<PAGE>

FISCAL 1998 ANNUAL REPORT




                                        [NeoMagic logo]

<PAGE>

DIFFERENTIATION THROUGH INTEGRATION

NeoMagic Corporation is the pioneer of embedded semiconductor memory technology
and the world's first producer of a 128-bit single-chip multimedia accelerator
for notebook computers. As the first company to design and deliver integrated
DRAM, complex logic, and analog circuits in a single chip, NeoMagic enables
notebook manufacturers to offer portable PCs that achieve high-performance
multimedia display capabilities in compact, lightweight mobile designs with
increased battery life.

Less than three years after introducing its first product, NeoMagic's customer
list has grown to include virtually every major producer of PC-compatible
notebook computers worldwide. Based in Santa Clara, California, NeoMagic
maintains sales offices in Santa Clara, California; Austin, Texas; Japan and
Taiwan. NeoMagic's common stock trades on the Nasdaq stock market under the
symbol NMGC.



<PAGE>



FINANCIAL HIGHLIGHTS

<TABLE>
<CAPTION>
                                                          1996           1997           1998
                                                          ----           ----           ----
<S>                                                       <C>            <C>            <C>
       NET SALES (Millions)                                 .2           40.8           124.7
       NET INCOME PER SHARE (LOSS) (Dollars)                NA            .07             .82
       NET INCOME (LOSS) (Millions)                       (6.9)          (1.2)           20.8
       TOTAL ASSETS (Millions)                             8.7           27.5           107.6
</TABLE>


                                                                               1

<PAGE>



LETTER TO OUR STOCKHOLDERS



NeoMagic's fiscal year ended January 1998 (fiscal 1998) was a year of 
exceptional growth and notable success. We experienced continued improvements 
in revenues, gross margins, operating margins, and net profitability in each 
quarter of the fiscal year. We extended our product offering, expanded our 
market share, added major new customers, and strengthened the foundations of 
our company to allow us to build for the future.

FINANCIAL PERFORMANCE

We completed an initial public offering of common stock in the first quarter 
of our year, raising approximately $38 million to strengthen our financial 
position. Our revenues in fiscal 1998 grew by 206% compared to the prior 
fiscal year, and we finished the year with $124.7 million in sales compared 
to $40.8 million for the fiscal year ended January 1997. Fiscal 1998 was our 
first full year of profitability. Net income for the year was $20.8 million, 
or $0.82 per diluted share, compared to a net loss of $1.2 million, or a loss 
of $0.07 per diluted share for the prior year. We are particularly pleased 
that we were able to improve the level of profits during each quarter of a 
year of dramatic expansion in revenues. In November of 1997, the Fabless 
Semiconductor Association awarded NeoMagic the title of Best Financially 
Managed Public Fabless Semiconductor Company.

BUSINESS REVIEW

NeoMagic entered the year with a strong product offering in the first three 
members of our MagicGraph128 family of single-chip multimedia accelerators. 
In our second quarter we introduced the fourth member of this award-winning 
family, the MagicGraph128XD. The success of this product contributed 
significantly to our market share gains over the second half of the year, as 
it took a leading position in the new generation of notebook computers 
introduced in the fall.

During the fourth quarter we introduced the MagicGraph128ZV+, a new product 
targeted at the value-priced end of the notebook market. When value pricing 
was combined with the high performance, small size, and low power consumption 
of the MagicGraph family, this product quickly became a hit in the smallest 
ultra-portable notebook market. With this product NeoMagic now spans the 
market requirements from market-leading performance to highly economical 
solutions.

These new products helped attract major new customers to NeoMagic. During the 
course of the fiscal year we added such prestigious names as Gateway2000, 
IBM, Micron, Panasonic, Siemens, and Sony to our list of customers. They 
joined a client list which already included such notable computer makers as 
Acer, Compaq, Dell, Fujitsu, Hewlett-Packard, Hitachi, Mitsubishi, NEC, and 
Sharp. At the end of our fourth quarter, Toshiba introduced its Libretto 
100CT mini-notebook in Europe using our MagicGraph128XD, marking the first 
appearance of a NeoMagic product in a Toshiba machine. With this 
introduction, NeoMagic now counts all of the major notebook PC makers among 
our customers.

It has been our experience that in many cases a new customer will implement a 
single project as a trial of our technology, our product, and indeed our 
company. We work closely to help our customer complete the development of 
their machine, and then to meet their quality and production requirements. 
They learn the many benefits of our technology, and also observe first-hand 
the capabilities and dedication of our team. If our first project with a 
customer is successful, we often find expanded opportunities for our products 
within other segments of the customer's product line. Although we now count 
all major notebook PC makers as customers, we have not yet achieved the 
maximum potential for our market share. While some companies, most notably 
our earlier customers, now use NeoMagic accelerators in many or all of their 
notebook computers, at other companies there are customer models that still 
do not include a NeoMagic accelerator. Continued high levels of innovation, 
brisk execution, and dedicated support are still required for us to address 
the additional opportunities within our existing customers.



2

<PAGE>


"NEOMAGIC NOW SPANS THE MARKET REQUIREMENTS FROM MARKET-LEADING PERFORMANCE 
TO HIGHLY ECONOMICAL SOLUTIONS"

OUR VISION LOOKING FORWARD

When we formed NeoMagic a few short years ago, it was our vision to provide 
semiconductor solutions which would bring the performance and features of 
multimedia computing to the mobile computer market, without compromising 
size, weight, or battery life of the notebook PC. We described our mission as 
one of "mobilizing multimedia," and addressed the conflicting requirements of 
raising performance while reducing power and size with a revolutionary 
technology which we call MagicWare(TM). We have developed and proven the 
viability and the value of integrating large amounts of logic, analog 
functions, and memory onto a single chip. We have led our industry in a new 
technical direction.

We intend to continue building upon this vision. We will continue to enhance 
our existing product line with new architectures for higher performance, with 
new features, and with new manufacturing technologies. We will also begin to 
expand into new product areas. Our goals in the coming fiscal year are to 
introduce both a new family of multimedia accelerators to supplement the 
MagicGraph128 family, and also to introduce the first of our new product 
lines outside of the notebook multimedia accelerator arena.

We view the trend toward mobility as a long-term opportunity. Whatever form 
that opportunity may take, we foresee continued growing demand for electronic 
devices which enhance the productivity, education, and entertainment of an 
increasingly mobile population worldwide.

For NeoMagic, "mobilizing multimedia" means providing high-performance, small 
form-factor and long battery life semiconductor solutions for displaying, 
storing, capturing, or communicating text, graphics, video, and audio 
information. Our approach is one of providing "differentiation through 
integration," bringing together diverse technologies to provide value-added 
solutions which allow our customers' products to stand out in their 
respective markets. Our journey has just begun.

We welcome our stockholders, employees, vendors, and customers to join us in 
our journey.


       PICTURE                       PRAKASH AGARWAL, PRESIDENT AND
                                     CHIEF EXECUTIVE OFFICER (STANDING)
                                     KAMRAN ELAHIAN, CHAIRMAN (SEATED)



                                                                              3

<PAGE>


WWW.NEOMAGIC.COM



Computers have progressed from the room-sized, multi-ton mainframe to the 
five-pound notebook which fits easily into a briefcase. The way we use 
computers has progressed as well, from a tool for processing numbers and 
storing data, to a tool for accessing information and communicating ideas. 
The technology of multimedia is a critical part of this progress.

The NeoMagic story is the story of mobilizing multimedia. This means that we 
saw the need to add value to portable computing by delivering new technology 
that offers high-performance multimedia capabilities and increased battery 
life, in smaller, lighter weight computers. TO MORE FULLY APPRECIATE THIS 
VALUE, WE INVITE YOU TO STEP OUT OF THE WORLD OF PAPER AND INK, AND TO JOIN 
US IN OUR WORLD OF IMAGES, SIGHTS, AND SOUNDS.

AT WWW.NEOMAGIC.COM THE WRITTEN WORD IS ONLY THE BEGINNING. Learn about our 
products. See our customers. Review the latest news. And join us for a 
"virtual meeting" with our management. Through the technologies of multimedia 
and the world wide web, you can see, hear, and experience the NeoMagic story 
for yourself.

If you happen to have a notebook running graphics from a NeoMagic MagicGraph 
accelerator, your visual experience will be enhanced by downloading the 
"virtual meeting" and sizing the window to suit your own tastes.



4

<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>
                                                                                                          PERIOD FROM
                                                                                                          MAY 26, 1993
                                                                                                          (INCEPTION)
                                                                                                            THROUGH
                                                                                                          JANUARY 31,
YEAR ENDED JANUARY 31,                                  1998         1997         1996         1995          1994
---------------------------------------------------------------------------------------------------------------------
(in thousands, except per share data)
<S>                                                  <C>           <C>          <C>          <C>          <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net sales                                            $   124,654   $  40,792    $      243   $        -   $       -
Cost of sales                                             73,171      28,650           165            -           -
                                                     ----------------------------------------------------------------
Gross margin                                              51,483      12,142            78            -           -
Operating expenses:
    Research and development                              16,091       8,606         4,934        2,423         465
    Sales, general and administrative                     12,290       6,522         1,606          968         308
    Legal costs (1)                                            -      (1,503)          610        1,500           -
                                                     ----------------------------------------------------------------
        Total operating expenses                          28,381      13,625         7,150        4,891          773
Income (loss) from operations                             23,102      (1,483)       (7,072)      (4,891)        (773)
Other income (expense), net:
    Interest income and other                              2,643       1,366           385          194           16
    Interest expense                                      (1,298)     (1,046)         (182)         (94)           -
                                                     ----------------------------------------------------------------
Income (loss) before income taxes                         24,447      (1,163)       (6,869)      (4,791)        (757)
Provision for income taxes                                 3,667           -             -            -            -
                                                     ----------------------------------------------------------------
Net income (loss)                                    $    20,780   $  (1,163)   $   (6,869)  $   (4,791)  $     (757)
                                                     ----------------------------------------------------------------
                                                     ----------------------------------------------------------------
Pro forma basic net income (loss) per share (2)      $       .95   $    (.07)
Pro forma diluted net income (loss) per share (2)    $       .82   $    (.07)
Weighted common shares outstanding (2)                    21,924      17,238
Weighted common shares outstanding assuming
     dilution (2)                                         25,336      17,238
</TABLE>

<TABLE>
<CAPTION>

JANUARY 31,                                               1998         1997         1996         1995         1994
-------------------------------------------------------------------------------------------------------------------
<S>                                                  <C>           <C>          <C>         <C>           <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents                            $    35,004   $  13,458    $    6,877   $    4,902   $     530
Short-term investments                                    36,016           -             -            -           -
Working capital                                           53,518       1,398         4,069        2,846         618
Total assets                                             107,583      27,464         8,749        5,956       1,039
Long-term obligations                                        646       1,194           749          452         185
Total stockholders' equity                                65,127       4,200         4,542        3,313         753

STATISTICAL DATA:
Number of employees                                          162          94            44           23          10
Revenue/employee                                     $       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 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
Other income (expense), net:
    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 (2)                                 $    .11    $    .18    $    .29   $    .36
Diluted net income per share (2)                               $    .09    $    .15    $    .25   $    .32
Weighted common shares outstanding (2)                           19,845      22,161      22,713     22,976
Weighted average common shares outstanding assuming              23,398      25,893      26,144     25,907
   dilution (2)
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

<CAPTION>
FISCAL 1997                                                       Q1         Q2         Q3         Q4
----------------------------------------------------------------------------------------------------------
(unaudited, in thousands)
<S>                                                            <C>         <C>         <C>        <C>
Net sales                                                      $  3,520    $  5,954    $ 15,035   $ 16,283
Cost of sales                                                     2,818       5,485       9,994     10,353
                                                               --------    --------    --------   --------
Gross margin                                                        702         469       5,041      5,930
Operating expenses:
    Research and development                                      2,009       1,667       2,250      2,680
    Sales, general and administrative                               996       1,553       1,950      2,023
    Legal costs (1)                                                   -      (1,503)          -          -
                                                               --------    --------    --------   --------
        Total operating expenses                                  3,005       1,717       4,200      4,703
Income (loss) from operations                                    (2,303)     (1,248)        841      1,227
Other income (expense), net:
    Interest income and other                                     1,076          75          42        173
    Interest expense                                               (160)       (210)       (316)      (360)
                                                               --------    --------    --------   --------
Net income (loss)                                              $ (1,387)   $ (1,383)   $    567   $  1,040
                                                               --------    --------    --------   --------
                                                               --------    --------    --------   --------
</TABLE>

         The Company had 228 stockholders of record as of March 22, 1998. 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)  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.

                                                                              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 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 multimedia accelerators 
for sale to notebook computer manufacturers. The Company has developed the 
first commercially available high performance silicon technology that 
integrates large DRAM memory with analog and logic circuitry to provide a 
high performance multimedia solution on a single chip. The Company's 
MagicGraph128 family of pin-compatible multimedia accelerators incorporates a 
128-bit memory bus. The Company believes these products enable notebook PC 
manufacturers to deliver state-of-the-art multimedia capabilities while 
decreasing power consumption, size, system design complexity and cost.

         Since its inception in May 1993 through the end of fiscal 1996, 
NeoMagic was in the development stage and was primarily engaged in product 
development, product testing and the establishment of strategic relationships 
with customers and suppliers. Accordingly, the majority of the Company's 
operating expenses during such period were related to research and 
development activities. Since inception, the Company incurred losses in each 
fiscal year until fiscal year 1998. At the end of fiscal 1998 the Company had 
retained earnings of $7.2 million. The Company first recognized revenue on 
product sales in fiscal 1996. Operating results in fiscal 1998 have benefited 
from increased market acceptance of the Company's products. 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 product is sold by the distributors.

         All of the Company's net sales in fiscal 1998, 1997 and 1996 were 
derived from sales of its multimedia accelerator products, and the Company 
expects this trend to continue for the foreseeable future. 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 66.5%, 79.7% and 100% 
of the Company's net sales for fiscal 1998, 1997 and 1996, 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.

         Export sales are a critical part of the Company's business. Sales to 
customers located outside the United States (including sales to foreign 
operations of customers headquartered in the United States and foreign system 
manufactures who sell to United States-based OEMs) accounted for 83.2%, 
96.2% and 90.0% of the Company's net sales in fiscal 1998, 1997 and 1996, 
respectively. The Company expects that the net sales derived from purchases 
by international customers will continue to represent a significant portion 
of total net sales. All of the Company's sales are denominated in United 
States dollars.

         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") and Toshiba Corporation ("Toshiba") to produce its 
semiconductor wafers and uses other independent contractors to perform 
assembly, packaging and testing. The Company's relationships with Mitsubishi 
Electric and Toshiba 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 

8

<PAGE>

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


independent vendors. To date, all of the Company's wafer purchases, which 
constitute a significant part of its cost of goods sold, 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 with Mitsubishi Electric and 
Toshiba, the Company is obligated to provide rolling 12-month forecasts of 
anticipated purchases and place binding purchase orders 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.

         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 1998, 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,                       1998           1997           1996
----------------------------------------------------------------------------------
<S>                                           <C>            <C>            <C>
Net sales                                      100.0%        100.0%          100.0%
Cost of sales                                   58.7          70.2            67.9
                                               -----------------------------------
Gross margin                                    41.3          29.8            32.1

Operating expenses:

  Research and development                      12.9          21.1         2,030.4
  Sales, general and administrative              9.9          16.0           660.9
  Legal costs                                      -          (3.7)          251.0
                                               -----------------------------------
      Total operating expenses                  22.8          33.4         2,942.3
                                               -----------------------------------
Income (loss) from operations                   18.5          (3.6)       (2,910.2)

Other income (expense), net:
      Interest income and other                  2.1           3.3           158.4
      Interest expense                          (1.0)         (2.6)          (74.9)
                                               -----------------------------------
Income (loss) before income taxes               19.6          (2.9)       (2,826.7)
Provision for income taxes                       2.9             -               -
                                               -----------------------------------
Net income (loss)                               16.7%         (2.9)%      (2,826.7)%
                                               -----------------------------------
                                               -----------------------------------
</TABLE>

                                                                              9

<PAGE>

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


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 on, the personal computer industry with sales primarily 
in Asia, Japan, and the United States. Net sales were $124.7 million, $40.8 
million and $243,000 in fiscal 1998, 1997 and 1996, 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 product family which expanded 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, the Company's products 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 headquartered in the United States and 
foreign system manufacturers that sell to United States-based OEMs) accounted 
for 83.2%, 96.2% and 90.0% of net sales in fiscal 1998, 1997 and 1996, 
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.

         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. Three 
customers accounted for 34.6%, 28.6% and 14.4%, respectively of net sales in 
fiscal 1996. 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.

GROSS MARGIN

         Gross margin was $51.5 million and $12.1 million in fiscal 1998 and 
1997, respectively. The gross margin percentage increased to 41.3% of net 
sales in fiscal 1998 from 29.8% of net sales in fiscal 1997. The gross margin 
in fiscal 1997 was negatively impacted by costs stemming from a design error 
for which the Company recorded a $1.2 million reserve in the second quarter 
and excess inventory charges of $750,000 in both the third and fourth 
quarters. The additional increases in gross margin in fiscal 1998 were due 
primarily to lower wafer pricing and improved yields on higher production 
volumes.

         In the future, the Company's gross margin percentages may be 
affected by 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, 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 $16.1 
million, $8.6 million and $4.9 million in fiscal 1998, 1997 and 1996, 
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 1999.

10

<PAGE>

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


SALES, GENERAL AND ADMINISTRATIVE EXPENSES

         Sales, general and administrative expenses were $12.3 million, $6.5 
million and $1.6 million in fiscal 1998, 1997 and 1996, respectively. Sales, 
general and administrative expenses increased as a result of increased 
employee related expenses largely related to additional personnel, increased 
commissions associated with higher sales levels and higher administrative 
expenses associated with being a public company. Sales, general and 
administrative expenses are expected to increase in absolute dollars in 
fiscal 1999.

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, an additional 
accrual of $610,000 was recorded by the Company. In fiscal 1997, based on the 
dismissal of such litigation, the remaining reserve balance of $1.5 million 
was reversed. The settlement which gave rise to the dismissal did not involve 
cash payments, but did include a non-solicitation provision and certain 
contingent cross licensing provisions. The Company does not believe that such 
settlement will have a material adverse effect on the Company's future 
operations. See Note 10 of Notes to Consolidated Financial Statements.

OTHER INCOME (EXPENSE), NET.

         The Company incurs interest expense on borrowings under the 
Company's working capital line of credit and on lease obligations used to 
finance certain equipment. The Company earns interest on its cash and 
short-term investments. Other income (expense), net was $1.3 million, 
$320,000 and $203,000 in fiscal 1998, 1997 and 1996, respectively. The 
increase in other income (expense), net between fiscal 1998 and 1997 was due 
to interest income on higher cash and short-term investment balances 
maintained during fiscal 1998. The increase in other income (expense), net 
from fiscal 1996 to fiscal 1997 was due to approximately $1.0 million in 
proceeds received for non-recurring engineering services performed by 
NeoMagic, substantially offset by higher interest expense resulting from 
borrowings under the Company's working capital line and additional lease 
obligations used to finance certain equipment borrowings. The Company does 
not anticipate generating income from engineering services on a regular 
basis, if at all, in future periods. 

INCOME TAXES

         The Company's effective tax rate was 15% in fiscal 1998. The Company 
recorded no provision for federal or state income taxes in fiscal 1997 and 
1996. In fiscal 1998, the difference between the Company's 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 
increased $55.3 million in fiscal 1998 to $71.0 million at January 31, 1998 
from $15.7 million at January 31, 1997. The increase is 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 $52.1 million to $53.5 million at January 31, 1998 
from $1.4 million at January 31, 1997.

         In fiscal 1998 the Company generated $15.4 million of cash and cash 
equivalents from its operating activities, compared to $3.1 million and $6.4 
million of cash and cash equivalents used in operating activities in fiscal 
1997 and 1996, respectively. The increase in cash generated from operations 
is primarily attributable to $20.8 million in net income in fiscal 1998 
compared to net losses of $1.2 million and $6.9 million in fiscal 1997 and 
1996, respectively. The increases in cash generated from operating activities 
for fiscal 1998 was also related to changes in accrued expenses and accounts 
payable offset by increases in accounts receivable, inventory and deferred 
taxes.

                                                                             11

<PAGE>

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


         Net cash used for investing activities in fiscal 1998, 1997 and 1996 
was $40.5 million, $3.1 million and $728,000, respectively. The increase in 
fiscal 1998 was primarily due to $36.0 million of net purchases of short-term 
investments and $4.5 million of investments in property, plant and equipment. 
Net cash used for investing activities in fiscal 1997 and 1996 was related to 
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 provided by financing activities in fiscal 1998, 1997 and 
1996 was $46.7 million, $12.8 million and $9.1 million, respectively. The 
increase in fiscal 1998 primarily represents net proceeds from the initial 
public offering of $37.8 million, and the release of amounts previously held as 
restricted cash, offset in part by a decrease in the net proceeds related to 
the working capital line of credit. 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. Net cash provided by financing activities in fiscal 
1996 relate to net proceeds from issuances of noncumulative convertible 
preferred stock.

         At January 31, 1998 the Company's principal sources of liquidity 
included cash and cash equivalents and short-term investments of $71.0 
million and borrowings under the working capital line of credit agreement 
which provided 60 day extended credit terms on water purchases. In January 
1998, the working capital line of credit was revised such that for wafer 
shipments subsequent to January 31, 1998 payment for wafers must be made 
within 30 days of wafer shipment. 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 12 months. The Company currently expects to make approximately $8.0 to 
$9.0 million in capital expenditures during the next twelve months, 
consisting primarily of purchases of development tools and software and 
personal computer. Investments will continue in product development in new 
and existing areas of technology. Cash may also be used to acquire technology 
through purchases and strategic 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 and marketing, the timing of introductions of 
new products 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.

IMPACT OF CURRENCY EXCHANGE RATES

         Because the Company currently purchases wafers under purchase 
contracts denominated in yen, significant appreciation in the value of 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 from time to time enters into foreign currency forward contracts and 
foreign currency options to minimize 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 currency losses in the future, nor can the 
Company predict the effect of exchange rate fluctuations upon future 
operating results.

IMPACT OF YEAR 2000

       The Year 2000 Issue is the result of computer programs being written 
using two digits rather than four digits to define the applicable year. 
Computer programs that have time-sensitive software may recognize a date 
using "00" as the year 1900 rather than the year 2000. If the Company's 
internal systems do not correctly recognize date information when the year 
changes to 2000, there could be an adverse impact on the Company's 
operations. The Company has completed an assessment and does not believe that 
it will be required to modify or replace significant portions of its software 
so that its computer systems will function properly with respect to dates in 
the year 2000 and thereafter. The Company has also assessed the capability of 
its products sold to customers and believes that it has no exposure to 
contingencies related to the Year 2000 Issues for the products it has sold. 
Management believes that the likelihood of a material adverse impact due to 
problems with internal systems or products sold to

12

<PAGE>

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


customers is remote and expects that any costs to be incurred to assure year 
2000 capability will not have a material adverse effect on the Company's 
financial position or results of operations. The Company is contacting 
critical suppliers of products and services to determine that the suppliers' 
operations and the products and services they provide are year 2000 capable. 
There can be no assurance that another company's failure to ensure year 2000 
capability would not have an adverse effect on the Company.

FACTORS THAT MAY AFFECT RESULTS

FLUCTUATIONS IN QUARTERLY OPERATING RESULTS

       NeoMagic's quarterly and annual results of operations are effected by 
a variety of factors that could materially adversely effect 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); fluctuations in manufacturing yields; incorrect 
forecasting of future revenues; availability and cost of manufacturing 
capacity; 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; market acceptance of the 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 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; foreign exchange rate fluctuations; 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. The 
Company may be unable to adjust spending sufficiently in a timely manner to 
compensate for any unexpected sales shortfall, which could materially 
adversely effect 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 
effected.

RISKS ASSOCIATED WITH DEPENDENCE ON THE NOTEBOOK PC MARKET

        The Company's products are 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 forecast 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 opportunities to achieve crucial design wins, which could result 
in a material 

                                                                            13

<PAGE>

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


adverse effect in 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 future 
developments in other 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 in the Company's business, financial 
condition and results of operations.

PRODUCT CONCENTRATION; RISKS ASSOCIATED WITH MULTIMEDIA PRODUCTS

        The Company's revenues 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 product line, the 
Company's revenues and results of operations would be materially adversely 
effected 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 are unable at the beginning 
of each such transition to support the new feature sets or performance levels 
being required by notebook PC manufacturers, the Company would likely lose 
design wins and moreover, not have the opportunity to compete for new design 
wins until it was able to incorporate changes resulting from market 
transitions or to take advantage of future product transitions. Thus, 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 and 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. The failure of the Company to 
continue designing and introducing advanced products in a timely manner or to 
continue reducing product costs would have a material adverse effect on the 
Company's net sales, gross margins and results of operations.

CUSTOMER CONCENTRATION

       The Company's sales are concentrated within a limited customer base. 
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 agreements. As a result, 
the Company's business, financial condition and results of operations could 
be materially adversely effected 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 MagicGraph128 products feature large DRAM memory 
integrated with analog and logic circuitry on a single chip, while its 
competitors often provide only the graphics/video analog and logic circuitry 
on a separate chip to be used in conjunction with DRAMs supplied by others. 
The prices of the Company's products reflect many factors, including the 
prices of DRAM chips. As a result, the Company's business, financial 
condition and results of operations may be materially and adversely effected 
by unanticipated changes in the price of DRAMs. Such changes are typically 
sudden and dramatic and can extend over a significant period of time. For 
example, the average price of 4-Mbit DRAMs declined by more than 66% in 
fiscal 1998, and this decline effected the average selling prices of the 
Company's products. A significant reduction in the price of DRAMs could cause 
the Company's products to be less competitively priced, potentially effecting 
ongoing product pricing as well as resulting in the loss of design wins for 
new notebook PCs. In this circumstance, competitors without embedded DRAM 
potentially could be benefited by DRAM price reductions, and the Company 
could be forced to respond to pricing pressures precipitated by changes in 
the DRAM market by reducing the average selling prices of its products to 
current and prospective system manufacturer customers. Because the Company's 
product costs cannot be adjusted as rapidly as changes in average selling 
prices to system manufacturers, the Company's net sales and gross margin 
would be materially and adversely impacted.

14

<PAGE>

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


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 ("ATI"), Chips & Technologies, Inc. ("Chips & Technologies"--in January 
1998, Intel Corporation acquired Chips and Technologies), S3 Incorporated 
("S3")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. Furthermore, the Company expects that many of its 
competitors will seek to develop and introduce products that integrate large 
DRAM with analog and logic circuitry on a single chip. For example, Chips & 
Technologies, Trident and S3 have publicly disclosed that they have or will 
begin sampling an integrated multimedia accelerator solution for the notebook 
PC market that would directly compete with the Company's products. Certain of 
the Company's competitors offer 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 a microprocessor with a 
multimedia controller. Cyrix (acquired by National Semiconductor in July 
1997) is in production of such a product. The successful commercial 
introduction of such a product by competitors that integrates large DRAM with 
analog and logic circuitry on a single chip or a product that eliminates 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 demand as rapidly as companies that operate their own 
facilities, which could have a material adverse effect on its business, 
financial condition and results of operations. In addition, the prices of the 
Company's products reflect many factors, including the prices of DRAM chips 
and non-integrated graphics chips. Therefore, in some cases, the Company's 
products may be more expensive than competitive multiple chip solutions. The 
Company in the past has lost and in the future may lose design wins due to 
this price difference. Furthermore, a significant reduction in the price of 
DRAMs could cause the Company's products to be less competitively priced, 
potentially effecting ongoing product pricing as well as resulting in the 
loss of design wins for new notebook PCs. Uncompetitive pricing and loss of 
design wins could have a material and adverse effect on the Company's 
business, financial condition, and 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 products 
are primarily manufactured by Mitsubishi Electric Corporation ("Mitsubishi 
Electric") in Japan. In fiscal 1998, the Company began manufacturing wafers 
with Toshiba Corporation ("Toshiba") in Japan. Each of these manufacturing 
relationships are 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 single source manufactured. Because 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 
is four to nine months, there is no readily available alternative source of 
supply for any specific product. A manufacturing disruption experienced by 
either of the Company's manufacturing partners would impact the production of 
the Company's products for a substantial period of time, which 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 at Mitsubishi Electric or 
Toshiba is unsuccessful, the Company's business, financial condition and 
results of operations would be materially and adversely effected.

                                                                             15

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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 assurance, 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 Mitsubishi Electric and 
Toshiba to produce wafers of acceptable quality and with acceptable 
manufacturing yields, to deliver those wafers to the Company and its 
independent assembly and testing subcontractors on a timely basis and to 
allocate to the Company a portion of their manufacturing capacity sufficient 
to meet the Company's needs. On occasion, the Company has experienced some of 
these difficulties. Although the Company's products are designed using the 
process design rules of the particular manufacturer, there can be no 
assurance that either Mitsubishi Electric or Toshiba 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 either Mitsubishi Electric or Toshiba will continue to devote 
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. Any such difficulties would 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 is 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 and 
Toshiba, the Company is obligated to provide rolling 12-month forecasts of 
anticipated purchases and to place binding purchase orders 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 a shortage of wafers for a particular product. As a result of 
the long lead time for manufacturing wafers, semiconductor companies such as 
the Company from time-to-time must take charges for excess inventory. For 
example, the Company booked charges totaling $1.5 million for excess 
inventory in fiscal 1997. Significant write-offs of excess inventory could 
materially adversely affect 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 effect the Company's 
customer relationships and thereby materially adversely effect 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 price for wafers meeting certain acceptance criteria. Accordingly, 
the Company bears the risk of final yield of good die. Poor yields would 
materially adversely effect 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 both of 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 to identify, communicate and resolve manufacturing yield problems. 
As the Company's relationships with additional manufacturing partners 
develop, yields could be adversely effected due to difficulties associated 
with adopting the Company's technology and product design to the proprietary 
process technology and design rules of each manufacturer. Because of the 
Company's limited access to wafer fabrication capacity from its 
manufacturers, any decrease in manufacturing yields could result in an 
increase in the Company's per unit costs and force the Company to allocate 
its available product supply among its customers, thus 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 effected.

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 within the limited window of market demand. For 
example, both 3-D 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 Mitsubishi Electric, Toshiba and any additional 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 effected. 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. 

                                                                             17

<PAGE>

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


The multiple chip solutions offered by some of the Company's competitors are 
less complex to design and manufacture than the Company's integrated 
MagicGraph128 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.

       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 such products mature. Thus, the Company will need to 
introduce new products which are compelling enough in order to maintain 
average selling prices. There can be no assurance that the Company will 
successfully identify new product opportunities and develop and bring new 
products to market in a timely manner, 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 design into the products of its targeted customers. The failure of the 
Company's new product development efforts would have a material adverse 
effect on NeoMagic's business, financial condition and results of operations.

UNCERTAINTY REGARDING PATENTS AND PROTECTION OF PROPRIETARY RIGHTS

       The Company relies in part on patents to protect its intellectual 
property. In the United States, the Company has been issued five patents, 
each covering certain aspects of the design and architecture of the Company's 
multimedia accelerators. In addition, the Company has patent applications, 
pending in the United States Patent and Trademark Office (the "PTO"). There 
can be no assurance that the Company's pending patent applications, or any 
future applications will be approved, or that any issued patents will provide 
the Company with 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. Furthermore, there can be no assurance that 
others will not independently 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. 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. 
In November 1994, Cirrus Logic filed suit 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. The 
Company and Cirrus Logic settled the lawsuit in June 1996, but the Company 
incurred an aggregate of $703,000 in expenses in connection with such 
litigation during fiscal 1995 and fiscal 1996. This settlement did not 
involve cash 

18

<PAGE>

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


payments, but did include a non-solicitation provision and certain contingent 
cross-licensing provisions. In February 1997, Cirrus Logic sent the Company 
written notice asserting that the Company's MagicGraph128, MagicGraph128V and 
MagicGraph128ZV products infringe three 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, the Company was notified by certain of its customers that a 
law suit had been filed and served by a holder of a United States patent 
asserting that the video/graphics subsystem in such customers' notebook PCs, 
which use the Company's MagicGraph128 and MagicGraph128V products, infringe 
certain claims of the patent. 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. The Company believes that the Company's MagicGraph128 
and MagicGraph128V products do not infringe any of the claims of such patent. 
The Company's belief is based upon a legal opinion from its patent counsel, 
Townsend and Townsend and Crew LLP. There can be no assurances that the 
holders of such patent will not file a lawsuit against the Company or its 
customers, 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.

       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 claims 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 effect 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 foreign 
operations of customers headquartered in the United States and foreign system 
manufacturers that sell to United States-based OEMs) accounted for 83.2%, 
96.2% and 90.0% of the Company's net sales for fiscal 1998, 1997 and 1996, 
respectively. The Company expects that net sales derived from international 
sales will continue to represent a significant portion of its total net 
sales. Some of the Company's international sales are supported by letters of 
credit issued by its customers. Because the Company's international sales 
have to date been denominated in United States dollars, increases in the 
value of the United States dollar could increase the price in local 
currencies of the Company's products in foreign markets and make the 
Company's products relatively more expensive than competitors' products that 
are denominated in local currencies. All of the Company's wafers are, and for 
the foreseeable future, will be produced by foreign manufacturers. 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, products are priced in 
Japanese yen. As a result, the Company's cost 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 such 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 hedging against 
currency exchange rate fluctuations could have a material 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.

                                                                             19

<PAGE>

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


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, the timing and extent of spending to support research 
and development programs and expansion of sales and marketing, the timing of 
introductions of new products and enhancements to existing products and 
market acceptance of the Company's 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.

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 could continue to place a significant strain on the 
Company's limited personnel and other resources. To manage these expanded 
operations effectively, 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 effected.

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. Loss of the services of, or 
failure to recruit in a timely manner, 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 shares of Common Stock, like that of the 
common stock of many other semiconductor companies, has been and is likely to 
be highly volatile, and the market has from time to time experienced 
significant price and volume fluctuations that are unrelated to the operating 
performance of particular companies. The market price of the Common Stock 
could be subject to significant fluctuations in response to 
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, conditions in the 
semiconductor and PC industries, unanticipated shifts in the notebook PC 
market or industry standards, loss of customers, changes in DRAM pricing, the 
commencement of, developments in or outcome of litigation, 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,                                 1998         1997         1996
-------------------------------------------------------------------------------------------
(in thousands, except per share data)
<S>                                                  <C>           <C>          <C>
Net sales                                            $  124,654     $  40,792    $    243

Cost of sales                                            73,171        28,650         165
                                                     --------------------------------------
Gross margin                                             51,483        12,142          78

Operating expenses:
  Research and development                               16,091         8,606       4,934
  Sales, general and administrative                      12,290         6,522       1,606
  Legal costs                                                 -        (1,503)        610
                                                     --------------------------------------
               Total operating expenses                  28,381        13,625       7,150

Income (loss) from operations                            23,102        (1,483)     (7,072)

Other income (expense), net:
  Interest income and other                               2,643         1,366         385
  Interest expense                                       (1,298)       (1,046)       (182)
                                                     --------------------------------------
Income (loss) before income taxes                        24,447        (1,163)     (6,869)

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

Net income (loss)                                     $  20,780     $  (1,163)   $ (6,869)
                                                     --------------------------------------
                                                     --------------------------------------


Pro forma basic net income (loss) per share           $     .95     $    (.07)
Pro forma diluted net income (loss) per share         $     .82     $    (.07)

Weighted common shares outstanding                       21,924        17,238
Weighted common shares outstanding assuming
    dilution                                             25,336        17,238

</TABLE>


See accompanying notes.

                                                                              21
<PAGE>



NEOMAGIC CORPORATION
CONSOLIDATED BALANCE SHEETS


<TABLE>
<CAPTION>
JANUARY 31,                                                                   1998               1997
--------------------------------------------------------------------------------------------------------
(in thousands, except share and per share data)
<S>                                                                          <C>                <C>
ASSETS
Current assets:
  Cash and cash equivalents                                                   $ 35,004          $ 13,458
  Restricted cash equivalents                                                        -             2,224
  Short-term investments                                                        36,016                 -
  Accounts receivable, less allowance for doubtful accounts of
      $132 at January 31, 1998 and $25 at January 31, 1997                      11,236             2,205
  Inventory                                                                      9,342             5,237
  Other current assets                                                           3,730               344
                                                                              --------------------------
            Total current assets                                                95,328            23,468

Property, plant and equipment, net                                               6,232             3,395
Deferred tax assets                                                              5,669                 -
Other assets                                                                       354               601
                                                                              --------------------------

             Total assets                                                     $107,583          $ 27,464
                                                                              --------------------------
                                                                              --------------------------


LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Working capital line of credit                                              $ 21,041          $ 14,224
  Accounts payable                                                               9,490             5,175
  Accrued expenses                                                              10,652             1,617
  Current obligations under capital leases                                         627             1,054
                                                                              --------------------------
             Total current liabilities                                          41,810            22,070

Long-term obligations under capital leases and other                               646             1,194
                                                                              --------------------------
             Total liabilities                                                  42,456            23,264
Commitments and contingencies
Stockholders' equity:
  Noncumulative convertible preferred stock, $.001 par value:
      Authorized shares 2,000,000 at January 31, 1998 and 12,868,315
         at January 31, 1997
      Issued and outstanding shares - none at January 31, 1998 and
         12,259,614 at January 31, 1997                                              -                12
  Common stock, $.001 par value:
       Authorized shares - 60,000,000
       Issued and outstanding shares - 24,204,602 at January 31, 1998
          and 8,072,591 at January 31, 1997                                         24                 8
  Additional paid-in-capital                                                    61,263            20,471
  Notes receivable from stockholders                                              (559)             (822)
  Deferred compensation                                                         (2,801)           (1,889)
 Retained earnings  (Accumulated deficit)                                        7,200           (13,580)
                                                                              --------------------------
             Total stockholders' equity                                         65,127             4,200
                                                                              --------------------------

             Total liabilities and stockholders' equity                       $107,583          $ 27,464
                                                                              --------------------------
                                                                              --------------------------
</TABLE>

See accompanying notes.

22


<PAGE>



NEOMAGIC CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31,                                                      1998          1997          1996
---------------------------------------------------------------------------------------------------------------
(in thousands)
<S>                                                                      <C>           <C>           <C>
OPERATING ACTIVITIES:
Net income (loss)                                                         $20,780        $ (1,163)    $  (6,869)
Adjustments to reconcile net income (loss) to net cash provided 
by (used for) operating activities:
     Depreciation and amortization                                          1,679             813           528
     Amortization of deferred compensation                                    776             375             -
     Tax benefit from employee stock options                                  750               -             -
     Deferred taxes                                                        (8,571)              -             -
     Changes in operating assets and liabilities:
           Accounts receivable                                             (9,031)         (2,067)         (138)
           Inventory                                                       (4,105)         (4,906)         (331)
           Other current assets                                              (485)           (163)          (46)
           Other assets                                                       248            (482)         (103)
           Accounts payable                                                 4,315           4,606           314
           Accrued expenses                                                 9,035             (82)          232
                                                                         --------------------------------------
Net cash provided by (used for) operating activities                       15,391          (3,069)       (6,413)
                                                                         --------------------------------------
                                                                         --------------------------------------

INVESTING ACTIVITIES
     Purchases of property, plant and equipment                            (4,516)         (3,105)         (728)
     Purchases of short-term investments                                  (58,649)              -             -
     Maturities of short-term investments                                  22,633               -             -
                                                                         --------------------------------------
Net cash used for investing activities                                    (40,532)         (3,105)         (728)
                                                                         --------------------------------------
                                                                         --------------------------------------

FINANCING ACTIVITIES
     Proceeds from sale leaseback liability                                     -           1,689         1,243
     Payments on lease obligations                                           (975)           (966)         (639)
     Proceeds from working capital line of credit                          59,760          27,941           414
     Payments on working capital line of credit                           (52,943)        (14,131)            -
     Net proceeds from issuances of noncumulative convertible
         preferred stock                                                        -               -         8,047
     Net proceeds from issuance of common stock                            38,358             446            51
     Payments received from notes receivable from stockholders                263
     Amounts held as restricted cash equivalents                                -          (2,224)            -
     Release of amounts held as restricted cash equivalents                 2,224               -             -
                                                                         --------------------------------------
Net cash provided by financing activities                                  46,687          12,755         9,116
                                                                         --------------------------------------
                                                                         --------------------------------------
Net increase in cash and cash equivalents                                  21,546           6,581         1,975
Supplemental schedules of cash flow information
     Cash and cash equivalents at beginning of period                      13,458           6,877         4,902
                                                                         --------------------------------------
     Cash and cash equivalents at end of period                          $ 35,004        $ 13,458      $  6,877
                                                                         --------------------------------------
                                                                         --------------------------------------
     Cash paid during the year for:
          Interest                                                      $   1,298        $  1,045      $    153
          Taxes                                                         $   6,964        $      -      $      -

Supplemental schedules of noncash investing and financing activities
          Issuance of common stock in exchange for promissory notes     $      -         $    592     $     219
          Deferred compensation                                         $   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
                                                              --------------------  -----------------
                                                                 SHARES       AMT      SHARES     AMT
-----------------------------------------------------------------------------------------------------
(in thousands, except share data)
<S>                                                           <C>             <C>   <C>          <C>

Balance at January 31, 1995                                      9,439,614    $  9   6,183,030   $  6
-----------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------

Issuance of Series D preferred stock, net of issuance costs
 of $18                                                          2,820,000       3          --     --
Issuance of common stock under stock option plan                        --      --   1,008,257      1
Repurchase of common stock at cost and payments on
 promissory notes                                                       --      --    (268,654)    --
Net loss                                                                --      --          --     --
-----------------------------------------------------------------------------------------------------
Balance at January 31, 1996                                     12,259,614      12   6,922,633      7
-----------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------

Issuance of common stock under stock option plan                        --      --   1,465,750      1
Repurchase of common stock at cost and payments on
 promissory notes                                                       --      --    (315,792)    --
Payment of promissory note                                              --      --          --     --
Deferred compensation relating to stock options                         --      --          --     --
Amortization of deferred compensation relating to stock
 options                                                                --      --          --     --
Net loss                                                                --      --          --     --
-----------------------------------------------------------------------------------------------------
Balance at January 31, 1997                                     12,259,614      12   8,072,591      8
-----------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------

Issuance of common stock in conjunction with initial public
 offering                                                               --      --   3,475,000      4
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     --
Issuance of common stock under employee stock purchase plan             --      --      35,987     --
Repurchase of common stock at cost                                      --      --     (12,813)    --
Payment on promissory notes                                             --      --          --     --
Deferred compensation relating to stock options                         --      --          --     --
Amortization of deferred compensation relating to stock
 options                                                                --      --          --     --
Tax benefit attributable to stock options                               --      --          --     --
Net income                                                              --      --          --     --
-----------------------------------------------------------------------------------------------------
Balance at January 31, 1998                                             --    $ --  24,204,602   $ 24
-----------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------
 
<CAPTION>
                                                                          NOTES                        RETAINED
                                                              ADD'L     RECEIVABLE                     EARNINGS         TOTAL
                                                              PAID-IN      FROM         DEFERRED     (ACCUMULATED   STOCKHOLDERS'
                                                               CAPITAL  STOCKHOLDERS   COMPENSATION     DEFICIT)        EQUITY
(in thousands, except share data)
<S>                                                           <C>      <C>            <C>            <C>            <C>
---------------------------------------------------------------------------------------------------------------------------------
Balance at January 31, 1995                                   $ 9,008     $(162)        $    --        $ (5,548)       $ 3,313
---------------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------------

Issuance of Series D preferred stock, net of issuance costs
 of $18                                                         8,044        --              --              --          8,047
Issuance of common stock under stock option plan                  262      (219)             --              --             44
Repurchase of common stock at cost and payments on
 promissory notes                                                 (12)       19              --              --              7
Net loss                                                           --        --              --          (6,869)        (6,869)
---------------------------------------------------------------------------------------------------------------------------------
Balance at January 31, 1996                                    17,302      (362)             --         (12,417)         4,542
---------------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------------

Issuance of common stock under stock option plan                  997      (592)             --              --            406
Repurchase of common stock at cost and payments on
 promissory notes                                                 (92)      109              --              --             17
Payment of promissory note                                         --        23              --              --             23
Deferred compensation relating to stock options                 2,264        --          (2,264)             --             --
Amortization of deferred compensation relating to stock
 options                                                           --        --             375              --            375
Net loss                                                           --        --              --          (1,163)        (1,163)
---------------------------------------------------------------------------------------------------------------------------------
Balance at January 31, 1997                                    20,471      (822)         (1,889)        (13,580)         4,200
---------------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------------

Issuance of common stock in conjunction with initial public
 offering                                                      37,756        --              --              --         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        --              --              --            259
Issuance of common stock under employee stock purchase plan       367        --              --              --            367
Repurchase of common stock at cost                                (28)       --              --              --            (28)
Payment on promissory notes                                        --       263              --              --            263
Deferred compensation relating to stock options                 1,688        --          (1,688)             --             --
Amortization of deferred compensation relating to stock
 options                                                           --        --             776              --            776
Tax benefit attributable to stock options                         750        --              --              --            750
Net income                                                         --        --              --          20,780         20,780
---------------------------------------------------------------------------------------------------------------------------------
Balance at January 31, 1998                                   $61,263     $(559)        $(2,801)       $  7,200        $65,127
---------------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
 
See accompanying note.

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 on May 26, 
1993 in California and reincorporated in Delaware on February 13, 1997. The 
Company designs, develops and markets multimedia accelerator solutions for 
sale to notebook PC manufacturers. The Company's MagicWare technology 
integrates large DRAM memory with analog and logic circuitry to provide a 
high performance multimedia solution on a single chip.

BASIS OF PRESENTATION

         As of January 1996, the Company adopted a fiscal reporting period 
consisting of a fifty-two week period ending on the Sunday closest to the 
January month end. Fiscal years 1996, 1997 and 1998 ended on January 28, 26 
and 25, respectively. Fiscal year 1999 will be a fifty-three week fiscal year 
ending on January 31, 1999. For convenience, the accompanying 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.

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 of assets and liabilities, the 
disclosures of contingent assets and liabilities at the date of the financial 
statements and the reported amounts of revenues and expenses during the 
reported period. Actual results could differ from those estimates.

         All of the Company's products are currently manufactured by two 
companies in Japan, each under the terms of a five-year wafer supply 
agreement. A manufacturing disruption experienced by either of the Company's 
manufacturing partners could impact the production of the Company's products 
for a substantial period of time, which could 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 
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 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 include 
its effectiveness in risk reduction and one-to-one 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. Subsequent gains or losses on the related derivative instrument would 
be recognized in income in each period until the instrument matures, is 
terminated or sold.

                                                                             25
<PAGE>


NEOMAGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


CASH AND CASH EQUIVALENTS

         Cash equivalents consist of highly liquid financial instruments, 
consisting of investments in money market funds, commercial paper and 
municipal bonds with original maturities of 90 days or less at the time of 
acquisition.

         Management classifies investments as available-for-sale or 
held-to-maturity at the time of purchase and periodically reevaluates such 
designations. 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. Debt securities 
not classified as held-to-maturity are classified as available-for-sale and 
are reported at fair 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 other income (expense), net. The cost of securities sold is based 
on the specific identification method.

         While the Company's intent is to hold debt securities to maturity, 
they are classified as available-for-sale because the sale of such securities 
may be required prior to maturity. All are stated at cost, which approximates 
fair market value as of January 31, 1998 and 1997, and consist of the 
following (in thousands):

<TABLE>
<CAPTION>
JANUARY 31,                                                     1998           1997
------------------------------------------------------------------------------------
<S>                                                        <C>             <C>
Cash equivalents:
       Money market funds                                   $      5,272   $     6,803
       Commercial paper                                           24,197         6,594
       Municipal bonds                                                 -           800
                                                            --------------------------
                Total                                       $     29,469   $   14,197
                                                            --------------------------
                                                            --------------------------

Short-term investments:
        Medium term notes                                   $     11,158   $        -
        U.S. Government agencies                                   8,082            -
        Corporate bonds                                            7,148            -
        Corporate notes                                            5,602            -
        Market auction preferreds                                  2,028            -
        Foreign debt securities                                    1,011            -
        Commercial paper                                             987            -
                                                            --------------------------
                     Total                                  $     36,016   $        -
                                                            --------------------------
                                                            --------------------------
</TABLE>

         The above amounts for cash equivalents include $254,000 and 
$1,970,000 of money market funds and commercial paper, respectively, 
classified as restricted cash equivalents which were required to be 
maintained under the working capital line of credit as of January 31, 1997.

         Gross unrealized gains and losses on available-for-sale securities 
at January 31, 1998 and 1997 and gross realized gains and losses on sales of 
available-for-sale securities in fiscal 1998, 1997 and 1996 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.

26

<PAGE>


NEOMAGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


REVENUE RECOGNITION

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

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 PC's 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.

RESEARCH AND DEVELOPMENT EXPENSES

         Expenditures for research and development are expensed as incurred. 
In connection with the Company's product development efforts, it develops 
software (none of which is separately sold) that enable the Company's 
multimedia accelerator products to work with various personal computer 
operating systems. The development of such software generally occurs in 
parallel with the related accelerator product development and, accordingly, 
is expensed as incurred.

STOCK-BASED COMPENSATION

         In October 1995, the Financial Accounting Standards Board issued 
Statement of Financial Accounting Standards No. 123, "Accounting for 
Stock-Based Compensation" ("SFAS 123"). The Company adopted SFAS 123 in 
fiscal 1997. The Company accounts for employee stock options in accordance 
with Accounting Principles Board Opinion No. 25, and has adopted the 
"disclosure only" alternative described in SFAS 123.

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 earning 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.

RECENT ACCOUNTING PRONOUNCEMENTS

         The Company intends to adopt Statement of Financial Accounting 
Standards No. 130, "Reporting Comprehensive Income," ("SFAS 130") and 
Statement of Financial Accounting Standards No. 131, "Disclosures about 
Segments of an Enterprise and Related Information," ("SFAS 131") in fiscal 
1999. Both will require additional disclosure but will not have a material 
effect on the Company's financial position or results of operations. SFAS 130 
will first be reflected in the Company's first quarter of fiscal 1999 interim 
financial statements. Components of comprehensive income include items such 
as net income and changes in the value of available-for-sale securities. SFAS 
131 requires segments to be determined based on how management measures 
performance and makes decisions about allocating resources. SFAS 131 will 
first be reflected in the Company's fiscal 1999 Annual Report.

                                                                             27
<PAGE>


NEOMAGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


2.  SUMMARIZED BALANCE SHEET DETAILS

<TABLE>
<CAPTION>
JANUARY 31,                                                 1998                1997
------------------------------------------------------------------------------------------
(in thousands)
<S>                                                   <C>                 <C>
Inventory:
   Raw materials                                      $             989   $            464
   Work in process                                                1,904                948
   Finished goods                                                 6,449              3,825
                                                      ------------------------------------
Total                                                 $           9,342   $          5,237
                                                      ------------------------------------
                                                      ------------------------------------


Property, plant and equipment:
   Computer equipment and software                    $           8,017    $         4,288
   Furniture and fixtures                                           917                495
   Machinery and equipment                                          645                280
                                                      ------------------------------------
Total                                                             9,579              5,063
   Less accumulated depreciation and amortization                (3,347)            (1,668)
                                                      ------------------------------------
Property, plant and equipment, net                    $           6,232    $         3,395
                                                      ------------------------------------
                                                      ------------------------------------
Accrued Expenses:
   Compensation and related benefits                  $           3,005    $         1,141
    Income taxes                                                  4,524
   Other accruals                                                 3,123                476
                                                      ------------------------------------
Total                                                 $          10,652    $         1,617
                                                      ------------------------------------
                                                      ------------------------------------
</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,                          1998           1997          1996
-------------------------------------------------------------------------------------
(in thousands, except per share amounts)
<S>                                         <C>              <C>           <C>
Numerator:
   Net income (loss)                         $  20,780       $  (1,163)    $  (6,869)
                                             ----------------------------------------
                                             ----------------------------------------
Denominator:
   Denominator for basic earnings per
      share - weighted-average shares           20,361           4,978         2,665
   Effect of dilutive securities:
       Employee stock options                    3,227               -             -
        Warrants                                   185               -             -
        Convertible preferred stock              1,563               -             -
                                             ----------------------------------------
   Dilutive potential common shares              4,975               -             -
                                             ----------------------------------------

      Denominator for diluted earnings per
          share - adjusted weighted-average
          shares and assumed conversions        25,336           4,978         2,665
                                             ----------------------------------------
                                             ----------------------------------------

Basic earnings per share                     $    1.02      $     (.23)    $   (2.58)
Diluted earnings per share                   $     .82      $     (.23)    $   (2.58)
</TABLE>

28

<PAGE>


NEOMAGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


         The pro forma basic and pro forma diluted net income (loss) per 
share 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.

4. DERIVATIVE FINANICAL INSTRUMENTS

         Outstanding notional amounts of derivative financial instruments at 
January 31, 1998 were $42.8 million and $15 million for currency forward 
contracts and currency options, respectively. While the contract or notional 
amounts provide one measure of the volume of these transactions, they do not 
represent the amount of the Company's exposure to credit risk. The amounts 
potentially subject to credit risk (arising from the possible inability of 
counterparties to meet the terms of their contract) are generally limited to 
the amounts, if any, by which the counterparties' obligations exceed the 
obligations of the Company.

         The estimated fair value of currency forward contracts and currency 
options were $(1.3) million and $388,000, respectively, at January 31, 1998.

5. WORKING CAPITAL LINE OF CREDIT

         The Company maintained a revolving credit agreement ("Credit 
Agreement") with Mitsubishi International that provided extended credit terms 
to finance wafer inventory purchases. For periods prior to January 31, 1997, 
the agreement permitted 90 day extended credit terms and the interest rate 
was based on the lender's internal interest rate which was required to be at 
least 1.5% below the prime rate on the date of invoice, approximately 30 days 
after receipt of wafers. The Company also paid a commission of 1.25% to 2.00% 
based on the lending level during the prior calendar quarter. Effective 
January 31, 1997, Mitsubishi International's sole compensation for financing 
of the wafer purchases was a commission of 1.75% of wafer purchases and the 
extended credit terms was amended to 60 days. The Credit Agreement contains 
standard events of default which if triggered can permit Mitsubishi 
International to declare all amounts outstanding under the Credit Agreement 
due and payable. Effective January 5, 1998, in exchange for a reduction in 
the commission rate the Company and Mitsubishi International amended the 
agreement such that for shipments subsequent to January 31, 1998, 
payment for wafers must be made 30 days subsequent to shipment.

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:

<TABLE>
<CAPTION>
JANUARY 31,                                                        1998               1997
--------------------------------------------------------------------------------------------
(in thousands)
<S>                                                           <C>               <C>
Property, plant and equipment under capital lease             $       1,609      $      2,686
Accumulated amortization                                               (977)           (1,474)
                                                              -------------------------------
Net property, plant and equipment under capital lease         $         632      $      1,212
                                                              -------------------------------
                                                              -------------------------------
</TABLE>

                                                                             29

<PAGE>


NEOMAGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


Future minimum payments under capital leases consist of the following at 
January 31, 1998:

<TABLE>
<CAPTION>
FISCAL YEAR ENDING JANUARY 31,
-----------------------------------------------------------------
(in thousands)
<S>                                                       <C>
1999                                                      $   730
2000                                                          660
2001                                                           53
                                                          -------
Total minimum lease payments                                1,443
Amount representing interest                                  170
                                                          -------
Present value of net minimum lease payments                 1,273
Less current portion                                          627
                                                          -------
Long-term portion                                         $   646
                                                          -------
                                                          -------
</TABLE>


7. INCOME TAXES

         The provision in fiscal 1998, 1997 and 1996 consist of the following:


<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31,                                  1998           1997         1996
--------------------------------------------------------------------------------------------
(in thousands)
<S>                                                 <C>              <C>           <C>
Current:
   Federal                                           $  11,300       $      -      $       -
   State                                                   938              -              -
                                                     ---------------------------------------
                                                        12,238              -              -
Deferred:
   Federal                                              (7,870)             -              -
   State                                                  (701)             -              -
                                                     ---------------------------------------
                                                        (8,571)             -              -
                                                     ---------------------------------------
Total provision for income taxes                     $   3,667       $      -      $       -
                                                     ---------------------------------------
                                                     ---------------------------------------
</TABLE>

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

<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31,                                  1998                  1997                  1996
------------------------------------------------------------------------------------------------------------
(in thousands except percentages)
<S>                                                <C>                 <C>                     <C>
Pretax income (loss)                               $   24,447          $      (1,163)          $      6,869
Federal statutory rate                                     35%                    35%                    35%
Expected tax (benefit)                                  8,556                   (407)                (2,404)
State taxes (net of federal benefit)                      154                      -                      -
                                                                                   -                      -
Utilization of research and
    development tax credits                              (844)                     -                      -
Net operating loss not benefited                                -                407                  2,404
Utilization of net operating losses
     not previously benefited                          (4,199)                     -                      -
                                                   ----------------------------------------------------------
Provision for income taxes                         $    3,667          $           -           $          -
                                                   ----------------------------------------------------------
                                                   ----------------------------------------------------------
</TABLE>

30

<PAGE>


NEOMAGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

         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,                                 1998                   1997
--------------------------------------------------------------------------------------
(in thousands)
<S>                                                <C>                     <C>
Deferred tax assets:
    U.S. net operating loss carryforwards          $          -            $     4,800
    Research credit carryforwards                             -                    500
    Capitalized research and development                    490                    400
    Losses from foreign operations                        4,505                      -
    Reserves and accruals                                 2,835                      -
    Other                                                   741                      -
                                                   -----------------------------------
Total deferred tax assets                                 8,571                  5,700
Valuation allowance                                           -                 (5,700)
                                                   -----------------------------------
Net deferred tax asset                             $      8,571            $         -
                                                   -----------------------------------
                                                   -----------------------------------
</TABLE>

         The valuation allowance decreased by $5.7 million and increased by 
$700,000 in fiscal 1998 and 1997, respectively. Losses from foreign 
operations for fiscal 1998 were $12.9 million.

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, 1998 to purchase shares of common stock:

<TABLE>
<CAPTION>
NUMBER OF       EXERCISE PRICE     DATE
SHARES             PER SHARE       ISSUED           EXPIRATION OF WARRANTS
-----------------------------------------------------------------------------
<S>                  <C>           <C>                <C>
       43,200        $0.625        5/94                     March 2002
       36,666        $1.50         7/94                     March 2002
       15,789        $2.85         8/95                     March 2002
       ------
       95,655
</TABLE>

                                                                             31
<PAGE>


NEOMAGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


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 has reserved 7,775,000 shares of 
common stock for issuance under the Plan. Unless terminated sooner, the Plan 
will terminate automatically in December 2003. Vesting provisions for stock 
purchase rights and options granted under the Plan are determined by the 
Board of Directors. 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 if the holder is no longer employed by the Company. 
As of January 31, 1998, 1,131,540 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 schedule set out in the 
notice of grant.

         A summary of the Company's stock option activity, and related 
information for the three years ended January 31, 1998 follows:

<TABLE>
<CAPTION>
                                                           NUMBER OF       WEIGHTED AVERAGE
                                                           SHARES          EXERCISE PRICE
                                                           (OPTIONS)
------------------------------------------------------------------------------------------
<S>                                                        <C>              <C>
Balance at January 31, 1995                                     317,520         $   .15
    Granted                                                   1,448,100             .27
    Exercised                                                (1,008,257)            .26
    Canceled                                                   (182,863)            .22
                                                           -----------------------------
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
</TABLE>

         At January 31, 1998, options to purchase 403,975 shares of common 
stock were vested at prices ranging from $.15 to $21.81 and 1,050,200 shares 
of common stock were available for future grants under the Plan.

         The following table summarizes information about stock options 
outstanding at January 31, 1998:

<TABLE>
<CAPTION>
                                                  OPTIONS OUTSTANDING AND EXERCISABLE
                                      -------------------------------------------------------------
                                                               WEIGHTED AVERAGE
                                                               REMAINING            WEIGHTED
                                                               CONTRACTUAL          AVERAGE
RANGE OF EXERCISE PRICES                NUMBER OUTSTANDING     LIFE                 EXERCISE PRICE
-------------------------------------------------------------------------------------------------
<S>                                     <C>                    <C>                  <C>
$0.15 - $0.80                                        874,299         8.04           $      0.73
$1.00 - $ 3.50                                       349,826         8.62                  2.35
$7.50                                              1,198,900         8.94                  7.50
$9.60 - $13.31                                       439,000         9.39                 12.33
$13.50 - $15.20                                      372,000         9.79                 14.41
$15.40 - $21.81                                      429,000         9.62                 17.14
                                                   --------------------------------------------
                                                   3,663,025         8.92           $      7.80
                                                   --------------------------------------------
                                                   --------------------------------------------
</TABLE>

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 affect 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 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,                   1998                1997       1996                  1998
-------------------------------------------------------------------------------------------------------------
<S>                                      <C>                 <C>        <C>                   <C>
Risk-free interest rates                   5.9%              6.3%        5.6%                   5.5%
Volatility                                 .69                 -           -                    .74
Expected life of option in years           5.0               4.7         5.0                    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 1998 net income and earnings 
per share would have decreased by approximately $2.4 million, or $0.12 per 
share and $.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. The Company's fiscal 1996 net loss and 
net loss per share would have been increased by approximately $4,000, with no 
effect on basic and diluted earnings per share. For purposes of pro forma 
disclosures, the estimated fair value of the options is amortized to expense 
over the option's vesting period and stock purchased under the ESPP 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. Because SFAS 123 is 
applicable only to options granted subsequent to January 31, 1995, the pro 
forma effect will not be fully reflected until fiscal 1999.

         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.

         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 1998, 1997 and 1996 with exercise 
prices equal to the market price at the date of grant is, $8.39, $2.00 and 
$.06 per share, respectively.

                                                                             33
<PAGE>


NEOMAGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


DEFERRED STOCK COMPENSATION

         In connection with the grant of certain stock options to employees 
in fiscal 1998 and 1997, the Company recorded deferred compensation of 
$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. Such amount is presented as a reduction of 
stockholders' equity and is amortized ratably over the vesting period of the 
related options.

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. 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 1998, 35,987 shares of common stock at a price of $10.20 
per share were issued under the 1997 Purchase Plan. Shares available for 
purchase under the Purchase Plan were 464,013 at January 31, 1998.

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.

10.  COMMITMENTS AND CONTINGENCIES

COMMITMENTS

         In May 1996, the Company moved its principal headquarters to a new 
facility in Santa Clara, California, under a noncancellable operating lease 
that expires in April 2003. In January 1998 the Company entered into a second 
noncallellable operating lease for the building adjacent to its principal 
headquarters. This lease has a co-terminous provision with the original lease 
expiring on April 2003. The Company also leases sales offices in Texas and 
Taiwan under operating leases that expires in February 1999 and April 1999, 
respectively. Future minimum lease payments under operating leases at January 
31, 1998, are as follows:

<TABLE>
<CAPTION>
FISCAL YEAR ENDING JANUARY 31
-------------------------------------------
(in thousands)
<S>                                  <C>
1999                                 1,911
2000                                 1,905
2001                                 1,940
2002                                 1,994
2003                                 2,048
Thereafter                             520
                                  --------
Total minimum lease payments       $10,318
                                  --------
                                  --------
</TABLE>

34

<PAGE>


NEOMAGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


         Rental expense under  operating  leases was $988,000, $647,000 and 
$97,000 in fiscal 1998, 1997 and 1996, 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. As of January 31, 1998, future minimum rentals to be received 
under this noncancellable sublease totaled $340,000 and $15,000, in fiscal 
1999 and 2000, respectively.

 CONTINGENCIES

         In February 1997, Cirrus Logic sent the Company written notice 
asserting that the Company's MagicGraph128, MagicGraph128V and 
MagicGraph128ZV products infringe three 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.

       Furthermore, the Company was notified by certain of its customers that 
a lawsuit had been filed and served by a holder of a United States patent 
asserting that the video/graphics subsystem in such customers' notebook PCs, 
which use the Company's MagicGraph128 and MagicGraph128V products, infringe 
certain claims of the patent. 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. The Company believes that the Company's MagicGraph128 
and MagicGraph128V products do not infringe any of the claims of such patent. 
The Company's belief is based upon a legal opinion from its patent counsel, 
Townsend and Townsend and Crew LLP. 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 under the 
threat of litigation.

         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 June 1996, the litigation 
was dismissed and no amounts were required to be paid by the Company. The 
settlement agreement which gave rise to the dismissal did however include a 
non-solicitation provision and certain contingent cross-licensing provisions. 
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 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. In fiscal 
1996, three customers accounted for 34.6%, 28.6% and 14.4%, respectively, of 
net sales. Net sales to customers in Asia-Pacific, Japan, United States 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 and 82%, 8%, 10% and 0%, respectively, of net sales in fiscal 
1996.

                                                                             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, 1998 and 1997, and the related 
consolidated statements of operations, stockholders' equity, and cash flows 
for each of the three years in the period ended January 31, 1998. 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, 1998 and 1997, and the 
consolidated results of its operations and its cash flows for each of the 
three years in the period ended January 31, 1998, in conformity with 
generally accepted accounting principles.


                                                 ERNST & YOUNG LLP

San Jose, California
February 6, 1998


36

<PAGE>

                                                          NeoMagic Corporation

<TABLE>
<S>                               <C>                                         <C>
BOARD OF DIRECTORS                EXECUTIVE OFFICERS AS OF APRIL 1, 1998      CORPORATE HEADQUARTERS
Kamran Elahian                    A VIRTUAL MEETING WITH MANAGEMENT           NeoMagic Corporation
CHAIRMAIN                         IS AVAILABLE AT THE NEOMAGIC WEB SITE:      3260 Jay Stree
                                  WWW.NEOMAGIC.COM                            Santa Clara, CA 95054
Prakash Agarwal                                                               Telephone 408-988-7020
PRESIDENT AND CHIEF EXECUTIVE
OFFICER
                                  Prakash Agarwal                             REGISTRAR AND TRANSFER AGENT
Brian Dougherty                   PRESIDENT AND CHIEF EXECUTIVE OFFICER       BankBoston, NA
PRESIDENT, WINK COMMUNICATIONS                                                c/o Boston EquiServe
                                  Kamran Elahian                              PO Box 8040
Irwin Federman                    CHAIRMAIN                                   Boston, MA 02266-8040
GENERAL PARTNER, U.S. VENTURE
PARTNERS
                                  Niall Bartlett                              LEGAL COUNSEL
James Lally                       VICE PRESIDENT CORPORATE MARKETING          Wilson, Sonsini, Goodrich &
PARTNER, KLEINER, PERKINGS,                                                   Rosati
CAUFIELD & BYERS                                                              650 Page Mill Road
                                  Daniel Hauck                                Palo Alto, CA 94304-1050
Michael Moritz                    VICE PRESIDENT, WORLDWIDE SALES
GENERAL PARTNER, SEQUOIA CAPITAL                                              INDEPENDENT AUDITORS
                                  Dr. Clement Leung                           Ernst & Young LLP
Klaus Wiemer                      VICE PRESIDENT, CORPORATE R&D               55 Almaden Boulevard
MEISSNER+WURST GMBH, STUTTGART,                                               San Jose, CA 95113
GERMANY
                                  Ron Jankov
                                  SENIOR VICE PRESIDENT AND GENERAL MANAGER,  COMMON STOCK
                                  MULTIMEDIA PRODUCTS DIVISION                Nasdaq Symbol:  NMGC
                                   
                                  Ibrahim Korgav                              INVESTOR RELATIONS
                                  VICE PRESIDENT MANUFACTURING OPERATIONS     www.neomagic.com

                                  Merle McClendon                             FORM 10-K
                                  VICE PRESIDENT FINANCE AND                  A copy of the Company's current
                                  CHIEF FINANCIAL OFFICER                     Form 10-K as filed with the
                                                                              Securitied and Exchange     
                                                                              Commission may be obtained 
                                  Kenneth Murray                              without charge by writing: 
                                  VICE PRESIDENT HUMAN RESOURCES
                                                                              NeoMagic Corporation
                                  Deepraj Puar                                Investor Relations
                                  VICE PRESIDENT, TECHNOLOGY                  3260 Jay Street
                                                                              Santa Clara, CA 95054

                                                                              or by calling (408) 988-7020 X461

                                                                              or may be obtained through
                                                                              our website at www.neomagic.com
</TABLE>

<PAGE>

3260 Jay Street                                               [NeoMagic logo]
Santa Clara, CA 95054
Telephone 408 988 7020
Fax 408 988 7032
www.neomagic.com