<PAGE>

                                                             Exhibit 13.1

NEOMAGIC'S VISION, SINCE OUR FOUNDING, HAS BEEN TO PROVIDE SEMICONDUCTOR
SOLUTIONS THAT BRING THE EXCITEMENT OF HIGH-PERFORMANCE MULTIMEDIA CONTENT TO
MOBILE USERS.  BASED ON INNOVATIVE MAGICWARE TECHNOLOGY AND TWO SUCCESSFUL
PRODUCT FAMILIES, WE HAVE RISEN TO A POSITION OF LEADERSHIP IN

THE NOTEBOOK PC MULTIMEDIA ACCELERATOR MARKET, ENABLING A NEW GENERATION OF
THIN-AND-LIGHT MULTIMEDIA NOTEBOOK PCS.  WITH THIS AS OUR FOUNDATION, WE NOW
EXTEND OUR ACTIVITIES TO NEW MARKET OPPORTUNITIES THAT ARISE IN THE
INTERNET AGE.

NEOMAGIC'S INNOVATIVE TECHNOLOGIES FOR IMAGE PROCESSING, REAL-TIME MPEG-2
ENCODING, AND LOW-POWER SINGLE-CHIP EMBEDDED MEMORY SOLUTIONS CAN OFFER
ECONOMICAL WEB-FRIENDLY DIGITAL CAMERAS FOR THE CAPTURE OF MULTIMEDIA
CONTENT FOR A RICH INTERNET EXPERIENCE ON MOBILE PLATFORMS.
WE SEE THE DVD BECOMING A COMMON MEDIA FOR PC DATA, FOR IN-HOME AND PORTABLE
CONSUMER VIDEO AND AUDIO ENTERTAINMENT SYSTEMS, FOR ELECTRONIC GAME SYSTEMS, AND
MANY OTHER MULTIMEDIA DATA INTENSIVE APPLICATIONS, WHERE NEOMAGIC'S EMBEDDED
DRAM TECHNOLOGY CAN OFFER VALUE-ADDED SEMICONDUCTOR
SOLUTIONS FOR DVD DRIVE MANUFACTURERS.

<PAGE>

To Our Stockholders:

NeoMagic's fiscal year ended January of 1999 (fiscal 1999) was our second year
as a publicly held company, and was again a year of exceptional financial and
business results, and continued growth and progress. We achieved higher revenue,
higher operating profits, and greater market share in each successive quarter of
the fiscal year.   

We successfully launched a new family of products in our existing line of
multimedia accelerators for notebook computers, and grew to be the leading
supplier of notebook multimedia ICs worldwide.  We believe our success stems
from the combination of our proprietary MagicWare-TM- embedded DRAM technology,
our focus on mobility, and our broad product offering in the
MagicGraph-Registered Trademark-128 and MagicMedia-TM- 256 families of
multimedia accelerators for notebook PCs.  We also believe that the dramatic
growth of the World Wide Web has expanded our market and our opportunities,
bringing rich multimedia content to end-users at their offices and in their
homes, propelling us towards a future where anytime-anywhere access to the full
body of human knowledge can become an every day experience.

It is NeoMagic's strategy to participate in multiple market opportunities driven
by these trends towards multimedia, mobility, and the Internet. To extend beyond
the notebook arena, we moved forward this year with the formation of our
Consumer Products Division and the announcement of plans to enter into two new
market areas: digital cameras and Digital Versatile Disk (DVD) drive solutions.
Our plan includes leveraging our MagicWare embedded DRAM technology to deliver
innovative solutions for the capture, storage, and playback of multimedia
content for a rich Internet experience on mobile platforms.  

FINANCIAL PERFORMANCE
NeoMagic reported net sales for the fiscal year ended January 31, 1999 of $240.5
million, and net income of $31.2 million, or $1.19 per diluted share. Compared
to fiscal 1998, our revenue grew by 93% and our operating profit increased by
95%. We have now fully utilized the net operating loss carryforwards from our
formative years, causing our effective tax rate to increase from 15% to 34%
during the year. Yet, even with this added tax burden, our net profits grew by
50% from fiscal 1998.

NeoMagic's productivity, as measured by the annualized revenue per employee
during the fourth quarter, was amongst the highest in the semiconductor industry
at over $1.2 million per employee.

BUSINESS REVIEW
NeoMagic began the year by adding Toshiba, the world's leading producer of
notebook PCs, to our customer list.  With that addition, virtually every major
manufacturer of notebook PCs has now become a customer of NeoMagic for at least
a portion of their multimedia chip requirements. Market research firms confirmed
that in the fourth quarter of 1997, NeoMagic became the market leader among
notebook PC graphics vendors on a revenue basis. In the second quarter of 1998,
we became the market share leader based on unit shipments as well. Throughout
the year, there was continued demand for the MagicGraph128 family of multi-media
accelerators, with every one of our major customers adopting it across one or
more of their notebook models.

     [GRAPHIC]

KAMRAN ELAHIAN, CHAIRMAN (LEFT). 
PRAKASH AGARWAL, PRESIDENT AND 
CHIEF EXECUTIVE OFFICER (RIGHT).

In June 1998, NeoMagic announced the industry's first 256-bit multimedia
accelerator, the MagicMedia256AV. The first product in a new family, this chip
integrates audio and DVD video playback acceleration with high-performance PC
graphics, into a single twenty-one million transistor chip, with a peak internal
bandwidth of 3.2 gigabytes per second. The editors of PC Magazine recognized the
MagicMedia256AV for technical excellence at Comdex, and in the December issue of
the publication stated, "The latest graphics accelerator from NeoMagic is the
best on the market to date for performance notebooks." The MagicMedia256AV
quickly became a major factor in the market and in our business.  Sales of the
MagicMedia256AV grew sharply in the second half of the fiscal year, and over one
million units had been shipped by fiscal year end in January 1999.


The majority of our production capacity was provided by our long-term business
partner Mitsubishi Electric for production of both the MagicGraph128 and the
MagicMedia256 product lines. NeoMagic added Toshiba Semiconductor as an
additional manufacturing supplier, and during the fiscal year they served as a
significant source for the 256-bit product family. By the end of January 1999,
NeoMagic had shipped more than twelve million multimedia accelerators.

<PAGE>

Several awards were garnered over the year. In June, Prakash Agarwal was named
High-Tech "Entrepreneur of the Year" in Northern California by Ernst & Young
LLP.  In December, Agarwal was named one of the "Hot 25 Executives to Watch" by
ELECTRONIC BUSINESS NEWS, as an "industry mover and shaker" leading the Company
to effect major changes in the industry.    

The MagicGraph128 Design Team was awarded the Mobile Innovation Award by MOBILE
COMPUTING magazine in July.  

The Fabless Semiconductor Association (FSA) again recognized NeoMagic's
financial performance. In December 1998, the Company was chosen for the second
consecutive year as the Best Financially Managed Fabless Company. In selecting
NeoMagic Corporation as the winner, the FSA considered return on investment,
return on equity, inventory turns, days sales outstanding, cash per share, sales
per employee, and current ratio, comparing these indices with all other fabless 
semiconductor companies.

LOOKING FORWARD*
Our vision, since our founding, has been to provide semiconductor solutions for
delivering high-performance multimedia content to mobile users. We described our
mission as "mobilizing multimedia," and addressed the conflicting requirements
of raising performance while reducing power consumption and size. We have proven
the viability and value of the revolutionary MagicWare technology we developed,
which integrates large amounts of memory, logic, and analog functions into a
single chip. We have led our industry in a new technical direction and risen to
a position of leadership in the notebook PC multimedia accelerator market. 

Today NeoMagic's long-term strategy is to become a major supplier of fundamental
technologies for mobilizing the capture, storage, access, and playback of
digital multimedia content, bringing rich multimedia capabilities and
anywhere-anytime mobility to the internet experience. We envision a future where
easy-to-use, economical digital cameras will capture web-ready multimedia
images, where formats and storage media will allow multimedia content to move
seamlessly and fluidly between PCs and consumer electronics systems, and where
users will be able to access information, be it data, images, sound, or video,
wherever and whenever they choose.

We continue to invest in our notebook PC multimedia product line. We have
enabled a new generation of thin-and-light notebook PC products through the size
reductions and power savings that our integration provides. In our MagicGraph128
family, we provided the first single-chip graphics solutions, and in our
MagicMedia256 family we have now integrated audio and DVD video playback as
well, bringing higher levels of multimedia content to highly mobile platforms.
3D graphics will be integrated next, with insatiable demands for more memory in
order to achieve more performance and a richer visual environment. This
transition may offer expanded opportunities for differentiation, as our
proprietary MagicWare technology and embedded DRAM experience allow us to drive
levels of memory integration not achievable by our peers.

As we ended our fiscal year, we completed two acquisitions to bolster and
accelerate our new market activities. In February 1999, we announced the
acquisition of the Optical Drive Storage Group, located in Manchester, U.K.,
from Mitel Semiconductor, and the acquisition of Associative Computers, Ltd.,
(ACL) located in Raanana, Israel, from Robomatix. These groups have now become
NeoMagic's United Kingdom Development Center and NeoMagic's Israel Development
Center, respectively. These two recent acquisitions have bolstered NeoMagic's
already impressive intellectual property portfolio. The Company now has 15
issued patents, and more than 50 patent applications actively in process.  

We see the DVD becoming a common media for PC data, for in-home and portable
consumer video and audio entertainment systems, for electronic game systems, and
many other multimedia data intensive applications. A common aspect of these DVD
systems will be their ability to decode MPEG video streams, a feature they will
share with high-definition TV and satellite set-top boxes.  
                                          

<PAGE>


We believe that the consumer electronics and computer industries are now
approaching a significant point of inflection, as digital media converges onto a
cross-platform set of standard media and data formats. Our markets are poised
for explosive growth over the next several years.

The new NeoMagic United Kingdom Development Center's significant experience in
mixed-signal analog design and DVD optical storage read-channel technology, when
coupled with the Company's existing DVD controller development activities, will
expand the Company's ability to offer semiconductor solutions to DVD drive
manufacturers. 

The NeoMagic Israel Development Center's associative array processing
technology, when combined with NeoMagic's MagicWare embedded DRAM technology,
provides a technology platform from which the Company will develop products to
support new levels of image processing performance, including real time MPEG-2
encoding, in low-power single-chip solutions for economical web-friendly digital
cameras.


The proprietary embedded DRAM technology, which we have developed and proven,
will be the technical foundation upon which we build our long-term strategy. Our
success in notebook multimedia components has placed us firmly in a
market-leading position for mobile playback of multimedia content, and has given
us the resources and the opportunity to drive our technology into new market
areas. We are actively investing in developing solutions for new markets, and
with our recent acquisitions, we add newly acquired technology that will combine
with our MagicWare technology to provide compelling semiconductor solutions for
the capture and storage of digital multimedia content.

In summary, NeoMagic's business strategy reflects a coherent, multi-faceted
approach to revolutionizing and mobilizing digital multimedia for the Internet
age. Building upon our success in multimedia accelerators for portable PCs,
NeoMagic's long-term vision is to become the source for fundamental technologies
for mobilizing the capture, storage, access, and playback of digital multimedia
content for rich Internet experiences. The three markets now being pursued,
notebook multimedia accelerators, digital cameras, and DVD drives and recorders,
are projected to provide multi-billion dollar annual IC market opportunities
over the next several years. 


Our approach continues to be one of providing "differentiation through
integration," bringing together diverse technologies to provide value-added
semiconductor solutions which allow our customers' products to stand out in
their respective markets. With a strong technical foundation, a history of
successful execution, a worldwide talent pool, and a roadmap for multiple
generations of new products and revolutionary capabilities, we look forward to a
future of innovation and opportunity.

We welcome our stockholders, employees, vendors, and customers to join us as we
seek our futures together in the age of the Internet.




/s/ Kamran Elahian
Kamran Elahian
CHAIRMAN



/s/ Prakash Agarwal
Prakash Agarwal
PRESIDENT & CHIEF EXECUTIVE OFFICER


BE IT DATA, IMAGES, SOUND, OR VIDEO, WHEREVER AND WHENEVER THEY CHOOSE.

*    THIS SECTION CONTAINS FORWARD-LOOKING STATEMENTS WHICH REFLECT THE
     COMPANY'S CURRENT INTENTIONS AND EXPECTATIONS. ACTUAL EVENTS AND RESULTS
     COULD VARY SIGNIFICANTLY BASED ON A VARIETY OF FACTORS, WHICH ARE DESCRIBED
     IN THE "FACTORS THAT MAY AFFECT RESULTS" SECTION OF MANAGEMENT'S DISCUSSION
     AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS IN THIS
     DOCUMENT.
                                          

<PAGE>


BOARD OF DIRECTORS
Kamran Elahian
CHAIRMAN OF THE BOARD

Prakash Agarwal
PRESIDENT AND CHIEF EXECUTIVE OFFICER

Brian P. Dougherty
PRESIDENT, WINK COMMUNICATIONS

Irwin Federman
GENERAL PARTNER, U.S. VENTURE PARTNERS

Jim Lally
PARTNER, KLEINER, PERKINS, CAUFIELD & BYERS

Klaus Wiemer
MEISSNER+WURST GMBH, STUTTGART, GERMANY


EXECUTIVE OFFICERS AS OF APRIL 1, 1999
Prakash Agarwal
PRESIDENT AND CHIEF EXECUTIVE OFFICER

Niall Bartlett
VICE PRESIDENT, LAB DIRECTOR, NEOMAGIC TECHNOLOGY LAB

Kamran Elahian
CHAIRMAN OF THE BOARD

Amnon Fisher
SENIOR VICE PRESIDENT AND GENERAL MANAGER,
CONSUMER PRODUCTS DIVISION

Daniel Hauck
VICE PRESIDENT, WORLDWIDE SALES

Ron Jankov
SENIOR VICE PRESIDENT AND GENERAL MANAGER,
MULTIMEDIA PRODUCTS DIVISION

Ibrahim Korgav
VICE PRESIDENT, MANUFACTURING OPERATIONS

Dr. Clement Leung
VICE PRESIDENT, R&D NEOMAGIC TECHNOLOGY LAB

Merle McClendon
VICE PRESIDENT, FINANCE AND
CHIEF FINANCIAL OFFICER

Kenneth Murray
VICE PRESIDENT, HUMAN RESOURCES

Deepraj Puar
VICE PRESIDENT, TECHNOLOGY


CORPORATE HEADQUARTERS
NeoMagic Corporation
3260 Jay Street
Santa Clara, CA 95054
Telephone 408-988-7020


NEOMAGIC SALES OFFICES
NeoMagic Austin
8500 N. Mopac, Suite 812
Austin, TX 78759
Tel 512-343-9112

NeoMagic Hong Kong
Suite 3012, 30/F, Tower 1, The Gateway
25 Canton Road
Kowloon Hong Kong
Tel 852-2110-5700

NeoMagic International Taiwan
10FL-D, No. 170 Tun-Hwa North Road
Taipei, Taiwan, ROC
Tel 011-2-2547-3168


DEVELOPMENT OFFICES
NeoMagic Israel Ltd.
Raanana, Israel

NeoMagic U.K. Limited
Oldham, Greater Manchester, U.K.


NeoMagic Semiconductor
India Pvt. Ltd.
Kanpur, India

REGISTRAR AND TRANSFER AGENT 
BankBoston, NA 
c/o Boston EquiServe 
PO Box 8040
Boston, MA 02266-8040


LEGAL COUNSEL
Wilson Sonsini Goodrich & Rosati
650 Page Mill Road
Palo Alto, CA 94304-1050


INDEPENDENT AUDITORS
Ernst & Young LLP
55 Almaden Boulevard
San Jose, CA 95113


COMMON STOCK
Nasdaq Symbol: NMGC


INVESTOR INFORMATION
www.neomagic.com


FORM 10-K
A copy of the Company's current Form 10-K as filed with the Securities and
Exchange Commission may be obtained without charge by writing:

NeoMagic Corporation
Investor Relations
3260 Jay Street
Santa Clara, CA 95054

or by calling 408-988-7020 x461

or may be obtained through our
web site at www.neomagic.com



<PAGE>

FINANCIAL REPORT


<TABLE>
<CAPTION>
                                                                                                         PAGE
<S>                                                                                       <C>
Selected Consolidated Financial Data                                                                        6
Quarterly Data                                                                                              7
Management's Discussion and Analysis of Financial Condition and Results of Operations                       8
Consolidated Statements of Operations                                                                      21
Consolidated Balance Sheets                                                                                22
Consolidated Statements of Cash Flows                                                                      23
Consolidated Statements of Stockholders' Equity                                                            24
Notes to Consolidated Financial Statements                                                                 25
Report of Ernst & Young LLP, Independent  Auditors                                                         36
Corporate Directory                                                                         Inside back cover
</TABLE>


                                      5

<PAGE>

SELECTED CONSOLIDATED FINANCIAL DATA

<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31,                             1999          1998           1997           1996          1995
--------------------------------------------------------------------------------------------------------------------
(in thousands, except per share data)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
<S>                                            <C>            <C>            <C>            <C>            <C>
Net sales                                      $ 240,503      $ 124,654      $  40,792      $     243      $      --
Cost of sales                                    142,881         73,171         28,650            165             --
                                               ---------      ---------      ---------      ---------      ---------
Gross margin                                      97,622         51,483         12,142             78             --
Operating expenses:
      Research and development                    31,756         16,091          8,606          4,934          2,423
      Sales, general and administrative           20,740         12,290          6,522          1,606            968
      Legal costs (1)                                 --             --         (1,503)           610          1,500
                                               ---------      ---------      ---------      ---------      ---------
         Total operating expenses                 52,496         28,381         13,625          7,150          4,891
Income (loss) from operations                     45,126         23,102         (1,483)        (7,072)        (4,891)
      Interest income and other                    3,810          2,643          1,366            385            194
      Interest expense                            (1,339)        (1,298)        (1,046)          (182)           (94)
                                               ---------      ---------      ---------      ---------      ---------
Income (loss) before income taxes                 47,597         24,447         (1,163)        (6,869)        (4,791)
Provision for income taxes                        16,395          3,667             --             --             --
                                               ---------      ---------      ---------      ---------      ---------
Net income (loss)                              $  31,202      $  20,780      $  (1,163)     $  (6,869)     $  (4,791)
                                               ---------      ---------      ---------      ---------      ---------
                                               ---------      ---------      ---------      ---------      ---------
Basic net income (loss) per share (2)          $    1.32      $     .95      $    (.07)
Diluted net income (loss) per share (2)        $    1.19      $     .82      $    (.07)
Weighted common shares outstanding (2)            23,710         21,924         17,238
Weighted common shares outstanding
assuming dilution (2)                             26,153         25,336         17,238
</TABLE>




<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31,                             1999           1998           1997          1996           1995
--------------------------------------------------------------------------------------------------------------------
<S>                                            <C>            <C>            <C>            <C>            <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents                      $  36,631      $  35,004      $  13,458      $   6,877      $   4,902
Short-term investments                            56,097         36,016             --             --             --
Working capital                                   92,839         53,518          1,398          4,069          2,846
Total assets                                     144,374        107,583         27,464          8,749          5,956
Long-term obligations                                 --            646          1,194            749            452
Total stockholders' equity                       103,395         65,127          4,200          4,542          3,313

OTHER DATA:
Number of employees                                  234            162             94             44             23
Revenue/employee                               $   1,028      $     769      $     434      $       6      $      --
</TABLE>



(1)  Relates to amounts provided by the Company for estimated legal fees
     associated with litigation which was dismissed in the second quarter of
     fiscal 1997. The $1.5 million benefit in legal costs during the year ended
     January 31, 1997 was due to the reversal of previously provided legal fees
     as a result of such dismissal. See Note 10 of Notes to Consolidated
     Financial Statements.

(2)  See Note 1 and Note 3 of Notes to Consolidated Financial Statements.

                                      6
<PAGE>

Quarterly Data

<TABLE>
<CAPTION>
FISCAL 1999                                                              Q1           Q2            Q3            Q4
-----------------------------------------------------------------------------------------------------------------------
(unaudited, in thousands except per share data)
<S>                                                                  <C>           <C>           <C>           <C>
Net sales                                                            $ 47,738      $ 53,396      $ 67,401      $ 71,968
Cost of sales                                                          27,510        31,058        40,436        43,877
                                                                     --------      --------      --------      --------
Gross margin                                                           20,228        22,338        26,965        28,091
Operating expenses:
      Research and development                                          6,252         7,314         8,729         9,461
      Sales, general and administrative                                 4,356         4,848         5,845         5,691
                                                                     --------      --------      --------      --------
       Total operating expenses                                        10,608        12,162        14,574        15,152
Income from operations                                                  9,620        10,176        12,391        12,939
      Interest income and other                                           975           919         1,039           877
      Interest expense                                                   (324)         (372)         (245)         (398)
                                                                     --------      --------      --------      --------
Income before income taxes                                             10,271        10,723        13,185        13,418
Provision for income taxes                                              3,595         3,753         4,615         4,432
                                                                     --------      --------      --------      --------
Net income                                                           $  6,676      $  6,970      $  8,570      $  8,986
                                                                     --------      --------      --------      --------
                                                                     --------      --------      --------      --------
Basic net income per share (1)                                       $    .29      $    .30      $    .36      $    .37
Diluted net income per share (1)                                     $    .26      $    .27      $    .33      $    .34
Weighted common shares outstanding (1)                                 23,295        23,595        23,828        24,120
Weighted average common shares outstanding assuming dilution (1)       26,098        26,033        25,950        26,530
Price range common stock:

   Low                                                               $  15.75      $  12.63      $  10.69      $  14.00
   High                                                              $  21.81      $  22.50      $  17.13      $  22.88
</TABLE>

<TABLE>
<CAPTION>

FISCAL 1998                                                              Q1            Q2            Q3            Q4
-----------------------------------------------------------------------------------------------------------------------
(unaudited, in thousands except per share data)
<S>                                                                  <C>           <C>           <C>           <C>
Net sales                                                            $ 18,281      $ 24,570      $ 37,146      $ 44,657
Cost of sales                                                          11,171        14,522        21,568        25,910
                                                                     --------      --------      --------      --------
Gross margin                                                            7,110        10,048        15,578        18,747
Operating expenses:
    Research and development                                            2,467         3,338         4,924         5,362
    Sales, general and administrative                                   2,277         2,382         3,452         4,179
                                                                     --------      --------      --------      --------
        Total operating expenses                                        4,744         5,720         8,376         9,541
Income from operations                                                  2,366         4,328         7,202         9,206
    Interest income and other                                             316           646           823           858
    Interest expense                                                     (224)         (314)         (325)         (435)
                                                                     --------      --------      --------      --------
Income before income taxes                                              2,458         4,660         7,700         9,629
Provision for income taxes                                                369           699         1,155         1,444
                                                                     --------      --------      --------      --------
Net income                                                           $  2,089      $  3,961      $  6,545      $  8,185
                                                                     --------      --------      --------      --------
                                                                     --------      --------      --------      --------
Basic net income per share (1)                                       $    .11      $    .18      $    .29      $    .36
Diluted net income per share (1)                                     $    .09      $    .15      $    .25      $    .32
Weighted common shares outstanding (1)                                 19,845        22,161        22,713        22,976
Weighted average common shares outstanding assuming dilution (1)       23,398        25,893        26,144        25,907

Price range common stock (commencing March 13, 1997):

   Low                                                               $  11.13      $  11.63      $  13.50      $  12.31
   High                                                              $  15.75      $  26.13      $  22.88      $  18.13
</TABLE>

The Company had 214 stockholders of record as of March 28, 1999. The Company has
not paid any dividends on its common stock. The Company currently intends to
reinvest earnings in its business and does not anticipate paying cash dividends
to stockholders.

(1)  See Note 1 and Note 3 of Notes to Consolidated Financial Statements.

                                      7

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

     When used in this discussion, the words "expects," "anticipates" and
similar expressions are intended to identify forward-looking statements. Such
statements, which include statements concerning the timing of availability and
functionality of products under development, product mix, trends in average
selling prices, the growth rate of the market for notebook PCs, competition, the
percentage of export sales and sales to strategic customers, the adoption or
retention of industry standards, and the availability and cost of products from
the Company's suppliers, are subject to risks and uncertainties, including those
set forth below under "Factors that May Affect Results," that could cause actual
results to differ materially from those projected. These forward-looking
statements speak only as of the date hereof. The Company expressly disclaims any
obligation or undertaking to release publicly any updates or revisions to any
forward-looking statements contained herein, to reflect any changes in the
Company's expectations with regard thereto or any changes in events, conditions
or circumstances on which any such statement is based.

OVERVIEW

     The Company designs, develops and markets high-performance semiconductor
solutions for sale to original equipment manufacturers ("OEM") of mobile
computing products including notebook PCs, and more recently digital cameras and
DVD drives. The Company pioneered the first commercially available
high-performance silicon technology that integrates DRAM, complex logic and
analog circuits into a single chip. The Company's proprietary MagicWare(TM)
technology eliminates the need to drive signals off-chip to discrete memory,
achieving its performance advantage while actually lowering the power
consumption and extending the battery life for smaller, lighter weight portable
devices. The first commercial application for the Company's technology is in the
design, development and marketing of multimedia accelerators for sale to
notebook computer manufacturers. The Company's MagicGraph128 and MagicMedia256
families of pin-compatible multimedia accelerators incorporate 128-bit and
256-bit memory buses, respectively.

     All of the Company's net sales in fiscal 1999, 1998 and 1997 were derived
from sales of its multimedia accelerator products, and the Company expects this
trend to continue at least through fiscal 2000. The Company recognizes revenue
at the time of product shipment for product sales directly to customers. The
Company's policy is to defer recognition of revenue of shipments to distributors
until the distributors sell the product. Historically, a majority of the
Company's sales have been to a limited number of customers. Sales to the
Company's top five customers accounted for 64.9%, 66.5% and 79.7% of the
Company's net sales for fiscal 1999, 1998 and 1997, respectively. The Company
expects that a substantial portion of sales of its products will continue to be
to a limited number of customers for the foreseeable future. The customers
contributing significant amounts of net sales have varied and will continue to
vary depending on the timing and success of new product introductions by such
customers.

     The Company's products require semiconductor wafers manufactured with
state-of-the-art fabrication equipment and technology. NeoMagic has established
strategic relationships with Mitsubishi Electric Corporation ("Mitsubishi
Electric"), Toshiba Corporation ("Toshiba") and Infineon Technologies
("Infineon"), formerly Siemens Aktiengesellschaft Semiconductor Group, to
produce its semiconductor wafers and uses other independent contractors to
perform assembly, packaging and testing. The Company's foundry relationships are
formalized in separate five-year wafer supply agreements. These relationships
enable the Company to concentrate its resources on product design and
development, where NeoMagic believes it has greater competitive advantages, and
to eliminate the high cost of owning and operating a semiconductor wafer
fabrication facility. The Company depends on these suppliers to allocate to the
Company a portion of their manufacturing capacity sufficient to meet the
Company's needs, to produce products of acceptable quality and at acceptable
manufacturing yields and to deliver those products to the Company on a timely
basis. The Company purchases wafers and pays an agreed price for wafers meeting
certain acceptance criteria. All of the Company's products are assembled and
tested by independent vendors. To date, all of the Company's wafer purchases,
which constitute a significant part of its cost of sales, have been priced in
Japanese yen. As a result, exchange rate fluctuations can affect the Company's
gross margin. The Company has in the past hedged its exposure to fluctuations in
the exchange rate between the Japanese yen and the United States dollar by
purchasing forward contracts and options, and may continue to do so in the
future.

     Under its wafer supply agreements, the Company is obligated to provide
rolling 12-month forecasts of anticipated purchases and place binding purchase
orders up to four months prior to shipment. If the Company cancels a purchase
order, the Company must pay cancellation penalties based on the status of work
in process or the proximity of the cancellation to the delivery date. Forecasts
of monthly purchases may not increase or decrease by more than a certain
percentage from the previous month's forecast without the manufacturer's
consent. Thus, the Company must forecast and place purchase orders for wafers
long before it receives purchase orders from its own customers. This limits the
Company's ability to react to fluctuations in demand for its products, which can
be unexpected and dramatic and from time-to-time will cause the Company to have
an excess or a shortage of wafers for a particular product, which could cause
the Company to take charges for excess inventory or miss revenue opportunities.

                                      8
<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

     Prior to fiscal 1997, the Company was primarily engaged in research and
development and testing of its products. Accordingly, the majority of its
operating expenses were related to research and development activities. In
fiscal 1997, in connection with the commencement of commercial sales of its
products, the Company accelerated its investment in sales, marketing,
manufacturing and administrative infrastructures. Throughout fiscal 1999, the
Company has continued to devote resources to research and development efforts as
well as to make additional investments in sales, marketing, manufacturing and
administrative infrastructures to support the increased sales experienced within
the year. The Company expects to continue to devote substantial resources to
research and development efforts for the foreseeable future. All of the
Company's research and development costs have been expensed as incurred.

     The Company's fiscal year end is January 31. Any reference herein to a
fiscal year refers to the year ended January 31 of such year.

RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, certain financial
data as a percentage of net sales:

<TABLE>
<CAPTION>
YEARS ENDED JANUARY 31,                     1999         1998          1997
---------------------------------------------------------------------------
<S>                                        <C>          <C>          <C>
Net sales                                  100.0%       100.0%       100.0%
Cost of sales                               59.4         58.7         70.2
                                           -----        -----        ----- 
Gross margin                                40.6         41.3         29.8
Operating expenses:
   Research and development                 13.2         12.9         21.1
   Sales, general and administrative         8.6          9.9         16.0
   Legal costs                                --           --         (3.7)
                                           -----        -----        ----- 
            Total operating expenses        21.8         22.8         33.4
                                           -----        -----        ----- 
                                           -----        -----        ----- 
Income (loss) from operations               18.8         18.5         (3.6)
      Interest income and other              1.6          2.1          3.3
      Interest expense                       (.6)        (1.0)        (2.6)
                                           -----        -----        ----- 
Income (loss) before income taxes           19.8         19.6         (2.9)
Provision for income taxes                   6.8          2.9           --
                                           -----        -----        -----
Net income (loss)                           13.0%        16.7%        (2.9)%
                                           -----        -----        ----- 
                                           -----        -----        ----- 
</TABLE>

NET SALES

     The Company's net sales to date have been generated from the sale of its
multimedia accelerators. The Company's products are used in, and its business is
dependent upon, the personal computer industry with sales primarily in Asia,
Japan, and the United States. Net sales were $240.5 million, $124.7 million and
$40.8 million in fiscal 1999, 1998 and 1997, respectively. Net sales increased
primarily as a result of increased market acceptance of the Company's products,
introduction by the Company of additional products in its MagicGraph128 and
MagicMedia256 product families expanding the portion of the market addressed by
NeoMagic products, and the Company's investment in sales and marketing
activities. The Company expects that the percentage of its net sales represented
by any one product or type of product may change significantly from period to
period as new products are introduced and existing products reach the end of
their product life cycles. Due to competition, a decrease in DRAM pricing and
the trend in the market toward lower cost notebook computers, the Company's
products may experience declining unit average selling prices over time, which
at times can be substantial.

     Sales to customers located outside the United States (including sales to
foreign operations customers with headquarters in the United States, and foreign
system manufacturers that sell to United States-based OEMs) accounted for 83.6%,
83.2% and 96.2% of net sales in fiscal 1999, 1998 and 1997, respectively. The
Company expects that export sales will continue to represent a significant
portion of net sales, although there can be no assurance that export sales as a
percentage of net sales will remain at current levels. All sales transactions
were denominated in United States dollars.

     Three customers accounted for 19.8%, 17.1% and 10.5%, respectively, of net
sales in fiscal 1999. Five customers accounted for 14.4%, 13.6%, 13.5%, 13.3%
and 11.7%, respectively, of net sales in fiscal 1998. Three customers accounted
for 31.6%, 19.8% and 14.6%, respectively, of net sales in fiscal 1997. The
Company expects a significant portion of its future sales to remain concentrated
with a limited number of strategic customers. There can be no assurance that the
Company will be able to retain its strategic customers, or that such customers
will not cancel or reschedule orders, or in the event orders are canceled, that
such orders will be replaced by other orders. In addition, sales to any
particular customer may fluctuate significantly from quarter to quarter. The
occurrence of any such events or the loss of a strategic customer could have a
material adverse effect on the Company's operating results.

                                      9
<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

GROSS MARGIN

     Gross margin was $97.6 million, $51.5 million and $12.1 million in fiscal
1999, 1998 and 1997, respectively. The gross margin percentage decreased to
40.6% of net sales in fiscal 1999 from 41.3% of net sales in fiscal 1998 due
primarily to declines in unit average selling prices stemming from the market
trend toward lower priced notebooks and increased competition. Also affecting
fiscal 1999 gross margin was a decrease in the dollar/yen exchange rate
(primarily in the fourth fiscal quarter) and low production yields on new
product ramp-ups. These factors were mitigated in part by other product cost
decreases stemming from the Company's cost reduction efforts. The gross margin
percentage increased to 41.3% of net sales in fiscal 1998 from 29.8% of net
sales in fiscal 1997 due to lower wafer pricing and improved yields in fiscal
1998, and the inclusion in fiscal 1997 of inventory charges relating to a design
error and excess inventory of $1.2 million and $1.5 million, respectively.

     In the future, the Company's gross margin percentages may be affected by
the continued trend in the market toward lower priced notebooks, increased
competition and related decreases in unit average selling prices (particularly
with respect to older generation products), changes in the mix of products sold,
timing of volume shipments of new products, the availability and cost of
products from the Company's suppliers, manufacturing yields (particularly on new
products) and foreign currency exchange rate fluctuations.

RESEARCH AND DEVELOPMENT EXPENSES

     Research and development expenses include compensation and associated costs
relating to development personnel, operating system software costs and
prototyping costs, which are comprised of photomask costs and pre-production
wafer costs. Research and development expenses were $31.8 million, $16.1 million
and $8.6 million in fiscal 1999, 1998 and 1997, respectively. The Company has
made, and intends to continue to make, significant investments in research and
development to remain competitive by developing new and enhanced products to
serve its identified markets. Research and development expenses increased
primarily due to increased employee related expenses and to a lesser extent
consulting, engineering and equipment related expenses. Research and development
expenses are expected to increase in absolute dollars in fiscal 2000.

SALES, GENERAL AND ADMINISTRATIVE EXPENSES

     Sales, general and administrative expenses were $20.7 million, $12.3
million and $6.5 million in fiscal 1999, 1998 and 1997, respectively. Sales,
general and administrative expenses increased as a result of increased
commissions associated with higher sales levels and increased employee related
expenses largely related to additional personnel. Sales, general and
administrative expenses are expected to increase in absolute dollars in fiscal
2000.

LEGAL COSTS

     Legal costs consist of amounts provided by the Company for estimated legal
fees associated with the litigation with Cirrus Logic, which was dismissed in
the second quarter of fiscal 1997. In fiscal 1995, the Company accrued $1.5
million for such legal costs. In fiscal 1996, the Company recorded an additional
accrual for legal costs of $610,000. In fiscal 1997, based on the dismissal of
such litigation, the remaining reserve balance of $1.5 million was reversed. See
Note 10 of Notes to Consolidated Financial Statements.

INTEREST INCOME AND OTHER

     The Company earns interest on its cash and short-term investments. Interest
income and other was $3.8 million, $2.6 million and $1.4 million in fiscal 1999,
1998 and 1997, respectively. The increases in both fiscal 1999 and fiscal 1998
stemmed from higher interest income earned on higher cash and short-term
investment balances.

INTEREST EXPENSE

     The Company pays interest and commissions on wafer purchases and interest
on its leases. Interest expense was $1.3 million, $1.3 million and $1.0 million
in fiscal 1999, 1998 and 1997, respectively. The increase in interest expense
from fiscal 1997 to fiscal 1999 reflects increased wafer purchases, offset in
part by lower interest and commission rates under the working capital line of
credit. See Note 5 of Notes to Consolidated Financial Statements for further
discussion of the working capital line of credit.

                                      10
<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

INCOME TAXES

     The Company's effective tax rate was 34% in fiscal 1999 and 15% in fiscal
1998. The Company recorded no provision for federal or state income taxes in
fiscal 1997. The increase in the fiscal 1999 effective tax rate stems from net
operating loss carryforwards being fully utilized in fiscal 1998. The difference
between the Company's fiscal 1999 effective tax rate and the statutory rate is
primarily due to the utilization of research and development tax credits. The
difference between the Company's fiscal 1998 effective tax rate and the
statutory rate is primarily due to the utilization of the Company's net
operating loss carryforwards.

LIQUIDITY AND CAPITAL RESOURCES

     The Company's cash, cash equivalents and short-term investments were $92.7
million, $71.0 million and $15.7 million as of the end of fiscal 1999, 1998 and
1997, respectively. The increase in cash, cash equivalents and short-term
investments in fiscal 1999 stems primarily from cash provided by operating
activities, offset in part by the pay-down of the working capital line of credit
and investments in property, plant and equipment. In January 1998, in exchange
for a lower commission rate, the payment terms on wafer purchases were changed
from payable in 90 days from shipment to payable in 30 days from shipment. The
increase in cash, cash equivalents and short-term investments in fiscal 1998 was
due to net proceeds from the issuance of common stock related to the initial
public offering in the first quarter of fiscal 1998 and net cash provided from
operations. Working capital increased $39.9 million to $92.8 million at January
31, 1999 from $52.9 million at January 31, 1998.

     Cash and cash equivalents provided from (used for) operating activities
were $45.1 million, $15.4 million and ($3.1) million in fiscal 1999, 1998 and
1997, respectively. The cash provided from operating activities in fiscal 1999
stems primarily from $31.2 million in net income, an increase in accounts
payable and a reduction in deferred taxes, offset in part by increased accounts
receivable, inventory and other assets. The cash provided from operating
activities in fiscal 1998 stems primarily from $20.8 million in net income and
increases in accrued expenses and accounts payable, offset by increases in
accounts receivable, inventory and deferred taxes. The cash used for operating
activities in fiscal 1997 stems primarily from $1.2 million in net loss and
increases in accounts receivable and inventory, offset in part by increases in
accounts payable.

     Net cash used for investing activities in fiscal 1999, 1998 and 1997 was
$25.5 million, $40.5 million and $3.1 million, respectively. Net cash used for
investing activities in fiscal 1999 related primarily to $20.1 million of net
purchases of short-term investments and $5.4 million of investments in property,
plant and equipment. Net cash used for investing activities in fiscal 1998 and
1997 was related to net purchases of short-term investments and investments in
property, plant and equipment. Continued expansion of the Company's business may
require higher levels of capital equipment purchases, technology investments,
foundry investments and other payments to secure manufacturing capacity. The
timing and amount of future investments will depend primarily on the growth of
the Company's future revenues.

     Net cash used for financing activities in fiscal 1999 was $18.0 million,
compared to net cash provided by financing activities of $46.7 million and $12.8
million in fiscal 1998 and 1997, respectively. The net cash used for financing
activities in fiscal 1999 related primarily to the pay-down of the working
capital line of credit of $21.0 million, offset in part by proceeds from the
issuance of common stock. The net cash provided by financing activities in
fiscal 1998 primarily represents net proceeds from the initial public offering
of $37.8 million, net proceeds related to the working capital line of credit and
the release of amounts previously held as restricted cash. Net cash provided by
financing activities in fiscal 1997 relates primarily to net proceeds of $13.8
million related to the working capital line of credit, offset by amounts held as
restricted cash and cash equivalents.

     At January 31, 1999, the Company's principal sources of liquidity included
cash, cash equivalents and short-term investments of $92.7 million. The Company
believes these available funds and anticipated funds from operations will
satisfy the Company's projected working capital and capital expenditure
requirements through the next twelve months. The Company currently expects to
spend approximately $7.0 million to $10.0 million on capital items during the
next twelve months, consisting primarily of purchases of development tools and
software and personal computers. Investments will continue in new product
development in new and existing areas of technology. Cash may also be used to
acquire technology through purchases and strategic acquisitions, such as the
acquisitions in February 1999 of ACL and the Optical Drive Development Group
(see Note 12 of Notes to Consolidated Financial Statements for further
discussion of recent acquisitions). The Company's future capital requirements
will depend on many factors including the rate of net sales growth, the timing
and extent of spending to support research and development programs, expansion
of sales, marketing and administrative infrastructure, the timing of new product
introductions and enhancements to existing products, and market acceptance of
the Company's products. The Company expects that it may need to raise additional
equity or debt financing in the future. There can be no assurance that
additional equity or debt financing, if required, will be available on
acceptable terms or at all.

                                      11
<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

IMPACT OF CURRENCY EXCHANGE RATES

     Because the Company currently purchases all wafers under purchase contracts
denominated in yen, significant appreciation in the value of the yen relative to
the value of the U.S. dollar would make the wafers relatively more expensive to
the Company, which could have a material adverse effect on the Company's
business, financial condition and results of operations. The Company generally
enters into foreign currency forward contracts and foreign currency options to
minimize short-term foreign currency fluctuation exposures related to these firm
purchase commitments. The Company does not use derivative financial instruments
for speculative or trading purposes. The Company's accounting policies for these
instruments are based on the Company's designation of such instruments as
hedging transactions. The criteria the Company uses for designating an
instrument as a hedge include its effectiveness in risk reduction and one-to-one
matching of derivative instruments to underlying transactions. Notwithstanding
the measures the Company has adopted, due to the unpredictability and volatility
of currency exchange rates and currency controls, there can be no assurance that
the Company will not experience foreign currency losses in the future, nor can
the Company predict the effect of exchange rate fluctuations upon future
operating results.

IMPACT OF YEAR 2000

     Like many other companies, the year 2000 computer issue creates risks for
the Company. If computer systems do not correctly recognize and process date
information beyond calendar year 1999, there could be an adverse impact on the
Company's operations. Computer programs that have time-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000.

     The Company has completed an initial assessment of its internal computer
systems, and does not believe that it will be required to modify or replace
significant portions of its internal systems so that they will function properly
with respect to dates in the year 2000 and thereafter. The Company's internal
computer systems consist primarily of third party software tools for
engineering, sales, finance and human resources functions. The Company has
reviewed its internal business software including system software for order
management, finance, purchasing and human resources. All major system software
was found to be year 2000 compliant. The Company is working closely with the
suppliers of its engineering software tools on the year 2000 issue, and plans to
have all such tools updated and tested for year 2000 compliance by the middle of
fiscal 2000. The Company is also reviewing its networks, telephones, PCs and
workstations, and expects all to be in compliance by the middle of fiscal 2000.
For all new software purchases, the Company requires year 2000 compliance.

     NeoMagic does not operate its own manufacturing facilities. Rather, the
Company's products are manufactured and tested by independent third party
suppliers, primarily located in Asia and Japan. The Company believes that its
most reasonably likely worst case year 2000 scenario would relate to problems
with its third-party suppliers rather than with the Company's internal systems
or its products. The Company has contacted critical suppliers of products and
services to determine whether or not the suppliers' operations and the products
and services they provide are year 2000 capable. Highest priority is being
placed on working with suppliers that are critical to the delivery of the
Company's products to customers. A worst case scenario involving a critical
supplier would be the partial or complete shutdown of the supplier and its
resulting inability to provide its products or services to the Company on a
timely basis. The Company continues to monitor its suppliers and will develop
specific contingency plans by the middle of fiscal 2000 to address issues
related to suppliers that are not considered to be taking all steps necessary to
ensure year 2000 capability. Where efforts to work with critical suppliers to
ensure year 2000 capability have not been successful, contingency planning
generally emphasizes the identification of substitute and second-source
suppliers where available or planned increases in inventory levels of specific
products in advance of the end of calendar year 1999. This contingency planning
is expected to be ongoing through calendar 1999.

     The Company's year 2000 efforts to date have largely been carried out with
existing personnel, and the incremental costs incurred to date have been less
than $250,000. Management believes that incremental costs to be incurred going
forward to assure that its internal systems and products are year 2000 capable
will be less than $250,000. However, the Company is not in a position to
identify or to avoid all possible adverse year 2000 scenarios, particularly as
it relates to its third-party suppliers. Due to the large number of variables
involved, the Company cannot provide an estimate of the damage it might suffer
if any of these adverse scenarios were to occur. As such, there can be no
assurance that the failure to ensure year 2000 capability by a supplier or
another third party would not have a material adverse effect on the Company's
financial condition or overall results of operations.

                                      12

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

FACTORS THAT MAY AFFECT RESULTS

FLUCTUATIONS IN QUARTERLY OPERATING RESULTS

     NeoMagic's quarterly and annual results of operations are affected by a
variety of factors that could materially adversely affect net sales, gross
margin and income from operations. These factors include, among others, demand
for the Company's products, changes in product or customer mix (i.e. the portion
of the Company's revenues represented by the Company's various products and
customers), incorrect forecasting of future revenues, fluctuations in
manufacturing yields, availability and cost of manufacturing capacity, foreign
exchange rate fluctuations, unanticipated delays or problems in the introduction
or performance of the Company's next generation of products, the Company's
ability to introduce new products in accordance with OEM design requirements and
design cycles, the Company's ability to leverage its technology across new
markets, market acceptance of the end-products of the Company's customers,
changes in the timing of product orders due to unexpected delays in the
introduction of products of the Company's customers or due to the life cycles of
such customers' products ending earlier than anticipated, new product
announcements or product introductions by NeoMagic's competitors, competitive
pressures resulting in lower average selling prices, the volume of orders that
are received and can be fulfilled in a quarter, the rescheduling or cancellation
of orders by customers which cannot be replaced with orders from other
customers, supply constraints for the other components incorporated into its
customers' notebook PC products, the unanticipated loss of any strategic
relationship, seasonality associated with the tendency of PC sales to increase
in the second half of each calendar year, the level of expenditures for research
and development and sales, general and administrative functions of the Company,
costs associated with future litigation, and costs associated with protecting
the Company's intellectual property. Any one or more of these factors could
result in the Company failing to achieve its expectations as to future revenues
and profits. The Company may be unable to adjust spending sufficiently in a
timely manner to compensate for any unexpected sales shortfall, which could
materially adversely affect quarterly operating results. Accordingly, the
Company believes that period-to-period comparisons of its operating results
should not be relied upon as an indication of future performance. In addition,
the results of any quarterly period are not indicative of results to be expected
for a full fiscal year. In future quarters, the Company's operating results may
be below the expectations of public market analysts or investors. In such event,
the market price of the Common Stock would be materially adversely affected.

RISKS ASSOCIATED WITH DEPENDENCE ON THE NOTEBOOK PC MARKET

     The Company's products are currently used only in notebook PCs. The
notebook PC market is characterized by rapidly changing technology, evolving
industry standards, frequent new product introductions and significant price
competition, resulting in short product life cycles and regular reductions of
average selling prices over the life of a specific product. Although the
notebook PC market has grown substantially in recent years, there is no
assurance that such growth will continue. A reduction in sales of notebook PCs,
or a reduction in the growth rate of such sales, would likely reduce demand for
the Company's products. Moreover, such changes in demand could be large and
sudden. Since PC manufacturers often build inventories during periods of
anticipated growth, they may be left with excess inventories if growth slows or
if they have incorrectly forecasted product transitions. In such cases, the PC
manufacturers may abruptly suspend substantially all purchases of additional
inventory from suppliers such as the Company until the excess inventory has been
absorbed. Any reduction in the demand for notebook PCs in general, or for a
particular product that incorporates the Company's multimedia accelerators,
could have a material adverse impact on the Company's business, financial
condition and results of operations.

     The Company's ability to compete in the future will depend on its ability
to identify and ensure compliance with evolving industry standards.
Unanticipated changes in industry standards could render the Company's products
incompatible with products developed by major hardware manufacturers and
software developers, including Intel Corporation and Microsoft Corporation. The
Company could be required, as a result, to invest significant time and effort to
redesign its products to ensure compliance with relevant standards. If the
Company's products are not in compliance with prevailing industry standards for
a significant period of time, the Company could miss crucial OEM design cycles,
which could result in a material adverse effect on the Company's business,
financial condition and results of operations. In addition, the Company's
products are designed to afford the notebook PC manufacturer significant
advantages with respect to product performance, power consumption and size. To
the extent that other future developments in notebook PC components or
subassemblies incorporate one or more of the advantages offered by the Company's
products, the market demand for the Company's products may be negatively
impacted, which could result in a material adverse effect on the Company's
business, financial condition and results of operations.

                                      13

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

PRODUCT CONCENTRATION, RISKS ASSOCIATED WITH MULTIMEDIA PRODUCTS

     The Company's revenues currently are entirely dependent on the market for
multimedia accelerators for notebook PCs, and on the Company's ability to
compete in that market. Since the Company has no other revenue generating
product line, the Company's revenues and results of operations would be
materially adversely affected if for any reason it were unsuccessful in selling
multimedia accelerators. The notebook PC market frequently undergoes transitions
in which products rapidly incorporate new features and performance standards on
an industry-wide basis. If the Company's products were unable to support the new
feature sets or performance levels stemming from such a transition, the Company
would likely not have the opportunity to compete for new design wins until it
was able to incorporate the new feature sets or performance requirements into
its products. A failure to develop products with required feature sets or
performance standards, or a delay as short as a few months in bringing a new
product to market, could significantly reduce the Company's net sales for a
substantial period, which would have a material adverse effect on the Company's
business, financial condition and results of operations.

     The notebook PC multimedia market is characterized by extreme price
competition. Leading-edge products may command higher average selling prices,
but prices decline throughout the product life cycle as comparable or more
advanced products are introduced into the market. As a result, the Company's
ability to maintain average selling prices and gross margins depends
substantially on its ability to continue introducing new products. Its ability
to maintain gross margins is also dependent upon its ability to reduce product
costs throughout a product life cycle by instituting cost reduction design
changes and yield improvements, persuading customers to adopt cost-reduced
versions of its products, and successfully managing its manufacturing and
subcontractor relationships. Failure by the Company to continually design and
introduce advanced products in a timely manner and to reduce product costs on
older products would have a material adverse effect on the Company's net sales,
gross margins and results of operations.

CONSUMER PRODUCT EXECUTION

     The Company announced the formation of the Consumer Products division in
June 1998. The division will explore consumer semiconductor product
opportunities in emerging markets such as digital video disks, digital cameras,
and other consumer products that can benefit from the advantages of embedded
DRAM MagicWare(TM) technology pioneered by NeoMagic. In February 1999, the
Company completed two acquisitions to further the development efforts of the
Consumer Products division. The Company acquired the Optical Drive Development
Group and associated DVD intellectual properties from Mitel Semiconductor in
Manchester, England and the assets and intellectual properties of ACL of Tel
Aviv, Israel from Robomatix Technologies Ltd. The DVD and digital camera markets
are new and evolving. The Company's ability to compete in these new markets will
depend on its ability to identify and ensure compliance with evolving industry
standards, develop and market compelling semiconductor solutions, and deliver
those solutions to the market in a timely and cost effective manner. Any such
new product development program faces substantial risks and uncertainties,
including risks as to the costs, timing and results of engineering efforts,
competitive risks and market development risks. There can be no assurance that
the products the Company expects to introduce will incorporate the features,
functionality and pricing demanded by the market, or will be introduced within
the appropriate window of market demand. The failure of the Company to
successfully introduce new products and achieve market acceptance for such
products would have a material adverse effect on the Company's business,
financial condition and results of operations.

CUSTOMER CONCENTRATION

     The Company's sales are concentrated within a limited customer base in the
notebook PC market. The Company expects that a small number of customers will
continue to account for a substantial portion of its net sales for the
foreseeable future. Furthermore, the majority of the Company's sales are made on
the basis of purchase orders rather than pursuant to long-term purchase
agreements. As a result, the Company's business, financial condition and results
of operations could be materially adversely affected by the decision of a single
customer to cease using the Company's products, or by a decline in the number of
notebook PCs sold by a single customer.

EFFECTS OF CHANGES IN DRAM PRICING

     The Company's products feature large DRAM memory integrated with analog and
logic circuitry on a single chip, while its competitors often provide discrete
analog and logic circuitry to be used in conjunction with DRAM supplied by
others. The selling prices of the Company's products reflect many factors,
including the prices of DRAM chips. As the Company places firm purchase
commitments for wafers some 3 to 4 months in advance, significant reductions in
the market price of DRAM could cause the Company's products to become less
competitively priced relative to competing discrete solutions with
non-integrated DRAM. In this circumstance, the Company could be forced to
respond to pricing pressures precipitated by changes in the DRAM market by
reducing the average

                                      14

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

selling prices of its products to current and prospective customers. Recently,
the DRAM market has experienced significant price erosion, which has been a
factor in the overall decline in the average selling price of the Company's
products. Because the Company's product costs cannot be adjusted as rapidly as
changes in the market price of DRAM, the Company's business, financial condition
and results of operations may be materially and adversely affected by
unanticipated changes in the price of DRAM.

COMPETITION

     The market for multimedia accelerators for notebook PCs in which the
Company competes is intensely competitive and is characterized by rapid
technological change, evolving industry standards and declining average selling
prices. NeoMagic believes that the principal factors of competition in this
market are performance, price, features, power consumption, size and software
support. The ability of the Company to compete successfully in the rapidly
evolving notebook PC market depends on a number of factors, including success in
designing and subcontracting the manufacture of new products that implement new
technologies, product quality, reliability, price, the efficiency of production,
design wins for NeoMagic's integrated circuits, ramp up of production of the
Company's products for particular system manufacturers, end-user acceptance of
the system manufacturers' products, market acceptance of competitors' products
and general economic conditions. There can be no assurance that the Company will
be able to compete successfully in the future.

     NeoMagic competes with major domestic and international companies, some of
which have substantially greater financial and other resources than the Company
with which to pursue engineering, manufacturing, marketing and distribution of
their products. The Company's principal competitors include ATI Technologies
(ATI), Chips & Technologies, Inc. ("Chips & Technologies"- in January 1998,
Intel Corporation acquired Chips and Technologies) and Trident Microsystems,
Inc. ("Trident"). NeoMagic may also face increased competition from new entrants
into the notebook PC multimedia accelerator market including companies currently
selling products designed for desktop PCs. Some of the Company's competitors,
including Chips & Technologies and Trident have announced or introduced
multimedia accelerator products that integrate large DRAM with analog and logic
circuitry on a single chip. Certain of the Company's competitors may offer
products with more functionality and/or higher processor speeds at the expense
of battery life and power consumption than the Company's product offerings.
These feature sets may be more competitive for certain applications than the
Company's products. Potential competition also could come from manufacturers
that integrate the multimedia accelerator with other systems components. For
example, Cyrix (acquired by National Semiconductor in July 1997) is in
production of an integrated microprocessor and graphics accelerator. Further,
several of the Company's competitors have announced plans to develop products
that integrate the multimedia accelerator with the core logic chip set. The
successful commercial introduction by competitors of products that integrate
large DRAM with analog and logic circuitry on a single chip or that eliminate
the need for a separate multimedia accelerator in notebook PCs could have a
material adverse effect on the Company's business, financial condition and
results of operations.

     Some of the Company's current and potential competitors operate their own
manufacturing facilities. Since the Company does not operate its own
manufacturing facility and must make binding commitments to purchase products,
it may not be able to reduce its costs and cycle time or adjust its production
to meet changing demand as rapidly as companies that operate their own
facilities, which could have a material adverse effect on the Company's results
of operations.

DEPENDENCE ON MANUFACTURING RELATIONSHIPS

     The Company's products require wafers manufactured with state-of-the-art
fabrication equipment and techniques. The Company's wafers currently are
manufactured by Mitsubishi Electric and Toshiba in Japan. In February 1999, the
Company entered into a wafer supply agreement with Infineon (formerly Siemens)
of Germany. Each of these manufacturing relationships is covered under the terms
of a five-year wafer supply agreement. The Company expects that, for the
foreseeable future, some of its products will be manufactured by a single
source. Since, in the Company's experience, the lead time needed to establish a
strategic relationship with a new DRAM partner is at least 12 months and the
estimated time for a foundry to switch to a new product line ranges from four to
nine months, there may be no readily available alternative source of supply for
specific products. A manufacturing disruption experienced by any of the
Company's manufacturing partners or the failure of one of the Company's
manufacturing partners to dedicate adequate resources to the production of the
Company's products would have a material adverse effect on the Company's
business, financial condition and results of operations. Furthermore, in the
event that the transition to the next generation of manufacturing technologies
by the Company's manufacturing partners is unsuccessful, the Company's business,
financial condition and results of operations would be materially and adversely
affected.

                                      15

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

     There are many other risks associated with the Company's dependence upon
third-party manufacturers, including: reduced control over delivery schedules,
quality, manufacturing yields and cost; the potential lack of adequate capacity
during periods of excess demand; limited warranties on wafers supplied to the
Company; and potential misappropriation of NeoMagic intellectual property. The
Company is dependent on its manufacturing partners to produce wafers with
acceptable quality and manufacturing yields, deliver those wafers on a timely
basis to the Company's third-party assembly subcontractors and to allocate to
the Company a portion of their manufacturing capacity sufficient to meet the
Company's needs. Although the Company's products are designed using the process
design rules of the particular manufacturer, there can be no assurance that the
Company's manufacturing partners will be able to achieve or maintain acceptable
yields or deliver sufficient quantities of wafers on a timely basis or at an
acceptable cost. Additionally, there can be no assurance that the Company's
manufacturing partners will continue to devote adequate resources to the
production of the Company's products or continue to advance the process design
technologies on which the manufacturing of the Company's products are based. The
Company in the past has experienced difficulties in some of these areas, and
there can be no assurance that in the future the Company will not experience
supply-related difficulties, which could have a material adverse effect on the
Company's business, financial condition and results of operations.

     The Company's products are assembled and tested by third-party
subcontractors. The Company does not have long-term agreements with any of these
subcontractors. Such assembly and testing is conducted on a purchase order
basis. As a result of its reliance on third-party subcontractors to assemble and
test its products, the Company cannot directly control product delivery
schedules, which could lead to product shortages or quality assurance problems
that could increase the costs of manufacturing or assembly of the Company's
products. Due to the amount of time normally required to qualify assembly and
test subcontractors, product shipments could be delayed significantly if the
Company were required to find alternative subcontractors. Any problems
associated with the delivery, quality or cost of the assembly and test of the
Company's products could have a material adverse effect on the Company's
business, financial condition and results of operations.

INVENTORY RISK

     Under its wafer supply agreements with Mitsubishi Electric, Toshiba and
Infineon, the Company is obligated to provide rolling 12-month forecasts of
anticipated purchases and to place binding purchase orders three to four months
prior to shipment from the suppliers. If the Company cancels a purchase order,
it must pay cancellation penalties based on the status of work in process or the
proximity of the cancellation to the delivery date. Forecasts of monthly
purchases may not increase or decrease by more than a certain percentage from
the previous month's forecast without the manufacturer's consent. Thus, the
Company must make forecasts and place purchase orders for wafers long before it
receives purchase orders from its own customers. This limits the Company's
ability to react to fluctuations in demand for its products, which can be
unexpected and dramatic, and from time-to-time will cause the Company to have an
excess or shortage of wafers for a particular product. Also, many of the
Company's customers are moving to "just in time" relationships with their
vendors, which can shift the risk of carrying inventory back to the supplier. As
a result of the long lead-time for manufacturing wafers and the increase in
"just in time" ordering by PC manufacturers, semiconductor companies such as the
Company from time-to-time must take charges for excess inventory. Significant
write-offs of excess inventory could have a material adverse effect on the
Company's financial condition and results of operations. Conversely, failure to
order sufficient wafers would cause the Company to miss revenue opportunities
and, if significant, could impact sales by the Company's customers, which could
adversely affect the Company's customer relationships and thereby materially
adversely affect the Company's business, financial condition and results of
operations.

MANUFACTURING YIELDS

     The fabrication of semiconductors is a complex and precise process. Because
NeoMagic's products feature the integration of large DRAM memory with analog and
logic circuitry on a single chip, a manufacturer must obtain acceptable yields
of both the memory and logic portions of such products, compounding the
complexity of the manufacturing process. As a result, the Company may face
greater manufacturing challenges than its competitors. Minute levels of
contaminants in the manufacturing environment, defects in masks used to print
circuits on a wafer, difficulties in the fabrication process or other factors
can cause a substantial percentage of wafers to be rejected or a significant
number of die on each wafer to be nonfunctional. Many of these problems are
difficult to diagnose and time consuming or expensive to remedy. As a result,
semiconductor companies often experience problems in achieving acceptable wafer
manufacturing yields, which are represented by the number of good die as a
proportion of the total number of die on any particular wafer. The Company
purchases wafers, not die, and pays an agreed upon price for wafers meeting
certain acceptance criteria. Accordingly, the Company bears the risk of the
yield of good die from wafers purchased meeting the acceptance criteria. Poor
yields would materially adversely affect the Company's net sales, gross margins
and results of operations.

                                      16

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

     Semiconductor manufacturing yields are a function of both product design,
which is developed largely by the Company, and process technology, which is
typically proprietary to the manufacturer. Historically, the Company has
experienced lower yields on new products. Since low yields may result from
either design or process technology failures, yield problems may not be
effectively determined or resolved until an actual product exists that can be
analyzed and tested to identify process sensitivities relating to the design
rules that are used. As a result, yield problems may not be identified until
well into the production process, and resolution of yield problems would require
cooperation by, and communication between, the Company and the manufacturer. For
example, a design error that resulted in lower than expected yields of finished
products caused the Company to take a $1.2 million charge in fiscal 1997. This
risk is compounded by the offshore location of the Company's manufacturers,
increasing the effort and time required identifying, communicating and resolving
manufacturing yield problems. As the Company's relationships with additional
manufacturing partners develop, yields could be adversely affected due to
difficulties associated with adopting the Company's technology and product
design to the proprietary process technology and design rules of each
manufacturer. Any significant decrease in manufacturing yields could result in
an increase in the Company's per unit product cost and could force the Company
to allocate its available product supply among its customers, potentially
adversely impacting customer relationships as well as revenues and gross
margins. There can be no assurance that the Company's manufacturers will achieve
or maintain acceptable manufacturing yields in the future. The inability of the
Company to achieve planned yields from its manufacturers could have a material
adverse effect on the Company's business, financial condition and results of
operations. Furthermore, the Company also faces the risk of product recalls
resulting from design or manufacturing defects which are not discovered during
the manufacturing and testing process. In the event of a significant number of
product returns, the Company's net sales and gross margin could be materially
adversely affected.

DEPENDENCE ON NEW PRODUCT DEVELOPMENT, RAPID TECHNOLOGICAL CHANGE

     The Company's business, financial condition and results of operations will
depend to a significant extent on its ability to maintain its position in the
market for multimedia accelerator products that integrate large DRAM with analog
and logic circuitry on a single chip. As a result, the Company believes that
significant expenditures for research and development will continue to be
required in the future. The notebook PC market for which the Company's products
are designed is intensely competitive and is characterized by rapidly changing
technology, evolving industry standards and declining average selling prices.
Notebook PC manufacturers demand products incorporating rich features and
functionality in order to achieve product differentiation. The Company must
anticipate the features and functionality that the consumer of notebook PCs will
demand, incorporate those features and functionality into products that meet the
exacting design requirements of the notebook PC manufacturers, price its
products competitively, and introduce the products to the market on a timely
basis. For example, 3-D, digital audio and DVD functionality are becoming
increasingly important for notebook PCs. The Company's ability to compete may
depend on its ability to incorporate these features in its products. The success
of new product introductions is dependent on several factors, including proper
new product definition, timely completion and introduction of new product
designs, the ability of strategic manufacturing partners to effectively design
and implement the manufacture of new products, quality of new products,
differentiation of new products from those of the Company's competitors and
market acceptance of NeoMagic's and its customers' products. There can be no
assurance that the products the Company expects to introduce will incorporate
the features and functionality demanded by system manufacturers and consumers of
notebook PCs, will be successfully developed, or will be introduced within the
appropriate window of market demand. The failure of the Company to successfully
introduce new products and achieve market acceptance for such products would
have a material adverse effect on the Company's business, financial condition
and results of operations.

     The integration of large DRAM memory with analog and logic circuitry on a
single chip is highly complex and is critical to the Company's success. Because
of the complexity of its products, however, NeoMagic has experienced delays from
time to time in completing development and introduction of new products. In the
event that there are delays in the completion of development of future products,
including the products currently expected to be announced over the next year,
the Company's business, financial condition, and results of operations would be
materially adversely affected. Although the development cycles for the memory
and logic portions of the Company's products have been relatively synchronized
to date, there can be no assurance that this synchronization will continue in
the future. In addition, there can be no assurance that fundamental advances in
either the memory or logic components of the Company's products will not
significantly increase the complexity inherent in the design and manufacture of
the Company's products, rendering the Company's product technologically
infeasible or uncompetitive. The multiple chip solutions offered by some of the
Company's competitors are less complex to design and manufacture than the
Company's integrated products. As a result, these competitive solutions may be
less expensive, particularly during periods of depressed DRAM prices. The time
required for competitors to develop and introduce competing products may be
shorter and manufacturing yields may be better than those experienced by the
Company.

                                      17

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

     As the markets for the Company's products continue to develop and
competition increases, NeoMagic anticipates that product life cycles will
shorten and average selling prices will decline. In particular, average selling
prices and, in some cases, gross margin for each of the Company's products will
decline as the products mature. Thus, the Company will need to continue
introducing compelling new products at relatively higher average selling prices
in order to maintain overall average selling prices. There can be no assurance
that the Company will successfully identify new product opportunities or develop
and bring to market new products in a timely manner. Further, there can be no
assurance that products or technologies developed by others will not render
NeoMagic's products or technologies obsolete or uncompetitive, or that the
Company's products will be selected for new designs by its customers. The
failure of the Company's new product development efforts and its ability to
bring new products to market on a timely basis would have a material adverse
effect on NeoMagic's business, financial condition and results of operations.

UNCERTAINTY REGARDING PATENTS AND PROTECTION OF PROPERTY RIGHTS

     The Company relies in part on patents to protect its intellectual property.
In the United States, the Company has been issued ten patents, each covering
certain aspects of the design and architecture of the Company's multimedia
accelerators. The Company also acquired and/or licensed intellectual properties
in the areas of mixed signal analog design and array-based processing as part of
the February 1999 acquisitions of the Optical Drive Development Group and ACL.
Additionally, the Company and its newly acquired businesses have patent
applications pending. There can be no assurance that the Company's pending
patent applications, or any future applications will be approved. Further, there
can be no assurance that any issued patents will provide the Company with
significant intellectual property protection, competitive advantages, or will
not be challenged by third parties, or that the patents of others will not have
an adverse effect on the Company's ability to do business. In addition, there
can be no assurance that others will not indepen-dently develop similar
products, duplicate the Company's products or design around any patents that may
be issued to the Company.

     The Company also relies on a combination of mask work protection,
trademarks, copyrights, trade secret laws, employee and third-party
nondisclosure agreements and licensing arrangements to protect its intellectual
property. Despite these efforts, there can be no assurance that others will not
independently develop substantially equivalent intellectual property or
otherwise gain access to the Company's trade secrets or intellectual property,
or disclose such intellectual property or trade secrets, or that the Company can
meaningfully protect its intellectual property. A failure by the Company to
meaningfully protect its intellectual property could have a material adverse
effect on the Company's business, financial condition and results of operations.

     As a general matter, the semiconductor industry is characterized by
substantial litigation regarding patent and other intellectual property rights.
In December 1998, the Company filed a lawsuit in the United States District
Court for the District of Delaware against Trident Microsystems, Inc. The suit
alleges that Trident's embedded DRAM graphics accelerators infringe certain
patents held by NeoMagic Corporation. In January 1999, Trident filed a counter
claim against the Company alleging an attempted monopolization in violation of
antitrust laws, arising from NeoMagic's filing of the patent infringement action
against Trident in December. The Company has filed for a summary motion to
dismiss the antitrust claim. There can be no assurance as to the result of the
request for summary motion, the patent infringement suit and the counter-suit
for antitrust filed by Trident.

     The Company in the past has been, and in the future may be, notified that
it may be infringing the intellectual property rights of third parties. For
example, in February 1997, Cirrus Logic Inc. ("Cirrus Logic") sent the Company
written notice asserting that the Company's MagicGraph128, MagicGraph128V and
MagicGraph128ZV products infringe six United States patents held by Cirrus
Logic. Since receiving the notice of alleged infringement, the Company has
advised Cirrus Logic that the Company does not believe that any of its products
infringe any claims of the patents. The Company also has undergone a
confidential external infringement review and has conducted its own internal
infringement review, and the Company continues to believe that the Cirrus Logic
infringement allegations are unfounded. However, there can be no assurances that
Cirrus Logic will not file a lawsuit against the Company or that the Company
would prevail in any such litigation. Any protracted litigation by Cirrus Logic
or the success of Cirrus Logic in any such litigation could have a material and
adverse effect on the Company's financial position or results of operations.

     Further, in February 1999, the Company was contacted by two of its
customers that they have been notified of potential infringement by a holder of
three United States patents and are requesting indemnification from NeoMagic. At
this time, the Company's counsel is in the preliminary stage of analyzing these
patents but has not reached a conclusion. The Company may have certain
indemnification obligations to customers with respect to the infringement of
third-party intellectual property rights by its products. There can be no
assurance that the Company's potential obligations to indemnify such customers
will not have a material adverse effect on the Company's business, financial
condition and results of operations. Further, there can be no assurances that
the Company or such customers would prevail in any patent litigation, or that
such customers will continue to purchase the Company's products while the
Company is under the threat of litigation.

                                      18

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

     Any patent litigation, whether or not determined in the Company's favor or
settled by the Company, would at a minimum be costly and could divert the
efforts and attention of the Company's management and technical personnel from
productive tasks, which could have a material adverse effect on the Company's
business, financial condition and results of operations. There can be no
assurance that current or future infringement claims by third parties or
requests for indemnification by other customers or end users of the Company's
products resulting from infringement claims will not be asserted in the future
or that such assertions, if proven to be true, will not materially adversely
affect the Company's business, financial condition and results of operations. In
the event of any adverse ruling in any such matter, the Company could be
required to pay substantial damages, which could include treble damages, cease
the manufacturing, use and sale of infringing products, discontinue the use of
certain processes, or to obtain a license under the intellectual property rights
of the third party claiming infringement. There can be no assurance, however,
that a license would be available on reasonable terms or at all. Any limitations
on the Company's ability to market its products, or delays and costs associated
with redesigning its products or payments of license fees to third parties, or
any failure by the Company to develop or license a substitute technology on
commercially reasonable terms could have a material adverse effect on the
Company's business, financial condition and results of operations.

DEPENDENCE ON INTERNATIONAL SALES AND SUPPLIERS

     Export sales are a critical part of the Company's business. Sales to
customers located outside the United States (including sales to the foreign
operations of customers with headquarters in the United States and foreign
system manufacturers that sell to United States-based OEMs) accounted for 83.6%,
83.2% and 96.2% of the Company's net sales for fiscal 1999, 1998 and 1997,
respectively. The Company expects that net sales derived from international
sales will continue to represent a significant portion of its total net sales.
Letters of credit issued by customers support a portion of the Company's
international sales. To date, the Company's international sales have been
denominated in United States dollars. Increases in the value of the U.S. dollar
relative to the local currency of the Company's customers could make the
Company's products relatively more expensive than competitors' products sold in
the customer's local currency.

     International manufacturers produce all of the Company's wafers. In
addition, many of the assembly and test services used by the Company are
procured from international sources. Under the Company's wafer supply agreements
with Mitsubishi Electric and Toshiba, wafers are priced in Japanese yen. As a
result, the Company's costs of goods sold are subject to fluctuations in the
yen-dollar exchange rates. The Company has in the past hedged its exposure to
fluctuations in foreign currency exchange rate by purchasing foreign exchange
contracts and will continue to do so in the future. However, there can be no
assurance that such hedging will be adequate. Significant wafer or assembly and
test service price increases, fluctuations in currency exchange rates or the
Company's inability to fully hedge against currency exchange rate fluctuations
could have a material and sudden adverse effect on the Company's business,
financial condition and results of operations.

     International sales and manufacturing operations are subject to a variety
of risks, including fluctuations in currency exchange rates, tariffs, import
restrictions and other trade barriers, unexpected changes in regulatory
requirements, longer accounts receivable payment cycles, potentially adverse tax
consequences and export license requirements. In addition, the Company is
subject to the risks inherent in conducting business internationally including
foreign government regulation, political and economic instability, and
unexpected changes in diplomatic and trade relationships. Moreover, the laws of
certain foreign countries in which the Company's products may be developed,
manufactured or sold, including various countries in Asia, may not protect the
Company's intellectual property rights to the same extent as do the laws of the
United States, thus increasing the possibility of piracy of the Company's
products. There can be no assurance that one or more of these risks will not
have a material adverse effect on the Company's business, financial condition
and results of operations.

NEED FOR ADDITIONAL CAPITAL

     The Company requires substantial working capital to fund its business,
particularly to finance inventories and accounts receivable and for capital
expenditures. The Company believes that its existing capital resources will be
sufficient to meet the Company's capital requirements through the next 12
months, although the Company could be required, or could elect, to seek to raise
additional capital during such period. The Company's future capital requirements
will depend on many factors, including the rate of net sales growth, timing and
extent of spending to support research and development programs in new and
existing areas of technology, expansion of sales and marketing support
activities, and timing and customer acceptance for new products and enhancements
to existing products. The Company may raise additional equity or debt financing
in the future. There can be no assurance that additional equity or debt
financing, if required, will be available on acceptable terms or at all.

                                      19

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)

MANAGEMENT OF EXPANDED OPERATIONS

     The Company has experienced, and may continue to experience, periods of
rapid growth and expansion both domestically and internationally, which have
placed and may continue to place a significant strain on the Company's limited
personnel and other resources. To manage these expanded operations effectively,
including the operations of recently acquired entities in the U.K. and Israel,
the Company will be required to continue to improve its operational, financial
and management systems. The Company is dependent upon its ability to
successfully hire, train, motivate and manage its employees, especially its
management and development personnel. If the Company's management is unable to
manage its expanded operations effectively, the Company's business, financial
condition and results of operations could be materially adversely affected.

DEPENDENCE ON QUALIFIED PERSONNEL

     The Company's future success depends in part on the continued service of
its key engineering, sales, marketing, manufacturing, finance and executive
personnel, and its ability to identify, hire and retain additional personnel.
There is intense competition for qualified personnel in the semiconductor
industry, and there can be no assurance that the Company will be able to
continue to attract and train qualified personnel necessary for the development
of its business. The Company's anticipated growth is expected to place increased
demands on the Company's resources and will likely require the addition of new
management personnel and the development of additional expertise by existing
management personnel. Failure to recruit key personnel in a timely manner, or
the loss of existing key technical and management personnel could be
significantly detrimental to the Company's product development programs or
otherwise have a material adverse effect on the Company's business, financial
condition and results of operations.

VOLATILITY OF STOCK PRICE

     The market price of the Company's Common Stock, like that of other
semiconductor companies, has been and is likely to continue to be, highly
volatile. The market has from time to time experienced significant price and
volume fluctuations that may be unrelated to the operating performance of
particular companies. The market price of the Company's Common Stock could be
subject to significant fluctuations in response to various factors, including
quarter-to-quarter variations in the Company's anticipated or actual operating
results, announcements of new products, technological innovations or setbacks by
the Company or its competitors, general conditions in the semiconductor and PC
industries, unanticipated shifts in the notebook PC market or industry
standards, loss of key customers, changes in DRAM pricing, litigation
commencement or developments, changes in or the failure by the Company to meet
estimates of the Company's performance by securities analysts, market conditions
for high technology stocks in general, and other events or factors.

                                      20

<PAGE>

NEOMAGIC CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31,                                      1999          1998           1997
------------------------------------------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                      <C>            <C>            <C>      
Net sales                                                $ 240,503      $ 124,654      $  40,792

Cost of sales                                              142,881         73,171         28,650
                                                         ---------      ---------      ---------

Gross margin                                                97,622         51,483         12,142

Operating expenses:
   Research and development                                 31,756         16,091          8,606
   Sales, general and administrative                        20,740         12,290          6,522
   Legal costs                                                  --             --         (1,503)
                                                         ---------      ---------      ---------
      Total operating expenses                              52,496         28,381         13,625

Income (loss) from operations                               45,126         23,102         (1,483)
Interest income and other                                    3,810          2,643          1,366
   Interest expense                                         (1,339)        (1,298)        (1,046)
                                                         ---------      ---------      ---------

Income (loss) before income taxes                           47,597         24,447         (1,163)

Provision for income taxes                                  16,395          3,667             --
                                                         ---------      ---------      ---------

Net income (loss)                                        $  31,202      $  20,780      $  (1,163)
                                                         ---------      ---------      ---------
                                                         ---------      ---------      ---------

Basic net income (loss) per share                        $    1.32      $     .95      $    (.07)
Diluted net income (loss) per share                      $    1.19      $     .82      $    (.07)

Weighted common shares outstanding                          23,710         21,924         17,238
Weighted common shares outstanding assuming dilution        26,153         25,336         17,238
</TABLE>

See accompanying notes.

                                      21

<PAGE>

NEOMAGIC CORPORATION
CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
JANUARY 31,                                                                                     1999          1998
---------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<S>                                                                                          <C>            <C>      
ASSETS
Current assets:
   Cash and cash equivalents                                                                 $  36,631      $  35,004
   Short-term investments                                                                       56,097         36,016
   Accounts receivable, less allowance for doubtful accounts of $225 at January 31, 1999
      and $132 at January 31, 1998                                                              19,363         11,236
   Inventory                                                                                    19,046          9,342
   Other current assets                                                                          2,681          3,730
                                                                                             ---------      ---------
               Total current assets                                                            133,818         95,328

Property, plant and equipment, net                                                               8,335          6,232
Deferred tax assets                                                                              1,034          5,669
Other assets                                                                                     1,187            354
                                                                                             ---------      ---------

               Total assets                                                                  $ 144,374      $ 107,583
                                                                                             ---------      ---------
                                                                                             ---------      ---------

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
   Accounts payable                                                                          $  31,296      $   9,490
   Working capital line of credit                                                                   --         21,041
   Compensation and related benefits                                                             4,046          3,005
   Income taxes                                                                                  3,059          4,524
   Other accruals                                                                                1,876          3,123
   Obligations under capital leases                                                                702          1,273
                                                                                             ---------      ---------
               Total current liabilities                                                        40,979         42,456
Commitments and contingencies
Stockholders' equity:
   Noncumulative convertible preferred stock, $.001 par value:
        Authorized shares - 2,000,000 Issued
        and outstanding shares - none at January 31, 1999 and 1998                                  --             --
   Common stock, $.001 par value:
            Authorized shares - 60,000,000
            Issued and outstanding shares - 24,890,291 at January 31, 1999 and
             24,204,602 at January 31, 1998                                                         25             24
   Additional paid-in-capital                                                                   67,286         61,263
   Notes receivable from stockholders                                                             (554)          (559)
   Deferred compensation                                                                        (1,764)        (2,801)
   Retained earnings                                                                            38,402          7,200
                                                                                             ---------      ---------
               Total stockholders' equity                                                      103,395         65,127
                                                                                             ---------      ---------
               Total liabilities and stockholders' equity                                    $ 144,374      $ 107,583
                                                                                             ---------      ---------
                                                                                             ---------      ---------
</TABLE>


See accompanying notes.

                                      22
<PAGE>


NEOMAGIC CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31,                                                       1999          1998          1997
----------------------------------------------------------------------------------------------------------------
(IN THOUSANDS)
<S>                                                                        <C>           <C>           <C>      
OPERATING ACTIVITIES
Net income (loss)                                                          $ 31,202      $ 20,780      $ (1,163)
Adjustments to reconcile net income (loss) to net cash provided by
(used for) operating activities:
      Depreciation and amortization                                           3,281         1,679           813
      Amortization of deferred compensation                                     807           776           375
      Tax benefit from employee stock options                                 2,661           750            --
      Deferred taxes                                                          5,896        (8,571)           --
      Changes in operating assets and liabilities:
            Accounts receivable                                              (8,127)       (9,031)       (2,067)
            Inventory                                                        (9,704)       (4,105)       (4,906)
            Other current assets                                               (212)         (485)         (163)
            Other assets                                                       (833)          248          (482)
            Accounts payable                                                 21,806         4,315         4,606
            Compensation and related benefits                                 1,041         1,864         1,141
            Income taxes                                                     (1,465)        4,524            --
            Other accruals                                                   (1,247)        2,647        (1,223)
                                                                           --------      --------      --------
Net cash provided by (used for) operating activities                         45,106        15,391        (3,069)
                                                                           --------      --------      --------
                                                                           --------      --------      --------
INVESTING ACTIVITIES
      Purchases of property, plant and equipment                             (5,384)       (4,516)       (3,105)
      Purchases of short-term investments                                   (69,616)      (58,649)           --
      Maturities of short-term investments                                   49,535        22,633            --
                                                                           --------      --------      --------
Net cash used for investing activities                                      (25,465)      (40,532)       (3,105)
                                                                           --------      --------      --------
                                                                           --------      --------      --------
FINANCING ACTIVITIES
     Proceeds from sale leaseback liability                                      --            --         1,689
     Payments on lease obligations                                             (571)         (975)         (966)
     Proceeds from working capital line of credit                                --        59,760        27,941
     Payments on working capital line of credit                             (21,041)      (52,943)      (14,131)
     Net proceeds from issuance of common stock, net of repurchases           3,593        38,358           446
     Payments received from notes receivable from stockholders                    5           263            --
     Amounts held as restricted cash equivalents                                 --            --        (2,224)
     Release of amounts held as restricted cash equivalents                      --         2,224            --
                                                                           --------      --------      --------
Net cash provided by (used for) financing activities                        (18,014)       46,687        12,755
                                                                           --------      --------      --------
                                                                           --------      --------      --------
Net increase in cash and cash equivalents                                     1,627        21,546         6,581
Cash and cash equivalents at beginning of period                             35,004        13,458         6,877
                                                                           --------      --------      --------
Cash and cash equivalents at end of period                                 $ 36,631      $ 35,004      $ 13,458
                                                                           --------      --------      --------
                                                                           --------      --------      --------
Supplemental schedules of cash flow information
   Cash paid during the year for:
      Interest                                                             $  1,339      $  1,298      $  1,045
      Taxes                                                                $  9,303      $  6,964      $     --
Supplemental schedules of non-cash investing and financing  activities
      Issuance of common stock in exchange for promissory notes            $     --      $     --      $    592
         Deferred compensation                                             $   (230)     $  1,688      $  2,264
</TABLE>

See accompanying notes.

                                      23

<PAGE>

NEOMAGIC CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                     NONCUMULATIVE
                                                       CONVERTIBLE                                                           
                                                     PREFERRED STOCK                     COMMON STOCK                 ADD'L  
                                               ---------------------------       ----------------------------        PAID-IN     
(IN THOUSANDS, EXCEPT SHARE DATA)                SHARES            AMT            SHARES             AMT             CAPITAL
------------------------------------------------------------------------------------------------------------------------------
<S>                                            <C>             <C>                <C>            <C>              <C>        
Balance at January 31, 1996                    12,259,614      $        12        6,922,633      $         7      $    17,302
                                               ----------      -----------        ---------      -----------      -----------
Issuance of common stock under
      stock option plan                                --               --        1,465,750                1              997
Repurchase of common stock at cost
      and payments on promissory notes                 --               --         (315,792)              --              (92)
Payment of promissory note                             --               --               --               --               -- 
Deferred compensation
   relating to stock options                           --               --               --               --            2,264
Amortization of deferred compensation
   relating to stock options                           --               --               --               --               -- 
Net loss                                               --               --               --               --               -- 
                                               ----------      -----------        ---------      -----------      -----------
Balance at January 31, 1997                    12,259,614               12        8,072,591                8           20,471
                                               ----------      -----------        ---------      -----------      -----------
Issuance of common stock in
      conjunction with initial public
      offering                                         --               --        3,475,000                4           37,756
Conversion of preferred stock to
      common stock in conjunction
    with initial public offering              (12,259,614)             (12)      12,259,614               12               -- 
Exercise of warrants                                   --               --          206,498               --               -- 
Issuance of common stock under
      stock option plan                                --               --          167,725               --              259
Issuance of common stock under
      employee stock purchase plan                     --               --           35,987               --              367
Repurchase of common stock at cost                     --               --          (12,813)              --              (28)
Payment on promissory notes                            --               --               --               --               -- 
Deferred compensation
    relating to stock options                          --               --               --               --            1,688
Amortization of deferred compensation
      relating to stock options                        --               --               --               --               -- 
Tax benefit attributable to stock options              --               --               --               --              750
Net income                                             --               --               --               --               -- 
                                               ----------      -----------        ---------      -----------      -----------
Balance at January 31, 1998                            --               --       24,204,602               24           61,263
                                               ----------      -----------        ---------      -----------      -----------
Issuance of common stock under
      stock option plan                                --               --          598,030                1            2,330
Issuance of common stock under
      employee stock purchase plan                     --               --          117,679               --            1,285
Repurchase of common stock at cost                     --               --          (30,020)              --              (23)
Payment on promissory notes                            --               --               --               --               -- 
Deferred compensation
      relating to stock options                        --               --               --               --             (230)
Amortization of deferred compensation
      relating to stock options                        --               --               --               --               -- 
Tax benefit attributable to stock options              --               --               --               --            2,661
Net income                                             --               --               --               --               -- 
                                               ----------      -----------        ---------      -----------      -----------
Balance at January 31, 1999                            --      $        --       24,890,291      $        25      $    67,286
                                               ----------      -----------        ---------      -----------      -----------
</TABLE>

<TABLE>
<CAPTION>
                                                                                RETAINED
                                                 NOTES                           EARNINGS         TOTAL
                                             RECEIVABLE FROM   DEFERRED        (ACCUMULATED    STOCKHOLDERS'
                                              STOCKHOLDERS    COMPENSATION        DEFICIT)        EQUITY
------------------------------------------------------------------------------------------------------------
<S>                                          <C>              <C>              <C>             <C>        
Balance at January 31, 1996                   $      (362)     $        --      $   (12,417)     $     4,542
                                              -----------      ---------        -----------      -----------
Issuance of common stock under
      stock option plan                              (592)              --               --              406
Repurchase of common stock at cost
      and payments on promissory notes                109               --               --               17
Payment of promissory note                             23               --               --               23
Deferred compensation
   relating to stock options                           --           (2,264)              --               --
Amortization of deferred compensation
   relating to stock options                           --              375               --              375
Net loss                                               --               --           (1,163)          (1,163)
                                              -----------      ---------        -----------      -----------
Balance at January 31, 1997                          (822)          (1,889)         (13,580)           4,200
                                              -----------      ---------        -----------      -----------
Issuance of common stock in
      conjunction with initial public
      offering                                         --               --               --           37,760
Conversion of preferred stock to
      common stock in conjunction
    with initial public offering                       --               --               --               --
Exercise of warrants                                   --               --               --               --
Issuance of common stock under
      stock option plan                                --               --               --              259
Issuance of common stock under
      employee stock purchase plan                     --               --               --              367
Repurchase of common stock at cost                     --               --               --              (28)
Payment on promissory notes                           263               --               --              263
Deferred compensation
    relating to stock options                          --           (1,688)              --               --
Amortization of deferred compensation
      relating to stock options                        --              776               --              776
Tax benefit attributable to stock options              --               --               --              750
Net income                                             --               --           20,780           20,780
                                              -----------      ---------        -----------      -----------
Balance at January 31, 1998                          (559)          (2,801)           7,200           65,127
                                              -----------      ---------        -----------      -----------
Issuance of common stock under
      stock option plan                                --               --               --            2,331
Issuance of common stock under
      employee stock purchase plan                     --               --               --            1,285
Repurchase of common stock at cost                     --               --               --              (23)
Payment on promissory notes                             5               --               --                5
Deferred compensation
      relating to stock options                        --              230               --
Amortization of deferred compensation
      relating to stock options                        --              807               --              807
Tax benefit attributable to stock options              --               --               --            2,661
Net income                                             --               --           31,202           31,202
                                              -----------      ---------        -----------      -----------
Balance at January 31, 1999                   $      (554)     $    (1,764)     $    38,402      $   103,395
                                              -----------      ---------        -----------      -----------
</TABLE>



See accompanying notes.

                                      24

<PAGE>

NEOMAGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.  ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

DESCRIPTION OF BUSINESS

     NeoMagic Corporation (the "Company") was incorporated in 1993 in California
and reincorporated in Delaware in February 1997. The Company pioneered the
integration of DRAM, complex logic and analog circuits into a single integrated
circuit. The Company designs, develops and markets high-performance
semiconductor solutions for sale to original equipment manufacturers ("OEMs") of
mobile computing products. The first commercial application of the Company's
technology is in the multimedia accelerator market for notebook PCs.

BASIS OF PRESENTATION

     The Company's fiscal year consists of a fifty-two week period ending on the
Sunday closest to the January month end. Fiscal years 1997 and 1998 ended on
January 26 and 25, respectively. Fiscal year 1999 ended on January 31, 1999 and
was a fifty-three week fiscal year. For convenience, the accompanying
consolidated financial statements have been presented as ending on the last day
of the calendar month.

PRINCIPALS OF CONSOLIDATION

     The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries, NeoMagic Japan (KK) and NeoMagic
International. All significant intercompany balances and transactions have been
eliminated.

RECLASSIFICATIONS

     Certain amounts for prior years have been reclassified to conform to
current year presentation.

RISKS AND UNCERTAINTIES

     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts in the financial statements and
accompanying notes.

ACTUAL RESULTS COULD DIFFER FROM THOSE ESTIMATES.

     All of the Company's wafers are currently manufactured by third-party
suppliers, each under the terms of five-year wafer supply agreements. A
manufacturing disruption experienced by any of the Company's manufacturing
partners or the failure of one of the Company's manufacturing partners to devote
adequate resources to the production of the Company's products would have a
material adverse effect on the Company's business, financial condition and
results of operations.

     Under the wafer supply agreements, the Company must provide rolling
12-month forecasts of anticipated purchases and place binding purchase orders
three to four months prior to shipment. This limits the Company's ability to
react to fluctuations in demand for its products, which can be unexpected and
dramatic. To the extent the Company cannot accurately forecast the number of
wafers required, it may have either a shortage or an excess supply of wafers,
which could have an adverse effect on the Company's financial condition and
results of operations.

FOREIGN CURRENCY TRANSACTIONS

     Foreign operations are measured using the U.S. dollar as the functional
currency. Accordingly, monetary accounts are measured using the foreign exchange
rate at the balance sheet date. Operating accounts and nonmonetary balance sheet
accounts are remeasured at the rate in effect at the date of the transaction.
The effects of foreign currency remeasurement are reported in current operations
and have not been material to date.

DERIVATIVE FINANCIAL INSTRUMENTS

     The Company utilizes derivative financial instruments to hedge wafer
inventory purchases, which are priced in yen. The Company utilizes foreign
currency forward contracts and options to minimize foreign currency fluctuation
exposures related to these purchase commitments. The Company does not use
derivative financial instruments for speculative or trading purposes. The
Company's accounting policy for these instruments is based on the Company's
designation of such instruments as a hedge transaction. The criteria the Company
uses for designating an instrument as a hedge includes its effectiveness in risk
reduction and matching of derivative instruments to underlying transactions.
Gains and losses on currency forward contracts and options that are designated
as hedges, for which a firm commitment has been attained, are deferred and
recognized in income in the same period that the underlying transactions are
settled. Gains and losses on any instrument not meeting the above criteria would
be recognized in income in the current period. If an underlying hedged
transaction is terminated earlier than initially anticipated, the offsetting
gain or loss on the related derivative instrument would be recognized in income
in the same period.

                                      25

<PAGE>

NEOMAGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

CASH AND CASH EQUIVALENTS

     All highly liquid investments purchased with an original maturity of 90
days or less are considered cash equivalents. Investments with an original
maturity of greater than 90 days, but less than one year, are classified as
short-term investments.

     The Company accounts for investments in accordance with Statement of
Financial Accounting Standards No. 115 ("SFAS 115"), "Accounting for Certain
Investments in Debt and Equity Securities." Under SFAS 115, investments in
marketable equity securities and debt securities are classified as
held-to-maturity when the Company has the positive intent and ability to hold
the securities to maturity. Held-to-maturity securities are stated at amortized
cost with corresponding premiums or discounts amortized to interest income over
the life of the investment. Securities not classified as held-to-maturity are
classified as available-for-sale and are reported at fair market value.
Unrecognized gains or losses on available-for-sale securities are included, net
of tax, in stockholders' equity until their disposition. Realized gains and
losses and declines in value judged to be other than temporary on
available-for-sale securities are included in interest income and other. The
cost of securities sold is based on the specific identification method.

     All cash equivalents and short-term investments are classified as available
for sale and are recorded at fair market value. For all classifications of
securities, cost approximates fair market value as of January 31, 1999 and 1998,
and consists of the following:

<TABLE>
<CAPTION>
JANUARY 31,                                           1999        1998
----------------------------------------------------------------------
(IN THOUSANDS)
<S>                                                <C>         <C>
Cash and cash equivalents:
       Money market funds                          $12,042     $ 5,272
       Commercial paper                             21,074      24,197
       Municipal bonds                               2,015          --
       Bank accounts                                 1,500       5,535
                                                   -------     -------
            Total                                  $36,631     $35,004
                                                   -------     -------
                                                   -------     -------
Short-term investments:
        Market auction preferred - non-taxable     $21,811     $    --
        Market auction preferred - taxable          10,026       2,028
        Medium term notes                            9,272      11,158
        Commercial paper                             6,930         987
        Corporate notes                              4,165       5,602
        U.S. Government agencies                     3,025       8,082
        Corporate bonds                                868       7,148
        Foreign debt securities                         --       1,011
                                                   -------     -------
               Total                               $56,097     $36,016
                                                   -------     -------
                                                   -------     -------
</TABLE>

     Gross realized and unrealized gains and losses on available-for-sale
securities in fiscal 1999, 1998 and 1997 were immaterial.

INVENTORY

     Inventories are stated at the lower of cost or market value. Cost is
determined by the first-in, first-out method.

PROPERTY, PLANT AND EQUIPMENT

     Property, plant and equipment is stated at cost, net of accumulated
depreciation and amortization. Depreciation and amortization are provided on a
straight-line basis over the estimated useful life of the respective assets,
generally three to five years or, in the case of property under capital leases,
over the lesser of the useful life of the assets or lease term.

REVENUE RECOGNITION

     Revenue from product sales is recognized upon shipment, net of estimated
returns. Revenue on shipment to distributors is deferred until the distributor
sells the product.

                                      26

<PAGE>

NEOMAGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

CONCENTRATION OF CREDIT RISK

     The Company sells its products to notebook PC OEMs as well as to
third-party system manufacturers who design and manufacture notebook PCs on
behalf of the brand name OEMs. The Company performs continuing credit
evaluations of its customers and, generally, does not require collateral.
Letters of credit may be required from its customers in certain circumstances.

EARNINGS PER SHARE

     In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"). SFAS
128 replaces the calculation of primary and fully diluted earnings per share
with basic and diluted earnings per share. Unlike primary earnings per share,
basic earnings per share excludes any dilutive effects of options, warrants, and
convertible securities. Diluted earnings per share is very similar to fully
diluted earnings per share.

COMPREHENSIVE INCOME

     The Company adopted Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income," ("SFAS 130") during the quarter ended April
30, 1998. SFAS 130 establishes new standards for the reporting and displaying of
comprehensive income and its components. The adoption of this Statement had no
impact on the Company's net income or stockholders' equity. SFAS 130 requires
unrealized gains or losses on the Company's available-for-sale securities and
foreign currency translation adjustments to be included in comprehensive income.
Gross unrealized gains and losses on available-for-sale securities and foreign
currency translation adjustments for fiscal years 1999, 1998 and 1997 were
immaterial.

RECENT ACCOUNTING PRONOUNCEMENTS

     In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, ("SFAS 131") "Disclosures about Segments
of an Enterprise and Related Information." The statement changes standards for
the way that public business enterprises identify and report operating segments
in annual and interim financial statements. This statement requires selected
information about an enterprise's operating segments. Currently, the Company has
one operating segment by which management evaluates performance. All of the
Company's net sales to date have been derived from the sale of multimedia
accelerators, and the Company expects this to continue through fiscal 2000.

     In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, ("SFAS 133") "Accounting for Derivative
Instruments and Hedging Activities." The Standard will require companies to
record all derivatives held on the balance sheet at fair value. Derivatives that
are not hedges must be adjusted to fair value through income. If the derivative
is a hedge, changes in the fair value of the derivative is either offset against
the change in fair value of the hedged assets, liabilities, or firm commitments
through earnings, or recognized in other comprehensive income until the value
related to the ineffective portion of a hedge, if any, is recognized in
earnings. The Company expects to adopt SFAS 133 as of the beginning of its
fiscal year 2001. The effect of adoption of the Standard is currently being
evaluated, but is not expected to have a material effect on the Company's
financial position or results of operations.

                                      27

<PAGE>

NEOMAGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

2.  SUMMARIZED BALANCE SHEET DETAILS

<TABLE>
<CAPTION>
JANUARY 31,                                                  1999        1998
-------------------------------------------------------------------------------
(IN THOUSANDS)
<S>                                                      <C>           <C>
Inventory:
      Raw materials                                      $  6,396      $    989
      Work in process                                       4,717         1,904
      Finished goods                                        7,933         6,449
                                                         --------      --------
Total                                                    $ 19,046      $  9,342
                                                         --------      --------
                                                         --------      --------
Property, plant and equipment:
      Computer equipment and software                    $ 12,179      $  8,017
      Furniture and fixtures                                1,645           917
      Machinery and equipment                               1,139           645
                                                         --------      --------
Total                                                      14,963         9,579
      Less accumulated depreciation and amortization       (6,628)       (3,347)
                                                         --------      --------
Property, plant and equipment, net                       $  8,335      $  6,232
                                                         --------      --------
                                                         --------      --------
</TABLE>

3.  EARNINGS PER SHARE

     In February 1998, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 98 ("SAB 98"). Under SAB 98, certain shares of
convertible preferred stock, options and warrants to purchase common stock,
issued at prices substantially below the per share price sold in the Company's
initial public offering in March 1997, previously included in the computation of
shares outstanding pursuant to Staff Accounting Bulletins Nos. 55, 64 and 83,
are now excluded from the computation. Basic and diluted earnings per share have
been retroactively restated to apply the requirements of SAB 98.

Per share information calculated on this basis is as follows:

<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31,                                                     1999       1998       1997
-------------------------------------------------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                                                                     <C>         <C>        <C>
Numerator:
      Net income (loss)                                                 $   31,202  $ 20,780   $(1,163)
                                                                        ----------  --------   ------- 
Denominator:
      Denominator for basic earnings per share - weighted-average shares    23,710    20,361     4,978
      Effect of dilutive securities:
            Employee stock options                                           2,354     3,227        --
         Warrants                                                               89       185        --
         Convertible preferred stock                                            --     1,563        --
                                                                        ----------  --------   ------- 
      Dilutive potential common shares                                       2,443     4,975        --
                                                                        ----------  --------   ------- 
         Denominator for diluted earnings per share - adjusted weighted-
      average shares and assumed conversions                                26,153    25,336     4,978
                                                                        ----------  --------   ------- 
                                                                        ----------  --------   ------- 
Basic earnings per share                                                   $  1.32   $  1.02   $  (.23)
Diluted earnings per share                                                 $  1.19   $   .82   $  (.23)
</TABLE>

     The basic and diluted net income (loss) per share data presented in the
statements of operations has been computed as described above and also gives
effect, even if antidilutive, to 12,259,614 preferred shares that were
automatically converted to common stock upon the closing of the Company's
initial public offering in March 1997, using the if-converted method.

                                      28

<PAGE>

NEOMAGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

4.  DERIVATIVE FINANCIAL INSTRUMENTS

     All of the Company's sales and the majority of its purchases are
denominated in U.S. dollars. However, the Company's wafer purchases are
denominated in Japanese yen. The Company enters into foreign exchange forward
and option contracts to hedge this foreign currency exposure. Outstanding
foreign currency forward and option contracts at January 31, 1999 totaled $36.7
million and $0, respectively. Outstanding foreign currency forward and option
contracts at January 31, 1998 totaled $42.8 million and $15 million,
respectively. The Company does not enter into speculative foreign exchange
contracts to profit on exchange rate fluctuations.

     Using the exchange rate at the reporting date, the estimated fair market
value of the foreign currency forward contracts at January 31, 1999 is
($598,000).

5.  LINES OF CREDIT

     Prior to February 1998, the Company maintained a revolving credit agreement
("Working Capital Line") with Mitsubishi International Corporation ("MIC") that
provided extended payment terms to finance wafer purchases. In exchange for the
extended terms and other consulting and logistic support services provided by
MIC, the Company paid to MIC interest and commissions. In January 1998, in
exchange for a reduction in the commission rate, the Company and MIC amended the
agreement such that for shipments subsequent to January 31, 1998, payment for
wafers must be made 30 days after wafer shipment. In fiscal 1999, all amounts
owed to MIC for wafer purchases are reflected in accounts payable.

     In August 1998, NeoMagic International, a subsidiary of NeoMagic
Corporation, established a $10 million line of credit used for letters of
credit. The line of credit is collateralized by deposits equal to the total
current balances of all outstanding letters of credit. As of January 31,1999,
there was no balance outstanding under the line of credit.

6.  OBLIGATIONS UNDER CAPITAL LEASES

     The Company has entered into various capital leases, including sale and
leaseback transactions to finance purchases of property, plant and equipment,
software and masks. Obligations under capital leases represent the present value
of future payments under the equipment lease agreements. Under the terms of the
lease agreements, warrants to purchase the Company's common stock were granted
as described in Note 8. Property, plant and equipment includes the following
amounts for leases that have been capitalized and are active:

<TABLE>
<CAPTION>
JANUARY 31,                                                  1999         1998
-------------------------------------------------------------------------------
(IN THOUSANDS)
<S>                                                       <C>          <C>
Property, plant and equipment under capital lease         $   935      $ 1,609
Accumulated amortization                                     (665)        (977)
                                                          -------      -------
Net property, plant and equipment under capital lease     $   270      $   632
                                                          -------      -------
                                                          -------      -------
</TABLE>

Future minimum payments under capital leases consist of the following at January
31, 1999:

<TABLE>
<CAPTION>
FISCAL YEAR ENDING JANUARY 31,
-----------------------------------------------------
(IN THOUSANDS)
<S>                                             <C>
2000                                            $755
                                                ----
Total minimum lease payments                     755
Amount representing interest                      53
                                                ----
Present value of net minimum lease payments      702
Less current portion                             702
                                                ----
Long-term portion                               $ --
                                                ----
                                                ----
</TABLE>

                                      29

<PAGE>

NEOMAGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

7. INCOME TAXES

The provision for income taxes in fiscal 1999, 1998 and 1997 consist of the
following :

<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31,                  1999         1998          1997
--------------------------------------------------------------------------
(IN THOUSANDS)
<S>                                  <C>           <C>           <C>
Current:
      Federal                        $ 10,168      $ 11,300      $      --
      State                               331           938             --
                                     --------      --------      ---------
                                       10,499        12,238             --
Deferred:
      Federal                           5,640        (7,870)            --
      State                               256          (701)            --
                                     --------      --------      ---------
                                        5,896        (8,571)            --
                                     --------      --------      ---------
Total provision for income taxes     $ 16,395      $  3,667      $      --
                                     --------      --------      ---------
                                     --------      --------      ---------
</TABLE>

     The tax benefit associated with dispositions from employee stock plans
reduced taxes currently payable for fiscal 1999 and 1998 by $2.7 million and
$0.8 million, respectively.

The Company's income tax provision differs from the federal statutory rate of
35% due to the following:

<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31,                                             1999          1998           1997
--------------------------------------------------------------------------------------------------------
(IN THOUSANDS EXCEPT PERCENTAGES)
<S>                                                              <C>           <C>              <C>
Pretax income (loss)                                             $ 47,597      $  24,447        $(1,163)
Federal statutory rate                                                 35%            35%            35%
Expected tax (benefit)                                             16,659          8,556           (407)

State taxes (net of federal benefit)                                  381            154             --
Utilization of research and development tax credits                (1,239)          (844)            --
Net operating loss not benefited                                       --             --            407
Utilization of net operating losses not previously benefited           --         (4,199)            --
Other                                                                 594             --             --
                                                                 --------       --------       --------
Provision for income taxes                                       $ 16,395       $  3,667       $     --
                                                                 --------       --------       --------
                                                                 --------       --------       --------
</TABLE>

     Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities are as follows:

<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31,                             1999       1998
------------------------------------------------------------------
(IN THOUSANDS)
<S>                                              <C>        <C>
Deferred tax assets:

        Capitalized research and development     $  490     $  490
        Losses from foreign operations              788      4,505
        Reserves and accruals                     1,110      2,835
         Other                                      287        741
                                                 ------     ------
Total deferred tax assets                         2,675      8,571
Valuation allowance                                  --         --
                                                 ------     ------
Net deferred tax assets                          $2,675     $8,571
                                                 ------     ------
                                                 ------     ------
</TABLE>

Cumulative losses from foreign operations through fiscal 1999 were immaterial.

                                      30

<PAGE>

NEOMAGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

8.  STOCKHOLDERS' EQUITY

INITIAL PUBLIC OFFERING

     In March 1997, the Company completed an initial public offering of
3,475,000 shares of common stock. The Company received net proceeds of $37.8
million. In connection with the initial public offering, Series A, B, C and D
preferred stock, then outstanding, converted into 12,259,614 shares of common
stock.

PREFERRED STOCK

     In December 1996, the Board of Directors approved an amendment to the
Certificate of Incorporation to allow the issuance of up to 2,000,000 shares of
preferred stock and to determine the price, rights, preferences, privileges and
restrictions, including voting rights of those shares without any further vote
or action by the stockholders.

WARRANTS

     The Company granted warrants in connection with certain lease arrangements.
The Company had the following warrants outstanding at January 31, 1999 to
purchase shares of common stock:

<TABLE>
<CAPTION>
NUMBER      EXERCISE PRICE
OF SHARES   PER SHARE           DATE ISSUED     EXPIRATION OF WARRANTS
----------------------------------------------------------------------
<S>         <C>                 <C>             <C>
43,200      $0.625              May 1994        March 2002
36,666      $1.50               July 1994       March 2002
15,789      $2.85               August 1995     March 2002
------
95,655
</TABLE>

In February 1999, the warrants were exercised.

STOCK PLAN

     In July 1993, the Company adopted the 1993 Stock Plan (the "Plan") whereby
the Board of Directors may grant incentive stock options, nonstatutory stock
options and stock purchase rights to employees, consultants and directors. The
Company reserved 7,775,000 shares of common stock for issuance under the Plan.
In June 1998, an additional 875,000 shares were approved by the Shareholders of
the Company at the Annual Shareholders meeting, bringing the total reserved
under the Plan to 8,650,000 shares. Unless terminated sooner, the Plan will
terminate automatically in December 2003. The Board of Directors determines
vesting provisions for stock purchase rights and options granted under the Plan.
Stock options expire no later than ten years from the date of grant. In the
event of voluntary or involuntary termination of employment with the Company for
any reason, with or without cause, all unvested options are forfeited and all
vested options must be exercised within a thirty-day period or they are
forfeited. Certain of the options and stock purchase rights are exercisable
immediately upon grant. However, common shares issued on exercise of options
prior to vesting are subject to repurchase by the Company. As of January 31,
1999, 551,502 shares of common stock were subject to this repurchase provision.
Other options granted under the Plan are exercisable during their term in
accordance with the vesting schedules set out in the option agreement.

     In June 1998, the Company adopted the 1998 Nonstatutory Stock Option Plan
whereby the Board of Directors may grant nonstatutory stock options to
employees, consultants and directors. The Company reserved 2,500,000 shares of
common stock for issuance under the Plan. Unless terminated sooner, the plan
will terminate automatically in June 2008.

     In September 1998, the Board of Directors approved a resolution allowing
employees to exchange their existing vested and unvested stock options for new
options having an exercise price of $11.50 per share, the then current market
price of the Company's common stock. Options to purchase 2,085,700 shares, with
an average original exercise price of $15.48 per share, were exchanged by
employees. Vested exchanged options were not exercisable by the employees until
March 31, 1999. Options exchanged are included in the fiscal 1999 canceled and
granted numbers below.

                                      31

<PAGE>

NEOMAGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

A summary of the Company's stock option activity, and related information for
the three years ended January 31, 1999 follows:

<TABLE>
<CAPTION>
                                                  NUMBER OF      WEIGHTED
                                                  SHARES         AVERAGE
                                                  (OPTIONS)      EXERCISE PRICE
-------------------------------------------------------------------------------
<S>                                              <C>             <C>
Balance at January 31,1996                          574,500          $  .22
      Granted                                     3,385,000            3.02
      Exercised                                  (1,465,750)            .61
      Canceled                                      (53,000)            .77
                                                  ---------          ------
Balance at January 31, 1997                       2,440,750            3.86
      Granted                                     1,446,000           13.68
      Exercised                                    (167,725)           1.54
      Canceled                                      (56,000)           6.32
                                                  ---------          ------
Balance at January 31, 1998                       3,663,025            7.80
   Granted                                        3,751,700           13.43
   Exercised                                       (598,030)           3.94
   Canceled                                      (2,485,350)          14.61
                                                  ---------          ------
Balance at January 31, 1999                       4,331,345          $ 9.30
</TABLE>


     At January 31, 1999, options to purchase 849,870 shares of common stock
were vested at prices ranging from $.15 to $22.44 and 3,189,120 shares of common
stock were available for future grants under the Plan.

The following table summarizes information about stock options outstanding at
January 31, 1999:

<TABLE>
<CAPTION>
                                     OPTIONS OUTSTANDING AND EXERCISABLE
                                ---------------------------------------------
                                                 WEIGHTED
                                                 AVERAGE
                                                 REMAINING     WEIGHTED
                                NUMBER           CONTRACTUAL   AVERAGE
RANGE OF EXERCISE PRICES        OUTSTANDING      LIFE          EXERCISE PRICE
-----------------------------------------------------------------------------
<S>                             <C>              <C>           <C>
$0.15 - $0.80                     590,024          7.08        $    0.77
$1.00 - $ 3.50                    154,346          7.57             2.14
$7.50                             918,108          7.93             7.50
$9.60 - $11.13                    187,167          9.23            10.59
$11.50                          2,077,200          9.01            11.50
$12.63 - $22.44                   404,500          9.41            16.72
                                ---------          ----        ---------
                                4,331,345          8.51        $    9.30
                                ---------          ----        ---------
                                ---------          ----        ---------
</TABLE>

EMPLOYEE STOCK PURCHASE PLAN

     The Company's 1997 Employee Stock Purchase Plan (the "1997 Purchase Plan")
was adopted by the Board of Directors in December 1996, effective upon the
completion of the initial public offering in March 1997. A total of 500,000
shares of common stock has been reserved for issuance under the 1997 Purchase
Plan. The 1997 Purchase Plan is intended to qualify under Section 423 of the
Internal Revenue Code and has consecutive and overlapping twenty-four month
offering periods that begin every six months. The 1997 Purchase Plan commenced
after the completion of the initial public offering. Each twenty-four month
offering period includes four six-month purchase periods, during which payroll
deductions are accumulated and at the end of which, shares of common stock are
purchased with a participant's accumulated payroll deductions. The 1997 Purchase
Plan permits eligible employees to purchase common stock through payroll
deductions of up to 10% of the employee's compensation. The price of common
stock to be purchased under the 1997 Purchase Plan is 85% of the lower of the
fair market value of the common stock at the beginning of the offering period or
at the end of the relevant purchase period.

     In fiscal 1999 and 1998, 117,679 and 35,987 shares of common stock at an
average price of $10.92 and $10.20 per share, respectively, were issued under
the 1997 Purchase Plan. Shares available for purchase under the 1997 Purchase
Plan were 346,334 at January 31, 1999.

                                      32

<PAGE>

NEOMAGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

STOCK-BASED COMPENSATION

     The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for its employee stock awards because, as
discussed below, the alternative fair value accounting provided for under
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123") requires use of option valuation models that were not
developed for use in valuing employee stock options. Under APB 25, when the
exercise price of the Company's employee stock options equals the market price
of the underlying stock on the date of grant, no compensation is recognized.

     The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions, including the expected stock price
volatility. Because the Company's options have characteristics significantly
different from those of traded options and because changes in the subjective
input assumptions can materially effect the fair value estimate, in the opinion
of management, the existing models do not necessarily provide a reliable single
measure of the fair value of its options.

     In fiscal 1999 and 1998, the fair value of each option grant was estimated
on the date of the grant using the Black-Scholes option-pricing model using a
dividend yield of 0% and the following additional weighted-average assumptions.
In fiscal 1997, the fair value for each option grant was estimated at the date
of grant using the minimum value method using a dividend yield of 0% with the
below weighted average assumptions. The minimum value method differs from
methods designed to estimate the fair value of an option, such as the
Black-Scholes option pricing model, because it does not consider the effect of
expected volatility.

<TABLE>
<CAPTION>
                                                                                 EMPLOYEE STOCK
                                            EMPLOYEE OPTION PLANS                PURCHASE PLAN
                                       --------------------------------       -------------------
YEAR ENDED JANUARY 31,                  1999         1998         1997         1999         1998
-------------------------------------------------------------------------------------------------
<S>                                    <C>           <C>          <C>          <C>          <C>
Risk-free interest rates                 4.8%         5.9%         6.3%         5.4%         5.5%
Volatility                               .65          .69           --          .70          .74
Expected life of option in years         5.0          5.0          4.7         1.01          0.6
</TABLE>

     Had compensation costs been determined based upon the fair value at the
grant date for awards under these plans, consistent with the methodology
prescribed under SFAS 123, the Company's fiscal 1999 net income and earnings per
share would have decreased by approximately $8.9 million, or $0.38 per share and
$0.34 per share for basic and diluted earnings per share, respectively. The
Company's fiscal 1998 net income and earnings per share would have decreased by
approximately $2.4 million, or $0.12 per share and $0.09 per share for basic and
diluted earnings per share, respectively. The Company's fiscal 1997 net loss and
net loss per share would have been increased by approximately $153,000, or $0.03
per share for both basic and diluted earnings per share. For purposes of pro
forma disclosures, the estimated fair value of the options is amortized over the
option's vesting period and stock purchased under the 1997 Purchase Plan is
amortized over the six month purchase period. The effects on pro forma
disclosure of applying SFAS 123 are not likely to be representative of the
effects on pro forma disclosure of future years.

     The basic and diluted net income (loss) per share above does not assume the
conversion of preferred stock effective upon the closing of the Company's
initial public offering and is calculated using the weighted average number of
shares of common stock outstanding as described in Note 1.

     There were no options granted during fiscal 1999 with an exercise price
less than the market price at the date of grant. The weighted average fair value
of options granted during fiscal 1998 and 1997 with exercise prices less than
the market price at the date of grant is $12.55 and $1.28 per share,
respectively. The weighted average fair value of options granted during fiscal
1999, 1998 and 1997 with exercise prices equal to the market price at the date
of grant is $13.40, $8.39 and $2.00 per share, respectively.

DEFERRED STOCK COMPENSATION

     In connection with the grant of certain stock options to employees in
fiscal 1999, 1998 and 1997, the Company recorded deferred compensation of
($230,000), $1,688,000 and $2,264,000, respectively for the difference between
the fair value of common stock for accounting purposes and the option exercise
price at the date of grant. The fiscal 1998 and 1997 amounts are presented as a
reduction of stockholders' equity and are amortized ratably over the vesting
period of the related options. The fiscal 1999 amount reflects the unamortized
portion related to the cancellation of these options upon employee terminations.

                                      33

<PAGE>

NEOMAGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

9.  SAVINGS PLAN

     The Company maintains a savings plan under Section 401(k) of the Internal
Revenue Code. Under the plan, employees may contribute up to 20% of their
pre-tax salaries per year, but not more than the statutory limits. In April
1998, the Company initiated a matching program, whereby the Company contributes
$0.20 for every dollar the employee contributes to the plan up to the first 6%
of earnings. The Company made matching contributions to employees of $128,000 in
fiscal 1999.

10.  COMMITMENTS AND CONTINGENCIES

COMMITMENTS

     In May 1996, the Company moved its principal headquarters to a new facility
in Santa Clara, California, under a non-cancelable operating lease that expires
in April 2003. In January 1998, the Company entered into a second non-cancelable
operating lease for the building adjacent to its principal headquarters. This
lease has a co-terminous provision with the original lease expiring in April
2003. The Company leases offices in India, Hong Kong, Taiwan and Texas under
operating leases that expire at various times through September 2000. Future
minimum lease payments under operating leases as of January 31, 1999 are as
follows:

<TABLE>
<CAPTION>
FISCAL YEAR ENDING JANUARY 31:
---------------------------------------------------------
(IN THOUSANDS)
<S>                                            <C>
2000                                           $   2,043
2001                                               1,998
2002                                               1,994
2003                                               2,047
2004                                                 520
                                               ---------
Total minimum lease payments                   $   8,602
                                               ---------
                                               ---------
</TABLE>

     Rental expense under operating leases was $2,004,000, $988,000, and
$647,000 in fiscal 1999, 1998 and 1997, respectively.

     In fiscal 1997, the Company began subletting a portion of its main
operating facility under operating leases expiring through March 1998. This
sublease was terminated in October 1997, prior to the expiration date of the
sublease. Rental income related to this sublease in fiscal 1998 and 1997 was
$168,000 and $175,000, respectively.

     In January 1998, the Company signed an additional sublease agreement.
Rental income related to this sublease agreement was $458,000 in fiscal 1999. As
of January 31, 1999, future minimum rentals to be received under this sublease
total $46,000 in fiscal 2000.

CONTINGENCIES

     In February 1999, the Company was contacted by two of its customers that
they have been notified of potential infringement by a holder of three United
States patents and are requesting indemnification from NeoMagic. At this time,
the Company's counsel is in the preliminary stage of analyzing these patents but
has not reached a conclusion. The Company may have certain indemnification
obligations to customers with respect to the infringement of third-party
intellectual property rights by its products. There can be no assurance that the
Company's potential obligations to indemnify such customers will not have a
material adverse effect on the Company's business, financial condition and
results of operations. Further, there can be no assurances that the Company or
such customers would prevail in any patent litigation, or that such customers
will continue to purchase the Company's products while the Company is under the
threat of litigation.

     In December 1998, the Company filed a lawsuit in the United States District
Court for the District of Delaware against Trident Microsystems, Inc.
("Trident"). The suit alleges that Trident's embedded DRAM graphics accelerators
infringe certain patents held by NeoMagic Corporation. In January 1999, Trident
filed a counter claim against the Company alleging an attempted monopolization
in violation of antitrust laws, arising from NeoMagic's filing of the patent
infringement action against Trident in December. The Company has filed for a
summary motion to dismiss the antitrust claim. There can be no assurance as to
the result of the request for summary motion, the patent infringement suit and
the counter-suit for antitrust filed by Trident.

                                      34

<PAGE>

NEOMAGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

     In February 1997, Cirrus Logic Inc. ("Cirrus Logic") sent the Company
written notice asserting that the Company's MagicGraph128, MagicGraph128V and
MagicGraph128ZV products infringe six United States patents held by Cirrus
Logic. Since receiving the notice of alleged infringement, the Company has
advised Cirrus Logic that the Company does not believe that any of its products
infringe any claims of the patents. The Company also has undergone a
confidential external infringement review and has conducted its own internal
infringement review, and the Company continues to believe that the Cirrus Logic
infringement allegations are unfounded. However, there can be no assurances that
Cirrus Logic will not file a lawsuit against the Company or that the Company
would prevail in any such litigation. Any protracted litigation by Cirrus Logic,
or the success of Cirrus Logic in any such litigation, could have a material and
adverse effect on the Company's financial position and results of operations.

     In November 1994, one of the Company's competitors (the "plaintiff") filed
an action against the Company and certain of its employees claiming among other
things, breach of fiduciary duty, breach of and interference with contract, and
misappropriation of trade secrets. In fiscal 1996 and 1995, the Company recorded
charges to operations totaling $610,000 and $1,500,000, respectively, for
estimated legal costs related to the litigation. In fiscal 1997, due to the
dismissal of the litigation, legal costs were reduced by $1,503,000 due to the
reversal of previously estimated legal fees.

11.  SIGNIFICANT CUSTOMERS AND EXPORT SALES

     In fiscal 1999 three customers accounted for 19.8%, 17.1% and 10.5%,
respectively, of net sales. In fiscal 1998, five customers accounted for 14.4%,
13.6%, 13.5%, 13.3% and 11.7%, respectively, of net sales. In fiscal 1997 three
customers accounted for 31.6%, 19.8% and 14.6%, respectively, of net sales.
Fiscal 1999 net sales to customers in Taiwan, Japan, North America and Europe
totaled 50.9%, 29.0%, 16.9% and 3.2%, respectively, of net sales. Net sales to
customers in Taiwan, Japan, North America and Europe totaled 50.3%, 29.7%, 16.8%
and 3.2%, respectively, of net sales in fiscal 1998 and 61.7%, 34.5%, 3.8% and
0%, respectively, of net sales in fiscal 1997.

12.  SUBSEQUENT EVENTS

     In February 1999, the Company completed two acquisitions to further its
development efforts of consumer products. The Company acquired the Optical Drive
Development Group and associated DVD intellectual properties from Mitel
Semiconductor in Manchester, England for $4 million in cash. The group is a team
of 16 professionals with experience in mixed-signal analog design and a DVD
optical storage read-channel product line. The Company also acquired the assets
and intellectual property of ACL of Tel Aviv, Israel from Robomatix Technologies
Ltd. for $5 million in cash and a net exercise warrant to purchase up to 100,000
shares of NeoMagic common stock at an exercise price of $20 per share. An
additional $1million in cash incentives were paid to certain employees of ACL.
As part of this acquisition, NeoMagic will acquire a team of 10 engineering and
research professionals from ACL who have developed an array-based processing
architecture. Both acquisitions will be recorded using the purchase method of
accounting.

     In February 1999, the Company signed a 5-year wafer supply agreement with
Infineon Technologies (formerly Siemens Aktiengesselschaft Semiconductor Group)
of Germany. The agreement reflects terms similar to those with Mitsubishi and
Toshiba, except that the wafers will be purchased in U.S. dollars. The Company
does not anticipate volume production at Infineon until the fourth quarter of
fiscal 2000.

                                      35

<PAGE>


REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS



The Board of Directors and Stockholders
NeoMagic Corporation

     We have audited the accompanying consolidated balance sheets of NeoMagic
Corporation as of January 31, 1999 and 1998, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended January 31, 1999. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.

     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

     In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
NeoMagic Corporation at January 31, 1999 and 1998, and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended January 31, 1999, in conformity with generally accepted accounting
principles.


                                           /s/ Ernst & Young LLP

San Jose, California
February 12, 1999


                                      36