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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended March 31, 2003

or

For the transition period from              to             

COMMISSION FILE NO.: 0-33213

MAGMA DESIGN AUTOMATION, INC.

(Exact name of Registrant as specified in its charter)

2 Results Way

Cupertino, California 95014

(408) 864-2000

(Address, including zip code, and telephone number, including area code, of the registrant’s principal executive offices)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

COMMON STOCK, par value $.0001 per share

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

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

The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing sale price of the Common Stock on September 30, 2002 as reported on the Nasdaq National Market, was $215,832,218. This calculation does not reflect a determination that certain persons are affiliates of the Registrant for any other purpose.

As of June 18, 2003 Registrant had outstanding 30,717,754 shares of Common Stock, $.0001 par value.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s proxy statement to be delivered to the stockholders in connection with Registrant’s 2003 Annual Meeting of Stockholders to be held on August 29, 2003, are incorporated by reference into Part II and Part III of this Form 10-K. The Registrant’s proxy statement is required to be filed within 120 days of the Registrant’s fiscal year end.

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MAGMA DESIGN AUTOMATION, INC.

FISCAL 2003 FORM 10-K

TABLE OF CONTENTS

When used in this offering circular, the terms “Magma,” “we,” “our” and “us” refer to Magma Design Automation, Inc. and its consolidated subsidiaries, unless otherwise specified.

Magma, Blast Noise and FixedTiming are registered trademarks, and Blast Create, Blast Fusion, Blast Fusion APX, Blast Plan, Blast Rail, GlassBox and “The Fastest Path from RTL to Silicon” are trademarks, of Magma Design Automation. All other product and company names are trademarks and registered trademarks of their respective companies.

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PART I

ITEM 1.     BUSINESS.

Overview

We provide design and implementation software that enables chip designers to reduce the time it takes to design and produce complex integrated circuits used in the communications, computing, consumer electronics, networking and semiconductor industries. Our products are used in all major phases of the chip development cycle, from initial design through physical implementation.

An important technical foundation of our software products is our patented FixedTiming methodology, which allows our customers to reduce the number of iterations that are often required in conventional integrated circuit design processes. Our single data model architecture is a key enabler for this methodology and for our ability to deliver automated signal integrity detection and correction. It contains logical and physical information about the design and is resident in core memory during execution, which makes it possible to analyze the design and make rapid tradeoff decisions during the physical design process.

Our software products enable chip designers to meet critical time-to-market objectives, improve chip performance and handle chip designs involving millions of components. Blast Create enables logic designers to visualize, evaluate and improve code quality, design constraints, testability and analysis. Blast Create, Blast Fusion and Blast Fusion APX combine into one integrated chip design flow what traditionally had been separate logic design and physical design processes. This integrated flow significantly reduces timing closure iterations, allowing our customers to accelerate the time it takes to design and produce deep submicron integrated circuits. Blast Plan enables hierarchical planning and partitioning of a design into blocks that can be designed separately and later combined into a complex chip or system-on-a-chip. Blast Noise detects and corrects signal interference, or crosstalk, in physical designs. Blast Rail is a correct-by-construction rail design solution that is integrated with our design implementation flow.

We provide consulting, training and services to help our customers more rapidly adopt our technology. We also provide post-contract support, or maintenance, for our products.

Technology

Our patented FixedTiming methodology and single data model architecture are the technical foundation of our Blast Fusion and Blast Chip Products.

FixedTiming Methodology

Our patented FixedTiming methodology allows us to reduce the timing closure iterations that are often required between the front-end and back-end processes in conventional integrated circuit design flows. These timing closure iterations are caused by the fact that the final circuit timing cannot be accurately calculated until the physical layout is completed. In deep submicron integrated circuits, timing performance is primarily determined by the physical layout of the wiring that connects the logic gates to achieve the desired circuit functionality. Timing that is estimated during the front-end process is often not realized in the final layout, and the design team must iterate between the front-end and back-end processes modifying the design in an attempt to reach the desired timing performance. Since each timing closure iteration can add one or more weeks to the design cycle, the time it takes to design and produce an integrated circuit can be severely impacted.

Our FixedTiming methodology is designed to predict circuit speeds prior to detailed physical design. We then use a series of design refinements during physical design to achieve a final timing that is very close to the predicted circuit speed. This approach reduces the need for timing closure iterations that exist in conventional flows and can significantly reduce the time it takes to design and produce deep submicron integrated circuits.

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There are several differences between the conventional approach to integrated circuit design and our FixedTiming methodology. In the conventional flow, synthesis is used to transform a computer program description of the desired circuit functionality into a circuit-level description, or netlist, that is comprised of gates from a semiconductor manufacturer’s library. A gate is a basic building block that performs a specific logic function. Gates are typically available in different sizes, or drive strengths, in the library. Larger gates are required to drive large loads, which are caused by long wires or wires that are connected to the inputs of many other gates. Smaller gates are used to drive smaller loads. For a given wire, the larger the size of the gate, the shorter the signal delay through the gate and the wire that it is driving. The job of the synthesis tool is to produce a netlist that delivers the desired circuit functionality and meets the required circuit timing. The synthesis tool produces this netlist without knowing what the final layout will look like. Since the synthesis tool must determine which size gates to choose from the library, it must either rely on statistical estimates of the wire loads or perform a coarse placement of the gates to build estimates of what the wiring might look like. In both of these cases, the estimates often do not correlate well with the actual loads presented by the wires in the final layout.

Following synthesis, the gates specified in the netlist are placed in the layout. If the actual load on a given gate is larger than the load that was estimated during synthesis, the delay will be longer than was predicted by synthesis. If the particular gate and load are critical to the performance of the integrated circuit, this will limit the operating speed of the integrated circuit and force the design team into timing closure iterations. Typically, there are many of these critical paths on a complex integrated circuit that must be addressed.

Our FixedTiming methodology recognizes that wire loads cannot be accurately estimated prior to layout. Because of this, we do not choose gate sizes during the synthesis process. Instead we rely on the use of placeholder gates, called SuperCells, that we create automatically by analyzing the vendor’s library. Each SuperCell is just like a gate from the library, but we assume that its size is completely flexible. Therefore only one SuperCell is required for each logic function in the library, rather than the collection of gates of different sizes that are required in the conventional approach.

Before beginning physical layout, we apply our optimization technology to determine and set the delays that each gate and its load must have in order to meet the desired circuit speed. During placement, we use the SuperCells instead of the actual gates in the library. As the design progresses and we gain more information about the location and length of the wires, we continuously adjust the size of each SuperCell to keep the circuit delay as constant as possible. We increase the size of a SuperCell as the load on it increases and decrease it in size as the load decreases. As a result, we develop an overall circuit that is well balanced electrically, since each gate is sized optimally for the wire load that it is driving. This often results in layouts that are more compact and use less power than layouts derived using the conventional approach. Once we have determined the final placement for each gate, we replace each SuperCell in the layout with the closest matching size gate in the semiconductor vendor’s library. Using this approach, we are able to reduce the timing closure iterations that often occur in conventional integrated circuit design approaches.

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In addition to helping us reduce timing closure iterations, we believe SuperCells enable faster and higher capacity synthesis. In conventional synthesis, the tool optimizes the circuit using library cells. Because a given logical function may be represented in the library by a collection of different gate sizes, the synthesis tool must try every permutation of gate size during optimization. If the circuit is large, the number of permutations becomes very large, which negatively impacts run times and memory usage and puts a practical limit on capacity. Since the SuperCell concept has only one gate per logical function, the optimization search space can be much smaller. As a result, run times are significantly improved and the capacity of the system is much larger. Running on a standard engineering workstation, our system has a capacity of up to five million gates, an order of magnitude improvement over existing systems.

Single Data Model Architecture

Our single data model architecture is a key enabler for our FixedTiming methodology as well as our ability to deliver automated signal integrity detection and correction. This architecture also forms the basis for our Diamond SI verification product. We believe we are the only electronic design automation vendor that offers a complete integrated circuit design implementation flow based on a single data model. The single data model contains all of the logical and physical information about the design and is resident in core memory during execution. The various functional elements of our software such as the implementation engines for synthesis, placement and routing, and our analysis software for timing, delay extraction and signal integrity all operate directly on this data model. Because the data model is concurrently available to all of the engines and analysis software, it makes it possible to analyze the design and make rapid tradeoff decisions during the physical design process. During optimization and placement, for example, our system continuously adjusts the sizes of SuperCells in the design as more accurate information about the layout is obtained from the data model. Additionally, our implementation software can instantly access our analysis software and continuously check for signal integrity problems during layout and take steps to avoid them. Existing approaches force the designer to

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perform signal integrity analysis after the layout is completed. Problems that are found then must be manually corrected, which may also affect timing closure and cause further iterations.

Conventional electronic design automation flows are typically based on a collection of software programs that have their own associated data models. Data sharing and communications between software tools are accomplished either through file interfaces or through the establishment of a common database. If a common database is used, then each tool communicates with the database through a programming interface. For example, a software tool that is requested to send information to the common database must extract the data from its own data model, translate it into a form usable by the common database and then call on the programming interface to write the information to the database. Similarly, the software tool that requested the data must obtain the information from the common database through the programming interface, translate it into the format of its local data model and re-build the data model before the data can be used. The multiple data model approach has several limitations. It results in inefficient use of memory because the design data is replicated in various forms in memory. There are also capacity limitations due to the inefficient use of memory. In addition, there are performance limitations because the process of sharing data among software tools requires the use of a programming interface and the rebuilding of the data models each time that data is exchanged.

Our single data model is designed to overcome these limitations. Memory is used more efficiently, capacity is higher, and performance is faster than in conventional systems because there is only one copy of the design data in memory. This eliminates the need for cumbersome data translations or reading and writing of data through a programming interface.

Products

Blast Fusion is our flagship product that provides significant advantages over traditional back-end design software. Our Blast Chip product broadens the capabilities of Blast Fusion by adding front-end synthesis capability. In the front-end process, the chip design is conceptualized and written as a register transfer level computer program, or Register Transfer Level (“RTL”) file, that describes the required functionality of the chip. We also offer Blast Noise, our product that detects and corrects noise and other electrical problems in deep submicron chips, as a separate product to be used with Blast Chip and Blast Fusion. Blast Chip was discontinued in 2003 and its capabilities are now largely available in our Blast Create product, announced in April 2003.

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Similar to the conventional design flow, our design flow starts by reading in technology libraries and constraint files. The following diagram illustrates our integrated design flow and where our products fit within this design flow.

Blast Fusion, first shipped in April 1999, is our physical design software that shortens the time it takes to design and produce deep submicron integrated circuits. The Blast Fusion flow starts by reading in the netlist, target library and design constraints. The netlist is optimized for circuit performance taking into account placement information that specifies the location of the gates in the chip layout. At the conclusion of this step, Blast Fusion generates a report that predicts the final timing performance that is achievable in the completed chip layout. In the final step, detailed physical design, Blast Fusion generates the final chip layout by performing the routing of wires that are needed to connect the gates into the desired circuit configuration and meet the timing performance requirements.

Blast Fusion is intended for use by chip design teams and other groups whose responsibility it is to take a design from netlist to completed chip layout. In the conventional Application Specific Integrated Circuit “ASIC” design flow, front-end designers use synthesis software to translate and optimize their RTL files into a netlist that is then handed off to the ASIC or semiconductor vendor or separate layout design group for physical design using Blast Fusion. Sales of Blast Fusion accounts for the majority of our revenue.

Blast Chip, first shipped in May 2000, extends the capabilities of Blast Fusion by adding RTL synthesis to the flow. At the beginning of the design flow, Blast Chip reads and synthesizes the RTL files that describe the desired functionality of the design. After this step, the design flow is identical to the Blast Fusion flow. Blast Chip is intended for use by system design teams, chip design teams and other groups whose responsibility it is to take a design from concept to completed chip layout. This bundle was later defined in fiscal 2003, to be the two major component pieces of this flow, Blast Create for logic design and Blast Fusion for physical design.

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Blast Noise, first shipped in September 2000, is our noise detection and correction product. Interference, or noise from wires in close proximity to each other, can decrease chip performance or cause chip failure, particularly at .18 micron and below. Blast Noise works with Blast Fusion and Blast Chip to actively detect potential noise problems and correct them during the physical design process.

Blast Plan, first shipped in September 2001, delivers hierarchical design planning capabilities for use in implementing complex integrated circuit and system-on-chip designs. In a hierarchical design methodology, a chip design is partitioned into blocks that are designed and implemented individually and then later assembled to create the entire chip. Blast Plan works with Blast Fusion and Blast Chip to streamline the hierarchical planning and design of large chips and system-on-chips within a single environment.

Diamond SI, first shipped in January 2002, is our stand-alone system for post-layout signal integrity verification and is based in part on technology obtained through our merger with Moscape, Inc. The initial release of Diamond SI focuses on accurate crosstalk noise analysis. Future releases of Diamond SI are planned to also address signal electromigration and voltage drop. Diamond SI is suitable for use with either Magma or non-Magma chip design flows.

New Products

Blast Create is a key component of Magma’s RTL-to-GDSII IC design solution. It enables logic designers to synthesize, visualize, evaluate and improve the quality of their RTL code, design constraints, testability requirements and floorplan by building and analyzing a flat silicon virtual prototype that portrays the design in silicon. The physical netlist generated by Blast Create provides a clean handoff between RTL designer and layout engineer, eliminating back-to-front iterations necessary for timing closure in conventional flows.

Blast Rail provides IC designers with integrated power analysis and planning, voltage-drop analysis, voltage-drop-induced delay analysis, and electromigration analysis on rail wires and vias. This enables designers to maintain power integrity in their designs. Blast Rail is fully integrated with Magma’s RTL-to-GDSII implementation flow to enable a correct-by-construction rail design solution.

Services

We provide consulting, training and chip design services to help our customers more rapidly adopt our technology. Design services include assisting our customers on complex chip design challenges and providing services ranging from the design and implementation of specific blocks to complete chip designs, including the delivery of the final chip layout, ready for release to manufacturing. We also provide post-contract support, or maintenance, for our products.

Customers

We license our software products to semiconductor manufacturers and electronic products companies around the world. Our costumers include Broadcom, Infineon, NEC, Texas Instruments, Toshiba and Vitesse.

In fiscal 2003, NEC and Toshiba each accounted for at least 10% of our total revenue and together accounted for 30% of our total revenue.

Product Backlog

For fiscal 2003 and fiscal 2002 we had approximately $180 million and $121 million in backlog, respectively. We define backlog as non-cancelable contractual commitments by our customers, through purchase orders or contracts that have no contingencies other than our performance. We expect that we will ultimately be able to recognize this backlog as revenue. However, if a customer defaults and fails to pay amounts owed, we

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may not be able to recognize expected revenue from backlog. In the current economic environment it is possible that customers from whom we expect to derive revenue from backlog will default or that the level of defaults will increase. Any material payment default by our customers could reduce the amount of backlog we recognize as revenue and could have a material adverse effect on our financial condition and results of operations.

Revenue by Geographic Areas

We generated 39% of our total revenue from sales outside the United States for fiscal 2003, compared to 22% in fiscal 2002. Additional disclosure regarding financial information on geographic areas is included in Note 11 of our Consolidated Financial Statements in Item 8 of this Annual Report.

Sales and Marketing

We license our products primarily through a direct sales force focused primarily on the industry leaders in the communications, computing, consumer electronics, networking and semiconductor industries. We have North American sales offices in California, Massachusetts, North Carolina, Pennsylvania, Texas, Washington and Canada. Internationally, we have European offices in Belgium, Germany, and the United Kingdom, an office in Israel and Asian offices in Japan, Korea, India and Taiwan. Our direct sales force is supported by a larger group of field application engineers that work closely with the customers’ technical chip design professionals.

As of March 31, 2003, we had 147 employees in our marketing, sales and technical sales support organizations. We intend to continue to expand our sales and field application engineering personnel on a worldwide basis.

Competition

The electronic design automation industry is highly competitive and characterized by technological change, evolving standards, and price erosion. Major competitive factors in the market we address include technical innovation, product features and performance, level of integration, reliability, price, total system cost, reduction in design cycle time, customer support and reputation.

We currently compete with companies that hold dominant shares in the electronic design automation market. In particular, Cadence Design Systems, Inc. and Synopsys, Inc. are continuing to broaden their product lines to provide an integrated design flow. Each of these companies has a longer operating history and significantly greater financial, technical and marketing resources, as well as greater name recognition and larger installed customer bases than we do. These companies also have established relationships with our current and potential customers and can devote substantial resources aimed at preventing us from establishing or enhancing our customer relationships. Our competitors are better able to offer aggressive discounts on their products, a practice that they often employ. Our competitors offer a more comprehensive range of products than we do; for example, we do not offer logic simulation, formal verification, full-feature custom layout editing, analog or mixed signal products, which can sometimes be an impediment to our winning a particular customer order. In addition, our industry has traditionally viewed acquisitions as an effective strategy for growth in products and market share and our competitors’ greater cash resources and higher market capitalization may give them a relative advantage over us in buying companies with promising new chip design products or companies that may be too large for us to acquire without a strain on our resources. Examples of acquisitions by our competitors include Synopsys’ acquisition of Avant! and Cadence’s acquisition of Silicon Perspectives, Inc. and Get2Chip. Further consolidation in the electronic design automation market could result in an increasingly competitive environment. Competitive pressures may prevent us from obtaining market share or require us to reduce the price of products and services, which could harm our business. To execute our business strategy successfully, we must continue to increase our sales worldwide. If we fail to do so in a timely manner or at all, we may not be able to gain market share and our business and operating results could suffer.

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

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

Research and Development

We devote a substantial portion of our resources to developing new products and enhancing our existing products, conducting product testing and quality assurance testing, improving our core technology and strengthening our technological expertise in the electronic design automation market. Our research and development expenditures for fiscal 2003, 2002 and 2001 were $18.7 million, $18.2 million and $20.6 million, respectively. There have not been any customer-sponsored research activities since the inception of the Company.

As of March 31, 2003, our research and development group consisted of 90 employees. We have engineering centers in California, Texas and the Netherlands. Our engineers are focused in the areas of product development, advanced research, product engineering and design services. Our product development group develops our common core technology and is responsible for ensuring that each product fits into this common architecture. Our advanced research group works independently from our product development group to assess and develop new technologies to meet the evolving needs of integrated circuit design automation. Our product engineering group is primarily focused on product releases and customization. Our design services group is specifically focused on, and assists in completing, customer designs for commercial applications.

Intellectual Property

Currently, we have eight issued patents in the United States. We also have eight U.S. patent applications pending before the U.S. Patent and Trademark Office. Of these patent applications, one was recently allowed by the U.S. Patent and Trademark Office. In addition, we also have pursued patent protection in some foreign (non-U.S.) jurisdictions. Specifically, we have pending non-U.S. patent applications that are based on certain of the corresponding U.S. patents and patent applications. We also have two issued patents in Taiwan. Patent protection affords only limited protection for our technology. The term of patent protection is 20 years from the earliest effective filing date of the patent application. Our patents will expire on various dates between April 2018 and April 2019. We do not know if our patent applications or any future patent application will result in a patent being issued with the scope of the claims we seek, if at all, or whether any patents we may receive will be challenged or invalidated. Rights that may be granted under our patent applications that may issue in the future may not provide us competitive advantages. Further, patent protection in foreign jurisdictions where we may need this protection may be limited or unavailable.

It is difficult to monitor unauthorized use of technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. In addition, our competitors may independently develop technology similar to ours. We will continue to assess appropriate occasions for seeking patent and other intellectual property protections for those aspects of our technology that we believe constitute innovations providing significant competitive advantages.

Our success depends in part upon our rights in proprietary software technology. We have patent applications pending for some of our proprietary software technology. We rely on a combination of copyright, trade secret, trademark and contractual protection to establish and protect our proprietary rights that are not protected by

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patents, and we enter into confidentiality agreements with those of our employees and consultants involved in product development. We routinely require our employees, customers and potential business partners to enter into confidentiality and nondisclosure agreements before we will disclose any sensitive aspects of our products, technology or business plans. We require employees to agree to surrender to us any proprietary information, inventions or other intellectual property they generate or come to possess while employed by us. Despite our efforts to protect our proprietary rights through confidentiality and license agreements, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. These precautions may not prevent misappropriation or infringement of our intellectual property.

Third parties may infringe or misappropriate our copyrights, trademarks and similar proprietary rights. Many of our contracts contain provisions indemnifying our customers from third party intellectual property infringement claims. In addition, other parties may assert infringement claims against us. Although we have not received notice of any alleged infringement, our products may infringe issued patents that may relate to our products. In addition, because patent applications in the United States are not publicly disclosed until the patent is issued, applications may have been filed which relate to our software products. We may be subject to legal proceedings and claims from time to time in the ordinary course of our business, including claims of alleged infringement of the trademarks and other intellectual property rights of third parties. Intellectual property litigation is expensive and time-consuming and could divert management’s attention away from running our business. This litigation could also require us to develop non-infringing technology or enter into royalty or license agreements. These royalty or license agreements, if required, may not be available on acceptable terms, if at all, in the event of a successful claim of infringement. Our failure to develop non-infringing technology or license the proprietary rights on a timely basis would harm our business.

Employees

As of March 31, 2003, we had 270 full-time employees, including 90 in research and development, 147 in sales and marketing and 33 in general and administrative. None of our employees are covered by collective bargaining agreements. We believe our relations with our employees are good.

Corporate Information

We were incorporated in Delaware in 1997. Our principal executive offices are located at 2 Results Way, Cupertino, California 95014 and our telephone number is (408) 864-2000. Our common stock is traded on the Nasdaq National Market under the ticker symbol LAVA. Our Web site address is www.magma-da.com. The information in our Web site is not incorporated by reference into this annual report.

ITEM 2.     PROPERTIES.

Our corporate headquarters are located in Cupertino, California, where we occupy approximately 42,000 square feet under a lease expiring in December 2003. We have North American sales offices in California, Massachusetts, North Carolina, Pennsylvania, Texas, Washington and Canada. Internationally, we have European offices in Belgium, Germany, the United Kingdom and the Netherlands; offices in Israel and Asian offices in Japan, Korea, India and Taiwan. We believe our current facilities are adequate to support our current and near-term operations. However, if we need additional space, adequate space may not be available on commercially reasonable terms or at all.

ITEM 3.     LEGAL PROCEEDINGS.

On February 6, 2003, we entered into a definitive agreement to settle a lawsuit initially filed in Santa Clara County, California Superior Court in August of 2001 by Prolific, Inc. The plaintiff filed two amended complaints during the course of the litigation. The second amended complaint, which was filed in September 2002 and was pending prior to the settlement agreement, alleged breach of contract, concealment, undisclosed conflict of

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interest, promissory fraud and misrepresentation arising out of an OEM distribution agreement. The plaintiff’s second amended complaint sought damages of $14.7 million, as well as other damages from any gains, profits and advantages lost and punitive damages.

The settlement agreement provides that we make two installment payments in the aggregate amount of $1.85 million. The first payment of $0.925 million was made in February 2003 and the second payment of $0.925 million will be made in July 2003. The settlement is included in general and administrative expense in the accompanying consolidated financial statements. Approximately $0.925 is accrued as of March 31, 2003. Other than payment of the settlement amount, there are no continuing obligations by the parties to each other.

We may be subject to various other claims and legal actions arising in the ordinary course of business.

ITEM 4.     SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

Not applicable.

EXECUTIVE OFFICERS OF THE COMPANY

Pursuant to General Instruction G (3), the information regarding our executive officers required by Item 401(b) of Regulation S-K, is listed below in Part I of this filing.

The following table provides the names, offices, and ages of each of our executive officers as of June     , 2003:

Rajeev Madhavan has served as our Chief Executive Officer and Chairman of the Board of Directors since our inception in April 1997. Mr. Madhavan served as our President from our inception until May 2001. Prior to co-founding Magma, from July 1994 until February 1997, Mr. Madhavan founded and served as the President and Chief Executive Officer of Ambit Design Systems, Inc., an electronic design automation software company, later acquired by Cadence Design Systems, Inc., an electronic design automation software company.

Roy E. Jewell has served as our President since May 2001 and as one of our directors since July 2001. Mr. Jewell has served as our Chief Operating Officer since March 2001. From March 1999 to March 2001, Mr. Jewell served initially as the Chief Executive Officer and later as a consultant at a company he co-founded, Clarisay, Inc., a supplier of surface acoustic wave filters. From January 1998 to March 1999, Mr. Jewell was a member of the CEO Staff at Avant! Corporation, a provider of software products for integrated circuit designs. From July 1992 to January 1998, Mr. Jewell was the President and Chief Executive Officer of Technology Modeling Associates, Inc. or TMA, subsequently acquired by Avant! Corporation. Prior to that time, Mr. Jewell served in various marketing positions at TMA.

Gregory C. Walker has served as our Chief Financial Officer and Vice President—Finance since August 2002, and as our Senior Vice President—Finance since September 2002. From April 1999 to April 2002 he served as Chief Financial Officer, and most recently as interim Chief Executive Officer, for Accrue Software, Inc., a leading provider of customer relationship management products. From October 1997 to March 1999, Mr. Walker was Chief Financial Officer at Duet Technologies, Inc., a provider of semiconductor design services

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and software. From January 1997 through September 1997, Mr. Walker served as Chief Financial Officer of NeTpower, Inc., a manufacturer of work stations and servers. From December 1990 to January 1997, Mr. Walker served as Treasurer, Vice President of Finance and acting Chief Financial Officer at Synopsys, Inc., a supplier of electronic design automation solutions for the global electronic market. Prior to working at Synopsys, Mr. Walker held various positions in financial operations at Xerox Corporation and IBM Corporation.

Saeid Ghafouri has served as our Senior Vice President, Worldwide Field Operations since September 2002. From September 1999 to September 2002 Mr. Ghafouri was President and Chief Executive Officer of Empact Software, Inc., an enterprise software company. He served as President and Chief Executive Officer of an electronic design automation company, interHDL, which was acquired by Avant! Corporation, from April 1998 to September 1999. Prior to that Mr. Ghafouri served in various management positions between June 1996 and April 1998 at Synopsys, Inc., most recently as Vice President—Business Development for library products. He spent eight years with Cadence Design Systems Inc., between March 1986 and May 1994, where he served in various positions in Sales, Marketing and Applications Engineering.

Hamid Savoj co-founded our company and has served as our Senior Vice President, Product Development since September 2002. Before that he served as our Vice President, Product Development since July 2000. Between April 1997 and July 2000 he served as Magma’s principal engineer. From April 1994 to April 1997 Mr. Savoj was a senior member of the consulting staff at Cadence Design Systems.

Venktesh Shukla has served as our Senior Vice President, Marketing and Business Development since September 2002. Before that Mr. Shukla was Chief Executive Officer of Everypath, Inc., a leader in enterprise mobile computing, from April 1999 to January 2002. Prior to Everypath, he served from June 1996 to April 1999 as Vice President of Marketing at Ambit Design Systems where he was the key architect of Ambit’s successful entry into the logic synthesis market. Prior to Ambit, from January 1995 to January 1996, Mr. Shukla served as Vice President of Marketing at Systems & Networks, Inc., an enterprise network planning software provider. He was at Cadence Design Systems Inc. between June 1990 and December 1994 where he served most recently as Vice President of Marketing, Director of Product Marketing, and Strategic Marketing Manager.

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PART II

Our common stock is traded on the Nasdaq National Market under the symbol “LAVA”. Public trading commenced on November 20, 2001. Prior to that, there was no public market for our common stock. The following table sets forth, for the periods indicated, the high and low per share sale prices of our common stock, as reported by the Nasdaq National Market on its consolidated transaction reporting system.

As of June 18, 2003, there were approximately 483 holders of record (not including beneficial holders of stock held in street names) of our common stock.

Dividend Policy

We have not declared or paid cash dividends on our capital stock and do not anticipate paying any cash dividends in the foreseeable future. We expect to retain future earnings, if any, to fund the development and growth of our business. Our Board of Directors will determine future dividends, if any.

Recent Sales of Unregistered Securities

Under the terms of a Purchase Agreement dated May 16, 2003, we sold $150 million of our Zero Coupon Convertible Subordinated Notes due May 15, 2008 to Credit Suisse First Boston LLC and UBS Warburg LLC. The issuance and sale of the notes and the subsequent offering of the notes by the initial purchasers were exempt from the registration provisions of the Securities Act of 1933, as amended by Section 4(2) of the Securities Act. We sold the notes for cash. The aggregate offering price was $150 million and our net proceeds were $145.3 million.

The notes will mature on May 15, 2008 and are convertible on or before the maturity date into shares of our common stock at an initial conversion price of $22.86 per share, subject to adjustment for certain events. This is equivalent to a conversion rate of approximately 43.7445 shares per $1,000 principal amount of notes. The notes will not accrete interest. Fees paid to the initial purchasers of $4.5 million have been classified as debt discount. We will accrete these fees using an effective interest rate of 0.6% over the term of the notes.

ITEM 6.     SELECTED FINANCIAL DATA

The following selected consolidated financial data for the fiscal years ended March 31, 2003, 2002, 2001, 2000 and 1999 has been derived from our audited financial statements. This data includes the accounts of Magma and its wholly-owned and majority-owned subsidiaries. In August 2000, Magma merged with Moscape in a transaction that has been accounted for as a pooling-of-interests business combination. Before the combination,

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Moscape’s fiscal year ended December 31. In recording the pooling-of-interests combination, Moscape’s financial statements for the years ended December 31, 1999 and 1998 were combined with Magma’s financial statements for the years ended March 31, 2000, and 1999, respectively. The operating results of Moscape for the three months ended March 31, 2000 are excluded from the consolidated statements of operations for the years ended March 31, 2001 and 2000. An adjustment has been made to stockholders’ deficit as of August 9, 2000 to reflect the results of operations of Moscape for the three months ended March 31, 2000.

The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and the notes thereto in Item 8, “Financial Statements and Supplementary Data” and the information contained in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. Historical results are not necessarily indicative of future results.

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This Management’s Discussion and Analysis of Financial Condition and Results of Operation section should be read in conjunction with “Selected Consolidated Financial Data” and our consolidated financial statements and results appearing elsewhere in this report. Throughout the Management’s Discussion section, we make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. You can often identify these and other forward looking statements by terms such as “becoming,” “may,” “will,” “should,” “predicts”, “potential,” “continue,” “anticipates,” “believes,” “estimates,” “seeks,” “expects,” “plans,” “intends,” or using negative of such words, or comparable terminology. Although we believe that the expectations reflected in these forward-looking statements are reasonable, and we have based these expectations on our beliefs and assumptions, such expectations may prove to be incorrect. Our actual results of operations and financial performance could differ significantly from those expressed in or implied by our forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to: increasing competition in the electronic design automation market; the impact of the economic recession; the impact of SARS on business activities in Asia; effects that terrorist activities or events in the Middle East may have on Magma, its customers and industry; any delay of customer orders or failure of customers to renew licenses; weaker-than-anticipated sales of Magma’s products and services; weakness in the semiconductor or electronic systems industries; the ability to successfully manage Magma’s expanding operations; the ability to attract and retain the key management and technical personnel needed to operate Magma successfully; the ability to continue to deliver competitive products to customers to help them get their products to market; and changes in accounting rules.

Overview

We provide design and implementation software that enables chip designers to reduce the time it takes to design and produce complex integrated circuits used in the communications, computing, consumer electronics, networking and semiconductor industries. Our products are used in all major phases of the chip development cycle, from initial design through physical implementation.

An important technical foundation of our software products is our patented FixedTiming methodology, which allows our customers to reduce iterations that are often required in conventional integrated circuit design processes. Our single data model architecture is a key enabler for this methodology and for our ability to deliver automated signal integrity detection and correction. It contains logical and physical information about the design and is resident in core memory during execution, which makes it possible to analyze the design and make rapid tradeoff decisions during the physical design process.

Our software products enable chip designers to meet critical time-to-market objectives, improve chip performance and handle chip designs involving millions of components. Blast Create enables logic designers to visualize, evaluate and improve code quality, design constraints, testability and analysis. Blast Create, Blast Fusion and Blast Fusion APX combine into one integrated chip design flow what traditionally had been separate logic design and physical design processes. Our integrated flow significantly reduces timing closure iterations, allowing our customers to accelerate the time it takes to design and produce deep submicron integrated circuits.

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Blast Plan enables hierarchical planning and partitioning of a design into blocks that can be designed separately and later combined into a complex chip or system-on-a-chip. Blast Noise detects and corrects signal interference, or crosstalk, in physical designs. Blast Rail is a correct-by-construction rail design solution that is integrated with our design implementation flow.

We provide consulting, training and services to help our customers more rapidly adopt our technology. Design services include assisting our customers in the utilization of our products for complex chip design challenges. We also provide post-contract support, or maintenance, for our products.

We license our software products to semiconductor manufacturers and electronic products companies around the world. Our customers include Broadcom, Infineon, NEC, Texas Instruments, Toshiba and Vitesse. NEC and Toshiba each accounted for at least 10% of revenue, and together accounted for approximately 30% of revenue, in fiscal 2003.

We were incorporated in Delaware in 1997. Our principal executive offices are located at 2 Results Way, Cupertino, California 95014 and our telephone number is (408) 864-2000.

In the second quarter of fiscal 2003, we transferred a number of research and development personnel who previously performed a combination of research and development and customer service activities to our service organization if their activities are limited to providing customer service. Accordingly, we have recorded their expenses into cost of sales.

On May 14, 2003, we repurchased 209,753 shares of common stock from Roy Jewell, Magma’s President and Chief Operating Officer, for an aggregate purchase price of $3,565,805, or $17.00 per share, which was the closing sale price of the common stock on that date, and Mr. Jewell repaid his indebtedness to us in the same amount. On that date, we also granted Mr. Jewell an option to purchase 297,393 shares of common stock at an exercise price of $7.00 per share, vesting monthly through March 5, 2005. In connection with the grant of the option, we expect to recognize approximately $3.0 million of deferred stock-based compensation over the 22-month vesting period of the option.

On May 22, 2003, we issued $150.0 million principal amount of our Zero Coupon Convertible Subordinated Notes due May 15, 2008 (the “Notes”) resulting in net proceeds to us of approximately $145.3 million. The Notes do not bear coupon interest and are convertible into shares of our common stock at an initial conversion price of $22.86 per share, for an aggregate of 6,561,680 shares. The Notes are subordinated to our existing and future senior indebtedness and effectively subordinated to all indebtedness and other liabilities of our subsidiaries. Magma may not redeem the Notes prior to their maturity date. Magma paid approximately $4.5 million in fees to the initial purchasers of the Notes, which will be accounted for as debt discount and approximately $0.2 million for debt issuance costs. The shares issuable on the conversion of Notes will be included in “fully diluted shares outstanding” under the as-if-converted method of accounting for purposes of our diluted earnings per share calculation.

In connection with the issuance and sale of the Notes, we repurchased approximately 1.1 million shares of our common stock at a price of $18.00 per share for a cash payment of approximately $20.0 million from one of the initial purchasers of the Notes and those shares were retired as of May 30, 2003. We also entered into an arrangement with Credit Suisse First Boston International (“CSFB International) that is intended to limit potential dilution resulting from the issuance of shares of our common stock upon conversion of the Notes. Under this arrangement, which was consummated contemporaneously with the issuance of the Notes, CSFB International agreed to sell to Magma, for $22.86 per share, up to 6,561,680 shares of our common stock to cover our obligation to issue shares upon conversion of the Notes. In addition, we issued CSFB International a warrant to purchase up to 6,561,675 shares of common stock for a purchase price of $31.50 per share. Purchases and sales under this arrangement may be made only upon expiration of the Notes or their earlier conversion (to the extent therof). Our net cost incurred in connection with this arrangement was approximately $20.3 million.

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On June 10, 2003, we entered into an agreement to acquire Aplus Technologies Inc. for a combination of cash and shares of common stock, including up to approximately $4.5 million in cash and up to 1,079,420 shares of our common stock, for an aggregate value of approximately $22.3 million. Approximately 28% of the aggregate purchase consideration will be payable at closing of the acquisition, which is expected to occur in the quarter ending September 30, 2003. The remaining 72% of the purchase consideration is payable pursuant to an earnout arrangement, under which 7% will be payable based upon Aplus Technologies bookings in fiscal 2004, 35% will be payable upon completion of certain technology milestones, and 30% will be payable based on operating income targets no later than March 31, 2005. Upon completion of the milestones, we will recognize additional purchase price equal to the fair value of the cash paid and stock issued to Aplus shareholders on the date the milestones are achieved.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. Preparing these financial statements requires our management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, bad debts, and investments. Our estimates are based on historical experience and on various other assumptions we believe are reasonable under the circumstances. Actual results may differ from these estimates.

Revenue Recognition

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

License revenue

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

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

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For transactions in which we bundle maintenance for the entire license term into a time-based license agreement, no VSOE of fair value exists for each element of the arrangement. For these agreements, where the only undelivered element is maintenance, we recognize revenue ratably over the contract term. If an arrangement involves extended payment terms—that is, where less than 80% is due in one year from the contract date—we recognize revenue to the extent of the lesser of the portion of the amount presently due and payable or the ratable portion of the entire fee.

For our perpetual licenses and some time-based license arrangements, we unbundle maintenance, by including maintenance for only the first year of the license term, with maintenance renewable by the customer at the rate stated in their agreements with us. In these unbundled licenses, the aggregate renewal period is greater than or equal to the initial maintenance period. The stated rate for maintenance renewal in these contracts is VSOE of the fair value of maintenance in both our unbundled time-based and perpetual licenses. In the fourth quarter of fiscal 2003, we changed our business practice for pricing of maintenance renewals from a fixed percentage of annual list price to a fixed percentage of the annual net license fee. We believe these new pricing policies better reflect the underlying economics of our software license agreements as we enter into larger scale license arrangements with our customers, which include substantial discounts from our list prices. Where the only undelivered element is maintenance, we recognize license revenue using the residual method. If an arrangement involves extended payment terms, revenue recognized using the residual method is limited to amounts due and payable.

Services revenue

We derive services revenue primarily from consulting and training for our software products and from maintenance fees for our products. Most of our license agreements include maintenance, generally for a one-year period, renewable annually. Services revenue from maintenance arrangements is recognized on a straight-line basis over the maintenance term. Because we have VSOE of fair value for consulting and training services, revenue is recognized as these services are delivered or completed.

Allowance for doubtful accounts

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

To date our receivables have not had any particular concentrations that, if not collected, would have a significant impact on our operating income (loss). The allowance for doubtful accounts represents our best estimate, but changes in circumstances relating to accounts receivable may result in a requirement for additional allowances in the future.

Investments

We invest in debt and equity of privately held technology companies for business and strategic purposes. These companies are typically in the early stage of development and are expected to incur substantial losses in the near-term. Therefore, these companies may never become publicly traded. Even if they do, an active trading market for their securities may never develop and we may never realize any return on these investments. Further, if these companies are not successful, we could incur charges related to write-downs or write-offs of these investments.

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We review the assumptions underlying the operating performance and cash flow forecasts based on information requested from these privately held companies on at least a quarterly basis. Assessing each investment’s carrying value requires significant judgment by management. If we determine that an other-than- temporary decline in fair value exists in a strategic investment, we write down the investment to its fair value and record the related expense in other income (expense) in our consolidated statement of operations.

During fiscal year 2003, we determined that the decline in value of certain strategic investments was other-than-temporary and recorded write-downs of these investments totaling $573,000. During fiscal 2002 and 2001 we recorded no investment write-downs.

Deferred Tax Asset Valuation Allowance

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

Valuation of Long-Lived Intangible Assets

As we acquire intangible assets through acquisitions, we will review long-lived assets for impairment in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Asset” whenever events or changes in circumstances indicate that the carrying amount of such an asset may not be recoverable. Such events or circumstances include, but are not limited to, a significant decrease in the fair value of the underlying business or asset, a significant decrease in the benefits realized from the acquired business, difficulty and delays in integrating the business or a significant change in the operations of the acquired business or use of an asset.

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Results of Operations

The following table sets forth income statement data as a percentage of total revenue for the periods indicated:

Fiscal Years Ended March 31, 2003 and 2002

Revenue

Revenue increased from $46.4 million in fiscal 2002 to $75.1 million in fiscal 2003 due to the increases in both license and service revenue. Of the $75.1 million of revenue recognized during fiscal 2003, approximately $63.6 million is license revenue. The increase in revenue is due to sales to new customers, which increased by more than 100% from the prior year, proliferation to additional design group designers in existing customers and the additions of new products. Our revenue consists of perpetual, bundled and unbundled time-based license agreements. Revenue for bundled time-based licenses is generally recognized over the contract period while revenue from unbundled time-based and perpetual licenses are generally recognized at the beginning of the contract period. PCS for unbundled time-based and perpetual licenses is recognized over the contract period. Certain significant contracts with extended payment terms entered into in recent quarters provide for payments, which are weighted towards the latter part of the contract term. Accordingly, if the payment terms are extended, the revenue from these contracts is recognized as amounts become due and payable. Revenue recognized under these arrangements will be higher in the latter part of the contract term. Our ability to recognize revenue in the future on contracts with extended payment terms will be subject to the customer’s continuing credit worthiness. Although we plan to enter into both bundled and unbundled time-based license agreements and perpetual license

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agreements in the future, we expect to derive the majority of our revenue in the foreseeable future from unbundled time-based license agreements.

License revenue

License revenue increased 66.5%, from $38.2 million in fiscal 2002 to $63.6 million in fiscal 2003. For fiscal 2003, the increase was primarily due to increased license revenue from our design and implementation software products, specifically from the introduction of Blast Fusion APX as well as from existing products, such as Blast Fusion, Blast Noise and to a lesser extent from Blast Chip. For the quarter ended September 30, 2001, we began to recognize revenue from perpetual and unbundled time-based license agreements using the residual method under SOP 98-9 which revenue recognition is accelerated. In the fourth quarter of fiscal 2003 we changed our revenue model for maintenance from a fixed percentage of list price to a percentage of the net license fee. We believe this methodology for recording maintenance is substantive and better reflects the underlying economics as the company enters into larger scale license arrangements with our customers. We expect license revenue to continue to grow in absolute dollars during fiscal 2004.

Services revenue

Services revenue increased 40.2%, from $8.2 million in fiscal 2002 to $11.5 million in fiscal 2003. This increase was primarily due to consulting services provided to licensees of our design and implementation software products. Although we intend to continue to offer these consulting services, we expect consulting service revenue as a percent of total revenue to remain flat.

Cost of Revenue

Cost of revenue consists primarily of cost of license revenue and, to a lesser extent, cost of consulting services for our design and implementation software products and amortization of technology acquired. Cost of revenue consists primarily of salary and related costs for engineers associated with technical services, including quality assurance, and cost of engineers associated with post-contract customer support, consulting services, and amortization of acquired technology. To date, the cost of service revenue for analysis and verification products has been insignificant. Cost of revenue increased in absolute dollars from $8.3 million or 18% of revenue in fiscal 2002 to $11.5 million or 15% of revenue in fiscal 2003. The increase is primarily due to costs associated with additional support required by our expanding customer base combined with costs related to increased design services. The cost of sales relating to design services increased as a result of increased services revenue. In addition, we transferred the costs associated with all research and development employees who work in design services to cost of sales at the beginning of the second quarter of fiscal 2003 because such employees activities were revised and now only perform work on customer related activities. We expect cost of sales to decline as a percentage of revenue due to the emphasis on higher margin software products.

Operating Expenses

Research and development

During the second quarter of fiscal 2003, we transferred the costs associated with all research and development employees who work in design services to cost of sales because such employees will only perform work on customer related activities. Research and development expense consists primarily of salaries, bonuses and benefits of engineering personnel, depreciation of engineering equipment, and outside engineering services from contractors and consultants as we continue to invest in our technology. Research and development expense increased in absolute dollars from $18.2 million or 39% of revenue in fiscal 2002 to $18.7 million or 25% of revenue in fiscal 2003. The fiscal 2003 increase of $0.5 million was attributed to an increase in travel expense of $0.3 million, payroll related expenses of $3.5 million due to an increase in headcount, and outside services of consultants of $0.5 million. These increases were offset by $3.8 million of costs transferred to cost of sales. These costs were associated with a number of research and development personnel who previously performed a

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combination of research and development and services activities for our services organization. Their activities were changed limiting them to providing services only. Development costs incurred in the research and development of new technology and enhancements to existing technology are expensed as incurred until technological feasibility in the form of a working model has been established. To date, we have not capitalized any costs for our software development as technological feasibility is established concurrently with the general release of the product. Although we expect research and development expense to increase in absolute dollars and that these expenses will fluctuate as a percentage of total revenue, our objective is to reduce research and development expenses as a percentage of total revenue over time.

Sales and marketing

Sales and marketing expense consists primarily of salaries, sales commissions, bonuses, benefits and related costs of sales and marketing personnel, tradeshows and other marketing activities. Sales and marketing expense increased from $22.9 million or 49% of revenue in fiscal 2002 to $25.7 million or 34% of revenue in fiscal 2003. The increase was primarily due to increases in payroll related expenses of $2.9 million resulting from headcount increases to support the sales plan, advertising expense of $0.3 million, third party sales representative commissions of $1.0 million resulting from growth outside the United States, principally in Asia, travel expense of $0.6 million and office related expense of $0.5 million. In addition, an increase of $0.9 million related to the change in business focus of the field application engineers toward sales support, from customer design services charged to cost of sales in the prior year. These increases were partially offset by a reduction of $3.3 million in commission expense resulting from a change in the compensation plan, $0.1 million in industry tradeshow related expenses. For fiscal year 2004, the Company is changing its sales compensation plan such the commissions earned on fiscal year 2004 orders will be equivalent to payments made. Payments will be spread on a ratable basis over two to six quarters depending on the dollar amount of an individual order. We expect sales and marketing expense to increase in absolute dollars in connection with the anticipated expansion of our customer base and the number and amount of our license agreements. . Although we expect sales and marketing expense to increase in absolute dollars and that these expenses will fluctuate as a percentage of total revenue, our objective is to reduce sales and marketing expenses as a percentage of total revenue over time.

General and administrative

General and administrative expense consists of salaries, bonuses, benefits and related costs of finance and administrative personnel and outside service expenses including legal, accounting and recruiting services. General and administrative expense increased 78% from $6.0 million or 13% of revenue in fiscal 2002 to $10.7 million or 14% of revenue in fiscal 2003. Of the net increase of $4.7 million, $1.9 million was related to the settlement with Prolific, Inc. Other increases include outside services of $1.2 million primarily from legal and accounting services, insurance expense of $0.4 million, bad debt expense of $0.6 million, travel expenses of $0.1, office related expenses of $0.2 million and payroll related expenses of $0.3 million. Although we expect general and administrative expense to increase in absolute dollars and that these expenses will fluctuate as a percentage of total revenue, our objective is to reduce general and administrative expenses as a percentage of total revenue over time.

Stock-based compensation

Stock-based compensation expense consists of the amortization of deferred stock-based compensation resulting from the grant of stock options at exercise prices less than the fair value of the underlying common stock on the grant date for officers and employees and the fair value of the stock options granted to consultants and other non-employees. The options granted to officers and employees generally vest over four years, with 25% vesting after one year and the balance vesting ratably over the remaining 36 months. Stock-based compensation declined 29%, to $4.8 million or 7% of revenue in fiscal 2003 from $6.8 million or 15% of revenue in fiscal 2002. For the year ended March 31, 2003, stock-based compensation included $4.3 million related to employees, of which $1.2 million was associated with our asset purchase of VeraTest, which occurred in fiscal 2003 and $0.5 million expense related to consultant options.

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Other Income (Expense), Net

Other income (expense), net was $1.3 million in fiscal 2003 and $(13.8) million in fiscal 2002. Interest income increased from $1.0 million in fiscal 2002 to $1.8 million in fiscal 2003 due to a change in the investment policy to include long-term investments beginning in the fourth quarter and more funds being available for investment on average for the year ended March 31, 2003. Interest and other expense decreased from $14.8 million in fiscal 2002 to $0.6 million in fiscal 2003. This decrease was primarily attributable to a non-cash charge of $14.6 million related to the $25 million subordinated convertible promissory notes issued in July and August 2001. Such charges will not be incurred in future periods since the promissory notes were automatically converted into common stock on the completion of our initial public offering in November 2001. For the year ended March 31, 2003, we had an other-than-temporary decline in fair value of $0.6 million related to two of our strategic investments.

Income Taxes

Prior to fiscal year 2003, we have incurred net losses since inception for federal and state tax purposes and have not recognized any tax benefit. We are in a net deferred tax asset position, which has been fully reserved. We will continue to provide a valuation allowance for our net deferred tax assets until it becomes more likely than not that the net deferred tax assets will be realized. The increase of income taxes of $0.9 million between the years ended March 31, 2003 and 2002 is primarily due to foreign tax expenses and U.S. federal alternative minimum tax.

As of March 31, 2003, we had approximately $85.0 million of federal and $26.0 million of state net operating loss carry-forwards to offset future taxable income. The federal net operating loss carry-forwards expire on various dates from 2019 through 2021. The state net operating loss carry-forwards expire on various dates from 2006 through 2013. Utilization of net operating losses and credits is subject to a substantial annual limitation due to the change in ownership provisions of the Internal Revenue Code of 1986 and similar state provisions. The annual limitation may result in the expiration of net operating losses and credits before utilization.

Fiscal Years Ended March 31, 2002 and 2001

Revenue

Revenue increased from $11.8 million in fiscal 2001 to $46.4 million in fiscal 2002. Of the $46.4 million of revenue recognized during fiscal 2002, approximately $38.2 million is license revenue. While to date we have focused primarily on time-based license agreements on which revenue has been recognized ratably, we also began to enter into perpetual licenses and unbundled time-based license agreements during the quarter ended September 30, 2001. For the year ended March 31, 2002, revenue from our ratable time-based licenses accounted for approximately 77% of our total revenue, and revenue from our perpetual and our unbundled time-based license agreements accounted for approximately 23% of our total revenue.

License revenue

License revenue increased from $11.3 million in fiscal 2001 to $38.2 million in fiscal 2002. This increase was primarily due to an increase in license revenue from our design and implementation software products, specifically from Blast Fusion and to a lesser extent from Blast Chip, which was first shipped in May 2000. In addition, beginning in the quarter ended September 30, 2001, we began to recognize revenue under perpetual and unbundled time-based license agreements using the residual method under which revenue is recognized more rapidly. For the year ended March 31, 2002, $7.2 million and $3.2 million, respectively, were derived from perpetual licenses and unbundled time-based license agreements using the residual method.

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Services revenue

Services revenue increased from $0.6 million in fiscal 2001 to $8.2 million in fiscal 2002. This increase was primarily due to consulting services provided to licensees of our design and implementation software products.

Cost of Revenue

Cost of revenue increased from $5.8 million or 49% of revenue in fiscal 2001 to $8.3 million or 18% of revenue in fiscal 2002. This increase in absolute dollars was primarily due to costs associated with additional support required by our expanding customer base combined with costs related to increased design services.

Operating Expenses

Research and development

Research and development expense decreased from $20.6 million or 174% of revenue in fiscal 2001 to $18.2 million or 39% of revenue in fiscal 2002. This decrease was primarily due to reductions of $0.9 million in outside service expense, $1.0 million in payroll related expenses, and $0.3 million in travel expenses.

Sales and marketing

Sales and marketing expense increased from $21.6 million or 182% of revenue in fiscal 2001 to $22.9 million or 49% of revenue in fiscal 2002. The increase was primarily due to an increase in commission expense of $3.6 million. This increase was partially offset by a reduction of $0.2 million in industry tradeshow related expenses, a reduction of $1.5 million in distribution commission expense which includes a $725,000 credit associated with the termination of a distribution agreement, and reductions in travel and outside services.

General and administrative

General and administrative expense decreased from $7.2 million or 61% of revenue in fiscal 2001 to $6.0 million or 13% of revenue in fiscal 2002. Of the net decrease of $1.2 million, outside services decreased by $0.8 million, payroll related expenses decreased by $0.5 million, and facility and support costs applicable to general and administration decreased by $0.2 million. These costs were partially offset by increases of $0.2 million in insurance expense and $0.1 million in bad debt expense.

Amortization of stock based compensation

Amortization of stock-based compensation was $6.8 million or 15% of revenue in fiscal 2002 and $3.7 million or 32% of revenue in fiscal 2001. As of March 31, 2002, we had recorded cumulative deferred stock-based compensation of approximately $21.0 million from the grant of stock options to officers, employees and consultants. As of March 31, 2002, deferred stock-based compensation was $7.2 million.

Other Income (Expense), Net

Other income (expense), net was $(13.8) million in fiscal 2002 and $1.2 million in fiscal 2001. Interest income decreased from $1.4 million to $1.0 million in fiscal 2002 due to significantly lower market interest rates from high-grade investments and less funds being available for investment on average for the year ended March 31, 2002. Other income (expense) increased from $232,000 in fiscal 2001 to $14.8 million in fiscal 2002. This increase was primarily attributable to a non-cash charge of $14.6 million related to the $25 million subordinated convertible promissory notes issued in July and August 2001.

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Income Taxes

The increase of income taxes of $150,000 between the years ended March 31, 2002 and 2001 is primarily due to increases in foreign income taxes.

Liquidity and Capital Resources

As of March 31, 2003, working capital was $69.0 million compared to $84.0 million as of March 31, 2002. Cash and cash equivalents and short-term investments as of March 31, 2003 were $67.8 million compared to $91.9 million as of March 31, 2002.

Net cash provided by operating activities was $3.0 million for the year ended March 31, 2003, compared to $12.5 million used for the year ended March 31, 2002. For the year ended March 31, 2003 net cash provided by operating activities was primarily due to net income of $3.1 million and non-cash items of $4.9 million of depreciation and amortization, $4.8 million of amortization of stock-based compensation, $0.6 million of provision for doubtful accounts, and $0.6 million related to loss on write-down of investments. These increases were offset by changes in accounts receivable, prepaids and other current assets, accounts payable, deferred revenue, accrued expenses, other assets, other long-term liabilities and accounts payable. For the year ended March 31, 2002 significant non-cash related adjustments included $11.8 million interest expense related to the beneficial conversion feature of our subordinated convertible promissory notes sold in July and August 2001, $2.2 million amortization of debt discount and issuance costs and $0.6 million accrued interest, which were subsequently converted into shares of our common stock, as well as, related to such promissory notes. In addition, other non-cash related adjustments include amortization of stock-based compensation of $6.8 million and depreciation and amortization of $4.4 million.

Net cash used in investing activities was $21.7 million for the year ended March 31, 2003, compared to $17.1 million for the year ended March 31, 2002. Of the cash used in investing activities in fiscal 2003, $28.9 million was used for purchase of long-term investments, $3.2 million was used for purchase of property and equipment and $3.1 million was used for purchase of short-term investments, which was offset by the net sale of short-term investments of $13.5 million. For fiscal 2002, $13.9 million was for the purchase of short-term and other investments and $3.3 million for purchases of property and equipment.

Cash provided by financing activities was $5.0 million for the year ended March 31, 2003, compared to $93.4 million for the year ended March 31, 2002. Cash provided for the year ended March 31, 2003, was primarily due to proceeds from issuance of common stock of $4.9 million. For the year ended March 31, 2002, cash provided was primarily related to the $67.4 million of net proceeds from our initial public offering combined with $24.8 million proceeds from the issuance of subordinated notes and warrants.

As of March 31, 2003, our principal source of liquidity consisted of $95.7 million in cash and cash equivalents, short-term and long-term investments. We believe that our existing cash and cash equivalents and short-term investments will be sufficient to meet our anticipated operating and working capital expenditure requirements in the ordinary course of business for at least the next 12 months. If we require additional capital resources to grow our business internally or to acquire complementary technologies and businesses at any time in the future, we may use cash or need to sell additional equity or debt securities. The sale of additional equity or convertible debt securities may result in more dilution to our existing stockholders. Financing arrangements may not be available to us, or may not be available in amounts or on terms acceptable to us.

As of March 31, 2003, our principal commitment consisted of operating leases, the future amount of which was $2.4 million through fiscal 2006 for office facilities. Although we have no material commitments for capital expenditures, we anticipate a substantial increase in our capital expenditures and lease commitments with our anticipated growth in operations, infrastructure, and personnel.

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The following summarizes our contractual obligations at March 31, 2003, and the effect such obligations are expected to have on our liquidity and cash flows in future periods (in millions):

On May 22, 2003, we issued $150.0 million principal amount of our Zero Coupon Convertible Subordinated Notes due May 15, 2008 (the “Notes”) resulting in net proceeds to us of approximately $145.3 million. The Notes do not bear coupon interest and are convertible into shares of our common stock at an initial conversion price of $22.86 per share, for an aggregate of approximately 6.56 million shares. The Notes are subordinated to our existing and future senior indebtedness and effectively subordinated to all indebtedness and other liabilities of our subsidiaries. Magma may not redeem the Notes prior to their maturity date. Magma paid approximately $4.5 million for debt discount and approximately $200,000 for debt issuance costs.

Newly Adopted and Recently Issued Accounting Pronouncements

On April 1, 2002 we adopted Statement of Financial Accounting Standards (“SFAS”) 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, which addresses financial accounting and reporting for the impairment of long-lived assets. While SFAS 144 supersedes SFAS 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of”, it retains many of the fundamental provisions of SFAS 121. SFAS 144 also supersedes the accounting and reporting provisions of Accounting Principles Board Opinion No. 30, “Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” (“APB 30”), for the disposal of a segment of a business. However, SFAS 144 retains the requirement of APB 30 to report separately discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as held for sale. SFAS 144 is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The Company’s adoption of SFAS 144 did not have a material effect on its consolidated financial statements.

In June 2002, the FASB issued SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities”, which provides guidance on the recognition and measurement of liabilities associated with exit or disposal activities. Those activities can include eliminating or reducing product lines, terminating employees and contracts, and relocating plant facilities and personnel. The provisions of SFAS 146 will not supersede the accounting requirements for costs to restructure operations acquired in a business combination. Under SFAS 146, companies are required to record a liability for a cost associated with an exit or disposal activity when that liability is incurred and can be measured at fair value as opposed to being recognized at the date of an entities commitment to an exit plan under EITF No. 94-3. The new requirements are effective prospectively for exit and disposal activities initiated after December 31, 2002. The Company adopted this standard beginning January 1, 2003 and the adoption of SFAS 146 did not have a material effect on its consolidated financial statements.

In December 2002, the FASB, issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.” SFAS No. 148 amends SFAS No. 123 “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The annual disclosure provisions are effective for fiscal years ending after December 15, 2002. The Company adopted the disclosure requirements of this standard in fiscal 2003 and the adoption of SFAS 148 did not have a material effect on its consolidated financial statements.

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In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” For guarantees issued or modified after December 31, 2002, a liability shall be recognized for the fair value of the obligation undertaken in issuing the guarantee. The disclosure requirements are effective for interim and annual financial statements for periods ending after December 15, 2002. See Note 7 for disclosures required by FIN 45. The adoption of FIN 45 did not have a material effect on the Company’s consolidated financial statements.

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” The effective date of Interpretation No. 46 is the first interim period beginning after June 15, 2003 for interests in variable interest entities acquired before February 1, 2003 and immediately to interests in variable interest entities created after January 31, 2003. The Company does not expect the adoption of SFAS issued Interpretation No. 46; effective beginning on July 1, 2003, to have a material effect on its consolidated financial statements.

On May 15, 2003, the FASB issued SFAS No. 150 “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” The statement requires issuer to classify as liabilities (or assets in some circumstances) three classes of freestanding financial instruments that embody obligations for the issuer. Generally, the statement is effective for financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim period after June 15, 2003. The Company is currently evaluating whether the adoption of SFAS No. 150 will have a material effect on its consolidated financial statements.

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

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

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

We were incorporated in April 1997 and introduced our first principal software product, Blast Fusion, in April 1999. Our business model is still emerging, and the revenue and income potential of our business and market is unproven. We have a limited history of generating revenue from our software products. As a result of our short operating history, we have limited financial data that can be used to evaluate our business. Our software products represent a new approach to the challenges presented in the electronic design automation market, which to date has been dominated by established companies with longer operating histories. Key markets within the electronic design automation industry may fail to adopt our proprietary technologies and software products. Any evaluation of our business and our prospects must be considered in light of our limited operating history and the risks and uncertainties often encountered by relatively young companies.

We have a history of losses prior to fiscal 2003 and had an accumulated deficit of approximately $118.5 million as of March 31, 2003; if we do not increase profitability, our public stock-trading price would be likely to decline.

We had an accumulated deficit of approximately $118.5 million as of March 31, 2003. Although we achieved profitability in fiscal 2003, we incurred losses in prior years. If we incur new losses, or do not increase profitability at a level expected by securities analysts or investors, the market price of our common stock is likely to decline. If we incur net losses, we may not be able to maintain or increase our number of employees or our investment in capital equipment, sales, marketing, and research and development programs, and we may not be able to continue to operate.

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

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

Customer payment defaults may cause us to be unable to recognize revenue from backlog and may have a material adverse effect on our financial condition and results of operations.

As of March 31, 2003, we had approximately $180.5 million in backlog, which we define as non-cancelable contractual commitments by our customers, through purchase orders or contracts that have no contingencies other than our performance. We expect that we will ultimately be able to recognize this backlog as revenue. However, if a customer defaults and fails to pay amounts owed, we may not be able to recognize expected revenue from backlog. In the current economic environment it is possible that customers from whom we expect to derive revenue from backlog will default or that the level of defaults will increase. Any material payment default by our customers could reduce the amount of backlog we recognize as revenue and could have a material adverse effect on our financial condition and results of operations.

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

Customers for our software products typically commit significant resources to evaluate available software. The complexity of our products requires us to spend substantial time and effort to assist potential customers in evaluating our software and in benchmarking it against our competition. In addition, potential customers may be limited in their current spending by existing time-based licenses with their legacy vendors. In these cases, customers delay a significant new commitment to our software until the term of the existing license has expired. Also, because our products require a significant investment of time and cost by our customers, we must target

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those individuals within the customer’s organization who are able to make these decisions on behalf of their companies. These individuals tend to be senior management in an organization, typically at the vice president level. We may face difficulty identifying and establishing contact with such individuals. Even after initial acceptance, the negotiation and documentation processes can be lengthy. Our sales cycle typically ranges between three and nine months, but can be longer. Any delay in completing sales in a particular quarter could cause our operating results to fall below expectations.

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

Our business depends on sales to a small number of customers. In fiscal 2003, we had two customers that each accounted for more than 10% of our revenue and that together accounted for approximately 30% of our revenue. In fiscal 2002, we had two customers that each accounted for more than 10% of our revenue and that together accounted for approximately 32% of our revenue.

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

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

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

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

We currently compete with companies that hold dominant shares in the electronic design automation market, such as Cadence and Synopsys. Each of these companies has a longer operating history and significantly greater financial, technical and marketing resources than we do, as well as greater name recognition and larger installed customer bases. Our competitors are better able to offer aggressive discounts on their products, a practice they often employ. Our competitors offer a more comprehensive range of products than we do; for example, we do not offer logic simulation, formal verification, full-feature custom layout editing, analog or mixed signal products, which can sometimes be an impediment to our winning a particular customer order. In addition, our industry has traditionally viewed acquisitions as an effective strategy for growth in products and market share and our competitors’ greater cash resources and higher market capitalization may give them a relative advantage over us in buying companies with promising new chip design products or companies that may be too large for us to acquire without a strain on our resources. Examples of acquisitions by our competitors

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include Synopsys’ acquisition of Avant! and Cadence’s acquisition of Get2Chip. Further consolidation in the electronic design automation market could result in an increasingly competitive environment. Competitive pressures may prevent us from gaining market share, require us to reduce the price of products and services or cause us to lose existing customers, which could harm our business. To execute our business strategy successfully, we must continue to increase our sales worldwide. If we fail to do so in a timely manner or at all, we may not be able to gain market share and our business and operating results could suffer.

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

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

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

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

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

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

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

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

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

Demand for our products is driven by new integrated circuit design projects. The demand from semiconductor and systems companies is uncertain and difficult to predict. Slower growth in the semiconductor

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and systems industries, a reduced number of design starts, reduction of electronic design automation budgets or continued consolidation among our customers would harm our business and financial condition. We have experienced slower growth in revenue than we anticipated as a result of the prolonged downturn and decreased spending by our customers in the semiconductor and systems industries.

The primary customers for our products are companies in the communications, computing, consumer electronics, networking and semiconductor industries. Any significant downturn in our customers’ markets or in general economic conditions that results in the cutback of research and development budgets or the delay of software purchases would be likely to result in lower demand for our products and services and could harm our business. For example, the United States economy, including the semiconductor industry, is currently experiencing a slowdown, which has negatively impacted and may continue to impact our business and operating results. Terrorist attacks in the United States, the aftermath of war with Iraq and other worldwide events including in the Middle East have increased uncertainty in the United States economy. If the economy continues to decline as a result of the economic, political and social turmoil, existing customers may delay their implementation of our software products and prospective customers may decide not to adopt our software products, either of which could negatively impact our business and operating results.

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

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

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

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

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

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

Our products depend on complex software, both internally developed and licensed from third parties. Our customers may use our products with other companies’ products, which also contain complex software. If our software does not meet our customers’ performance requirements, our customer relationships may suffer. Also, a limited number of our contracts include specified ongoing performance criteria. If our products fail to meet these

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criteria, it may lead to termination of these agreements and loss of future revenue. Complex software often contains errors. Any failure or poor performance of our software or the third-party software with which it is integrated could result in:

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

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

We generated 39% of our total revenue from sales outside North America for fiscal 2003, compared to 22% in fiscal 2002. While all of our international sales to date have been denominated in U.S. dollars, our international operating expenses have been denominated in foreign currencies. As a result, a decrease in the value of the U.S. dollar relative to the foreign currencies could increase the relative costs of our overseas operations, which could reduce our operating margins.

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

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

Future changes in accounting standards for interpretations thereof, specifically those changes affecting software revenue recognition, could require us to change our methods of revenue recognition. These changes

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could result in deferral of revenue recognized in current periods to subsequent periods or in accelerated recognition of deferred revenue to current periods, each of which could cause shortfalls in meeting the expectations of investors and securities analysts. Our stock price could decline as a result of any shortfall. Future implementation of internal controls reporting and attestation requirements will impose additional financial and administrative obligations on us that could adversely affect our results.

Changes in effective tax rates could affect our results of operations.

Our future effective tax rates could be adversely affected by the following:

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

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

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

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

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

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

We depend on our senior executives, and our research and development, sales and marketing personnel, who are critical to our business. We do not have long-term employment agreements with our key employees, and we do not maintain any key person life insurance policies. If we lose the services of any of these key executives, our product development processes and sales efforts could be slowed. We may also incur increased operating

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expenses and be required to divert the attention of other senior executives to search for their replacements. The integration of our new executives or any new personnel could disrupt our ongoing operations.

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

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

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

If our sales force compensation arrangements are designed poorly, we may lose sales personnel and resources.

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

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

Periods of growth followed by efforts to realign costs when revenue growth is slower than anticipated have placed a strain on our management, administrative and financial resources. For example, in the third quarter of fiscal year 2003, we laid off 32 employees. Over time we have significantly expanded our operations in the United States and internationally, and we plan to continue to expand the geographic scope of our operations. To pace the growth of our operations with the growth in our revenue, we must continue to improve administrative, financial and operations systems, procedures and controls. Failure to improve our internal procedures and controls could result in a disruption of our operations and harm to our business. If we are unable to manage our growth the execution of our business plan could be delayed.

We may have difficulty assimilating technology, personnel and operations from acquisitions, and these difficulties may disrupt our business and divert management’s attention.

We have made acquisitions and we may continue to pursue acquisitions that we believe may complement our business. If we do acquire additional companies, the integration of the separate operations of our company and an acquisition partner may result in problems related to integration of technology and management teams, either of which could divert management’s attention from day-to-day operations. We may not realize all of the anticipated benefits of acquisitions, and we may not be able to retain key management, technical and sales personnel after an acquisition. Our products incorporate software licensed from third parties, and if we lose or are unable to maintain any of these software licenses, our product shipments could be delayed or reduced.

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We use software, such as front-end language processing, license keying software and schematic viewing software that we license from third parties. We have also licensed the rights to some technologies from various universities, including the Technical University of Eindhoven, Delft University and the University of California, Berkeley. These third-party software licenses may not continue to be available on commercially reasonable terms, or at all. If we cannot maintain existing third-party technology licenses or enter into licenses for other existing or future technologies needed for our products, we could be required to cease or delay product shipments while we seek to develop alternative technologies.

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

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

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

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

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

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

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

To establish and protect our proprietary rights, we rely on a combination of trademark, copyright and trade secret laws, and contractual restrictions, such as confidentiality agreements and licenses. Our ability to compete and grow our business could suffer if these rights are not adequately protected. We seek to protect our source

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code for our software, documentation and other written materials under trade secret and copyright laws. We license our software pursuant to agreements, which impose certain restrictions on the licensee’s ability to utilize the software. We also seek to avoid disclosure of our intellectual property by requiring employees and consultants with access to our proprietary information to execute confidentiality agreements. Our proprietary rights may not be adequately protected because:

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

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

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

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

We may also become involved in litigation unrelated to intellectual property infringement claims. For example, in August 2001, a complaint was filed against us alleging breach of contract, among other things. This litigation was recently settled. We may not be successful in defending other claims that may be made against us. Regardless of the outcome, litigation can result in substantial expense and could divert the efforts of our management and technical personnel.

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

Our directors, executive officers and stockholders who currently own over 5% of our common stock beneficially own a substantial portion of our outstanding common stock. These stockholders, if they vote

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together, will be able to significantly influence all matters requiring stockholder approval. For example, they may be able to elect most of our directors, delay or prevent a transaction in which stockholders might receive a premium over the market price for their shares or prevent changes in control or management.

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

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

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

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

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

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

In addition, Section 203 of the Delaware General Corporation Law and the terms of our stock option plans may discourage, delay or prevent a change in control of our company. That section generally prohibits a Delaware corporation from engaging in a business combination with an interested stockholder for three years after the date the stockholder became an interested stockholder. Also, our stock option plans include change-in-

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control provisions that allow us to grant options or stock purchase rights that will become vested immediately upon a change in control of us.

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

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

We transact some portions of our business in various foreign currencies. Accordingly, we are subject to exposure from adverse movements in foreign currency exchange rates. This exposure is primarily related to operating expenses in the United Kingdom, Europe and Japan, which are denominated in the respective local currencies. As of December 31, 2002, we had no hedging contracts outstanding. We do not currently use financial instruments to hedge operating expenses in the United Kingdom and Japan denominated in the respective local currency. We assess the need to utilize financial instruments to hedge currency exposures on an ongoing basis.

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

In May 2003, we issued $150 million principal amount of our zero coupon convertible notes due May 2008. We will be required to repay that principal amount in full in May 2008 unless the holders of those notes elect to convert them into our common stock before the repayment date. The conversion price of the notes is $22.86 per share. If the price of our common stock does not rise above that level, conversion of the notes is unlikely and we would be required to repay the principal amount of the notes in cash. There have been previous quarters in which we have experienced shortfalls in revenue and earnings from levels expected by securities analysts and investors, which have had an immediate and significant adverse effect on the trading price of our common stock. In addition, the stock market in recent years has experienced extreme price and trading volume fluctuations that often have been unrelated or disproportionate to the operating performance of individual companies. These broad market fluctuations may adversely affect the price of our stock, regardless of our operating performance. Because the notes are convertible into shares of our common stock, volatility or depressed prices for our common stock could have a similar effect on the trading price of the notes.

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

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

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

Our convertible notes are general unsecured obligations of Magma and are subordinated in right of payment to all of our existing and future senior indebtedness, which we may incur in the future. In the event of our

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

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

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

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

ITEM 7A.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. The primary objective of our investment activities is to preserve principal while maximizing yields without significantly increasing risk. This is accomplished by investing in widely diversified short-term and long-term investments, consisting primarily of investment grade securities, substantially all of which mature within the next twenty-four months. A hypothetical 100 basis point decrease in interest rates would result in an approximate $475,000 decline (less than 1%) in the fair value of our available-for-sale securities.

Foreign Currency Exchange Risk

We transact some portions of our business in various foreign currencies. Accordingly, we are subject to exposure from adverse movements in foreign currency exchange rates. This exposure is primarily related to operating expenses in the United Kingdom and Japan, which are denominated in the respective local currency. As of March 31, 2003, we had no hedging contracts outstanding. We do not currently use financial instruments to hedge operating expenses in the United Kingdom and Japan denominated in the respective local currency. We assess the need to utilize financial instruments to hedge currency exposures on an ongoing basis.

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ITEM 8.     FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

MAGMA DESIGN AUTOMATION, INC. AND SUBSIDIARIES

Index to Consolidated Financial Statements and Financial Statement Schedule

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INDEPENDENT AUDITORS’ REPORT

The Board of Directors and Stockholders

Magma Design Automation, Inc.:

We have audited the accompanying consolidated balance sheets of Magma Design Automation, Inc. and subsidiaries as of March 31, 2003 and 2002, and the related consolidated statements of operations, redeemable convertible preferred stock and stockholders’ equity (deficit), and cash flows for each of the years in the three-year period ended March 31, 2003. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule as listed in the Index to Consolidated Financial Statements. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 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 financial position of Magma Design Automation, Inc. and subsidiaries as of March 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended March 31, 2003, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the financial statement schedule, when considered in relation to the consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

/s/    KPMG LLP        

Mountain View, California

April 28, 2003 except as to note 12, which is

    as of June 10, 2003

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MAGMA DESIGN AUTOMATION, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

See accompanying notes to consolidated financial statements.

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MAGMA DESIGN AUTOMATION, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)