Back to GetFilings.com




QuickLinks -- Click here to rapidly navigate through this document



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 intentions and expectations. However, actual events and results could vary significantly based on a variety of factors including, but not limited to: customer acceptance of new NeoMagic products, the market acceptance of handheld system products developed and marketed by customers which use the Company's products, the Company's ability to execute product development plans on schedule, and the Company's ability to access advanced manufacturing technologies in sufficient capacity. These factors along with those set forth below under "Factors that May Affect Future Results," are subject to risks and uncertainties 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

        NeoMagic develops and sells applications processors to enable new generations of handheld systems, offering low power, small form-factor, and high performance multimedia features and performance. Previously, the Company provided semiconductor solutions for the Notebook PC Multimedia Accelerator marketplace. In April 2000, the Company announced its intention to exit this market and is now focused solely on developing, manufacturing and selling applications processors for the Handheld Systems market. The Company has recently begun to generate revenues from this new product effort. Throughout the year, the Company expects to see customers introducing new handheld systems that use the Company's chips, primarily in Japan, Europe, and the Far East. The Company also expects to launch additional new members of its MiMagic™ family of applications processors as fiscal 2003 and fiscal 2004 progresses. The Company anticipates growth in sales for each successive quarter of the fiscal year.

        NeoMagic has established strategic relationships with third-party manufacturing partners to produce semiconductor products for the Company. Pursuant to these strategic relationships, NeoMagic designs the overall product, including the logic and analog circuitry, and the manufacturing partners manufacture the wafers, perform testing and package the products. NeoMagic is focused on leveraging its core competencies in integrating logic, analog and memory, along with graphics, video, 3D and other multimedia technologies, drivers, middleware and operating system software, and power management in its continued development of solutions that facilitate the mobilization of multimedia applications.

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

Results of Operations

Critical Accounting Policies

        The process of preparing financial statements requires the use of estimates on the part of the Company's management. The estimates used by management are based on the Company's historical experiences combined with management's understanding of current facts and circumstances. Certain of the Company's accounting policies are considered critical as they are both important to the portrayal of its financial condition and results and require significant or complex judgment on the part of

Page 11 of 26



management. For a description of what we believe to be the Company's most critical accounting policies and estimates, refer to the Company's Annual Report on Form 10-K for the year ended January 31, 2002 filed with the Securities and Exchange Commission. There have been no changes in any of our accounting policies since January 31, 2002.

Net sales

        Net sales were $494 thousand and $856 thousand for the three months and six months ended July 31, 2002, respectively, compared to $188 thousand and $268 thousand for the three months and six months ended July 31, 2001. Net sales increased due to the Company's shipments of its new applications processors for the Handheld Systems market in the three months and six months ended July 31, 2002. Sales for the six months ended July 31, 2001 were of the Company's legacy notebook products.

        Sales to customers located outside the United States (including sales to the foreign operations of customers with headquarters in the United States, and foreign system manufacturers that sell to United States-based OEMs) accounted for 94% and 100% of net sales in the three months ended July 31, 2002 and 2001, respectively. Export sales accounted for 89% and 98% of net sales in the six months ended July 31, 2002 and 2001, respectively. All sales transactions were denominated in United States dollars.

        Three customers accounted for 46%, 27% and 16% of net sales for the three months ended July 31, 2002. Two customers accounted for 77% and 20% of net sales in the three months ended July 31, 2001. Three customers accounted for 28%, 26%, and 25% of net sales for the six months ended July 31, 2002. Three customers accounted for 54%, 23%, and 14% of net sales for the six months ended July 31, 2001.

Gross Margin (loss)

        Gross margin (loss) were $(226) thousand and $188 thousand for the three months ended July 31, 2002 and 2001, respectively. Gross margin (loss) was $(449) thousand and $261 thousand in the six months ended July 31, 2002 and 2001, respectively. The negative gross margins in the three and six month periods ended July 31, 2002 are due to under absorption of manufacturing overhead resulting from low production levels. The Company's sales in the three and six month periods ended July 31, 2001 were of its fully reserved legacy notebook products.

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, pre-production wafer costs, and amortization of intangibles relating to development stage products. Research and development expenses were $5.5 million and $6.1 million for the three months ended July 31, 2002 and 2001, respectively. Research and development expenses were $12.5 million and $13.3 million for the six months ended July 31, 2002 and 2001, respectively. These expenses include amortization of deferred compensation of $0.1 million and $0.5 million for the three months ended July 31, 2002 and 2001, respectively and $0.8 million and $1.0 million for the six months ended July 31, 2002 and 2001, respectively. The decreases of $0.6 million and $0.8 million in total research and development expenses for the three months and six months ended July 31, 2002 are primarily related to lower consulting costs offset somewhat by increased amortization of acquired and licensed intangibles relating to products which are under research and development stage. Included in the expenses for the six months ended July 31, 2002, were expenses of $0.6 million to write off certain Licensed Intellectual Property. The Company has made, and intends to continue to make, significant investments in research and development as it focuses on developing products for the Handheld Systems market.

Page 12 of 26



Sales, General and Administrative Expenses

        Sales, general and administrative expenses were $2.3 million and $2.1 million for the three months ended July 31, 2002 and 2001, respectively. Sales, general and administrative expenses were $5.7 million and $3.9 million for the six months ended July 31, 2002 and 2001, respectively. These expenses include amortization of deferred compensation of $0.2 million and $0.1 million for the three months ended July 31, 2002 and 2001, respectively and $0.8 million and $0.2 million for the six months ended July 31, 2002 and 2001, respectively. Sales, general and administrative expenses increased in absolute dollars due primarily to increased sales expenses related to the Company's new product efforts for the Handheld Systems market as well as increased amortization of deferred compensation resulting from the acquisition of LinkUp Systems in December 2001.

Special Charges

        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 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.

Income Net of Expenses from Sale of DVD Assets

        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

Page 13 of 26



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 three months ended April 30, 2002.

Interest and Other Income

        The Company earns interest on its cash equivalents, short-term investments, and restricted cash. Interest and other income was $0.7 million and $0.8 million for the three months ended July 31, 2002 and 2001, respectively. Interest and other income was $1.3 million and $2.1 million for the six months ended July 31, 2002 and 2001, respectively. The decrease in interest and other income is primarily due to significantly lower interest rates and to lower cash balances.

Interest Expense

        Interest expense was $0 and $0 for the three months ended July 31, 2002 and 2001, respectively. Interest expense was $0 and $11,000 for the six months ended July 31, 2002 and 2001, respectively. Interest expense for the Company is not significant since the Company does not have any debt instruments outstanding.

Income Taxes

        The Company recorded a $6.3 million tax benefit in the six months ended July 31, 2002, primarily related to changes in the federal tax law. The Job Creation and Worker Assistance Act of 2002 was enacted on March 9, 2002 and contained provisions extending the net loss carry-back period from two to five years. This change will permit the Company to utilize net operating losses incurred in fiscal 2002 to recover taxes paid in prior periods. The $6.3 million benefit represents additional refunds that the Company expects to claim on the 2002 net operating loss carry-back due to the change in tax law.

Liquidity and Capital Resources

        The Company's cash, cash equivalents and short-term investments increased $2.0 million in the six months ended July 31, 2002 to $73.9 million from $71.9 million at January 31, 2002.

        Cash and cash equivalents provided by operating activities for the six months ended July 31, 2002 was $0.7 million, compared to $24.3 million of net cash used in operating activities for the six months ended July 31, 2001. The cash provided by operating activities stems primarily from non-cash depreciation and deferred compensation amortization charges, a decrease in restricted cash and other current assets, and increases in the wafer purchase agreement restructuring liability, accounts payable, and compensation and related benefits partially offset by a net loss of $13.0 million, increases in income taxes receivable and accounts receivable, as well as decreases in income taxes payable and in other accruals.

        Net cash provided by investing activities for the six months ended July 31, 2002, was $7.2 million, compared to $3.0 million of net cash provided by investing activities for the six months ended July 31, 2001. Net cash provided by investing activities for the six months ended July 31, 2002 related primarily to net proceeds from the maturities of short-term investments of $6.4 million and proceeds from the sale of DVD assets of $1.6 million, partially offset by purchases of property, plant and equipment of $0.8 million.

        Net cash provided by financing activities was $0.5 million for the six months ended July 31, 2002, compared to $0.6 million of net cash provided by financing activities for the six months ended July 31,

Page 14 of 26



2001. The net cash provided by financing activities primarily represents net proceeds from the issuance of common stock.

        At July 31, 2002, the Company's principal sources of liquidity included cash, cash equivalents and short-term investments of $73.9 million. The Company believes that it will not generate cash from operations during the next twelve months. The Company 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. After this period, capital requirements will depend on many factors, including general economic conditions, 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. To the extent that existing cash, cash equivalents and short-term investment balances and any cash from operations are insufficient to fund the Company's future activities, the Company 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.

        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 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.

Page 15 of 26


        The Company leases offices in Santa Clara, California, India and Israel under operating leases that expire at various times through April 2010. Future minimum lease payments under non-cancelable operating leases as of July 31, 2002 are as follows:

Fiscal year ending January 31:
(in thousands)

   
2003*   $ 1,065
2004*     1,185
2005     1,057
2006     1,083
2007     1,095
Thereafter     3,497
   
Total minimum lease payments   $ 8,982
   

*
2003 and 2004 are net of sublease income of $60,000 and $30,000, respectively.

Factors that May Affect Future Results

Our Annual and Quarterly Performance May Fluctuate

        The Company's quarterly and annual results of operations are affected by a variety of factors that could materially adversely affect net sales, gross margin and operating results. These factors include, among others, the ability of the Company to increase its customer base and its sales, the abilities of manufacturing subcontractors to make adequate and timely deliveries, access to advanced production process technologies from manufacturing subcontractors, recruiting and retaining employees including those with engineering expertise in new disciplines. In particular, the Company's new product development efforts and customer engagements in System-on-Chip integration and supporting multimedia technologies such as MPEG-4 streaming video represent new endeavors and consequently carry greater risks of successful and timely execution. Any one or more of these factors could result in the Company failing to achieve its expectations as to future revenues and profits. Furthermore, the majority of the Company's sales were historically made, and are expected to continue to be made, on the basis of purchase orders rather than pursuant to long-term purchase agreements, which increases the difficulty of forecasting sales. 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 restructuring in April of 2000, and 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.

We have a Limited Customer Base

        The Company's sales were historically concentrated within a limited customer base in the notebook PC market. The Company has now exited the notebook PC market and is generating revenues from products for the Handheld Systems market. The Company expects to have commitments from only a limited number of customers during fiscal 2003. The Company expects that a small number of customers will account for a substantial portion of its net sales for the foreseeable future. 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 Handheld Systems sold by a single customer.

Page 16 of 26


We May Lose Our Customer Base

        The Company's products are designed to afford the Handheld Systems manufacturer significant advantages with respect to product performance, power consumption and size. To the extent that other future developments in 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.

We Face Intense Competition in Our Markets

        The market for semiconductor solutions for Handheld Systems, in which the Company is now focused, 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 this new rapidly evolving Handheld Systems market depends on a number of factors including, success in designing and subcontracting the manufacture of new products that implement 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, NeoMagic's ability to provide appropriate applications software support, and general economic conditions.

        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 Intel's StrongARM and XScale product lines, Texas Instruments' OMAP product line, and a number of vertically integrated electronics firms who are developing their own solutions. NeoMagic may also face increased competition from new entrants into the Handheld Systems Semiconductor market including companies currently at developmental stages. 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. Although current products for Handheld Systems do not utilize embedded DRAM, the Company's product developments may utilize embedded DRAM technologies to produce System-on-Chip technology for a portion of future product efforts. NeoMagic has significant intellectual properties and historically demonstrated expertise in this technology. The Company is now also exploring alternative technologies such as Multi-Chip module ("MCM") solutions and other packaging related approaches to combining multiple chips. The successful commercial introduction by competitors of products that integrate DRAM with analog and logic circuitry on a single chip, or the inability of the Company to produce products for their new market, 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 may from time-to-time 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 business, financial condition and results of operations.

Our Products May be Incompatible with Evolving Industry Standards and Market Trends

        The Company's ability to compete in the future will also depend on its ability to identify and ensure compliance with evolving industry standards and market trends. Unanticipated changes in market trends and industry standards could render the Company's products incompatible with products

Page 17 of 26



developed by major hardware manufacturers and software developers. As a result, the Company could be required 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 and market trends. There can be no assurance that the Company will be able to 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 market trends and 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.

We Depend on New Product Development to Meet Rapid Market and Technological Change

        The Company is now focused on providing high-performance semiconductor solutions for sale to original equipment manufacturers of Handheld Systems. New product planning is primarily focused on application processors for Handheld Systems, and multimedia technologies for integration into such processors, such as MPEG-4 video compression, image processing, graphics, and audio technologies. The Company's future business, financial condition and results of operations will depend to a significant extent on its ability to develop new products that address these market opportunities. As a result, the Company believes that significant expenditures for research and development will continue to be required in the future.

        The markets for Handheld Systems are emerging opportunities, characterized by rapidly changing infrastructure, evolving industry standards and uncertain average selling prices. The Company must anticipate the features and functionality that consumers and infrastructure providers will demand, incorporate those features and functionality into products that meet the exacting design requirements of equipment manufacturers, price its products competitively and introduce the products to the market on a timely basis. 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 to create or acquire Intellectual Property, 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 the Company'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, will be successfully developed, or will be introduced within the appropriate window of market demand, nor can there be assurance that customers who utilize the Company's semiconductor products will achieve the levels of market success with their own system products that they may project to the Company.

        Because of the complexity of its products, the Company has experienced delays from time to time in completing development and introduction of new products. In addition, the Company is producing and continuing the development of new products in markets in which the Company has little history. In the event that there are delays in ramping production of current products, or in the completion of development of future products, including the products currently under development for introduction over the next 12 to 18 months, the Company's potential future business, financial condition, and results of operations will be materially adversely affected. In addition, the time required for competitors to develop and introduce competing products may be shorter, manufacturing yields may be better, and production costs may be lower than those experienced by the Company.

        The Company has exited the Notebook PC market and is generating revenues from its Handheld System products. Until the Company achieves substantial growth in revenue, it will continue to incur substantial losses. There is no assurance as to how quickly revenues will grow.

Page 18 of 26



We Depend on Third-Party Manufacturers to Produce Our Products

        The Company's products require wafers manufactured with state-of-the-art fabrication equipment and techniques. The Company currently utilizes several foundries for wafer fabrication. 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 wafer fabrication 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 the Company's manufacturing partners, the failure of the Company's manufacturing partners to dedicate adequate resources to the production of the Company's products, or the financial instability of the Company's manufacturing partners 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 partner 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.

We Rely on Third-Party Subcontractors to Assemble and Test Our Products

        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.

We May Encounter Inventory Excess or Shortage

        The Company has wafer supply relationships with several foundries to support the Company's product efforts. Normally, 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. The Company orders wafers for deliveries at least three to five 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

Page 19 of 26



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 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.    As a result of the long lead-time for manufacturing wafers and the increase in "just in time" ordering by manufacturers, semiconductor companies such as the Company from time-to-time must take charges for excess inventory. The Company did in fact incur such charges in fiscal 2001 of $9.2 million. Significant write-offs of excess inventory have had and could continue to 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.

Our Manufacturing Yields May Fluctuate

        The fabrication of semiconductors is an extremely complex process, which typically includes hundreds of process steps. Minute levels of contaminants in the manufacturing environment, defects in masks used to print circuits on a wafer, utilization of equipment with variations and numerous 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 experienced such yield problems in fiscal 2000, which materially adversely affected the Company's net sales, gross margins and results of operations in fiscal 2000 and 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. This risk is compounded by the offshore location of the Company's manufacturers, increasing the effort and time required identifying, communicating and resolving manufacturing yield problems. As the Company's relationships with 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.

Page 20 of 26



Uncertainty and Litigation Risk Associated with Patents and Protection of Proprietary Rights

        The Company relies in part on patents to protect its intellectual property. As of July 31, 2002 the Company has been issued 59 patents, each covering certain aspects of the design and architecture of the Company's products. Additionally, the Company has numerous 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. The Court ruled that there was no infringement by Trident. The Company filed an appeal in the United States Court of Appeals for the Federal Circuit. On April 17, 2002, the United States Court of Appeals for the Federal Circuit affirmed the lower court's judgment of non-infringement on one patent and vacated the courts judgment of non-infringement of another patent, thereby remanding it to the lower court for further proceedings. 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.

        Any patent litigation, whether or not determined in the Company's favor or settled by the Company, would at a minimum be costly and could divert the efforts and attention of the Company's management and technical personnel from productive tasks, which could have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that current or future infringement claims by third parties or claims for indemnification by other customers or end users of the Company's products resulting from infringement claims will not be asserted in the future or that such assertions, if proven to be true, will not materially adversely 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.

Page 21 of 26



We Depend on International Sales and Suppliers

        Export sales have been a critical part of the Company's business. Sales to customers located outside the United States (including sales to the foreign operations of customers with headquarters in the United States and foreign system manufacturers that sell to United States-based OEMs) accounted for 94% and 100% of the Company's net sales for the three months ended July 31, 2002 and 2001, respectively. Export sales accounted for 89% and 98% of net sales in the six months ended July 31, 2002 and 2001, respectively. The Company expects that net sales derived from international sales will continue to represent a significant portion of its total net sales. To date, the Company's international sales have been denominated in United States dollars. Increases in the value of the U.S. dollar relative to the local currency of the Company's customers could make the Company's products relatively more expensive than competitors' products sold in the customer's local currency.

        International manufacturers have produced, and are expected to continue to produce for the foreseeable future, all of the Company's wafers. In addition, many of the assembly and test services used by the Company are procured from international sources. Under the Company's purchase orders with manufacturing suppliers, the wafers are priced in U.S. dollars.

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

We May Need Additional Capital

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

We are Dependent on Qualified Personnel

        The Company's future success depends in part on the continued service of its key engineering, sales, marketing, manufacturing, finance and executive personnel, and its ability to identify, hire and retain additional personnel. There is intense competition for qualified personnel in the semiconductor industry, and there can be no assurance that the Company will be able to continue to attract and retain qualified personnel necessary for the development of its business. The Company has experienced the loss of certain key personnel and also reduced personnel in its restructuring. If the Company's headcount is not appropriate for its future direction and the Company fails to recruit key personnel

Page 22 of 26



critical to its future direction in a timely manner, it may have a material adverse effect on the Company's business, financial condition and results of operations.

Our Stock Price May Be Volatile

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


Item 3.    Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

        The Company's cash equivalents, short-term investments, and restricted cash are exposed to financial market risk due to fluctuations in interest rates, which may affect our interest income. As of July 31, 2002, the Company's cash equivalents, short-term investments, and restricted cash earned interest at an average rate of 3.5%. Due to the short-term nature of the Company's investment portfolio, operating results or cash flows are vulnerable to sudden changes in market interest rates. Assuming a decline of 10% in the market interest rates at July 31, 2002, with consistent cash balances, interest income would be adversely affected by approximately $64,000 per quarter. The Company does not use its investment portfolio for trading or other speculative purposes.

Foreign Currency Exchange Risk

        Currently all of the Company's sales and the majority of its expenses are denominated in U.S. dollars. As a result, the Company has relatively little exposure to foreign currency exchange rate risk. The Company does not currently enter into forward exchange contracts to hedge exposures denominated in foreign currencies or any other derivative financial instruments for trading or speculative purposes. However, in the event exposure to foreign currency risk increases, the Company may choose to hedge those exposures.

Page 23 of 26




Part II.    Other Information

Item 1.    Legal Proceedings

        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. The Court ruled that there was no infringement by Trident. The Company filed an appeal in the United States Court of Appeals for the Federal Circuit. On April 17, 2002, the United States Court of Appeals for the Federal Circuit affirmed the lower court's judgment of non-infringement on one patent and vacated the courts judgment of non-infringement of another patent, thereby remanding it to the lower court for further proceedings. 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.


Item 2.    Changes in Securities

        None.


Item 3.    Defaults Upon Senior Securities

        None.


Item 4.    Submission of Matters to a Vote of Security Holders

        The Annual Meeting of Stockholders was held on June 13, 2002. The matters voted upon at the meeting and results of the voting with respect to those matters were as follows:


 
  Votes For
  Withheld
Prakash C. Agarwal   24,021,448   1,673,621
Brian P. Dougherty   24,376,299   1,318,770
James Lally   24,286,129   1,408,940
Paul Richman   24,287,299   1,407,770
Anil Gupta   24,284,199   1,410,870

Votes For
  Against
  Abstain
24,985,391   617,285   92,393

Votes For
  Against
  Abstain
20,725,948   4,893,445   75,676

Page 24 of 26



Votes For
  Against
  Abstain
25,234,845   421,557   38,667


Item 5.    Other Information

        Not applicable.


Item 6.    Exhibits and Reports on Form 8-K


10.22   Full and Final Release from the Wafer Supply Agreement and the Product Sourcing Agreement
99.1   Financial Statement Certification

Page 25 of 26



SIGNATURES

        Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

    NEOMAGIC CORPORATION
(Registrant)

 

 

/s/  
STEPHEN T. LANZA      
STEPHEN T. LANZA
Chief Financial Officer
(Principal Financial and Accounting Officer)

 

 

September 11, 2002

Page 26 of 26




QuickLinks

INDEX
NEOMAGIC CORPORATION CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (In thousands, except per share data) (Unaudited)
NEOMAGIC CORPORATION CONSOLIDATED CONDENSED BALANCE SHEETS (In thousands)
NEOMAGIC CORPORATION CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited)
NEOMAGIC CORPORATION NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
SIGNATURES