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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)



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



For the quarterly period ended June 30, 2004



or



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



For the transition period from  to
.



Commission File No.: 0-33213



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MAGMA DESIGN AUTOMATION, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                        
|-------------------------------------------------------------- |  | ---------------------------------------
|Delaware                                                       |  | 77-0454924                             
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification Number)



5460 Bayfront Plaza

Santa Clara, California 95054

(Address of principal executive offices)



Telephone: (408) 565-7500

(Registrants telephone number, including area code)



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



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).Yes x No ̈



On July 30, 2004, 35,000,797 shares of Registrants Common Stock, $.0001 par value were outstanding.



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##### Table of Contents

MAGMA DESIGN AUTOMATION, INC.



FORM
10-Q



QUARTERLY PERIOD ENDED JUNE 30, 2004



INDEX



| |  |                               |  |               |  |                                                                                                   |  |     
| |  | ----------------------------- |  | ------------- |  | ------------------------------------------------------------------------------------------------- |  | ----
| |  |                               |  |               |  |                                                                                                   |  | Page
| |  | Part I: Financial Information |  | 1            
| |  |                               |  |              
| |  |                               |  | Item 1:       |  | Financial Statements                                                                              |  | 1   
| |  |                               |  |              
| |  |                               |  |               |  | Condensed Consolidated Balance Sheets at June 30, 2004 and March 31, 2004                         |  | 1   
| |  |                               |  |              
| |  |                               |  |               |  | Condensed Consolidated Statements of Operations for the Three Months Ended June 30, 2004 and 2003 |  | 2   
| |  |                               |  |              
| |  |                               |  |               |  | Condensed Consolidated Statements of Cash Flows for the Three Months Ended June 30, 2004 and 2003 |  | 3   
| |  |                               |  |              
| |  |                               |  |               |  | Notes to Condensed Consolidated Financial Statements                                              |  | 4   
| |  |                               |  |              
| |  |                               |  | Item 2:       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations             |  | 13  
| |  |                               |  |              
| |  |                               |  | Item 3:       |  | Quantitative and Qualitative Disclosures About Market Risk                                        |  | 37  
| |  |                               |  |              
| |  |                               |  | Item 4:       |  | Controls and Procedures                                                                           |  | 38  
| |  |                              
| |  | Part II: Other Information    |  | 38           
| |  |                               |  |              
| |  |                               |  | Item 1:       |  | Legal Proceedings                                                                                 |  | 38  
| |  |                               |  |              
| |  |                               |  | Item 2:       |  | Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities                  |  | 39  
| |  |                               |  |              
| |  |                               |  | Item 6:       |  | Exhibits and Reports on Form 8-K                                                                  |  | 40  
| |  |                               | 
| |  |                               |  | Signatures    |  | 41                                                                                               
| |  |                               | 
| |  |                               |  | Exhibit Index |  | 42                                                                                               



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##### Table of Contents

PART I: FINANCIAL INFORMATION



|Item 1. | Financial Statements
|------- | --------------------



MAGMA DESIGN AUTOMATION, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

(unaudited)



|                                           |  |              |          |   |               |   |          |  
|------------------------------------------ |  | ------------ | -------- | - | ------------- | - | -------- | -
|                                           |  | June 30,2004 |          |   | March 31,2004 |  
|ASSETS                                     |  |              |          |   |               |   |          |  
|Current assets:                            |  |              |          |   |               |   |          |  
|Cash and cash equivalents                  |  | $            | 55,391   |   |               | $ | 72,684   |  
|Restricted cash                            |  |              | 2,665    |   |               |   | 2,662    |  
|Short-term investments                     |  |              | 196      |   |               |   |         |  
|Accounts receivable, net                   |  |              | 30,495   |   |               |   | 34,237   |  
|Prepaid expenses and other current assets  |  |              | 9,021    |   |               |   | 9,588    |  
|                                           |  |              |          |   |               |   |          |  
|Total current assets                       |  |              | 97,768   |   |               |   | 119,171  |  
|Property and equipment, net                |  |              | 18,644   |   |               |   | 15,196   |  
|Intangibles, net                           |  |              | 89,466   |   |               |   | 62,793   |  
|Goodwill                                   |  |              | 33,587   |   |               |   | 33,529   |  
|Long-term investments                      |  |              | 95,296   |   |               |   | 78,158   |  
|Other assets                               |  |              | 6,392    |   |               |   | 5,628    |  
|                                           |  |              |          |   |               |   |          |  
|Total assets                               |  | $            | 341,153  |   |               | $ | 314,475  |  
|                                           |  |              |          |   |               |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY       |  |              |          |   |               |   |          |  
|Current liabilities:                       |  |              |          |   |               |   |          |  
|Accounts payable                           |  | $            | 1,707    |   |               | $ | 1,658    |  
|Accrued expenses                           |  |              | 19,175   |   |               |   | 19,132   |  
|Deferred revenue                           |  |              | 23,429   |   |               |   | 19,947   |  
|                                           |  |              |          |   |               |   |          |  
|Total current liabilities                  |  |              | 44,311   |   |               |   | 40,737   |  
|Convertible subordinated notes             |  |              | 150,000  |   |               |   | 150,000  |  
|Deferred income taxes                      |  |              | 15,828   |   |               |   | 5,102    |  
|Other long-term liabilities                |  |              | 1,755    |   |               |   | 897      |  
|                                           |  |              |          |   |               |   |          |  
|Total liabilities                          |  |              | 211,894  |   |               |   | 196,736  |  
|Contingencies (Note 9)                     |  |              |          |   |               |   |          |  
|Stockholders equity:                      |  |              |          |   |               |   |          |  
|Common stock                               |  |              | 3        |   |               |   | 3        |  
|Additional paid-in capital                 |  |              | 242,256  |   |               |   | 226,586  |  
|Deferred stock-based compensation          |  |              | (1,527   | ) |               |   | (718     | )
|Accumulated deficit                        |  |              | (109,598 | ) |               |   | (107,063 | )
|Accumulated other comprehensive loss       |  |              | (1,875   | ) |               |   | (1,069   | )
|                                           |  |              |          |   |               |   |          |  
|Total stockholders equity                 |  |              | 129,259  |   |               |   | 117,739  |  
|                                           |  |              |          |   |               |   |          |  
|Total liabilities and stockholders equity |  | $            | 341,153  |   |               | $ | 314,475  |  
|                                           |  |              |          |   |               |   |          |  



See accompanying notes
to unaudited condensed consolidated financial statements.



1



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##### Table of Contents

MAGMA DESIGN AUTOMATION, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)



|                                                                          |  |                            |        |   |      |   |        |  
|------------------------------------------------------------------------- |  | -------------------------- | ------ | - | ---- | - | ------ | -
|                                                                          |  | Three Months EndedJune 30, |       
|                                                                          |  | 2004                       |        |   | 2003 |  
|Revenue:                                                                  |  |                            |        |   |      |   |        |  
|Licenses                                                                  |  | $                          | 30,892 |   |      | $ | 20,517 |  
|Services                                                                  |  |                            | 5,137  |   |      |   | 2,296  |  
|                                                                          |  |                            |        |   |      |   |        |  
|Total revenue                                                             |  |                            | 36,029 |   |      |   | 22,813 |  
|Cost of revenue*                                                          |  |                            | 5,042  |   |      |   | 3,246  |  
|                                                                          |  |                            |        |   |      |   |        |  
|Gross profit                                                              |  |                            | 30,987 |   |      |   | 19,567 |  
|                                                                          |  |                            |        |   |      |   |        |  
|Operating expenses:                                                       |  |                            |        |   |      |   |        |  
|Research and development                                                  |  |                            | 9,569  |   |      |   | 5,008  |  
|In-process research and development                                       |  |                            | 4,009  |   |      |   |       |  
|Sales and marketing                                                       |  |                            | 11,267 |   |      |   | 7,089  |  
|General and administrative                                                |  |                            | 3,625  |   |      |   | 2,438  |  
|Amortization of intangible assets                                         |  |                            | 4,475  |   |      |   |       |  
|Amortization of stock-based compensation**                                |  |                            | 458    |   |      |   | 3,978  |  
|Restructuring charge                                                      |  |                            | 502    |   |      |   |       |  
|                                                                          |  |                            |        |   |      |   |        |  
|Total operating expenses                                                  |  |                            | 33,905 |   |      |   | 18,513 |  
|                                                                          |  |                            |        |   |      |   |        |  
|Operating income (loss)                                                   |  |                            | (2,918 | ) |      |   | 1,054  |  
|                                                                          |  |                            |        |   |      |   |        |  
|Other income (expense):                                                   |  |                            |        |   |      |   |        |  
|Interest income                                                           |  |                            | 553    |   |      |   | 608    |  
|Interest expense                                                          |  |                            | (246   | ) |      |   | (111   | )
|Other expense, net                                                        |  |                            | (562   | ) |      |   | (753   | )
|                                                                          |  |                            |        |   |      |   |        |  
|Other expense, net                                                        |  |                            | (255   | ) |      |   | (256   | )
|                                                                          |  |                            |        |   |      |   |        |  
|Income (loss) before income taxes                                         |  |                            | (3,173 | ) |      |   | 798    |  
|Benefit from (Provision for) income taxes                                 |  |                            | 638    |   |      |   | (725   | )
|                                                                          |  |                            |        |   |      |   |        |  
|Net income (loss)                                                         |  | $                          | (2,535 | ) |      | $ | 73     |  
|                                                                          |  |                            |        |   |      |   |        |  
|Net income (loss) per common share:                                       |  |                            |        |   |      |   |        |  
|Basic                                                                     |  | $                          | (0.08  | ) |      | $ | 0.00   |  
|                                                                          |  |                            |        |   |      |   |        |  
|Diluted                                                                   |  | $                          | (0.08  | ) |      | $ | 0.00   |  
|                                                                          |  |                            |        |   |      |   |        |  
|Shares used in calculation:                                               |  |                            |        |   |      |   |        |  
|Basic                                                                     |  |                            | 33,671 |   |      |   | 30,764 |  
|                                                                          |  |                            |        |   |      |   |        |  
|Diluted                                                                   |  |                            | 33,671 |   |      |   | 36,152 |  
|                                                                          |  |                            |        |   |      |   |        |  
|* Stock-based compensation included in cost of revenue                    |  | $                          | 4      |   |      | $ | 4      |  
|                                                                          |  |                            |        |   |      |   |        |  
|** Components of stock-based compensation included in operating expenses: |  |                            |        |   |      |   |        |  
|Research and development                                                  |  | $                          | 290    |   |      | $ | 1,559  |  
|Sales and marketing                                                       |  |                            | 25     |   |      |   | 131    |  
|General and administrative                                                |  |                            | 143    |   |      |   | 2,288  |  
|                                                                          |  |                            |        |   |      |   |        |  
|                                                                          |  | $                          | 458    |   |      | $ | 3,978  |  
|                                                                          |  |                            |        |   |      |   |        |  



See accompanying notes
to unaudited condensed consolidated financial statements.



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MAGMA DESIGN AUTOMATION, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                                           |  |                            |         |   |      |   |         |  
|------------------------------------------------------------------------------------------ |  | -------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                           |  | Three Months EndedJune 30, |        
|                                                                                           |  | 2004                       |         |   | 2003 |  
|Cash flows from operating activities:                                                      |  |                            |         |   |      |   |         |  
|Net income (loss)                                                                          |  | $                          | (2,535  | ) |      | $ | 73      |  
|Adjustments to reconcile net income to net cash provided by operating activities:          |  |                            |         |   |      |   |         |  
|Depreciation and amortization                                                              |  |                            | 7,284   |   |      |   | 1,129   |  
|In-process research and development                                                        |  |                            | 4,009   |   |      |   |        |  
|Provision for doubtful accounts                                                            |  |                            | 116     |   |      |   | 45      |  
|Interest expense on convertible subordinated note                                          |  |                            | 245     |   |      |   | 111     |  
|Share in losses of private company investments                                             |  |                            | 331     |   |      |   | 792     |  
|Accrued interest on notes receivable from stockholders                                     |  |                            |        |   |      |   | 8       |  
|Amortization of stock-based compensation                                                   |  |                            | 462     |   |      |   | 3,982   |  
|Restructuring charge                                                                       |  |                            | 502     |   |      |   |        |  
|Deferred income taxes                                                                      |  |                            | (1,153  | ) |      |   |        |  
|Income tax benefit realized from employee stock options                                    |  |                            | 26      |   |      |   |        |  
|Change in operating assets and liabilities:                                                |  |                            |         |   |      |   |         |  
|Accounts receivable                                                                        |  |                            | 2,825   |   |      |   | (3,048  | )
|Prepaid expenses and other assets                                                          |  |                            | 835     |   |      |   | (4,882  | )
|Accounts payable                                                                           |  |                            | 49      |   |      |   | (15     | )
|Accrued expenses                                                                           |  |                            | (4,651  | ) |      |   | 938     |  
|Deferred revenue                                                                           |  |                            | 4,041   |   |      |   | 3,155   |  
|Other long-term liabilities                                                                |  |                            | 82      |   |      |   | (64     | )
|                                                                                           |  |                            |         |   |      |   |         |  
|Net cash provided by operating activities                                                  |  |                            | 12,468  |   |      |   | 2,224   |  
|                                                                                           |  |                            |         |   |      |   |         |  
|Cash flows from investing activities:                                                      |  |                            |         |   |      |   |         |  
|Asset purchases and acquisitions, net of cash acquired                                     |  |                            | (9,089  | ) |      |   |        |  
|Purchase of property and equipment                                                         |  |                            | (4,797  | ) |      |   | (794    | )
|Purchase of short-term investments                                                         |  |                            | (196    | ) |      |   |         |  
|Purchase of long-term investments                                                          |  |                            | (31,452 | ) |      |   | (54,961 | )
|Proceeds from the sale of long-term investments                                            |  |                            | 13,358  |   |      |   |        |  
|Purchase of strategic equity investments                                                   |  |                            | (250    | ) |      |   |        |  
|Restricted cash                                                                            |  |                            | (3      | ) |      |   |        |  
|Other assets                                                                               |  |                            |        |   |      |   | 197     |  
|                                                                                           |  |                            |         |   |      |   |         |  
|Net cash used in investing activities                                                      |  |                            | (32,429 | ) |      |   | (55,558 | )
|                                                                                           |  |                            |         |   |      |   |         |  
|Cash flows from financing activities:                                                      |  |                            |         |   |      |   |         |  
|Net proceeds from issuance of convertible subordinated notes                               |  |                            |        |   |      |   | 145,187 |  
|Proceeds from issuance of common stock                                                     |  |                            | 2,591   |   |      |   | 5,571   |  
|Repurchase of common stock                                                                 |  |                            |        |   |      |   | (19,980 | )
|Purchase of hedge instrument                                                               |  |                            |        |   |      |   | (56,154 | )
|Proceeds from issuance of common stock warrant                                             |  |                            |        |   |      |   | 35,904  |  
|Proceeds from repayment of notes receivable from stockholder                               |  |                            |        |   |      |   | 214     |  
|                                                                                           |  |                            |         |   |      |   |         |  
|Net cash provided by financing activities                                                  |  |                            | 2,591   |   |      |   | 110,742 |  
|                                                                                           |  |                            |         |   |      |   |         |  
|Effect of foreign currency translation on cash and cash equivalents                        |  |                            | 77      |   |      |   | 6       |  
|                                                                                           |  |                            |         |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                                       |  |                            | (17,293 | ) |      |   | 57,414  |  
|Cash and cash equivalents at beginning of period                                           |  |                            | 72,684  |   |      |   | 64,756  |  
|                                                                                           |  |                            |         |   |      |   |         |  
|Cash and cash equivalents at end of period                                                 |  | $                          | 55,391  |   |      | $ | 122,170 |  
|                                                                                           |  |                            |         |   |      |   |         |  
|Supplemental disclosure:                                                                   |  |                            |         |   |      |   |         |  
|Non-cash investing and financing activities:                                               |  |                            |         |   |      |   |         |  
|Deferred stock-based compensation                                                          |  | $                          | (458    | ) |      | $ | (4,288  | )
|                                                                                           |  |                            |         |   |      |   |         |  
|Settlement of note receivable from shareholder in connection with purchase of common stock |  | $                          |        |   |      | $ | (3,566  | )
|                                                                                           |  |                            |         |   |      |   |         |  
|Cash paid for:                                                                             |  |                            |         |   |      |   |         |  
|Taxes                                                                                      |  | $                          |        |   |      | $ | 203     |  
|                                                                                           |  |                            |         |   |      |   |         |  



See accompanying notes
to unaudited condensed consolidated financial statements.



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MAGMA DESIGN AUTOMATION, INC.



NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



Note 1. Basis of Presentation



The interim
unaudited condensed consolidated financial statements included herein have been prepared by Magma Design Automation, Inc. (Magma or the Company), pursuant to the rules and regulations of the United States Securities and
Exchange Commission (SEC). Certain information and note disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed
or omitted, pursuant to these rules and regulations. However, management believes that the disclosures are adequate to ensure that the information presented is not misleading. The interim unaudited condensed consolidated financial statements
reflect, in the opinion of management, all adjustments necessary (consisting only of normal recurring adjustments) to present a fair statement of results for the interim periods presented. The operating results for any interim period are not
necessarily indicative of the results that may be expected for the entire fiscal year ending March 31, 2005. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Companys Form 10-K for
the year ended March 31, 2004, as filed with the SEC on June 8, 2004. The accompanying unaudited condensed consolidated balance sheet at March 31, 2004 is derived from audited consolidated financial statements at that date.



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



Note 2. Stock-Based Compensation



The Company accounts for stock-based employee compensation arrangements in accordance with provisions of APB Opinion No. 25, Accounting for Stock
Issued to Employees, as interpreted by FASB Interpretation No. 44 (FIN 44), Accounting for Certain Transactions Involving Stock Compensationan Interpretation of APB 25 and Emerging Issues Task Force No. 00-23
(EITF 00-23), Issues related to the Accounting for Stock Compensation under APB 25 and FIN 44, and Financial Accounting Standards Board Interpretation (FIN) No. 28, Accounting for Stock Appreciation Rights
and Other Variable Stock Option or Award Plans, and complies with the disclosure provisions of SFAS No. 148, Accounting for Stock-Based CompensationTransition and Disclosurean amendment of SFAS 123. Under APB Opinion
No. 25, compensation expense is based on the difference, if any, on the date of the grant, between the fair value of the Companys stock and the exercise price. SFAS No. 123 as amended by SFAS No. 148 requires a fair value based
method of accounting for an employee stock option or similar equity instrument. Had compensation cost for the Companys stock-based compensation plan been determined using the Black-Scholes option pricing model at the grant date for awards
granted in accordance with the provisions of SFAS No. 123, the Companys net income (loss) would have been the amounts indicated below (in thousands):



|                                                                                                                                |  |                            |        |   |      |   |        |  
|------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------- | ------ | - | ---- | - | ------ | -
|                                                                                                                                |  | Three Months EndedJune 30, |       
|                                                                                                                                |  | 2004                       |        |   | 2003 |  
|Net income (loss) attributed to common stockholders:                                                                            |  |                            |        |   |      |   |        |  
|As reported                                                                                                                     |  | $                          | (2,535 | ) |      | $ | 73     |  
|Add: Stock-based employee compensation expense included in reported net income, net of related tax effects                      |  |                            | 462    |   |      |   | 3,982  |  
|Deduct: Stock-based employee compensation expense determined under fair value method for all awards, net of related tax
effects |  |                            | (5,573 | ) |      |   | (6,576 | )
|                                                                                                                                |  |                            |        |   |      |   |        |  
|Pro forma                                                                                                                       |  | $                          | (7,646 | ) |      | $ | (2,521 | )
|                                                                                                                                |  |                            |        |   |      |   |        |  
|Net income (loss) per share, basic:                                                                                             |  |                            |        |   |      |   |        |  
|As reported                                                                                                                     |  | $                          | (0.08  | ) |      | $ | 0.00   |  
|                                                                                                                                |  |                            |        |   |      |   |        |  
|Pro forma                                                                                                                       |  | $                          | (0.23  | ) |      | $ | (0.08  | )
|                                                                                                                                |  |                            |        |   |      |   |        |  
|Net income (loss) per share, diluted:                                                                                           |  |                            |        |   |      |   |        |  
|As reported                                                                                                                     |  | $                          | (0.08  | ) |      | $ | 0.00   |  
|                                                                                                                                |  |                            |        |   |      |   |        |  
|Pro forma                                                                                                                       |  | $                          | (0.23  | ) |      | $ | (0.08  | )
|                                                                                                                                |  |                            |        |   |      |   |        |  



Such pro forma
disclosures may not be representative of future compensation cost because options vest over several years and additional grants are made each year.



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The weighted average fair value per option at the date of grant for options granted to employees during
the three months ended June 30, 2004 and 2003, was $6.16 and $7.29, respectively. The fair value of options at the date of grant was estimated using the Black-Scholes option pricing model using the following assumptions:



|                               |  |                             |   |  |            |  
|------------------------------ |  | --------------------------- | - |  | ---------- | -
|                               |  | Three Months Ended June 30, |  
|                               |  | 2004                        |   |  | 2003       |  
|Stock options:                 |  |                             |   |  |            |  
|Risk-free interest             |  | 3.00                        | % |  | 2.09       | %
|Expected life                  |  | 2.78 years                  |   |  | 4.75 years |  
|Expected dividend yield        |  | 0                           | % |  | 0          | %
|Volatility                     |  | 44                          | % |  | 73         | %
|                               | 
|                               |  | Three Months Ended June 30, |  
|                               |  | 2004                        |   |  | 2003       |  
|Employee stock purchase plans: |  |                             |   |  |            |  
|Risk-free interest             |  | 1.71                        | % |  | 1.25       | %
|Expected life                  |  | 1.13 years                  |   |  | .37 years  |  
|Expected dividend yield        |  | 0                           | % |  | 0          | %
|Volatility                     |  | 44                          | % |  | 77         | %



Note 3. Basic and Diluted Net
Income (Loss) Per Share



The Company computes net income
per share in accordance with SFAS 128, Earnings per Share. Basic net income (loss) per share is computed by dividing net income attributable to common stockholders (numerator) by the weighted average number of common shares outstanding
(denominator) during the period. Diluted net income per share gives effect to all dilutive potential common shares outstanding during the period including stock options and warrants using the treasury stock method and preferred stock using the
as-if-converted method.



The following is a reconciliation of
the weighted average common shares used to calculate basic net income per share to the weighted average common and potential common shares used to calculate diluted net income per share for the three months ended June 30, 2004 and 2003 (in
thousands):



|                                                                                                   |  |              |  |             
|-------------------------------------------------------------------------------------------------- |  | ------------ |  | ------------
|                                                                                                   |  | June 30,2004 |  | June 30,2003
|Weighted average common shares used to calculate basic net income (loss) per share                 |  | 33,671       |  | 30,764      
|Options outstanding using the treasury method                                                      |  |             |  | 2,401       
|Redeemable convertible subordinated notes using the as-if-converted method                         |  |             |  | 2,812       
|Warrants outstanding using the treasury stock method                                               |  |             |  | 21          
|Common stock subject to repurchase                                                                 |  |             |  | 154         
|                                                                                                   |  |              |  |             
|Weighted average common and potential common shares used to calculate diluted net income per share |  | 33,671       |  | 36,152      
|                                                                                                   |  |              |  |             



For the three months
ended June 30, 2004, all potential common shares outstanding during the period were excluded from the computation of diluted net loss per share as their effect would be anti-dilutive. For the three months ended June 30, 2003, 469,595 shares of
common stock issuable under stock option plans were excluded from the computation of diluted net income per share because their option exercise prices were greater than the average market price, which would result in anti-dilution under the treasury
stock method. The weighted-average exercise price of common stock issuable under stock option plans that were excluded from the computation was $11.53 and $19.50 for the three months ended June 30, 2004 and 2003, respectively.



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##### Table of Contents

Note 4. Cash equivalents and investments



Cash equivalents, short-term investments, and long-term investments are detailed as follows:



|                                       |  |                |         |                  |   |                 |  |   |                      |   |  |   |        
|-------------------------------------- |  | -------------- | ------- | ---------------- | - | --------------- |  | - | -------------------- | - |  | - | -------
|                                       |  | Cost           |         | Unrealized Gains |   | Unrealized Loss |  |   | Estimated Fair Value
|                                       |  | (in thousands)
|June 30, 2004                          |  |                |         |                  |   |                 |  |   |                      |   |  |   |        
|Classified as current assets:          |  |                |         |                  |   |                 |  |   |                      |   |  |   |        
|Cash                                   |  | $              | 31,626  |                  | $ |                |  | $ |                     |   |  | $ | 31,626 
|Money market funds                     |  |                | 3,663   |                  |   |                |  |   |                     |   |  |   | 3,663  
|Municipal obligations                  |  |                | 20,297  |                  |   |                |  |   |                     |   |  |   | 20,297 
|                                       |  |                |         |                  |   |                 |  |   |                      |   |  |   |        
|                                       |  |                | 55,586  |                  |   |                |  |   |                     |   |  |   | 55,586 
|Classified as non-current assets:      |  |                |         |                  |   |                 |  |   |                      |   |  |   |        
|Corporate bonds                        |  |                | 50,588  |                  |   |                |  |   | (484                 | ) |  |   | 50,104 
|Government / Municipal debt securities |  |                | 45,480  |                  |   |                |  |   | (288                 | ) |  |   | 45,192 
|                                       |  |                |         |                  |   |                 |  |   |                      |   |  |   |        
|Total                                  |  | $              | 151,654 |                  | $ |                |  | $ | (772                 | ) |  | $ | 150,882
|                                       |  |                |         |                  |   |                 |  |   |                      |   |  |   |        
|                                       |  |                |         |                 
|                                       |  | Cost           |         | Unrealized Gains |   | Unrealized Loss |  |   | Estimated Fair Value
|                                       |  | (in thousands)
|March 31, 2004                         |  |                |         |                  |   |                 |  |   |                      |   |  |   |        
|Classified as current assets:          |  |                |         |                  |   |                 |  |   |                      |   |  |   |        
|Cash                                   |  | $              | 15,888  |                  | $ |                |  | $ |                     |   |  | $ | 15,888 
|Money market funds                     |  |                | 1,746   |                  |   |                |  |   |                     |   |  |   | 1,746  
|Municipal obligations                  |  |                | 55,050  |                  |   |                |  |   |                     |   |  |   | 55,050 
|                                       |  |                |         |                  |   |                 |  |   |                      |   |  |   |        
|Corporate bonds                        |  |                | 72,684  |                  |   |                |  |   |                     |   |  |   | 72,684 
|Classified as non-current assets:      |  |                | 38,580  |                  |   | 118             |  |   | (10                  | ) |  |   | 38,688 
|Debt securities                        |  |                | 39,394  |                  |   | 88              |  |   | (12                  | ) |  |   | 39,470 
|                                       |  |                |         |                  |   |                 |  |   |                      |   |  |   |        
|Total                                  |  | $              | 150,658 |                  | $ | 206             |  | $ | (22                  | ) |  | $ | 150,842
|                                       |  |                |         |                  |   |                 |  |   |                      |   |  |   |        



Note 5. Asset Purchases



Mojave, Inc.



On April 29, 2004, the Company completed its acquisition of Mojave, Inc.
(Mojave), a privately held developer of advanced technology for integrated circuit manufacturability and verification. The acquisition of Mojave will allow Magma to more comprehensively address its customers needs of designing and
verifying semiconductors that are manufacturable with desirable yield and performance. Manufacturability is a key design parameter as semiconductor process technology moves to sub-90nm geometries. The total initial purchase price of the Mojave
acquisition is currently estimated to be approximately $25.1 million and the transaction has been accounted for as an asset purchase transaction. The Company acquired all of the outstanding common stock of Mojave in exchange for initial
consideration of $24.2 million, which consisted of 607,554 shares of Magma common stock valued at $11.8 million and $12.4 million in cash. In addition to the initial merger consideration, the Company agreed to pay contingent consideration of up to
$115 million, half in stock and half in cash, based on product orders over a period ending March 31, 2009, but such payments are contingent on the achievement of certain technology milestones. We did not assume any stock options or warrants.



Magma allocated the initial purchase price of $25.1 million
less $0.9 million of legal, other professional expenses and other costs directly associated with the acquisition to the fair values of the assets acquired and liabilities assumed. The preliminary fair value of the existing technology and assembled
workforce intangible assets and in-process research and development were determined by management based on preliminary estimates. A summary of the purchase price allocation and the amortization periods of the intangible assets acquired is as follows
(in thousands):



|                                              |  |                  |         |  
|--------------------------------------------- |  | ---------------- | ------- | -
|                                              |  | Amount Allocated |        
|Allocation of the preliminary purchase price: |  |                  |         |  
|Net tangible assets acquired                  |  | $                | 611     |  
|Intangible assets acquired:                   |  |                  |         |  
|Existing technology                           |  |                  | 29,261  |  
|Assembled workforce                           |  |                  | 622     |  
|In-process research and development           |  |                  | 4,009   |  
|Deferred compensation                         |  |                  | 1,320   |  
|Deferred stock-based compensation             |  |                  | 1,254   |  
|Deferred tax liabilities                      |  |                  | (11,953 | )
|                                              |  |                  |         |  
|Total purchase price                          |  | $                | 25,124  |  
|                                              |  |                  |         |  
|Amortization period of existing technology    |  |                  | 5 years |  
|Amortization period of assembled workforce    |  |                  | 4 years |  



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##### Table of Contents

The value assigned to existing technology was based upon future discounted cash flows related to the
existing technologys projected income streams using discount rate of 16%. The Company believes this rate was appropriate given the business risks inherent in marketing and selling this technology. Factors considered in estimating the
discounted cash flows to be derived from the existing technology included risks related to the characteristics and applications of the technology, existing and future markets and an assessment of the age of the technology within its life span.



The valuation method used to value in-process research and
development is a form of discounted cash flow method. This approach is a widely recognized appraisal method and is commonly used to value technology assets. The value of the in-process technology is the sum of the discounted expected future cash
flows attributable to the in-process technology, taking into consideration the percentage of completion of products utilizing this technology, utilization of pre-existing technology, the risks related to the characteristics and applications of the
technology, existing and future markets and the technological risk associated with completing the development of the technology. The cash flows derived from the in-process technology project were discounted at a rate of 30%. The Company believes the
rate used was appropriate given the risks associated with the technologies for which commercial feasibility had not been established. The percentage of completion for the in-process project was determined by identifying the elapsed time and costs
invested in the project as a ratio of the total time and costs required to bring the project to technical and commercial feasibility, as well as consideration of engineering milestones required to complete the project. The percentage of completion
for the in-process project acquired was 12.4%. Schedules were based on managements estimate of tasks completed and the tasks to be completed to bring the project to technical and commercial feasibility. Revenue resulting from IPR&D project
is expected to commence in calendar year 2005.



Development of
in-process technology remains a substantial risk to the Company due to a variety of factors including the remaining effort to achieve technical feasibility, rapidly changing customer requirements and competitive threats from other companies and
technologies. Additionally, the value of other intangible assets acquired may become impaired. The in-process research and development valuation, as well as the valuation of other intangible assets was prepared and determined by management with the
assistance of an independent appraisal firm, based on input from the Company and the acquired companys management, using valuation methods that are recognized by the United States Securities and Exchange Commission staff.



The preliminary purchase price allocation for the Mojave acquisition is
subject to revision as more detailed analysis is completed and additional information on the fair values of Mojaves assets and liabilities become available. Any change in the fair value of the net assets of Mojave will change the amount of the
purchase price allocable to identified intangible assets and IPR&D.



As part of the initial consideration for the Mojave acquisition, the Company paid cash of $1.3 million which was recorded as deferred cash compensation and issued Magma common stock with a value of $1.3 million which was recorded as
deferred stock-based compensation. Both the cash and the shares were unearned on the acquisition date and will be earned based on continued provision of employment services by the former Mojave employees in accordance with pre-defined vesting
schedules which range from 20 to 41 months. Accordingly, both the deferred cash compensation and the deferred stock-based compensation are treated as compensation, are excluded from the allocated purchase price and are charged to operating expense
as services are performed. During the three months ended June 30, 2004, the Company amortized $0.1 million and $0.1 million of deferred cash compensation and deferred stock-based compensation, respectively.



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Other asset purchase



On April 16, 2004, the Company acquired another privately-held company that
was engaged in development of formal verification technology. Pursuant to a merger agreement signed on April 14, 2004, we paid the initial consideration of approximately $600,000 in cash, less $60,000 which we withheld to secure the indemnification
obligations of the acquired companys stockholders. In addition to the initial merger consideration, we may pay up to an additional $1.4 million upon the achievement of certain technology milestones set forth in the merger agreement. No
contingent consideration yet has been paid under the agreement as of June 30, 2004 because the milestone dates have not occurred. This transaction has been accounted for as an asset purchase transaction.



Based on managements estimates and appraisal, the initial consideration
of $600,000 and $76,000 of legal and other professional expenses directly associated with this transaction were entirely allocated to a developed technology intangible asset and included in the intangible asset balance on the Companys
condensed consolidated balance sheet as of June 30, 2004. This developed technology intangible asset is being amortized to cost of revenue over the estimated economic life of three years.



Note 6. Goodwill and Other Intangible Assets



The following table summarizes the components of goodwill, other intangible assets and related accumulated amortization balances as of June
30, 2004 and March 31, 2004 (in thousands):



|                              |  |                       |         |                          |   |         |                    |  |                       |        |                          |   |        |                    |   |        |   |  |   |       
|----------------------------- |  | --------------------- | ------- | ------------------------ | - | ------- | ------------------ |  | --------------------- | ------ | ------------------------ | - | ------ | ------------------ | - | ------ | - |  | - | ------
|                              |  | June 30, 2004         |         | March 31, 2004          
|                              |  | Gross Carrying Amount |         | Accumulated Amortization |   |         | Net CarryingAmount |  | Gross Carrying Amount |        | Accumulated Amortization |   |        | Net CarryingAmount
|Goodwill                      |  | $                     | 33,587  |                          | $ |        |                    |  | $                     | 33,587 |                          | $ | 33,529 |                    | $ |       |   |  | $ | 33,529
|                              |  |                       |         |                          |   |         |                    |  |                       |        |                          |   |        |                    |   |        |   |  |   |       
|Other intangible assets:      |  |                       |         |                          |   |         |                    |  |                       |        |                          |   |        |                    |   |        |   |  |   |       
|Developed technology          |  | $                     | 61,017  |                          | $ | (6,314  | )                  |  | $                     | 54,703 |                          | $ | 29,507 |                    | $ | (3,316 | ) |  | $ | 26,191
|Licensed technology           |  |                       | 22,996  |                          |   | (1,916  | )                  |  |                       | 21,080 |                          |   | 22,988 |                    |   |       |   |  |   | 22,988
|Customer relationship or base |  |                       | 2,200   |                          |   | (309    | )                  |  |                       | 1,891  |                          |   | 2,200  |                    |   | (200   | ) |  |   | 2,000 
|Patents                       |  |                       | 11,582  |                          |   | (1,609  | )                  |  |                       | 9,973  |                          |   | 11,282 |                    |   | (1,032 | ) |  |   | 10,250
|Acquired customer contracts   |  |                       | 900     |                          |   | (212    | )                  |  |                       | 688    |                          |   | 900    |                    |   | (137   | ) |  |   | 763   
|Assembled workforce           |  |                       | 822     |                          |   | (82     | )                  |  |                       | 740    |                          |   | 200    |                    |   | (31    | ) |  |   | 169   
|Trademark                     |  |                       | 400     |                          |   | (74     | )                  |  |                       | 326    |                          |   | 400    |                    |   | (45    | ) |  |   | 355   
|Other                         |  |                       | 100     |                          |   | (35     | )                  |  |                       | 65     |                          |   | 100    |                    |   | (23    | ) |  |   | 77    
|                              |  |                       |         |                          |   |         |                    |  |                       |        |                          |   |        |                    |   |        |   |  |   |       
|Total                         |  | $                     | 100,017 |                          | $ | (10,551 | )                  |  | $                     | 89,466 |                          | $ | 67,577 |                    | $ | (4,784 | ) |  | $ | 62,793
|                              |  |                       |         |                          |   |         |                    |  |                       |        |                          |   |        |                    |   |        |   |  |   |       



For the three months
ended June 30, 2004, amortization expense related to other intangible assets was $5.8 million, of which $1.3 million was included in cost of revenue as they related to the products sold, while the remaining $4.5 million is shown as a separate line
item in the Companys unaudited condensed consolidated statement of operations. For the three months ended June 30, 2003, $0.1 million of other intangible amortization expense was entirely included in cost of revenue as they related to the
products sold during that period.



Note 7. Restructuring charge



During the three months ended June 30, 2004, the Company
recorded a net restructuring charge of $0.5 million related to employee termination costs for 7 employees resulting from the Companys realignment to current business conditions. The Company anticipates that accrued termination costs of $0.6
million as of June 30, 2004 will be paid out by September 30, 2004



Note 8.
Convertible Subordinated Notes



On May 22, 2003, the
Company completed an offering of $150.0 million principal amount of Zero Coupon Convertible Subordinated Notes due May 15, 2008 (the Notes) to qualified buyers pursuant to Rule 144A under the Securities Act of 1933, resulting in net
proceeds to the Company of approximately $145.1 million. The Notes do not bear coupon interest and are convertible into shares of the Companys common stock at a conversion price of $22.86 per share, for an aggregate of 6,561,680 shares. The



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Notes are subordinated to the Companys existing and future senior indebtedness and effectively subordinated to all
indebtedness and other liabilities of the Companys subsidiaries. The Company may not redeem the Notes prior to their maturity date. The Company paid approximately $4.5 million in transaction fees to the underwriters of the offering and
approximately $0.3 million in other debt issuance costs. The Company is amortizing the transaction fees and issuance costs over the life of the Notes using the effective interest method. As of June 30, 2004, approximately $1.3 million of transaction
fees and debt issuance costs had been amortized. The shares issuable on the conversion of the Notes are included in fully diluted shares outstanding for the three months ended June 30, 2003 under the if-converted method of accounting for
purposes of calculating diluted earnings per share. Such shares are excluded from fully diluted shares outstanding for the three months ended June 30, 2004 as their effect would be anti-dilutive.



In order to minimize the dilutive effect from the issuance of the Notes, the
Company undertook the following additional transactions concurrent with the issuance of the Notes:



| |  | The Company repurchased approximately 1.1 million shares of its common stock at a price of $18.00 per share, or approximately $20.0 million, from one of the initial purchasers of
the Notes, and those shares were retired as of May 30, 2003.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The Company and Credit Suisse First Boston International (CSFB International) entered into convertible bond hedge and warrant transactions with respect to the
Companys common stock, the exposure for which is held by CSFB International. Under the convertible bond hedge arrangement, CSFB International agreed to sell to the Company, for $22.86 per share, up to 6,561,680 shares of Magma common stock to
cover the Companys obligation to issue shares upon conversion of the Notes. In addition, the Company issued CSFB International a warrant to purchase up to 6,561,680 shares of common stock for a purchase price of $31.50 per share. Purchases and
sales under this arrangement may be made only upon expiration of the Notes or their earlier conversion (to the extent thereof). Both transactions may be settled at the Companys option either in cash or net shares, and will expire on the
earlier of a conversion event or the maturity of the convertible debt on May 15, 2008. The transactions are expected to reduce the potential dilution from conversion of the Notes. The net cost incurred in connection with these arrangements was
approximately $20.3 million, which is presented in stockholders equity as a reduction of additional paid-in-capital, in accordance with the guidance in Emerging Issues Task Force Issue No. 00-19, Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Companys Own Stock. That net cost consists of the $56.2 million cost of the convertible bond hedge, offset in part by the $35.9 million proceeds from the issuance of the warrant.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Note 9. Contingencies



From time to time, the Company is involved in other disputes that arise in the ordinary
course of business. The number and significance of these disputes is increasing as the Companys business expands and the Company grows larger. Any claims against the Company, whether meritorious or not, could be time consuming, result in
costly litigation, require significant amounts of management time and result in the diversion of significant operational resources. As a result, these disputes could harm the Companys business, financial condition, results of operations or
cash flows.



Indemnification Obligations



The Company enters into standard license agreements in the ordinary course
of business. Pursuant to these agreements, the Company agrees to indemnify its customers for losses suffered or incurred by them as a result of any patent, copyright, or other intellectual property infringement claim by any third party with respect
to the Companys products. These indemnification obligations have perpetual terms. The Companys normal business practice is to limit the maximum amount of indemnification to the amount received from the customer. On occasion, the maximum
amount of indemnification the Company may be required to make may exceed its normal business practices. The Company estimates the fair value of its indemnification obligations as insignificant, based upon its historical experience concerning product
and patent infringement claims. Accordingly, the Company has no liabilities recorded for indemnification under these agreements as of June 30, 2004.



The Company has agreements whereby its officers and directors are indemnified for certain events or occurrences while the officer or director is, or was,
serving at the Companys request in such capacity. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has a directors and officers
insurance policy that reduces its exposure and enables the Company to recover a portion of future amounts paid. As a result of the Companys insurance policy coverage, the Company believes the estimated fair value of these indemnification
agreements is minimal. Accordingly, no liabilities have been recorded for these agreements as of June 30, 2004.



In connection with certain of the Companys recent business acquisitions, it has also agreed to assume, or cause Company subsidiaries to assume, the
indemnification obligations of those companies to their respective officers and directors.



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Warranties



The Company offers its customers a warranty that its products will conform to the documentation provided with the products. To date, there have been no
payments or material costs incurred related to fulfilling these warranty obligations. Accordingly, the Company has no liabilities recorded for these warranties as of June 30, 2004. The Company assesses the need for a warranty reserve on a quarterly
basis, and there can be no guarantee that a warranty reserve will not become necessary in the future.



Note 10. Promissory Note



In October 2001, the Companys President, Mr. Roy Jewell, exercised an option to purchase 428,570 shares of common stock at the exercise price of $10.50 per share by executing a full recourse promissory note of approximately $4.5
million bearing interest of 5.5% per annum and due in March 2006. Terms of the note provided that if Mr. Jewell were still employed by the Company on any anniversary of his date of hire, up to $2.7 million note principal and $0.4 million related
total interest to maturity would be forgiven. The forgivable portion of the note and related interest was recorded as a reduction of notes receivable from stockholders and a charge to deferred compensation, which would be amortized to compensation
expense over the five-year term of the note. On May 14, 2003, the Company repurchased 209,753 shares of common stock from Mr. Jewell for an aggregate purchase price of $3.6 million, or $17.00 per share, which was the closing sale price of the common
stock on that date, and he repaid the principal and related accrued interest outstanding under the promissory note in full.



On May 14, 2003, concurrently with the transaction described above, the Company granted Mr. Jewell an option to purchase 297,393 shares of its common
stock at an exercise price of $7.00 per share, of which the first 209,753 shares vested immediately upon grant and the remaining 87,640 shares vest in equal monthly installments through March 5, 2005. In connection with this option grant, the
Company recognized approximately $2.1 million of stock-based compensation immediately upon grant with respect to the vested shares and recorded $0.9 million of deferred stock-based compensation to be amortized over vesting period of 22 months for
the remaining shares. During the three months ended June 30, 2004 and 2003, the Company amortized $0.1 million and $0.3 million, respectively, of such deferred stock-based compensation.



Note 11. Comprehensive Income (Loss)



Comprehensive income (loss) includes net income attributed to common stockholders, unrealized loss on investments and foreign currency translation
adjustments as follows (in thousands):



|                                                         |  |                            |        |   |      |   |    
|-------------------------------------------------------- |  | -------------------------- | ------ | - | ---- | - | ---
|                                                         |  | Three MonthsEnded June 30,
|                                                         |  | 2004                       |        |   | 2003
|Net income (loss)                                        |  | $                          | (2,535 | ) |      | $ | 73 
|Unrealized gain (loss) on available-for-sale investments |  |                            | (883   | ) |      |   | 66 
|Foreign currency translation adjustments                 |  |                            | 77     |   |      |   | 6  
|                                                         |  |                            |        |   |      |   |    
|Comprehensive income (loss)                              |  | $                          | (3,341 | ) |      | $ | 145
|                                                         |  |                            |        |   |      |   |    



Components of
accumulated other comprehensive loss, net of related tax effect, were as follows (in thousands):



|                                                         |  |              |        |   |               |   |        |  
|-------------------------------------------------------- |  | ------------ | ------ | - | ------------- | - | ------ | -
|                                                         |  | June 30,2004 |        |   | March 31,2004 |  
|Unrealized gain (loss) on available-for-sale investments |  | $            | (772   | ) |               | $ | 111    |  
|Foreign currency translation adjustments                 |  |              | (1,103 | ) |               |   | (1,180 | )
|                                                         |  |              |        |   |               |   |        |  
|Accumulated other comprehensive loss                     |  | $            | (1,875 | ) |               | $ | (1,069 | )
|                                                         |  |              |        |   |               |   |        |  



Note 12. Segment Information



The Company adopted the provisions of SFAS No. 131,
Disclosures about Segments of an Enterprise and Related Information, which requires the reporting of segment information using the management approach. Under this approach, operating segments are identified in substantially
the same manner as they are reported internally and used by the Companys President and Chief Operating Officer (COO) for purposes of evaluating performance and allocating resources. Based on this approach, the Company has one
reportable segment as the COO reviews financial information on a basis consistent with that presented in the condensed consolidated financial statements.



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Revenue from the United States, Europe, Japan and Asia-Pacific region, which includes, India, South
Korea, Taiwan, Hong Kong and the Peoples Republic of China, was as follows (in thousands):



|                               |  |                            |        |   |      |   |        |  
|------------------------------ |  | -------------------------- | ------ | - | ---- | - | ------ | -
|                               |  | Three Months EndedJune 30, |       
|                               |  | 2004                       |        |   | 2003 |  
|United States                  |  | $                          | 22,977 |   |      | $ | 12,625 |  
|Europe                         |  |                            | 4,850  |   |      |   | 5,091  |  
|Japan                          |  |                            | 5,566  |   |      |   | 4,634  |  
|Asia Pacific (excluding Japan) |  |                            | 2,636  |   |      |   | 463    |  
|                               |  |                            |        |   |      |   |        |  
|                               |  | $                          | 36,029 |   |      | $ | 22,813 |  
|                               |  |                            |        |   |      |   |        |  
|                               | 
|                               |  | Three Months EndedJune 30, |       
|                               |  | 2004                       |        |   | 2003 |  
|United States                  |  |                            | 64     | % |      |   | 55     | %
|Europe                         |  |                            | 14     |   |      |   | 23     |  
|Japan                          |  |                            | 15     |   |      |   | 20     |  
|Asia Pacific (excluding Japan) |  |                            | 7      |   |      |   | 2      |  
|                               |  |                            |        |   |      |   |        |  
|                               |  |                            | 100    | % |      |   | 100    | %
|                               |  |                            |        |   |      |   |        |  



Revenue attributable
to significant customers, representing 10% or more of total revenue for at least one of the respective periods, is summarized as follows:



|           |  |                            |   |  |      |  
|---------- |  | -------------------------- | - |  | ---- | -
|           |  | Three Months EndedJune 30, |  
|           |  | 2004                       |   |  | 2003 |  
|Customer A |  | 27                         | % |  | 17   | %
|Customer B |  | 6                          |   |  | 14   |  
|Customer C |  | 5                          |   |  | 11   |  



The Company has
substantially all of its long-lived assets located in the United States.



Note 13. Newly Adopted and Recently Issued Accounting Pronouncements



In December 2003, the FASB issued additional guidance clarifying the provisions of FASB Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 (FIN 46-R). FIN
46-R provides a deferral of FIN 46 for certain entities. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The adoption of this standard for the period ended March 31, 2004
had no material impact on its financial statements.



In
December 2003, the Staff of the Securities and Exchange Commission issued Staff Accounting Bulletin No. 104 (SAB 104), Revenue Recognition, which superseded SAB 101, Revenue Recognition in Financial Statements.
SAB 104s primary purpose is to rescind the accounting guidance contained in SAB 101 related to multiple-element revenue arrangements that was superseded as a result of the issuance of the Emerging Issues Task Force (EITF) 00-21,
Accounting for Revenue Arrangements with Multiple Deliverables. Additionally, SAB 104 rescinds the SECs related Revenue Recognition in Financial Statements Frequently Asked Questions and Answers issued with SAB 101 that
had been codified in SEC Topic 13, Revenue Recognition. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104,
which was effective upon issuance. The adoption of SAB 104 did not have a material effect on our financial position or results of operations.



In March 2004, EITF reached a consensus on recognition and measurement guidance previously discussed under EITF 03-01, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments. The consensus clarifies the meaning of other-than-temporary impairment and its application to investments classified as either available-for-sale or held-to



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maturity under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and
investments accounted for under the cost method or the equity method. The Task Force developed a basic three-step model in evaluating whether an investment is other-than-temporarily impaired and reached a consensus that additional disclosures are
required for cost method investments. The recognition and measurement guidance is applied to other-than-temporary impairment evaluations in reporting periods beginning after June 15, 2004. The application of this consensus effective July 1, 2004 did
not have a material effect on our consolidated results of operations.



In April 2004, the Emerging Issues Task Force issued Statement No. 03-06 Participating Securities and the Two-Class Method Under FASB Statement No. 128, Earnings Per Share (EITF 03-06). EITF 03-06 addresses a
number of questions regarding the computation of earnings per share by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the company when, and if, it
declares dividends on its common stock. The issue also provides further guidance in applying the two-class method of calculating earnings per share, clarifying what constitutes a participating security and how to apply the two-class method of
computing earnings per share once it is determined that a security is participating, including how to allocate undistributed earnings to such a security. EITF 03-06 is effective for periods beginning after March 31, 2004. The adoption of EITF 03-06
did not have a material effect on our financial position or results of operations.



In July 2004, EITF reached a tentative consensus on EITF Issue No. 04-08, The Effect of Contingently Convertible Debt on Diluted Earnings per Share, that the impact of contingently convertible debt, such
as the Companys zero-coupon convertible senior notes, should be included in diluted net income per share computations regardless of whether the market price trigger has been met. If the EITFs tentative consensus is ratified by the FASB,
the provisions are expected to be effective for reporting periods ending after December 15, 2004. We believe that the application of this consensus will not have a material effect on our financial condition or results of operations.



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|ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------



This Managements Discussion and Analysis of Financial Condition and Results of Operation section should be read in
conjunction with Selected Consolidated Financial Data and our condensed consolidated financial statements and results appearing elsewhere in this report. Throughout this section, we make forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. You can often identify these and other forward looking statements by terms such as becoming, may, will,
should, predicts, potential, continue, anticipates, believes, estimates, seeks, expects, plans, intends, or
comparable terminology. These forward-looking statements include, but are not limited to, our expectations about revenue and various operating expenses. Although we believe that the expectations reflected in these forward-looking statements are
reasonable, and we have based these expectations on our beliefs and assumptions, such expectations may prove to be incorrect. Our actual results of operations and financial performance could differ significantly from those expressed in or implied by
our forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to: increasing competition in the electronic design automation market; the continuing impact of the economic recession; any delay
of customer orders or failure of customers to renew licenses; weaker-than-anticipated sales of Magmas products and services; weakness in the semiconductor or electronic systems industries; Magmas ability to manage Magmas expanding
operations; the ability to attract and retain the key management and technical personnel needed to operate Magma successfully; the ability to continue to deliver competitive products to customers to help them get their products to market; and
changes in accounting rules.



Executive Summary



Magma Design Automation provides electronic design automation, or EDA,
software products and related services. Our software enables chip designers to reduce the time it takes to design and produce complex integrated circuits used in the communications, computing, consumer electronics, networking and semiconductor
industries. Our products are used in all major phases of the chip development cycle, from initial design through physical implementation. Our focus is on software used to design the most technologically advanced integrated circuits, specifically
those with a measurement of 0.13 micron and smaller. See Item 1, Business in our Annual Report on Form 10-K for the year ended March 31, 2004 for a more complete description of our business.



As an EDA software provider, we generate substantially all of our revenues
from the semiconductor and electronics industries. Our customers typically fund purchases of our software and services out of their research and development budgets. As a result, our revenues are heavily influenced by our customers long-term
business outlook and willingness to invest in new chip designs.



Beginning in late calendar 2000, the semiconductor industry entered its steepest and longest downturn of the past 20 years, with industry sales dropping significantly from late 2000 to early 2002. As a result, over the past three years our
customers have focused on controlling costs and reducing risk, reducing R&D expenditures, cutting back on design starts, purchasing from fewer suppliers, requiring more favorable pricing and payment terms from suppliers, and pursuing
consolidation within their own industry. Further, during this downturn, many start-up semiconductor design companies failed or were acquired, and the pace of investment in new companies declined.



In response to these conditions, we have focused on providing the most
technologically advanced products to address each step in the integrated circuit, or IC, design process, on integrating these products into broad platforms, and on expanding our product offerings. Our goal is to be the EDA technology supplier of
choice for our customers as they pursue longer-term, broader and more flexible relationships with fewer suppliers.



While the semiconductor industry experienced a moderate recovery in 2003, our customers have remained cautious. It is therefore not yet clear when
improved demand in our own customers electronics end markets will cause them to significantly increase their R&D spending or their design starts, and hence their spending on EDA.



Despite the condition of the semiconductor industry as
described above, we were able to achieve the following during the first quarter of fiscal 2005:



| |  | We achieved record quarterly revenue of $36.0 million during the first quarter of fiscal 2005, up 6 percent from the prior quarter and up 58% from the same quarter in fiscal 2004.
License sales for the quarter ended June 30, 2004 accounted for approximately 86%of total revenue, compared to 87% in the prior quarter and 90% from the same quarter in the prior year. Revenue increased primarily from sales of additional licenses
and services to existing customers in North America and Japan.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  | We continued to penetrate our market, and during the first quarter of fiscal 2005 passed the 150-customer threshold. To take advantage of opportunities to gain market share and
support this growth, we accelerated hiring and have approximately 100 open positions, primarily in the field support organization and R&D.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Our technology continues to be the first choice among designers working on the most advanced designs. Magma customers are working on many 90-nanometer designs, 15 by one of our
major customers alone. We have also incorporated next-generation routing rules to support 65-nanometer designs.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | We successfully completed acquisition of Mojave, Inc. during the quarter. With the acquisition of Mojave, we will be able more comprehensively to address our customers needs
for designing and verifying semiconductors that are manufacturable with desirable yield and performance, which is a key design parameter as semiconductor process technology moves to sub-90nm geometries.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Critical Accounting Policies and Estimates



In preparing our financial statements, we make estimates, assumptions and
judgments that can have a significant impact on our net revenue, operating income or loss and net income or loss, as well as on the value of certain assets and liabilities on our balance sheet. We believe that the estimates, assumptions and
judgments involved in the accounting policies described below have the greatest potential impact on our financial statements, so we consider these to be our critical accounting policies. We consider the following accounting policies related to
revenue recognition, allowance for doubtful accounts, investments, asset purchases and business combinations, deferred taxes and valuation of long-lived assets to be our most critical policies due to the estimation processes involved in each.



Revenue recognition



We recognize revenue in accordance with Statement of Position
(SOP) 97-2, as modified by SOP 98-9, which generally requires revenue earned on software arrangements involving multiple elements (such as software products, upgrades, enhancements, maintenance, installation and training) to be allocated
to each element based on the relative fair values of the elements. The fair value of an element must be based on evidence that is specific to us. If evidence of fair value does not exist for each element of a license arrangement and maintenance is
the only undelivered element, then all revenue for the license arrangement is recognized over the term of the agreement. If evidence of fair value does exist for the elements that have not been delivered, but does not exist for one or more delivered
elements, then revenue is recognized using the residual method, under which recognition of revenue for the undelivered elements is deferred and the residual license fee is recognized as revenue immediately.



Our revenue recognition policy is detailed in Note 1 of the Notes to
Consolidated Financial Statements. Management has made significant judgments related to revenue recognition; specifically, in connection with each transaction involving our products (referred to as an arrangement in the accounting
literature) we must evaluate whether our fee is fixed or determinable and we must assess whether collectibility is probable. These judgments are discussed below.



The fee is fixed or determinable. With respect to each arrangement, we must make a judgment as to whether the
arrangement fee is fixed or determinable. If the fee is fixed or determinable, then revenue is recognized upon delivery of software (assuming other revenue recognition criteria are met). If the fee is not fixed or determinable, then the revenue
recognized in each period (subject to application of other revenue recognition criteria) will be the lesser of the aggregate of amounts due and payable or the amount of the arrangement fee that would have been recognized if the fees had been fixed
or determinable.



Except in cases where we grant extended
payment terms to a specific customer, we have determined that our fees are fixed or determinable at the inception of our arrangements based on the following:



| |  | The fee our customers pay for our products is negotiated at the outset of an arrangement and is generally based on the specific volume of products to be delivered.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Our license fees are not a function of variable-pricing mechanisms such as the number of units distributed or copied by the customer or the expected number of users of the product
delivered.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In order for an arrangement to be
considered fixed or determinable, 100% of the arrangement fee must be due within one year or less from the order date. We have a history of collecting such arrangements fee according to contractual terms. Arrangements with payment terms extending
beyond 12 months are considered not to be fixed or determinable.



Collectiblity is probable. In order to recognize revenue, we must make a judgment of the collectibility of the arrangement fee. Our judgment of the collectibility is applied on a customer-by-customer basis pursuant to our credit
review policy. We typically sell



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to customers for which there is a history of successful collection. New customers are subjected to a credit review
process, which evaluates the customers financial positions and ability to pay. If it is determined from the outset of an arrangement that collectibility is not probable based upon our credit review process, revenue is recognized on a cash
receipts basis (as each payment is collected).



License
revenue



We derive license revenue primarily from
licenses of our design and implementation software and, to a much lesser extent, from licenses of our analysis and verification products. We license our products under time-based and perpetual licenses.



We recognize license revenue after the execution of a license agreement and
the delivery of the product to the customer, provided that there are no uncertainties surrounding the product acceptance, fees are fixed or determinable, collection is probable and there are no remaining obligations other than maintenance. For
licenses where we have vendor-specific objective evidence of fair value VSOE, for maintenance, we recognize license revenue using the residual method. For these licenses, license revenue is recognized in the period in which the license
agreement is executed assuming all other revenue recognition criteria are met. For licenses where we have no VSOE for maintenance, we recognize license revenue ratably over the maintenance period, or if extended payment terms exist, based on the
amounts due and payable.



For transactions in which we bundle
maintenance for the entire license term into a time-based license agreement, no VSOE of fair value exists for each element of the arrangement. For these agreements, where the only undelivered element is maintenance, we recognize revenue ratably over
the contract term. If an arrangement involves extended payment termsthat is, where payment for less than 100% of the license, services and initial post contract support is due within one year of the contract datewe recognize revenue to
the extent of the lesser of the portion of the amount due and payable or the ratable portion of the entire fee.



For our perpetual licenses and some time-based license arrangements, we unbundle maintenance by including maintenance for up to first year of the license
term, with maintenance renewable by the customer at the rates stated in their agreements with us. In these unbundled licenses, the aggregate renewal period is greater than or equal to the initial maintenance period. The stated rate for maintenance
renewal in these contracts is VSOE of the fair value of maintenance in both our unbundled time-based and perpetual licenses. Where the only undelivered element is maintenance, we recognize license revenue using the residual method. If an arrangement
involves extended payment terms, revenue recognized using the residual method is limited to amounts due and payable.



If we were to change any of these assumptions or judgments, it could cause a material increase or decrease in the amount of revenue that we report in a
particular period. Amounts invoiced relating to arrangements where revenue cannot be recognized are reflected on our balance sheet as deferred revenue and recognized over time as the applicable revenue recognition criteria are satisfied.



Services revenue



We derive services revenue primarily from consulting and training for our
software products and from maintenance fees for our products. Most of our license agreements include maintenance, generally for a one-year period, renewable annually. Services revenue from maintenance arrangements is recognized on a straight-line
basis over the maintenance term. Because we have VSOE of fair value for consulting and training services, revenue is recognized as these services are performed or completed. Our consulting and training services are generally not essential to the
functionality of the software. Our products are fully functional upon delivery of the product. Additional factors considered in determining whether the revenue should be accounted for separately include, but are not limited to: degree of risk,
availability of services from other vendors, timing of payments and impact of milestones or acceptance criteria on our ability to recognize the software license fee.



Unbilled Accounts Receivable



Unbilled accounts receivable represent revenue that has been recognized in advance of being invoiced to the customer. In all
cases, the revenue and unbilled receivables are for contracts which are non-cancelable, there are no contingencies and where the customer has taken delivery of both the software and the encryption key required to operate the software. We typically
generate invoices 45 days in advance of contractual due dates, and we invoice the entire amount of the unbilled accounts receivable within one year from the contract inception. As of June 30, 2004 and March 31, 2004, unbilled accounts receivable
were approximately $7.8 million and $14.9 million, respectively. These amounts were included in accounts receivable on our consolidated balance sheets for these periods.



Allowance for doubtful accounts



We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make
required payments. We regularly review the adequacy of our accounts receivable allowance after considering the size of the accounts receivable balance, each customers expected ability to pay and our collection history with each customer. We
review significant invoices that are past due to determine if an allowance is appropriate using the factors described above. We also monitor our accounts receivable for concentration in any one customer, industry or geographic region.



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To date, our receivables have not had any particular concentrations that, if not collected, would have a
significant impact on our operating income. The allowance for doubtful accounts represents our best estimate, but changes in circumstances relating to accounts receivable may result in a requirement for additional allowances in the future. If actual
losses are significantly greater than the reserve we have established, that would increase our general and administrative expenses and reduce our reported net income. Conversely, if actual credit losses are significantly less than our reserve, this
would decrease our general and administrative expenses and our reported net income would increase.



Accounting for asset purchases and business combinations



We are required to allocate the purchase price of acquired assets and business combinations to the tangible and intangible
assets acquired, liabilities assumed, as well as in-process research and development based on their estimated fair values. Such a valuation requires management to make significant estimates and assumptions, especially with respect to intangible
assets.



Critical estimates in valuing certain of the
intangible assets include but are not limited to: future expected cash flows from license sales, maintenance agreements, consulting contracts, customer contracts, acquired workforce and acquired developed technologies and patents; expected costs to
develop the in-process research and development into commercially viable products and estimating cash flows from the projects when completed; the acquired companys brand awareness and market position, as well as assumptions about the period of
time the acquired brand will continue to be used in the combined companys product portfolio; and discount rates. Managements estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain
and unpredictable. Assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur.



Other estimates associated with the accounting for these acquisitions may change as additional information becomes available regarding the assets acquired
and liabilities assumed resulting in changes in the purchase price allocation.



Goodwill impairment



Our long-lived assets include goodwill and other intangible assets. Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, requires that goodwill be tested for impairment at the reporting unit
level (operating segment or one level below an operating segment) on an annual basis and between annual tests in certain circumstances. Application of the goodwill impairment test requires judgment, including the identification of reporting units,
assigning assets and liabilities to reporting units, assigning goodwill to reporting unit, and determining the fair value of the reporting unit. We have determined that we have one reporting segment (see Note 12 of the Notes to the Unaudited
Condensed Consolidated Financial Statements under Item 1 of this report) Significant judgments required to estimate the fair value of a reporting unit include estimating future cash flows, determining appropriate discount rates and other
assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value for the reporting unit. Any impairment losses recorded in the future could have a material adverse impact on our financial condition and
results of operations.



Valuation of long-lived
intangible assets



Statement of Financial Accounting
Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, requires that we record an impairment charge on finite-lived intangibles or long-lived assets to be held and used when we determine that the carrying
value of intangible assets and long-lived assets may not be recoverable. Based on the existence of one or more indicators of impairment, we measure any impairment of intangibles or long-lived assets based on a projected discounted cash flow method
using a discount rate determined by our management to be commensurate with the risk inherent in our business model. Our estimates of cash flows require significant judgment based on our historical results and anticipated results and are subject to
many factors.



Deferred tax asset valuation allowance



We account for income taxes in accordance with SFAS
109, Accounting for Income Taxes. We assess the likelihood that our net deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we establish a valuation allowance. We
consider future taxable income and ongoing prudent and feasible tax planning strategies in assessing the amount of the valuation allowance. However, adjustments could be required in the future if we determine that the amount to be realized is
greater or less than the amount we have recorded.



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Strategic investments in privately held companies



At June 30, 2004, the carrying value of our portfolio of strategic equity
investments in non-marketable equity securities (privately held companies) totaled $1.7 million. Our ability to recover our investments in private, non-marketable equity securities and to earn a return on these investments is primarily dependent on
how successfully these companies are able to execute to their business plans and how well their products are accepted, as well as their ability to obtain additional capital funding to continue operations and to grow. In the current equity market
environment, their ability to obtain additional funding as well as to take advantage of liquidity events, such as initial public offerings, mergers and private sales, may be significantly constrained.



Under our accounting policy, the carrying value of a non-marketable
investment is the amount paid for the investment unless it has been determined to be other than temporarily impaired, in which case we write the investment down to its impaired value. We review all of our investments periodically for impairment;
however, for non-marketable equity securities, the impairment analysis requires significant judgment. This analysis includes assessment of each investees financial condition, the business outlook for its products and technology, its projected
results and cash flows, the likelihood of obtaining subsequent rounds of financing and the impact of any relevant contractual equity preferences held by us or others. If an investee obtains additional funding at a valuation lower than our carrying
amount, we presume that the investment is other than temporarily impaired, unless specific facts and circumstances indicate otherwise, such as when we hold contractual rights that give us a preference over the rights of other investors. As the
equity markets have declined significantly over the past few years, we have experienced substantial impairments in our portfolio of non-marketable equity securities. If equity market conditions do not improve, as companies within our portfolio
attempt to raise additional funds, the funds may not be available to them, or they may receive lower valuations, with more onerous investment terms than in previous financings, and the investments will likely become impaired. However, we are not
able to determine at the present time which specific investments are likely to be impaired in the future, or the extent or timing of individual impairments. We recorded impairment charges related to these non-marketable equity investments of $0.3
million and $0.7 million during the three months ended June 30, 2004 and 2003, respectively.



Results of Operations



Revenue



Revenue consists of licenses
revenue and services revenue. License revenue consists of fees for time-based or perpetual licenses of our products. Services revenue consists of fees for services, such as post-contract customer support (PCS), customer training and
consulting. We recognize revenue based on the specific terms and conditions of the license contracts with our customer for our products and services as described in detail above in our Critical Accounting Policies and Estimates. For
management reporting and analysis purposes we classify our revenues into the following four categories which are described in detail below:



| |  | Ratable
| | - | -------



| |  | Due & Payable
| | - | -------------



| |  | Cash Receipts
| | - | -------------



| |  | Turns or Up-front/ Perpetual.
| | - | -------------------------------



We also classify our license arrangements as either bundled or unbundled. Unbundled license contracts include optional maintenance periods while bundled
contracts do not include optional maintenance periods.



We use
these alternatives to the summary presentation required under generally accepted accounting principles to provide greater insight into the reporting and monitoring of trends in the components of our revenues and to assist us in managing our
business. It is important to note that the characterization of an individual contract may change over time. For example, a contract originally characterized as Ratable may be redefined as Cash Receipts should that customer be having difficulty in
making payments in a timely fashion. In cases where a contract has been re-characterized for management reporting purposes, prior periods are not restated to reflect that change. The following table shows the breakdown of revenue by license category
as defined for management reporting and analysis purposes:



|                       |  |           |  |                             |        |  |      |   |  |   |        |  |     |  
|---------------------- |  | --------- |  | --------------------------- | ------ |  | ---- | - |  | - | ------ |  | --- | -
|                       |  |           |  | Three months ended June 30, |       
|                       |  |           |  | 2004                        |        |  | 2003 |  
|Revenue category:      |  |           |  |                             |        |  |      |   |  |   |        |  |     |  
|License revenues       |  |           |  |                             |        |  |      |   |  |   |        |  |     |  
|Ratable                |  | Bundled   |  | $                           | 4,863  |  | 13   | % |  | $ | 9,582  |  | 42  | %
|Due & Payable          |  | Unbundled |  |                             | 15,352 |  | 43   | % |  |   | 3,770  |  | 16  | %
|Cash Receipts          |  | Unbundled |  |                             | 2,577  |  | 7    | % |  |   | 335    |  | 2   | %
|Turns                  |  | Unbundled |  |                             | 8,100  |  | 23   | % |  |   | 6,830  |  | 30  | %
|                       |  |           |  |                             |        |  |      |   |  |   |        |  |     |  
|Total license revenues |  |           |  |                             | 30,892 |  | 86   | % |  |   | 20,517 |  | 90  | %
|Maintenance & services |  |           |  |                             | 5,137  |  | 14   | % |  |   | 2,296  |  | 10  | %
|                       |  |           |  |                             |        |  |      |   |  |   |        |  |     |  
|Total Revenues         |  |           |  | $                           | 36,029 |  | 100  | % |  | $ | 22,813 |  | 100 | %
|                       |  |           |  |                             |        |  |      |   |  |   |        |  |     |  



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Bundled Licenses: RatableFor bundled time-based licenses that bundle maintenance with the license
fee and do not provide for optional maintenance terms, we recognize license revenue ratably over the contract term, or as customer payments become due and payable, if less. All of these revenues for both license and the maintenance are classified as
license revenue in our statement of operations. For unbundled time-based with a term of less than fifteen (15) months, we recognize license revenue ratably over the license term, or as customer payments become due and payable, if less. For
management reporting and analysis purposes, we refer to these types of licenses generally as Ratable. Additionally we generally refer to all time-based licenses recognized on a ratable basis as Long Term, independent of the
actual length of term of the license.



For unbundled time-based
or perpetual licenses, with a term of fifteen months or greater, we categorize these license contracts based on the payment term structure and classify them either as Due and Payable or Cash Receipts defined as follows:



Unbundled Licenses: Due and Payable/Time-based licenses
with long term payments:For unbundled time-based licenses which include optional maintenance where the payment terms do not fall within one year, we recognize license revenue on a due and payable basis. Maintenance revenue for an unbundled
agreement is recognized ratably over the maintenance term and is included in the services line of our statement of operations. For management reporting and analysis purposes, we refer to this type of license generally as Due and Payable/Long
Term Time-Based Licenses.



Unbundled Licenses: Cash
Receipts.We recognize revenue from customers who have not met our predetermined credit criteria on a cash receipts basis to the extent that revenue has otherwise been earned. Such customers generally order short-term time based licenses or
separate annual maintenance. License revenue is recognized as we receive cash payments from the customer. Maintenance is recognized ratably over the maintenance term after the customer has remitted payment and is classified as services in our
statement of operations. For management reporting and analysis purposes, we refer to this type of license generally as Cash Receipts.



Unbundled Licenses: Turns/Perpetual or Time-based licenses with short-term payments.We recognize license revenue on unbundled
time-based and perpetual licenses, upon shipment as long as the payment terms require the customer to pay 100% of license fee and initial period of PCS within one year from the agreement date and payments are generally linear or front-end loaded.
Maintenance is purchased separately, generally on an annual basis and the agreements provide for optional maintenance in subsequent years. Maintenance revenue is recognized ratably over the maintenance term and is classified as services in our
statement of operations. In all of these cases, the contracts are non-cancelable, and the customer has taken delivery of both the software and the encryption key required to operate the software. For management reporting and analysis purposes, we
refer to this type of license generally as either Perpetual or Upfront Time-Based Licenses.



Our license revenue in any given quarter is dependent upon the mix and volume of perpetual or short term time-based licenses ordered during the quarter
and the amount of long term ratable or due and payable, and cash receipts license revenue recognized during the quarter. In general, we refer to license revenue recognized from perpetual or short term time based licenses during the quarter as
up-front or turns revenue, for management reporting and analysis purposes. All other types of revenue are generally referred to as from backlog. We set our revenue targets for any given period based, in part, upon an assumption that we will achieve
a certain level of orders and a certain license mix of short term licenses. The precise mix of orders fluctuates substantially from period to period and affects the revenue we recognize in the period. If we achieve our target level of total orders
but are unable to achieve our target license mix, we may not meet our revenue targets (if we have more-than-expected long term licenses) or may exceed them (if we have more-than-expected short term or perpetual licenses). If we achieve the target
license mix but the overall level of orders is below the target level, then we may not meet our revenue targets as described in the risk factors below.



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Three Months Ended June 30, 2004 and 2003



Revenue, cost of revenue and gross profit



The table below sets forth the fluctuations in revenue, cost of revenue and gross profit data for the three months ended
June 30, 2003 and the three months ended June 30, 2004 (in thousands, except percentage data):



|                |  |                                 |        |                     |       |   |                                 |   |                     |  |       |                     |  |                    |        |  |       |  
|--------------- |  | ------------------------------- | ------ | ------------------- | ----- | - | ------------------------------- | - | ------------------- |  | ----- | ------------------- |  | ------------------ | ------ |  | ----- | -
|                |  | Three MonthsEnded June 30, 2004 |        | PercentageOfRevenue |       |   | Three MonthsEnded June 30, 2003 |   | PercentageofRevenue |  |       | Year toYearIncrease |  | IncreasePercentage |       
|Revenue:        |  |                                 |        |                     |       |   |                                 |   |                     |  |       |                     |  |                    |        |  |       |  
|Licenses        |  | $                               | 30,892 |                     | 85.7  | % |                                 | $ | 20,517              |  | 89.9  | %                   |  | $                  | 10,375 |  | 50.6  | %
|Services        |  |                                 | 5,137  |                     | 14.3  | % |                                 |   | 2,296               |  | 10.1  | %                   |  |                    | 2,841  |  | 123.7 | %
|                |  |                                 |        |                     |       |   |                                 |   |                     |  |       |                     |  |                    |        |  |       |  
|Total revenue   |  |                                 | 36,029 |                     | 100.0 | % |                                 |   | 22,813              |  | 100.0 | %                   |  |                    | 13,216 |  | 57.9  | %
|                |  |                                 |        |                     |       |   |                                 |   |                     |  |       |                     |  |                    |        |  |       |  
|Cost of revenue |  |                                 | 5,042  |                     | 14.0  | % |                                 |   | 3,246               |  | 14.2  | %                   |  |                    | 1,796  |  | 55.3  | %
|                |  |                                 |        |                     |       |   |                                 |   |                     |  |       |                     |  |                    |        |  |       |  
|Gross profit    |  | $                               | 30,987 |                     | 86.0  | % |                                 | $ | 19,567              |  | 85.8  | %                   |  | $                  | 11,420 |  | 58.4  | %
|                |  |                                 |        |                     |       |   |                                 |   |                     |  |       |                     |  |                    |        |  |       |  



We market our products
and related services to customers in four geographic regions: the United States, Europe (Europe, the Middle East and Africa), Japan, and Asia Pacific. Internationally, we market our products and services primarily through our subsidiaries and
various distributors. Revenues are attributed to geographic areas based on the country in which the customer is domiciled. The table below sets forth geographic distribution of revenue data for the three months ended June 30, 2003 and the three
months ended June 30, 2004 (in thousands, except percentage data):



|                               |  |                                 |        |                     |       |   |                                 |   |                     |  |       |                                |  |   |                                |   |  |       |   
|------------------------------ |  | ------------------------------- | ------ | ------------------- | ----- | - | ------------------------------- | - | ------------------- |  | ----- | ------------------------------ |  | - | ------------------------------ | - |  | ----- | --
|                               |  | Three MonthsEnded June 30, 2004 |        | PercentageofRevenue |       |   | Three MonthsEnded June 30, 2003 |   | PercentageofRevenue |  |       | Year toYearIncrease (decrease) |  |   | Percentage Increase (decrease) |  
|Domestic                       |  | $                               | 22,977 |                     | 63.8  | % |                                 | $ | 12,625              |  | 55.3  | %                              |  | $ | 10,352                         |   |  | 82.0  | % 
|                               |  |                                 |        |                     |       |   |                                 |   |                     |  |       |                                |  |   |                                |   |  |       |   
|International:                 |  |                                 |        |                     |       |   |                                 |   |                     |  |       |                                |  |   |                                |   |  |       |   
|Europe                         |  |                                 | 4,850  |                     | 13.5  | % |                                 |   | 5,091               |  | 22.3  | %                              |  |   | (241                           | ) |  | (4.7  | )%
|Japan                          |  |                                 | 5,566  |                     | 15.4  | % |                                 |   | 4,634               |  | 20.3  | %                              |  |   | 932                            |   |  | 20.1  | % 
|Asia-Pacific (excluding Japan) |  |                                 | 2,636  |                     | 7.3   | % |                                 |   | 463                 |  | 2.1   | %                              |  |   | 2,173                          |   |  | 469.3 | % 
|                               |  |                                 |        |                     |       |   |                                 |   |                     |  |       |                                |  |   |                                |   |  |       |   
|Total International            |  |                                 | 13,052 |                     | 36.2  | % |                                 |   | 10,188              |  | 44.7  | %                              |  |   | 2,864                          |   |  | 28.1  | % 
|                               |  |                                 |        |                     |       |   |                                 |   |                     |  |       |                                |  |   |                                |   |  |       |   
|Total revenue                  |  | $                               | 36,029 |                     | 100.0 | % |                                 | $ | 22,813              |  | 100.0 | %                              |  | $ | 13,216                         |   |  | 57.9  | % 
|                               |  |                                 |        |                     |       |   |                                 |   |                     |  |       |                                |  |   |                                |   |  |       |   



Revenue



| |  | Revenue for the first quarter of fiscal 2005 was $36.0 million, up 6 percent from the prior quarter and up 58% from the same quarter in the prior year.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | License revenue increased in the first quarter of fiscal 2005 as compared to the prior quarter and the first quarter in fiscal 2004 due to large orders executed during the
quarter in North America and Japan. These orders came from existing customers who require additional license capacity due to the continued proliferation to their design group designers using Magma existing and new products, principally Blast Fusion
APX. One customer accounted for greater than 10% of the quarterly revenue. License revenue for the quarter ended June 30, 2004 accounted for approximately 86% of total revenue, compared to 87% in the prior quarter and 90% from the first quarter in
fiscal 2004.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Service revenue increased in the first quarter of fiscal 2005 as compared to the prior quarter and the first quarter in fiscal 2004 primarily due to our large customers
accelerating their deployment of our licenses and placing additional services orders. Service revenue for the quarter ended June 30, 2004 accounted for approximately 14% of total revenue, which was consistent with the prior quarter and 10% from the
first quarter in fiscal 2004.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

| |  | Domestic revenue increased in the first quarter of fiscal 2005 as compared to the prior quarter and the first quarter in fiscal 2004 due primarily to our existing customers
in North America purchasing additional licenses and the new technology products. Domestic revenue for the quarter ended June 30, 2004 accounted for approximately 64% of total revenue, compared to 56% in the prior quarter and 55% from the first
quarter in fiscal 2004.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | International revenue increased in the first quarter of fiscal 2005 compared to the first quarter of fiscal 2004 due primarily to our existing customers in Japan and
Asia-Pacific purchasing additional licenses and the addition of new technology products. International revenue for the first quarter of fiscal 2005 accounted for approximately 36% of total revenue, compared to 44% in the prior quarter and 45% from
the first quarter in fiscal 2004. The decline in international revenue as a percentage of revenue in the first quarter of fiscal 2005 was primarily due to the greater growth of our domestic revenue compared to that of international revenue during
the period.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Gross profit



Cost of revenue primarily consists of personnel and
related costs to provide product support, consulting services and training. Cost of revenue also includes software production costs, product packaging, documentation, amortization of acquired developed technology and other intangible assets, and
amortization of deferred stock-based compensation. Management allocates these expenses to cost of upfront licenses, cost of time-based licenses and cost of services, based on orders booked within a given quarter. Accordingly, the costs allocated to
upfront licenses, time-based licenses and services are heavily dependent on the mix of software orders received during any given period.



| |  | Gross profit as a percentage of revenueremained relatively stable during the three months ended June 30, 2004 compared to the three months ended June 30, 2003 despite
license revenue, which has a higher gross margin compared to service revenue, accounted for a lower percentage of total revenue for the period. This was due to the growth in total revenue for the three months ended June 30, 2004 and that our cost of
revenue consists primarily of payroll related costs for application engineers, which are fixed in nature.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Operating expenses



The table below sets forth operating expense data for the three months ended June 30, 2003 and the three months ended June 30, 2004 (in thousands, except
percentage data):



|                                         |  |                                 |        |                     |      |   |                                 |   |                     |  |      |                               |  |   |                              |   |  |       |   
|---------------------------------------- |  | ------------------------------- | ------ | ------------------- | ---- | - | ------------------------------- | - | ------------------- |  | ---- | ----------------------------- |  | - | ---------------------------- | - |  | ----- | --
|                                         |  | Three MonthsEnded June 30, 2004 |        | PercentageofRevenue |      |   | Three MonthsEnded June 30, 2003 |   | PercentageofRevenue |  |      | Year toYearIncrease(Decrease) |  |   | Increase(Decrease)Percentage |  
|Operating expenses:                      |  |                                 |        |                     |      |   |                                 |   |                     |  |      |                               |  |   |                              |   |  |       |   
|Research and development                 |  | $                               | 9,569  |                     | 26.6 | % |                                 | $ | 5,008               |  | 22.0 | %                             |  | $ | 4,561                        |   |  | 91.1  | % 
|In-process research and development      |  |                                 | 4,009  |                     | 11.1 | % |                                 |   |                    |  | 0.0  | %                             |  |   | 4,009                        |   |  | 100.0 | % 
|Sales and marketing                      |  |                                 | 11,267 |                     | 31.3 | % |                                 |   | 7,089               |  | 31.1 | %                             |  |   | 4,178                        |   |  | 58.9  | % 
|General and administrative               |  |                                 | 3,625  |                     | 10.1 | % |                                 |   | 2,438               |  | 10.7 | %                             |  |   | 1,187                        |   |  | 48.7  | % 
|Restructuring costs                      |  |                                 | 502    |                     | 1.4  | % |                                 |   |                    |  | 0.0  | %                             |  |   | 502                          |   |  | 100.0 | % 
|Amortization of intangible assets        |  |                                 | 4,475  |                     | 12.4 | % |                                 |   |                    |  | 0.0  | %                             |  |   | 4,475                        |   |  | 100.0 | % 
|Amortization of stock-based compensation |  |                                 | 458    |                     | 1.3  | % |                                 |   | 3,978               |  | 17.4 | %                             |  |   | (3,520                       | ) |  | (88.5 | )%
|                                         |  |                                 |        |                     |      |   |                                 |   |                     |  |      |                               |  |   |                              |   |  |       |   
|Total operating expenses                 |  | $                               | 33,905 |                     | 94.1 | % |                                 | $ | 18.513              |  | 81.2 | %                             |  | $ | 15,392                       |   |  | 83.1  | % 
|                                         |  |                                 |        |                     |      |   |                                 |   |                     |  |      |                               |  |   |                              |   |  |       |   



| |  | Research and development expense increased in the three months ended June 30, 2004 compared to the three months ended June 30, 2003 primarily due to an increase in payroll
related expenses of $2.9 million as we more than doubled our research and development headcount through direct hiring as well as business acquisitions. The remainder of the increase was caused by increases in common expenses (e.g., facility related
expenses) of $1.0 million and software maintenance costs of $0.6 million, both of which were caused by the headcount increase. The remainder of the fluctuation in research and development expenses was accounted for by other individually
insignificant items.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In-process research and development expense of $4.0 million for the three months ended June 30, 2004 represents the charge recorded in connection with our acquisition of
Mojave, Inc.. The charge was recorded based on managements preliminary purchase price allocation.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

| |  | Sales and marketing expense increased in the three months ended June 30, 2004 compared to the three months ended June 30, 2003 primarily due to an increase in payroll related
expenses of $3.8 million as we increased our sales and marketing headcount by 56% (primarily application engineers) through direct hiring as well as business acquisitions. Travel and entertainment expenses also increased by $0.5 million in the three
months ended June 30, 2004 due to the increases in the headcount and sales activity. The remainder of the fluctuation in sales and marketing expenses was accounted for by other individually insignificant items.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | General and administrative expense increased in the three months ended June 30, 2004 compared to the three months ended June 30, 2003 primarily due to increases in
professional service fees of $0.7 million and payroll related expenses of $0.6 million. The increase in professional service fees in the three months ended June 30, 2004 was primarily due to the increase in our activity related to the Sarbanes-Oxley
Act of 2002, as well as legal expenses related to patent applications. The increase in payroll related expenses was caused by the increase in headcount related to general and administrative activities, which increased by 79% in the three months
ended June 30, 2004 compared to the three months ended June 30, 2003. The remainder of the fluctuation in general and administrative expenses was accounted for by other individually insignificant items.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Restructuring costs of $0.5 million in the three months ended June 30, 2004 represents a $0.5 million charge recorded in connection with employee terminations.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Amortization of intangible assets of $4.5 million in the three months ended June 30, 2004 represents amortization of intangible assets recorded in connection with business
combinations and asset purchases completed subsequent to June 30, 2003. The intangible assets being amortized include trademarks, customer contracts, customer relationships, no ship rights and assembled workforces that were identified in the
purchase price allocation for each business combination and asset purchase transaction.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Amortization of deferred stock-based compensation decreased in the three months ended June 30, 2004 compared to the three months ended June 30, 2003 primarily due the
decrease in amortization of deferred stock-based compensation (recorded in connection with our IPO in November 2001) of $1.5 million. Amortization of deferred stock-based compensation for the three months ended June 30, 2003 also included $2.1
million of stock-based compensation charge related to the stock option granted to the President of the Company in that period. No such charge was recorded for the three months ended June 30, 2004. These decreases in amortization of deferred
stock-based compensation was offset by recording of stock-based compensation expense of $0.1 million related to our Mojave acquisition in the three months ended June 30, 2004.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Other items



The table below sets forth other data for the three months ended June 30,
2003 and the three months ended June 30, 2004 (in thousands, except percentage data):



|                                          |  |                                 |      |   |                     |      |    |                                 |   |      |                     |  |      |                   |  |   |                              |   |  |       |   
|----------------------------------------- |  | ------------------------------- | ---- | - | ------------------- | ---- | -- | ------------------------------- | - | ---- | ------------------- |  | ---- | ----------------- |  | - | ---------------------------- | - |  | ----- | --
|                                          |  | Three MonthsEnded June 30, 2004 |      |   | PercentageofRevenue |      |    | Three MonthsEnded June 30, 2003 |   |      | PercentageofRevenue |  |      | Year toYearchange |  |   | PercentageIncrease(Decrease) |  
|Other income (expense), net:              |  |                                 |      |   |                     |      |    |                                 |   |      |                     |  |      |                   |  |   |                              |   |  |       |   
|Interest income                           |  | $                               | 553  |   |                     | 1.5  | %  |                                 | $ | 608  |                     |  | 2.7  | %                 |  | $ | (55                          | ) |  | (9.0  | )%
|Interest expense                          |  |                                 | (246 | ) |                     | (0.7 | )% |                                 |   | (111 | )                   |  | (0.5 | )%                |  |   | (135                         | ) |  | 121.6 | % 
|Other expense, net                        |  |                                 | (562 | ) |                     | (1.6 | )% |                                 |   | (753 | )                   |  | (3.3 | )%                |  |   | 191                          |   |  | (25.4 | )%
|                                          |  |                                 |      |   |                     |      |    |                                 |   |      |                     |  |      |                   |  |   |                              |   |  |       |   
|Total other expense, net                  |  | $                               | (255 | ) |                     | (0.7 | )% |                                 | $ | (256 | )                   |  | (1.1 | )%                |  | $ | 1                            |   |  | 0.4   | % 
|                                          |  |                                 |      |   |                     |      |    |                                 |   |      |                     |  |      |                   |  |   |                              |   |  |       |   
|Benefit from (provision for) income taxes |  | $                               | 638  |   |                     | 1.8  | %  |                                 | $ | (725 | )                   |  | (3.2 | )%                |  | $ | 1,363                        |   |  | 188.0 | % 
|                                          |  |                                 |      |   |                     |      |    |                                 |   |      |                     |  |      |                   |  |   |                              |   |  |       |   



| |  | Interest income decreased slightly in the three months ended June 30, 2004 compared to the three months ended June 30, 2003 primarily due to our maintaining lower average
cash and investments balance during the period. The average cash balance during the three months ended June 30, 2003 was higher as we received $124 million of net proceeds in connection with our convertible subordinated debt offering, common stock
warrant and bond hedge transactions, all of which were completed in May 2003.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

| |  | Interest expense represents amortization of debt discount and issuance costs, which were recorded in connection with our convertible subordinated debt offering completed in
May 2003. The increase in amortization of debt discount and issuance costs in the three months ended June 30, 2004 was primarily due to having a full quarters worth of amortization during that period compared to having amortization only for a
part of the quarter for the three months ended June 30, 2003.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Other expense, net in the three months ended June 30, 2004 decreased compared to the three months ended June 30, 2003 primarily due to the decrease in the charge associated
with other than temporary impairment in our strategic investments by $0.4 million. Such charge was determined based on our periodic review of investee company financial performance. The decrease in the charge for our strategic investments was offset
by an increase in foreign exchange loss of $0.2 million, which was caused by an unfavorable exchange rate fluctuation between the U.S. Dollar and the Japanese Yen as well as the U.S. Dollar and the Euro during the three months ended June 30, 2004.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Benefit from (provision for) income taxes. We are in a net deferred tax asset position, which has been fully reserved. We will continue to provide a valuation allowance for
our deferred tax assets until it becomes more likely than not that the deferred tax assets will be realizable. The Company will continue to evaluate the realizability of the deferred tax assets on a quarterly basis. For the three months ended June
30, 2004, we had a benefit from income taxes of $0.6 million. The net benefit was comprised of a deferred tax benefit of $1.1 million related to the amortization of intangible assets, current federal income taxes of $0.2 million, foreign income
taxes of $0.2 million, and state income taxes of $0.1 million. For the three months ended June 30, 2003, we had a provision for income taxes of $0.7 million which primarily consisted of foreign and state income taxes. Our effective tax rate varies
from the U.S. statutory rate primarily due to changes in our valuation allowance, state taxes, foreign income at other than U.S. rates, deferred compensation, in-process R&D, and foreign withholding taxes.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Liquidity and Capital Resources



At June 30, 2004, our principal source of liquidity was our cash and cash
equivalents and investments. We had $55.4 million in unrestricted cash and cash equivalents, and $95.5 million in short and long-term investments. Our investment portfolio consists primarily of fixed-income securities, with maturities of two years
or less, diversified among industries and individual issuers. Our investments are generally liquid, investment grade securities.



On July 28, 2004, we announced that our board of directors authorized Magma to repurchase up to 1,000,000 shares of common stock. Repurchase of our common
stock will be made from time to time in private transactions or open market purchases in accordance with the securities laws and other legal requirements. The program may be discontinued at any time without prior notice. The repurchased shares are
expected to be used for Magmas employee benefit plans; any portion of the repurchased shares not used for that purpose will be available for other general corporate purposes. No time limit was set for the completion of the program.



On April 29, 2004, we completed its acquisition of Mojave, Inc.
(Mojave), a privately held developer of advanced technology for integrated circuit manufacturability and verification. The acquisition of Mojave will allow Magma to more comprehensively address its customers needs of designing and
verifying semiconductors that are manufacturable with desirable yield and performance. Manufacturability is a key design parameter as semiconductor process technology moves to sub-90nm geometries. The total initial purchase price of the Mojave
acquisition is currently estimated to be approximately $25.1 million and the transaction has been accounted for as an asset purchase transaction. We acquired all of the outstanding common stock of Mojave in exchange for initial consideration of
$24.2 million, which consisted of 607,554 shares of Magma common stock valued at $11.8 million and $12.4 million in cash. In addition to the initial merger consideration, we agreed to pay contingent consideration of up to $115 million, half in stock
and half in cash, based on product orders over a period ending March 31, 2009, but such payments are contingent on the achievement of certain technology milestones. No contingent consideration yet has been paid under the agreement because the
milestone dates have not occurred.



On April 16, 2004, we
acquired another privately held company that was engaged in development of formal verification technology, for cash consideration of approximately $600,000, less $60,000 withheld to secure indemnification obligations. In addition, we may pay up to
an additional $1.4 million upon the achievement of technology milestones set forth in the acquisition agreement. No contingent consideration yet has been paid under the agreement because the milestone dates have not occurred.



On May 22, 2003, we issued $150.0 million principal amount of our Zero Coupon
Convertible Subordinated Notes due May 15, 2008 (the Notes) resulting in net proceeds to us of approximately $145.1 million. The Notes do not bear coupon interest and are convertible into shares of our common stock at an initial
conversion price of $22.86 per share, for an aggregate of approximately 6.56 million shares. The Notes are subordinated to our existing and future senior indebtedness and effectively subordinated to all indebtedness and other liabilities of our
subsidiaries. We may not redeem the Notes prior to their maturity date. In order to minimize



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the dilutive effect from the issuance of the Notes, we undertook the following additional transactions concurrent with
the issuance of the Notes:



| |  | We repurchased approximately 1.1 million shares of common stock at a price of $18.00 per share, or approximately $20.0 million, from one of the initial purchasers of the Notes, and
those shares were retired as of May 30, 2003.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | We entered into convertible bond hedge and warrant transactions with Credit Suisse First Boston International (CSFB International) with respect to our common stock.
Under the convertible bond hedge arrangement, CSFB International agreed to sell us, for $22.86 per share, up to 6.56 million shares of our common stock to cover our obligation to issue shares upon conversion of the Notes. In addition, we issued CSFB
International a warrant to purchase up to 6.56 million shares of common stock for a purchase price of $31.50 per share. Purchases and sales under this arrangement may be made only upon expiration of the Notes or their earlier conversion (to the
extent thereof). Both transactions may be settled at our option either in cash or net shares, and will expire on the earlier of a conversion event or the maturity of the convertible debt on May 15, 2008. The net cost incurred in connection with
these arrangements, which consists of the $56.2 million cost of the convertible bond hedge, offset in part by the $35.9 million proceeds from the issuance of the warrant, was approximately $20.3 million.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The table below (in thousands) sets forth the key components of cash flow for
the three months ended June 30, 2004 and 2003:



|                                          |  |                             |         |   |      |   |         |  
|----------------------------------------- |  | --------------------------- | ------- | - | ---- | - | ------- | -
|                                          |  | Three Months Ended June 30, |        
|                                          |  | 2004                        |         |   | 2003 |  
|Net cash provided by operating activities |  | $                           | 12,395  |   |      | $ | 2,224   |  
|Net cash used in investing activities     |  | $                           | (32,356 | ) |      | $ | (55,558 | )
|Net cash provided by financing activities |  | $                           | 2,591   |   |      | $ | 110,742 |  



Three months
ended June 30, 2004



During the three months ended
June 30, 2004, our operating activities provided net cash of $12.4 million. Cash was provided by net income adjusted for non-cash related items and changes in working capital including decreases in accounts receivable and prepaid expenses and other
assets and an increase in deferred revenue. The decrease in accounts receivable was primarily due to strong cash collection during the three months ended June 30, 2004. A detail of our accounts receivable balance as of June 30, 2004 is provided
below (in millions, except for percentages):



Gross
accounts receivable balance and their due dates



|                          |  |                        |               |   |           |               |      |   |               |   |     |               |  |   |     |   |  |   |     |  
|------------------------- |  | ---------------------- | ------------- | - | --------- | ------------- | ---- | - | ------------- | - | --- | ------------- |  | - | --- | - |  | - | --- | -
|                          |  | Balance atJune 30,2004 |               |   | Due Dates |              
|                          |  |                        | Q2Fiscal 2005 |   |           | Q3Fiscal 2005 |      |   | Q4Fiscal 2005 |   |     | Q1Fiscal 2006 | 
|Billed                    |  | $                      | 23.1          |   |           | $             | 23.1 |   |               | $ |    |               |  | $ |    |   |  | $ |    |  
|Percentage due            |  |                        |               |   |           |               | 100  | % |               |   |    |               |  |   |    |   |  |   |    |  
|                          |  |                        |               |   |          
|Unbilled                  |  |                        | 7.8           |   |           |               | 4.5  |   |               |   | 2.3 |               |  |   | 0.9 |   |  |   | 0.1 |  
|                          |  |                        |               |   |           |               |      |   |               |   |     |               |  |   |     |   |  |   |     |  
|Percentage due            |  |                        | 100           | % |           |               | 58   | % |               |   | 29  | %             |  |   | 12  | % |  |   | 1   | %
|                          |  |                        |               |   |          
|Gross accounts receivable |  | $                      | 30.9          |   |           | $             | 27.6 |   |               | $ | 2.3 |               |  | $ | 0.9 |   |  | $ | 0.1 |  
|                          |  |                        |               |   |           |               |      |   |               |   |     |               |  |   |     |   |  |   |     |  
|Percentage due            |  |                        |               |   |           |               | 89   | % |               |   | 7   | %             |  |   | 3   | % |  |   | 1   | %



Gross billed
accounts receivable balance and their aging



|                                         |  |                        |         |   |                           |                   |      |   |                    |   |     |                    |  |   |     |   |  |   |     |  
|---------------------------------------- |  | ---------------------- | ------- | - | ------------------------- | ----------------- | ---- | - | ------------------ | - | --- | ------------------ |  | - | --- | - |  | - | --- | -
|                                         |  | Balance atJune 30,2004 |         |   | Aging as of June 30, 2004 |                  
|                                         |  |                        | Current |   |                           | > 30 daysPast Due |      |   | > 60 daysPast Due* |   |     | > 90 daysPast Due* | 
|Billed accounts receivable               |  | $                      | 23.1    |   |                           | $                 | 19.8 |   |                    | $ | 0.2 |                    |  | $ | 0.2 |   |  | $ | 2.9 |  
|                                         |  |                        |         |   |                           |                   |      |   |                    |   |     |                    |  |   |     |   |  |   |     |  
|Percentage of billed accounts receivable |  |                        | 100     | % |                           |                   | 86   | % |                    |   | 1   | %                  |  |   | 1   | % |  |   | 12  | %

---

|* | Of $2.9 million that is more than 90 days past due as of June 30, 2004, no revenue has been recognized on $1.9 million and $0.4 million is fully reserved in allowance for doubtful
accounts.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The decrease in prepaid and other assets was primarily
caused by decreases in prepaid commission expense and prepaid software maintenance expense. Prepaid commission decreased during the first quarter fiscal 2005 primarily due to orders recorded by us in fiscal 2003 of approximately $100 million for
which we paid advance commissions but the entire order value has not been recognized as revenue as of June 30, 2004. We expect advance commission to decrease in fiscal 2005 as these orders are recognized as revenue.



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Cash provided by the changes in accounts receivable, prepaid and other assets and deferred revenue was
offset by a decrease in accrued liabilities during the three months ended June 30, 2004, which was primarily caused by a payout of accrued bonuses during the period.



Our investing activities used net cash of $32.4 million during the three months ended June 30, 2004. We used cash to
complete the Mojave and other asset purchase transactions during the three months ended June 30, 2004 in order to broaden our product offerings and to incorporate certain key technologies into our existing products and paid a total of $9.1 million
in cash, net of cash acquired. We also made strategic investment of $0.3 million in a privately held technology companies for business and strategic purposes. We may make additional strategic equity investments in the future by using our cash and
cash equivalents and investments. We had a net purchase of $18.2 million of short and long-term investments as we invested our excess cash resources. During the three months ended June 30, 2004, we acquired property and equipment totaling $4.8
million. The property and equipment expenditures were primarily for purchases of computer equipment and research and development tools to support our growing operations. We expect to make capital expenditures of approximately $9.8 million for the
remainder of fiscal 2005. These capital expenditures will be used to support selling and marketing and product development activities. We will use our cash and cash equivalents and investments to fund these purchases.



Our financing activities provided net cash of $2.6 million for the three
months ended June 30, 2004. The sole source of cash was $2.6 million of cash received from the exercise of stock options and shares purchased under the employee stock purchase plan during the period.



Three months ended June 30, 2003



Net cash provided by operating activities was $2.2 million for the three
months ended June 30, 2003, compared to net cash used of $1.4 million for the three months ended June 30, 2002. For the three months ended June 30, 2003, cash flow from operating activities included increases in deferred revenue of $3.2 million and
accrued expenses of $0.9 million, net of acquired balances. These increases were offset by increases in accounts receivable of $3.0 million and prepaid expenses of $4.9 million. For the three months ended June 30, 2002, cash flow from activities
included increases in accounts receivable of $1.4 million, net of acquired balances and accounts payable of $0.9 million, net of acquired balances. These increases were offset by decreases in prepaid expenses of $0.4 million, accrued expenses of
$3.5 million, and deferred revenue of $3.2 million. In addition, significant non-cash related adjustments for the three months ended June 30, 2003 and 2002 included depreciation and amortization of $1.1 million and $1.2 million, respectively,
amortization of stock-based compensation of $4.0 million and $1.9 million and provisions for doubtful accounts of $45,000 and $300,000.



Net cash used by investing activities was $55.6 million for the three months ended June 30, 2003, compared to net cash provided of $11.7 million for the
three months ended June 30, 2002. Of the cash used by investing activities for the three months ended June 30, 2003, $55.0 million was used for the purchase of investments, $0.8 million was used for purchases of property and equipment and $0.2
million was provided from other assets. For the three months ended June 30, 2002, $13.5 million cash was provided from proceeds from sales of investments offset by purchases of property and equipment of $1.3 million and $0.4 million was used for
purchases of other assets.



Cash provided by financing
activities was $110.7 million and $1.3 million for the three months ended June 30, 2003 and June 30, 2002, respectively. Cash provided by financing activities for the three months ended June 30, 2003 consisted of net proceeds from convertible
subordinated notes of $145.2 million and cash received from exercises of stock options of $5.6 million. In addition, we repurchased 1,110,000 shares at $18 per share for an aggregate amount of $20.0 million. We also used $56.2 million for the
purchase of a hedge and sold a warrant for $35.9 million related to our issuance of convertible subordinated notes. For the three months ended June 30, 2002, cash provided of $1.3 million was due to proceeds from the exercise of stock options.



Capital resources



We believe that our existing cash and cash equivalents and long-term
investments will be sufficient to meet our anticipated operating and working capital expenditure requirements in the ordinary course of business for at least the next 12 months. If we require additional capital resources to grow our business
internally or to acquire complementary technologies and businesses at any time in the future, we may use cash or need to sell additional equity or debt securities. The sale of additional equity or convertible debt securities may result in more
dilution to our existing stockholders. Financing arrangements may not be available to us, or may not be available in amounts or on terms acceptable to us.



Our acquisition agreements related to certain business combination and asset purchase transactions obligate us to pay certain contingent cash compensation
based on continued employment and meeting certain revenue or project milestones. As of June 30, 2004, total cash contingent compensation that could be paid under our acquisition agreements assuming all contingencies are met is $78.8 million.



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Contractual obligations



As of June 30, 2004, our principal commitments consisted of operating leases, the future amount of which was $13.3 million
through fiscal 2011 for office facilities, and repayment of the convertible subordinated notes of $150.0 million due in fiscal 2009. Although we have no material commitments for capital expenditures, we anticipate a substantial increase in our
capital expenditures and lease commitments with our anticipated growth in operations, infrastructure, and personnel.



The following summarizes our contractual obligations at June 30, 2004, and the effect such obligations are expected to have on our liquidity and cash
flows in future periods (in millions):



|                              |  |                        |       |                 |   |          |  |          |     |              |   |       |  |   |    
|----------------------------- |  | ---------------------- | ----- | --------------- | - | -------- |  | -------- | --- | ------------ | - | ----- |  | - | ---
|                              |  | Payments due by period
|Contractual Obligations       |  | Total                  |       | Less than1 year |   | 1-3Years |  | 4-5Years |     | After 5Years
|Operating lease obligations   |  | $                      | 13.3  |                 | $ | 2.8      |  | $        | 4.2 |              | $ | 4.1   |  | $ | 2.2
|Convertible subordinated note |  |                        | 150.0 |                 |   |         |  |          |    |              |   | 150.0 |  |   |   
|Strategic equity investment   |  |                        | 0.3   |                 |   | 0.3      |  |          |    |              |   |      |  |   |   
|                              |  |                        |       |                 |   |          |  |          |     |              |   |       |  |   |    
|Total                         |  | $                      | 163.6 |                 | $ | 3.1      |  | $        | 4.2 |              | $ | 154.1 |  | $ | 2.2
|                              |  |                        |       |                 |   |          |  |          |     |              |   |       |  |   |    



In addition to the
enforceable and legally binding obligations quantified in the table above, we have other obligations for goods and services entered into in the normal course of business. These obligations, however, either are not enforceable or legally binding or
are subject to change based on our business decisions.



Off-balance Sheet Arrangements



Our
off-balance sheet arrangements consist solely of operating leases as described above.



Indemnification Obligations



We enter into standard license agreements in the ordinary course of business. Pursuant to these agreements, we agree to indemnify our customers for losses suffered or incurred by them as a result of any patent,
copyright, or other intellectual property infringement claim by any third party with respect to our products. These indemnification obligations have perpetual terms. Our normal business practice is to limit the maximum amount of indemnification to
the amount received from the customer. On occasion, the maximum amount of indemnification we may be required to make may exceed its normal business practices. We estimate the fair value of its indemnification obligations as insignificant, based on
our historical experience concerning product and patent infringement claims. Accordingly, we have no liabilities recorded for indemnification under these agreements as of June 30, 2004.



We have agreements whereby our officers and directors are indemnified for certain events or occurrences while the officer or
director is, or was, serving at our request in such capacity. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have a directors and officers insurance
policy that reduces our exposure and enables us to recover a portion of future amounts paid. As a result of our insurance policy coverage, we believe the estimated fair value of these indemnification agreements is minimal. Accordingly, no
liabilities have been recorded for these agreements as of June 30, 2004.



In connection with recent business acquisitions, we agreed to assume, or cause our subsidiaries to assume, indemnification obligations to the officers and directors of acquired companies.



Warranties



We offer our customers a warranty that our products will conform to the
documentation provided with the products. To date, there have been no payments or material costs incurred related to fulfilling these warranty obligations. Accordingly, we have no liabilities recorded for these warranties as of June 30, 2004. We
assess the need for a warranty reserve on a quarterly basis, and there can be no guarantee that a warranty reserve will not become necessary in the future.



Newly Adopted and Recently Issued Accounting Pronouncements



In December 2003, the FASB issued additional guidance clarifying the provisions of FASB Interpretation No. 46, Consolidation of Variable Interest
Entities, an Interpretation of ARB No. 51 (FIN 46-R). FIN 46-R provides a deferral of FIN 46 for certain entities. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the



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equity investors in the entity do not have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The adoption of this standard for the period ended March 31, 2004 had no material impact on its financial
statements.



In December 2003, the Staff of the Securities and
Exchange Commission issued Staff Accounting Bulletin No. 104 (SAB 104), Revenue Recognition, which superseded SAB 101, Revenue Recognition in Financial Statements. SAB 104s primary purpose is to rescind the
accounting guidance contained in SAB 101 related to multiple-element revenue arrangements that was superseded as a result of the issuance of the Emerging Issues Task Force (EITF) 00-21, Accounting for Revenue Arrangements with
Multiple Deliverables. Additionally, SAB 104 rescinds the SECs related Revenue Recognition in Financial Statements Frequently Asked Questions and Answers issued with SAB 101 that had been codified in SEC Topic 13,
Revenue Recognition. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104, which was effective upon issuance.
The adoption of SAB 104 did not have a material effect on our financial position or results of operations.



In March 2004, EITF reached a consensus on recognition and measurement guidance previously discussed under EITF 03-01, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments. The consensus clarifies the meaning of other-than-temporary impairment and its application to investments classified as either available-for-sale or held-to-maturity
under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and investments accounted for under the cost method or the equity method. The Task Force developed a basic three-step model in evaluating whether an
investment is other-than-temporarily impaired and reached a consensus that additional disclosures are required for cost method investments. The recognition and measurement guidance is applied to other-than-temporary impairment evaluations in
reporting periods beginning after June 15, 2004. The application of this consensus effective July 1, 2004 did not have a material effect on our consolidated results of operations.



In April 2004, the Emerging Issues Task Force issued Statement No. 03-06 Participating Securities and the Two-Class
Method Under FASB Statement No. 128, Earnings Per Share (EITF 03-06). EITF 03-06 addresses a number of questions regarding the computation of earnings per share by companies that have issued securities other than common
stock that contractually entitle the holder to participate in dividends and earnings of the company when, and if, it declares dividends on its common stock. The issue also provides further guidance in applying the two-class method of calculating
earnings per share, clarifying what constitutes a participating security and how to apply the two-class method of computing earnings per share once it is determined that a security is participating, including how to allocate undistributed earnings
to such a security. EITF 03-06 is effective for periods beginning after March 31, 2004. The adoption of EITF 03-06 did not have a material effect on our financial position or results of operations.



In July 2004, EITF reached a tentative consensus on EITF Issue No. 04-08,
The Effect of Contingently Convertible Debt on Diluted Earnings per Share, that the impact of contingently convertible debt, such as the Companys zero-coupon convertible senior notes, should be included in diluted net income per
share computations regardless of whether the market price trigger has been met. If the EITFs tentative consensus is ratified by the FASB, the provisions are expected to be effective for reporting periods ending after December 15, 2004. We
believe that the application of this consensus will not have a material effect on our financial condition or results of operations.



FACTORS THAT MAY AFFECT OUR BUSINESS AND FUTURE RESULTS OF OPERATIONS AND FINANCIAL CONDITION



Our business faces many risks. The risks described below may not be the only risks we face. Additional risks that we do
not yet know of or that we currently think are immaterial may also impair our business operations. If any of the events or circumstances described in the following risks actually occur, our business, financial condition or results of operations
could suffer, and the trading price of our common stock could decline.



Our limited operating history makes it difficult to evaluate our business and prospects.



We were incorporated in April 1997 and introduced our first principal software product, Blast Fusion, in April 1999. We have a limited history of
generating revenue from our software products, and the revenue and income potential of our business and market is still unproven. As a result of our short operating history, we have limited financial data that can be used to evaluate our business.
We have only been profitable for seven of the last eight fiscal quarters, and we were not profitable prior to fiscal 2003. Our software products represent a new approach to the challenges presented in the electronic design automation market, which
to date has been dominated by established companies with longer operating histories. Key markets within the electronic design automation industry may fail to adopt our proprietary technologies and software products. Any evaluation of our business
and our prospects must be considered in light of our limited operating history and the risks and uncertainties often encountered by relatively young companies.



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We have a history of losses prior to fiscal 2003 and have an accumulated deficit of approximately $109.6 million as of
June 30, 2004; if we do not increase profitability, the public trading price of our stock would be likely to decline.



We had an accumulated deficit of approximately $109.6 million as of June 30, 2004. Although we achieved profitability in fiscal 2003 and fiscal 2004, we
incurred losses in prior years. If we incur new losses, or do not increase profitability at a level expected by securities analysts or investors, the market price of our common stock is likely to decline. If we incur net losses, we may not be able
to maintain or increase our number of employees or our investment in capital equipment, sales, marketing, and research and development programs, and we may not be able to continue to operate.



Our quarterly results are difficult to predict, and if we miss quarterly financial
expectations, our stock price could decline.



Our
quarterly revenue and operating results are difficult to predict, and fluctuate from quarter to quarter. It is likely that our operating results in some periods will be below investor expectations. If this happens, the market price of our common
stock is likely to decline. Fluctuations in our future quarterly operating results may be caused by many factors, including:



| |  | size and timing of customer orders, which are received unevenly and unpredictably throughout a fiscal year;
| | - | -----------------------------------------------------------------------------------------------------------



| |  | the mix of products licensed and types of license agreements;
| | - | -------------------------------------------------------------



| |  | our ability to recognize revenue in a given quarter;
| | - | ----------------------------------------------------



| |  | timing of customer license payments
| | - | -----------------------------------



| |  | the relative mix of time-based licenses bundled with maintenance, unbundled time-based license agreements and perpetual license agreements, each of which has different revenue
recognition practices;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | size and timing of revenue recognized in advance of actual customer billings and customers with graduated payment schedules which may result in higher accounts receivable balances
and DSO;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the relative mix of our license and services revenues;
| | - | ------------------------------------------------------



| |  | our ability to win new customers and retain existing customers;
| | - | ---------------------------------------------------------------



| |  | changes in our pricing and discounting practices and licensing terms and those of our competitors;
| | - | --------------------------------------------------------------------------------------------------



| |  | changes in the level of our operating expenses, including increases in incentive compensation payments that may be associated with future revenue growth;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | changes in the interpretation of the authoritative literature under which we recognize revenue;
| | - | -----------------------------------------------------------------------------------------------



| |  | the timing of product releases or upgrades by us or our competitors; and
| | - | ------------------------------------------------------------------------



| |  | the integration, by us or our competitors, of newly-developed or acquired products.
| | - | -----------------------------------------------------------------------------------



Customer payment defaults may cause us to be unable to recognize revenue from backlog, and changes in the type of orders comprising
backlog could affect the proportion of revenue recognized from backlog each quarter, which could have a material adverse effect on our financial condition and results of operations and on investor expectations.



As of June 30, 2004, we had approximately $300 million in backlog, which we
define as non-cancelable contractual commitments by our customers through purchase orders or contracts. A portion of this backlog is variable based on volume of usage of our products by the customers or includes specific future deliverables or is
recognized in revenue on a cash receipts basis. Management has estimated variable usage based on customers forecasts, but there can be no assurance that these estimates will be realized. In addition, it is possible that customers from whom we
expect to derive revenue from backlog will default and as a result we may not be able to recognize expected revenue from backlog. If a customer defaults and fails to pay amounts owed, or if the level of defaults increases, our bad debt expense is
likely to increase. Any material payment default by our customers could have a material adverse effect on our financial condition and results of operations.



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Our lengthy and unpredictable sales cycle, and the large size of some orders, makes it difficult for us to forecast
revenue and increases the magnitude of quarterly fluctuations, which could harm our stock price.



Customers for our software products typically commit significant resources to evaluate available software. The complexity of our products requires us to
spend substantial time and effort to assist potential customers in evaluating our software and in benchmarking it against our competition. As the complexity of the products we sell increases, we expect the sales cycle to lengthen. In addition,
potential customers may be limited in their current spending by existing time-based licenses with their legacy vendors. In these cases, customers delay a significant new commitment to our software until the term of the existing license has expired.
Also, because our products require a significant investment of time and cost by our customers, we must target those individuals within the customers organization who are able to make these decisions on behalf of their companies. These
individuals tend to be senior management in an organization, typically at the vice president level. We may face difficulty identifying and establishing contact with such individuals. Even after initial acceptance, the negotiation and documentation
processes can be lengthy. Our sales cycle typically ranges between three and nine months, but can be longer. Any delay in completing sales in a particular quarter could cause our operating results to fall below expectations.



We rely on a small number of customers for a significant portion of our revenue, and our
revenue could decline due to delays of customer orders or the failure of existing customers to renew licenses or if we are unable to maintain or develop relationships with current or potential customers.



Our business depends on sales to a small number of customers. In the three
months ended June 30, 2004, we had one customer that accounted for 27% of our revenue. In the twelve months ended March 31, 2004, we had two customers that accounted for 10% or more of our revenue, and that together accounted for approximately 24%
of our revenue. In the twelve months ended March 31, 2003, we had two customers that each accounted for more than 10% of our revenue and that together accounted for approximately 30% of our revenue.



We expect that we will continue to depend upon a relatively small number of
customers for a substantial portion of our revenue for the foreseeable future. If we fail to sell sufficient quantities of our products and services to one or more customers in any particular period, or if a large customer reduces purchases of our
products or services, defers orders, or fails to renew licenses, our business and operating results will be harmed.



Most of our customers license our software under time-based licensing agreements, with terms that typically vary from 15 months to 48 months. Most of our
license agreements automatically expire at the end of the term unless the customer renews the license with us or purchases a perpetual license. If our customers do not renew their licenses, we may not be able to maintain our current revenue or may
not generate additional revenue. Some of our license agreements allow customers to terminate an agreement prior to its expiration under limited circumstancesfor example, if our products do not meet specified performance requirements or goals.
If these agreements are terminated prior to expiration or we are unable to collect under these agreements, our revenue may decline.



Some contracts with extended payment terms provide for payments which are weighted toward the later part of the contract term. Accordingly, as the payment
terms are extended, the revenue from these contracts is not recognized evenly over the contract term, but is recognized as the lesser of the cumulative amounts due and payable or ratably for bundled agreements, and as amounts become due and payable
for unbundled agreements, at each period end. Revenue recognized under these arrangements will be higher in the later part of the contract term, which puts our revenue recognition in the future at greater risk of the customers continuing
credit-worthiness. In addition, some of our customers have extended payment terms, which creates additional credit risk.



We compete against companies that hold a large share of the electronic design automation market. If we cannot compete successfully, we will not gain market share.



We currently compete with companies that hold dominant
shares in the electronic design automation market, such as Cadence and Synopsys. Each of these companies has a longer operating history and significantly greater financial, technical and marketing resources than we do, as well as greater name
recognition and larger installed customer bases. Our competitors are better able to offer aggressive discounts on their products, a practice they often employ. Our competitors offer a more comprehensive range of products than we do; for example, we
do not offer logic simulation, formal or layout verification, full-feature custom layout editing, analog or mixed signal products, which can sometimes be an impediment to our winning a particular customer order. In addition, our industry has
traditionally viewed acquisitions as an effective strategy for growth in products and market share and our competitors greater cash resources and higher market capitalization may give them a relative advantage over us in buying companies with
promising new chip design products or companies that may be too large for us to acquire without a strain on our resources. Further consolidation in the electronic design automation market could result in an increasingly competitive environment.
Competitive pressures may prevent us from gaining market share, require us to reduce the price of products and services or cause us to lose existing customers, which could harm our business. To execute our business strategy successfully, we must
continue to increase our sales worldwide. If we fail to do so in a timely manner or at all, we may not be able to gain market share and our business and operating results could suffer.



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Also, a variety of small companies continue to emerge, developing and introducing new products. Any of
these companies could become a significant competitor in the future. We also compete with the internal chip design automation development groups of our existing and potential customers. Therefore, these customers may not require, or may be reluctant
to purchase, products offered by independent vendors.



Our
competitors may develop or acquire new products or technologies that have the potential to replace our existing or new product offerings. The introduction of these new or additional products by competitors may cause potential customers to defer
purchases of our products. If we fail to compete successfully, we will not gain market share and our business will fail.



We may not be successful in integrating the operations of acquired companies and acquired technology.



We expect to continuously evaluate the possibility of accelerating our
growth through acquisitions, as is customary in the electronic design automation industry. Achieving the anticipated benefits of past and possible future acquisitions will depend in part upon whether we can integrate the operations, products and
technology of acquired companies with our operations, products and technology in a timely and cost-effective manner. The process of integrating with acquired companies and acquired technology is complex, expensive and time-consuming, and may cause
an interruption of, or loss of momentum in, the product development and sales activities and operations of both companies. In addition, the earnout arrangements we use, and expect to continue to use, to consummate some of our acquisitions, pursuant
to which we agreed to pay additional amounts of contingent consideration based on the achievement of certain revenues, bookings or product development milestones, can sometimes complicate integration efforts. We cannot be sure that any part or all
of the integration will be accomplished on a timely basis, or at all. Assimilating previously acquired companies such as Silicon Metrics Corporation and Mojave, Inc. or any other companies we may seek to acquire in the future, involves a number of
other risks, including, but not limited to:



| |  | adverse effects on existing customer relationships, such as cancellation of orders or the loss of key customers;
| | - | ----------------------------------------------------------------------------------------------------------------



| |  | difficulties in integrating or an inability to retain key employees of the acquired company;
| | - | --------------------------------------------------------------------------------------------



| |  | the risk that earnouts based on revenues will prove difficult to administer due to the complexities of revenue recognition accounting;
| | - | --------------------------------------------------------------------------------------------------------------------------------------



| |  | the risk that actions incentivized by earnout provisions will ultimately prove not to be in Magmas best interest as its interests may change over time;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | difficulties in integrating the operations of the acquired company, such as information technology resources, manufacturing processes, and financial and operational data;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | difficulties in integrating the technologies of the acquired company into our products;
| | - | ---------------------------------------------------------------------------------------



| |  | diversion of management attention;
| | - | ----------------------------------



| |  | potential incompatibility of business cultures;
| | - | -----------------------------------------------



| |  | potential dilution to existing stockholders if we have to incur debt or issue equity securities to pay for any future acquisitions; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------



| |  | additional expenses associated with the amortization of intangible assets.
| | - | --------------------------------------------------------------------------



We may not be able to hire the number of qualified engineering personnel required for our business, particularly field application engineering personnel, which would
harm our ability to grow.



We continue to experience
difficulty in hiring and retaining skilled engineers with appropriate qualifications to support our growth strategy. Our success depends on our ability to identify, hire, train and retain qualified engineering personnel with experience in integrated
circuit design. Specifically, we need to continue to attract and retain field application engineers to work with our direct sales force to technically qualify new sales opportunities and perform design work to demonstrate our products
capabilities to customers during the benchmark evaluation process. Competition for qualified engineers is intense, particularly in Silicon Valley where our headquarters is located. If we lose the services of a significant number of our engineers or
we cannot hire additional engineers, we will be unable to increase our sales or implement or maintain our growth strategy.



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Because many of our current competitors have pre-existing relationships with our current and potential customers, we
might not be able to gain market share, which could harm our operations.



Many of our competitors, including Cadence and Synopsys, have established relationships with our current and potential customers and can devote substantial resources aimed at preventing us from establishing or
enhancing our customer relationships. These existing relationships can make it difficult for us to obtain additional customers due to the substantial investment that these potential customers have already made in their current design flows. If we
are unable to gain market share due to these relationships with our potential customers, our operating results could be harmed.



Our operating results will be significantly harmed if chip designers do not adopt Blast Fusion and Blast Fusion APX.



Blast Fusion and Blast Fusion APX have accounted for a significant majority
of our revenue since our inception and we believe that revenue from Blast Fusion and Blast Fusion APX and related products will account for most of our revenue for the foreseeable future. If integrated circuit designers do not continue to adopt
Blast Fusion and Blast Fusion APX, our operating results will be significantly harmed. We must continue market penetration of Blast Fusion and Blast Fusion APX to achieve our growth strategy and financial success.



If the industries into which we sell our products experience recession or other cyclical
effects affecting our customers research and development budgets, our revenue would be likely to decline.



Demand for our products is driven by new integrated circuit design projects. The demand from semiconductor and systems companies is uncertain and
difficult to predict. Slower growth in the semiconductor and systems industries, a reduced number of design starts, reduction of electronic design automation budgets or continued consolidation among our customers would harm our business and
financial condition. We have experienced slower growth in revenue than we anticipated as a result of the prolonged downturn and decreased spending by our customers in the semiconductor and systems industries.



The primary customers for our products are companies in the communications,
computing, consumer electronics, networking and semiconductor industries. Any significant downturn in our customers markets or in general economic conditions that results in the cutback of research and development budgets or the delay of
software purchases would be likely to result in lower demand for our products and services and could harm our business. For example, the United States economy, including the semiconductor industry, has recently experienced a slowdown, which has
negatively impacted and may continue to impact our business and operating results. While the semiconductor industry experienced a moderate recovery in 2003, our customers have remained cautious, and it is not yet clear when increased R&D
spending will occur. Terrorist attacks in the United States, the ongoing events in Iraq and other worldwide events including in the Middle East have increased uncertainty in the United States economy. If the economy continues to decline as a result
of the economic, political and social turmoil, existing customers may delay their implementation of our software products and prospective customers may decide not to adopt our software products, either of which could negatively impact our business
and operating results.



In addition, the markets for
semiconductor products are cyclical. In recent years, some Asian countries have experienced significant economic difficulties, including devaluation and instability, business failures and a depressed business environment. These difficulties
triggered a significant downturn in the semiconductor market, resulting in reduced budgets for chip design tools, which, in turn, negatively impacted us. We have experienced delayed orders and slower deployment of our products under new orders as a
result of reduced budgets for chip design tools. In addition, the electronics industry has historically been subject to seasonal and cyclical fluctuations in demand for its products, and this trend may continue in the future. These industry
downturns have been, and may continue to be, characterized by diminished product demand, excess manufacturing capacity and subsequent erosion of average selling prices.



Difficulties in developing and achieving market acceptance of new products and delays in planned release dates of our software products
and upgrades may harm our business.



To succeed, we will
need to develop innovative new products. We may not have the financial resources necessary to fund all required future innovations. Also, any revenue that we receive from enhancements or new generations of our proprietary software products may be
less than the costs of development. If we fail to develop and market new products in a timely manner, our reputation and our business will suffer.



Our costs of customer engagement and support are high, so our gross margin may decrease if we incur higher-than-expected costs associated with providing support
services in the future or if we reduce our prices.



Because of the complexity of our products, we typically incur high field application engineering support costs to engage new customers and assist them in their evaluations of our products. If we fail to manage our customer engagement and
support costs, our operating results could suffer. In addition, our gross margin may decrease if we are unable to manage support costs associated with the mix of license and services revenue we generate or if we reduce prices in response to
competitive pressure.



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Product defects could cause us to lose customers and revenue, or to incur unexpected expenses.



Our products depend on complex software, both internally developed and
licensed from third parties. Our customers may use our products with other companies products, which also contain complex software. If our software does not meet our customers performance requirements, our customer relationships may
suffer. Also, a limited number of our contracts include specified ongoing performance criteria. If our products fail to meet these criteria, it may lead to termination of these agreements and loss of future revenue. Complex software often contains
errors. Any failure or poor performance of our software or the third-party software with which it is integrated could result in:



| |  | delayed market acceptance of our software products;
| | - | ---------------------------------------------------



| |  | delays in product shipments;
| | - | ----------------------------



| |  | unexpected expenses and diversion of resources to identify the source of errors or to correct errors;
| | - | -----------------------------------------------------------------------------------------------------



| |  | damage to our reputation;
| | - | -------------------------



| |  | delayed or lost revenue; and
| | - | ----------------------------



| |  | product liability claims.
| | - | -------------------------



Our product functions are often critical to our customers, especially because of the resources our customers expend on the design and fabrication of
integrated circuits. Many of our licensing agreements contain provisions to provide a limited warranty, which provides the customer with a right of refund for the license fees if we are unable to correct errors reported during the warranty period.
If our contractual limitations are unenforceable in a particular jurisdiction or if we are exposed to product liability claims that are not covered by insurance, a successful claim could harm our business. We currently do not carry product liability
insurance.



Much of our business is international, which exposes us to risks
inherent to doing business internationally that could harm our business. We also intend to expand our international operations. If our revenue from this expansion does not exceed the expenses associated with this expansion, our business and
operating results could suffer.



We generated 36% of our
total revenue from sales outside North America for the three months ended June 30, 2004, compared to 45% in the three months ended June 30, 2003. While most of our international sales to date have been denominated in U.S. dollars, our international
operating expenses have been denominated in foreign currencies. As a result, a decrease in the value of the U.S. dollar relative to the foreign currencies could increase the relative costs of our overseas operations, which could reduce our operating
margins.



The expansion of our international operations
includes the maintenance of sales offices in Europe, the Middle East, and the Asia Pacific region. If our revenue from international operations does not exceed the expense of establishing and maintaining our international operations, our business
could suffer. Additional risks we face in conducting business internationally include:



| |  | difficulties and costs of staffing and managing international operations across different geographic areas;
| | - | -----------------------------------------------------------------------------------------------------------



| |  | changes in currency exchange rates and controls;
| | - | ------------------------------------------------



| |  | uncertainty regarding tax and regulatory requirements in multiple jurisdictions;
| | - | --------------------------------------------------------------------------------



| |  | the possible lack of financial and political stability in foreign countries, preventing overseas sales growth;
| | - | --------------------------------------------------------------------------------------------------------------



| |  | on-going events in Iraq; and
| | - | ----------------------------



| |  | the effects of terrorist attacks in the United States and any related conflicts or similar events worldwide.
| | - | ------------------------------------------------------------------------------------------------------------



Future changes in accounting standards, specifically changes affecting revenue
recognition, could cause adverse unexpected revenue fluctuations.



Future changes in accounting standards for interpretations thereof, specifically those changes affecting software revenue recognition, could require us to change our methods of revenue recognition. These changes could result in deferral of
revenue recognized in current periods to subsequent periods or in accelerated recognition of deferred revenue to current periods, each of which



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could cause shortfalls in meeting the expectations of investors and securities analysts. Our stock price could decline as
a result of any shortfall. Future implementation of internal controls reporting and attestation requirements will impose additional financial and administrative obligations on us and will cause us to incur substantial implementation costs from third
party consultants, that could adversely affect our results.



Changes in laws
and regulations that affect the governance of public companies has increased our operating expenses and will continue to do so.



Recently enacted changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and the
listing requirements for The NASDAQ Stock Market have imposed new duties on us and on our executives, directors, attorneys and independent accountants. In order to comply with these new rules, we have hired and expect to hire additional personnel
and use additional outside legal, accounting and advisory services, which have increased and are likely to continue increasing our operating expenses. In particular, we expect to incur additional administrative expenses as we implement Section 404
of the Sarbanes-Oxley Act, which requires management to report on, and our Independent Registered Public Accounting Firm to attest to, our internal controls. For example, we expect to incur significant expenses in connection with the implementation,
documentation and testing of our existing and possibly newly implemented control systems. Management time associated with these compliance efforts necessarily reduces time available for other operating activities, which could adversely affect
operating results. If we are unable to achieve full and timely compliance with these regulatory requirements, we could be required to incur additional costs, expend additional management time on remedial efforts and make related public disclosures
that could adversely affect our stock price and result in securities litigation.



Forecasting the Companys tax rates is complex and subject to uncertainty.



Management must make significant assumptions, judgments and estimates to determine our current provision for income taxes, deferred tax assets and
liabilities, and any valuation allowance that may be recorded against our deferred tax assets. These assumptions, judgments and estimates are difficult to make due to their complexity and the relevant tax law is often changing. Our future effective
tax rates could be adversely affected by the following:



| |  | an increase in expenses not deductible for tax purposes, including deferred stock-based compensation and write-offs of acquired in-process research and development;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | changes in the valuation of our deferred tax assets and liabilities;
| | - | --------------------------------------------------------------------



| |  | future changes in ownership as defined by Internal Revenue Code Sections 382 and 383 which may limit realization of certain assets;
| | - | -----------------------------------------------------------------------------------------------------------------------------------



| |  | changes in forecasts of pre-tax profits and losses by jurisdiction used to estimate tax expense by jurisdiction; or
| | - | -------------------------------------------------------------------------------------------------------------------



| |  | changes in tax laws or interpretations of such tax laws.
| | - | --------------------------------------------------------



In addition, we may not be able to use net operating losses as our management planned if there is a change in the tax laws on these losses.



Our success will depend on our ability to keep pace with the rapidly evolving technology
standards of the semiconductor industry. If we are unable to keep pace with rapidly changing technology standards, our products could be rendered obsolete, which would cause our operating results to decline.



The semiconductor industry has made significant technological advances. In
particular, recent advances in deep sub-micron technology have required electronic design automation companies to continuously develop or acquire new products and enhance existing products. The evolving nature of our industry could render our
existing products and services obsolete. Our success will depend, in part, on our ability to:



| |  | enhance our existing products and services;
| | - | -------------------------------------------



| |  | develop and introduce new products and services on a timely and cost-effective basis that will keep pace with technological developments and evolving industry standards;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  | address the increasingly sophisticated needs of our customers; and
| | - | ------------------------------------------------------------------



| |  | acquire other companies that have complementary or innovative products.
| | - | -----------------------------------------------------------------------



If we are unable, for technical, legal, financial or other reasons, to respond in a timely manner to changing market conditions or customer requirements,
our business and operating results could be seriously harmed.



Because
competition for qualified personnel is intense in our industry, we may not be able to recruit necessary personnel, which could impact the development or sales of our products.



Our success will also depend on our ability to attract and retain senior management, sales, marketing and other key
personnel. Because of the intense competition for such personnel, it is possible that we will fail to retain key technical and managerial personnel. If we are unable to retain our existing personnel, or attract and train additional qualified
personnel, our growth may be limited due to our lack of capacity to develop and market our products. This could harm the markets perception of our business and our ability to achieve our business goals.



Our success is highly dependent on the technical, sales, marketing and managerial
contributions of key individuals, and we may be unable to recruit and retain these personnel.



We depend on our senior executives, and our research and development, sales and marketing personnel, who are critical to our business. We do not have
long-term employment agreements with our key employees, and we do not maintain any key person life insurance policies. If we lose the services of any of these key executives, our product development processes and sales efforts could be slowed. We
may also incur increased operating expenses and be required to divert the attention of other senior executives to search for their replacements. The integration of our new executives or any new personnel could disrupt our ongoing operations.



If we fail to maintain competitive stock option packages for our employees,
or if our stock price declines materially for a protracted period of time, we might have difficulty retaining our employees and our business may be harmed.



In todays competitive technology industry, employment decisions of highly skilled personnel are influenced by stock option packages, which offer
incentives above traditional compensation only where there is a consistent, long-term upward trend over time of a companys stock price. If our stock price declines due to market conditions, investors perceptions of the technology
industry or managerial or performance problems we have, our stock option incentives may lose value to key employees, and we may lose these employees or be forced to grant additional options to retain them. This in turn could result in:



| |  | immediate and substantial dilution to investors resulting from the grant of additional options necessary to retain employees; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------



| |  | potential compensation charges against the company, which could negatively impact our operating results.
| | - | --------------------------------------------------------------------------------------------------------



In addition, if we were required to account for stock options as an operating expense, our net income would be reduced or
net losses increased. Accordingly, our financial results would be adversely affected, particularly relative to companies that grant fewer stock options. If we reduce our level of stock option grants, our ability to recruit and retain employees may
be adversely affected.



If the accounting treatment for employee stock
options changes, our earnings will be adversely affected and we may be forced to change our employee compensation and benefits practices.



We currently account for the issuance of employee stock options under principles that do not require us to record compensation expense for options granted
at fair market value. Under a newly-proposed accounting standard, public companies would be required to report compensation expense related to stock options and other forms of stock-based compensation based on the estimated value of the awards at
the date of grant. We expect the final standard to be issued later in 2004, and to be effective for us beginning in our fiscal 2006. If that proposed standard is adopted in its current form, our expenses will be higher and our earnings will decline
compared to our current accounting. As a result, we may consider changing our employee compensation practices, and those changes could make it harder for us to retain existing employees and attract qualified candidates.



If our sales force compensation arrangements are not designed effectively, we may lose
sales personnel and resources.



Designing an effective
incentive compensation structure for our sales force is critical to our success. We have experimented, and continue to experiment, with different systems of sales force compensation. If our incentives are not well designed, we may experience reduced
revenue generation, and we may also lose the services of our more productive sales personnel, either of which would reduce our revenues or potential revenues.



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Fluctuations in our growth place a strain on our management systems and resources, and if we fail to manage the pace
of our growth our business could be harmed.



Periods of
growth followed by efforts to realign costs when revenue growth is slower than anticipated have placed a strain on our management, administrative and financial resources. For example, in the first quarter of fiscal year 2005 and the third quarter of
fiscal year 2003, we laid off 7 and 32 employees, respectively. Over time we have significantly expanded our operations in the United States and internationally, and we plan to continue to expand the geographic scope of our operations. To pace the
growth of our operations with the growth in our revenue, we must continue to improve administrative, financial and operations systems, procedures and controls. Failure to improve our internal procedures and controls could result in a disruption of
our operations and harm to our business. We expect to incur a significant amount of consulting and other fees and expenses to document and enhance our financial processes and accounting controls and capabilities in order to achieve certification
under Section 404 of the Sarbanes-Oxley Act of 2002. If we are unable to manage our growth the execution of our business plan could be delayed.



If chip designers and manufacturers do not integrate our software into existing design flows, or if other software companies do not cooperate in working with us to
interface our products with their design flows, demand for our products may decrease.



To implement our business strategy successfully, we must provide products that interface with the software of other electronic design automation software companies. Our competitors may not support our or our
customers efforts to integrate our products into their existing design flows. We must develop cooperative relationships with competitors so that they will work with us to integrate our software into a customers design flow. Currently,
our software is designed to interface with the existing software of Cadence, Synopsys and others. If we are unable to convince customers to adopt our software products instead of those of competitors offering a broader set of products, or if we are
unable to convince other semiconductor companies to work with us to interface our software with theirs to meet the demands of chip designers and manufacturers, our business and operating results will suffer.



We may not obtain sufficient patent protection, which could harm our competitive position
and increase our expenses.



Our success and ability to
compete depends to a significant degree upon the protection of our software and other proprietary technology. We currently have a number of issued patents in the United States, but this number is relatively few in relation to our competitors.



These legal protections afford only limited protection for our
technology. In addition, rights that may be granted under any patent application that may issue in the future may not provide competitive advantages to us. Further, patent protection in foreign jurisdictions where we may need this protection may be
limited or unavailable. It is possible that:



| |  | our pending U.S. and non-U.S. patents may not be issued;
| | - | --------------------------------------------------------



| |  | competitors may design around our present or future issued patents or may develop competing non-infringing technologies;
| | - | ------------------------------------------------------------------------------------------------------------------------



| |  | present and future issued patents may not be sufficiently broad to protect our proprietary rights; and
| | - | ------------------------------------------------------------------------------------------------------



| |  | present and future issued patents could be successfully challenged for validity and enforceability.
| | - | ---------------------------------------------------------------------------------------------------



We believe the patent portfolios of our competitors are far larger than ours, and this may increase the risk that they may
sue us for patent infringement and may limit our ability to counterclaim for patent infringement or settle through patent cross-licenses.



We rely on trademark, copyright and trade secret laws and contractual restrictions to protect our proprietary rights, and if these rights are not sufficiently
protected, it could harm our ability to compete and generate income.



To establish and protect our proprietary rights, we rely on a combination of trademark, copyright and trade secret laws, and contractual restrictions, such as confidentiality agreements and licenses. Our ability to
compete and grow our business could suffer if these rights are not adequately protected. We seek to protect our source code for our software, documentation and other written materials under trade secret and copyright laws. We license our software
pursuant to agreements, which impose certain restrictions on the licensees ability to utilize the software. We also seek to avoid disclosure of our intellectual property by requiring employees and consultants with access to our proprietary
information to execute confidentiality agreements. Our proprietary rights may not be adequately protected because:



| |  | laws and contractual restrictions in U.S. and foreign jurisdictions may not prevent misappropriation of our technologies or deter others from developing similar technologies;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  | competitors may independently develop similar technologies and software code;
| | - | -----------------------------------------------------------------------------



| |  | for some of our trademarks, federal U.S. trademark protection may be unavailable to us;
| | - | ---------------------------------------------------------------------------------------



| |  | our trademarks may not be protected or protectable in some foreign jurisdictions;
| | - | ---------------------------------------------------------------------------------



| |  | the validity and scope of our U.S. and foreign trademarks could be successfully challenged; and
| | - | -----------------------------------------------------------------------------------------------



| |  | policing unauthorized use of our products and trademarks is difficult, expensive and time-consuming, and we may be unable to determine the extent of this unauthorized use.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The laws of some countries in which we market
our products may offer little or no protection of our proprietary technologies. Reverse engineering, unauthorized copying or other misappropriation of our proprietary technologies could enable third parties to benefit from our technologies without
paying us for it, which would harm our competitive position and market share.



We may face intellectual property infringement or other claims against us or our customers that could be costly to defend and result in our loss of significant rights.



Many of our contracts contain provisions in which we agree to indemnify our customers from third-party intellectual property
infringement claims. Other parties may assert intellectual property infringement claims against us or our customers, and our products may infringe the intellectual property rights of third parties. We have also acquired or may hereafter acquire
software as a result of our past or future acquisitions, and we may be subject to claims that such software infringes the intellectual property rights of third parties. If we become involved in litigation, we could lose our proprietary rights and
incur substantial unexpected operating costs. Intellectual property litigation is expensive and time-consuming and could divert managements attention from our business. If there is a successful claim of infringement, we may be required to
develop non-infringing technology or enter into royalty or license agreements, which may not be available on acceptable terms, if at all.



Our failure to develop non-infringing technologies or license the proprietary rights on a timely basis would harm our business. Our products may infringe
third-party patents that may relate to our products. Also, we may be unaware of filed patent applications that relate to our software products. We believe the patent portfolios of our competitors are far larger than ours, and this may increase the
risk that they may sue us for patent infringement and may limit our ability to counterclaim for patent infringement or settle through patent cross-licenses.



We may also become involved in litigation unrelated to intellectual property infringement claims. For example, in August 2001, a complaint was filed
against us alleging breach of contract, among other things. This litigation was settled in early 2003. In addition, we may acquire companies that are engaged in intellectual property litigation. For example, Silicon Metrics was involved in such
litigation when we acquired it, but the litigation has since been dismissed. We may not be successful in defending other claims that may be made against us. Regardless of the outcome, litigation can result in substantial expense and could divert the
efforts of our management and technical personnel.



Our directors, executive
officers and principal stockholders own a substantial portion of our common stock and this concentration of ownership may allow them to elect most of our directors and could delay or prevent a change in control of Magma.



Our directors, executive officers and stockholders who currently own over 5%
of our common stock beneficially own a substantial portion of our outstanding common stock. These stockholders, if they vote together, will be able to significantly influence all matters requiring stockholder approval. For example, they may be able
to elect most of our directors, delay or prevent a transaction in which stockholders might receive a premium over the market price for their shares or prevent changes in control or management.



Our stock price may decline significantly because of stock market fluctuations that affect
the prices of technology stocks. A decline in our stock price could result in securities class action litigation against us, that could divert managements attention and harm our business.



The stock market has experienced significant price and volume fluctuations
that have adversely affected the market prices of common stock of technology companies. These broad market fluctuations may reduce the market price of our common stock. In the past, securities class action litigation has often been brought against a
company after periods of volatility in the market price of securities. We may in the future be a target of similar litigation. Securities litigation could result in substantial costs and divert managements attention and resources, which could
harm our ability to execute our business plan.



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We may need additional capital in the future, but there is no assurance that funds would be available on acceptable
terms.



In the future we may need to raise additional
capital in order to achieve growth or other business objectives. This financing may not be available in sufficient amounts or on terms acceptable to us and may be dilutive to existing stockholders. If adequate funds are not available or are not
available on acceptable terms, our ability to expand, develop or enhance services or products, or respond to competitive pressures would be limited.



Our certificate of incorporation, bylaws and Delaware corporate law contain anti-takeover provisions which could delay or prevent a change in control even if the
change in control would be beneficial to our stockholders. We could also adopt a stockholder rights plan, which could also delay or prevent a change in control.



Delaware law, as well as our certificate of incorporation and bylaws, contain anti-takeover provisions that could delay or
prevent a change in control of our company, even if the change of control would be beneficial to the stockholders. These provisions could lower the price that future investors might be willing to pay for shares of our common stock. These
anti-takeover provisions:



| |  | authorize the Board of Directors without prior stockholder approval to create and issue preferred stock that can be issued increasing the number of outstanding shares and deter or
prevent a takeover attempt;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | prohibit stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our stockholders;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------



| |  | establish a classified Board of Directors requiring that not all members of the board be elected at one time;
| | - | -------------------------------------------------------------------------------------------------------------



| |  | prohibit cumulative voting in the election of directors, which would otherwise allow less than a majority of stockholders to elect director candidates;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | limit the ability of stockholders to call special meetings of stockholders; and
| | - | -------------------------------------------------------------------------------



| |  | require advance notice requirements for nominations for election to the Board of Directors and proposals that can be acted upon by stockholders at stockholder meetings.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In addition, Section 203 of the Delaware General
Corporation Law and the terms of our stock option plans may discourage, delay or prevent a change in control of our company. That section generally prohibits a Delaware corporation from engaging in a business combination with an interested
stockholder for three years after the date the stockholder became an interested stockholder. Also, our stock option plans include change-in-control provisions that allow us to grant options or stock purchase rights that will become vested
immediately upon a change in control of us.



The board of
directors also has the power to adopt a stockholder rights plan, which could delay or prevent a change in control even if the change in control appeared to be beneficial to stockholders. These plans, sometimes called poison pills, are
sometimes criticized by institutional investors or their advisors and could affect our rating by such investors or advisors. If the board were to adopt such a plan it might have the effect of reducing the price that new investors are willing to pay
for shares of our common stock.



We are subject to risks associated with
changes in foreign currency exchange rates.



We transact
some portions of our business in various foreign currencies. Accordingly, we are subject to exposure from adverse movements in foreign currency exchange rates. This exposure is primarily related to operating expenses in the United Kingdom, Europe
and Japan, which are denominated in the respective local currencies. As of March 31, 2004, we had no hedging contracts outstanding. We do not currently use financial instruments to hedge operating expenses denominated in Euro, British Pounds and
Japanese Yen. We assess the need to utilize financial instruments to hedge currency exposures on an ongoing basis.



The convertible notes we issued in May 2003 are debt obligations that must be repaid in cash in May 2008 if they are not converted into our common stock at an earlier
date, which is unlikely to occur if the price of our common stock does not exceed the conversion price.



In May 2003, we issued $150 million principal amount of our zero coupon convertible notes due May 2008. We will be required to repay that principal amount
in full in May 2008 unless the holders of those notes elect to convert them into our common stock before the repayment date. The conversion price of the notes is $22.86 per share. If the price of our common stock does not rise above



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that level, conversion of the notes is unlikely and we would be required to repay the principal amount of the notes in
cash. There have been previous quarters in which we have experienced shortfalls in revenue and earnings from levels expected by securities analysts and investors, which have had an immediate and significant adverse effect on the trading price of our
common stock. In addition, the stock market in recent years has experienced extreme price and trading volume fluctuations that often have been unrelated or disproportionate to the operating performance of individual companies. These broad market
fluctuations may adversely affect the price of our stock, regardless of our operating performance. Because the notes are convertible into shares of our common stock, volatility or depressed prices for our common stock could have a similar effect on
the trading price of the notes.



Hedging transactions and other transactions
may affect the value of our common stock and our convertible notes.



We entered into hedging arrangements with Credit Suisse First Boston International at the time we issued our convertible notes, with the objective of reducing the potential dilutive effect of issuing common stock upon
conversion of the notes. These hedging arrangements are likely to have caused Credit Suisse First Boston International and others to take positions in our common stock in secondary market transactions or to enter into derivative transactions at or
after the sale of the notes. Any market participants entering into hedging arrangements are likely to modify their hedge positions from time to time prior to conversion or maturity of the notes by purchasing and selling shares of our common stock or
other securities, which may increase the volatility and reduce the market price of our common stock.



Our convertible notes are subordinated and there are no financial covenants in the indenture.



Our convertible notes are general unsecured obligations of Magma and are subordinated in right of payment to all of our existing and future senior
indebtedness, which we may incur in the future. In the event of our bankruptcy, liquidation or reorganization, or upon acceleration of the notes due to an event of default under the indenture and in certain other events, our assets will be available
to pay obligations on the notes only after all senior indebtedness has been paid. As a result, there may not be sufficient assets remaining to pay amounts due on any or all of the outstanding notes. In addition, we will not make any payments on the
notes in the event of payment defaults or other specified defaults on our designated senior indebtedness.



Neither we nor our subsidiaries are restricted under the indenture for the notes from incurring additional debt, including senior indebtedness. If we or
our subsidiaries incur additional debt or other liabilities, our ability to pay our obligations on the notes could be adversely affected. We expect that we and our subsidiaries from time to time will incur additional indebtedness and other
liabilities.



We may be unable to meet the requirements under the indenture
to purchase our convertible notes upon a change in control.



Upon a change in control, which is defined in the indenture to include some cash acquisitions and private company mergers, note holders may require us to purchase all or a portion of the notes they hold. If a change in control were to
occur, we might not have enough funds to pay the purchase price for all tendered notes. Future credit agreements or other agreements relating to our indebtedness might prohibit the redemption or repurchase of the notes and provide that a change in
control constitutes an event of default. If a change in control occurs at a time when we are prohibited from purchasing the notes, we could seek the consent of our lenders to purchase the notes or could attempt to refinance this debt. If we do not
obtain a consent, we could not purchase the notes. Our failure to purchase tendered notes would constitute an event of default under the indenture, which might constitute a default under the terms of our other debt. In such circumstances, or if a
change in control would constitute an event of default under our senior indebtedness, the subordination provisions of the indenture would possibly limit or prohibit payments to note holders. Our obligation to offer to purchase the notes upon a
change in control would not necessarily afford note holders protection in the event of a highly leveraged transaction, reorganization, merger or similar transaction involving us.



|ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|------- | ----------------------------------------------------------



Interest Rate Risk



Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. The primary objective of our investment
activities is to preserve principal while maximizing yields without significantly increasing risk. This is accomplished by investing in widely diversified short-term and long-term investments, consisting primarily of investment grade securities,
substantially all of which mature within the next twenty-four months. A hypothetical 100 basis point increase in interest rates would result in approximately a $1.1 million decline in the fair value of our available-for-sale securities.



Market Risk



The fair value of our fixed rate long-term debt is sensitive to interest rate changes. Interest rate changes would result in
increases or decreases in the fair value of our debt, due to differences between market interest rates and rates in effect at the inception of our debt obligation. Changes in the fair value of our fixed rate debt have no impact on our cash flows or
consolidated financial statements.



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Credit Risk



We completed an offering on May 22, 2003 of $150 million principal amount of convertible subordinated notes due May 15, 2008. Concurrent with the issuance
of the convertible notes, we entered into convertible bond hedge and warrant transactions with respect to our common stock, the exposure for which is held by Credit Suisse First Boston International. Both the bond hedge and warrant transactions may
be settled at our option either in cash or net shares and expire on May 15, 2008. The transactions are expected to reduce the potential dilution from conversion of the notes. Subject to the movement in the share price of our common stock, we could
be exposed to credit risk in the settlement of these options in our favor. Based on a review of the possible net settlements and the credit strength of Credit Suisse First Boston International and its affiliates, we believe that we do not have a
material exposure to credit risk arising from these option transactions.



Foreign Currency Exchange Risk



We transact
some portions of our business in various foreign currencies. Accordingly, we are subject to exposure from adverse movements in foreign currency exchange rates. This exposure is primarily related to operating expenses in the United Kingdom and Japan,
which are denominated in the respective local currency. As of June 30, 2004, we had no currency hedging contracts outstanding. We do not currently use financial instruments to hedge operating expenses denominated in Euro, British Pounds and Japanese
Yen. We assess the need to utilize financial instruments to hedge currency exposures on an ongoing basis.



|ITEM 4. | CONTROLS AND PROCEDURES
|------- | -----------------------



Evaluation of disclosure controls and procedures. We maintain disclosure controls and procedures, as such term is defined in Rule
13a-15(e) under the Securities Exchange Act of 1934 (the Exchange Act), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed,
summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial
Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and
operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its
judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon assumptions about the likelihood of future events, and there can be
no assurance that any design will succeed in achieving its stated goals under all potential future conditions. However, our disclosure controls and procedures have been designed to meet, and management believes that they meet, reasonable assurance
standards.



Based on their evaluation as of the end of the
period covered by this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer have concluded that, subject to the limitations noted above, our disclosure controls and procedures were effective to ensure that material
information relating to us, including our consolidated subsidiaries, is made known to them by others within those entities, particularly during the period in which this Quarterly Report on Form 10-Q was being prepared. Although our principal
executive officer and principal accounting officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report, we continue to enhance our controls by hiring qualified personnel in key
functional areas, implementing a new computerized system to automate a number of procedures related to quarterly and year-end close process, and creating procedures to address the impact of acquisitions on a timely basis.



Changes in internal controls. There was no change in our internal
control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) identified in connection with the evaluation described above that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.



PART II. OTHER INFORMATION



|ITEM 1. | LEGAL PROCEEDINGS
|------- | -----------------



From time to time, the Company is involved in disputes that arise in the ordinary course of business. The number and significance of these disputes is
increasing as the Companys business expands and the Company grows larger. Any claims against the Company, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and
result in the diversion of significant operational resources. As a result, these disputes could harm the Companys business, financial condition, results of operations or cash flows.



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|ITEM 2. | CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES
|------- | --------------------------------------------------------------------------------



Recent Sales Of Unregistered Securities



On April 29, 2004, we issued a total of 607,554 shares of our common stock in connection with our acquisition of Mojave, Inc. pursuant to a definitive
agreement signed on February 23, 2004. In addition to the initial merger consideration we may issue contingent consideration of up to $115 million, half in stock and half in cash, based on product orders over a period ending March 31, 2009, but such
payments are contingent on the achievement of certain technology milestones. These securities were issued in connection with the fairness hearing held by and the related notice issued by the Department of Corporations of the state of California and
in reliance upon the exemption from the registration requirements of the Securities Act of 1933 provided by Section 3(a)(10) thereof.



Issuer Purchases of Equity Securities



We repurchased no shares of our common stock during the first quarter of fiscal 2005.



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



(a) Exhibits.



|              |  |                                                                                                                                                                                                                                                                                                 
|------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Exhibit Description                                                                                                                                                                                                                                                                             
|3.1           |  | Amended and Restated Certificate of Incorporation (incorporated by reference to the exhibit of the same number to the Companys Form 10-K for the year ended March 31, 2002 filed on June
28, 2002).                                                                                            
|              | 
|3.2           |  | Certificate of Correction to Amended and Restated Certificate of Incorporation (incorporated by reference to the exhibit of the same number to the Companys Form 10-K for the year ended
March 31, 2002 filed on June 28, 2002).                                                               
|              | 
|3.3           |  | Amended and Restated Bylaws (incorporated by reference to the exhibit of the same number to the Companys Form 10-K for the year ended March 31, 2002 filed on June 28,
2002).                                                                                                                  
|              | 
|4.1           |  | Form of Common Stock Certificate (incorporated by reference to the exhibit of the same number to Amendment No. 6 to the Companys Registration Statement on Form S-1 (File No.
333-60838)).                                                                                                     
|              | 
|4.2           |  | Amended and Restated Investors Rights Agreement, dated July 31, 2001, by and among the Companys and the parties who are signatories thereto (incorporated by reference to the
exhibit of the same number to the Companys Form 10-K for the year ended March 31, 2002 filed on June 28, 2002).
|              | 
|31.1          |  | Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer.                                                                                                                                                                                                                          
|              | 
|31.2          |  | Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer.                                                                                                                                                                                                                          
|              | 
|32.1          |  | Section 1350 Certification of Principal Executive Officer.                                                                                                                                                                                                                                      
|              | 
|32.2          |  | Section 1350 Certification of Principal Financial Officer.                                                                                                                                                                                                                                      



(b)
Reports on Form 8-K.



On May 5, 2004, Magma furnished a
current report on Form 8-K to provide under Item 12 Magmas press release and conference call transcript in connection with its results of operations and financial condition for its fiscal year and quarter ended March 31, 2004. This Form 8-K is
not filed for purposes of Section 18 of the Securities and Exchange Act of 1934 or incorporated into this or any other filing of the Company.



On May 14, 2004, Magma filed a current report on Form 8-K to report under Item 2 and 7 the acquisition of Mojave, Inc.



40



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##### Table of Contents

SIGNATURES



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



|                      |  |                               |  |                                                                           
|--------------------- |  | ----------------------------- |  | --------------------------------------------------------------------------
|                      |  | MAGMA DESIGN AUTOMATION, INC.
|                      |  |                              
|Dated: August 9, 2004 |  | By                            |  | /s/    GREGORY C. WALKER                                                  
|                      |  |                               |  | Gregory C. Walker                                                         
|                      |  |                               |  | Senior Vice PresidentFinance and Chief Financial Officer                 
|                      |  |                               |  | (Principal Financial and Accounting Officer and Duly Authorized Signatory)



41



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##### Table of Contents

EXHIBIT INDEX



TO



MAGMA DESIGN AUTOMATION, INC.



QUARTERLY REPORT ON FORM 10-Q



FOR THE QUARTER ENDED JUNE 30, 2004



|              |  |                                                                                                                                                                                                                                                                                                 
|------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Exhibit Description                                                                                                                                                                                                                                                                             
|3.1           |  | Amended and Restated Certificate of Incorporation (incorporated by reference to the exhibit of the same number to the Companys Form 10-K for the year ended March 31, 2002 filed on June
28, 2002).                                                                                            
|              | 
|3.2           |  | Certificate of Correction to Amended and Restated Certificate of Incorporation (incorporated by reference to the exhibit of the same number to the Companys Form 10-K for the year ended
March 31, 2002 filed on June 28, 2002).                                                               
|              | 
|3.3           |  | Amended and Restated Bylaws (incorporated by reference to the exhibit of the same number to the Companys Form 10-K for the year ended March 31, 2002 filed on June 28,
2002).                                                                                                                  
|              | 
|4.1           |  | Form of Common Stock Certificate (incorporated by reference to the exhibit of the same number to Amendment No. 6 to the Companys Registration Statement on Form S-1 (File No.
333-60838)).                                                                                                     
|              | 
|4.2           |  | Amended and Restated Investors Rights Agreement, dated July 31, 2001, by and among the Companys and the parties who are signatories thereto (incorporated by reference to the
exhibit of the same number to the Companys Form 10-K for the year ended March 31, 2002 filed on June 28, 2002).
|              | 
|31.1          |  | Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer.                                                                                                                                                                                                                          
|              | 
|31.2          |  | Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer.                                                                                                                                                                                                                          
|              | 
|32.1          |  | Section 1350 Certification of Principal Executive Officer.                                                                                                                                                                                                                                      
|              | 
|32.2          |  | Section 1350 Certification of Principal Financial Officer.                                                                                                                                                                                                                                      



42