NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1. BASIS OF PRESENTATION

The Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q have been prepared by Cadence Design Systems, Inc., or Cadence, without audit, pursuant to the rules and regulations of the United States Securities and Exchange Commission, or the SEC. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, Cadence believes that the disclosures contained in this Quarterly Report on Form 10-Q comply with the requirements of Section 13(a) of the Securities Exchange Act of 1934, as amended, or the Exchange Act, for a Quarterly Report on Form 10-Q and are adequate to make the information presented not misleading. These Condensed Consolidated Financial Statements are meant to be, and should be, read in conjunction with the Consolidated Financial Statements and the Notes thereto included in Cadence’s Annual Report on Form 10-K for the fiscal year ended January 1, 2011. Certain prior period balances have been reclassified to conform to current period presentation.

The unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q reflect all adjustments (which include only normal, recurring adjustments and those items discussed in these Notes) that are, in the opinion of management, necessary to state fairly the results of operations, cash flows and financial position for the periods and dates presented. The results for such periods are not necessarily indicative of the results to be expected for the full fiscal year.

Preparation of the Condensed Consolidated Financial Statements in conformity with United States 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 revenue and expenses during the reporting period. Actual results could differ from those estimates.

Cadence adopted new revenue recognition standards on the first day of fiscal 2011. See Note 3 for an additional description of Cadence’s adoption of these standards.

Cadence evaluated subsequent events through the date on which this Quarterly Report on Form 10-Q was filed with the SEC.

NOTE 2. CONVERTIBLE NOTES

2.625% Cash Convertible Senior Notes Due 2015

In June 2010, Cadence issued $350.0 million principal amount of its 2.625% Cash Convertible Senior Notes Due 2015, or the 2015 Notes. The 2015 Notes have a stated interest rate of 2.625%, mature on June 1, 2015 and contain a conversion feature based on Cadence’s stock price, but the 2015 Notes may only be converted to cash and not equity. The indenture for the 2015 Notes does not contain any financial covenants. Interest on the 2015 Notes is payable semi-annually each December 1st and June 1st.

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Prior to March 1, 2015, holders may convert their 2015 Notes into cash only upon the occurrence of any one of the following conversion conditions, or the 2015 Notes Conversion Conditions:

As of October 1, 2011, none of the 2015 Notes Conversion Conditions were met. As of July 2, 2011, the stock price 2015 Notes Conversion Condition was met and the 2015 Notes were convertible into cash during the three months ended October 1, 2011. As of July 2, 2011, Cadence had classified the net liability associated with the 2015 Notes as a current liability on its Condensed Consolidated Balance Sheet because the 2015 Notes were convertible as of that date, but because the 2015 Notes were not convertible as of October 1, 2011, the net liability of the 2015 Notes are classified as long-term. As of October 1, 2011, the net liability of the 2015 Notes was $290.6 million.

From March 1, 2015 through May 28, 2015, holders may convert their 2015 Notes into cash at any time, regardless of the occurrence of any of the 2015 Conversion Conditions. Cadence may not redeem the 2015 Notes prior to maturity.

The initial cash conversion rate for the 2015 Notes payable to the holders of the 2015 Notes upon conversion, is 132.5205 shares of Cadence common stock for each $1,000 principal amount of the 2015 Notes, equivalent to a cash conversion price of approximately $7.55 per share of Cadence common stock, payable in cash upon conversion. The conversion value of the 2015 Notes increases to the extent Cadence’s stock price exceeds $7.55 per share. Upon conversion, holders will receive cash equal to the settlement amount, as determined pursuant to the indenture, which is calculated based on the volume weighted average price of Cadence’s common stock over a specified period relating to the conversion date. If a fundamental change, as defined in the indenture for the 2015 Notes (which includes certain fundamental corporate changes relating to Cadence, such as certain mergers, recapitalizations, or sales of substantially all of its assets, or the delisting of its common stock), were to occur prior to maturity of the 2015 Notes and Cadence’s stock price were greater than $6.16 per share at that time, then the holders of the 2015 Notes would be entitled to a “make-whole” premium in the form of an increase to the conversion rate.

The cash conversion feature of the 2015 Notes, or the 2015 Notes Embedded Conversion Derivative, requires bifurcation from the 2015 Notes and is accounted for as a derivative liability. The fair value of the 2015 Notes Embedded Conversion Derivative at the time of issuance of the 2015 Notes was $76.6 million and was recorded as original debt discount for purposes of accounting for the debt component of the 2015 Notes. This discount is amortized as interest expense using the effective interest method over the term of the 2015 Notes. The 2015 Notes Embedded Conversion Derivative is recorded on Cadence’s Condensed Consolidated Balance Sheet as of October 1, 2011 at its estimated fair value of $179.7 million.

At the time the 2015 Notes were issued, Cadence also entered into hedge transactions, or the 2015 Notes Hedges, to limit additional cash payments that may be due to the 2015 Note holders if the underlying Cadence stock price increases during the term of the 2015 Notes. Under the terms of the 2015 Notes Hedges, Cadence has the option to receive the cash that may be due to note holders upon maturity of the 2015 Notes or upon conversion of the 2015 Notes by the holders in excess of the $350.0 million principal amount of the notes, subject to certain conversion rate adjustments. This option expires on June 1, 2015 and must be settled in cash. The aggregate cost of the 2015 Notes Hedges was $76.6 million. The 2015 Notes

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Hedges are accounted for as derivative assets. The 2015 Notes Hedges are recorded on Cadence’s Condensed Consolidated Balance Sheet as of October 1, 2011 at their estimated fair value of $179.7 million. The 2015 Notes Embedded Conversion Derivative liability and the 2015 Notes Hedges asset are adjusted to fair value each reporting period and unrealized gains and losses are reflected in Cadence’s Condensed Consolidated Income Statements. The 2015 Notes Embedded Conversion Derivative and the 2015 Notes

Hedges are designed to have similar fair values. Accordingly, the changes in the fair values of these instruments during the three and nine months ended October 1, 2011, did not have a net impact on Cadence’s Condensed Consolidated Income Statements for the respective periods.

The classification of the 2015 Notes, the 2015 Notes Embedded Conversion Derivative liability and the 2015 Notes Hedges asset as current or long-term on the Condensed Consolidated Balance Sheet is evaluated at each balance sheet date and may change from time to time depending on whether the closing stock price threshold 2015 Notes Conversion Condition is met.

To reduce the hedging cost, Cadence also sold warrants in separate transactions, or the 2015 Warrants, for the purchase of up to approximately 46.4 million shares of Cadence’s common stock at a price of $10.78 per share, for total proceeds of $37.5 million, which was recorded as an increase in Stockholders’ equity. The 2015 Warrants expire on various dates from September 2015 through December 2015 and must be settled in net shares. Changes in the fair value of the 2015 Warrants will not be recognized in Cadence’s Condensed Consolidated Financial Statements as long as the instruments remain classified as equity.

The components of the 2015 Notes as of October 1, 2011 and January 1, 2011 were as follows:

The effective interest rate and components of interest expense of the 2015 Notes for the three and nine months ended October 1, 2011 and October 2, 2010 were as follows:

As of October 1, 2011, the if-converted value of the 2015 Notes to the note holders exceeded the principal amount of the 2015 Notes. The total fair value of the 2015 Notes was $481.5 million.

1.375% Convertible Senior Notes Due December 15, 2011 and 1.500% Convertible Senior Notes Due December 15, 2013

In December 2006, Cadence issued $250.0 million principal amount of its 1.375% Convertible Senior Notes Due December 15, 2011, or the 2011 Notes, and $250.0 million principal amount of its 1.500% Convertible Senior Notes Due December 15, 2013, or the 2013 Notes. The 2011 Notes have a stated

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interest rate of 1.375% and mature on December 15, 2011. The 2013 Notes have a stated interest rate of 1.500% and mature on December 15, 2013. Both the 2011 Notes and the 2013 Notes may be settled in cash up to the principal amount of the notes and in shares to the extent the conversion price exceeds the principal amount of the notes. The indentures for the 2011 Notes and the 2013 Notes do not contain any financial covenants. Interest on the 2011 Notes and the 2013 Notes is payable semi-annually each December 15th and June 15th. The remaining principal balance as of October 1, 2011 is $150.0 million for the 2011 Notes and $144.5 million for the 2013 Notes.

Prior to the maturity of the 2011 Notes and the 2013 Notes, holders may convert their notes upon the occurrence of any one of the following conversion conditions, or the 2011 Notes and 2013 Notes Conversion Conditions:

As of October 1, 2011, none of the 2011 Notes and 2013 Notes Conversion Conditions had been met.

From November 2, 2011 in the case of the 2011 Notes, and November 1, 2013 in the case of the 2013 Notes, and until the close of business on the trading day immediately preceding the maturity date, holders may convert their 2011 Notes or 2013 Notes into cash and Cadence shares at any time, regardless of the occurrence of any of the 2011 Notes and 2013 Notes Conversion Conditions. Cadence may not redeem the 2011 Notes or the 2013 Notes prior to maturity.

The initial conversion rate for the 2011 Notes and the 2013 Notes is 47.2813 shares of Cadence common stock for each $1,000 principal amount of the 2011 Notes and the 2013 Notes, equivalent to a conversion price of approximately $21.15 per share of Cadence common stock. Upon conversion, as defined in the indentures for the 2011 Notes and the 2013 Notes, holders will receive cash for the principal amount of the notes. If the conversion value exceeds the principal amount of the notes, holders will receive shares of Cadence’s common stock for the amount that the conversion value exceeds the principal amount of the notes.

If a fundamental change, as defined in the indentures for the 2011 Notes and the 2013 Notes (which includes certain fundamental corporate changes relating to Cadence, such as certain mergers, recapitalizations, or sales of substantially all of its assets, or the delisting of its common stock), were to occur prior to maturity and Cadence’s stock price were greater than $18.00 per share at that time, the holders may be entitled to a “make-whole” premium in the form of an increase to the conversion rate.

The classification of the 2011 Notes and 2013 Notes as a current or long-term liability on the Condensed Consolidated Balance Sheet is evaluated at each balance sheet date and may change from time to time, depending on whether the closing stock price threshold 2011 Notes and 2013 Notes Conversion Condition is met for that particular quarter. The 2011 Notes mature on December 15, 2011 and the liability component of the 2011 Notes is classified as a current liability as of October 1, 2011.

During the nine months ended October 2, 2010, Cadence purchased in the open market $100.0 million principal amount of the 2011 Notes and $100.0 million principal amount of the 2013 Notes. During the three months ended January 1, 2011, Cadence purchased in the open market $5.5 million principal amount of the 2013 Notes. At settlement, the fair value of the liability component of the notes immediately

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prior to its extinguishment was measured first, and the difference between the fair value of the aggregate consideration remitted to its holders and the fair value of the liability component of the notes immediately prior to its extinguishment was attributed to the reacquisition of the equity component of the notes. The remaining consideration remitted was allocated to the debt component of the notes.

The loss on early extinguishment of debt for the fiscal 2010 repurchases was as follows:

At the time the 2011 Notes and the 2013 Notes were issued, Cadence also entered into hedge transactions, or the 2011 and 2013 Notes Hedges, to reduce the impact of potential dilution resulting from conversion of the 2011 Notes or the 2013 Notes. Under the terms of the 2011 and 2013 Notes Hedges, Cadence has the option to receive the amount of shares that may be owed to the 2011 Notes or the 2013 Notes holders at maturity or upon conversion of the notes, subject to certain conversion rate adjustments. These options expire on December 15, 2011 in the case of the 2011 Notes, and on December 15, 2013 in the case of the 2013 Notes, and must be settled in net shares. The aggregate cost of the 2011 and 2013 Notes Hedges was $119.8 million and was recorded as a reduction to Stockholders’ equity. In connection with the purchase of a portion of the 2011 Notes and 2013 Notes in June and November 2010, Cadence also sold a portion of the 2011 and 2013 Notes Hedges representing options to purchase approximately 9.7 million shares of Cadence’s common stock for proceeds of $0.4 million. The estimated fair value of the remaining 2011 and 2013 Notes Hedges was $1.9 million as of October 1, 2011. Subsequent changes in the fair value of the 2011 and 2013 Notes Hedges will not be recognized in Cadence’s Condensed Consolidated Financial Statements as long as the instruments remain classified as equity.

To reduce the hedging cost, Cadence also sold warrants in separate transactions, or the 2011 and 2013 Notes Warrants, for the purchase of up to 23.6 million shares of Cadence’s common stock at a price of $31.50 per share for proceeds of $39.4 million, which was recorded as an increase in Stockholders’ equity. In connection with the purchase of a portion of the 2011 Notes and the 2013 Notes in June and November 2010, Cadence also purchased a portion of the 2011 and 2013 Notes Warrants, reducing the number of shares of Cadence common stock available for purchase by 9.7 million shares at a cost of $0.1 million. The 2011 and 2013 Notes Warrants expire on various dates from February 2012 through April 2012 in the case of the 2011 Notes, and February 2014 through April 2014 in the case of the 2013 Notes, and must be settled in net shares. Changes in the fair value of the 2011 and 2013 Notes Warrants will not be recognized in Cadence’s Condensed Consolidated Financial Statements as long as the instruments remain classified as equity.

The components of the 2011 Notes and 2013 Notes as of October 1, 2011 and January 1, 2011 were as follows:

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The effective interest rate and components of interest expense of the 2011 Notes and 2013 Notes for the three and nine months ended October 1, 2011 and October 2, 2010, were as follows:

As of October 1, 2011, the if-converted value of the 2011 Notes and 2013 Notes to the note holders did not exceed the principal amount of the 2011 Notes and 2013 Notes. The total fair value of the 2011 Notes and 2013 Notes, including the equity component, was $288.7 million.

Zero Coupon Zero Yield Senior Convertible Notes Due 2023

In August 2003, Cadence issued $420.0 million principal amount of its Zero Coupon Zero Yield Senior Convertible Notes Due 2023, or the 2023 Notes. As of October 1, 2011, the remaining balance and the total fair value of the 2023 Notes was $0.2 million.

NOTE 3. REVENUE RECOGNITION

Cadence adopted new revenue recognition accounting standards on the first day of fiscal 2011 for revenue arrangements that include both hardware and software elements. These new standards require companies to account for product or service deliverables separately rather than as one combined unit in a multiple element arrangement, or MEA. Under these new standards, hardware products containing software components and nonsoftware components that function together to deliver the hardware product’s essential functionality are excluded from the pre-existing software revenue standards. In addition, hardware components of a tangible product containing software components are always excluded from the pre-existing software revenue standards. The residual method is no longer allowed when allocating consideration for arrangements under these new accounting standards.

An MEA is any arrangement that includes or contemplates rights to a combination of software or hardware products, software license types, services, training or maintenance in a single arrangement. From time to time, Cadence may include individual deliverables in separately priced and separately executed contracts with the same customer. Cadence evaluates all relevant facts and circumstances in determining whether the separate contracts should be accounted for individually as distinct arrangements or whether the separate contracts are, in substance, an MEA. Significant judgment can be involved in determining whether a group of contracts might be so closely related that they are, in effect, part of a single arrangement.

For a single transaction or MEA that includes software and nonsoftware elements, Cadence allocates consideration to all deliverables based on their relative standalone selling prices. In these circumstances, the new accounting standards establish a hierarchy to determine the standalone selling price to be used for allocating consideration to deliverables as follows:

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The new accounting standards do not generally change the separate elements identified in Cadence’s revenue transactions. For MEAs that contain software and nonsoftware elements, Cadence allocates the consideration to software or software-related elements as a group, and to any nonsoftware element separately based on the standalone selling price hierarchy. The consideration allocated to each element is then recognized as revenue when the basic revenue recognition criteria are met for each element. Once the consideration is allocated to the group of software and software-related elements, it then follows the recognition principles of pre-existing software accounting guidance.

The most significant impact of the adoption of the new revenue recognition accounting standards is the timing of revenue recognition for Cadence’s hardware products when sold with other hardware products or with software licenses for which revenue is recognized ratably. Using the residual method under the pre-existing accounting standards, revenue was recognized when all undelivered elements had vendor-specific objective evidence of fair value, or VSOE. In an arrangement that included multiple hardware products, revenue for the delivered hardware products was required to be deferred until the final hardware product was delivered. In these arrangements, the time period between shipment of the first hardware product and the last hardware product can vary, generally ranging from one to four quarters. Under the newly adopted accounting standards, the consideration allocated to each hardware product will be recognized as revenue upon the respective delivery of each hardware product. In addition, if a hardware product is sold with nonessential software licenses, hardware revenue will no longer be required to be recognized ratably over the software license term.

Cadence adopted these new accounting standards on a prospective basis. Therefore, revenue will continue to be recognized in future periods under the pre-existing accounting standards for arrangements that were entered into on or prior to January 1, 2011. Cadence began applying the new accounting standards for arrangements entered into or materially modified on or after January 2, 2011. If Cadence had accounted for arrangements entered into on or after January 2, 2011 under the pre-existing accounting standards, revenue for the three months ended October 1, 2011 would have been $9.0 million less than reported and revenue for the nine months ended October 1, 2011 would have been $11.1 million less than reported. Changes in assumptions or judgments or changes to the elements in an arrangement could cause a material increase or decrease in the amount of revenue that Cadence reports in a particular period.

Cadence has established VSOE for certain service offerings based upon the pricing of these elements when sold separately. VSOE for maintenance is based upon the customer’s stated annual renewal rate. Cadence has not established VSOE for any of its products, for annual maintenance that is not cancellable by the customer, or for maintenance of less than 12 months.

TPE is determined based on competitor prices for similar deliverables when sold separately. Generally, Cadence’s offerings contain significant differentiation such that comparable pricing of products with similar functionality cannot be obtained. Furthermore, Cadence is unable to reliably determine what similar competitor products’ selling prices are when those products are sold on a stand-alone basis. Therefore, Cadence typically is not able to obtain TPE and TPE is not used to determine any standalone selling prices.

Cadence calculates the ESP of its hardware products based on its pricing practices, including the historical average prices charged for comparable hardware products. Cadence’s process for determining ESP for its software deliverables without VSOE or TPE takes into account multiple factors that vary depending upon the unique facts and circumstances related to each deliverable. Key external and internal factors considered in developing the ESPs include prices charged by Cadence for similar arrangements, historical pricing practices and the nature of the product. In addition, when developing ESPs, Cadence may consider other factors as appropriate including the pricing of competitive alternatives if they exist, and product-specific business objectives.

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Cadence generally has a minimum of two deliverables contained in arrangements involving the sale of its hardware. The first deliverable is the hardware product and software essential to the functionality of the hardware product delivered at the time of sale, and the second deliverable is the right to receive maintenance on the hardware product and the hardware product’s essential software. Cadence allocates consideration between these deliverables based on the relative standalone selling price for each deliverable. Consideration allocated to the hardware product and the related essential software is recognized as revenue at the time of delivery provided all other conditions for revenue recognition have been met. Consideration allocated to the maintenance is deferred and recognized as revenue on a straight-line basis over the respective maintenance terms.

Cadence accounts for MEAs that consist only of software or software-related products in accordance with industry-specific accounting guidance for software and software-related transactions. If VSOE exists for all undelivered elements, the consideration is allocated using the residual method. Under the residual method, the VSOE of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized up-front as the software products are delivered. If VSOE does not exist for all elements to support the allocation of the total fee among all elements of the arrangement, or if VSOE does not exist for all undelivered elements to apply the residual method, revenue is recognized ratably over the term of the undelivered elements.

NOTE 4. ACQUISITIONS

For each of Cadence’s acquisitions, the results of operations and the estimated fair value of the assets acquired and liabilities assumed have been included in Cadence’s Condensed Consolidated Financial Statements from the date of the acquisition.

2011 Acquisitions

During the nine months ended October 1, 2011, Cadence acquired companies for a combined purchase price of $49.3 million and recorded a total of $32.3 million of goodwill and $21.6 million of other intangible assets with a weighted average life of approximately 7 years. The $32.3 million of goodwill recorded in connection with these acquisitions is not expected to be deductible for income tax purposes. The fair value of the intangible assets acquired with these companies was determined using the income approach with significant inputs that are not observable in the market. Key assumptions include the economy in general, conditions and demands specific to electronic design automation software development, expected future cash flows, the timing of the expected future cash flows and discount rates consistent with the level of risk.

One of the 2011 acquisitions includes contingent consideration payments based on certain future financial measures associated with the acquired technology. Cadence makes estimates regarding the fair value of contingent consideration liabilities on the acquisition date and at the end of each reporting period until the contingency is resolved. Cadence estimates the fair value of these liabilities based on Cadence’s expectations as to the projected financial measures and Cadence’s assessment of the probability of achievement. Cadence believes that its estimates and assumptions are reasonable, but there is significant judgment involved. Changes in the fair value of contingent consideration liabilities subsequent to the acquisition are recorded in General and administrative expense in Cadence’s Condensed Consolidated Income Statements.

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The contingent consideration arrangement for the 2011 acquisition requires payments of up to $5.0 million if certain financial measures are met during the three-year period subsequent to October 1, 2011. The initial fair value of the contingent consideration arrangement of $3.5 million was determined using significant inputs that are not observable in the market. Key assumptions include discount rates consistent with the level of risk of achievement and probability-adjusted revenue projections. The expected outcomes were recorded at net present value. The fair value of the contingent consideration was $3.6 million as of October 1, 2011 which included $0.1 million of accretion of the contingent consideration recorded after the date of acquisition.

Denali Software, Inc.

In June 2010, Cadence acquired Denali Software, Inc., or Denali. Denali was a privately-held provider of electronic design automation software and intellectual property used in system-on-chip design and verification. Cadence acquired Denali to expand its portfolio to provide system component modeling and intellectual property integration. The aggregate initial purchase price was $296.8 million, which was paid in cash. Of the $12.6 million of purchase price payments that were deferred on the acquisition date, $1.0 million remains unpaid as of October 1, 2011 and is conditioned upon certain Denali shareholders remaining employees of Cadence over the stated retention periods. Of the $12.6 million deferred purchase price, Cadence expensed $10.2 million during fiscal 2010, $1.2 million during the nine months ended October 1, 2011 and Cadence will expense the remaining $1.2 million over the stated retention periods.

The financial information in the table below summarizes the combined results of operations of Cadence and Denali, on a pro forma basis, as though the companies had been combined as of the beginning of the three and nine months ended October 2, 2010. The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place on January 3, 2010 or of results that may occur in the future.

Acquisition-Related Contingent Consideration

Cadence accounts for business combinations with acquisition dates on or before January 3, 2009 under the purchase method in accordance with Statement of Financial Accounting Standard, or SFAS, No. 141, “Business Combinations,” and contingent consideration is added to Goodwill as it is paid. See Note 5 for the amount of Goodwill recorded during the nine months ended October 1, 2011 in connection with acquisitions accounted for under SFAS No. 141. Cadence accounts for business combinations with acquisition dates after January 3, 2009 under the acquisition method in accordance with the Accounting Standards Codification and contingent consideration is recorded at fair value on the acquisition date.

In connection with Cadence’s business combinations and asset acquisitions completed before October 1, 2011, Cadence may be obligated to make payments based on, or subject to the satisfaction of,

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certain performance metrics. If performance is such that these payments are fully achieved, Cadence may be obligated to pay up to an aggregate of $30.7 million in cash during the next 55 months. Of the $30.7 million, up to $20.8 million would be expensed in Cadence’s Condensed Consolidated Income Statements and up to $5.6 million would be recorded as additional goodwill.

Acquired intangibles with finite lives as of January 1, 2011 were as follows, excluding intangibles that were fully amortized as of January 2, 2010:

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As of January 1, 2011, Cadence also had a $0.5 million in-process research and development intangible that had an indefinite useful life. This intangible was placed into service during the nine months ended October 1, 2011 and is being amortized over its useful life.

Amortization of acquired intangibles for the three and nine months ended October 1, 2011 and October 2, 2010 was as follows:

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

Estimated amortization expense for the following five fiscal years and thereafter is as follows:

NOTE 6. FINANCIAL INSTRUMENTS

Fair Value of Financial Instruments

Inputs to valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect Cadence’s market assumptions.

The fair value of Cadence’s cash and cash equivalents, short-term investments, receivables, accounts payable, accrued liabilities and foreign currency forward exchange contracts approximate their carrying value due to the short-term nature of these instruments. The fair values of Cadence’s installment contract receivables approximate their carrying values based upon current market rates of interest. The fair values of Cadence’s 2011 Notes, 2013 Notes and 2015 Notes are influenced by interest rates, Cadence’s stock price and stock price volatility and are determined by market trading. The fair values of the embedded conversion derivative and hedge transaction associated with Cadence’s 2015 Notes are determined using an option pricing model based on observable inputs, including Cadence’s stock price, stock price volatility and risk-free interest rates. See Note 2 for the fair value of Cadence’s 2011 Notes, 2013 Notes, 2015 Notes, 2023 Notes, and Cadence’s convertible notes hedges and warrants.

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On a quarterly basis, Cadence measures at fair value certain financial assets and liabilities. The fair value of financial assets and liabilities was determined using the following levels of inputs as of October 1, 2011:

The 2015 Notes Hedges and the 2015 Notes Embedded Conversion Derivative are classified as Level 2 because these assets and liabilities are not actively traded and are valued using standard pricing methodologies that use observable market data for all inputs. The fair values of the 2015 Notes Hedges and 2015 Notes Embedded Conversion Derivative are determined using an option pricing model based on observable inputs, such as implied volatility of Cadence’s common stock, risk-free interest rate and other factors. The foreign currency exchange contracts are classified as Level 2 because the fair value of these contracts is determined based on observable foreign currency exchange rates.

Cadence acquired intangible assets of $21.6 million in connection with business combinations during the nine months ended October 1, 2011. The fair value of these intangible assets was estimated using Level 3 inputs. See Note 4 for an additional description of these business combinations and the key inputs used in the valuations.

The liabilities included in Level 3 represent the fair value of contingent consideration associated with certain of Cadence’s 2011 acquisitions. See Note 4 for an additional description of these business combinations and the key inputs used in the valuation of these liabilities. The following table summarizes Level 3 activity for the nine months ended October 1, 2011:

Cadence vacated or consolidated certain facilities in connection with restructuring plans initiated in 2010 and recorded lease losses of $1.5 million during the nine months ended October 1, 2011, which are included in Restructuring and other charges (credits) in Cadence’s Condensed Consolidated Income Statements. The fair value of these lease losses was estimated using Level 3 inputs including estimated sublease income after facilities are vacated, lease buyout costs, certain contractual costs to maintain vacated facilities and discount rates. See Note 7 for an additional description of Cadence’s lease loss estimates.

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The fair value of financial assets and liabilities was determined using the following levels of inputs as of January 1, 2011:

Marketable Securities

During the nine months ended October 1, 2011, Cadence sold available-for-sale securities and received $9.6 million in proceeds, net of $0.4 million of transaction costs, and recognized a gain of $8.0 million as Other income (expense), net in its Condensed Consolidated Income Statements.

The cost basis of Cadence’s remaining marketable securities was $2.0 million as of October 1, 2011. The cost basis of Cadence’s marketable securities as of January 1, 2011 was $3.2 million.

Non-Marketable Securities

Cadence uses either the cost or equity method of accounting to account for its long-term, non-marketable investment securities included in Other assets in its Condensed Consolidated Balance Sheets. It is Cadence’s policy to review the fair value of its investment securities on a regular basis to determine whether its investments in these companies are other-than-temporarily impaired. This evaluation includes, but is not limited to, reviewing each company’s cash position, financing needs, earnings or revenue outlook, operational performance, management or ownership changes and competition. If Cadence believes the carrying value of an investment is in excess of its fair value, and this difference is other-than-temporary, it is Cadence’s policy to write down the investment to reduce its carrying value to fair value.

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During the three months ended October 1, 2011, Cadence recognized gains of $5.4 million related to sales of cost-method investments with carrying amounts of $1.5 million. During the nine months ended October 1, 2011, Cadence recognized a gain of $2.7 million from the sale of an equity method investment. Gains and losses on the sale of non-marketable securities are recognized as Other income (expense), net in Cadence’s Condensed Consolidated Income Statements.

The carrying value of Cadence’s non-marketable securities was $10.3 million as of October 1, 2011 and $9.3 million as of January 1, 2011.

NOTE 7. RESTRUCTURING AND OTHER CHARGES

During the fourth quarter of fiscal 2010, Cadence initiated a restructuring plan, or the 2010 Restructuring Plan. Cadence initiated restructuring plans in each year from 2001 through 2005, in 2008 and in 2009, which are referred to collectively as the Other Restructuring Plans. Cadence initiated the 2010 Restructuring Plan, and the Other Restructuring Plans, collectively known as the Restructuring Plans, in an effort to operate more efficiently.

As of October 1, 2011, the amount accrued for the Restructuring Plans was as follows:

Cadence regularly evaluates the adequacy of its lease loss, severance and related benefits accruals, and adjusts the balances based on actual costs incurred or changes in estimates and assumptions. Cadence may incur future charges to reflect actual costs incurred or for changes in estimates related to amounts previously recorded under the Restructuring Plans. The maximum lease loss could be as high as $8.3 million and will be influenced by rental rates and the amount of time it takes to find suitable tenants to sublease the facilities.

The accrual for the Restructuring Plans is recorded in Cadence’s Condensed Consolidated Balance Sheets as follows:

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Total severance and termination benefits of $8.2 million were paid to employees before October 1, 2011. The remaining severance and termination benefits payments are expected to be paid after October 1, 2011 and are included in Accounts payable and accrued liabilities in Cadence’s Condensed Consolidated Balance Sheet as of October 1, 2011. Because of varying regulations in the jurisdictions and countries in which Cadence operates, these workforce reductions are expected to be completed and realized by the end of fiscal 2011.

Cadence recorded Restructuring and other charges related to lease loss accruals during the nine months ended October 1, 2011 for facilities that Cadence vacated or consolidated during that period. Cadence recorded credits during the three months ended October 1, 2011 related to changes in estimates related to the accruals for those facilities. Cadence also recorded credits during the three and nine months ended October 1, 2011 for adjustments to severance and related benefits costs that were less than previously estimated.

The following table presents activity for the 2010 Restructuring Plan for the three months ended October 1, 2011: