UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

CADENCE DESIGN SYSTEMS, INC.

(Exact name of Registrant as Specified in Its Charter)

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

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

      On April 2, 2005, 276,310,619 shares of the registrant’s common stock, $0.01 par value, were outstanding.

CADENCE DESIGN SYSTEMS, INC.

INDEX

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

CADENCE DESIGN SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

ASSETS

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

CADENCE DESIGN SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

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

CADENCE DESIGN SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

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

CADENCE DESIGN SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

      The Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q, or this Quarterly Report, have been prepared by Cadence Design Systems, Inc., or Cadence, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission, or the SEC. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, Cadence believes that the disclosures contained in this Quarterly Report comply with the requirements of Section 13(a) of the Securities Exchange Act of 1934, as amended, for a Quarterly Report on Form  10-Q and are adequate to make the information presented not misleading. These Condensed Consolidated Financial Statements are meant to be, and should be, read in conjunction with the Consolidated Financial Statements and the notes thereto included in Cadence’s Annual Report on Form 10-K for the fiscal year ended January 1, 2005.

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

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

      Cadence reclassified $45.7 million of its auction rate securities from Cash and cash equivalents to Short-term investments as of April 3, 2004. This reclassification decreased Cash flows from investing activities by $45.7 million for the three months ended April 3, 2004 in the accompanying Condensed Consolidated Statements of Cash Flows. Cadence also reclassified the net gains and losses from its non-qualified deferred compensation plan in its Condensed Consolidated Statements of Operations, which decreased Deferred compensation by $3.9 million and decreased Other income (expense), net, by $3.9 million for the three months ended April 3, 2004. In addition, certain other reclassifications have been made to prior period amounts to conform to the current period presentation.

      The table below provides a pro forma illustration of the financial results of operations as if Cadence had accounted for its grants of employee stock options under the fair value method of Statement of Financial Accounting Standards, or SFAS, No. 123, “Accounting for Stock–Based Compensation.” The impact of employee stock options on the pro forma financial results of operations was estimated at the date of grant using the Black-Scholes option-pricing model. Cadence used expected volatility, as well as other economic data, to estimate the volatility for the option grants during the three months ended April 2, 2005 and April 3, 2004 because management believes the amount yielded by this method is representative of prospective trends. Cadence considered implied volatility in market-traded options on its common stock as well as third party volatility quotes. Cadence determined the estimated fair values of its options granted and shares purchased

under its employee stock purchase plans, or ESPPs, for the three months ended April 2, 2005 and April 3, 2004 using the following weighted average assumptions, assuming a dividend yield of zero for all periods:

      The following table illustrates the effect on net income (loss) and net income (loss) per share as if Cadence had applied the fair value recognition provisions of SFAS No. 123 to stock-based compensation:

      For many of Cadence’s acquisitions, payment of a portion of the purchase price is contingent upon the acquired entity’s achievement of certain performance goals, which relate to one or more of the following criteria: revenue, bookings, product proliferation, product development and employee retention. The portion of the contingent purchase price, or earnout, associated with employee retention is recorded as compensation

expense. The specific performance goal levels, and amounts and timing of earnout payments, vary with each acquisition.

      In the three months ended April 2, 2005, Cadence recorded $20.8 million of goodwill for achieved earnouts payable to former stockholders of acquired companies. The $20.8 million of goodwill consisted of $1.4 million of cash payments made, $18.1 million accrued for future cash payments, and the issuance of 0.1 million shares of Cadence’s common stock valued at $1.3 million.

      In connection with Cadence’s acquisitions completed prior to April 2, 2005, Cadence may be obligated to pay up to an aggregate of $40.0 million in cash during the next 12 months and an additional $37.0 million in cash during the three years following the next 12 months if certain performance goals related to one or more of the following criteria are achieved in full: revenue, bookings, product proliferation, product development and employee retention.

      Goodwill

      In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” Cadence conducts an annual impairment analysis of goodwill, which it completed during the third quarter of 2004. Based on the results of the impairment review, Cadence has determined that no indicators of impairment existed for any of its reporting units during 2004. In addition, no events or circumstances have indicated that it is more likely than not that an impairment loss has been incurred during the interim periods since the annual impairment analysis. Accordingly, no impairment charge has been recognized.

      The changes in the carrying amount of goodwill for the three months ended April 2, 2005 were as follows:

      Acquired intangibles, net

      Acquired intangibles with finite lives as of April 2, 2005 and January 1, 2005 were as follows:

     For the three months ended April 2, 2005, amortization of acquired intangibles was $24.9 million, as compared to $26.2 million for the three months ended April 3, 2004.

      Amortization of costs from existing technology is included in Cost of product and Cost of services. Amortization of costs from acquired maintenance contracts is included in Cost of maintenance.

      Marketable Securities

      Cadence accounts for its marketable securities as available-for-sale and classifies them as Short-term investments in the Condensed Consolidated Balance Sheets. Net recognized gains from the sale of available-for-sale marketable securities were $4.5 million for the three months ended April 2, 2005 and $3.3 million for the three months ended April 3, 2004. During the three months ended April 2, 2005, Cadence had net sales of $108.3 million of its auction rate securities and had no auction rate securities as of April 2, 2005.

      Cadence accounts for marketable securities held in its non-qualified deferred compensation trust as trading securities. Cadence classifies these securities as Other assets in the Condensed Consolidated Balance Sheets because the securities are not available for Cadence’s use in current operations. Net recognized gains from the appreciation of trading marketable securities were $4.5 million for the three months ended April 2, 2005. Net recognized losses from the depreciation of trading marketable securities were $3.9 million for the three months ended April 3, 2004.

      There were no recognized losses from other-than-temporary declines in the market value of marketable securities for the three months ended April 2, 2005. Recognized losses from other-than-temporary declines in the market value of marketable securities totaled $0.7 million in the three months ended April 3, 2004.

      Non-Marketable Securities

      Cadence uses either the cost or equity method of accounting for its long-term, non-marketable investment securities included in Other assets in the Condensed Consolidated Balance Sheets. Cadence recorded net gains from the sale of non-marketable investment securities of $1.2 million during the three months ended April 2, 2005 and $1.3 million during the three months ended April 3, 2004. If Cadence determines that an other-than-temporary decline in fair value exists for a non-marketable equity security, it writes down the investment to its fair value and records the related write-down as an investment loss in its Condensed Consolidated Statements of Operations.

      The following table presents the carrying value of Cadence’s non-marketable securities made directly by Cadence or indirectly through Telos Venture Partners, L.P., Telos Venture Partners II, L.P., and Telos Venture Partners III, L.P.

      Cadence recorded write-downs due to other-than-temporary declines in value of its cost method investments of $5.0 million during the three months ended April 2, 2005 and $1.2 million during the three months ended April 3, 2004. These write-downs are included in Other income (expense), net, in the Condensed Consolidated Statements of Operations.

      During the first three months of 2005, Cadence’s voting interest ranged from approximately 12% to 49% of the following privately-held companies: Accent S.r.l., Ammocore Technology, Inc., CoWare, Inc., Fyre Storm, Inc., Theta Microelectronics, Inc. and ZCIST Co., Ltd.

      During the first three months of 2004, Cadence’s voting interest ranged from approximately 10% to 49% of the following privately-held companies: Accent S.r.l., Ammocore Technology, Inc., Coventor, Inc., CoWare, Inc., Fyre Storm, Inc., Hierarchical Design, Inc., Integrated Memory Logic, Inc., iReady Corporation, Neolinear, Inc., Rio Design Automation, Inc., Theta Microelectronics, Inc. and ZCIST Co., Ltd.

      Effective October 2, 2004, the beginning of Cadence’s fourth quarter of 2004, and upon the adoption of Emerging Issues Task Force, or EITF, No. 02-14, “Whether an Investor Should Apply the Equity Method of Accounting to Investments Other Than Common Stock,” if Cadence determined that it had the ability to exercise significant influence over the investee and the investment was in the form of in-substance common stock, the investment was accounted for under the equity method. For certain investments previously accounted for under the equity method, Cadence determined that these investments were not in-substance common stock because of the remaining value attributable to the common shareholders.

      The following table presents summary operating data of our equity method investees for the three months ended April 2, 2005:

      In accordance with the equity method of accounting, Cadence records its proportional share of the investees’ gains or losses in Other income (expense), net. Cadence records its interest in equity method gains and losses in the quarter following occurrence because it is not practicable to obtain investee financial statements prior to the issuance of Cadence’s Condensed Consolidated Financial Statements. Cadence’s proportional share of its investees’ net losses was $2.4 million for the three months ended April 2, 2005 and

$6.3 million for the three months ended April 3, 2004. Cadence recorded write-downs due to other-than-temporary declines in value of its equity method investments of $1.2 million during the three months ended April 2, 2005. Cadence did not recognize a write-down due to other-than-temporary declines in value of its equity method investments during the three months ended April 3, 2004. These write-downs are included in Other income (expense), net, in the Condensed Consolidated Statements of Operations. As of April 2, 2005, the difference between the carrying value of Cadence’s investments in these investee companies and Cadence’s share of the underlying net assets of the investee companies was immaterial. There were no remaining balances for equity method investments as of April 2, 2005 in the Condensed Consolidated Balance Sheet.

      Cadence initiated a separate plan of restructuring in each year since 2001 in an effort to reduce operating expenses and improve operating margins and cash flows.

      The restructuring plans initiated each year from 2001 through 2004, or the 2001 Restructuring, 2002 Restructuring, 2003 Restructuring and 2004 Restructuring, respectively, were intended to decrease costs by reducing workforce and consolidating facilities and resources, in order to align Cadence’s cost structure with expected revenues. The 2001 and 2002 Restructurings primarily related to Cadence’s design services business and certain other business or infrastructure groups throughout the world. The 2003 and 2004 Restructurings were targeted at reducing costs throughout the company.

      During the three months ended April 2, 2005, Cadence initiated a new plan of restructuring, the 2005 Restructuring, in an effort to decrease costs by reducing workforce and consolidating facilities throughout the company in order to align its cost structure with expected revenue.

      Cadence accounts for restructuring charges in accordance with SEC Staff Accounting Bulletin No. 100, “Restructuring and Impairment Charges.” Since 2001, Cadence has undertaken significant restructuring initiatives. The individual components of the restructuring activities initiated prior to fiscal 2003 were accounted for in accordance with EITF No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring),” and EITF No. 88-10, “Costs Associated with Lease Modifications or Terminations.”

      For restructuring activities initiated after fiscal 2002, Cadence accounted for the facilities and asset-related portions of these restructurings in accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” The severance and benefits charges were accounted for in accordance with SFAS No. 112, “Employers’ Accounting for Postemployment Benefits – An Amendment of FASB Statements No. 5 and 43.” The asset impairments recorded in 2004 were accounted for in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”

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

      Since 2001, Cadence has recorded facilities consolidation charges of $86.3 million related to space reductions or closures of 48 sites. As of April 2, 2005, 28 of these sites had been vacated and space reductions had occurred at the remaining 20 sites. Cadence expects to pay all of the remaining facilities-related restructuring liabilities for all of its restructuring plans prior to 2016.

      As of April 2, 2005, Cadence’s estimate of the accrued lease loss related to all worldwide restructuring activities initiated since 2001 is $31.8 million. This amount will be adjusted in the future based upon changes in the assumptions used to estimate the lease loss. The lease loss could range as high as $47.4 million if sublease rental rates decrease in applicable markets or if it takes longer than currently expected to find a suitable tenant to sublease the facilities.

      Total restructuring costs accrued as of April 2, 2005 were $42.9 million, consisting of $17.9 million in Accounts payable and accrued liabilities and $25.0 million in Other long-term liabilities. Cadence expects to pay substantially all remaining severance and benefits and asset-related restructuring liabilities prior to 2006.

      Restructuring and other charges incurred by plan of restructuring for the three months ended April 2, 2005 were as follows:

      Restructuring and other charges incurred by plan of restructuring for the three months ended April 3, 2004 were as follows:

      Activity for the three months ended April 2, 2005 associated with each plan of restructuring is discussed below.

2005 Restructuring

      During the three months ended April 2, 2005, Cadence initiated a plan of restructuring that reduced its workforce by approximately 230 employees and consolidated facilities and resources throughout the company. Costs resulting from the 2005 Restructuring included severance payments, severance-related benefits, outplacement services, lease costs associated with facilities vacated and downsized, and charges for assets written-off as a result of the restructuring.

      Severance and benefits expenses associated with the workforce reduction were approximately $15.1 million. All terminations and termination benefits associated with the 2005 Restructuring were communicated to the affected employees prior to April 2, 2005, with all termination benefits expected to be paid by December 31, 2005.

      Facilities-related expenses of $1.6 million include payments required under leases, net of estimated sublease income, lease buyout costs and costs to maintain the facilities during the abandonment period for facilities vacated as part of the 2005 Restructuring.

      Asset-related and other charges of $1.5 million include $1.1 million of charges associated with the 2005 Restructuring and $0.4 million of other charges. The $1.1 million of asset-related restructuring charges related to the write-off of leasehold improvements for facilities vacated and downsized under the 2005 Restructuring

and disposal of excess equipment. The $0.4 million of other charges relate to disposal of other assets not associated with the restructuring.

      The following table presents the activity associated with restructuring and other charges related to the 2005 Restructuring for the three months ended April 2, 2005:

2004 Restructuring

      Cadence recorded a net credit of $0.2 million during the three months ended April 2, 2005, which relates to reversing the portion of the severance and other benefits accrual in excess of the remaining expected obligation.

      The following table presents the activity associated with restructuring and other charges related to the 2004 Restructuring for the three months ended April 2, 2005:

2003 Restructuring

      During the three months ended April 2, 2005, Cadence recorded a net credit of $0.5 million related to the 2003 Restructuring, which was primarily due to changes in estimated sublease income related to vacated and downsized facilities included in the 2003 Restructuring.

      The following table presents the activity associated with restructuring and other charges related to the 2003 Restructuring for the three months ended April 2, 2005:

2002 Restructuring and 2001 Restructuring

      The remaining accrual balances for the 2002 and 2001 Restructurings relate to lease obligations for facilities vacated and downsized included in these restructurings. The amounts recorded in these restructurings during the three months ended April 2, 2005 relate primarily to payments of the remaining obligations, net of applicable sublease income.

      The following table presents the activity associated with the excess facilities components of the 2002 and 2001 Restructurings for the three months ended April 2, 2005:

     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. Periodically, Cadence reviews the status of each significant matter and assesses its potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount or the range of loss can be estimated, Cadence accrues a liability for the estimated loss in accordance with SFAS No. 5, “Accounting for Contingencies.” Legal proceedings are subject to uncertainties, and the outcomes are difficult to predict. Because of such uncertainties, accruals are based only on the best information available at the time. As additional information becomes available, Cadence reassesses the potential liability related to pending claims and litigation matters and may revise estimates.

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

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

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

      The Internal Revenue Service, or IRS, and other tax authorities regularly examine Cadence’s income tax returns. In November 2003, the IRS completed its field examination of Cadence’s federal income tax returns for the tax years 1997 through 1999 and issued a Revenue Agent’s Report, or the RAR, in which the IRS proposes to assess an aggregate tax deficiency for the three-year period of approximately $143.0 million, plus interest, which interest will accrue until the matter is resolved. This interest is compounded daily at rates published by the IRS, which rates are adjusted quarterly and have been between four and nine percent since 1997. The IRS may also make similar claims for years subsequent to 1999 in future examinations. The RAR is not a final Statutory Notice of Deficiency, and Cadence has protested certain of the proposed adjustments with the Appeals Office of the IRS where the matter is presently being considered. The most significant of the disputed adjustments relates to transfer pricing arrangements that Cadence has with a foreign subsidiary. Cadence believes that the proposed IRS adjustments are inconsistent with applicable tax laws, and that Cadence has meritorious defenses to the proposed adjustments.

      The IRS is currently examining Cadence’s federal income tax returns for the tax years 2000 through 2002.

      Significant judgment is required in determining Cadence’s provision for income taxes. In determining the adequacy of its provision for income taxes, Cadence has assessed the likelihood of adverse outcomes resulting from these examinations, including the current IRS examination and the IRS RAR for tax years 1997 through 1999. However, the ultimate outcome of tax examinations cannot be predicted with certainty, including the total amount payable or the timing of any such payments upon resolution of these issues. In addition, Cadence cannot be certain that such amount will not be materially different than that which is reflected in its historical income tax provisions and accruals. Should the IRS or other tax authorities assess additional taxes as a result of a current or a future examination, Cadence may be required to record charges to operations in future periods that could have a material adverse effect on its results of operations, financial position or cash flows in the period or periods recorded.

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

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

      The following table presents the calculation for the numerator and denominator used in the basic and diluted net income (loss) per share computations for the three months ended April 2, 2005 and the three months ended April 3, 2004:

      The following table presents the potential shares of Cadence common stock outstanding at April 2, 2005 and April 3, 2004 that were not included in the computation of diluted net income (loss) per share because the effect of including these shares would have been antidilutive:

      In August 2001, the Cadence Board of Directors authorized a program to repurchase shares of Cadence’s common stock with a value of up to $500.0 million in the aggregate. Cadence did not repurchase any shares of its common stock under its repurchase plan during the three months ended April 2, 2005 and April 3, 2004. As of April 2, 2005, the remaining repurchase authorization under this program totaled $123.0 million.

      The following table presents the common shares issued under Cadence’s ESPPs for the three months ended April 2, 2005 and April 3, 2004:

      The purchase dates under Cadence’s ESPPs are in February and August.

      At April 2, 2005, Cadence had four other stock-based employee compensation plans (excluding the director plan). Cadence accounts for these plans under the recognition and measurement principles of Accounting Principles Board, or APB, Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Under APB Opinion No. 25, compensation expense is recognized if an option’s exercise price on the measurement date is below the fair value of Cadence’s common stock. The compensation, if any, is amortized to expense over the vesting period.

      Using the Black-Scholes option-pricing model, the weighted average fair value of options granted during the three months ended April 2, 2005 was $4.65, as compared to $6.70 during the three months ended April 3, 2004.

      For fixed awards, Cadence amortizes deferred compensation to expense using the straight-line method over the period that the stock options and restricted stock vest, which is generally three to four years. For variable awards, compensation expense is recognized on an accelerated basis in accordance with FASB Interpretation No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans.” For the three months ended April 2, 2005 and April 3, 2004, Cadence recorded Deferred compensation of $11.4 million and $4.0 million, respectively.

      Deferred compensation expense includes stock-based compensation expense and compensation expense associated with the net gains and losses from Cadence’s non-qualified deferred compensation plans. The following table presents the components of the Deferred compensation expense for the three months ended April 2, 2005 and April 3, 2004:

      The following table presents the activity recorded in Deferred compensation included in the accompanying Condensed Consolidated Balance Sheet as of April 2, 2005:

      During the three months ended April 2, 2005, Cadence issued 0.5 million shares of restricted stock to certain employees. As reflected in the table above, Cadence recorded deferred stock compensation of $7.3 million in the accompanying Condensed Consolidated Balance Sheets in connection with these restricted stock awards.

NOTE 10. OTHER COMPREHENSIVE LOSS

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

      The following table sets forth the activity in Other comprehensive loss:

NOTE 11. SEGMENT AND GEOGRAPHY REPORTING

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

      During 2004, Cadence combined its three operating segments into one segment. Cadence’s CEO reviews Cadence’s consolidated results within only one segment. In making operating decisions, the CEO primarily considers consolidated financial information, accompanied by disaggregated information about revenues by geographic region. In prior years, Cadence’s chief operating decision maker reviewed Cadence’s consolidated results within three segments: Product, Services and Maintenance. As required by SFAS No. 131, the prior year information in this footnote has been restated to conform to the current year presentation.

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

      The following table presents a summary of revenue by geography:

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

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

      One customer accounted for 14% of total revenue for the three months ended April 2, 2005. No one customer accounted for more than 10% of total revenue during the three months ended April 3, 2004.

NOTE 12. SUBSEQUENT EVENT

      On April 7, 2005, Cadence acquired Verisity Ltd., or Verisity, an Israeli corporation. Verisity is a provider of verification process automation solutions. Cadence acquired Verisity in an all-cash transaction for a net purchase price of approximately $268.0 million. The net purchase price consists of payments to stockholders of $315.0 million, or $12.00 for each outstanding share of Verisity stock, and approximately $17.0 million of acquisition costs, offset by approximately $64.0 million of cash received from Verisity in the acquisition. This merger will be accounted for under the purchase method of accounting.

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

      The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q, or this Quarterly Report, and in conjunction with our Annual Report on Form 10-K for the fiscal year ended January 1, 2005. Certain of such statements, including, without limitation, statements regarding the extent and timing of future revenues and expenses and customer demand, statements regarding the deployment of our products, statements regarding our reliance on third parties and other statements using words such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “should,” “will” and “would,” and words of similar import and the negatives thereof, constitute forward-looking statements. These statements are predictions based upon our current expectations about future events. Actual results could vary materially as a result of certain factors, including but not limited to, those expressed in these statements. We refer you to the “Factors That May Affect Future Results,” “Results of Operations,” “Disclosures About Market Risk,” and “Liquidity and Capital Resources” sections contained in this Quarterly Report, and the risks discussed in our other SEC filings, which identify important risks and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements.

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

Overview

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

      As part of our strategy, we have acquired companies, businesses and third party intellectual property to obtain technology and key personnel, and we expect to continue making acquisitions in the future.

      During the last decade, the worldwide communications, business productivity and consumer electronics markets accounted for much of the growth in the electronics industry. Ever-decreasing silicon manufacturing process geometries, coupled with the move to 300 millimeter wafer production, are causing IC unit cost decreases, enabling die-per-wafer volume increases and greater complexity for providers of electronic devices. At the same time, the development of ICs with greater functionality complicates effective integration of components into complete electronics systems. These market and technology forces pose major challenges for the global electronics design community, and consequently create significant opportunities and challenges for EDA products and services providers. In response to these challenges, we have initiated significant restructuring activities over the past several years, including during the three months ended April 2, 2005, to better align our cost structure with projected demand for our products and services and their resulting projected revenues.

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

      We continue to experience a customer preference for renewable license types, which are term and subscription, and expect the timing of license renewals to continue to impact our results of operations.

      For many of our acquisitions, payment of a portion of the purchase price is contingent upon the acquired entity’s achievement of certain performance goals, which relate to one or more of the following criteria: revenue, bookings, product proliferation, product development and employee retention. The portion of the contingent purchase price, or earnout, associated with employee retention is recorded as compensation expense. The specific performance goal levels, and amounts and timing of earnout payments, vary with each acquisition.

      In the three months ended April 2, 2005, we recorded $20.8 million of goodwill for achieved earnouts payable to former stockholders of acquired companies. The $20.8 million of goodwill consisted of $1.4 million of cash payments made, $18.1 million accrued for future cash payments, and the issuance of 0.1 million shares of our common stock valued at $1.3 million.

      In connection with our acquisitions completed prior to April 2, 2005, we may be obligated to pay up to an aggregate of $40.0 million in cash during the next 12 months and an additional $37.0 million in cash during the three years following the next 12 months if certain performance goals related to one or more of the following criteria are achieved in full: revenue, bookings, product proliferation, product development and employee retention.

Critical Accounting Estimates

      In preparing our Condensed Consolidated Financial Statements, we make assumptions, judgments and estimates that can have a significant impact on our revenue, operating income (loss) and net income (loss), as well as on the value of certain assets and liabilities on our Condensed Consolidated Balance Sheets. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. On a regular basis, we evaluate our assumptions, judgments and estimates and make changes accordingly. We believe that the assumptions, judgments and estimates involved in the accounting for revenue recognition, accounting for income taxes, valuation of long-lived and intangible assets and goodwill, and restructuring charges have the greatest potential impact on our Condensed Consolidated Financial Statements; therefore, we consider these to be our critical accounting estimates. Historically, our assumptions, judgments and estimates relative to our critical accounting estimates have not differed materially from actual results.

Revenue recognition

      We apply the provisions of Statement of Position, or SOP 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 product revenue transactions where the software is not incidental. We also apply the provisions of Statement of Financial Accounting Standards, or SFAS No. 13, “Accounting for Leases,” to all hardware lease transactions. We recognize revenue when persuasive evidence of an arrangement exists, the product has been delivered, the fee is fixed or determinable, collection of the resulting receivable is probable, and vendor-specific objective evidence of fair value, or VSOE, exists.

      We license software using three different license types:

      Persuasive evidence of an arrangement – Generally, we use the customer signed contract as evidence of an arrangement for subscription and term licenses and hardware leases. If a customer signed contract does not exist, we have historically used a purchase order as evidence of an arrangement for perpetual licenses, hardware sales, maintenance renewals and small fixed-price service projects, such as training classes and small, standard methodology service engagements of approximately $10,000 or less. For all other service engagements, we use a signed professional services agreement and a statement of work to evidence an arrangement. Sales through our distributors are evidenced by a master agreement governing the relationship, together with binding purchase orders from the distributor on a transaction-by-transaction basis.

      Product delivery – Software and the corresponding access keys are generally delivered to customers electronically. Electronic delivery occurs when we provide the customer access to the software. Occasionally, we will deliver the software on a compact disc with standard transfer terms of free-on-board shipping point. Our software license agreements generally do not contain conditions for acceptance. With respect to hardware, delivery of an entire system is deemed to occur upon its successful installation.

      Fee is fixed or determinable – We assess whether a fee is fixed or determinable at the outset of the arrangement, primarily based on the payment terms associated with the transaction. In our assessment of whether a fee is fixed or determinable, we use installment contracts that extend up to a maximum of five years from the contract date for certain term and subscription licenses and we have established a history of collecting under the original contract without providing concessions on payments, products or services. Our installment contracts that do not include a substantial up front payment have payment periods that are equal to or less than the term of the licenses and the payments are collected quarterly in equal or nearly equal installments, when evaluated over the entire term of the arrangement.

      Significant judgment is involved in assessing whether a fee is fixed or determinable, including assessing whether a contract amendment constitutes a concession. Our experience has been that we are able to determine whether a fee is fixed or determinable. While we do not expect that experience to change, if we no longer were to have a history of collecting under the original contract without providing concessions on term licenses, revenue from term licenses would be required to be recognized when payments under the installment contract become due and payable. Such a change could have a material impact on our results of operations.

      Collection is probable – We have concluded that collection is not probable for license arrangements executed with entities in certain countries. For all other countries, we assess collectibility at the outset of the arrangement based on a number of factors, including the customer’s past payment history and its current creditworthiness. If in our judgment collection of a fee is not probable, we defer the revenue until the uncertainty is removed, which generally means revenue is recognized upon our receipt of cash payment. Our experience has been that we are able to estimate whether collection is probable. While we do not expect that experience to change, if we were to determine that collection is not probable for any license arrangement with installment payment terms, revenue from such license would be recognized generally upon the receipt of cash payment. Such a change could have a material impact on our results of operations.

      Vendor-Specific Objective Evidence of Fair Value – Our VSOE for certain product elements of an arrangement is based upon the pricing in comparable transactions when the element is sold separately. VSOE for maintenance is generally based upon the customer’s stated annual renewal rates. VSOE for services is generally based on the price charged when the services are sold separately. For multiple element arrangements, VSOE must exist to allocate the total fee among all delivered and undelivered elements in the arrangement. If VSOE 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. If VSOE of all undelivered elements exists but VSOE does not exist for one or more delivered elements, revenue is recognized using the residual method. Under the residual method, the VSOE of the undelivered elements is deferred, and the remaining portion of the arrangement fee is recognized as revenue as elements are delivered. Our experience

has been that we are able to estimate VSOE. While we do not expect that experience to change, if we could no longer support VSOE for undelivered elements of multiple element arrangements, revenue would be deferred until we have VSOE for the undelivered elements or all elements are delivered, whichever is earlier. Such a change could have a material impact on our results of operations.

      Finance Fee Revenue – Finance fees result from discounting to present value the product revenue derived from our installment contracts in which the payment terms extend beyond one year from the effective date of the contract. Finance fees are recognized using a method that approximates the effective interest method over the relevant license term and are classified as product revenue. Finance fee revenue represented 2% of total revenue for the three months ended April 2, 2005 and 1% of total revenue for the three months ended April 3, 2004.

      Services Revenue – Services revenue consists primarily of revenue received for performing methodology and design services. These services are not related to the functionality of the products licensed. Revenue from service contracts is recognized either on the time and materials method, as work is performed, or on the percentage-of-completion method. For contracts with fixed or not-to-exceed fees, we estimate on a monthly basis the percentage-of-completion, which is based on the completion of milestones relating to the arrangement. We have a history of accurately estimating project status and the costs necessary to complete projects. A number of internal and external factors can affect our estimates, including labor rates, utilization and efficiency variances and specification and testing requirement changes. If different conditions were to prevail such that accurate estimates could not be made, then the use of the completed contract method would be required and the recognition of all revenue and costs would be deferred until the project was completed. Such a change could have a material impact on our results of operations.

Accounting for income taxes

      We provide for the effect of income taxes in our Condensed Consolidated Financial Statements in accordance with SFAS No. 109, “Accounting for Income Taxes”, or SFAS No. 109, and Financial Accounting Standards Board Interpretation No. 18, or FIN No. 18, “Accounting For Income Tax in Interim Periods (An Interpretation of APB Opinion No. 28)”. Under SFAS No. 109, income tax expense (benefit) is recognized for the amount of taxes payable or refundable for the current year, and for deferred tax assets and liabilities for the tax consequences of events that have been recognized in an entity’s financial statements or tax returns. FIN No. 18 specifies that tax payable (or tax benefit) for an interim period related to ordinary income (or loss) shall be computed at an estimated annual effective tax rate and the tax payable (or tax benefit) related to all items other than ordinary income (or loss) shall be individually computed and recognized when items occur. Estimates of the annual effective tax rate at the end of interim periods are based on our evaluations of possible future events and transactions and may be subject to subsequent refinement or revision.

      We must make significant assumptions, judgments and estimates to determine our current provision for income taxes, our deferred tax assets and liabilities and any valuation allowance to be recorded against our deferred tax assets. Our judgments, assumptions and estimates relating to the current provision for income taxes take into account estimates of the annual pre-tax book income and the geographic mix of income, current tax laws, our interpretation of current tax laws and possible outcomes of current and future audits conducted by foreign and domestic tax authorities. Changes in our estimates of the geographic mix of income or the annual pre-tax income, tax laws or our interpretation of tax laws and developments in current and future tax audits could significantly impact the amounts provided for income taxes in our results of operations, financial position or cash flows. Our assumptions, judgments and estimates, relating to the value of our net deferred tax assets, take into account predictions of the amount and category of future taxable income from potential sources including tax planning strategies that would, if necessary, be implemented to prevent a loss carryforward or tax credit carryforward from expiring unused. Actual operating results and the underlying amount and category of income in future years could render our current assumptions, judgments and estimates of recoverable net deferred taxes inaccurate, thus materially affecting our results of operations and financial position.

      See the factors affecting future results below entitled “Our operating results could be adversely affected as a result of changes in our effective tax rates”, “We have received an examination report from the Internal Revenue Service proposing a tax deficiency in certain of our tax returns, and the outcome of the examination or any future examinations involving similar claims may have a material adverse effect on our results of operations and cash flows” and “Forecasting our estimated annual effective tax rate is complex and subject to uncertainty, and material differences between forecasted and actual tax rates could have a material impact on our results of operations”.

Valuation of long-lived and intangible assets, including goodwill

      At least annually we review goodwill resulting from business combinations for impairment in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.”

      Our annual impairment review process compares the fair value of each reporting unit to its carrying value, including the goodwill related to the reporting unit. To determine the reporting unit’s fair value, we utilize a combination of the income and market valuation approaches.

      The income approach provides an estimate of fair value based on the discounted expected future cash flows. These expected future cash flows are based on our assumed market segment growth rates, assumed market segment share growth rates, estimated costs and appropriate discount rates based on the reporting units’ weighted average cost of capital as determined by considering the observable weighted average cost of capital of comparable companies. Our estimates of market segment growth, our market segment share growth and costs are based on historical data, various internal estimates and a variety of external sources, and are developed as part of our routine long-range planning process.

      The market approach provides an estimate of the fair value of the equity of a business by comparing it to publicly traded companies in similar lines of business. The conditions and prospects of companies in similar lines of business depend on common factors such as overall demand for their products and services. Factors such as size, growth, profitability, risk and return on investment are also analyzed and compared to comparable companies. Various price or market multiples are then applied to our reporting units’ operating results to arrive at an estimate of fair value.

      In determining our overall conclusion of reporting unit fair value, we considered the estimated values derived from both the income and market valuation approaches. The weighting applied to the market approach depends on the similarity of the comparable businesses to the reporting unit.

      We review long-lived assets, including certain identifiable intangibles, for impairment whenever events or changes in circumstances indicate that we will not be able to recover the asset’s carrying amount in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”

      For long-lived assets to be held and used, including acquired intangibles, we initiate our review whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. Recoverability of an asset is measured by comparing its carrying amount to the expected future undiscounted cash flows expected to result from the use and eventual disposition of that asset, excluding future interest costs that would be recognized as an expense when incurred. 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:

      Material impairment charges could be necessary should different conditions prevail or different judgments be made.

Restructuring charges

      We account for restructuring charges in accordance with SEC Staff Accounting Bulletin No. 100, “Restructuring and Impairment Charges.” Since fiscal 2001, we have undertaken significant restructuring initiatives. All restructuring activities initiated prior to fiscal 2003 were accounted for in accordance with EITF No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)” and EITF No. 88-10, “Costs Associated with Lease Modifications or Terminations.” For restructuring activities initiated after fiscal 2002, we accounted for the facilities and asset-related portions of these restructurings in accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” In addition, for all periods presented, we accounted for the facilities and asset-related portions of these restructurings in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” The severance and benefits charges were accounted for in accordance with SFAS No. 112, “Employers’ Accounting for Postemployment Benefits – An Amendment of FASB Statements No. 5 and 43.”

      These restructuring initiatives have required us to make a number of estimates and assumptions related to losses on excess facilities vacated or consolidated, particularly estimating when, if at all, we will be able to sublet vacated facilities and if we do, the sublease terms. Closure and space reduction costs that are part of our restructuring charges include payments required under leases, less any applicable estimated sublease income after the facilities are abandoned, lease buyout costs and certain contractual costs to maintain facilities during the abandonment period.

      In addition, we have recorded estimated provisions for termination benefits and outplacement costs, and other restructuring costs. We regularly evaluate the adequacy of our restructuring accrual, and adjust the balance based on changes in estimates and assumptions. We may incur future charges for new restructuring activities as well as changes in estimates to amounts previously recorded.

Results of Operations

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

      A substantial portion of our software product licenses are subscription licenses. As a result, we expect that our revenue will be less susceptible to short-term fluctuations in volume than if more of our licenses were of the term or perpetual type. Because a substantial portion of our revenue is recognized over multiple periods, we do not believe that pricing volatility has been a material component of the change in our product revenue from period to period, and we have not analyzed changes in pricing on a company-wide basis from one period to the next.

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

      Product revenue recognized in any period is affected by the extent to which customers purchase subscription, term or perpetual licenses, and the extent to which contracts contain flexible payment terms. The

timing of product revenue recognition is also affected by changes in the extent to which existing contracts contain flexible payment terms and changes in contractual arrangements (e.g., subscription to term) with existing customers. The dollar size and duration of contracts, and consequently product revenues recognized, are also affected by the competitiveness of our products.

Revenue and Revenue Mix by Product Group

      We analyze our software and hardware businesses by product group, combining revenues for both product and maintenance because of their interrelationship. We have formulated a design solution strategy that combines our design technologies into “platforms,” which are included in the various product groups described below. We introduced our first platform in September 2002. The data described below for product groups for periods before a platform was introduced aggregates the revenues from the individual products associated with that particular platform.

      Our product groups are:

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

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

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

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

      System Interconnect: This product group consists of our printed circuit board and integrated circuit package design products, including the Allegro® system interconnect design platform, which enables consistent co-design of integrated circuits, IC packages, and printed circuit boards.

      The table below shows our revenue for the three months ended April 2, 2005 and April 3, 2004:

      Product and maintenance revenue were higher in the three months ended April 2, 2005, as compared to the three months ended April 3, 2004, primarily because of increased revenue from licenses for Functional Verification, Digital IC and Design for Manufacturing products.

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

      In the three months ended July 3, 2004, we recognized $11.0 million of revenue from the sale of intellectual property, or IP. This sale of IP is included in Services and other in the preceding table and in Product revenue in the accompanying Condensed Consolidated Statement of Operations.

Revenue by Geography

Revenue by Geography as a Percent of Total Revenue

      The rate of revenue change varies geographically due to differences in the timing and extent of term license renewals for existing customers in those regions. In addition, both our domestic and international businesses have been affected by the revenue trends discussed above in this section entitled “Results of Operations.” In the three months ended April 2, 2005, one customer in Japan accounted for 14% of our consolidated revenue.

      Changes in foreign currency exchange rates caused our revenue to increase by $3.4 million in the three months ended April 2, 2005, as compared to the three months ended April 3, 2004, primarily due to a strengthening of the Japanese yen in relation to the U.S. dollar.

Cost of Revenue

Cost of Revenue as a Percent of Related Revenue

      Cost of product includes costs associated with the sale or lease of our hardware and licensing of our software products. Cost of product primarily includes the cost of employee salaries and benefits, amortization of intangible assets directly related to Cadence products, the cost of technical documentation and royalties payable to third-party vendors. Cost of product associated with our Cadence Verification Acceleration, or CVA, hardware products also includes materials, assembly labor and overhead. These additional manufacturing costs make our cost of hardware product higher, as a percentage of revenue, than our cost of software product.

      A summary of Cost of product is as follows:

      Cost of product increased $3.4 million in the three months ended April 2, 2005, as compared to the three months ended April 3, 2004, primarily due to an increase of $4.8 million in amortization of intangible assets, partially offset by a $1.2 million decrease in royalty expenses.

      Cost of product in the future will depend primarily upon the actual mix of hardware and software product contracts in any given period and the degree to which we license and incorporate third-party technology in our products licensed or sold in any given period.

      Cost of services primarily includes employee salary and benefits, costs to maintain the infrastructure necessary to manage a services organization, and provisions for contract losses, if any. Cost of services decreased $0.6 million in the three months ended April 2, 2005, as compared to the three months ended April 3, 2004, primarily due to a decrease in salary and benefit costs resulting from decreases in the number of employees in our services business.

      Cost of maintenance includes the cost of customer services, such as hot-line and on-site support, certain employees and documentation of maintenance updates. Cost of maintenance revenue increased $0.6 million in the three months ended April 2, 2005, as compared to the three months ended April 3, 2004, due to a $0.6 million increase in salary and benefit costs.

Operating Expenses

Expenses as a Percent of Total Revenue

Operating Expense Summary

      Overall operating expenses increased by $7.6 million in the three months ended April 2, 2005, as compared to the same period in 2004, primarily due to an increase in bonus expense as a result of greater progress towards the achievement of certain bonus objectives.

      Foreign currency exchange rates increased operating expenses by $1.7 million in the three months ended April 2, 2005, as compared to the same period in 2004, primarily due to the strengthening of the euro, British pound and Japanese yen in relation to the U.S. dollar.

Marketing and Sales

      Marketing and sales expense decreased $1.5 million in the three months ended April 2, 2005, as compared to the same period in 2004. The decrease in Marketing and sales expense in the three months ended April 2, 2005 is primarily due to a decrease of $0.7 million in commissions, employee salaries and benefits as compared to 2004.

Research and Development

      Research and development expense increased $3.2 million in the three months ended April 2, 2005, as compared to the same period in 2004, primarily due to a $4.7 million increase in salaries and benefits, partially offset by a $1.2 million reduction in depreciation expense.

General and Administrative

      General and administrative expense increased $5.9 million in the three months ended April 2, 2005, as compared to the same period in 2004, primarily due to a $3.0 million increase in salaries and benefits, an increase of $1.4 million in the loss on the sales of receivables and an increase of $1.3 million related to our use of outside services.

Amortization of Acquired Intangibles

      Amortization of acquired intangibles decreased $5.3 million in the three months ended April 2, 2005, as compared to the same period in 2004, primarily due to a $5.2 million decrease in the amortization of acquired intangibles reflecting the full amortization of intangible assets from prior year acquisitions.

Deferred Compensation

      We amortize deferred compensation related to fixed awards using the straight-line method over the period that the stock options and restricted stock vest. We recognize stock compensation expense related to variable awards using an accelerated method over the period that the stock options and restricted stock are earned.

      Deferred compensation increased $7.4 million for the three months ended April 2, 2005, as compared to the same period in 2004, due to a $7.3 million increase in deferred compensation expense related to our Non-Qualified Deferred Compensation Plan, and a $2.9 million increase in the amortization of deferred compensation related to restricted stock grants. This increase was partially offset by a $2.8 million decrease in the amortization of deferred compensation primarily related to our previously completed acquisitions.

Restructuring and Other Charges

      We have initiated a separate plan of restructuring in each year since 2001 in an effort to reduce operating expenses and improve operating margins and cash flows.

      The restructuring plans initiated each year from 2001 through 2004, or the 2001 Restructuring, 2002 Restructuring, 2003 Restructuring and 2004 Restructuring, respectively, were intended to decrease costs by reducing workforce and consolidating facilities and resources, in order to align our cost structure with expected revenues. The 2001 and 2002 Restructurings primarily related to our design services business and certain other business or infrastructure groups throughout the world. The 2003 and 2004 Restructurings were targeted at reducing costs throughout the company.

      During the three months ended April 2, 2005 we initiated a new plan of restructuring, or the 2005 Restructuring, in an effort to decrease costs by reducing workforce and consolidating facilities throughout the company in order to align our cost structure with expected revenue.

      A summary of restructuring and other charges by plan of restructuring for the three months ended April 2, 2005 is as follows: