**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

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(Mark One)

**x**                              Annualreport pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934 for the fiscal year ended September 30, 2004

**OR**

**o**                                 Transitionreport pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934 for the transition period from                         to                         .

**Commissionfile number: 000-33291**

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NASSDA CORPORATION

(Exact name of registrantas specified in its charter)

| **Delaware**(State or other jurisdiction of  incorporation or organization)                                                  | ** ** | **77-0494462**(I.R.S. Employer  Identification Number) |
|------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|
| **2650  San Tomas Expressway  Santa Clara, California 95051**

(Address of  principal executive offices, including zip code) |
| **(408) 988-9988**

(Registrant’s  Telephone Number, including area code)                                          |

 

Securities registeredpursuant to Section 12(b) of the Act:   **None**

Securities RegisteredPursuant to Section 12(g) of the Act:   **CommonStock, $0.001 par value**

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports) and (2) has been subject to such requirements for the past90 days. Yes x No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-Kis not contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of the Form 10-K or any amendment to thisForm 10-K. x

Indicate by check mark ifthe registrant is an accelerated filer (as defined in Rule 12b-2 ofthe Securities Exchange Act of 1934, as amended). x

The aggregate market valueof the voting stock held by non-affiliates of the Registrant, based onthe closing sale price of the Registrant’s common stock on March 31, 2004,the last business day of Registrant’s most recently completed second fiscalquarter, as reported on the Nasdaq National Market, was approximately$70,077,184. Shares of common stock held by each executive officer and directorand by each person who may be deemed to be an affiliate of the Registrant havebeen excluded from this computation. The determination of affiliate status forthis purpose is not necessarily a conclusive determination for other purposes. Asof November 30, 2004, the Registrant had 27,457,621 shares of its commonstock, $0.001 par value, issued and outstanding.

**DOCUMENTSINCORPORATED BY REFERENCE**

The Registrant has notincorporated by reference any documents into this Form 10-K.

 

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**NASSDA CORPORATIONANNUAL REPORT ON FORM 10-KFor The Fiscal Year Ended September 30, 2004TABLE OF CONTENTS**
| PART I   | 1             |
|---------------|---------------|
|          | ITEM  1.      | Business | 1 |
|          | ITEM 2.       | Properties | 15 |
|          | ITEM 3.       | Legal Proceedings | 16 |
|          | ITEM 4.       | Submission  of Matters to a Vote of Security Holders | 19 |
| PART II  | 20            |
|          | ITEM 5.       | Market  for Common Equity, Related Stockholder Matters and Issuer  Purchases of Equity Securities | 20 |
|          | ITEM 6.       | Selected  Financial Data | 20 |
|          | ITEM 7.       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations       | 22 |
|          | ITEM 7A.      | Quantitative  and Qualitative Disclosures About Market Risk | 51 |
|          | ITEM 8.       | Financial  Statements and Supplementary Data | 53 |
|          | ITEM 9.       | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure      | 79 |
|          | ITEM 9A.      | Controls and  Procedures | 79 |
|          | ITEM 9B.      | Other Information | 79 |
| PART III | 80            |
|          | ITEM 10.      | Directors  and Executive Officers | 80 |
|          | ITEM 11.      | Executive  Compensation | 82 |
|          | ITEM 12.      | Security  Ownership of Certain Beneficial Owners and Management and  Related Stockholder Matters | 89 |
|          | ITEM 13.      | Certain  Relationships and Related Transactions | 91 |
|          | ITEM 14. | Principal  Accountant Fees And Services | 91 |
| PART IV  | 93            |
|          | ITEM 15.      | Exhibits  and Financial Statement Schedules | 93 |
| SIGNATURES    | 96            |

 

 

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**PART I**

*This reportcontains forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933 and Section 21E of the Securities ExchangeAct of 1934 about Nassda Corporation (“Nassda,” “we,” “us” or “our company”). Thesestatements include, among other things, statements concerning our futureoperations, financial condition and prospects, and business strategies. Thewords “may,” “will,” “continue,” “estimate,” “project,” “intend,” “believe,” “expect,”“anticipate” and other similar expressions generally identify forward-lookingstatements. Forward-looking statements in this Form 10-Kinclude, but are not limited to, statements regarding the following: theeffectiveness and advantages of our products, our marketing and product developmentstrategies, factors relating to demand for our products, hiring of additionalpersonnel, the proprietary nature of our products, including infringement andenforcement of proprietary rights, competition and our ability to compete,sufficiency of our facilities, the completion of the proposed merger between usand Synopsys and resolution of legal proceedings.*

*Investors in our common stock are cautioned not toplace undue reliance on forward-looking statements. Forward-lookingstatements are not guarantees of future performance. The forward-lookingstatements are subject to substantial risks and uncertainties that could causeour future business, financial condition, or results of operations to differmaterially from our historical results or currently anticipated results. Investorsshould carefully review the information contained under the caption “FactorsAffecting Future Results” contained in “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” and elsewhere in, or incorporatedby reference into, this report. All forward-looking statements are basedon information available to us on the date hereof, and we assume no obligationto update forward-looking statements. These forward-lookingstatements are made in reliance upon the safe harbor provision of The PrivateSecurities Litigation Reform Act of 1995.*

**ITEM1.**   Business

**RecentDevelopments**

We are a leading provider of full-chip circuitsimulation and analysis software for the design and verification of complexnanometer-scale semiconductors. By enabling semiconductor designers toidentify and correct nanometer design problems, our software provides a numberof key benefits to our customers, including an improved ability to achievefirst silicon success, reduced chip production costs, accelerated time tomarket through shortened design cycles and enhanced chip performance.

We entered into anagreement of merger with Synopsys Inc.(“Synopsys”) and North Acquisition Sub, Inc., a whollyowned subsidiary of Synopsys, dated as of November 30, 2004 pursuant towhich we agreed to be acquired by Synopsys in an all cash transaction for $7per share. Subject to approvals by our stockholders and receipt of variousregulatory approvals, we expect the consummation of the merger to occur duringthe first calendar quarter of 2005. Upon closing, all outstanding trade secretand patent infringement litigation by Synopsys against us and certain of ourofficers, directors and employees will be settled and our officers, directorsand employees who are defendants in the litigation between Synopsys and us willmake settlement payments to Synopsys in the aggregate amount of $61.6 million andwill not exercise options to purchase our common stock valued at approximately$5.9 million. As a result of the litigation settlement, we recorded a one-timecharge of $67.5 million in the quarter ended September 30, 2004. Accordingly,our net loss was $67.3 million for the quarter ended September 30, 2004and $64.9 million for the fiscal year ended September 30, 2004.

**Overview**

We believe that our first product, HSIM, is theelectronic design automation (EDA) industry’s first hierarchical circuitsimulator that meets the detailed verification challenges of today’s integratedcircuit designs. We believe that our second product, LEXSIM, is the first toolable to simulate the nanometer 

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effects of both the powernetwork and signal interconnects for complex integrated circuits, or ICs, withmillions of transistors and extracted parasitic elements. We believe that ourthird product, CRITIC, is the first tool able to provide accurate analysis ofnanometer effects automatically on critical signal paths and clock networks forcomplex, high-performance digital ICs designed with high-endapplications specific integrated circuits (ASIC) or customer-ownedtooling (COT) flows. In May 2003, we released our fourth product, HANEX,which we believe to be the first hybrid timing analysis tool to automaticallyidentify critical paths and report timing violations, which incorporate theimpact of crosstalk effects on signal delays in high-speed custom digitalICs.

In April 2004, we released the HSIMplusplatform for the comprehensive simulation and analysis of high-performanceanalog, mixed-signal, memory and system-on-chip designsincluding important post-layout effects. The platform, based on version5.0 of our HSIM hierarchical simulator, includes technologies first deployed inLEXSIM and provides a suite of advanced circuit analyses and post-layoutanalyses for ICs manufactured in 130 nanometer processes and below. Theseanalyses address major concerns of nanometer IC designers including reliabilityof power and signal networks, the timing impact of dynamic voltage drop inpower networks, dynamic crosstalk noise due to coupling capacitance and MOSFETdevice reliability. The LEXSIM product was no longer offered for sale as aseparate product as of August 2004, since all of its features are nowsupported by the HSIMplus platform.

We were incorporated inCalifornia in August 1998. We reincorporated in Delaware in September 2001.Our principal executive offices are located at 2650 San Tomas Expressway, SantaClara, California 95051. Our telephone number at that location is(408) 988-9988.

**Available Information**

We are subject to the reporting requirements under theSecurities Exchange Act of 1934. Consequently, we are required to file reportsand information with the Securities and Exchange Commission (SEC), includingreports on the following forms: annual report on Form 10-K, quarterlyreports on Form 10-Q, current reports on Form 8-K, andamendments to those reports filed or furnished pursuant to Section 13(a) or15(d) of the Securities Exchange Act of 1934. These reports and otherinformation concerning our company may be accessed through the SEC’s website athttp://www.sec.gov. The public may read and copy any materials that we filewith the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW,Washington, DC 20549. The public may obtain information on the operation of thePublic Reference Room by calling the SEC at 1-800-SEC-0330.

You may also find on ourwebsite at http://www.nassda.com electronic copies of our annual report on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K,and amendments to those reports filed or furnished pursuant to Section 13(a) or15(d) of the Securities Exchange Act of 1934. We place these filings onour website as soon as reasonably possible after they are filed with the SEC. Thecontent of our website is not incorporated by reference in this Annual Reporton Form 10-K.

**IndustryBackground**

Technological advances in thesemiconductor industry have stimulated strong demand for communicationsequipment, personal computers, wireless devices, digital consumer and othersemiconductor-based products. Competition and the rapid pace ofelectronic innovation have also decreased the life cycles of these products,making time to market critical to the success of new product introductions. Electronicsmanufacturers have been able to offer smaller, higher performance products byusing faster and more complex semiconductors. These advances have been drivenin significant part by reductions in the size of semiconductor circuitelements, or feature sizes. Feature sizes have shrunk from 3.0 microns inthe 1980s to 0.5 microns ten years ago and 0.09 microns, or90 nanometers, today. Several semiconductor companies have begun theirefforts of developing the technology necessary for feature sizes that are65 nanometers 

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and below. We believe thatthe proportion of chips with feature sizes at or below 0.18 microns, whichwe refer to as nanometer-scale semiconductors, will increasesignificantly in the future.

Decreasing feature sizeshave enabled the development of higher capacity and more complex memory andprocessor circuits, as well as systems-on-a-chip, or SoCs. SoCscombine traditionally separate microprocessor, memory and communicationsdevices onto a single chip. Mixed-signal designs combine both analog anddigital circuits. Today’s SoCs typically incorporate embedded memory blockswith digital and analog circuit components. SoCs offer significant cost, powerand performance advantages over systems that use discrete chips to achieve thesame functionality.

*Complex Nanometer-ScaleSemiconductor Design Flow*

The sequence of procedures usedto develop and verify integrated circuit designs is commonly referred toas the IC design flow. This design flow can be broadly divided into two types:a digital design flow and a custom design flow, including analog, mixed-signaland memory designs. Complex SoCsdevices that incorporate multiple memory and analog components use separatedesign flows for the analog/mixed—signal/memory and digital portions of thedesign. The digital design flow is relatively straightforward and designers canuse simple models of the logic gates to describe the design. Analog, mixed-signaland memory components require a more complex design flow that models thecircuit at the transistor level to account for the greater circuit sensitivityto transistor behavior and electrical effects from the interconnects, or thewires connecting individual transistors.

As semiconductor designscontinue to incorporate increasingly smaller nanometer-scale featuresizes, circuit simulation and analysis in both the digital and custom designflows become more critical to ensure that chips function correctly. Innanometer-scale semiconductors, transistors and interconnects are sodensely packed that the different components of a chip may interact in unintendedways and interfere with the proper functioning of the whole chip. The pre-layoutverification stage assumes that the wiring or interconnect is ideal and theseeffects are either ignored or crudely estimated in the analysis. These effectscan be more accurately analyzed after the design has been committed to aspecific layout for a silicon chip. This is known as the post-layoutstage of the design process. Most of theseunintended physical and electrical interactions, or parasitic effects, arenegligible at larger feature sizes and thus have traditionally been ignored inchip designs. As designs become more dense, however, accurate circuitsimulation and analysis of transistor behavior and parasitic effects becomefundamentally critical to the successful design and manufacture of complexnanometer-scale semiconductors.

*Challenges ofComplex Nanometer-Scale Semiconductor Design and Verification*

The trends towardnanometer-scale feature sizes and the increased use of embedded memories,analog and mixed-signal components have created new challenges fordetailed simulation and analysis of designs prior to manufacture. In addition,the integration of designs from third-party suppliers, known asintellectual property, or IP, such as processor cores, into SoCs dramatically increases the totaltransistor count, thus creating additional potential points of failure. Asfeature sizes decrease, the parasitic effects that occur in nanometer-scaleanalog and mixed-signal and memory circuits make the design and analysisof these circuits increasingly more difficult than digital circuits. As aresult, circuit verification of complex nanometer-scale semiconductordesigns requires sophisticated simulation and analysis of the following:

·       *Functionality*.   Semiconductor designsmust be verified to determine whether they meet their exact functionalspecifications. These simulations determine whether the chips will operate asintended under a variety of scenarios and conditions. Simulating functionalityof complex nanometer-scale semiconductors overwhelms the capacity andperformance of traditional simulation tools. Functional verification of mixed-signalSoC designs is even more challenging because the analog and memory portions ofthe circuit require a highly accurate simulator.

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·       *Timing behavior*.   Electrical signalsmust move through a semiconductor at precise time intervals in order for thechip to function properly at the specified operating frequency. As featuresizes continue to shrink, it becomes increasingly difficult to determine theimpact of parasitic effects on the timing of signal propagation. This makes itmore difficult to determine whether the signal timing for the entire nanometer-scalesemiconductor design is correct because there are numerous possible signalpaths and all signals must work consistently and synchronously.

·       *Power behavior*.   Due to the demandfor extended battery life of electronic products and low semiconductorpackaging costs, nanometer-scale semiconductors must consume power withinproduct specifications. Power supply current simulation, leakage currentsimulation and power analysis are necessary to help predict the power level fora given circuit and reduce any excessive power to ensure power consumptionremains at or below the design specification.

·       *Electrical supply*.   Maintaining appropriate electricalsupplies to all components of a chip is crucial for proper chipperformance. As the complexity of nanometer-scalesemiconductors increases, it becomes difficult to predict the impact offluctuations in local electrical supply voltages. This problem is exacerbatedwhen the overall supply voltage level decreases in supporting smaller feature-sizedcircuits and lower power consumption. These supply voltage fluctuations canlead to circuit performance degradation or functionality failure.

·       *Signal integrity*.   Feature size reductions have decreased thedistances between interconnects. These reduced distances increase thelikelihood of unintended interference between signals flowing through adjacentwires. This problem is exacerbated by high-speed designs and the use ofmixed-signal circuits in which analog components are particularlysusceptible to interference from nearby devices. As the feature sizes decreaseto 0.13 microns or lower, the non-digital device behavior may alsocause signal integrity degradation and must be addressed.

·       *Nonlinear device behavior*.   Thenonlinear device behavior at the 0.13 micron process node or below is anintrinsic nature of semiconductor device physics, which can complicate thebehavior found in circuits with larger feature sizes. Under nanometer-scaleconditions, certain presumed digital circuit operations may exhibit analogcircuit behavior unexpected by the designer, which must be addressed to achievea successful design.

·       *Thermal effects*.   Ascurrents pass through devices in a circuit, heat is generated. In a densecircuit operating at a high clock frequency, excessive heat may raise the chiptemperature and cause the circuit to change functionality. Thermal effectsusually cause high temperature circuit component areas (hot spots) to operateat reduced signal speeds and therefore create overall chip performancedegradation and possible functional errors.

·       *Spectral behavior*.   Semiconductorsfor communications applications are required to operate within a limited rangeof the radio frequency spectrum. The verification process for chips thatincorporate radio frequency components must confirm that the chips areoperating within the specified spectrum to avoid unwanted signal distortion andinterference.

Managing the challenges associated with simulation andanalysis of complex designs has emerged as a critical hurdle in the design andfirst silicon success of complex nanometer-scalesemiconductors such as SoCs. The sizeand features of complex nanometer-scalesemiconductors demand full-chip simulation and analysis. However, the volume of data required for the simulation ofcomplex nanometer-scale semiconductors has in general exceeded thecapacity of traditional simulation software.

Designers using traditional simulation software mustperform partial simulations by partitioning the circuit into smaller blocks andverifying them independently. Independent simulation and analysis of theseblocks alone may lead to a potential for error when these independent blocksare ultimately integrated to form the entire chip. For example, when allcomponents are brought together, inconsistent signal 

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exchanges among adjacentblocks, subtle timing errors or an excessive local supply voltage drop cancause a design to fail, or total power usage may exceed specified limits. Ifthe design fails, the chip must be redesigned and remanufactured, which can betime consuming and costly. We believe that the cost for the redesign andremanufacture of a flawed semiconductor may be $1.0 million or more for a0.13 micron semiconductor. We expect this cost to increase substantiallyfor semiconductors with feature sizes below 0.13 microns.

Inaddition to the high cost to redesign and remanufacture a flawed chip, delayscaused by design flaws can cause product launch postponements orcancellation, lost revenue or reduced market share, each of which can result in failure of products, divisions andeven businesses. As a result, we believe that there is a significantmarket opportunity for a solution that enables semiconductor manufacturers toachieve first silicon success by providing rapid, accurate, full-chipcircuit simulation and analysis of complex nanometer-scalesemiconductor designs.

**TheNassda Solution**

We provide full-chip circuit simulation andanalysis software solutions for the design and verification of complex nanometer-scale semiconductordesigns. Our software helps our customers reduce time to market and achievefirst silicon success by simulating and analyzing complex chip designs rapidlyand accurately. Our software assists semiconductor designers to confirm thattheir designs perform correctly at the pre-layout and post-layoutverification stages. In particular, our software enables our customers tosimulate and analyze the behavior of designs at the level of the semiconductor’ssmallest and most fundamental circuit structures, consisting of transistors andinterconnect elements such as resistors, capacitors and inductors.

Our software provides the following key benefits toour customers:

·       *First silicon success and reduced production cost*.   Byenabling designers of complex chips to accurately verify their designs beforethey are released for the manufacture of prototype semiconductors, a step inthe design process known as tapeout, our software can help customers achievefirst silicon success. Our customers benefit by reducing or avoiding thesignificant costs and delays associated with repeatedly redesigning andremanufacturing their chips when these chips fail to function correctly aftermanufacturing.

·       *Accelerated time to market through shortened designcycles*.   Our software has the ability to rapidly simulate andanalyze complex nanometer-scalesemiconductor designs, which assists our customers in shortening their design cycles and accelerating theirproducts’ time to market. Time to market is critical to our customers’ability to remain competitive and capture market share.

·       *Enhanced chip performance and reliability*.   Oursoftware is developed to help our customers design and produce faster, lower power and more reliable chips. Our software’scapacity enables customers to simulate designs that are significantlymore complex without sacrificing quality of results. We believe that byenabling customers to simulate and analyze large, highly complex designsrapidly and accurately, our customers can develop more reliable products withhigher performance and lower power consumption. Our software’s efficientprocessing time also enables our customers to optimize their designs throughadditional analyses without lengthening the design cycle.

·       *Broad application*.   Designers can use our software inseveral stages of the semiconductor design flow. Early in the design process,our software helps designers to design and optimize circuit blocks, as well as to characterize IP cores. Later,at the post-layout stage of the design process, our softwareassists customers to simulate, analyze andoptimize timing and power behavior to determine whether the entire chipwill function correctly and meet functionality, power and timing specifications.Our software also is applicable to a wide range of semiconductor productcategories ranging from 

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analog, mixed-signal,memory, and SoC to high-speed ASIC and custom digital circuits. Thecapabilities provided by our software go beyond circuit simulation and includehybrid timing analysis, supply voltage fluctuation analysis, and power andsignal interconnect current density reliability analyses.

·       *Ease of adoption and integration*.   Wedesigned our software to be easy to learn, use and integrate into a customer’sexisting design environment. Because our software is compatible with standardfile formats supported in most design environments such as SPICE, DSPF andSPEF, the integration becomes straightforward and most designers requireminimal training to become proficient users.

Key features of oursoftware include the following:

·       *High capacity*.   Our software is designed to simulate andanalyze chips of up to a billion transistors efficiently and accurately.Our software accomplishes this through our hierarchical database technologythat stores repeated instances of identical subcircuits efficiently, therebyreducing memory usage substantially and increasing simulation capacity. Identicalsubcircuits need to be captured and maintained only once, which makes thesimulation more efficient and consumes less computer memory. As a result, oursoftware is capable of performing simulation and analysis of significantlylarger designs at the transistor level than traditionalcircuit simulators. In addition, at the post-layout stage, the number ofextracted parasitic elements can be as high as tens to hundreds of millions. Oursoftware can read in these elements in tens of gigabytes of data volume andmanage to process them and create reduced equivalent network structures forfinal simulation and analyses. We believe that our software is the most capablesimulator in handling large post-layout circuit verification on themarket today.

·       *Full-chip simulation capability*.   Thecapacity afforded by our hierarchical technology enables our software tosimulate and analyze not just large circuit blocks but also full-chipdesigns rapidly. Full-chip simulation is critical in verifying complex nanometer-scale designs because thecircuit behavior of individual blocks may differ from the behavior of thoseblocks in a full-chip environment and it is necessary to ascertain thefunctionality, timing and power behavior of the chip as a whole. Only throughsuch full-chip verification and analyses can a complex nanometer-scalesilicon success be assured.

·       *Speed and accuracy*.   In addition toincreased capacity, our hierarchical database and simulation algorithms alsosubstantially reduce the computing time required for complex circuit simulationand analysis. Relative to traditional circuit simulation software, our softwaregenerates results more efficiently. Shorter turnaround time for each simulationcan help reduce the design and verification cycle and allow more thoroughanalyses at circuit level. By analyzing the design at the transistor level, oursoftware achieves a higher level of accuracy as compared to that of the gate-levelor the switch-level simulators. It also gives more reliable simulationresults and correlates with real silicon more closely than those from the gate-levelor switch-level simulators. By applying the hybrid analysis approach, asfound in our HANEX product, to digital circuits, there is no need to use testvectors as otherwise would be required in simulation and hence the overallanalysis efficiency can be increased significantly.

·       *Digital, analog and memorycircuit simulation*.   Oursoftware is designed to concurrently simulate digital, analog and memorycircuit components found inside an entire chip. We believe this full-chipconcurrent analysis capability for various types of components is critical todesigners who would otherwise have to use multiple software to test thesedifferent components separately. Independent analysis of separate blocks maynot ensure that the entire design will perform as intended when the blocks areintegrated. To ensure the overall product specifications are met, concurrentsimulation and analyses are necessary to provide the final verification of anintegrated circuit with its various analog, digital and memory components.

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·       *Timing analysis*.   Our softwareconducts timing simulations and employs various timing analysis methods toreport timing problems to designers. By analyzing the design at the transistorlevel, our software provides accurate timing information not available indigital simulators or analyzers performing at the logic gate level. Oursoftware can also analyze timing changes due to electrical, temperature andmanufacturing variations so that designers can determine whether the designwill operate properly under varied operating conditions. Among the electricalinfluences, capacitance between signal interconnects may cause serious changesto signal delays as the feature size goes below 130 nm. Our software analyzesthe coupling capacitance effects on delays accurately and provides dependabletiming analysis results.

·       *Power and reliability analysis*.   Theanalysis capabilities of our software predict the power consumption withdetailed accuracy in complex nanometer-scale designs. Because oursoftware predicts power usage and localizes unintended power loss quickly andaccurately, entire designs can be optimized to provide the desired performancewith reduced power consumption. Our software further uses the calculatedcurrents on power and signal interconnects to identify current densityreliability problems in these metal-wiring structures. Such metalmigration problems usually will not appear initially during chip operations andthus can be very difficult to detect. After a period of time, the conductivityof the metal interconnect becomes eroded, timing errors emerge and even wirebreakdown may occur when an excessive local metal migration takes place, whichwill cause chip functionality failures. Because our products provide sufficientspeed and capacity, these effects can be analyzed prior to chip manufacture.

·       *Simulation of parasitic effects*.   Oursoftware is engineered to simulate the electrical problems at the post-layoutstage caused by the parasitic effects existing in complex nanometer-scale semiconductors. Theseparasitic effects, if not fully understood and analyzed, can cause silicon failures.For example, our software simulates signal integrity problems associated withinterference among interconnects that obscure real signals. Signal oscillationsor reference voltage bouncing due to inductance effects can also degrade signalintegrity. Additionally, our software is designed to accurately simulate theeffects of electrical supply voltage drops on performance and handle theintroduction of large amount of parasitic data without significant speedreduction as compared to traditional simulation tools.

**Products**

HSIM provides full-chip circuit simulation,analysis and optimization of complex nanometer-scale semiconductors. HSIMcombines the simulation of functionality, timing, power, signal integrity,spectral behavior and related parasitic effects to allow comprehensive analysisof complex circuits in many design styles. To meet our customers’ diversifiedneeds, we offer HSIM in three separate configurations: HSIM-XL, HSIM-MSand HSIM-SC.

Our HSIM-XL, the highest capacity configurationof HSIM, is designed for simulation of memories, SoCs and other large, complex designs containing 10 milliontransistors or more. HSIM-XL’s high capacity is designed to enablesimulation of complex nanometer-scalechips at both the pre-layout and the more computationally intensive post-layoutphases of the semiconductor design flow.

Our HSIM-MS configuration is designed to providehigh speed simulation and analysis of mixed-signal designs and othercircuits containing up to 10 million transistors. Relative to traditionalcircuit simulators, HSIM-MS operates significantly faster and withgreater accuracy for the mid-ranged circuit sizes. Like HSIM-XL,HSIM-MS can be used to simulate chips at both the pre-layout andpost-layout stages of the design flow, although post-layoutsimulation of very complex nanometer-scaledesigns may require HSIM-XL or options from the HSIMplusplatform.

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Our HSIM-SC configuration is designed for rapidand accurate simulation of smaller analog and mixed-signal circuits of upto 100,000 transistors. HSIM-SC is used primarily during the initialdesign stages of these semiconductors or for block level design verificationand optimization. It is also often used for cell library and small memoryintellectual property characterizations.

HSIMplus is our software platform built onthe HSIM simulator to provide a highly integrated solution for nanometer-scaleIC design challenges, including options for dynamic voltage drop analysisconsidering the timing impact of supply voltage variations; reliabilityanalysis of supply voltage and signal interconnects; signal coupling andcrosstalk interference effects; and analysis of performance degradation due toaging of transistors. Other options include integration with the popular analogdesign environment from Cadence Design Systems, Inc., integrations withdigital simulators that work at a higher level of abstraction, as well asautomatic circuit design rules screening and checking for detectingpotential flaws.

HSIMplus employs sophisticated techniquesto read in high volume post-layout parasitic data and reduce parasiticnetworks associated with voltage supply, ground busses and signal interconnects.It can also back annotate the extracted post-layout parasitics onto thepre-layout hierarchical netlist of a given design. This combination oftechniques enables HSIMplus to provide the highest capacity andspeed for effective post-layout simulation of large nanometer-scaleICs. In particular, HSIMplus is effective in its dynamic supplyvoltage drop simulation so that designers can use it to investigate the circuitperformance degradation caused by such supply voltage variations. As processtechnology migrates to feature sizes of 0.13 microns or lower, supplyvoltage fluctuation problems become increasingly severe. The ability of HSIMplusto predict dynamic instantaneous supply voltage drop effects on circuitbehavior helps reduce silicon iterations and get commercially shippablesemiconductor products to market sooner.

CRITIC is a full-chip critical timing delay calculatordesigned for rapid post-layout timing verification of high-speedASIC and cell-based digital ICs, including their associated clocknetworks. CRITIC complements traditional gate-level based static timinganalysis verification methods with fast, accurate transistor-levelanalysis of timing performance of circuits using nanometer process technologiesof 0.13 microns and lower. The important cross coupling capacitanceeffects on delay are fully accounted in CRITIC to assure the analysis accuracy.CRITIC automates such post-layout timing delay analysis of both signalnets and clock nets with minimal designer intervention, which can helpdesigners to ensure their final timing sign off.

HANEX is a circuit-level hybrid timing and crosstalkanalysis tool for leading-edge custom digital designs, which can also acceptvarious logic circuit design styles. HANEX analyzes the timing of nanometer-scalecircuits and determines critical delay paths using a combination of dynamic andstatic methods that accurately capture nanometer parasitic effects on circuitsignal delays and reduce the number of false paths reported. Without testvectors, HANEX can identify worst-case critical signal delay paths that limitthe maximum speed of the circuitry. HANEX fills the gap between static analysismethods and the increasing requirements for more accurate timing analysis toensure successful silicon for leading-edge high-performance designs. Webelieve HANEX delivers results with the accuracy of dynamic simulation and thespeed and comprehensive coverage of static analysis. As a result, we believeHANEX helps custom digital IC designers gain detailed timing results withSPICE-like accuracy in hours, improved substantially from the days or weeksrequired by traditional simulation approaches or from the less accurate, lessreliable results from pure static timing analyzers.

To date, we have derivedsubstantially all of our software licensing and maintenance fees from thelicensing and support of HSIM. If we remain a stand-alone company, we do notexpect the HSIMplus options, CRITIC and HANEX to account for anymeaningful percent of our total revenue until the second half of fiscal 2005.

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**Customers**

Oursoftware has been licensed to over 250 organizations worldwide. Based uponrevenues generated from inception to September 30, 2004, the followingtable lists our top 20 end users and what we believe to be the types ofdesigns for which they use our software:
| **End User**                              | ** ** | ** ** | ** ** | **Communications** | ** ** | **Memory** | ** ** | **Analog/  Mixed Signal** | ** ** | **CPU/MCU** |
|-------------------------------------------|------------|------------|------------|--------------------|------------|------------|------------|---------------------------|------------|-------------|
| Advanced Micro Devices, Inc.         | ** ** | **ü** | ** ** | **ü**         | ** ** | ** ** | ** ** | **ü**                |
| Altera Corporation                        | ** ** | **ü** | ** ** | ** **         | ** ** | **ü** | ** ** | ** **                |
| Broadcom Corporation                      | ** ** | **ü** | ** ** | **ü**         | ** ** | **ü** | ** ** | ** **                |
| Fujitsu Limited                           | ** ** | **ü** | ** ** | **ü**         | ** ** | **ü** | ** ** | **ü**                |
| Hitachi, Ltd.                             | ** ** | ** ** | ** ** | **ü**         | ** ** | **ü** | ** ** | **ü**                |
| Matsushita Electric  Industrial Co., Ltd. | ** ** | **ü** | ** ** | **ü**         | ** ** | **ü** | ** ** | ** **                |
| Mitsubishi Corporation                    | ** ** | **ü** | ** ** | **ü**         | ** ** | **ü** | ** ** | **ü**                |
| Micron Technology, Inc.              | ** ** | ** ** | ** ** | **ü**         | ** ** | **ü** | ** ** | ** **                |
| National Semiconductor  Corporation       | ** ** | **ü** | ** ** | ** **         | ** ** | **ü** | ** ** | ** **                |
| Name Withheld at Request  of Customer     | ** ** | **ü** | ** ** | **ü**         | ** ** | **ü** | ** ** | **ü**                |
| NEC Electronics  Corporation              | ** ** | **ü** | ** ** | **ü**         | ** ** | **ü** | ** ** | **ü**                |
| Philips Electronics  Nederland B.V.       | ** ** | **ü** | ** ** | **ü**         | ** ** | **ü** | ** ** | ** **                |
| Samsung Electronics Co.,  Ltd.            | ** ** | **ü** | ** ** | **ü**         | ** ** | **ü** | ** ** | **ü**                |
| SanDisk Corporation                       | ** ** | ** ** | ** ** | **ü**         | ** ** | ** ** | ** ** | ** **                |
| STMicroelectronics                        | ** ** | **ü** | ** ** | **ü**         | ** ** | **ü** | ** ** | **ü**                |
| Texas  Instruments, Inc.             | ** ** | **ü** | ** ** | ** **         | ** ** | **ü** | ** ** | ** **                |
| Toshiba Corporation                       | ** ** | **ü** | ** ** | **ü**         | ** ** | **ü** | ** ** | **ü**                |
| VIA  Technologies, Inc.              | ** ** | **ü** | ** ** | ** **         | ** ** | **ü** | ** ** | **ü**                |
| Virage Logic Corporation                  | ** ** | ** ** | ** ** | **ü**         | ** ** | ** ** | ** ** | ** **                |
| Xilinx, Inc.                         | ** ** | **ü** | ** ** | ** **         | ** ** | **ü** | ** ** | ** **                |

 

In our fiscal years ended September 30,2002 (“fiscal 2002”), 2003 (“fiscal 2003”) and 2004 (“fiscal 2004), MarubeniSolutions, our Japanese distributor, accounted for approximately 19.4%, 15.5%and 18.2% of our total revenue, respectively. In fiscal 2003, BroadcomCorporation accounted for approximately 10.5% of our total revenue. No othercustomer or distributor accounted for more than 10% of our total revenue duringany of these periods.

**Technology**

Our software isdesigned to provide more accurate results, significantly higher capacity andfaster speed through the following technologies:

·       *Hierarchical database and simulation engine*.   Weuse a hierarchical database to store the design during simulation. Our hierarchical database technology deliverssignificant capacity improvements and reduces memory usage by storingrepeated instances of identical subcircuits once and reusing them when required.Complex chips, particularly memory circuits, are typically created with ahierarchy in which the overall design isdivided up into various subcircuits, many of which are used repeatedly withinthe design. When simulation and analysis are performed using traditionalsimulation tools, however, this hierarchy is fully expanded so that allinstances of identical subcircuits are replicated and stored in memory whilethe simulation is running. As a result, simulation of large designs withtraditional simulation tools places asignificant processing burden and memory usage constraint on computingresources, particularly at the post-layout stage of design analysis. Analysisby traditional simulation tools becomes computationally infeasible whendesigns consist of tens of millions of 

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transistors. To acceleratesimulation performance, our software reuses simulated behavior for identicalsubcircuits operating under almost identical conditions during a very shortperiod of time.

·       *Effective parasitic reduction*.   Theinterconnects for nanometer-scalesemiconductors are modeled as networks of individual parasitic elements, suchas resistors, capacitors and inductors. Bysimulating the parasitic effects, a designer can determine how these networksare likely to interfere with the intended functionality and the timing behaviorof the design. As the number of transistors in a design increases and featuresize decreases, the number of parasitic elements extracted from a given layout can increase substantially. Incorporationof the parasitic element data into a simulation may require asignificant amount of memory storage which can exceed the capacity oftraditional simulation tools. An excessive number of parasitic elements willgenerally slow down the simulation speed substantially and make the turnaroundtime of traditional simulation tools undesirable. Our parasitic reductiontechnology reduces the complexity of the parasitic data and therefore decreasesthe storage requirement, while at the same time improving simulationperformance and retaining the desired accuracy.

·       *Efficient signal integrityanalysis*.   Our software isdesigned to accurately simulate noise problems caused by signalinteraction among adjacent interconnects through coupling capacitors andsimulate electrical supply voltage fluctuation effects on the circuit behavior.Additionally, inductive parasitic effects can cause noise in the forms ofcircuit oscillations or ground bounces which are also simulated efficiently. Oursoftware handles the introduction of these parasitic elements withoutsignificant speed degradation as compared to traditionalsimulation tools.

·       *Hierarchical back annotation.*   The HSIMplusplatform optionally offers a proprietary technique that annotates parasiticelements from a flat extraction onto the pre-layout netlist of a designwhile maintaining the hierarchies in the pre-layout design. Thistechnique enables our hierarchical simulation engine to be used for post-layoutanalysis without suffering from the performance degradation or circuit sizelimitation inherent in traditionalsolutions, and offers greater speed and capacity than HSIM alone for post-layoutverification of the most complex semiconductor designs based on the flatextraction circuit data.

·       *Hybrid timing analysistechnology.  *To improve the accuracy of pure static timinganalysis, we developed HANEX, a new hybrid timing analysis that combines ourstatic timing analysis and dynamic simulation to form a new generation timinganalysis for complex nanometer-scale high-speed custom digitaldesigns. Dynamic simulation provides high timing accuracy and static timinganalysis detects worst-case timing delay paths without using any testvectors. Their combination creates a more ideal solution for analyzing timingbehavior for high performance custom digital circuits. HANEX takes into accountthe crosstalk coupling effects on signal delays and reduce false critical pathsoften reported by traditional pure static timing analyzers. As processtechnology continues to migrate to smaller feature sizes, the accuracy oftiming delay with reduced false paths will have an increasing importance inpredicting the timing behavior of nanometer-scale designs.

**Customer Service and Support**

Our software is designed to be installed quickly andused effectively by our customers, thus minimizing the level of supportrequired. However, our customers’ design activities are highly complex. Webelieve that high quality user service and support are critical to the successof our business. We have developed, and expect to continue to improve (to the extent we remain a stand-alone company),our comprehensive service and support organization to manage user accounts. Asof September 30, 2004 we had 13 direct service and support officesworldwide.

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Our service and supportorganization assists customers with product evaluation, installation andconfiguration. Our service and support organization also assists customers toresolve issues that arise from their complex design tasks. We generally respondto user support requests quickly and provide supplemental software patches toaddress individual user design issues. Effective execution of these tasksrequires highly trained and skilled engineers familiar with our products,customers’ design tasks and with third-party products that may be used bythe designer in connection with our software. We provide our support viaelectronic mail, our web site, facsimile, telephone and on-site asnecessary.

**Salesand Marketing**

We sell our softwaredirectly through our sales force in North America and Europe and primarilyindirectly through distributors in Asia. Revenue attributable to sales outsideNorth America accounted for 42.0%, 39.6% and 36.1% of our total revenue infiscal 2002, 2003 and 2004, respectively. While we continue to seek to diversifyour user base and expand the portion of our total revenue which is derived fromdirect sales, we anticipate that to the extent we remain a stand-alone company,our operating results will continue to depend, to a lesser extent, on arelatively high volume of sales through a relatively small number ofinternational distributors and other channel partners.

*Direct sales*

As of September 30,2004, our direct sales and support staff consisted of 49 employees based in 16sales and support offices. We have domestic direct sales and support offices inScottsdale, Arizona; Santa Clara, California; Irvine, California; Cambridge,Massachusetts; Austin and Dallas, Texas; Redbank and Allendale, New Jersey;Brooklyn, New York and Sammamish, Washington. We also have direct sales and/orsupport offices in Vancouver, Canada; Grenoble, France; Munich, Germany;Bangalore, India; Israel; Singapore; and Taipei, Taiwan. Direct sales accountedfor approximately 72.1%, 75.3% and 74.2% of our total revenue in fiscal 2002,2003 and 2004, respectively. Our sales teams generally include sales managersand applications engineers for each territory. Our typical sales cycle rangesfrom three to six months and may be longer, particularly in today’s challengingeconomic and competitive environment.

*Indirect sales*

In addition to our direct salesstrategy, we have established indirect sales channels through distributorsin Asia. Currently, our software is distributed by an exclusive distributor inJapan and nonexclusive distributors in China, Hong Kong, Korea and Taiwan. Ourrelationships with distributors play a critical role in extending our reach tomore customers. Revenue from distributorswas approximately 27.9%, 24.7% and 25.8% of our total revenue in fiscal 2002,2003 and 2004, respectively. Our distributors typically perform marketing,sales and technical support functions in their country or region. Ouragreements with our distributors do not obligate the distributors to purchaseor sell any minimum number of licenses of our software. Most arrangementsprovide incentives to the distributors to provide a small number of sales andsupport personnel dedicated to our software, provide basic support to end usersand use their best efforts to jointly promote our software in their territory. We provide product enhancements andbackup support for more complex questions and issues raised by end users whopurchase our software through our distributors. Most of our distributorarrangements are for a term of one year and are renewed annually uponmutual consent. Generally, either party may terminate the arrangement for amaterial default by the other party or by written request within a specifiedperiod prior to the end of each annual term.

Revenue from MarubeniSolutions, our Japanese distributor, accounted for approximately 19.4%, 15.5%and 18.2% of our total revenue for fiscal 2002, 2003 and 2004, respectively. MarubeniSolutions accounted for 23.0% of our accounts receivable at September 30,2002, 18.4% of our accounts receivable at September 30, 2003 and 29.3% ofour accounts receivable at September 30, 2004.

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*Marketing*

We focus our marketingefforts to create awareness of Nassda and our software and generate leads forour sales organization. Our strategy is to distinguish our software by its highcapacity, accuracy and performance, ease of use and time to market advantages. Weemploy a wide variety of communication channels to inform customers andpotential customers about our software. These channels include our web site,print and web advertising, public relations, live seminars, trade shows andtechnical publications.

**Research and Development**

We have invested significant time and resources increating a structured process for undertaking all product development projects.This process involves key functional groups within our company and is designedto provide a framework for defining and addressing the steps required to bringproduct concepts and development projects to market successfully.

Wehave actively recruited engineers and software developers with expertise anddegrees in computer science, semiconductor physics, electricalengineering and other engineering disciplines. As of September 30, 2004,we had 52 employees engaged in research and development activities, of whom 24held doctorate degrees. Our research and development expenses were$5.5 million in fiscal 2002, $7.1 million in fiscal 2003 and$8.9 million in fiscal 2004.

**ProprietaryRights**

Our software relies on ourinternally developed intellectual property and other proprietary rights. Werely primarily on a combination of patent, copyright, trademark and tradesecret laws, confidentiality procedures and contractual provisions to protectour intellectual property and other proprietary rights. However, we believe that these measures afford only limitedprotection. To date we have two patents issued by the U.S. Patent andTrademark Office. We have two registeredtrademarks, Nassda and HSIM, and four trademarks, CircuitCheck, CRITIC,HANEX and LEXSIM. We also generally enter into confidentiality agreements withour employees and technical consultants. Despite our efforts to protect ourproprietary rights, unauthorized parties may attempt to copy aspects of oursoftware or obtain and use information that we regard as proprietary. Policingunauthorized use of our software is difficult and we are unable to determinethe extent to which piracy of our software exists. In addition, the laws ofsome foreign countries do not protect our proprietary rights as fully as thelaws of the United States. We are not aware that our software employstechnologies that infringe any proprietary rights of third parties. We expectthat software developers will increasingly be subject to infringement claims asthe number of products and competitors in our industry segment grows and thefunctionality of products in different industry segments overlaps. Except asdescribed under the heading “Legal Proceedings,” we are unawareof any claims that our software violates any other party’s proprietary rights.

**Competition**

We compete in markets that are intensely competitiveand rapidly evolving. We face competition primarily from large electronicdesign automation software product vendors that provide software suites toperform a variety of design functions for all types of semiconductors. We haveexperienced and, to the extent we remain a stand-alone company, expect tocontinue to experience increased competition from current and potentialcompetitors, many of which have significantly greater financial, technical,marketing and other resources.

Companies offering competitiveproducts vary in scope and breadth. Our competitors include providers ofgeneral purpose semiconductor design and verification software such as CadenceDesign Systems, Inc., Mentor Graphics Corporation, Synopsys, Inc. andvarious privately held companies. In addition, our software also competes withsoftware developed internally by design groups of semiconductor companies. 

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While all of theseorganizations compete with us, some also have cooperative marketing or salesrelationships with us.

We believe that theprincipal competitive factors in our market include:

·       highperformance and accuracy;

·       shortrun time;

·       easeof use;

·       depthand breadth of product features;

·       highquality user support;

·       frequencyof product updates;

·       conformanceto industry standards;

·       interoperability;and

·       price.

We believe that we competefavorably on some of these factors. However, we expect competition in theelectronic design automation software market for complex nanometer-scale semiconductors toincrease significantly as new companies enter the market and currentcompetitors expand their product lines and services.Many of these potential competitors are likely to enjoy substantial competitiveadvantages, including greater resources that can be devoted to thedevelopment, promotion and sale of their products. In addition, these potential competitors may have moreestablished sales channels, broader product offerings, greater softwaredevelopment experience and/or greater name recognition.

**Employees**

As of September 30,2004, we had 116 full time employees, of whom 52 were engaged in research anddevelopment, 51 in sales, user support services and marketing, and 13 infinance, administration and operations. None of our employees is represented bya labor union. We have not experienced any work stoppages and consider ourrelations with our employees to be good.

**Executive Officers and Key Employees**

Thefollowing table lists our executive officers and key employees and their agesas of September 30, 2004:
| **Name**                         | ** ** | ** ** | ** ** | **Age**                                                                 | ** ** | **Position(s)** |
|----------------------------------|------------|------------|------------|-------------------------------------------------------------------------|------------|-----------------|
| Sang S. Wang, Ph.D.         |       | 59         |       | Chief Executive Officer and Chairman                                    |
| An-Chang Deng, Ph.D.             |       | 49         |       | President, Chief Operating Officer and Director                         |
| Tammy S. Liu                |       | 48         |       | Chief Financial Officer and Vice President, Finance  and Administration |
| John A. Yelinek             |       | 55         |       | Vice President, Major Accounts                                          |
| Dermott Lynch                    |       | 43         |       | Acting Vice President, Worldwide Sales and Support                      |
| Walter Chan                      |       | 40         |       | Vice President, Software Engineering                                    |
| Iouri Feinberg                   |       | 37         |       | Vice President, Technology Research                                     |
| Jeong-Tyng Li                    |       | 47         |       | Vice President, Digital Product Development                             |
| Andrei V. Tcherniaev, Ph.D. |       | 40         |       | Vice President, Simulation Core Technology                              |
| Graham P. Bell              |       | 48         |       | Senior Director, Marketing                                              |

 

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*Sang**S. Wang* has served as our Chief ExecutiveOfficer and Chairman of the board of directors since April 1999. From March 1997to March 1998, Dr. Wang served as Senior Vice President and Co-GeneralManager of the EPIC Technology Group of Synopsys and as a member of the boardof director of Synopsys. From September 1986 to February 1997, Dr. Wangserved as Chairman and Chief Executive Officer of EPIC Design Technology, Inc.,a publicly traded electronic design automation software company that wasacquired by Synopsys in February 1997. Prior to co-founding EPICDesign Technology, Dr. Wang was a member of the senior technical staff andmanager of computer aided design at Advanced Micro Devices. Dr. Wang holdsa B.S. in electrical engineering from National Taiwan University, an M.S. inphysics from Ohio State University and a Ph.D. in electrical engineering fromStanford University.

*An-Chang Deng**,***one of our co-founders, served asour Chief Executive Officer from August 1998 to April 1999, ChiefFinancial Officer from August 1998 to September 2000 and Presidentand Chief Operating Officer since August 1998. He has served on our boardof directors since August 1998. From March 1997 to August 1998, Dr. Dengwas Vice President of Research and Development of the EPIC Technology Group ofSynopsys. From January 1992 to February 1997, Dr. Deng served asVice President of Research and Development for EPIC Design Technology. From September 1989to January 1992, Dr. Deng served as a developer of timing andanalysis products at Cadence. From 1986 to September 1989, Dr. Dengwas an assistant professor of electrical engineering at Texas A&MUniversity. Dr. Deng holds a B.S. in electrical engineering from NationalTaiwan University, an M.S. in electrical engineering from the University ofNotre Dame and a Ph.D. in electrical engineering and computer science from theUniversity of California at Berkeley.

*Tammy**S. Liu* has served as our Chief FinancialOfficer, Vice President, Finance and Administration and Secretary since September 2000.From August 1997 to August 2000, Ms. Liu was an independentfinancial consultant for startup companies. From March 1997 to July 1997,Ms. Liu served as Interim Acting Chief Financial Officer of Synopsys. FromJanuary 1994 through February 1997, Ms. Liu served as ChiefFinancial Officer and Secretary of EPIC Design Technology. From January 1990to September 1993, Ms. Liu served as Chief Financial Officer of PiEDesign Systems, Inc., a manufacturer of system level verification tools. From1988 to December 1989, she served as Corporate Controller of PlexusComputers, Inc., a manufacturer of image processing computers. Prior to1988, Ms. Liu served in a variety of financial management positions atCadence and Finnigan Corporation, a manufacture of mass spectrometers.Ms. Liu holds a B.S. in accounting from Baruch College and an M.B.A. fromSanta Clara University.

*John**A. Yelinek* has served as our VicePresident, Worldwide Sales and Support since October 2002 and served asour Vice President, Sales from January 2000 to September 2002. From March 1997to December 1999, Mr. Yelinek served as Vice President of Sales ofthe EPIC Technology Group of Synopsys. From November 1992 to March 1997,Mr. Yelinek served in a variety of positions with EPIC Design Technology,including Vice President, North American Sales. From 1983 to April 1992, Mr. Yelinekserved in a variety of positions at Cadence, the most recent of which wasDirector of Integrated Circuit Sales. Mr. Yelinek holds a B.A. in biologyfrom the University of California at San Diego.

*Dermott Lynch***has served as our Acting Vice President, Worldwide Salesand Support since August 2004, Vice President, Domestic Sales from April 2004to July 2004, Western Region SalesDirector from November 2003 to March 2004 and Senior Sales Managerfrom June 2000 to October 2002. From June 1996 to May 2000,Mr. Lynch served in a variety of positions with Sente, Inc., a poweranalysis company, including Vice President of Business Development andInternational Sales. From 1993 to 1996, Mr. Lynch served in a variety ofpositions at Quad Design, a division of Viewlogic Systems, including Directorof Technical Marketing.  Mr. Lynchholds a B.E. and a M.S. in Engineering from University College, Dublin,Ireland.

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*Walter Chan**,***one of our co-founders, has served as our Vice President,Software Engineering since September 2002 and Director of SoftwareDevelopment from August 1998 to September 2002. Mr. Chan servedas a development manager of Synopsys in the EPIC Technology Group from March 1997to August 1998. From January 1993 to March 1997, Mr. Chan servedas software developer and software development manager at EPIC DesignTechnology. From December 1988 to January 1993, Mr. Chan servedas a system software engineer at Sun Microsystems. Mr. Chan holds a B.A.in computer science from the University of California at Berkeley.

*Iouri Feinberg**,***one of our co-founders, hasserved as our Vice President, Technology Research since September 2002 andDirector of Technology Research from August 1998 to September 2002.Mr. Feinberg served as an Engineer Manager of the EPIC Design TechnologyGroup of Synopsys from March 1997 to August 1998. From May 1995to February 1997, Mr. Feinberg served in a variety of positions withEPIC Design Technology, including Senior Developer and Staff Engineer. Prior tojoining EPIC Design Technology, Mr. Feinberg was a Senior Engineer ofSilvaco Data Systems, an electronic design automation company. Mr. Feinbergholds a M.S. in computer science from St. Petersburg Engineering Academy.

*Jeong-Tyng**Li* has served as our Vice President, Digital Product Developmentsince April 2003, Director of Circuit Analysis Development from November 2001to March 2003 and Architect of Physical Design and Analysis from December 2000to October 2001. Dr. Li served as a Director of Router at MentorGraphics from July 2000 to November 2000. Dr. Li also held avariety positions at Avant! Corporation, which was acquired by Synopsys in June 2002,from July 1995 to June 2000, including Head of Physical Synthesis. Priorto joining Avant!, from January 1990 to June 1995, Dr. Li was aco-founder and Director of Emulation Compiler of PiE Design Systems, Inc.,a manufacturer of system level verification tools which later mergedwith Quickturn Design Systems, Inc. Dr. Li holds a B.S. in electricalengineering from National Taiwan University and a Ph.D. in electricalengineering from University of California at Berkeley.

*Andrei V.**Tcherniaev**,* one of our co-founders, has served as our Vice President,Simulation Core Technology since September 2002 and Director of TechnologyDevelopment from August 1998 to September 2002. From March 1997to August 1998, Dr. Tcherniaev served as a project leader of the EPICTechnology Group of Synopsys. From April 1995 to March 1997, Dr. Tcherniaevserved as a developer of timing simulation tools at EPIC Design Technology. FromSeptember 1991 to April 1995, Dr. Tcherniaev served as adeveloper of circuit and device simulation tools at Silvaco Data Systems. From July 1990to August 1991, Dr. Tcherniaev served as a research scientist inMoscow Institute of Physics and Technology. Dr. Tcherniaev holds a M.S. inphysics and Ph.D. in microelectronics from the Moscow Institute of Physics andTechnology.

*Graham**P. Bell* has served as our Senior Directorof Marketing since June 2003 and served as our Director of Marketing from January 2001to May 2003. From February 1999 to December 2000, Mr. Bellserved as Director of Marketing of Averant, Inc., an electronic designautomation software company. From February 1998 to February 1999, Mr. Bellserved as a product line manager of the EPIC Technology Group of Synopsys. FromSeptember 1996 to December 1997, Mr. Bell served as a MarketingManager of View Logic. From June 1995 to September 1996, Mr. Bellserved as a co-founder of Avista Design Systems, Inc., a designverification software company. Mr. Bell holds a B.C.S. in computer sciencefrom Carleton University, Ottawa, Canada.

**ITEM 2.   Properties**

Our principal officesconsist of 23,716 square feet of leased office space in Santa Clara, Californiawhich house substantially all of our research and development and a majority ofour domestic sales and support services employees, as well as all marketing,administration and finance employees. Wemaintain leased sales or support offices, each of which is 1,600 square feet orless, in or near Scottsdale, Arizona; Irvine, California; Austin and Dallas,Texas; Cambridge, Massachusetts; Grenoble, France; Munich, Germany; and Taipei,Taiwan. We also have sales or support centers in New Jersey, New York,Washington 

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domesticallyand Canada, India, Israel and Singapore internationally. Other than the leasesfor our Santa Clara, California and Grenoble, France offices, none of theleases for our sales offices is of more than 12 months in duration.

**ITEM 3.   LegalProceedings**

Synopsys has filed claimsagainst us in state and federal court, which we refer to in this document asthe State Court Action and the Federal Court Actions. These claims are based onthe alleged facts and circumstances relating to the departure of our fivefounders from their employment at Synopsys, the founding of our company and thedevelopment and sale of HSIM and our other products. Each of our founders and Dr. Sang S.Wang, our Chief Executive Officer, became an employee of Synopsys when Synopsysacquired EPIC Design Technology in February 1997. Dr. Wang resignedfrom Synopsys in March 1998 and served as a consultant to Synopsys until June 1998.Dr. An-Chang Deng, our President, and our four other foundersresigned from Synopsys at approximately the same time in August 1998 andbecame employees of our company immediately thereafter. Dr. Wang became anemployee of our company in April 1999. None of Drs. Wang or Deng orour four other founders was subject to a noncompetition agreement with Synopsysat any time.

In February 2000,Synopsys filed a complaint in the Superior Court of the State of California inthe County of Santa Clara (Case No. CV787950) against us and Dr. Deng,our President. The State Court Action complaint alleged breach of contract,breach of fiduciary trust, diversion of corporate opportunity and constructivetrust. In September 2001, Synopsys filed its second amended complaint,which added claims of inducing/aiding and abetting breach of fiduciary duty,including/aiding and abetting diversion of corporate opportunity,misappropriation of trade secrets, civil conspiracy, breach of confidence andunfair competition, and added as individual defendants Dr. Wang and ourfour other founders. In September 2002, Synopsys filed a supplementalsecond amended complaint that contained supplemental allegations but added nonew claims or parties. In January 2003, the discovery referee issuedorders creating rebuttable presumptions in favor of Synopsys on certainevidentiary issues to sanction us for erasure of certain computer filesrequested in discovery by Synopsys. These rulings meant that we must prove attrial that we did not take or use Synopsys’ source code or other confidentialinformation, rather than the usual requirement that Synopsys provide such proofin the first instance. We filed a motion for reconsideration of this order andin March 2003, the court denied our motion, concluding that it was barredon procedural grounds. In January 2003, Synopsys filed a third amendedcomplaint, which contained supplemental allegations but added no new claims orparties. We have filed an answer denying Synopsys’ allegations. In August 2003,Synopsys filed several motions for terminating sanctions against us, which wereheard in January 2004. InJune 2004, the Court ruled on Synopsys’ motions for terminating sanctions.The Discovery Referee vacated the orders of January 2003 that created therebuttable presumptions in favor of Synopsys, but issued new orders. Theseorders limit our defenses regarding the timing and the development of theinitial HSIM source code and the evidence that we and the remaining individualdefendants can present at trial. For purposes of trial, among other things, theorders established as facts that: (i) the first 60,000 lines of sourcecode of HSIM and all the ideas and concepts reflected therein, to the extentthey were not publicly known, were copied or derived from Synopsys’ source codeor other Synopsys’ materials while the individual defendants were employed bySynopsys and (ii) we and the individual defendants acted in concert tointentionally alter, destroy, lose or misplace items requested in discovery andconceal evidence. These orders also struck the answer of one individualdefendant, Jeh-Fu Tuan. The Discovery Referee denied Synopsys’ request tostrike our answers and the answers of the remaining individual defendants.In August 2004, we filed a writ petition in the California Court ofAppeal, Sixth Appellate District in San Jose, seeking to overturn these orders.In October 2004, the Court of Appeal requested that Synopsys fileopposition to the petition and provided us with the opportunity to file a replyto Synopsys’ opposition. In October 2004, the Superior Court vacated thepreviously set January 2005 trial date and stayed all trial proceedingspending final determination of the writ proceedings. Synopsys has requestedunspecified damages of at least $25 million, an injunction, a 

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constructivetrust on unspecified intellectual property belonging to us and other relief. Further,in September 2003, Synopsys notified us that it reserves the right to seekup to $80 million in punitive damages with respect to claims for whichpunitive damages are allowed under California Civil Code Section 3294, andup to $50 million in punitive damages with respect to the trade secretclaims under California Civil Code Section 3426.3(c).

In May 2001, Synopsysfiled a complaint in the United States District Court, Northern District ofCalifornia, San Jose division (Case No. CO1-20423 PVT) against us,alleging that our HSIM software infringes U.S. Patent No. 5,878,053entitled “Hierarchical Power Network Simulation and Analysis tool forreliability testing of Deep Submicron IC Designs” (the “053 Patent”),which is purportedly assigned to Synopsys. Since the case began, Synopsys hasalso alleged that our subsequently released HSIM 2.0 and LEXSIM products,infringe the 053 Patent. Synopsys has requested relief including damagesfrom $4.1 million to $13.7 million and an injunction. Synopsys hasalso requested that any damage award be trebled for alleged willfulinfringement. In June 2001, we filed an answer to the complaint denying infringementof a valid, enforceable patent and asserting counterclaims. We have sinceamended our counterclaims. Our current counterclaims allege that, among otherthings, the 053 Patent is invalid, unenforceable and not infringed andthat Synopsys has violated federal antitrust and state unfair competition laws.

From time to time, thecourt has ruled on summary judgment motions in the case. In May 2002, thecourt granted summary judgment in favor of Synopsys on our invalidity defensesand counterclaims, concluding that they were barred by the doctrine of assignorestoppel. The court denied Synopsys’ motion with respect to ourunenforceability defense and counterclaim. In November 2002, the courtissued an order granting summary judgment in favor of Synopsys on certainantitrust counterclaims based on the doctrine of assignor estoppel. However,the court declined to rule on Synopsys’ motion with respect to our otherantitrust and unfair competition counterclaims. In addition, the court issued aruling construing the claims of the 053 Patent in August 2002.

In September 2002,the U.S. Patent and Trademark Office granted our request for ex partereexamination of the 053 Patent based on prior art not previouslyconsidered by the Patent Office. We moved to stay the federal litigationpending the outcome of the reexamination and the court granted our motion in December 2002.In August 2004, the U.S. Patent and Trademark Office issued a finalrejection of all of the claims of the 053 Patent. Synopsys has appealed thefinal rejection to the U.S. Patent and Trademark Office Board of Patent Appealsand Interferences.

Activity on several othersummary judgment motions has been suspended because the court stayed thefederal litigation. In November 2002, Synopsys filed three motions forsummary judgment. The first motion asked the court to enter judgment beforetrial that our products infringe the 053 Patent. The second motion askedthe court to rule before trial against us on our defense that the053 Patent is unenforceable because Synopsys committed inequitable conductin obtaining the patent. We submitted oppositions to both of these motions. Synopsys’third motion asked the court to rule before trial against us on ourremaining antitrust counterclaims. Because of the court’s prior rulings againstus on our other antitrust counterclaims, we did not oppose this motion. In November 2002,we also filed a summary judgment motion, which asked the court to enterjudgment before trial that our products do not infringe the 053 Patent. Synopsysopposed this motion. The court issued its order staying the federal litigationbefore the parties’ reply briefs were due.

In June 2003,Synopsys filed a second complaint in the United States District Court, NorthernDistrict of California, San Francisco Division (Case No. C03-2664RS) against us, alleging that the our products, including but not limited toHSIM and HANEX software products, infringe Synopsys U.S. Patent No. 6,249,898entitled “Methods and Systems for Reliability Analysis of CMOS VLSI CircuitsBased on Stage Partitioning and Node Activities” (the “898 Patent”). In July 2003,we filed an answer denying that we infringe the 898 Patent and assertingas defenses that the 898 Patent is invalid and unenforceable. We 

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alsobrought a declaratory judgment counterclaim seeking judgment that the898 Patent is not infringed by us and that the 898 Patent is invalidand unenforceable. In August 2003, Synopsys filed a motion to dismissthese defenses and counterclaims on the ground that we are barred fromcontesting the validity and enforceability of the 898 Patent based on thedoctrine of assignor estoppel. Synopsys’ motion also sought to strike ourdefenses of laches, patent misuse and unclean hands on the ground that we hadnot pleaded them with sufficient particularity. We opposed Synopsys’ motions. InOctober 2003, the court denied Synopsys’ motion to dismiss and strike theinvalidity and unenforceability defenses and counterclaims and granted Synopsys’motion to strike the laches, patent misuse and unclean hands defenses withleave to amend the pleadings. In March 2004, Synopsys filed a motionfor partial summary judgment on the ground that we are barred from contestingthe validity and enforceability of the 898 Patent based on the doctrine ofassignor estoppel. In April 2004, the Court ruled that we are barred underthe doctrine of assignor estoppel from asserting the 898 Patent is invalidor unenforceable by virtue of pre-assignment inequitable conduct. The court issued a ruling construing theclaims of the 898 Patent in July 2004. The court has set thecase for trial beginning on April 25, 2005.

We entered into anagreement of merger dated as of November 30,2004 with Synopsys and North Acquisition Sub, Inc., a Delaware corporationand wholly owned subsidiary of Synopsys (“Merger Sub”), pursuant to which,subject to satisfaction or waiver of the conditions therein, Merger Sub willmerge with and into our company and we will become a wholly owned subsidiary ofSynopsys. Subject to the consummation of the merger, Synopsys, our company andcertain employees, officers and directors of our company, as applicable, haveagreed to settle the State Court Action and the Federal Court Actions. In connection with the merger agreement, theparties have submitted stipulations in the State Court Action and Federal CourtActions to toll the proceedings pending the consummation of the merger. Pursuantto the tolling agreements, we, Synopsys and the individual defendants haveagreed not to take further action with respect to the State Court Action andthe Federal Court Actions during the period prior to the closing of theproposed merger. In the event that the proposed merger did not occur and themerger agreement were terminated, we, Synopsys and the individual defendantswould no longer have any obligation to settle the State Court Action or theFederal Court Actions. We expect that if the merger did not occur and themerger agreement wasterminated, that aperiod of time would be necessary for the applicable Courts to reschedulevarious hearings and trials and that there would be a substantial delay fromthe original trial dates. Although we continue to believe that we would havemeritorious defenses were the parties to proceed with the State Court Action andthe Federal Court Actions, we cannot provide any assurance that we will prevailor that our defenses or our ability to achieve a desirable outcome will not beaffected by the proposed merger and related events. See also Note 12 of thenotes to our consolidated financial statements.

In July 2004, we andcertain of our officers and directors were named in a securities class actionlawsuit filed in the United States District Court for the Northern District ofCalifornia. The complaint asserts claims against our company, Sang S.Wang, An-Chang Deng, Tammy Shu-Hua Liu and Yen-Son Huang onbehalf of a putative class of persons who purchased our stock between December 13,2001 and June 11, 2004. The class action alleges that the named defendantsviolated certain provisions of the Securities Exchange Act of 1934 by makingmaterially false and misleading representations in press releases and financialstatements filed with the SEC relating to our financial results. The complaint’sallegations derive largely from allegations contained in the State CourtAction, and derive from allegations contained in the complaint concerning the053 Patent. A second class action was filed on September 9, 2004 inthe United States District Court for the Northern District of California. On September 27,2004, one plaintiff moved for lead plaintiff status in the first filed classaction. These two cases were consolidated on October 7, 2004. On November 4,2004, the judge granted the motion of NECA-IBEW Pension Fund (The DecaturPlan) for appointment as lead plaintiff. Plaintiff must file a consolidatedcomplaint by January 14, 2005, and defendants’ motion to dismiss iscurrently due January 28, 2005. The case is in the preliminary stages, andit is not possible for us to quantify the impact, if any, on our company. An 

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unfavorableoutcome in this case could have a material adverse effect on our business,financial condition, results of operations and cash flow. In addition, theexpense of defending any litigation may be costly and divert our attention fromthe day to day operations of our business.

On August 16, 2004, apurported derivative complaint was filed against us and our directors in theCourt of Chancery of the State of Delaware. This complaint alleged that theboard of directors breached its fiduciary duty by failing to appoint a specialcommittee to investigate the claims asserted in the Synopsys litigation and byallowing two directors to destroy evidence in the State Court Action. Thecomplaint also alleges that the board of directors breached its fiduciary dutyby allowing our company to go public with the knowledge of the alleged tradesecret misappropriation and by causing the issuance of allegedly false publicstatements regarding our financial condition on account of this allegedmisappropriation. The complaint seeks equitable relief and an unspecifiedamount of damages on behalf of our company. On October 15, 2004, thedefendants filed a motion to Dismiss or Stay on the grounds that the case isnot ripe for adjudication and also filed a Motion for Protective Order StayingDiscovery. On December 3, 2004, plaintiff filed oppositions to thesemotions. Defendants must file reply briefs by January 10, 2005. The caseis still in the preliminary stages, and it is not possible for us to quantifythe impact, if any, on our company. An unfavorable outcome in this case couldhave a material adverse effect on our business, financial condition, results ofoperations and cash flow. In addition, the expense of defending any litigationmay be costly and divert management’s attention from the day to day operationsof our business.

On December 1, 2004,we and certain of our officers and directors were named in a class actioncomplaint filed against us and certain of our officers and directors in theCourt of Chancery of the State of Delaware. This complaint, brought by RobertIsrael, alleges that defendants entered into the merger agreement with Synopsysfor inadequate consideration. The complaint also alleges that the mergeragreement was an unlawful plan to shield our board of directors and certainmembers of our management from liability to Synopsys in the State Court Actionand Federal Court Actions, and to shield them from liability to our company forclaims asserted by the plaintiff in the pending derivative action. Plaintiffseeks to enjoin the proposed merger, or alternatively seeks damages if theproposed merger is consummated. The case is still in the preliminary stages,and it is not possible for us to quantify the impact, if any, on our company. Anunfavorable outcome in this case could have a material adverse effect on ourbusiness, financial condition, results of operations and cash flow. Inaddition, the expense of defending any litigation may be costly and divertmanagement’s attention from the day to day operations of our business.

On December 3, 2004we and certain of our officers and directors were named in a complaint filed inthe Superior Court of California, Santa Clara County. The complaint is apurported stockholder class action brought by Frank A. Lettieri arising out ofdefendants’ conduct in selling our company to Synopsys at an allegedly inadequate and unfairprice. Defendants allegedly arrived at an unfair price so that at least two ofits directors could avoid or significantly reduce their exposure in a pendinglawsuit. As a result of this conduct, defendants allegedly breached fiduciaryduties. Defendants allegedly structured the terms of the proposed merger to fit the needsof Synopsys, instead of seeking to obtain the highest price reasonablyavailable to us. The complaint seeks an injunction of the acquisition, and theimplementation of a procedure to ensure the highest possible price forstockholders. The complaint also seeks to direct the individual defendants toexercise their fiduciary duties to obtain a transaction in the best interest ofthe stockholders at the highest price. The complaint seeks to rescind the proposed merger and to impose aconstructive trust upon any benefits improperly received by defendants as aresult of improper conduct. The case is in the preliminary stages, and it isnot possible for us to quantify the impact, if any, on our company. Anunfavorable outcome in this case could have a material adverse effect on ourbusiness, financial condition, results of operations and cash flow. Inaddition, the expense of defending any litigation may be costly and divert ourattention from the day to day operations of our business.

**ITEM 4.   Submissionof Matters to a Vote of Security Holders**

None.

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**PART II**

**ITEM 5.**   Marketfor Common Equity, Related Stockholder Matters and Issuer Purchases of EquitySecurities

Ourcommon stock has been traded on the Nasdaq National Market under the symbol “NSDA”since our initial public offering in December 2001. The following tablesets forth, for the periods indicated, the high and low closing prices reportedon the Nasdaq National Market.
| ** **                                  | ** ** | **High** | ** ** | **Low** | ** ** |
|---------------------------------------------|------------|----------|------------|---------|------------|
| Fiscal Year Ended  September 30, 2004: |       |     |       |    |       |
| Fourth Quarter                              |       | $        | 4.48       |    | $          | 3.49 |   |
| Third Quarter                               |       | 7.15     |       | 3.85    |       |
| Second Quarter                              |       | 8.47     |       | 6.87    |       |
| First Quarter                               |       | 8.64     |       | 7.05    |       |
| Fiscal Year Ended  September 30, 2003: |       |     |       |    |       |
| Fourth Quarter                              |       | $        | 9.22       |    | $          | 7.25 |   |
| Third Quarter                               |       | 9.05     |       | 5.39    |       |
| Second Quarter                              |       | 11.93    |       | 5.10    |       |
| First Quarter                               |       | 13.87    |       | 4.48    |       |

 

The closing price of our common stock on the NasdaqNational Market was $6.88 on December 10, 2004. As of December 10,2004, there were 27,457,621 shares of our common stock issued and outstandingand held by approximately 59 stockholders of record.

The information requiredby this Item regarding equity compensation plans is incorporated by referenceto the information set forth in Item 12 of this Annual Report on Form 10-K.

**DividendPolicy**

We have never declared orpaid cash dividends on our capital stock. We currently expect to retain futureearnings, if any, for use in the operation and expansion of our business and donot anticipate paying any cash dividends in the foreseeable future.

**ITEM 6.**   Selected FinancialData

The selected consolidated financial data set forthbelow are qualified for the three year period ended September 30, 2004 by,and should be read in conjunction with, the Consolidated Financial Statementsand Notes thereto and “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” included elsewhere in this report. Theresults for the fiscal year ended September 30, 2004 are not necessarilyindicative of the results for any future period.

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Thehistorical results presented below are not necessarily indicative of futureresults.
| ** **                                      | ** ** | **Fiscal Years Ended September 30,**           | ** ** |
|-------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **2000**                                                           | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                      | ** ** | **(in thousands, except per share data)** | ** ** |
| **Consolidated Statement of  Operations Data:** | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue:                                        |       |                                                               |       |   |   |   |   |   |   |   |   |
| Product                                         |       | $                                                                  | 5,710      |   | $ | 15,152 |   | $ | 19,101 |   | $ | 11,796 |   | $ | 8,937 |   |
| Subscription                                    |       | 596                                                                |       | 4,009 |   | 9,587 |   | 14,601 |   | 22,356 |   |
| Maintenance                                     |       | 464                                                                |       | 2,782 |   | 5,219 |   | 8,658 |   | 10,174 |   |
| Total revenue                                   |       | 6,770                                                              |       | 21,943 |   | 33,907 |   | 35,055 |   | 41,467 |   |
| Cost of revenue:                                |       |                                                               |       |   |   |   |   |   |   |   |   |
| Product                                         |       | 37                                                                 |       | 308 |   | 259 |   | 241 |   | 227 |   |
| Subscription                                    |       | 8                                                                  |       | 121 |   | 276 |   | 343 |   | 443 |   |
| Maintenance                                     |       | 32                                                                 |       | 412 |   | 685 |   | 802 |   | 1,035 |   |
| Total cost of revenue                           |       | 77                                                                 |       | 841 |   | 1,220 |   | 1,386 |   | 1,705 |   |
| Gross profit                                    |       | 6,693                                                              |       | 21,102 |   | 32,687 |   | 33,669 |   | 39,762 |   |
| Operating expenses:                             |       |                                                               |       |   |   |   |   |   |   |   |   |
| Research and development                        |       | 2,318                                                              |       | 5,107 |   | 5,478 |   | 7,145 |   | 8,851 |   |
| Sales and marketing                             |       | 2,453                                                              |       | 7,140 |   | 9,388 |   | 10,774 |   | 11,607 |   |
| General and administrative                      |       | 427                                                                |       | 3,355 |   | 7,773 |   | 10,653 |   | 16,328 |   |
| Litigation settlement                           |       | —                                                             |       | — |   | — |   | — |   | 67,463 |   |
| Stock-based compensation*                       |       | 97                                                                 |       | 2,369 |   | 1,005 |   | 955 |   | 796 |   |
| Total operating expenses                        |       | 5,295                                                              |       | 17,971 |   | 23,644 |   | 29,527 |   | 105,045 |   |
| Income (loss)  from operations                  |       | 1,398                                                              |       | 3,131 |   | 9,043 |   | 4,142 |   | (65,283 | ) |
| Interest income                                 |       | 157                                                                |       | 415 |   | 949 |   | 986 |   | 1,002 |   |
| Other income  (expense), net                    |       | 3                                                                  |       | (1 | ) | (9 | ) | (37 | ) | (9 | ) |
| Income (loss)  before taxes                     |       | 1,558                                                              |       | 3,545 |   | 9,983 |   | 5,091 |   | (64,290 | ) |
| Provision for income  taxes                     |       | (556                                                               | )          | (1,454 | ) | (3,579 | ) | (1,527 | ) | (608 | ) |
| Net income (loss)                               |       | $                                                                  | 1,002      |   | $ | 2,091 |   | $ | 6,404 |   | $ | 3,564 |   | $ | (64,898 | ) |
| Basic net income  (loss) per share              |       | $                                                                  | 0.22       |   | $ | 0.28 |   | $ | 0.32 |   | $ | 0.14 |   | $ | (2.45 | ) |
| Basic weighted  average shares outstanding      |       | 4,467                                                              |       | 7,461 |   | 20,116 |   | 25,058 |   | 26,457 |   |
| Diluted net  income (loss) per share            |       | $                                                                  | 0.06       |   | $ | 0.10 |   | $ | 0.23 |   | $ | 0.12 |   | $ | (2.45 | ) |
| Diluted weighted  average shares outstanding    |       | 17,878                                                             |       | 21,616 |   | 27,697 |   | 28,781 |   | 26,457 |   |

----

 
| *Stock-based  compensation includes: |   |   |   |   |   |   |   |   |   |   |   |
|--------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| Research and development             |   | $      | 42     |   | $      | 1,907  |   | $      | 426    |   | $      | 422 |   | $ | 349 |   |
| Sales and marketing                  |   | 38     |   | 233    |   | 346    |   | 300    |   | 224    |   |
| General and administrative           |   | 17     |   | 229    |   | 233    |   | 233    |   | 223    |   |
| Operating expenses                   |   | $      | 97     |   | $      | 2,369  |   | $      | 1,005  |   | $      | 955 |   | $ | 796 |   |

 
| ** **                                         | ** ** | **As of September 30,** | ** ** |
|----------------------------------------------------|------------|------------------------------|------------|
| ** **                                         | ** ** | **2000**                     | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                         | ** ** | **(in thousands)**           | ** ** |
| **Consolidated Balance Sheet Data**                |       |                         |       |   |   |   |   |   |   |   |   |
| Cash, cash  equivalents and short-term investments |       | $                            | 4,473      |   | $ | 12,175 |   | $ | 78,452 |   | $ | 92,165 |   | $ | 101,440 |   |
| Working capital                                    |       | 2,210                        |       | 6,552 |   | 71,597 |   | 80,709 |   | 19,487 |   |
| Total assets                                       |       | 5,567                        |       | 18,849 |   | 86,722 |   | 99,472 |   | 109,007 |   |
| Long-term  debt, less current portion              |       | —                       |       | 1,709 |   | 54 |   | 64 |   | 57 |   |
| Convertible  preferred stock                       |       | 2,018                        |       | 2,018 |   | — |   | — |   | — |   |
| Total stockholders’  equity                   |       | 477                          |       | 5,169 |   | 73,054 |   | 81,665 |   | 20,352 |   |
|                                                    |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**ITEM 7.   Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

*This reportcontains forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933 and Section 21E of the Securities ExchangeAct of 1934. These statements include, among other things, statements concerning our future operations, financialcondition and prospects and business strategies. The words “may,” “will,” “continue,”“estimate,” “project,” “intend,” “believe,” “expect,” “anticipate,” andother similar expressions generally identify forward-looking statements. Forward-lookingstatements in this Item 7 include, but are not limited to, statementsregarding: impact of quarterly fluctuations of revenue, revenue from the saleof our products, including the future composition of our revenues and futurerevenues from international operations, future operating results, increasedspending due to legal fees and the hiring of new personnel, future liquidityand capital requirements, sufficiency of cash and cash equivalents andavailability of funds, effect of and exposure to foreign currency exchangerates, intellectual property rights and consequences of intellectual propertydisputes. In evaluating these statements, you should specifically considervarious factors including those discussed in “Factors Affecting Future Results.”*

*Investors in our common stock are cautioned not toplace undue reliance on forward-looking statements. Forward-lookingstatements are not guarantees of future performance. Forward-lookingstatements are subject to substantial risks and uncertainties that could causeour future business, financial condition or results of operations to differmaterially from our historical results or currently anticipated results. Investorsshould carefully review the information contained under the caption “FactorsAffecting Future Results” beginning on page 38 of this Management’sDiscussion and Analysis of Financial Condition and Results of Operations andelsewhere in or incorporated by reference into this report. The followingdiscussion and analysis also should be read in conjunction with “SelectedConsolidated Financial Data” and our Consolidated Financial Statements andNotes thereto included elsewhere in this report. All forward-lookingstatements included in this document are based on information available to uson the date hereof and do not include the effects of the proposed merger withSynopsys. We assume no obligation to update any such forward-lookingstatements. These forward-looking statements are made in reliance uponthe safe harbor provision of The Private Securities Litigation Reform Act of1995.*

**Overview**

We are a leading providerof full-chip circuit simulation and analysis software for the design andverification of complex semiconductors. Our customers use our software toreduce time-to-market and achieve first silicon success bysimulating complex designs rapidly and accurately.

*Recent Developments*

We entered into an agreement of merger dated as of November 30, 2004 withSynopsys and North Acquisition Sub, Inc. The merger agreement providesthat North Acquisition Sub, Inc. will be merged with and into our companyand we will become a wholly-owned subsidiary of Synopsys.

Under the terms of the merger agreement, (i) eachoutstanding share of our common stock will be converted into the right toreceive $7.00 in cash and (ii) each option to purchase shares our commonstock will be converted into an option to purchase that number of shares ofSynopsys common stock based on the ratio of the $7.00 per share mergerconsideration to the average closing price of Synopsys common stock during aten-trading day period ending on and including the second trading dayprior to the closing. The per share exercise price of each option assumed willbe adjusted by dividing the existing per share exercise price by the ratioreferenced in the prior sentence.

The merger is conditioned upon, among other things, (i) approvalof the holders of the majority of our common stock, (ii) approval of theholders of the majority of our common stock other than our directors, officersand other founders, (iii) clearance under the Hart-Scott-RodinoAntitrust Improvements Act of 

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1976 (“HSR”) and (iv) othercustomary conditions. There can be no assurance that the merger will beconsummated in a timely manner, if at all.

Upon the closing of themerger, our officers, directors and employees who are defendants in the StateCourt Action between Synopsys and us will make settlement payments to Synopsysin the aggregate amount of $61.6 million and will not exercise options topurchase our common stock valued at approximately $5.9 million. Although thesettlement payments are being made by these individuals and they will not bereimbursed by us, the settlement is deemed to be an expense in accordance withStaff Accounting Bulletin Topic 5-T, “Accounting for Expenses or LiabilitiesPaid by Principal Stockholders,” because we are a defendant in the State CourtAction. As a result, we recorded a litigation settlement charge of approximately$67.5 million in the quarter and fiscal year ended September 30, 2004. Thissettlement charge excludes legal fees, which are recorded within general andadministrative expenses.

*Our Products*

We released our firstproduct, HSIM, in July 1999. In February 2002,with the release of HSIM 2.0, we also introduced two new options,CircuitCheck and Cadence Analog Artist Integration, which are sold as separateoptions. We released our second major product, LEXSIM, in May 2002, andour third product, CRITIC, in December 2002. In April 2003, wereleased HSIM 3.0 with a new digital co-simulation interface option, andin May 2003, we released on a limited basis our fourth product, HANEX. Inaddition, we released theHSIMplus platform in April 2004 for the comprehensivesimulation and analysis of high-performance analog, mixed-signal,memory and system-on-chip designs including important post-layouteffects. The LEXSIM product was no longer offered for sale as a separateproduct as of August 2004, since all of its features are now supported bythe HSIMplus platform.

*Current EconomicEnvironment*

The general economic environment has been challengingover the last three years as the semiconductor industry experienced a prolongedeconomic downturn. As a result, research and development capital budgets havebeen reduced substantially and at the same time, the numbers of design startsand potential users have decreased due to budget cuts and layoffs. The EDAindustry has endured this difficult period by providing flexible licensestructures and payment terms, such as time-based licenses withinstallment payments, competitive pricing, bundling/packaging of suites oftools and continuing the trend toward industry consolidation, especially bylarge EDA vendors. As a relatively small company in the EDA industry offering alimited number of products as compared to the large EDA vendors who offerproducts for the whole design flow, we have had to compete by creating leadingtechnology and solutions, providing high levels of customer support, remainingflexible in licensing structure and payment terms and offering substantialdiscounts which lowered our average selling prices. More recently, there havebeen some improvements in the global economy and the semiconductor industry. Designstarts for 180nm and below have increased and designers need tools that cansolve their nanometer design problems. However, we have not experienced anymaterial changes in our customers’ purchasing behavior and continue to believethat our customers will continue to spend conservatively in fiscal 2005 withtight control on their research and development budgets.

Our fiscal year ends on September 30.Throughout this report we refer to the fiscal year ended September 30,2003 as fiscal 2003, the fiscal year ended September 30, 2004 as fiscal2004 and so on.

*Sources of Revenue*

We derive substantiallyall of our revenue from software licensing and maintenance fees. To date, wehave derived substantially all of our revenue from the licensing and support ofHSIM. To the extent we remain a stand-alone company, we expect HSIM to continueto account for a majority of our revenue. To 

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theextent we remain a stand-alone company, we also expect our other products,CRITIC and HANEX together with the options of HSIMplus,toaccount for an increasing portion of our revenue. Our software does not requirecustomization and generally does not require on-site implementationservices. As a result, we have not generated a significant amount ofprofessional service or consulting revenue. We do not consider backlog to be ameaningful measure of future revenue because our customers can generally cancelorders without penalty.

*ProductRevenue—Perpetual Licenses*

Historically, we havegenerated the majority of our total revenue from perpetual licenses. As morecustomers have been purchasing time-based licenses, product revenue as apercent of total revenue and in absolute dollars has decreased and accountedfor 21.6% of our total revenue in fiscal 2004 as compared to 33.6% of our totalrevenue in fiscal 2003. Perpetual license customers pay a one-timelicense fee and are entitled to use the software as long as they desire. Toreceive support, periodic updates and new enhancements from us, perpetuallicense customers must purchase maintenance contracts.

*SubscriptionRevenue—Time-Based Licenses*

Our time-basedlicenses give the customer the right to use our software for a fixed period oftime, typically one to three years, and include maintenance. Time-basedlicenses can be renewed for one or more years. At times, customers may alsoacquire additional licenses for a shorter term, typically multiples of one-monthlicenses, to be used when they reach certain stages of the design process inconjunction with their other time-based or perpetual licenses. Theseshorter term licenses are sold primarily to help customers with their peakusage demands. To date, revenue from these shorter term licenses has not beensignificant. An increasing absolute dollar amount and proportion of our totalrevenue is derived from time-based licenses, as more of our largecustomers who initially subscribe to time-based licenses renew thoselicenses or subscribe to additional time-based licenses. In today’schallenging economic environment, some of the customers who had purchasedperpetual licenses previously and new customers are also choosing to purchasetime-based licenses due to their flexible licensing and payment terms.

*Maintenance Revenue*

Our perpetual licensecustomers typically purchase maintenance contracts and renew them annually. Customerswho purchase maintenance receive support, updates and enhancements when we makethem available to our general installed base. To the extent that we remain astand-alone company, we anticipate that as an increasing proportion of ourfuture licenses come from time-based licenses, maintenance revenue maydecrease as a percent of total revenue. Maintenance revenue may also fluctuatefrom quarter to quarter due to the timing of annual renewals.

*Deferred Revenue*

We include in deferredrevenue time-based licenses and maintenance that are invoiced in advanceand are either paid or due. We generally recognize deferred revenue from thesesources ratably over the contract period on a straight-line basis. Deferredrevenue also consists of deferred perpetual license fees for which all of therevenue recognition criteria have not been met. Deferred revenue fluctuatesdepending on the timing of perpetual licenses meeting all the revenuerecognition criteria, as well as the number, subscription period, payment termsand timing of renewals or new purchases of time-based licenses andmaintenance contracts. We classify deferred revenue expected to be recognizedbeyond one year from the balance sheet date as long-term deferredrevenue.

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*Foreign CurrencyTransactions*

Our revenue is generallydenominated in United States dollars; however, our operating expenses ininternational locations are denominated in local currencies. Historically, ourexposure to foreign exchange fluctuations has been minimal.

**Critical Accounting Policies**

*Revenue Recognition*

We recognize revenue in accordance with the provisionsof American Institute of Certified Public Accountants Statement of Position 97-2(“SOP 97-2”), *Software RevenueRecognition*. The application of SOP 97-2 requiresjudgment, including whether a software arrangement includes multiple elements,and if so, whether vendor-specific objective evidence (“VSOE”) of fairvalue exists for each of those elements. When certain elements of anarrangement are delivered at different times, the ability to identify VSOE forthose undelivered elements could materially impact the amount of earned andunearned revenue.

We recognize andreport revenue in three separate categories: product revenue, subscriptionrevenue and maintenance revenue. Product revenue is derived from perpetuallicense fees. Subscription revenue is derived from time-based licensefees and includes maintenance during the license period. We recognize productrevenue and subscription revenue when all of the following conditions are met: 

·       awritten purchase order and license agreement or other contract has beenexecuted;

·       theproduct and the production license key have been delivered;

·       useracceptance periods, if any, have expired;

·       thelicense fee is fixed and determinable; and 

·       collectionof the fee is probable.

VSOE exists for maintenance on perpetual licensesbased on renewal rates. Our customers generally purchase the first year ofmaintenance when they purchase a perpetual license, so we use the residualmethod to determine the allocation of revenue to the license portion ofmultiple element arrangements involving perpetual licenses. Because we bundleboth the license and maintenance into our agreements for time-basedlicenses for the entire term, VSOE does not exist for each element of thearrangement. Therefore, we recognize subscription revenue from time-basedlicenses ratably over the period of the license. Maintenance revenue is derivedfrom the annual maintenance contracts that are purchased by perpetual licensees.We generally recognize revenue from maintenance ratably over the maintenanceperiod, which is typically one year.

Future changes inaccounting pronouncements, including those affecting revenue recognition, couldrequire us to change our methods of revenue recognition. These changes couldcause us to defer revenue from current periods to subsequent periods oraccelerate recognition of deferred revenue to current periods.

*Allowance forDoubtful Accounts*

We maintain an allowancefor doubtful accounts based on management’s best estimate of probable lossesinherent in the outstanding accounts receivable balance. Management determinesthe allowance based on known troubled accounts, historical experience and othercurrently available evidence. If the financial condition of our customers wereto deteriorate, resulting in an impairment of their ability to make payments,additional allowances may be required.

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*Sales CommissionAccrual and Expenses*

Sales commissions areearned and paid to our sales force for each order received, shipped andcollected. Based on our policies, we pay a portion of the sales commissionsbased on both bookings and collections and the commission rate varies dependingon each sales person’s ability to attain his or her annual quota. Commissionrates increase as the sales person achieves a certain percent of his or herannual quota. We determine an estimated average annual commission rate duringthe first three fiscal quarters for purposes of accruing commissions. We adjustthe balance of the commission accrual and the actual commission expense at theend of each fiscal year based on each sales person’s actual commission rates.

*ContingentLiabilities*

We are subject to several legal proceedings andclaims, the outcomes of which are subject to significant uncertainty. StandardFinancial Accounting Standards (SFAS) No. 5, *Accountingfor Contingencies*, requires that an estimated loss from a losscontingency should be accrued by a charge to income if it is probable that anasset has been impaired or a liability has been incurred and the amount of theloss can be reasonably evaluated, taking into account the degree of probabilityof an unfavorable outcome and the ability to make a reasonable estimate of theamount of loss, among other factors. Changes in these factors could materiallyimpact our financial position or our results of operations. We regularlyevaluate current information available to us to determine whether such accrualsshould be recorded. 

Upon the closing of themerger, our officers, directors and employees who are defendants in thelitigation between Synopsys and us will make settlement payments to Synopsys inthe aggregate amount of $61.6 million and will not exercise options to purchaseour common stock valued at approximately $5.9 million. Although the settlementpayments are being made by these individuals and they will not be reimbursed byus, the settlement is deemed to be an expense in accordance with StaffAccounting Bulletin Topic 5-T, “Accounting for Expenses or Liabilities Paid byPrincipal Stockholders,” because we are a defendant in the State Court Action. Asa result, we recorded a litigation settlement charge of approximately $67.5million in the quarter and fiscal year ended September 30, 2004. This settlementcharge excludes legal fees, which are recorded within general andadministrative expenses.

**Recent Accounting Pronouncements**

In January 2003, the Financial AccountingStandards Board (“FASB”) issued FASB Interpretation 46 (“FIN 46”), *Consolidation of Variable Interest Entities*inJanuary 2003, and a revised interpretation of FIN 46 (“FIN 46-R”)*.*FIN 46 requires certain variableinterest entities (“VIEs”) to be consolidated by the primary beneficiary of theentity if the equity investors in the entity do not have the characteristics ofa controlling financial interest or sufficient equity at risk for the entity tofinance its activities without additional subordinated financial support fromother parties. The provisions of FIN 46 are effective immediately for allarrangements entered into after January 31, 2003. We have not invested inany entities that we believe are variable interest entities for which we arethe primary beneficiary. The adoption of FIN 46-R had no impact onour financial position, results of operations or cash flows.

In November 2003, theEmerging Issues Task Force (“EITF”) reached an interim consensus onIssue 03-01, *“The Meaning ofOther-Than-Temporary Impairment and its Application to CertainInvestment”* to require additional disclosure requirements forsecurities classified as available-for-sale or held-to-maturityfor fiscal years ending after December 15, 2003. In March 2004, theEITF reached a final consensus on this Issue and provided additional guidancein determining whether investment securities have an impairment which should beconsidered other-than-temporary in reporting periods after June 15,2004. The adoption of this Issue had no impact on our financial position,results of operations or cash flows.

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**Results of Operations**

Thefollowing table sets forth the results of our operations expressed as a percentof total revenue. Our historical operating results are not necessarilyindicative of the results for any future period.
| ** **                     | ** ** | **Years Ended September 30,** | ** ** |
|--------------------------------|------------|----------------------------------------------|------------|
| ** **                     | ** ** | **2002**                                     | ** ** | **2003** | ** ** | **2004** | ** ** |
| Revenue:                       |       |                                         |       |   |   |   |   |
| Product                        |       | 56.3                                         | %          | 33.6 | % | 21.6 | % |
| Subscription                   |       | 28.3                                         |       | 41.7 |   | 53.9 |   |
| Maintenance                    |       | 15.4                                         |       | 24.7 |   | 24.5 |   |
| Total revenue                  |       | 100.0                                        |       | 100.0 |   | 100.0 |   |
| Cost of revenue:               |       |                                         |       |   |   |   |   |
| Product                        |       | 0.8                                          |       | 0.7 |   | 0.5 |   |
| Subscription                   |       | 0.8                                          |       | 1.0 |   | 1.1 |   |
| Maintenance                    |       | 2.0                                          |       | 2.3 |   | 2.5 |   |
| Total cost of revenue          |       | 3.6                                          |       | 4.0 |   | 4.1 |   |
| Gross profit                   |       | 96.4                                         |       | 96.0 |   | 95.9 |   |
| Operating  expenses:           |       |                                         |       |   |   |   |   |
| Research and development       |       | 16.2                                         |       | 20.4 |   | 21.3 |   |
| Sales and marketing            |       | 27.7                                         |       | 30.7 |   | 28.0 |   |
| General and administrative     |       | 22.9                                         |       | 30.4 |   | 39.4 |   |
| Litigation settlement          |       | —                                       |       | — |   | 162.7 |   |
| Stock-based compensation       |       | 3.0                                          |       | 2.7 |   | 1.9 |   |
| Total operating expenses       |       | 69.8                                         |       | 84.2 |   | 253.3 |   |
| Income (loss)  from operations |       | 26.6                                         |       | 11.8 |   | (157.4 | ) |
| Interest income                |       | 2.8                                          |       | 2.8 |   | 2.4 |   |
| Other income  (expense), net   |       | —                                       |       | (0.1 | ) | 0.0 |   |
| Income (loss)  before taxes    |       | 29.4                                         |       | 14.5 |   | (155.0 | ) |
| Provision for  taxes           |       | (10.5                                        | )          | (4.3 | ) | (1.5 | ) |
| Net income (loss)              |       | 18.9                                         | %          | 10.2 | % | (156.5 | )% |

 

**Fiscal Years Ended September 30,2003 and 2004**

*Revenue*

*TotalRevenue.*   Totalrevenue consists of product, subscription and maintenance revenue. Totalrevenue increased by 18.3%, or $6.4 million, from$35.1 million in fiscal 2003 to $41.5 million in fiscal 2004. Theincrease was primarily attributable to an increase in our end user baseresulting in substantial growth in subscription and maintenance revenue,partially offset by decreases in perpetual license sales.

Revenue from sales outside of North America accountedfor 39.6% and 36.1% of total revenue for fiscal 2003 and 2004, respectively. Revenuefrom Japan was 15.5% and 18.2% of our total revenue in fiscal 2003 and 2004,respectively. No other country outside North America accounted for more than10% of our total revenue in either period.

Marubeni Solutions, our exclusive distributor forJapan, accounted for approximately 15.5% and 18.2% of our total revenue forfiscal 2003 and 2004, respectively. Broadcom Corporation accounted forapproximately 10.5% of our total revenue for fiscal 2003. No other customer ordistributor accounted for more than 10% of our total revenue during eitherperiod.

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Deferred revenue includes perpetual license fees forwhich all of the revenue recognition criteria has not been met, time-basedlicense fees that have been invoiced and are due or collected for which werecognize revenue ratably over the term of the license period, and maintenancefees on perpetual licenses for which we also recognize revenue ratably over theterm of the maintenance period. Our total deferred revenue increased from$9.8 million as of September 30, 2003 to $10.6 million as of September 30,2004. The increase in deferred revenue was primarily due to increases in bothdeferred product license revenue and deferred maintenance revenue frommaintenance of perpetual licenses.

*ProductRevenue.*   Product revenue decreased by 24.2%, or$2.9 million, from $11.8 million for fiscal 2003 to $8.9 millionfor fiscal 2004. The decrease was primarily due to more customers, particularlymajor accounts, purchasing time-based licenses as compared to perpetuallicenses and lower customer demand due to tighter budgets in a prolongedeconomic downturn. As a percent of total revenue, product revenue decreasedfrom 33.6% for fiscal 2003 to 21.6% for fiscal 2004.

*SubscriptionRevenue.*   Subscription revenue increased by53.1%, or $7.8 million, from $14.6 million for fiscal 2003 to$22.4 million for fiscal 2004. The increase was primarily due to newcustomers purchasing time-based licenses, as well as existing customerspurchasing additional time-based licenses and renewing their expired time-basedlicenses. As a percent of total revenue, subscription revenue rose from 41.7%for fiscal 2003 to 53.9% for fiscal 2004.

*Maintenance Revenue.*   Maintenancerevenue increased by 17.5%, or $1.5 million, from $8.7 million forfiscal 2003 to $10.2 million for fiscal 2004. The increase in maintenancerevenue was due to the increase in the number of perpetual licenses in ourinstalled base. As a percent of total revenue, maintenance revenue decreasedfrom 24.7% for fiscal 2003 to 24.5% for fiscal 2004. If maintenance revenueincreases as a percent of total revenue, our gross profit as a percent of totalrevenue, or gross margin, may decrease because of lower margins on maintenancerevenue due to incremental maintenance support costs.

*Cost of Revenue*

*Costof Product Revenue.*   Cost of product revenueconsists primarily of royalties due from us to third parties under originalequipment manufacturer arrangements. We incur only minimal costs to deliver oursoftware as the product and documentation are primarily sent electronically. Ourcost of product revenue decreased by 5.8%, or $14,000, from $241,000 for fiscal2003 to $227,000 for fiscal 2004 due to a decrease in the sublicensing of third-partyproducts. As a percent of total revenue, the cost of product revenue decreasedfrom 0.7% for fiscal 2003 to 0.5% for fiscal 2004.

*Costof Subscription Revenue.*   Cost of subscriptionrevenue consists primarily of personnel and allocated overhead expenses forsupport of time-based licenses. Our cost of subscription revenueincreased by 29.2%, or $100,000, from $343,000 for fiscal 2003 to $443,000 forfiscal 2004. The increase in cost of subscription revenue was primarily due tothe increase in personnel and other costs associated with the support of alarger number of time-based licenses. As a percent of total revenue, thecost of subscription revenue increased slightly from 1.0% in fiscal 2003 to1.1% for fiscal 2004.

*Cost of MaintenanceRevenue.*   Cost of maintenance revenue consistsprimarily of personnel and other expenses related to providing maintenancesupport to our customers who purchase perpetual licenses. Our cost ofmaintenance revenue increased by 29.1%, or $233,000, from $802,000 for fiscal2003 to $1.0 million for fiscal 2004. The increase in cost of maintenancerevenue was primarily due to increased hiring of dedicated support personnel toprovide support to a growing installed user base. As a percent of totalrevenue, the cost of maintenance revenue increased from 2.3% for fiscal 2003 to2.5% for fiscal 2004.

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*Operating Expenses*

In fiscal 2002, 2003 and 2004, legal fees and otherexpenses related to the State Court Action and Federal Court Actions, which areincluded within general and administrative expenses, were $5.6 million,$7.8 million and $12.8 million, respectively. In the event that themerger with Synopsys is not consummated, we expect the cost of the State CourtAction and Federal Court Actions to increase as we continue to defend ourselvesvigorously and the lawsuits move toward trial. Additionally, in the event wewere to continue as a stand-alone company, we also expect costs related tobeing a public company, such as directors’ and officers’ liabilities insurance,professional fees, particularly for the compliance of Sarbanes-OxleyAct 404, and various filing fees to increase our general andadministrative expenses.

In fiscal 2004, we accrued bonuses of an aggregate ofapproximately $1.5 million earned by our employees for their services infiscal 2004. Approximately $584,000 of these bonuses was paid in October 2004and the remainder will be paid in December 2004. In fiscal 2003, weaccrued bonuses of an aggregate of $900,000 earned by our employees for theirservices in fiscal 2003. These bonuses were paid in December 2003. Infiscal 2002, we accrued bonuses of an aggregate of $760,000 earned by ouremployees for their services in fiscal 2002 to be paid on specified schedules. Inaddition, our executive officers orally agreed that they would not receivetheir base salaries in fiscal 2002 and fiscal 2003. In October 2003, ourcompensation committee of our board of directors reinstated the salaries of ourexecutive officers and we paid base salaries of approximately $743,000 to theseofficers in fiscal 2004. As a result of our varying significant bonus accrualsand the foregone salaries in fiscal 2002 and fiscal 2003, our compensationexpense in fiscal 2004 was not consistent with compensation expense in fiscal2002 or fiscal 2003 and may not be indicative of future periods.

*Researchand Development.*   Research and developmentexpenses consist of engineering costs to develop new products, such as LEXSIM,CRITIC and HANEX, enhance existing products, such as the release of HSIMplus platform in April 2004,and perform quality assurance activities. Our research and development expensesincreased by 23.9%, or $1.7 million, from $7.1 million for fiscal2003 to $8.9 million for fiscal 2004. The increase in research anddevelopment expenses was primarily due to the hiring of additional research anddevelopment personnel and increases in bonuses. Research and developmentheadcount increased from 42 at September 30, 2003 to 52 at September 30,2004. As a percent of total revenue, research and development expensesincreased from 20.4% in fiscal 2003 to 21.3% in fiscal 2004.

*Salesand Marketing.*   Sales and marketing expensesconsist primarily of salaries, commissions, travel, promotional and advertisingcosts. Our sales and marketing expenses increased by 7.7%, or $833,000, from$10.8 million for fiscal 2003 to $11.6 million for fiscal 2004. Theabsolute dollar increases in sales and marketing expenses were primarily due tothe hiring of additional sales, application engineering and marketingpersonnel, the total number of whom increased from 47 at September 30,2003 to 51 at September 30, 2004 and increased marketing expenses. As apercent of total revenue, sales and marketing expenses decreased from 30.7% infiscal 2003 to 28.0% in fiscal 2004.

*Generaland Administrative.*   Generaland administrative expenses represent corporate, finance, humanresource, administrative, legal and consulting expenses. Our general andadministrative expenses increased by 53.3%, or $5.6 million, from$10.7 million for fiscal 2003 to $16.3 million for fiscal 2004. As apercent of total revenue, general and administrative expenses increased from30.4% for fiscal 2003 to 39.4% for fiscal 2004. The increase in general andadministrative expenses was primarily due to litigation legal fees. As a percentof total revenue, legal fees increased from 23.4% for fiscal 2003 to 31.4% forfiscal 2004. General and administrative headcount increased from 11 at September 30,2003 to 13 at September 30, 2004. In addition, in the event the mergerwith Synopsys is not consummated, we expect the cost of the State Court Actionand Federal Court Actions to increase as we continue to defend ourselvesvigorously and the lawsuits move toward trial.

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*Stock-BasedCompensation.*   We did not record any deferredstock-based compensation in fiscal 2003 or fiscal 2004. We have beenamortizing stock-based compensation recorded previously over the vestingperiod of the related options, which is generally four years. We amortized$955,000 and $796,000 of stock-based compensation in fiscal 2003 andfiscal 2004, respectively. We expect aggregate stock-based compensationexpense of approximately $235,000 during fiscal 2005. Stock-basedcompensation expense decreased by 16.6%, or $159,000, from $955,000 for fiscal2003 to $796,000 for fiscal 2004. As a percent of total revenue, stock-basedcompensation expense decreased slightly from 2.7% for fiscal 2003 to 1.9% forfiscal 2004.

*Interest Income*

Interest income increasedby 1.6%, or $16,000, from $986,000 for fiscal 2003 to $1.0 million for fiscal2004. As a percent of total revenue, interest income decreased from 2.8% to2.4% of total revenue for fiscal 2003 and fiscal 2004, respectively.

*Other Income(Expense), Net*

Our other income(expense), net remained relatively unchanged and was insignificant for fiscal2003 and fiscal 2004.

*Income Taxes*

The provision for incometaxes as a percent of income (loss) before taxes was 30.0% and 0.9% for fiscal2003 and fiscal 2004, respectively. The decrease in the effective tax rate fromthe prior year was primarily due to lower taxable annual income for fiscal 2004, the adjustmentsmade to the fiscal 2003 tax accrual based on the tax returns filed in June 2004and higher foreign source revenue which resulted in higher ETI exclusion andlower tax rate. Additionally, the one-time litigation settlement charge of$67.5 million recorded in the fiscal quarter ended September 30, 2004 isnot tax deductible and resulted in a permanent difference between book net lossand taxable income.

**Fiscal Years Ended September 30,2002 and 2003**

*Revenue*

*TotalRevenue.*   Total revenue increased$1.2 million, from $33.9 million for fiscal 2002 to$35.1 million for fiscal 2003. This increase was attributable to anincrease in our end user base resulting in substantial growth in subscriptionand maintenance revenue, partially offset by decreases in perpetual licensesales.

Revenue from sales outside of North America accountedfor 42.0% and 39.6% of total revenue for fiscal 2002 and fiscal 2003,respectively. Revenue from Japan was 19.4% and 15.5% of total revenue in fiscal2002 and fiscal 2003, respectively. No other country outside North Americaaccounted for more than 10% of our total revenue in either period.

Marubeni Solutions accounted for approximately 19.4%and 15.5% of our total revenue for fiscal 2002 and 2003, respectively. BroadcomCorporation accounted for approximately 10.5% of our total revenue for fiscal2003. No other customer or distributor accounted for more than 10% of our totalrevenue during either period.

Deferred revenue increased from $6.1 million asof September 30, 2002 to $9.8 million as of September 30, 2003. Thisincrease in deferred revenue was primarily due to increases in both deferredtime-based license revenue and deferred maintenance revenue from newpurchases and renewals of time-based licenses and maintenance forperpetual licenses.

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*ProductRevenue.**  *Productrevenue decreased by $7.3 million, from $19.1 million for fiscal 2002to $11.8 million for fiscal 2003. As a percent of total revenue, productrevenue decreased from 56.3% for fiscal 2002 to 33.6% for fiscal 2003, as thegrowth rate in sales of perpetual licenses was outpaced by growth in time-basedlicenses.

*SubscriptionRevenue.*   Subscription revenue increased by$5.0 million, from $9.6 million for fiscal 2002 to $14.6 millionfor fiscal 2003. This increase was primarily due to new customers purchasingtime-based licenses, as well as existing customers purchasing additionaltime-based licenses and renewing their expired time-based licenses.As a percent of total revenue, subscription revenue rose from 28.3% for fiscal2002 to 41.7% for fiscal 2003.

*Maintenance Revenue.*   Maintenancerevenue increased by $3.5 million, from $5.2 million for fiscal 2002to $8.7 million for fiscal 2003. The increase in maintenance revenue wasdue to the increase in the number of perpetual licenses in our installed base. Asa percent of total revenue, maintenance revenue increased from 15.4% for fiscal2002 to 24.7% for fiscal 2003.

*Cost of Revenue*

*Costof Product Revenue.*   Cost of product revenuedecreased by $18,000, from $259,000 for fiscal 2002 to $241,000 for fiscal 2003.As a percent of total revenue, the cost of product revenue decreased slightlyfrom 0.8% for fiscal 2002 to 0.7% for fiscal 2003. The decrease in the cost ofproduct revenue was primarily due to a decrease in third-partiesroyalties from lower sales of third-party products.

*Costof Subscription Revenue.*   Cost of subscriptionrevenue increased by $67,000, from $276,000 for fiscal 2002 to $343,000 forfiscal 2003. The increase in cost of subscription revenue was primarily due toincreased personnel and other costs associated with the support of a larger numberof time-based licenses. As a percent of total revenue, the cost ofsubscription revenue increased from 0.8% for fiscal 2002 to 1.0% for fiscal2003.

*Cost of MaintenanceRevenue.*   Cost of maintenance revenue increasedby $117,000, from $685,000 for fiscal 2002 to $802,000 for fiscal 2003. Theincrease in cost of maintenance revenue was primarily due to the increasedhiring of dedicated support personnel to provide support to a growing installeduser base. As a percent of total revenue, the cost of maintenance revenueincreased from 2.0% for fiscal 2002 to 2.3% for fiscal 2003.

*Operating Expenses*

*Researchand Development.*   Research and developmentexpenses increased by $1.6 million, from $5.5 million for fiscal 2002to $7.1 million for fiscal 2003. The increase in research and developmentexpenses in absolute dollars was primarily due to the hiring of additionalresearch and development personnel and increases in bonuses. As a percent oftotal revenue, research and development expenses increased from 16.2% in fiscal2002 to 20.4% in fiscal 2003.

*Salesand Marketing.*   Sales and marketing expensesincreased by $1.4 million, from $9.4 million for fiscal 2002 to$10.8 million for fiscal 2003. The absolute dollar increase in sales andmarketing expenses was primarily due to the hiring of additional sales,application engineering and marketing personnel. As a percent of total revenue,sales and marketing expenses increased from 27.7% in fiscal 2003 to 30.7% infiscal 2003.

*Generaland Administrative.*   General and administrativeexpenses increased by $2.9 million, from $7.8 million for fiscal 2002to $10.7 million for fiscal 2003. As a percent of total revenue, generaland administrative expenses increased from 17.0% for fiscal 2002 to 23.4% forfiscal 2003. The increase in general and administrative expenses was primarilydue to legal fees and costs related to being a public 

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company. As a percent oftotal revenue, legal fees increased from 17.0% during fiscal 2002 to 23.4%during fiscal 2003 primarily due to increased litigation related costs.

*Stock-BasedCompensation.*   We did not record any deferredstock-based compensation in fiscal 2002 or 2003. We amortized$1.0 million and $955,000 of stock-based compensation in fiscal 2002and fiscal 2003, respectively.

*Interest Income*

Interest income increasedby $37,000, from $949,000 for fiscal 2002 to $986,000 for fiscal 2003. Due toprofitability and positive cash flow, cash and investment balances increased infiscal 2003, which resulted in increased interest income despite lower interestrates. As a percent of total revenue, interest income stayed flat at 2.8% forfiscal 2002 and fiscal 2003.

*Other Income(Expense), Net*

Our other income(expense), net decreased by $28,000 from a net expense of $9,000 for fiscal2002 to a net expense of $37,000 for fiscal 2003.

*Income Taxes*

The provision for incometaxes as a percent of income before taxes was 35.9% and 30.0% for fiscal 2002and fiscal 2003, respectively. The decrease in the effective tax rate from theprior year was primarily due to the reduction of state income taxes as a resultof increases in tax credits.

**Liquidity and Capital Resources**

From inception through fiscal 2004, we have financedour operations primarily through public offerings of our common stock, the saleof common stock to employees and cash from net income. Total net proceeds ofour December 2001 initial public offering after deducting underwritingdiscounts and offering expenses, including the exercise of the over-allotmentoption, were approximately $57.2 million.

As of September 30, 2004, we had cash, cash equivalentsand short-term investments of $101.4 million, an increase of$9.2 million from $92.2 million as of September 30, 2003, andworking capital of $19.5 million, a decrease of $61.2 million from$80.7 million as of September 30, 2003. The decrease in workingcapital in fiscal 2004 is primarily due to accrued litigation settlement of$67.5 million. Upon the closing of our merger with Synopsys, our officers,directors and employees who are defendants in the State Court Action will makesettlement payments to Synopsys in the aggregate amount of approximately $61.6million and will not exercise options to purchase our common stock valued atapproximately $5.9 million. We will not make any cash payments to Synopsys tosettle the State Court Action or the Federal Court Actions or reimburse any ofthe individual defendants for the settlement payments they make to Synopsys.

Average days sales outstanding decreased from38 days as of September 30, 2002 to 20 days as of September 30,2003 and to 11 days as of September 30, 2004. The decrease in dayssales outstanding in fiscal 2003 was due to a majority of our total revenue inthe fourth quarter of fiscal 2003 being either derived from deferred revenue orbacklog that was invoiced early in the quarter, which left little uncollectedas of September 30, 2003. The decrease in fiscal 2004 was primarily due tothe increase in time-based licenses revenue with quarterly or installmentpayment terms.

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Net cash provided by operating activities was$9.0 million, $11.8 million and $7.5 million for fiscal 2002,fiscal 2003 and fiscal 2004, respectively. Net cash provided by operatingactivities for fiscal 2002 and fiscal 2003 resulted primarily from net incomeand increases in accrued liabilities and deferred revenue. In addition, infiscal 2003, a decrease in accounts receivable also resulted in additionalincrease in net cash provided by operating activities. In fiscal 2004, the netloss was offset by an increase in accrued litigation settlement, other accruedliabilities, and accounts payable and a decrease in accounts receivable.

Net cash used in investing activities was$29.1 million, $4.2 million and $3.5 million for fiscal 2002,fiscal 2003 and fiscal 2004, respectively. In these periods, the net cash usedprimarily related to the purchase of investment securities with maturities of91 days to one year and purchases of property and equipment.

Capital expenditures were approximately $331,000,$482,000 and $256,000 for fiscal 2002, fiscal 2003 and fiscal 2004,respectively. Our capital expenditures consisted of purchases of computerequipment, software and office furniture and fixtures.

Net cash provided by financing activities was$57.5 million, $2.4 million and $2.1 million for fiscal 2002,fiscal 2003 and fiscal 2004, respectively. For fiscal 2002, net cash providedby financing activities was primarily due to the net proceeds from the sale of5.75 million shares of common stock in our initial public offering. Forfiscal 2003 and fiscal 2004, net cash provided by financing activities wasprimarily due to the net proceeds from stock option exercises and employeestock plan purchases.

As of September 30, 2004, we had no borrowings,lines of credit, outstanding equipment leases or lease lines.

To the extent themerger does not occur and we remain a stand-alone company, we intend tocontinue to invest heavily in the development of new products and enhancementsto existing products. We also intend to increase our sales and marketingoperations. Our future liquidity and capital requirements will depend onnumerous factors, including:

·       theamount and timing of orders and their respective payment terms;

·       theextent to which our existing and new products gain market acceptance;

·       theextent to which customers continue to renew annual time-based licensesand maintenance;

·       thecost and timing of expansion of product research and development efforts,including such efforts outside North America, and the success of thesedevelopment efforts;

·       thecost and timing of expansion of sales and marketing activities, including suchactivities outside North America;

·       thecost of litigation and damages when and if awarded; and

·       availableborrowings under future credit arrangements, if any.

In the event the mergerwere not to occur in the next 12 months or at all, we believe that our currentcash and investment balances and any cash generated from operations, will besufficient to meet our operating and capital requirements for at least the next12 months. However, it is possible that we may require additionalfinancing within this period. We have no current plans, and we are notcurrently negotiating to obtain additional financing. The factors describedabove will affect our future capital requirements and the adequacy of ouravailable funds. In addition, even if we raise sufficient funds to meet ouranticipated cash needs during the next 12 months, we may need to raiseadditional funds beyond this time. We may be required to raise those fundsthrough public or private financings, strategic relationships or otherarrangements. We cannot assure you that such funding, if needed, will beavailable on terms attractive to us, or at all. Furthermore, any additionalequity financing may be dilutive to stockholders, and 

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debtfinancing, if available, may involve restrictive covenants. If we fail to raisecapital as and when needed, our failure could have a negative impact on ourability to pursue our business strategy and regain profitability.

*Stock RepurchaseProgram*

In October 2002, ourboard of directors authorized a stock repurchase program of up to$5.0 million of our common stock over a 12 month period, which our boardextended for another 12 month period in October 2003 and which expired in September 2004.As of the date we filed this Annual Report on Form 10-K with theSEC, we had not repurchased any shares under this program.

*ContractualObligations*

Theimpact that our contractual obligations as of September 30, 2004 areexpected to have on our liquidity and cash flow in future periods is as follows(in thousands):
| ** **                                           | ** ** | ** ** | ** ** | **Payments Due by Period** | ** ** |
|------------------------------------------------------|------------|------------|------------|-------------------------------------------|------------|
| ** **                                           | ** ** | **Total**  | ** ** | **Less than  1 Year**           | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More than  5 Years** | ** ** |
| Long-term  debt, including current portion           |       | $          | —     |                                      |       | $ | — |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | — |   |   |
| Capital lease  obligation, including current portion |       | —     |       |                                      | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Operating lease  obligations                         |       | 855        |       |                                      | 603        |   |   |   | 252 |   |   |   | — |   |   |   | — |   |   |
| Purchase  obligations                                |       | 58         |       |                                      | 58         |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Other long-term  liabilities on Balance Sheet        |       | 57         |       |                                      | —     |   |   |   | 57 |   |   |   | — |   |   |   | — |   |   |
| Total                                                |       | $          | 970        |                                      |       | $ | 661 |   |   |   | $ | 309 |   |   |   | $ | — |   |   |   | $ | — |   |   |

 

**Factors Affecting Future Results**

**Risks Related to the Merger**

**The announcement ofour merger with Synopsys may have a negative impact on our business.**

We executed an agreement of merger dated as of November 30, 2004 providing for our acquisitionby Synopsys. Under the terms of the agreement, each outstanding share of ourcommon stock will be converted into the right to receive $7.00 in cash. The announcementand pendency of the merger may have a negative impact on our ability to sellour products and attract new customers and may impact our future revenue. Inparticular, prospective customers could be reluctant to purchase licenses forour products if they are uncertain about the continuation of our productofferings or the willingness of Synopsys to support and maintain existingproducts. Uncertainty created by the announcement of the merger may cause somecustomers to delay their purchase decisions until the closing of the merger,which could cause our financial results to be significantly below theexpectations of market analysts. Our results of operations have been negativelyaffected by a $67.5 million non-cash expense we were required to record for thesettlement payments to be made by the individual defendants upon closing of themerger. Our results of operations have been and will continue to be adverselyaffected by increased legal and professional fees related to the merger. Themerger may also have a negative impact on our ability to retain employees andexisting customers and maintain strategic relationships.

The merger is subject toapproval by various regulatory agencies, and there can be no assurance that themerger will be successfully completed. In the event that the merger is notsuccessfully completed, our results of operations and common stock price wouldbe materially adversely affected.

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**If the merger is not completed, our share price andfuture business and operations could be harmed.**

If the merger isnot completed, we will be subject to a number of material risks, including butnot limited to the following:

·       ournew customer pipeline and ability to close sales may be adversely affected;

·       costsrelated to the merger (including litigation filed in connection with themerger), such as legal, accounting and other professional fees, must be paideven if the merger is not completed and we have incurred and will continue toincur significant merger-related costs;

·       ourrelationships with some of our customers may be adversely affected as they maydelay or defer purchasing decisions;

·       ourability to attract and retain employees may be adversely affected;

·       wemay be required to pay Synopsys a termination fee of up to $6 millionunder certain circumstances;

·       wemay be required to pay Synopsys a termination fee of up to $1 millionunder certain circumstances;

·       theprice of our common stock may decline to the extent that the current marketprice for our common stock reflects a market assumption that the merger will becompleted;

·       internaldecisions we may make in response to the effects the merger may have on ouroperations; and

·       wewill be required to incur additional legal expenses as we resume our efforts todefend ourselves in the State Court Action and Federal Court Actions.

**Provisions of themerger agreement may discourage other companies from entering into a merger orother business combination with us which might otherwise benefit ourstockholders.**

Under specified circumstances, we may be required topay Synopsys a termination fee of up to $6 million. This restriction maydiscourage other companies from entering into a merger or other businesscombination with us which might otherwise benefit our stockholders. Further, ifthe merger is terminated and our board of directors determines to seek anothermerger or business combination, we may not be able to find a merger partner. Anyother merger partner may not be willing to pay an equivalent, higher or moreattractive merger consideration than that which is proposed to be paid bySynopsys in the merger.

**We are currently adefendant in two lawsuits filed in connection with the announcement of ourproposed merger with Synopsys. The prosecution of these lawsuits could have asubstantial negative impact on our business. Should we not prevail, theproposed merger may be enjoined.**

On December 1, 2004, we and certain of ourofficers and directors were named in a class action complaint filed against usand certain of our officers and directors in the Court of Chancery of the Stateof Delaware. This complaint, brought by Robert Israel, alleges that defendantsentered into the merger agreement with Synopsys for inadequate consideration. Thecomplaint also alleges that this agreement was an unlawful plan to shield ourboard of directors and certain members of our management from liability toSynopsys in the State Court Action and Federal Court Actions, and to shieldthem from liability to our company for claims asserted by the plaintiff in thepending derivative action. Plaintiff seeks to enjoin the proposed merger, oralternatively seeks damages if the proposed merger is consummated. The case isstill in the preliminary stages, and it is not possible for us to quantify theimpact, if any, on our company. An unfavorable outcome in this case could havea material adverse effect on our business, financial condition, results ofoperations and cash flow. In addition, the expense of defending any litigationmay be costly and divert management’s attention from the day to day operationsof our business.

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On December 3, 2004we and certain of our officers and directors were named in a complaint filed inthe Superior Court of California, Santa Clara County. The complaint is apurported stockholder class action brought by Frank A. Lettieri arising out ofdefendants’ conduct in selling our company to Synopsys at an inadequate andunfair price. Defendants allegedly arrived at an unfair price so that at leasttwo of its directors could avoid or significantly reduce their exposure in apending lawsuit. As a result of this conduct, defendants allegedly breachedfiduciary duties. Defendants allegedly structured the terms of the proposed merger to fit the needs ofSynopsys, instead of seeking to obtain the highest price reasonably availableto us. The complaint seeks an injunction of the acquisition, and theimplementation of a procedure to ensure the highest possible price forstockholders. The complaint also seeks to direct the individual defendants toexercise their fiduciary duties to obtain a transaction in the best interest ofthe stockholders at the highest price. The complaint seeks to rescind the proposed merger  and to impose aconstructive trust upon any benefits improperly received by defendants as aresult of improper conduct. The case is in the preliminary stages, and it isnot possible for us to quantify the impact, if any, on our company. Anunfavorable outcome in this case could have a material adverse effect on ourbusiness, financial condition, results of operations and cash flow. Inaddition, the expense of defending any litigation may be costly and divert ourattention from the day to day operations of our business.

**Risks We May Face in the Event the Merger is notCompleted**

**We have relied and, in the event the merger is notcompleted, expect to continue to rely on HSIM for a substantial majority of ourrevenue, and a decline in sales of licenses for HSIM could cause our revenue todecline.**

Historically, we have derived substantially all of ourrevenue from HSIM. We believe HSIM is the first hierarchical simulator thatmeets the circuit verification challenges of complex nanometer semiconductors. Inthe event the merger is not completed, we expect that the revenue from thisproduct will continue to account for a substantial majority of our revenue forfiscal 2005. The electronic design automation software market, including themarket for hierarchical simulator software, is characterized by rapidtechnological change, frequent new product introductions, uncertain productlife cycles and evolving industry standards. If our competitors introduce newproducts, special bundling and/or offer aggressive pricing that compete withHSIM, our revenue could decline materially and our results of operations couldbe harmed. For instance, in fiscal 2003 and fiscal 2004, certain competitorswere offering extremely competitive prices either by substantial discounting orbundling their products which resulted in a longer sales cycle for HSIM ordelays by prospective customers in making their purchasing decisions. Anyfactors adversely affecting the pricing of our licenses of or demand for HSIM,including competition or technological change, could cause our revenue todecline materially and our business to suffer.

**Our revenue woulddecline substantially if our existing customers do not purchase additionallicenses or renew existing time-based licenses and maintenance from us.**

We rely on additional perpetual and time-basedlicense revenue from our existing customers, as well as annual maintenancerenewals for our perpetual licenses and renewals of our time-basedlicenses when they expire. Even if we are successful in generating revenue fromour software to new customers, we would experience a decline in revenue if ourexisting customers do not purchase additional licenses of our software or renewtheir expired time-based licenses or annual maintenance for perpetuallicenses. Since fiscal 2002, our revenue from perpetual licenses as a percentof total revenue has continued to decrease as a result of more customers’preference to purchase time-based licenses, lower demand and averageselling prices due to much tighter budgets. Revenue from time-basedlicenses and maintenance has increased steadily over the last three fiscalyears and, in the event the merger is not completed, we expect it to continueto increase. For instance, in fiscal 2004, 78.4% of our total revenue wasderived from time-based licenses and maintenance as compared to 66.4% and43.7% for fiscal 2003 and fiscal 2002, respectively. As 

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more of our revenue isattributable to time-based licenses, our revenue could decline materiallyif our customers do not renew their existing time-based licenses orpurchase additional time-based licenses.

**We are currently adefendant in three lawsuits brought by Synopsys. The prosecution of theselawsuits could have a substantial negative impact on our business. ShouldSynopsys prevail, we may be required to pay substantial monetary damages or beprevented from selling our software.**

Synopsys has filed the State Court Action and FederalCourt Actions against us. These claims are based on the alleged facts andcircumstances relating to the departure of our five founders from theiremployment at Synopsys, the founding of our company and the development andsale of HSIM and our other products. Each of our founders and Dr. Sang S.Wang, our Chief Executive Officer, became an employee of Synopsys when Synopsysacquired EPIC Design Technology in February 1997. Dr. Wang resignedfrom Synopsys in March 1998 and served as a consultant to Synopsys until June 1998.Dr. An-Chang Deng, our President, and our four other foundersresigned from Synopsys at approximately the same time in August 1998 andbecame employees of our company immediately thereafter. Dr. Wang became anemployee of our company in April 1999. None of Drs. Wang or Deng orour four other founders was subject to a noncompetition agreement with Synopsysat any time.

In February 2000, Synopsys filed a complaint inthe Superior Court of the State of California in the County of Santa Clara(Case No. CV787950) against us and Dr. Deng, our President. The StateCourt Action complaint alleged breach of contract, breach of fiduciary trust,diversion of corporate opportunity and constructive trust. In September 2001,Synopsys filed its second amended complaint, which added claims ofinducing/aiding and abetting breach of fiduciary duty, including/aiding andabetting diversion of corporate opportunity, misappropriation of trade secrets,civil conspiracy, breach of confidence and unfair competition, and added asindividual defendants Dr. Wang and our four other founders. In September 2002,Synopsys filed a supplemental second amended complaint that containedsupplemental allegations but added no new claims or parties. In January 2003,the discovery referee issued orders creating rebuttable presumptions in favorof Synopsys on certain evidentiary issues to sanction us for erasure of certaincomputer files requested in discovery by Synopsys. These rulings meant that wemust prove at trial that we did not take or use Synopsys’ source code or otherconfidential information, rather than the usual requirement that Synopsysprovide such proof in the first instance. We filed a motion for reconsiderationof this order and in March 2003, the court denied our motion, concludingthat it was barred on procedural grounds. In January 2003, Synopsys fileda third amended complaint, which contained supplemental allegations but addedno new claims or parties. We have filed an answer denying Synopsys’ allegations.In August 2003, Synopsys filed several motions for terminating sanctionsagainst us, which were heard in January 2004. In June 2004, the Court ruled onSynopsys’ motions for terminating sanctions. The Discovery Referee vacated theorders of January 2003 that created the rebuttable presumptions in favorof Synopsys, but issued new orders. These orders limit our defenses regardingthe timing and the development of the initial HSIM source code and the evidencethat we and the remaining individual defendants can present at trial. Forpurposes of trial, among other things, the orders established as facts that: (i) thefirst 60,000 lines of source code of HSIM and all the ideas and conceptsreflected therein, to the extent they were not publicly known, were copied orderived from Synopsys’ source code or other Synopsys’ materials while theindividual defendants were employed by Synopsys and (ii) we and theindividual defendants acted in concert to intentionally alter, destroy, lose ormisplace items requested in discovery and conceal evidence. These orders alsostruck the answer of one individual defendant, Jeh-Fu Tuan. The DiscoveryReferee denied Synopsys’ request to strike our answers and the answers of theremaining individual defendants. In August 2004, we filed a writpetition in the California Court of Appeal, Sixth Appellate District in SanJose, seeking to overturn these orders. In October 2004, the Court ofAppeal requested that Synopsys file opposition to the petition and provided uswith the opportunity to file a reply to Synopsys’ opposition. In October 2004,the Superior Court vacated the previously set January 2005 trial date andstayed all trial proceedings pending final determination of the writ 

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proceedings. Synopsys hasrequested unspecified damages of at least $25 million, an injunction, aconstructive trust on unspecified intellectual property belonging to us andother relief. Further, in September 2003, Synopsys notified us that itreserves the right to seek up to $80 million in punitive damages withrespect to claims for which punitive damages are allowed under California CivilCode Section 3294, and up to $50 million in punitive damages withrespect to the trade secret claims under California Civil Code Section 3426.3(c).

In May 2001, Synopsys filed a complaint in theUnited States District Court, Northern District of California, San Josedivision (Case No. CO1-20423 PVT) against us, alleging that our HSIMsoftware infringes U.S. Patent No. 5,878,053 entitled “Hierarchical PowerNetwork Simulation and Analysis tool for reliability testing of Deep SubmicronIC Designs” (the “053 Patent”), which is purportedly assigned to Synopsys.Since the case began, Synopsys has also alleged that our subsequently releasedHSIM 2.0 and LEXSIM products, infringe the 053 Patent. Synopsys hasrequested relief including damages from $4.1 million to $13.7 millionand an injunction. Synopsys has also requested that any damage award be trebledfor alleged willful infringement. In June 2001, we filed an answer to thecomplaint denying infringement of a valid, enforceable patent and assertingcounterclaims. We have since amended our counterclaims. Our currentcounterclaims allege that, among other things, the 053 Patent is invalid,unenforceable and not infringed and that Synopsys has violated federalantitrust and state unfair competition laws.

From time to time, the court has ruled on summaryjudgment motions in the case. In May 2002, the court granted summaryjudgment in favor of Synopsys on our invalidity defenses and counterclaims,concluding that they were barred by the doctrine of assignor estoppel. Thecourt denied Synopsys’ motion with respect to our unenforceability defense andcounterclaim. In November 2002, the court issued an order granting summaryjudgment in favor of Synopsys on certain antitrust counterclaims based on thedoctrine of assignor estoppel. However, the court declined to rule onSynopsys’ motion with respect to our other antitrust and unfair competitioncounterclaims. In addition, the court issued a ruling construing the claims ofthe 053 Patent in August 2002.

In September 2002, the U.S. Patent and TrademarkOffice granted our request for ex parte reexamination of the 053 Patentbased on prior art not previously considered by the Patent Office. We moved tostay the federal litigation pending the outcome of the reexamination and thecourt granted our motion in December 2002. In August 2004, the U.S.Patent and Trademark Office issued a final rejection of all of the claims ofthe 053 Patent. Synopsys has appealed the final rejection to the U.S.Patent and Trademark Office Board of Patent Appeals and Interferences.

Activity on several other summary judgment motions hasbeen suspended because the court stayed the federal litigation. In November 2002,Synopsys filed three motions for summary judgment. The first motion asked thecourt to enter judgment before trial that our products infringe the053 Patent. The second motion asked the court to rule before trialagainst us on our defense that the 053 Patent is unenforceable becauseSynopsys committed inequitable conduct in obtaining the patent. We submittedoppositions to both of these motions. Synopsys’ third motion asked the court torule before trial against us on our remaining antitrust counterclaims. Becauseof the court’s prior rulings against us on our other antitrust counterclaims,we did not oppose this motion. In November 2002, we also filed a summaryjudgment motion, which asked the court to enter judgment before trial that ourproducts do not infringe the 053 Patent. Synopsys opposed this motion. Thecourt issued its order staying the federal litigation before the parties’ replybriefs were due.

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In June 2003, Synopsys filed a second complaintin the United States District Court, Northern District of California, SanFrancisco Division (Case No. C03-2664 RS) against us, alleging thatthe our products, including but not limited to HSIM and HANEX softwareproducts, infringe Synopsys U.S. Patent No. 6,249,898 entitled “Methodsand Systems for Reliability Analysis of CMOS VLSI Circuits Based on StagePartitioning and Node Activities” (the “898 Patent”). In July 2003,we filed an answer denying that we infringe the 898 Patent and assertingas defenses that the 898 Patent is invalid and unenforceable. We alsobrought a declaratory judgment counterclaim seeking judgment that the898 Patent is not infringed by us and that the 898 Patent is invalidand unenforceable. In August 2003, Synopsys filed a motion to dismissthese defenses and counterclaims on the ground that we are barred fromcontesting the validity and enforceability of the 898 Patent based on thedoctrine of assignor estoppel. Synopsys’ motion also sought to strike ourdefenses of laches, patent misuse and unclean hands on the ground that we hadnot pleaded them with sufficient particularity. We opposed Synopsys’ motions. InOctober 2003, the court denied Synopsys’ motion to dismiss and strike theinvalidity and unenforceability defenses and counterclaims and granted Synopsys’motion to strike the laches, patent misuse and unclean hands defenses withleave to amend the pleadings. In March 2004, Synopsys filed a motionfor partial summary judgment on the ground that we are barred from contestingthe validity and enforceability of the 898 Patent based on the doctrine ofassignor estoppel. In April 2004, the Court ruled that we are barred underthe doctrine of assignor estoppel from asserting the 898 Patent is invalidor unenforceable by virtue of pre-assignment inequitable conduct. The court issued a ruling construing theclaims of the 898 Patent in July 2004. The court has set thecase for trial beginning on April 25, 2005.

We entered into an agreement of merger dated as of November 30, 2004 withSynopsys and North Acquisition Sub, Inc., a Delaware corporation andwholly owned subsidiary of Synopsys (“Merger Sub”), pursuant to which, subjectto satisfaction or waiver of the conditions therein, Merger Sub will merge withand into our company and we will become a wholly owned subsidiary of Synopsys. Subjectto the consummation of the merger, Synopsys, our company and certain employees,officers and directors of our company, as applicable, have agreed to settle theState Court Actions and Federal Court Actions. In connection with the merger agreement, theparties have submitted stipulations in the State Court Actions and FederalCourt Actions to toll the proceedings pending the consummation of the merger. Pursuantto the tolling agreements, we, Synopsys and the individual defendants haveagreed not to take further action with respect to the State Court Action andthe Federal Court Actions during the period prior to the closing of theproposed merger. In the event that the proposed merger did not occur and themerger agreements were terminated, we, Synopsys and the individual defendantswould no longer have any obligation to settle the State Court Action or theFederal Court Actions. We expect that if the merger did not occur and themerger agreement  was terminated, that a period of time would benecessary for the applicable Courts to reschedule various hearings and trialsand that there would be a substantial delay from the original trial dates. Althoughwe continue to believe that we have meritorious defenses were the parties toproceed with the State Court Action and the Federal Court Actions, we cannotprovide any assurance that we will prevail or that our defenses or our abilityto achieve a desirable outcome will not be affected by the proposed merger andrelated events. See Note 12 of the notes to our consolidated financialstatements.

In July 2004, we and certain of our officers anddirectors were named in a securities class action lawsuit filed in the UnitedStates District Court for the Northern District of California. The complaintasserts claims against our company, Sang S. Wang, An-Chang Deng,Tammy Shu-Hua Liu and Yen-Son Huang on behalf of a putative classof persons who purchased our stock between December 13, 2001 and June 11,2004. The class action alleges that the named defendants violated certainprovisions of the Securities Exchange Act of 1934 by making materially falseand misleading representations in press releases and financial statements filedwith the SEC relating to our financial results. The complaint’s allegationsderive largely from allegations contained in the State Court Action, and derivefrom allegations contained in the complaint concerning the 053 Patent. Asecond class action was filed on September 9, 2004 in the United StatesDistrict Court for the Northern District of California. On September 27,2004, 

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one plaintiff moved forlead plaintiff status in the first filed class action. These two cases wereconsolidated on October 7, 2004. On November 4, 2004, the judgegranted the motion of NECA-IBEW Pension Fund (The Decatur Plan) forappointment as lead plaintiff. Plaintiff must file a consolidated complaint by January 14,2005, and defendants’ motion to dismiss is currently due January 28, 2005.The hearing on the motion to dismiss is set for March 4, 2005. The case isin the preliminary stages, and it is not possible for us to quantify theimpact, if any, on our company. An unfavorable outcome in this case could havea material adverse effect on our business, financial condition, results ofoperations and cash flow. In addition, the expense of defending any litigationmay be costly and divert our attention from the day to day operations of ourbusiness.

On August 16, 2004, a purported derivativecomplaint was filed against us and our directors in the Court of Chancery ofthe State of Delaware. This complaint alleged that the board of directorsbreached its fiduciary duty by failing to appoint a special committee toinvestigate the claims asserted in the Synopsys litigation and by allowing twodirectors to destroy evidence in the State Court Action. The complaint alsoalleges that the board of directors breached its fiduciary duty by allowing ourcompany to go public with the knowledge of the alleged trade secretmisappropriation and by causing the issuance of allegedly false publicstatements regarding our financial condition on account of this allegedmisappropriation. The complaint seeks equitable relief and an unspecified amountof damages on behalf of our company. On October 15, 2004, the defendantsfiled a motion to Dismiss or Stay on the grounds that the case is not ripe foradjudication and also filed a Motion for Protective Order Staying Discovery. OnDecember 3, 2004, plaintiff filed oppositions to these motions. Defendantsmust file reply briefs by January 10, 2005. The case is still in thepreliminary stages, and it is not possible for us to quantify the impact, ifany, on our company. An unfavorable outcome in this case could have a materialadverse effect on our business, financial condition, results of operations andcash flow. In addition, the expense of defending any litigation may be costlyand divert management’s attention from the day to day operations of our business.

**If semiconductordesign and manufacturing companies continue to experience recession or otherconditions which impact their operating budgets, they may delay or cancelpurchases of our software, which would reduce our revenues and cause ourbusiness to suffer.**

The primary customers for our software aresemiconductor design and manufacturing companies. Any significant downturn inour customers’ markets, or domestic and global conditions, which result in thereduction of research and development budgets or the delay of softwarepurchases, would likely result in a decline in demand for our software andservices and could harm our business. Since early 2000, the semiconductorindustry has experienced a substantial decline in order volume and revenue andthat downturn has continued. This could result in our customers delaying orcanceling the purchase of our software. Any of these occurrences could have asignificant impact on our operating results, revenues and costs and may causethe market price of our common stock to decline or become more volatile. Forexample, we experienced a substantial change in customers’ purchasing behaviorduring the three months ended March 31, 2003 due to the prolonged economicdownturn and concerns for their own financial stability. Consequently, as acost-cutting measure, customers either suspended or reduced their capitalbudgets dramatically, which adversely affected our revenue. In addition, wewere unable to meet revenue and earnings expectations for the quarter ended March 31,2003 and had to lower our revenue and earnings guidance for the quarter ended June 30,2003 and fiscal 2003. As a result, the market price of our common stock wasnegatively impacted.

In addition, the markets for semiconductor productsare cyclical. For example, in recent years certain Asian countries haveexperienced significant economic difficulties, including currency devaluationand instability, business failures and a depressed business environment. Morerecently, certain Asian countries have also experience difficulties fromconcerns about and the impact of closures due to SARS. These difficulties havetriggered a significant downturn in the semiconductor market, resulting inreduced budgets for semiconductor design tools which, in turn, has negativelyimpacted us. We cannot predict what 

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impact the recentprolonged economic slowdown and in particular, the semiconductor industry, willhave on our business, but it may result in fewer purchases of licenses of oursoftware, substitution to our lower priced configurations by customers whopreviously licensed our higher priced configurations or nonrenewal of time-basedlicenses or maintenance.

**Because many of ourcurrent competitors have greater resources than we do and pre-existingrelationships with our potential customers, we might not be able to achievesufficient market penetration to regain profitability or gain additional marketshare.**

We face significant competition from larger companiesthat market suites of electronic design automation products that address all oralmost all steps in the semiconductor design process. Many of these competitorshave substantially greater financial, customer support, technical and marketingresources, larger customer bases, longer operating histories, greater name recognitionand more established relationships in the industry than we do. We cannot besure that we will have the resources or expertise to compete successfully inthe future. If we are unable to gain additional market share due to their pre-existingrelationships with our potential customers, our operating results could beharmed.

Our software is used to simulate and analyze complexnanometer-scale semiconductor designs. Our competitors in the electronicsdesign automation industry who offer products that are used for other segmentsof the semiconductor design process often bundle their products together tooffer discounts on products competitive with those we offer, making thoseproducts extremely attractive for our customers or potential customers to use. Inaddition, these competitors may not support our effort to integrate oursoftware into their existing software. These competitors include such companiesas Cadence, Synopsys and Mentor Graphics. Since these competitors offer a morecomprehensive range of products than we do, they are often able to respond morequickly or price more effectively to take advantage of new or changingopportunities and respond to new technologies and customer requirements. Wecannot assure you that we will be able to compete successfully in suchenvironments. If we lose such opportunities to our competitors, our results ofoperations could be harmed significantly.

**Our businessdepends on continued demand for complex nanometer-scale semiconductorsand the electronic equipment that incorporate them.**

Our software is used to design complex nanometer-scalesemiconductors that are an integral part of portable consumer electronics,networking equipment, wireless communications equipment, multimedia devices andpersonal computers. As a result, if the demand for these devices and businessesof the manufacturers of these products do not continue to grow, our revenue andbusiness will suffer. Demand for portable consumer electronics may decrease ifmobile phone, electronic mail or Internet use declines, the cost of thoseservices increases or consumers fail to adopt latest generation portableelectronics. Potential consumers of portable consumer electronics may use ormodify existing equipment and never adopt next generation portable consumerelectronics. Demand for other complex electronic equipment, such as networkingequipment, may decrease if service providers do not experience subscribergrowth or defer network build outs or other capital spending.

Purchases of licenses of our software are largelydependent upon the commencement of new design projects by semiconductormanufacturers and their customers, the number of design engineers and theincreasing complexity of designs. Since late 2000, the semiconductor industryhas experienced a sharp decline in orders and revenue and many companies havereduced the number of design engineers and/or design projects. The outlook forthe electronics industry is uncertain and we cannot predict how long thecurrent downturn will last. Many semiconductor manufacturers and vendors ofproducts incorporating semiconductors have announced earnings shortfalls andemployee layoffs.

Budget cuts have impacted the number of orders wereceive from our customers and our customers in general have been seekinglarger discounts and extended payment terms or purchasing time-basedlicenses 

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in lieu of more costlyperpetual licenses. We believe our customers’ and potential customers’ internalbudgets have been and will continue to be subject to heightened scrutiny andthe time required to receive budgetary approvals has lengthened. We cannotpredict whether purchases of licenses of our software will be further deferreddue to budget constraints or whether the number of complex nanometer-scalesemiconductor design starts by our customers will be slower or decline evenfurther.

**If we lose any ofour key personnel, our ability to manage our business and continue our growthwould be negatively impacted.**

Our future success depends in part on our ability toenhance our existing products and achieve market acceptance of new, innovativeproducts and technologies. Our software and technologies are complex and tosuccessfully implement our business strategy and manage our business, an indepth understanding of circuit design and the physical behavior of complexnanometer-scale semiconductors is required. We do not have long-termemployment agreements with our founders and the loss of the services of any ofour key employees could adversely affect our business and slow our productdevelopment process. We do not maintain key person life insurance on any of ouremployees.

**If we do notcontinue to expand our sales force and customer service and supportorganization, our revenue may not grow.**

Approximately 72.1%, 75.3% and 74.2% of our total revenuefor fiscal 2002, fiscal 2003 and fiscal 2004, respectively, were from ourdirect sales efforts. Our software requires sophisticated sales efforts byexperienced and knowledgeable personnel. Competition for these individuals isintense due to the limited number of people available with the necessary salesexperience and technical understanding of electronic design automation products.Hiring customer service and support personnel is also very competitive in ourindustry due to the limited number of people available with the necessarytechnical skills. Our sales and support staff consisted of 49 persons as of September 30,2004. If we are unable to successfully train and integrate sales and supportpersonnel and continue to identify, hire, train and retain new qualifiedindividuals, our revenue may not grow.

**If we are unable toattract and retain qualified research and development personnel, our businesswill suffer.**

There is a limited number of qualified softwareengineer and research and development personnel with the necessary experienceand understanding of complex nanometer-scale semiconductor designproducts in the San Francisco Bay Area, where our primary facility is located. Thescarcity of qualified persons may cause us to incur higher salary costs orrequire us to provide larger stock option grants. We have a small research anddevelopment facility in Taiwan, out of which five of our engineers currentlyoperate, to broaden the pool of software engineers from which we can recruit. Wecannot assure you that this strategy will help us satisfy our need forqualified personnel. Further, we may encounter other difficulties with managinggeographically separate research and development activities. If we fail toattract, motivate and retain engineers and research and development personnel,we may be unable to develop or enhance our software, meet the demands of ourcustomers in a timely manner or remain competitive and our business wouldsuffer.

**Because we rely ondistributors for a large portion of our revenue, our revenue could decline ifour existing distributors do not continue to purchase software licenses from usor represent us in those markets.**

A majority of our sales outside North America andEurope are conducted through distributors. Sales by our distributors accountedfor approximately 27.9%, 24.7% and 25.8% of our total revenue in fiscal 2002,fiscal 2003 and fiscal 2004, respectively. We rely on Marubeni Solutions as theexclusive distributor of our software in Japan. Sales to Marubeni Solutions accountedfor 19.4%, 15.5% and 18.2% of our total revenue in fiscal 2002, fiscal 2003 andfiscal 2004, respectively. We cannot be certain that we will be able to attractdistributors that market our software effectively or provide timely and costeffective user support 

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and service. Further, ouragreements with our distributors do not obligate the distributor to purchaseany amount of licenses of our software or sell licenses of our software. Consequently,one or more of our distributors may not continue to represent our software ordevote a sufficient amount of effort and resources to selling our licenses ofsoftware in their territories. We may from time to time be forced to terminaterelationships with distributors who do not maintain an appropriate level ofsales. We may also decide to sell our software in a particular territorydirectly and terminate relationships with a particular distributor. As aresult, our sales in a given territory may decrease substantially or ceaseuntil a suitable replacement distributor can be found or we are able toestablish or provide adequate sales and support efforts for that territory. Evenif we are successful in selling licenses of our software through newdistributors, the rate of growth of our total revenue could be harmed if ourexisting distributors do not continue to sell licenses of our software.

**If we fail toadequately match our expenses to anticipated revenue in any given quarter, ouroperating results could fall below market expectations and cause the price ofour stock to decline.**

Because of the prolonged economic downturn, extendedsales cycle, seasonal fluctuations in our business, cyclicality of thesemiconductor industry and the rapidly evolving market for complex nanometer-scalesemiconductors, our ability to accurately forecast our quarterly revenue islimited. As a result, it is difficult to predict the revenue we will recognizein any given quarter.

We expect toexperience seasonal fluctuations in our revenue due to:

·       financialstability and outlook of our customers;

·       capitalbudgeting and purchasing cycles of our customers;

·       economicincentives for our sales force;

·       lengtheningof the sales cycle due to limited resources as a result of layoffs by ourcustomers, longer approval process, summer holidays, particularly in Europe andJapan; and

·       thenumber of orders received for perpetual licenses versus time-basedlicenses.

Commissions represent a significant portion of oursales force compensation, which is structured to encourage sales closures priorto fiscal year end. As a result, we expect that sales efforts will intensify inthe fourth fiscal quarter which could result in our revenue being flat orslightly lower in the first and second quarters of the subsequent fiscal year.

It is difficult for us to evaluate the degree to whichthese factors may reduce our sales because our revenue growth historically hadmasked the impact of these factors. In addition, most of our costs arerelatively fixed in the short term and our business may not grow rapidly enoughto absorb the costs of our personnel and facilities. As a result, we may beunable to reduce our expenses to avoid or minimize the negative impact on ourquarterly operating results if anticipated revenue is not realized. Forexample, for the three months ended March 31, 2003, our revenue andearnings fell short of our previous guidance and market expectation and werevised our guidance for the quarter ended June 30, 2003 and fiscal 2003to project much lower revenue and earnings than previously given, whichnegatively impacted the trading price of our common stock. Although we wereable to achieve revenue and earnings results that met the revised guidance foreach of the following five quarters, we again revised our earnings target in July 2004for the quarter ended September 30, 2004 primarily due to the expectedincrease in litigation related costs. We did not see any meaningfulimprovements in our customers’ spending pattern and our outlook continues to becautious. These trends could materially affect our quarter to quarter operatingresults, which could negatively impact our stock price.

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**We may not succeed in creating market acceptance forCRITIC, HANEX and**HSIMplusplatform and its related post-layoutoptions, and our revenue may decline as a result.

We released our second major product, LEXSIM, in May 2002,our third product, CRITIC, in December 2002, our fourth product, HANEX, inMay 2003 and reconfigured LEXSIM into post-layout options for thenew HSIMplusplatform in May 2004. To date, these products and options otherthan HSIM have accounted for only an immaterial portion of our revenue. Eventhough we expect products or options other than HSIM to account for a smallpercentage of our total revenue in fiscal 2005, our future growth andprofitability could be affected by our ability to increase sales of our otherproducts and options. Furthermore, marketing new products requires significantadditional expenses and resources. If we fail to market them successfully, ourrevenue may decline.

**If we fail toenhance our circuit simulation and analysis software and develop and introducenew circuit simulation and analysis software on a timely basis, we may not beable to address the needs of our customers, our technology may become obsoleteand our results of operations may be harmed.**

The electronic design automation software market ischaracterized by rapid technological change, frequent new product introductionsand enhancements, uncertain product life cycles, changes in user demands andevolving industry standards. The introduction of software embodying newtechnologies and the emergence of new industry standards can render existingsoftware in the semiconductor design industry obsolete and unmarketable. Forinstance, if customers widely adopt new engineering languages to describe theirsemiconductor designs and our software fails to support those languagesadequately, demand for our software will suffer. To be successful as astand-alone company, we must devote a substantial amount of our resources toenhance our software, keep pace with changes within our industry and developand market new technologies. If our enhanced products or our future productsand technologies do not achieve market acceptance, we may not be able tomaintain our market share or recoup our development costs. As a result, ouroperating results would be harmed.

**Our sales cycle isunpredictable and may be more than six months, so we may fail to adequatelymatch our expenses to anticipated revenue in any given period or meet marketexpectations.**

Our sales cycle, orthe period between our initial contact with a potential customer and thecustomer’s purchase of a license of our software, generally ranges from threeto six months but may be longer, particularly in the current economic downturn.We cannot predict the exact length of our sales cycle, which at times hasexceeded six months. The unpredictability of our sales cycle makes it difficultto plan our expenses and forecast our results of operations for any givenperiod. If we do not correctly predict the timing of our customers’ purchases,the amount of revenue we recognize in a given quarter could be negativelyimpacted, which could harm our operating results. Our sales cycle may lengthenbecause of several factors, including:

·       limitedand decreased capital spending due to weakness in the semiconductor industryand customers’ uncertainty about economic recovery;

·       competitionfrom other electronic design automation software vendors;

·       longtechnical evaluation periods and validation periods for the integration of oursoftware with our potential customers’ existing semiconductor design flow;

·       thesignificant investment of resources required by customers to purchase andintegrate our software into their design flow, particularly customers withlarge semiconductor design organizations;

·       limitedaccess to key decision makers of potential customers to authorize the adoptionof our software;

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·       budgetcycles of our customers which affect the timing of purchases; and

·       delayof purchases due to product combination announcements or planned introductionsof new products by our competitors or us.

If we were to experience a delay in our orders, itcould harm our ability to meet our forecasts or investors’ expectations for agiven quarter and ultimately result in the decrease of our stock price. Further,if our sales cycle unexpectedly lengthens in general, it would adversely affectthe timing of our revenue recognition, which could cause us not to meet marketexpectations and cause our stock price to suffer. For instance, for the threemonths ended June 30, 2003 and March 31, 2003, our revenue decreasedas compared to the previous quarters because we experienced longer salescycles, which negatively impacted our ability to receive orders and recognize revenue.

**Our expansion intointernational markets will result in higher personnel costs or distributorcommissions and could reduce our operating margins.**

In order to penetrate international markets further,we must either expand the number of distributors who sell licenses of oursoftware or increase our direct international sales presence. As we increaseour direct international sales presence, our sales efforts may be delayed as webegin our local sales activities and we may incur higher personnel costs thatmay not result in additional revenue. These costs and the time to establish alocal sales presence could harm our operating results. We may not realizecorresponding growth in operating margins from growth in international salesdue to the higher costs of these sales. We have increased our sales and supportresources in Europe over the last two years and have established offices inFrance, Germany, India, Israel and Singapore. However, the expected returns onthose investments have not been realized, primarily due to the economicslowdown. To date, we have relied primarily on international distributors inAsia and have only recently begun to employ direct sales and support personnelin Singapore and India. Even if we expand our direct and indirect internationalselling efforts, our efforts may not create or increase international marketdemand for our software or generate revenue sufficient to recoup the cost ofthis expansion.

**We expect to incurlosses in the future, the market price of our common stock could decline.**

Although we had net income for the four years ended September 30,2003, we have incurred losses for the quarter and year ended September 30,2004, we may continue to incur losses in the future. In order to fund ourgrowth and implement our strategies, we must continue to increase ourinvestment in research and development, sales and marketing and otheroperations. Our litigation related costs also increased substantially in fiscal2004 as compared to fiscal 2003 and, in the event the proposed merger withSynopsys is not consummated, we expect these costs to increase in fiscal 2005totaling an estimated $18.0 million to $20.0 million. As a result, weexpect to incur substantial losses and the market price of our common stock maydecline, perhaps substantially.

To the extent thatwe remain a stand-alone company, we anticipate that our expenses will increasesubstantially in the next 12 months as we:

·       increaseour sales and marketing activities, particularly by expanding our direct salesforce;

·       continueto increase the size and number of locations of our support organization;

·       continueto invest in research and development to enhance our existing products andtechnologies and develop new circuit simulation and analysis products;

·       implementadditional internal systems, develop additional infrastructure and hireadditional management to keep pace with our growth; and

·       resumeour efforts to defend ourselves vigorously against the State Court Action andthe Federal Court Actions.

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Any failure to significantly increase our revenue aswe implement our strategies would also harm our ability to maintainprofitability and could negatively impact the market price of our common stock.

**If we are not ableto preserve the value of our software’s intellectual property, our businesswill suffer.**

Our software is differentiated from that of ourcompetitors by our internally developed technology. If we fail to protect ourintellectual property, other vendors could sell circuit simulation and analysissoftware with capabilities similar to ours, and this could reduce demand forour software. We protect our intellectual property through a combination ofcopyright, patent, trade secret and trademark laws. We have a patent programand to date have two patents issued by the U.S. Patent and Trademark Office. Wegenerally enter into confidentiality or license agreements with our employees,consultants and corporate partners, and generally seek to control access to ourintellectual property and the distribution of our software, documentation andother proprietary information. However, we believe that these measures affordonly limited protection. Others may develop technologies that are similar orsuperior to our technology or design around the copyrights and trade secrets weown. Unauthorized parties may attempt to copy or otherwise obtain and use oursoftware or technology. Policing unauthorized use of our software is difficultand expensive, and we cannot be certain that the steps we have taken willprevent misappropriation of our technology, particularly in foreign countrieswhere the laws may not protect our proprietary rights as fully as those in theUnited States. If our means of protecting our proprietary rights is inadequateor ineffective, our business may be severely harmed.

**A protractedinfringement claim or a significant damage award would adversely impact ouroperating results.**

Substantiallitigation and threats of litigation regarding intellectual property rightsexist in our industry. We expect that circuit simulation and analysis designsoftware may be increasingly subject to third-party infringement claimsas the number of competitors in our industry segment grows and thefunctionality of products in different industry segments overlaps. We are notaware of any valid proprietary rights of third parties that our softwareinfringes. We are currently a defendant in the State Court Action and FederalCourt Actions. Additional third parties other than Synopsys may claim that weinfringe their intellectual property rights. Any claims, with or without merit,could:

·       betime consuming to defend;

·       resultin costly litigation and/or damage awards;

·       divertour management’s attention and resources;

·       causecustomers to cancel or delay orders;

·       causeproduct shipment delays; or

·       requireus to seek to enter into royalty or licensing agreements.

These royalty or licensing agreements may not beavailable on terms acceptable to us, if at all. A successful claim of productinfringement against us or our failure to license the infringed or similartechnology could adversely affect our business. We would not be able to selllicenses of the impacted software without exposing ourselves to litigation riskand damages or we may be required to redevelop the software and incursignificant additional expense. Because we expect to derive substantially allof our revenue from HSIM in fiscal 2005, to the extent we remain a stand-alonecompany, anything that would limit our ability to license HSIM would harm ourbusiness.

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**Any potential dispute involving our intellectualproperty could include our customers and strategic partners, which couldtrigger our indemnification obligations with them and result in substantialexpense.**

In any potential dispute involving our intellectualproperty, our customers and strategic partners could also become the target oflitigation. This could trigger our technical support and indemnificationobligations in our license agreements which could result in substantial expenseto us. In addition to the time and expense required for us to supply suchsupport or indemnification to our customers and strategic partners, any suchlitigation could severely disrupt or shut down the business of our customersand strategic partners, which in turn could hurt our relations with ourcustomers and strategic partners, result in potential claims for damages andcause licenses for our software to decrease.

**Significant errors in our software, our inability tocorrect errors or the failure of our software to conform to specifications couldresult in our customers demanding refunds from us or asserting claims fordamages against us.**

Because our circuitsimulation and analysis software is complex, our software could fail to performas anticipated. Further, significant errors in our software may be found in thefuture or errors may not be corrected satisfactorily for our customers. Thedetection of any significant errors may result in:

·       productliability claims or damage awards;

·       theloss of or delay in market acceptance and sales of our software;

·       injuryto our reputation and hindered market acceptance of our software;

·       diversionof development resources from new software to fix errors in existing software;

·       costsof corrective actions or returns of defective software;

·       reductionin maintenance or time-based license renewal rates; or

·       delaysin shipping dates for our software.

We have warranted that our software will operate inaccordance with our user documentation. If our software fails to conform tothese specifications, customers could demand a refund for the purchase price orassert and collect on claims for damages.

Moreover, because our software is used in connectionwith other vendors’ products that are used to design complex nanometer-scalesemiconductors, significant liability claims may be asserted against us if oursoftware does not work properly individually or with other vendors’ products. Ouragreements with customers typically contain provisions intended to limit ourexposure to liability claims. However, these limitations may not preclude allpotential claims and we have only minimal insurance against such liabilities. Regardlessof their merit, liability claims could require us to spend significant time andexpense in litigation and divert management’s attention from other businesspursuits. If successful, a product liability claim could require us to paysignificant damages. Any claims, whether or not successful, could seriouslydamage our reputation and our business.

**Because our strategy to expand our internationaloperations is subject to uncertainties, we may not be able to enter new marketsoutside North America or generate a significant level of revenue or profitmargins from those markets.**

Customers outside North America accounted for 42.0%,39.6% and 36.0% of our total revenue in fiscal 2002, fiscal 2003 and fiscal2004, respectively. We have limited experience marketing and directly licensingour software internationally.

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We have directsales offices in France, Germany, India, Israel, Singapore and Taiwan, and relyprimarily on indirect sales in Asia. Although our sales contracts provide forpayment for our software licenses in United States dollars, our expensesincurred in foreign locations are generally denominated in the applicable localcurrency. To date we have not undertaken any foreign currency hedgingtransactions, and as a result, our future expense levels from internationaloperations may be unpredictable due to exchange rate fluctuations. Ourinternational operations are subject to other risks, including:

·       theimpact of recessions in economies outside North America;

·       difficultiesand costs of staffing and managing foreign operations;

·       foreigncurrency fluctuations;

·       reducedprotection for intellectual property rights in some countries;

·       changesin import or export duties, quotas or controls, which could prevent us fromshipping our software into markets outside North America;

·       greaterdifficulty in accounts receivable collection and longer collection periods;

·       unexpectedchanges in regulatory requirements;

·       propermaintenance of corporate formalities by our foreign subsidiaries;

·       potentiallyadverse tax consequences, including the impact of expiry of tax holidays; and

·       politicaland economic instability.

**To the extent we remain a stand-alone company, weintend to pursue strategic relationships but these efforts could substantiallydivert management attention and resources.**

In order toestablish strategic relationships with semiconductor technology leaders andleading electronic design automation tool providers, we may need to expendsignificant resources and will need to commit a significant amount ofmanagement time and attention, with no guarantee of success. We may be unableto establish key industry strategic relationships if any of the followingoccur:

·       potentialindustry partners become concerned about our ability to protect theirintellectual property;

·       potentialindustry partners develop their own solutions to address circuit simulation andanalysis of complex nanometer-scale semiconductors;

·       ourcompetitors establish relationships with industry partners with which we seekto establish a relationship; or

·       potentialindustry partners attempt to restrict our ability to enter into relationshipswith their competitors.

We have only recently entered into our currentstrategic relationships. These relationships may not continue or be successful.We also may be unable to find additional industry partners that are suitable.

**To the extent we remain a stand-alone company, we maynot be able to expand our proprietary technologies if we do not makeacquisitions or investments or fail to successfully integrate the acquiredcompanies with our business.**

To expand our proprietary technologies, we may acquireor make investments in complementary businesses, technologies or products ifappropriate opportunities arise. We may be unable to identify suitableacquisition or investment candidates at reasonable prices or on reasonableterms, or complete future acquisitions or investments, any of which could slowour growth strategy. We may have difficulty 

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integrating the products,personnel, culture, ideologies or technologies of any acquisitions we mightmake. These difficulties could disrupt our ongoing business, distract ourmanagement and employees and increase our expenses. In addition, the keypersonnel of the acquired company may decide not to work for us and if ourcustomers are uncertain about our ability to operate on a combined basis, theycould delay or cancel orders for our software. Furthermore, we may have toincur debt or issue equity securities to pay for any future acquisition, theissuance of which would be dilutive to our existing stockholders. We also couldhave difficulty in assimilating the acquired company’s or division’s personneland operations, which could negatively affect our operating results.

**The markets for complex nanometer-scalesemiconductors are evolving rapidly and if these markets do not develop andexpand as we anticipate, the demand for our software and our revenue woulddecline.**

We depend on the growing use of circuit simulation andanalysis software to design complex nanometer-scale semiconductors foruse in portable consumer electronics, networking equipment and otherapplications. The market for complex nanometer-scale semiconductors maynot grow if customers choose to use other types of semiconductors that might bemore affordable or available with shorter time-to-market schedules.This could cause electronic equipment manufacturers to limit the number of newcomplex nanometer-scale semiconductors they design and would reduce theirneed for our software. If demand for our software were to decline, we maychoose to lower the prices of our software or we may sell fewer licenses andhave lower maintenance renewal rates. In addition, if equipment manufacturersdo not widely adopt the use of complex nanometer-scale semiconductors orif there is a wide acceptance of alternative semiconductors that provideenhanced capabilities, the market price of our stock could decline due to ourlower operating results or investors’ assessment that the growth potential forlicenses of our software is limited.

The markets forcomplex nanometer-scale semiconductors are evolving rapidly and we cannotpredict their potential sizes or future growth rates. Our success in generatingrevenue in these evolving markets will depend on, among other things, ourability to:

·       educatepotential customers about the benefits of complex nanometer-scalesemiconductors and the use of our software to design them;

·       establishand maintain relationships with leading semiconductor manufacturers, electronicequipment designers, portable consumer electronic manufacturers, networking equipmentand other electronics companies;

·       utilizeour research and development efforts to anticipate and adapt to evolvingmarkets; and

·       predictand base our software on technology that ultimately becomes industry standard.

**We face competition from internally developedsemiconductor design software and if our customers elect to continue to useinternally designed tools, our business may suffer.**

We face significant competition from internal designsoftware groups of semiconductor manufacturers. These internal groups competewith us for access to potential customers’ circuit simulation and analysissoftware budgets and may eventually compete with us to supply circuitsimulation and analysis software to other semiconductor manufacturers. Wecannot assure you that internal groups will not expand their internallydesigned tools to compete directly with ours or actively sell their internallydesigned tools to other semiconductor manufacturers or, if they do, that wewill be able to compete against them successfully.

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**We may not be able to compete effectively if oursoftware is delayed or does not incorporate new required features.**

Our future success depends on our ability to enhanceexisting software, develop and introduce new products, satisfy userrequirements, meet industry standards and achieve market acceptance. We may notsuccessfully identify new product opportunities or develop and bring newproducts to market in a timely and cost effective manner. Significant delays inour new software releases or significant problems or delays in enhancingexisting products to keep pace with new design techniques for complex nanometer-scalesemiconductors could seriously damage our business. We have, from time to time,experienced delays in the scheduled introduction of new and enhanced softwareand we may experience similar delays in the future. For example, in early 2001we experienced delays in the development of a new product which caused us torevise our expected release date for this product by several months. More recently,we have also delayed the release of another product in order to allow for anextended beta testing period. We cannot assure you that we will not experienceadditional difficulties that could delay or prevent the successful development,introduction and marketing of this software or that our new software andproduct enhancements will achieve market acceptance. If we are unable todevelop, introduce and successfully market new or enhanced software in a timelymanner in response to changing market conditions or customer requirements, ourbusiness, operating results and financial condition may be harmed.

**We may sell fewer licenses of our products if othervendors’ products are no longer compatible with ours.**

Our ability to sell licenses of our software dependsin part on the compatibility of our software with other vendors’ software andhardware products. These vendors may change their products so that they will nolonger be compatible with our software. If that were to happen, our businessand future operating results would suffer if we were no longer able to offercommercially viable or competitive products.

**We do not have a consulting staff, and our revenue maysuffer if customers demand extensive consulting or other support services.**

Our software is designed to be deployed quickly andeasily by our customers and to require limited support from us. Many of ourcompetitors offer extensive consulting services in addition to circuitsimulation and analysis products. If we introduce software that requires extensiveconsulting services for specific designs, or if our customers wish to purchasea broad spectrum of software and services that includes extensive consultingservices from a single vendor, we would be required to change our businessmodel and cost structure to provide consulting services. Specifically, we wouldbe required to hire and train consultants or outsource the required consultingservices. If these events were to occur, our future gross margin would likelysuffer because of the added expense of hiring and retaining consultingpersonnel.

**Our common stock is subject to substantial price andvolume fluctuations due to a number of factors, many of which are beyond ourcontrol, and those fluctuations may prevent our stockholders from reselling ourcommon stock at a profit.**

The securities markets have experienced extreme priceand volume fluctuations recently and the market prices of the securities oftechnology companies have been especially volatile. This market volatility, aswell as general economic or political conditions, could reduce the market priceof our common stock regardless of our operating performance. In addition, ouroperating results could be below the expectations of investment analysts andinvestors and, in response, the market price of our common stock may decreasesignificantly and prevent investors from reselling their shares of our commonstock at or above the price at which they purchased the shares. For example, inApril 2003 we reported our financial results for the three months ended March 31,2003, which were below previous guidance and market expectations and in June 2004,material negative rulings were issued by the Discovery Referee against us, as aresult of which the stock prices of our common stock were adversely impacted.

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**Our growth could place a significant strain on ourmanagement systems and resources and we may be unable to effectively controlour costs and implement our business strategies as a result.**

We had 116 employees as of September 30, 2004 andexpect our headcount to double over the next two fiscal years to the extent weremain a stand-alone company. Our productivity and the quality of our softwaremay be adversely affected if we do not integrate, train and motivate our newemployees quickly and effectively and manage our resources efficiently. We alsocannot be sure that our revenue will continue to grow at a sufficient rate toabsorb the costs associated with the increased personnel.

We expect that anyfuture growth we experience will continue to place a significant strain on ourmanagement, systems and resources. To manage the anticipated growth of ouroperations, we will be required to:

·       hire,train, manage and retain additional qualified personnel, especially softwareengineers and sales staff;

·       improveexisting and implement new operational, financial and management informationcontrols, reporting systems and procedures;

·       maintaina high level of customer service and support; and

·       establishrelationships with additional corporate partners and maintain our existingrelationships.

**If we account for employee stock options using thefair value method, it could significantly increase operating expenses.**

There has been ongoingpublic debate whether stock options granted to employees should be treated as acompensation expense and, if so, how to properly value such charges. In 2004,the Financial Accounting Standard Board (FASB) issued an Exposure Draft, “Share-BasedPayment: an amendment of FASB statements No. 123 and 95,” which wouldrequire us to recognize, as an expense, the fair value of stock options andother stock-based compensation to employees beginning July 1, 2005and in subsequent reporting periods. If we elect or are required to record anexpense for our stock-based compensation plans using the fair valuemethod as described in the Exposure Draft, we could have significant andongoing expenses, which could significantly affect our business growth.

**ITEM 7A.   Quantitative and QualitativeDisclosures About Market Risk**

We develop products primarily in the United States andsell those products primarily in North America, Europe and Japan. Our revenuefor sales outside of North America was approximately 42.0%, 39.6% and 36.0% oftotal revenue for fiscal 2002, fiscal 2003 and fiscal 2004, respectively. As a result,our financial results could be affected by factors such as changes in foreigncurrency exchange rates or weak economic conditions in foreign markets. As allof our sales are currently made in United States dollars, a strengthening ofthe United States dollar could make our software less competitive in foreignmarkets.

Our interest income is sensitive to changes in thegeneral level of United States interest rates, particularly since the majorityof our investments are in short-term instruments. The fair value of fixedrate securities may be adversely impacted because of changes in short-terminterest rates and credit ratings. Therefore, our future interest income may benegatively affected by changes in interest rates or we may suffer principallosses if we were to sell securities that have declined in value because ofchanges in interest rates or issuer credit ratings. A sensitivity analysisassuming a hypothetical 10% movement in interest rates applied to our cashequivalent and short-term investments balances at September 30, 2004would change interest income by approximately $113,000 on an annual basis. However,due to the nature of our short-term investments, we have concluded thatwe do not have material market risk exposure. We do not hold or issuederivatives, derivative commodity instruments or other financial instrumentsfor trading or speculative purposes.

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We invest funds inexcess of current operating requirements in:

·       obligationsof the United States government and its agencies;

·       investmentgrade state and local government obligations;

·       securitiesof United States corporations rated A1 or P1 by Standard & Poor’s orMoody’s equivalents; and/or

·       moneymarket funds, deposits or notes issued or guaranteed by United States and non-UnitedStates commercial banks meeting certain credit rating and net worthrequirements with maturities of less than one year.

As of September 30, 2004, our cash, cashequivalents and short-term investments consisted primarily of demanddeposits, money market funds and corporate notes held by large institutions inthe United States and agency securities of the United States government andstate municipalities.

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**ITEM 8.   Financial Statements and SupplementaryData**

**Quarterly Results of Operations**

Thefollowing table presents our operating results for each of the eight quartersin the period ended September 30, 2004. The information for each of thesequarters is unaudited and has been prepared on the same basis as our auditedfinancial statements appearing elsewhere in this report. In the opinion of ourmanagement, all necessary adjustments, consisting only of normal recurringadjustments, have been included to present fairly the unaudited quarterlyresults when read in conjunction with our audited consolidated financialstatements and the related notes appearing elsewhere in this report. Theseoperating results are not necessarily indicative of the results of any futureperiod.
| ** **                             | ** ** | **Quarters Ended**                                               | ** ** |
|----------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                             | ** ** | **Dec. 31,  2002**                                               | ** ** | **March 31,  2003** | ** ** | **June 30,  2003** | ** ** | **Sept. 30,  2003** | ** ** | **Dec. 31,  2003** | ** ** | **March 31,  2004** | ** ** | **June 30,  2004** | ** ** | **Sept. 30,  2004** | ** ** |
| ** **                             | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Revenue:                               |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Product                                |       | $                                                                     | 4,632      |   |   | $ | 3,211 |   |   | $ | 1,892 |   | $ | 2,061 |   | $ | 3,003 |   |   | $ | 1,571 |   |   | $ | 2,643 |   | $ | 1,720 |   |
| Subscription                           |       | 3,748                                                                 |       |   | 3,443 |   |   | 3,558 |   | 3,852 |   | 4,242 |   |   | 5,755 |   |   | 5,793 |   | 6,566 |   |
| Maintenance                            |       | 1,955                                                                 |       |   | 2,145 |   |   | 2,058 |   | 2,500 |   | 2,482 |   |   | 2,461 |   |   | 2,519 |   | 2,712 |   |
| Total revenue                          |       | 10,335                                                                |       |   | 8,799 |   |   | 7,508 |   | 8,413 |   | 9,727 |   |   | 9,787 |   |   | 10,955 |   | 10,998 |   |
| Cost of revenue:                       |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Product                                |       | 66                                                                    |       |   | 63 |   |   | 69 |   | 43 |   | 91 |   |   | 74 |   |   | 49 |   | 13 |   |
| Subscription                           |       | 86                                                                    |       |   | 84 |   |   | 90 |   | 83 |   | 105 |   |   | 104 |   |   | 108 |   | 126 |   |
| Maintenance                            |       | 201                                                                   |       |   | 197 |   |   | 211 |   | 193 |   | 226 |   |   | 259 |   |   | 268 |   | 282 |   |
| Total cost of revenue                  |       | 353                                                                   |       |   | 344 |   |   | 370 |   | 319 |   | 422 |   |   | 437 |   |   | 425 |   | 421 |   |
| Gross profit                           |       | 9,982                                                                 |       |   | 8,455 |   |   | 7,138 |   | 8,094 |   | 9,305 |   |   | 9,350 |   |   | 10,530 |   | 10,577 |   |
| Operating expenses:                    |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Research and development               |       | 1,529                                                                 |       |   | 1,706 |   |   | 1,968 |   | 1,942 |   | 2,032 |   |   | 2,010 |   |   | 2,419 |   | 2,390 |   |
| Sales and marketing                    |       | 2,876                                                                 |       |   | 2,873 |   |   | 2,659 |   | 2,366 |   | 2,678 |   |   | 2,662 |   |   | 3,245 |   | 3,022 |   |
| General and  administrative            |       | 2,464                                                                 |       |   | 2,414 |   |   | 2,457 |   | 3,318 |   | 3,774 |   |   | 3,623 |   |   | 3,735 |   | 5,196 |   |
| Litigation settlement                  |       | —                                                                |       |   | — |   |   | — |   | — |   | — |   |   | — |   |   | — |   | 67,463 |   |
| Stock-based  compensation              |       | 248                                                                   |       |   | 248 |   |   | 229 |   | 230 |   | 224 |   |   | 218 |   |   | 189 |   | 165 |   |
| Total operating expenses          |       | 7,117                                                                 |       |   | 7,241 |   |   | 7,313 |   | 7,856 |   | 8,708 |   |   | 8,513 |   |   | 9,588 |   | 78,236 |   |
| Income (loss) from  operations    |       | 2,865                                                                 |       |   | 1,214 |   |   | (175 | ) | 238 |   | 597 |   |   | 837 |   |   | 942 |   | (67,659 | ) |
| Interest income                        |       | 268                                                                   |       |   | 256 |   |   | 222 |   | 240 |   | 236 |   |   | 242 |   |   | 253 |   | 271 |   |
| Other income  (expense), net           |       | (20                                                                   | )          |   | (10 | ) |   | 11 |   | (18 | ) | (16 | ) |   | (4 | ) |   | 1 |   | 10 |   |
| Income (loss)  before taxes            |       | 3,113                                                                 |       |   | 1,460 |   |   | 58 |   | 460 |   | 817 |   |   | 1,075 |   |   | 1,196 |   | (67,378 | ) |
| Benefit  (provision) for taxes         |       | (1,090                                                                | )          |   | (438 | ) |   | 138 |   | (137 | ) | (245 | ) |   | (323 | ) |   | (130 | ) | 90 |   |
| Net income (loss)                      |       | $                                                                     | 2,023      |   |   | $ | 1,022 |   |   | $ | 196 |   | $ | 323 |   | $ | 572 |   |   | $ | 752 |   |   | $ | 1,066 |   | $ | (67,288 | ) |
| Basic shares                           |       | 24,363                                                                |       |   | 24,889 |   |   | 25,326 |   | 25,653 |   | 25,957 |   |   | 26,251 |   |   | 26,666 |   | 26,953 |   |
| Basic earnings  (loss) per share  |       | $                                                                     | 0.08       |   |   | $ | 0.04 |   |   | $ | 0.01 |   | $ | 0.01 |   | $ | 0.02 |   |   | $ | 0.03 |   |   | $ | 0.04 |   | $ | (2.50 | ) |
| Diluted shares                         |       | 28,923                                                                |       |   | 28,487 |   |   | 28,546 |   | 29,167 |   | 29,149 |   |   | 29,213 |   |   | 28,959 |   | 26,953 |   |
| Diluted earnings  (loss) per share     |       | $                                                                     | 0.07       |   |   | $ | 0.04 |   |   | $ | 0.01 |   | $ | 0.01 |   | $ | 0.02 |   |   | $ | 0.03 |   |   | $ | 0.04 |   | $ | (2.50 | ) |

 

*QuarterlyFluctuations*

We believe seasonal factors in our business may causeboth the total revenue and each of its components to fluctuate from quarter toquarter. These seasonal factors include patterns in the capital budgeting,purchasing cycles of our current and prospective customers, the mix betweenperpetual and time-based licenses, timing of the renewals of time-basedlicenses and maintenance, and payment terms which may impact the timing ofrevenue recognition. During the three months ended March 31, 2003, weexperienced a substantial change in customers’ purchasing behavior due to theprolonged economic downturn and concerns about their own financial stability. Therefore,as a cost-cutting measure, customers 

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either suspended orreduced their capital budgets dramatically, which adversely affected ourrevenue. Consequently, total revenue and earnings were lower than expected forthe quarter ended March 31, 2003. In addition, more customers preferred topurchase time-based licenses due to their flexible licensing structureand payment terms. As a result, we also experienced decreases in perpetuallicense purchases in the three months ended March 31, 2003, June 30,2003, March 31, 2004 and September 30, 2004. Further, commissionsrepresent a significant portion of our sales force compensation, which isstructured to encourage sales booking closures prior to fiscal year end. As aresult, we expect that sales efforts will intensify in the fourth fiscalquarter, which could result in our revenue being flat or slightly lower in thesecond and third quarters of the subsequent fiscal year. General andadministrative expenses increased by approximately $1.5 million in thethree months ended September 30, 2004 relative to the three months ended June 30,2004 primarily due to the increases in litigation and related costs. For thequarter ended September 30, 2004, we have also recorded a one-timenon-cash expense of $67.5 million for litigation settlement. As a result, weincurred a net loss of $67.3 million for the quarter ended September 30,2004 and $64.9 million for the fiscal year ended September 30, 2004.

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**NASSDA CORPORATION**

**INDEX TOCONSOLIDATED FINANCIAL STATEMENTS**
|                                                                                                                                                                        | ** ** | **Page** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| Report of Independent Registered  Public Accounting Firm                                                                                                               |       | 56       |   |
| Consolidated Balance Sheets as of  September 30, 2003 and 2004                                                                                                    |       | 57       |   |
| Consolidated Statements of  Operations for each of the three fiscal years ended September 30, 2002,  2003 and 2004                                                |       | 58       |   |
| Consolidated Statements of  Stockholders’ Equity and Comprehensive Income (Loss) for each of the three  fiscal years ended September 30, 2002, 2003 and 2004 |       | 59       |   |
| Consolidated Statements of Cash  Flows for each of the three fiscal years ended September 30, 2002, 2003  and 2004                                                |       | 60       |   |
| Notes to Consolidated Financial  Statements                                                                                                                            |       | 61       |   |

 

55

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

To the Board of Directorsand Stockholders ofNassda Corporation:

We have audited the accompanying consolidated balancesheets of Nassda Corporation and subsidiaries (the “Company”) as of September 30,2003 and 2004, and the related consolidated statements of operations,stockholders’ equity and comprehensive income (loss) and cash flows for each ofthe three years in the period ended September 30, 2004. Our audits alsoincluded the consolidated financial statement schedule listed inItem 15(a)(2). These consolidated financial statements and consolidatedfinancial statement schedule are the responsibility of the Company’s management.Our responsibility is to express an opinion on the consolidated financialstatements and consolidated financial statement schedule based on our audits.

We conducted our audits in accordance with standardsof the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, suchconsolidated financial statements present fairly, in all material respects, thefinancial position of the Company as of September 30, 2003 and 2004 andthe results of its operations and its cash flows for each of the three years inthe period ended September 30, 2004 in conformity with accountingprinciples generally accepted in the United States of America. Also, in ouropinion, such consolidated financial statement schedule listed in Item15(a)(2), when considered in relation to the basic consolidated financial statementsas a whole, presents fairly, in all material respects, the information setforth therein.
| /s/ DELOITTE & TOUCHE LLP |   |
|---------------------------------------------------|--------|
|                                              |   |
| San Jose, California                              |
| December 3, 2004                             |

 

56

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**NASSDA CORPORATIONCONSOLIDATED BALANCE SHEETS(in thousands, except share and per share amounts)**
| ** **                                                                                                                                                                         | ** ** | **September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                         | ** ** | **2003**               | ** ** | **2004** | ** ** |
| **Assets:**                                                                                                                                                                        |       |                   |       |   |   |
| Current assets:                                                                                                                                                                    |       |                   |       |   |   |
| Cash and cash equivalents                                                                                                                                                          |       | $                      | 53,145     |   | $ | 59,298 |   |
| Short-term investments                                                                                                                                                             |       | 39,020                 |       | 42,142 |   |
| Accounts receivable, net of allowances of $92 and  $82 at September 30, 2003 and September 30, 2004, respectively                                                        |       | 1,874                  |       | 1,302 |   |
| Prepaid expenses and other current assets                                                                                                                                          |       | 996                    |       | 1,093 |   |
| Deferred income taxes                                                                                                                                                              |       | 2,568                  |       | 3,768 |   |
| Total current assets                                                                                                                                                               |       | 97,603                 |       | 107,603 |   |
| Property and  equipment, net                                                                                                                                                       |       | 704                    |       | 483 |   |
| Other assets                                                                                                                                                                       |       | 1,165                  |       | 921 |   |
| Total assets                                                                                                                                                                       |       | $                      | 99,472     |   | $ | 109,007 |   |
| **Liabilities  and Stockholders’ Equity:**                                                                                                                                    |       |                   |       |   |   |
| Current liabilities:                                                                                                                                                               |       |                   |       |   |   |
| Accounts payable                                                                                                                                                                   |       | $                      | 230        |   | $ | 2,168 |   |
| Other accrued liabilities                                                                                                                                                          |       | 7,682                  |       | 8,342 |   |
| Accrued litigation settlement (Note 12)                                                                                                                                            |       | —                 |       | 67,463 |   |
| Deferred revenue                                                                                                                                                                   |       | 8,982                  |       | 10,143 |   |
| Total current liabilities                                                                                                                                                          |       | 16,894                 |       | 88,116 |   |
| Deferred revenue                                                                                                                                                                   |       | 849                    |       | 482 |   |
| Other long-term  liabilities                                                                                                                                                       |       | 64                     |       | 57 |   |
| Total liabilities                                                                                                                                                                  |       | 17,807                 |       | 88,655 |   |
| Commitments and  Contingencies (Notes 5 and 10)                                                                                                                               |       |                   |       |   |   |
| Stockholders’ equity:                                                                                                                                                         |       |                   |       |   |   |
| Preferred stock, $0.001 par value, 10,000,000 shares  authorized: no shares issued and outstanding                                                                                 |       | —                 |       | — |   |
| Common stock, par value $0.001: 110,000,000 shares  authorized; 25,999,439 and 27,025,604 shares outstanding at  September 30, 2003 and September 30, 2004, respectively |       | 26                     |       | 27 |   |
| Additional paid-in capital                                                                                                                                                         |       | 70,343                 |       | 73,117 |   |
| Deferred stock-based compensation                                                                                                                                                  |       | (1,117                 | )          | (235 | ) |
| Accumulated other comprehensive (loss)                                                                                                                                             |       | (4                     | )          | (76 | ) |
| Retained earnings (accumulated deficit)                                                                                                                                            |       | 12,417                 |       | (52,481 | ) |
| Total stockholders’ equity                                                                                                                                                    |       | 81,665                 |       | 20,352 |   |
| Total liabilities and  stockholders’ equity                                                                                                                                   |       | $                      | 99,472     |   | $ | 109,007 |   |

 

See accompanying notes to consolidated financial statements.

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**NASSDA CORPORATIONCONSOLIDATED STATEMENTS OFOPERATIONS(in thousands, except per share and per share amounts)**
| ** **                                           | ** ** | **Years Ended September 30,** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                           | ** ** | **2002**                                     | ** ** | **2003** | ** ** | **2004** | ** ** |
| Revenue:                                             |       |                                         |       |   |   |   |   |
| Product                                              |       | $                                            | 19,101     |   | $ | 11,796 |   | $ | 8,937 |   |
| Subscription                                         |       | 9,587                                        |       | 14,601 |   | 22,356 |   |
| Maintenance                                          |       | 5,219                                        |       | 8,658 |   | 10,174 |   |
| Total revenue                                        |       | 33,907                                       |       | 35,055 |   | 41,467 |   |
| Cost of revenue:                                     |       |                                         |       |   |   |   |   |
| Product                                              |       | 259                                          |       | 241 |   | 227 |   |
| Subscription                                         |       | 276                                          |       | 343 |   | 443 |   |
| Maintenance                                          |       | 685                                          |       | 802 |   | 1,035 |   |
| Total cost of revenue                                |       | 1,220                                        |       | 1,386 |   | 1,705 |   |
| Gross profit                                         |       | 32,687                                       |       | 33,669 |   | 39,762 |   |
| Operating expenses:                                  |       |                                         |       |   |   |   |   |
| Research and development                             |       | 5,478                                        |       | 7,145 |   | 8,851 |   |
| Sales and marketing                                  |       | 9,388                                        |       | 10,774 |   | 11,607 |   |
| General and administrative                           |       | 7,773                                        |       | 10,653 |   | 16,328 |   |
| Litigation settlement (Note 12)                      |       | —                                       |       | — |   | 67,463 |   |
| Stock-based compensation*                            |       | 1,005                                        |       | 955 |   | 796 |   |
| Total operating expenses                             |       | 23,644                                       |       | 29,527 |   | 105,045 |   |
| Income (loss)  from operations                       |       | 9,043                                        |       | 4,142 |   | (65,283 | ) |
| Interest income                                      |       | 949                                          |       | 986 |   | 1,002 |   |
| Other income  (expense), net                         |       | (9                                           | )          | (37 | ) | (9 | ) |
| Income (loss)  before taxes                          |       | 9,983                                        |       | 5,091 |   | (64,290 | ) |
| Provision for  income taxes                          |       | (3,579                                       | )          | (1,527 | ) | (608 | ) |
| Net income (loss)                                    |       | $                                            | 6,404      |   | $ | 3,564 |   | $ | (64,898 | ) |
| Earnings (loss)  per share:                          |       |                                         |       |   |   |   |   |
| Basic                                                |       | $                                            | 0.32       |   | $ | 0.14 |   | $ | (2.45 | ) |
| Diluted                                              |       | $                                            | 0.23       |   | $ | 0.12 |   | $ | (2.45 | ) |
| Shares used in computing  earnings (loss) per share: |       |                                         |       |   |   |   |   |
| Basic                                                |       | 20,116                                       |       | 25,058 |   | 26,457 |   |
| Diluted                                              |       | 27,697                                       |       | 28,781 |   | 26,457 |   |

----

 
| *Stock-based  compensation includes: |   |   |   |   |   |   |   |
|--------------------------------------|--------|--------|--------|--------|--------|--------|--------|
| Research and development             |   | $      | 426    |   | $      | 422    |   | $ | 349 |   |
| Sales and marketing                  |   | 346    |   | 300    |   | 224    |   |
| General and administrative           |   | 233    |   | 233    |   | 223    |   |
| Total                                |   | $      | 1,005  |   | $      | 955    |   | $ | 796 |   |

 

See accompanying notes to consolidated financial statements.

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**NASSDA CORPORATION**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITYAND COMPREHENSIVE INCOME (LOSS)**

**(in thousands, exceptshare amounts)**
| ** **                                                                  | ** ** | **Common Stock** | ** ** | **Additional  Paid-In** | ** ** | **Deferred  Stock-Based** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Retained  Earnings  (Accumulated** | ** ** | **Total  Stockholders’** | ** ** | **Total  Comprehensive** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|---------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|-------------------------------|------------|--------------------------|------------|
| ** **                                                                  | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Capital**               | ** ** | **Compensation**                      | ** ** | **Income (Loss)**               | ** ** | **Deficit)**                  | ** ** | **Equity**               | ** ** | **Income (Loss)** | ** ** |
| **Balance  at October 1, 2001**                                        |       | 12,149,867            |       |                    | $          | 12                        |       |                                  |       | $                                    | 6,126      |                          |       |                     | $          | (3,429 | ) |   |   | $ | 11 |   |   |   | $ | 2,449 |   |   |   | $ | 5,169 |   |   |   | $ | 2,102 |   |   |
| Exercise of stock  options                                                  |       | 422,252               |       |                    | —     |                      |       |                                  | 187        |                                 |       |                          |       |                     |       |   |   |   |   |   |   |   |   |   | 187 |   |   |   |   |   |   |
| Issuance of common  stock under employee stock purchase plan                |       | 36,920                |       |                    | —     |                      |       |                                  | 345        |                                 |       |                          |       |                     |       |   |   |   |   |   |   |   |   |   | 345 |   |   |   |   |   |   |
| Conversion of  preferred  stock                                             |       | 6,575,997             |       |                    | 7          |                      |       |                                  | 1,843      |                                 |       |                          |       |                     |       |   |   |   |   |   |   |   |   |   | 1,850 |   |   |   |   |   |   |
| Issuance of common  stock to public, net of issuance   costs of $6,076 |       | 5,750,000             |       |                    | 6          |                      |       |                                  | 57,168     |                                 |       |                          |       |                     |       |   |   |   |   |   |   |   |   |   | 57,174 |   |   |   |   |   |   |
| Amortization of  employee deferred stock-based compensation                 |       |                  |       |                    |       |                      |       |                                  |       |                                 |       |                          | 1,005      |                     |       |   |   |   |   |   |   |   |   |   | 1,005 |   |   |   |   |   |   |
| Reversal of stock-based  compensation for cancellation of stock options     |       |                  |       |                    |       |                      |       |                                  | (216       | )                                    |       |                          | 216        |                     |       |   |   |   |   |   |   |   |   |   | — |   |   |   |   |   |   |
| Income tax benefit  from employee stock transactions                   |       |                  |       |                    |       |                      |       |                                  | 925        |                                 |       |                          |       |                     |       |   |   |   |   |   |   |   |   |   | 925 |   |   |   |   |   |   |
| Unrealized loss on    short-term investments                                |       |                  |       |                    |       |                      |       |                                  |       |                                 |       |                          |       |                     |       |   | (5 | ) |   |   |   |   |   |   | (5 | ) |   |   | $ | (5 | ) |   |
| Net income                                                                  |       |                  |       |                    |       |                      |       |                                  |       |                                 |       |                          |       |                     |       |   |   |   |   |   | 6,404 |   |   |   | 6,404 |   |   |   | 6,404 |   |   |
| **Balance  at September 30, 2002**                                     |       | 24,935,036            |       |                    | 25         |                      |       |                                  | 66,378     |                                 |       |                          | (2,208     | )                        |       |   | 6 |   |   |   | 8,853 |   |   |   | 73,054 |   |   |   | $ | 6,399 |   |   |
| Exercise of stock  options                                                  |       | 900,203               |       |                    | 1          |                      |       |                                  | 1,370      |                                 |       |                          |       |                     |       |   |   |   |   |   |   |   |   |   | 1,371 |   |   |   |   |   |   |
| Issuance of common  stock under employee stock purchase plan                |       | 164,200               |       |                    |       |                      |       |                                  | 1,002      |                                 |       |                          |       |                     |       |   |   |   |   |   |   |   |   |   | 1,002 |   |   |   |   |   |   |
| Amortization of  employee deferred stock-based compensation                 |       |                  |       |                    |       |                      |       |                                  |       |                                 |       |                          | 955        |                     |       |   |   |   |   |   |   |   |   |   | 955 |   |   |   |   |   |   |
| Reversal of stock-based  compensation for cancellation of stock options     |       |                  |       |                    |       |                      |       |                                  | (136       | )                                    |       |                          | 136        |                     |       |   |   |   |   |   |   |   |   |   | — |   |   |   |   |   |   |
| Income tax benefit  from employee stock transactions                   |       |                  |       |                    |       |                      |       |                                  | 1,729      |                                 |       |                          |       |                     |       |   |   |   |   |   |   |   |   |   | 1,729 |   |   |   |   |   |   |
| Unrealized loss on    short-term investments                                |       |                  |       |                    |       |                      |       |                                  |       |                                 |       |                          |       |                     |       |   | (10 | ) |   |   |   |   |   |   | (10 | ) |   |   | $ | (10 | ) |   |
| Net income                                                                  |       |                  |       |                    |       |                      |       |                                  |       |                                 |       |                          |       |                     |       |   |   |   |   |   | 3,564 |   |   |   | 3,564 |   |   |   | 3,564 |   |   |
| **Balance  at September 30, 2003**                                     |       | 25,999,439            |       |                    | 26         |                      |       |                                  | 70,343     |                                 |       |                          | (1,117     | )                        |       |   | (4 | ) |   |   | 12,417 |   |   |   | 81,665 |   |   |   | $ | 3,554 |   |   |
| Exercise of stock  options                                                  |       | 803,389               |       |                    | 1          |                      |       |                                  | 976        |                                 |       |                          |       |                     |       |   |   |   |   |   |   |   |   |   | 977 |   |   |   |   |   |   |
| Issuance of common  stock under employee stock purchase plan                |       | 222,776               |       |                    |       |                      |       |                                  | 1,117      |                                 |       |                          |       |                     |       |   |   |   |   |   |   |   |   |   | 1,117 |   |   |   |   |   |   |
| Amortization of  employee deferred stock-based compensation                 |       |                  |       |                    |       |                      |       |                                  |       |                                 |       |                          | 796        |                     |       |   |   |   |   |   |   |   |   |   | 796 |   |   |   |   |   |   |
| Reversal of stock-based  compensation for cancellation of stock options     |       |                  |       |                    |       |                      |       |                                  | (86        | )                                    |       |                          | 86         |                     |       |   |   |   |   |   |   |   |   |   | — |   |   |   |   |   |   |
| Income tax benefit  from employee stock transactions                   |       |                  |       |                    |       |                      |       |                                  | 767        |                                 |       |                          |       |                     |       |   |   |   |   |   |   |   |   |   | 767 |   |   |   |   |   |   |
| Unrealized loss on    short-term investments                                |       |                  |       |                    |       |                      |       |                                  |       |                                 |       |                          |       |                     |       |   | (72 | ) |   |   |   |   |   |   | (72 | ) |   |   | $ | (72 | ) |   |
| Net income (loss)                                                           |       |                  |       |                    |       |                      |       |                                  |       |                                 |       |                          |       |                     |       |   |   |   |   |   | (64,898 | ) |   |   | (64,898 | ) |   |   | (64,898 | ) |   |
| **Balance  at September 30, 2004**                                     |       | 27,025,604            |       |                    | $          | 27                        |       |                                  |       | $                                    | 73,117     |                          |       |                     | $          | (235 | ) |   |   | $ | (76 | ) |   |   | $ | (52,481 | ) |   |   | $ | 20,352 |   |   |   | $ | (64,970 | ) |   |

 

See accompanying notes to consolidated financial statements.

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**NASSDA CORPORATIONCONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands)**
| ** **                                                                                          | ** ** | **Years Ended September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2002**                                     | ** ** | **2003** | ** ** | **2004** | ** ** |
| **Operating activities**                                                                            |       |                                         |       |   |   |   |   |
| Net income (loss)                                                                                   |       | $                                            | 6,404      |   | $ | 3,564 |   | $ | (64,898 | ) |
| Adjustments to reconcile net income (loss) to net cash  provided by (used in) operating activities: |       |                                         |       |   |   |   |   |
| Depreciation                                                                                        |       | 438                                          |       | 548 |   | 471 |   |
| Provision for  doubtful accounts                                                                    |       | 25                                           |       | 15 |   | — |   |
| Loss on disposal  of property and equipment                                                         |       | —                                       |       | 14 |   | 6 |   |
| Stock-based  compensation                                                                           |       | 1,005                                        |       | 955 |   | 796 |   |
| Deferred income  taxes                                                                              |       | 445                                          |       | (954 | ) | (959 | ) |
| Changes in operating  assets and liabilities:                                                       |       |                                         |       |   |   |   |   |
| Accounts  receivable                                                                                |       | (2,415                                       | )          | 2,267 |   | 572 |   |
| Prepaid expenses  and other current assets                                                          |       | 202                                          |       | (443 | ) | (94 | ) |
| Accounts payable                                                                                    |       | 444                                          |       | (325 | ) | 1,938 |   |
| Other accrued  liabilities                                                                          |       | 2,549                                        |       | 2,417 |   | 1,427 |   |
| Accrued litigation  settlement                                                                      |       | —                                       |       | — |   | 67,463 |   |
| Deferred revenue                                                                                    |       | 1,593                                        |       | 3,766 |   | 794 |   |
| Long-term  liabilities                                                                              |       | (1,655                                       | )          | 10 |   | (7 | ) |
| Net cash provided  by operating activities                                                          |       | 9,035                                        |       | 11,834 |   | 7,509 |   |
| **Investing activities**                                                                            |       |                                         |       |   |   |   |   |
| Purchases of short-term  investments                                                                |       | (54,004                                      | )          | (62,537 | ) | (47,323 | ) |
| Proceeds from  maturity of short-term investments                                                   |       | 25,224                                       |       | 58,799 |   | 44,129 |   |
| Purchases of  property and equipment                                                                |       | (331                                         | )          | (482 | ) | (256 | ) |
| Other assets                                                                                        |       | 40                                           |       | 1 |   | — |   |
| Net cash used in  investing activities                                                              |       | (29,071                                      | )          | (4,219 | ) | (3,450 | ) |
| **Financing activities**                                                                            |       |                                         |       |   |   |   |   |
| Proceeds from  issuance of common stock, net of issuance costs                                      |       | 57,174                                       |       | — |   | — |   |
| Proceeds from sale  of common stock                                                                 |       | 532                                          |       | 2,373 |   | 2,094 |   |
| Repurchase of  preferred stock                                                                      |       | (168                                         | )          | — |   | — |   |
| Net cash provided  by financing activities                                                          |       | 57,538                                       |       | 2,373 |   | 2,094 |   |
| Increase in cash  and cash equivalents                                                              |       | 37,502                                       |       | 9,988 |   | 6,153 |   |
| Cash and cash  equivalents, beginning of period                                                     |       | 5,655                                        |       | 43,157 |   | 53,145 |   |
| Cash and cash  equivalents, end of period                                                           |       | $                                            | 43,157     |   | $ | 53,145 |   | $ | 59,298 |   |
| **Supplemental disclosure of cash flow information**                                                |       |                                         |       |   |   |   |   |
| Cash paid for  income taxes                                                                         |       | $                                            | 3,041      |   | $ | 319 |   | $ | 822 |   |
| **Noncash investing and financing activities**                                                      |       |                                         |       |   |   |   |   |
| Unrealized loss on  short-term investments                                                          |       | $                                            | (5         | ) | $ | (10 | ) | $ | (72 | ) |
| Reversal of  deferred stock-based compensation                                                      |       | $                                            | (216       | ) | $ | (136 | ) | $ | (86 | ) |
| Income tax benefit  from employee stock transactions                                                |       | $                                            | 925        |   | $ | 1,729 |   | $ | 767 |   |
| Conversion of  preferred stock to common stock                                                      |       | $                                            | 1,850      |   | $ | — |   | $ | — |   |

 

See accompanying notes to consolidated financial statements.

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**NASSDA CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1. Business andSummary of Significant Accounting Policies**

***Business***—NassdaCorporation (the “Company”) was incorporated in California on August 31,1998 to provide full-chip circuit simulation and analysis software forthe design and verification of complex nanometer-scale semiconductors. OnSeptember 28, 2001 the Company reincorporated in the State of Delaware.

The Company operates on a 52 week fiscal year ending September 30.Fiscal 2002 ended on September 30, 2002, fiscal 2003 ended on September 30,2003 and fiscal 2004 ended on September 30, 2004. Fiscal 2005 will end on September 30,2005.

***Initial PublicOffering****—*TheCompany commenced its initial public offering in which the Company sold5 million shares of common stock at $11.00 per share in December 2001.The net proceeds the Company received from this offering after deductingunderwriting discounts and offering expenses were approximately$49.6 million. All outstanding shares of preferred stock wereautomatically converted into common stock on a share for share basisimmediately prior to the first closing of the sale of the shares in the initialpublic offering. The Company’s common stock began trading on the NasdaqNational Market on December 13, 2001.

In January 2002, the underwriters of the Company’sinitial public offering exercised their over-allotment option to purchasean additional 750,000 shares of common stock at $11.00 per share. The netproceeds the Company received pursuant to this over-allotment optionafter deducting underwriting discounts were approximately $7.6 million.

***Basis ofPresentation***—The consolidated financial statementsinclude the Company and its wholly owned subsidiaries. All significantintercompany accounts and intercompany profits have been eliminated.

***Fair Value ofFinancial Instruments***—Cash and cash equivalents,accounts receivable and accounts payable are carried at cost, whichapproximates fair value due to the short maturity of these instruments.

***Certain SignificantRisks and Uncertainties***—The Company is subject tocertain risks and uncertainties. The Company is a defendant in various lawsuits(see Note 10). Should the Company not prevail in any of these lawsuits,the Company may be required to pay substantial monetary damages and/or beprevented from selling the Company’s software. In addition, the Companybelieves changes in any of the following areas could have a material adverseeffect on the Company’s future financial position or results of operations: theeconomic environment; new product development, including market receptiveness;changes in overall demand for products and services offered by the Company;changes in customer relationships; litigation or claims against the Companybased on intellectual property, patent, product regulatory or other factors;competition from other products; existing product obsolescence; the ability toattract and retain qualified employees; and the ability to obtain additionalfinancing.

***Concentration ofCredit Risk***—Financial instruments that potentiallysubject the Company to concentration of credit risk consist of cash, cashequivalents, short-term investments and accounts receivables. The Companymaintains its cash, cash equivalents and short-term investments with highcredit quality financial institutions. Credit risk is mitigated by the Company’scredit evaluation process and reasonably short terms for collection. TheCompany does not require collateral or other security to support accountsreceivable.

***Use of Estimates***—Thepreparation of consolidated financial statements in accordance with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and 

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assumptions that affectthe reported amounts of assets and liabilities at the date of the consolidatedfinancial statements and the reported amounts of revenues and expenses duringthe reporting period. Actual results could differ from those estimates.

***Cash andEquivalents***—The Company considers all liquid debtinstruments with maturities of three months or less as of the date of purchaseto be cash equivalents. The Company’s cash equivalents are maintained with highquality credit institutions and their recorded cost approximates their fairmarket value.

***Short-TermInvestments***—The Company classifies its short-terminvestments as available for sale. In accordance with Statement of FinancialAccounting Standards (“SFAS”) No. 115, *Accountingfor Certain Investments in Debt and Equity Securities*, instrumentsare reported at fair value, with unrealized gains and losses excluded fromearnings and reported as a separate component of stockholders’ equity.

***Property andEquipment***—Property and equipment are stated atcost and are depreciated over their estimated useful lives of three years usingthe straight line method.

***Long-LivedAssets***—In accordance with SFAS No. 144, *Accounting for the Impairment or Disposal of Long-LivedAssets*, the Company evaluates its long-lived assets forimpairment whenever events or changes in circumstances indicated that thecarrying amount of an asset may not be recoverable. When the sum of theundiscounted future net cash flows expected to result from the use of the assetand its eventual disposition is less than its carrying amount, an impairmentloss would be measured based on the discounted cash flows compared to thecarrying amount. No impairment charge has been recorded in any of the periodspresented.

***SoftwareDevelopment Costs***—Costs for the development of newsoftware products and substantial enhancements to existing software productsare expensed as incurred until technological feasibility has been established,at which time any additional costs are capitalized in accordance with SFAS No. 86,*Computer Software To Be Sold, Leased, orOtherwise Marketed*. The costs to develop such software have not beencapitalized as the Company believes its current software development process isessentially completed concurrent with the establishment of technologicalfeasibility.

***Revenue Recognition***—TheCompany recognizes revenue in accordance with the provisions of AmericanInstitute of Certified Public Accountants Statement of Position (“SOP”) 97-2,*Software Revenue Recognition*, asamended by SOP 98-4, *Deferral ofthe Effective Date of Certain Provisions of SOP 97-2*, andSOP 98-9, *Modification ofSOP 97-2, Software Revenue Recognition with Respect to CertainTransactions.*The Company recognizes and reports revenue in threeseparate categories: product revenue, subscription revenue and maintenancerevenue. Product revenue is derived from perpetual license fees. Subscriptionrevenue is derived from time-based license fees and includes maintenanceduring the license period. The Company recognizes product revenue andsubscription revenue when all of the following conditions are met:

·       awritten purchase order and license agreement or other contract has beenexecuted;

·       theproduct and the production license key have been delivered;

·       useracceptance periods, if any, have expired;

·       thelicense fee is fixed and determinable; and

·       collectionof the fee is probable.

Vendor specific objective evidence exists formaintenance on perpetual licenses based on renewal rates. The Company’scustomers generally purchase the first year of maintenance when they purchase aperpetual license, so the Company uses the residual method to determine theallocation of revenue to the license portion of multiple element arrangementsinvolving perpetual licenses. Because the Company 

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bundles both the licenseand maintenance into its agreements for time-based licenses for theentire term, vendor specific objective evidence does not exist for each elementof the arrangement. Therefore, the Company recognizes subscription revenue fromtime-based licenses ratably over the period of the license. Maintenancerevenue is derived from the annual maintenance contracts that are purchased byperpetual licensees. The Company generally recognizes revenue from maintenanceratably over the maintenance period, which is typically one year.

For sales made through all distributors, the Companyrecognizes revenue when the software has been sold to the end users and allother revenue recognition criteria have been met. When the distributor is theprimary obligor in the arrangement, has latitude in establishing prices and hascredit risk, the Company records revenue based on amounts invoiced to thedistributor (rather than the amount invoiced by the distributor to the endusers). When the Company is the primary obligor in the arrangement, haslatitude in establishing price and has credit risk, the Company records revenuebased on amounts invoiced to the end customer (with the related commissionspaid to the distributors reported as sales and marketing expense).

***Research andDevelopment***—Research and development expenses arecharged to operations as incurred.

***Stock-BasedCompensation***—The Company accounts for stock-basedawards to employees using the intrinsic value method in accordance withAccounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees*, and all of itsinterpretations and presents pro forma disclosures required by SFAS No. 123,*Accounting for Stock-BasedCompensation*.

The Company accounts for equity instruments issued tononemployees in accordance with the provisions of SFAS No. 123 andEmerging Issues Task Force Issue No. 96-18, *Accounting for Equity Instruments That Are Issued toOther Than Employees for Acquiring, or in Conjunction with Selling, Goods orServices*, which requires that the fair value of such instruments berecognized as an expense over the period in which the related services arereceived.

UnderSFAS No. 123, the Company is required to disclose pro forma informationregarding option grants made to its employees based on specified valuationtechniques that produce estimated compensation charges. The Company’scalculations are based on a single option valuation approach and forfeituresare recognized as they occur. For pro forma purposes, the estimated fair valueof the Company’s stock-based awards is amortized over the respectivevesting period. The weighted-average estimated fair value of stockoptions issued during fiscal 2002, fiscal 2003 and fiscal 2004 was $5.88, $4.32and $3.64 per share, respectively. The Company’s pro forma net income (loss),basic earnings (loss) per share and diluted earnings (loss) per share underSFAS No. 123 would have been as follows (in thousands, except per shareamounts):
| ** **                                                                                               | ** ** | **September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                               | ** ** | **2002**               | ** ** | **2003** | ** ** | **2004** | ** ** |
| Net income (loss)  as reported                                                                           |       | $                      | 6,404      |   | $ | 3,564 |   | $ | (64,898 | ) |
| Add: stock based  employee compensation expense included in reported net income (loss), net of  taxes    |       | 916                    |       | 651 |   | 686 |   |
| Less: stock-based  employee compensation expense determined under fair value based method, net  of taxes |       | (3,581                 | )          | (5,310 | ) | (5,860 | ) |
| Pro forma net  income (loss)                                                                             |       | $                      | 3,739      |   | $ | (1,095 | ) | $ | (70,072 | ) |
| Basic earnings (loss)  per share:                                                                        |       |                   |       |   |   |   |   |
| As reported                                                                                              |       | $                      | 0.32       |   | $ | 0.14 |   | $ | (2.45 | ) |
| Pro forma                                                                                                |       | $                      | 0.19       |   | $ | (0.04 | ) | $ | (2.65 | ) |
| Diluted earnings (loss)  per share:                                                                      |       |                   |       |   |   |   |   |
| As reported                                                                                              |       | $                      | 0.23       |   | $ | 0.12 |   | $ | (2.45 | ) |
| Pro forma                                                                                                |       | $                      | 0.14       |   | $ | (0.04 | ) | $ | (2.65 | ) |

 

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Thefair value of options at the date of grant was estimated using the minimalvalue method through the date of the Company’s initial public offering in December 2001,and the Black-Scholes option pricing model for options granted thereafter,with the following weighted-average assumptions:
| ** **                      | ** ** | **Years Ended September 30,** | ** ** |
|---------------------------------|------------|----------------------------------------------|------------|
| ** **                      | ** ** | **  2002  **             | ** ** | **  2003  ** | ** ** | **  2004  ** | ** ** |
| *Stock  Option Plans*:          |       |                                         |       |   |   |   |   |   |   |   |   |   |   |
| Risk-free  interest rate        |       |                                         | 4.0        | % |   |   | 2.89 | % |   |   | 3.33 | % |   |
| Expected  volatility            |       |                                         | 70.0       | % |   |   | 85.4 | % |   |   | 75.1 | % |   |
| Expected life (in  years)       |       |                                         | 4.5        |   |   |   | 4.5 |   |   |   | 4.5 |   |   |
| Expected dividend               |       |                                         | 0.0        | % |   |   | 0.0 | % |   |   | 0.0 | % |   |
| *Employee Stock Purchase Plan*: |       |                                         |       |   |   |   |   |   |   |   |   |   |   |
| Risk-free  interest rate        |       |                                         | 1.86       | % |   |   | 1.18 | % |   |   | 1.22 | % |   |
| Expected  volatility            |       |                                         | 70.0       | % |   |   | 85.4 | % |   |   | 69.6 | % |   |
| Expected life (in  years)       |       |                                         | 0.5        |   |   |   | 1.0 |   |   |   | 1.0 |   |   |
| Expected dividend               |       |                                         | 0.0        | % |   |   | 0.0 | % |   |   | 0.0 | % |   |

 

***Income Taxes***—TheCompany accounts for income taxes using an asset and liability approach. Deferredtax assets are recognized for future deductions and operating loss and creditcarryforwards, net of a valuation allowance to reduce net deferred tax assetsto amounts that are more likely than not to be realized.

***Earnings (Loss) PerShare***—Basic earnings (loss) per share (“EPS”) iscomputed by dividing net income (loss) by the weighted average common sharesoutstanding for the period. Diluted EPS reflects the potential dilution thatwould occur if securities or other contracts to issue common stock wereexercised or converted into common stock. The effects of any potential dilutivesecurities are excluded from the calculation of EPS during periods with a netloss as the effect would be anti-dilutive.

***Foreign CurrencyTranslation***—The functional currency of the Company’sforeign subsidiaries is the United States dollar. Accordingly, current assetsand liabilities are translated to United States dollars at the exchange ratesin effect as of the balance sheet date, long-term assets and liabilities aretranslated to United States dollars at the historical exchange rates, andresults of operations are translated using the average rates in effect for theperiod presented. Transaction gains and losses, which are included in otherincome (expense) in the accompanying consolidated statements of income, havenot been significant.

***Comprehensive Income(Loss)****—*Comprehensive income (loss) for the fiscal 2002,2003 and 2004 has been disclosed within the consolidated statement ofstockholders’ equity and comprehensive income (loss).

***Recently IssuedAccounting Standards***—In January 2003, theFinancial Accounting Standards Board (“FASB”) issued FASB Interpretation 46 (“FIN 46”),*Consolidation of Variable Interest Entities*inJanuary 2003, and a revised interpretation of FIN 46 (“FIN 46-R”)*.*FIN 46 requires certain variableinterest entities (“VIEs”) to be consolidated by the primary beneficiary of theentity if the equity investors in the entity do not have the characteristics ofa controlling financial interest or sufficient equity at risk for the entity tofinance its activities without additional subordinated financial support fromother parties. The provisions of FIN 46 were effective immediately for allarrangements entered into after January 31, 2003. The Company has notinvested in any entities that the Company believes are variable interestentities for which it is the primary beneficiary. The adoption of FIN 46-Rhad no impact on the Company’s financial position, results of operations orcash flows.

In November 2003, theEmerging Issues Task Force (“EITF”) reached an interim consensus onIssue 03-01, *“The Meaning ofOther-Than-Temporary Impairment and its Application to CertainInvestment”* to require additional disclosure requirements forsecurities classified as available-for-sale or held-to-maturityfor fiscal years ending after December 15, 2003. In March 2004, theEITF reached a final 

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consensuson this Issue and provided additional guidance in determining whetherinvestment securities have an impairment which should be considered other-than-temporary inreporting periods after June 15, 2004. The adoption of this Issue had noimpact on the Company’s financial position, results of operations or cashflows.

**2. Short-termInvestments**

TheCompany classifies investments with original maturities of three months or lesswhen acquired as cash equivalents and all investments with original maturitiesof longer than three months but one year or less as short term investments. Allof the Company’s cash equivalents and short-term investments areclassified as available-for-sale and are reported at fair value,with unrealized gains and losses included in stockholders’ equity as acomponent of accumulated other comprehensive income, net of taxes, if any. Thefair value of short-term investments is determined based on quoted marketprices. The cost of securities sold is based on the specific identificationmethod and realized gains and losses are included in other income, net. TheCompany has cash equivalents and investments with various high qualityinstitutions and all investments are made in accordance with the policyapproved by the board of directors which includes limiting the amount of creditrisk to any one institution. The cost basis and estimated fair values ofavailable-for-sale investment securities are shown below (inthousands):
| ** **                                               | ** ** | **Cost** | ** ** | **Unrealized  Gain** | ** ** | **Unrealized  (Loss)** | ** ** | **Fair Market  Value** | ** ** |
|----------------------------------------------------------|------------|----------|------------|----------------------|------------|------------------------|------------|-----------------------------|------------|
| **September 30,  2003**                             |       |     |       |                 |       |                   |       |                        |       |   |   |   |   |   |   |
| Cash and cash  equivalents:                              |       |     |       |                 |       |                   |       |                        |       |   |   |   |   |   |   |
| Cash                                                     |       | $        | 2,511      |                 |       | $                      | —     |                        |       |   | $ | — |   |   |   | $ | 2,511 |   |   |
| Money Market  funds                                      |       | 8,265    |       |                 | —     |                   |       |                        | —     |   |   |   | 8,265 |   |   |
| Corporate Notes                                          |       | 2,000    |       |                 | —     |                   |       |                        | —     |   |   |   | 2,000 |   |   |
| Tax-exempt  municipal obligations                        |       | 40,369   |       |                 | —     |                   |       |                        | —     |   |   |   | 40,369 |   |   |
| Total cash and  cash equivalents                         |       | 53,145   |       |                 | —     |                   |       |                        | —     |   |   |   | 53,145 |   |   |
| Short-term  investments:                                 |       |     |       |                 |       |                   |       |                        |       |   |   |   |   |   |   |
| Corporate Notes                                          |       | 3,873    |       |                 | 2          |                   |       |                        | (1         | ) |   |   | 3,874 |   |   |
| Tax-exempt  municipal obligations                        |       | 3,400    |       |                 | —     |                   |       |                        | (3         | ) |   |   | 3,397 |   |   |
| U.S. government  agency notes                            |       | 31,753   |       |                 | —     |                   |       |                        | (4         | ) |   |   | 31,749 |   |   |
| Total short-term  investments                            |       | 39,026   |       |                 | 2          |                   |       |                        | (8         | ) |   |   | 39,020 |   |   |
| Total cash, cash  equivalents and short-term investments |       | $        | 92,171     |                 |       | $                      | 2          |                        |       |   | $ | (8 | ) |   |   | $ | 92,165 |   |   |
| **September 30,  2004**                             |       |     |       |                 |       |                   |       |                        |       |   |   |   |   |   |   |
| Cash and cash  equivalents:                              |       |     |       |                 |       |                   |       |                        |       |   |   |   |   |   |   |
| Cash                                                     |       | $        | 1,100      |                 |       | $                      | —     |                        |       |   | $ | — |   |   |   | $ | 1,100 |   |   |
| Money Market  funds                                      |       | 346      |       |                 | —     |                   |       |                        | —     |   |   |   | 346 |   |   |
| Corporate notes                                          |       | 998      |       |                 | —     |                   |       |                        | —     |   |   |   | 998 |   |   |
| Tax-exempt  municipal obligations                        |       | 56,854   |       |                 | —     |                   |       |                        | —     |   |   |   | 56,854 |   |   |
| Total cash and  cash equivalents                         |       | 59,298   |       |                 | —     |                   |       |                        | —     |   |   |   | 59,298 |   |   |
| Short-term  investments:                                 |       |     |       |                 |       |                   |       |                        |       |   |   |   |   |   |   |
| Corporate notes                                          |       | 4,467    |       |                 | —     |                   |       |                        | (5         | ) |   |   | 4,462 |   |   |
| Tax-exempt  municipal obligations                        |       | 1,514    |       |                 | —     |                   |       |                        | (2         | ) |   |   | 1,512 |   |   |
| U.S. government  agency notes                            |       | 36,259   |       |                 | —     |                   |       |                        | (91        | ) |   |   | 36,168 |   |   |
| Total short-term  investments                            |       | 42,240   |       |                 | —     |                   |       |                        | (98        | ) |   |   | 42,142 |   |   |
| Total cash, cash  equivalents and short-term investments |       | $        | 101,538    |                 |       | $                      | —     |                        |       |   | $ | (98 | ) |   |   | $ | 101,440 |   |   |

 

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All investments held bythe Company as of September 30, 2003 and 2004 had original maturities of12 months or less. As of September 30, 2004, the unrealized loss onshort-term investments was due to the increase in interest rates.

**3. Property andEquipment**

Propertyand equipment consisted of (in thousands):
| ** **                     | ** ** | **September 30,** | ** ** |
|--------------------------------|------------|------------------------|------------|
| ** **                     | ** ** | **2003**               | ** ** | **2004** | ** ** |
| Computer  equipment            |       | $                      | 936        |   | $ | 1,124 |   |
| Furniture and  fixtures        |       | 513                    |       | 535 |   |
| Software                       |       | 497                    |       | 506 |   |
| Leasehold  improvements        |       | 49                     |       | 52 |   |
|                           |       | 1,995                  |       | 2,217 |   |
| Less accumulated  depreciation |       | (1,291                 | )          | (1,734 | ) |
| Property and equipment,  net   |       | $                      | 704        |   | $ | 483 |   |

 

Depreciation expense forfiscal 2002, 2003 and 2004 was approximately $438,000, $548,000 and $471,000,respectively.

**4. Other AccruedLiabilities**

Otheraccrued liabilities consisted of (in thousands):
| ** **                                 | ** ** | **September 30,** | ** ** |
|--------------------------------------------|------------|------------------------|------------|
| ** **                                 | ** ** | **2003**               | ** ** | **2004** | ** ** |
| Accrued  compensation and related benefits |       | $                      | 1,796      |   | $ | 2,119 |   |
| Accrued bonuses                            |       | 893                    |       | 1,591 |   |
| Income taxes  payable                      |       | 1,713                  |       | 1,790 |   |
| Accrued legal                              |       | 2,214                  |       | 1,845 |   |
| Other                                      |       | 1,066                  |       | 997 |   |
| Total                                      |       | $                      | 7,682      |   | $ | 8,342 |   |

 

During fiscal 2003, the Company accrued bonuses of$900,000 earned by its employees. These bonuses were distributed to employeesin December 2003.

During fiscal 2004, theCompany accrued bonuses of $1.5 million earned by its employees. Approximately$584,000 of these bonuses were paid in October 2004 and the remainingamount will be paid in December 2004.

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**5. LeaseCommitments**

TheCompany leases its facilities under various noncancelable operating leases. In December 2002,the Company entered into a three-year operating lease for itsheadquarters located in Santa Clara, California, which began in February 2003and will expire in March 2006. These noncancelable operating leases beganexpiring in October 2003. Rent expense was $600,000 in fiscal 2002, $784,000in fiscal 2003 and $742,000 in fiscal 2004. The aggregate future noncancelableminimum rentals or operating leases are as follows (in thousands):
| Years Ending  September 30, |   |   |   |
|----------------------------------|--------|--------|--------|
| 2005                             |   | $      | 603    |   |
| 2006                             |   | 252    |   |
|                             |   | $      | 855    |   |

 

**6. Stockholders’Equity**

***Preferred Stock***

In August 2001, theCompany’s board of directors approved and, in September 2001, thestockholders approved, the authorization of 10,000,000 shares of undesignatedpreferred stock to be available for issuance concurrently with theeffectiveness of the Company’s initial public offering. As of September 30,2004, there were no such shares issued or outstanding.

***Common Stock***

In September 2001, the Company’s board ofdirectors and stockholders authorized the Company to issue up to 110,000,000shares of its common stock.

In December 2001 and January 2002, theCompany sold 5,750,000 shares of common stock in an initial public offering ata price of $11.00 per share. Net proceeds from all shares sold, lessunderwriting discounts and related expenses, were approximately$57.2 million.

Common stock issued to certain employees is subject torepurchase agreements whereby the Company has the option to repurchase theunvested shares upon termination of employment at the original issuance price. Thenumber of shares subject to repurchase is generally reduced at a rate of 1/48thper month, with a certain amount being vested immediately. At September 30,2004, no shares were subject to repurchase by the Company.

At September 30,2004, the Company had reserved the following authorized but unissued shares ofcommon stock:
| Stock Options:                |   |       |   |
|-------------------------------|--------|------------|--------|
| Options outstanding           |   | 7,051,107  |   |
| Reserved for  future grants   |   | 4,032,734  |   |
| Employee Stock  Purchase Plan |   | 2,789,495  |   |
| Total                         |   | 13,873,336 |   |

 

**Employee andDirector Stock Plans**

***1998 Stock Option Plan***

In 1998, the Companyadopted the 1998 Stock Option Plan, which included both incentive andnonstatutory stock options. Under the 1998 Stock Option Plan, the Company couldgrant options to purchase up to 11,069,197 shares of common stock to employees,directors and service providers at prices 

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not lessthan the fair market value at date of grant for incentive stock options and notless than 85% of the fair market value for nonstatutory options. These optionsgenerally expired ten years from the date of grant and were generallyexercisable at any time after the date of grant and when the shares were vested.Options granted to a person who, at the time of the grant, owned more than 10%of the voting power of all classes of stock, were at prices no less than 110%of the fair market value and had a term of no more than five years. Incentivestock options and nonstatutory options generally vested at a rate of 25% on thefirst anniversary of the grant date and 1/48 per month thereafter. Sharesissued upon exercise prior to vesting were subject to a right of repurchase bythe Company, which lapsed according to the original option-vestingschedule. At September 30, 2004, no shares of common stock issued uponexercise of options under the 1998 Stock Option Plan were subject to repurchaseby the Company. Upon the effectiveness of the Company’s initial public offeringin December 2001, the 1998 Stock Option Plan was terminated as to futuregrants.

***2001 Stock Option Plan***

In August 2001, theCompany adopted the 2001 Stock Option Plan and 3,999,999 shares of common stockwere reserved for issuance thereunder. The 2001 Stock Option Plan becameeffective in December 2001, upon the Company’s initial public offering. OnOctober 1 of each year, the number of shares in the reserve will increaseby the lesser of 3,999,999 shares of common stock; 6.0% of outstanding sharesof common stock on the last day of the previous fiscal year; or an amountdetermined by the board of directors. Pursuant to the 2001 Stock Option Plan, theboard of directors may grant either incentive or non-qualified stockoptions to purchase shares of the Company’s common stock to eligibleindividuals at not less than 100% of the fair market value of those shares onthe date of the grant. Stock options generally vest over a period of four yearsand expire ten years from the date of grant. The plan will terminate in August 2011,unless the board of directors terminates it sooner. As of September 30,2004, 3,746,327 shares of common stock were reserved for future grants underthe 2001 Stock Option Plan. On October 18, 2004, the board of directorsapproved an increase to the reserve of 1,621,536 shares, representing 6% of theCompany’s outstanding common stock on September 30, 2004.

***2001 Employee Stock Purchase Plan***

In August 2001, theCompany adopted the 2001 Employee Stock Purchase Plan (“ESPP”) and 666,667shares of common stock were reserved for issuance thereunder. The ESPP becameeffective upon the Company’s initial public offering in December 2001. Underthe ESPP, eligible employees are permitted to have salary withholdings of up to15% of their compensation (up to $25,000 annually) to purchase shares of commonstock at a price equal to 85% of the lesser of the fair market value per shareof Company common stock on the start date of the offering period or the end ofthe purchase period. On October 1 of each year, the number of shares inthe reserve will increase by the lesser of 2,666,666 shares of common stock;5.0% of outstanding shares of common stock on the last day of the previousfiscal year; or an amount determined by the board of directors. The plan willterminate in August 2011, unless the board of directors terminates itsooner. In fiscal 2002, 2003 and 2004, 36,920, 164,200 and 222,776 shares ofcommon stock were issued under the ESPP at a weighted average price of $9.35,$6.11 and $ 5.01, respectively. The weighted average fair value of the fiscal2002, 2003 and 2004 issuances were $6.16, $2.80 and $3.41, respectively. As of September 30,2004 2,789,495 shares of common stock were reserved for future issuance underthe ESPP. On October 18, 2004, the board of directors approved an increaseto the reserve of 1,351,280 shares, representing 5% of the Company’soutstanding common stock on September 30, 2004.

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***2001 Director Option Plan***

In August 2001, the Company adopted the 2001Director Option Plan and 266,667 shares of common stock were reserved forissuance thereunder. The 2001 Director Option Plan became effective upon theCompany’s initial public offering in December 2001. On October 1 ofeach year, the number of shares in the reserve will increase by the lesser of100,000 shares of common stock; 0.4% of outstanding shares of common stock onthe last day of the previous fiscal year; or an amount determined by the boardof directors. The plan will terminate in August 2011, unless the board ofdirectors terminates it sooner. The 2001 Director Option Plan provides for aninitial grant to a new nonemployee director of an option to purchase 40,000shares of common stock. Subsequent to the initial grants, each nonemployeedirector will be automatically granted an option to purchase 20,000 shares ofcommon stock on October 1 of each year. As of September 30, 2004,286,407 shares of common stock were reserved for future issuance under the 2001Director Option Plan. On October 18, 2004, the board of directors approvedan increase to the reserve of 100,000 shares, representing 0.37% of the Company’soutstanding common stock on September 30, 2004.

Optionactivities under the Stock Option Plans were as follows:
| ** **                                                                                                                               | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|--------------------------------------------|------------|
| Outstanding,  September 30, 2001 (986,814 shares vested and exercisable at a weighted  average exercise price of $0.67 per share)   |       | 5,350,587                  |       |                                       | $          | 1.47 |   |   |
| Granted (weighted  average fair value of $5.88 per share)                                                                                |       | 2,065,320                  |       |                                       | 10.10      |   |   |
| Exercised                                                                                                                                |       | (422,252                   | )          |                                       | 0.44       |   |   |
| Canceled                                                                                                                                 |       | (211,667                   | )          |                                       | 4.90       |   |   |
| Outstanding,  September 30, 2002 (2,340,499 shares vested and exercisable at a  weighted average exercise price of $1.48 per share) |       | 6,781,988                  |       |                                       | 4.06       |   |   |
| Granted (weighted  average fair value of $4.32 per share)                                                                                |       | 1,771,900                  |       |                                       | 6.55       |   |   |
| Exercised                                                                                                                                |       | (900,203                   | )          |                                       | 1.52       |   |   |
| Canceled                                                                                                                                 |       | (347,473                   | )          |                                       | 6.71       |   |   |
| Outstanding,  September 30, 2003 (3,034,703 shares vested and exercisable at a  weighted average exercise price of $2.90 per share) |       | 7,306,212                  |       |                                       | 4.85       |   |   |
| Granted (weighted  average fair value of $3.64 per share)                                                                                |       | 1,006,500                  |       |                                       | 6.15       |   |   |
| Exercised                                                                                                                                |       | (803,389                   | )          |                                       | 1.22       |   |   |
| Canceled                                                                                                                                 |       | (458,216                   | )          |                                       | 7.58       |   |   |
| Outstanding,  September 30, 2004 (4,129,895 shares vested and exercisable at a  weighted average exercise price of $4.06 per share) |       | 7,051,107                  |       |                                       | 5.27       |   |   |

 

At September 30, 2004, 4,032,734 shares wereavailable for future grant under the 2001 Stock Option Plan and the 2001Directors Option Plan.

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Additionalinformation regarding options outstanding as of September 30, 2004 was asfollows:
| ** **                              | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|-----------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| **Range of Exercise  Prices** | ** ** | ** **                   | ** ** | **Number Outstanding**  | ** ** | **Weighted  Average  Remaining  Contractual Life** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Number Exercisable** | ** ** | **Weighted Average  Exercise Price** | ** ** |
| ** **                              | ** ** | **(in thousands)**      | ** ** | **(in years)**          | ** ** | ** ** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| $  0.02  - $  0.10  |       |                         | 1,353      |                         |       |   | 5.25 |   |   |   | $ | .06 |   |   |   | 1,353 |   |   |   | $ | 0.06 |   |   |
| $  1.13                       |       |                         | 310        |                         |       |   | 6.18 |   |   |   | $ | 1.13 |   |   |   | 283 |   |   |   | $ | 1.13 |   |   |
| $  1.88  - $  2.25  |       |                         | 580        |                         |       |   | 4.65 |   |   |   | $ | 2.02 |   |   |   | 524 |   |   |   | $ | 2.02 |   |   |
| $  3.00  - $  3.38  |       |                         | 474        |                         |       |   | 5.94 |   |   |   | $ | 3.11 |   |   |   | 403 |   |   |   | $ | 3.11 |   |   |
| $  4.29                       |       |                         | 487        |                         |       |   | 9.78 |   |   |   | $ | 4.29 |   |   |   | 0 |   |   |   | $ | 0.00 |   |   |
| $  5.35  - $  6.60  |       |                         | 1,603      |                         |       |   | 8.46 |   |   |   | $ | 6.46 |   |   |   | 371 |   |   |   | $ | 6.34 |   |   |
| $  7.09  - $  9.00  |       |                         | 1,421      |                         |       |   | 7.74 |   |   |   | $ | 8.51 |   |   |   | 741 |   |   |   | $ | 8.69 |   |   |
| $11.00 - $11.89                         |       |                         | 743        |                         |       |   | 7.42 |   |   |   | $ | 11.28 |   |   |   | 409 |   |   |   | $ | 11.26 |   |   |
| $13.45 - $16.96                         |       |                         | 80         |                         |       |   | 7.64 |   |   |   | $ | 14.55 |   |   |   | 46 |   |   |   | $ | 14.60 |   |   |
| $  0.02 -  $16.96             |       |                         | 7,051      |                         |       |   | 7.09 |   |   |   | $ | 5.27 |   |   |   | 4,130 |   |   |   | $ | 4.06 |   |   |
|                                         |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Additional Stock Plan Information***

As discussed inNote 1, the Company accounts for its stock-based awards using theintrinsic value method in accordance with Accounting Principles Board No. 25,*Accounting for Stock Issued to Employees*,and its related interpretations. The Company uses the intrinsic value method inaccounting for its stock-based compensation arrangements for employees,whereby compensation is recognized to the extent the fair value of theunderlying common stock exceeds the exercise price of the stock options at thedate of grant. Deferred stock-based compensation of $2.5 million wasrecorded during fiscal 2001 for the excess of the fair value of the commonstock underlying the options at the grant date over the exercise price of theoptions. This amount is being amortized on a straight line basis over thevesting period, generally four years. Amortization of deferred compensationrelated to employee grants was $1.0 million, $955,000 and $796,000 infiscal 2002, fiscal 2003 and fiscal 2004, respectively.

**7. Earnings (Loss)per Share**

Basic earnings (loss) per share (“EPS”) is computed bydividing net income (loss) by the weighted average common shares outstandingfor the period. Diluted EPS reflects the potential dilution that would occur ifsecurities or other contracts to issue common stock were exercised or convertedinto common stock. The effects of any potential dilutive securities areexcluded from the calculation of EPS during periods with a net loss as theeffect would be anti-dilutive.

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Duringfiscal 2002, fiscal 2003 and fiscal 2004, the Company had securitiesoutstanding that could potentially dilute basic earnings (loss) per share inthe future, but these securities were excluded in the computation of dilutedearnings (loss) per share in such periods as their effect would have beenantidilutive. At September 30, 2002, 2003 and 2004, options to purchase494,000, 1.8 million and 7.1 million shares of common stock, respectively,were excluded from the diluted earnings (loss) per share computation. Thefollowing table is a reconciliation of the numerators and denominators used incomputing basic and diluted earnings (loss) per share (in thousands, except pershare data):
| ** **                                                                          | ** ** | **Years Ended September 30,** | ** ** |
|-------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                          | ** ** | **2002**                                     | ** ** | **2003** | ** ** | **2004** | ** ** |
| Net income (loss)  (numerator):                                                     |       | $                                            | 6,404      |   | $ | 3,564 |   | $ | (64,898 | ) |
| Shares (denominator):                                                               |       |                                         |       |   |   |   |   |
| Weighted average common shares outstanding                                          |       | 22,075                                       |       | 25,580 |   | 26,565 |   |
| Weighted average common shares subject to repurchase                                |       | (1,959                                       | )          | (522 | ) | (108 | ) |
| Shares used in  basic computation                                                   |       | 20,116                                       |       | 25,058 |   | 26,457 |   |
| Weighted average  common shares subject to repurchase                               |       | 1,959                                        |       | 522 |   | — |   |
| Common shares  issuable upon exercise of stock options (treasury stock method) |       | 4,318                                        |       | 3,201 |   | — |   |
| Convertible  preferred stock                                                        |       | 1,304                                        |       | — |   | — |   |
| Shares used in diluted computation                                                  |       | 27,697                                       |       | 28,781 |   | 26,457 |   |
| Basic earnings  (loss) per share                                                    |       | $                                            | 0.32       |   | $ | 0.14 |   | $ | (2.45 | ) |
| Diluted earnings (loss)  per share                                                  |       | $                                            | 0.23       |   | $ | 0.12 |   | $ | (2.45 | ) |

 

**8. Income Taxes**

Theincome tax provision consisted of the following (in thousands):
| ** **                 | ** ** | **Years Ended September 30,** | ** ** |
|----------------------------|------------|----------------------------------------------|------------|
| ** **                 | ** ** | **2002**                                     | ** ** | **2003** | ** ** | **2004** | ** ** |
| Current:                   |       |                                         |       |   |   |   |   |
| Federal                    |       | $                                            | 2,488      |   | $ | 2,105 |   | $ | 1,525 |   |
| State                      |       | 414                                          |       | 336 |   | 22 |   |
| Foreign                    |       | 232                                          |       | 40 |   | 20 |   |
|                       |       | 3,134                                        |       | 2,481 |   | 1,567 |   |
| Deferred:                  |       |                                         |       |   |   |   |   |
| Federal                    |       | 399                                          |       | (616 | ) | (840 | ) |
| State                      |       | 46                                           |       | (338 | ) | (119 | ) |
|                       |       | 445                                          |       | (954 | ) | (959 | ) |
| Provision for income taxes |       | $                                            | 3,579      |   | $ | 1,527 |   | $ | 608 |   |

 

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Theamount of income tax expense recorded differed from the amount using thestatutory federal income tax rate (35.0%) for the following reasons:
| ** **                                     | ** ** | **Years Ended September 30,**             | ** ** |
|------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                     | ** ** | **    2002    ** | ** ** | **    2003    ** | ** ** | **   2004   ** | ** ** |
| Federal statutory  tax                         |       |                                                     | 35.0       | % |   |   | 35.0 | % |   |   | (35.0 | )% |   |
| State income  taxes net of federal tax benefit |       |                                                     | 4.9        |   |   |   | — |   |   |   | (0.1 | ) |   |
| Tax credits                                    |       |                                                     | (1.4       | ) |   |   | (3.5 | ) |   |   | (0.5 | ) |   |
| Foreign  withholding tax                       |       |                                                     | 0.9        |   |   |   | 0.7 |   |   |   | (0.3 | ) |   |
| Deferred stock-based  compensation             |       |                                                     | 2.8        |   |   |   | 1.2 |   |   |   | 0.3 |   |   |
| ETI exclusion                                  |       |                                                     | (3.5       | ) |   |   | (1.3 | ) |   |   | (0.1 | ) |   |
| Tax-exempt  interest                           |       |                                                     | (1.3       | ) |   |   | (3.4 | ) |   |   | (0.3 | ) |   |
| Litigation  settlement                         |       |                                                     | —     |   |   |   | — |   |   |   | 36.7 |   |   |
| Other                                          |       |                                                     | (1.5       | ) |   |   | 1.3 |   |   |   | 0.2 |   |   |
| Effective tax rate                             |       |                                                     | 35.9       | % |   |   | 30.0 | % |   |   | 0.9 | % |   |

 

Income(loss) before income taxes was as follows (in thousands):
| ** **                         | ** ** | **Years Ended September 30,** | ** ** |
|------------------------------------|------------|----------------------------------------------|------------|
| ** **                         | ** ** | **2002**                                     | ** ** | **2003** | ** ** | **2004** | ** ** |
| Domestic                           |       | $                                            | 9,812      |   | $ | 5,974 |   | $ | (63,475 | ) |
| Foreign                            |       | 171                                          |       | (883 | ) | (815 | ) |
| Income (loss) before  income taxes |       | $                                            | 9,983      |   | $ | 5,091 |   | $ | (64,290 | ) |

 

Significantcomponents of the Company’s net deferred tax assets were as follows (inthousands):
| ** **                       | ** ** | **Years Ended September 30,** | ** ** |
|----------------------------------|------------|----------------------------------------------|------------|
| ** **                       | ** ** | **2003**                                     | ** ** | **2004** | ** ** |
| Deferred tax  assets:            |       |                                         |       |   |   |   |   |   |   |
| Net operating loss carryforward  |       |                                         | $          | 13 |   |   |   | $ | — |   |   |
| Accrued compensation             |       |                                         | 343        |   |   |   | 1,036 |   |   |
| Reserves and accrued liabilities |       |                                         | 182        |   |   |   | 151 |   |   |
| Deferred revenue                 |       |                                         | 2,168      |   |   |   | 2,203 |   |   |
| Stock compensation               |       |                                         | 640        |   |   |   | 638 |   |   |
| Depreciation and amortization    |       |                                         | —     |   |   |   | 26 |   |   |
| Credits                          |       |                                         | 494        |   |   |   | 735 |   |   |
| Total deferred  tax assets       |       |                                         | 3,840      |   |   |   | 4,789 |   |   |
| Deferred tax  liabilities:       |       |                                         |       |   |   |   |   |   |   |
| Depreciation and amortization    |       |                                         | (2         | ) |   |   | — |   |   |
| Prepaid expenses                 |       |                                         | (127       | ) |   |   | (132 | ) |   |
| Total deferred  tax liabilities  |       |                                         | (129       | ) |   |   | (132 | ) |   |
| Total net  deferred tax asset    |       |                                         | 3,711      |   |   |   | 4,657 |   |   |
| Valuation  allowance             |       |                                         | (13        | ) |   |   | — |   |   |
| Net deferred tax assets          |       |                                         | $          | 3,698 |   |   |   | $ | 4,657 |   |   |

 

Current net deferred taxes at September 30, 2003and 2004 were $2.6 million and $3.8 million, respectively. Noncurrentnet deferred tax assets at September 30, 2003 and 2004 of$1.1 million and $890,000, respectively, were included in other assets.

At September 30, 2003, the Company had foreignloss carryforwards of approximately $37,000, which would have expired in 2008. TheCompany recorded a full valuation allowance against the loss 

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carryfowards based on theCompany’s evaluation of the likelihood of realization of future tax benefitsresulting from these loss carryforwards. However, in the year ended September 30,2004, these loss carryforwards were fully utilized, and the valuation allowancewas therefore released.

At September 30, 2004, the Company had federaland California research and development credit carryforwards of approximately$341,000 and $394,000, respectively, to offset future tax liabilities. Thefederal credit begins expiring in 2023 and the state credit has no expiration. Theresearch and development credits were calculated through June 30, 2004 asthe research tax credit provision in Internal Revenue Code Section 41expired on June 30, 2004. Although the research tax credit provision wassubsequently extended by Congress until June 30, 2005, the extension wasnot approved until October 4, 2004, after the end of the Company’s fiscalyear. The research credit earned during the period from July 1, 2004 to September 30,2004 will be reflected in the financial statements for the fiscal year ending September 30,2005.

Current federal and California state tax laws includesubstantial restrictions on the utilization of tax credits in the event of anownership change of a corporation. Accordingly, the Company’s ability toutilize tax credit carryforwards may be limited as a result of such ownershipchange as defined. Such a limitation could result in the expiration ofcarryforwards before they are utilized.

The pretax income (loss)from foreign operations was $171,000, $(883,000), and $(815,000) in fiscal2002, 2003 and 2004, respectively. Undistributed earnings of the Company’sforeign subsidiaries are considered to be indefinitely reinvested and,accordingly, no provision for federal and state income taxes has been providedthereon. Upon distribution of those earnings in the form of a dividend orotherwise, the Company would be subject to both United States income taxes(subject to an adjustment for foreign tax credits) and withholding taxespayable to the various foreign countries. It is not practical to estimate theincome tax liability that might be incurred on the remittance of such earnings.

**9. Employee BenefitPlan**

The Company hasestablished a 401(k) tax deferred savings plan (the “401(k) Plan”) whichpermits participants to make contributions by salary deduction pursuant to Section 401(k)of the Internal Revenue Code. The Company may, at its discretion, make matchingcontributions to the 401(k) Plan. The Company is responsible for administrativecosts of the 401(k) Plan. The Company did not make any matching contributionsin fiscal 2002, fiscal 2003 or fiscal 2004.

**10. Contingencies**

*Legal Proceedings*

Synopsys has filed claims against the Company in stateand federal courts. These claims are based on the alleged facts and circumstancesrelating to the departure of the Company’s five founders from their employmentat Synopsys, the founding of the Company and the development and sale of HSIMand the Company’s other products. Each of the Company’s founders and Dr. Sang S.Wang, its Chief Executive Officer, became an employee of Synopsys when Synopsysacquired EPIC Design Technology in February 1997. Dr. Wang resignedfrom Synopsys in March 1998 and served as a consultant to Synopsys until June 1998.Dr. An-Chang Deng, the Company’s President, and the Company’s fourother founders resigned from Synopsys at approximately the same time in August 1998and became employees of the Company immediately thereafter. Dr. Wangbecame an employee of the Company in April 1999. None of Drs. Wang orDeng or the Company’s four other founders was subject to a noncompetitionagreement with Synopsys at any time.

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In February 2000, Synopsys filed a complaint inthe Superior Court of the State of California in the County of Santa Clara(Case No. CV787950) against the Company and Dr. Deng, the Company’sPresident. The State Court Action complaint alleged breach of contract, breachof fiduciary trust, diversion of corporate opportunity and constructive trust. InSeptember 2001, Synopsys filed its second amended complaint, which addedclaims of inducing/aiding and abetting breach of fiduciary duty,including/aiding and abetting diversion of corporate opportunity,misappropriation of trade secrets, civil conspiracy, breach of confidence andunfair competition, and added as individual defendants Dr. Wang and theCompany’s four other founders. In September 2002, Synopsys filed asupplemental second amended complaint that contained supplemental allegationsbut added no new claims or parties. In January 2003, the discovery refereeissued orders creating rebuttable presumptions in favor of Synopsys on certainevidentiary issues to sanction the Company for erasure of certain computerfiles requested in discovery by Synopsys. These rulings meant that the Companymust prove at trial that the Company did not take or use Synopsys’ source codeor other confidential information, rather than the usual requirement thatSynopsys provide such proof in the first instance. The Company filed a motionfor reconsideration of this order and in March 2003, the court denied itsmotion, concluding that it was barred on procedural grounds. In January 2003,Synopsys filed a third amended complaint, which contained supplementalallegations but added no new claims or parties. The Company has filed an answerdenying Synopsys’ allegations. In August 2003, Synopsys filed severalmotions for terminating sanctions against the Company, which were heard in January 2004.In June 2004, the Court ruled on Synopsys’ motions for terminating****sanctions. The Discovery Referee vacated the orders of January 2003that created the rebuttable presumptions in favor of Synopsys, but issued neworders. These orders limit the Company’s defenses regarding the timing anddevelopment of the initial HSIM source code and the evidence that the Companyand the remaining individual defendants can present at trial. For purposes oftrial, among other things, the orders established as facts that: (i) thefirst 60,000 lines of source code of HSIM and all the ideas and conceptsreflected therein, to the extent they were not publicly known, were copied orderived from Synopsys’ source code or other Synopsys’ materials while theindividual defendants were employed by Synopsys and (ii) the Company andthe individual defendants acted in concert to intentionally alter, destroy,lose or misplace items requested in discovery and conceal evidence. Theseorders also struck the answer of one individual defendant, Jeh-Fu Tuan. TheDiscovery Referee denied Synopsys’ request to strike the Company’s answers andthe answers of the remaining individual defendants. In August 2004, theCompany filed a writ petition in the California Court of Appeal, SixthAppellate District in San Jose, seeking to overturn these orders. In October 2004,the Court of Appeal requested that Synopsys file opposition to the petition andprovided the Company with the opportunity to file a reply to Synopsys’opposition. In October 2004, the Superior Court vacated the previously setJanuary 2005 trial date and stayed all trial proceedings pending finaldetermination of the writ proceedings. The Company opposes each of thesemotions and intends to file oppositions within the time permitted by law. Synopsyshas requested unspecified damages of at least $25 million, an injunction,a constructive trust on unspecified intellectual property belonging to theCompany and other relief. Further, in September 2003, Synopsys notifiedthe Company that it reserves the right to seek up to $80 million inpunitive damages with respect to claims for which punitive damages are allowedunder California Civil Code Section 3294, and up to $50 million inpunitive damages with respect to the trade secret claims under California CivilCode Section 3426.3(c).

In May 2001, Synopsys filed a complaint in theUnited States District Court, Northern District of California, San Josedivision (Case No. CO1-20423 PVT) against the Company, alleging thatthe Company’s HSIM software infringes U.S. Patent No. 5,878,053 entitled “HierarchicalPower Network Simulation and Analysis tool for reliability testing of DeepSubmicron IC Designs” (the “053 Patent”), which is purportedly assigned toSynopsys. Since the case began, Synopsys has also alleged that the Company’ssubsequently released HSIM 2.0 and LEXSIM products, infringe the053 Patent. Synopsys has requested relief including damages from$4.1 million to $13.7 million and an injunction. Synopsys has alsorequested that any damage award be trebled for alleged willful infringement. InJune 2001, the Company 

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filed an answer to thecomplaint denying infringement of a valid, enforceable patent and assertingcounterclaims. The Company has since amended its counterclaims. The Company’scurrent counterclaims allege that, among other things, the 053 Patent isinvalid, unenforceable and not infringed and that Synopsys has violated federalantitrust and state unfair competition laws.

From time to time, the court has ruled on summaryjudgment motions in the case. In May 2002, the court granted summaryjudgment in favor of Synopsys on the Company’s invalidity defenses andcounterclaims, concluding that they were barred by the doctrine of assignorestoppel. The court denied Synopsys’ motion with respect to the Company’sunenforceability defense and counterclaim. In November 2002, the courtissued an order granting summary judgment in favor of Synopsys on certainantitrust counterclaims based on the doctrine of assignor estoppel. However,the court declined to rule on Synopsys’ motion with respect to the Company’sother antitrust and unfair competition counterclaims. In addition, the courtissued a ruling construing the claims of the 053 Patent in August 2002.

In September 2002, the U.S. Patent and TrademarkOffice granted the Company’s request for ex parte reexamination of the053 Patent based on prior art not previously considered by the PatentOffice. The Company moved to stay the federal litigation pending the outcome ofthe reexamination and the court granted the Company’s motion in December 2002.In August 2004, the U.S. Patent and Trademark Office issued a finalrejection of all of the claims of the 053 Patent. Synopsys has appealedthe final rejection to the U.S. Patent and Trademark Office Board of PatentAppeals and Interferences.

Activity on several other summary judgment motions hasbeen suspended because the court stayed the federal litigation. In November 2002,Synopsys filed three motions for summary judgment. The first motion asked thecourt to enter judgment before trial that the Company’s products infringe the053 Patent. The second motion asked the court to rule before trialagainst the Company on its defense that the 053 Patent is unenforceablebecause Synopsys committed inequitable conduct in obtaining the patent. TheCompany submitted oppositions to both of these motions. Synopsys’ third motionasked the court to rule before trial against the Company on its remainingantitrust counterclaims. Because of the court’s prior rulings against theCompany on its other antitrust counterclaims, the Company did not oppose thismotion. In November 2002, the Company also filed a summary judgmentmotion, which asked the court to enter judgment before trial that its productsdo not infringe the 053 Patent. Synopsys opposed this motion. The courtissued its order staying the federal litigation before the parties’ replybriefs were due.

In June 2003, Synopsys filed a second complaintin the United States District Court, Northern District of California, SanFrancisco Division (Case No. C03-2664 RS) against the Company,alleging that the Company’s products, including but not limited to HSIM andHANEX software products, infringe Synopsys U.S. Patent No. 6,249,898entitled “Methods and Systems for Reliability Analysis of CMOS VLSI CircuitsBased on Stage Partitioning and Node Activities” (the “898 Patent”). In July 2003,the Company filed an answer denying that the Company infringes the898 Patent and asserting as defenses that the 898 Patent is invalidand unenforceable. The Company also brought a declaratory judgment counterclaimseeking judgment that the 898 Patent is not infringed by the Company andthat the 898 Patent is invalid and unenforceable. In August 2003,Synopsys filed a motion to dismiss these defenses and counterclaims on theground that the Company is barred from contesting the validity andenforceability of the 898 Patent based on the doctrine of assignorestoppel. Synopsys’ motion also sought to strike the Company’s defenses oflaches, patent misuse and unclean hands on the ground that the Company had notpleaded them with sufficient particularity. The Company opposed Synopsys’motions. In October 2003, the court denied Synopsys’ motion to dismiss andstrike the invalidity and unenforceability defenses and counterclaims andgranted Synopsys’ motion to strike the laches, patent misuse and unclean handsdefenses with leave to amend the pleadings. In March 2004, Synopsys fileda motion for partial summary judgment on the ground that the Company is barredfrom contesting the validity and enforceability of the 898 Patent based onthe doctrine of assignor estoppel. In April 2004, the Court ruled that theCompany is barred under the doctrine of assignor estoppel from asserting the898 Patent is invalid or unenforceable by virtue of 

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pre-assignmentinequitable conduct. The court issued a ruling construing the claims of the898 Patent in July 2004. The court has set the case for trialbeginning on April 25, 2005.

The Company entered into an agreement of merger dated November 30,2004 with Synopsys and North Acquisiton Sub, Inc. a Delaware corporationand wholly owned subsidiary of Synopsys (“Merger Sub”), pursuant to which,subject to satisfaction or waiver of the conditions therein, Merger Sub willmerge with and into the Company and the Company will become a wholly ownedsubsidiary of Synopsys. Subject to the consummation of the merger, Synopsys,the Company and certain employees, officers and directors of the Company, asapplicable, have agreed to settle the State Court Action and the Federal CourtActions. In connection with the merger agreement, the parties have submittedstipulations in the State Court Action and Federal Court Actions to toll theproceedings pending the consummation of the merger (See Note 12).

In July 2004, the Company and certain of itsofficers and directors were named in a securities class action lawsuit filed inthe United States District Court for the Northern District of California. Thecomplaint asserts claims against the Company, Sang S. Wang, An-ChangDeng, Tammy Shu-Hua Liu and Yen-Son Huang on behalf of a putativeclass of persons who purchased the Company’s stock between December 13,2001 and June 11, 2004. The class action alleges that the named defendantsviolated certain provisions of the Securities Exchange Act of 1934 by makingmaterially false and misleading representations in press releases and financialstatements filed with the SEC relating to the Company’s financial results. Thecomplaint’s allegations derive largely from allegations contained in the StateCourt Action, and derive from allegations contained in the complaint concerningthe 053 Patent. A second class action was filed on September 9, 2004in the United States District Court for the Northern District of California. OnSeptember 27, 2004, one plaintiff moved for lead plaintiff status in thefirst filed class action. These two cases were consolidated on October 7,2004. On November 4, 2004, the judge granted the motion of NECA-IBEWPension Fund (The Decatur Plan) for appointment as lead plaintiff. Plaintiffmust file a consolidated complaint by January 14, 2005, and defendants’motion to dismiss is currently due January 28, 2005. The hearing on themotion to dismiss is set for March 4, 2005. The case is in the preliminarystages, and it is not possible for the Company to quantify the impact, if any,on the Company. An unfavorable outcome in this case could have a materialadverse effect on the Company’s business, financial condition, results ofoperations and cash flow. In addition, the expense of defending any litigationmay be costly and divert the Company’s attention from the day to day operationsof the Company’s business.

On August 16, 2004 a purported derivativecomplaint was filed against the Company and its directors in the Court ofChancery of the State of Delaware. This complaint alleged that the board ofdirectors breached its fiduciary duty by failing to appoint a special committeeto investigate the claims asserted in the Synopsys litigation and by allowingtwo directors to destroy evidence in the State Court Action. The complaint alsoalleges that the board of directors breached its fiduciary duty by allowing theCompany to go public with the knowledge of the alleged trade secretmisappropriation and by causing the issuance of allegedly false publicstatements regarding the Company’s financial condition on account of thisalleged misappropriation. The complaint seeks equitable relief and an unspecifiedamount of damages on behalf of the Company. On October 15, 2004, thedefendants filed a motion to Dismiss or Stay on the grounds that the case isnot ripe for adjudication and also filed a Motion for Protective Order StayingDiscovery. On December 3, 2004, plaintiff filed oppositions to thesemotions. Defendants must file reply briefs by January 10, 2005. The caseis still in the preliminary stages, and it is not possible for the Company toquantify the impact, if any, on the Company. An unfavorable outcome in thiscase could have a material adverse effect on the Company’s business, financialcondition, results of operations and cash flow. In addition, the expense ofdefending any litigation may be costly and divert management’s attention fromthe day to day operations of the Company’s business.

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On December 1, 2004, the Company and certain ofits officers and directors were named in a class action complaint filed againstthe Company and certain of its officers and directors in the Court of Chanceryof the State of Delaware. This complaint, brought by Robert Israel, allegesthat defendants entered into the merger agreement with Synopsys for inadequateconsideration. The complaint also alleges that this agreement was an unlawfulplan to shield our board of directors and certain members of our managementfrom liability to Synopsys in the State Court Action and Federal Court Actions,and to shield them from liability to our company for claims asserted by theplaintiff in the pending derivative action. Plaintiff seeks to enjoin theproposed merger, or alternatively seeks damages if the proposed merger isconsummated. The case is still in the preliminary stages, and it is notpossible for us to quantify the impact, if any, on our company. An unfavorableoutcome in this case could have a material adverse effect on our business,financial condition, results of operations and cash flow. In addition, theexpense of defending any litigation may be costly and divert management’sattention from the day to day operations of the Company’s business.

On December 3, 2004,the Company and certain of its officers and directors were named in a complaintfiled in the Superior Court of California, Santa Clara County. The complaint isa purported stockholder class action brought by Frank A. Lettieri arising outof defendants’ conduct in selling the Company to Synopsys at an inadequate andunfair price. Defendants allegedly arrived at an unfair price so that at leasttwo of its directors could avoid or significantly reduce their exposure in apending lawsuit. As a result of this conduct, defendants allegedly breachedfiduciary duties. Defendants allegedly structured the terms of the proposed merger to fit the needsof Synopsys, instead of seeking to obtain the highest price reasonablyavailable to the Company. The complaint seeks an injunction of the acquisition,and the implementation of a procedure to ensure the highest possible price forstockholders. The complaint also seeks to direct the individual defendants toexercise their fiduciary duties to obtain a transaction in the best interest ofthe stockholders at the highest price. The complaint seeks to rescind the proposed merger and to impose aconstructive trust upon any benefits improperly received by defendants as aresult of improper conduct. The case is in the preliminary stages, and it isnot possible for the Company to quantify the impact, if any, on the Company. Anunfavorable outcome in this case could have a material adverse effect on theCompany’s business, financial condition, results of operations and cash flow. Inaddition, the expense of defending any litigation may be costly and divert theCompany’s attention from the day to day operations of its business.

*Other Contingencies*

The Company from time to time enters into certaintypes of contracts that contingently require it to indemnify parties againstthird party claims. These contracts primarily relate to: (i) certainagreements with the Company’s officers, directors and employees and thirdparties, under which the Company may be required to indemnify such persons forliabilities arising out of their duties to the Company and (ii) agreementsunder which the Company indemnifies customers and partners for claims arisingfrom intellectual property infringement.

The terms of such obligations vary. Generally, amaximum obligation is not explicitly stated. Because the obligated amounts ofthese types of agreements often are not explicitly stated, the overall maximumamount of the obligations cannot be reasonably estimated. Historically, theCompany has not been obligated to make significant payments for theseobligations, and no liabilities have been recorded for these obligations on theCompany’s balance sheet as of September 30, 2004.

In general, the Company provides its customers a 90-daylimited warranty in connection with the licensing of its software that thesoftware will perform substantially in accordance with the Company’sdocumentation. The Company does not maintain a general warranty reserve for estimatedcosts at the time revenue is recognized due to its extensive quality testing ofthe software. To date, the Company has incurred minimal costs related to thislimited warranty obligation.

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The Company’s standardsoftware license and maintenance agreements include an infringementindemnification provision for claims from third parties related to the Company’sintellectual property. The agreements generally limit the scope of theavailable remedies in a variety of industry-standard methods, including butnot limited to a right to control the defense or settlement of any claim,procure the right for continued usage, and a right to replace or modify theinfringing products to make them non-infringing. Such indemnificationprovisions are accounted for in accordance with SFAS No. 5. To date, theCompany has not incurred any costs related to any claims under suchindemnification provisions.

**11. Customer andGeographic Information**

The Company operates in one reportable segment toprovide full-chip circuit simulation and analysis software solutions forthe design and verification of complex nanometer-scale semiconductors.

Revenuefrom customers by geographic area was as follows (in thousands):
| ** **    | ** ** | **Years Ended September 30,** | ** ** |
|---------------|------------|----------------------------------------------|------------|
| ** **    | ** ** | **2002**                                     | ** ** | **2003** | ** ** | **2004** | ** ** |
| Revenue:      |       |                                         |       |   |   |   |   |
| United States |       | $                                            | 19,618     |   | $ | 20,949 |   | $ | 26,494 |   |
| Japan         |       | 6,593                                        |       | 5,449 |   | 7,533 |   |
| Other         |       | 7,696                                        |       | 8,657 |   | 7,440 |   |
|          |       | $                                            | 33,907     |   | $ | 35,055 |   | $ | 41,467 |   |

 

For fiscal 2003 and fiscal 2004, the long-livedassets with the Company’s foreign subsidiaries located outside the UnitedStates totaled approximately $53,000 and $28,000, respectively, and theremainder was located within the United States.

TheCompany had revenue from individual customers in excess of 10% of revenue asfollows:
| ** ** | ** ** | **Years Ended September 30,** | ** ** |
|------------|------------|----------------------------------------------|------------|
| ** ** | ** ** | **2002**                                     | ** ** | **2003** | ** ** | **2004** | ** ** |
| *Customer* |       |                                         |       |   |   |   |   |   |   |   |   |   |   |
| A*         |       |                                         | 19         | % |   |   | 16 | % |   |   | 18 | % |   |
| B          |       |                                         | —     |   |   |   | 11 | % |   |   | — |   |   |

----

*Distributor

TheCompany had accounts receivable from individual customers in excess of 10% ofgross accounts receivable as follows:
| ** ** | ** ** | **Years Ended September 30,**                                     | ** ** |
|------------|------------|----------------------------------------------------------------------------------|------------|
| ** ** | ** ** | **      2003      ** | ** ** | **      2004      ** | ** ** |
| *Customer* |       |                                                                             |       |   |   |   |   |   |   |
| A*         |       |                                                                             | 18         | % |   |   | 29 | % |   |
| B          |       |                                                                             | —     |   |   |   | 11 | % |   |
| C          |       |                                                                             | 16         | % |   |   | 7 | % |   |

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*Distributor

**12. Proposed Mergerand Litigation Settlement**

The Company entered into an agreement of merger dated November 30,2004 with Synopsys and North Acquisition Sub, Inc., a wholly ownedsubsidiary of Synopsys. The merger agreement provides that North AcquisitionSub, Inc. will be merged with and into the Company and the Company willbecome a 

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wholly owned subsidiary ofSynopsys. Under the terms of the merger agreement, (i) each outstandingshare of the Company common stock will be converted into the right to receive$7.00 in cash and (ii) each option to purchase shares of the Companycommon stock (excluding certain options that will not be exercised) will beconverted into an option to purchase that number of shares of Synopsys commonstock based on the ratio of the $7.00 per share merger consideration to theaverage closing price of Synopsys common stock during a ten-trading dayperiod ending on and including the second trading day prior to the closing. Theper share exercise price of each option assumed will be adjusted by dividingthe existing per share exercise price by the ratio referenced in the priorsentence. The merger is conditioned upon, among other things, (i) approvalof the holders of the majority of the Company common stock, (ii) approvalof the holders of the majority of the Company common stock other than itsdirectors, officers and other founders, (iii) clearance under the Hart-Scott-RodinoAntitrust Improvements Act of 1976, and (iv) other customary conditions.

Upon the closing of themerger, the Company’s officers, directors and employees who are defendants inthe State Court Action between Synopsys and the Company will make settlementpayments to Synopsys in the aggregate amount of $61.6 million and will notexercise options to purchase Company common stock valued at approximately $5.9million. Although the settlement payments are being made by these individualsand they will not be reimbursed by the Company, the settlement is deemed to bean expense in accordance with Staff Accounting Bulletin Topic 5-T, “Accountingfor Expenses or Liabilities Paid by Principal Stockholders,” because theCompany is a defendant in the State Court Action. As a result, the Companyrecorded a litigation settlement charge of approximately $67.5 million in thequarter and fiscal year ended September 30, 2004.

**ITEM 9.   Changes in and Disagreements withAccountants on Accounting and Financial Disclosure**

Not applicable.

**ITEM 9A.   Controls and Procedures**

**(a)   Evaluationof disclosure controls and procedures.**

Wehave carried out an evaluation, under the supervision and with theparticipation of our management, including our Chief Executive Officer and ourChief Financial Officer, of the effectiveness of the design and operation ofour disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act) as of the end of the periodcovered by this Annual Report. Based upon that evaluation, our Chief ExecutiveOfficer and our Chief Financial Officer concluded that our disclosure controlsand procedures are effective to ensure that material information required to bedisclosed by us in the reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission rules and forms.

**(b)   Changesin internal controls.**

There was no change in ourinternal control over financial reporting during the fourth quarter of theperiod covered by this Annual Report that had materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

**ITEM 9B.   Other Information**

Not applicable.

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**PART III**

**ITEM 10.   Directors and Executive Officers**

*InformationConcerning the Incumbent Directors*

Thefollowing table sets forth the name and age of our directors as of November 30,2004, the principal occupation of each and the period during which each hasserved as our director. Information as to the stock ownership of each of ourdirectors and all of our current executive officers as a group is set forth inItem 12 below.
| **Name**                   | ** ** | ** ** | ** ** | **Age**                                         | ** ** | **Position(s) with Nassda** | ** ** | **Director  Since** |
|----------------------------|------------|------------|------------|-------------------------------------------------|------------|-----------------------------|------------|---------------------|
| *Class I nominees:*   |       |       |       |                                            |       |                        |
| Yen-Son Huang              |       | 59         |       | Director                                        |       | 2000                        |
| Sang S. Wang               |       | 59         |       | Chairman, Chief Executive Officer and Director  |       | 1999                        |
| *Class II directors:* |       |       |       |                                            |       |                        |
| Bernard Aronson            |       | 74         |       | Director                                        |       | 2001                        |
| An-Chang Deng              |       | 49         |       | President, Chief Operating Officer and Director |       | 1998                        |
| *Class III director:* |       |       |       |                                            |       |                        |
| Edward C.V. Winn           |       | 66         |       | Director                                        |       | 2001                        |

 

*Yen-SonHuang*has served on our board of directors since March 2000. SinceAugust 2000, Dr. Huang has served as Chief Executive Officer andChairman of the board of directors of ForteMedia, a developer and manufacturerof noise free communications chips and software. From April 1998 to July 2000,Dr. Huang served as Chief Executive Officer and Chairman of the board ofdirectors of Novas Software, Inc., a logic debugging software company. FromOctober 1997 to March 1998, Dr. Huang was a private investor andconsultant. From June 1993 to September 1997, Dr. Huang servedon the board of directors and in various management positions includingExecutive Vice President of Quickturn Design Systems, Inc., which wasacquired by Cadence Design Software, Inc. in 1999. From January 1990to June 1993 Dr. Huang served as President of PiE Design Systems, Inc.Dr. Huang holds a B.S. and a M.S. in electrical engineering fromChaio-Tung University, Taiwan, and a Ph.D. in electrical engineering andcomputer science from Santa Clara University.

*Sang**S. Wang* has served as our Chief ExecutiveOfficer and Chairman of the board of directors since April 1999. From March 1997to March 1998, Dr. Wang served as Senior Vice President and Co-GeneralManager of the EPIC Technology Group of Synopsys, Inc. and as a member ofthe board of director of Synopsys. From September 1986 to February 1997,Dr. Wang served as Chairman and Chief Executive Officer of EPIC DesignTechnology, Inc., a publicly traded electronic design automation softwarecompany that was acquired by Synopsys in February 1997. Prior to co-foundingEPIC Design Technology, Dr. Wang was a member of the senior technicalstaff and manager of computer aided design at Advanced Micro Devices, Inc.Dr. Wang also serves as a member of the board of directors of ElectronicDesign Automation Consortium, an industry group. Dr. Wang holds a B.S. inelectrical engineering from National Taiwan University, an M.S. in physics fromOhio State University and a Ph.D. in electrical engineering from StanfordUniversity.

*An-ChangDeng,***one of our co-founders,served as our Chief Executive Officer from August 1998 to April 1999,Chief Financial Officer from August 1998 to September 2000 andPresident and Chief Operating Officer since August 1998. He has served onour board of directors since August 1998. From March 1997 to August 1998,Dr. Deng was Vice President of Research and Development of the EPICTechnology Group of Synopsys. From January 1992 to February 1997, Dr. Dengserved as Vice President 

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of Research andDevelopment for EPIC Design Technology. From September 1989 to January 1992,Dr. Deng served as a developer of timing and analysis products at Cadence.From 1986 to September 1989, Dr. Deng was an assistant professor ofelectrical engineering at Texas A&M University. Dr. Deng holds a B.S.in electrical engineering from National Taiwan University, an M.S. inelectrical engineering from the University of Notre Dame and a Ph.D. inelectrical engineering and computer science from the University of Californiaat Berkeley.

*BernardAronson***hasserved on our board of directors since December 2001. Mr. Aronson hasserved as President, Chief Executive Officer and a Director of Synplicity, Inc.,an electronic design automation company, since July 1997. From February toJuly 1997, Mr. Aronson served as Senior Vice President and co-generalmanager of the EPIC Design Technology Group of Synopsys. From July 1991 toFebruary 1997, Mr. Aronson served as President of EPIC DesignTechnology, and also served as a director of EPIC Design Technology from March 1992to February 1997, until its merger with Synopsys. From March 1990 to April 1991,Mr. Aronson served as Executive Vice President of Zoran Corporation, a semiconductorcompany. Mr. Aronson holds a B.S. in Electrical Engineering from the CityUniversity of New York.

*EdwardC.V. Winn***hasserved on our board of directors since August 2001. Mr. Winn isretired. From March 1992 until his retirement in January 2000, Mr. Winnserved in various capacities with TriQuint Semiconductor, Inc., acommunications semiconductor company, most recently as Executive VicePresident, Finance and Administration, and Chief Financial Officer. From 1985until December 1991, he served in various capacities with Avantek, Inc.,a microwave semiconductor corporation, most recently as Product Group VicePresident. Mr. Winn is also a director of Endwave Corporation, a supplierof radio frequency subsystems for broadband and wireless access systems, andOmniVision Technologies, Inc., a developer of single chip image sensors.Mr. Winn received a B.S. in Physics from Rensselaer Polytechnic Instituteand an M.B.A. from Harvard University.

There are no familyrelationships between any director or executive officer. Our board of directorshas determined that Mr. Aronson, Dr. Huang and Mr. Winn areindependent under Rule 4200(a)(15) of the National Association ofSecurities Dealers’ listing standards. We do not have a policy with respect todirector attendance at annual meetings. One director attended our 2003 annualmeeting of stockholders.

*Audit Committee*

The Company’s board ofdirectors adopted a written charter for the audit committee in May 2001,which was amended in January 2003. The Company’s board of directors hasdetermined that Mr. Edward C.V. Winn is an “audit committee financialexpert,” as defined in the rules of the Securities and Exchange Commission.Mr. Winn is “independent,” as that term is used in Item 7(d)(3)(iv) ofSchedule 14A under the Securities Exchange Act of 1934, as amended.

*Code of Ethics*

TheCompany’s board of directors adopted a code of ethics for principalexecutive and senior financial officers in October 2003, which was amendedin April 2004. The Company’sboard of directors also adopted a code of business conduct and ethics for allemployees, agents and contractors in October 2003. The Company has posted both codes of ethics on our website atwww.nassda.com on our Corporate Governance page. The Company intends to satisfy the disclosure requirement underItem 10 of Form 8-K regarding any amendments to or waivers from thecode of ethics that applies to our principal executive and senior financialofficers by posting such information on our website at www.nassda.com.

*Section 16(A) BeneficialOwnership Reporting Compliance*

Section 16(a) of the Securities Exchange Actof 1934 requires our officers and directors, and persons who own more than tenpercent of a registered class of our equity securities, to file reports ofownership 

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and changes in ownershipwith the Securities and Exchange Commission and the National Association ofSecurities Dealers, Inc. Executive officers, directors and greater thanten percent stockholders are required by Securities and Exchange Commissionregulations to furnish us with copies of all Section 16(a) forms theyfile. Based solely on our review of the copies of such forms that we havereceived, or written representations from reporting persons, we believe thatduring the fiscal year ending September 30, 2004 all executive officers,directors and greater than ten percent stockholders complied with allapplicable filing requirements except for two Forms 4 required to be filedby John Yelinek reporting option grants that were inadvertently filed late on January 29,2004 and March 30, 2004 with the SEC.

Certain informationrequired by this item concerning executive officers is set forth in Part Iof this Report in “Business—Executive Officers.”

**ITEM 11.   Executive Compensation**

*SummaryCompensation Table*

Thefollowing summary compensation table sets forth certain information regardingthe compensation of our chief executive officer and our three next most highlycompensated executive officers for fiscal 2004 for services rendered in allcapacities for the years indicated. Each of the named executive officers hadagreed not to receive his or her salary in fiscal 2002 and 2003.
|                                                      | ** ** | ** ** | ** ** | ** **       | ** ** | **Long-Term  Compensation  Awards** | ** ** | ** **           | ** ** |
|------------------------------------------------------|------------|------------|------------|------------------|------------|-------------------------------------|------------|----------------------|------------|
| ** **                                           | ** ** | ** ** | ** ** | **Annual**       | ** ** | **Securities**                      | ** ** | ** **           | ** ** |
| ** **                                           | ** ** | **Fiscal** | ** ** | **Compensation** | ** ** | **Underlying**                      | ** ** | **All Other**   | ** ** |
| **Name And Principal Position**       | ** ** | ** ** | ** ** | **Year**         | ** ** | **Salary**                          | ** ** | **Bonus/Commission** | ** ** | **Options(#)** | ** ** | **Compensation** | ** ** |
| Sang S. Wang                                    |       | 2004       |       | $                | 230,717    |                                |       | $                    | 72,500     | (1) |   |   | — |   |   |   | $ | 12,873 | (2) |   |
| Chief Executive Officer and                          |       | 2003       |       | —           |       |                                | 36,000     | (1)                  |       |   | — |   |   |   | 11,764 | (2) |   |
| Chairman                                             |       | 2002       |       | —           |       |                                | 16,200     | (1)                  |       |   | — |   |   |   | 15,140 | (2) |   |
| An-Chang Deng                                        |       | 2004       |       | 197,583          |       |                                | 60,250     | (3)                  |       |   | — |   |   |   | 12,849 | (2) |   |
| President, Chief  Operating                          |       | 2003       |       | —           |       |                                | 34,000     | (3)                  |       |   | — |   |   |   | 12,563 | (2) |   |
| Officer and  Director                                |       | 2002       |       | —           |       |                                | 17,667     | (3)                  |       |   | 26,666 |   |   |   | 11,560 | (2) |   |
| Tammy S. Liu                                    |       | 2004       |       | 183,375          |       |                                | 49,750     | (4)                  |       |   | 20,000 |   |   |   | 12,897 | (2) |   |
| Chief Financial Officer,  Vice                       |       | 2003       |       | —           |       |                                | 30,000     | (4)                  |       |   | 40,000 |   |   |   | 12,638 | (2) |   |
| President, Finance and  Administration and Secretary |       | 2002       |       | —           |       |                                | 13,500     | (4)                  |       |   | — |   |   |   | 11,627 | (2) |   |
| John A. Yelinek                                 |       | 2004       |       | 143,913          |       |                                | 239,376    | (5)                  |       |   | 12,000 |   |   |   | 10,278 | (2) |   |
| Vice President,  Worldwide Sales                     |       | 2003       |       | —           |       |                                | 308,749    | (5)                  |       |   | 20,000 |   |   |   | 8,343 | (2) |   |
| and Support                                          |       | 2002       |       | —           |       |                                | 275,151    | (5)                  |       |   | — |   |   |   | 9,294 | (2) |   |
|                                                      |            |            |            |                  |            |                                     |            |                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          A bonus of $16,200 wasearned in fiscal 2002, of which $14,850 was paid in fiscal 2003 and $1,350 waspaid in October 2003. A bonus of $36,000 was earned in fiscal 2003, whichwas paid in December 2003. Bonuses totaling $72,500 were earned in fiscal2004, of which $12,500 was paid in October 2004 and the remainder $60,000will be paid in December 2004.

(2)          Consists of healthinsurance benefits, life insurance premiums and personal benefits.

(3)          A bonus of $17,667 wasearned in fiscal 2002, of which $667 was paid in fiscal 2002, $15,583 was paidin fiscal 2003 and $1,417 was paid in October 2003. A bonus of $34,000 wasearned in fiscal 2003, which was paid in December 2003. Bonuses totaling$60,250 were earned in fiscal 2004, of which $10,250 was paid in October 2004and the reminder $50,000 will be paid in December 2004.

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(4)          A bonus of $13,500 wasearned in fiscal 2002, of which $12,375 was paid in fiscal 2003 and $1,125 waspaid in October 2003. A bonus of $30,000 was earned in fiscal 2003, whichwas paid in December 2003. Bonuses totaling $49,750 were earned in fiscal2004, of which $9,750 was paid in October 2004 and the remainder $40,000will be paid in December 2004.

(5)          Includessales commissions of $263,151 earned in fiscal 2002 of which $44,010 was paidin fiscal 2003, sales commissions of $294,749 earned in fiscal 2003 of which$53,172 was paid in fiscal 2004, and sales commissions of $191,376 earned infiscal 2004 of which $11,658 is payable in fiscal 2005. Includes bonuses of$12,000 earned in fiscal 2002 of which $11,000 was paid in fiscal 2003 and$1,000 was paid in October 2003, bonuses of $14,000 earned in fiscal 2003,all of which was paid in December 2003, and bonuses of $48,000 earned infiscal 2004 of which $20,000 was paid in fiscal 2004, $18,000 was paid in October 2004and the remainder $10,000 will be paid in December 2004. The aggregatesales commission and bonus amounts for fiscal 2002 has been amended to reflectthe amount earned by Mr. Yelinek during the respective fiscal years.

*Option Grants inFiscal 2004*

Thefollowing table provides information relating to stock options awarded to eachof the executive officers identified in the summary compensation table duringfiscal 2004. All such options were awarded under the Company’s 2001 stockoption plan.
| ** **           | ** ** | ** **                                          | ** ** | **Individual Grants**                                                  | ** ** | ** **                    | ** ** | ** **         | ** ** |
|----------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|-------------------------------|------------|--------------------|------------|
| ** **           | ** ** | **Number of  Securities  Underlying  Options** | ** ** | **Percent of  Total Options  Granted to  Employees in** | ** ** | **Exercise  Price Per**  | ** ** | **Expiration**     | ** ** | **Potential Realizable Value  At Assumed Rates of Stock  Price Appreciation for  Option Term (5)** | ** ** |
| **Name**             | ** ** | ** **                                          | ** ** | **Granted(#)**                                                              | ** ** | **Fiscal 2004 (%)** | ** ** | **Share($)(3)(4)** | ** ** | **Date** | ** ** | **      5% ($)      ** | ** ** | **      10% ($)      ** | ** ** |
| Sang S. Wang    |       |                                                | —     |                                                                        |       |                          | —     |               |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| An-Chang  Deng       |       |                                                | —     |                                                                        |       |                          | —     |               |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Tammy S. Liu    |       |                                                | 20,000     | (1)                                                                         |       |                          | 2.11       |               |       |   | $ | 4.29 |   |   |   | 7/11/14 |   |   |   | 54,000 |   |   |   | 136,700 |   |   |
| John A. Yelinek |       |                                                | 12,000     | (2)                                                                         |       |                          | 1.27       |               |       |   | $ | 8.25 |   |   |   | 1/11/14 |   |   |   | 62,300 |   |   |   | 157,800 |   |   |
|                      |            |                                                     |            |                                                                             |            |                               |            |                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          100% of the sharessubject to the option will be fully vested on May 31, 2005, subject to theexecutive’s continuing to be an employee on such dates.

(2)          10% of the aggregatenumber of shares subject to the option will be vested and exercisable twelvemonths following the grant date; 20% of the aggregate number of shares subjectto the option will be vested and exercisable on a pro rata monthly basis duringthe second year after the grant date; 30% of the aggregate number of sharessubject to the option will be vested and exercisable on a pro rata monthlybasis during the third year after the grant date; and 40% of the aggregatenumber of shares subject to the option will be vested and exercisable on a prorata monthly basis during the fourth year after the grant date, subject to theexecutive’s continuing to be an employee on such dates.

(3)          Options were granted atan exercise price equal to the fair market value of our common stock on thedate of grant.

(4)          Full payment may consistof any consideration and method of payment authorized by the administrator andpermitted by the plan and the stock option agreement under the plan.

(5)          Thepotential realizable values are based on the assumption that our common stockappreciates at the annual rate shown (compounded annually) from the date ofgrant until the expiration of the ten year option term. These numbers arecalculated based on the requirements promulgated by the Securities and ExchangeCommission and do not reflect our estimate of future price growth.

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*Aggregate OptionExercises in Last Fiscal Year and Fiscal Year-End Option Values*

The following table provides information relating tooption exercises by the executive officers identified in the summarycompensation table during fiscal 2004. In addition, it indicates the number andvalue of vested and unvested options held by these executive officers as of September 30,2004.

The “RealizedValue” on option exercises is equal to the difference between the fair marketvalue of our common stock on the date of exercise less the exercise price. The “Valueof Unexercised In-the-Money Options at September 30, 2004” isbased on $3.55 per share, the closing sales price of our common stock intrading on the Nasdaq National Market on September 30, 2004, less theexercise price, multiplied by the aggregate number of shares subject tooutstanding options.
| ** **           | ** ** | **Shares  Acquired ** | ** ** | ** **           | ** ** | **Number of Securities  Underlying Unexercised  Options at  September 30, 2004** | ** ** | **Value of Unexercised  In-the-Money Options at  September 30, 2004** | ** ** |
|----------------------|------------|----------------------------|------------|----------------------|------------|----------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|
| **Name**             | ** ** | ** **                 | ** ** | **on Exercise** | ** ** | **Realized Value**                                                                                        | ** ** | **Exercisable(#)**                                                                                  | ** ** | **Unexercisable(#)** | ** ** | **Exercisable ($)** | ** ** | **Unexercisable ($)** | ** ** |
| Sang S Wang          |       |                       | —     |                 |       |                                                                                                           | —     |                                                                                                |       |   | 23,332 |   |   |   | 3,334 |   |   |   | 5,833 |   |   |   | 834 |   |   |
| An-Chang  Deng       |       |                       | —     |                 |       |                                                                                                           | —     |                                                                                                |       |   | 23,332 |   |   |   | 3,334 |   |   |   | 5,833 |   |   |   | 834 |   |   |
| Tammy S. Liu    |       |                       | —     |                 |       |                                                                                                           | —     |                                                                                                |       |   | 22,999 |   |   |   | 50,334 |   |   |   | 6,416 |   |   |   | 917 |   |   |
| John A. Yelinek |       |                       | 49,999     |                 |       |                                                                                                           | $          | 199,996                                                                                             |       |   |   | 13,999 |   |   |   | 34,668 |   |   |   | 4,583 |   |   |   | 4,584 |   |   |
|                      |            |                            |            |                      |            |                                                                                                                |            |                                                                                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*EmploymentArrangements*

In fiscal 2002, the Company awarded bonuses of anaggregate of $58,700 payable to its named executive officers for their servicesin fiscal 2002. Specifically, Dr. Wang was entitled to an aggregate of$16,200, Dr. Deng was entitled to an aggregate of $17,000, Ms. Liuwas entitled to an aggregate of $13,500 and Mr. Yelinek was entitled to anaggregate of $12,000. These bonuses were paid over a twelve-month periodbeginning November 2002 and had been fully paid as of October 30,2003.

In fiscal 2003, the Company awarded bonuses of anaggregate of $114,000 payable to its named executive officers for theirservices in fiscal 2003. Specifically, Dr. Wang was entitled to $36,000, Dr. Dengwas entitled to $34,000, Ms. Liu was entitled to $30,000 and Mr. Yelinekwas entitled to $14,000. These bonuses were paid in December 2003.

Each of the namedexecutive officers orally agreed that he or she would not receive his or herbase salary in fiscal 2002 and fiscal 2003. However, the payment of the bonusesearned in fiscal 2001, fiscal 2002 and fiscal 2003 were not contingent uponthese persons receiving no base salaries or upon continued employment. Each ofthe named executive officers began receiving their base salaries in October 2003.Effective November 2004, the base salaries are $250,000, $205,000,$195,000 and $160,000 for Dr. Wang, Dr. Deng, Ms. Liu and Mr. Yelinek,respectively.

*DirectorCompensation*

Directors who are not employees receive automaticoption grants under our 2001 director option plan. Each new nonemployeedirector is automatically granted an option to purchase 40,000 shares of ourcommon stock at the time he or she is first elected to our board of directors. Eachnonemployee director receives a subsequent option grant to purchase 20,000shares of our common stock on October 1 of each year provided that he orshe is a member of our board of directors on such date. All options grantedunder the director option plan are granted at the fair market value of ourcommon stock as reported on the Nasdaq National Market on the date of the grant.The initial 40,000 share grants become exercisable at a rate of 1¤3of the shares one year after the date of grant and 1¤36thof the shares per month thereafter. The subsequent 20,000 share grants becomeexercisable at the rate of 1¤24thof the shares per month beginning with the thirteenth month following the dateof grant. On October 1, 2004, Mr. Aronson, Dr. Huang and 

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Mr. Winn eachreceived a subsequent option to purchase 20,000 shares of our common stock atan exercise price of $3.70 per share.

Beginning April 2003, each nonemployee directoralso receives a cash retainer of $15,000 per year plus a fee of $1,000 per in-personboard meeting attended by the director. A fee of $500 will be paid for eachtelephonic board meeting. The chairman of our board of directors, if anonemployee director, receives an additional retainer of $20,000 per year. Thechairmen of the audit, compensation and nominating and governance committeesreceive additional retainers of $20,000, $10,000 and $10,000, respectively peryear. Directors also receive a fee of $1,000 per in-person meeting or$500 per telephonic meeting for participation in committee meetings. Directorsonly receive one in-person meeting fee for attendance at more than oneboard or committee meeting on the same day.

In August 2004, aspecial committee of our board of directors consisting of Mr. Aronson, Dr. Huangand Mr. Winn was formed to evaluate potential strategic transactionsinvolving the Company. In connection with their participation on the specialcommittee, each of Dr. Huang and Mr. Aronson will receive a cashretainer in the amount of $40,000, and Mr. Winn, as the chairman of thespecial committee, will receive a cash retainer in the amount of $50,000.

*CompensationCommittee Interlocks and Insider Participation*

The Company’s compensationcommittee is responsible for determining salaries, incentives and other formsof compensation for directors, officers and other employees. The Company’scompensation committee consists of Mr. Aronson, Dr. Huang and Mr. Winn.Dr. Wang, the Company’s chief executive officer, participates in alldiscussions regarding salaries and incentive compensation for all employees andconsultants. He is excluded, however, from discussions regarding his own salaryand incentive compensation and deliberations regarding salaries and incentivecompensation for all employees and consultants. No interlocking relationshipexists between any member of the Company’s compensation committee and anymember of any other company’s board of directors or compensation committee.

*Company Performance*

*Notwithstanding anystatement to the contrary in any of the Company’s previous or future filingswith the Securities and Exchange Commission, the following information relatingto the price performance of our common stock will not be deemed “filed” with theCommission or “soliciting material” under the Securities Exchange Act of 1934,as amended, and will not be incorporated by reference into any such filings.*

The registration statementcovering the Company’sinitial public offering became effective December 12, 2001, and the Company’s common stock begantrading on the Nasdaq National Market on December 13, 2001. The followinggraph shows a comparison, from December 12, 2001 through September 30,2004 of cumulative total return for ourcommon stock, Standard & Poor’s 500 Index and the Standard &Poor’s Information Technology Index. Such returns are based on historicalresults and are not intended to suggest future performance. Data for theStandard & Poor’s 500 Index and the Standard & Poor’sInformation Technology Index assume reinvestment of dividends. The Company has never paid dividends onits common stock and has no present plans to do so.

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**COMPARISON OF 33MONTH CUMULATIVE TOTAL RETURN***

AMONG NASSDA CORPORATION, THE S & P 500 INDEX

AND THE S & PINFORMATION TECHNOLOGY INDEX

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*       Assumes $100 invested on December 13, 2001, in our commonstock, the Standard & Poor’s Index and Standard & Poor’sInformation Technology Index.

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**REPORT OF THE COMPENSATION COMMITTEE OF THE BOARD OFDIRECTORS ON COMPENSATION**

During fiscal 2004,executive compensation matters were approved by the compensation committee ofthe board of directors, which currently consists of Bernard Aronson, Yen-SonHuang and Edward C.V. Winn. The following is the report of the compensationcommittee of the board of directors with respect to compensation during fiscal2004.

**General Compensation Philosophy**

The compensationcommittee operates under a written charter adopted by the board of directors inAugust 2001 and amended in January 2003. The primary objectives ofthe executive compensation policies include the following:

·       Toattract, motivate, and retain a highly qualified executive management team;

·       Tolink executive compensation to our financial performance as well as to defineindividual management objectives established by the compensation committee;

·       Tocompensate competitively with the practices of similarly situated technologycompanies; and

·       Tocreate management incentives designed to enhance stockholder value.

Nassda competes in anaggressive and dynamic industry and, as a result, the board of directorsbelieves that finding, motivating, and retaining quality employees,particularly senior managers, sales personnel and technical personnel, areimportant factors to Nassda’s future success. The compensation philosophy seeksto align the interests of stockholders and management by tying compensation toNassda’s financial performance, either directly in the form of salary andbonuses paid in cash or indirectly in the form of stock options and in certaininstances restricted stock granted to Nassda’s principal executive officers.

**CashCompensation**

Nassda seeks to provide cash compensation to itsexecutive officers, including base salary and bonus, at levels that arecommensurate with cash compensation of executives with comparableresponsibility at similarly situated technology companies. Annual increases inbase salary are determined on an individual basis based on market data and areview of the officer’s performance and contribution to various individual,departmental and corporate objectives. Cash bonuses are intended to provideadditional incentives to achieve such objectives.

The salaries of each of Nassda’s executive officerswere determined by the compensation committee and their cash bonuses wereapproved by the board of directors upon the recommendation of the chiefexecutive officer. Sang S. Wang has served as Nassda’s chief executiveofficer since April 1999. Each of Nassda’s executive officers orallyagreed not to receive his or her base salary for fiscal 2002 or fiscal 2003.Dr. Wang began receiving his base salary again in October 2003 andhis current annual base salary is $250,000. Dr. Wang earned a bonus of$36,000 for services performed in fiscal 2003, which was paid in December 2003and a bonus of $72,500 for services performed in fiscal 2004, of which $12,500was paid in October and the balance will be paid in December 2004.

In addition to annual salary, cash bonuses for thechief executive officer and the chief financial officer are based on variousperformance targets established by the board of directors.

Based on a review ofpublic company proxy data and other relevant market data, the compensationcommittee believes that cash compensation paid to Nassda’s executive officers,including the chief executive officer, was generally consistent with amountspaid to officers with similar responsibilities at 

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similarlysituated technology companies. We note that competition for qualifiedmanagement and technical personnel in Nassda’s industry is intense, and weexpect such competition to remain intense for the foreseeable future. As aresult, in order to insure access to qualified personnel, we believe that itwill continue to be necessary to provide compensation packages that are atleast competitive with, and in certain instances superior to, compensation paidby other similarly situated electronic design automation companies.

**Equity-Based Compensation**

Nassda provides long term incentives through its 2001stock option plan. Prior to Nassda’s December 2001 public offering, Nassdaprovided long-term incentives through its 1998 stock option plan. Stockoptions are periodically granted under the 2001 stock option plan to provideadditional incentive to executives and other employees to maximize long-termtotal return to our stockholders. Stock options are a particularly strongincentive, because they are valuable to employees only if the fair market valueof our common stock increases above the exercise price, which is set at thefair market value of Nassda’s common stock on the date the option is granted. Inaddition, employees must remain employed with Nassda for a fixed period of timein order for the options to vest fully. Options generally vest over a four-yearperiod to encourage option holders to remain employed by Nassda.

With respect to the sizeof the options granted to Nassda’s named executive officers, we consider theexecutive’s position with Nassda, the executive’s individual performance, thenumber of options held (if any) and the extent to which those options arevested, and any other factors that we may deem relevant. In fiscal 2004, wegranted 12,000 shares to Mr. Yelinek, Nassda’s Vice President of MajorAccount, vesting over four years and 20,000 shares to Ms. Liu, Nassda’sChief Financial Officer, vesting fully on May 31, 2005. Both options weregranted at an exercise price equal to the fair market value on the date of thegrant. No options were granted to any other Nassda’s named executive officer infiscal 2004.

**Tax Deductibility of Executive Compensation**

Section 162(m)of the Internal Revenue Code limits the federal income tax deductibility ofcompensation paid to Nassda’s chief executive officer and to each of the otherthree most highly-compensated executive officers. Nassda may deduct suchcompensation only to the extent that during any fiscal year the compensationpaid to such individual does not exceed $1 million or meet certainspecified conditions (including stockholder approval). Nassda has adopted apolicy that, where reasonably practicable, Nassda will seek to qualify variablecompensation paid to its executive officers for an exemption from thedeductibility limitations of 162(m).
|        | Respectfully submitted by: |
|--------|----------------------------|
|   | THE COMPENSATION COMMITTEE |
|   | Bernard Aronson            |
|   | Yen-Son Huang              |
|   | Edward C.V. Winn           |

 

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**ITEM 12.   Security Ownership of CertainBeneficial Owners and Management and Related Stockholder Matters**

The following table provides information relating tothe beneficial ownership of our common stock as of November 30, 2004 by:

·       eachstockholder known by us to own beneficially more than 5% of our common stock;

·       eachof our executive officers ;

·       eachof our directors; and

·       allof our directors and executive officers as a group.

Beneficial ownership isdetermined based on the rules of the Securities and Exchange Commission. Thecolumn captioned “Total Shares and Shares Underlying Exercisable OptionsBeneficially Owned” includes the number of shares of our common stock subjectto options that are currently exercisable or will become exercisable on orbefore January 29, 2005, sixty (60) days from November 30, 2004. Thenumber of shares subject to options that each beneficial owner has the right toacquire on or before January 29, 2005 is listed separately under thecolumn “Number of Shares Underlying Options.” These shares are not deemedexercisable for purposes of computing the beneficial ownership of any otherperson. Percent of beneficial ownership is based upon 27,457,621 shares of ourcommon stock outstanding as of November 30, 2004. The address for thoseindividuals for which an address is not otherwise provided is c/o NassdaCorporation, 2650 San Tomas Expressway, Santa Clara, California 95051. Unlessotherwise indicated, we believe the stockholders listed have sole voting orinvestment power with respect to all shares, subject to applicable communityproperty laws.
| **Name and Address**                                                                     | ** ** | ** ** | ** ** | **Number of  Outstanding  Shares  Beneficially  Owned** | ** ** | **Number of  Shares  Underlying  Options  Exercisable on  or before  January 29,  2005** | ** ** | **Total Shares  and Shares  Underlying  Exercisable  Options  Beneficially  Owned** | ** ** | **Percentage of  Outstanding  Shares  Beneficially  Owned** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|------------|------------|--------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| *Principal Stockholders*                                                                           |       |       |       |                                                         |       |                                                                                                         |       |                                                                                          |       |                                                             |       |   |   |
| Wasatch Advisors, Inc.(1)  150 Social Hall Avenue, Suite 400  Salt Lake City, Utah 84111 |       | 3,540,052  |       |                                                         | —     |                                                                                                         |       | 3,540,052                                                                                     |       |                                                             | 12.89      | % |   |
| T. Rowe Price Associates, Inc.(2)  100 East Pratt Street  Baltimore, Maryland 21202-1009      |       | 1,607,000  |       |                                                         | —     |                                                                                                         |       | 1,607,000                                                                                     |       |                                                             | 5.85       |   |   |
| Andrei Tcherniaev(3)                                                                               |       | 1,353,834  |       |                                                         | 287,774    |                                                                                                         |       | 1,641,608                                                                                     |       |                                                             | 5.92       |   |   |
| Walter Chan(4)                                                                                     |       | 1,372,999  |       |                                                         | 166,942    |                                                                                                         |       | 1,539,941                                                                                     |       |                                                             | 5.57       |   |   |
| Iouri Feinberg(5)                                                                                  |       | 1,333,000  |       |                                                         | 228,608    |                                                                                                         |       | 1,561,608                                                                                     |       |                                                             | 5.64       |   |   |
| *Executive Officers and  Directors*                                                                |       |       |       |                                                         |       |                                                                                                         |       |                                                                                          |       |                                                             |       |   |   |
| Sang S. Wang(6)                                                                               |       | 6,064,295  |       |                                                         | 25,554     |                                                                                                         |       | 6,089,849                                                                                     |       |                                                             | 22.16      |   |   |
| An-Chang Deng(7)                                                                                   |       | 4,920,500  |       |                                                         | 25,554     |                                                                                                         |       | 4,946,054                                                                                     |       |                                                             | 18.00      |   |   |
| Tammy S. Liu                                                                                  |       | 748,469    |       |                                                         | 27,777     |                                                                                                         |       | 776,246                                                                                       |       |                                                             | 2.82       |   |   |
| John A. Yelinek                                                                               |       | 253,802    |       |                                                         | 22,589     |                                                                                                         |       | 276,391                                                                                       |       |                                                             | 1.01       |   |   |
| Bernard Aronson                                                                                    |       | 25,000     |       |                                                         | 83,886     |                                                                                                         |       | 108,886                                                                                       |       |                                                             |       | * |   |
| Yen-Son Huang                                                                                      |       | —     |       |                                                         | 177,497    |                                                                                                         |       | 177,497                                                                                       |       |                                                             |       | * |   |
| Edward C. V. Winn                                                                                  |       | —     |       |                                                         | 89,441     |                                                                                                         |       | 89,441                                                                                        |       |                                                             |       | * |   |
| All current executive  officers and directors as a group (7 persons)                               |       |       |       |                                                         |       |                                                                                                         |       |                                                                                          |       |                                                             | 45.35      | % |   |

 

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*                    Less than 1%

(1)          Reflects ownership of 3,540,052 shares asreported on Schedule 13G/A for the period ended September 30, 2004 andfiled with the Securities and Exchange Commission on November 12, 2004.

(2)          Reflects ownership of1,607,000 shares as reported on Schedule 13F for the period ended September 30,2004 and filed with the Securities and Exchange Commission on November 23,2004.

(3)          Consists of 5,722 sharesheld by Gennadiy Bushuev, a friend of Dr. Tcherniaev’s, as custodian for Dr. Tcherniaev’sson, 1,346,112 shares held by a trust of which he is a trustee, and 2,000shares held by Mr. Tcherniaev’s son. Mr. Tcherniaev has voting anddispositive control over shares held by the trust and his son.

(4)          Consists of 1,316,555shares held by the Chan Family Revocable Trust, and 16,444 shares held by theChan Children’s Trusts for benefit of Mr. Chan’s children, both of which Mr. Chanis a trustee. Mr. Chan has voting and dispositive control over all suchshares. Includes 40,000 shares held by Mr. Chan’s wife as custodian forhis sons.

(5)          Consists of 1,253,000shares held by Mr. Feinberg and his wife’s trust, 57,530 shares in streetname and 22,470 shares held by the various Feinberg Children’s Trusts forbenefit of Mr. Feinberg’s children of which Mr. Feinberg is a trustee.Mr. Feinberg has voting and dispositive control over all such shares.

(6)          Includes 3,964,132shares of common stock held by the Wang Living Trust for the benefit of Dr. Wang’sfamily of which Dr. Wang is a trustee. Dr. Wang has voting anddispositive control over all such shares.

(7)          Includes16,000 shares held by Dr. Deng’s brother, 3,000 shares held by Dr. Deng’ssisters-in-law, 16,000 shares held by each of Dr. Deng’s two sons and30,000 shares held by the Deng Children’s Trust for the benefit of Dr. Deng’schildren of which Dr. Deng is a trustee. Also includes 658,788 shares heldjointly by An-Chang Deng and Mei-Chien Lu as husband and wife and316,712 held by Mei-Chien Lu. Dr. Deng has voting and dispositivecontrol over all such shares.

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*Equity CompensationPlan Information*

Thefollowing table provides information as of September 30, 2004 about ourcommon stock that may be issued upon the exercise of options and rights grantedto employees, consultants or members of our board of directors under allexisting equity compensation plans including the 1998 Stock Option Plan (whichwas terminated as to new grants in December 2001), the 2001 Stock OptionPlan, the 2001 Employee Stock Purchase Plan and the 2001 Director Stock OptionPlan.
| ** **                                                        | ** ** | **Number of  securities to be  issued upon  exercise of  outstanding  options,  warrants and  rights** | ** ** | **Weighted  average  exercise price  of outstanding  options,  warrants and  rights** | ** ** | **Number of  securities  remaining  available for  future issuance  under equity  compensation  plans  (excluding  securities  reflected in  column (a))** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Plan category**                                            | ** ** | ** **                                                                                                                           | ** ** | **(a)**                                                                                              | ** ** | **(b)**                                                                                                                                                                                  | ** ** | **(c)** | ** ** |
| Equity  compensation plans approved by security holders           |       |                                                                                                                                 | 7,051,107  | (1)                                                                                                  |       |                                                                                                                                                                                     | $          | 5.27 |   |   |   | 6,822,229 | (2) |   |
| Equity  compensation plans not approved by security holders  |       |                                                                                                                                 | —     |                                                                                                 |       |                                                                                                                                                                                     | $          | — |   |   |   | — |   |   |
| Total                                                             |       |                                                                                                                                 | 7,051,107  |                                                                                                 |       |                                                                                                                                                                                     | $          | 5.27 |   |   |   | 6,822,229 |   |   |
|                                                                   |            |                                                                                                                                      |            |                                                                                                      |            |                                                                                                                                                                                          |            |  |  |  |  |  |  |  |  |  |

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(1)          Of these shares ofcommon stock, 3,583,332 shares were subject to outstanding options under the1998 Stock Option Plan, 3,287,775 shares were subject to outstanding optionsunder the 2001 Stock Option Plan and 180,000 shares were subject to outstandingoptions under the 2001 Director Stock Option Plan.

(2)          Ofthese shares of common stock, 3,746,327 shares remain available for futureissuance under the 2001 Stock Option Plan, 286,407 shares remain available forfuture issuance under the 2001 Director Stock Option Plan and 2,789,495 sharesof our common stock are reserved for future issuance under our 2001 EmployeeStock Purchase Plan.

**ITEM 13.   Certain Relationships and RelatedTransactions**

We advanced an amount upto $250,000 to each of Mr. Sang S. Wang, our chief executive officer andchairman, and Dr. An-Chang Deng, our president and chief operatingofficer, in connection with their defense of the State Court Action in fiscal2004.

**ITEM 14.   Principal Accountant Fees AndServices**

The board of directors hasselected Deloitte & Touche LLP, independent registered publicaccounting firm, to audit our financial statements for the fiscal year ending September 30,2005. We expect that a representative of Deloitte & Touche LLP will bepresent at the 2005 annual meeting, will have the opportunity to make astatement if he or she desires to do so and will be available to answer anyappropriate questions.

*Audit Fees*

Audit fees billed to theCompany by Deloitte & Touche LLP totaled $292,279 and $297,000 for theaudit of our consolidated annual financial statements for fiscal year 2003 and2004, respectively, included in our Annual Reports on Form 10-K andthe reviews of the financial statements included in our Quarterly Reports on Form 10-Q.

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*Audit-RelatedFees*

Audit-related feesbilled to us by Deloitte & Touche LLP in fiscal 2004 totaled $9,310for services related to accounting principles. Deloitte & Touche LLPbilled us $7,500 in fiscal 2003 for services related to the implementation of Section 404of the Sarbanes-Oxley Act of 2002.

*Tax Fees*

Tax fees billed to us byDeloitte & Touche LLP during fiscal 2003 and fiscal 2004 totaled$126,760 and $149,276, respectively. These fees were comprised of $108,953 infiscal 2003 and $135,747 in fiscal 2004 for tax compliance, and $17,807 infiscal 2003 and $13,529 in fiscal 2004 for tax advice. Tax advice for fiscal2003 and fiscal 2004 primarily related to consultations regarding domestic andinternational tax matters.

*All Other Fees*

Fees billed to us by Deloitte & Touche LLPduring fiscal 2003 for litigation support services totaled $146,886. Beforeselecting Deloitte & Touche LLP, the audit committee carefully consideredDeloitte & Touche LLP’s qualifications as an independent registeredpublic accounting firm. This included a review of the qualifications of theengagement team, the quality control procedures the firm has established, anyissues raised by the most recent quality control review of the firm, as well asits reputation for integrity and competence in the fields of accounting andauditing. The audit committee’s review also included matters to be consideredunder the SEC’s rules regarding auditor independence, including the natureand extent of non-audit services, to ensure that the accountants’independence will not be impaired. The audit committee expressed itssatisfaction with Deloitte & Touche LLP in all of these respects. Theaudit committee pre-approves all audit and non-audit servicesprovided by Deloitte & Touche LLP, or subsequently approves non-auditservices in those circumstances where a subsequent approval is necessary andpermissible. All of the services provided by Deloitte & Touche LLPdescribed under “Audit-Related Fees,” “Tax Fees” and “All Other Fees”were pre-approved by the audit committee. The audit committee of ourboard of directors has determined that the provision of services by Deloitte &Touche LLP other than for audit related services is compatible with maintainingthe independence of Deloitte & Touche LLP as our independentregistered public accounting firm.

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**PART IV**

**ITEM 15.   Exhibits and Financial StatementSchedules**

**(a)(1)   FinancialStatements**

Thefollowing consolidated financial statements are set forth in Item 8 of thisAnnual Report:
|                                                                                                                                                                        | ** ** | ** ** | **Page** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|----------|------------|
| Report of Independent Registered  Public Accounting Firm                                                                                                               |       | 56         |     |
| Consolidated Balance Sheets as of  September 30, 2003 and 2004                                                                                                    |       | 57         |     |
| Consolidated Statements of  Operations for each of the three fiscal years ended September 30, 2002,  2003 and 2004                                                |       | 58         |     |
| Consolidated Statements of  Stockholders’ Equity and Comprehensive Income (Loss) for each of the three  fiscal years ended September 30, 2002, 2003 and 2004 |       | 59         |     |
| Consolidated Statements of Cash  Flows for each of the three fiscal years ended September 30, 2002, 2003  and 2004                                                |       | 60         |     |
| Notes to Consolidated Financial  Statements                                                                                                                            |       | 61         |     |
|                                                                                                                                                                        |            |            |          |            |  |

 

**(a)(2)**   Financial Statement Schedules

**SCHEDULE II:  VALUATION AND QUALIFYING ACCOUNTS**

**Forthe years ended September 30, 2002, 2003 and 2004**

**(inthousands)**
| **Allowance for Doubtful Accounts:** | ** ** | ** ** | ** ** | **Balance at  Beginning  of Period** | ** ** | **Additions  Charged  to Expense** | ** ** | **Deductions** | ** ** | **Balance  at End  of Period** | ** ** |
|-----------------------------------------------------|------------|------------|------------|------------------------------------------------|------------|-----------------------------------------|------------|----------------|------------|------------------------------------------|------------|
| Years Ended  September 30,                     |       |       |       |                                           |       |                                    |       |           |       |                                     |       |   |   |   |   |   |   |
| 2002                                                |       |       | $          | 112                                            |       |                                    |       | $              | 25         |                                     |       |   | $ | 50 |   |   |   | $ | 87 |   |   |
| 2003                                                |       |       | $          | 87                                             |       |                                    |       | $              | 15         |                                     |       |   | $ | 10 |   |   |   | $ | 92 |   |   |
| 2004                                                |       |       | $          | 92                                             |       |                                    |       | $              | —     |                                     |       |   | $ | 10 |   |   |   | $ | 82 |   |   |

 

**(a)(3)**   Exhibits
| Exhibit No. | ** ** | ** **                                                                                                                                                                                                   | ** ** | **Exhibit Title** |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|
| 2.1(1)           |       | Agreement of Merger dated November 30, 2004  among Synopsys, Inc., North Acquisition Sub, Inc., a Delaware  corporation and a wholly-owned subsidiary of Synopsys, Inc., and  Registrant |
| 2.2(1)           |       | Agreement to Settle Litigation dated  November 30, 2004, by and among Synopsys, Inc. and certain  employees of Registrant                                                                          |
| 2.2.1(1)         |       | Form of Release of Claims of certain employees  of Registrant by Synopsys, Inc. and Registrant                                                                                                     |
| 2.2.2(1)         |       | Form of General Release of Synopsys, Inc.  and Registrant by certain employees of Registrant                                                                                                       |
| 2.2.3(1)         |       | Form of ADEA Waiver by certain employees of  Registrant to Synopsys, Inc. and Registrant                                                                                                           |
| 2.3(1)           |       | Form of Voting Agreement dated  November 30, 2004, by and among Synopsys, Inc. and officers and  directors of Registrant                                                                      |
| 2.3.1(1)         |       | Form of Voting Agreement dated  November 30, 2004, by and among Synopsys, Inc. and certain other  employees of Registrant                                                                     |
| 2.4(1)           |       | Stipulation to Stay Action and Tolling Agreement  dated November 30, 2004 (relating to the State Court Action) among Synopsys, Inc.,  certain employees of Registrant and Registrant               |

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| 2.5(1)          |   | Stipulation to Stay  Action and Tolling Agreement dated November 30, 2004 (relating to  Federal Court Action Case No. C-03-2664 SI) among Synopsys, Inc.  and Registrant  |
|-----------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.6(1)          |   | Stipulation to Stay Action and Tolling Agreement  dated November 30, 2004 (relating to Federal Court Action Case  No. C-01-2519 SI) among Synopsys, Inc. and Registrant   |
| 2.7(1)          |   | Form of Intellectual Property Assignment  Agreement dated November 30, 2004 between Registrant and certain of its  employees                                                   |
| 2.8(1)          |   | Form of Resignation Letter dated  November 30, 2004 by certain employees of Registrant                                                                                         |
| 2.9(1)          |   | Form of Option Relinquishment Agreement dated  November 30, 2004 between Synopsys, Inc. and certain employees of  Registrant                                              |
| 2.10(1)         |   | Form of Noncompetition Agreement dated  November 30, 2004 by each of An-Chang Deng and Sang S. Wang                                                                            |
| 2.10.1(1)       |   | Form of Noncompetition Agreement dated  November 30, 2004 by certain employees of Registrant                                                                                   |
| 2.11(1)         |   | Form of Consulting Agreement dated  November 30, 2004 among Synopsys, Inc., Registrant and certain  employees of Registrant                                               |
| 2.12(1)         |   | Form of Cooperation and Support Agreement dated  November 30, 2004 among Synopsys, Inc., Registrant and certain  employees of Registrant                                  |
| 2.13(1)         |   | Form of Indemnification Agreement dated  November 30, 2004 between Registrant and certain employees of Registrant                                                              |
| 2.13.1(1)       |   | Form of Amended and Restated Indemnification  Agreement dated November 30, 2004 between Registrant and each of  An-Chang Deng and Sang S. Wang                                 |
| 2.14(1)         |   | Form of Release of Claims of  Synopsys, Inc. and Registrant for certain non-defendant officers and  directors of Registrant                                                    |
| 3.1.1(2)        |   | Amended and Restated Certificate of Incorporation                                                                                                                                        |
| 3.2(2)          |   | Bylaws                                                                                                                                                                                   |
| 10.1(2)         |   | Form of Indemnification Agreement between the  Registrant and each of its directors and officers                                                                                    |
| 10.2(2)         |   | Amended and Restated 1998 Stock Option Plan                                                                                                                                              |
| 10.2.1(2)       |   | Form of Stock Option Agreement under the 1998  Stock Option Plan                                                                                                                    |
| 10.3(2)         |   | 2001 Stock Option Plan                                                                                                                                                                   |
| 10.3.1(2)       |   | Form of Stock Option Agreement under the 2001  Stock Option Plan                                                                                                                    |
| 10.4(2)         |   | 2001 Director Option Plan                                                                                                                                                                |
| 10.4.1(2)       |   | Form of Director Option Agreement under 2001  Director Option Plan                                                                                                                  |
| 10.5(2)         |   | 2001 Employee Stock Purchase Plan                                                                                                                                                        |
| 10.5.1(2)       |   | Form of Subscription Agreement under the 2001 Employee  Stock Purchase Plan                                                                                                         |
| 10.6(2)         |   | Letter of Employment dated September 15, 2000  between the Registrant and Tammy Shu-Hua Liu                                                                                         |
| 10.8(2)†   |   | Exclusive Distributor Agreement dated  October 1, 1999 between the Registrant and Marubeni Solutions  Corporation                                                                   |
| 10.8.1(2)† |   | Amendment dated November 21, 2000 to Exclusive  Distributor Agreement dated October 1, 1999 between the Registrant and  Marubeni Solutions Corporation                         |
| 10.8.2(3)       |   | Amendment II dated February 14, 2002 to  Exclusive Distributor Agreement dated October 1, 1999 between the  Registrant and Marubeni Solutions Corporation                      |
| 10.8.3(4)† |   | Amendment III dated October 1, 2003 to  Exclusive Distributor Agreement dated October 1, 1999 between the  Registrant and Marubeni Solutions Corporation                       |
| 10.9.1(5)       |   | Lease dated December 20, 2002 between the  Registrant and San Tomas Properties, LLC for the premises located at Second  Floor of 2650 San Tomas Expressway, Santa Clara, California |

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| 10.9.2(5) |   | Addendum No. 1 to  the Lease dated December 20, 2002 between the Registrant and San Tomas  Properties, LLC                   |
|-----------|--------|----------------------------------------------------------------------------------------------------------------------------------------|
| 14.1(4)   |   | Code of Ethics for Principal Executive and Senior  Financial Officers                                                                  |
| 14.2(6)   |   | Amended and Restated Code of Ethics for Principal  Executive and Senior Financial Officers                                             |
| 21.1      |   | Subsidiaries                                                                                                                           |
| 23.1      |   | Consent of Independent Registered Public Accounting  Firm                                                                              |
| 24.1      |   | Power of Attorney (see Page 96)                                                                                                   |
| 31.1      |   | Certifications of Chief Executive Officer and Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 |
| 32.1      |   | Certifications of Chief Executive Officer and Chief  Financial Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002 |

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(1)          Incorporated byreference to the exhibits filed with the Registrant’s Current Report on Form 8-K/Aas filed on December 3, 2004.

(2)          Incorporatedby reference to the exhibit bearing the same number filed with the Registrant’sRegistration Statement on Form S-1 (Registration Statement 333-68934),which the Securities and Exchange Commission declared effective on December 12,2001.

(3)          Incorporated byreference to the exhibits filed with the Registrant’s Annual Report on Form 10-Kfor the fiscal year ended September 30, 2002, as filed on December 23,2003.

(4) Incorporatedby reference to the exhibit filed with the Registrant’s Annual Report on Form 10-Kfor the fiscal year ended September 30, 2003, as filed on November 26,2003.

(5)          Incorporated by reference to the exhibits filedwith the Registrant’s Quarterly Report on Form 10-Q for the fiscalquarter ended December 31, 2002, as filed on February 14, 2003.

(6)          Incorporated byreference to the exhibit filed with the Registrant’s Current Report on Form 8-Kas filed on April 14, 2004.

†                    Certaininformation in these exhibits has been omitted and filed separately with theSecurities and Exchange Commission pursuant to a confidentialtreatment request under 17 C.F.R. Sections 200.80(b)(4), 200.83 and230.46.

**(b)   Exhibits**

SeeItem 15(a)(3) above.

**(c)   Financial Statement Schedules**

SeeItem 15(a)(2) above.

95

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this annual report on Form 10-K to be signed on itsbehalf by the undersigned thereunto duly authorized in the City of Santa Clara,California, on December 14, 2004.
|        | NASSDA CORPORATION                                  |
|--------|-----------------------------------------------------|
|   | By                                                  | /s/ SANG S. WANG |
|   | Sang S. Wang                                   |
|   | *Chief  Executive Office and Chairman of the Board* |
|   | *(Principal  Executive Officer)*                    |
|   | By                                                  | /s/ TAMMY S. LIU |
|   | Tammy S. Liu                                   |
|   | *Chief  Financial Officer and Vice President,*      |
|   | *Finance  and Administration*                       |
|   | *(Principal  Financial Officer)*                    |

 

**POWEROF ATTORNEY**

KNOW ALL PERSONS BY THESE PRESENTS, that each personwhose signature appears below hereby constitutes and appoints Sang S. Wangand Tammy S. Liu and each of them acting individually, as his or herattorney-in-fact, each with full power of substitution, for him orher in any and all capacities, to sign any and all amendments to this Report onForm 10-K, and to file the same, with all exhibits thereto and otherdocuments in connection therewith, with the Securities and Exchange Commission.

Pursuantto the requirements of the Securities Exchange Act of 1934, this Report on Form 10-Khas been signed on behalf of the Registrant by the following persons and in thecapacities and on the dates indicated:
|                        | **Signature** | ** **                                                 | ** ** | ** **              | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|------------------------|---------------|------------------------------------------------------------|------------|-------------------------|-----------|------------|------------|------------|----------|------------|
| /s/  SANG S. WANG |          | Chief Executive Officer  and Chairman of the Board         |       | December 14,  2004 |
| Sang S. Wang      |          | (Principal Executive  Officer)                             |       |                    |
| /s/  TAMMY S. LIU |          | Chief Financial Officer  and Vice President,               |       | December 14,  2004 |
| Tammy S. Liu      |          | Finance and  Administration  (Principal Financial Officer) |       |                    |
| /s/ AN-CHANG DENG      |          | President, Chief  Operating Officer and Director           |       | December 14,  2004 |
| An-Chang  Deng         |          |                                                       |       |                    |
| /s/  YEN-SON HUANG     |          | Director                                                   |       | December 14,  2004 |
| Yen-Son  Huang         |          |                                                       |       |                    |
| /s/  EDWARD C. V. WINN |          | Director                                                   |       | December 14,  2004 |
| Edward C.V. Winn       |          |                                                       |       |                    |
| /s/  BERNARD ARONSON   |          | Director                                                   |       | December 14,  2004 |
| Bernard Aronson        |          |                                                       |       |                    |

 

96

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**EXHIBIT INDEX**
| Exhibit No. | ** ** | ** **                                                                                                                                                                                                   | ** ** | **Exhibit Title** |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|
| 2.1(1)           |       | Agreement  of Merger dated November 30, 2004 among Synopsys, Inc., North  Acquisition Sub, Inc., a Delaware corporation and a wholly-owned  subsidiary of Synopsys, Inc., and Registrant |
| 2.2(1)           |       | Agreement  to Settle Litigation dated November 30, 2004, by and among  Synopsys, Inc. and certain employees of Registrant                                                                          |
| 2.2.1(1)         |       | Form of  Release of Claims of certain employees of Registrant by Synopsys, Inc.  and Registrant                                                                                                    |
| 2.2.2(1)         |       | Form of  General Release of Synopsys, Inc. and Registrant by certain employees of  Registrant                                                                                                      |
| 2.2.3(1)         |       | Form of  ADEA Waiver by certain employees of Registrant to Synopsys, Inc. and  Registrant                                                                                                          |
| 2.3(1)           |       | Form of  Voting Agreement dated November 30, 2004, by and among Synopsys, Inc.  and officers and directors of Registrant                                                                      |
| 2.3.1(1)         |       | Form of  Voting Agreement dated November 30, 2004, by and among  Synopsys, Inc. and certain other employees of Registrant                                                                     |
| 2.4(1)           |       | Stipulation  to Stay Action and Tolling Agreement dated November 30, 2004 (relating  to the State Court Action) among Synopsys, Inc., certain employees of  Registrant and Registrant              |
| 2.5(1)           |       | Stipulation  to Stay Action and Tolling Agreement dated November 30, 2004 (relating  to Federal Court Action Case No. C-03-2664 SI) among Synopsys, Inc.  and Registrant                      |
| 2.6(1)           |       | Stipulation  to Stay Action and Tolling Agreement dated November 30, 2004 (relating  to Federal Court Action Case No. C-01-2519 SI) among Synopsys, Inc.  and Registrant                      |
| 2.7(1)           |       | Form of  Intellectual Property Assignment Agreement dated November 30, 2004  between Registrant and certain of its employees                                                                       |
| 2.8(1)           |       | Form of  Resignation Letter dated November 30, 2004 by certain employees of  Registrant                                                                                                            |
| 2.9(1)           |       | Form of  Option Relinquishment Agreement dated November 30, 2004 between  Synopsys, Inc. and certain employees of Registrant                                                                  |
| 2.10(1)          |       | Form of  Noncompetition Agreement dated November 30, 2004 by each of An-Chang  Deng and Sang S. Wang                                                                                               |
| 2.10.1(1)        |       | Form of  Noncompetition Agreement dated November 30, 2004 by certain employees of  Registrant                                                                                                      |
| 2.11(1)          |       | Form of  Consulting Agreement dated November 30, 2004 among Synopsys, Inc.,  Registrant and certain employees of Registrant                                                                   |
| 2.12(1)          |       | Form of  Cooperation and Support Agreement dated November 30, 2004 among  Synopsys, Inc., Registrant and certain employees of Registrant                                                      |
| 2.13(1)          |       | Form of  Indemnification Agreement dated November 30, 2004 between Registrant and  certain employees of Registrant                                                                                 |
| 2.13.1(1)        |       | Form of  Amended and Restated Indemnification Agreement dated November 30, 2004  between Registrant and each of An-Chang Deng and Sang S. Wang                                                     |
| 2.14(1)          |       | Form of  Release of Claims of Synopsys, Inc. and Registrant for certain  non-defendant officers and directors of Registrant                                                                        |
| 3.1.1(2)         |       | Amended  and Restated Certificate of Incorporation                                                                                                                                                           |
| 3.2(2)           |       | Bylaws                                                                                                                                                                                                       |
| 10.1(2)          |       | Form of  Indemnification Agreement between the Registrant and each of its directors  and officers                                                                                                       |
| 10.2(2)          |       | Amended  and Restated 1998 Stock Option Plan                                                                                                                                                                 |
| 10.2.1(2)        |       | Form of  Stock Option Agreement under the 1998 Stock Option Plan                                                                                                                                        |
| 10.3(2)          |       | 2001  Stock Option Plan                                                                                                                                                                                      |

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| 10.3.1(2)       |   | Form of  Stock Option Agreement under the 2001 Stock Option Plan                                                                                                                     |
|-----------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.4(2)         |   | 2001  Director Option Plan                                                                                                                                                                |
| 10.4.1(2)       |   | Form of  Director Option Agreement under 2001 Director Option Plan                                                                                                                   |
| 10.5(2)         |   | 2001  Employee Stock Purchase Plan                                                                                                                                                        |
| 10.5.1(2)       |   | Form of  Subscription Agreement under the 2001 Employee Stock Purchase Plan                                                                                                          |
| 10.6(2)         |   | Letter  of Employment dated September 15, 2000 between the Registrant and Tammy  Shu-Hua Liu                                                                                         |
| 10.8(2)†   |   | Exclusive  Distributor Agreement dated October 1, 1999 between the Registrant and  Marubeni Solutions Corporation                                                                    |
| 10.8.1(2)† |   | Amendment  dated November 21, 2000 to Exclusive Distributor Agreement dated  October 1, 1999 between the Registrant and Marubeni Solutions  Corporation                         |
| 10.8.2(3)       |   | Amendment  II dated February 14, 2002 to Exclusive Distributor Agreement dated  October 1, 1999 between the Registrant and Marubeni Solutions  Corporation                      |
| 10.8.3(4)† |   | Amendment  III dated October 1, 2003 to Exclusive Distributor Agreement dated  October 1, 1999 between the Registrant and Marubeni Solutions  Corporation                       |
| 10.9.1(5)       |   | Lease  dated December 20, 2002 between the Registrant and San Tomas Properties,  LLC for the premises located at Second Floor of 2650 San Tomas Expressway,  Santa Clara, California |
| 10.9.2(5)       |   | Addendum  No. 1 to the Lease dated December 20, 2002 between the Registrant  and San Tomas Properties, LLC                                                                      |
| 14.1(4)         |   | Code  of Ethics for Principal Executive and Senior Financial Officers                                                                                                                     |
| 14.2(6)         |   | Amended  and Restated Code of Ethics for Principal Executive and Senior Financial  Officers                                                                                               |
| 21.1            |   | Subsidiaries                                                                                                                                                                              |
| 23.1            |   | Consent  of Independent Registered Public Accounting Firm                                                                                                                                 |
| 24.1            |   | Power  of Attorney (see Page 95)                                                                                                                                                     |
| 31.1            |   | Certifications  of Chief Executive Officer and Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                    |
| 32.1            |   | Certifications  of Chief Executive Officer and Chief Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002                                                    |

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(1)          Incorporated byreference to the exhibits filed with the Registrant’s Current Report on Form 8-K/Aas filed on December 3, 2004.

(2)          Incorporatedby reference to the exhibit bearing the same number filed with the Registrant’sRegistration Statement on Form S-1 (Registration Statement 333-68934),which the Securities and Exchange Commission declared effective on December 12,2001.

(3)          Incorporated byreference to the exhibits filed with the Registrant’s Annual Report on Form 10-Kfor the fiscal year ended September 30, 2002, as filed on December 23,2003.

(4)                     Incorporatedby reference to the exhibit filed with the Registrant’s Annual Report on Form 10-Kfor the fiscal year ended September 30, 2003, as filed on November 26,2003.

(5)          Incorporated by reference to the exhibits filedwith the Registrant’s Quarterly Report on Form 10-Q for the fiscalquarter ended December 31, 2002, as filed on February 14, 2003.

(6)          Incorporated byreference to the exhibit filed with the Registrant’s Current Report on Form 8-Kas filed on April 14, 2004.

†                    Certaininformation in these exhibits has been omitted and filed separately with theSecurities and Exchange Commission pursuant to a confidentialtreatment request under 17 C.F.R. Sections 200.80(b)(4), 200.83 and230.46.

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