<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarter ended July 31, 1998
OR
_ TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to __________
Commission file number 333-20031
NEOMAGIC CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0344424
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
3260 Jay Street
Santa Clara, California 95054
(Address of principal executive offices) (Zip Code)
(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 X No
The number of shares of the Registrant's Common Stock, $.001 par value per
share, outstanding at August 23, 1998 was 24,614,000
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Page 1 of 23
<PAGE>
NEOMAGIC CORPORATION
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PAGE
<S> <C>
PART I. CONSOLIDATED CONDENSED FINANCIAL INFORMATION
Item 1. Unaudited Consolidated Condensed Financial Statements:
Consolidated Condensed Statements of Income
Three and six months ended July 31, 1998 and 1997 3
Consolidated Condensed Balance Sheets
July 31, 1998 and January 31, 1998 4
Consolidated Condensed Statements of Cash Flows
Six months ended July 31, 1998 and 1997 5
Notes to Unaudited Consolidated Condensed Financial Statements 6-7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 8-21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 22
Item 2. Changes in Securities and Use of Proceeds 22
Item 3. Defaults Upon Senior Securities 22
Item 4. Submission of Matters to a Vote of Security Holders 22
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 22
Signatures 23
</TABLE>
Page 2 of 23
<PAGE>
Part I. Financial Information
Item I. Financial Statements
NEOMAGIC CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 31, July 31,
------------------------- -------------------------
1998 1997 1998 1997
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Net sales $ 53,396 $ 24,570 $ 101,134 $ 42,851
Cost of sales 31,058 14,522 58,568 25,693
-------- -------- --------- --------
Gross margin 22,338 10,048 42,566 17,158
Operating expenses:
Research and development 7,314 3,338 13,566 5,805
Sales, general and administrative 4,848 2,382 9,204 4,659
-------- -------- --------- --------
Total operating expenses 12,162 5,720 22,770 10,464
-------- -------- --------- --------
Income from operations 10,176 4,328 19,796 6,694
Other income (expense), net:
Interest income and other 919 646 1,894 962
Interest expense (372) (314) (696) (538)
-------- -------- --------- --------
Income before income taxes 10,723 4,660 20,994 7,118
Provision for income taxes 3,753 699 7,348 1,068
-------- -------- --------- --------
Net income $ 6,970 $ 3,961 $ 13,646 $ 6,050
-------- -------- --------- --------
-------- -------- --------- --------
Basic earnings per share $ .30 $ .18 $ .58 $ .29
Diluted earnings per share $ .27 $ .15 $ .52 $ .25
Weighted common shares outstanding 23,595 22,161 23,445 21,003
Weighted common shares outstanding,
assuming dilution 26,033 25,893 26,066 24,646
</TABLE>
See accompanying notes to consolidated condensed financial statements.
Page 3 of 23
<PAGE>
NEOMAGIC CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
July 31, January 31,
1998 1998
-------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 38,589 $ 35,004
Short-term investments 31,245 36,016
Accounts receivable, net 11,099 11,236
Inventory 13,785 9,342
Other current assets 4,249 3,730
---------- ---------
Total current assets 98,967 95,328
Property and equipment, net 7,313 6,232
Deferred tax assets 5,669 5,669
Other assets 597 354
---------- ---------
Total assets $ 112,546 $ 107,583
---------- ---------
---------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Working capital line of credit $ - $ 21,041
Accounts payable 20,999 9,490
Accrued expenses 9,635 10,652
Obligations under capital leases 962 1,273
---------- ----------
Total current liabilities 31,596 42,456
Commitments and contingencies
Stockholders' equity:
Common stock 25 24
Additional paid-in-capital 62,812 61,263
Notes receivable from stockholders (554) (559)
Deferred compensation (2,179) (2,801)
Retained earnings 20,846 7,200
---------- ----------
Total stockholders' equity 80,950 65,127
---------- ----------
Total liabilities and
stockholders' equity $ 112,546 $ 107,583
---------- ----------
---------- ----------
</TABLE>
See accompanying notes to consolidated condensed financial statements.
Page 4 of 23
<PAGE>
NEOMAGIC CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended
July 31,
-------------------------
1998 1997
--------- ----------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income $ 13,646 $ 6,050
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 1,437 715
Amortization of deferred compensation 443 314
Changes in operating assets and liabilities:
Accounts receivable 137 (3,037)
Inventory (4,443) (3,135)
Other current assets (519) (246)
Other assets (243) 435
Accounts payable 11,509 550
Accrued expenses (1,017) 1,998
--------- ---------
Net cash provided by operating activities 20,950 3,644
--------- ---------
--------- ---------
INVESTING ACTIVITIES:
Purchases of property and equipment (2,518) (1,533)
Purchases of short-term investments (24,859) (22,928)
Maturities of short-term investments 29,630 1,000
--------- ---------
Net cash provided by (used for) investing
activities 2,253 (23,461)
--------- ---------
--------- ---------
FINANCING ACTIVITIES:
Payments on lease obligation (311) (582)
Proceeds from working capital line of credit - 24,041
Payments on working capital line of credit (21,041) (23,461)
Net proceeds from issuance of common stock 1,734 37,900
Amounts held as restricted cash - 2,224
--------- ---------
Net cash provided by (used for) financing
activities (19,618) 40,122
--------- ---------
--------- ---------
Net increase in cash and cash equivalents 3,585 20,305
Cash and cash equivalents at beginning
of period 35,004 13,458
--------- ---------
Cash and cash equivalents at end of period $ 38,589 $ 33,763
--------- ---------
--------- ---------
Supplemental schedules of cash flow information
Cash paid during the year for:
Interest $ 696 $ 558
Taxes $ 6,501 $ -
</TABLE>
See accompanying notes to consolidated condensed financial statements.
Page 5 of 23
<PAGE>
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. Certain prior year amounts have been reclassified to conform to
the current year presentation. 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, 1998, the operating results for the three and six months ended July
31, 1998 and 1997 and cash flows for the six months ended July 31, 1998 and
1997. 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, 1998, included in the Company's Form 10-K filed with
the Securities and Exchange Commission.
The results of operations for the six months ended July 31, 1998 are not
necessarily indicative of the results that may be expected for the year
ending January 31, 1999.
The second fiscal quarters of 1999 and 1998 ended on July 26, 1998 and
July 27, 1997, respectively. For ease of presentation, the accompanying
financial statements have been shown as ending on the last day of the
calendar month.
2. Inventory:
Inventory is stated at the lower of cost or market value. Cost is
determined by the first-in, first-out method.
<TABLE>
<CAPTION>
July 31, January 31,
1998 1998
-------- -----------
(in thousands)
<S> <C> <C>
Inventory consists of:
Raw materials $ 1,606 $ 989
Work in process 2,065 1,904
Finished goods 10,114 6,449
------- ------
Total $13,785 $9,342
------- ------
------- ------
</TABLE>
3. Earnings Per Share
The consolidated condensed financial statements are presented in
accordance with Statement of Financial Accounting Standards No. 128 ("SFAS
No. 128"), "Earnings per Share." Basic earnings per common share are computed
using the weighted average number of common shares outstanding during the
period. Diluted earnings per common share incorporate the common equivalent
shares from convertible preferred stock (using the if-converted method) and
the incremental shares issuable upon the assumed exercise of stock options
and warrants (using the treasury stock method).
Page 6 of 23
<PAGE>
<TABLE>
<CAPTION>
Per share information calculated on this basis is as follows:
(in thousands, except per share amount)
Three Months Ended Six Months Ended
July 31, July 31,
----------------------- -------------------------
1998 1997 1998 1997
--------- -------- --------- ---------
<S> <C> <C> <C> <C>
Numerator:
Net income $ 6,970 $ 3,961 $ 13,646 $ 6,050
-------- -------- --------- --------
Denominator:
Denominator for basic earnings per
share - weighted average shares
outstanding 23,595 22,161 23,445 21,003
Effect of dilutive securities:
Employee stock options 2,349 3,457 2,531 3,368
Warrants 89 275 90 275
-------- -------- --------- --------
Dilutive potential common shares 2,438 3,732 2,621 3,643
-------- -------- --------- --------
Denominator for diluted earnings
per share - adjusted
weighted-average shares outstanding 26,033 25,893 26,066 24,646
Basic earnings per share $ .30 $ .18 $ .58 $ .29
Diluted earnings per share $ .27 $ .15 $ .52 $ .25
</TABLE>
4. Comprehensive Income
The Company adopted Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income," ("SFAS 130") during the quarter ended April
30, 1998. SFAS 130 establishes new rules for the reporting and displaying of
comprehensive income and its components; however, the adoption of this
Statement had no impact on the Company's net income or stockholders' equity.
SFAS 130 requires unrealized gains or losses on the Company's
available-for-sale securities and foreign currency translation adjustments to
be included in comprehensive income. Gross unrealized gains and losses on
available-for-sales securities and foreign currency translation adjustments
at July 31, 1998 and 1997 were immaterial.
5. Recently Issued Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement
No. 133, Accounting for Derivative Instruments and Hedging Activities,
effective for fiscal years beginning after June 15, 1999. The standard will
require the Company to recognize all derivatives on the balance sheet at fair
value. Derivatives that are not hedges must be adjusted to fair value through
income. If the derivative is a hedge, depending on the nature of the hedge,
changes in the fair value of derivatives are either offset against the change
in fair value of assets, liabilities, or firm commitments through earnings or
recognized in other comprehensive income until the hedged item is recognized
in earnings. The change in a derivative's fair value related to the
ineffective portion of a hedge, if any, will be immediately recognized in
earnings. The Company expects to adopt the new standard in the fiscal quarter
ended April 31, 2000. The effect of adopting this standard is currently
being evaluated, but it is not expected to have a material effect on the
Company's financial position or results of operations.
Page 7 of 23
<PAGE>
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" and
similar expressions are intended to identify forward-looking statements.
Such statements, which include statements concerning the timing of
availability and functionality of products under development, product mix,
trends in average selling prices, the growth rate of the market for PCs, the
percentage of export sales and sales to strategic customers, the adoption or
retention of industry standards, and the availability and cost of products
from the Company's suppliers, are subject to risks and uncertainties,
including those set forth below under "Factors that May Effect Results," that
could cause actual results to differ materially from those projected. These
forward-looking statements speak only as of the date hereof. The Company
expressly disclaims any obligation or undertaking to release publicly any
updates or revisions to any forward-looking statements contained herein to
reflect any changes in the Company's expectations with regard thereto or any
changes in events, conditions or circumstances on which any such statement is
based.
OVERVIEW
The Company designs, develops and markets multimedia accelerators for
sale to notebook computer manufacturers. The Company has developed the first
commercially available high performance silicon technology that integrates
large DRAM memory with analog and logic circuitry to provide a high
performance multimedia solution on a single chip. The Company's
MagicGraph128 and MagicMedia256 families of pin-compatible multimedia
accelerators incorporates 128-bit and 256-bit memory buses. The Company
believes these products enable notebook PC manufactures to deliver
state-of-the-art multimedia capabilities while decreasing power consumption,
size, system design complexity and cost.
The following information should be read in conjunction with the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" on pages 8-20 of the Company's Fiscal 1998 Annual Report.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain financial
data as a percentage of net sales:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 31, July 31,
---------------------------------------------------
1998 1997 1998 1997
------ ------ ------ ------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 58.2 59.1 57.9 60.0
----- ----- ----- -----
Gross margin 41.8 40.9 42.1 40.0
Operating expenses:
Research and development 13.7 13.6 13.4 13.5
Selling, general and administrative 9.1 9.7 9.1 10.9
----- ----- ----- -----
Total operating expenses 22.8 23.3 22.5 24.4
----- ----- ----- -----
Income from operations 19.0 17.6 19.6 15.6
Other income (expense), net:
Interest income and other 1.7 2.6 1.9 2.2
Interest expense (.7) (1.3) (.7) (1.2)
----- ----- ----- -----
Income before income taxes 20.0 18.9 20.8 16.6
Provision for income taxes 7.0 2.8 7.3 2.5
----- ----- ----- -----
Net income 13.0% 16.1% 13.5% 14.1%
----- ----- ----- -----
----- ----- ----- -----
</TABLE>
Page 8 of 23
<PAGE>
NET SALES
The Company's net sales to date have been generated from the sale of its
multimedia accelerators. The Company's products are used in, and its
business is dependent on, the personal computer industry, with sales
primarily in Asia, Japan, and the United States. Net sales were $53.4
million for the three months ended July 31, 1998, compared to $24.6 million
for the three months ended July 31, 1997. Net sales were $101.1 million for
the six months ended July 31, 1998, compared to $42.9 million for the six
months ended July 31, 1997. Net sales increased primarily as a result of
increased market acceptance of the Company's MagicGraph128 products,
introduction by the Company of additional products in its MagicMedia256
product family which expanded the portion of the market addressed by NeoMagic
products, and the Company's investment in sales and marketing activities.
The Company expects that the percentage of its net sales represented by any
one product or type of product may change significantly from period to period
as new products are introduced and existing products reach the end of their
product life cycles. Due to competitive price pressures, the Company's
products experience declining unit average selling prices over time, which at
times can be substantial.
Export sales accounted for 89.2% and 79.3% of net sales in the three
months ended July 31, 1998 and 1997, respectively. Export sales accounted
for 87.8% and 82.5% of net sales in the six months ended July 31, 1998 and
1997, respectively. Approximately 58.6% and 61.0% of export sales for the
three and six months ended July 31, 1998 were to affiliates of United States
customers. The Company expects that export sales will continue to represent a
significant portion of net sales, although there can be no assurance that
export sales as a percentage of net sales will remain at current levels. All
sale transactions were denominated in U.S. dollars.
Four customers accounted for 23.0%, 18.0%, 11.0% and 10.2% of net sales
for the three months ended July 31, 1998. Five customers accounted for 18.2%,
14.5%, 12.7%, 12.4% and 12.4% of net sales for the three months ended July
31, 1997. Four customers accounted for 19.3%, 18.7%, 10.6% and 10.3% of net
sales for the six months ended July 31, 1998. Five customers accounted for
18.9%, 16.1%, 13.7%, 11.9% and 11.4% of net sales for the six months ended
July 31, 1997. The Company expects a significant portion of its future sales
to remain concentrated within a limited number of strategic customers. There
can be no assurance that the Company will be able to retain its strategic
customers or that such customers will not cancel or reschedule orders or, in
the event orders are canceled, that such orders will be replaced by other
sales. In addition, sales to any particular customer may fluctuate
significantly from quarter to quarter. The occurrence of any such events or
the loss of a strategic customer could have a material adverse effect on the
Company's operating results.
GROSS MARGIN
Gross margin was $22.3 million and $10.0 million for the three months
ended July 31, 1998 and 1997, respectively. Gross margin percentages
increased to 41.8% for the three months ended July 31, 1998 from 40.9% in the
three months ended July 31, 1997. Gross margin was $42.6 million and $17.2
million for the six months ended July 31, 1998 and 1997, respectively. Gross
margin percentages increased to 42.1% for the six months ended July 31, 1998
from 40.0% in the six months ended July 31, 1997. The increase in gross
margin percentage was due primarily to lower wafer pricing and improved
yields on higher production volumes, partially offset by declining average
selling prices.
In the future, the Company's gross margin percentages may be adversely
effected by increased competition and related decreases in unit average
selling prices (particularly with respect to older generation products),
timing of volume shipments of new products, the availability and cost of
products from the Company's suppliers, obtaining satisfactory production
yields and changes in the mix of products sold.
Page 9 of 23
<PAGE>
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses were $7.3 million and $3.3 million for
the three months ended July 31, 1998 and 1997, respectively. Research and
development expenses were $13.6 million and $5.8 million for the six months
ended July 31, 1998 and 1997, respectively. The Company has made, and
intends to continue to make, significant investments in research and
development to remain competitive by developing new and enhanced products to
serve its identified markets. Research and development expenses increased
primarily as a result of increased employee related expenses largely related
to additional personnel and to a lesser extent consulting, engineering and
equipment related expenses. Research and development spending is expected to
increase in absolute dollars in fiscal 1999 as compared to fiscal 1998.
SALES, GENERAL AND ADMINISTRATIVE EXPENSES
Sales, general and administrative expenses were $4.8 million and $2.4
million in the three months ending July 31, 1998 and 1997, respectively.
Sales, general and administrative expenses were $9.2 million and $4.7 million
in the six months ending July 31, 1998 and 1997, respectively. Sales,
general and administrative expenses increased primarily as a result of
increased commissions associated with higher sales and increased employee
related expenses largely related to additional personnel. The Company
anticipates that sales, general and administrative expenses will increase in
absolute dollars in fiscal 1999 as compared to fiscal 1998.
OTHER INCOME (EXPENSE), NET
Other income (expense), net increased to $547,000 in the three months
ended July 31, 1998 from $332,000 in the three months ended July 31, 1997.
Other income (expense), net increased to $1.2 million in the six months ended
July 31, 1998 from $424,000 in the six months ended July 31, 1997. The
increase in other income (expense), net is due primarily to additional
interest income resulting from higher average amounts of cash and short-term
investments in the three and six months ended July 31, 1998 compared to the
same periods in 1997.
INCOME TAXES
The Company's effective tax rate for the three and six months ended July
31, 1998 was 35% compared to an effective tax rate for the three and six
months ended July 31, 1997 of 15%. The lower effective tax rate for the
three and six months ended July 31, 1997 is primarily due to the utilization
of the Company's net operating loss carryforwards.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash, cash equivalents and short-term investments
decreased $1.2 million in the six months ended July 31, 1998 to $69.8 million
from $71.0 million at January 31, 1998. The decrease is primarily due to
increased payments against the working capital line of credit. In January
1998, the working capital line of credit was revised such that for wafer
shipments subsequent to January 31, 1998 payment for wafers must be made
within 30 days of wafer shipment. Working capital increased $14.5 million to
$67.4 million at July 31, 1998 from $52.9 million at January 31, 1998.
The Company generated approximately $21.0 million of cash and cash
equivalents in its operating activities during the six months ended July 31,
1998 compared to $3.6 million of net cash generated from operating activities
during the comparable period in the prior year. The increase in cash
generated from operations is primarily attributable to an $11.0 million
increase in accounts payable and a $7.6 million increase in net income from
the six month period ended July 31, 1998 compared to the same period the
prior year.
Page 10 of 23
<PAGE>
Net cash provided by investing activities for the six months ended July
31, 1998 was $2.3 million, compared to cash used by investing activities of
$23.5 million for the six months ended July 31, 1997. The increase in cash
provided by investing activities for the six month period ended July 31,
1998 compared to the six month period ended July 31, 1997 was primarily due
to a reduction in the net purchases of short-term investments of $26.7
million, offset partially by an increase of $1.0 million of investments in
property and equipment for the six month period ended July 31, 1998 compared
to the six month period ended July 31, 1997. The higher purchase of
short-term investments during the six months ended July 31, 1997 was related
to the investment of funds generated from the initial public offering.
Continued expansion of the Company's business may require higher levels of
capital equipment purchases, technology investments, foundry investments and
other payments to secure manufacturing capacity. The timing and amount of
future investments will depend primarily upon the growth of the Company's
future revenues.
Net cash used in financing activities for the six months ended July 31,
1998 was $19.6 million compared to net cash provided by financing activities
of $40.1 for the six months ended July 31, 1997. Net cash used in financing
activities for the six months ended July 31, 1998 relates primarily to
repayments against the working capital line of credit of $21.0 million offset
in part by net proceeds from the issuance of common stock. Net cash provided
by financing activities for the six months ended July 31, 1997 related
primarily to net proceeds from the initial public offering of $37.8 million
and the release of amounts previously held as restricted cash.
At July 31, 1998 the Company's principal sources of liquidity included
cash and cash equivalents and short-term investments of $69.8 million. The
Company believes these available funds and anticipated funds from operations
will satisfy the Company's projected working capital and capital expenditure
requirements through the next 12 months. Cash may also be used to acquire
technology through purchases and strategic acquisitions. The Company's future
capital requirements will depend upon many factors including the rate of net
sales growth, the timing and extent of spending to support research and
development programs in new and existing areas of technology, expansion of
sales and marketing, the timing of introductions of new products and
enhancements to existing products and market acceptance of the Company's
products. The Company expects that it may need to raise additional equity or
debt financing in the future. There can be no assurance that additional
equity or debt financing, if required, will be available on acceptable terms
or at all.
IMPACT OF YEAR 2000
Like many other companies, the year 2000 computer issue creates risks
for NeoMagic Corporation. If internal systems do not correctly recognize and
process date information beyond calendar year 1999, there could be an adverse
impact on the Company's operations. Computer programs that have
time-sensitive software may recognize a date using "00" as the year 1900
rather than the year 2000.
The Company has completed an assessment and does not believe that it
will be required to modify or replace significant portions of its software so
that its computer systems will function properly with respect to dates in the
year 2000 and thereafter. The Company has also assessed the capability of its
products sold to customers and believes that it has no exposure to
contingencies related to the year 2000 issues for the products it has sold.
Management believes that the likelihood of a material adverse impact due to
problems with internal systems or products sold to customers is remote and
expects that any costs to be incurred to assure year 2000 capability will not
have a material adverse effect on the Company's financial position or results
of operations. The Company is contacting critical suppliers of products and
services to determine that the suppliers' operations and the products and
services they provide are year 2000 capable. In addition the Company has
commenced work on a contingency plan to address potential problem areas
within internal systems and with suppliers and other third parties. It is
expected that contingency planning will be on-going throughout calendar year
1998 and 1999.
Page 11 of 23
<PAGE>
The Company has not incurred any costs to date related to preparing for
and evaluating year 2000 issues. Based on currently available information,
management does not believe that the year 2000 matters discussed above
related to internal systems or products sold to customers will have a
material adverse impact on the Company's financial condition or overall
trends in results of operations; however, it is uncertain to what extent the
Company may be affected by such matters. In addition, there can be no
assurance that the failure to ensure year 2000 capability by a supplier or
another third party would not have a material adverse effect on the Company.
FACTORS THAT MAY EFFECT RESULTS
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
NeoMagic's quarterly and annual results of operations are effected by a
variety of factors that could materially adversely effect net sales, gross
margin and income from operations. These factors include, among others,
demand for the Company's products; changes in product or customer mix, (i.e.
the portion of the Company's revenues represented by the Company's various
products and customers); fluctuations in manufacturing yields; incorrect
forecasting of future revenues; availability and cost of manufacturing
capacity; unanticipated delays or problems in the introduction or performance
of the Company's next generation of products; the Company's ability to
introduce new products in accordance with OEM design requirements and design
cycles; market acceptance of the products of the Company's customers; OEM
introduction of segment zero notebooks resulting in lower selling prices;
changes in the timing of product orders due to unexpected delays in the
introduction of products of the Company's customers or due to the life cycles
of such customers' products ending earlier than anticipated; new product
announcements or product introductions by NeoMagic's competitors; competitive
pressures resulting in lower selling prices; the volume of orders that are
received and can be fulfilled in a quarter; the rescheduling or cancellation
of orders by customers which cannot be replaced with orders from other
customers; supply constraints for the other components incorporated into its
customers' notebook PC products; foreign exchange rate fluctuations; the
unanticipated loss of any strategic relationship; seasonality associated with
the tendency of PC sales to increase in the second half of each calendar
year; the level of expenditures for research and development and sales,
general and administrative functions of the Company; costs associated with
future litigation; and costs associated with protecting the Company's
intellectual property. Any one or more of these factors could result in the
Company failing to achieve its expectations as to future revenues. The
Company may be unable to adjust spending sufficiently in a timely manner to
compensate for any unexpected sales shortfall, which could materially
adversely effect quarterly operating results. Accordingly, the Company
believes that period-to-period comparisons of its operating results should
not be relied upon as an indication of future performance. In addition, the
results of any quarterly period are not indicative of results to be expected
for a full fiscal year. In future quarters, the Company's operating results
may be below the expectations of public market analysts or investors. In
such event, the market price of the Common Stock would be materially
adversely effected.
RISKS ASSOCIATED WITH DEPENDENCE ON THE NOTEBOOK PC MARKET
The Company's products are used only in notebook PCs. The notebook PC
market is characterized by rapidly changing technology, evolving industry
standards, frequent new product introductions and significant price
competition, resulting in short product life cycles and regular reductions of
average selling prices over the life of a specific product. Although the
notebook PC market has grown substantially in recent years, there is no
assurance that such growth will continue. A reduction in sales of notebook
PCs, or a reduction in the growth rate of such sales, would likely reduce
demand for the Company's products. Moreover, such changes in demand could be
large and sudden. Since PC manufacturers often build inventories during
periods of anticipated growth, they may be left with excess inventories if
growth slows or if they have incorrectly forecasted product transitions. In
such cases, the PC manufacturers may abruptly suspend substantially all
purchases of additional inventory from suppliers such as the Company until
the excess inventory has been absorbed. Any reduction in the demand for
notebook PCs in general, or for a particular product that incorporates the
Company's multimedia
Page 12 of 23
<PAGE>
accelerators, could have a material adverse impact on the Company's business,
financial condition and results of operations.
The Company's ability to compete in the future will depend on its
ability to identify and ensure compliance with evolving industry standards.
Unanticipated changes in industry standards could render the Company's
products incompatible with products developed by major hardware manufacturers
and software developers, including Intel Corporation and Microsoft
Corporation. The Company could be required, as a result, to invest
significant time and effort to redesign its products to ensure compliance
with relevant standards. If the Company's products are not in compliance
with prevailing industry standards for a significant period of time, the
Company could miss opportunities to achieve crucial design wins, which could
result in a material adverse effect on the Company's business, financial
condition and results of operations. In addition, the Company's products are
designed to afford the notebook PC manufacturer significant advantages with
respect to product performance, power consumption and size. To the extent
that future developments in other notebook PC components or subassemblies
incorporate one or more of the advantages offered by the Company's products,
the market demand for the Company's products may be negatively impacted,
which could result in a material adverse effect on the Company's business,
financial condition and results of operations.
PRODUCT CONCENTRATION; RISKS ASSOCIATED WITH MULTIMEDIA PRODUCTS
The Company's revenues are entirely dependent on the market for
multimedia accelerators for notebook PCs, and on the Company's ability to
compete in that market. Since the Company has no other product line, the
Company's revenues and results of operations would be materially adversely
effected if for any reason it were unsuccessful in selling multimedia
accelerators. The notebook PC market frequently undergoes transitions in
which products rapidly incorporate new features and performance standards on
an industry-wide basis. If the Company's products are unable at the
beginning of each such transition to support the new feature sets or
performance levels being required by notebook PC manufacturers, the Company
would likely lose design wins and moreover, not have the opportunity to
compete for new design wins until it was able to incorporate changes
resulting from market transitions or to take advantage of future product
transitions. Thus, a failure to develop products with required feature sets
or performance standards or a delay as short as a few months in bringing a
new product to market could significantly reduce the Company's net sales for
a substantial period, which would have a material adverse effect on the
Company's business, financial condition and results of operations.
The notebook PC multimedia market is characterized by extreme price
competition. Leading-edge products may command higher average selling
prices, but prices decline throughout the product life cycle as comparable
and more advanced products are introduced into the market. As a result, the
Company's ability to maintain average selling prices and gross margins
depends substantially on its ability to continue introducing new products.
Its ability to maintain gross margins is also dependent upon its ability to
reduce product costs throughout a product life cycle by instituting cost
reduction design changes and yield improvements, persuading customers to
adopt cost-reduced versions of its products and successfully managing its
manufacturing and subcontractor relationships. The failure of the Company to
continue designing and introducing advanced products in a timely manner or to
continue reducing product costs would have a material adverse effect on the
Company's net sales, gross margins and results of operations.
CUSTOMER CONCENTRATION
The Company's sales are concentrated within a limited customer base.
The Company expects that a small number of customers will continue to account
for a substantial portion of its net sales for the foreseeable future.
Furthermore, the majority of the Company's sales are made on the basis of
purchase orders rather than pursuant to long-term agreements. As a result,
the Company's business, financial condition and results of operations could
be materially adversely effected by the decision of a single customer to
cease using the Company's products or by a decline in the number of notebook
PCs sold by a single customer.
Page 13 of 23
<PAGE>
EFFECTS OF CHANGES IN DRAM PRICING
The Company's products feature large DRAM memory integrated with analog
and logic circuitry on a single chip, while its competitors often provide
only the graphics/video analog and logic circuitry on a separate chip to be
used in conjunction with DRAMs supplied by others. The prices of the
Company's products reflect many factors, including the prices of DRAM chips.
As a result, the Company's business, financial condition and results of
operations may be materially and adversely effected by unanticipated changes
in the price of DRAMs. These changes are typically sudden and dramatic and
can extend over a significant period of time. Such changes are currently
occurring in the market. A significant reduction in the price of DRAMs could
cause the Company's products to be less competitively priced, potentially
effecting ongoing product pricing as well as resulting in the loss of design
wins for new notebook PCs. In this circumstance, competitors without
embedded DRAM potentially could be benefited by DRAM price reductions, and
the Company could be forced to respond to pricing pressures precipitated by
changes in the DRAM market by reducing the average selling prices of its
products to current and prospective system manufacturer customers. Because
the Company's product costs cannot be adjusted as rapidly as changes in
average selling prices to system manufacturers, the Company's net sales and
gross margin would be materially and adversely impacted.
COMPETITION
The market for multimedia accelerators for notebook PCs in which the
Company competes is intensely competitive and is characterized by rapid
technological change, evolving industry standards and declining average
selling prices. NeoMagic believes that the principal factors of competition
in this market are performance, price, features, power consumption, size and
software support. The ability of the Company to compete successfully in the
rapidly evolving notebook PC market depends on a number of factors, including
success in designing and subcontracting the manufacture of new products that
implement new technologies, product quality, reliability, price, the
efficiency of production, design wins for NeoMagic's integrated circuits,
ramp up of production of the Company's products for particular system
manufacturers, end-user acceptance of the system manufacturers' products,
market acceptance of competitors' products and general economic conditions.
There can be no assurance that the Company will be able to compete
successfully in the future.
NeoMagic competes with major domestic and international companies, some
of which have substantially greater financial and other resources than the
Company with which to pursue engineering, manufacturing, marketing and
distribution of their products. The Company's principal competitors include
ATI, Chips & Technologies, Inc. ("Chips & Technologies"- in January 1998,
Intel Corporation acquired Chips and Technologies), S3 Incorporated ("S3")
and Trident Microsystems, Inc. ("Trident"). NeoMagic may also face increased
competition from new entrants into the notebook PC multimedia accelerator
market including companies currently selling products designed for desktop
PCs. Furthermore, the Company expects that many of its competitors will seek
to develop and introduce products that integrate large DRAM with analog and
logic circuitry on a single chip. For example, Chips & Technologies and
Trident have publicly disclosed that they have or will begin sampling an
integrated multimedia accelerator solution for the notebook PC market that
would directly compete with the Company's products. Certain of the Company's
competitors offer more functionality and / or higher processor speeds at the
expense of battery life and power consumption than the Company's product
offerings. These feature sets may be more competitive for certain
applications than the Company's products. Potential competition also could
come from manufacturers that integrate a microprocessor or other components
with a multimedia controller. Cyrix (acquired by National Semiconductor in
July 1997) is in production of such a product. The successful commercial
introduction of such a product by competitors that integrates large DRAM with
analog and logic circuitry on a single chip or a product that eliminates the
need for a separate multimedia accelerator in notebook PCs could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Page 14 of 23
<PAGE>
Some of the Company's current and potential competitors operate their
own manufacturing facilities. Since the Company does not operate its own
manufacturing facility and must make binding commitments to purchase
products, it may not be able to reduce its costs and cycle time or adjust its
production to meet demand as rapidly as companies that operate their own
facilities, which could have a material adverse effect on its business,
financial condition and results of operations. In addition, the prices of the
Company's products reflect many factors, including the prices of DRAM chips
and non-integrated graphics chips. Therefore, in some cases, the Company's
products may be more expensive than competitive multiple chip solutions. The
Company in the past has lost and in the future may lose design wins due to
this price difference. Furthermore, a significant reduction in the price of
DRAMs could cause the Company's products to be less competitively priced,
potentially effecting ongoing product pricing as well as resulting in the
loss of design wins for new notebook PCs. Uncompetitive pricing and loss of
design wins could have a material and adverse effect on the Company's
business, financial condition, and results of operations.
DEPENDENCE ON MANUFACTURING RELATIONSHIPS
The Company's products require wafers manufactured with state-of-the-art
fabrication equipment and techniques. The Company's products are primarily
manufactured by Mitsubishi Electric Corporation ("Mitsubishi Electric") in
Japan. In fiscal 1998, the Company began manufacturing wafers with Toshiba
Corporation ("Toshiba") in Japan. Each of these manufacturing relationships
are covered under the terms of a five-year wafer supply agreement. The
Company expects that, for the foreseeable future, some of its products will
be single source manufactured. Because the lead time needed to establish a
strategic relationship with a new DRAM partner is at least 12 months and the
estimated time for a foundry to switch to a new product line is four to nine
months, there may be no readily available alternative source of supply for
any specific product. A manufacturing disruption experienced by either of
the Company's manufacturing partners would impact the production of the
Company's product for a substantial period of time, which would have a
material adverse effect on the Company's business, financial condition and
results of operations. Furthermore, in the event that the transition to the
next generation of manufacturing technologies at Mitsubishi Electric or
Toshiba is unsuccessful, the Company's business, financial condition and
results of operations would be materially and adversely effected.
There are many other risks associated with the Company's dependence upon
third party manufacturers, including: reduced control over delivery
schedules, quality assurance, manufacturing yields and cost; the potential
lack of adequate capacity during periods of excess demand; limited warranties
on wafers supplied to the Company; and potential misappropriation of NeoMagic
intellectual property. The Company is dependent on Mitsubishi Electric and
Toshiba to produce wafers of acceptable quality and with acceptable
manufacturing yields, to deliver those wafers to the Company and its
independent assembly and testing subcontractors on a timely basis and to
allocate to the Company a portion of their manufacturing capacity sufficient
to meet the Company's needs. On occasion, the Company has experienced some
of these difficulties. Although the Company's products are designed using
the process design rules of the particular manufacturer, there can be no
assurance that either Mitsubishi Electric or Toshiba will be able to achieve
or maintain acceptable yields or deliver sufficient quantities of wafers on a
timely basis or at an acceptable cost. Additionally, there can be no
assurance that either Mitsubishi Electric or Toshiba will continue to devote
resources to the production of the Company's products or continue to advance
the process design technologies on which the manufacturing of the Company's
products are based. Any such difficulties would have a material adverse
effect on the Company's business, financial condition and results of
operations.
The Company's products are assembled and tested by third party
subcontractors. The Company does not have long term agreements with any of
these subcontractors. Such assembly and testing is conducted on a purchase
order basis. As a result of its reliance on third party subcontractors to
assemble and test its products, the Company cannot directly control product
delivery schedules, which could lead to product shortages or quality
assurance problems that could increase the costs of manufacturing or assembly
of the Company's products. Due to the amount of time normally required to
qualify assembly
Page 15 of 23
<PAGE>
and test subcontractors, product shipments could be delayed significantly if
the Company is required to find alternative subcontractors. Any problems
associated with the delivery, quality or cost of the assembly and test of the
Company's products could have a material adverse effect on the Company's
business, financial condition and results of operations.
INVENTORY RISK
Under its wafer supply agreements with Mitsubishi Electric and Toshiba,
the Company is obligated to provide rolling 12-month forecasts of anticipated
purchases and to place binding purchase orders three to four months prior to
shipment from the suppliers. If the Company cancels a purchase order, it
must pay cancellation penalties based on the status of work in process or the
proximity of the cancellation to the delivery date. Forecasts of monthly
purchases may not increase or decrease by more than a certain percentage from
the previous month's forecast without the manufacturer's consent. Thus, the
Company must make forecasts and place purchase orders for wafers long before
it receives purchase orders from its own customers. This limits the
Company's ability to react to fluctuations in demand for its products, which
can be unexpected and dramatic, and from time-to-time will cause the Company
to have an excess or a shortage of wafers for a particular product. As a
result of the long lead time for manufacturing wafers, semiconductor
companies such as the Company from time-to-time must take charges for excess
inventory. For example, the Company booked charges totaling $1.5 million for
excess inventory in fiscal 1997. Significant write-offs of excess inventory
could materially adversely effect the Company's financial condition and
results of operations. Conversely, failure to order sufficient wafers would
cause the Company to miss revenue opportunities and, if significant, could
impact sales by the Company's customers, which could adversely effect the
Company's customer relationships and thereby materially adversely effect the
Company's business, financial condition and results of operations.
MANUFACTURING YIELDS
The fabrication of semiconductors is a complex and precise process.
Because NeoMagic's products feature the integration of large DRAM memory with
analog and logic circuitry on a single chip, a manufacturer must obtain
acceptable yields of both the memory and logic portions of such products,
compounding the complexity of the manufacturing process. As a result, the
Company may face greater manufacturing challenges than its competitors.
Minute levels of contaminants in the manufacturing environment, defects in
masks used to print circuits on a wafer, difficulties in the fabrication
process or other factors can cause a substantial percentage of wafers to be
rejected or a significant number of die on each wafer to be nonfunctional.
Many of these problems are difficult to diagnose and time consuming or
expensive to remedy. As a result, semiconductor companies often experience
problems in achieving acceptable wafer manufacturing yields, which are
represented by the number of good die as a proportion of the total number of
die on any particular wafer. The Company purchases wafers, not die, and pays
an agreed price for wafers meeting certain acceptance criteria. Accordingly,
the Company bears the risk of the yield of good die from wafers purchased
meeting the acceptance criteria. Poor yields would materially adversely
effect the Company's net sales, gross margins and results of operations.
Semiconductor manufacturing yields are a function both of product
design, which is developed largely by the Company, and process technology,
which is typically proprietary to the manufacturer. Historically, the
Company has experienced lower yields on new products. Since low yields may
result from either design or process technology failures, yield problems may
not be effectively determined or resolved until an actual product exists that
can be analyzed and tested to identify process sensitivities relating to the
design rules that are used. As a result, yield problems may not be
identified until well into the production process, and resolution of yield
problems would require cooperation by and communication between the Company
and the manufacturer. For example, a design error that resulted in lower
than expected yields of finished products caused the Company to take a $1.2
million charge in fiscal 1997. This risk is compounded by the offshore
location of the Company's manufacturers, increasing the effort and time
required to identify, communicate and resolve manufacturing yield problems.
As the Company's relationships with additional manufacturing partners
develop, yields could be adversely effected due to
Page 16 of 23
<PAGE>
difficulties associated with adopting the Company's technology and product
design to the proprietary process technology and design rules of each
manufacturer. Because of the Company's limited access to wafer fabrication
capacity from its manufacturers, any decrease in manufacturing yields could
result in an increase in the Company's per unit costs and force the Company
to allocate its available product supply among its customers, thus
potentially adversely impacting customer relationships as well as revenues
and gross margins. There can be no assurance that the Company's
manufacturers will achieve or maintain acceptable manufacturing yields in the
future. The inability of the Company to achieve planned yields from its
manufacturers could have a material adverse effect on the Company's business,
financial condition and results of operations. Furthermore, the Company also
faces the risk of product recalls resulting from design or manufacturing
defects which are not discovered during the manufacturing and testing
process. In the event of a significant number of product returns, the
Company's net sales and gross margin could be materially adversely effected.
DEPENDENCE ON NEW PRODUCT DEVELOPMENT; RAPID TECHNOLOGICAL CHANGE
The Company's business, financial condition and results of operations
will depend to a significant extent on its ability to maintain its position
in the market for multimedia accelerator products that integrate large DRAM
with analog and logic circuitry on a single chip. As a result, the Company
believes that significant expenditures for research and development will
continue to be required in the future. The notebook PC market for which the
Company's products are designed is intensely competitive and is characterized
by rapidly changing technology, evolving industry standards and declining
average selling prices. Notebook PC manufacturers demand products
incorporating rich features and functionality in order to achieve product
differentiation. The Company must anticipate the features and functionality
that the consumer of notebook PCs will demand, incorporate those features and
functionality into products that meet the exacting design requirements of the
notebook PC manufacturers, price its products competitively, and introduce
the products to the market within the limited window of market demand. For
example, both 3-D and DVD functionality are becoming increasingly important
for notebook PCs. The Company's ability to compete may depend on its ability
to incorporate these features in its products. The success of new product
introductions is dependent on several factors, including proper new product
definition, timely completion and introduction of new product designs, the
ability of Mitsubishi Electric, Toshiba and any additional strategic
manufacturing partners to effectively design and implement the manufacture of
new products, quality of new products, differentiation of new products from
those of the Company's competitors and market acceptance of NeoMagic's and
its customers' products. There can be no assurance that the products the
Company expects to introduce will incorporate the features and functionality
demanded by system manufacturers and consumers of notebook PCs, will be
successfully developed, or will be introduced within the appropriate window
of market demand. The failure of the Company to successfully introduce new
products and achieve market acceptance for such products would have a
material adverse effect on the Company's business, financial condition and
results of operations.
The integration of large DRAM memory with analog and logic circuitry on
a single chip is highly complex and is critical to the Company's success.
Because of the complexity of its products, however, NeoMagic has experienced
delays from time to time in completing development and introduction of new
products. In the event that there are delays in the completion of
development of future products, including the products currently expected to
be announced over the next year, the Company's business, financial condition
and results of operations would be materially adversely effected. Although
the development cycles for the memory and logic portions of the Company's
products have been relatively synchronized to date, there can be no assurance
that this synchronization will continue in the future. In addition, there
can be no assurance that fundamental advances in either the memory or logic
components of the Company's products will not significantly increase the
complexity inherent in the design and manufacture of the Company's products,
rendering the Company's product technologically infeasible or uncompetitive.
The multiple chip solutions offered by some of the Company's competitors are
less complex to design and manufacture than the Company's integrated
products. As a result, these competitive solutions may be less expensive,
particularly during periods of depressed DRAM prices. The time required for
competitors to
Page 17 of 23
<PAGE>
develop and introduce competing products may be shorter and manufacturing
yields may be better than those experienced by the Company.
As the markets for the Company's products continue to develop and
competition increases, NeoMagic anticipates that product life cycles will
shorten and average selling prices will decline. In particular, average
selling prices and, in some cases, gross margin for each of the Company's
products will decline as such products mature. Thus, the Company will need
to introduce new products which are compelling enough in order to maintain
average selling prices. There can be no assurance that the Company will
successfully identify new product opportunities and develop and bring new
products to market in a timely manner, that products or technologies
developed by others will not render NeoMagic's products or technologies
obsolete or uncompetitive, or that the Company's products will be selected
for design into the products of its targeted customers. The failure of the
Company's new product development efforts would have a material adverse
effect on NeoMagic's business, financial condition and results of operations.
UNCERTAINTY REGARDING PATENTS AND PROTECTION OF PROPRIETARY RIGHTS
The Company relies in part on patents to protect its intellectual
property. In the United States, the Company has been issued nine patents,
each covering certain aspects of the design and architecture of the Company's
multimedia accelerators. In addition, the Company has patent applications
pending in the United States Patent and Trademark Office. There can be no
assurance that the Company's pending patent applications, or any future
applications will be approved, or that any issued patents will provide the
Company with competitive advantages or will not be challenged by third
parties, or that the patents of others will not have an adverse effect on the
Company's ability to do business. Furthermore, there can be no assurance that
others will not independently develop similar products, duplicate the
Company's products or design around any patents that may be issued to the
Company.
The Company also relies on a combination of mask work protection,
trademarks, copyrights, trade secret laws, employee and third-party
nondisclosure agreements and licensing arrangements to protect its
intellectual property. Despite these efforts, there can be no assurance that
others will not independently develop substantially equivalent intellectual
property or otherwise gain access to the Company's trade secrets or
intellectual property, or disclose such intellectual property or trade
secrets, or that the Company can meaningfully protect its intellectual
property. A failure by the Company to meaningfully protect its intellectual
property could have a material adverse effect on the Company's business,
financial condition and results of operations.
As a general matter, the semiconductor industry is characterized by
substantial litigation regarding patent and other intellectual property
rights. The Company in the past has been, and in the future may be, notified
that it may be infringing the intellectual property rights of third parties.
In November 1994, Cirrus Logic Inc. ("Cirrus Logic") filed suit against the
Company and certain of its employees claiming, among other things, breach of
fiduciary duty, breach of and interference with contract and misappropriation
of trade secrets. The Company and Cirrus Logic settled the lawsuit in June
1996, but the Company incurred an aggregate of $703,000 in expenses in
connection with such litigation during fiscal 1995 and fiscal 1996. This
settlement did not involve cash payments, but did include a non-solicitation
provision and certain contingent cross-licensing provisions. In February
1997, Cirrus Logic sent the Company written notice asserting that the
Company's MagicGraph128, MagicGraph128V and MagicGraph128ZV products infringe
six United States patents held by Cirrus Logic. Since receiving the notice
of alleged infringement, the Company has advised Cirrus Logic that the
Company does not believe that any of its products infringe any claims of the
patents. The Company also has undergone a confidential external infringement
review and has conducted its own internal infringement review, and the
Company continues to believe that the Cirrus Logic infringement allegations
are unfounded. However, there can be no assurances that Cirrus Logic will
not file a lawsuit against the Company or that the Company would prevail in
any such litigation. Any protracted litigation by Cirrus Logic or the
Page 18 of 23
<PAGE>
success of Cirrus Logic in any such litigation could have a material and
adverse effect on the Company's financial position or results of operations.
Further, the Company was notified by certain of its customers that a law
suit had been filed and served by a holder of a United States patent
asserting that the video/graphics subsystem in such customers' notebook PCs,
which use the Company's MagicGraph128 and MagicGraph128V products, infringe
certain claims of the patent. The Company may have certain indemnification
obligations to customers with respect to the infringement of third-party
intellectual property rights by its products. There can be no assurance that
the Company's potential obligations to indemnify such customers will not have
a material adverse effect on the Company's business, financial condition and
results of operations. The Company believes that the Company's MagicGraph128
and MagicGraph128V products do not infringe any of the claims of such patent.
The Company's belief is based upon a legal opinion from its patent counsel,
Townsend and Townsend and Crew LLP. There can be no assurances that Company
or such customers would prevail in any patent litigation, or that such
customers will continue to purchase the Company's products while the Company
is under the threat of litigation.
Any patent litigation, whether or not determined in the Company's favor
or settled by the Company, would at a minimum be costly and could divert the
efforts and attention of the Company's management and technical personnel
from productive tasks, which could have a material adverse effect on the
Company's business, financial condition and results of operations. There can
be no assurance that current or future infringement claims by third parties
or claims for indemnification by other customers or end users of the
Company's products resulting from infringement claims will not be asserted in
the future or that such assertions, if proven to be true, will not materially
adversely effect the Company's business, financial condition and results of
operations. In the event of any adverse ruling in any such matter, the
Company could be required to pay substantial damages, which could include
treble damages, cease the manufacturing, use and sale of infringing products,
discontinue the use of certain processes or to obtain a license under the
intellectual property rights of the third party claiming infringement. There
can be no assurance, however, that a license would be available on reasonable
terms or at all. Any limitations on the Company's ability to market its
products, or delays and costs associated with redesigning its products or
payments of license fees to third parties, or any failure by the Company to
develop or license a substitute technology on commercially reasonable terms
could have a material adverse effect on the Company's business, financial
condition and results of operations.
DEPENDENCE ON INTERNATIONAL SALES AND SUPPLIERS
Export sales are a critical part of the Company's business. Sales to
customers located outside the United States (including sales to foreign
operations of customers headquartered in the United States and foreign system
manufacturers that sell to United States-based OEMs) accounted for 83.2%,
96.2% and 90.0% of the Company's net sales for fiscal 1998, 1997 and 1996,
respectively, and 87.8% for the first six months of fiscal 1999 ended July
31, 1998. The Company expects that net sales derived from international
sales will continue to represent a significant portion of its total net
sales. Some of the Company's international sales are supported by letters of
credit issued by its customers. Because the Company's international sales
have to date been denominated in United States dollars, increases in the
value of the United States dollar could increase the price in local
currencies of the Company's products in foreign markets and make the
Company's products relatively more expensive than competitors' products that
are denominated in local currencies. All of the Company's wafers are, and for
the foreseeable future, will be produced by foreign manufacturers. In
addition, the majority of the assembly and test services used by the Company
are procured from international sources. Under the Company's wafer supply
agreements with Mitsubishi Electric and Toshiba, products are priced in
Japanese yen. As a result, the Company's cost of goods sold are subject to
fluctuations in the yen-dollar exchange rates. The Company has in the past
hedged its exposure to fluctuations in such foreign currency exchange rate by
purchasing foreign exchange contracts and will continue to do so in the
future. However, there can be no assurance that such hedging will be
adequate. Significant wafer or assembly and test service price increases,
fluctuations in currency exchange rates or the Company's hedging against
currency exchange rate
Page 19 of 23
<PAGE>
fluctuations could have a material adverse effect on the Company's business,
financial condition and results of operations.
International sales and manufacturing operations are subject to a
variety of risks, including fluctuations in currency exchange rates, tariffs,
import restrictions and other trade barriers, unexpected changes in
regulatory requirements, longer accounts receivable payment cycles,
potentially adverse tax consequences and export license requirements. In
addition, the Company is subject to the risks inherent in conducting business
internationally including foreign government regulation, political and
economic instability, and unexpected changes in diplomatic and trade
relationships. Moreover, the laws of certain foreign countries in which the
Company's products may be developed, manufactured or sold, including various
countries in Asia, may not protect the Company's intellectual property rights
to the same extent as do the laws of the United States, thus increasing the
possibility of piracy of the Company's products. There can be no assurance
that one or more of these risks will not have a material adverse effect on
the Company's business, financial condition and results of operations.
IMPACT OF CURRENCY EXCHANGE RATES
Because the Company currently purchases wafers under purchase contracts
denominated in yen, significant appreciation in the value of yen relative to
the value of the U.S. dollar would make the wafers relatively more expensive
to the Company, which could have a material adverse effect on the Company's
business, financial condition and results of operations. The Company from
time to time enters into foreign currency forward contracts and foreign
currency options to minimize foreign currency fluctuation exposures related
to these firm purchase commitments. The Company does not use derivative
financial instruments for speculative or trading purposes. The Company's
accounting policies for these instruments are based on the Company's
designation of such instruments as hedging transactions. The criteria the
Company uses for designating an instrument as a hedge include its
effectiveness in risk reduction and one-to-one matching of derivative
instruments to underlying transactions. Notwithstanding the measures the
Company has adopted, due to the unpredictability and volatility of currency
exchange rates and currency controls, there can be no assurance that the
Company will not experience currency losses in the future, nor can the
Company predict the effect of exchange rate fluctuations upon future
operating results.
NEED FOR ADDITIONAL CAPITAL
The Company requires substantial working capital to fund its business,
particularly to finance inventories and accounts receivable and for capital
expenditures. The Company believes that its existing capital resources, will
be sufficient to meet the Company's capital requirements through the next 12
months, although the Company could be required, or could elect, to seek to
raise additional capital during such period. The Company's future capital
requirements will depend on many factors, including the rate of net sales
growth, the timing and extent of spending to support research and development
programs and expansion of sales and marketing, the timing of introductions of
new products and enhancements to existing products and market acceptance of
the Company's products. The Company may raise additional equity or debt
financing in the future. There can be no assurance that additional equity or
debt financing, if required, will be available on acceptable terms or at all.
MANAGEMENT OF EXPANDED OPERATIONS
The Company has experienced, and may continue to experience, periods of
rapid growth and expansion both domestically and internationally, which have
placed, and could continue to place a significant strain on the Company's
limited personnel and other resources. To manage these expanded operations
effectively, the Company will be required to continue to improve its
operational, financial and management systems. The Company is dependent upon
its ability to successfully hire, train, motivate and manage its employees,
especially its management and development personnel. If the Company's
management is unable to manage its expanded operations effectively, the
Company's business, financial condition and results of operations could be
materially adversely effected.
Page 20 of 23
<PAGE>
DEPENDENCE ON QUALIFIED PERSONNEL
The Company's future success depends in part on the continued service
of its key engineering, sales, marketing, manufacturing, finance and
executive personnel, and its ability to identify, hire and retain additional
personnel. There is intense competition for qualified personnel in the
semiconductor industry, and there can be no assurance that the Company will
be able to continue to attract and train qualified personnel necessary for
the development of its business. The Company's anticipated growth is
expected to place increased demands on the Company's resources and will
likely require the addition of new management personnel and the development
of additional expertise by existing management personnel. Loss of the
services of, or failure to recruit in a timely manner, key technical and
management personnel could be significantly detrimental to the Company's
product development programs or otherwise have a material adverse effect on
the Company's business, financial condition and results of operations.
VOLATILITY OF STOCK PRICE
The market price of the shares of Common Stock, like that of the common
stock of many other semiconductor companies, has been and is likely to be
highly volatile, and the market has from time to time experienced significant
price and volume fluctuations that are unrelated to the operating performance
of particular companies. The market price of the Common Stock could be
subject to significant fluctuations in response to quarter-to-quarter
variations in the Company's anticipated or actual operating results,
announcements of new products, technological innovations or setbacks by the
Company or its competitors, conditions in the semiconductor and PC
industries, unanticipated shifts in the notebook PC market or industry
standards, loss of customers, changes in DRAM pricing, the commencement of,
developments in or outcome of litigation, changes in or the failure by the
Company to meet estimates of the Company's performance by securities
analysts, market conditions for high technology stocks in general, and other
events or factors.
Page 21 of 23
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
None.
ITEM 2. Changes in Securities and Use of Proceeds
The Company completed its initial public offering pursuant to a
Registration Statement on Form S-1 in March 1997 and issued 3,575,000
shares (including direct sales of 125,000 shares and an additional
450,000 shares sold pursuant to the underwriters exercise of its
over-allotment option) of its Common Stock at a price of $12.00 per
share. The offering has been terminated and all the shares were sold.
The Company received approximately $37.8 million of cash from the
public offering, net of underwriting discounts, commissions, and other
offering costs. All of the proceeds from such offering have been
used.
ITEM 3. Defaults Upon Senior Securities
None.
ITEM 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Stockholder of NeoMagic Corporation was held on
June 4, 1998 in Santa Clara, California. 21,433,797 shares of common
stock or 87.82% of the total outstanding shares were present or
represented by proxies at the meeting. The matters voted upon at the
meeting and the results of those votes were as follows:
1. Election of directors, Kamran Elahian, Prakash C. Agarwal, Brian
P. Dougherty, Irwin Federman, James Lally and Klaus Wiemer. Mr.
Elahian received 19,983,229 affirmative votes and 1,450,568 votes
were withheld. Mr. Agarwal received 21,375,963 affirmative votes
and 57,834 votes were withheld. Mr. Dougherty received
17,544,374 affirmative votes and 3,889,423 votes were withheld.
Mr. Federman received 16,183,938 affirmative votes and 5,249,859
votes were withheld. Mr. Lally received 16,183,938 affirmative
votes and 5,249,859 votes were withheld. Mr. Wiemer received
21,381,963 affirmative votes and 51,834 votes were withheld.
2. Approval to increase the number of shares of Common Stock
available for grant under the Company's Amended 1993 Stock Plan
by 875,000 shares. The proposal received 12,946,838 affirmative
votes, 8,436,961 negative votes and 49,998 abstentions.
3. Appointment of Ernst & Young LLP as the Company's independent
auditors for the fiscal year ended January 31, 1999. The
proposal received 21,403,093 affirmative votes, 12,066 negative
votes and 18,638 abstentions.
ITEM 5. Other Information
Not applicable.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K
The Company did not file any reports on Form 8-K during the six months
ended July 31, 1998.
Page 22 of 23
<PAGE>
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)
Merle McClendon
-----------------------
MERLE MCCLENDON
Vice President, Finance
and Chief Financial Officer
(Principal Financial and Accounting Officer)
September 1, 1998
Page 23 of 23
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS FOR THE THREE AND SIX MONTH PERIOD ENDED JULY 31, 1998 AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JAN-31-1999
<PERIOD-START> APR-27-1998
<PERIOD-END> JUL-26-1998
<CASH> 38,589
<SECURITIES> 31,245
<RECEIVABLES> 11,099
<ALLOWANCES> 0
<INVENTORY> 13,785
<CURRENT-ASSETS> 98,967
<PP&E> 12,097
<DEPRECIATION> 4,784
<TOTAL-ASSETS> 112,546
<CURRENT-LIABILITIES> 31,596
<BONDS> 0
0
0
<COMMON> 25
<OTHER-SE> 80,925
<TOTAL-LIABILITY-AND-EQUITY> 112,546
<SALES> 53,396
<TOTAL-REVENUES> 53,396
<CGS> 31,058
<TOTAL-COSTS> 31,058
<OTHER-EXPENSES> 12,162
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 372
<INCOME-PRETAX> 10,723
<INCOME-TAX> 3,753
<INCOME-CONTINUING> 6,970
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,970
<EPS-PRIMARY> .30
<EPS-DILUTED> .27
</TABLE>
