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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q

(Mark One)


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

For the quarter ended July 31, 2002 OR

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

For the transition period from                              to                             

Commission file number 000-22009

NEOMAGIC CORPORATION
(Exact name of Registrant as specified in its charter)

DELAWARE
(State or other jurisdiction
of incorporation or organization)		   77-0344424
(I.R.S. Employer Identification No.)

3250 Jay Street
Santa Clara, California
(Address of principal executive offices)
 
95054
(Zip Code)

(408) 988-7020
(Registrant's telephone number, including area code)

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 ý    No o

The number of shares of the Registrant's Common Stock, $.001 par value, outstanding at July 31, 2002 was 28,275,375

Page 1 of 26

NEOMAGIC CORPORATION
FORM 10-Q


INDEX

 
  
   Page
PART I. CONSOLIDATED CONDENSED FINANCIAL INFORMATION    

Item 1.
Unaudited Consolidated Condensed Financial Statements:
 
 

 
Consolidated Condensed Statements of Operations
Three and Six months ended July 31, 2002 and 2001
 
3

 
Consolidated Condensed Balance Sheets
July 31, 2002 and January 31, 2002
 
4

 
Consolidated Condensed Statements of Cash Flows
Six months ended July 31, 2002 and 2001
 
5

 
Notes to Unaudited Consolidated Condensed Financial Statements
 
6-10

Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
11-23

Item 3.
Quantitative and Qualitative Disclosures about Market Risk
 
23

PART II.
OTHER INFORMATION
 
 

Item 1.
Legal Proceedings
 
24

Item 2.
Changes in Securities
 
24

Item 3.
Defaults Upon Senior Securities
 
24

Item 4.
Submission of Matters to a Vote of Security Holders
 
24-25

Item 5.
Other Information
 
25

Item 6.
Exhibits and Reports on Form 8-K
 
25

Signatures
 
26

Exhibit 10.22
Full and Final Release from the Wafer Supply Agreement and the Product Sourcing Agreement
 
 

Exhibit 99.1
Officer Certification
 
 

Page 2 of 26


Part I.    Financial Information

Item 1.    Financial Statements


NEOMAGIC CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)

 
   Three Months Ended
   Six Months Ended
  
 
   July 31,
2002
   July 31,
2001
   July 31,
2002
   July 31,
2001
  
Net sales   $ 494   $ 188   $ 856   $ 268  

Cost of sales
 
 
720
 
 
—
 
 
1,305
 
 
7
 
   
 
 
 
 

Gross margin (loss)
 
 
(226
)
 
188
 
 
(449
)
 
261
 

Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
  Research and development(1)     5,495     6,104     12,469     13,303  
  Sales, general and administrative(2)     2,341     2,069     5,709     3,948  
  Special Charges     2,200     —     3,600     —  
   
 
 
 
 
    Total operating expenses     10,036     8,173     21,778     17,251  
   
 
 
 
 

Loss from operations
 
 
(10,262
)
 
(7,985
)
 
(22,227
)
 
(16,990
)

Other income (expense), net:
 
 
 
 
 
 
 
 
 
 
 
 
 
  Income, net of expenses, from the sale of DVD assets     —     —     1,580     —  
  Interest income and other income     672     839     1,280     2,144  
  Interest expense     —     —     —     (11 )
   
 
 
 
 

Loss before income tax benefit
 
 
(9,590
)
 
(7,146
)
 
(19,367
)
 
(14,857
)

Income tax benefit
 
 
(339
)
 
(198
)
 
(6,339
)
 
(582
)
   
 
 
 
 

Net loss
 
$
(9,251
)
$
(6,948
)
$
(13,028
)
$
(14,275
)
   
 
 
 
 

Basic and diluted net loss per share
 
$
(0.33
)
$
(0.27
)
$
(0.46
)
$
(0.55
)

Weighted average common shares outstanding for basic and diluted
 
 
28,167
 
 
26,075
 
 
28,102
 
 
25,916
 
(1)
Includes $137 and $509 in amortization of deferred stock compensation for the three months ended July 31, 2002 and July 31, 2001, respectively, and $762 and $1,020 for the six months ended July 31, 2002 and July 30, 2001, respectively.

(2)
Includes $150 and $125 in amortization of deferred stock compensation for the three months ended July 31, 2002 and July 31, 2001, respectively, and $763 and $244 for the six months ended July 31, 2002 and July 31, 2001, respectively.

See accompanying notes to consolidated condensed financial statements.

Page 3 of 26


NEOMAGIC CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS
(In thousands)

 
   July 31,
2002
   January 31,
2002(1)
  
 
   (Unaudited)

    
  
ASSETS  

Current assets:
 
 
 
 
 
 
 
  Cash and cash equivalents   $ 47,390   $ 38,996  
  Short-term investments     26,549     32,914  
  Accounts receivable, net     297     125  
  Inventory     254     78  
  Income tax receivable     9,576     3,303  
  Other current assets     972     3,005  
   
 
 
    Total current assets     85,038     78,421  

Property, plant and equipment, net
 
 
2,954
 
 
3,734
 
Restricted cash     —     15,000  
Employee notes receivable     1,300     1,300  
Goodwill     4,175     3,792  
Intangibles, net     5,282     5,705  
Other assets     350     357  
   
 
 
   
Total assets
 
$
99,099
 
$
108,309
 
   
 
 

LIABILITIES AND STOCKHOLDERS' EQUITY
 

Current liabilities:
 
 
 
 
 
 
 
  Accounts payable     2,381     2,147  
  Compensation and related benefits     1,729     1,253  
  Income taxes payable     3,525     3,934  
  Deferred rent     418     582  
  Deferred gain on the sale of DVD assets     —     1,580  
  Wafer purchase agreement restructuring liability     3,600     —  
  Other accruals     257     607  
   
 
 
Total current liabilities     11,910     10,103  

Commitments and contingencies
 
 
 
 
 
 
 

Stockholders' equity:
 
 
 
 
 
 
 
  Common stock     28     28  
  Additional paid-in-capital     86,876     86,436  
  Deferred compensation     (431 )   (2,004 )
  Accumulated other comprehensive income     17     19  
  Retained earnings     699     13,727  
   
 
 
    Total stockholders' equity     87,189     98,206  
   
 
 
   
Total liabilities and stockholders' equity
 
$
99,099
 
$
108,309
 
   
 
 
(1)
Derived from the January 31, 2002 audited consolidated financial statements included in the Annual Report on Form 10-K of NeoMagic Corporation for fiscal year 2002.

See accompanying notes to consolidated condensed financial statements.

Page 4 of 26


NEOMAGIC CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

 
   Six Months Ended
  
 
   July 31,
2002
   July 31,
2001
  
Operating activities:              
Net loss   $ (13,028 ) $ (14,275 )
Adjustments to reconcile net loss to net cash used for operating activities:              
  Depreciation and amortization     1,544     1,907  
  Loss on disposal of property, plant and equipment     —     77  
  Loss on restructuring of wafer purchase agreement     3,600     —  
  Income, net of expenses, from the sale of DVD assets     (1,580 )   —  
  Amortization of deferred compensation     1,525     1,264  
  Changes in operating assets and liabilities:              
    Accounts receivable     (172 )   179  
    Inventory     (176 )   —  
    Income tax receivable     (6,273 )   896  
    Other current assets     2,033     73  
    Restricted cash     15,000     (15,000 )
    Other assets     47     369  
    Accounts payable     234     (2,121 )
    Compensation and related benefits     476     (742 )
    Income taxes payable     (409 )   3,394  
    Other accruals     (2,094 )   (274 )
   
 
 
Net cash provided by (used for) operating activities     727     (24,253 )
   
 
 

Investing activities:
 
 
 
 
 
 
 
  Net proceeds from the sale of DVD assets     1,580     —  
  Purchases of property, plant and equipment     (764 )   (881 )
  Purchases of short-term investments     (25,987 )   (29,928 )
  Maturities of short-term investments     32,350     33,824  
   
 
 
Net cash provided by investing activities     7,179     3,015  
   
 
 

Financing activities:
 
 
 
 
 
 
 
  Repayment on note receivable from stockholders     —     40  
  Net proceeds from issuance of common stock     488     523  
   
 
 
Net cash provided by financing activities     488     563  
   
 
 

Net increase (decrease) in cash and cash equivalents
 
 
8,394
 
 
(20,675
)
Cash and cash equivalents at beginning of period     38,996     72,852  
   
 
 
Cash and cash equivalents at end of period   $ 47,390   $ 52,177  
   
 
 
Supplemental schedules of cash flow information:              
Cash paid (received) during the period for:              
  Interest   $ —   $ 11  
  Taxes   $ 417   $ (5,700 )

See accompanying notes to consolidated condensed financial statements.

Page 5 of 26


NEOMAGIC CORPORATION
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

1.    Basis of Presentation:

        The unaudited consolidated condensed financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission and include the accounts of NeoMagic Corporation and its wholly owned subsidiaries collectively ("NeoMagic" or the "Company"). Certain information and footnote disclosures, normally included in financial statements prepared in accordance with generally accepted accounting principles, have been condensed or omitted pursuant to such rules and regulations. In the opinion of the Company, the financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial position at July 31, 2002, the operating results for the three and six months ended July 31, 2002 and 2001, and the cash flows for the six months ended July 31, 2002 and 2001. These financial statements and notes should be read in conjunction with the Company's audited financial statements and notes thereto for the year ended January 31, 2002, included in the Company's Form 10-K filed with the Securities and Exchange Commission.

        The results of operations for the three and six months ended July 31, 2002 are not necessarily indicative of the results that may be expected for the year ending January 31, 2003.

        The second fiscal quarters of 2003 and 2002 ended on July 28, 2002 and July 29, 2001, respectively. For ease of presentation, the accompanying financial statements have been shown as ending on the last day of the calendar month of July.

2.    Recent Accounting Pronouncements:

        NeoMagic adopted Statement of Financial Accounting Standards No. 144 (SFAS 144), "Accounting for the Impairment or Disposal of Long-Lived Assets," in the first quarter of fiscal 2003. The effect of adopting SFAS 144 did not have a material impact on the Company's financial position or results of operations.

        NeoMagic adopted Statement of Financial Accounting Standards No. 141 (SFAS 141) Business Combinations, and Statement of Financial Accounting Standards No. 142 (SFAS 142) Goodwill and Other Intangible Assets, in the first quarter of fiscal 2003. The Company is testing goodwill for impairment using the two-step process prescribed in SFAS 142. The Company has completed the first required impairment tests of goodwill and indefinite lived intangible assets as of February 1, 2002 and has determined there are indicators of impairment. The second step of the test, which is to determine the amount of impairment, will be completed by the end of fiscal 2003. Any impairment charge resulting from this impairment test will be reflected as the cumulative effect of a change in accounting principle in the second half of fiscal 2003. The Company has not yet determined the effect that the second step of the impairment test will have on the financial statements.

        In July 2002, the FASB approved SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 addresses the financial accounting and reporting for obligations associated with an exit activity, including restructuring, or with a disposal of long-lived assets. Exit activities include, but are not limited to, eliminating or reducing product lines, terminating employees and contracts and relocating plant facilities or personnel. SFAS No. 146 specifies that a company will record a liability for a cost associated with an exit or disposal activity only when that liability is incurred and can be measured at fair value. Therefore, commitment to an exit plan or a plan of disposal expresses only management's intended future actions and, therefore, does not meet the requirement for recognizing a liability and the related expense. SFAS No. 146 is effective prospectively for exit or disposal activities initiated after December 31, 2002, with earlier adoption encouraged. The Company

Page 6 of 26


does not anticipate that the adoption of SFAS No. 146 will have a material effect on its financial position or results of operations.

3.    Loss Per Share:

        The following data show the amounts used in computing loss per share and the effect on the weighted-average number of shares of diluted potential common stock.

        Per share information calculated on this basis is as follows:

 
   Three Months Ended
July 31,
   Six Months Ended
July 31,
  
(in thousands, except per share amounts)
  
  2002
   2001
   2002
   2001
  
Numerator:                          
 
Net loss
 
$
(9,251
)
$
(6,948
)
$
(13,028
)
$
(14,275
)

Denominator:
 
 
 
 
 
 
 
 
 
 
 
 
 
  Denominator for basic and diluted loss per share—weighted average shares outstanding     28,167     26,075     28,102     25,916  

Basic and diluted loss per share
 
$
(.33
)
$
(.27
)
$
(.46
)
$
(.55
)

        For the three months ended July 31, 2002 and July 31, 2001 and for the six months ended July 31, 2002 and July 31, 2001, respectively, basic earnings per share equals diluted earnings per share due to the net loss for those periods.

4.    Divestitures:

        In April 2000, pursuant to an asset purchase agreement, the Company sold the principal assets of the DVD product group to LSI Logic ("Buyer"). The assets primarily consisted of fixed assets and intangible assets. In exchange for the assets sold to the Buyer, the Company received $11.7 million in a lump-sum cash payment. An additional $2.3 million was contingent on the Company's performance of certain obligations related to the transfer of licenses with third parties to the Buyer. The Company wrote-off approximately $3.6 million in capitalized intellectual property, fixed assets and prepaid expenses related to the DVD product group that was transferred to the Buyer. In addition, the Company accrued approximately $0.6 million in transaction costs and approximately $2.3 million in retention packages for the affected employees during the first quarter of fiscal 2001. During the second quarter of fiscal 2001, the Company incurred additional costs of $0.3 million. During the third quarter of fiscal 2001, the Company received a $1.5 million cash payment which was previously contingent on the Company's performance of certain obligations related to the transfer of licenses with third parties to the Buyer. As a result, the Company recorded a pre-tax gain of approximately $6.5 million on the sale, which is recorded in Income, net of expenses, from the sale of DVD assets on the Consolidated Condensed Statements of Operations for the year ended January 31, 2001. In the first quarter of fiscal 2003, the Company received a $1.6 million cash payment previously contingent on the transfer of licenses with third parties to the Buyer, which is recorded as a gain in the Consolidated Condensed Statements of Operations for the six months ended July 31, 2002.

5.    Inventories:

        Inventories are stated at the lower of cost or market value. Cost is determined by the first-in, first-out method. The Company writes down the inventory value for estimated excess and obsolete inventory, based on management's assessment of future demand and market conditions. If actual future

Page 7 of 26


demand or market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

Inventory consists of:
   July 31,
2002
   January 31,
2002
 
   (in thousands)
Raw materials   $ 23   $ —
Work in process     34     —
Finished goods     197     78
   
 
  Total   $ 254   $ 78
   
 

6.    Accumulated Other Comprehensive Income:

        Total accumulated other comprehensive income was $17 thousand at July 31, 2002 and $19 thousand at January 31, 2002. Accumulated other comprehensive income consists entirely of unrealized gains on available for sale securities.

7.    Goodwill and Other Intangible Assets:

        Effective February 1, 2002, NeoMagic adopted SFAS 142, which was issued by the Financial Accounting Standards Board in July 2001. Under this standard, the Company ceased amortizing goodwill effective February 1, 2002. In addition, on adoption, the Company reclassified certain intangibles with net book value $383 thousand, consisting of assembled workforce and acquisition costs, which are no longer defined as an acquired intangible under SFAS 142, to goodwill. Accordingly, there was no amortization of assembled workforce and acquisition costs recognized during the six months ended July 31, 2002.

        The following table presents a reconciliation of previously reported net loss and net loss per share to the amounts adjusted to exclude goodwill and acquired workforce amortization (in thousands, except per share data):

 
   Three Months Ended
July 31,
   Six Months Ended
July 31,
  
 
   2002
   2001
   2002
   2001
  
Net loss:                          
  As reported   $ (9,251 ) $ (6,948 ) $ (13,028 ) $ (14,275 )
  Goodwill amortization     —     1     —     2  
  Workforce amortization     —     74     —     148  
  Acquisition costs amortization     —     21     —     42  
   
 
 
 
 
  As adjusted   $ (9,251 ) $ (6,852 ) $ (13,028 ) $ (14,083 )
   
 
 
 
 

Basic and diluted net loss per share:
 
 
 
 
 
 
 
 
 
 
 
 
 
  As reported     (0.33 ) $ (0.27 ) $ (0.46 ) $ (0.55 )
  Goodwill amortization     —     —     —     —  
  Workforce amortization     —     0.01     —     0.01  
  Acquisition costs amortization     —     —     —     —  
   
 
 
 
 
  As adjusted   $ (0.33 ) $ (0.26 ) $ (0.46 ) $ (0.54 )
   
 
 
 
 

Page 8 of 26

        Other intangible assets subject to amortization were as follows (in thousands):

July 31, 2002
   Cost
   Accumulated
Amortization
   Net
Licensed intellectual property   $ 2,331   $ —   $ 2,331
Core technology     1,800     (350 )   1,450
Developed technology     900     (263 )   637
Customer relationships     700     (136 )   564
Patents     1,690     (1,468 )   222
Assembled workforce     —     —     —
Acquisition costs     —     —     —
Other     107     (29 )   78
   
 
 
    $ 7,528   $ (2,246 ) $ 5,282
   
 
 
January 31, 2002
   Cost
   Accumulated
Amortization
   Net
Licensed intellectual property   $ 1,811   $ (327 ) $ 1,484
Core technology     1,800     (49 )   1,751
Developed technology     900     (38 )   862
Customer relationships     700     (19 )   681
Patents     1,690     (1,256 )   434
Assembled workforce     1,179     (885 )   294
Acquisition costs     354     (265 )   89
Other     114     (4 )   110
   
 
 
    $ 8,548   $ (2,843 ) $ 5,705
   
 
 

        Amortization expense for other intangible assets was $439 and $779 for the three and six months ended July 31, 2002, respectively. The Company wrote off licensed intangible properties with a cost of $1,484 and accumulated amortization of $327 for licensed intellectual property that was no longer used by the Company in the first quarter of fiscal 2003. The estimated annual amortization expense for other intangible assets is $896 for the remaining two quarters of fiscal 2003, $2,069 for the fiscal year ended January 31, 2004, $1,541 for the fiscal year ended January 31, 2005, and $776 for the fiscal year ended January 31, 2006.

        The Company is testing goodwill for impairment using the two-step process prescribed in SFAS 142. The Company has completed the first required impairment tests of goodwill and indefinite lived intangible assets as of February 1, 2002 and has determined that there are indicators of impairment. The second step of the test, which is to determine the amount of impairment, will be completed by the end of fiscal 2003. Any impairment charge resulting from this impairment test will be reflected as the cumulative effect of a change in accounting principle in the second half of fiscal 2003. The Company has not yet determined the effect that the second step of the impairment test will have on the financial statements.

8.    Wafer Purchase Agreement Restructuring Liability:

        In January 2001, the Company extended its wafer supply agreement with Infineon Technologies AG of Germany ("Infineon") through fiscal 2004 to ensure future wafer supply for the Company's new product efforts. The terms of the agreement provided that NeoMagic would make use of Infineon's 0.20 micron and 0.17 micron embedded DRAM (eDRAM) process technologies. The agreement also provided for access to additional capacity and to more advanced process technologies to be developed by Infineon. NeoMagic provided $15 million in guarantees towards its wafer purchases over the term of

Page 9 of 26


the agreement. The amount of guarantee is included as restricted cash on the balance sheet at January 31, 2002. At the end of fiscal year 2002, due to uncertainties over Infineon's continued eDRAM product development, the Company decided not to use Infineon's eDRAM technology for its future production. Discussions commenced between NeoMagic and Infineon on restructuring the wafer supply agreement with the intent to release NeoMagic from the related guarantee. Based on the progression of the negotiations, the Company has recorded special charges of $1.4 million and $1.1 million respectively during the first and second quarters of fiscal 2003, which represented the value of the settlement offered at that time. Subsequent to the second quarter of fiscal 2003, the Company and Infineon signed an Agreement to settle the contingency based on negotiations that occurred in September 2002. The Company adjusted the wafer purchase agreement restructuring liability by an additional $1.1 million to $3.6 million to reflect the value of the final settlement. These amounts are shown on the Consolidated Condensed Statements of Operations as a special charge for the three and six months ended July 31, 2002. On September 10, 2002 the Company paid $1.5 million in cash and issued 1.7 million shares of common stock to settle the claim under the agreement. As a result of the settlement, $15.0 million of restricted cash was released and reclassified to cash and cash equivalents on the Consolidated Condensed Balance Sheet at July 31, 2002.

9.    Unaudited Pro Forma Information:

        The consolidated statements of operations of NeoMagic presented throughout this report include the operating results of LinkUp Systems from the date of acquisition, December 18, 2001. The following pro forma information for the six months ended July 31, 2001 is presented as if the acquisition of LinkUp was consummated at the beginning of fiscal 2002. This unaudited pro forma data does not purport to represent the Company's actual results of operations had the LinkUp acquisition occurred at the beginning of fiscal 2002 and should not serve as a forecast of the Company's operating results for any future periods.

        The pro forma information for July 31, 2001 is based on historical results of operations of NeoMagic for the six-month period ended July 31, 2001 and historical results of LinkUp from January 1, 2001 to July 31, 2001 (in thousands, except per share data).

 
   Three Months Ended
July 31, 2001
   Six Months Ended
July 31, 2001
  
Pro forma net sales   $ 641   $ 1,175  

Pro forma net loss
 
$
(8,687
)
$
(17,753
)

Pro forma basic and diluted net loss per share
 
$
(0.31
)
$
(0.65
)

Page 10 of 26


Part I.    Financial Information

Item 2.    Management's Discussion and Analysis of Financial Condition 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 reflect management's current i