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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
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FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JANUARY 31, 2000,
OR
/ / TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 333-20031
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NEOMAGIC CORPORATION
(Exact name of Registrant as specified in its charter)
DELAWARE 77-0344424
State or other jurisdiction [I.R.S. Employer Identification No.]
of incorporation or organization
3260 JAY STREET
SANTA CLARA, CALIFORNIA 95054
Address of principal executive offices Zip Code
Registrant's telephone number, including area code (408) 988-7020
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, $.001
PAR VALUE
--------------------------
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 to Part III of this Form 10-K or any
amendment to this Form 10K. / /
The aggregate market value of voting stock held by non-affiliates of the
Registrant was approximately $125,411,786 as of February 27, 2000, based upon
the closing price on the Nasdaq National Market reported for such date. This
calculation does not reflect a determination that certain persons are affiliates
of the Registrant for any other purposes.
The number of shares of the Registrant's Common Stock, $.001 par value,
outstanding at February 27, 2000 was 25,592,118.
DOCUMENTS INCORPORATED BY REFERENCE
(1) Portions of the Registrant's Proxy Statement related to the 2000 Annual
Meeting of Stockholders, to be filed with the Securities and Exchange
Commission subsequent to the date hereof--Part III.
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NEOMAGIC CORPORATION
FORM 10-K
FOR THE FISCAL YEAR ENDED JANUARY 31, 2000
TABLE OF CONTENTS
PAGE
--------
PART I.
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 10
Item 3. Legal Proceedings........................................... 10
Item 4. Submission of Matters to a Vote of Security Holders......... 10
PART II.
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 11
Item 6. Selected Consolidated Financial Data........................ 11
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 13
Item 7A. Quantitative and Qualitative Disclosures about Market
Risk...................................................... 31
Item 8. Financial Statements and Supplementary Data................. 31
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures................................. 32
PART III.
Item 10. Directors and Executive Officers of the Registrant.......... 33
Item 11. Executive Compensation...................................... 33
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 33
Item 13. Certain Relationships and Related Transactions.............. 33
PART IV.
Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K.................................................. 33
Signatures............................................................ 54
PART I
ITEM 1. BUSINESS
GENERAL
NeoMagic Corporation (the "Company" or "NeoMagic") was incorporated as a
California corporation in May 1993. The Company was subsequently reincorporated
as a Delaware corporation in February 1997. The Company's initial public
offering occurred in March 1997. The Company operates in one industry segment.
NeoMagic designs, develops and markets high-performance semiconductor solutions
for sale to original equipment manufacturers ("OEMs") of mobile computing
products. To date, all the Company's net sales have been derived from the sale
of multimedia accelerators to the notebook PC market.
Multimedia applications require the storage, processing and display of
enormous streams of data. As a result, multimedia PCs have evolved to
incorporate higher capacity storage and system memory, faster microprocessors,
improved specialized multimedia accelerators, and higher quality displays.
However, due to the constraints imposed by the mobile form factor--the need for
low power consumption, small size, low weight, favorable thermal characteristics
and low cost, among others--the multimedia capabilities of notebook PCs have
historically lagged those of desktop computers. Until 1997, this limited the
effectiveness of multimedia applications in notebook PCs.
To fully mobilize multimedia, the Company believed notebook PC manufacturers
required a new approach for developing multimedia accelerators which deliver
higher performance while minimizing power consumption, system size, weight,
complexity and cost.
The Company, based on its knowledge of and experience in the industry, has
developed the first commercially available high performance silicon technology
that integrates large DRAM memory with analog and logic circuitry to provide
multimedia solutions on a single chip. NeoMagic pioneered a new technology to
provide multimedia semiconductor solutions for notebook PCs, which overcomes the
limitations of traditional architectures. Using this technology, the Company
developed its first two product lines: the MagicGraph128 and the MagicMedia256
families of pin-compatible, multimedia (graphics, text and video) accelerator
products incorporating a 128-bit and a 256-bit memory bus, respectively. These
products provide state-of-the art multimedia capability while decreasing power
consumption, size, weight, system design complexity and cost. The Company
introduced its first MagicGraph128 product in March 1995, and is currently in
production with the fourth generation of this product family. In June 1998, the
Company announced the industry's first 256-bit multimedia accelerator, the
MagicMedia256AV. This chip integrates audio and DVD video playback acceleration
with high-performance PC graphics, into a single twenty-one million transistor
chip, with a peak internal bandwidth of 3.2 gigabytes per second. Through
January 2000, the Company had shipped over twenty-two million units of its
multimedia accelerators.
The Company believes that the dramatic growth of the Internet has expanded
its market opportunities, by rich multimedia content to end-users at their
offices and in their homes. It is NeoMagic's strategy to participate in multiple
market opportunities driven by these trends towards multimedia, mobility, and
the Internet. To extend beyond the notebook arena, in 1998, the Company formed
the Consumer Products Division and announced plans to enter into two new market
areas: digital cameras and Digital Versatile Disk ("DVD") drive solutions. In
February, 1999, the Company completed two acquisitions to accelerate its new
market activities. The Company acquired the optical Drive Storage Group, located
in Manchester, England, from Mitel Semiconductor, and also acquired Associative
Computers, Ltd., ("ACL") located in Raanana, Israel from Robomatix. The
Company's plan included leveraging its MagicWare embedded DRAM technology with
the intellectual properties from these recent acquisitions to deliver innovative
solutions for the capture, storage, and playback of multimedia content for a
rich internet experience on mobile platforms. In February 2000, the Company
announced it had determined that embedded DRAM
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now provides less value in the current market for DVD products than initially
anticipated. The evolving DVD market is very cost sensitive, and has little
regard for low-power electronics or form-factor integration, taking this product
line further away from the Company's embedded DRAM technology roadmap over time.
As a result, the Company determined that it will no longer pursue opportunities
in the DVD market and, in February 2000, announced that it is seeking to sell
the product line, including the assets of the Optical Drive Storage Group
purchased in February 1999.
NeoMagic has established strategic relationships with third-party
manufacturing partners to produce semiconductor wafers for the Company's
products. Pursuant to these strategic relationships, NeoMagic designs the
overall product, including the logic and analog circuitry, and the manufacturing
partners design the DRAM modules, manufacture the wafers and perform memory
testing and repair. NeoMagic is focused on leveraging its core competencies in
logic, analog and memory integration, graphics/video, DVD, 3D and other
multimedia technologies, driver and BIOS software, and power management in its
continued development of solutions that facilitate the mobilization of
multimedia applications.
PRODUCTS
All of the Company's net sales in fiscal 2000 were from the sale of
multimedia accelerators to notebook PC OEMs, or to third-party subsystem
manufacturers who design and manufacture notebooks on behalf of the
OEMs. NeoMagic's products are currently used in notebooks sold by Acer, Compaq,
Dell, Fujitsu, IBM, Panasonic, Sharp, and Sony.
The products in the MagicGraph128 and MagicMedia256 product families
integrate DRAM with analog and logic circuitry on a single chip. NeoMagic's
products range from accelerators designed for notebook PCs that span across all
notebook categories including desktop replacement, mainstream, value-
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oriented, ultra-portable, and entry level systems. The following table sets
forth information with respect to the Company's main products:
MEMORY KEY FEATURES ADDED
PRODUCT PROJECT STATUS SIZE WITH NEW GENERATION
- ------- ----------------- ---------- -----------------------------
MagicGraph128XD.............. Volume production 2 MBytes Bus master for video
June 1997 acceleration, Spread spectrum
EMI* suppression, 1024x768
resolution with greater than
65,000 colors
MagicMedia256AV.............. Volume production 2.5 MBytes 256-bit integrated
August 1998 graphics/DVD integrated
audio, multiple display/dual
head, XGA/SXGA support,
camera port, and
MagicPass-TM- EMI reduction
MagicMedia256AV+............. Volume production 3 MBytes 256-bit integrated graphics/
January 2000 enhanced DVD integrated
audio, multiple display/dual
head, XGA/SXGA support,
camera port, and
MagicPass-TM- EMI reduction
MagicMedia256ZX.............. Volume production 4 MBytes 256-bit integrated
June 1999 graphics/DVD integrated
audio, multiple display/dual
head, highest 2D performance,
XGA/SXGA support, camera
port, and MagicPass-TM- EMI
reduction
MagicMedia256XL+............. Volume production 6 MBytes 256-bit integrated
November 1999 graphics/DVD integrated
audio, multiple display/dual
head, 3D pipeline, XGA/SXGA
support, camera port, and
MagicPass-TM- EMI reduction
- ------------------------
* Electro-Magnetic Interference
MAGICGRAPH128XD. A pin-compatible alternative to the MagicGraph128ZV+, the
MagicGraph128XD offers higher display resolutions, a larger number of
displayable colors, and higher performance, providing value oriented notebooks
with flexibility in display features and price/performance levels.
MAGICMEDIA256AV. The MagicMedia256AV is the first 256-bit multimedia
accelerator, providing high-end 2D graphics performance, integrated PCI audio
controller functions, and DVD video playback acceleration in a single-chip
multimedia solution for notebook computers. To complete the PCI audio solution
of a PC, MagicMedia256AV customers would add an AC97 audio codec as a companion
chip. As an industry-standard component, the AC97 compliant codec can be
acquired from third-party sources or from NeoMagic as the MagicWave3DX.
MAGICMEDIA256AV+. The MagicMedia256AV+ offers more memory, 3 Megabytes, for
enhanced DVD playback acceleration in a 256-bit multimedia accelerator,
providing high-end 2D graphics performance, and integrated PCI audio controller
functions in a single-chip multimedia solution for notebook computers.
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MAGICMEDIA256ZX. The MagicMedia256ZX offers 4 Megabytes of embedded memory
for the highest performance in 2D graphics and enhanced DVD playback
acceleration in a 256-bit multimedia accelerator with integrated PCI audio
controller functions in a single-chip multimedia solution for notebook
computers.
MAGICMEDIA256XL+. The MagicMedia256XL+ offers 6 Megabytes of embedded
memory for high performance 2D graphics, enhanced DVD playback, and a 3D
pipeline in a 256-bit multimedia accelerator with integrated PCI audio
controller functions in a single-chip multimedia solution for notebook
computers.
RESEARCH AND DEVELOPMENT
The Company considers the timely development and introduction of new
products to be essential to maintaining its competitive position and
capitalizing on market opportunities. Research and development efforts focus on
the design of new products and the enhancement or redesign for cost reduction
purposes of existing products that will help to maintain or increase the
Company's participation in various product areas. At January 31, 2000, the
Company had approximately 179 employees engaged in research and development.
Research and development expenses in fiscal 2000, 1999, and 1998 were
$38.0 million, $31.8 million and $16.1 million, respectively. The Company has
made, and intends to continue to make, significant investments in research and
development by developing new and enhanced products to serve its identified
markets. However, given the Company's projections for downward revenue and its
corresponding cost control efforts, research and development expenses are
expected to decrease in absolute dollars in fiscal 2001. The development and
successful introduction of new products presents a variety of risks, and there
can be no assurance that these or other product development efforts will be
completed at the time the Company expects, or that new products will be accepted
in the marketplace.
SALES AND MARKETING
NeoMagic's sales and marketing strategy is an integral part of the Company's
effort to become the leading supplier of semiconductor solutions to the leading
manufacturers of mobile products. To meet customer requirements and achieve
design wins, the Company's sales and marketing personnel work closely with its
customers, business partners and key industry trend-setters to define product
features, performance, price, and market timing of new products. The Company
employs a sales force with a high level of technical expertise and product and
industry knowledge to support a lengthy and complex design win process.
Additionally, the Company employs a highly trained team of application engineers
to assist customers in designing, testing and qualifying system designs that
incorporate NeoMagic products. The Company believes that the depth and quality
of this design support are key to improving customers' time-to-market deliveries
and maintaining a high level of customer satisfaction, which encourages
customers to utilize subsequent generations of NeoMagic's products.
In the United States, the Company sells its products to key customers
primarily through a direct sales force. In Japan, DIA Semicon acts as the
Company's sales representative. In Taiwan, Regulus acts as the Company's sales
representative, with support from the Company's Taiwan country manager. As of
January 31, 2000, NeoMagic employed 37 individuals in its sales, marketing and
support organizations, and maintained regional sales offices in California,
Texas, Hong Kong and Taiwan.
In many cases, notebook PCs are designed and manufactured by third party
system manufacturers on behalf of the final brand-name OEM. NeoMagic focuses on
developing long-term customer relationships with both the system manufacturer
and the brand-name OEM. The Company believes that this approach increases the
likelihood for design wins, improves the overall quality of support, and enables
the timely release of customer products to market. Although the Company will
continue to support sales and marketing activities, given the Company's
projections for downward revenue and its corresponding cost control efforts,
sales and marketing expenses will decrease in absolute dollars in fiscal 2001.
4
MANUFACTURING
The Company's products require semiconductor wafers manufactured with
state-of-the-art fabrication equipment and technology. The Company's products
are designed to be manufactured in accordance with the DRAM partners' design
rules and manufacturing processes. Each DRAM partner has a design team dedicated
to NeoMagic product development. The DRAM partners design the DRAM product
modules and NeoMagic designs the overall product, including the analog and logic
circuitry. The DRAM partners then aid the Company in design verification prior
to production. The DRAM partners manufacture the wafers, perform memory testing
and repair, and sell the Company finished wafers, with pricing determined on a
quarterly basis.
NeoMagic has strategic relationships with Mitsubishi Electric Corporation
("Mitsubishi Electric"), Toshiba Corporation ("Toshiba") and Infineon
Technologies ("Infineon"), formerly Siemens Aktiengesellschaft Semiconductor
Group ("Siemens"), to produce its semiconductor wafers. These relationships
enable the Company to concentrate its resources on product design and
development, where NeoMagic believes it has greater competitive advantages, and
to eliminate the high cost of owning and operating a semiconductor wafer
fabrication facility. The Company depends on these suppliers to allocate to the
Company a portion of their manufacturing capacity sufficient to meet the
Company's needs, to produce products of acceptable cost and quality and at
acceptable manufacturing yields, and to deliver those products to the Company on
a timely basis. A manufacturing disruption experienced by any of the Company's
manufacturing partners would have an adverse effect on the Company's business,
financial condition and results of operations. Furthermore, in the event that
the transition to the next generation of manufacturing technologies at one of
the Company's suppliers is unsuccessful, the Company's business, financial
condition and results of operations would be materially and adversely affected.
Additionally, there can be no assurances that any of the Company's manufacturing
partners will continue to devote resources to the production of the Company's
products or continue to advance the process design technologies on which the
manufacturing of the Company's products are based. Over the past year, the
Company has experienced insufficient allocation of manufacturing capacity for
its products by two of its manufacturing partners, inadequate manufacturing
yields and difficulties by one of its manufacturing partner to successfully
transition to a next generation manufacturing technology. These problems have
had a material adverse effect on the Company's business, financial condition and
results of operations and are likely to continue to have an adverse effect on
the Company's business, financial condition and results of operations in the
future.
The Company uses other third-party subcontractors to perform assembly and
testing of the Company's products. The Company develops its own software and
hardware for product testing. The Company does not have long-term agreements
with any of these subcontractors. As a result of this reliance on third-party
subcontractors to assemble and test its products, the Company cannot directly
control product delivery schedules, which could lead to product shortages or
quality assurance problems that could increase the costs of manufacturing or
assembly of the Company's products. Due to the amount of time normally required
to qualify assembly and test subcontractors, if the Company is required to find
alternative subcontractors, shipments could be delayed significantly. Any
problems associated with the delivery, quality or cost of the assembly and test
of the Company's products could have a material adverse effect on the Company's
business, financial condition and results of operations.
COMPETITION
The market for multimedia accelerators for notebook PCs in which the Company
participates is intensely competitive and is characterized by rapid
technological change, evolving industry standards and declining average selling
prices. NeoMagic believes that the principal factors of competition in this
market are performance, price, features, power consumption, size and software
support. The ability of the Company to compete successfully in the rapidly
evolving notebook PC market depends on a number of factors including, success in
designing and subcontracting the manufacture of new products that implement
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new technologies, product quality and reliability, price, the efficiency of
production, ramp up of production of the Company's products for particular
system manufacturers, end-user acceptance of the system manufacturers' products,
market acceptance of competitors' products and general economic conditions. The
Company's ability to compete in the future will also depend on its ability to
identify and ensure compliance with evolving industry standards. Unanticipated
changes in industry standards could render the Company's products incompatible
with products developed by major hardware manufacturers and software developers,
including Intel Corporation and Microsoft Corporation. The Company could be
required, as a result, to invest significant time and resources to redesign its
products or obtain license rights to technologies owned by third parties in
order to ensure compliance with relevant industry standards. There can be no
assurance that the Company could redesign its products or obtain the necessary
third-party licenses within the appropriate window of market demand. If the
Company's products are not in compliance with prevailing industry standards for
a significant period of time, the Company could miss crucial OEM design cycles,
which could result in a material adverse effect on the Company's business,
financial condition and results of operations. In addition, the Company's
products are designed to afford the notebook PC manufacturer significant
advantages with respect to product performance, power consumption and size. To
the extent that other future developments in notebook PC components or
subassemblies incorporate one or more of the advantages offered by the Company's
products, the market demand for the Company's products may be negatively
impacted. Over the past year, delays in the introduction and ramping of the
Company's new products have caused the Company to miss current OEM's design
cycles which has eroded the Company's market share and has had a material
adverse effect on the Company's business, financial condition and results of
operations.
NeoMagic competes with major domestic and international companies, some of
which have substantially greater financial and other resources than the Company
with which to pursue engineering, manufacturing, marketing and distribution of
their products. The Company's principal competitors include ATI Technologies
("ATI"), Chips & Technologies, Inc. ("Chips & Technologies"--in January 1998,
Intel Corporation acquired Chips and Technologies), S3 Incorporated ("S3") and
Trident Microsystems, Inc. ("Trident"). NeoMagic may also face increased
competition from new entrants into the notebook PC multimedia accelerator market
including companies currently selling products designed for desktop PCs. Certain
of the Company's competitors may offer products with more functionality and / or
higher processor speeds at the expense of battery life and power consumption
than the Company's product offerings. ATI, during 1999, produced and increased
market share with a Multi-Chip Module ("MCM") accelerator solution. The MCM
solution increases access memory both internally in the packaged module and
externally, with connections to discrete memory on the motherboard, for higher
performance at the expense of battery life and power consumption. Some of the
Company's competitors, including Chips & Technologies and Trident, have
announced or introduced multimedia accelerator products that integrate large
DRAM with analog and logic circuitry on a single chip. These feature sets may be
more competitive for certain applications than the Company's products. Potential
competition also could come from manufacturers that integrate the multimedia
accelerator with other systems components. For example, Intel Corporation is in
production with products that integrate microprocessors and graphics
accelerators. Further, several of the Company's competitors have announced plans
to develop products that integrate the multimedia accelerator with the core
logic chip set. The successful commercial introduction by competitors of
products that integrate DRAM with analog and logic circuitry on a single chip,
or that eliminate the need for a separate multimedia accelerator in notebook
PCs, could have a material adverse effect on the Company's business, financial
condition and operating results.
Some of the Company's current and potential competitors operate their own
manufacturing facilities. Since the Company does not operate its own
manufacturing facility and must make binding commitments to purchase products,
it may not be able to reduce its costs and cycle time or adjust its production
to meet changing demand as rapidly as companies that operate their own
facilities, which could have a material adverse effect on the Company's results
of operations.
6
INTELLECTUAL PROPERTY
The Company relies in part on patents to protect its intellectual property.
The Company has been issued numerous patents worldwide, each covering certain
aspects of the design and architecture of the Company's multimedia accelerators.
In Fiscal 2000, the Company also acquired and/or licensed intellectual
properties, the majority of which were in the areas of mixed signal analog
design and array-based processing as part of the February 1999 acquisitions of
the Optical Drive Development Group and ACL. Additionally, the Company and its
newly acquired businesses have patent applications pending. There can be no
assurance that the Company's pending patent applications, or any future
applications will be approved. Further, there can be no assurance that any
issued patents will provide the Company with significant intellectual property
protection, competitive advantages, or will not be challenged by third parties,
or that the patents of others will not have an adverse effect on the Company's
ability to do business. In addition, there can be no assurance that others will
not independently develop similar products, duplicate the Company's products or
design around any patents that may be issued to the Company.
The Company also relies on a combination of mask work protection,
trademarks, copyrights, trade secret laws, employee and third-party
nondisclosure agreements and licensing arrangements to protect its intellectual
property. Despite these efforts, there can be no assurance that others will not
independently develop substantially equivalent intellectual property or
otherwise gain access to the Company's trade secrets or intellectual property,
or disclose such intellectual property or trade secrets, or that the Company can
meaningfully protect its intellectual property. A failure by the Company to
meaningfully protect its intellectual property could have a material adverse
effect on the Company's business, financial condition and results of operations.
As a general matter, the semiconductor industry is characterized by
substantial litigation, regarding patent and other intellectual property rights.
In December 1998, the Company filed a lawsuit in the United States District
Court for the District of Delaware against Trident Microsystems, Inc. The suit
alleges that Trident's embedded DRAM graphics accelerators infringe certain
patents held by the Company. In January 1999, Trident filed a counter claim
against the Company alleging an attempted monopolization in violation of
antitrust laws, arising from NeoMagic's filing of the patent infringement action
against Trident in December. The Court has stayed all litigation concerning
Trident's antitrust claim pending resolution of NeoMagic's claim for patent
infringement. The patent infringement claim is scheduled for trial to commence
on July 31, 2000. Management believes the Company has valid defenses against
Trident's claims. There can be no assurance as to the results of the patent
infringement suit and the counter-suit for antitrust filed by Trident.
The Company in the past has been, and in the future may be, notified that it
may be infringing the intellectual property rights of third parties. For
example, in February 1997, Cirrus Logic Inc. ("Cirrus Logic") sent the Company
written notice asserting that the Company's MagicGraph128, MagicGraph128V and
MagicGraph128ZV products infringe six United States patents held by Cirrus
Logic. Since receiving the notice of alleged infringement, the Company has
advised Cirrus Logic that the Company does not believe that any of its products
infringe any claims of the patents. The Company also has undergone a
confidential external infringement review and has conducted its own internal
infringement review, and the Company continues to believe that the Cirrus Logic
infringement allegations are unfounded. However, there can be no assurances that
Cirrus Logic will not file a lawsuit against the Company or that the Company
would prevail in any such litigation. Any protracted litigation by Cirrus Logic
or the success of Cirrus Logic in any such litigation could have a material and
adverse effect on the Company's financial position or results of operations.
Any patent litigation, whether or not determined in the Company's favor or
settled by the Company, would at a minimum be costly and could divert the
efforts and attention of the Company's management and technical personnel from
productive tasks, which could have a material adverse effect on the
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Company's business, financial condition and results of operations. There can be
no assurance that current or future infringement claims by third parties or
claims for indemnification by other customers or end users of the Company's
products resulting from infringement claims will not be asserted in the future
or that such assertions, if proven to be true, will not materially adversely
affect the Company's business, financial condition and results of operations. In
the event of any adverse ruling in any such matter, the Company could be
required to pay substantial damages, which could include treble damages, cease
the manufacturing, use and sale of infringing products, discontinue the use of
certain processes or to obtain a license under the intellectual property rights
of the third party claiming infringement. There can be no assurance, however,
that a license would be available on reasonable terms or at all. Any limitations
on the Company's ability to market its products, or delays and costs associated
with redesigning its products or payments of license fees to third parties, or
any failure by the Company to develop or license a substitute technology on
commercially reasonable terms could have a material adverse effect on the
Company's business, financial condition and results of operations.
BACKLOG
Sales of the Company's products are primarily made pursuant to standard
purchase orders that are cancelable without significant penalties. These
purchase orders are subject to price renegotiations and to changes in quantities
of products and delivery schedules in order to reflect changes in customers'
requirements and manufacturing availability. Also, many of the Company's
customers are moving to "just in time" relationships with their vendors, whereby
orders for product deliveries are not provided to the supplier until just prior
to the requested delivery. A large portion of the Company's sales are made
pursuant to short lead-time orders. In addition, the Company's actual shipments
depend on the manufacturing capacity of the Company's suppliers and the
availability of products from such suppliers. As a result of the foregoing
factors, the Company does not believe that backlog is a meaningful indicator of
future sales.
EMPLOYEES
As of January 31, 2000, the Company employed a total of 278 full-time
employees, including 179 in research and development, 17 in customer service and
applications engineering, 20 in sales and marketing, 27 in manufacturing and 35
in finance and administration. The Company also employs, from time to time, a
number of temporary and part-time employees as well as consultants on a contract
basis. The Company's employees are not represented by a collective bargaining
organization, and the Company believes that its relations with its employees are
good.
MANAGEMENT
EXECUTIVE OFFICERS
The executive officers of the Company as of January 31, 2000 are as follows:
NAME AGE POSITION
- ---- --- ---------------------------------------------------
Prakash C. Agarwal........................ 46 President, Chief Executive Officer and Director
Kamran Elahian............................ 45 Chairman of the Board
Amnon Fisher*............................. 52 Vice President, General Manager--Consumer Products
Daniel Hauck.............................. 44 Vice President, Worldwide Sales
Ibrahim Korgav............................ 51 Vice President, Manufacturing Operations
Dr. Clement Leung......................... 50 Vice President, R&D NeoMagic Technology Labs
Merle McClendon........................... 44 Vice President, Finance and Chief Financial Officer
Deepraj Puar *............................ 53 Vice President, Technology
Mark Singer............................... 40 Vice President, Corporate Marketing
- ------------------------
* Resigned as Officers of the Company effective February 1, 2000
8
Prakash C. Agarwal, a co-founder of the Company, has been President, Chief
Executive Officer, and a Director of the Company since its inception in 1993.
Mr. Agarwal has over 20 years of engineering, marketing and general management
experience in the semiconductor industry. Prior to joining the Company, he was
employed as Vice President and General Manager of Cirrus Logic's Portable
Product Division. In addition to his duties as President of the Company,
Mr. Agarwal is on the Board of Directors of TelenComm, Inc. Mr. Agarwal holds a
BS and a MS degree in Electrical Engineering from the University of Illinois.
Kamran Elahian, a co-founder of the Company, has been Chairman of the Board
since the Company's inception in 1993. Mr. Elahian has co-founded several
Silicon Valley companies since 1981, including CAE Systems, Inc., a
computer-aided engineering software company, Cirrus Logic, a semiconductor
manufacturer and Momenta Corporation, a pen-based computer company. In addition
to his duties as Chairman of the Company, Mr. Elahian is the Chairman of
PlanetWeb, Inc., Centillium Communications, Inc., Actelis Networks, Cahoots,
KangarooNet, and Co-Chairman and founder of Schools Online, a not for profit
company. Mr. Elahian holds a BS degree in Computer Science and Mathematics and a
Masters of Engineering from the University of Utah.
Amnon Fisher joined the Company in June 1998 as Senior Vice President and
General Manager of the Consumer Products division. Mr. Fisher has over 20 years
experience in product development, marketing, and general management in the
semiconductor industry. Prior to joining NeoMagic, Mr. Fisher served as vice
president and general manager of LSI Logic Corporation, Consumer Products
Division. Prior to that, Mr. Fisher held management positions at Fujitsu
Microelectronics, Digital Equipment Corporation, and National Semiconductor
Corporation. Mr. Fisher holds a BS in Electrical Engineering from the Israel
Institute of Technology and a MS in Electrical Engineering from the City College
of New York.
Daniel Hauck joined the Company in March 1998 as Vice President, Worldwide
Sales. Mr. Hauck has over 18 years of sales experience. Prior to joining
NeoMagic, he was employed at Cirrus Logic where he spent 12 years in a variety
of senior sales management positions, most recently as Vice President, Business
Development & Asia Pacific Sales. Prior to Cirrus Logic, Mr. Hauck was employed
by Technology Marketing, Inc. and Rockwell International. Mr. Hauck is a
graduate of The Ohio Institute of Technology where he received his BS in
Electronic Engineering Technology.
Ibrahim Korgav joined the Company in 1994 as Vice President, Manufacturing
Operations. Mr. Korgav has over 20 years of experience in manufacturing
management in the semiconductor industry. Prior to joining the Company,
Mr. Korgav was the Vice President of Quality/Operations and a co-founder of
Micro Linear Corporation, a semiconductor manufacturer. Mr. Korgav holds a BS
degree in Engineering from Middle East Technical University (Ankara, Turkey) and
a MS degree in Mechanical Engineering from the University of Tulsa.
Dr. Clement Leung, a co-founder of the Company, served as Vice President,
Engineering from the Company's inception in 1993 until March 1998, when he
became Vice President, R&D, NeoMagic Technology Labs. Dr. Leung has 14 years of
engineering and management experience in the semiconductor industry, primarily
in the areas of integrated circuit design and computer-aided design systems.
Prior to joining the Company, he was employed as Director of Engineering of
Cirrus Logic's Portable Product Division. Dr. Leung holds a SB, a SM and a Ph.D.
degree from the Massachusetts Institute of Technology.
Merle McClendon joined the Company in January 1997 as Vice President,
Finance and Chief Financial Officer. Ms. McClendon has 20 years of finance
experience. From 1993 through 1996, Ms. McClendon was Vice President and
Corporate Controller at S3 Inc., a semiconductor company. From 1980 to 1993,
Ms. McClendon was employed by Deloitte & Touche, most recently as a Senior
Manager. Ms. McClendon is on the Board of Directors of Schools Online, a not for
profit company, is a Certified Public Accountant and holds a BS degree in
Business Administration from San Jose State University.
9
Deepraj Puar, a co-founder of the Company, has been Vice President,
Technology since the Company's inception in 1993. Mr. Puar has over 30 years of
engineering and management experience in the semiconductor industry, primarily
in the area of Memory and ASIC chip development. Prior to joining the Company,
Mr. Puar worked at Cirrus Logic, Signetics and Texas Instruments. Mr. Puar holds
a B.TECH degree from the Indian Institute of Technology, Kanpur (India) and a
MSEE degree from Michigan State University.
Mark Singer joined NeoMagic in March 1997 as a Senior Staff member managing
Strategic Business Planning and Corporate Communications. Mr. Singer has over
17 years management experience in the semiconductor industry. Prior to joining
NeoMagic, Mr. Singer was employed at Cirrus Logic, where he was a co-founder. A
California native, Mr. Singer holds a BS degree from the University of
California, Berkeley, School of Business.
ITEM 2. PROPERTIES
The Company's corporate headquarters, which is also its principal
administrative, selling and marketing, customer service, applications
engineering and product development facility, is located in Santa Clara,
California and consists of approximately 90,000 square feet under leases which
expire on April 30, 2003. The Company leases offices in Manchester, England,
Raanana, Israel, India, Hong Kong, Taiwan and Texas under operating leases that
expire at various times through September 2004. The Company believes its
existing facilities are adequate for its current needs, but that additional
space for growth will be required in the future.
ITEM 3. LEGAL PROCEEDINGS
In December 1998, the Company filed a lawsuit in the United States District
Court for the District of Delaware against Trident Microsystems, Inc. The suit
alleges that Trident's embedded DRAM graphics accelerators infringe certain
patents held by the Company. In January 1999, Trident filed a counter claim
against the Company alleging an attempted monopolization in violation of
antitrust laws, arising from NeoMagic's filing of the patent infringement action
against Trident in December. The Court has stayed all litigation concerning
Trident's antitrust claim pending resolution of NeoMagic's claim for patent
infringement. The patent infringement claim is scheduled for trial to commence
on July 31, 2000. Management believes the Company has valid defenses against
Trident's claims. There can be no assurance as to the results of the patent
infringement suit and the counter-suit for antitrust filed by Trident.
The Company in the past has been, and in the future may be, notified that it
may be infringing the intellectual property rights of third parties. For
example, in February 1997, Cirrus Logic Inc. sent the Company written notice
asserting that the Company's MagicGraph128, MagicGraph128V and MagicGraph128ZV
products infringe six United States patents held by Cirrus Logic. Since
receiving the notice of alleged infringement, the Company has advised Cirrus
Logic that the Company does not believe that any of its products infringe any
claims of the patents. The Company also has undergone a confidential external
infringement review and has conducted its own internal infringement review, and
the Company continues to believe that the Cirrus Logic infringement allegations
are unfounded. However, there can be no assurances that Cirrus Logic will not
file a lawsuit against the Company or that the Company would prevail in any such
litigation. Any protracted litigation by Cirrus Logic or the success of Cirrus
Logic in any such litigation could have a material and adverse effect on the
Company's financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
10
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Our common stock trades on the Nasdaq National Market under the symbol NMGC.
The high and low closing sales prices set forth below are as reported on the
Nasdaq National Market.
QUARTERLY DATA 1(ST) 2(ND) 3(RD) 4(TH)
FISCAL 2000 -------- -------- -------- --------
Price range common stock:
Low....................................................... $ 9.84 $ 7.31 $ 7.63 $ 7.78
High...................................................... $14.19 $11.88 $10.13 $11.69
FISCAL 1999
Price range common stock:
Low....................................................... $15.75 $12.63 $10.69 $14.00
High...................................................... $21.81 $22.50 $17.13 $22.88
The Company had 202 stockholders of record as of February 27, 2000. The
Company has not paid any dividends on its common stock. The Company currently
intends to retain earnings for use in its business and does not anticipate
paying cash dividends to stockholders.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected financial data is qualified in its entirety by and
should be read in conjunction with the more detailed consolidated financial
statements and related notes included elsewhere herein.
FIVE YEAR SUMMARY
YEAR ENDED JANUARY 31,
----------------------------------------------------
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net sales................................... $259,698 $240,503 $124,654 $40,792 $ 243
Cost of sales............................... 181,332 142,881 73,171 28,650 165
-------- -------- -------- ------- -------
Gross margin................................ 78,366 97,622 51,483 12,142 78
Operating expenses:
Research and development.................. 37,957 31,756 16,091 8,606 4,934
Sales, general and administrative......... 18,505 20,740 12,290 6,522 1,606
Acquired in-process research and
development(3).......................... 5,348 -- -- -- --
Legal costs(1)............................ -- -- -- (1,503) 610
-------- -------- -------- ------- -------
Total operating expenses................ 61,810 52,496 28,381 13,625 7,150
Income (loss) from operations............... 16,556 45,126 23,102 (1,483) (7,072)
Interest income and other................. 3,793 3,810 2,643 1,366 385
Interest expense.......................... (838) (1,339) (1,298) (1,046) (182)
-------- -------- -------- ------- -------
Income (loss) before income taxes........... 19,511 47,597 24,447 (1,163) (6,869)
Provision for income taxes.................. 6,806 16,395 3,667 -- --
-------- -------- -------- ------- -------
Net income (loss)........................... $ 12,705 $ 31,202 $ 20,780 $(1,163) $(6,869)
======== ======== ======== ======= =======
Basic net income (loss) per share(2)........ $ .51 $ 1.32 $ .95 $ (.07)
Diluted net income (loss) per share(2)...... $ .49 $ 1.19 $ .82 $ (.07)
Weighted common shares outstanding(2)....... 24,898 23,710 21,924 17,238
Weighted common shares outstanding assuming
dilution(2)............................... 25,834 26,153 25,336 17,238
11
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents.................... $ 33,097 $ 36,631 $ 35,004 $13,458 $6,877
Short-term investments 63,429 56,097 36,016 -- --
Working capital.............................. 101,948 92,839 53,518 1,398 4,069
Total assets................................. 149,136 144,374 107,583 27,464 8,749
Long-term obligations -- -- 646 1,194 749
Total stockholders' equity................... 120,215 103,395 65,127 4,200 4,542
OTHER DATA:
Number of employees.......................... 278 234 162 94 44
Revenue/employee............................. $ 934 $ 1,028 $ 769 $ 434 $ 6
- ------------------------
(1) Relates to amounts provided by the Company for estimated legal fees
associated with litigation which was dismissed in the second quarter of
fiscal 1997. The $1.5 million benefit in legal costs during the year ended
January 31, 1997 was due to the reversal of previously provided legal fees
as a result of such dismissal. See Note 11 of Notes to Consolidated
Financial Statements.
(2) See Note 1 and Note 4 of Notes to Consolidated Financial Statements.
(3) See Note 3 of Notes to Consolidated Financial Statements.
12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND
RESULTS OF OPERATIONS
When used in this discussion, the words "expects," "anticipates," "believes"
and similar expressions are intended to identify forward-looking statements.
Such statements, which include statements concerning the timing of availability
and functionality of products under development, the availability, cost and
yield of products from the Company's suppliers, product mix, trends in average
selling prices, the growth rate of the market for notebook PCs, competition, the
percentage of export sales and sales to strategic customers, the adoption or
retention of industry standards, are subject to risks and uncertainties,
including those set forth below under "Factors that May Affect Results," that
could cause actual results to differ materially from those projected. These
forward-looking statements speak only as of the date hereof. The Company
expressly disclaims any obligation or undertaking to release publicly any
updates or revisions to any forward-looking statements contained herein, to
reflect any changes in the Company's expectations with regard thereto or any
changes in events, conditions or circumstances on which any such statement is
based.
OVERVIEW
The Company designs, develops and markets high-performance semiconductor
solutions for sale to original equipment manufacturers of mobile computing
products including notebook PCs, and over the last several years, began
development of digital cameras and DVD drives. In February 2000, the Company
announced that it is seeking to sell the DVD product group which is still in the
research and development phase. The Company has determined that embedded DRAM
now provides less value in the current DVD market than anticipated. The DVD
market is very cost sensitive, and has little regard for low-power electronics
or form-factor integration, taking the product line further away from the
Company's embedded DRAM technology. The Company pioneered the first commercially
available high-performance silicon technology that integrates DRAM, complex
logic and analog circuits into a single chip. The Company's proprietary
MagicWare-TM- technology eliminates the need to drive signals off-chip to
discrete memory, achieving its performance advantage while actually lowering the
power consumption and extending the battery life for smaller, lighter weight
portable devices. The first commercial application for the Company's technology
is in the design, development and marketing of multimedia accelerators for sale
to notebook computer manufacturers. The Company's MagicGraph128 and
MagicMedia256 families of pin-compatible multimedia accelerators incorporate
128-bit and 256-bit memory buses, respectively.
All of the Company's net sales in fiscal 2000, 1999 and 1998 were derived
from sales of its multimedia accelerator products, and the Company expects this
trend to continue at least through fiscal 2002. The Company generally recognizes
revenue upon title passage for product sales directly to customers. The
Company's policy is to defer recognition of revenue of shipments to distributors
until the distributors sell the product. Historically, a majority of the
Company's sales have been to a limited number of customers. Sales to the
Company's top five customers accounted for 77.1%, 64.9%, and 66.5% of the
Company's net sales for fiscal 2000, 1999 and 1998, respectively. The Company
expects that a substantial portion of sales of its products will continue to be
to a limited number of customers for the foreseeable future. The customers
contributing significant amounts of net sales have varied and will continue to
vary depending on the timing and success of new product introductions by
NeoMagic and its customers.
The Company's products require semiconductor wafers manufactured with
state-of-the-art fabrication equipment and technology. NeoMagic currently has
strategic relationships with Mitsubishi Electric Corporation, Infineon
Technologies, formerly Siemens Aktiengesellschaft Semiconductor Group has also
purchased wafers from Toshiba Corporation during fiscal 2000 to produce its
semiconductor wafers and uses other independent contractors to perform assembly,
packaging and testing. The Company's foundry relationships are formalized in
separate five-year wafer supply agreements. These relationships enable the
Company to concentrate its resources on product design and development, where
NeoMagic believes it has greater competitive advantages, and to eliminate the
high cost of owning and operating a semiconductor wafer fabrication facility.
The Company depends on these suppliers to allocate to the Company a portion
13
of their manufacturing capacity sufficient to meet the Company's needs, to
produce products of acceptable quality and at acceptable manufacturing yields
and to deliver those products to the Company on a timely basis. The Company
purchases wafers and pays an agreed price for wafers meeting certain acceptance
criteria. All of the Company's products are assembled and tested by independent
vendors. To date, the majority of the Company's wafer purchases, which
constitute a majority of its cost of sales, have been priced in Japanese yen. As
a result, exchange rate fluctuations can affect the Company's gross margin. The
Company experienced such fluctuations during fiscal 2000 which have negatively
impacted the Company's gross margin and earnings. The Company has in the past
hedged its exposure to fluctuations in the exchange rate between the Japanese
yen and the United States dollar by purchasing forward contracts and options and
may continue to do so in the future.
Under its wafer supply agreements, the Company is obligated to provide
rolling 12-month forecasts of anticipated purchases and place binding purchase
orders up to three to four months prior to shipment. If the Company cancels a
purchase order, the Company must pay cancellation penalties based on the status
of work in process or the proximity of the cancellation to the delivery date.
Forecasts of monthly purchases may not increase or decrease by more than a
certain percentage from the previous month's forecast without the manufacturer's
consent. Thus, the Company must forecast and place purchase orders for wafers
long before it receives purchase orders from its own customers. This limits the
Company's ability to react to fluctuations in demand for its products, which can
be unexpected and dramatic and from time-to-time will cause the Company to have
an excess or a shortage of wafers for a particular product, which could cause
the Company to take charges for excess inventory or miss revenue opportunities.
Prior to fiscal 1997, the Company was primarily engaged in research and
development and testing of its products. Accordingly, the majority of its
operating expenses were related to research and development activities. In
fiscal 1997, in connection with the commencement of commercial sales of its
products, the Company accelerated its investment in sales, marketing,
manufacturing and administrative infrastructures. Throughout fiscal 2000, the
Company has continued to devote resources to research and development efforts as
well as to make additional investments in sales, marketing, manufacturing and
administrative infrastructures to support the increased sales. The Company
expects to continue to devote substantial resources to research and development
efforts for the foreseeable future. However, given the Company's projections for
downward revenue and its corresponding cost control efforts, research and
development expenses are expected to decrease in absolute dollars in fiscal
2001. All of the Company's research and development costs have been expensed as
incurred.
The Company's fiscal year end is January 31. Any references herein to a
fiscal year refers to the year ended January 31 of such year.
14
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain financial
data as a percentage of net sales:
YEAR ENDED JANUARY 31,
------------------------------
2000 1999 1998
-------- -------- --------
Net sales.............................................. 100.0% 100.0% 100.0%
Cost of sales.......................................... 69.8 59.4 58.7
----- ----- -----
Gross margin........................................... 30.2 40.6 41.3
Operating expenses:
Research and development............................. 14.6 13.2 12.9
Sales, general and administrative.................... 7.1 8.6 9.9
Acquired in process research and development......... 2.1 -- --
Total operating expenses........................... 23.8 21.8 22.8
----- ----- -----
Income from operations................................. 6.4 18.8 18.5
Interest income and other............................ 1.5 1.6 2.1
Interest expense..................................... (.4) (.6) (1.0)
----- ----- -----
Income before income taxes............................. 7.5 19.8 19.6
Provision for income taxes............................. 2.6 6.8 2.9
----- ----- -----
Net income............................................. 4.9% 13.0% 16.7%
===== ===== =====
NET SALES
The Company's net sales to date have been generated from the sale of its
multimedia accelerators. The Company's products are used in, and its business is
dependent upon, the personal computer industry with sales primarily in Asia,
Japan, and the United States. Net sales were $259.7 million, $240.5 million and
$124.7 million in fiscal 2000, 1999 and 1998, respectively. Net sales increased
primarily from shipments of the Company's products in its MagicMedia256 and
MagicGraph128 product families, and the Company's investment in sales and
marketing activities. The Company expects that the percentage of its net sales
represented by any one product or type of product may change significantly from
period to period when new products are introduced and existing products reach
the end of their product life cycles. Due to competition, the life cycle of the
Company's products and the trend in the market toward lower cost notebook
computers, the Company's products have, and may continue to experience declining
unit average selling prices over time, which at times can be substantial. The
Company expects that net sales, for fiscal 2001 will decline over the current
year levels due to delays in new product introductions which have caused the
Company to lose design wins and market share. Over the past year, delays in the
introduction and ramping of the Company's new products have caused the Company
to miss current OEM's design cycles which has eroded the Company's market share
and has had a material adverse effect on the Company's business, financial
condition and results of operations.
Sales to customers located outside the United States (including sales to
foreign operations customers with headquarters in the United States, and foreign
system manufacturers that sell to United States-based OEMs) accounted for 80.2%,
83.6% and 83.2% of net sales in fiscal 2000, 1999 and 1998, respectively. The
Company expects that export sales will continue to represent a significant
portion of net sales, although there can be no assurance that export sales as a
percentage of net sales will remain at current levels. All sales transactions
were denominated in United States dollars.
Five customers accounted for 20.2%, 19.6%, 12.9%, 12.3% and 12.1%
respectively, of net sales in fiscal 2000. Three customers accounted for 19.8%,
17.1% and 10.5%, respectively, of net sales in fiscal 1999. Five customers
accounted for 14.4%, 13.6%, 13.5%, 13.3% and 11.7%, respectively, of net sales
in
15
fiscal 1998. The Company expects a significant portion of its future sales to
remain concentrated with a limited number of strategic customers. There can be
no assurance that the Company will be able to retain its strategic customers, or
that such customers will not cancel or reschedule orders, or in the event orders
are canceled, that such orders will be replaced by other orders. In addition,
sales to any particular customer may fluctuate significantly from quarter to
quarter. The occurrence of any such events or the loss of a strategic customer
could have a material adverse effect on the Company's operating results.
GROSS MARGIN
Gross margin was $78.4 million, $97.6 million and $51.5 million in fiscal
2000, 1999, and 1998, respectively. The gross margin percentage decreased to
30.2% of net sales in fiscal 2000 from 40.6% of net sales in fiscal 1999 due
primarily to increases in wafer prices for the Company's MagicMedia256 product
line. Also affecting fiscal 2000 gross margin was a decrease in the dollar/yen
exchange rate throughout the year and low production yields on new product
ramp-ups. The gross margin percentage decreased to 40.6% of net sales in fiscal
1999 from 41.3% of net sales in fiscal 1998 due to declines in unit average
selling prices stemming from the market trend toward lower priced notebooks and
increased competition. These factors were mitigated in part by other product
cost decreases stemming from the Company's cost reduction efforts.
In the future, the Company's gross margin percentages may be affected by
increased competition and related decreases in unit average selling prices
(particularly with respect to older generation products), changes in the mix of
products sold, timing of volume shipments of new products, the availability and
cost of products from the Company's suppliers, manufacturing yields
(particularly on new products), continued trend in the market toward lower
priced notebooks, and foreign currency exchange rate fluctuations. The Company
has announced that it expects declines in revenues, gross margins, and results
of operations for fiscal 2001 based on the delay of the introduction of its new
products. As a result of this delay, the Company's existing products may
experience sharper declines in demand and average selling prices and the
Company's inventories on order may not be fully sellable at acceptable prices
which would necessitate inventory write-offs either for excess quantities or
lower of cost or market considerations. Such a write-off, when determined, would
have a material adverse effect on gross margins and results of operations.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses include compensation and associated costs
relating to development personnel, operating system software costs and
prototyping costs, which are comprised of photomask costs and pre-production
wafer costs. Research and development expenses were $38.0 million,
$31.8 million and $16.1 million in fiscal 2000, 1999 and 1998, respectively. The
Company has made, and intends to continue to make, significant investments in
research and development to remain competitive by developing new and enhanced
products to serve its identified markets. Research and development expenses
increased in fiscal 2000 primarily as a result of increased employee related
expenses on higher headcount, increased prototyping costs associated with new
product development, and amortization of intangibles associated with the
acquisitions of ACL and the Optical Drive Development Group of Mitel
Corporation. Because the Company's projections for downward revenue will result
in corresponding cost control, research and development expenses are expected to
decrease in absolute dollars in fiscal 2001.
SALES, GENERAL AND ADMINISTRATIVE EXPENSES
Sales, general and administrative expenses were $18.5 million,
$20.7 million and $12.3 million in fiscal 2000, 1999, and 1998 respectively.
Sales, general and administrative expenses decreased in fiscal 2000 due
primarily to lower outside commissions and the Company's ongoing cost reduction
efforts. Sales, general and administrative expenses increased in fiscal 1999 as
a result of increased commissions associated with higher sales levels and
increased employee related expenses largely related to additional personnel and
legal costs related to the intellectual property lawsuit. Because the
Company's projections for downward revenue will result in decreased commissions
and cost control, sales, general and administrative expenses are expected to
decrease in absolute dollars in fiscal 2001.
16
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT
The Company incurred approximately $5.3 million of charges for acquired
in-process research and development ("IPRD") in connection with its fiscal 2000
acquisitions of the Optical Drive Storage Group from Mitel Semiconductor and
Associative Computers, Ltd., ("ACL"). The amount allocated to the acquired
in-process research and development was determined using the income approach,
which discounts expected future cash flows from each of the technologies under
development to their net present value, at an appropriate risk-adjusted rate of
return. The technologies under development were analyzed to determine their
technological accomplishments; the existence and utilization of core
technologies; the existence of any alternative future uses; their technological
feasibility; and the stage of completion of the development activities,
including the efforts required to complete the remaining development activities.
The technologies under development were classified as developed technology, IPRD
completed, IPRD to be completed or future development activities. Projected
future net cash flows attributable to each of these categories were discounted
to their net present value using a discount rate which was derived based on the
Company's estimated weighted average cost of capital plus a risk premium to
account for the inherent uncertainty surrounding the successful completion of
each project and the associated estimated cash flows. The IPRD charge includes
only the fair value of IPRD completed. The technologies underlying the IPRD
amounts were deemed to have no alternative future uses. The fair value assigned
to developed technology is included in other assets, and no value was assigned
to the IPRD to be completed or future development activities. The Company
believes that these fair values do not exceed the amount a third party would pay
for each such in-process technology. Failure to timely deliver commercially
viable products to the market, or to achieve market acceptance or the revenue
and expense forecasts could have a significant impact on the financial results
and operations of the acquired businesses.
The total charge for IPRD for the Optical Drive Storage Group transaction,
completed in February 1999, was approximately $2.0 million. The technologies
acquired from this group were mixed signal analog and digital video disk ("DVD")
optical storage read-channel technologies. The Optical Drive Storage Group's
development efforts were estimated to be approximately 50% complete at the date
of the acquisition. NeoMagic planned to integrate these technologies with its
embedded DRAM technologies and develop products for the DVD Notebook, DVD
Desktop and DVD Player/Recorder markets. Prior to the acquisition, the Optical
Drive Storage Group had generated no revenues. Revenue from commercially viable
products for these markets was not anticipated until late calendar 2000 or in
2001. The discount rates used for the IPRD technologies and developed
technologies were 40% and 25%, respectively.
The total charge for IPRD for the ACL transaction, completed in
February 1999, was approximately $3.3 million. The technologies acquired from
ACL were associative array (parallel) processing architectures that enabled high
speed computing. ACL's development efforts were estimated to be approximately
42% complete at the date of the acquisition. NeoMagic planned to integrate these
technologies with its embedded DRAM technologies and develop products for the
digital camera and camcorder markets. Prior to the acquisition, ACL had
generated no revenues. Revenues from commercially viable products for the above
markets were not anticipated until late calendar 2001. The discount rates used
for the IPRD technologies and developed technologies were each 50%.
Except for the Company's plans to no longer pursue the development
activities acquired from the Optical Drive Storage Group, there have been no
significant changes in the assumptions used in the IPRD analyses relating to the
timing of expected future revenues or the amount of development expenses and
efforts expected to be required to bring the in process research and development
technologies to completion and to achieve such revenues. Although management
believes it will realize its net investment in the technology and related net
assets acquired from the Optical Drive Storage Group ($1.5 million), significant
uncertainties exist and circumstances currently unknown may result in the need
to recognize an impairment of those assets in future financial periods. Should
impairment occur, the Company's financial condition and results of operations
could be materially adversely impacted.
17
INTEREST INCOME AND OTHER
The Company earns interest on its cash and short-term investments. Interest
income and other was $3.8 million, $3.8 million and $2.6 million in fiscal 2000,
1999, and 1998, respectively. The increase in fiscal 1999 stemmed from higher
interest income earned on higher cash and short-term investment balances.
INTEREST EXPENSE
The Company pays interest and commissions on wafer purchases and interest on
its leases. Interest expense was $0.8 million, $1.3 million, and $1.3 million in
fiscal 2000, 1999 and 1998, respectively. The decrease in interest expense from
fiscal 1999 to fiscal 2000 reflects lower interest and commission rates. See
Note 6 of Notes to Consolidated Financial Statements for further discussion of
the working capital line of credit.
INCOME TAXES
The Company's effective tax rate was 35% in fiscal 2000, 34% in fiscal 1999
and 15% in fiscal 1998. The increase in the effective tax rate from fiscal 1999
to fiscal 2000 was due to the establishment of a valuation allowance related to
acquisitions during the year, offset by research and development credits. The
increase in the fiscal 1999 effective tax rate stems from net operating loss
carryforwards being fully utilized in fiscal 1998. The difference between the
Company's fiscal 2000 effective tax rate and the statutory rate is primarily due
to the utilization of research and development tax credits. The difference
between the Company's fiscal 1998 effective tax rate and the statutory rate is
primarily due to the utilization of the Company's net operating loss
carryforwards.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash, cash equivalents and short-term investments were
$96.5 million, $92.7 million, and $71.0 million as of the end of fiscal 2000,
1999 and 1998, respectively. The increase in cash, cash equivalents and
short-term investments in fiscal 2000 stems primarily from cash provided by
operating activities, offset in part by the two acquisitions completed in
February 1999 for $10.4 million and purchases of property, plant and equipment
of $7.4 million. The increase in cash, cash equivalents and short-term
investments in fiscal 1999 stems primarily from cash provided by operating
activities, offset in part by the pay-down of the working capital line of credit
and investments in property, plant and equipment. In January 1998, in exchange
for a lower commission rate, the payment terms on wafer purchases were changed
from payable in 90 days from shipment to payable in 30 days from shipment.
Working capital increased $9.1 million to $101.9 million at January 31, 2000
from $92.8 million at January 31, 1999.
Cash and cash equivalents provided from operating activities were
$19.6 million, $45.1 million and $15.4 million in fiscal 2000, 1999, and 1998
respectively. The cash provided from operating activities in fiscal 2000 stems
primarily from $12.7 million in net income and a decrease in inventory, offset
in part by a decrease in accounts payable. The cash provided from operating
activities in fiscal 1999 stems primarily from $31.2 million in net income, an
increase in accounts payable and a reduction in deferred taxes, offset in part
by increased accounts receivable, inventory and other assets. The cash provided
from operating activities in fiscal 1998 stems primarily from $20.8 million in
net income and increases in accrued expenses and accounts payable, offset by
increases in accounts receivable, inventory and deferred taxes.
Net cash used for investing activities in fiscal 2000, 1999 and 1998 was
$25.2 million, $25.5 million and $40.5 million respectively. Net cash used for
investing activities in fiscal 2000 related primarily to cash paid of
$10.4 million for two acquisitions, $7.3 million of net purchases of short-term
investments and $7.4 million of investments in property, plant and equipment.
Net cash used for investing activities in fiscal 1999 related primarily to
$20.1 million of net purchases of short-term investments and $5.4 million of
investments in property, plant and equipment. Net cash used for investing
activities in fiscal 1998 was related to net purchases of short-term investments
and investments in property, plant and equipment.
18
Continued operation of the Company's business may require higher levels of
capital equipment purchases, technology investments, foundry investments and
other payments to secure manufacturing capacity. The timing and amount of future
investments will depend primarily on the level of the Company's future revenues.
Net cash provided by financing activities in fiscal 2000 was $2.0 million,
compared to net cash used for financing activities of $18.0 million in fiscal
1999 and net cash provided by financing activities of $46.7 million in fiscal
1998. The net cash provided by financing activities in fiscal 2000 primarily
represents net proceeds from the issuance of common stock. The net cash used for
financing activities in fiscal 1999 related primarily to the pay-down of the
working capital line of credit of $21.0 million, offset in part by proceeds from
the issuance of common stock. The net cash provided by financing activities in
fiscal 1998 primarily represents net proceeds from the initial public offering
of $37.8 million, net proceeds related to the working capital line of credit and
the release of amounts previously held as restricted cash.
At January 31, 2000, the Company's principal sources of liquidity included
cash, cash equivalents and short-term investments of $96.5 million. The Company
believes that it will not generate cash over the upcoming twelve months, and
believes the current cash, cash equivalents and short-term investments will
satisfy the Company's projected working capital and capital expenditure
requirements through the next twelve months. Investments will continue in new
product development in new and existing areas of technology. The Company's
future capital requirements will depend on many factors including the rate of
net sales, the timing and extent of spending to support research and development
programs, the timing of any new product introductions and enhancements to
existing products, and market acceptance of the Company's products. The Company
expects that it may need to raise additional equity or debt financing in the
future. There can be no assurance that additional equity or debt financing, if
required, will be available on acceptable terms or at all.
IMPACT OF CURRENCY EXCHANGE RATES
Because the Company currently purchases the majority of its wafers under
purchase contracts denominated in yen, significant appreciation in the value of
the yen relative to the value of the U.S. dollar would make the wafers
relatively more expensive to the Company, which would have a material adverse
effect on the Company's business, financial condition and results of operations.
The Company generally enters into foreign currency forward contracts to minimize
short-term foreign currency fluctuation exposures related to these firm purchase
commitments. The Company does not use derivative financial instruments for
speculative or trading purposes. The Company's accounting policies for these
instruments are based on the Company's designation of such instruments as
hedging transactions. The criteria the Company uses for designating an
instrument as a hedge include its effectiveness in risk reduction and one-to-one
matching of derivative instruments to underlying transactions. Notwithstanding
the measures the Company has adopted, due to the unpredictability and volatility
of currency exchange rates and currency controls, there can be no assurance that
the Company will not experience currency losses in the future, nor can the
Company predict the effect of exchange rate fluctuations upon future operating
results. The Company experienced such fluctuations during fiscal 2000 which have
negatively impacted the Company's gross margin and results of operations.
IMPACT OF YEAR 2000
As of the date of this filing, the Company has not incurred any significant
business disruptions as a result of Year 2000 issues. We are also not aware of
any material problems with our customers or vendors. Accordingly, we do not
anticipate incurring material expenses or experiencing any material disruptions
as a result of any Year 2000 issues.
19
FACTORS THAT MAY AFFECT RESULTS
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
NeoMagic's quarterly and annual results of operations are affected by a
variety of factors that could materially adversely affect net sales, gross
margin and income from operations. These factors include, among others,
availability and cost of manufacturing capacity, demand for the Company's
products, fluctuations in manufacturing yields, changes in product or customer
mix (i.e. the portion of the Company's revenues represented by the Company's
various products and customers), incorrect forecasting of future revenues,
foreign exchange rate fluctuations, unanticipated delays or problems in the
introduction or performance of the Company's next generation of products, the
Company's ability to introduce new products in accordance with OEM design
requirements and design cycles, the Company's ability to leverage its technology
across new markets, market acceptance of the end-products of the Company's
customers, changes in the timing of product orders due to unexpected delays in
the introduction of products of the Company's customers or due to the life
cycles of such customers' products ending earlier than anticipated, new product
announcements or product introductions by NeoMagic's competitors, competitive
pressures resulting in lower average selling prices, the volume of orders that
are received and can be fulfilled in a quarter, the rescheduling or cancellation
of orders by customers which cannot be replaced with orders from other
customers, supply constraints for the other components incorporated into its
customers' notebook PC products, the unanticipated loss of any strategic
relationship, seasonality associated with the tendency of PC sales to increase
in the second half of each calendar year, the level of expenditures for research
and development and sales, general and administrative functions of the Company,
costs associated with future litigation, and costs associated with protecting
the Company's intellectual property. Any one or more of these factors could
result in the Company failing to achieve its expectations as to future revenues
and profits. The Company may be unable to adjust spending sufficiently in a
timely manner to compensate for any unexpected sales shortfall, which could
materially adversely affect quarterly operating results. Accordingly, the
Company believes that period-to-period comparisons of its operating results
should not be relied upon as an indication of future performance. In addition,
the results of any quarterly period are not indicative of results to be expected
for a full fiscal year. In future quarters, the Company's operating results may
be below the expectations of public market analysts or investors. Since the
Company's announcement of its expectation of declining revenues, gross margins
and operating results, the market price of the Common Stock has been and is
expected to be for some time in the future, materially adversely affected.
RISKS ASSOCIATED WITH DEPENDENCE ON THE NOTEBOOK PC MARKET
The Company's products are currently used only in notebook PCs. The notebook
PC market is characterized by rapidly changing technology: evolving industry
standards, frequent new product introductions and significant price competition,
resulting in short product life cycles and regular reductions of average selling
prices over the life of a specific product. Although the notebook PC market has
grown substantially in recent years, there is no assurance that such growth will
continue. A reduction in sales of notebook PCs, or a reduction in the growth
rate of such sales, would likely reduce demand for the Company's products.
Moreover, such changes in demand could be large and sudden. Since PC
manufacturers often build inventories during periods of anticipated growth, they
may be left with excess inventories if growth slows or if they have incorrectly
forecasted product transitions. In such cases, the PC manufacturers may abruptly
suspend substantially all purchases of additional inventory from suppliers such
as the Company until the excess inventory has been absorbed. Any reduction in
the demand for notebook PCs in general, or for a particular product that
incorporates the Company's multimedia accelerators, could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company's ability to compete in the future will depend on its ability to
identify and ensure compliance with evolving industry standards. Unanticipated
changes in industry standards could render the Company's products incompatible
with products developed by major hardware manufacturers and
20
software developers, including Intel Corporation and Microsoft Corporation. The
Company could be required, as a result, to invest significant time and effort to
redesign its products to ensure compliance with relevant standards. If the
Company's products are not in compliance with prevailing industry standards for
a significant period of time, the Company could miss crucial OEM design cycles,
which could result in a material adverse effect on the Company's business,
financial condition and results of operations. Over the past year, delays in the
introduction and ramping of the Company's new products have caused the Company
to miss current OEM's design cycles which has eroded the Company's market share
and has had a material adverse effect on the Company's business, financial
condition and results of operations. In addition, the Company's products are
designed to afford the notebook PC manufacturer significant advantages with
respect to product performance, power consumption and size. To the extent that
other future developments in notebook PC components or subassemblies incorporate
one or more of the advantages offered by the Company's products, the market
demand for the Company's products may be negatively impacted, which could result
in a material adverse effect on the Company's business, financial condition and
results of operations.
PRODUCT CONCENTRATION, RISKS ASSOCIATED WITH MULTIMEDIA PRODUCTS
The Company's revenues currently are entirely dependent on the market for
multimedia accelerators for notebook PCs, and on the Company's ability to
compete in that market. Since the Company has no other revenue generating
product line, the Company's revenues and results of operations would be
materially adversely affected if for any reason it were unsuccessful in selling
multimedia accelerators or technology advances eliminated or reduced the demand
for such accelerators. The notebook PC market frequently undergoes transitions
in which products rapidly incorporate new features and performance standards on
an industry-wide basis. If the Company's products were unable to support the new
feature sets or performance levels stemming from such a transition, the Company
would likely not have the opportunity to compete for new design wins until it
was able to incorporate the new feature sets or performance requirements into
its products. A failure to develop products with required feature sets or
performance standards, or a delay as short as a few months in bringing a new
product to market, could significantly reduce the Company's net sales for a
substantial period, which would have a material adverse effect on the Company's
business, financial condition and results of operations. In fiscal 2000, the
Company experienced a manufacturing delay in bringing its new product into the
market in the required time frame with the appropriate feature set, resulting in
an adverse effect to the Company's results of operations for fiscal 2000. These
events are expected to continue to cause a material adverse effect on the
Company's business, financial condition and results of operations in fiscal
2001.
The notebook PC multimedia market is characterized by extreme price
competition. Leading-edge products may command higher average selling prices,
but prices decline throughout the product life cycle as comparable and more
advanced products are introduced into the market. As a result, the Company's
ability to maintain average selling prices and gross margins depends
substantially on its ability to continue introducing new products. Its ability
to maintain gross margins is also dependent upon its ability to reduce product
costs throughout a product life cycle by instituting cost reduction design
changes and yield improvements, persuading customers to adopt cost-reduced
versions of its products, and successfully managing its manufacturing and
subcontractor relationships. Failure by the Company to continually design and
introduce advanced products in a timely manner and to reduce product costs on
these older products would have, and is having, a material adverse effect on the
Company's net sales, gross margins and results of operations. As a result of the
delay and interruption of new product introductions, the Company will experience
a material adverse effect on revenues, gross margins and operating results for
fiscal 2001. Accordingly, the Company has announced its plan to restructure its
business for the expected decreased revenue related to its current expectations.
21
CONSUMER PRODUCT EXECUTION
The Company announced the formation of the Consumer Products division in
June 1998. The division was formed to explore consumer semiconductor product
opportunities in emerging markets such as digital video disks, digital cameras,
and other consumer products that can benefit from the advantages of embedded
DRAM MagicWare-TM- technology pioneered by NeoMagic. In February 1999, the
Company completed two acquisitions to further the development efforts of the
Consumer Products division. The Company acquired the Optical Drive Development
Group and associated DVD intellectual properties from Mitel Semiconductor in
Manchester, England and the assets and intellectual properties of ACL of
Tel Aviv, Israel from Robomatix Technologies Ltd. The DVD and digital camera
markets are new and evolving. Any such new product development program faces
substantial risks and uncertainties, including risks as to the costs, timing and
results of engineering efforts, competitive risks and market development risks.
In February 2000, the Company announced that it is seeking to sell the DVD
product group that is still in the research and development phase. The Company
has determined that embedded DRAM now provides less value in the current DVD
market than previously anticipated. The evolving DVD market is very cost
sensitive, and has little regard for low-power electronics or form-factor
integration, taking the product line further away from the Company's embedded
DRAM technology. The Company's ability to compete in new markets such as digital
camera and other consumer products will depend on its ability to identify and
ensure compliance with evolving industry standards, develop and market
compelling semiconductor solutions, and deliver those solutions to the market in
a timely and cost effective manner. There can be no assurance that future
products the Company expects to introduce will incorporate the features,
functionality and pricing demanded by the market, or will be introduced within
the appropriate window of market demand. The failure of the Company to
successfully introduce new products and achieve market acceptance for such
products could have a material adverse effect on the Company's business,
financial condition and results of operations. As a result of the delay in
introducing its products in a time frame and cost structure that makes such
products competitive, the Company is currently reconsidering its product plans
and research and development efforts for fiscal 2001. The Company cannot predict
what impact these efforts will have on future periods.
CUSTOMER CONCENTRATION
The Company's sales are concentrated within a limited customer base in the
notebook PC market. The Company expects that a small number of customers will
continue to account for a substantial portion of its net sales for the
foreseeable future. Furthermore, the majority of the Company's sales are made on
the basis of purchase orders rather than pursuant to long-term purchase
agreements. As a result, the Company's business, financial condition and results
of operations could be materially adversely affected by the decision of a single
customer to cease using the Company's products, or by a decline in the number of
notebook PCs sold by a single customer.
EFFECTS OF CHANGES IN DRAM PRICING
The Company's products feature large DRAM memory integrated with analog and
logic circuitry on a single chip, while its competitors often provide discrete
analog and logic circuitry to be used in conjunction with DRAM supplied by
others. The selling prices of the Company's products reflect many factors,
including the prices of DRAM chips. As the Company places firm purchase
commitments for wafers some 3 to 5 months in advance, significant reductions in
the market price of DRAM could cause the Company's products to become less
competitively priced relative to competing discrete solutions with
non-integrated DRAM. In this circumstance, the Company could be forced to
respond to pricing pressures precipitated by changes in the DRAM market by
reducing the average selling prices of its products to current and prospective
customers. Recently, the DRAM market has experienced significant price erosion,
which has been a factor in the overall decline in the average selling price of
the Company's products. Because the Company's product costs cannot be adjusted
as rapidly as changes in the market price of DRAM, the
22
Company's business, financial condition and results of operations may be
materially adversely affected by unanticipated changes in the price of DRAM.
COMPETITION
The market for multimedia accelerators for notebook PCs in which the Company
competes is intensely competitive and is characterized by rapid technological
change, evolving industry standards and declining average selling prices.
NeoMagic believes that the principal factors of competition in this market are
performance, price, features, power consumption, size and software support. The
ability of the Company to compete successfully in the rapidly evolving notebook
PC market depends on a number of factors, including success in designing and
subcontracting the manufacture of new products that implement new technologies,
product quality, reliability, price, the efficiency of production, design wins
for NeoMagic's integrated circuits, ramp up of production of the Company's
products for particular system manufacturers, end-user acceptance of the system
manufacturers' products, market acceptance of competitors' products and general
economic conditions. There can be no assurance that the Company will be able to
compete successfully in the future.
NeoMagic competes with major domestic and international companies, some of
which have substantially greater financial and other resources than the Company
with which to pursue engineering, manufacturing, marketing and distribution of
their products. The Company's principal competitors include ATI Technologies
("ATI"), Chips & Technologies, Inc. ("Chips & Technologies"- in January 1998,
Intel Corporation acquired Chips and Technologies), S3 Incorporated ("S3") and
Trident Microsystems, Inc. ("Trident"). NeoMagic may also face increased
competition from new entrants into the notebook PC multimedia accelerator market
including companies currently selling products designed for desktop PCs. Some of
the Company's competitors, including Chips & Technologies and Trident have
announced or introduced multimedia accelerator products that integrate large
DRAM with analog and logic circuitry on a single chip. Certain of the Company's
competitors may offer products with more functionality and / or higher processor
speeds at the expense of battery life and power consumption than the Company's
product offerings. These feature sets may be more competitive for certain
applications than the Company's products. ATI, during 1999, produced and
increased market share with a Multi-Chip Module (MCM) accelerator solution. The
MCM solution increases access memory both internally in the packaged module and
externally, with connections to discrete memory on the motherboard, for higher
performance at the expense of battery life and power consumption. Some of the
Company's competitors, including Chips & Technologies and Trident, have
announced or introduced multimedia accelerator products that integrate large
DRAM with analog and logic circuitry on a single chip. These feature sets may be
more competitive for certain applications than the Company's products. Potential
competition also could come from manufacturers that integrate the multimedia
accelerator with other systems components. For example, Intel Corporation is in
production with products that integrate microprocessors and graphics
accelerators. Further, several of the Company's competitors have announced plans
to develop products that integrate the multimedia accelerator with the core
logic chip set. The successful commercial introduction by competitors of
products that integrate DRAM with analog and logic circuitry on a single chip,
or that eliminate the need for a separate multimedia accelerator in notebook
PCs, could have a material adverse effect on the Company's business, financial
condition and operating results.
Some of the Company's current and potential competitors operate their own
manufacturing facilities. Since the Company does not operate its own
manufacturing facility and must make binding commitments to purchase products,
it may not be able to reduce its costs and cycle time or adjust its production
to meet changing demand as rapidly as companies that operate their own
facilities, which could have a material adverse effect on the Company's results
of operations. The Company expects that its revenues will decline significantly
from the prior year's revenue and accordingly is monitoring its inventory levels
for product on hand and on order. The Company orders wafers for deliveries at
least 3-5 months in advance and with the additional time to assemble and test
wafers, the Company can have orders for finished goods that will not be
available for up to six months into the future. If the Company does not have
sufficient demand for its products and cannot cancel its current and future
commitments without material impact, the Company may experience excess
inventory, which will result in write-offs affecting gross margin and results of
operations.
23
DEPENDENCE ON MANUFACTURING RELATIONSHIPS
The Company's products require wafers manufactured with state-of-the-art
fabrication equipment and techniques. Mitsubishi Electric and Toshiba in Japan
and Infineon in Germany currently manufacture the Company's wafers. Each of
these manufacturing relationships is covered under the terms of a five-year
wafer supply agreement. The Company expects that, for the foreseeable future,
some of its products will be manufactured by a single source. Since, in the
Company's experience, the lead time needed to establish a strategic relationship
with a new DRAM partner is at least 12 months, and the estimated time for a
foundry to switch to a new product line ranges from four to nine months, there
may be no readily available alternative source of supply for specific products.
A manufacturing disruption experienced by any of the Company's manufacturing
partners or the failure of one of the Company's manufacturing partners to
dedicate adequate resources to the production of the Company's products would
have a material adverse effect on the Company's business, financial condition
and results of operations. Furthermore, in the event that the transition to the
next generation of manufacturing technologies by the Company's manufacturing
partners is unsuccessful, the Company's business, financial condition and
results of operations would be materially and adversely affected.
There are many other risks associated with the Company's dependence upon
third party manufacturers, including: reduced control over delivery schedules,
quality, manufacturing yields and cost; the potential lack of adequate capacity
during periods of excess demand; limited warranties on wafers supplied to the
Company; and potential misappropriation of NeoMagic's intellectual property. The
Company is dependent on its manufacturing partners to produce wafers with
acceptable quality and manufacturing yields, deliver those wafers on a timely
basis to the Company's third party assembly subcontractors and to allocate to
the Company a portion of their manufacturing capacity sufficient to meet the
Company's needs. Although the Company's products are designed using the process
design rules of the particular manufacturer, there can be no assurance that the
Company's manufacturing partners will be able to achieve or maintain acceptable
yields or deliver sufficient quantities of wafers on a timely basis or at an
acceptable cost. Additionally, there can be no assurance that the Company's
manufacturing partners will continue to devote adequate resources to the
production of the Company's products or continue to advance the process design
technologies on which the manufacturing of the Company's products are based.
Over the past year, the company has experienced supply-related issues including
insufficient allocation of manufacturing capacity, yield issues and difficulties
of its partner to successfully transition to a next generation manufacturing
technology. These problems have had a material effect on the Company's business,
financial condition and results of operations which the Company expects will
continue into fiscal 2001.
The Company's products are assembled and tested by third party
subcontractors. The Company does not have long-term agreements with any of these
subcontractors. Such assembly and testing is conducted on a purchase order
basis. As a result of its reliance on third party subcontractors to assemble and
test its products, the Company cannot directly control product delivery
schedules, which could lead to product shortages or quality assurance problems
that could increase the costs of manufacturing or assembly of the Company's
products. Due to the amount of time normally required to qualify assembly and
test subcontractors, product shipments could be delayed significantly if the
Company were required to find alternative subcontractors. Any problems
associated with the delivery, quality or cost of the assembly and test of the
Company's products could have a material adverse effect on the Company's
business, financial condition and results of operations.
INVENTORY RISK
Under its wafer supply agreements with Mitsubishi Electric, Toshiba and
Infineon, the Company is obligated to provide rolling 12-month forecasts of
anticipated purchases and to place binding purchase orders three to four months
prior to shipment from the suppliers. The Company expects that its revenues will
decline significantly from the prior year's revenue and accordingly is
monitoring its inventory levels for product on hand and on order. The Company
orders wafers for deliveries at least 3-5 months in advance
24
and with the additional time to assemble and test wafers, the Company can have
orders for finished goods that will be available up to six months into the
future. If the Company does not have sufficient demand for its products and
cannot cancel its current and future commitments without material impact, the
Company may experience excess inventory, which will result in a write-off
affecting gross margin and results of operations. If the Company cancels a
purchase order, it must pay cancellation penalties based on the status of work
in process or the proximity of the cancellation to the delivery date. Forecasts
of monthly purchases may not increase or decrease by more than a certain
percentage from the previous month's forecast without the manufacturer's
consent. Thus, the Company must make forecasts and place purchase orders for
wafers long before it receives purchase orders from its own customers. This
limits the Company's ability to react to fluctuations in demand for its
products, which can be unexpected and dramatic, and from time-to-time will cause
the Company to have an excess or shortage of wafers for a particular product.
Also, many of the Company's customers are moving to "just in time" relationships
with their vendors, which can shift the risk of carrying inventory back to the
supplier. As a result of the long lead-time for manufacturing wafers and the
increase in "just in time" ordering by PC manufacturers, semiconductor companies
such as the Company from time-to-time must take charges for excess inventory.
Significant write-offs of excess inventory could have a material adverse effect
on the Company's financial condition and results of operations. Conversely,
failure to order sufficient wafers would cause the Company to miss revenue
opportunities and, if significant, could impact sales by the Company's
customers, which could adversely affect the Company's customer relationships and
thereby materially adversely affect the Company's business, financial condition
and results of operations. At January 31, 2000, the Company has issued
outstanding purchase orders totaling over $45.0 million with its manufacturing
partners for the delivery of wafers over the next five months. If orders from
NeoMagic's customers do not meet the Company's expectations, the Company may be
required to incur cancellation charges related to the purchase orders with its
manufacturing partners and/or charges for the write off of excess inventory.
MANUFACTURING YIELDS
The fabrication of semiconductors is a complex and precise process. Because
NeoMagic's products feature the integration of large DRAM memory with analog and
logic circuitry on a single chip, a manufacturer must obtain acceptable yields
of both the memory and logic portions of such products, compounding the
complexity of the manufacturing process. As a result, the Company may face
greater manufacturing challenges than its competitors. Minute levels of
contaminants in the manufacturing environment, defects in masks used to print
circuits on a wafer, difficulties in the fabrication process or other factors
can cause a substantial percentage of wafers to be rejected or a significant
number of die on each wafer to be nonfunctional. Many of these problems are
difficult to diagnose and time consuming or expensive to remedy. As a result,
semiconductor companies often experience problems in achieving acceptable wafer
manufacturing yields, which are represented by the number of good die as a
proportion of the total number of die on any particular wafer. The Company
purchases wafers, not die, and pays an agreed upon price for wafers meeting
certain acceptance criteria. Accordingly, the Company bears the risk of the
yield of good die from wafers purchased meeting the acceptance criteria. The
Company is currently experiencing such yield problems which has affected, and is
expected to continue to, materially adversely affect the Company's net sales,
gross margins and results of operations in fiscal 2001.
Semiconductor manufacturing yields are a function of both product design,
which is developed largely by the Company, and process technology, which is
typically proprietary to the manufacturer. Historically, the Company has
experienced lower yields on new products. Since low yields may result from
either design or process technology failures, yield problems may not be
effectively determined or resolved until an actual product exists that can be
analyzed and tested to identify process sensitivities relating to the design
rules that are used. As a result, yield problems may not be identified until
well into the production process, and resolution of yield problems would require
cooperation by and communication between the Company and the manufacturer. For
example, a design error that resulted in lower than expected yields of finished
products caused the Company to take a $1.2 million charge in fiscal 1997. This
risk is compounded by the
25
offshore location of the Company's manufacturers, increasing the effort and time
required identifying, communicating and resolving manufacturing yield problems.
As the Company's relationships with new manufacturing partners develop, yields
could be adversely affected due to difficulties associated with adopting the
Company's technology and product design to the proprietary process technology
and design rules of each manufacturer. Any significant decrease in manufacturing
yields could result in an increase in the Company's per unit product cost and
could force the Company to allocate its available product supply among its
customers, potentially adversely impacting customer relationships as well as
revenues and gross margins. There can be no assurance that the Company's
manufacturers will achieve or maintain acceptable manufacturing yields in the
future. The inability of the Company to achieve planned yields from its
manufacturer for its newest product, the MagicMedia256XL+, has had, and is
expected to continue to have, a material adverse effect on the Company's net
sales, gross margins and results of operations in fiscal 2001.
DEPENDENCE ON NEW PRODUCT DEVELOPMENT, RAPID TECHNOLOGICAL CHANGE
The Company's business, financial condition and results of operations will
depend to a significant extent on its ability to maintain its position in the
market for multimedia accelerator products that integrate large DRAM with analog
and logic circuitry on a single chip. As a result, the Company believes that
significant expenditures for research and development will continue to be
required in the future. The notebook PC market for which the Company's products
are designed is intensely competitive and is characterized by rapidly changing
technology, evolving industry standards and declining average selling prices.
Notebook PC manufacturers demand products incorporating rich features and
functionality in order to achieve product differentiation. The Company must
anticipate the features and functionality that the consumer of notebook PCs will
demand, incorporate those features and functionality into products that meet the
exacting design requirements of the notebook PC manufacturers, price its
products competitively, and introduce the products to the market on a timely
basis. For example, 3-D has become increasingly important for notebook PCs. The
Company's ability to compete may depend on its ability to incorporate these
features in its products. The success of new product introductions is dependent
on several factors, including proper new product definition, timely completion
and introduction of new product designs, the ability of strategic manufacturing
partners to effectively design and implement the manufacture of new products,
quality of new products, differentiation of new products from those of the
Company's competitors and market acceptance of NeoMagic's and its customers'
products. There can be no assurance that the products the Company expects to
introduce will incorporate the features and functionality demanded by system
manufacturers and consumers of notebook PCs, will be successfully developed, or
will be introduced within the appropriate window of market demand. The Company
is currently unable to successfully introduce its new products and achieve
market acceptance for such products at the appropriate cost and feature set
within the window of market demand. This situation will have a material adverse
effect on the Company's business, financial condition and results of operations
in fiscal 2001.
The integration of large DRAM memory with analog and logic circuitry on a
single chip is highly complex and is critical to the Company's success. Because
of the complexity of its products, however, NeoMagic has experienced delays from
time to time in completing development and introduction of new products. In the
event that there are delays in the completion of development of future products,
including the products currently expected to be announced over the next year,
the Company's business, financial condition, and results of operations will be
materially adversely affected. Although the development cycles for the memory
and logic portions of the Company's products have been relatively synchronized
to date, there can be no assurance that this synchronization will continue in
the future. In addition, there can be no assurance that fundamental advances in
either the memory or logic components of the Company's products will not
significantly increase the complexity inherent in the design and manufacture of
the Company's products, rendering the Company's product technologically
infeasible or uncompetitive. The multiple chip solutions offered by some of the
Company's competitors are less complex to design and
26
manufacture than the Company's integrated products. As a result, these
competitive solutions may be less expensive, particularly during periods of
depressed DRAM prices. The time required for competitors to develop and
introduce competing products may be shorter and manufacturing yields may be
better than those experienced by the Company.
As the markets for the Company's products continue to develop and
competition increases, NeoMagic anticipates that product life cycles will
shorten and average selling prices will decline. In particular, average selling
prices and, in some cases, gross margin for each of the Company's products will
decline as the products mature. Thus, the Company will need to continue
introducing compelling new products at relatively higher average selling prices
in order to maintain overall average selling prices. There can be no assurance
that the Company will successfully identify new product opportunities or develop
and bring to market new products in a timely manner. The Company is currently
experiencing difficulties in bringing its latest product to market which will
have a material adverse impact on NeoMagic's business, financial condition and
results of operations for fiscal 2001. Further, there can be no assurance that
products or technologies developed by others will not render NeoMagic's products
or technologies obsolete or uncompetitive, or that the Company's products will
be selected for new designs by its customers.
UNCERTAINTY REGARDING PATENTS AND PROTECTION OF PROPRIETARY RIGHTS
The Company relies in part on patents to protect its intellectual property.
The Company has been issued numerous patents worldwide, each covering certain
aspects of the design and architecture of the Company's multimedia accelerators.
In fiscal 2000, the Company also acquired and/or licensed intellectual
properties, the majority of which were in the areas of mixed signal analog
design and array-based processing as part of the February 1999 acquisitions of
the Optical Drive Development Group and ACL. Additionally, the Company and its
newly acquired businesses have patent applications pending. There can be no
assurance that the Company's pending patent applications, or any future
applications will be approved. Further, there can be no assurance that any
issued patents will provide the Company with significant intellectual property
protection, competitive advantages, or will not be challenged by third parties,
or that the patents of others will not have an adverse effect on the Company's
ability to do business. In addition, there can be no assurance that others will
not independently develop similar products, duplicate the Company's products or
design around any patents that may be issued to the Company.
The Company also relies on a combination of mask work protection,
trademarks, copyrights, trade secret laws, employee and third-party
nondisclosure agreements and licensing arrangements to protect its intellectual
property. Despite these efforts, there can be no assurance that others will not
independently develop substantially equivalent intellectual property or
otherwise gain access to the Company's trade secrets or intellectual property,
or disclose such intellectual prop