MENTOR GRAPHICS CORP - FORM 10-Q

MENTOR GRAPHICS CORP - FORM 10-Q - December 7, 2010

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EXCEL - IDEA: XBRL DOCUMENT - MENTOR GRAPHICS CORP	Financial_Report.xls
EX-32 - CERTIFICATIONS OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER - MENTOR GRAPHICS CORP	dex32.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER OF REGISTRANT - MENTOR GRAPHICS CORP	dex311.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER OF REGISTRANT - MENTOR GRAPHICS CORP	dex312.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended October 31, 2010

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

For the transition period from to

Commission File No. 1-34795

MENTOR GRAPHICS CORPORATION

(Exact name of registrant as specified in its charter)

Oregon

93-0786033

(State or other jurisdiction of

incorporation or organization)

(IRS Employer

Identification No.)


8005 SW Boeckman Road, Wilsonville, Oregon		97070-7777
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (503) 685-7000

None

(Former name, former address and former

fiscal year, if changed since last report)

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

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


Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company ¨
				(Do not check if a smaller reporting company)

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

Number of shares of common stock, no par value, outstanding as of December 3, 2010: 109,672,191

MENTOR GRAPHICS CORPORATION

Index to Form 10-Q


		Page Number
PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements (unaudited)

	Condensed Consolidated Statements of Operations for the three months ended October 31, 2010 and 2009		3

	Condensed Consolidated Statements of Operations for the nine months ended October 31, 2010 and 2009		4

	Condensed Consolidated Balance Sheets as of October 31, 2010 and January 31, 2010		5

	Condensed Consolidated Statements of Cash Flows for the nine months ended October 31, 2010 and 2009		6

	Notes to Unaudited Condensed Consolidated Financial Statements		7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		27

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		41

Item 4.	Controls and Procedures		43

PART II. OTHER INFORMATION

Item 1A.	Risk Factors		44

Item 6.	Exhibits		50

SIGNATURES			51

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements

Mentor Graphics Corporation

Condensed Consolidated Statements of Operations

(Unaudited)


Three months ended October 31,	2010			2009
*In thousands, except per share data*
Revenues:
System and software	$	148,101		$	106,344
Service and support		90,836			82,852

Total revenues		238,937			189,196

Cost of revenues:
System and software		11,218			2,966
Service and support		24,445			21,414
Amortization of purchased technology		3,299			3,089

Total cost of revenues		38,962			27,469

Gross margin		199,975			161,727

Operating expenses:
Research and development		70,727			64,293
Marketing and selling		82,603			73,093
General and administration		23,396			22,820
Equity in earnings of Frontline		(415	)		—
Amortization of intangible assets		1,445			2,796
Special charges		1,578			5,993

Total operating expenses		179,334			168,995

Operating income (loss)		20,641			(7,268	)
Other expense, net		(206	)		(1,004	)
Interest expense		(4,324	)		(4,385	)

Income (loss) before income tax		16,111			(12,657	)
Income tax expense		854			14,377

Net income (loss)	$	15,257		$	(27,034	)

Net income (loss) per share:
Basic	$	0.14		$	(0.28	)

Diluted	$	0.14		$	(0.28	)

Weighted average number of shares outstanding:
Basic		109,364			97,854

Diluted		112,139			97,854

See accompanying notes to unaudited condensed consolidated financial statements.

Mentor Graphics Corporation

Condensed Consolidated Statements of Operations

(Unaudited)


Nine months ended October 31,	2010			2009
*In thousands, except per share data*
Revenues:
System and software	$	346,042		$	325,646
Service and support		261,406			239,946

Total revenues		607,448			565,592

Cost of revenues:
System and software		20,409			17,366
Service and support		69,511			63,135
Amortization of purchased technology		10,428			8,965

Total cost of revenues		100,348			89,466

Gross margin		507,100			476,126

Operating expenses:
Research and development		199,904			187,427
Marketing and selling		230,889			221,124
General and administration		69,118			68,042
Equity in earnings of Frontline		(1,761	)		—
Amortization of intangible assets		5,742			8,554
Special charges		8,052			15,890

Total operating expenses		511,944			501,037

Operating loss		(4,844	)		(24,911	)
Other expense, net		(1,361	)		(1,262	)
Interest expense		(13,378	)		(13,259	)

Loss before income tax		(19,583	)		(39,432	)
Income tax expense		2,432			21,824

Net loss	$	(22,015	)	$	(61,256	)

Net loss per share:
Basic	$	(0.21	)	$	(0.64	)

Diluted	$	(0.21	)	$	(0.64	)

Weighted average number of shares outstanding:
Basic		106,942			95,636

Diluted		106,942			95,636

See accompanying notes to unaudited condensed consolidated financial statements.

Mentor Graphics Corporation

Condensed Consolidated Balance Sheets

(Unaudited)


As of	October 31, 2010			January 31, 2010
*In thousands*
Assets
Current assets:
Cash and cash equivalents	$	64,287		$	99,340
Short-term investments		3			3
Trade accounts receivable, net of allowance for doubtful accounts of $3,344 as of October 31, 2010 and $3,607 as of January 31, 2010		300,334			289,750
Other receivables		12,935			10,186
Inventory		6,215			3,630
Prepaid expenses and other		19,792			15,813
Deferred income taxes		11,321			11,891

Total current assets		414,887			430,613
Property, plant, and equipment, net of accumulated depreciation of $257,940 as of October 31, 2010 and $252,269 as of January 31, 2010		138,689			121,795
Term receivables		144,725			164,898
Goodwill		497,288			458,313
Intangible assets, net of accumulated amortizaton of $151,533 as of October 31, 2010 and $135,363 as of January 31, 2010		29,847			26,029
Deferred income taxes		5,487			7,047
Other assets		43,471			14,346

Total assets	$	1,274,394		$	1,223,041

Liabilities and Stockholders’ Equity
Current liabilities:
Short-term borrowings	$	11,669		$	37,874
Current portion of notes payable		2,000			32,272
Accounts payable		17,364			9,985
Income taxes payable		8,316			3,971
Accrued payroll and related liabilities		71,284			77,008
Accrued liabilities		37,330			44,122
Deferred revenue		139,282			153,965

Total current liabilities		287,245			359,197
Notes payable		207,078			156,075
Deferred revenue		9,370			9,534
Income tax liability		40,050			36,791
Other long-term liabilities		21,375			21,427

Total liabilities		565,118			583,024

Commitments and contingencies (Note 8)
Stockholders’ equity:
Common stock, no par value, 300,000 shares authorized as of October 31, 2010 and 200,000 shares authorized as of January 31, 2010; 109,471 shares issued and outstanding as of October 31, 2010 and 100,478 issued and outstanding as of January 31, 2010		749,211			662,595
Accumulated deficit		(70,757	)		(48,742	)
Accumulated other comprehensive income		30,822			26,164

Total stockholders’ equity		709,276			640,017

Total liabilities and stockholders’ equity	$	1,274,394		$	1,223,041

See accompanying notes to unaudited condensed consolidated financial statements.

Mentor Graphics Corporation

Condensed Consolidated Statements of Cash Flows

(Unaudited)


Nine months ended October 31,	2010			2009
*In thousands*
Operating Cash Flows:
Net loss		(22,015	)	$	(61,256	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization of property, plant, and equipment		23,169			23,626
Amortization		19,872			21,600
Impairment of cost-basis investments		—			113
Equity in (income) losses of unconsolidated entities, net of dividends received		1,110			738
Gain on debt extinguishment		—			(380	)
Stock-based compensation		16,591			20,976
Deferred income taxes		(3,462	)		(454	)
Changes in other long-term liabilities		(3,120	)		(5,565	)
Other		252			231
Changes in operating assets and liabilities, net of effect of acquired businesses:
Trade accounts receivable, net		541			56,392
Prepaid expenses and other		(2,439	)		24,785
Term receivables, long-term		18,596			11,369
Accounts payable and accrued liabilities		(19,811	)		(21,212	)
Income taxes receivable and payable		(1,332	)		4,439
Deferred revenue		(20,857	)		(42,448	)

Net cash provided by operating activities		7,095			32,954

Investing Cash Flows:
Proceeds from sales and maturities of short-term investments		—			1,990
Increase in restricted cash		(999	)		—
Purchases of property, plant, and equipment		(36,769	)		(17,951	)
Acquisitions of businesses and equity interests, net of cash acquired		(13,204	)		(3,940	)

Net cash used in investing activities		(50,972	)		(19,901	)

Financing Cash Flows:
Proceeds from issuance of common stock		15,632			10,310
Net decrease in short-term borrowings		(6,247	)		(9,121	)
Debt and equity issuance costs		(971	)		(515	)
Proceeds from notes payable and revolving credit facility		80,225			—
Repayments of notes payable and revolving credit facility		(81,763	)		(23,450	)

Net cash provided by (used in) financing activities		6,876			(22,776	)

Effect of exchange rate changes on cash and cash equivalents		1,948			732

Net change in cash and cash equivalents		(35,053	)		(8,991	)
Cash and cash equivalents at the beginning of the period		99,340			93,642

Cash and cash equivalents at the end of the period	$	64,287		$	84,651

See accompanying notes to unaudited condensed consolidated financial statements.

Mentor Graphics Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

All numerical references are in thousands, except for percentages and per share data.

(1)

General—The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with United States (U.S.) generally accepted accounting principles (GAAP) and reflect all material normal recurring adjustments. However, certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). In the opinion of management, the condensed consolidated financial statements include adjustments necessary for a fair presentation of the results of the interim periods presented. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes included in our Annual Report on Form 10-K for the fiscal year ended January 31, 2010.

The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, and contingencies as of the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates. Any changes in estimates will be reflected in the financial statements in future periods.

(2)	*Summary of Significant Accounting Policies*

Principles of Consolidation

The condensed consolidated financial statements include our financial statements and those of our wholly-owned and majority-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

We do not have off-balance sheet arrangements, financings, or other similar relationships with unconsolidated entities or other persons, also known as special purpose entities. In the ordinary course of business, we lease certain equipment and certain real properties, primarily field sales offices, and research and development facilities, as described in Note 8. “Commitments and Contingencies.”

Revenue Recognition

We report revenue in two categories based on how the revenue is generated: (i) system and software and (ii) service and support.

System and software revenues – We derive system and software revenues from the sale of licenses of software products, emulation hardware systems, and finance fee revenues from our long-term installment receivables resulting from product sales. We primarily license our products using two different license types:

1. Term licenses – We use this license type primarily for software sales. This license type provides the customer with the right to use a fixed list of software products for a specified time period, typically three years, with payments spread over the license term, and does not provide the customer with the right to use the products after the end of the term. Term license arrangements may allow the customer to share products between multiple locations and remix product usage from the fixed list of products at regular intervals during the license term. We generally recognize product revenue from term license arrangements upon product delivery and start of the license term. In a term license agreement where we provide the customer with rights to unspecified or unreleased future products, we recognize revenue ratably over the license term. When all other criteria for revenue recognition have been met, we recognize revenue from emulation hardware system sales upon delivery.

2. Perpetual licenses – We use this license type for software and emulation hardware system sales. This license type provides the customer with the right to use the product in perpetuity and typically does not provide for extended payment terms. We generally recognize product revenue from perpetual license arrangements upon product delivery assuming all other criteria for revenue recognition have been met.

We include finance fee revenues from the accretion on the discount of long-term installment receivables in System and software revenues.

Service and support revenues – We derive service and support revenues from software and hardware post-contract maintenance or support services and professional services, which include consulting, training, and other services. We recognize revenue ratably over the support services term. We record professional service revenue as the services are provided to the customer.

adopted FASB Accounting Standards Update (ASU) No. 2009-13 Revenue Recognition (Topic 605)- “Multiple-Deliverable Revenue Arrangements” and ASU No. 2009-14 Software (Topic 985)- “Certain Revenue Arrangements That Include Software Elements,” (together the ASUs). The adoption of the ASUs did not have a material impact to revenue in periods subsequent to adoption. However, it may result in recognition of revenue into periods earlier than that revenue would have been recognized prior to the adoption of the ASUs. We apply the authoritative guidance in Topic 605 applicable to multiple-element arrangements to the sale of our emulation hardware systems that contain software components and non-software components that function together to deliver the hardware’s essential functionality.

We determine whether product revenue recognition is appropriate based upon the evaluation of whether the following four criteria have been met:

1. Persuasive evidence of an arrangement exists – Generally, we use either a customer signed contract or qualified customer purchase order as evidence of an arrangement for both term and perpetual licenses. For professional service engagements, we generally use a signed professional services agreement and a statement of work to evidence an arrangement. Sales through our distributors are evidenced by an agreement governing the relationship, together with binding purchase orders from the distributor on a transaction-by-transaction basis.

2. Delivery has occurred – We generally deliver software and the corresponding access keys to customers electronically. Electronic delivery occurs when we provide the customer access to the software. We may also deliver the software on a compact disc. With respect to emulation hardware systems, we transfer title to the customer upon shipment. We offer non-essential installation services for emulation hardware system sales or the customer may elect to perform the installation without our assistance. Our software license and emulation hardware system agreements generally do not contain conditions for acceptance.

3. 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. We have established a history of collecting under the original contract with installment terms without providing concessions on payments, products, or services. Additionally, for installment contracts, we determine that the fee is fixed or determinable if the arrangement has a payment schedule that is within the term of the licenses and the payments are collected in equal or nearly equal installments, when evaluated on a cumulative basis. If the fee is not deemed to be fixed or determinable, we recognize revenue as payments become due and payable.

Significant judgment is involved in assessing whether a fee is fixed or determinable. We must also make these judgments when assessing whether a contract amendment to a term arrangement (primarily in the context of a license extension or renewal) constitutes a concession. Our experience has been that we are able to determine whether a fee is fixed or determinable for term licenses. 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.

4. Collectibility is probable – To recognize revenue, we must judge collectibility of the arrangement fees on a customer-by-customer basis pursuant to our credit review process. We typically sell to customers with whom there is a history of successful collection. We evaluate the financial position and a customer’s ability to pay whenever an existing customer purchases new products, renews an existing arrangement, or requests an increase in credit terms. For certain industries for which our products are not considered core to the industry or the industry is generally considered troubled, we impose higher credit standards. If we determine that collectibility is not probable based upon our credit review process or the customer’s payment history, we recognize revenue as payments are received.

Multiple element arrangements involving software licenses – For multiple element arrangements involving software and other software-related deliverables, vendor-specific objective evidence of fair value (VSOE) must exist to allocate the total fee among all delivered and non-essential undelivered elements of the arrangement. If undelivered elements of the arrangement are essential to the functionality of the product, we defer revenue until the essential elements are delivered. If VSOE does not exist for one or more non-essential undelivered elements, we defer revenue until such evidence exists for the undelivered elements, or until all elements are delivered, whichever is earlier. If VSOE of all non-essential undelivered elements exist but VSOE does not exist for one or more delivered elements, we recognize revenue using the residual method. Under the residual method, we defer revenue related to the undelivered elements based upon VSOE and we recognize the remaining portion of the arrangement fee as revenue for the delivered elements, assuming all other criteria for revenue recognition are met. If we can no longer establish VSOE for non-essential undelivered elements of multiple element arrangements, we defer revenue until all elements are delivered or VSOE was established for the undelivered elements, whichever is earlier.

renewal history where the services are sold separately. We also base VSOE for professional services and installation services for emulation hardware systems upon the price charged when the services are sold separately.

Prior to February 1, 2010, for emulation hardware systems where the software was determined to be more than incidental under prior authoritative guidance, we recognized revenue consistent with the discussion above for multiple element arrangements involving software licenses.

Multiple element arrangements involving hardware – Effective February 1, 2010, for multiple element arrangements involving our emulation hardware systems, we allocate revenue to each element based on the relative selling price of each deliverable. In order to meet the separation criteria to allocate revenue to each element we must determine the standalone selling price of each element using a hierarchy of evidence. The authoritative guidance requires that, in the absence of VSOE or third-party evidence (TPE), a company must develop an estimated selling price (ESP). ESP is defined as the price at which the vendor would transact if the deliverable was sold by the vendor regularly on a standalone basis. The vendor should consider market conditions as well as entity-specific factors when estimating a selling price.

When VSOE or TPE does not exist, we base our ESP for certain elements in arrangements based on either costs incurred to manufacture a product plus a reasonable profit margin or standalone sales to similar customers. In determining profit margins, we consider current market conditions, pricing strategies related to the class of customer, and the level of penetration we have with the customer. In other cases, we may have limited sales on a standalone basis to the same or similar customers and/or guaranteed pricing on future purchases of the same item. If we are not able to develop ESP for one or more elements or we are unable to demonstrate value on a standalone basis of an element, we could be required to combine elements which could impact the timing of revenue recognition if not delivered together. We no longer apply the residual method for hardware arrangements.

Investment in Frontline

In connection with our acquisition of Valor Computerized Systems, Ltd. (Valor) on March 18, 2010, we acquired Valor’s 50% interest in a joint venture, Frontline P.C.B. Solutions Limited Partnership (Frontline). We use the equity method of accounting for Frontline which results in reporting our investment as one line within Other assets in the Condensed Consolidated Balance Sheet and our share of earnings on one line in the Condensed Consolidated Statement of Operations.

We actively participate in regular and periodic activities with respect to Frontline such as budgeting, business planning, marketing, and direction of research and development projects. Accordingly, we have included our interest in the earnings of Frontline as a component of Operating income (loss).

(3)

Fair Value Measurement—We measure financial instruments at fair value on a quarterly basis. The FASB established a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources. Unobservable inputs reflect our market assumptions. The fair value hierarchy consists of the following three levels:

•

Level 1—Quoted prices for identical instruments in active markets;

•

Level 2—Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations whose significant inputs are observable; and

•

Level 3—One or more significant inputs to the valuation model are unobservable.

The following table presents information about financial liabilities required to be carried at fair value on a recurring basis as of October 31, 2010:


	Fair Value			Level 1		Level 2			Level 3
Foreign currency exchange contracts	$	(675	)	$	—	$	(675	)	$	—
Contingent consideration		(1,291	)		—		—			(1,291	)

Total	$	(1,966	)	$	—	$	(675	)	$	(1,291	)

The following table presents information about financial liabilities required to be carried at fair value on a recurring basis as of January 31, 2010:


	Fair Value			Level 1		Level 2			Level 3
Foreign currency exchange contracts	$	(4,619	)	$	—	$	(4,619	)	$	—
Contingent consideration		(1,822	)		—		—			(1,822	)

Total	$	(6,441	)	$	—	$	(4,619	)	$	(1,822	)

We use an income approach to determine the fair value of our foreign currency exchange contracts. The net gains or losses for foreign currency exchange contracts designated as cash flow hedges, which are linked to a specific transaction, are reported in Accumulated other comprehensive income in Stockholders’ equity until the forecasted transaction occurs or the hedge is no longer effective. Once the forecasted transaction occurs or the hedge is no longer effective, we reclassify the gains or losses attributable to the foreign currency exchange contracts to our Condensed Consolidated Statement of Operations. We record foreign currency exchange contracts based on quoted market prices for similar instruments.

We recognize changes in fair value for foreign currency exchange contracts entered into to offset the variability in exchange rates on certain short-term monetary assets and liabilities in Other expense, net, in our Condensed Consolidated Statement of Operations. The fair value of foreign currency exchange contracts is included in Accrued liabilities on our Condensed Consolidated Balance Sheet. See further discussion in Note 5. “Derivative Instruments and Hedging Activities.”

In connection with a fiscal 2010 acquisition, payment of a portion of the purchase price is contingent upon the acquired business’ achievement of certain revenue goals. We have estimated the fair value of this contingent consideration as the present value of the expected contingent payments over the term of the arrangement discounted at a rate of 16% and have included the balance in Other long-term liabilities on our Condensed Consolidated Balance Sheet. During the nine months ended October 31, 2010, we recorded a decrease in our liability for contingent consideration resulting in a gain of $533 in Special charges in our Condensed Consolidated Statement of Operations. The change in the liability was due to a change in the timing of a future product release.

The following table summarizes Level 3 activity:


Balance as of January 31, 2010	$	1,822
Change in estimate		(533	)
Interest expense		2

Balance as of October 31, 2010	$	1,291

The carrying amounts of cash equivalents, Short-term investments, Trade accounts receivable, net, Term receivables, Accounts payable, and Accrued liabilities approximate fair value because of the short-term nature of these instruments or because amounts have been appropriately discounted.

The following table summarizes the fair value and carrying value of Notes payable:


As of	October 31, 2010		January 31, 2010
Fair value of Notes payable	$	223,625	$	192,321
Carrying value of Notes payable	$	209,078	$	188,347

We based the fair value of Notes payable on the quoted market price or rates available to us for instruments with similar terms and maturities. Of the total carrying value of Notes payable, $2,000 as of October 31, 2010 and $32,272 as of January 31, 2010, was classified as current on our Condensed Consolidated Balance Sheets. The carrying amount of Short-term borrowings of $11,669 as of October 31, 2010 and $37,874 as of January 31, 2010 approximates fair value because of the short-term nature of the instruments.

(4)

Business Combinations—For each acquisition, the excess of the fair value of the consideration transferred over the fair value of the net tangible assets acquired and net tangible liabilities assumed was allocated to various identifiable intangible assets and goodwill. Identifiable intangible assets typically consist of purchased technology and customer-related intangibles, which are amortized to expense over their useful lives. Goodwill, representing the excess of the purchase consideration over the fair value of net tangible and identifiable intangible assets, is not amortized.

Acquisitions during the nine months ended October 31, 2010


Acquisition	Total Consideration Transferred		Net Tangible Assets Acquired		Identifiable Intangible Assets Acquired		Deferred Tax Liability			Goodwill
Valor	$	86,903	$	47,497	$	18,600	$	(11,636	)	$	32,442
Other		6,550		22		1,480		—			5,048

Total	$	93,453	$	47,519	$	20,080	$	(11,636	)	$	37,490

On March 18, 2010, we acquired all of the outstanding common shares of Valor, a provider of productivity improvement software solutions for the printed circuit board manufacturing supply chain. The acquisition was an investment aimed at extending our scope into the market for printed circuit board systems manufacturing solutions. Under the terms of the merger agreement, Valor shareholders received 5,621 shares of our common stock and cash of $32,715. The common stock issued to the former common shareholders of Valor had a fair value of $47,163, based on our closing price on March 18, 2010 of $8.39 per share. Additionally, under the merger agreement, we converted Valor’s outstanding stock options into options to purchase shares of our common stock, resulting in additional consideration of $7,025. Included in net tangible assets acquired was the fair value of the Frontline investment of $29,500 and cash acquired of $27,110.

The identified intangible assets acquired consisted of purchase technology of $12,300 and other intangibles of $6,300. We are amortizing purchased technology to Cost of revenues over three years and other intangibles to Operating expenses over one to four years. The goodwill created by the transaction is not deductible for tax purposes. Key factors that make up the goodwill created by the transaction include expected synergies from the combination of operations and the knowledge and experience of the acquired workforce and infrastructure.

As part of our acquisition accounting for Valor, we have recognized provisional amounts for the fair value of certain assets acquired and liabilities assumed. During the quarter ended October 31, 2010, we adjusted certain deferred tax liabilities and liabilities associated with uncertain tax provisions assumed in the Valor acquisition, resulting in an increase in goodwill of approximately $4,200. We are continuing to review these matters during the measurement period, and if we obtain new information about the facts and circumstances that existed at the acquisition date that identifies adjustments to the initially recorded balances, the acquisition accounting will be revised to reflect the resulting adjustments to the provisional amounts.

Other acquisitions for the nine months ended October 31, 2010 consisted of two privately-held companies, which were not material individually or in the aggregate. Both of these acquisitions included an upfront payment which was treated as consideration for the business combination. In addition, one of the acquisitions called for potential future payments, which were not considered contingent consideration and will be expensed as incurred if and when specific milestones are achieved.

Acquisitions during the nine months ended October 31, 2009


Acquisition	Total Consideration Transferred		Net Tangible Assets Acquired		Identifiable Intangible Assets Acquired		Deferred Tax Liability			Goodwill
LogicVision, Inc.	$	15,352	$	1,151	$	7,470	$	—		$	6,731
Other		5,000		424		1,710		(553	)		3,419

	$	20,352	$	1,575	$	9,180	$	(553	)	$	10,150

On August 18, 2009, we acquired all of the outstanding common shares of LogicVision, Inc. (LogicVision), a test and yield learning company in the semiconductor design-for-test sector. The acquisition was an investment aimed at extending our product offerings within the electronic design automation industry. Under the terms of the purchase agreement, LogicVision shareholders received 0.2006 of a share of our common stock for each LogicVision common share. Accordingly, we issued 1,903 shares of our common stock to the former common shareholders of LogicVision, resulting in consideration transferred for the common stock of $14,289, at our closing price on August 18, 2009 of $7.51 per share. The purchase agreement also required that we exchange our stock options for LogicVision’s outstanding stock options resulting in additional consideration of $1,063, representing the fair value of stock options issued that are attributable to the pre-combination service period. The identified intangible assets acquired consisted of purchase technology of $5,260 and other intangibles of $2,210. The goodwill created by the transaction is not deductible for tax purposes. Key factors that make up the goodwill created by the transaction include expected synergies from the combination of operations, future technologies, and the knowledge and experience of the acquired workforce.

Other acquisitions for the nine months ended October 31, 2009 consisted of two privately held companies, which were not material individually or in the aggregate. Both of these acquisitions included an upfront payment which was treated as consideration for the business combination. In addition, each acquisition called for potential future payments, which were not considered contingent consideration and will be expensed as incurred if and when specific milestones are achieved.

The separate results of operations for the acquisitions during the nine months ended October 31, 2010 and 2009 were not material, individually or in the aggregate, compared to our overall results of operations and accordingly pro-forma financial statements of the combined entities have been omitted.

(5)

Derivative Instruments and Hedging Activities—We are exposed to fluctuations in foreign currency exchange rates. To manage the volatility, we aggregate exposures on a consolidated basis to take advantage of natural offsets. The primary exposures are the Japanese yen, where we are in a long position, and the euro and the British pound, where we are in a short position. Most large European revenue contracts are denominated and paid to us in U.S. dollars while our European expenses, including substantial research and development operations, are paid in local currencies causing a short position in the euro and the British pound. In addition, we experience greater inflows than outflows of Japanese yen as almost all Japanese-based customers contract and pay us in Japanese yen. While these exposures are aggregated on a consolidated basis to take advantage of natural offsets, substantial exposures remain.

To partially offset the net exposures in the euro, British pound, and the Japanese yen, we enter into foreign currency exchange contracts of less than one year which are designated as cash flow hedges. Any gain or loss on Japanese yen contracts is classified as product revenue when the hedged transaction occurs while any gain or loss on euro and British pound contracts is classified as operating expense when the hedged transaction occurs. During the nine months ended October 31, 2010, we entered into 988 new foreign currency forward contracts, of which 34 contracts with a total gross notional value of $162,051 remain outstanding as of October 31, 2010.

We formally document all relationships between foreign currency exchange contracts and hedged items as well as our risk management objectives and strategies for undertaking various hedge transactions. All hedges designated as cash flow hedges are linked to forecasted transactions and we assess, both at inception of the hedge and on an ongoing basis, the effectiveness of the foreign currency exchange contracts in offsetting changes in the cash flows of the hedged items. We report the effective portions of the net gains or losses on foreign currency exchange contracts as a component of Accumulated other comprehensive income in Stockholders’ equity. Accumulated other comprehensive income associated with hedges of forecasted transactions is reclassified to the Condensed Consolidated Statement of Operations in the same period the forecasted transaction occurs. We discontinue hedge accounting prospectively when we determine that a foreign currency exchange contract is not highly effective as a hedge. To the extent a forecasted transaction is no longer deemed probable of occurring, we prospectively discontinue hedge accounting treatment and we reclassify deferred amounts to Other expense, net in the Condensed Consolidated Statement of Operations. We noted no such instance during the nine months ended October 31, 2010 or 2009.

The fair values and balance sheet presentation of our derivative instruments as of October 31, 2010 are summarized as follows:


	Location		Asset Derivatives		Liability Derivatives
Derivatives designated as hedging instruments:
Cash flow forwards		Accrued liabilities	$	1,738	$	(1,909	)
Derivatives not designated as hedging instruments:
Non-designated forwards		Accrued liabilities		171		(675	)

Total derivatives			$	1,909	$	(2,584	)

The fair values and balance sheet presentation of our derivative instruments as of January 31, 2010 are summarized as follows:


	Location		Asset Derivatives		Liability Derivatives
Derivatives designated as hedging instruments:
Cash flow forwards		Accrued liabilities	$	91	$	(1,867	)
Derivatives not designated as hedging instruments:
Non-designated forwards		Accrued liabilities		159		(3,002	)

Total derivatives			$	250	$	(4,869	)

We had foreign currency exchange contracts outstanding with a gross notional value of $176,982 as of October 31, 2010 and $182,572 as of January 31, 2010. Notional amounts do not quantify risk or represent our assets or liabilities but are used in the calculation of cash settlements under the contracts.

By using derivative instruments, we subject ourselves to credit risk. If a counterparty fails to fulfill its performance obligations under a derivative contract, our credit risk will equal the fair value of the derivative instrument. Generally, when the fair value of our derivative contracts is a net asset, the counterparty owes us, thus creating a receivable risk. We minimize counterparty credit risk by entering into derivative transactions with major financial institutions and, therefore, we do not expect material losses as a result of default by our counterparties.

The pre-tax effect of derivative instruments in cash flow hedging relationships on income and other comprehensive income (OCI) for the nine months ended October 31, 2010 is as follows:


Derivatives Designated as Hedging Instruments	Loss Recognized in OCI on Derivatives (Effective Portion)			Loss Reclassified from Accumulated OCI into Income (Effective Portion)				Gain Recognized in Income on Derivatives (Ineffective Portion and Amount Excluded from Effectiveness Testing)
	Amount			Location	Amount			Location	Amount
Cash flow forwards	$	(3,117	)	Revenues	$	(657	)	Other expense, net	$	46
				Operating expenses		(4,079	)

Total	$	(3,117	)		$	(4,736	)		$	46

The gain on cash flow forwards of $46 recognized in Other expense, net for the nine months ended October 31, 2010 was related to the time value exclusion of foreign currency forward contracts from our assessment of hedge effectiveness.

The pre-tax effect of derivative instruments in cash flow hedging relationships on income and OCI for the nine months ended October 31, 2009 is as follows:


Derivatives Designated as Hedging Instruments	Gain Recognized in OCI on Derivatives (Effective Portion)		Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)				Gain (Loss) Recognized in Income on Derivatives (Ineffective Portion and Amount Excluded from Effectiveness Testing)
	Amount		Location	Amount			Location	Amount
Cash flow forwards	$	5,832	Revenues	$	(2,009	)	Other expense, net	$	152
			Operating expenses		1,312
Cash flow options		13	Revenues		(311	)	Other expense, net		(5	)
			Operating expenses		(841	)

Total	$	5,845		$	(1,849	)		$	147

Included in the gain on cash flow forwards of $152 recognized in Other expense, net for the nine months ended October 31, 2009 was a gain of $149 related to the time value exclusion of foreign currency forward contracts from our assessment of hedge effectiveness.

The hedge balance in Accumulated other comprehensive income, before tax effect, was $175 as of October 31, 2010 and $1,794 as of January 31, 2010. The hedge balance in Accumulated other comprehensive income, after tax effect was $396 as of October 31, 2010 and $1,587 as of January 31, 2010. The balance represents a net unrealized loss on foreign currency exchange contracts related to hedges of forecasted revenues and expenses expected to occur within the next twelve months. We will transfer this amount to the Condensed Consolidated Statement of Operations upon recognition of the related revenues and recording of the respective expenses. We expect substantially all of the hedge balance in Accumulated other comprehensive income to be reclassified to the Condensed Consolidated Statement of Operations within the next twelve months.

We enter into foreign currency exchange contracts to offset the earnings impact relating to the variability in exchange rates on certain short-term monetary assets and liabilities denominated in non-functional currencies. We do not designate these foreign currency contracts as hedges. The effect of derivative instruments not designated as hedging instruments on income for the nine months ended October 31, 2010 is as follows:

The effect of derivative instruments not designated as hedging instruments on income for the nine months ended October 31, 2009 is as follows:

(6)	*Short-Term Borrowings*—Short-term borrowings consisted of the following:


As of	October 31, 2010		January 31, 2010
Senior revolving credit facility	$	—	$	20,000
Collections of previously sold accounts receivable		6,725		13,388
Other borrowings		4,944		4,486

Short-term borrowings	$	11,669	$	37,874

We have a syndicated, senior, unsecured, four-year revolving credit facility that terminates June 1, 2011. In April 2010, we amended the revolving credit facility to reduce the maximum borrowing capacity from $140,000 to $100,000 and retained an option to increase the maximum borrowing capacity by $30,000. Under this revolving credit facility, we have the option to pay interest based on: (i) London Interbank Offered Rate (LIBOR) with varying maturities commensurate with the borrowing period we select, plus a spread of between 1.0% and 1.6%, or (ii) a base rate plus a spread of between 0.0% and 0.6%, based on a pricing grid tied to a financial covenant. The base rate is defined as the higher of: (i) the federal funds rate, as defined, plus 0.5%, (ii) the prime rate of the lead bank, or (iii) one-month LIBOR plus 1.0%. As a result of these interest rate options, our interest expense associated with borrowings under this revolving credit facility will vary with market interest rates. In addition, commitment fees are payable on the unused portion of the revolving credit facility at rates between 0.25% and 0.35% based on a pricing grid tied to a financial covenant. We paid commitment fees of $61 for the three months ended October 31, 2010 and $185 for the nine months ended October 31, 2010 compared to $112 for the three months ended October 31, 2009 and $296 for the nine months ended October 31, 2009. This revolving credit facility contains certain financial and other covenants, including the following:

•

Our adjusted quick ratio (ratio of the sum of cash and cash equivalents, short-term investments, and net current receivables to total current liabilities) shall not be less than 0.85;

•

Our tangible net worth (stockholders’ equity less goodwill and other intangible assets) must exceed the calculated required tangible net worth as defined in the credit agreement, which establishes a fixed level of required tangible net worth. Each quarter the required level increases by 70% of any positive net income in the quarter (but in the aggregate no more than 70% of positive net income for any full fiscal year), 100% of the amortization of intangible assets in the quarter, and 100% of certain stock issuance proceeds. The required level also decreases each quarter by certain amounts of acquired intangible assets;

•

Our leverage ratio (ratio of total liabilities less subordinated debt to the sum of subordinated debt and tangible net worth) shall be less than 2.20;

•

Our senior leverage ratio (ratio of total debt less subordinated debt to the sum of subordinated debt and tangible net worth) shall not be greater than 0.90; and

•

Our minimum cash and accounts receivable ratio (ratio of the sum of cash and cash equivalents, short-term investments, and 47.5% of net current accounts receivable, to outstanding credit agreement borrowings) shall not be less than 1.25.

The revolving credit facility prevents us from paying dividends.

We were in compliance with all financial covenants as of October 31, 2010. If we fail to comply with the financial covenants and do not obtain a waiver from our lenders, we would be in default under the revolving credit facility and our lenders could terminate the facility and demand immediate repayment of all outstanding loans under the revolving credit facility.

During the nine months ended October 31, 2010, we borrowed $40,000 against the revolving credit facility and repaid $60,000. As of October 31, 2010, we had no balance outstanding against this revolving credit facility, compared to an outstanding balance of $20,000 as of January 31, 2010.

Short-term borrowings include amounts collected from customers on accounts receivable previously sold on a non-recourse basis to financial institutions. These amounts are remitted to the financial institutions in the following quarter.

We generally have other short-term borrowings, including multi-currency lines of credit, capital leases, and other borrowings. Interest rates are generally based on the applicable country’s prime lending rate, depending on the currency borrowed.

(7)	*Notes Payable*—Notes payable consist of the following:


As of	October 31, 2010			January 31, 2010
6.25% Debentures due 2026, issued 2006	$	157,065		$	154,832
6.25% Debentures due 2026, issued fiscal 2011		31,727			—
Floating Rate Debentures due 2023		—			32,272
Term Loan due 2013		19,000			—
Other		1,286			1,243

Notes payable		209,078			188,347
Floating Rate Debentures due 2023, current portion		—			(32,272	)
Term Loan due 2013, current portion		(2,000	)		—

Notes payable, long-term	$	207,078		$	156,075

6.25% Debentures due 2026: In March 2006, we issued $200,000 of 6.25% Convertible Subordinated Debentures (6.25% Debentures) due 2026 in a private offering pursuant to SEC Rule 144A under the Securities Act of 1933. Interest on the 6.25% Debentures is payable semi-annually in March and September.

The principal amount, unamortized debt discount, net carrying amount of the liability component, and carrying amount of the equity component of the 6.25% Debentures, issued 2006, are as follows:


As of	October 31, 2010			January 31, 2010
Principal amount	$	165,000		$	165,000
Unamortized debt discount		(7,935	)		(10,168	)

Net carrying amount of the liability component	$	157,065		$	154,832

Equity component	$	21,766		$	21,766

The unamortized debt discount will be amortized to interest expense using the effective interest method through February 2013.

We recognized the following amounts in Interest expense in the Condensed Consolidated Statements of Operations related to the 6.25% Debentures, issued 2006:


	Three months ended October 31,				Nine months ended October 31,
	2010		2009		2010		2009
Interest expense at the contractual interest rate	$	2,578	$	2,578	$	7,744	$	7,734
Amortization of debt discount		760		698		2,233		2,051

The effective interest rate on the 6.25% Debentures, issued 2006, was 8.60% for the nine months ended October 31, 2010 and 2009.

In July 2010, we issued $11,509 in aggregate principal amount of the 6.25% Debentures, plus a nominal cash amount, in exchange for $11,509 in aggregate principal of the Floating Rate Debentures. In accordance with the FASB guidance in ASC 470-50, “Debt – Modification and Extinguishment,” the exchange was treated as the extinguishment

of the original debt and the issuance of new debt. The terms of the new 6.25% Debentures issued in this transaction are substantially the same as the terms of our existing 6.25% Debentures. We recorded a loss on the extinguishment of debt of $345 during the nine months ended October 31, 2010 for cash paid to debt holders in connection with this transaction. This loss was included in Interest expense in our Condensed Consolidated Statement of Operations.

In October 2010, we issued $20,000 of 6.25% Convertible Subordinated Debentures due 2026 in a private offering pursuant to SEC Rule 144A under the Securities Act of 1933. The terms of the new 6.25% Debentures issued in this transaction are substantially the same as the terms of our existing 6.25% Debentures. We received $20,225 in cash upon issuance of the debentures.

The principal amount, unamortized premium, and net carrying amount of the 6.25% Debentures, issued fiscal 2011, are as follows:


As of	October 31, 2010		January 31, 2010
Principal amount	$	31,509	$	—
Unamortized debt premium		218		—

Net carrying amount of the liability component	$	31,727	$	—

No equity component was recorded for 6.25% Debentures, issued fiscal 2011, as the conversion feature was deemed to be non-beneficial when the debt was issued.

The unamortized debt premium will be amortized to interest expense using the effective interest method through February 2013.

The 6.25% Debentures are convertible, under certain circumstances, into our common stock at a conversion price of $17.968 per share for a total of 10,937 shares as of October 31, 2010. These circumstances include:

•

The market price of our common stock exceeding 120% of the conversion price;

•

The market price of the 6.25% Debentures declining to less than 98% of the value of the common stock into which the 6.25% Debentures are convertible;

•

A call for the redemption of the 6.25% Debentures;

•

Specified distributions to holders of our common stock;

•

If a fundamental change, such as a change of control, occurs; or

•

During the ten trading days prior to, but not on, the maturity date.

Upon conversion, in lieu of shares of our common stock, for each $1 principal amount of the 6.25% Debentures a holder will receive an amount of cash equal to the lesser of: (i) $1 or (ii) the conversion value of the number of shares of our common stock equal to the conversion rate. If such conversion value exceeds $1, we will also deliver, at our election, cash or common stock, or a combination of cash and common stock with a value equal to the excess. If a holder elects to convert 6.25% Debentures in connection with a fundamental change in the company that occurs prior to March 6, 2011, the holder will also be entitled to receive a make whole premium upon conversion in some circumstances. The 6.25% Debentures rank pari passu with the Floating Rate Convertible Subordinated Debentures (Floating Rate Debentures) due 2023. We may redeem some or all of the 6.25% Debentures for cash on or after March 6, 2011. The holders, at their option, may redeem some or all of the 6.25% Debentures for cash on March 1, 2013, 2016, or 2021. During the nine months ended October 31, 2010, we did not repurchase any 6.25% Debentures.

Floating Rate Debentures due 2023: In August 2003, we issued $110,000 of Floating Rate Debentures in a private offering pursuant to SEC Rule 144A under the Securities Act of 1933. Interest on the Floating Rate Debentures is payable quarterly in February, May, August, and November at a variable interest rate equal to 3-month LIBOR plus 1.65%. The effective interest rate was 1.95% for the nine months ended October 31, 2010 and 2.60% for the nine months ended October 31, 2009. We retired the remaining obligation of $20,763 during the three months ended October 31, 2010 utilizing cash on hand.

During the nine months ended October 31, 2009, we purchased on the open market and retired Floating Rate Debentures with a principal balance of $3,830 for a total purchase price of $3,450. In connection with this purchase, during the nine months ended October 31, 2009, we incurred a before tax net gain on the early extinguishment of debt of $354, which included a $380 discount on the repurchased Floating Rate Debentures and a write-off of $26 for a portion of unamortized deferred debt issuance costs.

Term Loan due 2013: In April 2010, we entered into a three-year term loan (Term Loan) for $20,000 to repay borrowings under our revolving credit facility used to purchase office buildings in Fremont, California. Fixed principal of $500 and accrued interest payments are payable quarterly in February, May, August, and November. The remaining

principal balance is payable in April 2013. We have the option to pay interest based on: (i) LIBOR plus 4.5%, or (ii) a base rate plus 3.5%. The base rate is defined as the higher of: (i) the federal funds rate, as defined, plus 0.5%, (ii) the prime rate of the lead bank, or (iii) one-month LIBOR plus 1.0%. As a result of these interest rate options, our interest expense associated with borrowings under the Term Loan will vary with market interest rates. Additionally, the term loan requires us to have a minimum cash and cash equivalent balance as of the last day of the quarter. If we fail to comply with this covenant and do not obtain a waiver from our lenders, we would be in default under the Term Loan and our lenders could terminate the loan and demand immediate repayment of the outstanding loan. The Term Loan is collateralized by our Wilsonville, Oregon campus which includes land, buildings, and improvements with a carrying value of approximately $40,000. This amount is reported in our Condensed Consolidated Balance Sheet within Property, plant, and equipment, net.

During the nine months ended October 31, 2010, we repaid $1,000 on the Term Loan and the principal amount of $19,000 remains outstanding. The effective interest rate was 4.90% for the nine months ended October 31, 2010.

Other Notes Payable: In November 2009, we issued a subordinated note payable as part of a business combination. The note bears interest at a rate of 3.875% and is due in full along with all accrued interest on November 17, 2012.

(8)	*Commitments and Contingencies*

Leases

We lease a majority of our field sales offices and research and development facilities under non-cancelable operating leases. In addition, we lease certain equipment used in our research and development activities. This equipment is generally leased on a month-to-month basis after meeting a six-month lease minimum. There have been no significant changes to the future minimum lease payments due under non-cancelable operating leases disclosed in our Annual Report on Form 10-K for the fiscal year ended January 31, 2010.

Income Taxes

As of October 31, 2010, we had a liability of $44,040 for income taxes associated with uncertain income tax positions; $3,990 of which was classified as short-term liabilities in our Condensed Consolidated Balance Sheet, as we generally anticipate the settlement of such liabilities will require payment of cash within the next twelve months. The remaining $40,050 of income tax associated with uncertain tax position was classified as long-term liabilities. Certain liabilities may result in the reduction of deferred tax assets rather than settlement in cash. We are not able to reasonably estimate the timing of any cash payments required to settle the long-term liabilities and do not believe that the ultimate settlement of these obligations will materially affect our liquidity.

Indemnifications

Our license and service agreements generally include a limited indemnification provision for claims from third parties relating to intellectual property we license to customers. The indemnification is generally limited to the amount paid by the customer or a set cap. As of October 31, 2010, we were not aware of any material liabilities arising from these indemnification obligations.

Legal Proceedings

From time to time we are involved in various disputes and litigation matters that arise in the ordinary course of business. These include disputes and lawsuits relating to intellectual property rights, contracts, distributorships, and employee relations matters. Periodically, we review the status of various disputes and litigation matters and assess our potential exposure. When we consider the potential loss from any dispute or legal matter probable and the amount or the range of loss can be estimated, we will accrue a liability for the estimated loss. Legal proceedings are subject to uncertainties, and the outcomes are difficult to predict. Because of such uncertainties, we base accruals on the best information available at the time. As additional information becomes available, we reassess the potential liability related to pending claims and litigation matters and may revise estimates. We believe that the outcome of current litigation, individually and in the aggregate, will not have a material effect on our results of operations.

(9)	*Accounting for Stock-Based Compensation*

Stock Option Plans and Stock Plans

On July 1, 2010, our shareholders approved the 2010 Omnibus Incentive Plan (Incentive Plan) which replaces our prior 1982 Stock Option Plan, Nonqualified Stock Option Plan, 1986 Stock Plan, and 1987 Non-Employee Directors’ Stock Plan. The Incentive Plan is administered by the Compensation Committee of our Board of Directors and permits accelerated vesting of outstanding options, restricted stock units, restricted stock awards, and other equity incentives upon the occurrence of certain changes in control of our company. The implementation of the Incentive Plan did not modify the terms of any awards granted under prior plans.

Stock options under the Incentive Plan are generally expected to vest over four years, have an expiration date of ten years from the date of grant, and an exercise price not less than the fair market value of the shares on the date of grant.

As of October 31, 2010, a total of 8,920 shares of common stock were available for future grant under the above Incentive Plan.

We assumed the stock plans of Valor on March 18, 2010. Under the terms of our merger agreement with Valor, options outstanding under these plans were converted to options to purchase shares of our common stock. Options issued under these plans vest over four years from the original grant date and have an expiration date of 10 years from the original grant date. The exercise price of each converted option is equal to the product of the original exercise price and the original number of options granted divided by the number of converted options received. These stock plans have been suspended and no future awards will be granted under these plans. Options for a total of 2,160 shares of our common stock have been authorized and issued under the Valor plans.

On December 14, 2009, our shareholders approved the exchange of certain options for restricted stock units. Eligible for the exchange were options held by non-executive employees with an exercise price equal to or greater than $11.00 which were granted prior to January 7, 2009 and expire after August 15, 2010. The offer expired February 5, 2010. Effective February 8, 2010 a total of 6,945 options were exchanged for 557 restricted stock units. Total incremental cost of $491 resulted from this exchange. The incremental cost will be amortized over 2 years.

Stock options outstanding, the weighted average exercise price, and transactions involving the stock option plans are summarized as follows:


	Options Outstanding			Weighted Average Exercise Price
Balance as of January 31, 2010		18,982		$	12.98
Granted		508		$	10.14
Assumed in acquisition		2,160		$	5.05
Exercised		(1,088	)	$	4.92
Forfeited		(66	)	$	7.41
Expired		(1,085	)	$	16.83
Exchanged		(6,945	)	$	16.77

Balance as of October 31, 2010		12,466		$	16.70

The following table summarizes activity involving restricted stock, including restricted stock units:


	Restricted Stock			Weighted Average Grant Date Fair Value
Nonvested as of January 31, 2010		226		$	9.46
Granted		1,955		$	9.57
Released		(11	)	$	12.62
Cancelled		(18	)	$	8.04

Nonvested as of October 31, 2010		2,152		$	9.56

Employee Stock Purchase Plans

We have an employee stock purchase plan (ESPP) for U.S. employees and an ESPP for certain foreign subsidiary employees. Prior to July 1, 2010, the ESPPs generally provided for overlapping two-year offerings commencing on January 1 and July 1 of each year with purchases every six months during those offering periods. On July 1, 2010, the ESPPs were amended. Beginning July 1, 2010, the ESPPs provide for six month offerings commencing on January 1 and July 1 of each year with purchases on June 30 and December 31 of each year. Each eligible employee may purchase up to six thousand shares of stock on each purchase date at prices no less than 85% of the lesser of the fair market value of the shares on the offering date or on the purchase date. Offerings in process as of July 1, 2010 with two year terms extending beyond that date were replaced by the six month offering beginning on July 1, 2010. There was no incremental value associated with the replacement of unexpired ESPP purchase rights. As of October 31, 2010, 5,112 shares remain available for future purchase under the ESPPs.

Stock-Based Compensation Expense

We estimate the fair value of stock options and purchase rights under our ESPPs using a Black-Scholes option-pricing model. The Black-Scholes option-pricing model incorporates several highly subjective assumptions including expected volatility, expected term, and interest rates.

In reaching our determination of expected volatility for options, we include the following elements:

•

Historical volatility of our shares of common stock;

•

Historical volatility of shares of comparable companies;

•

Implied volatility of our traded options; and

•

Implied volatility of traded options of comparable companies.

In determining expected volatility for purchase rights under our ESPP, we use the historical volatility of our shares of common stock. Prior to the July 1, 2010 offering, we based the expected term of our ESPP on the average term of the series of offerings. Beginning with the July 1, 2010 offering, the expected term will be the 6 month offering period. We base the expected term of our stock options on historical experience.

The risk-free interest rate for periods within the contractual life of the award is based on the U.S. Treasury yield curve in effect at the time of the grant.

The fair value of restricted stock units is the market value as of the grant date.

Using the Black-Scholes option-pricing model, the weighted average grant date fair values are summarized as follows:


	Three months ended October 31,				Nine months ended October 31,
	2010		2009		2010		2009
Options granted	$	5.04	$	4.05	$	5.02	$	3.58
Restricted stock units granted	$	10.35	$	—	$	9.57	$	5.14
ESPP purchase rights	$	2.21	$	2.75	$	2.11	$	2.86

The fair value calculations used the following assumptions:


	Three months ended October 31,						Nine months ended October 31,
Stock Option Plans	2010			2009			2010			2009
Risk-free interest rate		1.4	%		2.4	%		1.4% - 2.6	%		2.3% - 3.1	%
Dividend yield		0	%		0	%		0	%		0	%
Expected life (in years)		5.5 - 6.25			5.0			5.5 - 6.50			5.0 - 6.5
Volatility (range)		50	%		45	%		50% - 55	%		45% - 50	%
Weighted average volatility		50	%		45	%		51	%		47	%

	Three months ended October 31,						Nine months ended October 31,
Employee Stock Purchase Plans	2010			2009			2010			2009
Risk-free interest rate		1.1	%		0.7	%		1.1	%		1.1	%
Dividend yield		0	%		0	%		0	%		0	%
Expected life (in years)		1.23			1.25			1.24			1.25
Volatility (range)		46% - 72	%		46% - 49	%		45% - 72	%		44% - 49	%
Weighted average volatility		48	%		47	%		47	%		47	%

	Three months ended October 31,						Nine months ended October 31,
Acquired Company Options Exchange	2010			2009			2010			2009
Risk-free interest rate		—			1.6% - 3.2	%		0.1% - 3.3	%		1.6% - 3.2	%
Dividend yield		—			0.0	%		0	%		0.0	%
Expected life (in years)		—			3.5 - 8.4			0.1 - 7.7			3.5 - 8.4
Volatility (range)		—			54% - 59	%		35% - 72	%		54% - 59	%
Weighted average volatility		—			57	%		60	%		57	%


	Nine months ended October 31,
Employee Options Exchange	2010
Risk-free interest rate		0.2% - 2.7	%
Dividend yield		0	%
Expected life (in years)		0.5 - 5.9
Volatility (range)		43% - 77	%
Weighted average volatility		43	%

(10)

Incentive Stock Rights—Our Board of Directors has the authority to issue incentive stock in one or more series and to determine the relative rights and preferences of the incentive stock. On June 24, 2010, we adopted an Incentive Stock Purchase Rights Plan and declared a dividend distribution of one Right for each outstanding share of common stock, payable to holders of record on July 6, 2010. As long as the Rights are attached to our common stock, we will issue one Right with each new share of common stock so that all such shares will have attached Rights. Under certain conditions, each Right may be exercised to purchase 1/10,000 of a share of Series B Junior Participating Incentive Stock (Incentive Stock) at a purchase price of fifty dollars, subject to adjustment. The Rights are not presently exercisable and will only become exercisable if a person or group acquires or commences a tender offer to acquire 15% or more of our common stock. If a person or group acquires 15% or more of the common stock, each Right will be adjusted to entitle its holder to receive, upon exercise, common stock (or, in certain circumstances, other assets of ours) having a value equal to two times the exercise price of the Right or each Right will be adjusted to entitle its holder to receive, upon exercise, common stock of the acquiring company having a value equal to two times the exercise price of the Right, depending on the circumstances. The Rights expire on December 31, 2011 and may be redeemed by us for $0.001 per Right. The Rights do not have voting or dividend rights and have no dilutive effect on our earnings.

(11)

Net Income (Loss) Per Share—We compute basic net income (loss) per share using the weighted average number of common shares outstanding during the period. We compute diluted net income (loss) per share using the weighted average number of common shares and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares consist of common shares issuable upon exercise of stock options, restricted stock units, purchase rights from ESPPs, and warrants using the treasury stock method and common shares issuable upon conversion of the convertible subordinated debentures, if dilutive.

The following provides the computation of basic and diluted net income (loss) per share:


	Three months ended October 31,					Nine months ended October 31,
	2010		2009			2010			2009
Net income (loss)	$	15,257	$	(27,034	)	$	(22,015	)	$	(61,256	)

Weighted average common shares used to calculate basic and diluted net income (loss) per share		109,364		97,854			106,942			95,636
Employee stock options, restricted stock and employee stock purchase plan		2,775		—			—			—

Weighted average common and potential common shares used to calculate diluted net income (loss) per share		112,139		97,854			106,942			95,636

Basic net income (loss) per share	$	0.14	$	(0.28	)	$	(0.21	)	$	(0.64	)

Diluted net income (loss) per share	$	0.14	$	(0.28	)	$	(0.21	)	$	(0.64	)

We excluded from the computation of diluted net income (loss) per share stock options, restricted stock units, warrants, and ESPP purchase rights to purchase 7,178 shares of common stock for the three months ended October 31, 2010 and 15,376 shares of common stock for the nine months ended October 31, 2010 compared to 22,246 for the three and nine months ended October 31, 2009. The stock options, restricted stock units, warrants, and ESPP purchase rights were anti-dilutive either because we incurred a net loss for the period, the warrant price was greater than the average market price of the common stock during the period, or the stock options were determined to be anti-dilutive as a result of applying the treasury stock method.

The effect of the conversion of the Floating Rate Debentures was anti-dilutive for the three and nine months ended October 31, 2009 and therefore excluded from the computation of diluted net income (loss) per share. During the three months ended October 31, 2010 we retired the Floating Rate Debentures. The effect of the conversion of the 6.25% Debentures was anti-dilutive and therefore excluded from the computation of diluted net income (loss) per share. We assume that the 6.25% Debentures will be settled in common stock for purposes of calculating the dilutive effect of the 6.25% Debentures. If the Floating Rate Debentures and the 6.25% Debentures had been dilutive we would have included additional income and additional incremental common shares as shown in the following table:


	Three months ended October 31,				Nine months ended October 31,
Floating Rate Debentures	2010		2009		2010		2009
Additional income	$	—	$	136	$	—	$	507
Additional incremental common shares		—		1,379		—		1,427

	Three months ended October 31,				Nine months ended October 31,
6.25% Debentures (1)	2010		2009		2010		2009
Additional income	$	1,173	$	1,057	$	1,173	$	1,057

(1)

Dilutive net income (loss) would have included no incremental shares for the three and nine months ended October 31, 2010 and 2009 as the stock price was below the conversion rate.

The conversion features of the 6.25% Debentures, which allow for settlement in cash, common stock, or a combination of cash and common stock, are further described in Note 7. “Notes Payable.”

(12)	*Comprehensive Loss*—The following provides a summary of comprehensive loss:


Nine months ended October 31,	2010			2009
Net loss	$	(22,015	)	$	(61,256	)
Change in unrealized gain on derivative instruments		1,191			7,222
Change in accumulated translation adjustment		3,471			16,358
Change in pension liability		(4	)		(33	)

Comprehensive loss	$	(17,357	)	$	(37,709	)

(13)

Investment in Frontline Joint Venture—In connection with our acquisition of Valor on March 18, 2010, we acquired Valor’s interest in a joint venture, Frontline. Frontline is owned equally by Valor and Orbotech, Ltd., an Israeli company. The joint venture combined the computer-aided manufacturing operations of the two companies. As described in Note 2. “Summary of Significant Accounting Policies,” we use the equity method of accounting for our investment in Frontline. Frontline reports on a calendar year basis. As such, we record our interest in the earnings or losses of Frontline in the subsequent month following incurrence.

The following presents the summarized financial information of Frontline for the three months ended September 30, 2010 and for the period from March 18, 2010 through September 30, 2010:


As of September 30, 2010	Frontline Total		Mentor’s 50% Interest
Balance sheet data:
Assets:
Current assets	$	10,954	$	5,477
Property, plant, and equipment, net		213		107

Total assets	$	11,167	$	5,584

Liabilities:
Current liabilities	$	1,494	$	747
Other long-term liabilities		659		329

Total liabilities	$	2,153	$	1,076


	For the three months ended September 30, 2010						For the period from March 18, 2010 through September 30, 2010
	Frontline Total			Mentor’s 50% Interest			Frontline Total		Mentor’s 50% Interest
Operating results data:
Revenues:
System and software	$	3,797		$	1,899		$	10,909	$	5,455
Service and support		2,723			1,361			5,601		2,800

Total revenues		6,520			3,260			16,510		8,255

Cost of revenues:
System and software		18			9			89		45
Service and support		872			436			1,779		889

Total cost of revenues		890			445			1,868		934

Gross margin		5,630			2,815			14,642		7,321

Research and development		1,308			654			2,628		1,314
Marketing and selling		781			390			1,920		960
General and administration		180			91			375		188

Total operating expenses		2,269			1,135			4,923		2,462

Operating income		3,361			1,680			9,719		4,859
Interest income (expense)		(46	)		(23	)		13		7

Net income - as reported		3,315			1,657			9,732		4,866
Amortization of purchased technology and other identified intangible assets ⁽¹⁾		—			(1,242	)		—		(3,105	)

Equity in earnings of Frontline	$	3,315		$	415		$	9,732	$	1,761

(1)

Amount represents amortization of purchased technology and other identified intangible assets identified as part of the fair value of the Frontline investment. The purchased technology will be amortized over three years and other identified intangible assets will be amortized over three to four years. Other identified intangible assets include trade name and customer relationship intangibles.

(14)	*Special Charges*—The following is a summary of the components of the special charges:


	Three months ended October 31,				Nine months ended October 31,
	2010		2009		2010		2009
Employee severance and related costs	$	1,191	$	3,369	$	4,640	$	8,996
Excess leased facility costs		302		159		804		983
Other costs		85		2,465		2,608		5,911

Total special charges	$	1,578	$	5,993	$	8,052	$	15,890

Special charges primarily consist of costs incurred for employee terminations due to a reduction of personnel resources driven by modifications of business strategy or business emphasis. Special charges may also include expenses related to potential acquisitions, excess facility costs, and asset related charges.

Employee severance and related costs of $4,640 for the nine months ended October 31, 2010 included severance benefits, notice pay, and outplacement services. The total rebalance charge represents the aggregate of numerous unrelated rebalance plans which impacted several employee groups, none of which was individually material to our financial position or results of operations. We determined termination benefit amounts based on employee status, years of service, and local legal requirements. We communicated termination benefits to the affected employees prior to the end of the quarter in which we recorded the charge. Approximately 71% of these costs were paid during the nine months ended October 31, 2010. We expect to pay the remainder during the fiscal year ending January 31, 2011. There have been no significant modifications to the amount of these charges.

Excess leased facility costs of $804 for the nine months ended October 31, 2010 were primarily due to the abandonment of leased facilities.

Other special charges for the nine months ended October 31, 2010 included costs of $2,083 related to advisory fees, a recovery related to a casualty loss of $(566), and other costs of $1,184. Additionally, acquisition costs of $(93) during the nine months ended October 31, 2010 represent adjustments to prior acquisition assumptions on an earnout accrual and legal and other costs related to potential acquisitions.

Employee severance and related costs of $8,996 for the nine months ended October 31, 2009 included severance benefits, notice pay, and outplacement services. The total rebalance charge represents the aggregate of numerous unrelated rebalance plans which impacted several employee groups, none of which was individually material to our financial position or results of operations. We determined termination benefit amounts based on employee status, years of service, and local legal requirements. We communicated termination benefits to the affected employees prior to the end of the quarter in which we recorded the charge. Substantially all of these costs were paid during the fiscal year ended January 31, 2010. There have been no significant modifications to the amount of these charges.

Excess leased facility costs of $983 for the nine months ended October 31, 2009 were primarily due to the abandonment of leased facilities.

Other special charges for the nine months ended October 31, 2009 included costs of $3,525 related to advisory fees, charges of $566 related to a casualty loss, and other charges of $51. Additionally, other special charges included acquisition costs of $1,769 for legal and other costs related to a potential acquisition.

Accrued special charges are included in Accrued liabilities and Other long-term liabilities in the Condensed Consolidated Balance Sheets. The following table shows changes in accrued special charges during the nine months ended October 31, 2010:


	Accrued special charges as of January 31, 2010		Charges during the nine months ended October 31, 2010		Payments during the nine months ended October 31, 2010			Accrued special charges as of October 31, 2010 (1)
Employee severence and related costs	$	2,616	$	4,640	$	(5,184	)	$	2,072
Excess leased facility costs		4,110		804		(2,955	)		1,959
Other costs		2,298		2,608		(2,954	)		1,952

Total accrued special charges	$	9,024	$	8,052	$	(11,093	)	$	5,983

(1)

Of the $5,983 total accrued special charges as of October 31, 2010, $1,085 represented the long-term portion of accrued lease termination fees and other facility costs, net of sublease income. The remaining balance of $4,898 represented the short-term portion of accrued special charges.

(15)	*Other Expense, Net*—Other expense, net was comprised of the following:


	Three months ended October 31,						Nine months ended October 31,
	2010			2009			2010			2009
Interest income	$	342		$	169		$	885		$	824
Foreign currency exchange gain (loss)		(435	)		(688	)		(1,012	)		(896	)
Impairment of cost-basis investments		—			—			—			(113	)
Equity in losses of unconsolidated entities		—			(170	)		(271	)		(738	)
Other, net		(113	)		(315	)		(963	)		(339	)

Other expense, net	$	(206	)	$	(1,004	)	$	(1,361	)	$	(1,262	)

(16)

Related Party Transactions—Certain members of our Board of Directors also serve on the board of directors of certain of our customers. Management believes the transactions between these customers and us were carried out on an arm’s-length basis. The following table shows revenue recognized from these customers:


	Three months ended October 31,						Nine months ended October 31,
	2010			2009			2010			2009
Revenue from customers	$	7,543		$	7,276		$	27,438		$	24,721
Percentage of total revenue		3.2	%		3.8	%		4.5	%		4.4	%

(17)	*Supplemental Cash Flow Information*—The following provides information concerning supplemental disclosures of cash flow activities:


Nine months ended October 31,	2010		2009
Cash paid, net for:
Interest	$	13,214	$	13,477
Income taxes	$	9,776	$	10,354

During the nine months ended October 31, 2010, we acquired the outstanding shares of Valor. Under the terms of the merger agreement, Valor shareholders received 5,621 shares of our common stock and cash of $32,715. The common stock issued to the former common shareholders of Valor had a fair value of $47,163, based on our closing price on March 18, 2010 of $8.39 per share. Additionally, under the merger agreement, we converted Valor’s outstanding stock options into options to purchase shares of our common stock, resulting in additional consideration of $7,025. Included in the net tangible assets acquired was cash of $27,110.

As part of the Valor acquisition, we acquired an investment in Frontline. During the nine months ended October 31, 2010, we received returns on investment of $2,600 from Frontline which is included in net cash provided by operating activities in our Condensed Consolidated Statement of Cash Flows.

During the nine months ended October 31, 2009, we acquired all of the outstanding common stock of LogicVision in a non-cash transaction. In exchange for the LogicVision common stock, we issued common stock with an acquisition date fair value of $14,289. Also included in the consideration given for the LogicVision acquisition was $1,063 for the fair value of LogicVision outstanding stock options attributed to the pre-acquisition service, exchanged for our stock options. Total non-cash consideration given for the acquisition of LogicVision was $15,352.

(18)

Segment Reporting—We operate exclusively in the electronic design automation industry. We market our products and services worldwide, primarily to large companies in the military/aerospace, communications, computer, consumer electronics, semiconductor, networking, multimedia, and transportation industries. We sell and license our products through our direct sales force in North America, Europe, Japan, and the Pacific Rim and through distributors where third parties can extend sales reach more effectively or efficiently. Our Chief Operating Decision Makers (CODMs), which consist of the Chief Executive Officer and the President, review our consolidated results within one operating segment. In making operating decisions, our CODMs primarily consider consolidated financial information accompanied by disaggregated information by geographic region.

We eliminate all intercompany revenues and expenses in computing Revenues, Operating loss, and Loss before income tax. The corporate component of Operating loss represents research and development, corporate marketing and selling, corporate general and administration, special charges, and equity in earnings of Frontline. Geographic information is as follows:


	Three months ended October 31,						Nine months ended October 31,
	2010			2009			2010			2009
Revenues:
North America	$	116,644		$	79,432		$	254,930		$	242,371
Europe		60,347			45,078			151,812			140,741
Japan		21,227			31,118			73,056			81,051
Pacific Rim		40,719			33,568			127,650			101,429

Total revenues	$	238,937		$	189,196		$	607,448		$	565,592

Operating income (loss):
North America	$	67,503		$	45,759		$	134,491		$	136,272
Europe		37,967			24,706			87,544			77,376
Japan		10,100			21,154			40,956			51,494
Pacific Rim		31,964			25,331			102,225			75,259
Corporate		(126,893	)		(124,218	)		(370,060	)		(365,312	)

Total operating income (loss)	$	20,641		$	(7,268	)	$	(4,844	)	$	(24,911	)

Income (loss) before income tax:
North America	$	63,216		$	41,257		$	120,633		$	123,438
Europe		37,677			23,805			86,787			75,684
Japan		10,093			21,188			40,830			51,502
Pacific Rim		32,018			25,311			102,227			75,256
Corporate		(126,893	)		(124,218	)		(370,060	)		(365,312	)

Total income (loss) before income tax	$	16,111		$	(12,657	)	$	(19,583	)	$	(39,432	)

For the three months ended October 31, 2010, one customer accounted for approximately 10% of our Total revenues. For the nine months ended October 31, 2010, no single customer accounted for 10% or more of our Total revenues. For the three and nine months ended October 31, 2009, no single customer accounted for 10% or more of our Total revenues.


As of	October 31, 2010		January 31, 2010
Property, plant, and equipment, net:
North America	$	112,797	$	97,373
Europe		19,761		18,887
Japan		1,707		1,341
Pacific Rim		4,424		4,194

Total property, plant, and equipment, net	$	138,689	$	121,795

Total assets:
North America	$	758,301	$	761,567
Europe		390,667		319,165
Japan		97,330		106,493
Pacific Rim		28,096		35,816

Total assets	$	1,274,394	$	1,223,041

We segregate revenue into five categories of similar products and services. Each category includes both product and related support revenues. Revenue information is as follows:


	Three months ended October 31,				Nine months ended October 31,
	2010		2009		2010		2009
Revenues:
IC Design to Silicon	$	58,139	$	57,587	$	180,592	$	206,477
Integrated System Design		57,839		56,131		152,352		135,541
Scalable Verification		67,097		37,727		143,477		126,973
New & Emerging Products		39,627		24,905		83,931		59,925
Services & Other		16,235		12,846		47,096		36,676

Total revenues	$	238,937	$	189,196	$	607,448	$	565,592

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Unless otherwise indicated, numerical references are in millions, except for percentages and per share data.

Overview

The following discussion should be read in conjunction with the condensed consolidated financial statements and notes included elsewhere in this Form 10-Q. Certain of the statements below contain forward-looking statements. These statements are predictions based upon our current expectations about future trends and events. Actual results could vary materially as a result of certain factors, including but not limited to, those expressed in these statements. In particular, we refer you to the risks discussed in Part II, Item 1A. “Risk Factors” and in our other Securities and Exchange Commission (SEC) filings, which identify important risks and uncertainties that could cause our 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 Form 10-Q. All subsequent written or spoken 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 Form 10-Q are made only as of the date of this Form 10-Q. We do not intend, and undertake no obligation, to update these forward-looking statements.

The Company

We are a supplier of electronic design automation (EDA) systems — advanced computer software and emulation hardware systems used to automate the design, analysis, and testing of electronic hardware and embedded systems software in electronic systems and components. We market our products and services worldwide, primarily to large companies in the military/aerospace, communications, computer, consumer electronics, semiconductor, networking, multimedia, and transportation industries. Through the diversification of our customer base among these various customer markets, we attempt to reduce our exposure to fluctuations within each market. We sell and license our products through our direct sales force and a channel of distributors and sales representatives. In addition to our corporate offices in Wilsonville, Oregon, we have sales, support, software development, and professional service offices worldwide.

We focus on products and design platforms where we have leading market share, enabling us to spend more effort to cause adoption of our technology in new applications, especially for new markets in which EDA companies have not participated. We believe this strategy leads to a more diversified product and customer mix and can help reduce the volatility of our business and our credit risk while increasing our potential for growth. System customers make up a much larger percentage of our business than that of most of our EDA competitors.

We derive system and software revenues primarily from the sale of term software license contracts, which are typically three to four years in length. We generally recognize revenue for these arrangements upon product delivery at the beginning of the license term. Larger enterprise-wide customer contracts, which typically represent as much as 50% of our system and software revenue, drive the majority of our period-to-period revenue variances. We identify term licenses where collectibility is not probable and recognize revenue on those licenses when cash is received. Ratable license revenues also include short-term term licenses as well as other term licenses where we provide the customer with rights to unspecified or unreleased future products. For these reasons, the timing of large contract renewals, customer circumstances, and license terms are the primary drivers of revenue changes from period to period, with revenue changes also being driven by new contracts and increases in the capacity of existing contracts, to a lesser extent.

The EDA industry is highly competitive and is characterized by very strong leadership positions in specific segments of the EDA market. These strong leadership positions can be maintained for significant periods of time as the software can be difficult to master and customers are disinclined to make changes once their employees, as well as others in the industry, have developed familiarity with a particular software product. For these reasons, much of our profitability arises from niche areas in which we are the leader. We will continue our strategy of developing high quality tools with number one market share potential, rather than being a broad-line supplier with undifferentiated product offerings. This strategy allows us to focus investment in areas where customer needs are greatest and where we have the opportunity to build significant market share.

Our products and services are dependent to a large degree on new design projects initiated by customers in the integrated circuit and electronics system industries. These industries can be cyclical and are subject to constant and rapid technological change, rapid product obsolescence, price erosion, evolving standards, short product life cycles, and wide fluctuations in product supply and demand. Furthermore, extended economic downturns can result in reduced funding for development due to downsizing and other business restructurings. These pressures are offset by the need for the development and introduction of next generation products once an economic recovery occurs.

Our revenue has historically fluctuated quarterly and has generally been the highest in the fourth quarter of our fiscal year due to our customers’ corporate calendar year-end spending trends and the timing of contract renewals.

Known Trends and Uncertainties Impacting Future Results of Operations

In the United States (U.S.) and abroad, market and economic conditions have been volatile over the past two years, with tighter credit conditions, market volatility, modestly rising expectations for the U.S. and global economies generally, and market uncertainty and instability in both U.S. and international capital and credit markets.

As a result of these market conditions, the cost and availability of credit has been and may continue to be adversely affected by illiquid credit markets and wider credit spreads. Many lenders and institutional investors reduced, and in some cases, ceased to provide funding to borrowers due to the absence of a securitization market and concerns about the stability of the markets generally and the strength of counterparties specifically. Continued turbulence in the U.S. and international markets and economies may adversely affect our liquidity and financial condition, and the liquidity and financial condition of our customers. If these market conditions continue, they may limit our ability, and the ability of our customers, to access the capital markets to meet liquidity needs and timely refinance maturing liabilities, resulting in an adverse effect on our financial condition and results of operations.

Consistent with our revenue recognition policy, when individual customer credit worthiness declines to a level where we do not consider collectibility probable, we convert new transactions from up-front revenue recognition to cash-based revenue recognition and we may be required to modify the payment terms to meet the customer’s ability to pay. Our top ten accounts make up approximately 45% of our receivables, including both short and long-term balances and we have not experienced and do not presently expect to experience collection issues with these customers. Net of reserves, we have no receivables greater than 60 days past due, and continue to experience no difficulty in factoring our high quality receivables.

Bad debt expense recorded in the first nine months of fiscal 2011 was not material. However, we do have exposures within our receivables portfolio to customers with weak credit ratings. These receivables balances do not represent a material portion of our portfolio but could have a material adverse effect on earnings in any given quarter, should additional allowances for doubtful accounts be necessary.

A multi-quarter increase or decrease in service and support revenue can be an early indicator that our business is either strengthening or weakening. Our experience is that customers will scale back on the purchase of outsourcing services in times of economic decline or weakness. In the first nine months of fiscal 2011 and in the last six months of fiscal 2010, we noted an increase in software maintenance revenues.

Bookings during the first nine months of fiscal 2011 increased by approximately 20% compared to the first nine months of fiscal 2010. Bookings are the value of validated orders during a period for which revenue has been or will be recognized within six months for products and within twelve months for professional services and training. The ten largest transactions for the nine months ended October 31, 2010 accounted for approximately 45% of total system and software bookings compared to approximately 50% for the nine months ended October 31, 2009. The number of new customers during the nine months ended October 31, 2010, excluding PADS (our ready to use printed circuit board design tools) increased approximately 10% from the levels experienced during the nine months ended October 31, 2009.

Product Developments

During the nine months ended October 31, 2010, we continued to execute our strategy of focusing on challenges encountered by customers, as well as building upon our well-established product families. We believe that customers, faced with leading-edge design challenges in creating new products, generally choose the best EDA products in each category to build their design environment. Through both internal development and strategic acquisitions, we have focused on areas where we believe we can build a leading market position or extend an existing leading market position.

We believe that the development and commercialization of EDA software tools is generally a three to five year process with limited customer adoption and sales in the first years of tool availability. Once tools are adopted, however, their life spans tend to be long. We introduced new products and upgrades to existing products in the first half of fiscal 2011, including solutions acquired as a result of the Valor Computerized Systems, Ltd. (Valor) acquisition which target the printed circuit board manufacturing market. During the nine months ended October 31, 2010, we did not have any significant products reaching the end of their useful economic life.

Critical Accounting Policies

We base our discussion and analysis of our financial condition and results of operations upon our condensed consolidated financial statements which have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, and contingencies as of the date of the financial statements and the reported amounts of revenues and

expenses during the reporting periods. We evaluate our estimates on an on-going basis. We base our estimates on historical experience, current facts, and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of revenue, costs, and expenses that are not readily apparent from other sources. As future events and their effects cannot be determined with precision, actual results could differ from those estimates.

We believe that the accounting for revenue recognition, valuation of trade accounts receivable, valuation of deferred tax assets, income tax reserves, goodwill, intangible assets, long-lived assets, special charges, and accounting for stock-based compensation are the critical accounting estimates and judgments used in the preparation of our condensed consolidated financial statements. For further discussion of our critical accounting policies, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” in Part II of our Annual Report on Form 10-K for the year ended January 31, 2010.

Revenue Recognition

We report revenue in two categories based on how the revenue is generated: (i) system and software and (ii) service and support.

We include finance fee revenues from the accretion on the discount of long-term installment receivables in System and software revenues.

We apply the Financial Accounting Standards Board (FASB) guidance in Accounting Standards Codification (ASC) 985 “Revenue Recognition – Software” to the sale of licenses of software products. Beginning February 1, 2010, we adopted FASB Accounting Standards Update (ASU) No. 2009-13 Revenue Recognition (Topic 605)- “Multiple-Deliverable Revenue Arrangements” and ASU No. 2009-14 Software (Topic 985)- “Certain Revenue Arrangements That Include Software Elements,” (together the ASUs). The adoption of the ASUs did not have a material impact to revenue in periods subsequent to adoption. However, it may result in recognition of revenue into periods earlier than that revenue would have been recognized prior to the adoption of the ASUs. We apply the authoritative guidance in Topic 605 applicable to multiple-element arrangements to the sale of our emulation hardware systems that contain software components and non-software components that function together to deliver the hardware’s essential functionality.

We determine whether product revenue recognition is appropriate based upon the evaluation of whether the following four criteria have been met:

essential installation services for emulation hardware system sales or the customer may elect to perform the installation without our assistance. Our software license and emulation hardware system agreements generally do not contain conditions for acceptance.

We base our VSOE for certain product elements of an arrangement upon the pricing in comparable transactions when the element is sold separately. We primarily base our VSOE for term and perpetual support services upon customer renewal history where the services are sold separately. We also base VSOE for professional services and installation services for emulation hardware systems upon the price charged when the services are sold separately.

When VSOE or TPE does not exist, we base our ESP for certain elements in arrangements on either costs incurred to manufacture a product plus a reasonable profit margin or standalone sales to similar customers. In determining profit margins, we consider current market conditions, pricing strategies related to the class of customer, and the level of penetration we have with the customer. In other cases, we may have limited sales on a standalone basis to the same or similar customers and/or guaranteed pricing on future purchases of the same item. If we are not able to develop ESP for one or more elements or we are unable to demonstrate value on a standalone basis of an element, we could be required to

combine elements which could impact the timing of revenue recognition if not delivered together. We no longer apply the residual method for hardware arrangements.

RESULTS OF OPERATIONS

Revenues and Gross Margins


	Three months ended October 31,						Nine months ended October 31,
	2010		Change		2009		2010		Change		2009
System and software revenues	$	148.1		39%	$	106.3	$	346.0		6%	$	325.6
System and software gross margin	$	133.6		33%	$	100.3	$	315.2		5%	$	299.3
Gross margin percent		90%				94%		91%				92%
Service and support revenues	$	90.8		10%	$	82.9	$	261.4		9%	$	239.9
Service and support gross margin	$	66.4		8%	$	61.4	$	191.9		9%	$	176.8
Gross margin percent		73%				74%		73%				74%
Total revenues	$	238.9		26%	$	189.2	$	607.4		7%	$	565.6
Total gross margin	$	200.0		24%	$	161.7	$	507.1		7%	$	476.1
Gross margin percent		84%				85%		83%				84%

System and Software


	Three months ended October 31,						Nine months ended October 31,
	2010		Change		2009		2010		Change		2009
Upfront license revenues	$	128.6		47%	$	87.4	$	281.5		4%	$	271.4
Ratable license revenues		19.5		3%		18.9		64.5		19%		54.2

Total system and software revenues	$	148.1		39%	$	106.3	$	346.0		6%	$	325.6

We derive system and software revenue primarily from the sale of term software license contracts, which are typically three to four years in length. We generally recognize revenue for these arrangements upon product delivery at the beginning of the license term. Larger enterprise-wide customer contracts, which typically represent over 50% of our system and software revenue, drive the majority of our period-to-period revenue variances. For these reasons, the timing of contract renewals is the primary driver of revenue changes from period to period.

Our top ten customers accounted for approximately 65% of total System and software revenues for the three months ended October 31, 2010 and approximately 40% for the nine months ended October 31, 2010 compared to approximately 55% for the three months ended October 31, 2010 and 50% for the nine months ended October 31, 2009.

The increase in System and software revenues for the three months ended October 31, 2010 compared to the three months ended October 31, 2009 was due to the effect of acquisitions, increased revenues from Emulation products, and increased revenues from our top ten customers during the quarter. Increased revenues from our top ten customers, excluding the impact from acquisitions and Emulation products, was primarily due to revenues from semiconductor customers.

The increase in System and software revenues for the nine months ended October 31, 2010 compared to the nine months ended October 31, 2009 was due to the effect of acquisitions and increased revenues from Emulation products. The increase in System and software revenues for the nine months ended October 31, 2010 compared to the nine months ended October 31, 2009 was partially offset by a decrease in revenues from our IC Design to Silicon products. Silicon foundries largely completed their purchases related to the adoption of 45nm production during calendar year 2009.

One customer accounted for 10% of total revenues for the three months ended October 31, 2010. No single customer accounted for 10% or more of total revenues for the three months ended October 31, 2009 or the nine months ended October 31, 2010 or 2009.

System and software gross margin percentages were lower for the three and nine months ended October 31, 2010 compared to the three and nine months ended October 31, 2009 primarily due to a change in product mix as a result of higher emulation hardware product revenues. Emulation hardware product revenues typically have lower margins compared to our software product revenues.

Amortization of purchased technology to System and software cost of revenues was $3.3 for the three months ended October 31, 2010 and $10.4 for the nine months ended October 31, 2010 compared to $3.1 for the three months ended October 31, 2009 and $9.0 for the nine months ended October 31, 2009. The increase in amortization for the three and nine months ended October 31, 2010 was due to new purchased technology from acquisitions completed in the nine months ended October 31, 2010 and the second half of fiscal 2010, partially offset by certain purchased technology being fully amortized during fiscal 2010.

Service and Support

We derive service and support revenues from software and hardware post-contract maintenance or support services and professional services, which includes consulting, training, and other services. Professional services are a lower margin offering which is staffed according to fluctuations in demand. Support services operate under a less variable cost structure. Service and support revenues increased due to the effect of acquisitions completed in the nine months ended October 31, 2010 and in fiscal 2010, by $3.9 for the three months ended October 31, 2010 compared to the three months ended October 31, 2009 and $11.5 for the nine months ended October 31, 2010 compared to the nine months ended October 31, 2009. Additionally, consulting and training revenues increased primarily due to increased customer demand for services, by $2.0 for the three months ended October 31, 2010 compared to the three months ended October 31, 2009 and $5.6 for the nine months ended October 31, 2010 compared to the nine months ended October 31, 2009.

Geographic Revenues Information

Revenue by Geography


	Three months ended October 31,							Nine months ended October 31,
	2010		Change			2009		2010		Change			2009
North America	$	116.6		47%		$	79.4	$	254.9		5%		$	242.4
Europe		60.3		34%			45.1		151.8		8%			140.7
Japan		21.3		(32%	)		31.1		73.1		(10%	)		81.1
Pacific Rim		40.7		21%			33.6		127.6		26%			101.4

Total revenues	$	238.9		26%		$	189.2	$	607.4		7%		$	565.6

For the three months ended October 31, 2010, approximately one-fourth of European and almost all Japanese revenues were subject to exchange rate fluctuations as they were booked in local currencies. For the nine months ended October 31, 2010, approximately one-third of European and almost all Japanese revenues were subject to exchange rate fluctuations as they were booked in local currencies. We recognize additional revenues in periods when the U.S. dollar weakens in value against foreign currencies. Likewise, we recognize lower revenues in periods when the U.S. dollar strengthens in value against foreign currencies. Foreign currency had a nominal impact on Total revenues for the three months ended October 31, 2010 compared to the three months ended October 31, 2009 and approximately $3.9 for the nine months ended October 31, 2010 compared to the nine months ended October 31, 2009 primarily as a result of the strengthening Japanese yen against the U.S. dollar. Revenues in North America, Europe, and the Pac Rim increased for the three and nine months ended October 31, 2010 compared to the three and nine months ended October 31, 2009, primarily due to the timing of contract renewals. For additional description of how changes in foreign exchange rates affect our Condensed Consolidated Financial Statements, see discussion in Part I, “Item 3. Quantitative and Qualitative Disclosures About Market Risk –Foreign Currency Risk.”

Operating Expenses


	Three months ended October 31,								Nine months ended October 31,
	2010			Change			2009		2010			Change			2009
Research and development	$	70.7			10%		$	64.3	$	199.9			7%		$	187.4
Marketing and selling		82.6			13%			73.1		230.9			4%			221.1
General and administration		23.4			3%			22.8		69.1			2%			68.0
Equity in earnings of Frontline		(0.4	)		0%			—		(1.8	)		0%			—
Amortization of intangible assets		1.4			(50%	)		2.8		5.7			(34%	)		8.6
Special charges		1.6			(73%	)		6.0		8.1			(49%	)		15.9

Total operating expenses	$	179.3			6%		$	169.0	$	511.9			2%		$	501.0

Research and Development

Research and development expenses increased by $6.4 for the three months ended October 31, 2010 compared to the three months ended October 31, 2009, and $12.5 for the nine months ended October 31, 2010 compared to the nine months ended October 31, 2009. The components of these increases are summarized as follows:


	Change
	Three months ended October 31,			Nine months ended October 31,
Incremental expenses resulting from acquired businesses	$	3.2		$	11.3
Stock-based compensation		(0.6	)		(2.9	)
Salaries, variable compensation, and benefits expenses		4.8			5.6
Outside Services expenses		(1.4	)		(2.8	)
Other expenses		0.4			1.3

Total change in research and development expenses	$	6.4		$	12.5

Marketing and Selling

Marketing and selling expenses increased by $9.5 for the three months ended October 31, 2010 compared to the three months ended October 31, 2009, and $9.8 for the nine months ended October 31, 2010 compared to the nine months ended October 31, 2009. The components of these increases are summarized as follows:


	Change
	Three months ended October 31,			Nine months ended October 31,
Incremental expenses resulting from acquired businesses	$	3.4		$	8.5
Stock-based compensation		(0.6	)		(2.0	)
Salaries, variable compensation, and benefits expenses		5.6			4.0
Other expenses		1.1			(0.7	)

Total change in marketing and selling expenses	$	9.5		$	9.8

General and Administration

General and administration expenses increased by $0.6 for the three months ended October 31, 2010 compared to the three months ended October 31, 2009, and $1.1 for the nine months ended October 31, 2010 compared to the nine months ended October 31, 2009. The components of these increases are summarized as follows:


	Change
	Three months ended October 31,			Nine months ended October 31,
Incremental expenses resulting from acquired businesses	$	0.5		$	1.3
Salaries, variable compensation, and benefits expenses		(1.1	)		(2.3	)
Other expenses		1.2			2.1

Total change in general and administration expenses	$	0.6		$	1.1

We incur a substantial portion of our operating expenses outside the U.S. in various foreign currencies. When currencies weaken against the U.S. dollar, our operating expense performance is positively affected and when currencies strengthen, our operating expense performance is adversely affected. We experienced nominal currency movements in total operating expenses for the three months ended October 31, 2010 compared to the three months ended October 31, 2009 and unfavorable currency movements in total operating expenses of approximately $6.3 for the nine months ended October 31, 2010 compared to the nine months ended October 31, 2009. The impact of these currency movements is reflected in the movements in operating expenses detailed above.

Equity in Earnings of Frontline

In connection with our acquisition of Valor on March 18, 2010, we acquired Valor’s 50% interest in a joint venture, Frontline P.C.B. Solutions Limited Partnership (Frontline). Frontline is owned equally by Valor and Orbotech, Ltd., an Israeli company.

As required by U.S. GAAP, we use the equity method of accounting for our investment in Frontline which results in reporting our investment as one line within Other assets in the Condensed Consolidated Balance Sheet and our share of earnings as one line in the Condensed Consolidated Statement of Operations. Our fiscal year ends January 31st. Frontline’s fiscal year ends December 31st. We record our quarterly interest in the earnings or losses of Frontline based on its quarterly reported results.

As discussed in Note 2 “Summary of Significant Accounting Policies” of the condensed consolidated financial statements, we include our interest in the earnings or losses of Frontline as a component of Operating loss on our Condensed Consolidated Statement of Operations, due to our active participation in regular and periodic activities of Frontline such as budgeting, business planning, marketing, and direction of research and development projects.

The following presents the summarized financial information of Mentor’s 50% interest in Frontline for the three months ended September 30, 2010 and for the period from March 18, 2010 through September 30, 2010:


As of September 30, 2010	Mentor’s 50% Interest
Total assets	$	5.6
Total liabilities	$	1.1


	For the three months ended September 30, 2010		For the period from March 18, 2010 through September 30, 2010
Revenues	$	3.3	$	8.3
Cost of revenues		0.4		0.9

Gross margin		2.9		7.4

Operating expense		1.2		2.5

Net income-as reported		1.7		4.9
Amortization of purchased technology and other identified intangible assets		1.3		3.1

Equity in earnings of Frontline	$	0.4	$	1.8

Amortization of Intangible Assets

For the three and nine months ended October 31, 2010 compared to the three and nine months ended October 31, 2009, the decrease in amortization of intangible assets was primarily due to certain intangible assets being fully amortized during fiscal 2010 and fiscal 2011, partly offset by new intangible assets from our completed acquisitions occurring during the nine months ended October 31, 2010 and the second half of fiscal 2010.

Special Charges


	Three months ended October 31,							Nine months ended October 31,
	2010		Change			2009		2010		Change			2009
Employee severance and related costs	$	1.2		(65%	)	$	3.4	$	4.7		(48%	)	$	9.0
Excess leased facility costs		0.3		200%			0.1		0.8		(20%	)		1.0
Other costs, net		0.1		(96%	)		2.5		2.6		(56%	)		5.9

Total special charges	$	1.6		(73%	)	$	6.0	$	8.1		(49%	)	$	15.9

Employee severance and related costs of $1.2 for the three months ended October 31, 2010 and $4.7 for the nine months ended October 31, 2010 included severance benefits, notice pay, and outplacement services. The total rebalance charge represents the aggregate of numerous unrelated rebalance plans which impacted several employee groups, none of which was individually material to our financial position or results of operations. We determined termination benefit amounts based on employee status, years of service, and local legal requirements. We communicated termination benefits to the affected employees prior to the end of the quarter in which we recorded the charge. Approximately 71% of the year to date costs were paid during the nine months ended October 31, 2010. We expect to pay the remainder during the fiscal year ending January 31, 2011. There have been no significant modifications to the amount of these charges.

Excess leased facility costs of $0.3 for the three months ended October 31, 2010 and $0.8 for the nine months ended October 31, 2010 were primarily due to the abandonment of leased facilities.

Other special charges for the three months ended October 31, 2010 included costs of $(0.5) related to a change in the fair value of contingent consideration associated with a prior acquisition, $0.4 related to facility restoration and $0.2 in other charges. Other special charges for the nine months ended October 31, 2010 included costs of $2.1 related to advisory fees and $0.5 in other charges.

Employee severance and related costs of $3.4 for the three months ended October 31, 2009 and $9.0 for the nine months ended October 31, 2009 included severance benefits, notice pay, and outplacement services. The total rebalance charge represents the aggregate of numerous unrelated rebalance plans which impacted several employee groups, none of which were individually material to our financial position or results of operations. We determined termination benefit amounts based on employee status, years of service, and local legal requirements. We communicated termination benefits to the affected employees prior to the end of the quarter in which we recorded the charge. Substantially all of these costs were paid during the fiscal year ended January 31, 2010. There have been no significant modifications to the amount of these charges.

Excess leased facility costs of $1.0 for the nine months ended October 31, 2009 were primarily due to the abandonment of leased facilities and changes in the estimate of sublease income for previously abandoned leased facilities.

Other special charges for the three months ended October 31, 2009 included costs of $1.2 related to advisory fees, $1.2 related to acquisitions and other charges of $0.1. Other special charges for the nine months ended October 31, 2009 included costs of $3.5 related to advisory fees, $1.8 related to acquisitions and other charges of $0.6.

Other Expense, Net


	Three months ended October 31,								Nine months ended October 31,
	2010			Change		2009			2010			Change			2009
Interest income	$	0.3			50%	$	0.2		$	0.9			13%		$	0.8
Foreign currency exchange gain (loss)		(0.4	)		43%		(0.7	)		(1.0	)		(11%	)		(0.9	)
Other, net		(0.1	)		80%		(0.5	)		(1.3	)		(8%	)		(1.2	)

Other expense, net	$	(0.2	)		80%	$	(1.0	)	$	(1.4	)		(8%	)	$	(1.3	)

Provision for Income Taxes


	Three months ended October 31,							Nine months ended October 31,
	2010		Change			2009		2010		Change			2009
Income tax expense (benefit)	$	0.9		(94%	)	$	14.4	$	2.4		(89%	)	$	21.8

Generally, the provision for income taxes is the result of the mix of profit and loss earned by us and our subsidiaries in tax jurisdictions with a broad range of income tax rates, withholding taxes (primarily in certain foreign jurisdictions), changes in tax reserves, and the application of valuation allowances on deferred tax assets. Accounting guidance requires that on a quarterly basis we evaluate our provision for income tax expense (benefit) of U.S. and foreign jurisdictions based on our projected results of operations for the full year and record an adjustment in the current quarter.

For fiscal 2011, we anticipate losses in the U.S. but a net profit from international operations. Any tax benefit in the U.S. will generally be offset by an increase in the valuation allowance on U.S. deferred tax assets. For the nine months ended October 31, 2010, our effective tax rate was (12%), inclusive of $2.3 of favorable period specific items. For fiscal 2011, we project a 26% effective tax rate, with the inclusion of period specific items. This differs from tax computed at the U.S. federal statutory rate of 35% primarily due to:

•

Lower tax rates in the foreign jurisdiction where we have operations, offset by:

•

Projected U.S. losses for which no tax benefit will be recognized;

•

Non-deductible employee equity plan compensation expense; and

•

Withholding taxes in certain foreign jurisdictions.

Our full year rate may differ significantly from our current projections.

We have not provided for income taxes on the undistributed earnings of our foreign subsidiaries to the extent they are considered permanently re-invested outside of the U.S. Upon repatriation, some of these earnings may be sheltered by U.S. loss carryforwards, research and development credits and foreign tax credits, which may reduce the federal tax liability associated with any future foreign dividend. Determination of the amount of unrecognized deferred U.S. income tax liability is not practicable. To the extent that the earnings of our foreign subsidiaries are not treated as permanently reinvested, which include earnings of certain countries, we have considered the impact in our provision.

We determined deferred tax assets and liabilities based on differences between the financial reporting and tax basis of assets and liabilities. We calculated the deferred tax assets and liabilities using the enacted tax rates and laws that will be in effect when we expect the differences to reverse. Since 2004, we have determined it is uncertain whether our U.S. entity will generate sufficient taxable income and foreign source income to utilize foreign tax credit carryforwards, research and

experimentation credit carryforwards, and net operating loss carryforwards before expiration. Accordingly, we recorded a valuation allowance against those deferred tax assets for which realization does not meet the more likely than not standard. We have established valuation allowances related to certain foreign deferred tax assets based on historical losses as well as future expectations in certain jurisdictions. We will continue to evaluate the realizability of the deferred tax assets on a periodic basis.

We are subject to income taxes in the U.S. and in numerous foreign jurisdictions. In the ordinary course of business there are many transactions and calculations where the ultimate tax determination is uncertain. The statute of limitations for adjustments to our historic tax obligations will vary from jurisdiction to jurisdiction. In some cases it may be extended or be unlimited. Furthermore, net operating loss and tax credit carryforwards may be subject to adjustment after the expiration of the statute of limitations of the year such net operating losses and tax credits originated. Our larger jurisdictions generally provide for a statute of limitations from three to five years. We are currently under examination in various jurisdictions. The examinations are in different stages and timing of their resolution is difficult to predict. For U.S. federal income tax purposes, the tax years that remain open are fiscal year 2008 and forward.

We have reserves for taxes to address potential exposures involving tax positions that are being challenged or that could be challenged by taxing authorities even though we believe that the positions we have taken are appropriate. We believe our tax reserves are adequate to cover potential liabilities. We review the tax reserves quarterly and as circumstances warrant and adjust the reserves as events occur that affect our potential liability for additional taxes. It is often difficult to predict the final outcome or timing of resolution of any particular tax matter. Various events, some of which cannot be predicted, such as clarifications of tax law by administrative or judicial means, may occur and could require us to increase or decrease our reserves and effective tax rate. We expect to record additional reserves in future periods with respect to our tax filing positions. To the extent that uncertain tax positions resolve in our favor, it could have a positive impact on our effective tax rate.

LIQUIDITY AND CAPITAL RESOURCES

Our primary ongoing cash requirements will be for product development, operating activities, capital expenditures, debt service, and acquisition opportunities that may arise. Our primary sources of liquidity are cash generated from operations and borrowings on our revolving credit facility.

As of October 31, 2010, we had cash and cash equivalents of $64.3. The available cash and cash equivalents are held in accounts managed by third-party financial institutions and consist of invested cash and cash in our operating accounts.

At any point in time, we have significant balances in operating accounts that are with individual third-party financial institutions, which may exceed the Federal Deposit Insurance Corporation insurance limits or other regulatory insurance program limits. While we monitor daily the cash balances in our operating accounts and adjust the cash balances as appropriate, these cash balances could be impacted if the underlying financial institutions fail or are subject to other adverse conditions in the financial markets.

We anticipate that the following will be sufficient to meet our working capital needs on a short-term (twelve months or less) and a long-term (more than twelve months) basis:

•

Current cash balances;

•

Anticipated cash flows from operating activities, including the effects of selling customer term receivables;

•

Amounts available under existing revolving credit facilities; and

•

Other available financing sources, such as the issuance of debt or equity securities.

We have experienced no difficulties to date in raising debt. However, capital markets have been volatile, and we cannot assure you that we will be able to raise debt or equity capital on acceptable terms, if at all.


Nine months ended October 31,	2010			2009
Cash provided by operating activities	$	7.1		$	33.0
Cash used in investing activities	$	(51.0	)	$	(19.9	)
Cash provided by (used in) financing activities	$	6.9		$	(22.8	)

Operating Activities

Cash flows from operating activities consist of our net loss, adjusted for certain non-cash items and changes in operating assets and liabilities. Our cash flows from operating activities are significantly influenced by the payment terms on our license agreements and by our sales of qualifying accounts receivable. Our customers’ inability to fulfill payment obligations

could adversely affect our cash flow. Though we have not, to date, experienced a material level of defaults, material payment defaults by our customers as a result of current economic conditions or otherwise could have a material adverse effect on our financial condition. To address these concerns, we are monitoring our accounts receivable portfolio for customers with low or declining credit ratings and have increased our collection efforts.

Trade Accounts and Term Receivables


As of	October 31, 2010		January 31, 2010
Trade accounts receivable, net	$	300.3	$	289.8
Term receivables, long-term	$	144.7	$	164.9
Average days sales outstanding in short-term receivables		113 days		110 days
Average days sales outstanding in short-term receivable, net, excluding the current portion of term receivables		39 days		42 days

The increase in the average days sales outstanding in short-term receivables for the three months ended October 31, 2010 compared to the three months ended January 31, 2010 was due to an increase in accounts receivable in the third quarter of fiscal 2011 compared to the fourth quarter of fiscal 2010.

The current portion of term receivables was $196.8 as of October 31, 2010 and $178.9 as of January 31, 2010. The current portion of term receivables is attributable to multi-year term license sales agreements. We include amounts for term agreements that are due within one year in Trade accounts receivable, net, and balances that are due in more than one year in Term receivables, long-term. We use term agreements as a standard business practice and have a history of successfully collecting under the original payment terms without making concessions on payments, products, or services, although the impact of current economic conditions on our customers could affect this performance. Total term receivables were $341.5 as of October 31, 2010 compared to $343.8 as of January 31, 2010.

We enter into agreements to sell qualifying accounts receivable from time to time to certain financing institutions on a non-recourse basis. We received net proceeds from the sale of receivables of $39.2 for the nine months ended October 31, 2010 compared to $23.5 for the nine months ended October 31, 2009. We continue to have no difficulty in factoring receivables and continue to evaluate the economics of the sale of accounts receivable. We have not set a target for the sale of accounts receivable for the remainder of fiscal 2011.

Accrued Payroll and Related Liabilities


As of	October 31, 2010		January 31, 2010
Accrued payroll and related liabilities	$	71.3	$	77.0

The decrease in Accrued payroll and related liabilities as of October 31, 2010 compared to January 31, 2010 was primarily due to incentive payments made during the first half of fiscal 2011 on fiscal 2010 year-end accruals. We generally experience higher accrued payroll and related liability balances at year end primarily due to increased commission accruals associated with an increase in revenues in the fourth quarter. Additionally, we generally experience an increase in bonus accruals at year end which result from the full year achievement of results.

Investing Activities

Cash used in investing activities for the nine months ended October 31, 2010 primarily consisted of cash paid for capital expenditures and acquisitions of businesses, net of cash acquired, and equity interests.

Expenditures for property, plant, and equipment increased to $36.8 for the nine months ended October 31, 2010 compared to $18.0 for the nine months ended October 31, 2009. The expenditures for property, plant, and equipment for the nine months ended October 31, 2010 were primarily a result of spending on information technology and infrastructure improvements within facilities, including expenditures related to the renovation of office buildings in Fremont, California which were purchased in January 2010. We expect total capital expenditures for property, plant, and equipment for fiscal 2011 to be approximately $45.0. We plan to finance our investments in property, plant, and equipment using cash on hand or borrowings on the revolving credit facility.

During the nine months ended October 31, 2010, we acquired Valor through the issuance of common stock of $47.2 and cash consideration of $5.6, net of cash received of $27.1. We plan to finance future business acquisitions through a combination of cash and common stock issuances. The cash expected to be utilized includes cash on hand, cash generated from operating activities, and borrowings on the revolving credit facility.

Financing Activities

For the nine months ended October 31, 2010, cash provided by financing activities consisted primarily of $20.0 in proceeds from a term loan incurred to refinance the January 2010 purchase of office buildings in Fremont, California and proceeds from the issuance of common stock of $15.6. These proceeds were partially offset by net repayments of $20.0 on our revolving line of credit and a net decrease of $6.2 on our short-term borrowings. Additional discussion regarding the term loan is presented in the section below.

We may elect to purchase or otherwise retire some or all of our debentures with cash, stock, or other assets from time to time in the open market or privately negotiated transactions, either directly or through intermediaries, or by tender offer when we believe that market conditions are favorable to do so. Such purchases may have a material effect on our liquidity, financial condition, and results of operations.

Other factors affecting liquidity and capital resources

6.25% Debentures due 2026

Interest on the 6.25% Convertible Subordinated Debentures (6.25% Debentures) due 2026 is payable semi-annually in March and September. The 6.25% Debentures are convertible, under certain circumstances, into our common stock at a conversion price of $17.968 per share for a total of 10.9 shares as of October 31, 2010. Upon conversion, in lieu of shares of our common stock, for each one thousand dollar principal amount of the 6.25% Debentures a holder will receive an amount of cash equal to the lesser of: (i) one thousand dollars or (ii) the conversion value of the number of shares of our common stock equal to the conversion rate. If such conversion value exceeds one thousand dollars, we will also deliver, at our election, cash or common stock, or a combination of cash and common stock with a value equal to the excess. If a holder elects to convert their 6.25% Debentures in connection with a fundamental change in the company that occurs prior to March 6, 2011, the holder will also be entitled to receive a make whole premium upon conversion in some circumstances. We may redeem some or all of the 6.25% Debentures for cash on or after March 6, 2011. The holders, at their option, may redeem some or all of the 6.25% Debentures for cash on March 1, 2013, 2016, or 2021. During the nine months ended October 31, 2010, we did not repurchase any 6.25% Debentures.

In July 2010, we issued $11.5 in aggregate principal amount of the 6.25% Debentures, plus a nominal cash amount, in exchange for $11.5 in aggregate principal amount of the Floating Rate Debentures. The terms of the new 6.25% Debentures issued in this transaction are substantially the same as the terms of our existing 6.25% Debentures. We recorded a loss on the extinguishment of debt of $0.3 during the nine months ended October 31, 2010 for cash paid to debt holders in connection with this transaction.

In October 2010, we issued $20.0 in aggregate principal amount of the 6.25% Debentures for cash of $20.2. The terms of the new 6.25% Debentures issued in this transaction are substantially the same as the terms of our existing 6.25% Debentures. We intend to use the net proceeds from this sale of debentures for general corporate purposes.

As of October 31, 2010, a principal amount of $196.5 is outstanding.

Floating Rate Debentures due 2023

During the nine months ended October 31, 2010, we exchanged $11.5 in aggregate principal amount of the Floating Rate Convertible Subordinated Debentures (Floating Rate Debentures) due 2023 as noted above and redeemed the remaining $20.8 of outstanding Floating Rate Debentures utilizing cash on hand. No balance remains outstanding following this redemption.

Term Loan due 2013

In April 2010, we entered into a three-year term loan (Term Loan) to repay borrowings under our revolving credit facility used to purchase office buildings in Fremont, California. Fixed principal of $0.5 and interest payments are payable quarterly in February, May, August, and November. The remaining principal balance is payable in April 2013. We have the option to pay interest based on: (i) LIBOR plus 4.5%, or (ii) a base rate plus 3.5%. The base rate is defined as the higher of: (i) the federal funds rate, as defined, plus 0.5%, (ii) the prime rate of the lead bank, or (iii) one-month LIBOR plus 1.0%. As a result of these interest rate options, our interest expense associated with borrowings under the Term Loan will vary with market interest rates. Additionally, the Term Loan requires us to have a minimum cash and cash equivalent balance as of the last day of the quarter. If we were to fail to comply with this covenant and did not obtain a waiver from our lenders, we would be in default under the Term Loan and our lenders could terminate the loan and demand immediate repayment of the outstanding loan. The Term Loan is collateralized by our Wilsonville, Oregon campus which includes land, buildings, and improvements with a carrying value of approximately $40.0. This amount is reported in our Condensed Consolidated Balance Sheet within Property, plant, and equipment, net.

During the nine months ended October 31, 2010, we repaid $1.0 on the Term Loan and a principal balance of $19.0 remains outstanding. The effective interest rate was 4.90% for the nine months ended October 31, 2010.

For further information on the 6.25% Debentures, the Floating Rate Debentures, and the Term Loan, see Note 7. “Notes Payable” in Part I, Item 1. “Financial Statements.”

Revolving Credit Facility

We are party to a syndicated, senior, unsecured, four-year revolving credit facility with a maximum borrowing capacity of $100.0 with an option to increase the borrowing capacity by $30.0 in the future. Under this revolving credit facility, we have the option to pay interest based on: (i) LIBOR with varying maturities which are commensurate with the borrowing period we select, plus a spread of between 1.0% and 1.6%, or (ii) a base rate plus a spread of between 0.0% and 0.6%, based on a pricing grid tied to a financial covenant. The base rate is defined as the higher of: (i) the federal funds rate, as defined, plus 0.5%, (ii) the prime rate of the lead bank, or (iii) one-month LIBOR plus 1.0%. As a result of these interest rate options, our interest expense associated with borrowings under this revolving credit facility will vary with market interest rates. In addition, commitment fees are payable on the unused portion of the revolving credit facility at rates between 0.25% and 0.35% based on a pricing grid tied to a financial covenant.

We borrowed $40.0 against the revolving credit facility and repaid $60.0 during the nine months ended October 31, 2010. As of October 31, 2010, we had no balance outstanding against the revolving credit facility. The interest rate was 3.25% as of October 31, 2010.

The revolving credit facility terminates June 1, 2011. We plan to renew the revolving credit facility prior to the expiration date.

In November 2010, we borrowed $20.0 against the revolving credit facility.

For further information on our revolving credit facility, see Note 6. “Short-Term Borrowings” in Part I, Item 1. “Financial Statements.”

OFF-BALANCE SHEET ARRANGEMENTS

We do not have off-balance sheet arrangements, financings, or other similar relationships with unconsolidated entities or other persons, also known as special purpose entities. In the ordinary course of business, we lease certain real properties, primarily field sales offices, research and development facilities, and equipment.

OUTLOOK FOR FISCAL 2011

We expect revenues for the fourth quarter of fiscal 2011 to be approximately $293 with earnings per share for the same period of approximately $0.40 per diluted share. For the full fiscal year 2011, we expect revenues of approximately $900 with earnings per share of $0.19 per diluted share.

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

All numerical references in tables are in millions, except interest rates and contract rates.

Interest Rate Risk

We are exposed to interest rate risk primarily through our investment portfolio, short-term borrowings, and notes payable. We do not hold or issue derivative financial instruments for speculative or trading purposes.

We place our investments in instruments that meet high quality credit standards, as specified in our investment policy. The policy also limits the amount of credit exposure to any one issuer and type of instrument. We do not expect any material loss with respect to our investment portfolio.

The table below presents the carrying amount and related weighted-average fixed interest rates for our investment portfolio. The carrying amount approximates fair value as of October 31, 2010. In accordance with our investment policy, all short-term investments mature in twelve months or less.


Principal (notional) amounts in United States dollars	Carrying Amount		Average Fixed Interest Rate
Cash equivalents – fixed rate	$	2.0		0.11%

We had convertible subordinated debentures with a principal balance of $196.5 million outstanding with a fixed interest rate of 6.25% as of October 31, 2010 compared to a principal balance of $165.0 as of October 31, 2009. Interest rate changes for fixed rate debt affect the fair value of the debentures but do not affect future earnings or cash flow.

We had floating rate convertible subordinated debentures with no principal balance outstanding as of October 31, 2010 compared to a principal balance of $32.3 as of October 31, 2009. The floating rate convertible subordinated debenture has a variable interest rate of 3-month London Interbank Offered Rate (LIBOR) plus 1.65%. The effective interest rate was 1.95% for the nine months ended October 31, 2010 and 2.60% for the nine months ended October 31, 2009. Interest rate changes for variable interest rate debt generally do not affect the fair market value, but do affect future earnings and cash flow.

As of October 31, 2010, we had a syndicated, senior, unsecured, revolving credit facility, which expires on June 1, 2011. Borrowings under the revolving credit facility are permitted to a maximum of $100.0 million. Under this revolving credit facility, we have the option to pay interest based on: (i) LIBOR with varying maturities which are commensurate with the borrowing period we select, plus a spread of between 1.0% and 1.6%, or (ii) a base rate plus a spread of between 0.0% and 0.6%, based on a pricing grid tied to a financial covenant. The base rate is defined as the higher of: (i) the federal funds rate, as defined, plus 0.5%, (ii) the prime rate of the lead bank, or (iii) one-month LIBOR plus 1.0%. As a result of these interest rate options, our interest expense associated with borrowings under this revolving credit facility will vary with market interest rates. This revolving credit facility contains certain financial and other covenants, including financial covenants requiring the maintenance of specified liquidity ratios, leverage ratios, and minimum tangible net worth as well as restrictions on the payment of dividends. As of October 31, 2010 and 2009, we had no balance outstanding against this revolving credit facility. Interest rate changes for variable interest rate debt generally do not affect the fair market value, but do affect future earnings and cash flow.

In April 2010, we entered into a three-year term loan. Under this term loan, we have the option to pay interest based on: (i) LIBOR plus 4.5%, or (ii) a base rate plus 3.5%. The base rate is defined as the higher of: (i) the federal funds rate, as defined, plus 0.5%, (ii) the prime rate of the lead bank, or (iii) one-month LIBOR plus 1.0%. As a result of these interest rate options, our interest expense associated with borrowings under this term loan will vary with market interest rates. The term loan contains a covenant requiring the maintenance of minimum cash and cash equivalent balance. As of October 31, 2010, we had $19.0 million outstanding against this term loan. The effective interest rate was 4.90% for the nine months ended October 31, 2010. Interest rate changes for variable interest rate debt generally do not affect the fair market value, but do affect future earnings and cash flow.

We had other short-term borrowings of $4.9 million outstanding as of October 31, 2010 and $4.4 million as of October 31, 2009 with variable rates based on market indexes. Interest rate changes for variable interest rate debt generally do not affect the fair market value, but do affect future earnings and cash flow.

If the interest rates as of October 31, 2010 on the above variable rate borrowings were to increase or decrease by 1% and the level of borrowings outstanding remained constant, annual interest expense would increase or decrease by approximately $0.2 million.

Foreign Currency Risk

We transact business in various foreign currencies and have established a foreign currency hedging program to hedge certain foreign currency forecasted transactions and exposures from existing assets and liabilities. Our derivative instruments consist of short-term foreign currency exchange contracts, with a duration period of a year or less. We enter into contracts with counterparties who are major financial institutions and, as such we do not expect material losses as a result of defaults by our counterparties. We do not hold or issue derivative financial instruments for speculative or trading purposes.

We enter into foreign currency forward contracts to protect against currency exchange risk associated with expected future cash flows. Our practice is to hedge a majority of our existing material foreign currency transaction exposures, which generally represent the excess of expected euro and British pound denominated expenses over expected euro and British pound denominated revenues, and the excess of Japanese yen denominated revenue over expected Japanese yen denominated expenses. We also enter into foreign currency forward contracts to protect against currency exchange risk associated with existing assets and liabilities.

The following table provides volume information about our foreign currency forward program. The information provided is in U.S. dollar equivalent amounts. The table presents the gross notional amounts, at contract exchange rates, and the weighted average contractual foreign currency exchange rates. These forward contracts mature within the next twelve months.


As of	October 31, 2010				January 31, 2010
	Gross Notional Amount		Weighted Average Contract Rate		Gross Notional Amount		Weighted Average Contract Rate
Forward Contracts:
Japanese yen	$	69.5		83.44	$	29.6		90.67
Euro		34.2		0.75		77.2		0.69
Indian rupee		16.8		44.51		8.3		45.68
British pound		14.0		0.64		21.2		0.61
Swedish krona		9.2		6.64		14.2		7.04
Canadian dollar		8.4		1.02		6.5		1.03
Taiwan dollar		7.8		30.72		7.7		31.70
Other (1)		17.1		—		17.9		—

Total forward contracts	$	177.0			$	182.6

(1) Other includes 10 currencies which are the Swiss franc, Korean won, Danish kroner, Hungarian forint, Israeli shekel, Russian ruble, Norwegian kroner, Chinese yuan, Singapore dollar, and Polish zloty.

Item 4.

Controls and Procedures

(1) Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (Exchange Act), that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on the foregoing, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of the end of the period covered by this report.

(2) Changes in Internal Controls Over Financial Reporting

There has been no change in our internal control over financial reporting that occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1A.

Risk Factors

The forward-looking statements contained under “Outlook for Fiscal 2011” in Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and all other statements contained in this report that are not statements of historical fact, including without limitation, statements containing the words “believes,” “expects,” “projections,” and words of similar meaning, constitute forward-looking statements that involve a number of risks and uncertainties that are difficult to predict. Moreover, from time to time, we may issue other forward-looking statements. Forward-looking statements regarding financial performance in future periods, including the statements under “Outlook for Fiscal 2011,” do not reflect potential impacts of mergers or acquisitions or other significant transactions or events that have not been announced as of the time the statements are made. Actual outcomes and results may differ materially from what is expressed or forecast in forward-looking statements. We disclaim any obligation to update forward-looking statements to reflect future events or revised expectations. Our business faces many risks, and set forth below are some of the factors that could cause actual results to differ materially from the results expressed or implied by our forward-looking statements. Forward-looking statements should be considered in light of these factors.

Weakness in the United States (U.S.) and international economies may harm our business.

Our revenue levels are generally dependent on the level of technology capital spending, which includes worldwide expenditures for electronic design automation (EDA) software, hardware, and consulting services. The global economy continues to be weak, with generally slow growth and continuing uncertainty in the credit markets and banking systems. This uncertainty about future economic conditions could adversely affect our customers and postpone decisions to license or purchase our products, decrease our customers’ spending, and jeopardize or delay our customers’ ability or willingness to make payment obligations, any of which could adversely affect our business.

Our forecasts of our revenues and earnings outlook may be inaccurate.

Our revenues, particularly new software license revenues, are difficult to forecast. We use a “pipeline” system, a common industry practice, to forecast revenues and trends in our business. Sales personnel monitor the status of potential business and estimate when a customer will make a purchase decision, the dollar amount of the sale, and the products or services to be sold. These estimates are aggregated periodically to generate a sales pipeline. Our pipeline estimates may prove to be unreliable either in a particular quarter or over a longer period of time, in part because the “conversion rate” of the pipeline into contracts can be very difficult to estimate and requires management judgment. A variation in the conversion rate could cause us to plan or budget incorrectly and materially adversely impact our business or our planned results of operations. In particular, a slowdown in customer spending or weak economic conditions generally can reduce the conversion rate in a particular quarter as purchasing decisions are delayed, reduced in amount, or cancelled. The conversion rate can also be affected by the tendency of some of our customers to wait until the end of a fiscal quarter attempting to obtain more favorable terms. This may result in failure to agree to terms within the fiscal quarter and cause expected revenue to slip into a subsequent quarter.

Our business could be impacted by fluctuations in quarterly results of operations due to customer seasonal purchasing patterns, the timing of significant orders, and the mix of licenses and products purchased by our customers.

We have experienced, and may continue to experience, varied quarterly operating results. Various factors affect our quarterly operating results and some of these are not within our control, including customer demand and the timing of significant orders. We typically experience seasonality in demand for our products, due to the purchasing cycles of our customers, with revenues in the fourth quarter generally being the highest. If planned contract renewals are delayed or the average size of renewed contracts do not increase as we anticipate, we could fail to meet our and investors’ expectations, which could have a material adverse impact on our stock price.

Our revenues are also affected by the mix of licenses entered into where we recognize software revenues as payments become due and payable, on a cash basis, or ratably over the license term as compared to revenues recognized at the beginning of the license term. We recognize revenues ratably over the license term, for instance, when the customer is provided with rights to unspecified or unreleased future products. A shift in the license mix toward increased ratable, due and payable, and/or cash-based revenue recognition could result in increased deferral of software revenues to future periods and would decrease current revenues, which could result in us not meeting near-term revenue expectations.

The gross margin on our software is greater than that for our emulation hardware systems, software support, and professional services. Therefore, our gross margin may vary as a result of the mix of products and services sold. We also have a significant amount of fixed or relatively fixed costs, such as employee costs and purchased technology amortization, and

costs which are committed in advance and can only be adjusted periodically. As a result, a small failure to reach planned revenues would likely have a relatively large negative effect on resulting earnings. If anticipated revenues do not materialize as expected, our gross margins and operating results could be materially adversely impacted.

We face intense competition in the EDA industry.

Competition in the EDA industry is intense, which can lead to, among other things, price reductions, longer selling cycles, lower product margins, loss of market share, and additional working capital requirements. If our competitors offer significant discounts on certain products, we may need to lower our prices or offer other favorable terms to compete successfully. Any such changes would likely reduce margins and could materially adversely impact our operating results. Any broad-based changes to our prices and pricing policies could cause new software license and service revenues to decline or be delayed as the sales force implements and our customers adjust to the new pricing policies. Some of our competitors may bundle certain software products at low prices for promotional purposes or as a long-term pricing strategy. These practices could significantly reduce demand for our products or limit prices we can charge.

We currently compete primarily with two large companies: Synopsys, Inc. and Cadence Design Systems, Inc. We also compete with numerous smaller companies and compete with manufacturers of electronic devices that have developed their own EDA products internally. Some large customers may also develop internal tools, thereby reducing demand for our products.

Our international operations and the effects of foreign currency fluctuations expose us to additional risks.

We typically generate about half of our revenues from customers outside the U.S. and we generate approximately one-third of our expenses outside the U.S. Significant changes in currency exchange rates, particularly in the Japanese yen, euro, and the British pound, could have an adverse impact on us. In addition, international operations subject us to other risks including longer receivables collection periods, changes in a specific country’s or region’s economic or political conditions, trade protection measures, local labor laws, import or export licensing requirements, loss or modification of exemptions for taxes and tariffs, limitations on repatriation of earnings, and difficulties with licensing and protecting our intellectual property rights.

We derive a substantial portion of our revenues from relatively few product groups.

We derive a substantial portion of our revenues from sales of relatively few product groups and related support services. As a result, any factor adversely affecting sales of these products, including the product release cycles, market acceptance, product competition, performance and reliability, reputation, price competition, and economic and market conditions, could harm our operating results.

We are subject to the cyclical nature of the integrated circuit (IC) and electronics systems industries.

Purchases of our products and services are highly dependent upon new design projects initiated by customers in the IC and electronics systems industries. These industries are highly cyclical and are subject to constant and rapid technological change, rapid product obsolescence, price erosion, evolving standards, short product life cycles, and wide fluctuations in product supply and demand. The IC and electronics systems industries regularly experience significant downturns, often connected with, or in anticipation of, maturing product cycles within such companies or decline in general economic conditions. These downturns could cause diminished demand for our products and services.

Shortages of components for our hardware products may delay or reduce our sales and increase our costs.

The inability to obtain sufficient quantities of components and other materials necessary for the production of our hardware products could result in reduced or delayed sales or lost orders. Any delay in or loss of sales could adversely impact our operating results. From time to time, materials and components used in our production solutions or in other aspects of our customers’ products may become subject to allocation because of shortages of these materials and components. Future shortages of materials and components, including potential supply constraints of silicon, could cause delayed shipments, customer dissatisfaction, and lower revenue.

Customer payment defaults could adversely affect our timing of revenue recognition.

We use fixed-term license agreements as standard business practices with customers we believe are creditworthy. These multi-year, multi-element term license agreements have payments spread over the license term and are typically about three years in length for semiconductor companies and about four years in length for military and aerospace companies. The complexity of these agreements tends to increase the risk associated with collectibility from customers that can arise for a variety of reasons including ability to pay, product dissatisfaction, and disputes. If we are unable to collect under these

agreements, our results of operations could be materially adversely impacted. We use these fixed-term license agreements as a standard business practice and have a history of successfully collecting under the original payment terms without making concessions on payments, products, or services. If we no longer had a history of collecting without providing concessions on the terms of the agreements, then revenue would be required to be recognized under U.S. generally accepted accounting principles as the payments become due and payable over the license term. This change could have a material adverse impact on our near-term results.

IC and printed circuit board (PCB) technology evolves rapidly.

The complexity of ICs and PCBs continues to rapidly increase. In response to this increasing complexity, new design tools and methodologies must be invented or acquired quickly to remain competitive. If we fail to quickly respond to new technological developments, our products could become obsolete or uncompetitive, which could materially adversely impact our business.

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

Our customers use our products and services in designing and developing products that involve a high degree of technological complexity and have unique specifications. Due to the complexity of the systems and products with which we work, some of our products and designs can be adequately tested only when put to full use in the marketplace. As a result, our customers or their end users may discover errors or defects in our software, or the products or systems designed with or manufactured using tools that may not operate as expected. Errors or defects could result in:

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Loss of current customers and loss of, or delay in, revenue and loss of market share;

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Failure to attract new customers or achieve market acceptance;

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Diversion of development resources to resolve the problems resulting from errors or defects; and

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Increased support or service costs.

In addition, we include limited amounts of third-party technology in our products and we rely on those third parties to provide support services to us. Failure of those third parties to provide necessary support services could materially adversely impact our business.

Long sales cycles and delay in customer completion of projects make the timing of our revenues difficult to predict.

We have a lengthy sales cycle. A lengthy customer evaluation and approval process is generally required due to the complexity and expense associated with our products and services. Consequently, we may incur substantial expenses and devote significant management effort and expense to develop potential relationships that do not result in agreements or revenues and may prevent us from pursuing other opportunities. In addition, sales of our products and services is sometimes discretionary and may be delayed if customers delay approval or commencement of projects due to budgetary constraints, internal acceptance review procedures, timing of budget cycles, or timing of competitive evaluation processes.

Disruptions of our indirect sales channel could affect our future operating results.

Our indirect sales channel is comprised primarily of independent distributors. Our relationships with these distributors are important elements of our marketing and sales efforts. Our financial results could be adversely affected if our contracts with distributors were terminated, if our relationships with distributors were to deteriorate, if any of our competitors enter into strategic relationships with or acquire a significant distributor, or if the financial condition of our distributors were to weaken.

Any loss of our leadership position in certain segments of the EDA market could harm our business.

The industry in which we compete is characterized by very strong leadership positions in specific segments of the EDA market. For example, one company may have a large percentage of sales in the physical verification segment of the market while another may have a similarly strong position in mixed-signal simulation. These strong leadership positions can be maintained for significant periods of time as the software is difficult to master and customers are disinclined to make changes once their employees, as well as others in the industry, have developed familiarity with a particular software product. For these reasons, much of our profitability arises from niche areas in which we are the leader. Conversely, it is difficult for us to achieve significant profits in niche areas where other companies are the leaders. If for any reason we lose our leadership position in a niche, we could be materially adversely impacted.

Accounting rules governing revenue recognition are complex and may change.

The accounting rules governing software revenue recognition are complex and have been subject to authoritative interpretations that have generally made it more difficult to recognize software revenues at the beginning of the license period. If this trend continues, new and revised standards and interpretations could materially adversely impact our ability to meet near-term revenue expectations.

We may have additional tax liabilities.

Significant judgments and estimates are required in determining the provision for income taxes and other tax liabilities. Our tax expense may be impacted if our intercompany transactions, which are required to be computed on an arm’s-length basis, are challenged and successfully disputed by the tax authorities. Also, our tax expense could be impacted depending on the applicability of withholding taxes on software licenses and related intercompany transactions in certain jurisdictions. In determining the adequacy of income taxes, we assess the likelihood of adverse outcomes resulting from the Internal Revenue Service (IRS) and other tax authorities’ examinations. The IRS and tax authorities in countries where we do business regularly examine our tax returns. The ultimate outcome of these examinations cannot be predicted with certainty. Should the IRS or other tax authorities assess additional taxes as a result of examinations, we may be required to record charges to operations that could have a material impact on the results of operations, financial position, or cash flows.

Forecasting our income tax rate is complex and subject to uncertainty.

The computation of income tax expense (benefit) is complex as it is based on the laws of numerous taxing jurisdictions and requires significant judgment on the application of complicated rules governing accounting for tax provision under U.S. generally accepted accounting principles. Income tax expense (benefit) for interim quarters is based on a forecast of our global tax rate for the year, which includes forward looking financial projections, including the expectations of profit and loss by jurisdiction, and contains numerous assumptions. Various items cannot be accurately forecasted, and may be treated as discrete accounting. Examples of items which could cause variability in the rate include tax deductions for stock option expense, application of transfer pricing rules, and changes in our valuation allowance for deferred tax assets. Future events, such as changes in our business and the tax law in the jurisdictions where we do business, could also affect our rate. For these reasons, our global tax rate may be materially different than our forecast.

There are limitations on the effectiveness of controls.

We do not expect that disclosure controls or internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. Failure of our control systems to prevent error or fraud could materially adversely impact us.

We may not realize revenues as a result of our investments in research and development.

We incur substantial expense to develop new software products. Research and development activities are often performed over long periods of time. This effort may not result in a successful product offering. As a result, we could realize little or no revenues related to our investment in research and development.

We may acquire other companies and may not successfully integrate them.

The industry in which we compete has experienced significant consolidation in recent years. During this period, we have acquired numerous businesses and have frequently been in discussions with potential acquisition candidates, and we may acquire other businesses in the future. While we expect to carefully analyze all potential transactions before committing to them, we cannot assure that any completed transaction will result in long-term benefits to us or our shareholders or that we 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 we acquire another business, it could materially adversely impact us:

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Difficulties in combining previously separate businesses into a single unit;

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The substantial diversion of management’s attention from ongoing business when integrating the acquired business;

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The failure to realize anticipated benefits, such as cost savings and increases in revenues;

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The failure to retain key personnel of the acquired business;

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

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Unanticipated costs;

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Unanticipated liabilities or litigation in connection with or as a result of an acquisition, including claims from terminated employees, customers, or third parties;

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Adverse impacts on existing relationships with suppliers and customers; and

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Failure to understand and compete effectively in markets in which we have limited experience.

Acquired businesses may not perform as projected, which could result in impairment of acquisition-related intangible assets. Additional challenges include integration of sales channels, training and education of the sales force for new product offerings, integration of product development efforts, integration of systems of internal controls, and integration of information systems. Accordingly, in any acquisition there will be uncertainty as to the achievement and timing of projected synergies, cost savings, and sales levels for acquired products. All of these factors could impair our ability to forecast, meet revenues and earnings targets, and manage effectively our business for long-term growth. We cannot assure that we can effectively meet these challenges.

We may not adequately protect our proprietary rights or we may fail to obtain software or other intellectual property licenses.

Our success depends, in large part, upon our proprietary technology. We generally rely on patents, copyrights, trademarks, trade secret laws, licenses, and restrictive agreements to establish and protect our proprietary rights in technology and products. Despite precautions we may take to protect our intellectual property, we cannot assure that third parties will not try to challenge, invalidate, or circumvent these protections. The companies in the EDA industry, as well as entities and persons outside the industry, are obtaining patents at a rapid rate. We cannot predict if any of these patents will cover any of our products. In addition, many of these entities have substantially larger patent portfolios than we have. As a result, we may on occasion be forced to engage in costly patent litigation to protect our rights or defend our customers’ rights. We may also need to settle these claims on terms that are unfavorable; such settlements could result in the payment of significant damages or royalties, or force us to stop selling or redesign one or more products. We cannot assure that the rights granted under our patents will provide us with any competitive advantage, that patents will be issued on any of our pending applications, or that future patents will be sufficiently broad to protect our technology. Furthermore, the laws of foreign countries may not protect our proprietary rights in those countries to the same extent as U.S. law protects these rights in the U.S.

Some of our products include software or other intellectual property licensed from third parties, and we may have to seek new licenses or renew existing licenses for software and other intellectual property in the future. Failure to obtain software or other intellectual property licenses or rights from third parties on favorable terms could materially adversely impact us.

Our use of open source software could negatively impact our ability to sell our products and confusion regarding open source software may harm the market for our products.

The products, services or technologies we acquire, license, provide or develop may incorporate or use open source software. We monitor our use of open source software in an effort to avoid unintended consequences, such as reciprocal license grants, patent retaliation clauses, and the requirement to license our products at no cost. There is little or no legal precedent for interpreting the terms of these open source licenses; as a result, we may be subject to unanticipated obligations regarding our products which incorporate open source software. In addition, some customers may falsely believe that the customer’s intellectual property may be made public if used with our open source products. This confusion and misperception may harm the market for our products or services which use open source software.

Our failure to attract and retain key employees may harm us.

We depend on the efforts and abilities of our senior management, our research and development staff, and a number of other key management, sales, support, technical, and services personnel. Competition for experienced, high-quality personnel is intense, and we cannot assure that we can continue to recruit and retain such personnel. Our failure to hire and retain such personnel could impair our ability to develop new products and manage our business effectively.

We have global sales and research and development offices in parts of the world that are not as politically stable as the United States.

We have global sales and research and development offices, some of which are in parts of the world that are not as politically stable as the United States. As a result, we may face a greater risk of business interruption as a result of terrorist acts or military conflicts than businesses located domestically.

Oregon law and our shareholder rights plan may have anti-takeover effects.

The Oregon Control Share Act and the Business Combination Act limit the ability of parties who acquire a significant amount of voting stock to exercise control over us. These provisions may have the effect of lengthening the time required to acquire control of us through a proxy contest or the election of a majority of the Board of Directors. In June 2010, we adopted a shareholder rights plan, which has the effect of making it more difficult for a person to acquire control of us in a transaction not approved by our board of directors. The provisions of the Oregon Control Share Act and the Business Combination Act and our shareholder rights plan could have the effect of delaying, deferring, or preventing a change of control of us, could discourage bids for our common stock at a premium over the market price of our common stock and could materially adversely impact the market price of, and the voting and other rights of the holders of, our common stock.

We have a substantial level of indebtedness.

As of October 31, 2010, we had $228.5 million of outstanding indebtedness, which includes $196.5 million of 6.25% Convertible Subordinated Debentures (6.25% Debentures) due 2026, $19.0 million under a term loan, $1.3 in other notes payable, and $11.7 million in short-term borrowings. This level of indebtedness among other things could:

•

Make it difficult for us to satisfy our payment obligations on our debt;

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

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

•

Reduce funds available for use in our operations;

•

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

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Make us more vulnerable in the event of an increase in interest rates if we must incur new debt to satisfy our obligations under the 6.25% Debentures and term loan; and

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

We may also be unable to borrow funds as a result of an inability of financial institutions to lend due to restrictive lending policies and/or institutional liquidity concerns.

If we experience a decline in revenues, we could have difficulty paying amounts due on our indebtedness. Any default under our indebtedness could have a material adverse impact on our business, operating results, and financial condition.

Our stock price could become more volatile, and your investment could lose value.

All of the factors discussed in this “Risk Factors” section could affect our stock price. The timing of announcements in the public market regarding new products, product enhancements, or technological advances by our competitors or us, and any announcements by us of acquisitions, major transactions, or management changes could also affect our stock price. Our stock price is subject to speculation in the press and the analyst community, changes in recommendations or earnings estimates by financial analysts, changes in investors’ or analysts’ valuation measures for our stock, our credit ratings, and market trends unrelated to our performance. A significant drop in our stock price could also expose us to the risk of securities class actions lawsuits, which could result in substantial costs and divert management’s attention and resources, which could adversely affect our business.

Our revolving credit facility has financial and non-financial covenants, and default of any covenant could materially adversely impact us.

Our bank revolving credit facility imposes operating restrictions on us in the form of financial and non-financial covenants. Financial covenants include adjusted quick ratio, minimum tangible net worth, leverage ratio, senior leverage ratio, and minimum cash and accounts receivable ratio. If we were to fail to comply with the financial covenants and did not obtain a waiver from our lenders, we would be in default under the revolving credit facility and our lenders could terminate the facility and demand immediate repayment of all outstanding loans under the revolving credit facility. The declaration of an event of default could have a material adverse effect on our financial condition. We could also find it difficult to obtain other bank lines or credit facilities on comparable terms.

Our bank revolving credit facility terminates June 1, 2011. We could find it difficult to obtain comparable terms on a new revolving credit facility.

Item 6.

Exhibits



31.1		Certification of Chief Executive Officer of Registrant Pursuant to SEC Rule 13a-14(a)/15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Chief Financial Officer of Registrant Pursuant to SEC Rule 13a-14(a)/15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32		Certifications of Chief Executive Officer and Chief Financial Officer of Registrant Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS		XBRL Instance Document

101.SCH		XBRL Taxonomy Extension Schema Document

101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF		XBRL Taxonomy Extension Definition Linkbase Document

101.LAB		XBRL Taxonomy Extension Label Linkbase Document

101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

SIGNATURES

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


Dated: December 7, 2010				MENTOR GRAPHICS CORPORATION (Registrant)

				/S/ GREGORY K. HINCKLEY
				Gregory K. Hinckley
				President, Chief Financial Officer

Derivatives Not Designated as Hedging Instruments

Gain Recognized in Income on Derivatives

Location

Amount

Non-designated forwards

Other expense, net