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UNITED STATES

FORM 10-K

Commission file number 1-10606

CADENCE DESIGN SYSTEMS, INC.

2655 Seely Avenue, Building 5, San Jose, California 95134

(408) 943-1234

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

      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 o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     o

      Aggregate market value of the voting stock held on March 2, 2002 by non-affiliates of the registrant: $5,390,060,679

      Number of shares of common stock outstanding at March 2, 2002: 250,528,980

DOCUMENTS INCORPORATED BY REFERENCE

      Portions of the definitive proxy statement for the 2002 Annual Meeting are incorporated by reference into Part III hereof.

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CADENCE DESIGN SYSTEMS, INC.

2001 FORM 10-K ANNUAL REPORT

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PART I.

Item 1. Business

      Certain statements contained in this Annual Report on Form 10-K, including, without limitation, statements containing the words “believes,” “anticipate,” “estimates,” “expects,” “intends,” and words of similar import, constitute forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934. These statements are predictions based upon Cadence’s current expectations about future events and speak only as of the date of this annual report. Actual results could vary materially from those expressed in these statements. Readers are referred to “Marketing and Sales,” “Research and Development,” “Competition,” “Proprietary Technology,” “Manufacturing and Distribution,” and “Factors That May Affect Future Results” sections contained in this Annual Report on Form 10-K, which identify important risk factors that could cause actual results to differ from those contained in the forward-looking statements.

Overview

      Cadence Design Systems, Inc. provides comprehensive software and other technology and offers design and methodology services for the product development requirements of the world’s leading electronics companies. Cadence® licenses its leading-edge electronic design automation, or EDA, software and hardware technology and provides a range of services to companies throughout the world to help accelerate and manage their product development processes. Cadence’s products and services are used by companies to design and develop complex integrated circuits, or ICs, and electronic systems, including semiconductors, computer systems and peripherals, telecommunications and networking equipment, mobile and wireless devices, automotive electronics, consumer products and other advanced electronics. These industries are experiencing a general economic slowdown. This slowdown led Cadence to record in 2001 worldwide restructuring and asset impairment charges totaling $61.6 million, inventory write downs of $18.9 million and acquired intangibles write-offs of $25.8 million.

      Cadence’s headquarters are located at 2655 Seely Avenue, San Jose, California 95134. Its telephone number at that location is (408) 943-1234 and its web-site can be accessed at www.cadence.com.

Factors Driving The Electronic Design Automation Industry

      During the last decade, the worldwide electronics industry has experienced expansion, driven largely by the communications, business productivity and consumer electronics markets. Ever-decreasing silicon manufacturing process geometries coupled with the move to 300mm wafer production is driving integrated circuit cost decreases, volume increases and increasingly higher complexity for providers of electronics devices. At the same time, the development of more comprehensive integrated circuits complicates effective integration of components into complete electronic systems. From a design perspective, today’s complex ICs are system-on-a-chip, or SoC, devices. These SoC devices, as described in more detail below, contain one or more processors, memory and application-specific logic. Designing these SoC devices requires the convergence of what have previously been distinct domains for embedded software, digital logic, analog circuitry and printed circuit board, or PCB, design. This design convergence is changing the way companies create designs for these devices. These market and technology forces pose major challenges for the global electronics design community, and consequently create significant opportunities and challenges for EDA tools and services providers.

      The electronics industry is faced with increasing complexity of electronic devices. Design teams face major challenges in the migration to deep submicron design and SoC design.

      Deep submicron design refers to the design of integrated circuits that will have feature sizes smaller than 0.25 micron. IC feature sizes for wires, transistors and contacts decrease with each advance in the semiconductor manufacturing process. Each successive move to a smaller feature size (e.g., decreasing from 0.25 microns to 0.13 microns and smaller) requires introducing new capabilities throughout the entire design

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      SoC design refers to implementing an entire electronics sub-system on a single integrated circuit. Smaller feature sizes make it more economical to put additional circuitry on a single die. The ICs fabricated on these dies include one or more processors (microprocessors and digital signal processors), a high-performance bus, numerous memory devices and peripherals, custom digital logic, custom analog logic and millions of lines of software code. Such devices offer benefits in terms of price, performance, power and size. However, they are extremely difficult to design.

      These trends pose significant new challenges for electronics design teams. Specifically, deep submicron design requires designers to take into account many physical effects they previously ignored. SoC design requires new approaches to managing complexity and its related risks. The electronics industry addresses these challenges in a number of ways, including the use of new EDA tools, the upgrade of design methodologies, and offering integrated front-to-back design solutions.

Cadence Electronic Design Automation Tools

      Cadence offers the most comprehensive set of EDA tools in its industry. Cadence tools improve designer productivity and design quality throughout the electronic design process.

System-level Design Tools

      Cadence system-level design tools help design teams optimize their designs and provide a smooth path to detailed hardware design. The Cadence Virtual Component Co-design, or VCC, solution lets designers capture and verify system behavior independent of hardware and software implementation. Designers can then map the behavior to a variety of architectural implementations and analyze the results of each. Using this rapid exploration tool, teams can optimize their overall system-level design including critical hardware/software partitioning. VCC is also an ideal environment for platform-based design. For those portions of the behavior that are algorithmic in nature, the Cadence Signal Processing Worksystem solution provides a specialized environment for capturing and analyzing floating-point and fixed-point algorithms. It also serves as a system-level testbench environment, especially for communications and multimedia applications.

Functional and System-level Verification Tools

      Design teams need a range of simulation and hardware-based acceleration tools to verify the functionality of their designs. Cadence offers a comprehensive set of simulators and emulators for behavioral, register-transfer-level and gate-level functional verification. Cadence’s digital simulators include the NC-Verilog® simulator for the Verilog® language, NC-VHDL for the VHDL® language and NC-Sim, which simultaneously supports both languages. These simulators provide designers with the simulation performance and capacity they need to verify the functionality of complex designs. The Cadence Verification Cockpit provides an environment for creating testbenches, analyzing results and debugging designs at a transaction level. Cadence also provides standards-based transaction verification models for use in this environment.

      For design teams that need to accelerate simulations and/or verify designs at the system-level, the Cadence Quickturn® division offers acceleration and emulation solutions. Palladium^TM and CoBALT Ultra Design Verification Systems are built with 0.12 micron, custom silicon technology and are used for both simulation acceleration and in-circuit emulation. Mercury^TMPlus utilizes custom field programmable gate arrays, or FPGAs, and is used specifically for in-circuit emulation. Cadence also offers application-specific solutions that provide a complete verification environment for key applications such as 3G wireless communication, Packet over SONET networking, and other popular applications. The use of Quickturn solutions enables design teams to identify hardware and software problems that they would otherwise not find until the design is implemented in silicon.

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Automated Digital IC Design Tools

      Cadence’s unified synthesis/place-and-route system, or SP&R, provides a complete implementation path from register-transfer level, or RTL, through final layout for the most advanced designs. The SP&R system consists of Physically Knowledgeable Synthesis, or PKS, physical synthesis for front-end logic design and Silicon Ensemble® PKS, or SE-PKS optimization-place-and-route for back-end physical design. PKS provides simultaneous logic synthesis, placement and global routing. Silicon Ensemble-PKS provides a complete place-and-route environment, including the ability to re-optimize a design’s logic to meet new physical constraints. These tools have common timing, optimization, placement and routing engines to ensure single-pass accuracy as the design progresses from RTL to final layout. The SP&R flow supports power optimization, test synthesis and datapath compilation capabilities for automated digital design. With the CadMOS^TM suite of tools, Cadence now also offers an enhanced solution for signal integrity problems — such as crosstalk — that become more prevalent and critical at 0.13 micron and below designs. For leading-edge physical verification, Cadence offers the Assura^TM physical verification toolset created specifically for deep submicron designs.

      In December 2001, Cadence acquired Silicon Perspective Corporation, which produces the First Encounter® full-chip virtual prototyping solution. Design teams use the First Encounter solution to plan the physical implementation of large, hierarchical designs.

Custom and Analog Design Tools

      Cadence offers a comprehensive line of analog and mixed-signal design tools. Cadence Analog Design Environment is a front-to-back analog design automation solution for full-custom analog, digital mixed-signal and radio frequency, or RF, integrated circuit design. Within that environment, designers can use the Cadence Spectre® Circuit Simulator. RF designers can use the Cadence Spectre RF simulator on desktop workstations to perform full-chip, transistor-level circuit simulation of RF designs with 5,000+ devices.

      The Cadence Virtuoso® suite of custom IC layout tools provides a comprehensive set of layout capabilities including layout editing, placement, routing and physical verification for analog, custom digital mixed signal and RF ICs. Virtuoso Custom IC Layout includes correct-by-construction, connectivity-driven automation that dramatically boosts designer productivity over manual custom-layout techniques. Virtuoso Custom IC Layout is integrated with the Cadence Assura physical verification toolset, which offers automated, interactive physical and batch IC layout verification, extraction and layout enhancements for manufacturing. The Assura tool utilizes hierarchical processing techniques to significantly reduce verification cycle times and provide effective debugging capabilities.

      For years, analog/mixed-signal design teams have been seeking to move to a top-down approach. Cadence AMS Designer enables them to do so. It is a mixed-signal environment and analog/mixed-signal simulator, the latter of which is based on the Cadence NC-Sim and Spectre simulators.

Printed Circuit Board Design Tools

      Cadence offers a range of integrated PCB design solutions for both individual and team-based environments. For teams creating leading edge designs, Cadence provides a full front-to-back flow. Products include Allegro®, PCB layout, Concept® HDL schematic capture, PCB librarian expert, SPECCTRA® autorouter and SPECCTRAQuest^TM for design and analysis of high-speed digital systems. Recent product introductions focus on the challenges of integrating high-speed ICs into a board system. A new constraint management system targets the problem of escalating electrical constraints by allowing engineers to capture, manage and validate high-speed design rules at all stages of the design cycle. Advances in signal integrity and power delivery technologies enable engineers to analyze the interconnect from silicon to package to board.

      For individual productivity in the Windows-based PCB design market, Cadence offers the OrCAD® product line of integrated tools. Products include OrCAD Capture® schematic entry, PSpice® analog and mixed signal simulator and OrCAD Layout®.

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      For IC packaging design, the Cadence Advanced Package Designer and Advanced Package Engineer environments integrate electrical analysis and physical design through all phases of development, bridging the gaps between IC design, package design and package analysis.

Third-Party Tool and Partner Support

      Cadence supports the integration of third-party design tools through its Connections® Program. The Connections Program provides other EDA companies with access to Cadence products to ensure that Cadence tools work well in any design environment. To date, more than 130 companies have integrated their tools with Cadence software. Additionally, Cadence manages relationships with foundry and library provider partners to support customer-owned tooling, or COT, solutions for its customers. Cadence also assists and supports library providers in the integration of Cadence design and verification tools and model formats into COT library solutions.

Electronic Design Automation Services

      To complement its tools, Cadence provides a range of electronic design services that help optimize design team productivity. These include educational, support, design, verification, application service provider, or ASP, and methodology services. Cadence’s educational services include Internet, classroom and custom courses, the content of which ranges from how to use the most recent tool features to the latest design techniques. Support services include product maintenance and updates, and telephone and Internet-based technical support. Cadence also offers custom support services, which may include one or more of its standard support services plus account technical management, application and educational services and metrics reporting. Maintenance and support agreements are offered to customers either as part of Cadence product license agreement or under a separate maintenance agreement.

Design Services (Tality)

      In 2000, Cadence separated its electronics design services group into a new company named Tality Corporation. Tality filed a registration statement with the Securities and Exchange Commission for Tality’s initial public offering, or IPO. Tality’s separation from Cadence was substantially completed on October 4, 2000, and the electronic design services business operated as a subsidiary of Cadence. In April 2001, Cadence announced the withdrawal of the Tality IPO registration statement. Tality was reorganized during the second, third and fourth quarters of 2001, and is currently a wholly-owned subsidiary of Cadence.

      Tality’s engineering services and intellectual property are used for the design of complex electronic systems and integrated circuits. Tality focuses its offerings primarily on the communications market. Targeted segments of this market include wireline and wireless communications infrastructure and consumer communications products. The engineering services extend from product concept through manufacturing to help communications companies implement their product plans. Tality’s business has been adversely affected by the general slowdown in the economy and the electronics industry specifically. See “Management’s Discussion and Analysis of Financial Conditions and Results of Operations.”

Verification and ASP Services

      Cadence’s Quickturn division offers verification and ASP services through TtME® (Time-to-Market Engineering) services and the QuickCycles^TM programs. The TtME staff provides customers with consulting services, project services and/or complete turnkey services. QuickCycles^TM allows customers to access Quickturn verification systems on a pay-as-you-go basis, either on the customer site or remotely over a high-speed, secure network connection.

Methodology Services

      Cadence’s Methodology Services group offers a variety of services to help customers address electronic design challenges. It leverages Cadence’s cumulative experience and knowledge of design practices to improve productivity. Cadence has begun offering virtual computer aided design, known as VCAD, through which

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Marketing and Sales

      Cadence generally uses a direct sales force consisting of sales people and applications engineers to license its products and market its consulting and design services to prospective customers. Applications engineers provide technical pre-sales as well as post-sales support for software products. The Cadence Methodology Services group provides on-site capabilities to help customers improve productivity with Cadence and other EDA products. Due to the complexity of EDA products and the electronic design process in general, the sales cycle is generally long (three to six months or more). During the sales cycle, the Cadence direct sales force generally provides technical presentations, product demonstrations and on-site customer evaluations of Cadence software. Cadence also uses traditional marketing approaches to promote its products and services, including advertising, direct mail, telemarketing, trade shows, public relations and the Internet.

      Cadence markets and supports its products and services internationally through its subsidiaries and various distributors. Cadence markets its emulation hardware and consulting and design services in Japan through a wholly-owned subsidiary. Since the reorganization of Cadence’s distribution channel in Japan in 1997, Cadence has licensed its software products through Innotech Corporation, in which Cadence is an approximately 15% stockholder as of December 29, 2001.

Research and Development

      Cadence’s investment in research and development was $327.5 million in 2001, $292.4 million in 2000, and $244.9 million in 1999, prior to capitalizing software development costs of $30.2 million, $28.4 million, and $25.7 million, respectively. See “Notes to Consolidated Financial Statements” for a more complete description of Cadence’s capitalization of certain software development costs.

      The primary areas of Cadence’s research include SoC design, the design of silicon devices in the deep submicron range, high-speed board design, architectural-level design, high-performance logic verification technology and hardware/ software co-design.

      Cadence’s advanced research and development group, Cadence Laboratories, is focused on new technology. This group is chartered with identifying and developing prototype technologies in emerging design areas that will offer substantially improved alternatives to current EDA solutions.

Competition

      In the EDA products industry, Cadence currently competes with three large companies: Avant! Corporation, Mentor Graphics Corporation and Synopsys, Inc. In December 2001, Avant! and Synopsys announced their intention to merge, and if this merger is completed, the combined company could improve its competitive position with respect to Cadence. Cadence also competes with numerous smaller companies, a number of which have become publicly-traded companies or have combined with other EDA companies. Cadence also competes with manufacturers of electronic devices that have developed or have the capability to internally develop their own EDA products. Many manufacturers of electronic devices may be reluctant to purchase services from independent vendors such as Cadence because they wish to promote their own internal design departments. In the electronics design and methodology services industries, Cadence competes with numerous electronic design and consulting companies as well as with the internal design capabilities of electronics manufacturers. Other electronics companies and management consulting firms continue to enter the electronics design and methodology services industries.

      The EDA product market and the commercial electronic design and methodology services industries are highly competitive. If Cadence were unable to compete successfully in these industries, it could seriously harm Cadence’s business, operating results and financial condition. To compete in these industries, Cadence must identify and develop innovative and cost-competitive EDA products and market them in a timely manner. It must also gain industry acceptance for its design and methodology services and offer better strategic concepts,

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Proprietary Technology

      Cadence’s success depends, in part, upon its proprietary technology. Cadence generally relies on patents, copyrights, trademarks, trade secret laws, licenses and restrictive agreements to establish and protect its proprietary rights in technology and products. Despite precautions Cadence may take to protect its intellectual property, Cadence cannot assure you that third parties will not try to challenge, invalidate or circumvent these safeguards. Cadence also cannot assure you that the rights granted under its patents will provide it with any competitive advantages, patents will be issued on any of its pending applications, or future patents will be sufficiently broad to protect Cadence’s technology. Furthermore, the laws of foreign countries may not protect Cadence’s proprietary rights in those countries to the same extent as U.S. law protects these rights in the United States. Many Cadence products include software or other intellectual property licensed from third parties. Cadence may have to seek new or renew existing licenses for such software and other intellectual property in the future. The Cadence design services business also requires it to license the software or other intellectual property of third parties, including that of competitors. Cadence’s failure to obtain for its 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 Cadence’s business, operating results and financial condition.

Manufacturing and Distribution

      Cadence software production operations consist of configuring the proper version of a product, outsourcing the recording of the product on magnetic tape or CD-ROM, and producing customer-unique access keys allowing customers to use licensed products. Software and documentation are generally made available to customers electronically by secured electronic delivery, and to selected customers by electronic distribution over the Internet. User manuals and other documentation are generally available on CD-ROM, but are occasionally supplied in hard copy format.

      Cadence performs final assembly and test of its hardware emulation products in San Jose, California. Subcontractors manufacture all major subassemblies, including all individual printed circuit boards and custom integrated circuits, and supply them to Cadence for qualification and testing prior to their incorporation into the assembled product.

Employees

      As of March 2, 2002, Cadence employed approximately 5,600 persons, with approximately 2,975 in sales, services, marketing, support and manufacturing activities, 1,800 in product development and 825 in management, administration and finance. None of Cadence’s employees is represented by a labor union, and Cadence has experienced no work stoppages. Cadence believes that its employee relations are good.

Factors That May Affect Future Results

      The following risk factors and other information included in this Annual Report on Form 10-K should be carefully considered. The risks and uncertainties described below are not the only ones Cadence faces. Additional risks and uncertainties not currently known to Cadence or that Cadence currently deems immaterial also may impair Cadence’s business operations. If any of the following risks actually occurs, Cadence’s business, operating results and financial condition could be materially harmed. Unless specifically noted, references to Cadence in the discussion below are references to Cadence and its subsidiaries.

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Cadence is subject to the cyclical nature of the integrated circuit and electronics systems industries, and

      Purchases of Cadence’s products and services are highly dependent upon the commencement of new design projects by integrated circuit manufacturers and electronics systems companies. The integrated circuit industry is highly cyclical and is 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 integrated circuit and electronics systems industries have experienced significant downturns, often connected with, or in anticipation of, maturing product cycles of both these companies’ 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. During these downturns, the number of new design projects may decrease. Certain integrated circuit manufacturers and electronics systems companies announced a slowdown of demand and production in 2001 which has continued in 2002. Services and hardware revenue is expected to continue to be adversely affected by the general slowdown in the economy and in the electronics industry specifically. The current slowdown and any future downturns may reduce Cadence’s software and maintenance revenue and further reduce its services and hardware revenue and harm its results of operations.

Fluctuations in quarterly results of operations could hurt Cadence’s business and the market price of its

      Cadence has experienced, and may continue to experience, varied quarterly operating results. Various factors affect Cadence’s quarterly operating results and some of them are not entirely within Cadence’s control, including the timing of significant orders and the mix of licenses used to sell products. See “Management Discussion and Analysis of Financial Condition and Results of Operation — Critical Accounting Policies.” Cadence’s quarterly operating results are affected by the timing of significant orders for its software products because a significant number of contracts for software products are in excess of $5.0 million. The failure to close a contract for the sale of one or more orders of Cadence’s software products could seriously harm its quarterly operating results.

      Cadence’s quarterly operating results are affected by the mix of license types entered into in connection with the sale of software products. Cadence has three basic licensing models: term, subscription and perpetual. Term and perpetual licenses generally recognize the revenue for such licenses at the beginning of the license period, while subscription licenses recognize revenue ratably over the term of the license. In the fourth quarter of 2001, Cadence’s mix of software license types based on total contract value was approximately 50% term licenses, 40% subscription licenses and 10% perpetual licenses. Should different conditions prevail so that the mix of Cadence’s license types were to change to a higher proportion of subscription licenses, Cadence’s software license revenue in that period would decline because a greater portion of revenue would be recognized over time. That decline could have a material impact on the results of operations in the quarter of the change in mix.

      Sales of Cadence’s hardware products depend, in significant part, upon the decision of the prospective customer to commence a project for the design and development of complex integrated circuits and systems. These projects often require significant commitments of time and capital. Cadence’s hardware sales may be delayed if customers delay commencement of projects. Lengthy hardware sales cycles subject Cadence to a number of significant risks over which Cadence has little or no control, including insufficient, excess or obsolete inventory, variations in inventory valuation and fluctuations in quarterly operating results.

      In addition, Cadence bases its expense budgets partially on its expectations of future revenue. However, it is difficult to predict revenue levels or growth. Revenue levels that are below Cadence’s expectations could seriously hurt Cadence’s business, operating results and financial condition. Also, because of the timing of large orders and its customers’ buying patterns, Cadence may not learn of revenue shortfalls, earnings shortfalls or other failures to meet market expectations until late in a fiscal quarter, which could cause even more immediate and serious harm to the trading price of Cadence common stock. Many of Cadence’s services engagements are terminable with little or no advance notice and without penalty. Since a significant portion of

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      Cadence believes that quarter-to-quarter comparisons of its results of operations may not be meaningful. Therefore, stockholders should not view Cadence’s historical results of operations as reliable indicators of its future performance. If revenue or operating results fall short of the levels expected by public market analysts and investors, the trading price of Cadence common stock could decline dramatically.

The lengthy sales cycle of Cadence’s products and services makes the timing of its revenue difficult to

	predict and may cause its operating results to fluctuate unexpectedly

      Cadence has a lengthy sales cycle that generally extends at least three to six months. The length of the sales cycle may cause Cadence’s revenue and operating results to vary unexpectedly from quarter to quarter. The complexity and expense associated with Cadence’s business generally requires a lengthy customer education and approval process. Consequently, Cadence 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 Cadence from pursuing other opportunities.

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

	•	Customers’ budgetary constraints and internal acceptance review procedures;
	•	The timing of customers’ budget cycles; or
	•	The timing of customers’ competitive evaluation processes.

      If customers experience delays in their approval or project commencement activities, Cadence may not learn of, and therefore be able to communicate to the public, revenue or earnings shortfalls until late in a fiscal quarter.

Cadence’s failure to respond quickly to technological developments could make its products uncompetitive

	and obsolete

      The industries in which Cadence competes experience rapid technology developments, changes in industry standards, changes in customer requirements and frequent new product introductions and improvements. Currently, the electronic IC design industry is experiencing several revolutionary trends:

	•	Migration to Deep SubMicron: The size of features such as wires, transistors and contacts on ICs is shrinking due to advances in semiconductor manufacturing processes. Process feature sizes refer to the width of the transistors and the width and spacing of the interconnect on the IC. Feature size is normally identified by the headline transistor length, which is shrinking from 0.25 microns to 0.13 microns and smaller. This is commonly referred to in the semiconductor industry as the migration to deep submicron. It represents a major challenge for all levels of 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 infinitesimal proportions (for reference, the diameter of the period at the end of this sentence is approximately 400 microns) is challenging fundamental laws of physics and chemistry.
	•	The ability to design very large ICs, in particular integration of entire electronic systems onto a single chip instead of a circuit board (a process that is referred to in the industry as “SoC”), increases the complexity of managing a design that at the lowest level is represented by billions of shapes on the fabrication mask. In addition, systems typically incorporate microprocessors and digital signal processors that are programmed with software, requiring simultaneous design of the silicon chip and the related embedded software on the chip.

      If Cadence is unable to respond quickly and successfully to these developments and the evolution of these changes, Cadence may lose its competitive position and its products or technologies may become uncompetitive or obsolete. To compete successfully, Cadence must develop or acquire new products and improve its existing products and processes on a schedule that keeps pace with technological developments in its

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Cadence has historically suffered losses in its electronics design services business

      The market for electronics design services is relatively new, rapidly evolving and sensitive to customer budgetary constraints and engineering capacity. Tality has historically suffered losses, and it incurred significant expenses in connection with its separation. If Tality fails to increase its revenue to offset its expenses, Tality will continue to experience losses. Tality’s failure to succeed in the design services business may seriously harm Cadence’s business, operating results and financial condition.

The success of Cadence’s services businesses depend on factors that are difficult to control

      In order to be successful with its services, Cadence must overcome several factors that are difficult to control, including the following:

	•	Cadence’s cost of services personnel is high and reduces gross margin. Gross margin represents the difference between the amount of revenue from the sale of services and Cadence’s cost of providing those services. Cadence must pay high salaries to attract and retain professional services personnel. This results in a lower gross margin than the gross margin in Cadence’s software business. In addition, the high cost of training new services personnel or not fully utilizing these personnel can significantly lower gross margin, and it is difficult to adjust staffing levels quickly to reflect customer demand for services.
	•	A substantial portion of these services contracts is fixed-price contracts. This means that the customer pays a fixed price that has been agreed upon ahead of time, no matter how much time or how many resources Cadence must devote to perform the contract. If Cadence’s cost in performing the services consistently and significantly exceeds the amount the customer has agreed to pay, it could seriously harm Cadence’s business, operating results and financial condition.

Cadence’s inability to compete in its industries could seriously harm its business

      The EDA market and the commercial electronics design and methodology services industries are highly competitive. If Cadence were unable to compete successfully in these industries, it could seriously harm Cadence’s business, operating results and financial condition. To compete in these industries, Cadence must identify and develop innovative and cost competitive EDA software products and market them in a timely manner. It must also gain industry acceptance for its 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. Cadence cannot assure you that it will be able to compete successfully in these industries. Factors that could affect Cadence’s ability to succeed include:

	•	The development of competitive EDA products and design and methodology services could result in a shift of customer preferences away from Cadence’s products and services and significantly decrease revenue;
	•	The electronics design and methodology services industries are relatively new and electronics design companies and manufacturers are only beginning to purchase these services from outside vendors;
	•	Due to budgeting constraints or excess engineering capacity, electronics manufacturers often choose to perform design and methodology services internally, rather than purchase these services from outside vendors;
	•	The pace of technology change demands continuous technological development to meet the requirements of next-generation design challenges; and
	•	There are a significant number of current and potential competitors in the EDA industry and the cost of entry is low.

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      In the EDA products industry, Cadence currently competes with three large companies: Avant! Corporation, Mentor Graphics Corporation, and Synopsys, Inc. In December 2001, Synopsys and Avant! announced their intention to merge, and if this merger is completed, the combined company could improve its competitive position with respect to Cadence. Cadence also competes with numerous smaller companies, a number of which have become publicly-traded companies or have combined with other EDA companies. Cadence also competes with manufacturers of electronic devices that have developed or have the capability to develop their own EDA products. Many manufacturers of electronic devices may be reluctant to purchase services from independent vendors such as Cadence because they wish to promote their own internal design departments. In the electronics design and methodology services industries, Cadence competes with numerous electronic design and consulting companies as well as with the internal design capabilities of electronics manufacturers. Other electronics companies and management consulting firms continue to enter the electronic design and methodology services industries.

      Cadence’s success depends, in part, upon its proprietary technology. Many of Cadence’s products include software or other intellectual property licensed from third parties, and Cadence may have to seek new or renew existing licenses for software and other intellectual property in the future. Cadence’s design services business also requires it to license software or other intellectual property of third parties, including that of competitors. Cadence’s failure to obtain for its 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 Cadence’s business, operating results and financial condition.

      Also, Cadence generally relies on patents, copyrights, trademarks, trade secret laws, licenses and restrictive agreements to establish and protect its proprietary rights in technology and products. Despite precautions Cadence may take to protect its intellectual property, Cadence cannot assure you that third parties will not try to challenge, invalidate, or circumvent these safeguards. Cadence also cannot assure you that the rights granted under its patents will provide it with any competitive advantages, patents will be issued on any of its pending applications, or future patents will be sufficiently broad to protect Cadence’s technology. Furthermore, the laws of foreign countries may not protect Cadence’s proprietary rights in those countries to the same extent as U.S. law protects these rights in the United States.

      Cadence cannot assure you that its reliance on licenses from or to or restrictive agreements with third parties, or that patent, copyright, trademark and trade secret protections, will be enough to be successful and profitable in the industries in which Cadence competes.

      There are numerous patents in the EDA industry and new patents are being issued at a rapid rate. It is not always economically 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, Cadence may be forced to respond to or prosecute intellectual property infringement claims to protect its 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 Cadence’s business, operating results and financial condition. In settling these claims, Cadence 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 acceptable to Cadence. Being forced to enter into a license agreement with unfavorable terms could seriously harm Cadence’s business, operating results and financial condition. Any potential intellectual property litigation could force Cadence to do one or more of the following:

	•	Pay damages to the party claiming infringement;
	•	Stop licensing, 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.

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If Cadence were forced to take any of these actions, Cadence’s business and results of operations may be harmed.

      Cadence depends on several suppliers for certain key components and board assemblies used in its hardware-based verification products. Cadence’s inability to develop alternative sources or to obtain sufficient quantities of these components or board assemblies could result in delays or reductions in product shipments. In particular, Cadence currently relies on IBM for the hardware components for Cadence’s CoBALT^TM, Mercury^TMPLUS and Palladium^TM products. Other disruptions in supply may also occur. If there were such a reduction or interruption, Cadence’s results of operations would be seriously harmed. Even if Cadence can eventually obtain these components from alternative sources, a significant delay in Cadence’s ability to deliver products would result.

      Cadence has acquired numerous other businesses before and is likely to acquire other businesses in the future. While Cadence expects to analyze carefully all potential transactions before committing to them, Cadence cannot assure you that any transaction that is completed will result in long-term benefits to Cadence or its stockholders, or that Cadence’s management will be able to manage the acquired businesses effectively. In addition, growth through acquisition involves a number of risks. If any of the following events occurs after Cadence acquires another business, it could seriously harm Cadence’s 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 then integrating an acquired business;
	•	The discovery after the acquisition has been completed of liabilities assumed from the acquired business;
	•	The failure to realize anticipated benefits such as cost savings and revenue enhancements;
	•	The failure to retain key personnel of the acquired business;
	•	Difficulties related to assimilating the products of an acquired business in, for example, distribution, engineering and customer support areas;
	•	Unanticipated costs;
	•	Adverse effects on existing relationships with suppliers and customers; and
	•	Failure to understand and compete effectively in markets in which Cadence has limited previous experience.

      Cadence has significant operations outside the United States. Cadence’s revenue from international operations as a percentage of total revenue was approximately 45% for fiscal 2001 and 44% for fiscal 2000. Cadence also transacts business in various foreign currencies. Recent economic and political uncertainty and the volatility of foreign currencies in certain parts of the Asia-Pacific region have had, and may continue to have, a seriously harmful effect on Cadence’s revenue and operating results.

      Fluctuations in the rate of exchange between the U.S. dollar and the currencies of other countries in which Cadence conducts business could seriously harm its business, operating results and financial condition. For example, if there is an increase in the rate at which a foreign currency exchanges into U.S. dollars, it will take more of the foreign currency to equal a specified amount of U.S. dollars than before the rate increase. If Cadence prices its products and services in the foreign currency, it will receive less in U.S. dollars than it did before the rate increase went into effect. If Cadence prices its products and services in U.S. dollars, an increase in the exchange rate will result in an increase in the price for Cadence’s products and services

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	•	The adoption and expansion of government trade restrictions;
	•	Volatile foreign exchange rates and currency conversion risks;
	•	Limitations on repatriation of earnings;
	•	Reduced protection of intellectual property rights in some countries;
	•	Recessions in foreign economies;
	•	Longer receivables collection periods and greater difficulty in collecting accounts receivable;
	•	Difficulties in managing foreign operations;
	•	Political and economic instability;
	•	Business interruptions from terrorism, military operations and war;
	•	Unexpected changes in regulatory requirements;
	•	Tariffs and other trade barriers; and
	•	U.S. government licensing requirements for exports which make licenses difficult to obtain.

      Cadence expects that revenue from its international operations will continue to account for a significant portion of its total revenue.

      Exposure to foreign currency transaction risk can arise when transactions are conducted in a currency different from the functional currency of a Cadence subsidiary. A subsidiary’s functional currency is the currency in which it primarily conducts its operations, including product pricing, expenses and borrowings. Cadence uses foreign currency forward exchange contracts and purchases foreign currency put options to help protect against currency exchange risks. These forward contracts and put options allow Cadence to buy or sell specific foreign currencies at specific prices on specific dates. Increases or decreases in the value of Cadence’s foreign currency transactions are partially offset by gains and losses on these forward contracts and put options. Although Cadence attempts to reduce the impact of foreign currency fluctuations, significant exchange rate movements may hurt Cadence’s results of operations as expressed in U.S. dollars.

      Foreign currency exchange risk occurs for some of Cadence’s foreign operations whose functional currency is the local currency. The primary effect of foreign currency translation on Cadence’s results of operations is a reduction in revenue from a strengthening U.S. dollar, offset by a smaller reduction in expenses. Exchange rate gains and losses on the translation into U.S. dollars of amounts denominated in foreign currencies are included as a separate component of stockholders’ equity.

      Cadence must comply with U.S. Department of Commerce regulations in shipping its software products and other technologies outside the United States. Although Cadence has not had any significant difficulty complying with these regulations so far, any significant future difficulty in complying could harm Cadence’s business, operating results and financial condition.

      Competition for highly skilled employees is very intense. Cadence’s business depends on the efforts and abilities of its senior management, its research and development staff, and a number of other key management, sales, support, technical and services personnel. The high cost of training new personnel, not fully utilizing these personnel, or losing trained personnel to competing employers could reduce Cadence’s gross margins and harm its business and operating results. Competition for these personnel is intense, particularly in geographic areas recognized as high technology centers such as the Silicon Valley area, where Cadence’s principal offices are located, and the other locations where it maintains facilities. To attract and retain individuals with the requisite expertise, Cadence may be required to grant large numbers of stock options or other stock-based incentive awards, which may be dilutive to existing stockholders. Cadence may also be required to pay significant base salaries and cash bonuses, which could harm its operating results. If Cadence does not succeed in hiring and retaining candidates with appropriate qualifications, it will not be able to grow its business and its

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If Cadence becomes subject to unfair hiring claims, Cadence could be prevented from hiring needed

      Companies in Cadence’s 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 Cadence from hiring personnel or cause it to incur liability for damages. Cadence could also incur substantial costs in defending itself or its employees against these claims, regardless of their merits. Defending itself from these claims could also divert the attention of Cadence’s management away from its operations.

Errors or defects in Cadence’s products and services could expose it to liability and harm its reputation

      Cadence’s customers use its 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 Cadence works, some of its products and designs can be adequately tested only when put to full use in the marketplace. As a result, its customers or their end users may discover errors or defects in Cadence’s software or the systems Cadence designs, or the products or systems incorporating its design and intellectual property may not operate as expected. Errors or defects could result in:

	•	Loss of current customers and loss of or delay in revenue and loss of market share;
	•	Failure to attract new customers or achieve market acceptance;
	•	Diversion of development resources to resolving the problem;
	•	Increased service costs; and
	•	Liability for damages.

Anti-takeover defenses in Cadence’s charter, by-laws, and under Delaware law could prevent an acquisition

      Provisions of the Delaware General Corporation Law that apply to Cadence and its Certificate of Incorporation could make it difficult for another company to acquire control of Cadence. For example:

	•	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.
	•	Cadence’s Certificate of Incorporation allows Cadence’s 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 Cadence preferred stock that may be issued in the future may be superior to the rights of holders of its common stock.
	•	Cadence has a rights plan, commonly known as a “poison pill,” which would make it difficult for someone to acquire Cadence without the approval of Cadence’s Board of Directors.

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

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Item 2. Properties

      Cadence’s headquarters are located in San Jose, California, and Cadence owns the related land and buildings. Additionally, Cadence owns buildings in India and land and buildings in Scotland. The total square footage of Cadence’s owned buildings is approximately 984,000 square feet.

      Cadence leases additional facilities for its sales offices in the United States and various foreign countries, and its research and development and design services facilities in the United States and in foreign countries including the United Kingdom and India. Cadence subleases certain of these facilities where space is not fully utilized or has been involved in restructuring activities.

      Cadence believes that these facilities and the undeveloped land it owns adjacent to its current headquarters are adequate for its current needs and that suitable additional or substitute space will be available as needed to accommodate any expansion of Cadence’s operations.

Item 3. 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, contract law, distribution arrangements and employee relations matters.

      Cadence filed a complaint in the U.S. District Court for the Northern District of California on December 6, 1995 against Avant! Corporation and certain of its employees or agents for misappropriation of trade secrets, copyright infringement, conspiracy and other illegal acts involving intellectual property.

      On January 16, 1996, Avant! filed various counterclaims against Cadence and Joseph B. Costello, Cadence’s former President and Chief Executive Officer, and with leave of the court, on January 29, 1998, filed a second amended counterclaim. The second amended counterclaim alleges, inter alia, that Cadence and Mr. Costello had cooperated with the Santa Clara County, California, District Attorney and initiated and pursued its complaint against Avant! for anti-competitive reasons, engaged in wrongful activity in an attempt to manipulate Avant!’s stock price, and utilized certain pricing policies and other acts to unfairly compete against Avant! in the marketplace. The second amended counterclaim also alleges that certain Cadence insiders engaged in illegal insider trading with respect to Avant!’s stock. Cadence and Mr. Costello believe that they have meritorious defenses to Avant!’s claims, and each intends to defend such action vigorously. By an order dated July 13, 1996, the court bifurcated Avant!’s counterclaim from Cadence’s complaint and stayed the counterclaim pending resolution of Cadence’s complaint. The counterclaim remains stayed.

      In an order issued on December 19, 1997, as modified on January 26, 1998, the District Court entered a preliminary injunction barring Avant! from any further infringement of Cadence’s copyrights in Design Framework II® software, or selling, licensing or copying such product derived from Design Framework II, including, but not limited to, Avant!’s ArcCell products. On December 7, 1998, the District Court issued a further preliminary injunction, which enjoined Avant! from selling its Aquarius product line. Cadence posted a $10.0 million bond in connection with the issuance of the preliminary injunction. On July 30, 1999, the U.S. Court of Appeals for the Ninth Circuit affirmed the preliminary injunction.

      On July 25, 2001, Avant! was ordered to pay Cadence $194.6 million in criminal restitution after Avant! entered a plea of no contest and was found guilty by the Superior Court of the State of California of conspiracy to take and use Cadence’s trade secrets. This conspiracy included the theft by Avant! and certain individuals of Cadence intellectual property, including software code, as well as other trade secrets. As of December 29, 2001, approximately $196.0 million, consisting of all of the restitution award plus interest was received. This amount was recorded in restructuring, asset impairment and unusual items in Cadence’s Consolidated Statements of Operations.

      On September 7, 1999, the District Court ruled on the parties’ Motions for Summary Adjudication, and granted in part, and denied in part, each party’s motion regarding the scope of a June 6, 1994 Release Agreement between the parties. The court held that Cadence’s copyright infringement claim against Avant! is not barred by the release and that Cadence may proceed on that claim. The court also held that Cadence’s

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      In February 1998, Aptix Corporation and Meta Systems, Inc. filed a lawsuit against Quickturn Design Systems, Inc. in the U.S. District Court for the Northern District of California alleging that Quickturn infringed a U.S. patent owned by Aptix and licensed to Meta. In June 2000, the District Court entered judgment in favor of Quickturn, dismissing the complaint and declaring the patent unenforceable. The Court also granted summary judgment to Aptix, denying Quickturn’s abuse of process counterclaim. On September 8, 2000 the Court ordered Aptix to pay $4.2 million to Quickturn as reimbursement of attorneys’ fees and costs it incurred in the litigation. Aptix appealed the District’s Court’s judgment and posted a $2.0 million bond to secure the judgment. On June 8, 2001, the U.S. Court of Appeals for the Federal Circuit affirmed the District Court’s dismissal of Quickturn’s abuse of process counterclaim. On November 5, 2001, the Federal Circuit vacated the District Court’s judgment of unenforceability, but affirmed the District Court’s dismissal of Aptix’s and Meta’s complaint and the award of attorneys fees and costs.

      On January 7, 1999, in a suit captioned Mentor Graphics Corporation, et al. v. Lobo, et al., Delaware Chancery Court, New Castle County, Civ. Action No. 16843-NC (“Mentor II”), Mentor filed and served an amended complaint asserting claims against Cadence, Quickturn and the Quickturn Board of Directors for declaratory and injunctive relief for various alleged breaches of fiduciary duty purportedly owned by Quickturn and its Board of Directors to Quickturn’s shareholders in connection with the merger between Quickturn and Cadence. Mentor further alleged that Cadence aided and abetted Quickturn and its Board of Directors in those purported breaches. Mentor has not prosecuted the matter since January 1999. In May 2000, Mentor advised the Delaware Chancery Court of its objection to the settlement of a companion action brought on behalf of certain Quickturn shareholders, and sought an award of attorneys’ fees related to its prosecution of Mentor II as well as the prior related action, to which Cadence was not a party. Settlement of the companion action is conditioned upon approval of the Chancery Court and Mentor’s not being awarded attorneys’ fee for Mentor II. In an order dated August 17, 2001, the Chancery Court denied Mentor’s fee application. Mentor has indicated that it will appeal this order.

      On July 21, 1999, Mentor filed suit against Quickturn, which action is pending in the U.S. District Court for the Northern District of California, Civil Action No. C 99-5464. Mentor has alleged that Quickturn’s Mercury^TM and Mercury^TMPlus hardware emulation systems infringe U.S. Patent Nos. 5,777,489 and 5,790,832, allegedly assigned to Mentor. At Quickturn’s request, Cadence was added as a defendant. Quickturn and Cadence are vigorously defending themselves against Mentor’s claims, and have filed counterclaims for declaratory judgment of non-infringement and invalidity of these patents.

      On March 24, 2000, Mentor and Meta and several founders of Meta filed suit against Quickturn and Cadence and a former Quickturn employee in the U.S. District Court for the Northern District of California, Civil Action No. C-00-01030. The suit alleges infringement of U.S. Patent No. 5,574,832 allegedly assigned to Mentor, misappropriation of trade secrets and breach of confidence, and seeks unspecified damages, injunctive relief and the assignment to Mentor of a patent previously issued to Quickturn. Quickturn and Cadence are vigorously defending themselves against these claims, and have filed counterclaims for declaratory judgment of non-infringement and invalidity of U.S. Patent Nos. 5,754,827, 5,999,725 and 6,057,706 allegedly assigned to Mentor.

      On September 11, 2000, Mentor filed a complaint against Quickturn and Cadence in the U.S. District Court for the Northern District of California, Civil Action No. C-00-03291, accusing Quickturn and Cadence of infringing U.S. Patent No. 5,574,388, purportedly owned by Mentor, and seeking unspecified damages and injunctive relief. Cadence and Quickturn are vigorously defending themselves against Mentor’s claim, and have filed counterclaims for declaratory judgment of non-infringement of this patent. The parties have agreed to consolidate this action with Civil Action Nos. C 99-5464 and C 00-01030, described above, for purposes of discovery and pre-trial motions. A trial date has been set for October 7, 2002. Meanwhile, on November 3,

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      On November 2, 2000, Mentor and Meta filed a complaint for declaratory judgment against Quickturn and Cadence in the U.S. District Court for the District of Oregon (Case No. C-00-1489) seeking a ruling that Mentor’s proposed design verification approach (in which IC designers would use U.S.-based computer terminals to operate SimExpress emulation systems located overseas) will not infringe Quickturn’s patents and will not violate the permanent injunction entered by the Oregon District Court on July 7, 1999 in Civil Action No. C-96-00342. In January 2001, Quickturn and Cadence filed a Motion to Dismiss the action, based on lack of subject matter jurisdiction. On May 1, 2001, the Court provisionally granted Quickturn’s motion to dismiss. Cadence and Quickturn believe that Mentor’s complaint is without merit.

      On April 30, 1999, Cadence and several of its officers and directors were named as defendants in a lawsuit filed in the U.S. District Court for the Northern District of California, entitled Spett v. Cadence Design Systems, et al., civil action no. C 99-2082. The action was brought on behalf of a class of stockholders who purchased Cadence common stock between November 4, 1998 and April 20, 1999, and alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. On September 18, 2000, the District Court granted Cadence’s Motion to Dismiss Plaintiffs’ Claims with leave to amend. Plantiffs did not amend their complaint, and on November 29, 2001 an order was filed dismissing the claims with prejudice and granting judgment in favor of Cadence and the individual defendants.

      On February 25, 2000, Cadence and several of its officers were named as defendants in a lawsuit filed in the U.S. District Court for the Northern District of California, entitled Maxick v. Cadence Design Systems, Inc., File No. C 00-0658PJH. The action was brought on behalf of a class of shareholders of OrCAD, Inc., and alleges violations of Section 14(d)(7) of the Securities Exchange Act of 1934, and Rule 14d-10 thereunder. The lawsuit arose out of Cadence’s acquisition of OrCAD, which was completed in August 1999. The parties have settled the matter for the payment of $1.25 million by Cadence. The settlement is subject to court approval.

      In early 1999, Cadence entered into negotiations with Intelect Communications, Inc. (since renamed TeraForce Technology Corporation), and Intelect’s wholly-owned subsidiary, DNA Enterprises, Inc., with respect to a potential purchase of substantially all the assets of DNA. The transaction was not consummated and, in July 1999, Intelect and DNA filed suit against Cadence in a Texas state court alleging breach of contract, fraud, negligent misrepresentation and breach of fiduciary duty, seeking unspecified compensatory and punitive damages. Cadence has answered, denying liability. In January 2002, the court denied Cadence’s Motion for Partial Summary Judgment and set a trial for March 2002.

      On November 22, 2000, a former design services customer, Uniden Corporation, filed an action for fraud, negligent misrepresentation and breach of contract in the State Court of Texas against Cadence and other corporate defendants, seeking compensatory and punitive damages in an unspecified amount. The suit was filed after Cadence demanded payment of approximately $1.0 million for design services rendered to Uniden. Cadence since has filed a counterclaim to recover the approximately $1.0 million owed for services rendered. The parties agreed to dismiss voluntarily the actions pending in the State Court of Texas and to re-file in the State Court of California, County of Orange. Uniden refiled its complaint on July 2, 2001 in Orange County, California. Cadence filed its answer and counterclaim on September 12, 2001.

      On December 28, 2000, a former design services customer, Scanz Communications, Inc. and Scanz Communications, LLC (“Scanz”) filed an action for various causes of action in the Los Angeles Superior Court of California against Cadence and Tality Corporation and Tality, LP, seeking compensatory and

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      On June 7, 2001, Cadence, Tality Corporation and Tality, LP filed a cross-complaint against Scanz alleging breach of contract and unjust enrichment, and seeking declaratory relief. On July 12, 2001, Scanz filed an answer to Cadence’s cross-complaint denying all allegations. Trial in this matter is scheduled for September 23, 2002. Cadence intends to vigorously defend the claims alleged by Scanz.

      Management believes that the ultimate resolution of the disputes and litigation matters discussed above will not have a material adverse effect on Cadence’s business, operating results or financial condition. However, were an unfavorable ruling to occur in any specific period, there exists the possibility of a material adverse impact on the results of operations for such period.

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

      None

Executive Officers Of Cadence

      The executive officers of Cadence are as follows:

      Executive officers are appointed by the Board of Directors and serve at the discretion of the Board.

      H. RAYMOND BINGHAM has served as President and Chief Executive Officer of Cadence since April 1999. Mr. Bingham has been a director on the Cadence Board of Directors since November 1997. From 1993 to April 1999, Mr. Bingham served as Executive Vice President and Chief Financial Officer of Cadence. Prior to joining Cadence, Mr. Bingham was Executive Vice President and Chief Financial Officer of Red Lion Hotels for eight years. Mr. Bingham is a director of Legato Systems, Inc., Onyx Software Corporation and KLA-Tencor Corporation.

      KEVIN BUSHBY joined Cadence in 1995 as Vice President and General Manager, European Operations and became Executive Vice President, Worldwide Field Operations in 2001. From 1990 to 1995 Mr. Bushby held several positions with Unisys Corporation, most recently as Vice President Sales and Marketing, Client Server Systems Division. Prior to 1990, Mr. Bushby held positions in Convergent Technologies and Hewlett Packard.

      R.L. SMITH MCKEITHEN joined Cadence in 1996 as Vice President, General Counsel, and Secretary and became Senior Vice President, General Counsel, and Secretary in 1998. From 1994 to 1996, he served as Vice President, General Counsel, and Secretary of Strategic Mapping, Inc. From 1988 to 1994, he served as Vice President, General Counsel, and Secretary of Silicon Graphics, Inc.

      WILLIAM PORTER joined Cadence in 1994 as Vice President, Corporate Controller, and Assistant Secretary and became Senior Vice President and Chief Financial Officer in May 1999. From 1988 to 1994, Mr. Porter served as Technical Accounting and Reporting Manager and most recently as Controller of Cupertino Operations with Apple Computer, Inc., a personal computer company.

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PART II.

Item 5. Market for the Registrant’s Common Equity and Related Stockholder Matters

      Cadence common stock is traded on the New York Stock Exchange under the symbol CDN. Cadence has never declared or paid any cash dividends on its common stock in the past, and does not plan to pay cash dividends in the foreseeable future. As of March 4, 2002, Cadence had approximately 1,444 registered stockholders and estimates that it had approximately 32,161 beneficial owners of its common stock.

      The following table sets forth the high and low sales price for Cadence common stock for each calendar quarter in the two-year period ended December 29, 2001:

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Item 6. Selected Financial Data

      The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and the notes thereto and the information contained herein in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operation.” Historical results are not necessarily indicative of future results.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

      The following discussion should be read in conjunction with the five-year summary of selected financial data and the Consolidated Financial Statements and notes thereto included elsewhere in this Annual Report on Form 10-K. All references to years represent fiscal years unless otherwise noted. Except for the historical information contained in this Annual Report on Form 10-K, the following discussion contains forward-looking statements based on current expectations that involve certain risks and uncertainties. Cadence’s actual results could differ materially from those discussed herein. Factors that could cause actual results or performance to differ materially or contribute to such differences include, but are not limited to, those discussed below in “Results of Operations,” “Disclosures About Market Risk,” and “Liquidity and Capital Resources”.

Overview

          General

      Cadence provides comprehensive software and other technology and offers design and methodology services for the product development requirements of the world’s leading electronics companies. Cadence licenses its leading-edge EDA software and hardware technology and provides a range of services to its customers throughout the world to help them optimize their product development processes. Cadence’s products and services are used by companies to design and develop complex integrated circuits and electronic systems, including semiconductors, computer systems and peripherals, telecommunications and networking equipment, mobile and wireless devices, automotive electronics, consumer products and other advanced electronics

      In late 2000, both the U.S. economy in general and the electronics industry in particular began to experience a slowdown, the severity of which increased during 2001. This economic slowdown adversely affected the electronics industry, and in particular, negatively affected Cadence sales of design services through Tality and sales of hardware emulation products. The electronics industry slowdown, especially in the semiconductor industry, could potentially reduce Cadence’s revenue and harm its results of operations throughout 2002.

          Acquisitions

      Cadence has acquired numerous businesses and is likely to do so in the future. These acquisitions are described in more detail in “In-Process Technology” and in the notes to Cadence’s Consolidated Financial Statements.

      In December 2001, Cadence acquired Silicon Perspective®Corporation, or SPC, a privately-held design technology firm, for approximately 6.8 million shares of Cadence common stock, valued at $132.5 million. SPC provides electronic design tools that bridge the gap between front-end logic designers and the back-end physical design process. The purchase price could increase if certain predetermined performance goals are achieved in fiscal 2002 and 2003.

      In February 2001, Cadence acquired CadMOS Design Technology, Inc., a privately-held design tools firm, for approximately 3.6 million shares of Cadence common stock, valued at $92.7 million. The acquisition was accounted for as a purchase. CadMOS provides solutions to the noise problems experienced in ultra-deep submicron processes. The purchase price will increase up to an additional 488,970 shares if certain predetermined performance goals are achieved over the three years following the acquisition.

          Tality Separation

      On July 17, 2000, Cadence announced its plan to separate its electronics design services group into a new company named Tality Corporation. Tality filed a registration statement with the Securities and Exchange Commission for Tality’s IPO. Tality’s separation from Cadence was substantially completed on October 4, 2000, and the electronic design services business thereafter operated as a subsidiary of Cadence. As a result of the separation in the third quarter of 2000, Cadence recorded deferred stock compensation resulting from Tality option grants and sales of Tality restricted stock. On October 9, 2000, Cadence announced the

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          Restructurings and Assets Impairments

      In 2001, Cadence announced a worldwide restructuring plan targeted at reducing workforce and consolidating facilities and assets. The restructuring plan was initiated primarily due to the severe downturn in the economic environment in the electronics industry, particularly in the United States. The restructuring was primarily aimed at reducing excess personnel and capacity costs within its Tality subsidiary, dedicating Cadence’s resources to growth areas, and focusing on profit contribution. Cadence recorded $61.6 million of restructuring charges associated with the worldwide restructuring plan. Cadence’s restructuring plan and associated costs consisted of $20.8 million for reduction in personnel, $22.7 million to downsize and close excess facilities and $16.6 million of asset impairment charges related to certain long-lived assets. Management estimates that the restructuring will result in annualized cost reductions of approximately $70.4 million in employee salary and benefit costs and $47.6 million in facility costs.

      The restructuring plan resulted in a reduction of 705 employees, which were predominately Tality employees. While employee reductions are across all business functions, operating units and geographic regions, Cadence’s wireless communications-related areas within Tality were affected more than other areas. In addition, the number of temporary and contract workers employed by Cadence has been reduced.

      In February 2002, Cadence announced a further restructuring of its Tality business to increase its focus on communications IC design and intellectual property used in wireline communications equipment and to no longer provides board-level, mechanical and packaging services for data and telecommunications equipment. As a result, Tality will reduce its headcount by approximately 200 people. The reductions will result in the closure of its Ottawa, Canada; Lowell, Massachusetts; and Noida, India design centers. A restructuring charge of approximately $25.0 million will be taken in the first quarter of 2002 for severance, facility closure and related asset impairments.

          Avant! Restitution Award

      On July 25, 2001, Avant! Corporation was ordered to pay Cadence $194.6 million in criminal restitution after Avant! entered a plea of no contest and was found guilty by the Superior Court of the State of California of conspiracy to take and use Cadence’s trade secrets. This conspiracy included the theft by Avant! and certain individuals of Cadence intellectual property, including software code, as well as other trade secrets. As of December 29, 2001, approximately $196.0 million, consisting of all of the restitution award plus interest was received. This amount is recorded in restructuring, asset impairment and unusual items in Cadence’s Consolidated Statements of Operations.

Critical Accounting Policies

Cadence’s critical accounting policies are as follows:

	•	revenue recognition for its various business units;
	•	estimating valuation allowances and accrued liabilities;
	•	accounting for income taxes; and
	•	valuation of long-lived and intangible assets and goodwill.

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      Cadence derives revenue from three sources: (i) product revenue, which includes software licensing and hardware sales, (ii) maintenance revenue from software and hardware and (iii) services revenue. As described below, significant management judgments and estimates are made and used to determine the revenue recognized in any accounting period. Material differences may result in the amount and timing of Cadence’s revenue for any period if different conditions were to prevail, such as a different mix of license types or a different payment history, each as described below.

      Cadence applies the provisions of Statement of Position 97-2, “Software Revenue Recognition,” as amended by Statement of Position 98-9 “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions” to all transactions involving the sale of software products and sales of hardware where the software is not incidental.

      Cadence recognizes product revenue when persuasive evidence of an arrangement exists, the product has been delivered, the fee is fixed and determinable, collection of the resulting receivable is probable and vendor specific objective evidence exists to allocate the total fee among all delivered and undelivered elements in the arrangement. Vendor specific objective evidence of fair value is defined as the value of each element of an arrangement if sold separately and is established when a software vendor demonstrates a history of having sold the element separately and of collecting on that element from a representative sample of arrangements on a consistent basis. If vendor-specific objective evidence of fair value does not exist for all elements to support the allocation of the total fee among all delivered and undelivered elements of the arrangement, revenue is deferred until such evidence does exist for the undelivered elements, or until all elements are delivered, whichever is earlier.

      Cadence sells software using three license types. These license types are:

	•	Term licenses — software licensed for a specific time period, generally two to three years, with no rights to return or exchange the licensed software;
	•	Subscription licenses — software licensed for a specific time period, generally two to three years, with no rights to return and limited rights to exchange the licensed software for unspecified future technology; and
	•	Perpetual licenses — software licensed on a perpetual basis with no right to return or exchange the licensed software.

      For term and subscription licenses, Cadence uses a signed contract as evidence of an arrangement. For perpetual licenses, hardware sales and maintenance renewals, Cadence uses a purchase order as evidence of an arrangement. Sales through its Japanese distributor are evidenced by a master agreement governing the relationship together with binding purchase orders on a transaction-by-transaction basis. For services, Cadence uses a signed statement of work to evidence an arrangement.

      Software is delivered to customers electronically or on a CD-ROM. With respect to hardware, delivery of an entire system is deemed to occur upon installation.

      Cadence assesses whether the fee is fixed and determinable based on the payment terms associated with the transaction. Cadence uses installment contracts for term and subscription licenses for which it has established a history of collecting under the original contract without providing concessions on payments, products or services. The time periods of installment contracts are equal to or less than the time period of the licenses and are generally collected quarterly. If different conditions were to prevail and Cadence no longer had a history of collecting without providing concessions on term licenses, then revenue from term licenses would be required to be recognized ratably over the term of the licenses. This change would have a material impact on Cadence’s reported results. For example, approximately 50% of Cadence’s software license revenues were derived from term licenses in 2001.

      Cadence assesses collectibility based on a number of factors, including the customer’s past payment history and its current credit-worthiness. If Cadence determines that collection of a fee is not reasonably

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      Provided all the related conditions discussed above are met, Cadence recognizes revenue for each software license type as follows:

	•	Term licenses and Perpetual licenses — revenue associated with licensed software is recognized upon the effective date of the license; and
	•	Subscription licenses — revenue associated with licensed software is recognized ratably over the term of the license commencing upon the effective date of the license.

      Maintenance revenue consists of fees for providing technical support and software updates. Cadence recognizes all maintenance revenue ratably over the contract term regardless of the software license agreement type. For term and perpetual licenses, customers renew maintenance agreements annually.

      Services revenue consists primarily of revenue received for performing methodology and design services. Fixed-price methodology and design service contracts are accounted for using contract accounting, which is generally the percentage-of-completion method rather than the completed-contract method, and time and materials contracts are accounted for on a monthly basis as work is performed. In addition, for small fixed-price-projects, such as training classes and small, standard methodology service engagements of approximately $10,000 in size or less, revenue is recognized when the work is completed. Cadence has a history of accurately estimating project status and the cost to complete projects. If different conditions were to prevail where accurate estimates could not be made, then the use of the completed contract method would be required and all revenue and costs would be deferred until the project was completed. This change would have a material impact on Cadence’s reported results

     Estimating valuation allowances and accrued liabilities.

      The preparation of financial statements requires management to make estimates and assumptions that affect the reported amount of assets and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period.

      Management specifically analyzes accounts receivable and also analyzes historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in customer payment terms, changes in customer demand and sales returns when evaluating the adequacy of the allowance for doubtful accounts and sales returns in any accounting period. Material differences may result in the amount and timing of revenue and or expenses for any period if management made different judgments or utilized different estimates.

      Cadence has effected restructurings of its business units in the past and has established reserves at the low end of the range of estimable cost (as required by accounting standards) against outstanding commitments for leased properties that it has vacated. These reserves are based upon management’s estimate of the landlord’s willingness to negotiate a termination fee, the time require to sublet the properties and the amount of sublet income that might be generated between the date the property was vacated and expiration of the lease for each of the vacated properties. These estimates are reviewed and revised quarterly and may result in a substantial increase to restructuring expense should different conditions prevail than were anticipated in original management estimates.

      Cadence assesses the need for reserves on inventory based on forward projections of sales of hardware products that are updated monthly. As a result of these projections, all inventory value in excess of 12 months’ sales projections (except for inventory expected to be used in ongoing service and maintenance of the installed base of customer owned systems) is reserved. Once inventory is reserved, the reserve can only be relieved by the subsequent sale or scrapping of the inventory.

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      In preparing its consolidated financial statements, Cadence is required to estimate its income taxes in each of the jurisdictions in which it operates. This process involves estimating actual current tax liability together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the consolidated balance sheet. Cadence then assesses the likelihood that deferred tax assets will be recovered from future taxable income, and to the extent it believes that recovery is not likely, Cadence must establish a valuation allowance. To the extent Cadence establishes a valuation allowance for provision or increases this allowance in a period, Cadence includes an expense within the tax provision in its Consolidated Statement of Operations.

      Significant management judgment is required in determining the provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against net deferred tax assets. Cadence recorded a valuation allowance for 2001 due to uncertainties related to its ability to utilize some of the deferred tax assets, primarily consisting of certain net operating losses carried forward and foreign tax credits, before they expire. The valuation allowance is based on estimates of taxable income by jurisdiction in which Cadence operates and the period over which deferred tax assets will be recoverable. In the event that actual results differ from these estimates or Cadence adjust these estimates in future periods, Cadence may need to establish an additional valuation allowance, which could materially impact financial position and results of operations.

      Cadence periodically reviews long-lived assets, certain identifiable intangibles and goodwill related to these assets for impairment in accordance with SFAS No. 121, “Accounting for the Impairment of Long-lived Assets and For Long-lived Assets to be Disposed Of.”

      For assets to be held and used, including acquired intangibles, Cadence initiates its review whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. Recoverability of an asset is measured by comparison of its carrying amount to the expected future undiscounted cash flows (without interest charges) that the asset is expected to generate. Any impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair market value. Significant management judgment is required in the forecasting of future operating results which are used in the preparation of projected discounted cash flows and should different conditions prevail, material write downs of net intangible assets and/or goodwill could occur.

      It is reasonably possible that the estimates of anticipated future gross revenue, the remaining estimated economic life of the products and technologies, or both, could differ from those used to assess the recoverability of these costs and result in a write-down of the carrying amount or a shortened life of acquired intangibles in the future.

      In 2002, Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets” became effective and as a result, Cadence will cease to amortize approximately $311.0 million of goodwill. In lieu of amortization, Cadence is required to perform an initial impairment review of goodwill in 2002 and an annual impairment review thereafter. Cadence expects to complete its initial review during the first quarter of 2002, but does not expect to record an impairment charge upon completion of the initial impairment review. However, there can be no assurance that at the time the review is completed a material impairment charge will not be recorded.

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Results of Operations

Revenue

Sources of Revenue as a Percent of Total Revenue

      Product revenue increased $203.1 million in 2001 compared to 2000, primarily due to an overall increase in price and volume of license renewal with major customers, and to a lesser extent an increase in new sales of Cadence’s software products to new customers. The increase in sales volume was primarily due to an increase in sales volume of Cadence’s integrated circuit implementation products, which include synthesis place and route physical design and physical verification products. The increases were partially offset by a decrease in Quickturn product sales. Management expects Quickturn’s revenue to continue to decline due to the slowdown in the economy and the electronics industry in particular. Cadence’s software licenses revenue recognized on a ratable basis comprised 32%, 19% and 11% of software revenue for the years ended 2001, 2000 and 1999, respectively.

      Product revenue increased $122.0 million in 2000 compared to 1999, primarily due to an overall increase in price and volume of license renewals with major customers. The increases in sales volume of products was primarily attributable to increased sales of: intellectual property-creation products, which include mixed signal and simulation products; integrated circuit implementation products, which include place and route, physical design and physical verification products; and printed circuit board-related products.

      Services revenue decreased $72.6 million in 2001 compared to 2000, primarily due to a reduction in customers’ spending budgets for external services resulting in a decrease in engagements. The decrease was the result of the economic slowdown experienced in the telecommunications, consumer products and a decline in use of outside services by Cadence’s customers. Cadence believes that the slowdown will continue throughout 2002. Tality’s revenue declined $49.9 million in 2001 compared to 2000, primarily due to fewer active engagements and fewer services hours billed. Tality’s revenue is expected to continue to be affected by the slowdown in the economy generally and electronics industry specifically, and reductions of its workforce in connection with its restructurings. Methodology Services revenue declined $22.2 million in 2001 compared to 2000, primarily due to a general weakness in customer demand for short-term consulting services.

      Services revenue increased $41.1 million in 2000 compared to 1999, primarily due to an increase in Tality revenue of $69.5 million, partially offset by a decrease of $28.4 million in methodology services revenue. Tality’s revenue increase was primarily due to increases in the total size of active client engagements and total client service hours billed. The decrease in methodology services engagements was primarily due to lower staffing levels, which were insufficient to service additional projects.

      Maintenance revenue increased $20.4 million in 2001 compared to 2000, primarily due to the growth of Cadence’s installed customer base and the renewal of maintenance and support contracts. Maintenance revenue increased $23.2 million in 2000 compared to 1999, primarily due to the growth of the installed customer base.

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Revenue by Geography

Revenue by Geography as a Percent of Total Revenue

      International revenue increased $86.2 million in 2001 compared to 2000, primarily due to increases in product revenue worldwide and maintenance revenue in Europe and Asia, partially offset by a decrease in services revenue worldwide.

      International revenue decreased $7.7 million in 2000 compared to 1999, primarily due to decreases in product revenue in Japan and services revenue in Europe and Japan, partially offset by an increase in product and maintenance revenue in Europe.

      Differences in the rate of revenue growth over the periods presented and as compared geographically are primarily due to fluctuations in sales volume of integrated circuit implementation and intellectual property creation products and of Cadence’s design and methodology services offerings based upon contractual renewal cycles in Europe and a general economic decline in Japan.

      Foreign currency exchange rates negatively affected revenue by $19.9 million in 2001, primarily due to the weakening of the Japanese yen. Foreign currency exchange rates negatively affected revenue by $3.8 million in 2000, primarily due to the weakening of the British pound and German mark in relation to the U.S. dollar, partially offset by the strengthening of the Japanese yen in relation to the U.S. dollar. Additional information about revenue by geographic areas can be found under “Segment Reporting” in the Notes to Consolidated Financial Statements.

Cost of Revenue

Cost of Revenue as a Percent of Related Revenue

      Cost of product revenue includes costs of employee salary and benefit costs, packaging and documentation, royalties and amortization of capitalized development costs for software products. Manufacturing costs associated with hardware emulation system products include materials, labor and overhead.

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      Cost of product revenue increased $8.2 million in 2001 compared to 2000. The increase was primarily due to increases in inventory write-offs, partially offset by decreases in manufacturing expenses associated with the decrease in sales of emulation system products. In the year ended December 29, 2001, Cadence recorded an $18.9 million reserve against inventory in cost of product revenue. Of the $18.9 million, $15.2 million of the reserve was related to excess inventory from decreased sales forecasts and $3.7 million related to two product lines that were discontinued as part of Cadence’s restructuring. The excess inventory charge of $15.2 million was due to a sudden and significant decrease in forecasted revenue for emulation products and was calculated in accordance with Cadence’s policy, which is based on inventory in excess of 12-month demand. Inventory purchases and commitments are based on future sales forecasts. Cadence typically buys and builds inventory levels for certain key components to mitigate component supply constraints. Based on Cadence’s current 12-month demand forecast, Cadence does not anticipate that the excess inventory subject to these reserves will be used at a later date. Cost of product revenue increased $10.4 million in 2000 compared to 1999. The increase was primarily due to increases in manufacturing expenses associated with emulation system products and amortization of capitalized software development costs.

      Because the majority of Cadence’s cost of software product revenue does not vary significantly with changes in revenue, product gross margin increased in 2001 compared to 2000, primarily due to an increase in volume of license renewals with major customer.

      Cost of services revenue includes costs associated with providing services to customers, primarily employee salary and benefits, costs to recruit, develop and retain personnel and to maintain the infrastructure necessary to manage a services organization as well as provisions for lost contracts, if any. Cost of services revenue decreased $24.3 million in 2001 compared to 2000, primarily due to decreases in employee salary and benefit costs resulting from Cadence’s reduction of services professionals in connection with its restructuring initiated in 2001. Cost of services revenue increased $23.8 million in 2000 compared to 1999, primarily due to an increase in the number of design engineers in Tality.

      Services gross margin decreased in 2001 compared to 2000, primarily due to the slowdown in the economy generally and in the electronics systems industry in particular resulting in revenues declining faster than costs. Services gross margins remained relatively flat in 2000 as compared to 1999. Services gross margin has been, and may continue to be reduced by, Cadence’s inability to fully utilize its services resources.

      Cost of maintenance revenue includes the cost of customer services, such as hot-line and on-site support, production personnel, packaging and documentation of maintenance updates. Cost of maintenance increased $2.0 million in 2001 compared to 2000, primarily due to an increase in employee salary and benefit costs resulting from an increase in employee headcount. Cost of maintenance revenue increased $9.7 million in 2000 compared to 1999, primarily due to costs associated with the OrCAD acquisition and increases in employee salary and benefit costs and costs to invest in customer service. The OrCAD acquisition was completed in the third quarter of 1999, and therefore, there were no similar costs in the first seven months of 1999.

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Marketing and Sales

      Marketing and sales expenses increased $3.5 million in 2001 compared to 2000, primarily due to an increase in employee salary and benefit costs resulting from an increase in employee headcounts, partially offset by a decrease in commissions expense from volume and rate changes. Marketing and sales expenses increased $35.9 million in 2000 compared to 1999, primarily due to an increase in employee salary and benefit costs, the inclusion of OrCAD-related expenses for the full year of fiscal 2000, and marketing program costs, partially offset by lower consulting costs.

Research and Development

      Research and development expense, prior to the reduction for capitalization of software development costs was $327.5 million for 2001, $292.4 million for 2000 and $244.9 million for 1999, representing 23% of total revenue for 2001 and 2000 and 22% for 1999. Cadence capitalized software development costs of approximately $30.2 million for 2001, $28.4 million for 2000, and $25.7 million for 1999, which represented approximately 9% of total research and development expenditures for 2001 and 10% of research and development expenditures for 2000 and 1999. The increase in capitalized software development costs in each of these three years resulted primarily from increases in new product development projects that have reached technological feasibility. In any given period, the amount of capitalized software development costs may vary depending on the exact nature of the development performed.

      The increase in net research and development expenses of $33.4 million for 2001 compared to 2000, was primarily due to an increase in employee salary and benefit costs resulting from an increase in employee headcount. The increase in net research and development expenses of $44.7 million for 2000, compared to 1999, was primarily attributable to higher employee salary and benefit costs and the inclusion of OrCAD- related costs and expenses for the full year of fiscal 2000.

General and Administrative

      General and administrative expenses increased $20.1 million in 2001 compared to 2000, primarily due to an increase of employee salary and benefit costs resulting from an increase in employee headcount, increases in bad debt expenses related to Tality accounts receivable, and increased use of outside consulting services. General and administrative expenses increased $7.7 million in 2000 compared to 1999, primarily due to employee salary and benefit costs, partially offset by decreases in bad debt expense and consulting and outside services costs.

      Foreign currency exchange rates positively affected operating expenses by $9.3 million in 2001, compared to 2000, primarily due to the weakening of the Japanese yen and British pound in relation to the U.S. dollar. Foreign currency exchange rates positively affected operating expenses by $3.8 million in 2000, compared to 1999, primarily due to the weakening of the British pound, the German mark and the French franc in relation to the U.S. dollar, partially offset by the strengthening of the Japanese yen in relation to the U.S. dollar.

Amortization of Acquired Intangibles

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Amortization of Acquired Intangibles as a Percent of Total Revenue

      Amortization of acquired intangibles increased $11.8 million in 2001 compared to 2000, primarily due to the 2001 acquisition of CadMOS, partially offset by a reduction attributable to the write-off of Diablo goodwill in the second quarter of 2001. Amortization of acquired intangibles increased $18.7 million in 2000 compared to 1999, primarily due to a full year’s amortization related to Cadence’s 1999 acquisitions of OrCAD and Diablo, partially offset by the decrease in amortization related to the $13.3 million asset impairment charge of Excellent Design Inc. in the fourth quarter of 1999. For additional information regarding these acquisitions see “In-Process Technology.”

Amortization of Deferred Stock Compensation

Amortization of Deferred Stock Compensation as a Percent of Total Revenue

      Cadence records deferred stock compensation resulting from option grants for Tality stock, sales of Tality restricted stock and Cadence’s acquisitions of CadMOS and SPC. Deferred stock compensation from Tality option grants and restricted stock sales represents the difference between the exercise price of stock option grants to Tality employees and directors, and the price paid for restricted stock sales to certain Cadence executives and employees, and the deemed fair market value of Tality’s common stock at the time of those grants and sales. Deferred stock compensation from the CadMOS acquisition represents the difference between the exercise price of stock option grants to CadMOS employees and the fair market value of Cadence’s common stock at the time of acquisition. Cadence is amortizing the deferred stock compensation to expense over the period during which the stock options and restricted stock vest. In the second and third quarters of 2001, Cadence repurchased 1,740,000 restricted Tality shares from certain Cadence executives and employees, who then repaid their related notes payable to Cadence. Tality repurchased 220,000 restricted Tality shares from three of its directors. The purchase price was $6.10 per share, the fair market value of Tality stock at the time of repurchase. The increase in amortization of deferred stock compensation of $6.5 million for 2001 when compared to 2000, was primarily due to the absence of similar costs in the first six months of 2000. For the years ended December 29, 2001 and December 30, 2000, Cadence recorded a total of $40.4 million and $72.4 million of deferred stock compensation, respectively. Of the $40.4 million, $27.4 million is related to the acquisition of SPC, $10.0 million is related to the acquisition of CadMOS, and $3.0 million is related to Tality stock option grants. Of the $72.4 million, $64.1 million is related to the stock option grants and $8.3 million is related to the sales of Tality restricted stock in 2000. Cadence is amortizing the deferred stock compensation over the period during which the stock options and restricted stock were vesting. For the year ended December 29, 2001, Cadence reversed deferred stock compensation of $27.8 million related to the cancellation of options and the repurchase of Tality restricted stock.

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Unusual Items

      Described below are unusual items in 2001, 2000 and 1999.

Avant! Criminal Restitution

      On July 25, 2001, Avant! Corporation was ordered to pay Cadence $194.6 million in criminal restitution after Avant! entered a plea of no contest and was found guilty by the Superior Court of the State of California of conspiracy to take and use Cadence’s trade secrets. This conspiracy included the theft by Avant! and certain individuals of Cadence intellectual property, including software code, as well as other trade secrets. As of December 29, 2001, approximately $196.0 million, consisting of the entire restitution award plus interest was received. This amount was recorded in restructuring, asset impairment and unusual items in Cadence’s Consolidated Statements of Operations.

Tality IPO-Related Expense and Separation Costs

      In the year ended December 29, 2001, Cadence recorded $4.8 million in separation costs. Of the $4.8 million, $2.8 million related to the postponement of the Tality IPO and $2.0 million related toTality separation costs, primarily information systems separation and legal, accounting and consulting fees.

      In the year ended December 30, 2000, Cadence recorded $6.8 million in separation costs related to the separation, and the related planned IPO of Tality, Cadence’s then newly-formed subsidiary. These costs primarily include legal and accounting services, strategic business planning, information systems separation, development of compensation and benefits strategies, and recruitment and formation of Tality’s senior management team.

In-Process Technology

      In December 2001, Cadence acquired SPC, a privately-held design technology firm for approximately 6.8 million shares of Cadence stock, valued at $132.5 million. SPC provides electronic design tools that bridge the gap between front-end logic designers and the back-end physical design process. The purchase price could increase if certain predetermined performance goals are achieved in fiscal 2002 and 2003. In connection with the acquisition, Cadence acquired goodwill of $97.9 million and technology, trademarks, employee agreements and other assumed contractual obligations intangibles of $19.5 million. The technology and other acquired intangibles are being amortized over one to five years.

      Upon completion of the SPC acquisition, Cadence immediately charged to expense $8.6 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 has not been established. The value was determined by estimating the costs to develop the acquired in-process technology 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 included a factor that took into account the uncertainty surrounding the successful development of the acquired in-process technology. The in-process technology is expected to be

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      At the time of its acquisition by Cadence, SPC’s in-process research and development projects were related to the development of a signal integrity analysis and optimization tool, and development of an enhanced version of its routing-estimation technology. These capabilities are important for IC design at and below 0.13 micron geometries. The nature of the efforts to complete these projects related, in varying degrees, to the completion of all planning, designing, prototyping, verification and testing activities necessary to establish that the proposed technologies meet their design specifications, including functional, technical and economic performance requirements.

      The net cash flows resulting from the projects underway at SPC used to value the purchased research and development were based on management’s estimates of revenue, cost of revenue, research and development costs, selling, general and administrative costs, and income taxes from such projects. The revenue projections were based on the potential market size that the projects address, Cadence’s ability to gain market acceptance in these segments, and the life cycle of this in-process technology.

      Estimated total revenue from the acquired in-process technology is expected to peak in 2004 and decline rapidly thereafter as other new products are expected to enter the market. In addition, a portion of the anticipated revenue had been attributed to enhancements of the base technology under development, and has been excluded from net cash flow calculations. Existing technology was valued at $8.4 million. The net cash flows generated from the acquired in-process technology were expected to reflect earnings before interest, taxes and depreciation of approximately 35% of the revenue generated from in-process technology. However, there can be no assurance that these assumptions will prove accurate, or that Cadence will realize the anticipated benefit of the acquisition.

      The discount of the net cash flows to their present value was based on the weighted average cost of capital, or WACC. The WACC calculation produces the average required rate of return of an investment in an operating enterprise, based on the required rates of return from investments in various areas of the enterprise. The rate used to discount the net cash flows from purchased in-process technology was 36%. The discount rate is sometimes higher than the WACC due to the inherent uncertainties in the estimates, including the uncertainty surrounding the successful development of the acquired in-process technology, the useful life of such technology, the profitability levels of such technology, if any, and the uncertainty of technological advances, all of which were unknown at that time.

      In the three months ended June 30, 2001, Cadence acquired substantially all of the assets of two companies for a preliminary aggregate price of $10.5 million, of which $4.4 million was cash and $6.1 million was shares of Cadence common stock, plus future contingent payments. The acquisitions were accounted for as purchases. Upon consummation of the acquisitions, Cadence immediately charged to expense $1.0 million representing acquired in-process technology that had not yet reached technological feasibility and had no alternative future use.

      In February 2001, Cadence acquired CadMOS Design Technology, Inc., a privately-held design tools firm for approximately 3.6 million shares of Cadence common stock valued at $92.7 million. The acquisition was accounted for as a purchase. CadMOS provides solutions to the noise problems experienced in ultra-deep submicron processes. The purchase price will increase up to an additional 488,970 shares if certain predetermined performance goals are achieved over the three years following the acquisition. These goals are bookings, product development and continued employment of certain CadMOS employees. In connection with the acquisition, Cadence preliminarily allocated the purchase price primarily to goodwill of $58.3 million and technology and other intangibles of $12.9 million. The technology and other acquired intangibles are being amortized over three to five years. The results of operations of CadMOS and the estimated fair value of the

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      Upon consummation of the CadMOS acquisition, Cadence immediately charged to expense $12.1 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 has not been established. The value was determined by estimating the costs to develop the acquired in-process technology 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 included a factor that took into account the uncertainty surrounding the successful development of the acquired in-process technology. The in-process technology is expected to be commercially viable in 2002. As of December 29, 2001, expenditures to complete the in-process technology totaled $1.0 million and expenditures to complete the remaining in-process technology are expected to total approximately $0.9 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.

      At the time of its acquisition by Cadence, CadMOS’ in-process research and development projects were related to the development of a static timing analysis tool, the development of advanced fixing capabilities in the noise analysis area, and in the mixed signal area, the development of a flow to integrate with Cadence tools and a tool to analyze large application-specific integrated circuit designs for substrate noise. The nature of the efforts to complete these projects related, in varying degrees, to the completion of all planning, designing, prototyping, verification and testing activities necessary to establish that the proposed technologies meet their design specifications including functional, technical and economic performance requirements.

      The net cash flows resulting from the projects underway at CadMOS used to value the purchased research and development were based on management’s estimates of revenue, cost of revenue, research and development costs, selling, general and administrative costs and income taxes from such projects. The revenue projections were based on the potential market size that the projects address, Cadence’s ability to gain market acceptance in these segments, and the life cycle of this in-process technology.

      Estimated total revenue from the acquired in-process technology is expected to peak in 2004 and decline rapidly thereafter as other new products are expected to enter the market. In addition, a portion of the anticipated revenue had been attributed to enhancements of the base technology under development, and has been excluded from net cash flow calculations. Existing technology was valued at $3.6 million. The net cash flows generated from the acquired in-process technology were expected to reflect earnings before interest, taxes, and depreciation of approximately 50% of the revenue generated from in-process technology. However, there can be no assurance that these assumptions will prove accurate, or that Cadence will realize the anticipated benefit of the acquisition.

      The discount of the net cash flows to their present value was based on the WACC. The rate used to discount the net cash flows from purchased in-process technology was 28%. The discount rate is sometimes higher than the WACC due to the inherent uncertainties in the estimates, including the uncertainty surrounding the successful development of the acquired in-process technology, the useful life of such technology, the profitability levels of such technology, if any, and the uncertainty of technological advances, all of which were unknown at that time.

      In August 1999, Cadence acquired OrCAD, Inc., a supplier of computer-aided engineering and computer-aided design software and services for the printed circuit board industry, for cash. Cadence acquired all of the outstanding stock of OrCAD and assumed all outstanding OrCAD stock options. The purchase price was $131.4 million, and the acquisition was accounted for as a purchase.

      Upon consummation of the OrCAD acquisition, Cadence immediately charged to expense $11.8 million representing acquired in-process technology that had not yet reached technological feasibility and had no alternative future use. See “Notes to Consolidated Financial Statements.” The value assigned to acquired

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      At the time of its acquisition by Cadence, OrCAD’s in-process research and development projects in the schematic entry area were related to the development of an online component catalog and a new schematic design entry interface. In-process research and development projects in the simulation area were related to a rearchitecture of the simulation engine and replacement of the simulation engine. Additional features under development included randomized expressions and no selection limits. The nature of the efforts to complete these projects related, in varying degrees, to the completion of all planning, designing, prototyping, verification and testing activities that were necessary to establish that the proposed technologies meet their design specifications including functional, technical and economic performance requirements.

      The net cash flows resulting from the projects underway at OrCAD used to value the purchased research and development were based on management’s estimates of revenue, cost of revenue, research and development costs, selling, general and administrative costs and income taxes from such projects. The revenue projections were based on the potential market size that the projects address, Cadence’s ability to gain market acceptance in these segments, and the life cycle of this in-process technology.

      Estimated total revenue from the acquired in-process technology is expected to peak in 2001 and decline rapidly thereafter as other new products are expected to enter the market. In addition, a portion of the anticipated revenue had been attributed to enhancements of the base technology under development, and had been excluded from net cash flow calculations. Existing technology was valued at $10.8 million. The net cash flows generated from the acquired in-process technology were expected to reflect earnings before interest, taxes and depreciation of approximately 32% of the sales generated from in-process technology. However, there can be no assurance that these assumptions will prove accurate, or that Cadence will realize the anticipated benefit of the acquisition.

      The discount of the net cash flows to their present value was based on the WACC. The rate used to discount the net cash flows from purchased in-process technology was 22%. The discount rate is sometimes higher than the WACC due to the inherent uncertainties in the estimates, including the uncertainty surrounding the successful development of the acquired in-process technology, the useful life of such technology, the profitability levels of such technology, if any, and the uncertainty of technological advances, all of which were unknown at that time.

      In January 1999, Cadence acquired Design Automation, Inc., or DAI, a supplier of design verification technology used in SoC design. Cadence acquired all of the outstanding stock of DAI for approximately 0.6 million shares of Cadence common stock and $2.9 million of cash. The total purchase price was $25.7 million and the acquisition was accounted for as a purchase.

      Upon consummation of the DAI acquisition, Cadence immediately charged to expense $8.9 million representing acquired in-process technology that had not yet reached technological feasibility and had no alternative future use. See “Notes to Consolidated Financial Statements — Other Acquisitions.” The value assigned to acquired in-process technology was determined by identifying research projects in areas for which technological feasibility has not been established. The value was determined by estimating the costs to develop the acquired in-process technology 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 included a factor that took into account the uncertainty surrounding the successful development of the acquired in-process technology. Certain acquired in-process technology under development at the time of acquisition was initially expected to become commercially viable in 1999, but instead became viable in 2000. Expenditures to complete this in-process technology did not exceed $1.5 million.

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      At the time of its acquisition by Cadence, DAI had several significant research and development projects in process that were intended to provide a next generation environment for design verification and analysis. These efforts included the development of a highly automated approach for high-level test bench creation and analysis, a waveform viewer capable of supporting analog and mixed signal designs and a tool designed to analyze verification code coverage at the transactional level. The nature of the efforts to complete these in-process research and development projects related, in varying degrees, to the completion of all planning, designing, prototyping, verification and testing activities that were necessary to establish that the proposed in-process technologies meet their design specifications, which include functional, technical and economic performance requirements.

      The net cash flows generated by the projects underway at DAI used to value the acquired in-process technology were based on management’s estimates of revenue, cost of revenue, research and development costs, selling, general and administrative costs and income taxes from such projects. The revenue projections were based on the potential market size that these projects address, Cadence’s ability to gain market acceptance for these projects, and the life cycle of this in-process technology.

      Estimated total revenue from the acquired in-process technology is expected to peak in 2001 through 2002 and decline rapidly thereafter as other new products are expected to enter the market. In addition, a portion of the anticipated revenue has been attributed to enhancements of the base technology under development, and has been excluded from net cash flow calculations. Existing technology was valued at $11.4 million at the time of acquisition. The net cash flows generated from the acquired in-process technology are expected to reflect earnings before interest, taxes and depreciation of approximately 60% of the sales generated from in-process technology. However, there can be no assurance that these assumptions will prove accurate, or that Cadence will realize the anticipated benefits of this acquisition.

      The discount applied to the net cash flows to calculate the present value of such net cash flows was based on the WACC. The rate used to discount the net cash flows from purchased in-process technology was 22%.

Acquired Intangibles Write-Offs

      In reaction to the current decline in business conditions generally and the wireless communications industry in particular, Cadence restructured certain of its businesses and realigned resources to focus on profit contribution, high-growth markets and core opportunities. As a result, Cadence recorded a charge of $25.8 million in 2001 related to the impairment of goodwill and acquired intangibles associated with the acquisition of Diablo (a part of Tality). Key factors in this write-off were significant downsizing or reassignment of personnel directly related to these assets and abandonment of most of Diablo’s line of business. The charge was determined as the amount by which the carrying value of the intangible assets associated with Diablo’s acquisition exceeded the fair value of those assets.

      In 1999, Cadence incurred a total of $19.9 million in asset impairment charges. Of this amount, $13.3 million represented asset impairment of acquired intangibles from the Excellent Design, or EXD, acquisition. This asset impairment charge resulted from reduced Japanese sales and the loss of key EXD employees, which together resulted in diminished cash flow projections. Cadence entered into certain support agreements with third parties to provide support for EXD software tools previously sold by Cadence customers. The fair value of the EXD acquired intangibles was based on an evaluation of the present value of the estimated expected future cash flows, discounted at 16%. The remaining $6.6 million in asset impairment charges were incurred in connection with the cancellation of an information technology services contract with a third-party, the abandonment of capitalized software development costs associated with certain Cadence products that were discontinued, and the abandonment of certain third-party software licenses, related to Research and Development.

Restructurings Charges and Asset Impairments

      In 2001, Cadence announced a worldwide restructuring and asset impairment plan targeted at reducing workforce and consolidating facilities and assets. The restructuring plan was initiated primarily due to the severe downturn in the economic environment in the United States, particularly in the electronics industry.

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      The restructuring plan resulted in a reduction of 705 employees, which were predominately Tality employees. While employee reductions are across all business functions, operating units and geographic regions, Cadence’s wireless communications-related areas within Tality were affected more than other areas. In addition, the number of temporary and contract workers employed by Cadence has been reduced. Severance costs resulting from the restructuring included severance benefits, notice pay and out-placement services. As the result of the separation of Tality from Cadence, approximately $5.3 million of the restructuring charges was paid to certain Tality employees who were participants in Cadence’s employee stock purchase plan prior to Tality’s separation from Cadence in October 2000. All terminations and termination benefits were communicated to the affected employees prior to December 29, 2001. All severance benefits will be paid out before the end of the first quarter of 2002.

      Facilities consolidation charges of $22.7 million were incurred in connection with the downsizing and closing of 16 sites. Closure and downsizing costs included payments required under lease contracts, less any applicable estimated sublease income after the properties were abandoned, lease buyout costs, restoration costs associated with certain lease arrangements, and costs to maintain facilities during the period after abandonment. To determine the lease loss, which is the loss after Cadence’s cost recovery efforts from subleasing a building, certain assumptions were made related to the: (1) time period over which the relevant building would remain vacant, (2) sublease terms and (3) sublease rates, including common area charges. The lease loss is an estimate under Statement of Financial Accounting Standards No. 5 Accounting for Contingencies and represents the low end of the range, as required by this statement, $13.1 million, which will be adjusted in the future upon triggering events (e.g., change in estimate of time to sublease, actual sublease rates, etc.). Cadence has estimated that the high end of the lease loss could be $52.8 million if facilities operating lease rental rates continue to decrease in the applicable markets or if it takes longer than expected to find a suitable tenant to sublease the facility. As of December 29, 2001, six sites had been vacated and eight sites had been downsized.

      Asset-related charges of $16.6 million consisted primarily of $13.9 million of leasehold improvements for facilities and other fixed assets that were either abandoned or for which the resulting estimated future reduced cash flows were insufficient to cover the associated expenses. Cadence also recorded $2.2 million of asset-related charges for abandoned software and $1.5 million related to consulting services performed to restructure the research and development process.

      In 1999, Cadence recorded $13.3 million of restructuring charges that consisted of $11.3 million to terminate approximately 100 employees and $2.0 million to downsize and close excess facilities. Cadence’s restructuring plans were primarily aimed at reducing costs after Cadence merged with Quickturn, further restructuring of Cadence’s services business in Japan, and severance resulting from the resignation of Cadence’s former Chief Executive Officer. Severance costs include severance benefits, notice pay and outplacement services. All terminations and termination benefits were communicated to the affected employees prior to year-end and substantially all remaining severance benefits were paid in 2000.

      Facilities consolidation charges of $2.0 million were incurred in connection with the closure of 15 Quickturn facilities, including $1.0 million to close duplicate and excess facilities and $1.0 million of abandonment costs for the related leasehold improvements. Closure and exit costs include payments required under lease contracts, less any applicable sublease income after the properties were abandoned, lease buyout costs, restoration costs associated with certain lease arrangements, and costs to maintain facilities during the period after abandonment. Asset related write-offs consist of leasehold improvements of facilities that were

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      Liabilities for excess facilities and other restructuring charges are included in accrued and other long-term liabilities while severance and benefits liabilities are included in payroll and payroll-related accruals. Actual amounts of termination benefits, facilities and other restructuring-related payments can be found in Notes to Consolidated Financial Statements under “Restructuring, Asset Impairment and Unusual Items.”

Merger Costs

      In connection with the acquisition of Quickturn in 1999, Cadence charged to expense merger costs of $8.4 million, representing professional fees for financial advisors, attorneys and accountants.

Litigation Settlement

      In 1999, Cadence and Mentor announced the settlement of a patent infringement action pending in the U.S. District Court for the District of Oregon. As a result, the Court entered a judgment declaring that certain Quickturn patents are valid, enforceable and were infringed by Mentor’s sale of SimExpress products in the United States. Mentor is permanently enjoined from producing, marketing, or selling SimExpress emulation systems in the United States. In connection with the settlement, Mentor paid Cadence $3.0 million.

Other Income, net

      Other income, net for 2001, 2000 and 1999 is as follows:

      Other income, net, decreased $2.9 million in 2001, when compared to 2000, primarily due to a decrease in foreign exchange gains, partially offset by an increase in interest income. Other income, net, increased $3.2 million in 2000, when compared to 1999, primarily due to an increase in foreign exchange gains, partially offset by $2.2 million of investment losses from Telos Venture Partners, LP, in which Cadence holds a limited partnership interest, shown in other expense, net.

Income Taxes

      The provision for income taxes and the effective tax rates for 2001, 2000 and 1999 are as follows:

      As of December 29, 2001, Cadence had total net deferred tax assets of approximately $66.4 million. Realization of the deferred tax assets will be dependent on generating sufficient taxable income prior to the expiration of certain net operating loss and tax credit carryforwards. Although realization is not assured, management believes that it is more likely than not that the net deferred tax assets will be realized. The

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      The 2001 effective tax rate includes the approximately $196.0 million received from Avant! as criminal restitution, the write-off of acquired in-process technology of approximately $21.7 million and stock compensation amortization of approximately $17.9 million. The effective tax rate, excluding the Avant! restitution proceeds, the write-off of acquired in-process technology and stock compensation was 26.5%. The effective tax rate for 1999 includes the write-off of acquired in-process technology of approximately $20.7 million. The effective tax rate for 1999 excluding the write-off of acquired in-process technology was 28.9%.

Disclosures About Market Risk

Interest Rate Risk

      Cadence’s exposure to market risk for changes in interest rates relates primarily to its investment portfolio. While Cadence is exposed to interest rate fluctuations in many of the world’s leading industrialized countries, Cadence’s interest income and expense is most sensitive to fluctuations in the general level of U.S. interest rates. In this regard, changes in U.S. interest rates affect the interest earned on Cadence’s cash and cash equivalents, short-term and long-term investments and interest paid on its long-term debt obligations as well as costs associated with foreign currency hedges.

      Cadence invests in high quality credit issuers and, by policy, limits the amount of its credit exposure to any one issuer. As part of its policy, Cadence’s first priority is to reduce the risk of principal loss. Consequently, Cadence seeks to preserve its invested funds by limiting default risk, market risk and reinvestment risk. Cadence mitigates default risk by investing in only high quality credit securities that it believes to be low risk and by positioning its portfolio to respond appropriately to a significant reduction in a credit rating of any investment issuer or guarantor. The portfolio includes only marketable securities with active secondary or resale markets to ensure portfolio liquidity.

      On September 29, 2000, Cadence entered into two syndicated, senior unsecured credit facilities that allow Cadence to borrow up to $360.0 million. These two credit facilities are referred to as the 2000 Facilities. One of the 2000 Facilities is a $100.0 million three-year revolving credit facility, which terminates on September 29, 2003, referred to as the Three-Year Facility. The other 2000 Facility, referred to as the 364-Day Facility, consists of a $260.0 million, 364-day revolving credit facility convertible into a term loan. The 364-Day Facility will terminate on September 27, 2002, at which time loans outstanding thereunder may be converted to a one-year term loan with a maturity date of September 29, 2003, or, at the request of Cadence and with the consent of members of the bank group that wish to do so, the Facility may be extended for one additional 364-day period with respect to the portion of the 364-Day Facility outstanding loans that a consenting bank holds. For both of the 2000 Facilities, Cadence has the option to pay interest based on LIBOR plus a spread of between 1.25% and 1.50%, based on a pricing grid tied to a financial covenant, or the higher of (i) the Federal Funds Rate plus 0.50% or (ii) the prime rate. As a result, Cadence’s interest expense associated with borrowings under the 2000 Facilities will vary with market rates. In addition, commitment fees are payable on the unused portion of the Three-Year Facility at rates between 0.25% and 0.34% based on a pricing grid tied to a financial covenant and on the unused portion of the 364-Day Facility at a fixed rate of 0.225%. A utilization fee of 0.25% is payable on amounts borrowed under the 364-Day Facility whenever combined borrowings under the two 2000 Facilities exceed $118.8 million. Cadence may not borrow under the 364-Day Facility at any time that any portion of the Three-Year Facility remains unused. The 2000 Facilities contain certain financial and other covenants, which must be maintained. The financial covenants specify that Cadence must maintain a minimum EBITDA of not less than $200.0 million. Additionally, Cadence must maintain a minimum fixed charge coverage ratio (the ratio of EBITDA to the sum of (i) interest expense plus (ii) 20% of funded debt plus (iii) taxes paid in cash less (iv) capital lease payments) of not less than 1.5 to 1.0. Other covenants require Cadence to maintain a minimum one-to-one ratio of current assets to current liabilities and a maximum two-to-one funded debt to EBITDA ratio. From time to time, Cadence borrows under the 2000 Facilities. At December 29, 2001, there were no borrowings outstanding.

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      The table below presents the carrying value and related weighted average interest rates for Cadence’s interest bearing instruments. All highly liquid investments with an original maturity of three months or less at the date of purchase are considered to be cash equivalents; investments with original maturities between three and 12 months are considered to be short-term investments. Investments with original maturities greater than 12 months are considered long-term investments. As of December 29, 2001, all of Cadence’s investments have maturities of less than 12 months. The carrying value approximated fair value at December 29, 2001.

Foreign Currency Risk

      Cadence’s operations include transactions in foreign currencies and, as such, Cadence benefits from a weaker dollar and is adversely affected by a stronger dollar relative to major currencies worldwide. Accordingly, the primary effect of foreign currency transactions on Cadence’s results of operations is a reduction in revenue from a strengthening U.S. dollar, offset by a smaller reduction in expenses.

      Cadence enters 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 asset exposures decrease in value or underlying liability exposures increase in value. Conversely, a foreign currency forward exchange contract decreases in value when underlying asset exposures increase in value or underlying liability exposures decrease in value. Forward contracts are not accounted for as hedges 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.

      Cadence also purchases foreign currency put options from financial institutions to hedge the currency exchange risks associated with probable but not firmly committed transactions. Although there were no foreign currency put options outstanding in 2001, Cadence may choose to use put options in the future. A foreign currency put option acts as a hedge by increasing in value as the underlying transactional value decreases. Probable but not firmly committed transactions consist of revenue from Cadence’s products and maintenance contracts in a currency other than the functional currency. These transactions are made through Cadence’s subsidiaries in Ireland and Japan. The premium costs of the put options are recorded in prepaid expenses and other current assets while the gains and losses are deferred and recognized in income in the same period as the hedged transaction. Gains and losses on accounting hedges realized before the settlement date of the related hedged transaction are also generally deferred and recognized in income in the same period as the hedged transaction.

      Cadence does not use forward contracts and put options for trading purposes. Cadence’s ultimate realized gain or loss with respect to currency fluctuations will depend on the currency exchange rates in effect as the forward contracts and put options mature.

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      The table below provides information as of December 29, 2001 about Cadence’s forward foreign currency contracts. As of December 29, 2001, there were no put options outstanding. The information is provided in U.S. dollar equivalent amounts. The table presents the notional amounts, at contract exchange rates, and the weighted average contractual foreign currency exchange rates. These forward contracts mature prior to March 14, 2002.

      While Cadence actively manages its foreign currency risks on an ongoing basis, there can be no assurance that Cadence’s foreign currency hedging activities will substantially offset the impact of fluctuations in currency exchange rates on its results of operations, cash flows and financial position. On a net basis, foreign currency fluctuations did not have a material impact on Cadence’s results of operations and financial position during the year ended December 29, 2001. The realized gain (loss) on the forward contracts as they matured was not material to the consolidated operations of Cadence.

      Cadence repurchases shares of its common stock under its stock repurchase program. Repurchased shares may be used for general corporate purposes including the share issuance requirements of Cadence’s employee stock option and purchase plans and acquisitions. As part of this repurchase programs, Cadence has purchased and will purchase call options or has sold and will sell put warrants to mitigate equity price risk associate with its stock repurchase program. The put warrants, if exercised and settled by physical delivery of shares, would entitle the holder to sell shares of Cadence common stock to Cadence at a specified price. Similarly, the call options entitle Cadence to buy shares of Cadence common stock at a specified price. Cadence has the option to elect “net share settlement”, rather than physical settlement, of put warrants that are exercised; that is, Cadence has the right to settle the exercised put warrants with shares of Cadence common stock valued at the difference between the exercise price and the fair value of the stock at the date of exercise. These transactions may result in sales of a large number of shares and consequent decline in the market price of Cadence common stock. Cadence’s stock repurchase program includes the following characteristics:

	•	Call options allow Cadence to buy shares of its common stock on a specified day at a specified price. If the market price of the stock is greater than the exercise price of a call option, Cadence will typically exercise the option and receive shares of its stock. If the market price of the common stock is less than the exercise price of a call option, Cadence typically will not exercise the option.
	•	Call option issuers may accumulate a substantial number of shares of Cadence common stock in anticipation of Cadence’s exercising its call option and may dispose of these shares if and when Cadence fails to exercise its call option. This could cause the market price of Cadence common stock to fall.

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	•	Depending on the exercise price of the put warrants and the market price of Cadence common stock at the time of exercise, “net share settlement” of the put warrants with Cadence common stock could cause Cadence to issue a substantial number of shares to the holder of the put warrant. The holder may sell these shares in the open market, which could cause the price of Cadence common stock to fall.
	•	Put warrant holders may accumulate a substantial number of shares of Cadence common stock in anticipation of exercising their put warrants and may dispose of these shares if and when they exercise their put warrants and Cadence issues shares in settlement of their put warrants. This could also cause the market price of Cadence common stock to fall.

      The table below provides information as of December 29, 2001 about Cadence’s outstanding put warrants and call options. The table presents the contract amounts and the weighted average strike prices. The put warrants and call options expire on various dates through May 2002 and Cadence has the contractual ability to settle the options prior to their maturity.

Liquidity and Capital Resources

      At December 29, 2001, Cadence’s principal sources of liquidity consisted of $274.8 million of cash and cash equivalents and short-term investments, compared to $137.0 million at December 30, 2000, and two syndicated senior unsecured credit facilities totaling $360.0 million. As of December 29, 2001, Cadence had no outstanding borrowings under these credit facilities.

      Cash provided by operating activities increased $107.1 million to $250.9 million at December 29, 2001 as compared to the year ended December 30, 2000, primarily due to higher net income before depreciation and amortization and unusual items in 2001.

      At December 29, 2001, Cadence had net working capital of $162.5 million, as compared with $65.3 million at December 30, 2000. The working capital increase was driven primarily by increases in cash and cash equivalents of $121.1 million, short-term investments of $16.7 million and a decrease in accounts payable and accrued liabilities of $14.6 million, partially offset by a decrease in net receivables of $31.1 million and prepaid expenses and other of $26.7 million.

      In addition to its short-term investments, Cadence’s primary investing activities in 2001 consisted of acquisitions and the related acquired intangibles, purchases of property, plant and equipment, capitalization of software development costs and venture capital partnership investments, which combined represented $212.1 million at December 29, 2001, compared to $183.7 million at December 30, 2000 of cash used for investing activities.

      Cadence sells put warrants and purchases call options through private placements. See “Disclosures about Market Risk — Equity Price Risk” above. At December 29, 2001, Cadence had a maximum potential obligation related to put warrants to buy back 2.9 million shares of its common stock at an aggregate price of approximately $61.2 million. These put warrants expire at various dates through May 2002 and Cadence has the contractual ability to settle the put warrants and call options prior to their maturity. Cadence has the

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      Cadence has made permanent investments of assets including cash in foreign countries, for which no U.S. tax has been provided. At December 29, 2001, the cumulative amount of earnings upon which U.S. income taxes have not been provided are $501.0 million. At December 29, 2001, the unrecognized deferred tax liability for these earnings was $84.7 million.

      Cadence has entered into agreements whereby it may transfer qualifying accounts receivables, for which Cadence has recognized the related revenue, 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 fiscal years ended December 29, 2001 and December 30, 2000, Cadence transferred accounts receivable totaling $235.8 million and $201.2 million, respectively, which approximated fair value, to financing institutions on a non-recourse basis. Transfers of accounts receivable for cash are reported in Cadence’s Consolidated Statements of Cash Flows as a financing activity.

      Cadence also purchased $299.0 million of its stock and reissued $99.9 million of stock through its employee option and stock purchase programs.

      As part of its overall investment strategy, Cadence is a limited partner in Telos LP, a venture capital fund, and is committed to invest up to $100.0 million. As of December 29, 2001, Cadence had contributed approximately $76.4 million to the fund, net of operating expenses.

      On September 29, 2000, Cadence entered into two syndicated, senior unsecured credit facilities that allow Cadence to borrow up to $360.0 million. These two credit facilities are referred to as the 2000 Facilities. One of the 2000 Facilities is a $100.0 million three-year revolving credit facility that terminates on September 29, 2003, referred to as the Three-Year Facility. The other 2000 Facility, referred to as the 364-Day Facility, consists of a $260.0 million, 364-day revolving credit facility convertible into a term loan. The 364-Day Facility will terminate on September 27, 2002, at which time loans outstanding thereunder may be converted to a one-year term loan with a maturity date of September 29, 2003, or, at the request of Cadence and with the consent of members of the bank group that wish to do so, the Facility may be extended for one additional 364-day period with respect to the portion of the 364-Day Facility outstanding loans that a consenting bank holds. For both of the 2000 Facilities, Cadence has the option to pay interest based on LIBOR plus a spread of between 1.25% and 1.50%, based on a pricing grid tied to a financial covenant, or the higher of (i) the Federal Funds Rate plus 0.50% or (ii) the prime rate. As a result, Cadence’s interest expense associated with borrowings under the 2000 Facilities will vary with market rates. In addition, commitment fees are payable on the unused portion of the Three-Year Facility at rates between 0.25% and 0.34% based on a pricing grid tied to a financial covenant and on the unused portion of the 364-Day Facility at a fixed rate of 0.225%. A utilization fee of 0.25% is payable on amounts borrowed under the 364-Day Facility whenever combined borrowings under the two 2000 Facilities exceed $118.8 million. Cadence may not borrow under the 364-Day Facility at any time that any portion of the Three-Year Facility remains unused. The 2000 Facilities contain certain financial and other covenants, which must be maintained. The financial covenants specify that Cadence must maintain a minimum EBITDA of not less than $200.0 million. Additionally, Cadence must maintain a minimum fixed charge coverage ratio (the ratio of EBITDA to the sum of (i) interest expense plus (ii) 20% of funded debt plus (iii) taxes paid in cash less (iv) capital lease payments) of not less than 1.5 to 1.0. Other covenants require Cadence to maintain a minimum one-to-one ratio of current assets to current liabilities and a maximum two-to-one funded debt to EBITDA ratio. From time to time, Cadence borrows under the 2000 Facilities.

      Cadence anticipates that current cash and short-term investment balances, cash flow from operations, and its $360.0 million revolving credit facilities will be sufficient to meet its working capital and capital requirements on a short-and long-term basis.

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New Accounting Standards

      In August 2001, the FASB, issued SFAS, No. 143, “Accounting for Obligations Associated with the Retirement of Long-Lived Assets.” SFAS No. 143 addresses financial accounting and reporting for the retirement obligation of an asset. This statement provides that companies should recognize the asset retirement cost at its fair value as part of the cost of the asset and classify the accrued amount as a liability in the condensed Consolidated Balance Sheet. The asset retirement liability is then accreted to the ultimate payout as interest expense. The initial measurement of the liability would be subsequently updated for revised estimates of the discounted cash outflows. The Statement will be effective for fiscal years beginning after June 15, 2002. Cadence has not yet determined the effect SFAS No. 143 will have on its consolidated financial position, results of operations or cash flows.

      In June 2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other acquired assets. It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This Statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. With the adoption of this Statement, goodwill is no longer subject to amortization over its estimated useful life. Goodwill will be assessed for impairment each year using the fair-value-based test. This Statement becomes effective January 1, 2002. Cadence is currently analyzing the impact of SFAS 142 and expects to complete its analysis by the end of its fiscal quarter ended March 30, 2002. As of December 29, 2001, Cadence had existing net goodwill and identifiable assets of $396.3 million. Cadence expects that upon adoption of SFAS 142, Cadence would no longer record annual fiscal year amortization associated with existing goodwill of approximately $311.0 million.

      In June 2001, the FASB issued SFAS No. 141, “Business Combinations.” SFAS No. 141 addresses financial accounting and reporting for business combinations and it requires business combinations in the scope of this Statement to be accounted for using one method, the purchase method. The provisions of this Statement apply to all business combinations initiated after June 30, 2001. The adoption of this Statement did not have a material effect of Cadence’s consolidated financial position, results of operations or cash flows.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

      The information required by Item 7A is incorporated by reference from the section entitled “Disclosures About Market Risk” found in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Item 8. Financial Statements and Supplementary Data

      The financial statements required by Item 8 are submitted as a separate section of this Annual Report on Form 10-K. See Item 14.

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Summary Quarterly Data — Unaudited

      * Amounts reflect the reclassification between Cost of Revenue and Restructuring, Asset Impairment and Unusual Items.

Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

      None.

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PART III.

Item 10. Directors and Executive Officers of the Registrant

      The information required by Item 10 as to directors is incorporated by reference from the sections entitled “Election of Directors” and “Compliance with the Reporting Requirements of Section 16(a)” in Cadence’s definitive Proxy Statement for its 2002 annual stockholders’ meeting.

      The executive officers of Cadence are listed at the end of Part I of this Annual Report on Form 10-K.

Item 11. Executive Compensation

      The information required by Item 11 is incorporated by reference from the section entitled “Director and Executive Compensation” in Cadence’s definitive Proxy Statement for its 2002 annual stockholders’ meeting.

Item 12. Security Ownership of Certain Beneficial Owners and Management

      The information required by Item 12 is incorporated by reference from the section entitled “Security Ownership of Certain Beneficial Owners and Management” in Cadence’s definitive Proxy Statement for its 2002 annual stockholders’ meeting.

Item 13. Certain Relationships and Related Transactions

      The information required by Item 13 is incorporated by reference from the section entitled “Certain Transactions” in Cadence’s definitive Proxy Statement for its 2002 annual stockholders’ meeting.

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PART IV.

Item 14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K

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