The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements and notes thereto included in this Quarterly Report on Form 10-Q, or this Quarterly Report, and in conjunction with our Annual Report on Form 10-K for the fiscal year ended December 29, 2007. Certain of these statements, including, without limitation, statements regarding the extent and timing of future revenues and expenses and customer demand, statements regarding the deployment of our products, statements regarding our reliance on third parties and other statements using words such as "anticipates," "believes," "could," "estimates," "expects," "intends," "may," "plans," "should," "will" and "would," and words of similar import and the negatives thereof, constitute forward-looking statements. These statements are predictions based upon our current expectations about future events. Actual results could vary materially as a result of certain factors, including but not limited to, those expressed in these statements. We refer you to the "Risk Factors," "Results of Operations," "Disclosures About Market Risk," and "Liquidity and Capital Resources" sections contained in this Quarterly Report, and the risks discussed in our other Securities Exchange Commission, or SEC, filings, which identify important risks and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements.

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

Overview

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

We primarily generate revenue from licensing our EDA software, selling or leasing our hardware technology, providing maintenance for our software and hardware and providing design and methodology services. Our revenue recognition is significantly affected by the mix of license types executed in any given period. Our revenue may also be deferred until payments become due and payable or cash is received from certain customers and for certain contracts. Substantially all of our revenue is generated from IC manufacturers, IC designers and electronics systems companies and is dependent upon their commencement of new design projects. As a result, our revenue is significantly influenced by our customers' business outlook and investment in the introduction of new products and the improvement of existing products.

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

During 2007 and the first six months of 2008, we saw increasing pressures on the research and development budgets in our customer base due to the deceleration of growth in the electronics systems and semiconductor industries and the deteriorating macroeconomic environment. In this slowing and price-conscious environment, customers are looking for more flexibility in the type of software and hardware products they purchase and how and when they purchase them.

Facing uncertainty and cost pressures in their own businesses, some of our customers are waiting to purchase our products as long as they can and are increasingly seeking even more aggressive purchasing terms and conditions. As a result of this trend, we have forecasted lower business levels for the remainder of 2008. In addition, our recent announcement of the proposed acquisition of Mentor Graphics Corporation, or Mentor Graphics, has caused some customers to demand more flexibility in accessing new technology. To enable us to keep our focus on

the value of our technology and to assist with customer demands, we are moving to a license mix that will provide our customers with greater flexibility and will result in increased ratable revenue for us.

Our operating results are affected by the mix of license types executed in any given period. We license software using three different license types:
subscription, term and perpetual. Product revenue associated with term and perpetual licenses is generally recognized at the beginning of the license period, whereas product revenue associated with subscription licenses is recognized over multiple periods during the term of the license. In order to provide our customers with the desired flexibility, our license mix will change to a higher proportion of licenses that require ratable revenue recognition which will result in a decrease in our expected revenue for the second half of fiscal year 2008.

We plan operating expense levels primarily based on forecasted revenue levels. These expenses and the impact of long-term commitments are relatively fixed in the short term. However, a shortfall in revenue could lead to operating results below expectations because we may not be able to quickly reduce these fixed expenses in response to these short-term business changes. To offset some of the impact of our expected decrease in revenue, we have implemented cost savings initiatives, including reducing headcount, decreasing employee bonuses and reducing other discretionary spending. Due to the change in license mix noted above, we will recognize a net loss for fiscal 2008.

Semiconductor volumes grew during 2007 and have grown during the first six months of 2008, fueled by strong consumer demand in traditional and emerging markets, but at the same time, average selling prices have declined. Product performance and size specifications of the mobile and other consumer electronics market are requiring electronic systems to be smaller, consume less power and provide multiple functions in one system-on-chip, or SoC, or system-in-package, or SiP. The design challenge is also becoming more complex with each new generation of electronics and as providers of EDA solutions are required to deliver products that address these technical challenges and improve the efficiency and productivity of the design process.

With the addition of emerging nanometer design considerations to the already burgeoning set of traditional design tasks, complex SoC or IC design can no longer be accomplished using a collection of discrete design tools. What previously consisted of sequential design activities must be merged and accomplished nearly simultaneously without time-consuming data translation steps. We combine our design technologies into "platforms" addressing four major design activities: functional verification, digital IC design, custom IC design and system interconnect design. The four Cadence® design platforms are Incisive® functional verification, Encounter® digital IC design, Virtuoso® custom design and Allegro® system interconnect design platforms. In addition, we augment these platform product offerings with a set of design for manufacturing, or DFM, products that service both the digital and custom IC design flows. These four platforms, together with our DFM products, comprise our primary product lines.

Proposed Acquisition of Mentor Graphics Corporation

On May 2, 2008, we made a proposal to the board of directors of Mentor Graphics to acquire all of the outstanding shares of Mentor Graphics common stock for cash consideration of $16.00 per Mentor Graphics share, representing a total value of approximately $1.6 billion. On May 23, 2008, the Mentor Graphics board of directors informed us that it did not wish to pursue discussions with us given Mentor Graphics' desire to stay independent. On June 17, 2008, we publicly announced our offer and Mentor Graphics publicly confirmed that it received an unsolicited offer from us and that it previously rejected our offer. We currently expect to borrow in excess of $1.0 billion if we are successful in acquiring all of Mentor Graphics' outstanding shares and we are currently reviewing various alternatives for financing this transaction. There are no assurances that the acquisition will be completed or that financing will be available on terms that are acceptable to us.

Critical Accounting Estimates

In preparing our Condensed Consolidated Financial Statements, we make assumptions, judgments and estimates that can have a significant impact on our revenue, operating income and net income, as well as on the value of certain assets and liabilities on our Condensed Consolidated Balance Sheets. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under

the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. At least quarterly, we evaluate our assumptions, judgments and estimates and make changes accordingly. Historically, our assumptions, judgments and estimates relative to our critical accounting estimates have not differed materially from actual results.

For further information about our other critical accounting estimates, see the discussion under the heading "Critical Accounting Estimates" in our Annual Report on Form 10-K for the fiscal year ended December 29, 2007.

Results of Operations

We primarily generate revenue from licensing our EDA software, selling or leasing our hardware technology, providing maintenance for our software and hardware and providing design and methodology services. We principally utilize three license types: subscription, term and perpetual. The different license types provide a customer with different terms of use for our products, such as:

• The right to access new technology;
• The duration of the license; and
• Payment terms.

Customer decisions regarding these aspects of license transactions determine the license type, timing of revenue recognition and potential future business activity. For example, if a customer chooses a fixed term of use, this will result in either a subscription or term license. A business implication of this decision is that, at the expiration of the license period, the customer must decide whether to continue using the technology and therefore renew the license agreement. Because larger customers generally use products from two or more of our five product groups, rarely will a large customer completely terminate its relationship with us at expiration of the license. See the discussion under the heading "Critical Accounting Estimates" in our Annual Report on Form 10-K for the fiscal year ended December 29, 2007 for additional description of license types and timing of revenue recognition.

Although we believe that pricing volatility has not generally been a material component of the change in our revenue from period to period, we believe that the amount of revenue recognized in future periods will depend on, among other things, the competitiveness of our new technology, the length of our sales cycle, and the size, duration, terms, type and timing of our:

• Contract renewals with existing customers;
• Additional sales to existing customers; and
• Sales to new customers.

A substantial portion of our total revenue is recognized over multiple periods. However, a significant portion of our product revenue is recognized upon delivery of licensed software, which generally occurs upon the later of the effective date of the arrangement or delivery of the software product.

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

Revenue and Revenue Mix

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

Our product groups are:

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

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

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

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

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

Revenue by Period

The following table shows our revenue for the three and six months ended
June 28, 2008 and June 30, 2007 and the percentage change in revenue between
periods:


                     Three Months Ended                            Six Months Ended
                  June 28,        June 30,                     June 28,       June 30,
                    2008            2007         % Change        2008           2007         % Change
                                           (In millions, except percentages)

 Product         $    195.5      $    263.8          (26)%     $   351.7     $    501.7          (30)%
 Services              33.7            32.8             3%          65.9           64.7             2%
 Maintenance          100.3            94.4             6%         199.1          189.7             5%

 Total revenue   $    329.5      $    391.0          (16)%     $   616.7     $    756.1          (18)%

Product revenue decreased in the three and six months ended June 28, 2008, as compared to the three and six months ended June 30, 2007, primarily because of a challenging economic environment and a longer sales cycle. As a result, product revenue decreased for all product groups, and particularly for Digital IC Design, Design for Manufacturing, Functional Verification and Custom IC Design products.

Our product revenue is affected by the mix of license types executed in any given period. We license software using three different license types:
subscription, term and perpetual. Product revenue associated with term and perpetual licenses is generally recognized at the beginning of the license period, whereas product revenue associated with subscription licenses is recognized over multiple periods during the term of the license. Our expected revenue for the second half of fiscal 2008 will decrease due to the slowing and price-conscious environment, as well as changes to our license mix, which will result in a higher proportion of revenue recognized over multiple periods during the term of the license and decreased revenue recognized at the beginning of the license.

We have determined that Product revenue totaling $8.4 million recognized during the three months ended June 28, 2008 should have been recognized during the three months ended March 29, 2008. The effect on the Condensed Consolidated Financial Statements for the three months ended June 28, 2008 and March 29, 2008 is not considered material, and there is no effect to the Condensed Consolidated Financial Statements for the six months ended June 28, 2008.

Revenue by Product Group

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


                                                             Three Months Ended
                             June 28,        March 29,        December 29,        September 29,        June 30,
                               2008            2008               2007                2007               2007

Functional Verification            25%              20%                 26%                  20%             24%
Digital IC Design                  23%              27%                 27%                  27%             29%
Custom IC Design                   26%              25%                 25%                  32%             24%
System Interconnect                 9%              11%                  9%                   7%              8%
Design for Manufacturing            7%               6%                  6%                   6%              7%
Services and other                 10%              11%                  7%                   8%              8%

Total                             100%             100%                100%                 100%            100%

As described under the heading "Critical Accounting Estimates" in our Annual Report on Form 10-K for the fiscal year ended December 29, 2007, certain of our licenses allow customers the ability to remix among software products. Additionally, we have licensed a combination of our products to customers with the actual product selection and number of licensed users to be determined at a later date. For these arrangements, we estimate the allocation of the revenue to product groups based upon the expected usage of our products by these customers. The actual usage of our products by these customers may differ and, if that proves to be the case, the revenue allocation in the above table would differ.

Although we believe the methodology of allocating revenue to product groups is reasonable, there can be no assurance that such allocated amounts reflect the amounts that would result had the customer individually licensed each specific software solution at the outset of the arrangement.

Revenue by Geography


                                     Three Months Ended                                Six Months Ended
                                  June 28,         June 30,                        June 28,        June 30,
                                    2008             2007         % Change           2008            2007          % Change
                                                              (In millions, except percentages)

United States                    $    150.0       $    195.5            (23 )%    $    259.6      $    363.4           (29)%
Other Americas                          9.2              8.9              3 %           15.4            16.6            (7)%
Europe, Middle East and Africa         69.4             66.0              5 %          132.6           119.4             11%
Japan                                  60.8             55.5             10 %          135.9           153.6           (12)%
Asia                                   40.1             65.1            (38 )%          73.2           103.1           (29)%

Total revenue                    $    329.5       $    391.0            (16 )%    $    616.7      $    756.1           (18)%

Revenue by Geography as a Percent of Total Revenue


                                       Three Months Ended             Six Months Ended
                                   June 28,         June 30,      June 28,        June 30,
                                     2008             2007          2008            2007

  United States                          46%              50%           42%             48%
  Other Americas                          3%               2%            3%              2%
  Europe, Middle East and Africa         21%              17%           21%             16%
  Japan                                  18%              14%           22%             20%
  Asia                                   12%              17%           12%             14%

  Total                                 100%             100%          100%            100%

The rate of revenue change varies geographically primarily due to differences in the timing and size of term licenses in those regions. No one customer accounted for 10% or more of total revenue for the three months ended June 28, 2008 and one customer accounted for 18% of total revenue for the three months ended June 30, 2007. No one customer accounted for 10% or more of total revenue for the six months ended June 28, 2008 and one customer accounted for 11% of total revenue for the six months ended June 30, 2007.

Most of our revenue is transacted in the United States dollar. However, certain revenue transactions are in foreign currencies, primarily the Japanese yen, and we recognize additional revenue in periods when the United States dollar weakens in value against the Japanese yen. For additional description of how changes in foreign exchange rates affect our Condensed Consolidated Financial Statements, see the discussion under the heading "Item 3. Quantitative and Qualitative Disclosures About Market Risk - Disclosures About Market Risk - Foreign Currency Risk" below.

Stock-based Compensation Expense Summary

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


                                     Three Months Ended             Six Months Ended
                                 June 28,         June 30,      June 28,        June 30,
                                   2008             2007          2008            2007
                                                      (In millions)

    Cost of product              $     0.1       $     ----     $     0.1      $      0.1
    Cost of services                   1.1              1.0           2.1             1.9
    Cost of maintenance                0.7              0.6           1.3             1.2
    Marketing and sales                4.8              5.4           9.2            12.1
    Research and development           9.4             12.5          19.2            25.7
    General and administrative         5.4              7.5          11.1            13.7

    Total                        $    21.5       $     27.0     $    43.0      $     54.7

During the three months ended June 28, 2008, stock-based compensation expense decreased $5.5 million, as compared to the three months ended June 30, 2007, primarily due to:

• A decrease of $3.4 million in stock-compensation expense for restricted stock and stock bonuses, primarily due to new grants of restricted stock being valued at a lower stock price and a decrease in stock bonuses; and
• A decrease of $2.9 million in stock-compensation expense for stock options, primarily due to our increased use of restricted stock instead of stock options in recent years; partially offset by
• An increase of $0.8 million in stock-compensation expense primarily due to an increase in purchase rights granted under our ESPP during the current period.

During the six months ended June 28, 2008, stock-based compensation expense decreased $11.7 million, as compared to the six months ended June 30, 2007, primarily due to:

• A decrease of $7.5 million in stock-compensation expense for restricted stock and stock bonuses, primarily due to new grants of restricted stock being valued at a lower stock price and a decrease in stock bonuses; and
• A decrease of $5.9 million in stock-compensation expense for stock options, primarily due to our increased use of restricted stock instead of stock options in recent years; partially offset by
• An increase of $1.7 million in stock-compensation expense primarily due to an increase in purchase rights granted under our ESPP during the current period.

Cost of Revenue


                     Three Months Ended                        Six Months Ended
                 June 28,         June 30,                 June 28,        June 30,
                   2008             2007        % Change     2008            2007        % Change
                                        (In millions, except percentages)

   Product       $    18.0       $     12.8          41%   $    30.0      $     28.5           5%
   Services      $    27.2       $     23.4          16%   $    52.4      $     47.1          11%
   Maintenance   $    14.4       $     15.3         (6)%   $    29.0      $     30.4         (5)%

Cost of Revenue as a Percent of Related Revenue


                             Three Months Ended              Six Months Ended
                          June 28,        June 30,      June 28,         June 30,
                            2008            2007          2008             2007

            Product              9%              5%            9%               6%
            Services            81%             71%           80%              73%
            Maintenance         14%             16%           15%              16%

Cost of product includes costs associated with the sale or lease of our hardware . . .