of May 2, 2010 (in thousands):

	Carrying Value		Estimated Fair Value
May 2, 2010
Auction rate securities	$	16,512	$	16,512
Purchased put options	$	325	$	325

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 1, 2010 (in thousands):

	Three Months Ended August 1, 2010
Beginning balance	$	16,837
Net sales and settlements		(16,875	)
Gain on put option		38
Ending balance	$	—

6

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

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

	Cost		Gross Realized Gains		Gross Unrealized Losses			Estimated Fair  Value
August 1, 2010
Cash and cash equivalents
Cash (U.S. and international)	$	33,060	$	—	$	—		$	33,060
May 2, 2010
Cash and cash equivalents
Cash (U.S. and international)	$	57,518	$	—	$	—		$	57,518
Total cash and cash equivalents		57,518		—		—			57,518
Short-term investments:
Auction rate securities		16,875		—		(38	)		16,837
Total cash and cash equivalents and short-term investments	$	74,393	$	—	$	(38	)	$	74,355

As of August 1, 2010, the stated maturities within one year of the Company’s current investments classified as cash and cash equivalents were $33.1 million.

The fair value of outstanding forward exchange contracts was approximately $2.3 million and $2.1 million as of August 1, 2010 and May 2, 2010, respectively. The Company had realized losses on foreign currency forward exchange contracts of $0.2 million in both the fiscal quarters ended August 1, 2010 and August 2, 2009, respectively. As of August 1, 2010, the Company recorded an unrealized gain of $63,000 in other current assets. As of May 2, 2010, the Company recorded an unrealized loss of $19,000 in other current liabilities.

Short-term investments as of May 2, 2010 on the condensed consolidated balance sheets consisted of (i) ARS that were AAA rated and 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. On July 2, 2010, the Company exercised its put option and liquidated the $16.8 million ARS and used part of the proceeds to repay its outstanding $11.2 million secured line of credit to UBS.

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 were not currently liquid.

In October 2008, the Company entered into an agreement with UBS which provided the Company with Auction Rate Securities Rights (“Rights”) to sell the ARS at par value to UBS at any time during the period June 30, 2010 through July 2, 2012. These Rights, consisting of a nontransferable purchased put option, constituted a separate freestanding instrument accounted for separately from the ARS. The purchased put option was initially recorded at fair value (see Note 2 “Fair Value Option”). Additionally, UBS offered a “no net cost” loan to the Company of up to 75% of the market value of the ARS as determined by UBS until June 30, 2010 (see Note 11 “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 were transferred to trading securities and were classified as short-term investments pledged as collateral for the secured credit line as of May 2, 2010.

As of May 2, 2010 there was insufficient observable market information available to determine the fair value of the ARS. Prior to November 2, 2008, the Company estimated Level 3 fair values for these securities based on UBS’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 four 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.

Upon the exercise of the purchased put option on July 2, 2010, the Company recorded a gain of $38,000 for the three months ended August 1, 2010. This gain is reported in “Valuation gain, net” in the condensed consolidated statement of operations. For the three months ended August 2, 2009 the Company recorded a gain of $0.8 million for the ARS. This gain was offset by losses related to the purchased put option of $0.6 million.

7

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Note 4.    Basic and Diluted Net Loss Per Share

The Company computes net loss per share in accordance with ASC 260, Earnings per Share. Basic net loss per share is computed by dividing net loss attributable to common stockholders (numerator) by the weighted average number of common shares outstanding (denominator) during the period. Diluted net loss per share gives effect to all dilutive potential common shares outstanding during the period including stock options and redeemable convertible subordinated notes.

For the three months ended August 1, 2010 and August 2, 2009, 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 1, 2010		August 2, 2009
Shares of common stock issuable upon conversion of convertible notes		16,377		3,329
Shares of common stock issuable under stock option plans outstanding		9,211		9,012
Weighted average price of shares issuable under stock option plans	$	6.48	$	6.74

Note 5.    Balance Sheet Components

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

	August 1, 2010			May 2, 2010
Accounts receivable, net:
Trade accounts receivable	$	8,206		$	14,475
Unbilled receivable		4,367			2,943
Gross accounts receivable		12,573			17,418
Allowance for doubtful accounts		(164	)		(17	)
Total accounts receivable, net	$	12,409		$	17,401
Accrued expenses:
Accrued sales commissions	$	1,196		$	2,098
Accrued bonuses		81			4,456
Other payroll and related accruals		5,996			4,168
Acquisition accrual		69			353
Accrued professional fees		382			475
Income taxes payable		578			277
Restructuring accrual		466			2,366
Other		3,767			2,154
Total accrued expenses	$	12,535		$	16,347

Note 6.    Accumulated Other Comprehensive Loss

Accumulated other comprehensive loss consisted of (in thousands):

	August 1, 2010			May 2, 2010
Foreign currency translation adjustments	$	(4,720	)	$	(4,980	)
Accumulated Other Comprehensive loss	$	(4,720	)	$	(4,980	)

8

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Note 7.    Acquisitions

The Company did not make any material acquisitions during the three months ended August 1, 2010.

Acquisition-related earnouts and purchase of licensed technology

For a number of Magma’s previously completed acquisitions, the Company agreed to pay contingent consideration 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 and purchase of licensed technology (in thousands):

	Three Months Ended
	August 1, 2010		August 2, 2009
Goodwill:
Sabio Labs, Inc	$	4	$	6
Total goodwill		4		6
Intangible assets:
Licensed Technology		308		17
Total intangible assets		308		17
Total earnout consideration	$	312	$	23

Note 8.    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 (in thousands):

	Weighted Average Life (months)	August 1, 2010							May 2, 2010
		Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Goodwill		$	7,097	$	—		$	7,097	$	7,093	$	—		$	7,093
Other intangible assets:
Developed technology	43	$	115,436	$	(113,280	)	$	2,156	$	115,436	$	(112,897	)	$	2,539
Licensed technology	40		42,354		(39,820	)		2,534		42,046		(39,291	)		2,755
Customer relationship or base	70		5,575		(4,112	)		1,463		5,575		(3,981	)		1,594
Patents	57		13,015		(13,015	)		—		13,015		(13,004	)		11
Acquired customer contracts	33		1,390		(1,090	)		300		1,390		(1,090	)		300
Assembled workforce	45		1,252		(1,249	)		3		1,252		(1,248	)		4
No shop right	24		100		(100	)		—		100		(100	)		—
Non-competition agreements	36		600		(581	)		19		600		(572	)		28
Trademark	67		900		(662	)		238		900		(644	)		256
Total		$	180,622	$	(173,909	)	$	6,713	$	180,314	$	(172,827	)	$	7,487

During the three months ended August 1, 2010, the Company increased its goodwill by $4,000, reflecting purchase price adjustments related to acquired businesses.

9

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

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 1, 2010		August 2, 2009
Amortization of intangible assets included in:
Cost of revenue-licenses	$	616	$	775
Cost of revenue-bundled licenses and services		209		335
Operating expenses		256		305
Total	$	1,081	$	1,415

As of August 1, 2010, the estimated future amortization expense of intangible assets in the table above was as follows (in thousands):

Fiscal Year	Estimated Amortization Expense
2011 (remaining nine months)	$	3,065
2012		2,101
2013		1,123
2014		283
2015 and thereafter		141
	$	6,713

Note 9.    Convertible Notes, Current and Long-Term

The Company’s 2% Convertible Senior Notes due 2010 (the “2010 Notes”) matured on May 15, 2010. These notes bore interest at 2% per annum, with interest payable on May 15 and November 15 of each year since 2007. On May 15, 2010, the Company paid the remaining principal balance and the outstanding interest on the 2010 Notes of approximately $23.2 million.

On September 11, 2009, the Company completed an exchange offer pursuant to which an aggregate principal amount of $26.7 million of its 2010 Notes were exchanged for $26.7 million principal amount of newly issued 6% Convertible Senior Notes due 2014 (the “2014 Notes”). Because the terms of the 2014 notes were substantially different from the 2010 Notes, the exchange offer was treated as an extinguishment of the $26.7 million principal amount of the 2010 Notes.

In accordance with ASC 470-20, the fair value of the 2014 Notes when issued was allocated between the fair market value of the 2010 Notes extinguished and the reacquisition of the equity component originally recognized upon issuance of the 2010 Notes. The Company initially recorded the 2014 Notes at fair value of $28.5 million, including a debt premium of $1.8 million. The debt premium is being amortized to interest expense over the term of the 2014 Notes. $1.9 million of underwriting and legal fees related to the 2014 Notes offering was capitalized upon issuance and is being amortized over the term of the 2014 Notes using the effective interest method. $3.0 million was recorded for the reacquisition of the equity component related to the 2010 Notes as a reduction to additional paid-in-capital.

The Company recognized a net gain of $0.3 million on the extinguishment of the 2010 Notes. The net gain is comprised of a $1.2 million gain on the difference between the fair market value of the 2014 Notes and the $26.7 million principal amount of the 2010 Notes that was extinguished, which is offset by the reacquisition of the equity component and the write-off of approximately $0.8 million and $0.1 million in debt discount and issuance costs, respectively, related to the 2010 Notes exchanged.

The 2014 Notes mature on May 15, 2014 and bear interest at 6% per annum, with interest payable on May 15 and November 15 of each year, commencing May 15, 2010. The 2014 Notes 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 14.83 million shares. Upon conversion, the holders of the 2014 Notes will receive shares of common stock of the Company. Except in limited specific circumstances related to a change in control, holders will not receive a cash settlement, therefore, the Company is not required to separately account for the liability and equity components on the 2014 Notes. The 2014 Notes are unsecured senior indebtedness of Magma, which rank equally in right of payment to Magma’s credit facility with Wells Fargo Capital Finance, LLC. 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. After May 15, 2013, the Company has the option to redeem the 2014 Notes for cash in an amount equal to 100% of the aggregate outstanding principal amount at the time of such redemption.

10

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

During the three months ended August 1, 2010 the Company repurchased an aggregate principal amount of $2.75 million of the 2014 Notes for $4.8 million in cash. A loss on extinguishment of the 2014 Notes of $2.1 million is accounted for in the condensed consolidated statement of operations as“Loss on extinguishment of debt”. The unamortized amount of issuance costs related to the repurchased 2014 Notes of $0.2 million and the related debt premium of $0.2 million was written off. Subsequent to August 1, 2010, the Company engaged in separately negotiated transactions with certain holders of its 2014 Notes. Pursuant to those transactions, the holders converted an aggregate principal amount of $10.7 million of the 2014 Notes into 5,955,000 shares of the Company’s common stock. See Note 19, “Subsequent Events”.

The following table summarizes the Company’s carrying values and market-based fair values of these financial instruments as of August 1, 2010 and May 2, 2010 (in thousands):

	Carrying Value		Estimated Fair Value
August 1, 2010
Convertible senior notes due 2014	$	23,939	$	46,036
May 2, 2010
Convertible senior notes due 2010	$	23,250	$	23,250
Convertible senior notes due 2010	$	26,689	$	47,405

Note 10.    Term Loan and Revolving Loans

On March 19, 2010, the Company entered into a new credit facility with Wells Fargo Capital Finance, LLC (the “New Credit Facility”), which replaced the Company’s $15.0 million secured revolving line of credit facility with Wells Fargo Bank, N.A. (the “Credit Facility”). The New Credit Facility provides for a revolving loan not to exceed $15.0 million and a term loan of $15.0 million. The New Credit Facility expires March 19, 2014, and is secured by a first priority interest in all the Company’s assets. The term loan will be repaid in equal quarterly installments of $0.6 million, beginning October 31, 2010.

Under the terms of the New Credit Facility, outstanding borrowings and letter of credit liabilities may not, at any time, exceed the greater of $30.0 million or 40% of all “post-contract support” revenues and “time based license fee” revenues for the preceding twelve-month period. These requirements could, but to date have not, limited the Company’s borrowing availability.

The revolving and term loans bear interest at either a LIBOR Rate or a Base Rate, at management’s election, in each case determined as follows (plus a margin of 4.50 percentage points): (A) if at a LIBOR Rate, at a per annum rate equal to the LIBOR Rate of the greater of (i) 1.00% per annum or (ii) the one, two or three month LIBOR rate quoted by Bloomberg and (B) if at the Base Rate the greatest of (i) the Federal Funds Rate plus 0.5%, (ii) the three month LIBOR Rate plus 1.0% and (iii) the Wells Fargo prime rate. In addition, the Company is required to pay fees of 0.5% per annum on the unused amount of the New Credit Facility, 2.5% per annum for each letter of credit issued and quarterly administrative fees of $10,000.

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 maturity date of March 19, 2014.

The New Credit Facility contains covenants that, among other things, limit the Company’s ability to create liens, merge, consolidate, dispose of assets, incur indebtedness and guarantees, repurchase or redeem capital stock and indebtedness, make certain investments, acquisitions and capital expenditures, enter into certain transactions with affiliates or change the nature of the Company’s business. Events of Default under the New Credit Facility include, but are not limited to, payment defaults, covenant defaults, breaches of representations and warranties, cross defaults to certain other material agreements and indebtedness, bankruptcy and other insolvency events, actual or asserted invalidity of security interests or loan documents, and certain change of control events.

11

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

The New Credit Facility restricts the Company’s ability to pay dividends or make other distributions on the Company’s stock and requires that the Company maintain certain financial conditions. As of August 1, 2010, the Company had borrowed $15.0 million of term debt. The unused amount of the New Credit Facility as of August 1, 2010 is $13.3 million. As of August 1, 2010, the Company was in compliance with the covenants contained in the New Credit Facility.

The Company entered into the Credit Facility on October 31, 2008. As amended by the First Amendment dated March 11, 2009, the Second Amendment dated May 21, 2009, and the Third Amendment dated October 1, 2009, the Credit Facility (i) provided for a single revolving line of credit note of up to $15.0 million which replaced the two previous $7.5 million revolving line of credit notes, (ii) eliminated the requirement that Magma maintain a minimum accounts receivable borrowing base and cash collateral, and (iii) extended the term of the line of credit to September 30, 2010. The note bore an annual interest rate equal to a fluctuating rate of 3.5% above the one month LIBOR rate on outstanding borrowings. The Credit Facility also required that the Company provide certain financial statements to Wells Fargo, restricted the Company’s ability to pay dividends or make other distributions on its stock and required that the Company maintain certain financial conditions. As described above, the Credit Facility was terminated and replaced with the New Credit Facility in March 2010.

Note 11.    Secured Credit Line

In October 2008, the Company obtained a secured line of credit with UBS in conjunction with the settlement agreement it entered into with UBS with respect to the Company’s ARS. On July 2, 2010, the Company exercised its ARS put option and liquidated the $16.8 million of ARS and used part of the proceeds to repay the $11.2 million secured line of credit (see Note 3, “Fair Value of Financial Instruments”).

As amended January 22, 2009, the secured line of credit was a 100% Loan-to-Par Value No Net Cost loan program. Under this program the interest rate was based on the lesser of either the weighted average ARS coupon rate or the published UBS Bank rate. This new rate applied to existing outstanding balances and new advances. The initial line of credit obtained in October 2008 was due on demand and allowed 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. 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 were 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 would be automatically transferred to UBS as payments. If these payments were insufficient to pay all accrued interest by the monthly due date, then UBS would either require the Company to make additional interest payments or, at UBS’s discretion and capitalize unpaid interest as an additional advance. UBS’ intent was 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.

Note 12.    Restructuring charges

In fiscal 2009, the Company initiated a restructuring plan (“FY 2009 Restructuring Plan”) designed to improve its cost structure and to better align its resources and improve operating efficiencies. The Company recorded pre-tax restructuring charges of $0.7 million in the three months ended August 2, 2009. These costs related to severance, expatriate relocation, facilities, consolidation and termination, and other costs related to the restructuring. During the three months ended August 1, 2010, the Company did not initiate any additional restructuring activities, and adjustments were made to the previously estimated restructuring expense.

The cash payments associated with the net restructuring liability are expected to be paid through fiscal 2011. The restructuring liability activity was as follows (in thousands):

	Severance			Relocation			Facilities and Other			Net Liability
Balance at May 2, 2010	$	1,998		$	9		$	428		$	2,435
Restructuring provision		(3	)		(9	)		(2	)		(14	)
Cash payments		(1,757	)		—			(110	)		(1,867	)
Balance at August 1, 2010	$	238		$	(0	)	$	316		$	554

12

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Note 13.    Contingencies

The Company is subject to various legal proceedings and disputes that arise in the ordinary course of business from time to time. 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, as of August 1, 2010, no estimate could be made of the loss or range of loss, if any, from such litigation matters and disputes. Liabilities are recorded when a loss is probable and the amount can be reasonably estimated. No accrued legal settlement liabilities are recorded on the condensed consolidated balance sheet as of August 1, 2010 or May 2, 2010. Litigation settlement and legal fees are expensed in the period in which they are incurred.

InGenesis Insurance Company v. Magma Design Automation, et al., Case No. 06-5526-JW, in the United States District Court for the Northern District of California, Genesis seeks a declaration of its rights and obligations under an excess directors and officers liability policy for defense and settlement costs arising out of the securities class action against the Company, in re Magma Design Automation, Inc. Securities Litigation, as well as a related derivative lawsuit. Genesis seeks a return of $5.0 million it paid towards the settlement of the securities class action and derivative lawsuits from the Company or from another of the Company’s excess directors and officers liability insurers, National Union. The Company contends that either Genesis or National Union owes the settlement amounts, but not the Company. The trial court granted summary judgment for the Company and National Union, finding that Genesis owed the settlement amount. Genesis appealed to the Ninth Circuit Court of Appeals, and the Company cross-appealed. On July 12, 2010, the court of appeal reversed, ruling that Genesis does not owe the settlement amount under its policy, and remanded the case to the trial court for further proceedings. While there can be no assurance as to the ultimate disposition of the litigation, the Company does not believe that its resolution will have a material adverse effect on the Company’s financial position, results of operations or cash flows.

Indemnification Obligations

The Company enters into standard license agreements in the ordinary course of business. Pursuant to these agreements, the Company agrees to indemnify its customers for losses suffered or incurred by them as a result of any patent, copyright, or other intellectual property infringement claim by any third party with respect to the Company’s products. These indemnification obligations do not have a specific term. 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 1, 2010.

The Company has agreements whereby its officers and directors are indemnified for certain events or occurrences while the officer or director is, or was, serving at the Company’s request in such capacity. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has a directors’ and officers’ liability insurance policy that reduces its exposure and enables the Company to recover a portion of future amounts paid. As a result of the Company’s insurance policy coverage, the Company believes the estimated fair value of these indemnification agreements is insignificant. Accordingly, no liabilities have been recorded for these agreements as of August 1, 2010.

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 1, 2010.

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 1, 2010. 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.

13

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Note 14.    Retirement of Common Stock

In July, 2010 the Company used approximately $2.0 million to repurchase approximately 638,375 shares of its common stock in the open market. The repurchase prices ranged from $2.82 to $3.37 per share. The repurchased shares were retired immediately subsequent to the purchase.

Note 15.    Stock-Based Compensation

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

	Three Months Ended
	August 1, 2010		August 2, 2009
Cost of revenue	$	271	$	300
Research and development expense		1,235		1,133
Sales and marketing expense		725		935
General and administrative expense		753		813
Total stock-based compensation expense	$	2,984	$	3,181

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 1, 2010		August 2, 2009
Stock options	$	665	$	731
Restricted stock and restricted stock units		1,264		1,599
Employee stock purchase plan		1,055		851
Total stock-based compensation expense	$	2,984	$	3,181

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.

14

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

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 1, 2010			August 2, 2009
Stock options:
Expected life (years)		3.97			3.94
Volatility		71	%		85	%
Risk-free interest rate		1.20% – 1.53	%		1.50% – 2.10	%
Expected dividend yield		0	%		0	%
Weighted average grant date fair value	$	1.70		$	0.92
ESPP awards:
Expected life (years)		1.13			1.13
Volatility		71	%		85	%
Risk-free interest rate		0.43	%		0.54	%
Expected dividend yield		0	%		0	%
Weighted average grant date fair value	$	1.38		$	0.74

As of August 1, 2010, there was approximately $3.7 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 2.13 years.

As of August 1, 2010, the Company had $2.3 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 approximately 1.13 years. Cash received from the purchase of shares under the ESPP was $0.7 million and $0.5 million for the three months ended August 1, 2010 and August 2, 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 two to four years.

As of August 1, 2010, the Company had $0.1 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 0.8 years.

As of August 1, 2010, there was $6.9 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 1.93 years.

Note 16.    Income Taxes

The provision for income taxes was $0.3 million and $0.4 million for the three months ended August 1, 2010, and August 2, 2009, respectively.

For the three months ended August 1, 2010, the Company had approximately $18.4 million of total gross unrecognized tax benefits, of which $1.6 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 $15.2 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.

15

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

The Company’s fiscal 2011 effective tax rate differs from the combined federal and state statutory rate primarily due to changes in its U.S. valuation allowance, state taxes, foreign income taxed at other than U.S. rates, stock compensation expense, research and development credits and foreign withholding taxes.

Note 17.    Segment Information

The Company reports 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 1, 2010			August 2, 2009
North America*	$	17,917		$	14,999
Europe		1,983			7,640
Japan		5,819			2,569
Asia-Pacific (excluding Japan)		6,837			3,633
	$	32,556		$	28,841
	August 1, 2010			August 2, 2009
North America*		55	%		52	%
Europe		6	%		26	%
Japan		18	%		9	%
Asia-Pacific (excluding Japan)		21	%		13	%
		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 1, 2010 and August 2, 2009, the Company had one customer that represents 10% or more 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. The lease was amended in February 2007. In March 2010 the lease was extended for an additional three years. The lease expires in fiscal 2014. During the three months ended August 1, 2010 and August 2, 2009, the Company recorded $0.2 million of rent expense each quarter related to this lease and recognized $1.7 million from the sale of software licenses to this customer for each of the three months ended August 1, 2010 and August 2, 2009.

In July 2010, the Company announced the appointment of a new member to the Board of Directors, to serve until the Company’s 2012 annual meeting of stockholders. He was also appointed to the Audit Committee of the Board of Directors. He also serves as a director and Chairman of the Board, and Chairman of both the Audit Committee and the Corporate Governance and Nominating committee, for a customer of Magma. During the three months ended August 1, 2010, transactions with this customer were insignificant.

16

MAGMA DESIGN AUTOMATION, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Note 19.    Subsequent Events

Subsequent to the end of the quarter, in August, 2010, the Company engaged in separately negotiated transactions with certain note holders of its 2014 Notes. Pursuant to those transactions, the holders converted an aggregate principal amount of $10.7 million of their 2014 Notes into 5,955,000 shares of common stock. The Company incurred an inducement fee of $1.2 million on conversion, which included accrued interest from May 15, 2010 to the conversion date. The aggregate principal amount of the converted notes represented approximately 45% of the aggregate principal amount of the 2014 Notes outstanding at August 1, 2010. Subsequent to the conversion, $13.2 million principal balance of the 2014 Notes remain outstanding.

17

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 our Annual Report on Form 10-K for the fiscal year ended May 2, 2010. 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. Any statements that do not relate to historical or current facts or matters are forward-looking statements. 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, or the use of future tense. Statements concerning current conditions may also be forward-looking if they imply a continuation of current conditions. These forward-looking statements include, but are not limited to:

• our expectations about future revenue, operating expenses and results of operations

• our expectation that our sales cycle will lengthen

• our belief that we will have sufficient capital resources to fund our working capital requirements and operations, capital investments, and debt service during the next twelve months

• our belief that our acquisitions will enable us to compete successfully in the electronic design automation industry and our expectation that we will be able to make acquisitions in the future

• our expectation that we will be able to continue to use earnout arrangements to consummate our acquisitions and our belief that these arrangements will not complicate integration efforts

• our expected costs to develop in-process research and development from an acquired company into commercially viable products

• our expectations regarding legal proceedings, exposure to indemnification obligations and adequacy of insurance coverage

• our stock price volatility

Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, and we have based these expectations on our beliefs and assumptions, such expectations may prove to be incorrect. Our actual results of operations and financial performance could differ significantly from those expressed in or implied by our forward-looking statements. These statements involve certain known and unknown risks and uncertainties. Factors that could cause or contribute to such differences include, but are not limited to, the risks discussed under the heading “Risk Factors” or included elsewhere in this Quarterly Report on Form 10-Q, and in our Annual Report on Form 10-K for the fiscal year ended May 2, 2010. We do not intend, and undertake no obligation, to update any of our forward-looking statements after the date of this Quarterly Report on Form 10-Q to reflect actual results or future events or circumstances.

Overview

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

The semiconductor industry is highly volatile and cost-sensitive. Our customers focus on controlling costs and reducing risk, lowering R&D expenditures, decreasing 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.

18

To support our customers, we have focused on providing technologically advanced products to address each step in the integrated circuit design process, as well as integrating these products into broad platforms, 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 2011, we recognized revenue of $32.6 million, an increase of 13% from the first quarter of fiscal 2010. License revenue for the first quarter ended August 1, 2010 accounted for approximately 75% of total revenue, compared to 75% in the preceding quarter and 70% in the first quarter of the prior fiscal year.

Global Markets

Recent market and economic conditions have been unprecedented and challenging with tighter credit conditions and slower growth through fiscal 2010 and the first three months of fiscal 2011. 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.

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. For that reason and due to the estimation processes involved in each, we consider these to be our critical accounting policies.

Revenue recognition

We recognize revenue in accordance with ASC 985-605,Software – Revenue Recognition, 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 immediately recognized as revenue for the elements delivered.

Our revenue recognition policy is detailed in Note 1 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended May 2, 2010. 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 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 the 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.

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

Licenses revenue and bundled licenses and services revenue

We derive license revenue primarily from licenses of our design and implementation software and, to a lesser extent, from licenses of our analysis and verification products. We license our products under time-based and perpetual licenses whereby license revenue is recognized after the execution of a license agreement and the delivery of the product to the customer, provided that there are no uncertainties surrounding the product acceptance, fees are fixed or determinable, collection is probable and there are no remaining obligations other than maintenance.

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

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

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

Services revenue

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

Stock-based compensation

We account for stock-based compensation in accordance with ASC 718,Compensation – Stock Compensation(“ASC 718”). Under ASC 718, 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.

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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 that are non-cancelable, in which there are no contingencies and where the customer has taken delivery of both the software and the encryption key required to operate the software. We typically generate invoices 45 days in advance of contractual due dates, and we invoice the entire amount of the unbilled accounts receivable within one year from the contract inception.

Allowances for doubtful accounts

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

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.

As of August 1, 2010, two of our customers each accounted for more than 10% of total receivables. Neither customer is included in our allowance as of August 1, 2010.

Fair value option

We account for financial instruments in accordance with ASC 825-10,Financial Instruments Overall Recognition (“ASC 825-10”). ASC 825-10 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 ASC 825-10 in the first quarter of fiscal 2009. Our adoption of ASC 825-10 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 ARS under different methods.

We recorded a gain of $38,000 for the three months ended August 1, 2010, which is reported in “Valuation gain, net” in the condensed consolidated statement of operations. For the three months ended August 2, 2009, we recorded a gain of $0.8 million for the ARS. This gain was offset by losses related to the purchased put option of $0.6 million.

Cash equivalent and short-term investments

We account for our investments in accordance with ASC 320-10,Investments in Debt and Equity Securities (“ASC 320-10”). These investments are typically classified as available-for-sale, and are recorded on the balance sheet at fair 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 consolidated balance sheets. As of January 2, 2009, investments in ARS have been classified as trading, and are recorded on the balance sheet at fair value as of the balance sheet date, with gains or losses recorded as other income or expense on our consolidated statements of operations.

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On July 2, 2010 we exercised the purchased put option and liquidated the $16.8 million ARS. A gain of $38,000 on liquidation is recorded in “valuation gain, net” in the consolidated statements of operation for the three months ended August 1, 2010.

In October 2008, we entered into an agreement with UBS, which provided 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 were a separate freestanding instrument accounted for separately from the ARS, and were registered, nontransferable securities accounted for as a purchased put option initially recorded at fair value. 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, the ARS previously reported as available-for-sale were transferred to trading securities.

The purchased put option gave 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. The fair value of the purchased put option at May 2, 2010 represents the difference between the ARS with an estimated time to liquidity of 4.0 years and the ARS with an estimated time to liquidity of 0.2 year as the purchased put option allowed for the acceleration of liquidity and the avoidance of a below-market coupon rate.

We measure fair value in accordance with the provisions in ASC 820-10,Fair Value Measurements and Disclosures(“ASC 820-10”). ASC 820-10 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.

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, net” in the consolidated statement of operations for the three months ended August 2, 2009. 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.

Goodwill impairment

ASC 350-20,Goodwill (“ASC 350-20”), 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. 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.

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ASC 350-20 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 (single 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, our 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. Our estimate 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. Our 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. We also considered our market capitalization on the dates of its impairment tests in determining the fair value of the business.

During fiscal 2010, we conducted our annual goodwill impairment test at December 31, 2009, using the market 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 our common stock. At December 31, 2009, we determined that the fair value of the Company was greater than the net book value of the net assets of the reporting unit and therefore concluded there is no additional impairment of goodwill.

We performed the step one analysis in the first quarter of fiscal 2011 and determined that the fair value of our reporting unit was in excess of the net book value as of August 1, 2010.

Valuation of intangibles and long-lived assets

Our 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). We review our long-lived assets for impairment in accordance with ASC 360-10,Property, Plant and Equipment (“ASC 360-10”). For assets to be held and used, we initiate our 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 our review, no impairment is indicated.

Income taxes

We account for income taxes in accordance with ASC 740-10,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 1, 2010, 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 $1.6 million at August 1, 2010. Our ability to recover our investments in private, non-marketable equity securities and convertible notes and to earn a return on these investments is primarily dependent on how successfully these companies are able to execute on their business plans and how well their products are accepted, as well as their ability to obtain additional capital funding to continue operations.

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Under our accounting policy, the carrying value of a non-marketable investment is the amount paid for the investment unless it has been determined to be other than temporarily impaired, in which case we write the investment down to its estimated fair value. For equity investments where our ownership interest is between 20% to 50%, or where we 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 $34,000 and $0.1 million, respectively, for the three months ended August 1, 2010 and August 2, 2009.

Results of Operations

Revenue

Revenue is comprised of licenses revenue, bundled licenses and services revenue, and services revenue. Licenses revenue consists of fees for time-based or perpetual licenses of our software products. Bundled licenses and services revenue consists of fees for software licenses and post-contract customer support (“PCS”) where we do not have VSOE of fair value of PCS. Services revenue consists of fees for services, such as customer training, consulting and PCS associated with licenses where we have established VSOE to account for services separately. We recognize revenue based on the specific terms and conditions of the license contracts with our customers 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 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

Licenses revenue is divided into the following categories:

• Ratable

• Due & Payable

• Up-Front

• Cash Receipts

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.

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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. 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 as we receive cash payments from these customers to the extent that revenue has otherwise been earned. 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 current period as “Up-front” revenue, for management reporting and analysis purposes. All other types of revenue are generally referred to as revenue from backlog, such as license revenue recognized during the current period from perpetual or time-based licenses from contracts entered into in prior periods. 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.

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.

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Revenue, cost of revenue and gross profit

The table below sets forth the fluctuations in revenue, cost of revenue and gross profit data by category as defined for management reporting and analysis purposes for the three months ended August 1, 2010 and August 2, 2009 (in thousands, except for percentage data):

Three Months Ended:	August 1, 2010		% of Revenue		August 2, 2009		% of Revenue		Dollar Change			% Change
Revenue
Licenses revenue **
Ratable	$	6,017	18	%	$	7,119	24	%	$	(1,102	)	(15	)%
Due & Payable		12,240	38	%		10,053	35	%		2,187		22	%
Up-Front*		3,210	10	%		850	3	%		2,360		278	%
Cash Receipts		2,838	9	%		2,275	8	%		563		25	%
Total Licenses revenue		24,305	75	%		20,297	70	%		4,008		20	%
Services revenue **		8,251	25	%		8,544	30	%		(293	)	(3	)%
Total Revenue		32,556	100	%		28,841	100	%		3,715		13	%
Cost of Revenue
License		936	3	%		1,006	3	%		(70	)	(7	)%
Services		3,806	12	%		3,831	13	%		(25	)	(1	)%
Total cost of sales		4,742	15	%		4,837	17	%		(95	)	(2	)%
Gross Profit	$	27,814	85	%	$	24,004	83	%	$	3,810		16	%

* Includes $2,127 or 7% and $763 or 3% of total revenue from new contracts for the three months ended August 1, 2010 and August 2, 2009, respectively.

** Bundled licenses and services in the condensed consolidated statement of operations consisted of $6,178 of license revenue and $1,600 of service revenue for the three months ended August 1, 2010, and $6,158 of license revenue and $1,059 of service revenue for the three months ended August 2, 2009.

We market our products and related services to customers in four geographic regions: North America (Domestic), 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 1, 2010 and August 2, 2009 (in thousands, except for percentage data):

Three Months Ended:	August 1, 2010		% of Revenue		August 2, 2009		% of Revenue		Dollar Change			% Change
Domestic	$	17,917	55	%	$	14,999	52	%	$	2,918		19	%
International:
Europe		1,983	6	%		2,569	9	%		(586	)	(23	)%
Japan		5,819	18	%		3,633	13	%		2,186		60	%
Asia-Pacific (excluding Japan)		6,837	21	%		7,640	26	%		(803	)	(11	)%
Total international		14,639	45	%		13,842	48	%		797		6	%
Total revenue	$	32,556	100	%	$	28,841	100	%	$	3,715		13	%

Revenue

Revenue for first quarter ended August 1, 2010 was $32.6 million, an increase of 13% from first quarter of fiscal 2010.

Licenses revenueincreased by 20% in the three months ended August 1, 2010 as compared to three months ended August 2, 2009. License revenue as a percentage of total revenue increased by 5% compared to the three months ended August 2, 2009. We analyzed the license purchasing trends of our key customers, collectively representing 70% or more of our revenue. The increase in the license revenue was due to enhanced versions of several existing products gaining initial market acceptance, combined with some improvement in economic conditions in the semiconductor industry which resulted in an increase in customer spending compared to an atypical weakness in license revenue for the three months ended August 2, 2009.

• Ratable and Due & Payable revenue combined increased by $1.1 million or 6%, to $18.3 million for the three months ended August 1, 2010 as compared to $17.2 million for the three months ended August 2, 2009. As a percent of total revenue, Ratable and Due & Payable revenue combined decreased by 3% for the three months ended August 1, 2010 as compared to the three months ended August 2, 2009. The decrease as a percent of total revenue is the result of the mix and volume of revenue from backlog from long-term Ratable and Due & Payable contracts recognized during the quarter compared to Up-Front revenue. The mix and volume of contracts is primarily driven by customer requirements and is within our expected target of revenue from backlog.

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• Up-Front revenue increased $2.4 million in the three months ended August 1, 2010 as compared to the three months ended August 2, 2009. Upfront revenue as a percentage of total revenue increased from 3% in the three months ended August 2, 2009 to 10% for the three months ended August 1, 2010. The increase as a percent of total revenue is the result of the mix and volume of Up-Front revenue recognized during the quarter compared to revenue from backlog from long-term Ratable and Due & Payable contracts. The mix and volume of Up-Front contracts is primarily driven by customer requirements and includes $2.1 million, or 7% of total revenue from new contracts entered into in the quarter, and is within our target of 10% or less of total revenue.

• Cash Receipts revenue increased during the three months ended August 1, 2010 by $0.6 million as compared to the three months ended August 2, 2009. The increase is due to additional customers classified as cash receipts. This increase is the result of a continued concern for the financial condition with respect to some of our customers.

Services revenue decreased by $0.3 million during the three months ended August 1, 2010 as compared to the three months ended August 2, 2009. We believe the fluctuations were a result of timing of customer’s purchase of services.

Domestic revenue increased by $2.9 million or 19% during the three months ended August 1, 2010 as compared to the three months ended August 2, 2009.

International revenue increased by $0.8 million or 6% during the three months ended August 1, 2010 as compared to the three months ended August 2, 2009.

The increase in the domestic and international revenue is due to the improvement in economic conditions in the semiconductor industry which resulted in an increase in customer spending.

One customer accounted for 10% or more of total revenue for each of the fiscal quarters ended August 1, 2010 and August 2, 2009.

Cost of Revenue

Cost of licenses revenue primarily consists of amortization of acquired developed technology and other intangible assets that are fixed in nature, variable expenses such as royalties, and allocated outside sales representative expenses.

Cost of licenses revenue decreased by $0.1 million or 7% during the three months ended August 1, 2010 compared to the three months ended August 2, 2009. Amortization charges related to acquired developed technology and intangible assets decreased during the three months ended August 1, 2010 by $0.3 million as compared to the three months ended August 2, 2009 primarily due to the full amortization of significant intangible assets from acquisitions. The decrease was offset by an increase in the outside sales representative expenses by $0.2 million for the three months ended August 1, 2010, as compared to the three months ended August 2, 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 $25,000 for the three months ended August 1, 2010, as compared to the three months ended August 2, 2009. The change was primarily due to a net decrease in the consulting costs by $70,000 offset by an increase in pre-sale costs and repairs and maintenance costs by $50,000.

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Operating expenses

The table below sets forth operating expense data for the three months ended August 1, 2010 and August 2, 2009 (in thousands, except for percentage data):

Three Months Ended:	August 1, 2010			% of Revenue		August 2, 2009		% of Revenue		Dollar Change			% Change
Operating Expenses
Research and development	$	12,259		38	%	$	11,197	39	%	$	1,062		9	%
Sales and marketing		10,567		32	%		9,770	34	%		797		8	%
General and administrative		4,690		14	%		4,383	15	%		307		7	%
Amortization of intangible assets		256		1	%		305	1	%		(49	)	(16	)%
Restructuring charge		(14	)	—			703	2	%		(717	)	(102	)%
Total operating expenses	$	27,758		85	%	$	26,358	91	%	$	1,400		5	%

Research and development expenseincreased by $1.1 million in the three months ended August 1, 2010 as compared to the three months ended August 2, 2009. The increase was primarily due to an increase in compensation expense of $1.1 million as a result of salary restorations implemented at the beginning of the fiscal year. The increase was also attributable to the increase in stock based compensation by $0.1 million. This was offset by a decrease of $0.3 million related to common expenses, such as information technology and facility related expenses.

Sales and marketing expenseincreased by $0.8 million or 8% in the three months ended August 1, 2010 as compared to the three months ended August 2, 2009. The increase was primarily due to the increase in compensation expense of $0.5 million as a result of salary restorations implemented at the beginning of the fiscal year. The increase is also attributable to the increase in travel and entertainment expenses by $0.3 million; and an increase in marketing related expenses by $0.4 million. The increase was offset by a decrease in common expenses, such as information technology and facility related expenses of $0.3 million.

General and administrative expenseincreased by $0.3 million in the three months ended August 1, 2010 as compared to three months ended August 2, 2009. The increase in the expense was mainly to increase in compensation related expenses due to salary restorations implemented at the beginning of the fiscal year.

Amortization of intangible assets decreased by $49,000 during the three months ended August 1, 2010 as compared to three months ended August 2, 2009 primarily due to several existing developed technologies and patents having been fully amortized prior to or during the three months ended August 1, 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 chargesfor the three months ended August 1, 2010 was $(14,000) as compared to $0.7 million expense for the three months ended August 2, 2009. The reduction in expense recognized during the three months ended August 1, 2010 related to adjustments made to the previously estimated severance amounts. We did not initiate any further restructuring activity in the three months ended August 1, 2010.

Other items

The table below sets forth other data for the three months ended August 1, 2010 and August 2, 2009 (in thousands, except for percentage data):

Three Months Ended:	August 1, 2010			% of Revenue		August 2, 2009			% of Revenue		Dollar Change			% Change
Operating income, net
Interest income	$	29		0	%	$	45		—		$	(16	)	(36	)%
Interest expense and amortization of debt premium		(806	)	(2	)%		(1,157	)	(4	)%		351		(30	)%
Valuation gain, net		38		—			151		1	%		(113	)	(75	)%
Loss on extinguishment of debt		(2,093	)	(6	)%		—		—			(2,093	)	100	%
Other expense, net		(151	)	—			(601	)	(2	)%		450		(75	)%
Total other expense, net	$	(2,983	)	(8	)%	$	(1,562	)	(5	)%	$	(1,421	)	91	%
Provision for income taxes	$	(331	)	(16	)%	$	(396	)	1	%	$	65		(16	)%

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Interest income decreased by 16% in the three months ended August 1, 2010, compared to the three months ended August 2, 2009 primarily due to the lower interest rates on investments in money market funds and lower cash balances.

Interest expense & amortization of debt discount/premiumprimarily represents amortization of debt discount and issuance costs in connection with our 2010 Notes and 2014 Notes and interest on our term debt and line of credit facility. The interest expense increased primarily due to the higher rate of interest on the 2014 Notes as compared to the 2010 Notes, which resulted interest expense to increase by $0.1 million. Additionally, interest expense increased by $0.2 million due to the interest on the $15.0 million term debt that was incurred in the fourth quarter of fiscal 2010. The above increase was offset by a decrease in the debt discount and issuance cost amortization by $0.6 million. During the three months ended August 2, 2009, the amortization expense was related to the debt discount and issuance costs related to the 2010 Notes. For the three months ended August 1, 2010, the amortization expense related to debt issuance costs and was offset by the amortization of the debt premium of the 2014 Notes. This resulted in a lower expense for the first quarter of fiscal 2011.

Valuation gain, netrepresented a net gain of $38,000 in the three months ended August 1, 2010. See“Fair value option” discussion above.

Loss on extinguishment of debt represents loss incurred on the repurchase of $2.75 million of aggregate principal amount of the 2014 Notes for $4.8 million during the three months ended August 1, 2010.

Other expense, netdecreased by $0.5 million in the three months ended August 1, 2010, as compared to the three months ended August 2, 2009, primarily due to a decrease of $0.3 million in foreign exchange loss and a $0.2 million decrease in the loss on strategic investments.

Provision for income taxes.Our effective tax rate was 12% and 10%, in the first quarter of fiscal 2011 and 2010, respectively. Our effective tax rates vary from the U.S. statutory rate primarily due to changes in our U.S. valuation allowance, 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. Income tax expense was $0.3 million, and $0.4 million, in the first quarter of fiscal 2011 and 2010, 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 2009 remain open to examination by the major tax jurisdictions where we operate. At August 1, 2010, 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.

Liquidity and Capital Resources

The table below sets forth certain cash, cash equivalents and short-term investments as of August 1, 2010 and May 2, 2010, and cash flow data for the three months ended August 1, 2010 and August 2, 2009 (in thousands):

	August 1, 2010			May 2, 2010
Cash, cash equivalents and short-term investments	$	33,060		$	74,355
	Three Months Ended
	August 1, 2010			August 2, 2009
Net cash provided by operating activities	$	1,387		$	5,695
Net cash provided by (used in) investing activities	$	15,514		$	(191	)
Net cash used in financing activities	$	(41,360	)	$	(1,662	)

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Our cash and cash equivalents were approximately $33.1 million on August 1, 2010, a decrease of $41.3 million or 56% from cash, cash equivalents and short-term investments of $74.4 million at May 2, 2010, the end of fiscal 2010. The decrease is primarily due to the decrease in cash provided by operating activities of $4.3 million and an increase in the cash used in financing activities by $39.7 million, offset by an increase in the cash provided by investing activities of $15.7 million for the three months ended August 1, 2010 as compared to three months ended August 2, 2009.

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 1, 2010, we held an aggregate of $26.4 million in cash and cash equivalents in the United States and an aggregate of $6.7 million in foreign accounts.

Net cash provided by operating activities

Net cash provided by operating activities decreased by $4.3 million in the three months ended August 1, 2010 compared to three months ended August 2, 2009 due to an increase in costs and expenses of $4.2 million and a decrease in cash from customers by $3.5 million, offset by an increase in accrued and other liabilities of $1.7 million and a decrease in other assets by $1.6 million. The increase in costs and expenses was primarily due to salary restorations implemented at the beginning of the fiscal year and losses incurred on repurchase of our 2014 Notes. Increased sales and marketing activity and salary restoration resulted in an increase in sales and marketing expense of $0.8 million, an increase in research and development by $1.1 million, and an increase in general and administrative expense of $0.3 million.

Net cash provided by (used in) investing activities

Net cash provided by investing activities increased by $15.7 million for the three months ended August 1, 2010 compared to the three months ended August 2, 2009. The increase was primarily due to the cash received on exercise of the purchased put option related to the ARS securities of $16.8 million and decrease of $0.9 million paid for acquisition related earnouts, offset by the release of restricted cash of $1.3 million for acquisition related earnouts and $0.4 million from an increase in purchase of property and equipment.

Net cash used in financing activities

Net cash used in financing activities increased $39.7 million in the three months ended August 1, 2010, compared to the three months ended August 2, 2009. During the three months ended August 1, 2010, we paid the $23.2 million aggregate principal amount of the 2010 Notes; we also used $11.2 million to repay the UBS secured credit line. In addition we purchased 2014 Notes with an aggregate principal value of $2.75 million for $4.8 million and purchased 638,375 shares of common stock on the open market for $2.0 million.

Capital resources

Cash and cash equivalents available for use aggregated a total of $33.1 million at August 1, 2010.

We believe that our existing cash and cash equivalents will be sufficient to repay the current portion of the quarterly term debt installments beginning October 31, 2010 of $0.6 million per quarter and to meet our anticipated operating and working capital expenditure requirements in the ordinary course of business for at least the next 12 months.

On September 11, 2009 we completed an exchange offer pursuant to which an aggregate principal amount of $26.7 million of our 2010 Notes were exchanged for $26.7 million principal amount of newly issued 2014 Notes. As a result of the exchange, approximately $23.2 million aggregate principal amount of the 2010 Notes remained outstanding as at May 2, 2010. We paid the principal balance and the outstanding interest on these 2010 Notes May 15, 2010. On July 2, 2010 we exercised our purchased put option on the ARS and liquidated the $16.9 million of ARS with UBS and used the proceeds to pay the $11.2 million UBS secured credit line. On July 2, 2010, we repurchased $2.75 million of aggregate principal amount of the 2014 Notes, representing approximately 10.3% of the previously outstanding aggregate principal amount of 2014 Notes, in private transactions. These purchases were funded from our working capital. Subsequent to August 1, 2010, we engaged in separately negotiated transactions with certain holders of our 2014 Notes, pursuant to which the holders converted an aggregate principal amount of $10.7 million of the 2014 Notes into 5,955,000 shares of our common stock. As part of this conversion, we also prepaid the note holders a portion of their future interest. From time to time, we may enter into additional transactions in the future with respect to the repurchase or conversion of the $13.2 million remaining balance of convertible notes due May 2014 whenever conditions are sufficiently attractive. We will evaluate any such transactions in light of then-existing market conditions, taking into account our current liquidity and prospects for future access to capital. The amounts involved in any such transactions, individually or in the aggregate, may be material.

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Given the current adverse economic conditions generally, 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. In addition to the actions taken above to reduce our level of outstanding indebtedness as described above, 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 $1.4 million of cash from operations in the three months ended August 1, 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 our existing credit facility. It could be difficult to obtain additional financing on favorable terms, or at all, as the 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. However any of these factors could have a materially adverse impact on our financial position and results of operations.

Term Loan and Revolving Loans

On March 19, 2010, we entered into a new credit facility with Wells Fargo Capital Finance, LLC (the “New Credit Facility”), which replaced our previous $15.0 million secured revolving line of credit facility with Wells Fargo Bank, N.A (the “Credit Facility”). The New Credit Facility provides for a revolving loan not to exceed $15.0 million and a term loan of $15.0 million. The New Credit Facility expires March 19, 2014, and is secured by a first priority interest in all of our assets. The term loan will be repaid in equal quarterly installments of $0.6 million, beginning October 31, 2010.

Under the terms of the New Credit Facility, outstanding borrowings and letter of credit liabilities may not, at any time, exceed the greater of $30.0 million or 40% of all “post-contract support” revenues and “time based license fee” revenues for the preceding twelve-month period. These requirements could, but to date have not, limited our borrowing availability.

The revolving and term loans bear interest at either a LIBOR Rate or a Base Rate, at managements election, in each case determined as follows (plus a margin of 4.50 percentage points): (A) if at a LIBOR Rate, at a per annum rate equal to the LIBOR Rate of the greater of (i) 1.00% per annum or (ii) the one, two or three month LIBOR rate quoted by Bloomberg and (B) if at the Base Rate the greatest of (i) the Federal Funds Rate plus 0.5%, (ii) the three month LIBOR Rate plus 1.0% and (iii) the Wells Fargo prime rate. In addition, we are required to pay fees of 0.5% per annum on the unused amount of the New Credit Facility, 2.5% per annum for each letter of credit issued and quarterly administrative fees of $10,000.

We are required to pay interest and fees monthly, with the outstanding principal amount plus all accrued but unpaid interest and fees payable in full at the maturity date of March 19, 2014.

The proceeds of the New Credit Facility have been used to refinance some of our existing indebtedness, including repayment of the Credit Facility and a portion of our 2010 Notes, and to finance general corporate purposes, including permitted acquisitions and permitted investments, capital expenditures, working capital, letters of credit, and fees and expenses associated with the New Credit Facility.

The New Credit Facility contains covenants that, among other things, limit our ability to create liens, merge, consolidate, dispose of assets, incur indebtedness and guarantees, repurchase or redeem capital stock and indebtedness, make certain investments, acquisitions and capital expenditures, enter into certain transactions with affiliates or change the nature of our business. Events of Default under the New Credit Facility include, but are not limited to, payment defaults, covenant defaults, breaches of representations and warranties, cross defaults to certain other material agreements and indebtedness, bankruptcy and other insolvency events, actual or asserted invalidity of security interests or loan documents, and certain change of control events.

The New 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 1, 2010, we had borrowed $15.0 million of term debt under the New Credit Facility.

As of August 1, 2010, we were in compliance with the financial covenants contained in the New Credit Facility.

We entered into the Credit Facility on October 31, 2008. As amended by the First Amendment dated March 11, 2009, the Second Amendment dated May 21, 2009, and the Third Amendment dated October 1, 2009, the Credit Facility (i) provided for a single revolving line of credit note of up to $15.0 million replacing the two previous $7.5 million revolving line of credit notes, (ii) eliminated the requirement that Magma maintain a minimum accounts receivable borrowing base and cash collateral, and (iii) extended the term of the line of credit to September 30, 2010. The note bore an annual interest rate equal to a fluctuating rate of 3.5% above the one month LIBOR rate on outstanding borrowings. The Credit Facility also, among other things, required that we provide certain financial statements to Wells Fargo, restricted our ability to pay dividends or make other distributions on our stock and required that we maintain certain financial conditions. As described above, the Credit Facility was terminated and replaced with the New Credit Facility in March 2010.

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Convertible notes

On September 11, 2009 we completed an exchange offer pursuant to which an aggregate principal amount of $26.7 million of our 2010 Notes were exchanged for $26.7 million principal amount of newly issued 2014 Notes. As a result of the exchange, approximately $23.2 million principal amount of the 2010 Notes remained outstanding as of May 2, 2010. On May 15, 2010, we repaid the $23.2 million remaining outstanding balance of the 2010 Notes.

Our 2014 Notes mature on May 15, 2014 and bear interest at 6% per annum, with interest payable on May 15 and November 15 of each year, commencing May 15, 2010. The 2014 Notes are convertible into shares of our common stock at an initial conversion price of $1.80 per share, for an aggregate of approximately 14.83 million shares. Upon conversion, the holders of the 2014 Notes will receive shares of our common stock. The 2014 Notes are unsecured senior indebtedness, which rank equally in right of payment to the New Credit Facility and the 2010 Notes. The 2014 Notes are effectively subordinated in right of payment to the New Credit Facility to the extent of the security interest held by Wells Fargo Bank in our assets. After May 15, 2013, we have the option to redeem the 2014 Notes for cash in an amount equal to 100% of the aggregate outstanding principal amount at the time of such redemption.

In July 2010, we repurchased $2.75 million aggregate principal amount of the 2014 Notes, representing approximately 10.3% of the previously outstanding aggregate principal amount of the 2014 Notes, in private transactions. These purchases were funded from our working capital.

Subsequent to the end of the quarter, in August 2010 we engaged in separately negotiated transactions with certain holders of our 2014 Notes. Pursuant to those transactions, the holders converted an aggregate principal amount of $10.7 million of the 2014 Notes into 5,955,000 shares of our common stock. We incurred an inducement fee, which included the accrued interest, of $1.2 million on conversion of the 2014 Notes. The aggregate principal amount of the converted notes represented approximately 45% of the aggregate principal amount of the 2014 Notes outstanding as at August 1, 2010.

Contractual obligations

As of August 1, 2010, our principal contractual obligations are $52.6 million from fiscal 2011 through fiscal 2014. Contractual obligations consist of the operating leases on our office facilities for $6.5 million, $2.0 million in capital lease obligations for computer equipment, $3.5 million of purchase obligations, a term loan of $15.0 million, $1.7 million in letters of credit, and $23.9 million in 2014 Notes. We have no material commitments for capital expenditures and, as a result of the cost reduction plans we initiated in fiscal 2009, we do not anticipate an increase in our capital expenditures and lease commitments. 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 1, 2010. 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, are either unenforceable or not legally binding or are subject to change based on our business decisions.

Our acquisition agreements related to certain business combination and asset purchase transactions obligate us to pay certain contingent cash consideration based on meeting certain financial or project milestones and continued employment of certain employees. The total amount of cash contingent consideration that could be paid under our acquisition agreements, assuming all contingencies are met, was $4.5 million as of August 1, 2010. 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.

Income taxes

As of August 1, 2010 and August 2, 2009, we recorded unrecognized tax benefits of $18.4 million and $27.3 million, respectively, of which $1.7 million and $9.8 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.

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Off-balance Sheet Arrangements

As of August 1, 2010, 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 specified 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 1, 2010.

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 insignificant. Accordingly, no liabilities have been recorded for these agreements as of August 1, 2010.

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 1, 2010.

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 1, 2010. 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 1, 2010, a hypothetical 100 basis point increase in interest rates would not result in a material impact on the fair value of our cash equivalents.

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

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash, cash equivalents, short-term investments and accounts receivable. The Company’s cash, cash equivalents and short-term investments generally consist of government agencies, municipal obligations and money market funds with high-quality financial institutions. Accounts receivable are typically unsecured and are derived from license and service sales. The Company performs ongoing credit evaluations of its customers and maintains allowances for doubtful accounts.

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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 1, 2010, we had approximately $3.6 million of cash and money market funds in foreign currencies. We enter into foreign currency forward contracts to mitigate exposure in movements between the U.S. dollar and foreign currencies. The derivatives do not qualify for hedge accounting treatment under ASC 815. 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 1, 2010 and August 2, 2009, net foreign exchange losses totaled $0.2 million and gains totaled $0.5 million, respectively, and were included in “Other (expense), net” in our 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 quarter ended August 1, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are subject to certain legal proceedings and 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 our consolidated financial statements. However, the results of any litigation or dispute are inherently uncertain and, at August 1, 2010, no estimate could be made of the loss or range of loss, if any, from such litigation matters and disputes. Liabilities are recorded when a loss is probable and the amount can be reasonably estimated. No accrued legal settlement liabilities are recorded on the condensed consolidated balance sheet as of August 1, 2010 or May 2, 2010. Litigation settlement and legal fees are expensed in the period in which they are incurred.

InGenesis Insurance Company v. Magma Design Automation, et al., Case No. 06-5526-JW, in the United States District Court for the Northern District of California, Genesis seeks a declaration of its rights and obligations under an excess directors and officers liability policy for defense and settlement costs arising out of the securities class action against us, in re Magma Design Automation, Inc. Securities Litigation, as well as a related derivative lawsuit. Genesis seeks a return of $5 million it paid towards the settlement of the securities class action and derivative lawsuits from us or from another of our excess directors and officers liability insurers, National Union. We contend that either Genesis or National Union owes the settlement amounts, but not us. The trial court granted summary judgment for us and National Union, finding that Genesis owed the settlement amount. Genesis appealed to the Ninth Circuit Court of Appeals, and we cross-appealed. On July 12, 2010, the court of appeal reversed, ruling that Genesis does not owe the settlement amount under its policy, and remanded the case to the trial court for further proceedings. While there can be no assurance as to the ultimate disposition of the litigation, we do not believe that its resolution will have a material adverse effect on our financial position, results of operations or cash flows.

ITEM 1A. RISK FACTORS

A restated description of the risk factors associated with our business is set forth below. This description 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 2, 2010. We do not believe any of the changes constitute material changes from the risk factors previously disclosed in the Form 10-K for the year ended May 2, 2010.

We have a substantial amount of indebtedness, which could adversely affect our business, operating results or financial condition.

We currently have, and will continue to have for the foreseeable future, a substantial amount of indebtedness. As of August 1, 2010, we had an aggregate principal amount of approximately $41.0 million in outstanding debt, which was comprised of $23.9 million aggregate principal amount of 2014 Notes. On May 15, 2010, we repaid the $23.2 million outstanding 2010 Notes. In addition, as of August 1, 2010, we had outstanding borrowings of $15.0 million of term loans and two letters of credit totaling $1.7 million under our credit facility with Wells Fargo Capital Finance, LLC, which expires on March 19, 2014, and $0.4 million of other indebtedness. In August 2010, we engaged in separately negotiated transactions with certain holders of our 2014 Notes. Pursuant to those transactions, the holders converted an aggregate principal amount of $10.7 million of 2014 Notes into 5,955,000 shares of our common stock and, immediately following such conversion, we had an aggregate principal amount of approximately $13.2 million in outstanding debt. 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 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 which could cause a default under any other indebtedness then outstanding. 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 in our operations, 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 and our competitors with greater access to capital resources;

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

• increase our vulnerability in the event of an increase in interest rates if we must incur new debt to satisfy our obligations under our current indebtedness; 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.

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

As of August 1, 2010, we had cash and cash equivalents, excluding restricted cash, of $33.1 million.

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If adverse semiconductor industry or general economic conditions persist or worsen, we could experience further decreases in revenue. We continued our cost-cutting efforts initiated in fiscal 2009, including reducing the number of employees, capital spending, research and development projects and administrative expenses, 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 begins 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.

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 2014 Notes and under our credit facility with the Wells Fargo Bank, N.A. We may not generate sufficient cash flow from operations to cover our anticipated debt service obligations, including making payments on any outstanding notes or our credit facility. Our ability to meet our future debt service obligations will depend upon our future performance, which will be subject to financial, business and other factors affecting our operations, many of which are beyond our control. Accordingly, we cannot assure 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. 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.

We may 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, or at all. 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 existing $30.0 million credit facility may be adversely affected by our financial condition, results of operations and incurrence or maintenance of additional debt. 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 a $30.0 million credit facility with Wells Fargo Capital Finance, LLC, which consists of a $15.0 million term loan and a $15.0 million revolving loans. The new credit facility replaced the earlier $15.0 million credit facility we entered into with Wells Fargo in October 2008. The new $30.0 million credit facility imposes 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 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 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 from our lenders 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 and could make it difficult for us to obtain other credit facilities or bank lines on comparable terms in the future.

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 quarters. 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 additional sources of financing to repay or restructure our indebtedness or to obtain financing for our operations or investments or may increase the cost of obtaining financing.

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

Twenty percent 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. Moreover, existing customers may seek to renegotiate preexisting contractual commitments due to adverse changes in their own businesses, which may be increasingly likely given the current economic conditions. 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 relatively 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 relatively small number of customers. Although one customer accounted for 10% or more of our consolidated revenue for the first quarter ended August 1, 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 that 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 create additional credit risk.

To gain market share and maintain revenue, we must compete successfully 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.

We currently compete with companies that hold dominant shares in the EDA market, such as Cadence, Synopsys and Mentor. Each of these companies has a longer operating history and significantly greater financial, technical and marketing resources than we do, as well as greater name recognition and a larger installed customer base. Our competitors are better able to offer aggressive discounts on their products, a practice they often employ. Competition and corresponding pricing pressures among EDA vendors or other factors 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.

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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 that 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 the fiscal years ended May 3, 2009 and May 2, 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 and worldwide, 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 and global economies. If the global economic decline continues, 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.

Our industry is subject to cyclical fluctuation, which could affect our operating results.

The electronics industry has historically been subject to 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 cyclical industry downturns could harm our operating results.

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. Consequently, we may incur substantial expense and devote significant management time and effort to develop potential relationships that do not result in agreements or revenues and that may prevent us from pursuing other opportunities.

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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.

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;

• 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 a history of losses, except for fiscal 2003 and fiscal 2004, and had an accumulated deficit of approximately $387.1 million as of August 1, 2010. If we continue to incur losses, the trading price of our stock may decline.

We had an accumulated deficit of approximately $387.1 million as of August 1, 2010. Except for fiscal 2003 and fiscal 2004, we incurred losses in all other fiscal years since our incorporation in 1997. If we continue to incur losses, or if we fail to achieve profitability at levels expected by securities analysts or investors, the market price of our common stock may 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.

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. For another example, we currently face a lawsuit in which one of our insurers, Genesis Insurance Company, seeks the return of $5 million it paid towards the settlement of the putative stockholder and derivative lawsuits that arose out of the Synopsis patent infringement lawsuit. The case is pending and described in more detail in Item 1, “Legal Proceedings”. 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 that 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.

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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, as well as other factors, may cause our stock price to decline sharply and suddenly, 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 family of products, Titan or our other current and future products.

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

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 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 adopt 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.

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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 and cause our operating results to decline.

The semiconductor industry is characterized by rapid technology developments, changes in industry standards and customer requirements and frequent new product introductions and improvements. For our business to be successful, 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.

In particular, the semiconductor industry has recently made significant technological advances in deep sub-micron technology, which 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 in a timely and cost-effective manner 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 research and development expenditures have decreased in recent years, and we may not be able to develop new products or update existing products, which may reduce our revenue growth and net income for several years.

Developing EDA technology and integrating acquired technology into existing platforms is expensive, and these investments often require a long time to generate returns. We devote a substantial portion of our resources to developing new products and enhancing our existing products, conducting product testing and quality assurance testing, improving our core technology and strengthening our technological expertise in the EDA market. We believe that we must continue to devote substantial resources to our research and development efforts to maintain and improve our competitive position. Our research and development expenditures were $12.3 million and $11.2 million for the first quarter of fiscal 2011 and the first quarter of fiscal 2010, respectively. Research and development expenditures for fiscal year 2010 were $47.0 million, compared to $68.8 million for fiscal 2009. If we are required to invest significantly greater resources than anticipated in research and development efforts in the future, our operating expenses would increase. If these increased efforts do not result in a corresponding increase in revenue, or if our recent decrease in research and development expenditure results in a corresponding decrease in revenue, our operating results could decline. Further, research and development expenses are likely to fluctuate from time to time to the extent we make periodic incremental investments in research and development, and these investments may be independent of our level of revenue, which could negatively affect our financial results.

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;

• loss of customers and damage to our reputation;

• increased service costs:

• 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.

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 conditions and other factors. In addition, our stock price has declined significantly in light of our recent financial results.

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Even though we recently exchanged certain stock options of employees for restricted stock units as a means to try to retain employees, such an 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.

In addition, the NASDAQ Marketplace Rules require stockholder approval for new equity compensation plans and significant amendments to existing equity compensation plans, including increases in shares available for issuance under such plans, and prohibit brokers holding shares of our common stock in customer accounts from giving a proxy to vote on equity compensation plans unless the beneficial owner of the shares has given voting instructions. These regulations could make it more difficult for us to grant equity compensation to employees in the future. To the extent that these regulations make it more difficult or expensive to grant equity compensation to employees, we may incur increased compensation costs or find it difficult to attract, retain and motivate employees, which could adversely affect our business.

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. We initiated a restructuring plan in May 2008 for which we incurred restructuring charges of $10.7 million in fiscal 2009 and $2.7 million in fiscal 2010, primarily for employee termination and facility closure costs. It is possible we will make adjustments to our restructuring accrual based on the information we receive during fiscal 2011. 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 1, 2010. 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.

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We have entered into certain indemnification agreements whereby certain of our officers and directors are indemnified for certain events or occurrences while the officer or director is, or was, serving at our request in such capacity. Additionally, in connection with certain of our recent business acquisitions, we agreed to assume, or cause our subsidiaries to assume, indemnification obligations to the officers and directors of the acquired companies. While we have directors and officers insurance that reduces our exposure and enables us to recover a portion of any future amounts paid pursuant to our indemnification obligations to our officers and directors, the maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited. However, as a result of our directors and officers insurance coverage and our belief that our estimated potential exposure to our officers and directors for indemnification liabilities is minimal, no liabilities have been recorded for these agreements as of August 1, 2010. 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.

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;

• post-acquisition discovery of previously unknown liabilities assumed with the acquired business;

• unanticipated litigation in connection with or as a result of an acquisition;

• 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 2011, we generated 45% of our total revenue from sales outside North America, compared to 48% in first quarter of fiscal 2010.

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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.

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.

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 1, 2010, we had approximately $3.6 million of cash and money market funds in foreign currencies. During the third quarter of fiscal 2008, we started entering into foreign exchange forward contracts to mitigate the effects of our currency exposure risk for foreign currency transactions. 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.

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.

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Our ability to use our net operating losses (“NOLs”) and other tax attributes to offset future taxable income could be limited by an ownership change and/or decisions by California and other states to suspend the use of NOLs.

We have significant NOLs, research and development (“R&D”) tax credits, available to offset our future U.S. federal and state taxable income. Those NOLs are subject to limitations imposed by Section 382 of the Internal Revenue Code (and applicable state law). In addition, our ability to utilize any of our NOLs and other tax attributes may be subject to significant limitations under Section 382 of the Internal Revenue Code (and applicable state law) if we undergo an ownership change. In the event of an ownership change, Section 382 imposes an annual limitation (based upon our value at the time of the ownership change, as determined under Section 382 of the Internal Revenue Code) on the amount of taxable income a corporation may offset with NOLs. If we undergo an ownership change, Section 382 would also limit our ability to use R&D tax credits. In addition, if the tax basis of our assets exceeded the fair market value of our assets at the time of the ownership change, Section 382 could also limit our ability to use amortization of capitalized R&D and goodwill to offset taxable income for the first five years following an ownership change. Any unused annual limitation may be carried over to later years until the applicable expiration date for the respective NOLs. As a result, our inability to utilize these NOLs, credits or amortization as a result of any ownership changes could adversely impact our operating results and financial condition.

In addition, California and certain states have suspended use of NOLs for certain taxable years, and other states are considering similar measures. As a result, we may incur higher state income tax expense in the future. Depending on our future tax position, continued suspension of our ability to use NOLs in states in which we are subject to income tax could have an adverse impact on our operating results and financial condition.

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 SEC 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 2014 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 2014 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 2014 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.

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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;

• 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.

Our use of open source software could negatively impact our ability to sell our products.

The products, services or technologies we acquire, license, provide or develop may incorporate or use open source software. We monitor our use of open source software in an effort to avoid unintended consequences, such as reciprocal license grants, patent retaliation clauses, and the requirement to license our products at no cost. There is little or no legal precedent for interpreting the terms of these open source licenses, therefore we may be subject to unanticipated obligations regarding our products that incorporate open source software. In addition, disclosing the content of our source code could limit the intellectual property protection we can obtain or maintain for that source code or the products containing that source code and could facilitate intellectual property infringement claims against us.

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.

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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 Annual Report on Form 10-K, 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, equity markets in general and technology companies’ equities in particular have recently experienced extreme price and trading volume fluctuations that often have been unrelated or disproportionate to the operating performance of individual companies. These 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.

Our certificate of incorporation and bylaws, and Delaware corporate law contain anti-takeover provisions that 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; and

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

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 dilution to our current stockholders upon achievement of various milestones pursuant to our mergers and acquisitions.

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

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, whether the result of global climate change or other factors, could have a material adverse impact on our business, financial condition and/or operating results.

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

Recent Sales of Unregistered Securities

None.

Purchases of Equity Securities by the Issuer

The following table shows repurchases of shares of our common stock in the first quarter of fiscal 2011:

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 3 - May 31, 2010	0		—	0	15,004,464
June 1 - June 30, 2010	0		—	0	15,004,464
July 1 - August 1, 2010	638,375	$	3.07	638,375	13,044,188
	638,375	$	3.07	638,375

* The shares repurchased in the first quarter of fiscal 2011 were under our stock repurchase program that was announced in March 2008 with an authorized level of $20.0 million.

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ITEM 6. EXHIBITS

The following documents are filed as Exhibits to this report:

		Incorporated by Reference				Furnished	Filed
Exhibit
Number	Exhibit Description	Form	File No.	Exhibit	Filing Date	Herewith	Herewith
3.1	Amended and Restated Certificate of Incorporation	10-K	000-33213	3.1	June 28, 2002
3.2	Certificate of Correction to the Amended Certificate of Incorporation	10-K	000-33213	3.2	June 28, 2002
3.3	Amended and Restated Bylaws	10-K	000-33213	3.3	June 28, 2002
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 9, 2010		/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 1, 2010

Exhibit		Incorporated by Reference				Furnished	Filed
Number	Exhibit Description	Form	File No.	Exhibit	Filing Date	Herewith	Herewith
3.1	Amended and Restated Certificate of Incorporation	10-K	000-33213	3.1	June 28, 2002
3.2	Certificate of Correction to the Amended Certificate of Incorporation	10-K	000-33213	3.2	June 28, 2002
3.3	Amended and Restated Bylaws	10-K	000-33213	3.3	June 28, 2002
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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