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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549



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Form 10-Q



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(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------



For the quarterly period ended October 31, 2004



OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | -----------------------------------------------------------------------------------------



For the transition period from  to



Commission file number 000-22009



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NEOMAGIC CORPORATION

(Exact name of Registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|DELAWARE                                                       |  | 77-0344424                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|3250 Jay Street Santa Clara, California                        |  | 95054                               
|(Address of principal executive offices)                       |  | (Zip Code)                          



(408) 988-7020

Registrants telephone number, including area code



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Indicate by
check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No ̈



Indicate
by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)    Yes  x    No ̈



The number of shares of the Registrants Common Stock, $.001 par value, outstanding at October 31, 2004 was 32,842,385



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##### Table of Contents

NEOMAGIC CORPORATION

FORM 10-Q



INDEX



|               |  |                                                                                                       |  |      
|-------------- |  | ----------------------------------------------------------------------------------------------------- |  | -----
|               |  |                                                                                                       |  | PAGE 
|PART I.        |  | CONDENSED CONSOLIDATED FINANCIAL INFORMATION                                                          |  |      
|               |  |                                                                                                      
|Item 1.        |  | Unaudited Condensed Consolidated Financial Statements:                                                |  |      
|               |  |                                                                                                      
|               |  | Condensed Consolidated Statements of Operations Three and Nine months ended October 31, 2004 and 2003 |  | 3    
|               |  |                                                                                                      
|               |  | Condensed Consolidated Balance Sheets October 31, 2004 and January 31, 2004                           |  | 4    
|               |  |                                                                                                      
|               |  | Condensed Consolidated Statements of Cash Flows Nine months ended October 31, 2004 and 2003           |  | 5    
|               |  |                                                                                                      
|               |  | Notes to Unaudited Condensed Consolidated Financial Statements                                        |  | 6-11 
|               |  |                                                                                                      
|Item 2.        |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                 |  | 11-25
|               |  |                                                                                                      
|Item 3.        |  | Quantitative and Qualitative Disclosures about Market Risk                                            |  | 25   
|               |  |                                                                                                      
|Item 4.        |  | Controls and Procedures                                                                               |  | 25-26
|               |  |                                                                                                      
|PART II.       |  | OTHER INFORMATION                                                                                     |  |      
|               |  |                                                                                                      
|Item 1.        |  | Legal Proceedings                                                                                     |  | 26   
|               |  |                                                                                                      
|Item 2.        |  | Unregistered Sales of Equity Securities and Use of Proceeds                                           |  | 26   
|               |  |                                                                                                      
|Item 3.        |  | Defaults Upon Senior Securities                                                                       |  | 26   
|               |  |                                                                                                      
|Item 4.        |  | Submission of Matters to a Vote of Security Holders                                                   |  | 27   
|               |  |                                                                                                      
|Item 5.        |  | Other Information                                                                                     |  | 27   
|               |  |                                                                                                      
|Item 6.        |  | Exhibits                                                                                              |  | 27   
|               | 
|Signatures     |  | 28                                                                                                   
|               | 
|Exhibit Index  |  | 29-30                                                                                                
|               | 
|Certifications |  | 31-34                                                                                                



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Part I. Financial Information



Item 1. Financial Statements



NEOMAGIC CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)



|                                                                 |  |                    |        |   |                   |   |        |                  |  |   |                 |   |  |   |         |  
|---------------------------------------------------------------- |  | ------------------ | ------ | - | ----------------- | - | ------ | ---------------- |  | - | --------------- | - |  | - | ------- | -
|                                                                 |  | Three Months Ended |        |   | Nine Months Ended |  
|                                                                 |  | October 31,2004    |        |   | October 31,2003   |   |        | October 31, 2004 |  |   | October 31,2003 |  
|Net sales                                                        |  | $                  | 552    |   |                   | $ | 486    |                  |  | $ | 2,244           |   |  | $ | 1,332   |  
|                                                                 |  |                    |        |  
|Cost of Sales (1)                                                |  |                    | 663    |   |                   |   | 623    |                  |  |   | 2,422           |   |  |   | 1,630   |  
|                                                                 |  |                    |        |   |                   |   |        |                  |  |   |                 |   |  |   |         |  
|Gross loss                                                       |  |                    | (111   | ) |                   |   | (137   | )                |  |   | (178            | ) |  |   | (298    | )
|                                                                 |  |                    |        |  
|Operating expenses:                                              |  |                    |        |   |                   |   |        |                  |  |   |                 |   |  |   |         |  
|Research and development (2)                                     |  |                    | 4,189  |   |                   |   | 5,340  |                  |  |   | 13,876          |   |  |   | 14,849  |  
|Sales, general and administrative (3)                            |  |                    | 1,643  |   |                   |   | 1,835  |                  |  |   | 5,663           |   |  |   | 5,379   |  
|                                                                 |  |                    |        |   |                   |   |        |                  |  |   |                 |   |  |   |         |  
|Total operating expenses                                         |  |                    | 5,832  |   |                   |   | 7,175  |                  |  |   | 19,539          |   |  |   | 20,228  |  
|                                                                 |  |                    |        |   |                   |   |        |                  |  |   |                 |   |  |   |         |  
|Loss from operations                                             |  |                    | (5,943 | ) |                   |   | (7,312 | )                |  |   | (19,717         | ) |  |   | (20,526 | )
|                                                                 |  |                    |        |  
|Other income (expense), net:                                     |  |                    |        |   |                   |   |        |                  |  |   |                 |   |  |   |         |  
|Interest income and other income                                 |  |                    | 123    |   |                   |   | 363    |                  |  |   | 318             |   |  |   | 742     |  
|Interest expense                                                 |  |                    | (173   | ) |                   |   | (66    | )                |  |   | (250            | ) |  |   | (226    | )
|                                                                 |  |                    |        |   |                   |   |        |                  |  |   |                 |   |  |   |         |  
|Loss before income taxes                                         |  |                    | (5,993 | ) |                   |   | (7,015 | )                |  |   | (19,649         | ) |  |   | (20,010 | )
|Income tax expense                                               |  |                    | 5      |   |                   |   | 33     |                  |  |   | 19              |   |  |   | 39      |  
|                                                                 |  |                    |        |   |                   |   |        |                  |  |   |                 |   |  |   |         |  
|Net loss                                                         |  | $                  | (5,998 | ) |                   | $ | (7,048 | )                |  | $ | (19,668         | ) |  | $ | (20,049 | )
|                                                                 |  |                    |        |   |                   |   |        |                  |  |   |                 |   |  |   |         |  
|Basic and diluted net loss per share                             |  | $                  | (0.18  | ) |                   | $ | (0.23  | )                |  | $ | (0.61           | ) |  | $ | (0.66   | )
|                                                                 |  |                    |        |  
|Weighted average common shares outstanding for basic and diluted |  |                    | 32,829 |   |                   |   | 30,759 |                  |  |   | 32,475          |   |  |   | 30,498  |  

---

|(1) | Includes $4 and $11 in amortization of deferred stock compensation for the three months ended October 31, 2004 and 2003, respectively, and $8 and $26 for the nine months ended
October 31, 2004 and 2003, respectively
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Includes $55 and $128 in amortization of deferred stock compensation for the three months ended October 31, 2004 and 2003, respectively, and $145 and $285 for the nine months ended
October 31, 2004 and 2003, respectively.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Includes $17 and $104 in amortization of deferred stock compensation for the three months ended October 31, 2004 and 2003, respectively, and $107 and $191 for the nine months ended
October 31, 2004 and 2003, respectively.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



See
accompanying notes to condensed consolidated financial statements.

|
|



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NEOMAGIC CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)



|                                                            |  |                 |         |   |                     |   |         |  
|----------------------------------------------------------- |  | --------------- | ------- | - | ------------------- | - | ------- | -
|                                                            |  | October 31,2004 |         |   | January 31,2004 (1) |  
|                                                            |  | (Unaudited)     |         |   |                     |  
|ASSETS                                                      |  |                 |         |   |                     |   |         |  
|Current assets:                                             |  |                 |         |   |                     |   |         |  
|Cash and cash equivalents                                   |  | $               | 13,547  |   |                     | $ | 12,342  |  
|Short-term investments                                      |  |                 | 17,213  |   |                     |   | 30,240  |  
|Accounts receivable, net                                    |  |                 | 302     |   |                     |   | 384     |  
|Inventory                                                   |  |                 | 785     |   |                     |   | 102     |  
|Other current assets                                        |  |                 | 1,064   |   |                     |   | 974     |  
|                                                            |  |                 |         |   |                     |   |         |  
|Total current assets                                        |  |                 | 32,911  |   |                     |   | 44,042  |  
|                                                            |  |                
|Property, plant and equipment, net                          |  |                 | 4,265   |   |                     |   | 3,302   |  
|Intangibles, net                                            |  |                 | 1,899   |   |                     |   | 3,168   |  
|Other assets                                                |  |                 | 757     |   |                     |   | 349     |  
|                                                            |  |                 |         |   |                     |   |         |  
|Total assets                                                |  | $               | 39,832  |   |                     | $ | 50,861  |  
|                                                            |  |                 |         |   |                     |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                        |  |                 |         |   |                     |   |         |  
|Current liabilities:                                        |  |                 |         |   |                     |   |         |  
|Accounts payable                                            |  | $               | 1,483   |   |                     | $ | 1,344   |  
|Compensation and related benefits                           |  |                 | 1,600   |   |                     |   | 1,257   |  
|Income taxes payable                                        |  |                 | 3,672   |   |                     |   | 3,675   |  
|Other accruals                                              |  |                 | 258     |   |                     |   | 203     |  
|Current portion of capital lease obligations                |  |                 | 1,445   |   |                     |   | 1,756   |  
|                                                            |  |                 |         |   |                     |   |         |  
|Total current liabilities                                   |  |                 | 8,458   |   |                     |   | 8,235   |  
|                                                            |  |                
|Capital lease obligations                                   |  |                 | 2,555   |   |                     |   | 799     |  
|                                                            |  |                
|Mandatorily redeemable Series B convertible preferred stock |  |                 | 2,775   |   |                     |   |        |  
|                                                            |  |                
|Stockholders equity:                                       |  |                 |         |   |                     |   |         |  
|Common stock                                                |  |                 | 33      |   |                     |   | 32      |  
|Additional paid-in-capital                                  |  |                 | 95,506  |   |                     |   | 90,496  |  
|Deferred compensation                                       |  |                 | (1,648  | ) |                     |   | (535    | )
|Accumulated other comprehensive loss                        |  |                 | (19     | ) |                     |   | (6      | )
|Accumulated deficit                                         |  |                 | (67,828 | ) |                     |   | (48,160 | )
|                                                            |  |                 |         |   |                     |   |         |  
|Total stockholders equity                                  |  |                 | 26,044  |   |                     |   | 41,827  |  
|                                                            |  |                 |         |   |                     |   |         |  
|Total liabilities and stockholders equity                  |  | $               | 39,832  |   |                     | $ | 50,861  |  
|                                                            |  |                 |         |   |                     |   |         |  

---

|(1) | Derived from the January 31, 2004 audited consolidated financial statements included in the Annual Report on Form 10-K of NeoMagic Corporation for fiscal year 2004.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



See accompanying notes to condensed consolidated
financial statements.



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NEOMAGIC CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)



|                                                                                                                                               |  |                   |         |   |                 |   |         |  
|---------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | - | --------------- | - | ------- | -
|                                                                                                                                               |  | Nine Months Ended |        
|                                                                                                                                               |  | October 31,2004   |         |   | October 31,2003 |  
|Operating activities:                                                                                                                          |  |                   |         |   |                 |   |         |  
|Net loss                                                                                                                                       |  | $                 | (19,668 | ) |                 | $ | (20,049 | )
|Adjustments to reconcile net loss to net cash used for operating activities:                                                                   |  |                   |         |   |                 |   |         |  
|Depreciation and amortization                                                                                                                  |  |                   | 3,027   |   |                 |   | 2,850   |  
|(Gain) Loss on disposal of property, plant and equipment                                                                                       |  |                   | (1      | ) |                 |   | 3       |  
|Amortization of deferred compensation                                                                                                          |  |                   | 260     |   |                 |   | 502     |  
|Changes in operating assets and liabilities:                                                                                                   |  |                   |         |   |                 |   |         |  
|Accounts receivable                                                                                                                            |  |                   | 82      |   |                 |   | 35      |  
|Inventory                                                                                                                                      |  |                   | (683    | ) |                 |   | 251     |  
|Other current assets                                                                                                                           |  |                   | 99      |   |                 |   | 406     |  
|Other assets                                                                                                                                   |  |                   | (220    | ) |                 |   | 69      |  
|Accounts payable                                                                                                                               |  |                   | 139     |   |                 |   | (956    | )
|Compensation and related benefits                                                                                                              |  |                   | 343     |   |                 |   | 40      |  
|Income taxes payable                                                                                                                           |  |                   | (3      | ) |                 |   | 42      |  
|Tax benefit from employee stock options                                                                                                        |  |                   |        |   |                 |   | 355     |  
|Other accruals                                                                                                                                 |  |                   | 55      |   |                 |   | (1,082  | )
|                                                                                                                                               |  |                   |         |   |                 |   |         |  
|Net cash used in operating activities                                                                                                          |  |                   | (16,570 | ) |                 |   | (17,534 | )
|                                                                                                                                               |  |                   |         |   |                 |   |         |  
|Investing activities:                                                                                                                          |  |                   |         |   |                 |   |         |  
|Proceeds from the sale of property, plant, and equipment                                                                                       |  |                   | 6       |   |                 |   |        |  
|Purchases of property, plant, equipment and intangibles                                                                                        |  |                   | (114    | ) |                 |   | (425    | )
|Purchases of short-term investments                                                                                                            |  |                   | (17,790 | ) |                 |   | (52,357 | )
|Maturities of short-term investments                                                                                                           |  |                   | 30,804  |   |                 |   | 43,071  |  
|                                                                                                                                               |  |                   |         |   |                 |   |         |  
|Net cash provided by (used in) investing activities                                                                                            |  |                   | 12,906  |   |                 |   | (9,711  | )
|                                                                                                                                               |  |                   |         |   |                 |   |         |  
|Financing activities:                                                                                                                          |  |                   |         |   |                 |   |         |  
|Payments on capital lease obligations                                                                                                          |  |                   | (1,413  | ) |                 |   | (806    | )
|Net proceeds from issuance of common stock                                                                                                     |  |                   | 1,347   |   |                 |   | 264     |  
|Net proceeds from issuance of mandatorily redeemable Series B convertible preferred stock and Series A and B warrants to purchase common
stock |  |                   | 4,935   |   |                 |   |        |  
|                                                                                                                                               |  |                   |         |   |                 |   |         |  
|Net cash provided by (used in) financing activities                                                                                            |  |                   | 4,869   |   |                 |   | (542    | )
|                                                                                                                                               |  |                   |         |   |                 |   |         |  
|Net increase (decrease) in cash and cash equivalents                                                                                           |  |                   | 1,205   |   |                 |   | (27,787 | )
|Cash and cash equivalents at beginning of period                                                                                               |  |                   | 12,342  |   |                 |   | 37,428  |  
|                                                                                                                                               |  |                   |         |   |                 |   |         |  
|Cash and cash equivalents at end of period                                                                                                     |  | $                 | 13,547  |   |                 | $ | 9,641   |  
|                                                                                                                                               |  |                   |         |   |                 |   |         |  
|Supplemental schedules of cash flow information:                                                                                               |  |                   |         |   |                 |   |         |  
|Cash paid during the period for:                                                                                                               |  |                   |         |   |                 |   |         |  
|Interest                                                                                                                                       |  | $                 | 116     |   |                 | $ | 152     |  
|Taxes                                                                                                                                          |  | $                 | 21      |   |                 | $ | 55      |  



See accompanying notes
to condensed consolidated financial statements.



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NEOMAGIC CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



1. Basis of Presentation



The unaudited condensed consolidated 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 Note disclosures, normally included in financial statements prepared in accordance with generally accepted accounting principles, have been condensed or omitted pursuant to such rules and regulations. In the opinion of the Company, the financial
statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial position at October 31, 2004, the operating results for the three and nine months ended October 31, 2004 and
2003, and the cash flows for the nine months ended October 31, 2004 and 2003. 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,
2004, included in the Companys most recent Form 10-K filed with the Securities and Exchange Commission.



The results of operations for the three and nine months ended October 31, 2004 are not necessarily indicative of the results that may be expected for the
year ending January 31, 2005.



The third fiscal quarters of
2004 and 2003 ended on October 31, 2004 and October 26, 2003, respectively. The Companys quarters generally have 13 weeks. The first quarter of fiscal 2005 had 14 weeks, the second quarter of fiscal 2005 had 13 weeks, and the third quarter of
fiscal 2005 had 13 weeks. The first, second, and third quarters of fiscal 2004 each had 13 weeks. The Companys fiscal years generally have 52 weeks. Fiscal 2005 will have 53 weeks. For ease of presentation, the accompanying financial
statements have been shown as ending on the last day of the calendar month of October.



2. Stock Compensation



At October 31, 2004,
the Company had several stock-based employee compensation plans, including stock option plans and an employee stock purchase plan. The Company accounts for these plans under the intrinsic value method. The following table illustrates the effect on
net loss and loss per share if the Company had applied the fair value recognition method:



|                                                                                                                               |  |                               |        |   |                              |   |        |      |  |   |         |   |  |   |         |  
|------------------------------------------------------------------------------------------------------------------------------ |  | ----------------------------- | ------ | - | ---------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                                                               |  | Three Months EndedOctober 31, |        |   | Nine Months EndedOctober 31, |  
|(in thousands, except per share amounts)                                                                                       |  | 2004                          |        |   | 2003                         |   |        | 2004 |  |   | 2003    |  
|Net loss, as reported                                                                                                          |  | $                             | (5,998 | ) |                              | $ | (7,048 | )    |  | $ | (19,668 | ) |  | $ | (20,049 | )
|Add: Stock-based employee compensation expense included in reported net loss, net of related tax effects                       |  |                               | 76     |   |                              |   | 202    |      |  |   | 260     |   |  |   | 461     |  
|Less: Total stock-based compensation expense determined under the fair value method for all awards, net of related tax effects |  |                               | (873   | ) |                              |   | (870   | )    |  |   | (3,144  | ) |  |   | (2,381  | )
|                                                                                                                               |  |                               |        |   |                              |   |        |      |  |   |         |   |  |   |         |  
|Pro forma net loss                                                                                                             |  |                               | (6,795 | ) |                              |   | (7,716 | )    |  |   | (22,552 | ) |  |   | (21,969 | )
|                                                                                                                               |  |                               |        |   |                              |   |        |      |  |   |         |   |  |   |         |  
|Reported basic and diluted loss per share                                                                                      |  | $                             | (0.18  | ) |                              | $ | (0.23  | )    |  | $ | (0.61   | ) |  | $ | (0.66   | )
|                                                                                                                               |  |                               |        |   |                              |   |        |      |  |   |         |   |  |   |         |  
|Pro forma basic and diluted loss per share                                                                                     |  | $                             | (0.21  | ) |                              | $ | (0.25  | )    |  | $ | (0.69   | ) |  | $ | (0.72   | )
|                                                                                                                               |  |                               |        |   |                              |   |        |      |  |   |         |   |  |   |         |  



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In the three and nine months ended October 31, 2004 and 2003, respectively, the fair value of each option
grant was estimated on the date of the grant using the Black-Scholes option-pricing model using a dividend yield of 0% and the following additional weighted-average assumptions:



|                                 |  |                               |   |  |                              |   |  |                               |   |  |                              |   |  |      |   |  |      |   |  |      |   |  |      |  
|-------------------------------- |  | ----------------------------- | - |  | ---------------------------- | - |  | ----------------------------- | - |  | ---------------------------- | - |  | ---- | - |  | ---- | - |  | ---- | - |  | ---- | -
|                                 |  | Option Plans                  |   |  | Stock Purchase Plan          |  
|                                 |  | Three Months EndedOctober 31, |   |  | Nine Months EndedOctober 31, |   |  | Three Months EndedOctober 31, |   |  | Nine Months EndedOctober 31, |  
|                                 |  | 2004                          |   |  | 2003                         |   |  | 2004                          |   |  | 2003                         |   |  | 2004 |   |  | 2003 |   |  | 2004 |   |  | 2003 |  
|Risk-free interest rates         |  | 2.9                           | % |  | 2.7                          | % |  | 3.0                           | % |  | 2.0                          | % |  | 2.2  | % |  | 1.1  | % |  | 1.8  | % |  | 1.3  | %
|Volatility                       |  | 0.93                          |   |  | 0.93                         |   |  | 0.89                          |   |  | 0.67                         |   |  | 0.93 |   |  | 0.97 |   |  | 0.86 |   |  | 0.81 |  
|Expected life of option in years |  | 3.05                          |   |  | 4.28                         |   |  | 3.44                          |   |  | 2.80                         |   |  | 0.49 |   |  | 0.51 |   |  | 0.49 |   |  | 0.50 |  



The Black-Scholes
option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions
including the expected stock price volatility. Because the Companys employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect
the fair value estimate, in managements opinion, the Black-Scholes and other existing models do not necessarily provide a reliable single measure of its employee stock options.



3. Loss Per Share



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



Per share information calculated on this basis is as follows:



|                                                                                       |  |                               |        |   |                              |   |        |      |  |   |         |   |  |   |         |  
|-------------------------------------------------------------------------------------- |  | ----------------------------- | ------ | - | ---------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                       |  | Three Months EndedOctober 31, |        |   | Nine Months EndedOctober 31, |  
|(in thousands, except per share amounts)                                               |  | 2004                          |        |   | 2003                         |   |        | 2004 |  |   | 2003    |  
|Numerator:                                                                             |  |                               |        |   |                              |   |        |      |  |   |         |   |  |   |         |  
|Net loss                                                                               |  | $                             | (5,998 | ) |                              | $ | (7,048 | )    |  | $ | (19,668 | ) |  | $ | (20,049 | )
|Denominator:                                                                           |  |                               |        |   |                              |   |        |      |  |   |         |   |  |   |         |  
|Denominator for basic and diluted loss per share  weighted-average shares outstanding |  |                               | 32,829 |   |                              |   | 30,759 |      |  |   | 32,475  |   |  |   | 30,498  |  
|Basic and diluted loss per share                                                       |  | $                             | (.18   | ) |                              | $ | (.23   | )    |  | $ | (.61    | ) |  | $ | (.66    | )



For the three months
ended October 31, 2004 and October 31, 2003 and for the nine months ended October 31, 2004 and October 31, 2003, respectively, basic earnings per share and diluted earnings per share are the same because the effect of including stock options under
the treasury stock method would be anti-dilutive. During the three months ended October 31, 2004 and 2003, respectively, the Company excluded options to purchase 10,050,838 and 6,105,231 shares of common stock. During the nine months ended October
31, 2004 and 2003, respectively, the Company excluded options to purchase 5,342,288 and 6,467,348 shares of common stock.



4. Inventories



Inventories are stated at the lower of cost or market value. Cost is determined by the first-in, first-out method. The Company writes down the inventory
value for estimated excess and obsolete inventory, based on managements assessment of future demand and market conditions. If actual future demand or market conditions are less favorable than those projected by management, additional inventory
write-downs may be required.



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|                                      |  |                  |     |                  |   |    
|------------------------------------- |  | ---------------- | --- | ---------------- | - | ---
|Inventory consists of: (in
thousands) |  | October 31, 2004 |     | January 31, 2004
|Raw materials                         |  | $                | 445 |                  | $ | 7  
|Work in process                       |  |                  | 31  |                  |   |   
|Finished goods                        |  |                  | 309 |                  |   | 95 
|                                      |  |                  |     |                  |   |    
|Total                                 |  | $                | 785 |                  | $ | 102
|                                      |  |                  |     |                  |   |    



5. Accumulated Other Comprehensive
Loss



Net comprehenseive loss includes the Companys
net loss, as well as accumulated other comprehensive income/(loss) on available for sale securities. Net comprehensive loss for the three and nine month periods ended October 31, 2004 and 2003, respectively, is as follows:



|                                                               |  |                               |        |   |                              |   |        |      |  |   |         |   |  |   |         |  
|-------------------------------------------------------------- |  | ----------------------------- | ------ | - | ---------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                               |  | Three Months EndedOctober 31, |        |   | Nine Months EndedOctober 31, |  
|(in thousands, except per share amounts)                       |  | 2004                          |        |   | 2003                         |   |        | 2004 |  |   | 2003    |  
|Net loss                                                       |  | $                             | (5,998 | ) |                              | $ | (7,048 | )    |  | $ | (19,668 | ) |  | $ | (20,049 | )
|Net change in unrealized loss on available for sale securities |  |                               | 10     |   |                              |   | (16    | )    |  |   | (13     | ) |  |   | (33     | )
|                                                               |  |                               |        |   |                              |   |        |      |  |   |         |   |  |   |         |  
|Net comprehensive loss                                         |  | $                             | (5,988 | ) |                              | $ | (7,064 | )    |  | $ | (19,681 | ) |  | $ | (20,082 | )
|                                                               |  |                               |        |   |                              |   |        |      |  |   |         |   |  |   |         |  



Total accumulated
other comprehensive loss was $19 thousand at October 31, 2004 and $6 thousand at January 31, 2004. Accumulated other comprehensive loss consists entirely of unrealized losses on available for sale securities.



6. Intangible Assets



The following table provides a summary of the carrying amount of intangible assets that will continue to be amortized (in
thousands):



|                               |  |      |       |                         |   |        |     |  |   |      
|------------------------------ |  | ---- | ----- | ----------------------- | - | ------ | --- |  | - | -----
|October 31, 2004               |  | Cost |       | AccumulatedAmortization |   |        | Net
|Licensed intellectual property |  | $    | 3,275 |                         | $ | (1,476 | )   |  | $ | 1,799
|Core technology                |  |      | 1,800 |                         |   | (1,700 | )   |  |   | 100  
|                               |  |      |       |                         |   |        |     |  |   |      
|                               |  | $    | 5,075 |                         | $ | (3,176 | )   |  | $ | 1,899
|                               |  |      |       |                         |   |        |     |  |   |      
|                               |  |      |      
|January 31, 2004               |  | Cost |       | AccumulatedAmortization |   |        | Net
|Licensed intellectual property |  | $    | 3,275 |                         | $ | (657   | )   |  | $ | 2,618
|Core technology                |  |      | 1,800 |                         |   | (1,250 | )   |  |   | 550  
|                               |  |      |       |                         |   |        |     |  |   |      
|                               |  | $    | 5,075 |                         | $ | (1,907 | )   |  | $ | 3,168
|                               |  |      |       |                         |   |        |     |  |   |      



Amortization expense
for other intangible assets was $423 thousand and $423 thousand for the three months ended October 31, 2004 and 2003, respectively. Amortization expense for other intangible assets was $1,269 thousand and $789 thousand for the nine months ended
October 31, 2004 and 2003,



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respectively. Licensed intellectual property and core technology are amortized over three years. Estimated annual
amortization expense for other intangible assets is as follows as of October 31, 2004:



|                                               |  |   |      
|---------------------------------------------- |  | - | -----
|Fiscal years ending January 31, (in
thousands) |  |  
|2005                                           |  | $ | 373  
|2006                                           |  |   | 1,047
|2007                                           |  |   | 479  
|                                               |  |   |      
|Total                                          |  | $ | 1,899
|                                               |  |   |      



7. Obligations Under Capital Leases



Obligations under capital leases represent the present
value of future payments under the lease agreements. Property, plant and equipment include the following amounts for leases that have been capitalized:



|                                 |  |                 |       |   |                 |   |        |  
|-------------------------------- |  | --------------- | ----- | - | --------------- | - | ------ | -
|(in thousands)                   |  | October 31,2004 |       |   | January 31,2004 |  
|Software under capital lease     |  | $               | 4,243 |   |                 | $ | 4,073  |  
|Accumulated amortization         |  |                 | (467  | ) |                 |   | (1,738 | )
|                                 |  |                 |       |   |                 |   |        |  
|Net software under capital lease |  | $               | 3,776 |   |                 | $ | 2,335  |  
|                                 |  |                 |       |   |                 |   |        |  



Amounts capitalized under leases are
being amortized over a three-year period.



Future minimum payments under the
capital leases consist of the following, as of October 31, 2004:



|                                              |  |   |        |  
|--------------------------------------------- |  | - | ------ | -
|Fiscal year ending January 31, (in
thousands) |  |   |       
|2005                                          |  | $ | 465    |  
|2006                                          |  |   | 1,796  |  
|2007                                          |  |   | 1,548  |  
|2008                                          |  |   | 593    |  
|                                              |  |   |        |  
|Total minimum lease payments                  |  |   | 4,402  |  
|Less: amount representing interest            |  |   | (402   | )
|                                              |  |   |        |  
|Present value of net minimum lease payments   |  |   | 4,000  |  
|Less: current portion                         |  |   | (1,445 | )
|                                              |  |   |        |  
|Long-term portion                             |  | $ | 2,555  |  
|                                              |  |   |        |  



8. Mandatorily Redeemable Series B
Convertible Preferred Stock



On August 20, 2004, the
Company issued 5,000 shares of Mandatorily Redeemable Series B Convertible Preferred Stock (the Series B Preferred Stock), Series A Warrants for the purchase of 1,608,696 shares of common stock at $1.64 per share, and Series B Warrants
for the purchase of 1,000,000 shares of common stock at $1.60 per share for an aggregate cash purchase price of $5,000,000. After deducting certain transaction costs, net cash proceeds received by the Company were $4,935,000. In addition, the
Company incurred out-of-pocket expenses of approximately $392 thousand related to the financing. The Series B Preferred Stock is initially convertible at the option of the investor into 4,347,826 shares of the Companys Common Stock at a
conversion price of $1.15 per share, and is subject to certain anti-dilution provisions. The Series B Preferred Stock is redeemable by the Company for a mandatory payment of $5 million three years from the issue date if the conversion option has not
been exercised. The Series A Warrants to purchase common stock are exercisable for five years from the date of issuance. The



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Series B Warrants to purchase common stock are exercisable until 90 days after the date that a registration statement
relating to the common shares underlying the securities issued in this transaction is declared effective by the Securities and Exchange Commission. On September 24, 2004, this registration statement was declared effective.



In accordance with SFAS 150, the Company classified the estimated fair value
of the Mandatorily Redeemable Series B Convertible Preferred Stock as a liability. The Company estimated the fair values of the Series B Preferred Stock and the Series A and B Warrants and allocated the net proceeds of $4,935,000 based on relative
fair values in accordance with EITF 00-27 and calculated the intrinsic value of the conversion option embedded within the convertible preferred stock using the effective conversion price of $1.15 per common share. The intrinsic value of the
beneficial conversion option calculated was $1,203,000 and the fair value allocated to the Series A and Series B warrants was $1,153,000. The fair value allocated to the warrants and the intrinsic value of the beneficial conversion option were
recorded as credits to additional paid in capital in stockholders equity on the condensed consolidated balance sheets with an offsetting amount of $2,356,000 treated as a reduction in the $5 million liability recorded for the Mandatorily
Redeemable Series B Convertible Preferred Stock. The net recorded liability of $2,644,000 for the Mandatorily Redeemable Series B Convertible Preferred Stock will accrete to the redemption value of $5 million through charges to interest expense over
the three year period until mandatory redemption. The Company accreted interest expense of $131,000 during the third quarter of fiscal 2005.



The Companys out-of-pocket expenses of approximately $392,000 related to the financing were recorded as deferred financing costs on the condensed
consolidated balance sheets with $131,000 recorded in current assets. The Company recorded amortization of the deferred financing costs to interest expense of $22,000 during the third quarter of fiscal 2005.



9. Contingencies



As a general matter, the semiconductor industry has experienced substantial litigation regarding patent and other
intellectual property rights. In December 1998, the Company filed a lawsuit in the United States District Court for the District of Delaware seeking damages and an injunction against Trident Microsystems, Inc. The suit alleged that Tridents
embedded DRAM graphics accelerators infringe certain patents held by the Company. In January 1999, Trident filed a counter claim against the Company alleging an attempted monopolization in violation of antitrust laws, arising from NeoMagics
filing of the patent infringement action against Trident. The Court ruled that there was no infringement by Trident. Since January 1999, no further action has occurred on this counter claim. The Company filed an appeal in the United States Court of
Appeals, for the Federal Circuit. On April 17, 2002, the United States Court of Appeals for the Federal Circuit affirmed the lower courts judgment of non-infringement on one patent and vacated the courts judgment of non-infringement on
another patent, thereby remanding it to the lower court for further proceedings. In November 2002, the lower court heard oral arguments on cross-motions for summary judgment on the matter. In May 2003, the lower court ruled in favor of Trident. In
December 2003 the Company filed an appeal in the United States Court of Appeals, for the Federal Circuit. In August 2004 the Federal Circuit rejected the appeal and affirmed the lower courts decision of no infringement by the Trident products.
While the Company believes it has valid defenses against Tridents counter claim filed in 1999, there can be no assurance as to whether Trident will or will not proceed with the counter-suit.



10. Product Warranty



The Company generally sells products with a limited warranty of product quality and a limited indemnification of customers
against intellectual property infringement claims related to the Companys products. The Company accrues for known warranty and indemnification issues if a loss is probable and can be reasonably estimated, and accrues for estimated incurred but
unidentified issues based on historical activity. The accrual and the related expense for known issues were not significant as of and for the nine



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months periods ended October 31, 2004 and 2003. Due to product testing, the short time between product shipment and the
detection and correction of product failures, and a low historical rate of payments on indemnification claims, the accrual based on historical activity and the related expense were not significant for the nine months ended October 31, 2004 and 2003.



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations



When used in this discussion, the words expects, anticipates, believes and similar expressions are intended to
identify forward-looking statements. Such statements reflect managements current intentions and expectations. Examples of such forward-looking statements include statements regarding future revenues, expenses, losses and cash flows, the launch
of new products by NeoMagic and its customers and research and development activities. However, actual events and results could vary significantly based on a variety of factors including those set forth below under Factors that May Affect
Results. These forward-looking statements speak only as of the date hereof. The Company expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein, to
reflect any changes in the Companys expectations with regard thereto or any changes in events, conditions or circumstances on which any such statement is based.



Overview



NeoMagic designs, develops and markets high-performance, power-efficient Applications Processors that enable multimedia features and applications in
handheld systems. In the past, the Company provided semiconductor solutions for the notebook computer multimedia accelerator marketplace. In April 2000, the Company began to exit this market and is now focused solely on designing, developing and
selling Applications Processors and companion chips for the handheld systems market. The Company is now generating revenues from this new product effort. The Companys goal is to become a worldwide leader in Applications Processors.



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



NeoMagic introduced its MiMagic 5 Applications Processor (NMS9200) in November 2002, and began sampling the product in February 2003. Significant revenues
from the MiMagic 5 are not expected to be generated until the fiscal year-ending January 31, 2006.



NeoMagic introduced its MiMagic 6 Applications Processor (NMS9600) in June 2003, and began sampling the product in November 2003. The MiMagic 6 is the
first product to use an innovative proprietary architecture, called the Associative Processor Array (APA), as the core of its multimedia engine. The APA architecture uses a massively parallel approach to processing information, which means that APA
operates on multimedia data in parallel, without increasing clock rates. Existing competitive solutions use a sequential processing flow that operates on each individual data element in sequence, relying on ever-faster clock rates to improve
performance. These faster clock rates burn power more quickly, thus reducing battery life. The APA multimedia engine is capable of processing large amounts of multimedia data such as video, still pictures and audio simultaneously and at low clock
rates, resulting in low power consumption. Significant revenues from the MiMagic 6 are not expected to be generated until the fiscal year-ending January 31, 2006.



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The Companys fiscal year end is January 31. Any references herein to a fiscal year refer to the
year ended January 31 of such year. The third fiscal quarters of 2004 and 2003 ended on October 31, 2004 and October 26, 2003, respectively. For ease of presentation, the accompanying financial statements have been shown as ending on the last day of
the calendar month of October.



Critical Accounting Policies



NeoMagics discussion and analysis of its financial condition and
results of operations are based upon its consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company
to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those
related to intangible assets and long-lived assets, revenue recognition, inventories and income taxes. The Company bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the
circumstances, the results of which form the basis for making judgments about the amount and timing of revenue and expenses and the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ
from these estimates under different assumptions or conditions.



Intangible
Assets and Long Lived Assets



In accordance with SFAS 144,
Accounting for the Impairment or Disposal of Long Lived Assets, the Company evaluates the carrying value of its long-lived assets, consisting primarily of identifiable intangible assets, and property, plant and equipment, whenever
certain events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Such events or circumstances include, but are not limited to, a significant decline in the Companys market value, significant
reductions in projected future cash flows or gross margins, or macroeconomic factors including a prolonged economic downturn. In assessing the recoverability of long-lived assets, the Company compares the carrying value to the undiscounted future
cash flows the assets are expected to generate. If the total of the undiscounted future cash flows is less than the carrying amount of the assets, the Company will be required to write down such assets based on the excess of the carrying amount over
the fair value of the assets. Fair value is generally determined by calculating the discounted future cash flows using a discount rate based upon the weighted average cost of capital. Significant judgments and assumptions are required in the
forecast of future operating results used in the preparation of the estimated future cash flows, including gross profit margins, long-term forecasts of the amounts and timing of overall market growth and the Companys percentage of that market,
groupings of assets, discount rates and terminal growth rates. In addition, significant estimates and assumptions are required in the determination of the fair value of our tangible long-lived assets, including replacement cost, economic
obsolescence, and the value that could be realized in liquidation. Changes in these estimates could have a material adverse effect on the assessment of our long-lived assets, thereby requiring the Company to write-down or write-off long-lived
assets.



We continue to periodically evaluate our long-lived
assets for impairment in accordance with SFAS 144 and acknowledge it is possible that such evaluation might result in future adjustments for impairment. Such an impairment might adversely affect our operating results.



Revenue Recognition



The Company recognizes revenue from non-distributor product sales when the products are shipped to customers, title has
transferred, and no significant obligations remain. Thus, the Company requires the following: (i) execution of a written customer order, (ii) delivery of the product, (iii) fee is fixed or determinable, and (iv) collectibility of the proceeds is
probable. The Companys shipment terms are FOB shipping point.



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For products shipped to distributors, the Company defers recognition of revenue until the distributors
sell the products to their customers. On occasion, however, the Company will sell products with End of Life status to distributors under special arrangements without any price protection or return privileges for which the Company
recognizes revenue upon transfer of title, typically at the time of shipping.



At the end of each accounting period, the Company makes a determination of certain factors including sales returns and allowances, which could affect the amount of revenue recorded for the period. Sales returns
provisions include considerations for known but unprocessed sales returns and estimation for unknown returns based on historical experiences. Actual sales returns may vary significantly from historical experience and could have a material effect on
the Companys operating results.



Inventory Valuation



The Companys inventory valuation policy stipulates that at the end
of each reporting period we write-down or write-off our inventory for estimated obsolescence or unmarketable inventory. The amount of the write-down or write-off is equal to the difference between the cost of the inventory and the estimated market
value of the inventory based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs or write-offs may be required. Additionally,
as we introduce product enhancements and new products, demand for our existing products in inventory may decrease, requiring additional inventory write-downs.



Deferred Taxes



The Company records a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. Based on the
uncertainty of future pre-tax income, the Company has fully reserved its deferred tax assets. In the event the Company was to determine that it would be able to realize some or all of its deferred tax assets in the future, an adjustment to the
deferred tax asset would increase income in the period when such determination was made. The Company has also provided accruals for certain potential tax liabilities. If such amounts ultimately prove to be unnecessary, the resulting reversal of such
accruals would result in tax benefits being recorded in the period when the accruals are no longer deemed necessary.



Results of Operations



Net Sales



Net sales
were $0.6 million and $2.2 million for the three months and nine months ended October 31, 2004, respectively, compared to $0.5 million and $1.3 million for the three months and nine months ended October 31, 2003. Net sales increased in the three
months ended October 31, 2004 primarily due to a $0.2 million increase in shipments of our NMC 1110 companion chips due to product end of life notices sent to customers, partially offset by $0.1 million decrease in shipments of our MiMagic 3
applications processor for the handheld systems market. Net sales increased in the nine months ended October 31, 2004 primarily due to a $1.0 million increase in shipments of our MiMagic 3 applications processor for the handheld systems market and
$0.1 million increase in shipments of our NMC 1110 companion chips offset by $0.2 million decrease in shipments of NMC 1121 companion chips.



Sales to customers located outside the United States (including sales to the foreign operations of customers with headquarters in the United States, and
foreign system manufacturers that sell to United



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States-based OEMs) accounted for 82% and 91% of net sales in the three months ended October 31, 2004 and 2003,
respectively. Sales to customers located outside the United States accounted for 90% and 88% of net sales in the nine months ended October 31, 2004 and 2003, respectively. All sales transactions were denominated in United States dollars. The
following is a summary of the Companys net sales by major geographic area:



|                                                                  |  |                    |   |  |                   |   |  |                  |   |  |                  |  
|----------------------------------------------------------------- |  | ------------------ | - |  | ----------------- | - |  | ---------------- | - |  | ---------------- | -
|                                                                  |  | Three Months Ended |   |  | Nine Months Ended |  
|                                                                  |  | October 31, 2004   |   |  | October 31, 2003  |   |  | October 31, 2004 |   |  | October 31, 2003 |  
|Japan                                                             |  | 3                  | % |  | 45                | % |  | 10               | % |  | 45               | %
|Taiwan                                                            |  | 76                 | % |  | 44                | % |  | 49               | % |  | 40               | %
|Hong Kong                                                         |  | 0                  | % |  | 0                 | % |  | 28               | % |  | 0                | %
|United States                                                     |  | 18                 | % |  | 9                 | % |  | 10               | % |  | 12               | %
|Europe                                                            |  | 3                  | % |  | 2                 | % |  | 3                | % |  | 3                | %
|                                                                  |  |                    |   |  |                   |   |  |                  |   |  |                  |  
|                                                                  |  | 100                | % |  | 100               | % |  | 100              | % |  | 100              | %
|                                                                 
|The following customers accounted for more than 10% of net sales: | 
|                                                                  |  | Three Months Ended |   |  | Nine Months Ended |  
|                                                                  |  | October 31, 2004   |   |  | October 31, 2003  |   |  | October 31, 2004 |   |  | October 31, 2003 |  
|Edom Technology Co.**                                             |  | 62                 | % |  | 35                | % |  | 36               | % |  | 29               | %
|ESS Technology International, Inc.                                |  | *                  | % |  | *                 | % |  | 28               | % |  | *                | %
|Silicon Alliance Int.**                                           |  | 13                 | % |  | *                 | % |  | 13               | % |  | 11               | %
|Silicon Media, Inc.**                                             |  | *                  | % |  | 39                | % |  | *                | % |  | 33               | %
|Premier Components Distribution**                                 |  | 16                 | % |  | *                 | % |  | *                | % |  | *                | %
|Macnica, Inc.**                                                   |  | *                  | % |  | *                 | % |  | *                | % |  | 12               | %

---

|* | represents less than 10% of net revenue
|- | ---------------------------------------

|** | customer is a distributor
|-- | -------------------------



Gross Loss



Gross loss
was $111 thousand and $137 thousand for the three months ended October 31, 2004 and 2003, respectively. Gross loss was $178 thousand and $298 thousand in the nine months ended October 31, 2004 and 2003, respectively. The improvement in gross loss
for the three and nine months ended October 31, 2004 is primarily due to the increase in sales partially offset by an increase in amortization expense relating to core technology and licensed intellectual property of $366 thousand and $549 thousand,
respectively, for the three and nine months ended October 31, 2004. The gross loss for the nine months ended October 31, 2004 was favorably impacted by the sale of $59 thousand of inventory previously written-off partially offset by charges totaling
$24 thousand to write-off excess inventory for the Companys companion chips. The gross loss for the three and nine months ended October 31, 2003 was unfavorably impacted by charges of $93 thousand and $172 thousand to write-off excess
inventory and favorably impacted by the sale of $1 thousand and $8 thousand, respectively, of inventory previously written-off.



Research and Development Expenses



Research and development expenses include compensation and associated costs relating to development personnel, amortization of intangible assets and
prototyping costs, which are comprised of



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photomask costs and pre-production wafer costs. Research and development expenses were $4.2 million and $5.3 million for
the three months ended October 31, 2004 and 2003, respectively. Research and development expenses were $13.9 million and $14.8 million for the nine months ended October 31, 2004 and 2003, respectively. These expenses include amortization of deferred
compensation of $0.1 million and $0.1 million for the three months ended October 31, 2004 and 2003, respectively, and $0.1 million and $0.3 million for the nine months ended October 31, 2004 and 2003, respectively. The decrease of $1.1 million for
the three months ended October 31, 2004 is primarily due to lower mask costs of $0.5 million and lower acquired technology amortization of $0.2 million. The decrease of $0.9 million for the nine months ended October 31, 2004 is primarily related to
lower outside consultant costs of $0.3 million, lower mask costs of $0.2 million and lower allocation costs of $0.4 million, offset by increased labor costs of $0.2 million.



Sales, General and Administrative Expenses



Sales, general and administrative expenses were $1.6 million and $1.8 million for the three months ended October 31, 2004 and 2003, respectively.
Sales, general and administrative expenses were $5.7 million and $5.4 million for the nine months ended October 31, 2004 and 2003, respectively. These expenses include amortization of deferred compensation of $17 thousand and $104 thousand for the
three months ended October 31, 2004 and 2003, respectively, and $107 thousand and $191 thousand for the nine months ended October 31, 2004 and 2003, respectively. The decrease of $0.2 million for the three months ended October 31, 2004 is mainly due
to lower costs of boards used to demonstrate NeoMagic products of $0.2 million. The increase of $0.3 million for the nine months ended October 31, 2004 is primarily related to increased labor costs of $0.5 million mainly due to reinstatement of
salaries after a one-year reduction instituted in March 2003 and increased audit fees of $0.2 million offset by decreased costs of boards used to demonstrate NeoMagic products of $0.4 million.



Interest Income and Other



The Company currently earns interest on its cash equivalents and short-term
investments. Interest income and other was $0.1 million and $0.4 million for the three months ended October 31, 2004 and 2003, respectively. Interest income and other was $0.3 million and $0.7 million for the nine months ended October 31, 2004 and
2003, respectively. The decrease for the three and nine months ended October 31, 2004 in interest income and other is primarily due to lower average cash and short-term investment balances. In addition, other income for the three and nine months
ended October 31, 2003 includes $255 thousand received for the Companys holdings of Margi Systems Preferred Stock. The Company acquired shares of Margi Systems, Inc. preferred stock in January of 1998, for $300 thousand. The Company wrote off
the investment fully during the fourth quarter of fiscal year 2001, based on the Companys views of the financial prospects of Margi Systems at such time. Margi Systems was acquired by Harman International Industries, Inc. in September 2003. In
connection with the acquisition, the Company received $255 thousand for its holdings of Margi Systems preferred stock.



Interest Expense



Interest expense was $173 thousand and $66 thousand for the three months ended October 31, 2004 and 2003, respectively. Interest expense was $250 thousand
and $226 thousand for the nine months ended October 31, 2004 and 2003, respectively. Interest expense increased for the three and nine months ended October 31, 2004 due to accreted interest expense of $131 thousand recorded in the third quarter of
fiscal 2005 related to our Mandatorily Redeemable Series B Convertible Preferred Stock issued in August 2004 partially offset by lower interest expense on our capital leases. In addition, we recorded $22 thousand of interest amortization for
deferred financing costs related to our Mandatorily Redeemable Series B Convertible Preferred Stock during the third quarter of fiscal 2005.



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Income Taxes



In the three and nine months ended October 31, 2004, taxes consisted of foreign income taxes.



Liquidity and Capital Resources



The Companys cash, cash equivalents and short-term investments
decreased $11.8 million in the nine months ended October 31, 2004 to $30.8 million from $42.6 million at January 31, 2004.



The Company believes that it will not generate cash from operating activities over the upcoming twelve months, yet believes its current cash, cash
equivalents and short-term investments will satisfy the Companys projected working capital and capital expenditure requirements through the next twelve months. Investments will continue in the Companys new product development efforts in
the handheld systems marketplace. The Companys ability to increase sales of its MiMagic 3 and MiMagic 5 applications processors and the Companys ability to achieve design wins for the MiMagic 6 applications processor will be critical in
determining the Companys cash needs. The Companys future working capital requirements will depend on many factors including the rate of net sales, the timing and extent of spending to support research and development programs, the timing
of any new product introductions, and market acceptance of the Companys products. The Company needs to raise additional cash in the next several quarters to satisfy its projected working capital and capital expenditure requirements beyond the
next twelve months. There can be no assurance that additional financing will be available on acceptable terms or at all. On August 20, 2004, the Company closed a new round of financing when it issued preferred stock and warrants to purchase common
stock for net proceeds of $4.9 million. Out of pocket expenses were approximately $392 thousand. See Note 8, Mandatorily Redeemable Series B Convertible Preferred Stock, in the condensed consolidated financial statements for additional information.



Cash and cash equivalents used in operating activities for the
nine months ended October 31, 2004 was $16.6 million, compared to $17.5 million of net cash used in operating activities for the nine months ended October 31, 2003. The cash used in operating activities for the nine months ended October 31, 2004 is
due to primarily from a net loss of $19.7 million, as well as an increase in inventory of $0.7 million, partially offset by non-cash depreciation and amortization of $3.0 million, deferred compensation amortization charges of $0.3 million and an
increase in compensation and related benefits of $0.3 million. The cash used in operating activities for the nine months ended October 31, 2003 related to primarily from a net loss of $20.0 million, as well as decreases in accounts payable of $1.0
million and in other accruals of $1.1 million partially offset by non-cash depreciation and amortization of $2.9 million, deferred compensation amortization charges of $0.5 million, tax benefit from employee stock options of $0.4 million and
decreases in inventory of $0.3 million and other current assets of $0.4 million.



Net cash provided by investing activities for the nine months ended October 31, 2004, was $12.9 million, compared to $9.7 million of net cash used in investing activities for the nine months ended October 31, 2003.
Net cash provided by investing activities for the nine months ended October 31, 2004 is due to net maturities of short-term investments of $13.0 million partially offset by purchases of fixed assets and intangibles of $0.1 million. Net cash used in
investing activities for the nine months ended October 31, 2003 related primarily to net purchases of short-term investments of $9.3 million and purchases of fixed assets and intangibles of $0.4 million.



Net cash provided by financing activities was $4.9 million for the nine
months ended October 31, 2004, compared to $0.5 million of net cash used in financing activities for the nine months ended October 31, 2003. The net cash provided by financing activities for the nine months ended October 31, 2004 is due to proceeds
from the issuance of common stock of $1.3 million and the issuance of redeemable convertible preferred stock and warrants to purchase common stock of $4.9 million partially offset by payments on capital lease obligations of $1.4 million. The net
cash used in financing activities for the nine months ended October 31, 2003 is related to payments on capital lease obligations of $0.8 million offset by proceeds from the issuance of common stock of $0.3 million.



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The Companys lease for its headquarters in Santa Clara, California expires in April 2010. The
Company leases offices in Israel and India under operating leases that expire in September 2005 for Israel and in December 2006 for India.



The Company leases software licenses under capital leases. Refer to Note 7, Obligations under Capital Leases, in the condensed consolidated financial
statements for additional information.



The future minimum
payments relating to facility leases, software leases, and non-cancelable purchase orders are included in the contractual obligations table below.



Contractual Obligations



The following summarizes the Companys contractual obligations at October 31, 2004, and the effect such obligations are expected to have on our
liquidity and cash flow (in thousands).



|                                   |  |      |     |      |   |       |  |      |       |      |   |            |  |       |       |  |   |       |  |   |       
|---------------------------------- |  | ---- | --- | ---- | - | ----- |  | ---- | ----- | ---- | - | ---------- |  | ----- | ----- |  | - | ----- |  | - | ------
|                                   |  | 2005 |     | 2006 |   | 2007  |  | 2008 |       | 2009 |   | Thereafter |  | Total
|CONTRACTUAL OBLIGATIONS            |  |      |     |      |   |       |  |      |       |      |   |            |  |       |       |  |   |       |  |   |       
|Operating leases                   |  | $    | 296 |      | $ | 1,171 |  | $    | 1,101 |      | $ | 1,046      |  | $     | 1,073 |  | $ | 1,377 |  | $ | 6,064 
|Capital leases                     |  |      | 465 |      |   | 1,796 |  |      | 1,548 |      |   | 593        |  |       |      |  |   |      |  |   | 4,402 
|                                   |  |      |     |      |   |       |  |      |       |      |   |            |  |       |       |  |   |       |  |   |       
|Total contractual cash obligations |  | $    | 761 |      | $ | 2,967 |  | $    | 2,649 |      | $ | 1,639      |  | $     | 1,073 |  | $ | 1,377 |  | $ | 10,466
|                                   |  |      |     |      |   |       |  |      |       |      |   |            |  |       |       |  |   |       |  |   |       



Off-Balance Sheet Arrangements



As part of its ongoing business, the Company does not
participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities (SPEs), which would have been
established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of October 31, 2004, the Company is not involved in SPE transactions.



Factors that May Affect Future Results



We Expect to Continue to Incur Significant Losses in the Fiscal Year Ending January 31,
2005 and the Fiscal Year Ending January 31, 2006



The
Company has been incurring substantial losses as it invests heavily in new product development in advance of achieving significant customer sales. This is expected to continue during the remainder of the fiscal year ending January 31, 2005 and the
following fiscal year ending January 31, 2006. The Companys ability to achieve cash flow breakeven is likely to depend on the success of its MiMagic 5 and its MiMagic 6 products. However, even if the MiMagic 5, MiMagic 6, and subsequent
products achieve widespread customer acceptance, the length of customer design-in cycles would preclude substantial product shipments in the fiscal year ending January 31, 2005. Accordingly, even if these new products are successful, the Company is
likely to incur significant additional losses during the remainder of the fiscal year ending January 31, 2005 and the following fiscal year ending January 31, 2006.



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We Are Likely To Need Additional Capital



Given the long cycle times required to achieve design wins, convert customer design wins into production orders, and for the
customers to achieve volume shipments of their products, the Company is likely to require additional working capital to fund its business. The Company believes that its existing capital resources will be sufficient to meet the Companys capital
requirements through the next 12 months. However, the Company expects to raise additional capital within the next 12 months to fund future operating activities. The Companys future capital requirements will depend on many factors, including
the rate of net sales growth, timing and extent of spending to support research and development programs in new and existing areas of technology, expansion of sales and marketing support activities, and timing and customer acceptance of new
products. The Companys ability to raise capital and the terms of any financing will depend, in part, on the Companys ability to establish customer engagements and generate sales. As discussed below, revenue performance is difficult to
forecast. There can be no assurance that additional equity or debt financing, if required, will be available on acceptable terms or at all.



Our Revenues Are Difficult To Predict



For a variety of reasons, revenues are difficult to predict and may vary significantly from quarter to quarter. The Companys ability to achieve
design wins depends on many factors, many outside the Companys control, including changes in the customers strategic and financial plan, competitive factors and overall market conditions. As the Companys experience demonstrates,
design wins themselves do not always lead to production orders because the customer may cancel or delay products for a variety of reasons. Such reasons may include the performance of a particular product that may depend on components not supplied by
NeoMagic, market conditions, reorganizations or other internal developments at the customer and changes in customer personnel or strategy. Even when a customer has begun volume production of a product containing NeoMagic chips, volumes are difficult
to forecast because there may be no history to provide a guide, and because market conditions and other factors may cause changes in the customers plans. Because of the market uncertainties they face, many customers place purchase orders on a
short lead time basis, rather than providing reliable long-term purchase orders or purchase forecasts.



The difficulty in forecasting revenues increases the difficulty in forecasting the Companys working capital requirements. It also increases the
likelihood that the Company may overproduce particular parts, resulting in inventory charges, or underproduce particular parts, affecting our ability to meet customer requirements. The difficulty in forecasting revenues also restricts the
Companys ability to provide forward-looking revenue and earnings guidance to the financial markets and increases the chance that the Companys performance does not match forecasts.



We have a Limited Customer Base



Three customers accounted for 62%, 16% and 13% of net sales for the three
months ended October 31, 2004. Two customers accounted for 39% and 35% of net sales for the three months ended October 31, 2003. Three customers accounted for 36%, 28% and 13% of net sales for the nine months ended October 31, 2004. Four customers
accounted for 33%, 29%, 12% and 11% of net sales for the nine months ended October 31, 2003. The Company expects that a small number of customers will continue to



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account for a substantial portion of its net sales for the foreseeable future. Furthermore, the majority of the
Companys sales were historically made, and are expected to continue to be made, on the basis of purchase orders rather than pursuant to long-term purchase agreements. As a result, the Companys business, financial condition and results of
operations could be materially adversely affected by the decision of a single customer to cease using the Companys products, or by a decline in the number of handheld systems sold by a single customer.



We May Lose Our Customer Base



The Companys products are designed to afford the handheld systems
manufacturer significant advantages with respect to product performance, power consumption and size. To the extent that other future developments in components or subassemblies incorporate one or more of the advantages offered by the Companys
products, the market demand for the Companys products may be negatively impacted.



We Face Intense Competition in Our Markets



The market for applications processors 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 multimedia performance, price, features, power consumption, size and customer support. The ability of the Company to compete successfully in the applications processor market depends on a number of
factors including, success in designing and subcontracting the manufacture of new products that implement new technologies, product quality and reliability, price, ability to market and sell the Companys products, ramp of production of the
Companys products for particular system manufacturers, customer demand and acceptance of more sophisticated multimedia functionality on handheld systems, end-user acceptance of the system manufacturers products, market acceptance of
competitors products and general economic conditions.



NeoMagic competes with both 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 sources of competition include Texas Instruments, Renesas, certain of Samsungs S3C chips and ST Microelectronics Nomadik line, as well as self-developed products from a number of vertically
integrated electronics firms. NeoMagic may also face increased competition from new entrants into the market including companies currently at developmental stages. NeoMagic believes it has significant intellectual properties and has historically
demonstrated expertise in SOC technology. However, the inability of the Company to introduce timely new products for its market, to support these products in customer programs, or to manufacture these products could have a material adverse effect on
the Companys business, financial condition and operating results.



Some of the Companys current and potential competitors operate their own manufacturing facilities. Since the Company does not operate its own manufacturing facility and may from time-to-time make binding commitments to purchase
products, it may not be able to reduce its costs and cycle time or adjust its production to meet changing demand as rapidly as companies that operate their own facilities, which could have a material adverse effect on the Companys results of
operations.



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



The Companys ability to
compete in the future will also depend on its ability to identify and ensure compliance with evolving industry standards and market trends. Unanticipated changes in market trends and industry standards could render the Companys products
incompatible with products developed by major hardware manufacturers and software developers. As a result, the Company could be required to invest significant time and resources to redesign its products or obtain license rights to technologies owned



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by third parties in order to ensure compliance with relevant industry standards and market trends. There can be no
assurance that the Company will be able to redesign its products or obtain the necessary third-party licenses within the appropriate window of market demand. If the Companys products are not in compliance with prevailing market trends and
industry standards for a significant period of time, the Company could miss crucial OEM (Original Equipment Manufacturer) and ODM (Original Design Manufacturer) design cycles, which could result in a material adverse effect on the Companys
business, financial condition and results of operations.



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



The Company is focused on providing high-performance semiconductor solutions for sale to OEMs of handheld systems. New product planning is focused on integrated System-On-Chip (SOC) semiconductor products for handheld systems that integrate
multimedia technologies such as H.264 video compression, 3D graphics and audio technologies. The Companys future business, financial condition and results of operations will depend to a significant extent on its ability to develop new products
that address these market opportunities. As a result, the Company believes that significant expenditures for research and development will continue to be required in the future.



The Company must anticipate the features and functionality that consumers and infrastructure providers will demand,
incorporate those features and functionality into products that meet the exacting design requirements of equipment manufacturers, price its products competitively and introduce the products to the market on a timely basis. The success of new product
introductions is dependent on several factors, including proper new product definition, timely completion and introduction of new product designs, the ability to create or acquire intellectual property, the ability of strategic manufacturing
partners to effectively design and implement the manufacture of new products, quality of new products, differentiation of new products from those of the Companys competitors and market acceptance of the Companys and its customers
products. There can be no assurance that the products the Company expects to introduce will incorporate the features and functionality demanded by system manufacturers and consumers, will be successfully developed, or will be introduced within the
appropriate window of market demand, nor can there be assurance that customers who utilize the Companys semiconductor products will achieve the levels of market success with their own system products that they may project to the Company.



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



We Depend on Third-Party Manufacturers to Produce Our Products



The Companys products require wafers manufactured with state-of-the-art fabrication equipment and techniques. The
Company currently utilizes several foundries for wafer fabrication. The Company expects that, for the foreseeable future, some of its products will be manufactured by a single source. Since, in the Companys experience, the lead time needed to
establish a strategic relationship with a new wafer fabrication partner is at least 12 months, and the estimated time for a foundry to switch to a new product line ranges from four to nine months, there may be no readily available alternative source
of supply for specific products. A manufacturing disruption experienced by the Companys manufacturing partners, the failure of the Companys manufacturing partners to dedicate adequate resources to the production of the



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Companys products, or the financial instability of the Companys manufacturing partners would have a material
adverse effect on the Companys business, financial condition and results of operations. Furthermore, in the event that the transition to the next generation of manufacturing technologies by the Companys manufacturing partner is
unsuccessful, the Companys business, financial condition and results of operations would be materially and adversely affected.



There are many other risks associated with the Companys dependence upon third-party manufacturers, including: reduced control over delivery
schedules, quality, manufacturing yields and cost; the potential lack of adequate capacity during periods of excess demand; limited warranties on wafers supplied to the Company; and potential misappropriation of NeoMagics intellectual
property. The Company is dependent on its manufacturing partners to produce wafers with acceptable quality and manufacturing yields, deliver those wafers on a timely basis to the Companys third party assembly subcontractors and to allocate to
the Company a portion of their manufacturing capacity sufficient to meet the Companys needs. Although the Companys products are designed using the process design rules of the particular manufacturer, there can be no assurance that the
Companys manufacturing partners will be able to achieve or maintain acceptable yields or deliver sufficient quantities of wafers on a timely basis or at an acceptable cost. Additionally, there can be no assurance that the Companys
manufacturing partners will continue to devote adequate resources to the production of the Companys products or continue to advance the process design technologies on which the manufacturing of the Companys products are based.



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



The Companys products are assembled and tested by
third-party subcontractors. The Company does not have long-term agreements with any of these subcontractors. Such assembly and testing is conducted on a purchase order basis. As a result of its reliance on third-party subcontractors to assemble and
test its products, the Company cannot directly control product delivery schedules, which could lead to product shortages or quality assurance problems that could increase the costs of manufacturing or assembly of the Companys products. Due to
the amount of time normally required to qualify assembly and test subcontractors, product shipments could be delayed significantly if the Company were required to find alternative subcontractors. Any problems associated with the delivery, quality or
cost of the assembly and test of the Companys products could have a material adverse effect on the Companys business, financial condition and results of operations.



We May Encounter Inventory Excess or Shortage



The Company has wafer supply relationships with several foundries to support the Companys product efforts.
Normally, the Company places binding purchase orders two to three months prior to wafer shipment. The Company orders wafers for deliveries in advance and with the additional time to assemble and test wafers, the Company can have orders for finished
goods that will not be available for up to four months into the future. If the Company does not have sufficient demand for its products and cannot cancel its current and future commitments without material impact, the Company may experience excess
inventory, which will result in a write-off affecting gross margin and results of operations. If the Company cancels a purchase order, it must pay cancellation penalties based on the status of work in process or the proximity of the cancellation to
the delivery date. The Company must place purchase orders for wafers before it receives purchase orders from its own customers. This limits the Companys ability to react to fluctuations in demand for its products, which can be unexpected and
dramatic, and from time-to-time will cause the Company to have an excess or shortage of wafers for a particular product. As a result of the long lead-time for manufacturing wafers and the increase in just in time ordering by
manufacturers, semiconductor companies such as the Company from time-to-time must take charges for excess inventory. The Company did in fact incur such charges in fiscal 2001 of $9.2 million. Significant write-offs of excess inventory have had and
could continue to have a material adverse effect on the Companys financial condition and results



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of operations. Conversely, failure to order sufficient wafers would cause the Company to miss revenue opportunities and,
if significant, could impact sales by the Companys customers, which could adversely affect the Companys customer relationships and thereby materially adversely affect the Companys business, financial condition and results of
operations.



Our Manufacturing Yields May Fluctuate



The fabrication of semiconductors is an extremely complex process, which
typically includes hundreds of process steps. Minute levels of contaminants in the manufacturing environment, defects in masks used to print circuits on a wafer, utilization of equipment with variations and numerous other factors can cause a
substantial percentage of wafers to be rejected or a significant number of die on each wafer to be nonfunctional. Many of these problems are difficult to diagnose and time consuming or expensive to remedy. As a result, semiconductor companies often
experience problems in achieving acceptable wafer manufacturing yields, which are represented by the number of good die as a proportion of the total number of die on any particular wafer. The Company often purchases wafers, not die, and pays an
agreed upon price for wafers meeting certain acceptance criteria. Accordingly, the Company bears the risk of the yield of good die from wafers purchased meeting the acceptance criteria.



Semiconductor manufacturing yields are a function of both product design, which is developed largely by the Company, and
process technology, which is typically proprietary to the manufacturer. Historically, the Company has experienced lower yields on new products. Since low yields may result from either design or process technology failures, yield problems may not be
effectively determined or resolved until an actual product exists that can be analyzed and tested to identify process sensitivities relating to the design rules that are used. As a result, yield problems may not be identified until well into the
production process, and resolution of yield problems would require cooperation by and communication between the Company and the manufacturer. This risk is compounded by the offshore location of the Companys manufacturers, increasing the effort
and time required identifying, communicating and resolving manufacturing yield problems. As the Companys relationships with new manufacturing partners develop, yields could be adversely affected due to difficulties associated with adapting the
Companys technology and product design to the proprietary process technology and design rules of each manufacturer. Any significant decrease in manufacturing yields could result in an increase in the Companys per unit product cost and
could force the Company to allocate its available product supply among its customers, potentially adversely impacting customer relationships as well as revenues and gross margins. There can be no assurance that the Companys manufacturers will
achieve or maintain acceptable manufacturing yields in the future.



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



The Company relies in part on patents to protect its intellectual property. As of October 31, 2004, the Company has been issued 78 patents, each covering
certain aspects of the design and architecture of the Companys products. Additionally, the Company has numerous patent applications pending. There can be no assurance that the Companys pending patent applications, or any future
applications will be approved. Further, there can be no assurance that any issued patents will provide the Company with significant intellectual property protection, competitive advantages, or will not be challenged by third parties, or that the
patents of others will not have an adverse effect on the Companys ability to do business. In addition, there can be no assurance that others will not independently develop similar products, duplicate the Companys products or design
around any patents that may be issued to the Company.



The
Company also relies on a combination of mask work protection, trademarks, copyrights, trade secret laws, employee and third-party nondisclosure agreements and licensing arrangements to protect its intellectual property. Despite these efforts, there
can be no assurance that others will not independently develop substantially equivalent intellectual property or otherwise gain access to the Companys trade



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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 has
experienced substantial litigation regarding patent and other intellectual property rights. In December 1998, the Company filed a lawsuit in the United States District Court for the District of Delaware seeking damages and an injunction against
Trident Microsystems, Inc. The suit alleged that Tridents embedded DRAM graphics accelerators infringe certain patents held by the Company. In January 1999, Trident filed a counter claim against the Company alleging an attempted monopolization
in violation of antitrust laws, arising from NeoMagics filing of the patent infringement action against Trident. The Court ruled that there was no infringement by Trident. Since January 1999, no further action has occurred on this counter
claim. The Company filed an appeal in the United States Court of Appeals, for the Federal Circuit. On April 17, 2002, the United States Court of Appeals for the Federal Circuit affirmed the lower courts judgment of non-infringement on one
patent and vacated the courts judgment of non-infringement on another patent, thereby remanding it to the lower court for further proceedings. In November 2002, the lower court heard oral arguments on cross-motions for summary judgment on the
matter. In May 2003, the lower court ruled in favor of Trident. In December 2003 the Company filed an appeal in the United States Court of Appeals, for the Federal Circuit. In August 2004 the Federal Circuit rejected the appeal and affirmed the
lower courts decision of no infringement by the Trident products. While the Company believes it has valid defenses against Tridents counter claim filed in 1999, there can be no assurance as to whether Trident will or will not proceed
with the counter-suit.



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.



We Depend on International Sales and Suppliers



Export sales have been a critical part of the Companys business. Sales to customers located outside the United States (including sales to the
foreign operations of customers with headquarters in the United States and foreign system manufacturers that sell to United States-based OEMs) accounted for 82% and 91% of net sales in the three months ended October 31, 2004 and 2003, respectively.
Sales to customers located outside the United States accounted for 90% and 88% of net sales in the nine months ended October 31, 2004 and 2003, respectively. The Company expects that net sales derived from international sales will continue to
represent a significant portion of its total net sales. Letters of credit issued by customers have supported a portion of the Companys international sales. To date, the



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Companys international sales have been denominated in United States dollars. Increases in the value of the U.S.
dollar relative to the local currency of the Companys customers could make the Companys products relatively more expensive than competitors products sold in the customers local currency.



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



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



We are Dependent on Qualified Personnel



The Companys future success depends in part on the continued service of its key engineering, sales, marketing, manufacturing, finance and executive
personnel, and its ability to identify, hire and retain additional personnel. There is strong competition for qualified personnel in the semiconductor industry, and there can be no assurance that the Company will be able to continue to attract and
retain qualified personnel necessary for the development of its business. The Company has experienced the loss of certain key personnel and also reduced personnel in its restructuring. If the Companys headcount is not appropriate for its
future direction and the Company fails to recruit key personnel critical to its future direction in a timely manner, it may have a material adverse effect on the Companys business, financial condition and results of operations.



Our Financial Results Could Be Affected by Changes in Accounting Rules



Our financial results could be affected by potential changes in the
accounting rules governing the recognition of stock-based compensation expense. We measure compensation expense for our employee stock plans under the intrinsic value method of accounting prescribed by Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees. In addition, we provide pro forma disclosures of our operating results in our Notes to Consolidated Financial Statements as if the fair value method of accounting had been applied in accordance
with SFAS No. 123, Accounting for Stock-Based Compensation. Had we accounted for our compensation expense under the fair value method of accounting prescribed by SFAS 123, the charge would have been significant, totaling $3.6 million,
$5.6 million and $6.7 million during fiscal 2004, 2003 and 2002, respectively. Currently, the U. S. Congress, the Securities and Exchange Commission and the Financial Accounting Standards Board are considering changes to accounting rules concerning
the recognition of stock option compensation expense. If one or more of these proposals are implemented, we and other companies may be required to measure compensation expense using the fair value method, which would adversely affect our results of
operations by reducing our income or increasing our losses by an amount equal to such stock option charges.



Our Stock Price May Be Volatile



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



There may not be an active, liquid trading market for our common stock. In the third and fourth quarters of fiscal 2005 and in the first quarter of fiscal
2004, our common stock traded below the $1 minimum bid price requirement of the NASDAQ National Market. The stock price fell below $1 for twenty straight trading days between October 19, 2004 and November 16, 2004. If we fail to comply with the



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continued listing requirements of the NASDAQ National Market, including the minimum bid price per share requirement, we
may be delisted from trading on such market, and thereafter trading in our common stock, if any, would be conducted through the NASDAQ Small Cap Market, the over-the-counter market or on the Electronic Bulletin Board of the National Association of
Securities Dealers, Inc. There is no guarantee that an active trading market for our common stock will be maintained on the NASDAQ National Market. You may not be able to sell your shares quickly, at the market price or at all if trading in our
stock is not active.



Terrorist Attacks, Terrorist Threats, Geopolitical
Instability and Government Responses Thereto, May Negatively Impact All Aspects of NeoMagics Operations, Revenues, Costs and Stock Price.



The terrorist attacks in September 2001 in the United States and ensuing events and the resulting decline in consumer confidence has had a material
adverse effect on the economy. If consumer confidence does not fully recover, NeoMagics revenues and profitability will continue to be adversely impacted in fiscal 2005 and beyond. In addition, any similar future events may disrupt
NeoMagics operations or those of its customers and suppliers. In addition, these events have had and may continue to have an adverse impact on the U.S. and world economy, in general, and consumer confidence and spending in particular, which
could harm NeoMagics sales. Any of these events could increase volatility in the U.S. and world financial markets, which could harm NeoMagics stock price and may limit the capital resources available to it and its customers or suppliers.
This could have a significant impact on NeoMagics operating results, revenues and costs and may result in increased volatility in the market price of its common stock.



Item 3. Quantitative and Qualitative Disclosures about Market Risk



Interest Rate Risk



The Companys cash equivalents, short-term investments, and long-term investments are exposed to financial market risk due to fluctuations in interest rates, which may affect our interest income. As of October 31, 2004, the
Companys cash equivalents, short-term investments, and long-term investments earned interest at an average rate of 1.6%. Due to the short-term nature of the Companys investment portfolio, operating results or cash flows are vulnerable to
sudden changes in market interest rates. Assuming an increase or decrease of 10% in the market interest rates at October 31, 2004, with consistent cash balances, interest income would be affected by approximately $12 thousand per quarter. The
Company does not use its investment portfolio for trading or other speculative purposes.



Foreign Currency Exchange Risk



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



Item 4. Controls and Procedures



(a) Evaluation
of Disclosure Controls and Procedures



The Companys
management, with the participation of the Companys Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Companys disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of



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1934, as amended (the Exchange Act)) as of the end of the period covered by this report. Based on such
evaluation, the Companys Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Companys disclosure controls and procedures are effective in recording, processing, summarizing and
reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act.



It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there
can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.



(b) Changes in Internal Controls



During the second quarter of fiscal 2005, the Company established an Advisory and Disclosure Committee to formalize the reporting review process. The
purpose of the Committee is to review information to be released in quarterly earnings releases and other financial releases, as well as information to be filed in quarterly reports, annual reports and proxy statements, and to, determine disclosure
obligations and to report these matters to the Chief Executive Officer and Chief Financial Officer.



During the last fiscal quarter there have been no changes in the Companys internal control over financial reporting that have materially affected,
or are reasonably likely to materially affect, our internal control over financial reporting.



Part II. Other Information



Item 1. Legal Proceedings



As
a general matter, the semiconductor industry has experienced substantial litigation regarding patent and other intellectual property rights. In December 1998, the Company filed a lawsuit in the United States District Court for the District of
Delaware seeking damages and an injunction against Trident Microsystems, Inc. The suit alleged that Tridents embedded DRAM graphics accelerators infringe certain patents held by the Company. In January 1999, Trident filed a counter claim
against the Company alleging an attempted monopolization in violation of antitrust laws, arising from NeoMagics filing of the patent infringement action against Trident. The Court ruled that there was no infringement by Trident. Since January
1999, no further action has occurred on this counter claim. The Company filed an appeal in the United States Court of Appeals, for the Federal Circuit. On April 17, 2002, the United States Court of Appeals for the Federal Circuit affirmed the lower
courts judgment of non-infringement on one patent and vacated the courts judgment of non-infringement on another patent, thereby remanding it to the lower court for further proceedings. In November 2002, the lower court heard oral
arguments on cross-motions for summary judgment on the matter. In May 2003, the lower court ruled in favor of Trident. In December 2003 the Company filed an appeal in the United States Court of Appeals, for the Federal Circuit. In August 2004 the
Federal Circuit rejected the appeal and affirmed the lower courts decision of no infringement by the Trident products. While the Company believes it has valid defenses against Tridents counter claim filed in 1999, there can be no
assurance as to whether Trident will or will not proceed with the counter-suit.



Item 2. Unregistered Sales of Equity Securities and Use of Proceeds



None.



Item 3. Defaults Upon Senior Securities



None.



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



None.



Item 5. Other Information



Not
applicable.



Item 6. Exhibits



| | (a) | Exhibits
| | --- | --------



The exhibits listed in the accompanying Exhibit Index are filed or incorporated by reference as part of this Report on Form 10-Q.



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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/ Scott Sullinger                                 
|SCOTT SULLINGER                                     
|V.P. Finance and Chief Financial Officer            
|(Authorized Officer and Principal Financial Officer)
|                                                    
|December 10, 2004                                   



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EXHIBIT INDEX



The following Exhibits are filed as
part of, or incorporated by reference into, this Report:



|       |  |      |  |                                                                                                                                                                                            
|------ |  | ---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number |  |      |  | Description                                                                                                                                                                                
|3.1    |  | (1)  |  | Amended and Restated Certificate of Incorporation.                                                                                                                                         
|3.2    |  | (1)  |  | Bylaws.                                                                                                                                                                                    
|4.1    |  | (10) |  | Preferred Stock Rights Agreement dated December 19, 2002, between the Company and EquiServe Trust Company, N.A.                                                                            
|4.2    |  | (13) |  | Amendment to Rights Agreement, dated as of August 20, 2004, between the Company and EquiServe Trust Company, N.A.                                                                          
|4.3    |  | (12) |  | Series A Warrant to Satellite Strategic Finance Associates, LLC, dated August 20, 2004.                                                                                                    
|4.4    |  | (12) |  | Series B Warrant to Satellite Strategic Finance Associates, LLC, dated August 20, 2004.                                                                                                    
|4.5    |  | (12) |  | Registration Rights Agreement dated August 19, 2004 by and between the Company and Satellite Strategic Finance Associates, LLC.                                                            
|4.6    |  | (9)  |  | Certificate of Designation of Rights, Preferences and Privileges of Series A Participating Preferred Stock.                                                                                
|4.7    |  | (12) |  | Certificate of Designations, Preferences and Rights of the Series B Convertible Preferred Stock dated August 20, 2004                                                                      
|10.1   |  | (1)  |  | Form of Indemnification Agreement entered into by the Company with each of its directors and executive officers.                                                                           
|10.2   |  | (2)  |  | Lease Agreement, dated as of October 9, 1997, between the Company and A&P Family Investments, as landlord for the leased premises located at 3250 Jay Street.                              
|10.3   |  | (1)  |  | Amended and Restated 1993 Stock Plan and related agreements.                                                                                                                               
|10.4   |  | (2)  |  | Amendment No. 1, dated as of October 15, 1997, between the Company and A&P Family Investments, as landlord for the leased premises located at 3260 Jay Street.                             
|10.5   |  | (1)  |  | Lease Agreement, dated as of February 5, 1996, between the Company and A&P Family Investments, as landlord.                                                                                
|10.6   |  | (1)  |  | 1997 Employee Stock Purchase Plan, with exhibit.                                                                                                                                           
|10.7   |  | (4)  |  | 1998 Nonstatutory Stock Option Plan.                                                                                                                                                       
|10.8   |  | (4)  |  | Wafer Supply Agreement, dated as of March 15, 1999, between NeoMagic International Corporation and Siemens Aktiengesellschaft Semiconductor Group, now Infineon Technologies
AG.           
|10.9   |  | (5)  |  | General Amendment to the Wafer Supply Agreement with Product Sourcing Agreement, dated January 9, 2001, between NeoMagic International Corporation and Infineon Technologies
AG.           
|10.10  |  | (6)  |  | Employment Offer Letter dated May 10, 2000, between the Company and Sanjay Adkar.                                                                                                          
|10.11  |  | (6)  |  | Employee Loan Agreement dated May 10, 2000, between the Company and Sanjay Adkar.                                                                                                          
|10.12  |  | (6)  |  | Security Agreement dated September 1, 2001, between the Company and Stephen Lanza.                                                                                                         
|10.13  |  | (6)  |  | Promissory Note dated September 1, 2001, between the Company and Stephen Lanza.                                                                                                            
|10.14  |  | (7)  |  | Full and Final Release dated September 9, 2002, from the Wafer Supply Agreement and the Product Sourcing Agreement between NeoMagic International Corporation and Infineon Technologies
AG.
|10.15  |  | (8)  |  | Amendment No. 1, dated as of February 26, 2002, between the Company and A&P Family Investments, as landlord for the leased premises located at 3250 Jay Street.                            
|10.16  |  | (8)  |  | Amendment No. 2, dated as of April 7, 2000, between the Company and A&P Family Investments, as landlord for the leased premises located at 3260 Jay Street.                                



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|      |  |      |  |                                                                                                                                                                                                       
|----- |  | ---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.17 |  | (8)  |  | Amendment No. 3, dated as of February 26, 2002, between the Company and A&P Family Investments, as landlord for the leased premises located at 3260 Jay Street.                                       
|10.18 |  | (11) |  | Amendment No. 4, dated as of January 31, 2003, between the Company and A&P Family Investments, as landlord for the leased premises located at 3260 Jay Street.                                        
|10.19 |  | (12) |  | Securities Purchase Agreement dated August 19, 2004 by and between the company and Satellite Strategic Finance Associates, LLC.                                                                       
|31.1  |  |      |  | Certification of the Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 dated December
10, 2003.
|31.2  |  |      |  | Certification of the Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 dated December
10, 2003.
|32.1  |  |      |  | Certification by the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                
|32.2  |  |      |  | Certification by the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                

---

|(1) | Incorporated by reference to the Companys registration statement on Form S-1, registration no. 333-20031.
|--- | ----------------------------------------------------------------------------------------------------------

|(2) | Incorporated by reference to the Companys Form 10-Q for the period ended October 31, 1997.
|--- | -------------------------------------------------------------------------------------------

|(3) | Incorporated by reference to the Companys Form 10-K for the year ended January 31, 1998.
|--- | -----------------------------------------------------------------------------------------

|(4) | Incorporated by reference to the Companys Form 10-K for the year ended January 31, 1999.
|--- | -----------------------------------------------------------------------------------------

|(5) | Incorporated by reference to the Companys Form 10-K for the year ended January 31, 2001.
|--- | -----------------------------------------------------------------------------------------

|(6) | Incorporated by reference to the Companys Form 10-K for the year ended January 31, 2002.
|--- | -----------------------------------------------------------------------------------------

|(7) | Incorporated by reference to the Companys Form 10-Q for the quarter ended July 31, 2002.
|--- | -----------------------------------------------------------------------------------------

|(8) | Incorporated by reference to the Companys Form 10-Q for the quarter ended October 31, 2002.
|--- | --------------------------------------------------------------------------------------------

|(9) | Incorporated by reference to the Companys Form 8-A filed December 23, 2002.
|--- | ----------------------------------------------------------------------------

|(10) | Incorporated by reference to the Companys Form 8-K filed December 23, 2002.
|---- | ----------------------------------------------------------------------------

|(11) | Incorporated by reference to the Companys Form 10-K for the year ended January 31, 2003.
|---- | -----------------------------------------------------------------------------------------

|(12) | Incorporated by reference to the Companys Form 8-K filed August 20, 2004.
|---- | --------------------------------------------------------------------------

|(13) | Incorporated by reference to the Companys Form 8-A/A filed August 23, 2004.
|---- | ----------------------------------------------------------------------------



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