CADENCE DESIGN SYSTEMS INC, 10-Q, 2000-08-15

CADENCE DESIGN SYSTEMS INC
10-Q, 2000-08-15
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

------------------------

FORM 10-Q

(MARK ONE)

<TABLE>
<C> <S>
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
</TABLE>

FOR THE QUARTERLY PERIOD ENDED JULY 1, 2000
OR

<TABLE>
<C> <S>
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
</TABLE>

FOR THE TRANSITION PERIOD FROM ______________ TO ______________

COMMISSION FILE NUMBER 1-10606

------------------------

CADENCE DESIGN SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

------------------------

<TABLE>
<S> <C>
DELAWARE 77-0148231
(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)

2655 SEELY AVENUE, BUILDING 5, SAN 95134
JOSE, CALIFORNIA (zip code)
(Address of principal executive
offices)
</TABLE>

(408) 943-1234
(Registrant's telephone number, including area code)

------------------------

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

At August 4, 2000, there were 246,240,851 shares of the registrant's common
stock, $0.01 par value, outstanding.

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<PAGE>
CADENCE DESIGN SYSTEMS, INC.
INDEX

<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements:

Condensed Consolidated Balance Sheets:
July 1, 2000 and January 1, 2000................ 3

Condensed Consolidated Statements of Income:
Three and Six Months Ended July 1, 2000 and July
3, 1999....................................... 4

Condensed Consolidated Statements of Cash Flows:
Six Months Ended July 1, 2000 and July 3,
1999.......................................... 5

Notes to Condensed Consolidated Financial
Statements...................................... 6

Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............... 12

Item 3. Quantitative and Qualitative Disclosures About
Market Risk............................................. 27

PART II. OTHER INFORMATION

Item 1. Legal Proceedings................................. 31

Item 2. Changes in Securities and Use of Proceeds......... 32

Item 3. Defaults Upon Senior Securities................... 33

Item 4. Submission of Matters to a Vote of Security
Holders................................................. 33

Item 5. Other Information................................. 33

Item 6. Exhibits and Reports on Form 8-K.................. 33

Signatures.................................................. 34
</TABLE>

2
<PAGE>
PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CADENCE DESIGN SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)

ASSETS

<TABLE>
<CAPTION>
JULY 1, JANUARY 1,
2000 2000
----------- ----------
(UNAUDITED)
<S> <C> <C>
Current Assets:
Cash and cash equivalents................................. $ 113,165 $ 111,401
Short-term investments.................................... 6,278 7,357
Receivables, net.......................................... 231,839 248,034
Inventories, net.......................................... 15,219 19,872
Prepaid expenses and other................................ 117,774 93,248
---------- ----------
Total current assets.................................... 484,275 479,912

Property, plant, and equipment, net......................... 337,755 330,409
Software development costs, net............................. 10,725 10,692
Acquired intangibles, net................................... 366,984 402,154
Installment contract receivables............................ 45,907 84,160
Other assets................................................ 150,087 152,332
---------- ----------
$1,395,733 $1,459,659
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Notes payable and current portion of capital leases....... $ 3,447 $ 3,924
Accounts payable and accrued liabilities.................. 256,988 265,518
Deferred revenue.......................................... 192,468 152,116
---------- ----------
Total current liabilities............................... 452,903 421,558
---------- ----------
Long-term Liabilities:
Long-term notes payable and capital leases................ 4,198 25,024
Other long-term liabilities............................... 31,175 26,928
---------- ----------
Total long-term liabilities............................. 35,373 51,952
---------- ----------

Stockholders' Equity:
Common stock and capital in excess of par value........... 820,225 857,960
Treasury stock at cost.................................... (246,251) (240,748)
Retained earnings......................................... 338,063 344,247
Accumulated other comprehensive gain (loss)............... (4,580) 24,690
---------- ----------
Total stockholders' equity.............................. 907,457 986,149
---------- ----------
$1,395,733 $1,459,659
========== ==========
</TABLE>

The accompanying notes are an integral part of these condensed consolidated
financial statements.

3
<PAGE>
CADENCE DESIGN SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
------------------- -------------------
JULY 1, JULY 3, JULY 1, JULY 3,
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenue:
Product........................................... $140,383 $117,890 $245,915 $305,247
Services.......................................... 80,177 74,943 155,992 147,417
Maintenance....................................... 78,122 71,360 154,268 146,720
-------- -------- -------- --------
Total revenue................................... 298,682 264,193 556,175 599,384
-------- -------- -------- --------

Costs and Expenses:
Cost of product................................... 20,501 20,064 40,979 38,600
Cost of services.................................. 52,182 48,844 101,183 96,102
Cost of maintenance............................... 15,329 12,930 29,518 25,830
Amortization of acquired intangibles.............. 19,868 12,856 39,534 25,570
Marketing and sales............................... 95,031 82,936 181,198 162,999
Research and development.......................... 65,772 50,359 128,345 101,227
General and administrative........................ 23,751 20,903 46,283 42,163
Unusual items..................................... -- 19,648 -- 33,840
-------- -------- -------- --------

Total costs and expenses........................ 292,434 268,540 567,040 526,331
-------- -------- -------- --------

Income (loss) from operations................. 6,248 (4,347) (10,865) 73,053

Other income, net................................... 1,407 141 2,453 276
-------- -------- -------- --------

Income (loss) before provision (benefit) for
income taxes................................ 7,655 (4,206) (8,412) 73,329

Provision (benefit) for income taxes................ 2,029 (1,199) (2,229) 23,474
-------- -------- -------- --------

Net income (loss)............................. $ 5,626 $ (3,007) $ (6,183) $ 49,855
======== ======== ======== ========
Basic net income (loss) per share................... $ 0.02 $ (0.01) $ (0.03) $ 0.21
======== ======== ======== ========
Diluted net income (loss) per share................. $ 0.02 $ (0.01) $ (0.03) $ 0.19
======== ======== ======== ========

Weighted average common shares outstanding.......... 244,404 241,978 244,516 241,026
======== ======== ======== ========
Weighted average common and potential common shares
outstanding--assuming dilution.................... 258,583 241,978 244,516 257,016
======== ======== ======== ========
</TABLE>

The accompanying notes are an integral part of these condensed consolidated
financial statements.

4
<PAGE>
CADENCE DESIGN SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

<TABLE>
<CAPTION>
SIX MONTHS ENDED
-------------------
JULY 1, JULY 3,
2000 1999
-------- --------
<S> <C> <C>
Cash and Cash Equivalents at Beginning of Period............ $111,401 $209,074
-------- --------
Cash Flows from Operating Activities:
Net income (loss)......................................... (6,183) 49,855
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization........................... 95,819 76,736
Asset impairment and write-off of equipment and
non-current assets.................................... -- 4,974
Deferred income taxes................................... 14 13,584
Net investment gains on sale, equity loss, and
write-downs........................................... (5,124) 2,633
Write-off of acquired in-process technology............. -- 8,900
Minority interest expense............................... -- (126)
Provisions for losses on trade accounts receivable...... 883 6,250
Write-off of non-current assets......................... -- 2,145
Changes in operating assets and liabilities, net of
effect of acquired businesses:
Receivables........................................... (65,265) (54,947)
Inventories........................................... (809) 162
Prepaid expenses and other............................ (24,458) (16,666)
Installment contract receivables...................... 38,251 18,980
Accounts payable and accrued liabilities.............. 10,682 (6,441)
Income taxes payable.................................. -- (783)
Deferred revenue...................................... 40,352 21,804
Other long-term liabilities........................... 4,247 (5,834)
-------- --------
Net cash provided by operating activities........... 88,409 121,226
-------- --------

Cash Flows from Investing Activities:
Maturities of short-term investments--held-to-maturity.... 999 27,245
Purchases of short-term investments--held-to-maturity..... -- (57)
Maturities of short-term
investments--available-for-sale......................... 1,107 --
Purchases of property, plant, and equipment............... (46,652) (71,377)
Capitalization of software development costs.............. (14,714) (13,528)
Increase in acquired intangibles and other assets......... (21,848) (13,452)
Net investment in venture capital partnership and equity
investments............................................. (497) (5,770)
Cash effect of business acquisitions...................... (4,503) (2,806)
Sale of put warrants...................................... 25,516 3,609
Purchase of call options.................................. (25,516) (3,609)
-------- --------
Net cash used for investing activities.............. (86,108) (79,745)
-------- --------
Cash Flows from Financing Activities:
Proceeds from long-term debt.............................. -- 30,168
Principal payments on long-term debt and capital leases... (21,763) (165,000)
Proceeds from issuance of common stock.................... 40,945 49,642
Purchases of treasury stock............................... (98,631) (49,125)
Proceeds from transfer of financial assets in exchange for
cash.................................................... 80,808 77,162
-------- --------
Net cash provided by (used for) financing
activities........................................ 1,359 (57,153)
-------- --------
Effect of exchange rate changes on cash..................... (1,896) (442)
-------- --------
Net increase (decrease) in cash and cash equivalents........ 1,764 (16,114)
-------- --------
Cash and Cash Equivalents at End of Period.................. $113,165 $192,960
======== ========
</TABLE>

The accompanying notes are an integral part of these condensed consolidated
financial statements.

5
<PAGE>
CADENCE DESIGN SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

BASIS OF PRESENTATION

The condensed consolidated financial statements included herein have been
prepared by Cadence, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in consolidated financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. However, Cadence believes that the
disclosures are adequate to make the information presented not misleading. These
condensed consolidated financial statements should be read in conjunction with
the consolidated financial statements and the notes thereto included in
Cadence's Annual Report on Form 10-K for the fiscal year ended January 1, 2000.

The unaudited condensed consolidated financial statements included herein
reflect all adjustments (which include only normal, recurring adjustments) that
are, in the opinion of management, necessary to state fairly the results for the
periods presented. The results for such periods are not necessarily indicative
of the results to be expected for the full fiscal year.

The preparation of condensed consolidated financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the condensed consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.

Certain amounts in the condensed consolidated financial statements as of
January 1, 2000 and for the three and six months ended July 3, 1999 have been
reclassified to conform with the July 1, 2000 presentation.

INVENTORIES

Cadence's inventories include high technology parts and components for
complex computer systems that emulate the performance and operation of computer
chips and electronic systems.

A summary of inventories follows:

<TABLE>
<CAPTION>
JULY 1, JANUARY 1,
2000 2000
-------- ----------
(IN THOUSANDS)
<S> <C> <C>
Raw materials............................................ $12,615 $19,033
Work in process.......................................... 2,604 839
------- -------
Total inventories, net................................. $15,219 $19,872
======= =======
</TABLE>

6
<PAGE>
RESTRUCTURING

The following table summarizes Cadence's restructuring activity during the
six months ended July 1, 2000:

<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED JULY 1, 2000
------------------------------------------------------------
SEVERANCE
AND EXCESS OTHER
BENEFITS FACILITIES RESTRUCTURING ASSETS TOTAL
--------- ---------- ------------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Balance, January 1, 2000..................... $8,013 $6,464 $ 426 $5,861 $20,764
Non-cash charges........................... (110) (71) (62) (3,345) (3,588)
Cash charges............................... (1,650) (302) (364) (598) (2,914)
------ ------ ----- ------ -------
Balance, July 1, 2000........................ $6,253 $6,091 $ -- $1,918 $14,262
====== ====== ===== ====== =======
</TABLE>

CREDIT FACILITY

In October 1998, Cadence entered into a senior unsecured credit facility,
referred to as the 1998 Facility, with a syndicate of banks that allows Cadence
to borrow up to $355 million. As amended in September and November of 1999, the
1998 Facility is divided between a $177.5 million two year revolving credit
facility, referred to as the Two Year Facility, and a $177.5 million 364-day
revolving credit facility convertible into a one year term loan, referred to as
the 364-Day Facility. The Two Year Facility expires on September 29, 2001. The
364-Day Facility will either expire on September 27, 2000, be converted to a one
year term loan with a maturity date of September 27, 2001, or, at the request of
Cadence and with the agreement of the bank group, be renewed for one additional
year. Cadence has the option to pay interest based on LIBOR plus a spread of
between 1.25% and 1.50%, based on a pricing grid tied to a financial covenant,
or the higher of the (i) Federal Funds Rate plus 0.50% and (ii) prime rate. As a
result, Cadence's interest rate expenses associated with this borrowing will
vary with market rates. In addition, commitment fees are payable on the
unutilized portion of the Two Year Facility at rates between 0.23% and 0.30%
based on a pricing grid tied to a financial covenant and on the unutilized
portion of the 364-Day Facility at a fixed rate of 0.18%. The 1998 Facility
contains certain financial and other covenants.

During the six months ended July 1, 2000, Cadence repaid all of the
$20 million outstanding under the 1998 Facility at January 1, 2000. At July 1,
2000, there were no borrowings outstanding under the 1998 Facility.

COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) includes foreign currency translation gains and
losses and other unrealized gains and losses that have been previously excluded
from net income (loss) and reflected instead in equity. A summary of
comprehensive income (loss) follows:

<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
------------------- -------------------
JULY 1, JULY 3, JULY 1, JULY 3,
2000 1999 2000 1999
-------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Net income (loss)...................................... $ 5,626 $(3,007) $ (6,183) $49,855
Translation loss....................................... (1,549) (1,411) (1,667) (472)
Unrealized loss on investments......................... (20,826) (104) (27,603) (156)
-------- ------- -------- -------
Comprehensive income (loss).......................... $(16,749) $(4,522) $(35,453) $49,227
======== ======= ======== =======
</TABLE>

7
<PAGE>
NET INCOME (LOSS) PER SHARE

The following is a reconciliation of the weighted average common shares used
to calculate basic net income (loss) per share to the weighted average common
and potential common shares used to calculate diluted net income (loss) per
share:

<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
------------------- -------------------
JULY 1, JULY 3, JULY 1, JULY 3,
2000 1999 2000 1999
-------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Weighted average common shares used to calculate basic
net income (loss) per share........................... 244,404 241,978 244,516 241,026
Options............................................... 11,996 -- -- 14,368
Warrants and other contingent shares.................. 712 -- -- 307
Puts.................................................. 1,471 -- -- 1,315
------- ------- ------- -------
Weighted average common and potential common shares used
to calculate diluted net income (loss) per share...... 258,583 241,978 244,516 257,016
======= ======= ======= =======
</TABLE>

Had Cadence recorded net income for the six months ended July 1, 2000,
dilutive weighted outstanding options would have been 15.4 million and weighted
outstanding warrants, puts, and other dilutive contingent shares would have been
1.4 million.

CONTINGENCIES

Refer to Part II, Item 1 for a description of legal proceedings.

PUT WARRANTS AND CALL OPTIONS

Cadence has authorized three seasoned systematic stock repurchase programs
under which it repurchases common stock to satisfy estimated requirements for
shares to be issued under its Employee Stock Purchase Plan, or ESPP, the 1997
Nonstatutory Stock Option Plan, referred to as the 1997 Plan, and the 2000
Nonstatutory Stock Option Plan, referred to as the 2000 Plan. These repurchases
are intended to cover Cadence's expected reissuances under the ESPP for the next
12 months and both the 1997 Plan and 2000 Plan for the next 24 months.

As part of its authorized repurchase programs, Cadence has sold put warrants
through private placements. At July 1, 2000, there were 6.3 million put warrants
outstanding, each of which entitles the holder to sell one share of common stock
to Cadence on a specified date and at a specified price ranging from $18.02 to
$22.31 per share. Additionally, Cadence purchased call options that entitle
Cadence to buy shares of its common stock at a specified price to satisfy
anticipated stock repurchase requirements under Cadence's systematic stock
repurchase programs. At July 1, 2000, Cadence had 4.6 million call options
outstanding at exercise prices ranging from $18.27 to $22.56 per share. The put
warrants and call options outstanding at July 1, 2000 are exercisable on various
dates through February 2001 and Cadence has the contractual ability to settle
the options prior to their maturity. At July 1, 2000, the fair value of the call
options was approximately $12.1 million and the fair value of the put warrants
was approximately $16.7 million. The fair value of the put warrants and call
options was estimated by Cadence's investment bankers.

If exercised, Cadence has the right to settle the put warrants with that
number of shares of Cadence common stock having a value equal to the difference
between the exercise price and the fair value at the date of exercise.
Settlement of the put warrants with common stock could cause Cadence to issue a
substantial number of shares, depending on the exercise price of the put
warrants and the per share fair value of Cadence's common stock at the time of
exercise. In addition, settlement of put warrants in common stock could lead to
the disposition by put warrant holders of shares of Cadence's common stock

8
<PAGE>
that such holders may have accumulated in anticipation of the exercise of the
put warrants or call options, which may negatively affect the price of Cadence's
common stock. At July 1, 2000, because Cadence had the ability to settle these
put warrants with common stock, no amount was classified out of stockholders'
equity in the condensed consolidated balance sheets.

SEGMENT REPORTING

The following tables present information about reported segments for the
three months ended July 1, 2000 and July 3, 1999:

<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED JULY 1, 2000
--------------------------------------------------------
PRODUCT SERVICES MAINTENANCE OTHER TOTAL
-------- -------- ----------- --------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Revenue................................ $140,383 $80,177 $78,122 $ -- $298,682
Cost of revenue........................ 20,501 52,182 15,329 -- 88,012
Amortization of acquired intangibles... 10,562 9,306 -- -- 19,868
-------- ------- ------- --------- --------
Gross margin....................... 109,320 18,689 62,793 -- 190,802
Marketing and sales.................... -- -- -- (95,031) (95,031)
Research and development............... -- -- -- (65,772) (65,772)
General and administrative............. -- -- -- (23,751) (23,751)
Other income, net...................... -- -- -- 1,407 1,407
-------- ------- ------- --------- --------
Income (loss) before provision
(benefit) for income taxes........... $109,320 $18,689 $62,793 $(183,147) $ 7,655
======== ======= ======= ========= ========

<CAPTION>
FOR THE THREE MONTHS ENDED JULY 3, 1999
--------------------------------------------------------
Revenue. $117,890 $ 74,943 $ 71,360 $ -- $264,193
<S> <C> <C> <C> <C> <C>
Cost of revenue........................ 20,064 48,844 12,930 -- 81,838
Amortization of acquired intangibles... 11,632 1,224 -- -- 12,856
-------- ------- ------- --------- --------
Gross margin......................... 86,194 24,875 58,430 -- 169,499
Marketing and sales.................... -- -- -- (82,936) (82,936)
Research and development............... -- -- -- (50,359) (50,359)
General and administrative............. -- -- -- (20,903) (20,903)
Unusual items.......................... -- -- -- (19,648) (19,648)
Other income, net...................... -- -- -- 141 141
-------- ------- ------- --------- --------
Income (loss) before provision
(benefit) for income taxes........... $ 86,194 $24,875 $58,430 $(173,705) $ (4,206)
======== ======= ======= ========= ========
</TABLE>

9
<PAGE>
The following tables present information about reported segments for the six
months ended July 1, 2000 and July 3, 1999:

<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED JULY 1, 2000
--------------------------------------------------------
PRODUCT SERVICES MAINTENANCE OTHER TOTAL
-------- -------- ----------- --------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Revenue............................... $245,915 $155,992 $154,268 $ -- $556,175
Cost of revenue....................... 40,979 101,183 29,518 -- 171,680
Amortization of acquired
intangibles......................... 21,140 18,394 -- -- 39,534
-------- -------- -------- --------- --------
Gross margin........................ 183,796 36,415 124,750 -- 344,961
Marketing and sales................... -- -- -- (181,198) (181,198)
Research and development.............. -- -- -- (128,345) (128,345)
General and administrative............ -- -- -- (46,283) (46,283)
Other income, net..................... -- -- -- 2,453 2,453
-------- -------- -------- --------- --------
Income (loss) before provision
(benefit) for income taxes.......... $183,796 $ 36,415 $124,750 $(353,373) $ (8,412)
======== ======== ======== ========= ========

<CAPTION>
FOR THE SIX MONTHS ENDED JULY 3, 1999
--------------------------------------------------------
Revenue. $305,247 $147,417 $ 146,720 $ -- $599,384
<S> <C> <C> <C> <C> <C>
Cost of revenue....................... 38,600 96,102 25,830 -- 160,532
Amortization of acquired
intangibles......................... 22,951 2,619 -- -- 25,570
-------- -------- -------- --------- --------
Gross margin........................ 243,696 48,696 120,890 -- 413,282
Marketing and sales................... -- -- -- (162,999) (162,999)
Research and development.............. -- -- -- (101,227) (101,227)
General and administrative............ -- -- -- (42,163) (42,163)
Unusual items......................... -- -- -- (33,840) (33,840)
Other income, net..................... -- -- -- 276 276
-------- -------- -------- --------- --------
Income (loss) before provision
(benefit) for income taxes.......... $243,696 $ 48,696 $120,890 $(339,953) $ 73,329
======== ======== ======== ========= ========
</TABLE>

TALITY CORPORATION

On July 17, 2000, Cadence announced its plan to separate its electronics
design services group into a new, publicly traded company named Tality
Corporation, or Tality. In furtherance of this plan, Tality has filed a
registration statement with the Securities and Exchange Commission for its
initial public offering. The completion of the separation and initial public
offering is contingent upon certain conditions, including market conditions. The
financial statements and financial information in this Quarterly Report on
Form 10-Q do not give effect to the separation, which has not been completed as
of the date of this report. We expect that the separation of this business from
Cadence, including the transfer of related assets, liabilities and intellectual
property rights, will be substantially completed prior to the completion of the
initial public offering. Immediately following the separation and initial public
offering, Cadence will own approximately 80% of Tality's equity and consolidate
its financial results.

The full impact of the planned separation, if it occurs, on Cadence's
business, operating results, and financial condition cannot be predicted at this
time. However, certain incremental expenses are expected to be incurred in
future periods as decisions are made regarding the separation.

NEW ACCOUNTING STANDARDS

In March 2000, the Financial Accounting Standards Board, or FASB, issued
interpretation No. 44, "Accounting for Certain Transactions involving Stock
Compensation", an interpretation of Accounting

10
<PAGE>
Pinciples Board, or APB, Opinion No. 25. This interpretation provides guidance
regarding the application of APB Opinion No. 25 to stock compensation involving
employees. This interpretation is effective July 1, 2000 and is not expected to
have a material effect on Cadence's financial position, results of operations,
or cash flows.

In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin, No. 101, "Revenue Recognition in Financial Statements," or
SAB 101, which provides guidance on the recognition, presentation, and
disclosure of revenue in financial statements. SAB 101 will be adopted in the
fourth quarter of fiscal 2000. The adoption of this statement is not expected to
have a material effect on Cadence's financial position, results of operations,
or cash flows.

In June 1998, the FASB issued Statement of Financial Accounting Standards,
or SFAS, No. 133, "Accounting for Derivative Instruments and Hedging
Activities." SFAS No. 133 establishes accounting and reporting standards
requiring that every derivative instrument be recorded in the balance sheet as
either an asset or liability measured at its fair value. It requires that
changes in the derivative's fair value be recognized currently in earnings
unless specific hedge accounting criteria are met and that a company must
formally document, designate, and assess the effectiveness of transactions that
receive hedge accounting. In June 1999, SFAS No. 137, "Accounting for Derivative
Instruments and Hedging Activities--Deferral of the Effective Date of FASB
Statement No. 133," was issued. The statement defers the effective date of SFAS
No. 133 until the first quarter of fiscal 2001. The adoption of this statement
is not expected to have a material effect on Cadence's financial position,
results of operations, or cash flows.

11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO INCLUDED ELSEWHERE IN THIS
QUARTERLY REPORT ON FORM 10-Q. EXCEPT FOR HISTORICAL INFORMATION, THE FOLLOWING
DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS BASED ON CURRENT EXPECTATIONS
THAT INVOLVE CERTAIN RISKS AND UNCERTAINTIES. CADENCE'S ACTUAL RESULTS COULD
DIFFER MATERIALLY FROM THOSE DISCUSSED HEREIN. FACTORS THAT COULD CAUSE ACTUAL
RESULTS OR PERFORMANCE TO DIFFER MATERIALLY OR CONTRIBUTE TO SUCH DIFFERENCES
INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED BELOW IN "RESULTS OF
OPERATIONS," "LIQUIDITY AND CAPITAL RESOURCES," "FACTORS THAT MAY AFFECT FUTURE
RESULTS," AND "DISCLOSURES ABOUT MARKET RISK."

OVERVIEW

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

TALITY CORPORATION

On July 17, 2000, Cadence announced its plan to separate its electronics
design services group into a new, publicly traded company named Tality
Corporation, or Tality. In furtherance of this plan, Tality has filed a
registration statement with the Securities and Exchange Commission for its
initial public offering. The completion of the separation and initial public
offering is contingent upon certain conditions, including market conditions. The
financial statements and financial information in this Quarterly Report on
Form 10-Q do not give effect to a separation, which has not been completed as of
the date of this report. We expect that the separation of this business from
Cadence, including the transfer of related assets, liabilities and intellectual
property rights, will be substantially completed prior to the completion of the
initial public offering. Immediately following the separation and initial public
offering, Cadence will own approximately 80% of Tality's equity and consolidate
its financial results.

As Cadence executes the separation of Tality from Cadence, Cadence is
incurring certain incremental costs, primarily for legal and accounting
services, strategic business planning, information systems separation,
development of compensation and benefits strategies, and recruitment of certain
key Tality management. Direct costs of the Tality initial public offering, such
as the underwriter's commissions, legal, and accounting fees will be deducted
from the proceeds of the offering.

12
<PAGE>
RESULTS OF OPERATIONS

<TABLE>
<CAPTION>
SIX MONTHS
THREE MONTHS ENDED ENDED
--------------------- -------------------
JULY 1, JULY 3, JULY 1, JULY 3,
2000 1999 % CHANGE 2000 1999 % CHANGE
--------- --------- -------- -------- -------- --------
(IN MILLIONS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C> <C> <C>
REVENUE
Product.................................... $140.4 $117.9 19% $245.9 $305.3 (19)%
Services................................... 80.2 74.9 7% 156.0 147.4 6%
Maintenance................................ 78.1 71.4 9% 154.3 146.7 5%
------ ------ ------ ------
Total revenue............................ $298.7 $264.2 13% $556.2 $599.4 (7)%
====== ====== ====== ======

SOURCES OF REVENUE AS A PERCENT OF TOTAL REVENUE
Product.................................... 47% 45% 44% 51%
Services................................... 27% 28% 28% 25%
Maintenance................................ 26% 27% 28% 24%
</TABLE>

Product revenue increased $22.5 million and decreased $59.4 million in the
three and six months ended July 1, 2000, respectively, when compared to the same
periods in 1999. The increase in the three months ended July 1, 2000 was
primarily due to the increased sales volume of intellectual property creation
products, which include mixed signal and simulation products, as well as sales
of printed circuit board related product associated with the acquisition of
OrCAD, Inc., or OrCAD, which was completed in the third quarter of 1999 and for
which there were no similar sales in the comparable period in 1999. The decrease
in the six months ended July 1, 2000 was due to an overall decrease in sales
volume of Cadence's software products and the implementation of Cadence's
software subscription licensing model, first implemented during the third
quarter of 1999. The decrease in sales volume of products was primarily
attributable to lower sales of integrated circuit implementation products, which
include place and route and physical design and verification products, partially
offset by sales associated with the OrCAD acquisition.

Services revenue increased $5.3 million and $8.6 million in the three and
six months ended July 1, 2000, respectively, when compared to the same periods
in 1999, primarily due to an increase in demand for Cadence's design services
and billable hours incurred for design services, partially offset by a decrease
in methodology services engagements due to lower staffing levels in the current
periods. Increases in design services revenue were primarily due to an increase
in the wireless communications area with general increases in each of the other
remaining areas, wired communications, information appliances, and industrial
electronics.

Maintenance revenue increased $6.7 million and $7.6 million in the three and
six months ended July 1, 2000, respectively, when compared to the same periods
in 1999, primarily due to the growth of the installed customer base and the
renewal of maintenance and support contracts.

<TABLE>
<CAPTION>
SIX MONTHS
THREE MONTHS ENDED ENDED
--------------------- -------------------
JULY 1, JULY 3, JULY 1, JULY 3,
2000 1999 % CHANGE 2000 1999 % CHANGE
--------- --------- -------- -------- -------- --------
(IN MILLIONS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C> <C> <C>
REVENUE BY GEOGRAPHY
Domestic................................... $160.5 $142.9 12% $312.7 $277.5 13%
International.............................. 138.2 121.3 14% 243.5 321.9 (24)%
------ ------ ------ ------
Total revenue............................ $298.7 $264.2 13% $556.2 $599.4 (7)%
====== ====== ====== ======

REVENUE BY GEOGRAPHY AS A PERCENT OF TOTAL
REVENUE
Domestic................................... 54% 54% 56% 46%
International.............................. 46% 46% 44% 54%
</TABLE>

13
<PAGE>
International revenue increased $16.9 million and decreased $78.4 million in
the three and six months ended July 1, 2000, respectively, when compared to the
same periods in 1999. The increase in the three months ended July 1, 2000 was
primarily due to increases in product and maintenance revenue in Europe,
partially offset by a decrease in services revenue in Europe and product and
maintenance revenue in Japan. The decrease in the six months ended July 1, 2000
was primarily due to decreases in product revenue in Japan and Asia and
decreases in services revenue in Europe and Japan.

Foreign currency exchange rates positively affected revenue by $2.9 million
and $4.6 million during the three and six months ended July 1, 2000,
respectively, when compared to the same periods in 1999, primarily due to the
strengthening of the Japanese yen in relation to the U.S. dollar, offset
partially by the weakening of the British pound sterling and German deutsche
mark in relation to the U.S. dollar. Foreign currency exchange rates positively
affected revenue by $3.9 million and $8 million during the three and six months
ended July 3, 1999, respectively, primarily due to the strengthening of the
Japanese yen in relation to the U.S. dollar.

<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
--------------------- -------------------
JULY 1, JULY 3, JULY 1, JULY 3,
2000 1999 % CHANGE 2000 1999 % CHANGE
--------- --------- -------- -------- -------- --------
(IN MILLIONS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C> <C> <C>
COST OF REVENUE
Product................................ $20.5 $20.1 2% $ 41.0 $38.6 6%
Services............................... $52.2 $48.8 7% $101.2 $96.1 5%
Maintenance............................ $15.3 $12.9 19% $ 29.5 $25.8 14%

COST OF REVENUE AS A PERCENT OF RELATED
REVENUE
Product................................ 15% 17% 17% 13%
Services............................... 65% 65% 65% 65%
Maintenance............................ 20% 18% 19% 18%
</TABLE>

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

Cost of product revenue remained flat for the three months ended July 1,
2000 and increased $2.4 million for the six months ended July 1, 2000, when
compared to the same periods in 1999. The increase in cost of product revenue in
the six months ended July 1, 2000 was primarily due to higher manufacturing
costs associated with emulation system products.

Because the majority of Cadence's cost of software product revenue does not
vary significantly with changes in revenue, product gross margin increased in
the three months ended July 1, 2000, when compared to the same period in 1999,
primarily due to an increase in sales volume of software products. Product gross
margin decreased in the six months ended July 1, 2000, when compared to the same
period in 1999, due to a decrease in sales volume of software products and the
implementation of Cadence's software subscription licensing model, which was
implemented during the third quarter of 1999.

Cost of services revenue includes costs associated with providing services
to customers, primarily salaries and costs to recruit, develop, and retain
personnel, and costs to maintain the infrastructure necessary to manage a
services organization. Cost of services revenue increased $3.4 million and
$5.1 million in the three and six months ended July 1, 2000, respectively, when
compared to the same periods in 1999, primarily due to Cadence's addition of
services professionals, in connection with its acquisition of Diablo Research
Company LLC, or Diablo, which was completed in the fourth quarter of 1999.

Services gross margin remained flat for the three and six months ended
July 1, 2000, when compared to the same periods in 1999. Services gross margin
has been, and may continue to be, harmed by Cadence's inability to fully utilize
its services resources. In addition, services gross margin may continue to be
harmed

14
<PAGE>
by Cadence's inability to achieve operating efficiencies while implementing a
growing number of services offerings.

Cost of maintenance revenue includes the cost of customer services, such as
hot-line and on-site support, production personnel, packaging, and documentation
of maintenance updates. Cost of maintenance revenue increased $2.4 million and
$3.7 million in the three and six months ended July 1, 2000, respectively, when
compared to the same periods in 1999, due to increases in employee-related costs
and costs associated with the OrCAD acquisition which was completed in the third
quarter of 1999 for which there were no similar costs in the first six months of
1999.

<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
--------------------- -------------------
JULY 1, JULY 3, JULY 1, JULY 3,
2000 1999 2000 2000
--------- --------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C> <C>
AMORTIZATION OF ACQUIRED INTANGIBLES
Amortization of acquired intangibles........................ $19.9 $12.9 $39.5 $25.6

AMORTIZATION OF ACQUIRED INTANGIBLES AS A PERCENT OF TOTAL
REVENUE
Amortization of acquired intangibles........................ 7% 5% 7% 4%
</TABLE>

Amortization of acquired intangibles increased $7 million and $13.9 million
in the three and six months ended July 1, 2000, respectively, when compared with
the same periods in 1999, primarily due to the 1999 acquisitions of OrCAD and
Diablo.

<TABLE>
<CAPTION>
SIX MONTHS
THREE MONTHS ENDED ENDED
--------------------- -------------------
JULY 1, JULY 3, JULY 1, JULY 3,
2000 1999 % CHANGE 2000 1999 % CHANGE
--------- --------- -------- -------- -------- --------
(IN MILLIONS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C> <C> <C>
OPERATING EXPENSES
Marketing and sales........................ $95.0 $82.9 15% $181.2 $163.0 11%
Research and development................... $65.8 $50.4 31% $128.3 $101.2 27%
General and administrative................. $23.8 $20.9 14% $ 46.3 $ 42.2 10%

EXPENSES AS A PERCENT OF TOTAL REVENUE
Marketing and sales........................ 32% 31% 33% 27%
Research and development................... 22% 19% 23% 17%
General and administrative................. 8% 8% 8% 7%
</TABLE>

Marketing and sales expenses increased $12.1 million and $18.2 million in
the three and six months ended July 1, 2000, respectively, when compared to the
same periods in 1999, primarily due to an increase in employee-related costs and
costs associated with the 1999 acquisition of OrCAD for which there were no
similar costs in the first six months of 1999. Foreign currency exchange rates
for the three and six months ended July 1, 2000, when compared to the same
periods in 1999, had a negligible effect on reported marketing and sales
expense.

Cadence's expenses in research and development, prior to the reduction for
capitalization of software development costs, were $71.7 million, representing
24% of total revenue, in the three months ended July 1, 2000 and $57.5 million,
representing 22% of total revenue, for the three months ended July 3, 1999. For
the three and six months ended July 1, 2000, Cadence capitalized software
development costs of $6 million and $14.7 million, respectively, representing 8%
and 10% of total research and development expenditures, respectively. For the
three and six months ended July 3, 1999, Cadence capitalized software
development costs of $7.1 million and $13.5 million, respectively, representing
12% and 10% of total research and development expenditures, respectively. The
decrease and increase in capitalized software development costs for the three
and six month periods ended July 1, 2000, respectively, resulted primarily from
increases and decreases in hours incurred on new product development and new
product releases. In any given period, the amount of capitalized software
development costs may vary depending on the exact nature of the development
performed.

15
<PAGE>
The increase in net research and development expenses of $15.4 million and
$27.1 million for the three and six months ended July 1, 2000, respectively,
when compared to the same periods in 1999, was primarily attributable to
employee-related costs, consulting costs, and costs associated with the 1999
acquisition of OrCAD for which there were no similar costs in the first six
months of 1999.

General and administrative expenses increased $2.8 million and $4.1 million
in the three and six months ended July 1, 2000, respectively, when compared to
the same periods in 1999, primarily due to employee-related costs and costs
attributable to the OrCAD and Diablo acquisitions, offset partially by a
reduction in bad debt expense.

UNUSUAL ITEMS

The following table presents information regarding unusual items for the
three and six months ended July 3, 1999:

<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED ENDED
JULY 3, JULY 3,
1999 1999
------------ ----------
(IN MILLIONS)
<S> <C> <C>
Restructuring charges................................ $10.7 $12.9
Merger costs......................................... 8.4 8.4
Asset impairment..................................... 3.5 6.6
Litigation settlement................................ (3.0) (3.0)
Write-off of acquired in-process technology.......... -- 8.9
----- -----
Total unusual items.............................. $19.6 $33.8
===== =====
</TABLE>

RESTRUCTURING

In the three months ended July 3, 1999, Cadence recorded $10.7 million in
restructuring charges, including severance costs to terminate 49 employees and
to consolidate facilities. Severance costs of $8.7 million relate to
restructuring plans primarily aimed at reducing costs after Cadence merged with
Quickturn, further actions taken to restructure the Cadence services business in
Japan, and severance expense resulting from the resignation of Cadence's former
Chief Executive Officer.

Facilities consolidation charges of $2 million were incurred in connection
with the closure of 15 Quickturn facilities, including $1 million to close and
exit the excess facilities and $1 million of related leasehold improvement
abandonment costs. Closure and exit costs include payments required under lease
contracts, less any applicable sublease income, after the properties were
abandoned, lease buyout costs, restoration costs associated with certain lease
arrangements, and costs to maintain facilities during the period after
abandonment. Asset related costs written-off consist of leasehold improvements
of facilities that were abandoned and whose estimated fair market value is zero.
As of July 1, 2000, all of the 15 excess Quickturn sites had been vacated.
Noncancelable lease payments on vacated facilities will be paid out through
2003.

In the three months ended April 3, 1999, Cadence recorded $2.2 million in
severance costs to terminate 45 employees. These actions were taken to complete
Cadence's restructuring program initiated in the fourth quarter of 1998. The
restructuring plan was primarily aimed at reducing the costs of excess personnel
in its services business.

Actual amounts of termination benefits, facilities, and other restructuring
related payments can be found in Notes to Condensed Consolidated Financial
Statements under "RESTRUCTURING."

16
<PAGE>
MERGER COSTS

In connection with the acquisition of Quickturn, Cadence charged to expense
$8.4 million representing merger costs in the three month period ended July 3,
1999. These merger costs represented professional fees for financial advisors,
attorneys, and accountants.

ASSET IMPAIRMENT

In the three months ended July 3, 1999, Cadence incurred charges totaling
$3.5 million in connection with the cancellation of an information technology
services contract with a third-party and the abandonment of capitalized software
development costs associated with Cadence products that will no longer be sold.

In the three months ended April 3, 1999, Cadence incurred charges totaling
$3.1 million in connection with the abandonment of certain third-party software
licenses that will no longer be used by its design services business and
capitalized software development costs associated with Cadence products that
will no longer be sold.

The impairment losses recorded for the six months ended July 3, 1999 were
the amounts by which the carrying amounts of the intangible assets exceeded
their fair market values.

LITIGATION SETTLEMENT

In June 1999, Cadence and Mentor Graphics Corporation announced the
settlement of a patent infringement action pending in the United States District
Court for the District of Oregon. As a result, the court entered a judgment
declaring that certain Quickturn patents are valid, enforceable, and were
infringed by Mentor's sale of SimExpress products in the U.S. Mentor is
permanently enjoined from producing, marketing or selling SimExpress emulation
systems in the U.S. In connection with the settlement, Mentor paid Cadence
$3 million.

IN-PROCESS TECHNOLOGY

In January 1999, Cadence acquired Design Acceleration, Inc., or DAI, a
supplier of design verification technology used in system-on-a-chip, or SOC,
design. The total purchase price was $25.7 million and the acquisition was
accounted for as a purchase.

Upon consummation of the DAI acquisition, Cadence immediately charged to
expense $8.9 million representing acquired in-process technology that had not
yet reached technological feasibility and had no alternative future use. The
value assigned to acquired in-process technology was determined by identifying
research projects in areas for which technological feasibility has not been
established. The value was determined by estimating the costs to develop the
acquired in-process technology into commercially viable products, estimating the
resulting net cash flows from such projects, and discounting the net cash flows
back to their present value. The discount rate included a factor that took into
account the uncertainty surrounding the successful development of the acquired
in-process technology. Certain acquired in-process technology under development
at the time of acquisition was initially expected to become commercially viable
in 1999, but has since been delayed to 2000 and 2001. Expenditures to complete
this in-process technology are expected to total approximately $1.5 million.
These estimates are subject to change, given the uncertainties of the
development process, and no assurance can be given that deviations from these
estimates will not occur. Additionally, these projects will require expenditures
for additional research and development after they have reached a state of
technological and commercial feasibility.

To date, DAI's results have not differed significantly from the forecasted
assumptions. In addition, Cadence's research and development expenditures since
the acquisition have not differed materially from expectations. Revenue
contribution from the acquired technology falls within an acceptable range of
plans in its role in Cadence's suite of design systems and tools. The risks
associated with the research and

17
<PAGE>
development are still considered high and no assurance can be made that these
future products will meet market expectations.

OTHER INCOME AND INCOME TAXES

Other income increased $1.3 million and $2.2 million in the three and six
months ended July 1, 2000, respectively, when compared to the same periods in
1999, primarily due to an increase in foreign exchange gains and a decrease in
interest income. The decrease in interest income was due to a lower average
balance of invested cash and short-term investments.

Cadence's estimated effective tax rate for the three and six months ended
July 1, 2000 was 26.5%. The effective tax rate for the three and six months
ended July 3, 1999 was 28.5%, excluding the effect of the write-off of acquired
in-process technology of $8.9 million, which is not deductible for income tax
purposes. The decrease in the 2000 effective tax rate when compared to 1999 is
primarily due to foreign earnings being taxed at a lower rate.

LIQUIDITY AND CAPITAL RESOURCES

At July 1, 2000, Cadence's principal sources of liquidity consisted of
$119.4 million of cash and short-term investments, compared to $118.8 million at
January 1, 2000, and a $355 million senior unsecured credit facility. As of
July 1, 2000, Cadence had no outstanding borrowings under the credit facility.

Cash provided by operating activities decreased $32.8 million to
$88.4 million for the six months ended July 1, 2000, when compared to the six
months ended July 3, 1999. The decrease was primarily due to decreases in net
income before unusual items, deferred income taxes, receivables, and prepaid
expenses, partially offset by increases in depreciation and amortization,
installment contract receivables, accounts payable and accrued liabilities, and
deferred revenue.

At July 1, 2000, Cadence had net working capital of $31.5 million compared
with $58.4 million at January 1, 2000. The working capital decrease was driven
primarily by a decrease in receivables of $16.2 million and an increase in
deferred revenue of $40.4 million, partially offset by an increase in prepaid
expenses and other of $24.6 million, and to a lesser extent, a decrease in
accounts payable and accrued liabilities of $8.5 million. The increase in
prepaid expenses and other was primarily due to an increase in unbilled
professional services and prepaid income taxes.

In addition to its short-term investments, Cadence's primary investing
activities consisted of purchases of property, plant, and equipment,
capitalization of software development costs, acquired intangibles and other
assets, venture capital partnership investments and equity investments, and
business acquisitions, which combined represented $95.8 million and
$106.9 million of cash used for investing activities in the six months ended
July 1, 2000 and July 3, 1999, respectively.

Since 1994, Cadence has sold put warrants and purchased call options through
private placements. See "Notes to Condensed Consolidated Financial Statements."
At July 1, 2000, Cadence had a maximum potential obligation related to put
warrants to repurchase 6.3 million shares of its common stock at an aggregate
price of approximately $131 million. The put warrants will expire on various
dates through February 2001, and Cadence has the contractual ability to settle
the options prior to their maturity. Cadence has the ability to settle these put
warrants with stock and, therefore, no amount was classified out of
stockholders' equity in the condensed consolidated balance sheets.

Anticipated cash requirements for the remainder of 2000 includes working
capital, capital expenditures and payment of operating expenses, including
marketing and sales expense, research and development expense, general and
administrative expense and potential acquisitions of, or investments in,
complementary businesses or technologies, and the purchase of treasury stock
through Cadence's stock repurchase programs.

18
<PAGE>
As part of its overall investment strategy, Cadence has become a limited
partner in a venture capital fund and is committed to invest up to
$100 million. As of July 1, 2000, Cadence had contributed approximately
$45.2 million to this partnership, which is reflected in other assets in the
accompanying condensed consolidated balance sheets, net of operating losses.

Cadence anticipates that current cash and short-term investment balances,
cash flows from operations, and its $355 million revolving credit facility will
be sufficient to meet its working capital requirements on a short-and long-term
basis.

Cadence will continue to fund Tality's operations, as it has done
historically, through the date that Tality receives the net proceeds from its
planned initial public offering.

NEW ACCOUNTING STANDARDS

In March 2000, the Financial Accounting Standards Board, or FASB, issued
interpretation No. 44, "Accounting for Certain Transactions involving Stock
Compensation", an interpretation of Accounting Principles Board, or APB, Opinion
No. 25. This interpretation provides guidance regarding the application of APB
Opinion No. 25 to stock compensation involving employees. This interpretation is
effective July 1, 2000 and is not expected to have a material effect on
Cadence's financial position, results of operations, or cash flows.

FACTORS THAT MAY AFFECT FUTURE RESULTS

The following risk factors and other information included in this Quarterly
Report on Form 10-Q should be carefully considered. The risks and uncertainties
described below are not the only ones we face. Additional risks and
uncertainties not presently known to us or that we currently deem immaterial
also may impair our business operations. If any of the following risks actually
occurs, our business, operating results, and financial condition could be
materially harmed. The risk factors affecting Tality Corporation which,
immediately after its separation from Cadence and initial public offering, will
remain a subsidiary of Cadence, are described in detail in the Registration
Statement on Form S-1 filed by Tality Corporation with the Securities and
Exchange Commission on July 17, 2000, as amended.

WE ARE IN THE PROCESS OF RESTRUCTURING OUR DESIGN SERVICES GROUP AS A SEPARATE
COMPANY, WHICH MAY IMPACT OUR FINANCIAL RESULTS

Since 1995, Cadence has operated an internal electronics design services
group. On July 17, 2000, Cadence announced its plan to separate its design
services group into a separate company focused on

19
<PAGE>
providing design solutions and proprietary technology to electronics product
companies and integrated circuit manufacturers, and announced the planned
initial public offering of the separate company. Upon completion of this
offering, Cadence will hold approximately 80% of the voting power of the new
company. While Cadence does not currently plan to distribute to Cadence
stockholders its equity interests in Tality Corporation or its subsidiaries, it
will have the right at any time to convert and thereafter sell some or all of
its shares of voting stock. Cadence has agreed with the underwriters not to
transfer its equity interests in Tality Corporation and limited partnership
units in Tality, LP for 180 days after the date of the initial public offering
of Tality Corporation, except with the prior written consent of Goldman,
Sachs & Co. After the expiration of this 180-day period, Cadence will no longer
be restricted from transferring any of its common stock of Tality Corporation or
limited partnership units in Tality, LP to the public or its stockholders.
Cadence currently expects that the principal factors that it would consider in
determining whether and when to exchange, convert, sell or distribute to its
stockholders any of its shares or partnership units include:

- The relative market prices of its Tality's common stock and Cadence's
common stock;

- The ability of an affiliate of Tality to make sales under Rule 144 of the
Securities Act of 1933 or under an effective registration statement
covering Cadence's shares of Tality's common stock;

- The absence of any court order or other regulation prohibiting or
restricting such sales; and

- Other conditions affecting Tality's business or Cadence's business.

CADENCE ALSO RETAINS THE RIGHT TO SELL ANY OR ALL OF ITS TALITY, LP LIMITED
PARTNERSHIP UNITS TO ONE OR MORE THIRD PARTIES FOR STRATEGIC OR OTHER REASONS

In connection with the separation, Cadence will also enter into a number of
agreements governing the business relationships between the companies and the
provision of certain services, including provision of certain facilities, and
accounting, finance, legal, human resources and other administrative services.
As a result, Cadence will be obligated to provide certain services to Tality for
the periods defined in the various agreements.

CADENCE LACKS LONG-TERM EXPERIENCE IN ITS ELECTRONICS DESIGN AND METHODOLOGY
SERVICES BUSINESS

Cadence has no long-term experience in offering electronics design and
methodology services and therefore may not be as experienced in this business as
others. The market for these services is relatively new and rapidly evolving.
Cadence expects the expenses of the design services business to increase
substantially in connection with Tality's separation from Cadence and as it
continues to expand its operations. The rate of growth of the design services
group's revenue over prior periods may not continue or increase, and its
separation and expansion may prove more expensive than Cadence anticipates. If
Tality fails to increase its revenue to offset its expenses, the design services
group will continue to experience losses. Cadence's or Tality's failure to
succeed in these services businesses may seriously harm Cadence's business,
operating results, and financial condition.

THE SUCCESS OF CADENCE'S ELECTRONIC DESIGN AND METHODOLOGY SERVICES BUSINESSES
DEPENDS ON MANY FACTORS THAT ARE BEYOND ITS CONTROL

In order to be successful with its electronics design and methodology
services, Cadence must overcome several factors that are beyond its control,
including the following:

- MANY SERVICE CONTRACTS GENERALLY REPRESENT LARGE AMOUNTS OF REVENUE.
Cadence's electronics design and methodology services contracts generally
represent a relatively large amount of revenue per order. Therefore, the
loss of individual orders could seriously hurt Cadence's revenue and
operating results.

20
<PAGE>
- CADENCE'S COST OF SERVICES PERSONNEL IS HIGH AND REDUCES GROSS MARGIN.
Gross margin represents the difference between the amount of revenue from
the sale of services and Cadence's cost of providing those services.
Cadence must pay high salaries to professional services personnel to
attract and retain them. This results in a lower gross margin than the
gross margin in Cadence's software business. In addition, the high cost of
training new services personnel or not fully utilizing these personnel can
significantly lower gross margin.

Additionally, a substantial portion of these services contracts are
fixed-price contracts. This means that the customer pays a fixed price that has
been agreed upon ahead of time, no matter how much time or how many resources
Cadence must devote to perform the contract. If Cadence's cost in performing the
services consistently and significantly exceeds the amount the customer has
agreed to pay, it could seriously harm Cadence's business, operating results,
and financial condition.

CADENCE'S FAILURE TO RESPOND QUICKLY TO TECHNOLOGICAL DEVELOPMENTS COULD MAKE
ITS PRODUCTS UNCOMPETITIVE AND OBSOLETE

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

- The size of features such as wires, transistors, and contacts on chips is
shrinking due to advances in semiconductor manufacturing processes.
Process feature sizes refer to the width of the transistors and the width
and spacing of the interconnect on the chip. Feature size is normally
identified by the headline transistor length, which is shrinking from 0.35
microns to 0.18 microns and below. This is commonly referred to in the
semiconductor industry as the migration to deep submicron and represents a
major challenge for all levels of the semiconductor industry from design
and design automation to design of manufacturing equipment and the
manufacturing process itself. Shrinkage of transistor length to such
infinitesimal proportions (for reference, the diameter of the period at
the end of this sentence is approximately 400 microns) is challenging
fundamental laws of physics and chemistry.

- The ability to design very large chips, in particular integration of
entire electronic systems onto a single chip instead of a circuit board (a
process that is referred to in the industry as SOC), increases the
complexity of managing a design that at the lowest level is represented by
billions of shapes on the fabrication mask. In addition, systems typically
incorporate microprocessors and digital signal processors that are
programmed with software, requiring simultaneous design of the silicon
chip and the related embedded software on the chip.

If Cadence is unable to respond quickly and successfully to these
developments and changes, Cadence may lose its competitive position and its
products or technologies may become uncompetitive or obsolete. In order to
compete successfully, Cadence must develop or acquire new products and improve
its existing products and processes on a schedule that keeps pace with
technological developments in its industries. Cadence must also be able to
support a range of changing computer software, hardware platforms and customer
preferences. There is no guarantee that Cadence will be successful in this
regard.

CADENCE'S FAILURE TO OBTAIN SOFTWARE OR OTHER INTELLECTUAL PROPERTY LICENSES OR
ADEQUATELY PROTECT ITS PROPRIETARY RIGHTS COULD SERIOUSLY HARM ITS BUSINESS

Cadence's success depends, in part, upon its proprietary technology. Many of
Cadence's products include software or other intellectual property licensed from
third parties, and Cadence may have to seek new or renew existing licenses for
this software and other intellectual property in the future. Cadence's design
services business also requires it to license software or other intellectual
property of third parties. Cadence's failure to obtain for its use software or
other intellectual property licenses or other intellectual property rights on
favorable terms, or the need to engage in litigation over these licenses or
rights, could seriously harm Cadence's business, operating results, and
financial condition.

21
<PAGE>
Also, Cadence generally relies on patents, copyrights, trademarks and trade
secret laws to establish and protect its proprietary rights in technology and
products. Despite precautions Cadence may take to protect its intellectual
property, Cadence cannot assure you that third parties will not try to
challenge, invalidate, or circumvent these patents. Cadence also cannot assure
you that the rights granted under its patents will provide it with any
competitive advantages, patents will be issued on any of its pending
applications, or future patents will be sufficiently broad to protect Cadence's
technology. Furthermore, the laws of foreign countries may not protect Cadence's
proprietary rights in those countries to the same extent as U.S. law protects
these rights in the U.S.

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

INTELLECTUAL PROPERTY INFRINGEMENT BY OR AGAINST CADENCE COULD SERIOUSLY HARM
ITS BUSINESS

There are numerous patents in the EDA industry and new patents are being
issued at a rapid rate. It is not always economically practicable to determine
in advance whether a product or any of its components infringes the patent
rights of others. As a result, from time to time, Cadence may be forced to
respond to or prosecute intellectual property infringement claims to protect its
rights or defend a customer's rights. These claims, regardless of merit, could
consume valuable management time, result in costly litigation, or cause product
shipment delays, all of which could seriously harm Cadence's business, operating
results, and financial condition. In settling these claims, Cadence may be
required to enter into royalty or licensing agreements with the third parties
claiming infringement. These royalty or licensing agreements, if available, may
not have terms acceptable to Cadence. Being forced to enter into a license
agreement with unfavorable terms could seriously harm Cadence's business,
operating results, and financial condition.

CADENCE OBTAINS KEY COMPONENTS FOR ITS HARDWARE PRODUCTS FROM A LIMITED NUMBER
OF SUPPLIERS

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

FLUCTUATIONS IN QUARTERLY RESULTS OF OPERATIONS COULD HURT CADENCE'S BUSINESS
AND THE MARKET PRICE OF ITS STOCK

Cadence has experienced, and may continue to experience, varied quarterly
operating results. Various factors affect Cadence's quarterly operating results
and some of them are not within Cadence's control, including the mix of products
and services sold, the mix of licenses used to sell products and the timing of
significant orders for its software products by customers. Quarterly operating
results are affected by the mix of products sold because there are significant
differences in margins from the sale of hardware and software products and
services. For example, based on a three-year average in 1999 Cadence had
realized gross margins on software product sales of approximately 91% but
realized gross margins of approximately 65% on hardware product sales and 32% on
its performance of services. In the second quarter of 2000, realized gross
margins decreased to approximately 90% for software products and increased to
approximately 67% for hardware products and to 35% for services. In addition,
Cadence's quarterly operating results are affected by the mix of licenses
entered into in connection with the sale of software products. Cadence has three
basic licensing models: perpetual, fixed-term, and subscription. Perpetual and
fixed-term licenses recognize a larger portion of the revenue at the beginning
of the license period and

22
<PAGE>
subscription licenses recognize revenue ratably over each quarter of the term of
the license. As Cadence customers purchase more software products pursuant to
subscription agreements, future operating results may be lower than that of
comparable quarters in which perpetual and fixed-term licenses were in greater
use for software product transactions. Finally, Cadence's quarterly operating
results are affected by the timing of significant orders for its software
products because a significant number of contracts for software products are in
excess of $5 million. The failure to close a contract for the sale of one or
more orders of Cadence's software products could seriously harm its quarterly
operating results.

Cadence's hardware verification products typically have a lengthy sales
cycle, during which Cadence may expend substantial funds and management effort
without any assurance that a sale will result. Sales of Cadence's hardware
products depend, in significant part, upon the decision of the prospective
customer to commence a project for the design and development of complex
computer chips and systems. Such projects often require significant commitments
of time and capital. Cadence's hardware sales may be delayed if customers delay
commencement of projects. Lengthy hardware sales cycles subject Cadence to a
number of significant risks over which Cadence has little or no control,
including inventory obsolescence and fluctuations in quarterly operating
results.

In addition, Cadence bases its expense budgets partially on its expectations
of future revenue. However, it is difficult to predict revenue levels or growth.
Revenue levels that are below Cadence's expectations could seriously hurt
Cadence's business, operating results, and financial condition. If revenue or
operating results fall short of the levels expected by public market analysts
and investors, the trading price of Cadence common stock could decline
dramatically. Also, because of the timing of large orders and its customers'
buying patterns, Cadence may not learn of revenue shortfalls, earnings
shortfalls or other failures to meet market expectations until late in a fiscal
quarter, which could cause even more immediate and serious harm to the trading
price of Cadence common stock.

Because Cadence has no long-term experience providing services, it believes
that quarter-to-quarter comparisons of its results of operations may not be
meaningful. Therefore, stockholders should not view Cadence's historical results
of operations as reliable indicators of its future performance.

CADENCE EXPECTS TO ACQUIRE OTHER COMPANIES AND MAY NOT SUCCESSFULLY INTEGRATE
THEM OR THE COMPANIES IT RECENTLY ACQUIRED

Cadence has acquired other businesses before and may do so again. While
Cadence expects to analyze carefully all potential transactions before
committing to them, Cadence cannot assure you that any transaction that is
completed will result in long-term benefits to Cadence or its stockholders, or
that Cadence's management will be able to manage the acquired businesses
effectively. In addition, growth through acquisition involves a number of risks.
If any of the following events occurs after Cadence acquires another business,
it could seriously harm Cadence's business, operating results, and financial
condition:

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

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

- The discovery after the acquisition has been completed of liabilities
assumed from the acquired business;

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

- The failure to retain key personnel of the acquired business; and

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

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<PAGE>
CADENCE'S INTERNATIONAL OPERATIONS MAY SERIOUSLY HARM ITS FINANCIAL CONDITION
BECAUSE OF SEVERAL WEAK FOREIGN ECONOMIES AND THE EFFECT OF FOREIGN EXCHANGE
RATE FLUCTUATIONS

Cadence has significant operations outside the United States. Cadence's
revenue from international operations as a percentage of total revenue was
approximately 46% for the three months ended July 1, 2000 and July 3, 1999.
Cadence also transacts business in various foreign currencies. Recent economic
uncertainty and the volatility of foreign currencies in certain parts of the
Asia-Pacific region, has had, and may continue to have, a seriously harmful
effect on Cadence's revenue and operating results.

Fluctuations in the rate of exchange between the U.S. dollar and the
currencies of countries other than the U.S. in which Cadence conducts business
could seriously harm its business, operating results, and financial condition.
For example, if there is an increase in the rate at which a foreign currency
exchanges into U.S. dollars, it will take more of the foreign currency to equal
a specified amount of U.S. dollars than before the rate increase. If Cadence
prices its products and services in the foreign currency, it will receive less
in U.S. dollars than it did before the rate increase went into effect. If
Cadence prices its products and services in U.S. dollars, an increase in the
exchange rate will result in an increase in the price for Cadence's products and
services compared to those products of its competitors that are priced in local
currency. This could result in Cadence's prices being uncompetitive in markets
where business is transacted in the local currency. Cadence's international
operations may also be subject to other risks, including:

- The adoption and expansion of government trade restrictions;

- Volatile foreign exchange rates and currency conversion risks;

- Limitations on repatriation of earnings;

- Reduced protection of intellectual property rights in some countries;

- Recessions in foreign economies;

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

- Difficulties in managing foreign operations;

- Political and economic instability;

- Unexpected changes in regulatory requirements;

- Tariffs and other trade barriers; and

- U.S. government licensing requirements for export which make licenses
difficult to obtain.

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

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

Foreign currency exchange risk occurs for some of Cadence's foreign
operations whose functional currency is the local currency. The primary effect
of foreign currency translation on Cadence's results of operations is a
reduction in revenue from a strengthening U.S. dollar, offset by a smaller
reduction in

24
<PAGE>
expenses. Exchange rate gains and losses on the translation into U.S. dollars of
amounts denominated in foreign currencies are included as a separate component
of stockholders' equity.

CADENCE'S INABILITY TO DEAL EFFECTIVELY WITH THE CONVERSION TO THE EURO MAY
NEGATIVELY IMPACT ITS MARKETING AND PRICING STRATEGIES

On January 1, 1999, 11 member countries of the European Union adopted the
Euro as their common legal currency and established fixed conversion rates
between their sovereign currencies and the Euro. Transactions can be made in
either the sovereign currencies or the Euro until January 1, 2002, when the Euro
must be used exclusively. Currently, only electronic transactions may be
conducted using the Euro. Cadence believes that its internal systems and
financial institution vendors are capable of handling the Euro conversion and is
in the process of examining current marketing and pricing policies and
strategies that may be affected by conversion to the Euro. The cost of this
effort is not expected to materially hurt Cadence's results of operations or
financial condition. However, Cadence cannot assure you that all issues related
to the Euro conversion have been identified and that any additional issues would
not materially hurt Cadence's results of operations or financial condition. For
example, the conversion to the Euro may have competitive implications on
Cadence's pricing and marketing strategies and Cadence may be at risk to the
extent its principal European suppliers and customers are unable to deal
effectively with the impact of the Euro conversion. Cadence has not yet
completed its evaluation of the impact of the Euro conversion on its functional
currency designations.

FAILURE TO OBTAIN EXPORT LICENSES COULD HARM CADENCE'S BUSINESS

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

CADENCE'S INABILITY TO COMPETE IN ITS INDUSTRIES COULD SERIOUSLY HARM ITS
BUSINESS

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

- The development of competitive EDA products and design and methodology
services could result in a shift of customer preferences away from
Cadence's products and services and significantly decrease revenue;

- The electronics design and methodology services industries are relatively
new and electronics design companies and manufacturers are only beginning
to purchase these services from outside vendors;

- The pace of the technology change demands continuous technological
development to meet the requirements of next-generation design challenges;
and

- There are a significant number of current and potential competitors in the
EDA industry and the cost of entry is low.

In the electronic design automation products industry, Cadence currently
competes with a number of large companies, including Avant! Corporation, Mentor
Graphics Corporation, Synopsys, Inc. and Zuken-

25
<PAGE>
Redac, and numerous small companies. Cadence also competes with manufacturers of
electronic devices that have developed or have the capability to develop their
own EDA products. Many manufacturers of electronic devices may be reluctant to
purchase services from independent vendors such as Cadence because they wish to
promote their own internal design departments. In the electronics design and
methodology services industries, Cadence competes with numerous electronic
design and consulting companies as well as with the internal design capabilities
of electronics manufacturers. Other electronics companies and management
consulting firms continue to enter the electronic design and methodology
services industries.

CADENCE'S FAILURE TO ATTRACT, TRAIN, MOTIVATE, AND RETAIN KEY EMPLOYEES MAY HARM
ITS BUSINESS

Competition for highly skilled employees is very intense. Cadence's business
depends on the efforts and abilities of its senior management, its research and
development staff, and a number of other key management, sales, support,
technical, and services personnel. The robust economy and opportunities
available in other companies has made and could continue to make employee
retention and recruiting more difficult for Cadence. Additionally, Cadence
expects more than 1,000 of its employees to become employees of Tality in
connection with the separation of its design services group. Cadence's failure
to attract, train, motivate, and retain key employees would impair its
development of new products, its ability to provide design and methodology
services and the management of its businesses. This would seriously harm
Cadence's business, operating results, and financial condition.

IF CADENCE BECOME SUBJECT TO UNFAIR HIRING CLAIMS, CADENCE COULD BE PREVENTED
FROM HIRING NEEDED PERSONNEL, INCUR LIABILITY FOR DAMAGES AND INCUR
SUBSTANTIAL COSTS IN DEFENDING OURSELVES

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

ERRORS OR DEFECTS IN ITS DESIGNS COULD EXPOSE US TO LIABILITY AND HARM OUR
REPUTATION

Cadence's clients use its products and services in designing and developing
products that involve a high degree of technological complexity, each of which
has its own specifications and is based on various industry standards. Because
of the complexity of the systems and products with which Cadence works, some of
its products and designs can be adequately tested only when put to full use in
the marketplace. As a result, its clients or their end users may discover errors
or defects in Cadence's software or the systems Cadence designs, or the products
or systems incorporating its design and intellectual property may not operate as
expected. Errors or defects could result in:

- Loss of current clients and loss of or delay in revenue and loss of market
share;

- Failure to attract new clients or achieve market acceptance;

- Diversion of development resources to resolving the problem;

- Increased service costs; and

- Liability for damages.

26
<PAGE>
ANTI-TAKEOVER DEFENSES IN CADENCE'S CHARTER, BY LAWS, AND UNDER DELAWARE LAW
COULD PREVENT AN ACQUISITION OF CADENCE OR LIMIT THE PRICE THAT INVESTORS
MIGHT BE WILLING TO PAY FOR CADENCE COMMON STOCK

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

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

- Cadence's Certificate of Incorporation allows Cadence's Board of Directors
to issue, at any time and without stockholder approval, preferred stock
with such terms as it may determine. No shares of preferred stock are
currently outstanding. However, the rights of holders of any Cadence
preferred stock that may be issued in the future may be superior to the
rights of holders of its common stock.

- Cadence has a rights plan, commonly known as a "poison pill," which would
make it difficult for someone to acquire Cadence without the approval of
Cadence's Board of Directors.

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

DISCLOSURES ABOUT MARKET RISK

INTEREST RATE RISK

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

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

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based on LIBOR plus a spread of between 1.25% and 1.50%, based on a pricing grid
tied to a financial covenant, or the higher of the (i) Federal Funds Rate plus
0.50% and (ii) prime rate. As a result, Cadence's interest rate expenses
associated with this borrowing will vary with market rates. In addition,
commitment fees are payable on the unutilized portion of the Two Year Facility
at rates between 0.23% and 0.30% based on a pricing grid tied to a financial
covenant and on the unutilized portion of the 364-Day Facility at a fixed rate
of 0.18%. The 1998 Facility contains certain financial and other covenants.

The table below presents the carrying value and related weighted average
interest rates for Cadence's investment portfolio. All highly liquid investments
with an original maturity of three months or less at the date of purchase are
considered to be cash equivalents; investments with original maturities between
three and 12 months are considered to be short-term investments. Investments
with original maturities greater than 12 months are considered non-current
assets. As of July 1, 2000, substantially all of Cadence's investments have
maturities less than 12 months. The carrying value approximated fair value at
July 1, 2000.

<TABLE>
<CAPTION>
FAIR AVERAGE
VALUE INTEREST RATE
-------- -------------
<S> <C> <C>
(In millions, except for average interest rates)
Investment Securities:
Short-term investments--fixed rate........................ $ 6.3 5.75%
Long-term investments--fixed rate......................... 1.0 6.90%
-----
Total short-term and long-term securities............... 7.3 5.91%
Cash equivalents--fixed rate.............................. 15.7 6.25%
Cash equivalents--variable rate........................... 35.1 5.04%
-----
Total interest bearing instruments...................... $58.1 5.48%
=====
</TABLE>

INTEREST RATE SWAP RISK

Cadence entered into a 4.8% fixed interest rate-swap in connection with its
accounts receivable financing program to modify the interest rate
characteristics of the receivables sold to a financing institution on a
non-recourse basis. At July 1, 2000, the notional amount payable was
$13 million which will be amortized in quarterly installments of approximately
$2.2 million through October 2001. The estimated fair value at July 1, 2000 was
immaterial.

FOREIGN CURRENCY RISK

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

Cadence enters into foreign currency forward exchange contracts and
purchases foreign currency put options with financial institutions primarily to
protect against currency exchange risks associated with existing assets and
liabilities and probable but not firmly committed transactions, respectively.
Forward contracts are not accounted for as hedges and, therefore, the unrealized
gains and losses are recognized in other income, net in advance of the actual
foreign currency cash flows with the fair value of these forward contracts being
recorded as accrued liabilities.

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Cadence purchases put options to hedge the currency exchange risks
associated with probable but not firmly committed transactions. Probable but not
firmly committed transactions consist of revenue from Cadence's products and
maintenance contracts in a currency other than the functional currency. These
transactions are made through Cadence's subsidiaries in Ireland and Japan. The
premium costs of the put options are recorded in other current assets while the
gains and losses are deferred and recognized in income in the same period as the
hedged transaction. Gains and losses on accounting hedges realized before the
settlement date of the related hedged transaction are also generally deferred
and recognized in income in the same period as the hedged transaction. Cadence
does not use forward contracts and put options for trading purposes. Cadence's
ultimate realized gain or loss with respect to currency fluctuations will depend
on the currency exchange rates and other factors in effect as the forward
contracts and put options mature.

The table below provides information as of July 1, 2000 about Cadence's
forward contracts and put options. The information is provided in U.S. dollar
equivalent amounts. The table presents the notional amounts, at contract
exchange rates, and the weighted average contractual foreign currency exchange
rates. These forward contracts mature prior to August 17, 2000. The put options
mature prior to September 30, 2000.

<TABLE>
<CAPTION>
AVERAGE
NOTIONAL CONTRACT
AMOUNT RATE
-------- --------
<S> <C> <C>
Forward Contracts:
(In millions, except for average contract rates)
Japanese yen.............................................. $ 49.9 106.28
Euro...................................................... 31.8 0.94
British pound sterling.................................... 19.9 1.51
Canadian dollars.......................................... 2.9 1.47
Swedish krona............................................. 2.7 8.63
Hong Kong dollars......................................... 0.6 7.79
Singapore dollars......................................... 0.2 1.72
------
$108.0
======
Put Option:
Japanese yen.............................................. $ 9.3 107.00
======
</TABLE>

While Cadence actively manages its foreign currency risks on an ongoing
basis, there can be no assurance that Cadence's foreign currency hedging
activities will substantially offset the impact of fluctuations in currency
exchange rates on its results of operations, cash flows, and financial position.
On a net basis, foreign currency fluctuations did not have a material impact on
Cadence's results of operations and financial position during the three months
ended July 1, 2000. Due to the short-term nature of the forward contracts and
the put option, the fair value at July 1, 2000 was negligible. The realized gain
(loss) on the forward contracts and the put option as they matured was not
material to the consolidated operations of Cadence.

EQUITY PRICE RISK

As part of its authorized repurchase program, Cadence has sold put warrants
and purchased call options through private placements. The put warrants, if
exercised, would entitle the holder to sell shares of Cadence common stock to
Cadence at a specified price. Similarly, the call options entitle Cadence to buy
shares of Cadence common stock at a specified price.

Cadence repurchases shares of its common stock under stock repurchase
programs for issuance under its Employee Stock Purchase Plan, or ESPP, its 1997
Stock Option Plan, referred to as the 1997 Plan, and its 2000 Stock Option Plan.
As part of these repurchase programs, Cadence has purchased and will purchase
call options or has sold and will sell put warrants. These transactions may
result in sales of a large

29
<PAGE>
number of shares and consequent decline in the market price of Cadence common
stock. Cadence's stock repurchase program includes the following
characteristics:

- Call options allow Cadence to buy shares of its common stock on a
specified day at a specified price. If the market price of the stock is
greater than the exercise price of a call option, Cadence will typically
exercise the option and receive shares of its stock. If the market price
of the common stock is less than the exercise price of a call option,
Cadence typically will not exercise the option.

- Call option issuers may accumulate a substantial number of shares of
Cadence common stock in anticipation of Cadence's exercising its call
option and may dispose of these shares if and when Cadence fails to
exercise its call option. This could cause the market price of Cadence
common stock to fall.

- Put warrants allow the holder to sell to Cadence shares of Cadence common
stock on a specified day at a specified price. Cadence has the right to
settle the put warrants with shares of Cadence common stock valued at the
difference between the exercise price and the fair value of the stock at
the date of exercise.

- Depending on the exercise price of the put warrants and the market price
of Cadence common stock at the time of exercise, settlement of the put
warrants with Cadence common stock could cause Cadence to issue a
substantial number of shares to the holder of the put warrant. The holder
may sell these shares in the open market, which could cause the price of
Cadence common stock to fall.

- Put warrant holders may accumulate a substantial number of shares of
Cadence common stock in anticipation of exercising their put warrants and
may dispose of these shares if and when they exercise their put warrants
and Cadence issues shares in settlement of their put warrants. This could
also cause the market price of Cadence common stock to fall.

The table below provides information at July 1, 2000 about Cadence's
outstanding put warrants and call options. The table presents the contract
amounts and the weighted average strike prices. The put warrants and call
options expire on various dates through February 2001 and Cadence has the
contractual ability to settle the options prior to their maturity.

<TABLE>
<CAPTION>
2000 2001 ESTIMATED
MATURITY MATURITY FAIR VALUE
-------- -------- ----------
<S> <C> <C> <C>
(Shares and contract amounts in millions)
Put Warrants:
Shares.................................................... 6.1 0.2
Weighted average strike price............................. $20.72 $19.77
Contract amount........................................... $127.3 $ 3.7 $16.7
Call Options:
Shares.................................................... 4.5 0.1
Weighted average strike price............................. $20.94 $20.02
Contract amount........................................... $ 94.2 $ 2.8 $12.1
</TABLE>

30
<PAGE>
PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

From time to time Cadence is involved in various disputes and litigation
matters that arise in the ordinary course of business. These include disputes
and lawsuits related to intellectual property, licensing, contract law,
distribution arrangements, and employee relations matters.

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

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

In an order issued on December 19, 1997, as modified on January 26, 1998,
the District Court entered a preliminary injunction barring Avant! from any
further infringement of Cadence's copyrights in Design Framework II software, or
selling, licensing or copying such product derived from Design Framework II,
including, but not limited to, Avant!'s ArcCell products. On December 7, 1998,
the District Court issued a further preliminary injunction, which enjoined
Avant! from selling its Aquarius product line. Cadence posted a $10 million bond
in connection with the issuance of the preliminary injunction. On July 30, 1999,
the U.S. Court of Appeals for the Ninth Circuit affirmed the preliminary
injunction.

By an order dated July 22, 1997, the District Court stayed most activity in
the case pending in that court and ordered Avant! to post a $5 million bond in
light of related criminal proceedings pending against Avant! and several of its
executives.

On September 7, 1999, the District Court ruled on the parties' Motions for
Summary Adjudication, and granted in part, and denied in part, each party's
motion regarding the scope of a June 6, 1994 Release Agreement between the
parties. The Court held that Cadence's copyright infringement claim against
Avant! is not barred by the release and that Cadence may proceed on that claim.
The Court also held that Cadence's trade secret claim based on Avant!'s use of
Cadence's Design Framework II source code is barred by the release. The Ninth
Circuit has agreed to hear both parties' appeal from the District Court's order.
The trial date has been vacated pending a decision on the appeal.

On April 30, 1999, Cadence and several of its officers and directors were
named as defendants in a lawsuit filed in the U.S. District Court for the
Northern District of California, entitled Spett v. Cadence Design Systems, et
al., civil action no. C 99-2082. The action was brought on behalf of a class of
stockholders who purchased Cadence common stock between November 4, 1998 and
April 20, 1999, and alleges violations of Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934. The lawsuit arises out of Cadence's
announcement of its first quarter 1999 financial results.

In February 1998, Aptix Corporation and Meta Systems, Inc. filed a lawsuit
against Quickturn Design Systems, Inc. in the U.S. District Court for the
Northern District of California. In this lawsuit, entitled Aptix Corporation and
Meta Systems, Inc. v. Quickturn Design Systems, Civil Action No. C 98-00762

31
<PAGE>
WHA, Aptix and Meta Systems alleged that Quickturn infringed a U.S. patent owned
by Aptix and licensed to Meta. Quickturn filed a counterclaim requesting the
District Court to declare the Aptix patent invalid in view of the prior art and
unenforceable based on inequitable conduct during the prosecution of the patent.
In June 2000 the District Court entered judgment in favor of Quickturn,
dismissing the complaint and declaring the patent unenforceable. The plaintiffs
have filed a notice of appeal from the District's Court's judgment.

On July 21, 1999, Mentor filed suit against Quickturn in the U.S. District
Court for the District of Delaware, alleging that Quickturn's Mercury-TM-
hardware emulation systems infringe U.S. Patent Nos. 5,777,489 and 5,790,832
allegedly assigned to Mentor. At Quickturn's request, Cadence was added as a
party defendant. Mentor has since asserted that Quickturn's Mercury
Plus(Plus-TM-) emulation systems also infringe U.S. Patent Nos. 5,777,489 and
5,790,832. The complaint seeks a permanent injunction and unspecified damages.
Cadence intends to vigorously defend itself against these claims. On
December 14, 1999, this action was transferred to the U.S. District Court for
the Northern District of California, and renumbered Civil Action No. C 99-5464
SI.

On February 25, 2000, Cadence and several of its officers were named as
defendants in a lawsuit filed in the U.S. District Court for the Northern
District of California, entitled Maxick v. Cadence Design Systems, Inc., File
No. C 00 0658PJH. The action was brought on behalf of a class of shareholders of
OrCAD, Inc., and alleges violations of Section 14(d)(7) of the Securities
Exchange Act of 1934, as amended, and Rule 14d-10 thereunder. The lawsuit arises
out of Cadence's acquisition of OrCAD, which was completed in August 1999.

On March 24, 2000, Mentor and Meta and several founders of Meta filed suit
against Quickturn and Cadence and a former Quickturn employee in the U.S.
District Court for the Northern District of California, Civil Action No. C
00-01030 SI. The suit alleges patent infringement of a U.S. Patent allegedly
assigned to Mentor, misappropriation of trade secrets and breach of confidence,
and seeks unspecified damages, injunctive relief and the assignment to Mentor of
a patent previously issued to Quickturn. Cadence intends to vigorously defend
itself against these claims, and has filed a counterclaim for declaratory
judgment of invalidity of several patents allegedly assigned to Mentor.
Following a motion by Cadence, the former Quickturn employee was dismissed as a
party to the action. Discovery in the action has subsequently been consolidated
with discovery in Civil Action No. C 99-5464, the Mentor v. Quickturn suit
transferred from Delaware.

On January 7, 1999, in the suit, Mentor Graphics Corporation, et. al. v.
Lobo, et. al., Delaware Chancery Court, New Castle County, Civ. Action
No. 16843-NC, an amended complaint was filed and served by Mentor asserting
claims against Cadence, Quickturn Design Systems, Inc. and its Board of
Directors for declaratory and injunctive relief for various alleged breaches of
fiduciary duty purportedly owned by Quickturn and its Board of Directors to
Quickturn's shareholders in connection with the merger between Quickturn and
Cadence. Mentor alleged that Cadence aided and abetted Quickturn and its Board
of Directors in those purported breaches. Mentor has not prosecuted the matter
since January 1999. In May 2000, Mentor advised the Delaware Chancery Court of
its objection to the settlement of a companion action brought on behalf of
certain Quickturn shareholders. Mentor further advised the court that it would
seek an award of attorneys' fees related to its prosecution of the action. At
the request of the court, on July 28, 2000, Mentor filed its brief in support of
its standing to seek such an award. Cadence intends to vigorously oppose
Mentor's request.

Management believes that the ultimate resolution of the disputes and
litigation matters discussed above will not have a material adverse effect on
Cadence's business, operating results, or financial condition.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

None.

32
<PAGE>
ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

At the Annual Meeting of Stockholders held on May 24, 2000, the stockholders
of Cadence approved the following matters:

1. A proposal to elect eight (8) directors of Cadence to serve for the ensuing
year and until their successors are elected or until such director's earlier
resignation or removal.

<TABLE>
<CAPTION>
NOMINEE IN FAVOR WITHHELD
------- ----------- ---------
<S> <C> <C>
Carol A. Bartz.............................................. 215,429,157 994,735
H. Raymond Bingham.......................................... 210,083,179 6,340,713
Dr. Leonard Y. W. Liu....................................... 215,452,707 971,185
Donald L. Lucas............................................. 215,261,253 1,162,639
Dr. Alberto Sangiovanni-Vincentelli......................... 215,442,956 980,936
George M. Scalise........................................... 215,436,453 987,439
Dr. John B. Shoven.......................................... 215,441,858 982,034
Roger S. Siboni............................................. 215,436,538 987,354
</TABLE>

2. A proposal for the ratification of the selection of Arthur Andersen LLP as
independent public accountants for the fiscal year ending December 30, 2000
was approved by a vote of 216,074,304 for, 204,609 opposed, and 144,979
withheld.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) The following exhibits are filed herewith:

<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
------- ------------------------------------------------------------
<C> <S>
2.01 Master Separation Agreement, dated as of July 14, 2000 by
and among the registrant, Cadence Holders, Inc. and Tality
Corporation.
10.01 Form of Indemnity Agreement between Cadence Design Systems,
Inc. and its directors and executive officers.
27.01 Financial data schedule for the period ended July 1, 2000.
</TABLE>

(b) Reports on Form 8-K:

Cadence filed a Current Report on Form 8-K dated July 17, 2000
announcing the planned separation and initial public offering of its design
services group.

33
<PAGE>
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.

<TABLE>
<S> <C> <C> <C>
CADENCE DESIGN SYSTEMS, INC.
(REGISTRANT)

DATE: August 15, 2000 By: /s/ H. RAYMOND BINGHAM
------------- ---------------------------------------
H. Raymond Bingham
PRESIDENT, CHIEF EXECUTIVE OFFICER, AND
DIRECTOR

DATE: August 15, 2000 By: /s/ WILLIAM PORTER
------------- ---------------------------------------
William Porter
SENIOR VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
</TABLE>