<PAGE>
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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 October 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
of incorporation or organization) Identification No.)
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 November 29, 1998 was 24,804,192
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Page 1 of 23
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NEOMAGIC CORPORATION
FORM 10-Q
INDEX
PAGE
PART I. CONSOLIDATED CONDENSED FINANCIAL INFORMATION
Item 1. Unaudited Consolidated Condensed Financial Statements:
Consolidated Condensed Statements of Income
Three and nine months ended October 31, 1998 and 1997 3
Consolidated Condensed Balance Sheets
October 31, 1998 and January 31, 1998 4
Consolidated Condensed Statements of Cash Flows
Nine months ended October 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
Page 2 of 23
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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 Nine Months Ended
October 31, October 31,
------------------------- -----------------------------
1998 1997 1998 1997
------------------------- -----------------------------
<S> <C> <C> <C> <C>
Net sales $ 67,401 $ 37,146 $ 168,535 $ 79,997
Cost of sales 40,436 21,568 99,004 47,261
------------------------- -----------------------------
Gross margin 26,965 15,578 69,531 32,736
Operating expenses:
Research and development 8,729 4,924 22,295 10,729
Sales, general and administrative 5,845 3,452 15,049 8,111
------------------------- -----------------------------
Total operating expenses 14,574 8,376 37,344 18,840
------------------------- -----------------------------
Income from operations 12,391 7,202 32,187 13,896
Other income (expense):
Interest income and other 1,039 823 2,933 1,785
Interest expense (245) (325) (941) (863)
------------------------- -----------------------------
Income before income taxes 13,185 7,700 34,179 14,818
Provision for income taxes 4,615 1,155 11,963 2,223
------------------------- -----------------------------
Net income $ 8,570 $ 6,545 $ 22,216 $ 12,595
------------------------- -----------------------------
------------------------- -----------------------------
Basic earnings per share $ .36 $ .29 $ .94 $ .58
Diluted earnings per share $ .33 $ .25 $ .85 $ .50
Weighted common shares outstanding 23,828 22,713 23,573 21,573
Weighted common shares outstanding,
assuming dilution 25,950 26,144 26,027 25,145
</TABLE>
See accompanying notes to consolidated condensed financial statements.
Page 3 of 23
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NEOMAGIC CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
October 31, January 31,
1998 1998
----------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 52,164 $ 35,004
Short-term investments 22,184 36,016
Accounts receivable, net 17,511 11,236
Inventory 8,117 9,342
Other current assets 9,194 3,730
----------- ------------
Total current assets 109,170 95,328
Property and equipment, net 8,322 6,232
Deferred tax assets 5,669 5,669
Other assets 798 354
----------- ------------
Total assets $ 123,959 $ 107,583
----------- ------------
----------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Working capital line of credit $ - $ 21,041
Accounts payable 19,682 9,490
Accrued expenses 13,391 10,652
Obligations under capital leases 839 1,273
----------- ------------
Total current liabilities 33,912 42,456
Commitments and contingencies
Stockholders' equity:
Common stock 26 24
Additional paid-in-capital 63,094 61,263
Notes receivable from stockholders (554) (559)
Deferred compensation (1,935) (2,801)
Retained earnings 29,416 7,200
----------- ------------
Total stockholders' equity 90,047 65,127
----------- ------------
Total liabilities and stockholders' equity $ 123,959 $ 107,583
----------- ------------
----------- ------------
</TABLE>
See accompanying notes to consolidated condensed financial statements.
Page 4 of 23
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NEOMAGIC CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
October 31,
-------------------------
1998 1997
---------- ---------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income $ 22,216 $ 12,595
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 2,291 1,148
Amortization of deferred compensation 657 540
Changes in operating assets and liabilities:
Accounts receivable (6,275) (7,954)
Inventory 1,225 1,089
Other current assets (5,464) (186)
Other assets (444) (103)
Accounts payable 10,192 2,232
Accrued expenses 2,739 4,471
---------- ---------
Net cash provided by operating activities 27,137 13,832
---------- ---------
---------- ---------
INVESTING ACTIVITIES:
Purchases of property and equipment (4,381) (3,003)
Purchases of short-term investments (30,242) (47,265)
Maturities of short-term investments 44,074 9,000
---------- ---------
Net cash provided by (used for) investing activities 9,451 (41,268)
---------- ---------
---------- ---------
FINANCING ACTIVITIES:
Payments on lease obligation (434) (849)
Proceeds from working capital line of credit - 36,695
Payments on working capital line of credit (21,041) (38,442)
Net proceeds from issuance of common stock 2,047 38,495
Amounts held as restricted cash - 2,224
---------- ---------
Net cash provided by (used for) financing activities (19,428) 38,123
---------- ---------
---------- ---------
Net increase in cash and cash equivalents 17,160 10,687
Cash and cash equivalents at beginning of period 35,004 13,458
---------- ---------
Cash and cash equivalents at end of period $ 52,164 $ 24,145
---------- ---------
---------- ---------
Supplemental schedules of cash flow information
Cash paid during the year for:
Interest $ 941 $ 863
Taxes $ 9,301 $ 2,822
</TABLE>
See accompanying notes to consolidated condensed financial statements.
Page 5 of 23
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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
October 31, 1998, the operating results for the three and nine months ended
October 31, 1998 and 1997 and cash flows for the nine months ended October
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 nine months ended October 31, 1998 are
not necessarily indicative of the results that may be expected for the year
ending January 31, 1999.
The third fiscal quarters of 1999 and 1998 ended on October 26, 1998 and
October 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>
Inventory consists of: October 31, January 31,
1998 1998
--------------------------
(in thousands)
<S> <C> <C>
Raw materials $ 1,610 $ 989
Work in process 1,772 1,904
Finished goods 4,735 6,449
--------------------------
Total $ 8,117 $ 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 the incremental shares issuable upon the assumed exercise of
stock options and warrants (using the treasury stock method).
Page 6 of 23
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Per share information calculated on this basis is as follows:
(in thousands, except per share amount)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
October 31, October 31,
-----------------------------------------------------
1998 1997 1998 1997
-----------------------------------------------------
<S> <C> <C> <C> <C>
Numerator:
Net income $ 8,570 $ 6,545 $ 22,216 $ 12,595
-----------------------------------------------------
Denominator:
Denominator for basic earnings per share - weighted average
shares outstanding 23,828 22,713 23,573 21,573
Effect of dilutive securities:
Employee stock options 2,034 3,328 2,365 3,355
Warrants 88 103 89 217
-----------------------------------------------------
Dilutive potential common shares 2,122 3,431 2,454 3,572
-----------------------------------------------------
Denominator for diluted earnings per share -
adjusted weighted-average shares outstanding 25,950 26,144 26,027 25,145
Basic earnings per share $ .36 $ .29 $ .94 $ .58
Diluted earnings per share $ .33 $ .25 $ .85 $ .50
</TABLE>
4. Stock Options
In September 1998, the Board of Directors approved a resolution allowing
employees to exchange their existing vested and unvested stock options for
new options having an exercise price of $11.50 per share, the then current
market price of the Company's common stock. Options to purchase 2,085,700
shares, with an average original exercise price of $15.48 per share, were
exchanged by employees. Vested exchanged options are not exercisable by the
employees until March 31, 1999.
5. 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 October 31, 1998 and 1997 were immaterial.
6. 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 the derivative 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 30, 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
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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, 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, the availability and cost of products from the
Company's suppliers, manufacturing yields and exchange rate fluctuations are
subject to risks and uncertainties, including those set forth below under
"Factors that May Affect Results," that could cause actual results to differ
materially from those projected. These forward-looking statements speak only
as of the date hereof. The Company expressly disclaims any obligation or
undertaking to release publicly any updates or revisions to any
forward-looking statements contained herein to reflect any changes in the
Company's expectations with regard thereto or any changes in events,
conditions or circumstances on which any such statement is based.
OVERVIEW
The Company designs, develops and markets 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 incorporate 128-bit and 256-bit memory buses, respectively. 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.
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 Nine Months Ended
October 31, October 31,
-------------------- --------------------
1998 1997 1998 1997
-------------------- --------------------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 60.0 58.1 58.7 59.1
-------------------- --------------------
Gross margin 40.0 41.9 41.3 40.9
Operating expenses:
Research and development 13.0 13.2 13.2 13.4
Selling, general and administrative 8.6 9.3 8.9 10.1
-------------------- --------------------
Total operating expenses 21.6 22.5 22.1 23.5
-------------------- --------------------
Income from operations 18.4 19.4 19.2 17.4
Other income (expense):
Interest income and other 1.5 2.2 1.7 2.2
Interest expense (.4) (.9) (.6) (1.1)
-------------------- --------------------
Income before income taxes 19.5 20.7 20.3 18.5
Provision for income taxes 6.8 3.1 7.1 2.8
-------------------- --------------------
Net income 12.7% 17.6% 13.2% 15.7%
-------------------- --------------------
-------------------- --------------------
</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 $67.4
million for the three months ended October 31, 1998, compared to $37.1
million for the three months ended October 31, 1997. Net sales were $168.5
million for the nine months ended October 31, 1998, compared to $80.0 million
for the nine months ended October 31, 1997. Net sales increased primarily as
a result of increased market acceptance of the Company's MagicGraph128
products, introduction by the Company of 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 89.0% and 83.1% of net sales in the three
months ended October 31, 1998 and 1997, respectively. Export sales accounted
for 88.3% and 82.8% of net sales in the nine months ended October 31, 1998
and 1997, respectively. Approximately 50% and 58% of export sales for the
three and nine months ended October 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 23.7%, 16.8%, 11.0% and 10.2%, respectively
of net sales for the three months ended October 31, 1998. Five customers
accounted for 16.0%, 15.4%, 14.1%, 12.8% and 10.5%, respectively of net sales
for the three months ended October 31, 1997. Three customers accounted for
21.0%, 17.9% and 10.6%, respectively of net sales for the nine months ended
October 31, 1998. Five customers accounted for 16.7%, 15.8%, 14.7%, 12.3% and
11.0%, respectively of net sales for the nine months ended October 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 materially adverse effect on the Company's
operating results.
GROSS MARGIN
Gross margins were $27.0 million and $15.6 million for the three months
ended October 31, 1998 and 1997, respectively. Gross margin as a percent of
net sales decreased to 40.0% for the three months ended October 31, 1998 from
41.9% in the three months ended October 31, 1997. The decrease in gross
margin percentage was due primarily to declining average selling prices,
partially offset by declining average product costs. Gross margin was $69.5
million and $32.7 million for the nine months ended October 31, 1998 and
1997, respectively. Gross margin percentages increased to 41.3% for the nine
months ended October 31, 1998 from 40.9% in the nine months ended October 31,
1997. The increase in gross margin percentage was due primarily to lower
wafer pricing and improved yields, partially offset by declining average
selling prices.
In the future, the Company's gross margin percentages may be adversely
affected by increased competition and related decreases in unit average
selling prices, the timing of volume shipments of new products, the
availability and cost of products from the Company's suppliers, foreign
currency exchange rate fluctuations, manufacturing yields and changes in the
mix of products sold.
Page 9 of 23
<PAGE>
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses were $8.7 million and $4.9 million for
the three months ended October 31, 1998 and 1997, respectively. Research and
development expenses were $22.3 million and $10.7 million for the nine months
ended October 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 will increase in absolute dollars
in fiscal 1999 as compared to fiscal 1998.
SALES, GENERAL AND ADMINISTRATIVE EXPENSES
Sales, general and administrative expenses were $5.8 million and $3.5
million in the three months ending October 31, 1998 and 1997, respectively.
Sales, general and administrative expenses were $15.0 million and $8.1 million
in the nine months ending October 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. Sales, general and administrative
expenses will increase in absolute dollars in fiscal 1999 as compared to fiscal
1998.
OTHER INCOME (EXPENSE)
Other income (expense), net increased to $794,000 in the three months ended
October 31, 1998 from $498,000 in the three months ended October 31, 1997.
Other income (expense), net increased to $2.0 million in the nine months ended
October 31, 1998 from $922,000 in the nine months ended October 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 nine months ended October 31, 1998 compared to the same periods
in 1997.
INCOME TAXES
The Company's effective tax rate for the three and nine months ended
October 31, 1998 was 35% compared to an effective tax rate for the three and
nine months ended October 31, 1997 of 15%. The lower effective tax rate for the
three and nine months ended October 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 increased
$3.3 million in the nine months ended October 31, 1998 to $74.3 million from
$71.0 million at January 31, 1998. The increase is primarily due to cash
provided by operating activities, offset in part by increased payments against
the working capital line of credit. In January 1998, in exchange for a lower
commission rate, the payment term on wafer purchases was changed from payable in
90 days from shipment to payable in 30 days from shipment. Working capital
increased $22.4 million to $75.3 million at October 31, 1998 from $52.9 million
at January 31, 1998.
The Company generated approximately $27.1 million of net cash in its
operating activities during the nine months ended October 31, 1998 compared to
$13.8 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 $8.0 million increase in accounts
payable and a $9.6 million increase in net income from the nine month period
ended October 31, 1998 compared to the same period the prior year.
Net cash provided by investing activities for the nine months ended October
31, 1998 was $9.5 million, compared to cash used by investing activities of
$41.3 million for the nine months ended October
Page 10 of 23
<PAGE>
31, 1997. The increase in cash provided by investing activities for the nine
month period ended October 31, 1998 compared to the cash used for investing
activities the nine month period ended October 31, 1997 was primarily due to
a reduction in the net purchases and maturities of short-term investments of
$52.1 million, offset in part by an increase of $1.4 million of investments
in property and equipment. The larger purchases of short-term investments
during the nine months ended October 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 nine months ended October 31,
1998 was $19.4 million compared to net cash provided by financing activities of
$38.1 for the nine months ended October 31, 1997. Net cash used in financing
activities for the nine months ended October 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 of $2.0 million. Net
cash provided by financing activities for the nine months ended October 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 October 31, 1998 the Company's principal sources of liquidity included
cash and cash equivalents and short-term investments of $74.3 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
technologies. 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 computer 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 initial assessment of its internal computer
systems, and does not believe that it will be required to modify or replace
significant portions of its internal systems so that they will function properly
with respect to dates in the year 2000 and thereafter. The Company's internal
computer systems consist primarily of third party software tools for
engineering, sales, finance and human resources functions. The Company has made
inquiries of the software vendors and has been provided assurances that their
software either currently is, or soon will be, year 2000 capable.
NeoMagic does not operate its own manufacturing facilities. Rather, the
Company's products are manufactured and tested by independent third party
suppliers, primarily located in Asia and Japan. The Company believes that its
most reasonably likely worst case year 2000 scenario would relate to problems
with its third party suppliers rather than with the Company's internal systems
or its products. 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. Highest priority is being placed on
working with suppliers that are critical to the delivery of the Company's
product to customers. A worst case scenario involving a critical supplier would
be the partial or complete shutdown of the supplier and its resulting inability
to provide its products or services to the Company on a timely basis. The
Company will monitor its suppliers and will develop contingency plans to address
issues related to suppliers that are not considered to be taking all steps
necessary to ensure year 2000 capability. Where efforts to work with critical
suppliers to ensure year 2000 capability have not been successful, contingency
planning generally emphasizes the
Page 11 of 23
<PAGE>
identification of substitute and second-source supplier sites or planned
increases in inventory levels of specific products. This contingency planning
is expected to continue through 1999.
The Company's year 2000 efforts to date have largely been carried out
with existing personnel, and the costs incurred to date have not been
significant. Management believes that any costs to be incurred to assure that
its internal systems and products are year 2000 capable will not have a
material adverse effect on the Company's financial position or results of
operations. However, the Company is not in a position to identify or to
avoid all possible adverse year 2000 scenarios, particularly as it relates to
its third party suppliers. Due to the large number of variables involved, the
Company cannot provide an estimate of the damage it might suffer if any of
these adverse scenarios were to occur. As such, 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's
financial condition or overall results of operations.
FACTORS THAT MAY AFFECT RESULTS
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
NeoMagic's quarterly and annual results of operations are affected by a
variety of factors that could have a material adverse effect on 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; incorrect forecasting of future revenues; seasonality associated with
the tendency of PC sales to increase in the second half of each calendar
year; competitive pressures resulting in lower average selling prices;
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
low-end notebooks resulting in lower average 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; 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; fluctuations in manufacturing yields;
fluctuations in foreign exchange rates; availability and cost of
manufacturing capacity; supply constraints for the other components
incorporated into its customers' notebook PC products; the unanticipated loss
of any strategic relationship; 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 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. In such event, the market price of the Company's Common Stock
would be materially adversely affected.
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
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suspend substantially all purchases of additional inventory from suppliers
such as the Company until the excess inventory has been absorbed. Any
reduction in the demand for notebook PCs in general, or for a particular
product that incorporates the Company's multimedia accelerators, could have a
material adverse 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 affected 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 affected by the decision of a single
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customer to cease using the Company's products or by a decline in the number
of notebook PCs sold by a single customer.
EFFECTS OF CHANGES IN DRAM PRICING
The Company's products feature large DRAM memory integrated with analog
and logic circuitry on a single chip, while its competitors often provide
only the graphics/video analog and logic circuitry on a separate chip to be
used in conjunction with DRAMs supplied by others. The selling prices of the
Company's products reflect many factors, including the prices of DRAM chips.
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 customers. Recently, the DRAM market has experienced
significant price erosion, which has been a factor in the overall decline in
the average selling price of the Company's products. Because the Company's
product costs cannot be adjusted as rapidly as changes in average selling
prices to system manufacturers, the Company's business, financial condition
and results of operations may be materially and adversely affected by
unanticipated changes in the price of DRAM.
COMPETITION
The market for multimedia accelerators for notebook PCs in which the
Company competes is intensely competitive and is characterized by rapid
technological change, evolving industry standards and declining average
selling prices. NeoMagic believes that the principal factors of competition
in this market are performance, price, features, power consumption, size and
software support. The ability of the Company to compete successfully in the
rapidly evolving notebook PC market depends on a number of factors, including
success in designing and subcontracting the manufacture of new products that
implement new technologies, product quality, reliability, price, the
efficiency of production, design wins for NeoMagic's integrated circuits,
ramp up of production of the Company's products for particular system
manufacturers, end-user acceptance of the system manufacturers' products,
market acceptance of competitors' products and general economic conditions.
There can be no assurance that the Company will be able to compete
successfully in the future.
NeoMagic competes with major domestic and international companies, some
of which have substantially greater financial and other resources than the
Company with which to pursue engineering, manufacturing, marketing and
distribution of their products. The Company's principal competitors include
ATI Technologies (ATI), Chips & Technologies, Inc. ("Chips & Technologies"-
in January 1998, Intel Corporation acquired Chips and Technologies), S3
Incorporated and Trident Microsystems, Inc. ("Trident"). NeoMagic may also
face increased competition from new entrants into the notebook PC multimedia
accelerator market including companies currently selling products designed
for desktop PCs. Some of the Company's competitors, including Chips &
Technologies and Trident have introduced multimedia accelerator products that
integrate large DRAM with analog and logic circuitry on a single chip.
Certain of the Company's competitors may offer products with more
functionality and / or higher processor speeds at the expense of battery life
and power consumption than the Company's product offerings. These feature
sets may be more competitive for certain applications than the Company's
products. Potential competition also could come from manufacturers that
integrate the multimedia accelerator with other systems components. For
example, Cyrix (acquired by National Semiconductor in July 1997) is in
production of an integrated microprocessor and graphics accelerator. Further,
several of the Company's competitors have announced plans to develop products
that integrate the multimedia accelerator with the core logic chip set. The
successful commercial introduction by competitors of products that integrate
large DRAM with analog and logic circuitry on a single chip or that eliminate
the need for a separate multimedia accelerator in notebook PCs could have a
material adverse effect on the Company's business, financial condition and
results of operations.
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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 affected.
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 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
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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. Also,
there is a trend for customers to increasingly reduce on-site inventories.
OEM's are increasingly moving to "just in time" relationships with their
vendors which may shift the inventory carrying risk back to the supplier.
Further, 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 affect 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.
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
affect 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 affected due to difficulties associated
with adopting the Company's technology and product design to the proprietary
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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 affected.
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, 3-D, digital audio 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 affected. Although the development cycles for the memory
and logic portions of the Company's products have been relatively synchronized
to date, there can be no assurance that this synchronization will continue in
the future. In addition, there can be no assurance that fundamental advances in
either the memory or logic components of the Company's products will not
significantly increase the complexity inherent in the design and manufacture of
the Company's products, rendering the Company's product technologically
infeasible or uncompetitive. The multiple chip solutions offered by some of the
Company's competitors are less complex to design and manufacture than the
Company's integrated products. As a result, these competitive solutions may be
less expensive, particularly during periods of depressed DRAM prices. The time
required for competitors to develop and introduce competing products may be
shorter and manufacturing yields may be better than those experienced by the
Company.
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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 ten 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. 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. 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
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'
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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 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.
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 88.3% for the first nine months of fiscal 1999 ended October
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 the majority of 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 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
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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 the yen relative to
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 in new and existing areas of technology 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 affected.
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
Page 20 of 23
<PAGE>
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
None.
ITEM 3. Defaults Upon Senior Securities
None.
ITEM 4. Submission of Matters to a Vote of Security Holders
None.
ITEM 5. Other Information
Not applicable.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
EXHIBIT
NUMBER DESCRIPTION
------- -----------
27.1 Financial Data Schedule
(b) Reports on Form 8-K
The Company did not file any reports on Form 8-K during the nine months
ended October 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)
/s/ Merle McClendon
-------------------
MERLE MCCLENDON
Vice President, Finance
and Chief Financial Officer
(Principal Financial and Accounting Officer)
December 10, 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 NINE MONTH PERIOD ENDING OCTOBER 31, 1998, AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-31-1999
<PERIOD-START> JAN-26-1998
<PERIOD-END> OCT-25-1998
<CASH> 52,164
<SECURITIES> 22,184
<RECEIVABLES> 17,511
<ALLOWANCES> 0
<INVENTORY> 8,117
<CURRENT-ASSETS> 109,170
<PP&E> 13,960
<DEPRECIATION> 5,638
<TOTAL-ASSETS> 123,959
<CURRENT-LIABILITIES> 33,912
<BONDS> 0
0
0
<COMMON> 26
<OTHER-SE> 90,021
<TOTAL-LIABILITY-AND-EQUITY> 123,959
<SALES> 168,535
<TOTAL-REVENUES> 168,535
<CGS> 99,004
<TOTAL-COSTS> 99,004
<OTHER-EXPENSES> 37,344
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (941)
<INCOME-PRETAX> 34,179
<INCOME-TAX> 11,963
<INCOME-CONTINUING> 22,216
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 22,216
<EPS-PRIMARY> .94
<EPS-DILUTED> .85
</TABLE>
