e10vq

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


(Mark One)
x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2006
OR
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to

Commission file number 0-15867

CADENCE DESIGN SYSTEMS, INC.

(Exact Name of Registrant as Specified in Its Charter)


Delaware		77-0148231
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

2655 Seely Avenue, Building 5, San Jose, California (Address of Principal Executive Offices)		95134 (Zip Code)

(408) 943-1234

Registrant’s Telephone Number, including Area Code

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No

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

Large accelerated filer [ X ] Accelerated filer [ ] Non-accelerated filer [ ]

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

On September 30, 2006, 277,442,870 shares of the registrant’s common stock, $0.01 par value, were outstanding.

PART I. FINANCIAL INFORMATION


Item 1.	Financial Statements

CADENCE DESIGN SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)

ASSETS


	September 30,		December 31,
	2006		2005

Current Assets:
Cash and cash equivalents	$	757,510	$	861,315
Short-term investments		24,628		33,276
Receivables, net of allowance for doubtful accounts of $6,906 and $10,979, respectively		248,624		282,073
Inventories		29,075		28,902
Prepaid expenses and other		84,209		70,736

Total current assets		1,144,046		1,276,302
Property, plant and equipment, net of accumulated depreciation of $602,902 and $549,593, respectively		353,290		356,945
Goodwill		1,268,421		1,232,926
Acquired intangibles, net		126,872		153,847
Installment contract receivables		131,399		102,748
Other assets		255,714		278,544

Total Assets	$	3,279,742	$	3,401,312


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Current portion of long-term debt	$	44,000	$	32,000
Accounts payable and accrued liabilities		199,594		300,586
Current portion of deferred revenue		274,174		273,265

Total current liabilities		517,768		605,851

Long-Term Liabilities:
Long-term portion of deferred revenue		68,320		51,864
Convertible notes		420,000		420,000
Long-term debt		17,000		128,000
Other long-term liabilities		375,290		350,893

Total long-term liabilities		880,610		950,757

Stockholders’ Equity:
Common stock and capital in excess of par value		1,082,450		1,220,736
Deferred stock compensation		----		(90,076	)
Retained earnings		784,398		690,171
Accumulated other comprehensive income		14,516		23,873

Total stockholders’ equity		1,881,364		1,844,704

Total Liabilities and Stockholders’ Equity	$	3,279,742	$	3,401,312

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

CADENCE DESIGN SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)


	Three Months Ended						Nine Months Ended
	September 30,			October 1,			September 30,			October 1,
	2006			2005			2006			2005

Revenue:
Product	$	244,561		$	218,559		$	684,826		$	593,812
Services		34,262			31,684			99,798			93,513
Maintenance		87,325			87,138			268,251			263,504

Total revenue		366,148			337,381			1,052,875			950,829

Costs and Expenses:
Cost of product		14,097			18,565			54,669			62,674
Cost of services		23,034			23,545			70,995			69,632
Cost of maintenance		15,604			15,162			47,514			44,514
Marketing and sales		97,499			96,497			289,064			268,012
Research and development		110,335			100,575			342,133			291,966
General and administrative		35,240			35,108			109,267			101,846
Amortization of acquired intangibles		4,606			13,912			17,982			39,200
Restructuring and other charges		(15	)		3,782			(726	)		34,785
Write-off of acquired in-process technology		----			----			900			9,400

Total costs and expenses		300,400			307,146			931,798			922,029

Income from operations		65,748			30,235			121,077			28,800
Interest expense		(2,959	)		(1,217	)		(9,880	)		(3,943	)
Other income, net		9,993			4,667			53,191			11,356

Income before provision for income taxes and cumulative effect of change in accounting principle		72,782			33,685			164,388			36,213
Provision for income taxes		30,722			12,414			70,579			13,436

Net income before cumulative effect of change in accounting principle		42,060			21,271			93,809			22,777
Cumulative effect of change in accounting principle, net of tax		----			----			418			----

Net income	$	42,060		$	21,271		$	94,227		$	22,777

Net income per share before cumulative effect of change in accounting principle:
Basic	$	0.15		$	0.08		$	0.33		$	0.08

Diluted	$	0.14		$	0.07		$	0.30		$	0.08

Net income per share after cumulative effect of change in accounting principle:
Basic	$	0.15		$	0.08		$	0.34		$	0.08

Diluted	$	0.14		$	0.07		$	0.30		$	0.08

Weighted average common shares outstanding – basic		279,329			281,222			281,077			277,474

Weighted average common shares outstanding – diluted		312,266			317,741			314,190			312,587

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

CADENCE DESIGN SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)


	Nine Months Ended
	September 30,			October 1,
	2006			2005

Cash and Cash Equivalents at Beginning of Period	$	861,315		$	448,517

Cash Flows from Operating Activities:
Net income		94,227			22,777
Adjustments to reconcile net income to net cash provided by operating activities:
Cumulative effect of change in accounting principle		(418	)		----
Depreciation and amortization		113,862			143,725
Stock-based compensation		80,437			32,206
Equity in loss from investments, net		900			6,192
Gain on investments, net		(25,600	)		(16,045	)
Write-down of investment securities		1,429			10,184
Write-off of acquired in-process technology		900			9,400
Non-cash restructuring and other charges		122			2,179
Tax benefit from employee stock transactions		----			3,723
Tax benefit of call options		3,969			1,843
Deferred income taxes		13,697			(5,369	)
Proceeds from the sale of receivables		131,404			129,047
Provisions (recoveries) for losses (gains) on trade accounts receivable and sales returns		(3,727	)		569
Other non-cash items		4,035			3,151
Changes in operating assets and liabilities, net of effect of acquired businesses:
Receivables		77,489			123,076
Installment contract receivables		(195,038	)		(113,688	)
Inventories		(2,777	)		(5,052	)
Prepaid expenses and other		(9,368	)		(17,042	)
Other assets		5,108			(1,873	)
Accounts payable and accrued liabilities		(107,147	)		(49,132	)
Deferred revenue		13,275			(20,028	)
Other long-term liabilities		19,714			(10,232	)

Net cash provided by operating activities		216,493			249,611

Cash Flows from Investing Activities:
Proceeds from sale of available-for-sale securities		5,542			14,921
Proceeds from sale of short-term investments		----			289,225
Purchases of short-term investments		----			(180,975	)
Proceeds from the sale of long-term investments		21,599			6,033
Proceeds from the sale of property, plant and equipment		----			33,625
Purchases of property, plant and equipment		(48,270	)		(49,954	)
Purchases of software licenses		(6,409	)		(500	)
Investment in venture capital partnerships and equity investments		(2,000	)		(9,184	)
Cash paid in business combinations, net of cash acquired, and acquisition of intangibles		(65,352	)		(295,438	)

Net cash used for investing activities		(94,890	)		(192,247	)

Cash Flows from Financing Activities:
Principal payments on long-term debt		(99,000	)		(58	)
Tax benefit from employee stock transactions		7,556			----
Proceeds from issuance of common stock		126,315			109,408
Purchases of treasury stock		(258,384	)		----

Net cash provided by (used for) financing activities		(223,513	)		109,350

Effect of exchange rate changes on cash and cash equivalents		(1,895	)		3,539

Increase (decrease) in cash and cash equivalents		(103,805	)		170,253

Cash and Cash Equivalents at End of Period	$	757,510		$	618,770

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

CADENCE DESIGN SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1. BASIS OF PRESENTATION

The Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q have been prepared by Cadence Design Systems, Inc., or Cadence, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission, or the SEC. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, Cadence believes that the disclosures contained in this Quarterly Report comply with the requirements of Section 13(a) of the Securities Exchange Act of 1934, as amended, for a Quarterly Report on Form 10-Q and are adequate to make the information presented not misleading. These Condensed Consolidated Financial Statements are meant to be, and should be, read in conjunction with the Consolidated Financial Statements and the notes thereto included in Cadence’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005.

The unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q reflect all adjustments (which include only normal, recurring adjustments and those items discussed in these Notes) that are, in the opinion of management, necessary to state fairly the results for the periods presented. The results for such periods are not necessarily indicative of the results to be expected for the full fiscal year.

Preparation of the Condensed Consolidated Financial Statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the Condensed Consolidated Financial Statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cadence adopted the provisions of Statement of Financial Accounting Standards, or SFAS, No. 123R “Share-Based Payment,” on January 1, 2006 using the modified prospective transition method. SFAS No. 123R requires companies to recognize the cost of employee services received in exchange for awards of equity instruments based upon the fair value of those awards on the grant date. Using the modified prospective transition method of adopting SFAS No. 123R, Cadence began recognizing compensation expense for equity-based awards granted on or after January 1, 2006 and unvested awards granted prior to January 1, 2006. Under this method of implementation, no restatement of prior periods is required. However, prior period stock-based expense recognized under Accounting Principles Board Opinion, or APB, No. 25, “Accounting for Stock Issued to Employees” has been reclassified to conform to the current year presentation.

NOTE 2. STOCK-BASED COMPENSATION

Cadence has adopted equity incentive plans that provide for the grant to employees of stock-based awards, including stock options and restricted stock. In addition, the 1995 Directors Plan provides for the automatic grant of stock options to non-employee members of Cadence’s Board of Directors. Cadence also has an employee stock purchase plan, or ESPP, which enables employees to purchase shares of Cadence common stock. As of September 30, 2006, Cadence had 24.7 million shares of common stock remaining and authorized for issuance for awards under its equity incentive plans, the 1995 Directors Plan and the ESPP.

Stock-based compensation expense and the related income tax benefit recognized under SFAS No. 123R in the Condensed Consolidated Statements of Operations in connection with stock options, restricted stock and the ESPP for the three and nine months ended September 30, 2006 were as follows:


	Three		Nine
	Months Ended		Months Ended
	September 30, 2006		September 30, 2006
	(In thousands)

Stock-based compensation expense	$	24,273	$	80,437
Income tax benefit	$	7,738	$	24,969

The estimated fair value of Cadence’s stock-based awards, less expected forfeitures, is amortized over the awards’ vesting period, generally on a straight-line basis. The stock-based compensation expense for the three and nine months ended September 30, 2006 that would have been included in Cadence’s Condensed Consolidated Statements of Operations under the provisions of APB No. 25 were as follows:


	Three		Nine
	Months Ended		Months Ended
	September 30, 2006		September 30, 2006
	(In thousands)

Restricted stock	$	9,250	$	27,999
Options assumed in connection with prior acquisitions		2,235		6,952
Liability-based stock awards		1,776		6,611

Total stock-based compensation under APB No. 25	$	13,261	$	41,562

The adoption of SFAS No. 123R had the following impact on Cadence’s Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2006:


	Three		Nine
	Months Ended		Months Ended
	September 30, 2006		September 30, 2006
	(In thousands, except per share amounts)

Income before taxes	$	(11,012)	$	(38,875)
Net income	$	(7,498)	$	(28,007)
Basic net income per share	$	(0.03)	$	(0.10)
Diluted net income per share	$	(0.02)	$	(0.10)
Net cash provided by operating activities	$	(383)	$	(7,556)

As required by SFAS No. 123R, on January 1, 2006, Cadence eliminated the unamortized Deferred stock compensation of $90.1 million, which in turn reduced Common stock and capital in excess of par value by the same amount, which had been included in Stockholders’ Equity in Cadence’s Condensed Consolidated Balance Sheet as of December 31, 2005.

Cadence’s stock-based compensation expense during the three and nine months ended September 30, 2006 was as follows:


	Three		Nine
	Months Ended		Months Ended
	September 30, 2006		September 30, 2006
	(In thousands)

Stock options	$	11,354	$	38,216
Restricted stock		11,027		34,611
ESPP		1,892		7,610

Total stock-based compensation expense	$	24,273	$	80,437

Stock Options

The exercise price of each stock option granted under one of Cadence’s equity incentive plans equals the market price of Cadence’s common stock on the date of grant. Generally, option grants vest over four years, expire no later than ten years from the grant date and are subject to the employee’s continuing service to Cadence. The options granted under the 1995 Directors Stock Option Plan vest one year from the date of grant. Options assumed in connection with acquisitions generally have exercise prices that differ from the fair value of Cadence’s common stock on the date of acquisition and such options generally continue to vest under their original vesting schedule and expire on the original dates stated in the acquired company’s option agreements. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model. The weighted average grant date fair value of options granted during the three and nine months ended September 30, 2006 was $5.16 and $5.62, respectively. The weighted average assumptions used in the model for the three and nine months ended September 30, 2006, are outlined in the following table:


	Three	Nine
	Months Ended	Months Ended
	September 30, 2006	September 30, 2006

Dividend yield	None	None
Expected volatility	24.1%	24.6%
Risk-free interest rate	4.59%	4.83%
Expected life (in years)	5.3	5.4

The computation of the expected volatility assumption used in the Black-Scholes pricing model for new grants is based on implied volatility. When establishing the expected life assumption, Cadence reviews annual historical employee exercise behavior of option grants with similar vesting periods. The risk-free interest rate for the period within the expected life of the option is based on the yield of five-year United States Treasury notes at the time of grant.

A summary of the changes in stock options outstanding under Cadence’s equity incentive plans during the nine months ended September 30, 2006 is presented below:


						Weighted
						Average
						Remaining
				Weighted		Contractual		Aggregate
				Average		Terms		Intrinsic
	Shares			Exercise Price		(Years)		Value
	(In thousands, except per share amounts)


Options outstanding at December 31, 2005		63,946			$ 15.26		6.2		$ 197,215
Acquired options		306			$ 1.93
Granted		4,069			$ 16.99
Exercised		(6,880	)		$ 12.29
Canceled and forfeited		(4,384	)		$ 20.35

Options outstanding at September 30, 2006		57,057			$ 15.29		6.0		$ 164,216

Options vested at September 30, 2006		41,617			$ 15.65		5.1		$ 120,269

Options vested at September 30, 2006 and options expected to vest after September 30, 2006		54,609			$ 15.30		5.8		$ 158,812

The total intrinsic value of options exercised during the three and nine months ended September 30, 2006 was $3.7 and $32.1 million, respectively. Cash received from stock option exercises during the three and nine months ended September 30, 2006 was $9.5 and $84.6 million, respectively.

Restricted Stock

The cost of restricted stock awards is determined using the fair value of Cadence’s common stock on the date of the grant, and compensation expense is recognized over the vesting period. Generally, restricted stock awards vest over four years and are subject to the employee’s continuing service to Cadence.

Cadence issues some of its restricted stock with performance-based vesting. The terms of these restricted stock grants are consistent with grants of restricted stock described above, with the exception that they vest not upon the mere passage of time, but upon the attainment of certain predetermined performance goals. Each period, Cadence estimates the most likely outcome of such performance goals and recognizes the related stock-based compensation expense. The amount of stock-based compensation expense recognized in any one period can vary based on the attainment or estimated attainment of the various performance goals. If such performance goals are not met, no compensation expense is recognized and any previously recognized compensation expense is reversed.

A summary of the changes in restricted stock outstanding under Cadence’s equity incentive plans during the nine months ended September 30, 2006 is presented below:


						Weighted
						Average
				Weighted		Remaining
				Average		Contractual		Aggregate
				Grant Date		Terms		Intrinsic
	Shares			Fair Value		(Years)		Value
	(In thousands, except per share amounts)

Non-vested shares at December 31, 2005		6,439		$	15.40			$	108,947
Granted		1,380		$	16.75
Vested		(1,530	)	$	14.97
Forfeited		(219	)	$	15.42

Non-vested shares at September 30, 2006		6,070		$	15.81		2.4	$	102,955

Non-vested shares expected to vest after September 30, 2006		5,352		$	15.75		2.3	$	90,776

As of September 30, 2006, Cadence had $61.0 million of total unrecognized compensation expense, net of estimated forfeitures, related to restricted stock grants, which amount will be recognized over the remaining weighted average vesting period of 2.6 years. The total fair value of restricted stock that vested during the three and nine months ended September 30, 2006 was $7.3 million and $23.0 million, respectively.

Cumulative effect of change in accounting principle, net of tax

During the nine months ended September 30, 2006, a non-cash benefit of approximately $0.4 million for estimated forfeitures of restricted stock previously expensed was recorded as of the SFAS No. 123R implementation date as a one-time cumulative effect of change in accounting principle, net of tax. Pursuant to APB No. 25, stock-based compensation expense was not previously reduced for estimated future forfeitures, but instead was reversed upon actual forfeiture.

Employee Stock Purchase Plan

Under the ESPP, substantially all employees may purchase Cadence’s common stock at a price equal to 85 percent of the lower of the fair market value at the beginning of the applicable offering period or at the end of each applicable purchase period. The offering periods under the ESPP that began prior to August 1, 2006 were concurrent 24-month offering periods. Each offering period was divided into four consecutive six-month purchase periods. All offering periods that started before August 1, 2006 will continue until they are completed or until they are terminated as provided in the documents governing the ESPP. Participants in the ESPP will remain in the 24-month offering periods until these offering periods are completed or until such participant withdraws from the ESPP, whichever is earlier. Effective August 1, 2006, offering periods under the ESPP are six months long with a corresponding six month purchase period. New offerings begin on each August 1^st and February 1^st, and those offerings run consecutively rather than concurrently. Participants will be converted to the six-month offering periods starting with the next offering period in which the participants enroll on or after August 1, 2006.

The following table presents the shares of common stock issued under the ESPP for the three and nine months ended September 30, 2006:


	Three		Nine
	Months Ended		Months Ended
	September 30, 2006		September 30, 2006
	(In thousands, except per share amounts)

Cadence shares issued under the ESPP		1,812		3,640
Cash received from the exercise of purchase rights under Cadence’s ESPP	$	20,831	$	41,619
Weighted average purchase price per share	$	11.49	$	11.43

Compensation expense is calculated using the fair value of the employees’ purchase rights under the Black-Scholes option pricing model. Based on the Black-Scholes model, the weighted average estimated grant date fair value of purchase rights granted under the ESPP was $3.60 for the three months ended September 30, 2006 and $4.32 for the nine months ended September 30, 2006. The weighted average assumptions used in the model for the three and nine months ended September 30, 2006 are outlined in the following table:


	Three		Nine
	Months Ended		Months Ended
	September 30, 2006		September 30, 2006

Dividend yield		None		None
Expected volatility		24.1%		24.0%
Risk-free interest rate		5.18%		4.89%
Expected life (in years)		0.5		1.1

The computation of the expected volatility assumption used in the Black-Scholes pricing model for purchase rights is based on implied volatility. The expected life assumption is based on the average exercise date for the purchase periods in each offering period. The risk-free interest rate for the period within the expected life of the purchase right is based on the yield of United States Treasury notes in effect at the time of grant.

Tax Effects of Share-Based Compensation Awards

In November 2005, the Financial Accounting Standards Board, or FASB, issued Financial Statement Position, or FSP, on SFAS No. 123R-3, “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards.” Effective upon issuance, FSP No. 123R-3 provides for an alternative transition method for calculating the tax effects of stock-based compensation expense pursuant to SFAS No. 123R. The alternative transition method provides simplified approaches to establish the beginning balance of a tax benefit pool comprised of the additional paid-in capital, or APIC, related to the tax effects of employee stock-based compensation expense, and to determine the subsequent impact on the APIC tax benefit pool and the statement of cash flows of stock-based awards that were outstanding upon the adoption of SFAS No. 123R. Upon adoption of SFAS No. 123R, Cadence made the election to calculate the tax effects of stock-based compensation expense using the alternative transition method pursuant to FSP No. 123R-3 and computed the beginning balance of the APIC tax benefit pool by applying the simplified method, which resulted in an APIC tax benefit pool windfall position. Accordingly, upon adoption of SFAS No. 123R, Cadence had cumulative excess tax benefits from stock-based compensation available in APIC that could be used to offset an equal amount of future tax shortfalls (i.e., when the amount of the tax deductible stock-based compensation is less than the related stock-based compensation cost).

Stock-Based Compensation for the Three and Nine Months Ended October 1, 2005

During the three and nine months ended October 1, 2005, Cadence measured compensation expense for its employee stock-based compensation plans using the intrinsic value method under APB No. 25 and related interpretations. Cadence recognized in its Condensed Consolidated Statements of Operations $4.6 and $10.6 million of stock-based compensation expense for the intrinsic value of options Cadence assumed in connection with

acquisitions and $9.3 and $21.6 million of stock-based compensation expense for the intrinsic value of restricted stock awarded during the three and nine months ended October 1, 2005, respectively.

During the three and nine months ended October 1, 2005, Cadence followed the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended. The following table illustrates the effect on net income and net income per share for the three and nine months ended October 1, 2005 as if the fair value recognition provisions of SFAS No. 123, as amended, had been applied to options granted under Cadence’s equity incentive plans. For purposes of this pro forma disclosure, the estimated value of each option is recognized over the option’s vesting period. If Cadence had recognized the expense of the equity programs in the Condensed Consolidated Statements of Operations, additional paid-in capital would have increased by a corresponding amount, net of applicable taxes.


	Three			Nine
	Months Ended			Months Ended
	October 1, 2005			October 1, 2005
	(In thousands)

Net income (loss)
As reported	$	21,271		$	22,777
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects		11,242			27,630
Deduct: Stock-based employee compensation expense determined under fair-value method for all awards, net related tax effects		(26,170	)		(71,909	)

Pro forma net income (loss)	$	6,343		$	(21,502	)

Net income per share as reported:
Basic	$	0.08		$	0.08
Diluted	$	0.07		$	0.08
Pro forma net income (loss) per share:
Basic	$	0.02		$	(0.08	)
Diluted	$	0.02		$	(0.08	)

Cadence corrected an error in its disclosure for the three and nine months ended October 1, 2005 in stock-based compensation expense determined under the fair-value method for all awards, net of related tax effects, which correction resulted in a $11.2 million increase in stock-based employee compensation expense for the three months ended October 1, 2005 and a $27.6 million increase in stock-based employee compensation expense for the nine months ended October 1, 2005, and a $11.2 million decrease to pro forma net income for the three months ended October 1, 2005 and a $27.6 million increase to pro forma net loss for the nine months ended October 1, 2005.

For purposes of the weighted average estimated fair value calculations, the fair value of each stock option grant was estimated on the date of grant using the Black-Scholes option pricing model and the following assumptions:


	Three	Nine
	Months Ended	Months Ended
	October 1, 2005	October 1, 2005

Dividend yield	None	None
Expected volatility	23.0%	26.0%
Risk-free interest rate	4.18%	4.07%
Expected life (in years)	4.50	4.90

Based on the Black-Scholes option pricing model, the weighted average estimated fair value of employee stock option grants was $2.98 for the three months ended October 1, 2005 and $4.39 for the nine months ended October 1, 2005.

The following table presents the shares of common stock issued under Cadence’s ESPP for the three and nine months ended October 1, 2005:


	Three		Nine
	Months Ended		Months Ended
	October 1, 2005		October 1, 2005
	(In thousands, except per share amounts)

Cadence shares issued under the ESPP		1,573		3,913
Weighted average purchase price per share	$	11.22	$	9.73

Weighted average fair value per share	$	16.09	$	14.44

NOTE 3. ACQUISITIONS

In March 2006, Cadence acquired a company for an aggregate initial purchase price of $25.8 million, which included the payment of cash, the fair value of assumed options and acquisition costs. The $17.5 million of goodwill recorded in connection with this acquisition is not expected to be deductible for income tax purposes. The acquired company’s results of operations and the estimated fair values of the assets acquired and liabilities assumed have been included in Cadence’s Condensed Consolidated Financial Statements from the date of acquisition. Comparative pro forma financial information for the acquisition has not been presented because the effect on results of operations was not material to Cadence’s Condensed Consolidated Financial Statements.

For many of Cadence’s acquisitions, payment of a portion of the purchase price is contingent upon the acquired entity’s achievement of certain performance goals, which relate to one or more of the following criteria: revenue, bookings, product proliferation, product development and employee retention. The portion of the contingent purchase price, or earnout, associated with employee retention is recorded as compensation expense. The portion of the earnout that is not associated with employee retention is recorded as goodwill. The specific performance goal levels, and amounts and timing of earnout payments, vary with each acquisition.

During the nine months ended September 30, 2006, Cadence recorded $18.3 million of goodwill for achieved earnouts payable to former stockholders of acquired companies. Cash payments of the entire $18.3 million were made during the nine months ended September 30, 2006. In addition, Cadence recorded $0.1 million and $1.2 million in compensation expense related to these earnouts during the three and nine months ended September 30, 2006, respectively.

In connection with Cadence’s acquisitions completed prior to September 30, 2006, Cadence may be obligated to pay up to an aggregate of $5.0 million in cash during the next 12 months and an additional $2.0 million in cash in periods after the next 12 months through August 2008 if certain performance goals related to one or more of the above mentioned criteria are achieved in full.

NOTE 4. GOODWILL AND ACQUIRED INTANGIBLES

Goodwill

In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” Cadence conducts an annual impairment analysis of goodwill, which it completed during the third quarter of 2006. Based on the results of the impairment review, Cadence has determined that no indicators of impairment existed during 2006.

For purposes of SFAS No. 142, Cadence operates under one reporting unit. Cadence’s annual impairment review process compares the fair value of its reporting unit to its carrying value, including the goodwill related to the reporting unit. To determine the reporting unit’s fair value, Cadence utilized the market valuation approach in the current year evaluation.

The market approach provides an estimate of the fair value of Cadence based on the total number of shares of Cadence common stock outstanding, multiplied by the price per share. The estimated fair value is then compared to the carrying value of Cadence’s net assets. If the carrying value of Cadence’s net assets is greater than the aggregate

market value of its outstanding shares of common stock, additional fair value analyses are performed on the individual intangible assets, including goodwill, to determine if any intangible assets are impaired, and, if so, an impairment charge is recorded.

The changes in the carrying amount of goodwill for the nine months ended September 30, 2006 are as follows:


	(In thousands)

Balance as of December 31, 2005	$	1,232,926
Goodwill resulting from the acquisition during the period		17,493
Additions due to earnouts		18,275
Other		(273	)

Balance as of September 30, 2006	$	1,268,421

Acquired Intangibles, net

Acquired intangibles with finite lives as of September 30, 2006 and December 31, 2005 were as follows:


	As of September 30, 2006						As of December 31, 2005
					Weighted						Weighted
					Average						Average
	Gross Carrying		Accumulated		Remaining		Gross Carrying		Accumulated		Remaining
	Amount		Amortization		Useful Life		Amount		Amortization		Useful Life
	(In thousands)						(In thousands)

Existing technology and backlog	$	630,512	$	(567,446)		2.5 Years	$	623,360	$	(527,858)		2.5 Years
Agreements and relationships		64,579		(40,904)		4.2 Years		63,807		(33,824)		4.4 Years
Distribution rights		30,100		(9,782)		6.8 Years		30,100		(7,525)		7.5 Years
Tradenames, trademarks and patents		26,634		(6,821)		4.6 Years		11,034		(5,247)		4.9 Years

Total acquired intangibles	$	751,825	$	(624,953)		3.8 Years	$	728,301	$	(574,454)		3.7 Years

Cadence acquired intangible assets of $23.5 million during the nine months ended September 30, 2006, of which $8.5 million was acquired in connection with the acquisition described in Note 3. The remainder is included in Tradenames, trademarks and patents in the above table.

For the three months ended September 30, 2006, amortization of acquired intangibles was $12.2 million, as compared to $29.2 million for the three months ended October 1, 2005. For the nine months ended September 30, 2006, amortization of acquired intangibles was $50.5 million, as compared to $83.4 million for the nine months ended October 1, 2005. Amortization of costs from existing technology is included in Cost of product and Cost of services. Amortization of costs from acquired maintenance contracts is included in Cost of maintenance.

Estimated amortization expense for the fiscal years:


	(In thousands)
2006 – remaining period	$	12,802
2007		42,248
2008		29,535
2009		20,288
2010		10,079
Thereafter		11,920

Total estimated amortization expense	$	126,872

NOTE 5. RESTRUCTURING AND OTHER CHARGES

Cadence initiated a separate plan of restructuring in each year from 2001 through 2005 in an effort to reduce operating expenses and improve operating margins and cash flows. The restructuring plans initiated each year from 2001 through 2005, or the 2001 Restructuring, 2002 Restructuring, 2003 Restructuring, 2004 Restructuring and 2005 Restructuring, respectively, were intended to decrease costs through workforce reductions and facility and resource consolidation, in order to improve Cadence’s cost structure. The 2001 and 2002 Restructurings primarily related to Cadence’s design services business and certain other business or infrastructure groups throughout the world. The 2003 Restructuring, 2004 Restructuring and 2005 Restructuring were targeted at reducing costs throughout the company. The 2004 Restructuring has been completed and there was no remaining balance accrued for this restructuring as of September 30, 2006.

Cadence accounts for restructuring charges in accordance with SEC Staff Accounting Bulletin No. 100, “Restructuring and Impairment Charges,” as amended. The individual components of the restructuring activities initiated prior to fiscal year 2003 were accounted for in accordance with Emerging Issues Task Force, or EITF, No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring),” and EITF No. 88-10, “Costs Associated with Lease Modifications or Terminations.”

For restructuring activities initiated after fiscal year 2002, Cadence accounted for costs associated with leased facilities in accordance with SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities.” In addition, for all periods presented, Cadence accounted for the asset-related portions of these restructurings in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” For all periods presented, the severance and benefits charges were accounted for in accordance with SFAS No. 112, “Employers’ Accounting for Postemployment Benefits – An Amendment of FASB Statements No. 5 and 43.”

Facility closure and office space reduction costs included in these restructurings were comprised of payments required under leases, less any applicable estimated sublease income after the properties were abandoned, lease buyout costs and other contractual charges. To estimate the lease loss, which is the loss after Cadence’s cost recovery efforts from subleasing all or part of a building, Cadence management made certain assumptions related to the time period over which the relevant building would remain vacant and sublease terms, including sublease rates and contractual common area charges.

Since 2001, Cadence has recorded facilities consolidation charges of $97.1 million related to office space reductions or facility closures of 49 sites. As of September 30, 2006, 28 of these sites had been vacated and office space reductions had occurred at the remaining 21 sites. Cadence expects to pay remaining facilities-related restructuring liabilities for all of its restructuring plans prior to 2016.

As of September 30, 2006, Cadence’s accrued estimate of the lease loss related to all worldwide restructuring activities initiated since 2001 was $31.5 million. This amount may be adjusted in the future based upon changes in the assumptions used to estimate the lease loss. The lease loss could be as high as $35.1 million if sublease rental rates decrease in applicable markets or if it takes longer than currently expected to find a suitable tenant to sublease the facilities.

Total restructuring costs accrued as of September 30, 2006 were $31.5 million, consisting solely of lease losses, of which $4.7 million was Accounts payable and accrued liabilities and $26.8 million was Other long-term liabilities.

Restructuring and other charges for the three months ended September 30, 2006 were as follows:


	Severance
	and		Excess
	Benefits		Facilities			Total
	(In thousands)

2005 Plan	$	----	$	42		$	42
2003 Plan		----		(57	)		(57	)

Total	$	----	$	(15	)	$	(15	)

Restructuring and other charges for the nine months ended September 30, 2006 were as follows:


	Severance
	and			Excess
	Benefits			Facilities			Total
	(In thousands)

2005 Plan	$	(106	)	$	6		$	(100	)
2003 Plan		----			(239	)		(239	)
2002 Plan		----			(363	)		(363	)
2001 Plan		----			(24	)		(24	)

Total	$	(106	)	$	(620	)	$	(726	)

Restructuring and other charges for the three months ended October 1, 2005 were as follows:


	Severance
	and		Asset-		Excess
	Benefits		Related		Facilities		Total
	(In thousands)

2005 Plan	$	1,166	$	302	$	230	$	1,698
2003 Plan		----		----		2,084		2,084

Total	$	1,166	$	302	$	2,314	$	3,782

Restructuring and other charges for the nine months ended October 1, 2005 were as follows:


	Severance
	and			Asset-		Excess
	Benefits			Related		Facilities			Total
	(In thousands)

2005 Plan	$	20,832		$	2,401	$	1,959		$	25,192
2004 Plan		(343	)		----		----			(343	)
2003 Plan		----			----		4,613			4,613
2002 Plan		----			----		(411	)		(411	)
2001 Plan		----			----		5,734			5,734

Total	$	20,489		$	2,401	$	11,895		$	34,785

2005 Restructuring

During the year ended December 31, 2005, Cadence reduced its workforce by approximately 300 employees, including approximately 65 employees in its European design services business, and consolidated facilities and resources throughout the company. Costs resulting from the 2005 Restructuring included severance payments, severance-related benefits, outplacement services, lease costs associated with facilities vacated and downsized, and charges for assets written off as a result of the restructuring.

The following table presents the activity associated with restructuring and other charges related to the 2005 Restructuring for the three months ended September 30, 2006:


	Severance
	and		Excess
	Benefits		Facilities			Total
	(In thousands)

Balance, July 1, 2006	$	----	$	1,326		$	1,326
Restructuring and other charges, net		----		42			42
Non-cash charges		----		10			10
Cash payments		----		(80	)		(80	)
Effect of foreign currency translation		----		4			4

Balance, September 30, 2006	$	----	$	1,302		$	1,302

The following table presents the activity associated with restructuring and other charges related to the 2005 Restructuring for the nine months ended September 30, 2006:


	Severance
	and			Excess
	Benefits			Facilities			Total
	(In thousands)

Balance, December 31, 2005	$	102		$	1,590		$	1,692
Restructuring and other charges, net		(106	)		6			(100	)
Non-cash charges		----			27			27
Cash payments		(1	)		(350	)		(351	)
Effect of foreign currency translation		5			29			34

Balance, September 30, 2006	$	----		$	1,302		$	1,302

2003 Restructuring, 2002 Restructuring and 2001 Restructuring

The remaining balances for the 2003 Restructuring, 2002 Restructuring and 2001 Restructuring relate to lease obligations for facilities vacated and downsized as part of these restructurings. The following table presents the activity associated with restructuring and other charges related to the 2003 Restructuring, 2002 Restructuring and 2001 Restructuring for the three months ended September 30, 2006:


	2003			2002			2001
	Restructuring			Restructuring			Restructuring			Total
	(In thousands)

Balance, July 1, 2006	$	6,803		$	5,793		$	18,912		$	31,508
Restructuring and other charges, net		(57	)		----			----			(57	)
Non-cash charges		30			----			----			30
Cash payments		(316	)		(282	)		(1,009	)		(1,607	)
Effect of foreign currency translation		69			3			213			285

Balance, September 30, 2006	$	6,529		$	5,514		$	18,116		$	30,159

The following table presents the activity associated with restructuring and other charges related to the 2003 Restructuring, 2002 Restructuring and 2001 Restructuring for the nine months ended September 30, 2006:


	2003			2002			2001
	Restructuring			Restructuring			Restructuring			Total
	(In thousands)

Balance, December 3l, 2005	$	8,038		$	6,622		$	18,556		$	33,216
Restructuring and other charges, net		(239	)		(363	)		(24	)		(626	)
Non-cash charges		95			----			----			95
Cash payments		(1,884	)		(751	)		(1,710	)		(4,345	)
Effect of foreign currency translation		519			6			1,294			1,819

Balance, September 30, 2006	$	6,529		$	5,514		$	18,116		$	30,159

NOTE 6. TERM LOAN

On December 19, 2005, Castlewilder, a company incorporated in Ireland and a wholly-owned subsidiary of Cadence, entered into a syndicated term facility agreement, or Credit Agreement, with Banc of America Securities LLC as lead arranger, and Bank of America, N.A., as Administrative Agent. The Credit Agreement provides for a three-year $160.0 million unsecured term loan, or Term Loan. With the consent of all of the lenders, Castlewilder may, at the end of the second year of the loan, extend the maturity date to December 31, 2009.

Under the Credit Agreement, Castlewilder has the option to choose between two interest rates: (i) a base rate equal to the higher of the Federal Funds Rate plus 0.50% or the “prime rate” publicly announced by Bank of America, N.A., or (ii) a LIBOR-based rate equal to LIBOR plus 0.625%. The loan initially was a base rate loan that converted on December 22, 2005 into a LIBOR-based rate loan, which accrued interest monthly at an annual rate of 6.04% as of September 30, 2006. Castlewilder may, at its discretion, change the interest rate election each Interest Period, as defined in the Credit Agreement. The margin with respect to the Term Loan (if the loan is a LIBOR loan) may be increased or decreased depending upon Cadence’s consolidated leverage ratio.

Castlewilder is obligated to repay the outstanding principal amount of the Term Loan in quarterly installments in amounts equal to $8.0 million per quarter during 2006, $12.0 million per quarter during 2007 and $20.0 million per quarter during 2008 (with the quarterly repayment amount to be adjusted to $10.0 million per quarter during 2008 and 2009 if the maturity date of the loan is extended). Castlewilder is also obligated to pay accrued interest on the last day of each month or other interest period that Castlewilder may select under the terms of the Term Loan. If the Term Loan is converted into a base rate loan, Castlewilder is obligated to pay accrued interest on the last day of each quarter. Under the terms of the Term Loan, Castlewilder, at its election, may prepay the loan, in whole or in

part, with no prepayment fee. Pursuant to the Credit Agreement, any prepayment of the Term Loan will first be applied to the last remaining scheduled but unpaid principal installment.

During the nine months ended September 30, 2006, Castlewilder made its quarterly principal payments of $24.0 million, plus additional prepayments of $75.0 million, reducing the amount due in 2008. As of September 30, 2006, scheduled principal payments on the Term Loan are as follows:


	(In thousands)

2006 – remaining period	$	8,000
2007		48,000
2008		5,000

Total		61,000
Less: Current portion of long-term debt		(44,000	)

Long-term debt	$	17,000

Cadence has unconditionally guaranteed Castlewilder’s obligations under the Term Loan, and the Term Loan may become in default if Cadence fails to perform certain commitments set forth in the guaranty.

NOTE 7. CONTINGENCIES

Legal Proceedings

From time to time, Cadence is involved in various disputes and litigation matters that arise in the ordinary course of business. These include disputes and lawsuits related to intellectual property, mergers and acquisitions, licensing, contracts, distribution arrangements and employee relations matters. Periodically, Cadence reviews the status of each significant matter and assesses its potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount or the range of loss can be estimated, Cadence accrues a liability for the estimated loss in accordance with SFAS No. 5, “Accounting for Contingencies.” Legal proceedings are subject to uncertainties, and the outcomes are difficult to predict. Because of such uncertainties, accruals are based only on the best information available at the time. As additional information becomes available, Cadence reassesses the potential liability related to pending claims and litigation matters and may revise estimates.

While the outcome of these litigation matters cannot be predicted with any certainty, management does not believe that the outcome of any current matters will have a material adverse effect on Cadence’s consolidated financial position or results of operations.

Other Contingencies

Cadence provides its customers with a warranty on sales of hardware products for a 90-day period. These warranties are accounted for in accordance with SFAS No. 5. To date, Cadence has not incurred any significant costs related to warranty obligations.

Cadence’s product license and services agreements include a limited indemnification provision for claims from third parties relating to Cadence’s intellectual property. Such indemnification provisions are accounted for in accordance with SFAS No. 5. The indemnification is generally limited to the amount paid by the customer. To date, claims under such indemnification provisions have not been significant.

The Internal Revenue Service, or IRS, and other tax authorities regularly examine Cadence’s income tax returns. In November 2003, the IRS completed its field examination of Cadence’s federal income tax returns for the tax years 1997 through 1999 and issued a Revenue Agent’s Report, or RAR, in which the IRS proposes to assess an aggregate tax deficiency for the three-year period of approximately $143.0 million. The most significant of the disputed adjustments for the tax years 1997 through 1999 relates to transfer pricing arrangements that Cadence has with a foreign subsidiary. Cadence has protested certain of the proposed adjustments with the Appeals Office of the IRS where the matter is presently being considered.

In July 2006, the IRS completed its field examination of Cadence’s federal income tax returns for the tax years 2000 through 2002 and issued a RAR in which the IRS proposes to assess an aggregate tax deficiency for the three-year period of approximately $324.0 million. The IRS is contesting Cadence’s qualification for deferred recognition of certain proceeds received from restitution and settlement in connection with litigation during the period. The proposed tax deficiency for this item is approximately $152.0 million. The remaining proposed tax deficiency of approximately $172.0 million is primarily related to proposed adjustments to Cadence’s transfer pricing arrangements that Cadence has with foreign subsidiaries and to Cadence’s deductions for foreign trade income. The IRS took similar positions with respect to Cadence’s transfer pricing arrangements in the prior examination period and may make similar claims against Cadence’s transfer pricing arrangements in future examinations. Cadence has filed a timely protest with the IRS and will seek resolution of the issues through the Appeals Office of the IRS.

Cadence believes that the proposed IRS adjustments are inconsistent with applicable tax laws, and that Cadence has meritorious defenses to the proposed adjustments. The RARs are not final Statutory Notices of Deficiency but the IRS imposes interest on the proposed deficiencies until the matters are resolved. Interest is compounded daily at rates published by the IRS, which rates are adjusted quarterly and have been between four and ten percent since 1997.

Significant judgment is required in determining Cadence’s provision for income taxes. In determining the adequacy of its provision for income taxes, Cadence has assessed the likelihood of adverse outcomes resulting from tax examinations including the IRS RARs for tax years 1997 through 2002. However, the ultimate outcome of tax examinations cannot be predicted with certainty, including the total amount payable or the timing of any such payments upon resolution of these issues. In addition, Cadence cannot be certain that such amount will not be materially different than that which is reflected in its historical income tax provisions and accruals. Should the IRS or other tax authorities assess additional taxes as a result of a current or a future examination, Cadence may be required to record charges to operations in future periods that could have a material adverse effect on its results of operations, financial position or cash flows in the period or periods recorded.

During 2005, Cadence entered into a sale-leaseback agreement involving certain land and buildings in San Jose, California. The agreement, as amended in June 2006, stipulates that Cadence and the purchaser must receive certain approvals from local municipalities prior to October 31, 2006. If these conditions are met or waived by Cadence and the purchaser prior to October 31, 2006, Cadence would complete the sale of the buildings and lease the buildings from the purchaser for two years, with an option to extend the lease for an additional six months.

NOTE 8. NET INCOME PER SHARE

Basic net income per share is computed by dividing net income, the numerator, by the weighted average number of shares of common stock outstanding, less unvested restricted stock, the denominator, during the period. Diluted net income per share gives effect to equity instruments considered to be potential shares of common stock, if dilutive, computed using the treasury stock method of accounting.

Cadence accounts for the effect of its Zero Coupon Zero Yield Senior Convertible Notes due 2023, or the Notes, in the diluted net income per share calculation using the if-converted method of accounting. Under that method, the Notes are assumed to be converted to shares of common stock (weighted for the number of days outstanding in the period) at a conversion price of $15.65, and amortization of transaction fees, net of taxes, related to the Notes is added back to Net income.

The following table presents the calculation for the numerator and denominator used in the basic and diluted net income per share computations for the three and nine months ended September 30, 2006 and October 1, 2005:


	Three Months Ended				Nine Months Ended
	September 30,		October 1,		September 30,		October 1,
	2006		2005		2006		2005
	(In thousands, except per share amounts)

Net income before cumulative effect of change in accounting principle	$	42,060	$	21,271	$	93,809	$	22,777
Effect of dilutive securities:
Amortization of convertible notes transaction fees, net of tax		392		448		1,174		1,230

Net income before cumulative effect of change in accounting principle, as adjusted	$	42,452	$	21,719	$	94,983	$	24,007

Net income after cumulative effect of change in accounting principle	$	42,060	$	21,271	$	94,227	$	22,777
Effect of dilutive securities:
Amortization of convertible notes transaction fees, net of tax		392		448		1,174		1,230

Net income after cumulative effect of change in accounting principle, as adjusted	$	42,452	$	21,719	$	95,401	$	24,007

Weighted average common shares:
Weighted average common shares used to calculate basic net income per share		279,329		281,222		281,077		277,474
Convertible notes		26,837		26,837		26,837		26,837
Options		4,313		7,710		4,811		6,729
Restricted stock and ESPP shares		1,787		1,972		1,465		1,547

Weighted average common and potential common shares used to calculate diluted net income per share		312,266		317,741		314,190		312,587

Basic net income per share:
Net income per share before cumulative effect of change in accounting principle	$	0.15	$	0.08	$	0.33	$	0.08

Net income per share after cumulative effect of change in accounting principle	$	0.15	$	0.08	$	0.34	$	0.08

Diluted net income per share:
Net income per share before cumulative effect of change in accounting principle	$	0.14	$	0.07	$	0.30	$	0.08

Net income per share after cumulative effect of change in accounting principle	$	0.14	$	0.07	$	0.30	$	0.08

The following table presents the potential shares of Cadence common stock outstanding for the three and nine months ended September 30, 2006 and October 1, 2005 that were not included in the computation of diluted net income per share because the effect of including these shares would have been antidilutive:


	Three Months Ended				Nine Months Ended
	September 30,		October 1,		September 30,		October 1,
	2006		2005		2006		2005
	(In thousands)

Options to purchase shares of common stock (various expiration dates through 2016)		26,431		23,189		24,112		32,356
Warrants to purchase shares of common stock (various expiration dates through 2008)		26,829		26,829		26,829		26,829

Total potential shares of common stock excluded		53,260		50,018		50,941		59,185

NOTE 9. STOCK REPURCHASE PROGRAMS

In August 2001, the Cadence Board of Directors authorized a program to repurchase shares of Cadence common stock in the open market with a value of up to $500.0 million in the aggregate, which amount was exhausted during the three months ended April 1, 2006. In February 2006, the Cadence Board of Directors authorized a new program to repurchase shares of Cadence common stock with a value of up to $500.0 million in the aggregate.

The following table presents the shares repurchased under Cadence’s stock repurchase programs in the three and nine months ended September 30, 2006 and October 1, 2005:


	Three Months Ended				Nine Months Ended
	September 30,		October 1,		September 30,		October 1,
	2006		2005		2006		2005
	(In thousands)

Shares repurchased		6,000		----		15,000		----
Total cost of repurchased shares	$	97,554	$	----	$	258,384	$	----

As of September 30, 2006, the remaining repurchase authorization under Cadence’s repurchase program totaled $263.5 million.

NOTE 10. OTHER COMPREHENSIVE INCOME

Other comprehensive income includes foreign currency translation gains and losses and unrealized gains and losses on available-for-sale marketable securities, net of related tax effects. These transactions have been excluded from net income and are reflected instead in Stockholders’ Equity.

The following table sets forth Cadence’s comprehensive income for the three and nine months ended September 30, 2006 and October 1, 2005:


	Three Months Ended						Nine Months Ended
	September 30,			October 1,			September 30,			October 1,
	2006			2005			2006			2005
	(In thousands)

Net income	$	42,060		$	21,271		$	94,227		$	22,777
Translation gain (loss)		963			(994	)		(3,213	)		(3,592	)
Changes in unrealized holding gains (losses) on available-for-sale securities, net of related tax effects		(4,343	)		3,719			(6,144	)		(601	)

Comprehensive income	$	38,680		$	23,996		$	84,870		$	18,584


NOTE 11.	OTHER INCOME, NET

The following table sets forth Cadence’s Other income, net, for the three and nine months ended September 30, 2006 and October 1, 2005:


	Three Months Ended						Nine Months Ended
	September 30,			October 1,			September 30,			October 1,
	2006			2005			2006			2005
	(In thousands)

Interest income	$	9,863		$	4,346		$	29,593		$	9,847
Gains (losses) on sale of non-marketable securities		(480	)		1,014			16,366			2,465
Gains on available-for-sale securities		1,805			1,650			4,620			9,191
Gains on sale of non-marketable securities in Cadence’s non-qualified deferred compensation trust		----			----			2,130			----
Gains (losses) on trading securities in Cadence’s non-qualified deferred compensation trust		(863	)		1,523			2,484			4,389
Gains on foreign exchange		165			946			338			3,372
Equity loss from investments		(300	)		(1,488	)		(900	)		(6,192	)
Write-down of investments		(428	)		(3,078	)		(1,429	)		(10,184	)
Other income (expense)		231			(246	)		(11	)		(1,532	)

Total other income, net	$	9,993		$	4,667		$	53,191		$	11,356

In January 2006, KhiMetrics, Inc., a cost method investment held by Telos Venture Partners, a limited partnership in which Cadence and Cadence’s 1996 Deferred Compensation Venture Investment Plan Trust are the sole limited partners, was sold for consideration of $6.53 per share of common stock. Under the purchase agreement, 10% of the consideration is being held in escrow to pay the cost of resolving any claims that may be asserted against KhiMetrics on or before the first anniversary of the acquisition, at which time the escrow amount remaining after resolution of such claims will be distributed to the former stockholders of KhiMetrics. No gain was recorded on amounts held in escrow. In connection with this sale, Cadence received approximately $17.5 million in cash and recorded a gain of approximately $14.4 million during the nine months ended September 30, 2006. In addition, Cadence’s 1996 Deferred Compensation Venture Investment Plan Trust received $2.5 million in cash and recorded a gain of $2.1 million during the nine months ended September 30, 2006.

NOTE 12. SEGMENT AND GEOGRAPHY REPORTING

SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” requires disclosures of certain information regarding operating segments, products and services, geographic areas of operation and major customers. SFAS No. 131 reporting is based upon the “management approach”: how management organizes the company’s operating segments for which separate financial information is (i) available and (ii) evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Cadence’s chief operating decision maker is its President and Chief Executive Officer, or CEO.

Cadence’s CEO reviews Cadence’s consolidated results within one segment. In making operating decisions, the CEO primarily considers consolidated financial information, accompanied by disaggregated information about revenues by geographic region.

Outside the United States, Cadence markets and supports its products and services primarily through its subsidiaries. Revenue is attributed to geography based on the country in which the customer is domiciled. Long-lived assets are attributed to geography based on the country where the assets are located.

The following table presents a summary of revenue by geography:


	Three Months Ended				Nine Months Ended
	September 30,		October 1,		September 30,		October 1,
	2006		2005		2006		2005
	(In thousands)

North America:
United States	$	188,280	$	176,229	$	511,399	$	456,414
Other North America		7,928		4,651		24,673		17,825

Total North America		196,208		180,880		536,072		474,239

Europe, Middle East and Africa:
Germany		26,854		26,262		71,004		56,484
Other Europe, Middle East and Africa		52,975		43,507		133,618		111,918

Total Europe, Middle East and Africa		79,829		69,769		204,622		168,402

Japan and Asia:
Japan		49,246		65,793		206,418		234,567
Asia		40,865		20,939		105,763		73,621

Total Japan and Asia		90,111		86,732		312,181		308,188

Total	$	366,148	$	337,381	$	1,052,875	$	950,829


	Three Months Ended				Nine Months Ended
	September 30,		October 1,		September 30,		October 1,
	2006		2005		2006		2005
	(In thousands)

United States	$	188,280	$	176,229	$	511,399	$	456,414
Other		177,868		161,152		541,476		494,415

Total	$	366,148	$	337,381	$	1,052,875	$	950,829

The following table presents a summary of long-lived assets by geography:


	As of
	September 30,		December 31,
	2006		2005
	(In thousands)

North America:
United States	$	327,349	$	331,229
Other North America		139		227

Total North America		327,488		331,456

Europe, Middle East and Africa		9,146		8,491

Japan and Asia:
Japan		852		2,193
Asia		15,804		14,805

Total Japan and Asia		16,656		16,998

Total	$	353,290	$	356,945


	As of
	September 30,		December 31,
	2006		2005
	(In thousands)

United States	$	327,349	$	331,229
Other		25,941		25,716

Total	$	353,290	$	356,945

For management reporting purposes, Cadence organizes its products and services into six categories: Functional Verification, Digital IC Design, Custom IC Design, Design for Manufacturing, System Interconnect and Services and Other. The following table summarizes the revenue attributable to these categories for the fiscal periods presented:


	Three Months Ended				Nine Months Ended
	September 30,		October 1,		September 30,		October 1,
	2006		2005		2006		2005
	(In thousands)

Functional Verification	$	88,476	$	70,956	$	257,628	$	191,873
Digital IC Design		70,752		87,147		228,060		239,802
Custom IC Design		108,773		90,455		293,049		254,954
Design for Manufacturing		28,918		29,780		82,663		87,089
System Interconnect		34,967		27,359		91,677		83,598
Services and other		34,262		31,684		99,798		93,513

Total	$	366,148	$	337,381	$	1,052,875	$	950,829

During the three and nine months ended September 30, 2006, no one customer accounted for 10% or more of Cadence’s total revenue. During the three months ended October 1, 2005, one customer accounted for 22% of Cadence’s total revenue, but during the nine months ended October 1, 2005, no one customer accounted for 10% or more of Cadence’s total revenue.


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

The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements and notes thereto included in this Quarterly Report on Form 10-Q, or this Quarterly Report, and in conjunction with our Annual Report on Form 10-K for the fiscal year ended December 31, 2005. Certain of these statements, including, without limitation, statements regarding the extent and timing of future revenues and expenses and customer demand, statements regarding the deployment of our products, statements regarding our reliance on third parties and other statements using words such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “should,” “will” and “would,” and words of similar import and the negatives thereof, constitute forward-looking statements. These statements are predictions based upon our current expectations about future events. Actual results could vary materially as a result of certain factors, including but not limited to, those expressed in these statements. We refer you to the “Risk Factors,” “Results of Operations,” “Disclosures About Market Risk,” and “Liquidity and Capital Resources” sections contained in this Quarterly Report, and the risks discussed in our other SEC filings, which identify important risks and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements.

We urge you to consider these factors carefully in evaluating the forward-looking statements contained in this Quarterly Report. All subsequent written or oral forward-looking statements attributable to our company or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. The forward-looking statements included in this Quarterly Report are made only as of the date of this Quarterly Report. We do not intend, and undertake no obligation, to update these forward-looking statements.

Overview

We develop electronic design automation, or EDA, software, and intellectual property. We license software, sell or license intellectual property, sell or lease hardware technology and provide design and methodology services throughout the world to help manage and accelerate electronics product development processes. Our broad range of products and services are used by the world’s leading electronics companies to design and develop complex integrated circuits, or ICs, and personal and commercial electronics systems.

During the last decade, the communications, business productivity and consumer electronics markets accounted for much of the growth in the electronics industry. Ever-decreasing silicon manufacturing process geometries, coupled with the move to 300 millimeter wafer production, are causing IC unit cost decreases. This has enabled die-per-wafer volume efficiencies and increased complexity for manufacturers of electronic devices. At the same time, the development of ICs with greater functionality makes it more difficult to effectively integrate these components into complete electronics systems. These market and technology forces create major challenges for the global electronics design community, while simultaneously offering significant opportunities for providers of EDA products and services.

We have identified certain items that management uses as performance indicators to manage our business, including revenue, certain elements of operating expenses and cash flow from operations, and we describe these items more fully in “Results of Operations” below.

Critical Accounting Estimates

In preparing our Condensed Consolidated Financial Statements, we make assumptions, judgments and estimates that can have a significant impact on our revenue, operating income and net income, as well as on the value of certain assets and liabilities on our Condensed Consolidated Balance Sheets. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. At least quarterly, we evaluate our assumptions, judgments and estimates and make changes accordingly. Historically, our assumptions, judgments and estimates relative to our critical accounting estimates have not differed materially from actual results. Upon our adoption of Statement of Financial Accounting Standards, or SFAS, No. 123R, “Share-Based Payment” on January 1, 2006, the valuation of stock-based awards became a new critical accounting estimate as described below.

Valuation of stock-based awards

We account for stock-based compensation in accordance with the fair value recognition provisions of SFAS No. 123R. Under SFAS No. 123R, stock-based compensation expense is measured at the grant date based on the value of the award and is recognized as expense over the vesting period. Determining the fair value of stock-based awards at the grant date requires judgment, including estimating the expected term of stock options, the expected volatility of our stock, expected forfeitures and expected dividends. The computation of the expected volatility assumption used in the Black-Scholes pricing model for option grants is based on implied volatility as options for our stock are actively traded, the market prices of both the traded options and underlying shares are measured at a similar point in time to each other and on a date reasonably close to the grant date of the employee stock options, the traded options have exercise prices that are both near-the-money and close to the exercise price of the employee stock options, and the remaining maturities of the traded options on which the estimate is based are at least one year. When establishing the expected life assumption, we review annual historical employee exercise behavior with respect to option grants with similar vesting periods. In addition, judgment is also required in estimating the amount of stock-based awards that are expected to be forfeited. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially affected.

For further information about our other critical accounting estimates, see the discussion of “Critical Accounting Estimates” in our Form 10-K for the year ended December 31, 2005.

Results of Operations

We primarily generate revenue from licensing our EDA software, selling or leasing our hardware technology, selling or licensing our intellectual property, providing maintenance for our software and hardware and providing design and methodology services. We principally utilize three license types: subscription, term and perpetual. The different license types provide a customer with different terms of use for our products, such as (i) the right to access new technology, (ii) the duration of the license, and (iii) payment terms. Customer decisions regarding these aspects of license transactions determine the license type, timing of revenue recognition and potential future business activity. For example, if a customer chooses a fixed term of use, this will result in either a subscription or term license. A business implication of this decision is that, at the expiration of the license period, the customer must decide whether to continue using the technology and, if it decides to do so, renew the license agreement. Because larger customers generally use products from two or more of our five product groups, rarely will a large customer completely terminate its relationship with us upon expiration of the license. See “Critical Accounting Estimates” in our Form 10-K for the year ended December 31, 2005 for additional discussion of license types and timing of revenue recognition.

A substantial portion of our revenue is recognized over multiple periods. As a result, we do not believe that pricing volatility has been a material component of the change in our revenue from period to period.

The amount of revenue recognized in future periods will depend on, among other things, the terms and timing of our contract renewals with, or additional sales to, existing customers, the size of such transactions and sales to new customers.

The value and duration of contracts, and consequently product revenue recognized, is affected by the competitiveness of our products. Product revenue recognized in any period is also affected by the extent to which customers purchase subscription, term or perpetual licenses, and the extent to which contracts contain flexible payment terms. The timing of revenue recognition is also affected by changes in the extent to which existing contracts contain flexible payment terms and changes in contractual arrangements (e.g., subscription to term) with existing customers.

Revenue and Revenue Mix

We analyze our software and hardware businesses by product group, combining revenues for both product and maintenance because of their interrelationship. We have formulated a design solution strategy that combines our design technologies into “platforms,” which are included in the various product groups described below.

Our product groups are:

Functional Verification: Products in this group, which include the Incisive^® functional verification platform, are used to verify that the high level, logical specification of an IC design is correct.

Digital IC Design: Products in this group, which include the Encounter^® digital IC design platform, are used to accurately convert the high-level, logical specification of a digital IC into a detailed physical blueprint and then detailed design information showing how the IC will be physically implemented. This data is used for creation of the photomasks used in chip manufacture.

Custom IC Design: Our custom design products, which include the Virtuoso^® custom design platform, are used for ICs that must be designed at the transistor level, including analog, radio frequency, memories, high performance digital blocks and standard cell libraries. Detailed design information showing how the IC will be physically implemented is used for creation of the photomasks used in chip manufacture.

Design for Manufacturing: Included in this product group are our physical verification and analysis products. These products are used to analyze and verify that the physical blueprint of the integrated circuit has been constructed correctly and can be manufactured successfully.

System Interconnect: This product group consists of our printed circuit board, or PCB, and IC package design products, including the Allegro^® and OrCAD^® products. The Allegro system interconnect platform offering focuses on system interconnect design platform, which enables consistent co-design of ICs, IC packages and PCBs, while the OrCAD line focuses on cost-effective, entry-level PCB solutions.

Revenue by Period

The table below shows our revenue for the three and nine months ended September 30, 2006 and October 1, 2005 and the percentage change in revenue:


	Three Months Ended					Nine Months Ended
	September 30,		October 1,			September 30,		October 1,
	2006		2005		% Change	2006		2005		% Change
	(In millions, except percentages)

Product	$	244.5	$	218.6	12%	$	684.8	$	593.8	15%
Services		34.3		31.7	8%		99.8		93.5	7%
Maintenance		87.3		87.1	0%		268.3		263.5	2%

Total revenue	$	366.1	$	337.4	9%	$	1,052.9	$	950.8	11%

Product revenue was higher in the three months ended September 30, 2006, as compared to the three months ended October 1, 2005, primarily because of increased revenue from licenses for Custom IC Design, Functional Verification and System Interconnect products, which was partially offset by a decrease in revenue from licenses for Digital IC Design products. Product revenue was higher in the nine months ended September 30, 2006, as compared to the nine months ended October 1, 2005, primarily because of increased revenue from licenses for Functional Verification and Custom IC Design products, which was partially offset by a decrease in revenue from licenses for Digital IC Design products. Services revenue increased in the three and nine months ended September 30, 2006 as compared to the nine months ended October 1, 2005 due to an increase in utilization rates for our services personnel.

Revenue by Product Group

The following table shows for the past five consecutive quarters the percentage of product and related maintenance revenue contributed by each of our five product groups, and Services and other:


	Three Months Ended
	September 30,		July 1,		April 1,		December 31,		October 1,
	2006		2006		2006		2005		2005

Functional Verification		24%		22%		27%		25%		21%
Digital IC Design		19%		26%		20%		29%		26%
Custom IC Design		30%		27%		26%		22%		27%
Design for Manufacturing		8%		8%		8%		8%		9%
System Interconnect		10%		8%		9%		7%		8%
Services and other		9%		9%		10%		9%		9%

Total		100%		100%		100%		100%		100%

Revenue by Geography


	Three Months Ended					Nine Months Ended
	September 30,		October 1,			September 30,		October 1,
	2006		2005		% Change	2006		2005		% Change
	(In millions, except percentages)

United States	$	188.3	$	176.2	7%	$	511.4	$	456.4	12%
Other North America		7.9		4.7	68%		24.7		17.8	39%
Europe, Middle East and Africa		79.8		69.8	14%		204.6		168.4	21%
Japan		49.2		65.8	(25)%		206.4		234.6	(12)%
Asia		40.9		20.9	96%		105.8		73.6	44%

Total revenue	$	366.1	$	337.4	9%	$	1,052.9	$	950.8	11%

Revenue by Geography as a Percent of Total Revenue


	Three Months Ended				Nine Months Ended
	September 30,		October 1,		September 30,		October 1,
	2006		2005		2006		2005

United States		51%		52%		49%		48%
Other North America		2%		1%		2%		2%
Europe, Middle East and Africa		22%		21%		19%		18%
Japan		14%		20%		20%		25%
Asia		11%		6%		10%		7%

The rate of revenue change varies geographically primarily due to differences in the timing and size of term licenses in those regions. No single customer accounted for 10% or more of total revenue for the three or nine months ended September 30, 2006. One customer accounted for 22% of total revenue for the three months ended October 1, 2005, but no single customer accounted for 10% or more of total revenue for the nine months ended October 1, 2005.

Changes in foreign currency exchange rates, primarily due to fluctuations of the Japanese yen in relation to the United States dollar, caused our revenue to decrease by $1.4 million in the three months ended September 30, 2006, as compared to the three months ended October 1, 2005. Changes in foreign currency exchange rates, primarily due

to fluctuations of the Japanese yen in relation to the United States dollar, caused our revenue to decrease by $12.8 million in the nine months ended September 30, 2006, as compared to the nine months ended October 1, 2005. Additional information about revenue and other financial information by geography can be found in Note 12 to our Condensed Consolidated Financial Statements.

Stock-based Compensation Expense Summary

We adopted SFAS No. 123R on January 1, 2006, which adoption resulted in an increase in stock-based compensation expense of approximately $10.4 million in the three months ended September 30, 2006, as compared to the three months ended October 1, 2005, and an increase of approximately $48.2 million during the nine months ended September 30, 2006, as compared to the nine months ended October 1, 2005.

Stock-based compensation expense is reflected throughout our costs and expenses as follows:


	Three Months Ended				Nine Months Ended
	September 30,		October 1,		September 30,		October 1,
	2006		2005		2006		2005
	(In millions)

Cost of product	$	----	$	----	$	0.1	$	----
Cost of services		0.9		0.1		3.2		0.5
Cost of maintenance		0.6		0.1		2.0		0.3
Marketing and sales		5.7		2.1		18.7		6.8
Research and development		11.5		6.8		39.3		15.8
General and administrative		5.6		4.8		17.1		8.8

Total	$	24.3	$	13.9	$	80.4	$	32.2

Cost of Revenue


	Three Months Ended						Nine Months Ended
	September 30,		October 1,				September 30,		October 1,
	2006		2005		% Change		2006		2005		% Change
	(In millions, except percentages)

Product	$	14.1	$	18.6		(24)%	$	54.7	$	62.7		(13)%
Services	$	23.0	$	23.5		(2)%	$	71.0	$	69.6		2%
Maintenance	$	15.6	$	15.2		3%	$	47.5	$	44.5		7%

Cost of Revenue as a Percent of Related Revenue


	Three Months Ended				Nine Months Ended
	September 30,		October 1,		September 30,		October 1,
	2006		2005		2006		2005

Product		6%		8%		8%		11%
Services		67%		74%		71%		74%
Maintenance		18%		17%		18%		17%

Cost of Product

Cost of product includes costs associated with the sale or lease of our hardware and licensing of our software products. Cost of product primarily includes the cost of employee salary, benefits and other employee-related costs, including stock-based compensation expense, amortization of acquired intangibles directly related to Cadence products, the cost of technical documentation and royalties payable to third-party vendors. Cost of product associated with our hardware products also includes materials, assembly labor and overhead. These additional

manufacturing costs make our cost of hardware product higher, as a percentage of revenue, than our cost of software product.

A summary of Cost of product is as follows:


	Three Months Ended				Nine Months Ended
	September 30,		October 1,		September 30,		October 1,
	2006		2005		2006		2005
	(In millions)

Product related costs	$	7.8	$	5.4	$	27.7	$	22.4
Amortization of acquired intangibles		6.3		13.2		27.0		40.3

Total Cost of product	$	14.1	$	18.6	$	54.7	$	62.7

Cost of product decreased $4.5 million in the three months ended September 30, 2006, as compared to the three months ended October 1, 2005, primarily due to a decrease of $6.9 million in amortization of acquired intangibles, which was partially offset by an increase of $2.2 million in hardware costs attributable to increased hardware sales.

Cost of product decreased $8.0 million in the nine months ended September 30, 2006, as compared to the nine months ended October 1, 2005, primarily due to a decrease of $13.3 million in amortization of acquired intangibles and a decrease of $1.2 million in royalty costs, which were partially offset by an increase of $4.4 million in hardware costs attributable to increased hardware sales.

Cost of product in the future will depend primarily upon the extent to which we acquire intangible assets, acquire licenses and incorporate third-party technology in our products that are licensed or sold in any given period, and the actual mix of hardware and software product sales in any given period. Based on our current portfolio of intangibles, we expect the Amortization of acquired intangibles component of Cost of Product to continue decreasing as the amortization period assigned upon purchase of the intangible is completed.

Cost of Services

Cost of services primarily includes employee salary, benefits and other employee-related costs, costs to maintain the infrastructure necessary to manage a services organization, and provisions for contract losses, if any. Cost of services decreased $0.5 million in the three months ended September 30, 2006, as compared to the three months ended October 1, 2005, primarily due to a decrease of $1.3 million in salary, benefits and other employee-related costs, which was partially offset by an increase of $0.8 million in stock-based compensation expense.

Cost of services increased $1.4 million in the nine months ended September 30, 2006, as compared to the nine months ended October 1, 2005, primarily due to an increase of $2.7 million in stock-based compensation expense, which was partially offset by a decrease of $1.2 million in salary, benefits and other employee-related costs.

Cost of Maintenance

Cost of maintenance includes the cost of customer services, such as hot-line and on-site support, employee salary, benefits and other employee-related costs for certain employees, and documentation of maintenance updates. Cost of maintenance increased $0.4 million in the three months ended September 30, 2006, as compared to the three months ended October 1, 2005, primarily due to an increase of $0.5 million in stock-based compensation expense.

Cost of maintenance increased $3.0 million in the nine months ended September 30, 2006, as compared to the nine months ended October 1, 2005, primarily due to an increase of $1.7 million in stock-based compensation expense and an increase of $0.8 million in amortization of acquired intangibles.

Operating Expenses


	Three Months Ended						Nine Months Ended
	September 30,		October 1,				September 30,		October 1,
	2006		2005		% Change		2006		2005		% Change
	(In millions, except percentages)

Marketing and sales	$	97.5	$	96.5		1%	$	289.1	$	268.0		8%
Research and development		110.3		100.6		10%		342.1		292.0		17%
General and administrative		35.2		35.1		0%		109.3		101.8		7%

Total operating expenses	$	243.0	$	232.2		5%	$	740.5	$	661.8		12%

Expenses as a Percent of Total Revenue


	Three Months Ended				Nine Months Ended
	September 30,		October 1,		September 30,		October 1,
	2006		2005		2006		2005

Marketing and sales		27%		29%		27%		28%
Research and development		30%		30%		32%		31%
General and administrative		10%		10%		10%		11%

Operating Expense Summary

Overall operating expenses increased $10.8 million during the three months ended September 30, 2006, as compared to the three months ended October 1, 2005, while overall operating expenses increased $78.7 million in the nine months ended September 30, 2006, as compared to the nine months ended October 1, 2005, in each case primarily as a result of increases in stock-based compensation expense as well as salary, benefits and other employee-related costs, which include costs related to our acquisition of Verisity Ltd. in the second quarter of 2005.

Fluctuations in foreign currency exchange rates, primarily due to fluctuations of the European Union euro and the British pound, which were partially offset by fluctuations in the Japanese yen and the Indian rupee in relation to the United States dollar, increased operating expenses by $0.3 million in the three months ended September 30, 2006, as compared to the three months ended October 1, 2005. Fluctuations in foreign currency exchange rates, primarily due to fluctuations of the Japanese yen and the Indian rupee in relation to the United States dollar, decreased operating expenses by $2.9 million in the nine months ended September 30, 2006, as compared to the nine months ended October 1, 2005.

Marketing and Sales

Marketing and sales expense increased $1.0 million in the three months ended September 30, 2006, as compared to the three months ended October 1, 2005, primarily due to an increase of $3.6 million in stock-based compensation expense and an increase of $1.2 million in marketing programs, travel and customer conference costs, which were partially offset by a decrease of $4.6 million in salary, benefits and other employee-related costs.

Marketing and sales expense increased $21.1 million in the nine months ended September 30, 2006, as compared to the nine months ended October 1, 2005, primarily due to an increase of $11.9 million in stock-based compensation expense, an increase of $5.7 million in marketing programs, travel and customer conference costs and an increase of $5.0 million in salary, benefits and other employee-related costs.

Research and Development

Research and development expense increased $9.7 million in the three months ended September 30, 2006, as compared to the three months ended October 1, 2005, primarily due to an increase of $4.7 million in stock-based

compensation expense, an increase of $1.8 million in salary, benefits and other employee-related costs and an increase of $1.6 million of maintenance costs associated with third-party software.

Research and development expense increased $50.1 million in the nine months ended September 30, 2006, as compared to the nine months ended October 1, 2005, primarily due to an increase of $23.5 million in stock-based compensation expense, an increase of $19.0 million in salary, benefits and other employee-related costs, an increase of $3.3 million of maintenance costs associated with third-party software and an increase of $3.2 million in third-party development costs.

General and Administrative

General and administrative expense increased $0.1 million in the three months ended September 30, 2006, as compared to the three months ended October 1, 2005, primarily due to an increase of $5.0 million in losses on the sale of installment contract receivables, an increase of $0.8 million in stock-based compensation expense and an increase of $0.8 million in salary, benefits and other employee-related costs, which were partially offset by a decrease of $3.9 million in executive severance costs and a decrease of $3.0 million in bad debt expense.

General and administrative expense increased $7.5 million in the nine months ended September 30, 2006, as compared to the nine months ended October 1, 2005, primarily due to an increase of $8.3 million in stock-based compensation expense, an increase of $7.4 million in losses on the sale of installment contract receivables, an increase of $1.7 million in salary, benefits and other employee-related costs and an increase of $1.0 million in audit and tax fees, which were partially offset by a decrease of $7.1 million in executive severance costs and a decrease of $4.8 million in bad debt expense.

Amortization of Acquired Intangibles


	Three Months Ended				Nine Months Ended
	September 30,		October 1,		September 30,		October 1,
	2006		2005		2006		2005
	(In millions)

Amortization of acquired intangibles	$	4.6	$	13.9	$	18.0	$	39.2

Amortization of acquired intangibles decreased $9.3 million in the three months ended September 30, 2006, as compared to the three months ended October 1, 2005. Amortization of acquired intangible assets from prior year acquisitions decreased $9.9 million during this period as certain of these acquired intangible assets have been fully amortized, but was partially offset by $0.6 million of amortization of intangibles acquired during 2006.

Amortization of acquired intangibles decreased $21.2 million in the nine months ended September 30, 2006, as compared to the nine months ended October 1, 2005. Amortization of acquired intangible assets from prior year acquisitions decreased approximately $22.8 million during this period as certain of these acquired intangible assets have been fully amortized. This decrease was partially offset by $1.6 million of additional amortization related to intangible assets from the Verisity acquisition in 2005 and acquisitions of intangibles that occurred during the nine months ended September 30, 2006.

Based on our current portfolio of intangibles, we expect the Amortization of acquired intangibles to continue decreasing as the amortization period assigned upon purchase of the intangible is completed.

Restructuring and Other Charges

We initiated a separate plan of restructuring in each year from 2001 through 2005 in an effort to reduce operating expenses and improve operating margins and cash flows. The restructuring plans initiated each year from 2001 through 2005, or the 2001 Restructuring, 2002 Restructuring, 2003 Restructuring, 2004 Restructuring and 2005 Restructuring, respectively, were intended to decrease costs through workforce reductions and facility and resource consolidation, in order to improve our cost structure. The 2001 and 2002 Restructurings primarily related to our design services business and certain other business or infrastructure groups throughout the world. The 2003 Restructuring, 2004 Restructuring and 2005 Restructuring were targeted at reducing costs throughout the company.

The 2004 Restructuring has been completed and there is no remaining balance accrued for this restructuring as of September 30, 2006.

A summary of restructuring and other charges by plan of restructuring for the three months ended September 30, 2006 is as follows:


	Severance
	and		Excess
	Benefits		Facilities			Total
	(In millions)

2005 Plan	$	----	$	0.1		$	0.1
2003 Plan		----		(0.1	)		(0.1	)

Total	$	----	$	----		$	----

A summary of restructuring and other charges by plan of restructuring for the nine months ended September 30, 2006 is as follows:


	Severance
	and			Excess
	Benefits			Facilities			Total
	(In millions)

2005 Plan	$	(0.1	)	$	0.1		$	----
2003 Plan		----			(0.3	)		(0.3	)
2002 Plan		----			(0.4	)		(0.4	)

Total	$	(0.1	)	$	(0.6	)	$	(0.7	)

A summary of restructuring and other charges by plan of restructuring for the three months ended October 1, 2005 is as follows:


	Severance
	and		Asset-		Excess
	Benefits		Related		Facilities		Total
	(In millions)

2005 Plan	$	1.2	$	0.3	$	0.2	$	1.7
2003 Plan		----		----		2.1		2.1

Total	$	1.2	$	0.3	$	2.3	$	3.8

A summary of restructuring and other charges by plan of restructuring for the nine months ended October 1, 2005 is as follows:


	Severance
	and			Asset-		Excess
	Benefits			Related		Facilities			Total
	(In millions)

2005 Plan	$	20.8		$	2.4	$	2.0		$	25.2
2004 Plan		(0.3	)		----		----			(0.3	)
2003 Plan		----			----		4.6			4.6
2002 Plan		----			----		(0.4	)		(0.4	)
2001 Plan		----			----		5.7			5.7

Total	$	20.5		$	2.4	$	11.9		$	34.8

Frequently, asset impairments are based on significant estimates and assumptions, particularly regarding remaining useful life and utilization rates. We may incur other charges in the future if management determines that the useful life or utilization of certain long-lived assets has been reduced.

Facility closure and office space reduction costs include payments required under leases less any applicable estimated sublease income after the properties were abandoned, lease buyout costs, and other contractual charges. To determine the lease loss, which is the loss after our cost recovery efforts from subleasing all or part of a building, certain assumptions were made related to the time period over which the relevant building would remain vacant and sublease terms, including sublease rates and contractual common area charges.

As of September 30, 2006, our accrued estimate of the lease loss related to all worldwide restructuring activities initiated since 2001 was $31.5 million. This amount may be adjusted in the future based upon changes in the assumptions used to estimate the lease loss. The lease loss could be as high as $35.1 million if sublease rental rates decrease in applicable markets or if it takes longer than currently expected to find a suitable tenant to sublease the facilities. Since 2001, we have recorded facilities consolidation charges under the 2001 through 2005 Restructurings of $97.1 million related to reducing space in or the closing of 49 sites, of which 28 have been vacated and 21 have been downsized. We expect to pay all of the facilities-related restructuring liabilities for all our restructuring plans prior to 2016.

Because the restructuring charges and related benefits are derived from management’s estimates made during the formulation of the restructurings, based on then-currently available information, our restructuring activities may not achieve the benefits anticipated on the timetable or at the level contemplated. Demand for our products and services and, ultimately, our future financial performance, is difficult to predict with any degree of certainty. Accordingly, additional actions, including further restructuring of our operations, may be required in the future.

The following is further discussion of the activity under each restructuring plan:

2005 Restructuring – During the year ended December 31, 2005, we reduced our workforce by approximately 300 employees, including approximately 65 employees in our European design services business, and consolidated facilities and resources throughout the company. Costs resulting from the 2005 Restructuring included severance payments, severance-related benefits, outplacement services, lease costs associated with facilities vacated and downsized, and charges for assets written-off as a result of the restructuring.

We expect to incur an additional $1.0 million to $2.0 million of future costs in connection with the 2005 Restructuring, primarily for facilities-related charges, which will be expensed as incurred. The actual amount of additional costs incurred could vary depending on changes in market conditions and the timing of these restructuring activities.

2003 Restructuring – We expect to incur an additional $3.0 to $5.0 million of future costs in connection with the 2003 Restructuring, primarily for facilities-related charges, which will be expensed as incurred. The actual amount of additional costs incurred could vary depending on changes in market conditions and the timing of these restructuring activities.

Write-off of Acquired In-process Technology

In connection with the acquisition completed during the nine months ended September 30, 2006, we immediately charged to expense $0.9 million representing acquired in-process technology that had not yet reached technological feasibility and had no alternative future use. The value assigned to acquired in-process technology was determined by identifying research projects in areas for which technological feasibility had not been established. The value was determined by estimating costs to develop the various acquired in-process technologies into commercially viable products, estimating the resulting net cash flows from such projects and discounting the net cash flows back to their present value. The discount rate assumed in this calculation was 33% and included factors that reflect the uncertainty surrounding successful development of the acquired in-process technology. The in-process technologies are expected to be commercially viable in June 2007. As of September 30, 2006, $0.2 million was incurred to complete the in-process technology and aggregate expenditures to complete the remaining in-process technology are expected to be approximately $0.3 million.

These estimates are subject to change, given the uncertainties of the development process, and no assurance can be given that deviations from these estimates will not occur. Additionally, these projects will require additional research and development after they have reached a state of technological and commercial feasibility.

Interest Expense


	Three Months Ended				Nine Months Ended
	September 30,		October 1,		September 30,		October 1,
	2006		2005		2006		2005
	(In millions)

Interest expense	$	3.0	$	1.2	$	9.9	$	3.9

Interest expense increased $1.8 million in the three months ended September 30, 2006, as compared to the three months ended October 1, 2005, and $6.0 million in the nine months ended September 30, 2006, as compared to the nine months ended October 1, 2005. The increase for both periods was due to the interest expense and the amortization of loan fees associated with the Term Loan described in Note 6 to our Condensed Consolidated Financial Statements.

Other income, net

Other income, net, for the three and nine months ended September 30, 2006 and October 1, 2005 is as follows:


	Three Months Ended						Nine Months Ended
	September 30,			October 1,			September 30,			October 1,
	2006			2005			2006			2005
	(In millions)

Interest income	$	9.9		$	4.3		$	29.6		$	9.8
Gains (losses) on sale of non-marketable securities		(0.5	)		1.0			16.4			2.5
Gains on available-for-sale securities		1.8			1.7			4.6			9.2
Gains on sale of non-marketable securities in Cadence’s non-qualified deferred compensation trust		----			----			2.1			----
Gains (losses) on trading securities in Cadence’s non-qualified deferred compensation trust		(0.9	)		1.5			2.5			4.4
Gains on foreign exchange		0.2			0.9			0.3			3.4
Equity loss from investments		(0.3	)		(1.5	)		(0.9	)		(6.2	)
Write-down of investments		(0.4	)		(3.1	)		(1.4	)		(10.2	)
Other income (expense)		0.2			(0.1	)		----			(1.5	)

Total other income, net	$	10.0		$	4.7		$	53.2		$	11.4

Interest income increased $5.6 million in the three months ended September 30, 2006, as compared to the three months ended October 1, 2005, and $19.8 million in the nine months ended September 30, 2006, as compared to the nine months ended October 1, 2005. The increase for both periods was due to higher average cash balances during the periods and higher interest rates earned on Cash and cash equivalents.

such claims will be distributed to the former stockholders of KhiMetrics. No gain was recognized on amounts held in escrow. In connection with this sale, we received approximately $17.5 million in cash and recorded a gain of approximately $14.4 million during the nine months ended September 30, 2006. In addition, our 1996 Deferred Compensation Venture Investment Plan Trust received $2.5 million in cash and recorded a gain of $2.1 million during the nine months ended September 30, 2006.

Income Taxes

The following table presents the provision for income taxes and the effective tax rate for the three and nine months ended September 30, 2006 and October 1, 2005:


	Three Months Ended				Nine Months Ended
	September 30,		October 1,		September 30,		October 1,
	2006		2005		2006		2005
	(In millions, except percentages)

Provision for income taxes	$	30.7	$	12.4	$	70.6	$	13.4
Effective tax rate		42.2%		36.9%		42.9%		37.1%

Our effective tax rate for the three months ended September 30, 2006 and October 1, 2005 was 42.2% and 36.9%, respectively. Our effective tax rate for the nine months ended September 30, 2006 and October 1, 2005 was 42.9% and 37.1%, respectively. Our effective tax rate increased for the three and nine months ended September 30, 2006, compared to the three and nine months ended October 1, 2005, primarily due to the expiration on January 1, 2006 of the United States credit for increasing research activities, our adoption of SFAS No. 123R and a reduced benefit from foreign income taxed at a lower rate than the United States federal statutory rate.

We project our annual effective tax rate for the year ending December 30, 2006 to be approximately 43.0%. However, we may have volatility in our quarterly effective tax rates, including in the fourth quarter of 2006, due to disqualifying dispositions of shares issued under our employee stock purchase plan and incentive stock options for which we are not allowed to anticipate a tax deduction. Pursuant to SFAS No. 123R, the tax deduction will be recognized in the period of a disqualifying disposition. Our effective tax rate for the year ended December 31, 2005 was 62.0%. This decrease is primarily due to the non-recurring income taxes related to our 2005 repatriation of certain foreign earnings.

For 2006 and future years, we intend to indefinitely reinvest our undistributed foreign earnings and, accordingly, have not provided for the United States or foreign taxes that would be incurred if such earnings were repatriated to the United States.

The Internal Revenue Service, or IRS, and other tax authorities regularly examine our income tax returns. In November 2003, the IRS completed its field examination of our federal income tax returns for the tax years 1997 through 1999 and issued a Revenue Agent’s Report, or RAR, in which the IRS proposes to assess an aggregate tax deficiency for the three-year period of approximately $143.0 million. The most significant of the disputed adjustments for the tax years 1997 through 1999 relates to transfer pricing arrangements that we have with a foreign subsidiary. We have protested certain of the proposed adjustments with the Appeals Office of the IRS where the matter is presently being considered.

In July 2006, the IRS completed its field examination of our federal income tax returns for the tax years 2000 through 2002 and issued a RAR in which the IRS proposes to assess an aggregate tax deficiency for the three-year period of approximately $324.0 million. The IRS is contesting our qualification for deferred recognition of certain proceeds received from restitution and settlement in connection with litigation during the period. The proposed tax deficiency for this item is approximately $152.0 million. The remaining proposed tax deficiency of approximately $172.0 million is primarily related to proposed adjustments to our transfer pricing arrangements that we have with foreign subsidiaries and to our deductions for foreign trade income. The IRS took similar positions with respect to our transfer pricing arrangements in the prior examination period and may make similar claims against our transfer pricing arrangements in future examinations. We have filed a timely protest with the IRS and will seek resolution of the issues through the Appeals Office of the IRS.

Significant judgment is required in determining our provision for income taxes. In determining the adequacy of our provision for income taxes, we have assessed the likelihood of adverse outcomes resulting from tax examinations including the IRS RARs for tax years 1997 through 2002. However, the ultimate outcome of tax examinations cannot be predicted with certainty, including the total amount payable or the timing of any such payments upon resolution of these issues. In addition, we cannot be certain that such amount will not be materially different than that which is reflected in our historical income tax provisions and accruals. Should the IRS or other tax authorities assess additional taxes as a result of a current or a future examination, we may be required to record charges to operations in future periods that could have a material adverse effect on our results of operations, financial position or cash flows in the period or periods recorded.

Liquidity and Capital Resources


	As of
	September 30,		December 31,		%
	2006		2005		Change
	(In millions, except percentages)

Cash, cash equivalents and short-term investments	$	782.1	$	894.6		(13)%
Net Working Capital	$	626.3	$	670.5		(7)%


	Nine Months Ended
	September 30,			October 1,			%
	2006			2005			Change
	(In millions, except percentages)

Cash provided by operating activities	$	216.5		$	249.6			(13)%
Cash used for investing activities	$	(94.9	)	$	(192.2	)		(51)%
Cash provided by (used for) financing activities	$	(223.5	)	$	109.4			(304)%

Cash and cash equivalents and Short-term investments

As of September 30, 2006, our principal sources of liquidity consisted of $782.1 million of Cash and cash equivalents and Short-term investments, as compared to $894.6 million as of December 31, 2005. The primary sources of our cash in the first nine months of 2006 were customer payments under software licenses and from the sale or lease of our hardware products, payments for design and methodology services, proceeds from the sale of receivables, proceeds from the exercise of stock options and common stock purchases under our employee stock purchase plan, or ESPP, and proceeds received from the sale of investments. Our primary uses of cash in the first nine months of 2006 consisted of payments to former shareholders of acquired businesses, acquisition of intangibles, principal payments on the Castlewilder Term Loan, purchases of treasury stock, purchases of software licenses, payments relating to payroll, product, services and other operating expenses, and taxes.

Net working capital

As of September 30, 2006, we had net working capital of $626.3 million, as compared with $670.5 million as of December 31, 2005. The decrease in net working capital from December 31, 2005 to September 30, 2006 was primarily due to the decrease in Cash and cash equivalents and Short-term investments of $112.5 million, a decrease in Receivables of $33.4 million and an increase in the Current portion of long-term debt of $12.0 million. The decrease was partially offset by an increase in Prepaid expenses and other of $13.5 million, and a decrease in Accounts payable and accrued liabilities of $101.0 million.

Accounts payable and accrued liabilities decreased by $101.0 million from December 31, 2005 to September 30, 2006, primarily due to a decrease in the accrual for employee incentive compensation of $40.0 million, a decrease in the accrual for commissions of $10.2 million and a decrease in the accrual for the ESPP of $8.0 million. We generally expect these balances to be larger at the end of our second and fourth quarters and smaller at the end of our first and third quarters due to the timing of incentive compensation and commission payments and the issuance of our common stock under the ESPP. In addition, our accrual for income taxes decreased by $29.4 million from December 31, 2005 to September 30, 2006, primarily due to our payment in 2006 of taxes associated with our repatriation of $500.0 million of certain foreign earnings under the American Jobs Creation Act.

Cash flows from operating activities

Our cash flows from operating activities are significantly influenced by the payment terms set forth in our license agreements and by sales of our receivables. Net cash provided by operating activities decreased by $33.1 million to $216.5 million, during the nine months ended September 30, 2006, as compared to $249.6 million net cash provided by operating activities during the nine months ended October 1, 2005. The decrease was primarily due to a decrease in cash received from the collection of Receivables and Installment contract receivables of $126.9 million and an increase in payments of Accounts payable and accrued liabilities of $58.0 million, which includes an increase in tax payments of $25.9 million. The decrease was partially offset by an increase in net income of $71.5 million, an increase in Deferred revenue of $33.3 million and an increase in Other long-term liabilities of $29.9 million. Due to our adoption of SFAS No. 123R on January 1, 2006, $7.6 million of certain Tax benefits from employee stock transactions during the nine months ended September 30, 2006 were classified in Cash flows from financing activities. Prior to the adoption of SFAS No. 123R, the Tax benefits of employee stock transactions, if any, would have been recorded in Cash flows from operating activities.

We have entered into agreements whereby we may transfer qualifying accounts receivable to certain financing institutions on a non-recourse basis. These transfers are recorded as sales and accounted for in accordance with SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” During the nine months ended September 30, 2006, we received proceeds from the sale of receivables totaling $131.4 million, which approximated fair value, to financing institutions on a non-recourse basis, as compared to $129.0 million during the nine months ended October 1, 2005.

Cash flows from investing activities

Our primary investing activities consist of purchases and proceeds from the sale of property, plant and equipment, purchases and proceeds from short-term investments, proceeds from the sale of available-for-sale securities and long-term investments, acquiring businesses and intangibles and investing in venture capital partnerships and equity investments. During the nine months ended September 30, 2006, our investing activities used $94.9 million of cash, as compared to $192.2 million of cash used in the nine months ended October 1, 2005. The decrease in cash used by investing activities was primarily due to the decrease in payments to former shareholders of acquired companies of $230.1 million and the decrease of purchases of Short-term investments of $181.0 million, which were partially offset by the decrease in proceeds from the sale of Short-term investments of $289.2 million and a decrease in proceeds from the sale of property, plant and equipment of $33.6 million.

In January 2006, KhiMetrics, Inc., a cost method investment held by Telos Venture Partners, a limited partnership in which we and our 1996 Deferred Compensation Venture Investment Plan Trust are the sole limited partners, was sold for consideration of $6.53 per share of common stock. Under the purchase agreement, 10% of the consideration is being held in escrow to pay the cost of resolving any claims that may be asserted against KhiMetrics on or before the first anniversary of the acquisition, at which time the escrow amount remaining after resolution of such claims will be distributed to the former stockholders of KhiMetrics. No gain was recorded on amounts held in escrow. In connection with this sale, we received approximately $17.5 million in cash and recorded a gain of approximately $14.4 million during the nine months ended September 30, 2006. In addition, our 1996 Deferred Compensation Venture Investment Plan Trust received $2.5 million in cash and recorded a gain of $2.1 million during the nine months ended September 30, 2006.

We expect to continue our investing activities, including purchasing property, plant and equipment, purchasing intangible assets, purchasing software licenses and making long-term equity investments.

Cash flows from financing activities

Net cash used for financing activities was $223.5 million in the nine months ended September 30, 2006, as compared to net cash provided by financing activities of $109.4 million for the nine months ended October 1, 2005. During the nine months ended September 30, 2006, our primary use of cash for financing activities was $258.4 million to purchase treasury stock and $99.0 million of principal payments on the Castlewilder Term Loan. There were no significant uses of cash for financing activities during the nine months ended October 1, 2005. During the nine months ended September 30, 2006, financing activities provided cash of $126.3 million in proceeds from the sale of common stock upon exercise of stock options and exercise of rights under the ESPP, compared to $109.4 million in the nine months ended October 1, 2005.

We expect to continue our financing activities and may use cash reserves to repurchase stock under our stock repurchase program or to prepay principal installments on the Castlewilder Term Loan.

Other Factors Affecting Liquidity and Capital Resources

Income Taxes

We provide for United States income taxes on the earnings of our foreign subsidiaries unless the earnings are considered permanently invested outside of the United States. During the fourth quarter of 2005, we repatriated $500.0 million of certain foreign earnings which were previously considered to be indefinitely reinvested outside of the United States. We will invest these earnings in the United States pursuant to the American Jobs Creation Act guidelines. We paid $25.0 million of federal and state income taxes related to the repatriation during the nine months ended September 30, 2006. For 2006 and future years, we intend to indefinitely reinvest our foreign earnings outside of the United States.

We believe that the proposed IRS adjustments are inconsistent with applicable tax laws, and that we have meritorious defenses to the proposed adjustments. The RARs are not final Statutory Notices of Deficiency but the IRS imposes interest on the proposed deficiencies until the matters are resolved. Interest is compounded daily at rates published by the IRS, which rates are adjusted quarterly and have been between four and ten percent since 1997. While we are protesting certain of the proposed adjustments, we cannot predict with certainty the ultimate outcome of the tax examinations, including the amount payable, or timing of such payments, which may materially impact our cash flows in the period or periods resolved.

Term Loan

In December 2005, our Irish subsidiary, Castlewilder, entered into a syndicated term facility agreement, or Credit Agreement, with Banc of America Securities LLC as lead arranger, and Bank of America, N.A., as Administrative Agent. The Credit Agreement provides for a three-year $160.0 million unsecured term loan, or Term Loan. With the consent of all of the lenders, we may, at the end of the second year of the loan, extend the maturity date to December 31, 2009. Castlewilder’s obligations under the Credit Agreement are guaranteed by us and Cadence Technology Limited, a wholly-owned subsidiary of Castlewilder. Our guaranty contains certain financial covenants that must be maintained by us on a consolidated basis, as well as limitations on our ability to incur additional indebtedness and liens, make investments, dispose of assets, pay dividends or other distributions, engage in certain corporate transactions and certain other activities.

Under the Credit Agreement, we have the option to choose between two interest rates: (i) a base rate equal to the higher of the Federal Funds Rate plus 0.50% or the “prime rate” publicly announced by Bank of America, N.A., or (ii) a LIBOR-based rate equal to LIBOR plus 0.625%. The loan was initially a base rate loan that converted on December 22, 2005 into a LIBOR-based rate loan, which accrued interest monthly at an annual rate of 6.04% as of September 30, 2006. We may, at our discretion, change the interest rate election each Interest Period, as defined in the Credit Agreement. The margin with respect to the loan (if the loan is a LIBOR loan) may be increased or decreased depending upon our consolidated leverage ratio.

Castlewilder is obligated to repay the outstanding principal amount of the loan in quarterly installments in amounts equal to $8.0 million per quarter during 2006, $12.0 million per quarter during 2007 and $20.0 million per quarter during 2008 (with the quarterly repayment amount to be adjusted to $10.0 million per quarter during 2008 and 2009 if the maturity date of the loan is extended). Castlewilder is also obligated to pay accrued interest on the last day of each month or other interest period that we may select under the terms of the Credit Agreement. If the loan is converted into a base rate loan, we are obligated to pay accrued interest on the last day of each quarter. Under the terms of the Credit Agreement, Castlewilder, at its election, may prepay the loan, in whole or in part, with no prepayment fee. During the nine months ended September 30, 2006, Castlewilder made quarterly principal payments of $24.0 million, plus additional prepayments of $75.0 million of the principal amount due under the loan, thereby reducing principal payments due under the Term Loan in 2008.

Convertible Notes

In August 2003, we issued $420.0 million principal amount of Zero Coupon Zero Yield Senior Convertible Notes due 2023, or the Notes. We received net proceeds of approximately $406.4 million, after transaction fees of approximately $13.6 million that were recorded in Other assets and are being amortized to interest expense using the straight-line method over five years, which is the duration of the first redemption period. We issued the Notes at par and the Notes bear no interest. The Notes are convertible into our common stock initially at a conversion price of $15.65 per share, which would result in an aggregate of 26.8 million shares issued upon conversion, subject to adjustment upon the occurrence of specified events. The holders of the Notes may require us to repurchase for cash all or any portion of their Notes on August 15, 2008 for 100.25% of the principal amount, on August 15, 2013 for 100.00% of the principal amount or on August 15, 2018 for 100.00% of the principal amount, by providing to the paying agent a written repurchase notice. The repurchase notice must be delivered during the period commencing 30 business days prior to the relevant repurchase date and ending on the close of business on the business day prior to the relevant repurchase date. We may redeem for cash all or any part of the Notes on or after August 15, 2008 for 100.00% of the principal amount, except for those Notes that holders have required us to repurchase on August 15, 2008 or on other repurchase dates, as described above.

Concurrently with the issuance of the Notes, we entered into convertible notes hedge transactions whereby we have options to purchase up to 26.8 million shares of our common stock at a price of $15.65 per share. These options expire on August 15, 2008 and must be settled in net shares. The cost of the convertible notes hedge transactions to us was approximately $134.6 million. As of September 30, 2006, the estimated fair value of the options acquired in the convertible notes hedge transactions was $109.7 million.

In addition, we sold warrants to purchase up to 26.8 million shares of our common stock at a price of $23.08 per share. The warrants expire on various dates from February 2008 through May 2008 and must be settled in net shares.

We received approximately $56.4 million in cash proceeds for the sales of these warrants. As of September 30, 2006, the estimated fair value of the sold warrants was $17.6 million.

Sale-leaseback Agreement

During 2005, we entered into a sale-leaseback agreement involving certain land and buildings in San Jose, California. The agreement, as amended in June 2006, stipulates that we and the purchaser must receive certain approvals from local municipalities prior to October 31, 2006. If these conditions are met or waived by us and the purchaser prior to October 31, 2006, we would complete the sale of the buildings and lease the buildings from the purchaser for two years, with an option to extend the lease for an additional six months.

New Accounting Standards

In September 2006, the Financial Accounting Standards Board, or FASB, issued SFAS No. 157, “Fair Value Measurements,” which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS No. 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. Earlier adoption is permitted, provided the company has not yet issued financial statements, including for interim periods, for that fiscal year. We are currently evaluating the impact of SFAS No. 157, but do not expect the adoption of SFAS No. 157 to have a material impact on our consolidated financial position, results of operations or cash flows.

In July 2005, the FASB issued FASB Interpretation, or FIN, No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109,” which prescribes a new recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN No. 48 amends SFAS No. 5, “Accounting for Contingencies,” to eliminate its applicability to income taxes. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. The cumulative effect of applying the provisions of FIN No. 48 will be reported as an adjustment to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for the first fiscal year of adoption. We are currently studying the transition effects of adopting FIN No. 48 for our fiscal year 2007.


Item 3.	Quantitative and Qualitative Disclosures About Market Risk

Disclosures About Market Risk

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates primarily to our short-term investment portfolio and the Castlewilder Term Loan. While we are exposed to interest rate fluctuations in many of the world’s leading industrialized countries, our interest income and expense is most sensitive to fluctuations in the general level of United States interest rates. In this regard, changes in United States interest rates affect the interest earned on our cash and cash equivalents, short-term and long-term investments and costs associated with foreign currency hedges. We believe that our exposure to market rate risk for changes in interest rates related to the Castlewilder Term Loan is hedged by our short-term investment portfolio.

We invest in high quality credit issuers and, by policy, limit the amount of our credit exposure to any one issuer. As part of our policy, our first priority is to reduce the risk of principal loss. Consequently, we seek to preserve our invested funds by limiting default risk, market risk and reinvestment risk. We mitigate default risk by investing in only high quality credit securities that we believe to have low credit risk and by positioning our portfolio to respond appropriately to a significant reduction in a credit rating of any investment issuer or guarantor. The short-term interest-bearing portfolio includes only marketable securities with active secondary or resale markets to ensure portfolio liquidity.

The table below presents the carrying value and related weighted average interest rates for our interest-bearing instruments. All highly liquid investments with a maturity of three months or less at the date of purchase are considered to be cash equivalents; investments with maturities between three and 12 months are considered to be short-term investments. Investments with maturities greater than 12 months are considered long-term investments. The carrying value of our interest-bearing instruments approximated fair value at September 30, 2006 and is as follows:


	Carrying		Average
	Value		Interest Rate
	(In millions)

Interest-Bearing Instruments:
Commercial Paper – fixed rate	$	643.3		5.39%
Cash – variable rate		68.8		3.66%
Cash equivalents – variable rate		12.9		5.21%
Cash equivalents – fixed rate		8.9		1.89%

Total interest-bearing instruments	$	733.9		5.18%

Foreign Currency Risk

Our operations include transactions in foreign currencies and, therefore, we benefit from a weaker dollar, and we are adversely affected by a stronger dollar relative to major currencies worldwide. The primary effect of foreign currency transactions on our results of operations from a weakening United States dollar is an increase in revenue offset by a smaller increase in expenses. Conversely, the primary effect of foreign currency transactions on our results of operations from a strengthening United States dollar is a reduction in revenue offset by a smaller reduction in expenses.

We enter into foreign currency forward exchange contracts with financial institutions to protect against currency exchange risks associated with existing assets and liabilities. A foreign currency forward exchange contract acts as a hedge by increasing in value when underlying assets decrease in value or underlying liabilities increase in value due to changes in foreign exchange rates. Conversely, a foreign currency forward exchange contract decreases in value when underlying assets increase in value or underlying liabilities decrease in value due to changes in foreign exchange rates. These forward contracts are not designated as accounting hedges under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and, therefore, the unrealized gains and losses are recognized in Other income, net, in advance of the actual foreign currency cash flows with the fair value of these forward contracts being recorded as accrued liabilities or other assets.

Our policy governing hedges of foreign currency risk does not allow us to use forward contracts for trading purposes. Our forward contracts generally have maturities of 90 days or less. The effectiveness of our hedging program depends on our ability to estimate future asset and liability exposures. We enter into currency forward exchange contracts based on estimated future asset and liability exposures. Recognized gains and losses with respect to our current hedging activities will ultimately depend on how accurately we are able to match the amount of currency forward exchange contracts with actual underlying asset and liability exposures.

The table below provides information, as of September 30, 2006, about our forward foreign currency contracts. The information is provided in United States dollar equivalent amounts. The table presents the notional amounts, at contract exchange rates, and the weighted average contractual foreign currency exchange rates expressed as units of the foreign currency per United States dollar, which in some cases may not be the market convention for quoting a particular currency. All of these forward contracts mature prior to November 17, 2006.


			Weighted
			Average
	Notional		Contract
	Principal		Rate
	(In millions)

Forward Contracts:
Japanese yen	$	120.2		116.14
British pound sterling		45.6		0.53
European Union euro		11.6		0.79
Indian rupee		10.7		46.24
Canadian dollar		9.2		1.12
Other		21.2

Total	$	218.5

Estimated fair value	$	1.8

While we actively monitor our foreign currency risks, there can be no assurance that our foreign currency hedging activities will substantially offset the impact of fluctuations in currency exchange rates on our results of operations, cash flows and financial position.

Equity Price Risk

In August 2003, we issued $420.0 million principal amount of the Notes, for which we received net proceeds of approximately $406.4 million after transaction fees of approximately $13.6 million. Each $1,000 of principal of the Notes will initially be convertible into 63.8790 shares of our common stock, subject to adjustment upon the occurrence of specified events. Holders of the Notes may convert their Notes prior to maturity only if: (1) the price of our common stock reaches $22.69 during periods of time specified by the Notes, (2) specified corporate transactions occur, (3) the Notes have been called for redemption or (4) the trading price of the Notes falls below a certain threshold. In addition, in the event of a significant change in our corporate ownership or structure, the holders may require us to repurchase all or any portion of their Notes for 100% of the principal amount. For additional discussion of the Notes, see “Liquidity and Capital Resources” above.

We have a portfolio of equity investments that includes marketable equity securities and non-marketable equity securities. Our equity investments primarily are made in connection with our strategic investment program. Under our strategic investment program, from time to time we make cash investments in companies with distinctive technologies that are potentially strategically important to us.

The fair value of our portfolio of available-for-sale marketable equity securities, which are included in Short-term investments in the accompanying Condensed Consolidated Financial Statements, was $24.6 million as of September 30, 2006 and $33.3 million as of December 31, 2005. While we actively monitor these investments, we do not currently engage in any hedging activities to reduce or eliminate equity price risk with respect to these equity investments. Accordingly, we could lose all or part of our investment portfolio of marketable equity securities if there is an adverse change in the market prices of the companies we invest in.

Our investments in non-marketable equity securities would be negatively affected by an adverse change in equity market prices, although the impact cannot be directly quantified. Such a change, or any negative change in the financial performance or prospects of the companies whose non-marketable securities we own, would harm the ability of these companies to raise additional capital and the likelihood of our being able to realize any gains or

return of our investments through liquidity events such as initial public offerings, acquisitions and private sales. These types of investments involve a high degree of risk, and there can be no assurance that any company we invest in will grow or be successful. Accordingly, we could lose all or part of our investment.

Our investments in non-marketable equity securities had a carrying amount of $29.9 million as of September 30, 2006 and $37.9 million as of December 31, 2005. If we determine that an other-than-temporary decline in fair value exists for a non-marketable equity security, we write down the investment to its fair value and record the related write-down as an investment loss in our Condensed Consolidated Statements of Operations.


Item 4.	Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We carried out an evaluation required by Rule 13a-15 of the Securities Exchange Act of 1934, as amended, or the Exchange Act, under the supervision and with the participation of our management, including the Chief Executive Officer, or CEO, and the Chief Financial Officer, or CFO, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13-15(e) and 15d-15(e) under the Exchange Act) as of September 30, 2006.

The evaluation of our disclosure controls and procedures included a review of our processes and implementation and the effect on the information generated for use in this Quarterly Report. In the course of this evaluation, we sought to identify any significant deficiencies or material weaknesses in our disclosure controls and procedures, to determine whether we had identified any acts of fraud involving personnel who have a significant role in our disclosure controls and procedures, and to confirm that any necessary corrective action, including process improvements, was taken. This type of evaluation is done every fiscal quarter so that our conclusions concerning the effectiveness of these controls can be reported in our periodic reports filed with the SEC. The overall goals of these evaluation activities are to monitor our disclosure controls and procedures and to make modifications as necessary. We intend to maintain these disclosure controls and procedures, modifying them as circumstances warrant.

Based on their evaluation as of September 30, 2006, our CEO and CFO have concluded that our disclosure controls and procedures were sufficiently effective to ensure that the information required to be disclosed by us in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended September 30, 2006 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls

Our management, including our CEO and CFO, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. While our disclosure controls and procedures and internal control over financial reporting are designed to provide reasonable assurance of their effectiveness, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Cadence have been detected.

PART II. OTHER INFORMATION


Item 1.	Legal Proceedings

From time to time, we are involved in various disputes and litigation matters that arise in the ordinary course of business. These include disputes and lawsuits related to intellectual property, mergers and acquisitions, licensing, contracts, distribution arrangements and employee relations matters. Periodically, we review the status of each significant matter and assess its potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount or the range of loss can be estimated, we accrue a liability for the estimated loss in accordance with SFAS No. 5, “Accounting for Contingencies.” Legal proceedings are subject to uncertainties, and the outcomes are difficult to predict. Because of such uncertainties, accruals are based only on the best information available at the time. As additional information becomes available, we reassess the potential liability related to pending claims and litigation matters and may revise estimates.

While the outcome of these disputes and litigation matters cannot be predicted with any certainty, management does not believe that the outcome of any current matters will have a material adverse effect on our consolidated financial position or results of operations.


Item 1A.	Risk Factors

Our business faces many risks. Described below are what we believe to be the material risks that we face. If any of the events or circumstances described in the following risks actually occurs, our business, financial condition or results of operations could suffer.

Risks Related to Our Business

We are subject to the cyclical nature of the integrated circuit and electronics systems industries, and any
downturn in these industries may reduce our revenue.

Purchases of our products and services are dependent upon the commencement of new design projects by IC manufacturers and electronics systems companies. The IC and electronics systems industries are cyclical and are characterized by constant and rapid technological change, rapid product obsolescence and price erosion, evolving standards, short product life cycles and wide fluctuations in product supply and demand.

The IC and electronics systems industries have experienced significant downturns, often connected with, or in anticipation of, maturing product cycles of both these industries’ and their customers’ products and a decline in general economic conditions. These downturns have been characterized by diminished product demand, production overcapacity, high inventory levels and accelerated erosion of average selling prices. Any economic downturn in the industries we serve could harm our business, operating results and financial condition.

Our failure to respond quickly to technological developments could make our products uncompetitive and
obsolete.

The industries in which we compete experience rapid technology developments, changes in industry standards, changes in customer requirements and frequent new product introductions and improvements. Currently, the industries we serve are experiencing several revolutionary trends:


	•	Migration to nanometer design: the size of features such as wires, transistors and contacts on ICs continuously shrink due to the ongoing advances in semiconductor manufacturing processes. Process feature sizes refer to the width of the transistors and the width and spacing of interconnect on the IC. Feature size is normally identified by the transistor length, which is shrinking from 130 nanometers to 90 nanometers to 65 nanometers and smaller. This is commonly referred to in the semiconductor industry as the migration to nanometer design. It represents a major challenge for participants in the semiconductor industry, from IC design and design automation to design of manufacturing equipment and the manufacturing process itself. Shrinkage of transistor length to such proportions is challenging the industry in the application of more complex physics and chemistry that is needed to realize advanced silicon devices. For EDA tools, models of each component’s electrical properties and behavior become more complex as do requisite analysis, design and verification capabilities. Novel design tools and


		methodologies must be invented quickly to remain competitive in the design of electronics in the nanometer range.


	•	The challenges of nanometer design are leading some customers to work with older, less risky manufacturing processes. This may reduce their need to upgrade their EDA products and design flows.

	•	The ability to design system-on-a-chip devices, or SoCs, increases the complexity of managing a design that, at the lowest level, is represented by billions of shapes on the fabrication mask. In addition, SoCs typically incorporate microprocessors and digital signal processors that are programmed with software, requiring simultaneous design of the IC and the related software embedded on the IC.

	•	With the availability of seemingly endless gate capacity, there is an increase in design reuse, or the combining of off-the-shelf design IP with custom logic to create ICs. The unavailability of high-quality design IP that can be reliably incorporated into a customer’s design with Cadence IC implementation products and services could reduce demand for our products and services.

	•	Increased technological capability of the Field-Programmable Gate Array, which is a programmable logic chip, creates an alternative to IC implementation for some electronics companies. This could reduce demand for Cadence’s IC implementation products and services.

	•	A growing number of low-cost design and methodology services businesses could reduce the need for some IC companies to invest in EDA products.

If we are unable to respond quickly and successfully to these developments, we may lose our competitive position, and our products or technologies may become uncompetitive or obsolete. To compete successfully, we must develop or acquire new products and improve our existing products and processes on a schedule that keeps pace with technological developments and the requirements for products addressing a broad spectrum of designers and designer expertise in our industries. We must also be able to support a range of changing computer software, hardware platforms and customer preferences. We cannot guarantee that we will be successful in this effort.

We have experienced varied operating results, and our operating results for any particular fiscal period are
affected by the timing of significant orders for our software products, fluctuations in customer preferences
for license types and the timing of revenue recognition under those license types.

We have experienced, and may continue to experience, varied operating results. In particular, we have experienced net losses for some past periods and we may experience net losses in future periods. Various factors affect our operating results and some of them are not within our control. Our operating results for any period are affected by the timing of significant orders for our software products because a significant number of licenses for our software products are in excess of $5.0 million.

Our operating results are also affected by the mix of license types executed in any given period. We license software using three different license types: subscription, term and perpetual. Product revenue associated with term and perpetual licenses is generally recognized at the beginning of the license period, whereas product revenue associated with subscription licenses is recognized over multiple periods during the term of the license. Revenue may also be deferred under term and perpetual licenses until payments become due and payable from customers with nonlinear payment terms or as cash is collected from customers with lower credit ratings. In addition, revenue is impacted by the timing of license renewals, the extent to which contracts contain flexible payment terms and the mix of license types (i.e., perpetual, term or subscription) for existing customers, which changes could have the effect of accelerating or delaying the recognition of revenue from the timing of recognition under the original contract.

We plan operating expense levels primarily based on forecasted revenue levels. These expenses and the impact of long-term commitments are relatively fixed in the short term. A shortfall in revenue could lead to operating results below expectations because we may not be able to quickly reduce these fixed expenses in response to these short-term business changes.

You should not view our historical results of operations as reliable indicators of our future performance. If revenue or operating results fall short of the levels expected by public market analysts and investors, the trading price of our common stock could decline dramatically.

Our future revenue is dependent in part upon our installed customer base continuing to license or buy additional
products, renew maintenance agreements and purchase additional services.

Our installed customer base has traditionally generated additional new license, service and maintenance revenues. In future periods, customers may not necessarily license or buy additional products or contract for additional services or maintenance. Maintenance is generally renewable annually at a customer’s option, and there are no mandatory payment obligations or obligations to license additional software. If our customers decide not to renew their maintenance agreements or license additional products or contract for additional services, or if they reduce the scope of the maintenance agreements, our revenue could decrease, which could have an adverse effect on our results of operations.

We may not receive significant revenue from our current research and development efforts for several years, if
at all.

Internally developing software products, integrating acquired software products and integrating intellectual property into existing platforms is expensive, and these investments often require a long time to generate returns. Our strategy involves significant investments in software research and development and related product opportunities. We believe that we must continue to dedicate a significant amount of resources to our research and development efforts to maintain our competitive position. However, we cannot predict that we will receive significant, if any, revenue from these investments.

We have acquired and expect to acquire other companies and businesses and may not realize the expected benefits
of these acquisitions.

We have acquired and expect to acquire other companies and businesses in the future. While we expect to carefully analyze each potential acquisition before committing to the transaction, we may not be able to integrate and manage acquired products and businesses effectively. In addition, acquisitions involve a number of risks. If any of the following events occurs after we acquire another business, it could seriously harm our business, operating results and financial condition:


	•	Difficulties in combining previously separate businesses into a single unit;

	•	The substantial diversion of management’s attention from day-to-day business when evaluating and negotiating these transactions and integrating an acquired business;

	•	The discovery, after completion of the acquisition, of liabilities assumed from the acquired business or of assets acquired for which we cannot realize the anticipated value;

	•	The failure to realize anticipated benefits such as cost savings and revenue enhancements;

	•	The failure to retain key employees of the acquired business;

	•	Difficulties related to integrating the products of an acquired business in, for example, distribution, engineering and customer support areas;

	•	Unanticipated costs;

	•	Customer dissatisfaction with existing license agreements with Cadence which may dissuade them from licensing or buying products acquired by Cadence after the effective date of the license; and

	•	The failure to understand and compete effectively in markets in which we have limited experience.

In a number of our acquisitions, we have agreed to make future payments, or earnouts, based on the performance of the businesses we acquired. The performance goals pursuant to which these future payments may be made generally relate to achievement by the acquired business of certain specified bookings, revenue, product proliferation, product development or employee retention goals during a specified period following completion of the applicable acquisition. Future acquisitions may involve issuances of stock as payment of the purchase price for

the acquired business, grants of incentive stock or options to employees of the acquired businesses (which may be dilutive to existing stockholders), expenditure of substantial cash resources or the incurrence of material amounts of debt.

The specific performance goal levels and amounts and timing of contingent purchase price payments vary with each acquisition. In connection with our acquisitions completed prior to September 30, 2006, we may be obligated to pay up to an aggregate of $5.0 million in cash during the next 12 months and an additional $2.0 million in cash in periods after the next 12 months through August 2008 if certain performance goals related to one or more of the criteria mentioned above are achieved in full.

Our failure to attract, train, motivate and retain key employees may make us less competitive in our industries and
therefore harm our results of operations.

Our business depends on the efforts and abilities of our senior management, our research and development staff, and a number of other key management, sales, support, technical and services employees. The high cost of training new employees, not fully utilizing these employees, or losing trained employees to competing employers could reduce our gross margins and harm our business and operating results. Competition for highly skilled employees can be intense, particularly in geographic areas recognized as high technology centers such as the Silicon Valley area, where our principal offices are located, and the other locations where we maintain facilities. If economic conditions continue to improve and job opportunities in the technology industry become more plentiful, we may experience increased employee attrition and increased competition for skilled employees. To attract, retain and motivate individuals with the requisite expertise, we may be required to grant large numbers of stock options or other stock-based incentive awards, which may be dilutive to existing stockholders and increase compensation expense. We may also be required to pay key employees significant base salaries and cash bonuses, which could harm our operating results.

In addition, regulations adopted by NASDAQ require stockholder approval for new equity compensation plans and significant amendments to existing plans, including increases in shares available for issuance under such plans, and prohibit NASDAQ member organizations 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 materially and adversely affect our business.

The competition in our industries is substantial and we cannot assure you that we will be able to continue to
successfully compete in our industries.

The EDA market and the commercial electronics design and methodology services industries are highly competitive. If we fail to compete successfully in these industries, it could seriously harm our business, operating results and financial condition. To compete in these industries, we must identify and develop or acquire innovative and cost-competitive EDA products, integrate them into platforms and market them in a timely manner. We must also gain industry acceptance for our design and methodology services and offer better strategic concepts, technical solutions, prices and response time, or a combination of these factors, than those of other design companies and the internal design departments of electronics manufacturers. We cannot assure you that we will be able to compete successfully in these industries. Factors that could affect our ability to succeed include:


	•	The development by others of competitive EDA products or platforms and design and methodology services, which could result in a shift of customer preferences away from our products and services and significantly decrease revenue;

	•	Decisions by electronics manufacturers to perform design and methodology services internally, rather than purchase these services from outside vendors due to budget constraints or excess engineering capacity;

	•	The challenges of developing (or acquiring externally-developed) technology solutions that are adequate and competitive in meeting the requirements of next-generation design challenges;


	•	The significant number of current and potential competitors in the EDA industry and the low cost of entry;

	•	Intense competition to attract acquisition targets, which may make it more difficult for us to acquire companies or technologies at an acceptable price or at all; and

	•	The combination of or collaboration among many EDA companies to deliver more comprehensive offerings than they could individually.

We compete in the EDA products market primarily with Synopsys, Inc., Mentor Graphics Corporation and Magma Design Automation, Inc. We also compete with numerous smaller EDA companies, with manufacturers of electronic devices that have developed or have the capability to develop their own EDA products, and with numerous electronics design and consulting companies. Manufacturers of electronic devices may be reluctant to purchase design and methodology services from independent vendors such as us because they wish to promote their own internal design departments.

We may need to change our pricing models to compete successfully.

The highly competitive markets in which we compete can put pressure on us to reduce the prices of our products. If our competitors offer deep discounts on certain products in an effort to recapture or gain market segment share or to sell other software or hardware products, we may then need to lower our prices or offer other favorable terms to compete successfully. Any such changes would be likely to reduce our profit margins and could adversely affect our operating results. Any broadly-based changes to our prices and pricing policies could cause sales and software license revenues to decline or be delayed as our sales force implements and our customers adjust to the new pricing policies. Some of our competitors may bundle products for promotional purposes or as a long-term pricing strategy or provide guarantees of prices and product implementations. These practices could, over time, significantly constrain the prices that we can charge for our products. If we cannot offset price reductions with a corresponding increase in the number of sales or with lower spending, then the reduced license revenues resulting from lower prices could have an adverse effect on our results of operations.

We rely on our proprietary technology as well as software and other intellectual property rights licensed to us by
third parties, and we cannot assure you that the precautions taken to protect our rights will be adequate or
that we will continue to be able to adequately secure such intellectual property rights from third parties.

Our success depends, in part, upon our proprietary technology. We generally rely on patents, copyrights, trademarks, trade secret laws, licenses and restrictive agreements to establish and protect our proprietary rights in technology and products. Despite precautions we may take to protect our intellectual property, we cannot assure you that third parties will not try to challenge, invalidate or circumvent these safeguards. We also cannot assure you that the rights granted under our patents or attendant to our other intellectual property will provide us with any competitive advantages, or that patents will be issued on any of our pending applications, or that future patents will be sufficiently broad to protect our technology. Furthermore, the laws of foreign countries may not protect our proprietary rights in those countries to the same extent as applicable law protects these rights in the United States. Many of our products include software or other intellectual property licensed from third parties. We may have to seek new or renew existing licenses for such software and other intellectual property in the future. Our design and methodology services business holds licenses to certain software and other intellectual property owned by third parties, including that of our competitors. Our failure to obtain, for our use, software or other intellectual property licenses or other intellectual property rights on favorable terms, or the need to engage in litigation over these licenses or rights, could seriously harm our business, operating results and financial condition.

We could lose key technology or suffer serious harm to our business because of the infringement of our
intellectual property rights by third parties or because of our infringement of the intellectual property rights
of third parties.

There are numerous patents in the EDA industry and new patents are being issued at a rapid rate. It is not always practicable to determine in advance whether a product or any of its components infringes the patent rights of others. As a result, from time to time, we may be compelled to respond to or prosecute intellectual property infringement claims to protect our rights or defend a customer’s rights. These claims, regardless of merit, could

consume valuable management time, result in costly litigation, or cause product shipment delays, all of which could seriously harm our business, operating results and financial condition. In settling these claims, we may be required to enter into royalty or licensing agreements with the third parties claiming infringement. These royalty or licensing agreements, if available, may not have terms favorable to us. Being compelled to enter into a license agreement with unfavorable terms could seriously harm our business, operating results and financial condition. Any potential intellectual property litigation could compel us to do one or more of the following:


	•	Pay damages, license fees or royalties to the party claiming infringement;

	•	Stop licensing products or providing services that use the challenged intellectual property;

	•	Obtain a license from the owner of the infringed intellectual property to sell or use the relevant technology, which license may not be available on reasonable terms, or at all; or

	•	Redesign the challenged technology, which could be time-consuming and costly, or not be accomplished.

If we were compelled to take any of these actions, our business and results of operations may suffer.

If our security measures are breached and an unauthorized party obtains access to customer data, our
information systems may be perceived as being unsecure and customers may curtail their use of, or stop their
use of, our products and services.

Our products and services involve the storage and transmission of customers’ proprietary information, and breaches of our security measures could expose us to a risk of loss or misuse of this information, litigation and potential liability. Because techniques used to obtain unauthorized access or to sabotage information systems change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventive measures. If an actual or perceived breach of our security occurs, the market perception of the effectiveness of our security measures could be harmed and we could lose existing customers and our ability to obtain new customers.

We may not be able to effectively implement our restructuring activities, and our restructuring activities may not
result in the expected benefits, which would negatively impact our future results of operations.

The EDA market and the commercial electronics design and methodology services industries are highly competitive and change quickly. We have responded to increased competition and changes in the industries in which we compete, in part, by restructuring our operations and reducing the size of our workforce. Despite our restructuring efforts over the last few years, we cannot assure you that we will achieve all of the operating expense reductions and improvements in operating margins and cash flows currently anticipated from these restructuring activities in the periods contemplated, or at all. Our inability to realize these benefits, and our failure to appropriately structure our business to meet market conditions, could negatively impact our results of operations.

As part of our restructuring activities, we have reduced the workforce in certain revenue-generating portions of our business. This reduction in staffing levels could require us to forego certain future opportunities due to resource limitations, which could negatively affect our long-term revenues.

We cannot assure you that we will not be required to implement further restructuring activities or reductions in our workforce based on changes in the markets and industries in which we compete or that any future restructuring efforts will be successful.

The long sales cycle of our products and services makes the timing of our revenue difficult to predict and may
cause our operating results to fluctuate unexpectedly.

We have a long sales cycle that generally extends at least three to six months. The length of the sales cycle may cause our revenue and operating results to vary from quarter to quarter. The complexity and expense associated with our business generally requires a lengthy customer education, evaluation and approval process. Consequently, we may incur substantial expenses and devote significant management effort and expense to develop potential relationships that do not result in agreements or revenue and may prevent us from pursuing other opportunities.

In addition, sales of our products and services may be delayed if customers delay approval or commencement of projects because of:


	•	The timing of customers’ competitive evaluation processes; or

	•	Customers’ budgetary constraints and budget cycles.

Long sales cycles for acceleration and emulation hardware products subject us to a number of significant risks over which we have limited control, including insufficient, excess or obsolete inventory, variations in inventory valuation and fluctuations in quarterly operating results.

Also, because of the timing of large orders and our customers’ buying patterns, we may not learn of bookings shortfalls, revenue shortfalls, earnings shortfalls or other failures to meet market expectations until late in a fiscal quarter. These factors may cause our operating results to fluctuate unexpectedly.

The effect of foreign exchange rate fluctuations and other risks to our international operations may seriously
harm our financial condition.

We have significant operations outside the United States. Our revenue from international operations as a percentage of total revenue was approximately 49% for the three months ended September 30, 2006 and 48% for the three months ended October 1, 2005. We expect that revenue from our international operations will continue to account for a significant portion of our total revenue. We also transact business in various foreign currencies. Recent economic and political uncertainty and the volatility of foreign currencies in certain regions, most notably the Japanese yen, European Union euro, Indian rupee and the British pound have had, and may in the future have, a harmful effect on our revenue and operating results.

Fluctuations in the rate of exchange between the United States dollar and the currencies of other countries in which we conduct business could seriously harm our business, operating results and financial condition. For example, if there is an increase in the rate at which a foreign currency exchanges into United States dollars, it will take more of the foreign currency to equal the same amount of United States dollars than before the rate increase. If we price our products and services in the foreign currency, we will receive fewer United States dollars than we did before the rate increase went into effect. If we price our products and services in United States dollars, an increase in the exchange rate will result in an increase in the price for our products and services compared to those products of our competitors that are priced in local currency. This could result in our prices being uncompetitive in markets where business is transacted in the local currency.

Exposure to foreign currency transaction risk can arise when transactions are conducted in a currency different from the functional currency of one of our subsidiaries. A subsidiary’s functional currency is generally the currency in which it primarily conducts its operations, including product pricing, expenses and borrowings. Although we attempt to reduce the impact of foreign currency fluctuations, significant exchange rate movements may hurt our results of operations as expressed in United States dollars.

Our international operations may also be subject to other risks, including:


	•	The adoption or expansion of government trade restrictions;

	•	Limitations on repatriation of earnings;

	•	Limitations on the conversion of foreign currencies;

	•	Reduced protection of intellectual property rights in some countries;

	•	Recessions in foreign economies;

	•	Longer collection periods for receivables and greater difficulty in collecting accounts receivable;

	•	Difficulties in managing foreign operations;

	•	Political and economic instability;

	•	Unexpected changes in regulatory requirements;


	•	Tariffs and other trade barriers; and

	•	United States government licensing requirements for exports, which may lengthen the sales cycle or restrict or prohibit the sale or licensing of certain products.

We have offices throughout the world, including key research facilities outside of the United States. Our operations are dependent upon the connectivity of our operations throughout the world. Activities that interfere with our international connectivity, such as computer ”hacking” or the introduction of a virus into our computer systems, could significantly interfere with our business operations.

Our operating results could be adversely affected as a result of changes in our effective tax rates.

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


	•	Earnings being lower than anticipated in countries where we are taxed at lower rates as compared to the United States statutory tax rate;

	•	An increase in expenses not deductible for tax purposes, including certain stock compensation, write-offs of acquired in-process research and development and impairment of goodwill;

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

	•	Changes in tax laws or the interpretation of such tax laws;

	•	New accounting standards or interpretations of such standards; or

	•	A change in our decision to indefinitely reinvest foreign earnings.

Any significant change in our future effective tax rates could adversely impact our results of operations for future periods.

Forecasting our estimated annual effective tax rate is complex and subject to uncertainty, and material

differences between forecasted and actual tax rates could have a material impact on our results of operations.

Forecasts of our income tax position and resultant effective tax rate are complex and subject to uncertainty because our income tax position for each year combines the effects of a mix of profits and losses earned by us and our subsidiaries in tax jurisdictions with a broad range of income tax rates, as well as benefits from available deferred tax assets and costs resulting from tax audits. To forecast our global tax rate, pre-tax profits and losses by jurisdiction are estimated and tax expense by jurisdiction is calculated. If the mix of profits and losses, our ability to use tax credits, or effective tax rates by jurisdiction is different than those estimates, our actual tax rate could be materially different than forecasted, which could have a material impact on our results of operations.

Following our adoption of SFAS No. 123R, we may have additional volatility in our quarterly effective tax rates due to disqualifying dispositions of shares issued under our employee stock purchase plan and incentive stock options for which we are not allowed to anticipate a tax deduction. Pursuant to SFAS No. 123R, we will recognize a tax deduction in the period of a disqualifying disposition.

We have received examination reports from the Internal Revenue Service proposing tax deficiencies in certain of

our tax returns, and the outcome of current and future tax examinations may have a material adverse effect

on our results of operations and cash flows.

The Internal Revenue Service, or IRS, and other tax authorities regularly examine our income tax returns. In November 2003, the IRS completed its field examination of our federal income tax returns for the tax years 1997 through 1999 and issued a Revenue Agent’s Report, or RAR, in which the IRS proposes to assess an aggregate tax deficiency for the three-year period of approximately $143.0 million. The most significant of the disputed adjustments for the tax years 1997 through 1999 relates to transfer pricing arrangements that we have with a foreign subsidiary. We have filed a protest to certain of the proposed adjustments with the Appeals Office of the IRS where the matter is currently being considered. We are challenging these proposed adjustments vigorously.

In July 2006, the IRS completed its field examination of our federal income tax returns for the tax years 2000 through 2002 and issued a RAR, in which the IRS proposes to assess an aggregate tax deficiency for the three-year period of approximately $324.0 million. The IRS is contesting our qualification for deferred recognition of certain proceeds received from restitution and settlement in connection with litigation during the period. The proposed tax deficiency for this item is approximately $152.0 million. The remaining proposed tax deficiency of approximately $172.0 million is primarily related to proposed adjustments to our transfer pricing arrangements that we have with foreign subsidiaries and to our deductions for foreign trade income. The IRS took similar positions with respect to our transfer pricing arrangements in the prior examination period and may make similar claims against our transfer pricing arrangements in future examinations. We have filed a timely protest with the IRS and will seek resolution of the issues through the Appeals Office of the IRS.

Significant judgment is required in determining our provision for income taxes. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. In determining the adequacy of our provision for income taxes, we regularly assess the likelihood of adverse outcomes resulting from tax examinations including the IRS RARs for the tax years 1997 through 2002. We provide for tax liabilities on our Consolidated Balance Sheets unless we consider it probable that additional taxes will not be due. However, the ultimate outcome of tax examinations cannot be predicted with certainty, including the total amount payable or the timing of any such payments upon resolution of these issues. In addition, we cannot assure you that such amount will not be materially different than that which is reflected in our historical income tax provisions and accruals. Should the IRS or other tax authorities assess additional taxes as a result of a current or a future examination, we may be required to record charges to operations in future periods that could have a material impact on the results of operations, financial position or cash flows in the applicable period or periods recorded.

Failure to obtain export licenses could harm our business by rendering us unable to ship products and transfer

our technology outside of the United States.

We must comply with United States Department of Commerce regulations in shipping our software products and transferring our technology outside the United States and to foreign nationals. Although we have not had any significant difficulty complying with such regulations so far, any significant future difficulty in complying could harm our business, operating results and financial condition.

Errors or defects in our products and services could expose us to liability and harm our reputation.

Our customers use our products and services in designing and developing products that involve a high degree of technological complexity, each of which has its own specifications. Because of the complexity of the systems and products with which we work, some of our products and designs can be adequately tested only when put to full use in the marketplace. As a result, our customers or their end users may discover errors or defects in our software or the systems we design, or the products or systems incorporating our design and intellectual property may not operate as expected. Errors or defects could result in:


	•	Loss of current customers;

	•	Loss of or delay in revenue;

	•	Loss of market segment share;

	•	Failure to attract new customers or achieve market acceptance;

	•	Diversion of development resources to resolve the problem;

	•	Increased service costs; and

	•	Liability for damages.

If we become subject to unfair hiring claims, we could be prevented from hiring needed employees, incur liability

for damages and incur substantial costs in defending ourselves.

Companies in our industry whose employees accept positions with competitors frequently claim that these competitors have engaged in unfair hiring practices or that the employment of these persons would involve the disclosure or use of trade secrets. These claims could prevent us from hiring employees or cause us to incur liability for damages. We could also incur substantial costs in defending ourselves or our employees against these claims, regardless of their merits. Defending ourselves from these claims could also divert the attention of our management away from our operations.

Our business is subject to the risk of earthquakes, floods and other natural catastrophic events.

Our corporate headquarters, including certain of our research and development operations and certain of our distribution facilities, are located in the Silicon Valley area of Northern California, which is a region known to experience seismic activity. In addition, several of our facilities, including our corporate headquarters, certain of our research and development operations, and certain of our distribution operations, are in areas of San Jose, California that have been identified by the Director of the Federal Emergency Management Agency, or FEMA, as being located in a special flood area. The areas at risk are identified as being in a one hundred year flood plain, using FEMA’s Flood Hazard Boundary Map or the Flood Insurance Rate Map. If significant seismic or flooding activity were to occur, our operations may be interrupted, which would adversely impact our business and results of operations.

We maintain research and other facilities in parts of the world that are not as politically stable as the United

States, and as a result we may face a higher risk of business interruption from acts of war or terrorism than

businesses located only or primarily in the United States.

We maintain international research and other facilities, some of which are in parts of the world that are not as politically stable as the United States. Consequently, we may face a greater risk of business interruption as a result of terrorist acts or military conflicts than businesses located domestically. Furthermore, this potential harm is exacerbated given that damage to or disruptions at our international research and development facilities could have an adverse effect on our ability to develop new or improve existing products as compared to other businesses which may only have sales offices or other less critical operations abroad. We are not insured for losses or interruptions caused by acts of war or terrorism.

Risks Related to Our Securities and Indebtedness

Our debt obligations expose us to risks that could adversely affect our business, operating results and financial

condition, and could prevent us from fulfilling our obligations under such indebtedness.

We have a substantial level of debt. As of September 30, 2006, we had $420.0 million of outstanding indebtedness from our Zero Coupon Zero Yield Senior Convertible Notes due 2023, or Notes, that we issued in August 2003 and $61.0 million related to the Term Loan borrowed by our wholly-owned Irish subsidiary, which we have guaranteed. The level of our indebtedness, among other things, could:


	•	Make it difficult for us to satisfy our payment obligations on our debt as described below;

	•	Make it difficult for us to incur additional debt or obtain any necessary financing in the future for working capital, capital expenditures, debt service, acquisitions or general corporate purposes;

	•	Limit our flexibility in planning for or reacting to changes in our business;

	•	Reduce funds available for use in our operations;

	•	Make us more vulnerable in the event of a downturn in our business;

	•	Make us more vulnerable in the event of an increase in interest rates if we must incur new debt to satisfy our obligations under the Notes or Term Loan; or

	•	Place us at a possible competitive disadvantage relative to less leveraged competitors and competitors that have greater access to capital resources.

If we experience a decline in revenue due to any of the factors described in this section entitled “Risk Factors,” or otherwise, we could have difficulty paying amounts due on our indebtedness. In the case of the Notes, although the Notes mature in 2023, the holders of the Notes may require us to repurchase their notes at an additional premium of 0.25% in 2008, which makes it probable that we will be required to repurchase the Notes in 2008 if the Notes are not otherwise converted into our common stock. 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, including the Notes and the Term Loan, we would be in default, which would permit the holders of our indebtedness to accelerate the maturity of the indebtedness and could cause defaults under our other indebtedness. Any default under our indebtedness could have a material adverse effect on our business, operating results and financial condition.

The terms of the Notes do not prohibit us from incurring additional debt. In addition, our outstanding indebtedness under the Notes does not restrict our ability to pay dividends, issue or repurchase stock or other securities or require us to achieve or maintain any minimum financial results relating to our financial position or results of operations. Although the Notes do not contain such financial and other restrictive covenants, the documents governing the Term Loan do include such covenants, including certain restrictions on the incurrence of additional indebtedness and liens, disposition of assets, payment of cash dividends by us to our stockholders and our ability to engage in certain corporate transactions. We are also required by the documents governing the Term Loan to maintain certain minimum interest coverage and leverage ratios. Under the Term Loan, we are required to repay the principal amount thereof over a three year period. See “Other Factors Affecting Liquidity and Capital Resources” in Item 2 above. If we incur additional indebtedness or other liabilities, our ability to pay our obligations on our outstanding indebtedness could be adversely affected.

We may be unable to adequately service our indebtedness, which may result in defaults and other costs to us.

We may not have sufficient funds or may be unable to arrange for additional financing to pay the outstanding obligations due on our indebtedness. Any future borrowing arrangements or debt agreements to which we become a party may contain additional restrictions on or prohibitions against the repayment of our outstanding indebtedness, or otherwise have the effect of making it more difficult to repay our outstanding indebtedness. With respect to the Notes, at maturity, the entire outstanding principal amount of the Notes will become due and payable. Holders may require us to repurchase for cash all or any portion of the Notes on August 15, 2008 for 100.25% of the principal amount, August 15, 2013 for 100.00% of the principal amount and August 15, 2018 for 100.00% of the principal amount. As a result, although the Notes mature in 2023, the holders may require us to repurchase the Notes at an additional premium in 2008, which makes it probable that we will be required to repurchase the Notes in 2008 if the Notes are not otherwise converted into our common stock. If we are prohibited from paying our outstanding indebtedness, we could try to obtain the consent of lenders under those arrangements, or we could attempt to refinance the borrowings that contain the restrictions. If we do not obtain the necessary consents or refinance the borrowings, we may be unable to satisfy our outstanding indebtedness. Any such failure would constitute an event of default under our indebtedness, which could, in turn, constitute a default under the terms of any other indebtedness then outstanding.

In addition, a material default on our indebtedness could suspend our eligibility to register securities using certain registration statement forms under SEC guidelines which permit incorporation by reference of substantial information regarding us, which could potentially hinder our ability to raise capital through the issuance of our securities and will increase the costs of such registration to us.

Conversion of the Notes will dilute the ownership interests of existing stockholders.

The terms of the Notes permit the holders to convert the Notes into shares of our common stock. The Notes are convertible into our common stock initially at a conversion price of $15.65 per share, which would result in an aggregate of approximately 26.8 million shares of our common stock being issued upon conversion, subject to adjustment upon the occurrence of specified events. The conversion of some or all of the Notes will dilute the ownership interest of our existing stockholders. Any sales in the public market of the common stock issuable upon conversion could adversely affect prevailing market prices of our common stock. Prior to the conversion of the Notes, if the trading price of our common stock exceeds the conversion price of the Notes by 145.00% or more over specified periods, basic net income per share will be diluted if and to the extent the convertible notes hedge

instruments are not exercised. We may redeem for cash all or any part of the Notes on or after August 15, 2008 for 100.00% of the principal amount. The holders of the Notes may require us to repurchase for cash all or any portion of their Notes on August 15, 2008 for 100.25% of the principal amount, on August 15, 2013 for 100.00% of the principal amount, or on August 15, 2018 for 100.00% of the principal amount, by providing to the paying agent a written repurchase notice. The repurchase notice must be delivered during the period commencing 30 business days prior to the relevant repurchase date and ending on the close of business on the business day prior to the relevant repurchase date. We may redeem for cash all or any part of the Notes on or after August 15, 2008 for 100.00% of the principal amount, except for those Notes that holders have required us to repurchase on August 15, 2008 or on other repurchase dates, as described above.

Each $1,000 of principal of the Notes is initially convertible into 63.879 shares of our common stock, subject to adjustment upon the occurrence of specified events. Holders of the Notes may convert their Notes prior to maturity only if: (1) the price of our common stock reaches $22.69 during certain periods of time specified in the Notes, (2) specified corporate transactions occur, (3) the Notes have been called for redemption or (4) the trading price of the Notes falls below a certain threshold. As a result, although the Notes mature in 2023, the holders may require us to repurchase their notes at an additional premium in 2008, which makes it probable that we will be required to repurchase the Notes in 2008 if the Notes are not otherwise converted into our common stock. As of September 30, 2006, none of the conditions allowing holders of the Notes to convert had been met.

Although the conversion price is currently $15.65 per share, the convertible notes hedge and warrant transactions that we entered into in connection with the issuance of the Notes effectively increased the conversion price of the Notes until 2008 to approximately $23.08 per share, which would result in an aggregate issuance upon conversion prior to August 15, 2008 of approximately 18.2 million shares of our common stock. We have entered into convertible notes hedge and warrant transactions to reduce the potential dilution from the conversion of the Notes; however, we cannot guarantee that such convertible notes hedge and warrant instruments will fully mitigate the dilution. In addition, the existence of the Notes may encourage short selling by market participants because the conversion of the Notes could depress the price of our common stock.

We may, at the option of the Noteholders and only in certain circumstances, be required to repurchase the Notes

in cash or shares of our common stock.

Under the terms of the Notes, we may be required to repurchase the Notes following a significant change in our corporate ownership or structure, such as a change of control, prior to maturity of the Notes. Following a significant change in our corporate ownership or structure, in certain circumstances, we may choose to pay the repurchase price of the Notes in cash, shares of our common stock or a combination of cash and shares of our common stock. If we choose to pay all or any part of the repurchase price of Notes in shares of our common stock, this would result in dilution to the holders of our common stock.

Convertible notes hedge and warrant transactions entered into in connection with the issuance of the Notes may

affect the value of our common stock.

We entered into convertible notes hedge transactions with JP Morgan Chase Bank, an affiliate of one of the initial purchasers of the Notes, at the time of issuance of the Notes, with the objective of reducing the potential dilutive effect of issuing our common stock upon conversion of the Notes. We also entered into warrant transactions. In connection with our convertible notes hedge and warrant transactions, JP Morgan Chase Bank or its affiliates purchased our common stock in secondary market transactions and entered into various over-the-counter derivative transactions with respect to our common stock. This entity or its affiliates is likely to modify its hedge positions from time to time prior to conversion or maturity of the Notes by purchasing and selling shares of our common stock, other of our securities or other instruments it may wish to use in connection with such hedging. Any of these transactions and activities could adversely affect the value of our common stock and, as a result, the number of shares and the value of the common stock holders will receive upon conversion of the Notes. In addition, subject to movement in the price of our common stock, if the convertible notes hedge transactions settle in our favor, we could be exposed to credit risk related to the other party.

Rating agencies may provide unsolicited ratings on the Notes that could reduce the market value or liquidity of

our common stock.

We have not requested a rating of the Notes from any rating agency and we do not anticipate that the Notes will be rated. However, if one or more rating agencies independently elects to rate the Notes and assigns the Notes a rating lower than the rating expected by investors, or reduces such rating in the future, the market price or liquidity of the Notes and our common stock could be harmed. A resulting decline in the market price of the Notes as compared to the price of our common stock may require us to repurchase the Notes.

Anti-takeover defenses in our governing documents and certain provisions under Delaware law could prevent an

acquisition of our company or limit the price that investors might be willing to pay for our common stock.

Our governing documents and certain provisions of the Delaware General Corporation could make it difficult for another company to acquire control of our company. For example:


	•	Our certificate of incorporation allows our Board of Directors to issue, at any time and without stockholder approval, preferred stock with such terms as it may determine. No shares of preferred stock are currently outstanding. However, the rights of holders of any of our preferred stock that may be issued in the future may be superior to the rights of holders of our common stock.

	•	Section 203 of the Delaware General Corporation Law generally prohibits a Delaware corporation from engaging in any business combination with a person owning 15% or more of its voting stock, or who is affiliated with the corporation and owned 15% or more of its voting stock at any time within three years prior to the proposed business combination, for a period of three years from the date the person became a 15% owner, unless specified conditions are met.

All or any one of these factors could limit the price that certain investors would be willing to pay for shares of our common stock and could delay, prevent or allow our Board of Directors to resist an acquisition of our company, even if the proposed transaction were favored by a majority of our independent stockholders.

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

A. Recent Sales of Unregistered Securities:

None.

B. Stock Repurchases:

In August 2001, our Board of Directors authorized a program to repurchase shares of our common stock in the open market with a value of up to $500.0 million in the aggregate, which was exhausted during February 2006. In February 2006, our Board of Directors authorized a new program to repurchase shares of our common stock with a value of up to $500.0 million in the aggregate. The following table sets forth the repurchases we made during the three months ended September 30, 2006:


							Maximum Dollar
							Value of Shares that
					Total Number of		May Yet
	Total				Shares Purchased		Be Purchased Under
	Number of		Average		as Part of		Publicly Announced
	Shares		Price		Publicly Announced		Plan or Program*
Period	Purchased*		Per Share		Plan or Program		(in millions)

July 2, 2006 – August 5, 2006		1,034,757	$	16.05		1,000,000	$	345.0
August 6, 2006 – September 2, 2006		4,115,736	$	16.34		4,000,000	$	279.7
September 3, 2006 – September 30, 2006		1,023,661	$	16.15		1,000,000	$	263.5

Total		6,174,154	$	16.26		6,000,000

* Shares purchased that were not part of our publicly announced repurchase program represent the surrender of shares of restricted stock to pay income taxes due upon vesting, and do not reduce the maximum dollar value that may yet be purchased under our publicly announced repurchase program.

Item 3. Defaults Upon Senior Securities

None.

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

None.

Item 5. Other Information

None.


		Page

PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements:

	Condensed Consolidated Balance Sheets: September 30, 2006 and December 31, 2005		1

	Condensed Consolidated Statements of Operations: Three and Nine Months Ended September 30, 2006 and October 1, 2005		2

	Condensed Consolidated Statements of Cash Flows: Nine Months Ended September 30, 2006 and October 1, 2005		3

	Notes to Condensed Consolidated Financial Statements		4

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		24

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		40

Item 4.	Controls and Procedures		42

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings		44

Item 1A.	Risk Factors		44

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		57

Item 3.	Defaults Upon Senior Securities		57

Item 4.	Submission of Matters to a Vote of Security Holders		57

Item 5.	Other Information		57

Item 6.	Exhibits		58

	Signatures		59
EXHIBIT 31.01
EXHIBIT 31.02
EXHIBIT 32.01
EXHIBIT 32.02


Exhibit
Number			Exhibit Title

	31	.01	Certification of the Registrant’s Chief Executive Officer, Michael J. Fister, pursuant to Rule 13a-14 of the Securities Exchange Act of 1934.
	31	.02	Certification of the Registrant’s Chief Financial Officer, William Porter, pursuant to Rule 13a-14 of the Securities Exchange Act of 1934.
	32	.01	Certification of the Registrant’s Chief Executive Officer, Michael J. Fister, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	32	.02	Certification of the Registrant’s Chief Financial Officer, William Porter, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


DATE:	October 27, 2006	By:	/s/ Michael J. Fister

		Michael J. Fister President, Chief Executive Officer and Director



DATE:	October 27, 2006	By:	/s/ William Porter

		William Porter Executive Vice President and Chief Financial Officer