** **

**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington,D. C. 20549**

** **

**Form 10-Q**

** **

| **(Mark  One)**                                                                                                                                                                                                                 |                                                                                           |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                                                                                                            |                                                                                           |   |
| **ý**                                                                                                                                                                                                                      | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE  SECURITIES EXCHANGE ACT OF 1934**  |
|                                                                                                                                                                                                                            |                                                                                           |
| **For  the quarter ended April 30, 2003 OR**                                                                                                                                                                               |
|                                                                                                                                                                                                                            |                                                                                           |
| **o**                                                                                                                                                                                                                           | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                            |                                                                                           |
| **For  the transition period from                   to                 ** |
|                                                                                                                                                                                                                            |                                                                                           |
| **Commission  file number 000-22009**                                                                                                                                                                                           |
|                                                                                                                                                                                                                                 |                                                                                                |        |  |  |

** **

**NEOMAGIC CORPORATION**

(Exact name of Registrant as specified in its charter)

 

| **DELAWARE**                                                     |   | **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         |

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15 (d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes   ý   No   o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act)  Yes   o   No   ý

 

The number ofshares of the Registrant’s Common Stock, $.001 par value, outstanding atApril 30, 2003 was 30,277,155

 

 

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NEOMAGICCORPORATION

FORM 10-Q

 

**INDEX**

 
| PART  I.  CONSOLIDATED CONDENSED FINANCIAL  INFORMATION |
|--------------------------------------------------------------|
|                                                         |   |   |
| Item 1.                                                      | Unaudited Consolidated Condensed Financial  Statements: |
|                                                         |   |   |
|                                                         | Consolidated  Condensed Statements of Operations |
|                                                         |   | Three  months ended April 30, 2003 and 2002 |
|                                                         |   |   |
|                                                         | Consolidated  Condensed Balance Sheets |
|                                                         |   | April 30,  2003 and January 31, 2003 |
|                                                         |   |   |
|                                                         | Consolidated  Condensed Statements of Cash Flows |
|                                                         |   | Three  months ended April 30, 2003 and 2002 |
|                                                         |   |   |
|                                                         | Notes  to Unaudited Consolidated Condensed Financial Statements |
|                                                         |   |   |
| Item 2.                                                      | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |
|                                                         |   |   |
| Item 3.                                                      | Quantitative and Qualitative Disclosures about  Market Risk |
|                                                         |   |   |
| Item 4.                                                      | Controls and Procedures |
|                                                         |   |   |
| PART II.   OTHER INFORMATION                            |
|                                                         |   |   |
| Item  1.                                                     | Legal  Proceedings |
|                                                         |   |   |
| Item 2.                                                      | Changes in Securities |
|                                                         |   |   |
| Item 3.                                                      | Defaults Upon  Senior Securities |
|                                                         |   |   |
| Item  4.                                                     | Submission  of Matters to a Vote of Security Holders |
|                                                         |   |   |
| Item  5.                                                     | Other  Information |
|                                                         |   |   |
| Item 6.                                                      | Exhibits and  Reports on Form 8-K |
|                                                         |   |   |
| Signatures                                                   |
|                                                         |   |   |
| Certifications                                               |
|                                                              |  |  |  |

 

2

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Part I.  Financial Information

 

Item I.  Financial Statements

 

**NEOMAGIC CORPORATION**

**CONSOLIDATED CONDENSED STATEMENTS OFOPERATIONS**

(Unaudited)

 
|                                                           |   | **Three  Months Ended**  |   |
|----------------------------------------------------------------|--------|--------------------------|--------|
| **(In thousands, except per share data)**                      |   | **April 30,  2003** |   | **April 30,  2002** | ** ** |
| Net  sales                                                     |   | $                        | 624    |   | $ | 362 |   |
|                                                           |   |                     |   |   |   |
| Cost  of sales (1)                                             |   | 588                      |   | 585 |   |
|                                                           |   |                     |   |   |   |
| Gross  margin (loss)                                           |   | 36                       |   | (223 | ) |
|                                                           |   |                     |   |   |   |
| Operating  expenses:                                           |   |                     |   |   |   |
| Research  and development (2)                                  |   | 5,019                    |   | 6,974 |   |
| Sales,  general and administrative (3)                         |   | 1,777                    |   | 3,368 |   |
| Special  charges                                               |   | —                   |   | 1,400 |   |
| Total  operating expenses                                      |   | 6,796                    |   | 11,742 |   |
|                                                           |   |                     |   |   |   |
| Loss  from operations                                          |   | (6,760                   | )      | (11,965 | ) |
|                                                           |   |                     |   |   |   |
| Other  income (expense), net:                                  |   |                     |   |   |   |
| Income,  net of expenses, from the sale of DVD assets          |   | —                   |   | 1,580 |   |
| Interest  income and other income                              |   | 211                      |   | 608 |   |
| Interest  expense                                              |   | (87                      | )      | — |   |
|                                                           |   |                     |   |   |   |
| Loss  before income taxes                                      |   | (6,636                   | )      | (9,777 | ) |
|                                                           |   |                     |   |   |   |
| Income  tax benefit                                            |   | —                   |   | (6,000 | ) |
|                                                           |   |                     |   |   |   |
| Net  loss                                                      |   | $                        | (6,636 | ) | $ | (3,777 | ) |
|                                                           |   |                     |   |   |   |
| Basic  net loss per share                                      |   | $                        | (.22   | ) | $ | (.13 | ) |
| Diluted  net loss per share                                    |   | $                        | (.22   | ) | $ | (.13 | ) |
|                                                           |   |                     |   |   |   |
| Weighted  average common shares outstanding                    |   | 30,277                   |   | 28,036 |   |
| Weighted  average common shares outstanding, assuming dilution |   | 30,277                   |   | 28,036 |   |

 

----

(1)                Includes $6 inamortization of deferred stock compensation for the three months endedApril 30, 2003.

 

(2)                Includes $67 and$625 in amortization of deferred stock compensation for the three months endedApril 30, 2003 and April 30, 2002, respectively.

 

(3)                Includes $35 and$613 in amortization of deferred stock compensation for the three months endedApril 30, 2003 and April 30, 2002, respectively.

 

*Seeaccompanying notes to consolidated condensed financial statements.*

 

3

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**NEOMAGIC CORPORATION**

**CONSOLIDATED CONDENSED BALANCE SHEETS**

(Unaudited)

 
| **(In thousands)**                               |   | **April 30,  2003** |   | **January 31,  2003(1)** |   |
|--------------------------------------------------|--------|--------------------------|--------|-------------------------------|--------|
| **ASSETS**                                       |   |                     |   |                          |   |
| Current  assets:                                 |   |                     |   |                          |   |
| Cash  and cash equivalents                       |   | $                        | 15,512 |                          | $      | 37,428 |   |
| Short-term  investments                          |   | 44,542                   |   | 29,657                        |   |
| Accounts  receivable, net                        |   | 122                      |   | 118                           |   |
| Inventory                                        |   | 759                      |   | 535                           |   |
| Employee  note receivable                        |   | —                   |   | 1,200                         |   |
| Other  current assets                            |   | 1,304                    |   | 1,210                         |   |
| Total  current assets                            |   | 62,239                   |   | 70,148                        |   |
|                                             |   |                     |   |                          |   |
| Property,  plant and equipment, net              |   | 5,193                    |   | 5,840                         |   |
| Employee  note receivable                        |   | 100                      |   | 100                           |   |
| Intangibles,  net                                |   | 4,196                    |   | 4,349                         |   |
| Other  assets                                    |   | 468                      |   | 511                           |   |
|                                             |   |                     |   |                          |   |
| Total  assets                                    |   | $                        | 72,196 |                          | $      | 80,948 |   |
|                                             |   |                     |   |                          |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**   |   |                     |   |                          |   |
| Current  liabilities:                            |   |                     |   |                          |   |
| Accounts  payable                                |   | $                        | 2,408  |                          | $      | 2,864 |   |
| Compensation  and related benefits               |   | 1,191                    |   | 1,393                         |   |
| Income  taxes payable                            |   | 3,664                    |   | 3,633                         |   |
| Current  portion of capital lease obligations    |   | 1,602                    |   | 1,363                         |   |
| Other  accruals                                  |   | 1,016                    |   | 1,287                         |   |
| Total  current liabilities                       |   | 9,881                    |   | 10,540                        |   |
|                                             |   |                     |   |                          |   |
| Capital  lease obligations                       |   | 2,153                    |   | 2,521                         |   |
|                                             |   |                     |   |                          |   |
| Commitments  and contingencies                   |   |                     |   |                          |   |
|                                             |   |                     |   |                          |   |
| Stockholders’  equity:                      |   |                     |   |                          |   |
| Common  stock                                    |   | 30                       |   | 30                            |   |
| Additional  paid-in-capital                      |   | 88,661                   |   | 89,237                        |   |
| Deferred  compensation                           |   | (517                     | )      | (4                            | )      |
| Accumulated  other comprehensive income          |   | 9                        |   | 9                             |   |
| Accumulated  deficit                             |   | (28,021                  | )      | (21,385                       | )      |
| Total  stockholders’ equity                 |   | 60,162                   |   | 67,887                        |   |
|                                             |   |                     |   |                          |   |
| Total  liabilities and stockholders’ equity |   | $                        | 72,196 |                          | $      | 80,948 |   |

 

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(1)                Derived from theJanuary 31, 2003 audited consolidated financial statements included in theAnnual Report on Form 10-K of NeoMagic Corporation for fiscal year 2003.

 

*Seeaccompanying notes to consolidated condensed financial statements.*

 

4

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**NEOMAGIC CORPORATION**

**CONSOLIDATED CONDENSED STATEMENTS OFCASH FLOWS**

(Unaudited)

 
|                                                                          |   | **Three  Months Ended April 30,** | ** ** |
|-------------------------------------------------------------------------------|--------|----------------------------------------|------------|
| **(In thousands)**                                                            |   | **2003**                               |       | **2002** | ** ** |
|                                                                          |   |                                   | ** ** |   | ** ** |
| **Operating  activities:**                                                    |   |                                   |       |   |   |
| Net  loss                                                                     |   | $                                      | (6,636     | ) | $ | (3,777 | ) |
| Adjustments  to reconcile net loss to net cash used for operating activities: |   |                                   |       |   |   |
| Depreciation  and amortization                                                |   | 905                                    |       | 900 |   |
| Amortization  of deferred compensation                                        |   | 108                                    |       | 1,238 |   |
| Changes  in operating assets and liabilities:                                 |   |                                   |       |   |   |
| Accounts  receivable                                                          |   | (4                                     | )          | (66 | ) |
| Inventory                                                                     |   | (224                                   | )          | 11 |   |
| Income  tax receivable                                                        |   | —                                 |       | (6,000 | ) |
| Other  current assets                                                         |   | (94                                    | )          | (48 | ) |
| Other  assets                                                                 |   | 43                                     |       | 848 |   |
| Accounts  payable                                                             |   | (456                                   | )          | 187 |   |
| Compensation  and related benefits                                            |   | (202                                   | )          | 171 |   |
| Income  taxes payable                                                         |   | 31                                     |       | (286 | ) |
| Tax  benefit from employee stock options                                      |   | 3                                      |       | — |   |
| Other  accruals                                                               |   | (271                                   | )          | (374 | ) |
| Net  cash used in operating activities                                        |   | (6,797                                 | )          | (7,196 | ) |
|                                                                          |   |                                   |       |   |   |
| **Investing  activities:**                                                    |   |                                   | ** ** |   | ** ** |
| Net  proceeds from the sale of DVD assets                                     |   | —                                 |       | 1,580 |   |
| Purchases  of property, plant, equipment and intangibles                      |   | (105                                   | )          | (143 | ) |
| Purchases  of short-term investments                                          |   | (22,727                                | )          | (17,762 | ) |
| Maturities  of short-term investments                                         |   | 7,842                                  |       | 15,820 |   |
| Net  cash used in investing activities                                        |   | (14,990                                | )          | (505 | ) |
|                                                                          |   |                                   |       |   |   |
| **Financing  activities:**                                                    |   |                                   | ** ** |   | ** ** |
| Payments  on capital lease obligations                                        |   | (129                                   | )          | — |   |
| Net  proceeds from issuance of common stock                                   |   | —                                 |       | 62 |   |
| Net  cash provided by (used in) financing activities                          |   | (129                                   | )          | 62 |   |
|                                                                          |   |                                   |       |   |   |
| Net  decrease in cash and cash equivalents                                    |   | (21,916                                | )          | (7,639 | ) |
| Cash  and cash equivalents at beginning of period                             |   | 37,428                                 |       | 38,996 |   |
| Cash  and cash equivalents at end of period                                   |   | $                                      | 15,512     |   | $ | 31,357 |   |
| Supplemental  schedules of cash flow information:                             |   |                                   |       |   |   |
| Cash  paid during the period for:                                             |   |                                   |       |   |   |
| Interest                                                                      |   | $                                      | 24         |   | $ | — |   |
| Taxes                                                                         |   | $                                      | 6          |   | $ | 293 |   |

 

*See accompanying notes to consolidated condensed financialstatements*.

 

5

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**NEOMAGIC CORPORATION**

**NOTES TO UNAUDITED CONSOLIDATEDCONDENSED FINANCIAL STATEMENTS**

(Unaudited)

 

**1.****              Basis ofPresentation**

 

The unauditedconsolidated condensed financial statements have been prepared pursuant to therules and regulations of the Securities and Exchange Commission and include theaccounts of NeoMagic Corporation and its wholly owned subsidiaries collectively(“NeoMagic” or the “Company”).  Certaininformation and footnote disclosures, normally included in financial statementsprepared in accordance with generally accepted accounting principles, have beencondensed or omitted pursuant to such rules and regulations.  In the opinion of the Company, the financialstatements reflect all adjustments, consisting only of normal recurring adjustments,necessary for a fair presentation of the financial position at April 30,2003, and the operating results and cash flows for the three months endedApril 30, 2003 and 2002.  Thesefinancial statements and notes should be read in conjunction with the Company’saudited financial statements and notes thereto for the year endedJanuary 31, 2003, included in the Company’s Form 10-K filed with theSecurities and Exchange Commission.

 

The results of operations for the three months endedApril 30, 2003 are not necessarily indicative of the results that may beexpected for the year ending January 31, 2004.

 

The first fiscal quarters of 2004 and 2003 ended onApril 27, 2003 and April 28, 2002, respectively.  For ease of presentation, the accompanyingfinancial statements have been shown as ending on the last day of the calendarmonth of April.

 

**2.****              Recently IssuedAccounting Pronouncements**

 

InNovember of 2002, the EITF reached a consensus on Issue No.  00-21, “Revenue Arrangements with MultipleDeliverables.” EITF Issue No. 00-21 provides guidance on how to account forarrangements that involve the delivery or performance of multiple products,services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenuearrangements entered into in fiscal periods beginning after June 15,2003.  The Company is currentlyevaluating the effect that the adoption of EITF Issue No. 00-21 will have onits results of operations and financial condition.

 

In January of2003, the FASB issued FIN No. 46, “Consolidation of Variable Interest Entities.” FIN No. 46 requires avariable interest entity to be consolidated by a company if that company issubject to a majority of the risk of loss from the variable interest entity’sactivities or entitled to receive a majority of the entity’s residual returnsor both. The consolidation requirements of FIN No. 46 apply immediately tovariable interest entities created after January 31, 2003. Theconsolidation requirements apply to older entities in the first fiscal year orinterim period beginning after June 15, 2003. The Company is currentlyevaluating the provisions of FIN No. 46 and does not believe that it will havea material effect on its results of operations and financial condition.

 

**3.****              Stock Compensation**

 

In accordance with the intrinsic value method, theCompany does not recognize compensation cost for stock options granted at fairmarket value.

 

In December of 2002,the Financial Accounting Standards Board issued SFAS No. 148, which amends SFASNo. 123, to provide alternative methods of transition for an entity thatchanges to the fair value method of accounting for stock-based employeecompensation.  In addition, SFAS No. 148amends the disclosure provisions of SFAS No. 123 to require expanded and moreprominent disclosure of the effects of an entity’s accounting policy withrespect to stock-based employee compensation.

 

For purposes of pro forma disclosures, the estimatedfair value of options is amortized to expense over the options’ vesting period,and the estimated fair value of purchases under the employee stock

 

6

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purchase plan is expensed in the year of purchase as well as thestock-based employee compensation cost, net of related tax effects, that wouldhave been included in the determination of net income (loss) if the fair valuebased method had been applied to all awards.

 

Pro forma information regarding net loss and loss pershare has been determined as if the Company had accounted for its employeestock options and purchases under the employee stock purchase plan using thefair value method.  The fair value forthese options was estimated at the date of grant using a Black-Scholesoption-pricing model.

 

In the three months ended April 30, 2003 and 2002,respectively, the fair value of each option grant was estimated on the date ofthe grant using the Black-Scholes option-pricing model using a dividend yieldof 0% and the following additional weighted-average assumptions:

 

** **
|                                   |   | **Option Plans** |       | **Stock Purchase Plan** |       |
|----------------------------------------|--------|------------------|------------|-------------------------|------------|
| **Three  months ended April 30,** |   | **2003**         | ** ** | **2002**                | ** ** | **2003** | ** ** | **2002** | ** ** |
| Risk-free  interest rates              |   | 1.6              | %          | 4.5                     | %          | 1.45 | % | 2.2 | % |
| Volatility                             |   | .55              |       | .48                     |       | .68 |   | .73 |   |
| Expected  life of option in years      |   | 2.03             |       | 4.55                    |       | .49 |   | .49 |   |

 

The Black-Scholes option valuation model was developedfor use in estimating the fair value of traded options that have no vestingrestrictions and are fully transferable. In addition, option valuation models require the input of highlysubjective assumptions including the expected stock price volatility.  Because the Company’s employee stock optionshave characteristics significantly different from those of traded options, andbecause changes in the subjective input assumptions can materially affect thefair value estimate, in management’s opinion, the existing models do notnecessarily provide a reliable single measure of its employee stock options.

 

The Company’s pro formainformation is as follows:

 
| **Three months ended April 30,**                                                                                            |   | **2003** | ** ** | **2002** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|--------|----------|------------|----------|------------|
| Net  loss, as reported                                                                                                           |   | $        | (6,636     | )        | $          | (3,777 | ) |
| Add:  Stock-based employee compensation expense included in reported net loss, net  of related tax effects                       |   | 108      |       | 1,238    |       |
| Less:  Total stock-based compensation expense determined under the fair value method  for all awards, net of related tax effects |   | (771     | )          | (1,858   | )          |
| Pro  forma net loss                                                                                                              |   | (7,299   | )          | (4,397   | )          |
| Reported  basic and diluted loss per share                                                                                       |   | $        | (0.22      | )        | $          | (0.13 | ) |
| Pro  forma basic and diluted loss per share                                                                                      |   | $        | (0.24      | )        | $          | (0.16 | ) |

 

**4.****              Earnings (Loss) PerShare**

 

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

 

Per share information isas follows:

 
| **Three  months ended April 30,****(in  thousands except per share data)** |   | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------------------------------------------------|--------|----------|------------|----------|------------|
| Numerator:                                                                      |   |     |       |     |       |
| Net  income (loss)                                                              |   | $        | (6,636     | )        | $          | (3,777 | ) |
|                                                                            |   |     |       |     |       |
| Denominator:                                                                    |   |     |       |     |       |
| Denominator  for basic and diluted loss per share - weighted-average shares     |   | 30,277   |       | 28,036   |       |
|                                                                            |   |     |       |     |       |
| Basic  and diluted loss per share                                               |   | $        | (.22       | )        | $          | (.13 | ) |

 

7

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For the three months ended April 30, 2003 and2002, respectively, basic earnings per share equals diluted earnings per sharedue to the net loss for the quarter. During the three months ended April 30, 2003 and 2002, respectively,the Company excluded options to purchase 189,340 and 1,156,509 shares of commonstock.

 

**5.****              Divestitures**

 

InApril 2000, pursuant to an asset purchase agreement, the Company sold theprincipal assets of its DVD product group, primarily consisted of fixed assetsand intangible assets to LSI Logic (“Buyer”). The Company received $11.7 million in a lump-sum cash payment and anadditional $3.1 million was contingent on the Company’s performance of certainobligations related to the transfer of licenses with third parties to theBuyer. The Company wrote-off approximately $3.6 million in capitalizedintellectual property, fixed assets and prepaid expenses related to the DVDproduct group that was transferred to the Buyer.  In addition, the Company incurred approximately $0.6 million intransaction costs, approximately $2.3 million in retention packages for theaffected employees, and $0.3 million in additional costs during fiscal 2001.The Company received a $1.5 million cash payment which was previouslycontingent on the Company’s performance of certain obligations related to thetransfer of licenses with third parties to the Buyer in fiscal 2001.   As a result, the Company recorded a pre-taxgain of approximately $6.5 million on the sale, which is recorded in Income,net of expenses, from the sale of DVD assets on the Consolidated CondensedStatements of Operations for the year ended January 31, 2001.  In the first quarter of fiscal 2003, theCompany received the remaining contingent payment of $1.6 million uponcompleting the transfer of licenses with third parties to the Buyer, andrecorded as the amount as a gain in the consolidated condensed statement ofoperations for the fiscal year ended January 31, 2003.

 

**6.****              Inventories**

 

Inventories are stated at the lower of cost or marketvalue. Cost is determined by the first-in, first-out method.  The Company writes down the inventory valuefor estimated excess and obsolete inventory, based on management’s assessmentof future demand and market conditions. If actual future demand or market conditions are less favorable thanthose projected by management, additional inventory write-downs may berequired.

 
| **Inventory consists of:  (in thousands)** |   | **April 30,  2003** | ** ** | **January 31,  2003** | ** ** |
|--------------------------------------------|--------|--------------------------|------------|----------------------------|------------|
|                                       |   |                     |       |                       |       |
| Raw  materials                             |   | $                        | 8          |                       | $          | 117 |   |
| Work  in process                           |   | 79                       |       | 102                        |       |
| Finished  goods                            |   | 672                      |       | 316                        |       |
| Total                                      |   | $                        | 759        |                       | $          | 535 |   |

 

**7.****              Accumulated OtherComprehensive Income**

 

Total accumulated othercomprehensive income was $9 thousand at April 30, 2003 and atJanuary 31, 2003.  Accumulatedother comprehensive income consists entirely of unrealized gains on availablefor sale securities.

 

8

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**8.****              Intangible Assets**

 

The following table providesa summary of the carrying amount of intangible assets that will continue to beamortized and excludes amounts originally allocated to an intangible assetrepresenting the value of the assembled workforce:

 

Intangibleassets subject to amortization were as follows (in thousands):

 
| **April 30, 2003**         |   | **Cost** | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
|---------------------------------|--------|----------|------------|-------------------------------|------------|---------|------------|
|                            |   |     |       |                          |       |    |       |
| Licensed  intellectual property |   | $        | 3,274      |                          | $          | (78     | )          | $ | 3,196 |   |
| Core technology                 |   | 1,800    |       | (800                          | )          | 1,000   |       |
| Patents                         |   | 1,697    |       | (1,697                        | )          | —  |       |
|                            |   | $        | 6,771      |                          | $          | (2,575  | )          | $ | 4,196 |   |

 
| **January 31, 2003**       |   | **Cost** | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
|---------------------------------|--------|----------|------------|-------------------------------|------------|---------|------------|
|                            |   |     |       |                          |       |    |       |
| Licensed  intellectual property |   | $        | 3,244      |                          | $          | (45     | )          | $ | 3,199 |   |
| Core technology                 |   | 1,800    |       | (650                          | )          | 1,150   |       |
| Patents                         |   | 1,697    |       | (1,697                        | )          | —  |       |
|                            |   | $        | 6,741      |                          | $          | (2,392  | )          | $ | 4,349 |   |

 

Amortization expense forother intangible assets was $183 thousand and $563 thousand for the threemonths ended April 30, 2003 and 2002, respectively. Licensed intellectualproperty and core technology are amortized over three years.  Estimated annual amortization expense forother intangible assets is as follows as of April 30, 2003:

 
| **Fiscal years ending January 31,  (in thousands)** |   |   | **    ** |
|----------------------------------------------------------|--------|--------|--------------------|
| 2004                                                     |   | $      | 1,189              |   |
| 2005                                                     |   | 1,641  |               |
| 2006                                                     |   | 1,047  |               |
| 2007                                                     |   | 319    |               |
| Total                                                    |   | $      | 4,196              |   |

 

During the first quarter offiscal 2003, the Company wrote-off licensed intangible properties with a netbook value of $531 thousand relating to licensed intellectual property thatwill no longer be used.

 

**9.****              Obligations UnderCapital Leases**

 

In fiscal 2003, the Company entered into capitalleases to finance software licenses used in the design of semiconductors. Obligationsunder capital leases represent the present value of future payments under thelease agreements. Property, plant and equipment include the following amountsfor leases that have been capitalized:

 
| **(in thousands)**                |   | **April 30,  2003** |   | **January 31,  2003** | **    ** |
|-----------------------------------|--------|--------------------------|--------|----------------------------|--------------------|
| Software  under capital lease     |   | $                        | 4,073  |                       | $                  | 4,073 |   |
| Accumulated  amortization         |   | (720                     | )      | (381                       | )                  |
| Net  software under capital lease |   | $                        | 3,353  |                       | $                  | 3,692 |   |

 

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

 

Future minimum paymentsunder the capital leases consist of the following, as of April 30, 2003:

 
| **Fiscal year ending January 31,  (in thousands)** |   |   | **    ** |
|---------------------------------------------------------|--------|--------|--------------------|
| 2004                                                    |   | $      | 1,487              |   |
| 2005                                                    |   | 1,910  |               |
| 2006                                                    |   | 829    |               |
| Total  minimum lease payments                           |   | 4,226  |               |
| Less:  amount representing interest                     |   | (471   | )                  |
| Present  value of net minimum lease payments            |   | 3,755  |               |
| Less:  current portion                                  |   | (1,602 | )                  |
| Long-term  portion                                      |   | $      | 2,153              |   |

 

**10.****       Contingencies**

 

As a general matter, the semiconductor industry ischaracterized by substantial litigation, regarding patent and otherintellectual property rights.  InDecember 1998, the Company filed a lawsuit in the United States DistrictCourt for the District of Delaware seeking damages and an injunction againstTrident Microsystems, Inc.  The suitalleges that Trident’s embedded DRAM graphics accelerators infringe certainpatents held by the Company.  InJanuary 1999, Trident filed a counter claim against the Company allegingan attempted monopolization in violation of antitrust laws, arising fromNeoMagic’s filing of the patent infringement action against Trident. The Courtruled that there was no infringement by Trident. The Company filed an appeal inthe United States Court of Appeals, for the Federal Circuit.  On April 17, 2002, the United StatesCourt of Appeals for the Federal Circuit affirmed the lower court’s judgment ofnon-infringement on one patent and vacated the court’s judgment ofnon-infringement on another patent, thereby remanding it to the lower court forfurther proceedings. In November 2002, the lower court heard oralarguments on cross-motions for summary judgment on the matter.  In May 2003, the lower court ruled infavor of Trident. NeoMagic filed a notice of re-consideration with the court.Management believes the Company has valid defenses against Trident’s claims.There can be no assurance as to the results of the patent infringement suit andthe counter-suit for antitrust filed by Trident.

 

**11.****       Product Warranty**

 

The Company generally sells products with a limitedwarranty of product quality and a limited indemnification of customers againstintellectual property infringement claims related to the Company’s products.The Company accrues for known warranty and indemnification issues if a loss isprobable and can be reasonably estimated, and accrues for estimated incurredbut unidentified issues based on historical activity. The accrual and therelated expense for known issues were not significant as of and for the firstquarter of 2004 and 2003. Due to product testing, the short time betweenproduct shipment and the detection and correction of product failures, and alow historical rate of payments on indemnification claims, the accrual based onhistorical activity and the related expense were not significant as of and forthe first quarter of 2004 and 2003.

 

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**Part I.  Financial Information**

 

# **Item 2**.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations

# ** **

When used in this discussion, the words “expects,”“anticipates,” “believes” and similar expressions are intended to identifyforward-looking statements.  Suchstatements reflect management’s current intentions and expectations. Examplesof such forward-looking statements include statements regarding futurerevenues, expenses, losses and cash flows, the launch of new products andresearch and development activities. However, actual events and results could vary significantly based on avariety of factors including, but not limited to: customer acceptance of newNeoMagic products, the market acceptance of handheld system products developedand marketed by customers that use the Company’s products, the Company’sability to execute product and technology development plans on schedule, and theCompany’s ability to access advanced manufacturing technologies in sufficientcapacity without significant cash pre-payments or investment.  These factors along with those set forthbelow under “Factors that May Affect Results,” are subject to risks anduncertainties that could cause actual results to differ materially from thoseprojected.  These forward-lookingstatements speak only as of the date hereof. The Company expressly disclaims any obligation or undertaking to releasepublicly any updates or revisions to any forward-looking statements containedherein, to reflect any changes in the Company’s expectations with regardthereto or any changes in events, conditions or circumstances on which any suchstatement is based.

 

# **Overview**

# ** **

NeoMagic designs, develops, manufactures and sellshigh performance applications processors for handheld systems that enablemultimedia features and applications within a low-power, small form-factorsystem-on-chip (SOC).  In the past, theCompany provided semiconductor solutions for the notebook PC multimediaaccelerator marketplace.  InApril 2000, the Company began to exit this market and is now focusedsolely on developing, manufacturing and selling applications processors andcompanion chips for the handheld systems market.  The Company is now generating revenues from this new producteffort.  In fiscal 2004, the Companyexpects to see customers introducing new handheld systems that use the Company’schips, primarily in Europe and Asia. The Company also expects to launch an additional new member of itsMiMagicTM family of applications processors in fiscal 2004.

 

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

 

NeoMagic introduced the MiMagic 5 ApplicationsProcessor (NMS9200) in November 2002, and began sampling the product inFebruary 2003.  The Company expectsto start revenue shipments in late fiscal 2004 with significant revenues notexpected to be generated until fiscal 2005.

 

In November of 2002, the Company introduced a newtechnology platform, called Associative Processing Array (APA).  The APA architecture uses a massivelyparallel approach to processing information, which means that APA operates ondata in parallel.  Existing solutionsuse a sequential processing flow that typically implies operation on eachindividual data element in sequence, making use of ever-faster clocks to gain performance.With its ability to handle large amounts of data simultaneously and at lowerclock rates, the APA platform is targeted at multimedia data such as images,video and graphics.  The Companyanticipates that it will introduce products based on the APA architecture inthe first half of fiscal 2004.  Theseproducts are not expected to generate significant revenues during fiscal year2004.

 

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The Company’s fiscal year end is January 31.  Any references herein to a fiscal year referto the year ended January 31 of such year. The first fiscal quarters of 2004 and 2003 ended on April 27, 2003 andApril 28, 2002, respectively.  For easeof presentation, the accompanying financial statements have been shown asending on the last day of the calendar month of April.

 

**Resultsof Operations**

 

**Critical Accounting Policies**

 

NeoMagic’s discussion and analysis of its financialcondition and results of operations are based upon its consolidated financialstatements, which have been prepared in accordance with accounting principlesgenerally accepted in the United States. The preparation of these financialstatements requires the Company to make estimates and judgments that affect thereported amounts of assets, liabilities, revenues and expenses, and related disclosureof contingent assets and liabilities. On an on-going basis, the Companyevaluates its estimates, including those related to inventories, doubtfulaccounts, investments, intangible assets, income taxes, and contingencies andlitigation. The Company bases its estimates on historical experience and onvarious other assumptions that are believed to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe amount and timing of revenue and expenses and the carrying values of assetsand liabilities that are not readily apparent from other sources. Actualresults may differ from these estimates under different assumptions orconditions.

 

**Goodwill and Intangible Assets**

 

NeoMagic has significant tangible and intangibleassets on its balance sheet, including other purchased intangibles related toacquisitions.

 

In assessing the recoverability of goodwill andindefinite life intangible assets, the Company must make assumptions about theestimated future cash flows and other factors to determine the fair value ofthese assets.  Assumptions about futurerevenue and cash flows require significant judgment because of the currentstate of the economy, the fluctuation of actual revenue, and the timing ofexpenses.

 

As a result of adopting Statement of AccountingStandards (SFAS) 142, “Goodwill and Other Intangible Assets,” on February 1,2002, the Company discontinued the amortization of goodwill. Instead, goodwillwas reviewed for impairment upon adoption of SFAS 142 and again in the thirdquarter of fiscal 2002 because indicators of impairment were present.  In addition, on adoption of SFAS 142, theCompany reclassified certain intangibles with net book value $0.4 million,consisting of assembled workforce and acquisition costs, which are no longerdefined as an acquired intangible under SFAS 142, to goodwill.  Accordingly, there was no amortization ofassembled workforce and acquisition costs recognized during fiscal 2003.

 

Upon adoption of SFAS 142, the Company was required tocomplete the two-step transitional goodwill impairment test. The Companycompleted step one of the transitional impairment test during the secondquarter of fiscal 2003 and determined that there were indicators of impairment,as the carrying value of the reporting unit exceeded the fair value derivedfrom the market capitalization model. The second step of the transitionalimpairment test to determine the amount of impairment was completed in thethird quarter of fiscal 2003 by comparing fair value to carrying value, withany excess of carrying value over fair value being recorded as an impairmentloss. Based on the results of the second transitional impairment test, theCompany recorded a non-cash charge of $4.2 million, to reduce the carrying valueof its goodwill, which was reflected as a cumulative effect of an accountingchange in the fiscal 2003 consolidated statements of operations.

 

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For goodwill, the annual impairment evaluationincludes a comparison of the carrying value of the reporting unit  (including goodwill) to that reportingunit’s fair value.  If the reportingunit’s estimated fair value exceeds the reporting unit’s carrying value, noimpairment of goodwill exists.  If thefair value of the reporting unit does not exceed the unit’s carrying value,then an additional analysis is performed to allocate the fair value of thereporting unit to all of the assets and liabilities of that unit as if thatunit had been acquired in a business combination and the fair value of the unitwas the purchase price.  If the excessof the fair value of the reporting unit over the fair value of the identifiableassets and liabilities is less than the carrying value of the unit’s goodwill,an impairment charge is recorded for the difference.

 

Similarly, the impairment evaluation for indefinitelife intangible assets includes a comparison of the asset’s carrying value tothe asset’s fair value. When the carrying value exceeds fair value animpairment charge is recorded for the amount of the difference.  An intangible asset is determined to have anindefinite useful life when there are no legal, regulatory, contractual,competitive, economic or any other factors that may limit the period over whichthe asset is expected to contribute directly or indirectly to the future cashflows of the Company.  For such assets,in each reporting period, the Company also evaluates whether events andcircumstances continue to support the use of an indefinite useful life. If itis determined that the circumstances have changed and the intangible asset isdetermined to have a finite useful life, the asset will be amortizedprospectively over the estimated remaining useful life and accounted for in thesame manner as intangible assets that are subject to amortization.

 

Intangible assets are carried and reported atacquisition cost, net of accumulated amortization subsequent to acquisition.The acquisition cost is amortized over estimated useful lives, which range from2 to 3 years. Changes in circumstances such as the passage of new laws orchanges in regulations, technological advances, changes to the Company’sbusiness model, or changes in the capital strategy could result in the actualuseful lives differing from initial estimates. In those cases where the Company determines that the useful life of along-lived asset should be revised, the Company will depreciate the net bookvalue in excess of the estimated residual value over its revised remaininguseful life. Factors such as changes in the planned use of equipment, customerattrition, contractual amendments, or mandated regulatory requirements couldresult in shortened useful lives of intangible assets.

 

Long-lived assets and asset groups are evaluated forimpairment whenever events or changes in circumstances indicate that thecarrying amount of such assets may not be recoverable, or at least annually, inaccordance with SFAS 144.  The estimatedfuture cash flows are based upon, among other things, assumptions aboutexpected future operating performance and may differ from actual cashflows.  Long-lived assets evaluated forimpairment are grouped with other assets to the lowest level for whichidentifiable cash flows are largely independent of the cash flows of othergroups of assets and liabilities.  Ifthe sum of the projected undiscounted cash flows  (excluding interest) is less than the carrying value of theassets, the assets will be written down to the estimated fair value in theperiod in which the determination is made.

 

During the first quarter of fiscal 2003, the Companywrote-off licensed intangible properties with a net book value of $0.5 millionrelating to licensed intellectual property that will no longer be used.

 

During fiscal 2003, the Company also determined thatcertain intangible assets purchased as part of the LinkUp Systems Corporationacquisition completed in December 2001 were impaired and recorded a totalimpairment charge of $1,043 thousand.

 

**Inventory Valuation**

 

The Company’s inventory valuation policy stipulatesthat at the end of each reporting period we write-down or write-off ourinventory for estimated obsolescence or unmarketable inventory. The amount ofthe write-down or write-off is equal to the difference between the cost of theinventory and the estimated

 

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market value of the inventory based upon reasonable assumptions aboutfuture demand and market conditions. If actual market conditions are lessfavorable than those projected by management, additional inventory write-downsor write-offs may be required. Additionally, as we introduce productenhancements and new products demand for our existing products in inventory maydecrease. In the first quarter of fiscal 2001, consistent with this policy, werecorded a charge of $7.0 million for excess and obsolete write-downs relatedto restructuring the business.  In thefuture, we may find that similar assessments may warrant another write-down orwrite-off of inventory.

 

**Revenue Recognition**

 

The Company recognizes revenue from product sales whenthe products are shipped to customers; other than distributors, title hastransferred, and no significant obligations remain. In addition, the Companyrequires 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 areFOB shipping point.

 

With respect to products shipped to distributors, theCompany generally defers recognition of product revenue until the distributorssell its products to their customers. On occasion, however, the Company willsell products with “End of Life” status to its distributors under specialarrangements without any price protection or return privileges for which theCompany recognizes revenue upon transfer of title, based on shipping terms.

 

At the end of each accounting period, the Companymakes a determination of certain factors including sales returns andallowances, which could affect the amount of revenue recorded for the period.Sales returns provisions include considerations for known but unprocessed salesreturns and estimation for unknown returns based on historical experiences.

 

**Deferred Taxes**

 

The Company records a valuation allowance to reduceits deferred tax assets to the amount that is more likely than not to berealized. Based on the uncertainty of future pre-tax income, the Company hasfully reserved its deferred tax assets. In the event the Company was todetermine that it would be able to realize its deferred tax assets in thefuture, an adjustment to the deferred tax asset would increase income in theperiod when such determination was made. The Company has also provided forcertain potential tax liabilities. If such amounts ultimately prove to beunnecessary, the resulting reversal of such reserves would result in taxbenefits being recorded in the period when the reserves are no longer deemednecessary.

 

**NetSales**

 

Net sales were $624 thousand for the three monthsended April 30, 2003, compared to $362 thousand for the three months endedApril 30, 2002.  Net sales increased dueto the Company’s shipments of its MiMagic 3 applications processor for thehandheld systems market in the three months ended April 30, 2003.

 

Sales to customers located outside the United States(including sales to the foreign operations of customers with headquarters inthe United States, and foreign system manufacturers that sell to UnitedStates-based OEMs) accounted for 91% and 82% of net sales in the three monthsended April 30, 2003 and 2002, respectively. All sales transactions were denominated in United States dollars.

 

Four customers accounted for 35%, 24%, 18% and 11%,respectively, of net sales for the three months ended April 30, 2003.  Two customers accounted for 40% and 22% ofnet sales for the three months ended April 30, 2002.

 

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**Gross Margin (loss)**

 

Gross margin (loss) was $36 thousand and $(223)thousand for the three months ended April 30, 2003 and 2002, respectively.  The increase in gross margin is due toincreased sales covering fixed costs. In addition, in the first quarter offiscal 2004 the Company reviewed the percentage of time spent by manufacturingemployees between production and development and allocated $60 thousand of wagecosts related to development efforts to research and development expenses.  The negative gross margin for the threemonths ended April 30, 2002 is due to under absorption of manufacturingoverhead resulting from low production levels.

 

**Research and Development Expenses**

 

Research and development expenses include compensationand associated costs relating to development personnel, amortization ofintangible assets and prototyping costs, which are comprised of photo maskcosts and pre-production wafer costs. Research and development expenses were $5.0 million and $7.0 million forthe three months ended April 30, 2003 and 2002, respectively.  These expenses include amortization ofdeferred compensation of $0.1 million and $0.6 million for the three monthsended April 30, 2003 and 2002, respectively. The decrease is primarily related to lower amortization of deferredcompensation, lower amortization of acquired and licensed intangibles, andlower mask expenses offset somewhat by increased consulting expenses. Includedin the expenses for the three months ended April 30, 2002, were expenses of$0.6 million to write-off certain Licensed Intellectual Property. The Companyhas made, and intends to continue to make, significant investments in researchand development as it focuses on developing products for the handheld systemsmarket.

 

**Sales, General and AdministrativeExpenses**

 

Sales, general and administrative expenses were $1.8million and $3.4 million for the three months ended April 30, 2003 and 2002,respectively.  These expenses includeamortization of deferred compensation of $35 thousand and $600 thousand for thethree months ended April 30, 2003 and 2002, respectively. Sales, general andadministrative expenses decreased in absolute dollars primarily due to lowerlabor costs and lower amortization of deferred compensation.

 

**Special Charges**

 

In January 2001, the Company extended its wafer supplyagreement with Infineon Technologies AG of Germany (“Infineon”) through fiscal2004 to ensure future wafer supply for the Company’s new product efforts.  The terms of the agreement provided thatNeoMagic would make use of Infineon’s 0.20 micron and 0.17 micron embedded DRAM(eDRAM) process technologies.  Theagreement also provided for access to additional capacity and to more advancedprocess technologies to be developed by Infineon. NeoMagic provided $15.0million in guarantees towards its wafer purchases over the term of theagreement.  The amount of guarantee was includedas restricted cash on the Consolidated Balance Sheet, as of January 31, 2002.Due to uncertainties over Infineon’s continued eDRAM product development, theCompany decided not to use Infineon’s eDRAM technology for its futureproduction. Based on negotiations between NeoMagic and Infineon onrestructuring the wafer supply agreement with the intent to release NeoMagicfrom the related guarantee, the Company recorded $3.6 million in charges, whichreflects the value of the final settlement in fiscal 2003.  The $3.6 million charge is composed of a$1.5 million cash payment and the issuance of $2.1 million in commonstock.  The Company booked $1.4 millionof this charge in the first quarter of fiscal 2003 based on discussions withInfineon at that time.

 

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**Income Net of Expenses from Sale of DVD Assets**

 

In April 2000, pursuant to an asset purchaseagreement, the Company sold the principal assets of its DVD product group,primarily consisted of fixed assets and intangible assets to LSI Logic(“Buyer”).  The Company received $11.7million in a lump-sum cash payment and an additional $3.1 million wascontingent on the Company’s performance of certain obligations related to thetransfer of licenses with third parties to the Buyer. The Company wrote-offapproximately $3.6 million in capitalized intellectual property, fixed assetsand prepaid expenses related to the DVD product group that was transferred tothe Buyer.  In addition, the Companyincurred approximately $0.6 million in transaction costs, approximately $2.3million in retention packages for the affected employees, and $0.3 million inadditional costs during fiscal 2001. The Company received a $1.5 million cashpayment which was previously contingent on the Company’s performance of certainobligations related to the transfer of licenses with third parties to the Buyerin fiscal 2001.   As a result, theCompany recorded a pre-tax gain of approximately $6.5 million on the sale,which is recorded in Income, net of expenses, from the sale of DVD assets onthe Consolidated Condensed Statements of Operations for the year ended January31, 2001.  In the first quarter offiscal 2003, the Company received the remaining contingent payment of $1.6million upon completing the transfer of licenses with third parties to theBuyer, and recorded as the amount as a gain in the consolidated condensedstatement of operations for the fiscal year ended January 31, 2003.

 

**Interestand Other Income**

 

The Company earns interest on its cash and short-terminvestments.  Interest and other incomewas $0.2 million and $0.6 million for the three months ended April 30, 2003 and2002, respectively.  This decreaseprimarily is due to significantly lower interest rates and lower average cashand short-term investment balances.

 

**Interest Expense**

 

Interest expense was $87 thousand and $0 in the firstquarter of fiscal 2004 and 2003, respectively. Interest expense for the first quarter of fiscal 2004 is due to newcapital leases entered into in the latter half of fiscal 2003.

 

**IncomeTaxes**

 

The Company recorded a $6 million tax benefit for thethree months ended April 30, 2002, primarily related to changes in the federaltax law.  The Job Creation and WorkerAssistance Act of 2002 was enacted on March 9, 2002 and contained provisionsextending the net loss carry-back period from three to five years.  This change permitted the Company to utilizenet operating losses incurred in fiscal 2001 to recover taxes paid in priorperiods. The $6 million benefit represents additional refunds that the Companyclaimed on the 2001 net operating loss carry-back due to the change in tax law.

 

**Liquidity and Capital Resources**

 

The Company’s cash, cash equivalents and short-terminvestments decreased $7.0 million in the three months ended April 30,2003 to $60.1 million from $67.1 million at January 31, 2003.

 

Cash and cash equivalents used in operating activitiesfor the three months ended April 30, 2003 was $6.8 million, compared to $7.2million of net cash used in operating activities for the three months

 

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ended April 30, 2002.  The cashused in operating activities stems primarily from a net loss of $6.6 million,increases in inventory and accounts receivable, as well as decreases inaccounts payable, compensation and related benefits and in other accruals,partially offset by non-cash depreciation and amortization and deferredcompensation amortization charges.

 

Net cash used in investing activities for the threemonths ended April 30, 2003 was $15.0 million, compared to $0.5 million of netcash used in investing activities for the three months ended April 30, 2002.Net cash used in investing activities related primarily to net purchases ofshort-term investments of $14.9 million and fixed asset purchases of $0.1million.

 

Net cash used in financing activities was $129thousand for the three months ended April 30, 2003, compared to $62 thousand ofnet cash provided by financing activities for the three months ended April 30,2002. The net cash used in financing activities represents payments on capitallease obligations.

 

At April 30, 2003, the Company’s principal sources ofliquidity included cash, cash equivalents and short-term investments of $60.1million.  The Company believes that itwill not generate cash from operations during the next twelve months. TheCompany believes the current cash, cash equivalents and short-term investmentswill satisfy the Company’s projected working capital and capital expenditurerequirements through the next twelve months. After this period, capitalrequirements will depend on many factors, including general economicconditions, the rate of net sales growth, the timing and extent of spending tosupport research and development programs, the timing of any new productintroductions and enhancements to existing products, and market acceptance ofthe Company’s products.  To the extentthat existing cash, cash equivalents and short-term investment balances and anycash from operations are insufficient to fund the Company’s future activities,the Company may need to raise additional equity or debt financing in thefuture.  There can be no assurance thatadditional equity or debt financing, if required, will be available onacceptable terms or at all.

 

In May 1996, the Company moved its principalheadquarters to a new facility in Santa Clara, California, under anon-cancelable operating lease that expired in April 2003. In January 1998, theCompany entered into a second non-cancelable operating lease for the buildingadjacent to its principal headquarters. This lease had a co-terminus provision with the original lease, whichexpired in April 2003.  In March 2002,the Company extended the term for 45,000 square feet under this lease for anotherseven years with a termination date of April 2010.  The Company leases offices in India and Israel under operatingleases that expire at various times through December 2006.

 

The Company leases software licenses under capitalleases. Refer to note 9 of the consolidated condensed financial statements foradditional information.

 

The future minimum payments relating to the softwareleases and the facility leases are included in the contractual obligationstable below.

 

**Contractual Obligations**

 

The following summarizesthe Company’s contractual obligations at April 30, 2003, and the effect suchobligations are expected to have on our liquidity and cash flow (in thousands).

 
|                               |   | **2004** |       | **2005** |       | **2006** |       | **2007** |       | **2008** |       | **There  After** |       | **Total** |       |
|------------------------------------|--------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|------------------|------------|-----------|------------|
| **CONTRACTUAL OBLIGATIONS**        |   |     | ** ** |     | ** ** |     | ** ** |     | ** ** |     | ** ** |             | ** ** |      | ** ** |
| Operating leases                   |   | $        | 863        |     | $          | 1,131    |       | $        | 1,086      |     | $          | 1,113            |       | $         | 1,046      |   | $ | 2,450 |   | $ | 7,689 |   |
| Capital leases                     |   | 1,487    |       | 1,910    |       | 829      |       | —   |       | —   |       | —           |       | 4,226     |       |
|                               |   |     |       |     |       |     |       |     |       |     |       |             |       |      |       |
| Total contractual cash obligations |   | $        | 2,350      |     | $          | 3,041    |       | $        | 1,915      |     | $          | 1,113            |       | $         | 1,046      |   | $ | 2,450 |   | $ | 11,915 |   |

 

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The Company has open andcommitted purchase orders as of April 30, 2003 of $645,000.

 

**Factors that May Affect Results**

 

**We Expect to Continue to IncurSignificant Losses in Fiscal 2004**

 

The Company has been incurring substantial losses asit invests heavily in new product development in advance of achievingsignificant customer sales.  This isexpected to continue in fiscal year 2004. The Company’s ability to achieve cash flow breakeven is likely to dependon the success of its MiMagic 5, which has recently been released, and thesuccess of other products and technology still in development and scheduled forrelease in the second half of fiscal year 2004.  However, even if the MiMagic 5 and subsequent products achievewidespread customer acceptance, the length of customer design-in cycles wouldpreclude significant product shipments in fiscal 2004.  Accordingly, even if these new products aresuccessful, the Company will incur significant additional losses in fiscal2004.

 

**Our Annual and Quarterly Performance May Fluctuate**

 

The Company’s quarterlyand annual results of operations are affected by a variety of factors thatcould materially adversely affect net sales, gross margin and operatingresults.  These factors include, amongothers, the ability of the Company to increase its customer base and its sales,the abilities of manufacturing subcontractors to make adequate and timelydeliveries, access to advanced production process technologies frommanufacturing subcontractors, recruiting and retaining employees includingthose with engineering expertise in new disciplines. In particular, theCompany’s new product development efforts and customer engagements in System-on-Chipintegration and supporting multimedia technologies such as MPEG-4 streamingvideo represent new endeavors and consequently carry greater risks ofsuccessful and timely execution. Any one or more of these factors could resultin the Company failing to achieve its expectations as to future revenues andprofits.  Furthermore, the majority ofthe Company’s sales were historically made, and are expected to continue to bemade, on the basis of purchase orders rather than pursuant to long-termpurchase agreements, which increases the difficulty of forecasting sales.  The Company may be unable to adjust spendingsufficiently in a timely manner to compensate for any unexpected salesshortfall, which could materially adversely affect quarterly operating results. Accordingly, the Company believes thatperiod-to-period comparisons of its operating results should not be relied uponas an indication of future performance. In addition, the results of any quarterly period are not indicative ofresults to be expected for a full fiscal year. In future quarters, the Company’s operating results may be below theexpectations of public market analysts or investors.

 

**Our Financial Results could beAffected by Changes in Accounting Rules**

 

In August 2001, the FASB issued SFAS 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets.” SFAS 144 requires us toperform impairment analysis on our long-lived assets, other than goodwill, tobe held and used, whenever events or changes in circumstances indicate thecarrying amount may not be recoverable. An impairment loss will be recognizedif the carrying amount of a long-lived asset exceeds its fair value. SFAS 144retains the fundamental provisions of SFAS 121 related to (i) the recognitionand measurement of the impairment of long-lived assets to be held and used, and(ii) the measurement of long-lived assets to be disposed of by sale. As SFAS144 excludes goodwill, certain long-lived assets may be subject to impairmentcharges sooner than they would have been recorded under SFAS 121, which SFAS144 replaces. During the third and fourth quarter of fiscal 2003, we recordedimpairment charges of $873 thousand and $170 thousand, respectively, related toour long-lived assets as a result of our SFAS 144 analysis. If economic conditionsin our industry continue to deteriorate and adversely affect our

 

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business, we could be required to record additional impairment chargesrelated to our long-lived assets, which could have a material adverse effect onour results of operations and financial condition.

 

Our financial resultscould be affected by potential changes in the accounting rules governing therecognition of stock-based compensation expense. We measure compensationexpense for our employee stock plans under the intrinsic value method ofaccounting prescribed by Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees.” In addition, we provide pro formadisclosures of our operating results in our Notes to Consolidated FinancialStatements as if the fair value method of accounting had been applied inaccordance with SFAS No. 123, “Accounting for Stock-Based Compensation.” Had weaccounted for our compensation expense under the fair value method of accountingprescribed by SFAS 123, the charge would have been significant, totaling $5.6million, $6.7 million and $6.3 million during fiscal 2003, 2002 and 2001,respectively. Currently, the U. S. Congress, the Securities and ExchangeCommission and the Financial Accounting Standards Board are considering changesto accounting rules concerning the recognition of stock option compensationexpense. If one or more of these proposals are implemented, we and othercompanies may be required to measure compensation expense using the fair valuemethod, which would adversely affect our results of operations by reducing ourincome or increasing our losses by an amount equal to such stock optioncharges.

 

**We have a Limited Customer Base**

 

Four customers accountedfor 35%, 24%, 18%, and 11%, respectively of net sales in the three months endedApril 30, 2003.  Two customers accountedfor 40% and 22%, respectively, of net sales in the three months ended April 30,2002.  The Company expects that a small number of customers will accountfor a substantial portion of its net sales for the foreseeable future.  Furthermore, the majority of the Company’ssales was historically made, and is expected to continue to be made, on thebasis of purchase orders rather than pursuant to long-term purchaseagreements.  As a result, the Company’sbusiness, financial condition and results of operations could be materiallyadversely affected by the decision of a single customer to cease using theCompany’s products, or by a decline in the number of handheld systems sold by asingle customer.

 

**We May Lose Our Customer Base**

 

TheCompany’s products are designed to afford the handheld systems manufacturersignificant advantages with respect to product performance, power consumptionand size.  To the extent that otherfuture developments in components or subassemblies incorporate one or more ofthe advantages offered by the Company’s products, the market demand for theCompany’s products may be negatively impacted.

 

**We Face Intense Competition in Our Markets**

 

The market forapplications processors is intensely competitive and is characterized by rapidtechnological change, evolving industry standards and declining average sellingprices.  NeoMagic believes that theprincipal factors of competition in this market are imaging performance, price,features, power consumption, size and software support.  The ability of the Company to competesuccessfully in the applications processor market depends on a number of factorsincluding, success in designing and subcontracting the manufacture of newproducts that implement new technologies, product quality and reliability,price, ramp of production of the Company’s products for particular systemmanufacturers, customer demand and acceptance of more sophisticated multimediafunctionality on handheld systems, end-user acceptance of the systemmanufacturers’ products, market acceptance of competitors’ products and generaleconomic conditions.  The Company’sability to compete in the future will also depend on its ability to identifyand ensure compliance with evolving industry standards and market trends.  Unanticipated changes in market trends andindustry standards could render the Company’s products incompatible withproducts developed by major hardware manufacturers and software developers. Asa result, the Company could be required to invest significant time andresources to redesign its products or obtain license rights to

 

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technologies owned by third parties in order to ensurecompliance with relevant industry standards and market trends.  There can be no assurance that the Companywill be able to redesign its products or obtain the necessary third-partylicenses within the appropriate window of market demand.  If the Company’s products are not incompliance with prevailing market trends and industry standards for asignificant period of time, the Company could miss crucial OEM/ODM designcycles, which could result in a material adverse effect on the Company’s business,financial condition and results of operations.

 

NeoMagic competes with both domestic and internationalcompanies, some of which have substantially greater financial and otherresources than the Company with which to pursue engineering, manufacturing,marketing and distribution of their products. The Company’s principal competitors include Intel’s StrongARM and XScaleproduct lines, ST Microsystem’s Nomadik line, certain of Samsung’s S3C chipsand Texas Instruments’ OMAP product line, as well as a number of verticallyintegrated electronics firms who are developing their own solutions.  NeoMagic may also face increased competitionfrom new entrants into the handheld systems semiconductor market includingcompanies currently at developmental stages. NeoMagic has significant intellectual properties and historicallydemonstrated expertise in SOC technology. However, the inability of the Company to produce timely new products forits market could have a material adverse effect on the Company’s business, financialcondition and operating results.

 

Some of the Company’scurrent and potential competitors operate their own manufacturingfacilities.  Since the Company does notoperate its own manufacturing facility and may from time-to-time make bindingcommitments to purchase products, it may not be able to reduce its costs andcycle time or adjust its production to meet changing demand as rapidly ascompanies that operate their own facilities, which could have a materialadverse effect on the Company’s results of operations.

 

**Our Products May be Incompatible withEvolving Industry Standards and Market Trends**

 

The Company’s ability tocompete in the future will also depend on its ability to identify and ensurecompliance with evolving industry standards and market trends.  Unanticipated changes in market trends andindustry standards could render the Company’s products incompatible withproducts developed by major hardware manufacturers and software developers. Asa result, the Company could be required to invest significant time andresources to redesign its products or obtain license rights to technologiesowned by third parties in order to ensure compliance with relevant industrystandards and market trends.  There canbe no assurance that the Company will be able to redesign its products orobtain the necessary third-party licenses within the appropriate window ofmarket demand.  If the Company’sproducts are not in compliance with prevailing market trends and industry standardsfor a significant period of time, the Company could miss crucial OEM designcycles, which could result in a material adverse effect on the Company’sbusiness, financial condition and results of operations.

 

**We Depend on New Product Development toMeet Rapid Market and Technological Change**

 

The Company is now focused onproviding high-performance semiconductor solutions for sale to originalequipment manufacturers of handheld systems. New product planning is primarily focused on Integrated System-on-Chipsemiconductor products for handheld systems, and multimedia technologies forintegration into such products, such as MPEG-4 video compression, imageprocessing, graphics, and audio technologies. The Company’s future business, financial condition and results ofoperations will depend to a significant extent on its ability to develop newproducts that address these market opportunities. As a result, the Companybelieves that significant expenditures for research and development willcontinue to be required in the future.

 

The markets for handheld systemsare emerging opportunities, characterized by rapidly changing infrastructure,evolving industry standards and uncertain average selling prices.  The Company must anticipate the features andfunctionality that consumers and infrastructure providers will demand,

 

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incorporate those features and functionality intoproducts that meet the exacting design requirements of equipment manufacturers,price its products competitively and introduce the products to the market on atimely basis. The success of new product introductions is dependent on severalfactors, including proper new product definition, timely completion andintroduction of new product designs, the ability to create or acquire intellectualproperty, the ability of strategic manufacturing partners to effectively designand implement the manufacture of new products, quality of new products,differentiation of new products from those of the Company’s competitors andmarket acceptance of the Company’s and its customers’ products. There can be noassurance that the products the Company expects to introduce will incorporatethe features and functionality demanded by system manufacturers and consumers,will be successfully developed, or will be introduced within the appropriatewindow of market demand, nor can there be assurance that customers who utilizethe Company’s semiconductor products will achieve the levels of market successwith their own system products that they may project to the Company.

 

Because of the complexityof its products, the Company has experienced delays from time to time incompleting development and introduction of new products. In addition, theCompany is now beginning production and continuing the development of new productsin markets in which the Company has little history.  In the event that there are delays in ramping production ofcurrent products, or in the completion of development of future products,including the products currently under development for introduction over thenext 12 to 18 months, the Company’s potential future business, financialcondition, and results of operations will be materially adverselyaffected.  In addition, the timerequired for competitors to develop and introduce competing products may beshorter, manufacturing yields may be better, and production costs may be lowerthan those experienced by the Company.

 

**We Depend on Third-PartyManufacturers to Produce Our Products**

 

The Company’s products require wafers manufacturedwith state-of-the-art fabrication equipment and techniques. The Companycurrently utilizes several foundries for wafer fabrication. The Company expectsthat, for the foreseeable future, some of its products will be manufactured bya single source.  Since, in theCompany’s experience, the lead time needed to establish a strategicrelationship with a new wafer fabrication partner is at least 12 months, andthe estimated time for a foundry to switch to a new product line ranges fromfour to nine months, there may be no readily available alternative source ofsupply for specific products. A manufacturing disruption experienced by theCompany’s manufacturing partners, the failure of the Company’s manufacturingpartners to dedicate adequate resources to the production of the Company’sproducts, or the financial instability of the Company’s manufacturing partnerswould have a material adverse effect on the Company’s business, financialcondition and results of operations. Furthermore, in the event that the transition to the next generation ofmanufacturing technologies by the Company’s manufacturing partner isunsuccessful, the Company’s business, financial condition and results ofoperations would be materially and adversely affected.

 

There are many otherrisks associated with the Company’s dependence upon third-party manufacturers,including: reduced control over delivery schedules, quality, manufacturingyields and cost; the potential lack of adequate capacity during periods ofexcess demand; limited warranties on wafers supplied to the Company; andpotential misappropriation of NeoMagic’s intellectual property.  The Company is dependent on itsmanufacturing partners to produce wafers with acceptable quality andmanufacturing yields, deliver those wafers on a timely basis to the Company’sthird party assembly subcontractors and to allocate to the Company a portion oftheir manufacturing capacity sufficient to meet the Company’s needs.  Although the Company’s products are designedusing the process design rules of the particular manufacturer, there can be noassurance that the Company’s manufacturing partners will be able to achieve ormaintain acceptable yields or deliver sufficient quantities of wafers on atimely basis or at an acceptable cost. Additionally, there can be no assurance that the Company’s manufacturingpartners will continue to devote adequate resources to the production of theCompany’s products or continue to advance the process design technologies onwhich the manufacturing of the Company’s products are based.

 

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**We Rely on Third-Party Subcontractorsto Assemble and Test Our Products**

 

The Company’s products are assembled and tested bythird-party subcontractors. The Company does not have long-term agreements withany of these subcontractors. Such assembly and testing is conducted on apurchase order basis.  As a result ofits reliance on third-party subcontractors to assemble and test its products,the Company cannot directly control product delivery schedules, which couldlead to product shortages or quality assurance problems that could increase thecosts of manufacturing or assembly of the Company’s products.  Due to the amount of time normally requiredto qualify assembly and test subcontractors, product shipments could be delayedsignificantly if the Company were required to find alternativesubcontractors.  Any problems associatedwith the delivery, quality or cost of the assembly and test of the Company’sproducts could have a material adverse effect on the Company’s business,financial condition and results of operations.

 

**We May Encounter Inventory Excess or Shortage**

 

TheCompany has wafer supply relationships with several foundries to support theCompany’s product efforts.  Normally,the Company places binding purchase orders two to three months prior to wafershipment.  The Company orders wafers fordeliveries 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 forup to four months into the future. If the Company does not have sufficientdemand for its products and cannot cancel its current and future commitmentswithout material impact, the Company may experience excess inventory, whichwill result in a write-off affecting gross margin and results ofoperations.  If the Company cancels apurchase order, it must pay cancellation penalties based on the status of workin process or the proximity of the cancellation to the delivery date.  The Company must place purchase orders forwafers before it receives purchase orders from its own customers.  This limits the Company’s ability to reactto fluctuations in demand for its products, which can be unexpected anddramatic, and from time-to-time will cause the Company to have an excess orshortage of wafers for a particular product. As a result of the long lead-time for manufacturing wafers and theincrease in “just in time” ordering by manufacturers, semiconductor companiessuch 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 havea material adverse effect on the Company’s financial condition and results of operations.Conversely, failure to order sufficient wafers would cause the Company to missrevenue opportunities and, if significant, could impact sales by the Company’scustomers, which could adversely affect the Company’s customer relationshipsand thereby materially adversely affect the Company’s business, financialcondition and results of operations.

 

**Our Manufacturing Yields MayFluctuate**

 

The fabrication ofsemiconductors is an extremely complex process, which typically includeshundreds of process steps.  Minutelevels of contaminants in the manufacturing environment, defects in masks usedto print circuits on a wafer, utilization of equipment with variations andnumerous other factors can cause a substantial percentage of wafers to berejected or a significant number of die on each wafer to be nonfunctional.  Many of these problems are difficult todiagnose and time consuming or expensive to remedy.  As a result, semiconductor companies often experience problems inachieving acceptable wafer manufacturing yields, which are represented by thenumber of good die as a proportion of the total number of die on any particularwafer.  The Company often purchaseswafers, not die, and pays an agreed upon price for wafers meeting certainacceptance criteria.  Accordingly, theCompany bears the risk of the yield of good die from wafers purchased meetingthe acceptance criteria. The Company experienced such yield problems in fiscal2000, which materially adversely affected the Company’s net sales, grossmargins and results of operations in fiscal 2000 and 2001.

 

Semiconductor manufacturing yields are a function ofboth product design, which is developed largely by the Company, and processtechnology, which is typically proprietary to the manufacturer.  Historically, the Company has experiencedlower yields on new products.  Since lowyields may result from either design or process technology failures, yieldproblems may not be effectively determined or resolved until an actual productexists that can be analyzed and tested to identify process sensitivitiesrelating to the

 

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design rules that are used.  Asa result, yield problems may not be identified until well into the productionprocess, and resolution of yield problems would require cooperation by andcommunication between the Company and the manufacturer.  This risk is compounded by the offshorelocation of the Company’s manufacturers, increasing the effort and time requiredidentifying, communicating and resolving manufacturing yield problems.  As the Company’s relationships with newmanufacturing partners develop, yields could be adversely affected due todifficulties associated with adopting the Company’s technology and productdesign to the proprietary process technology and design rules of eachmanufacturer.  Any significant decreasein manufacturing yields could result in an increase in the Company’s per unitproduct cost and could force the Company to allocate its available productsupply among its customers, potentially adversely impacting customerrelationships as well as revenues and gross margins.  There can be no assurance that the Company’s manufacturers willachieve or maintain acceptable manufacturing yields in the future.

 

**Uncertaintyand Litigation Risk Associated with Patents and Protection of ProprietaryRights**

 

The Company relies inpart on patents to protect its intellectual property. As of April 30, 2003, theCompany has been issued 66 patents, each covering certain aspects of the designand architecture of the Company’s products. Additionally, the Company has numerous patent applications pending.  There can be no assurance that the Company’spending patent applications, or any future applications will be approved.  Further, there can be no assurance that anyissued patents will provide the Company with significant intellectual propertyprotection, 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 abilityto do business.  In addition, there canbe no assurance that others will not independently develop similar products,duplicate the Company’s products or design around any patents that may beissued to the Company.

 

The Company also relieson a combination of mask work protection, trademarks, copyrights, trade secretlaws, employee and third-party nondisclosure agreements and licensingarrangements to protect its intellectual property.  Despite these efforts, there can be no assurance that others willnot independently develop substantially equivalent intellectual property orotherwise gain access to the Company’s trade secrets or intellectual property,or disclose such intellectual property or trade secrets, or that the Companycan meaningfully protect its intellectual property.  A failure by the Company to meaningfully protect its intellectualproperty could have a material adverse effect on the Company’s business,financial condition and results of operations.

 

As a general matter, thesemiconductor industry is characterized by substantial litigation, regardingpatent and other intellectual property rights. In December 1998, the Company filed a lawsuit in the United StatesDistrict Court for the District of Delaware seeking damages and an injunction againstTrident Microsystems, Inc.  The suitalleges that Trident’s embedded DRAM graphics accelerators infringe certainpatents held by the Company.  In January1999, Trident filed a counter claim against the Company alleging an attemptedmonopolization in violation of antitrust laws, arising from NeoMagic’s filingof the patent infringement action against Trident. The Court ruled that therewas no infringement by Trident. The Company filed an appeal in the UnitedStates Court of Appeals, for the Federal Circuit.  On April 17, 2002, the United States Court of Appeals for theFederal Circuit affirmed the lower court’s judgment of non-infringement on onepatent and vacated the court’s judgment of non-infringement on another patent,thereby remanding it to the lower court for further proceedings. In November2002, the lower court heard oral arguments on cross-motions for summaryjudgment on the matter.  In May 2003,the lower court ruled in favor of Trident. NeoMagic filed a notice ofre-consideration with the court. Management believes the Company has validdefenses against Trident’s claims. There can be no assurance as to the resultsof the patent infringement suit and the counter-suit for antitrust filed byTrident.

 

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 theCompany’s management and technical personnel from productive tasks, which couldhave a material adverse effect on the Company’s business, financial conditionand results of operations.  There can beno assurance that current or future infringement claims by third parties orclaims for indemnification by other customers or end users of the Company’sproducts resulting from infringement claims will not be asserted in the futureor that such assertions, if proven to be true, will not materially adverselyaffect the Company’s business,

 

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financial condition andresults of operations.  In the event ofany adverse ruling in any such matter, the Company could be required to paysubstantial damages, which could include treble damages, cease themanufacturing, use and sale of infringing products, discontinue the use ofcertain processes, or to obtain a license under the intellectual propertyrights of the third party claiming infringement.  There can be no assurance, however, that a license would beavailable on reasonable terms or at all. Any limitations on the Company’s ability to market its products, ordelays and costs associated with redesigning its products or payments oflicense fees to third parties, or any failure by the Company to develop orlicense a substitute technology on commercially reasonable terms could have amaterial adverse effect on the Company’s business, financial condition andresults of operations.

 

**We Depend on International Sales andSuppliers**

 

Export sales havebeen a critical part of the Company’s business.  Sales to customers located outside the United States (includingsales to the foreign operations of customers with headquarters in the UnitedStates and foreign system manufacturers that sell to United States-based OEMs)accounted for 91% and 82% of net sales in the three months ended April 30, 2003and 2002, respectively.  The Companyexpects that net sales derived from international sales will continue torepresent a significant portion of its total net sales.  Letters of credit issued by customers havesupported a portion of the Company’s international sales.  To date, the Company’s international saleshave been denominated in United States dollars.  Increases in the value of the U.S. dollar relative to the localcurrency of the Company’s customers could make the Company’s productsrelatively more expensive than competitors’ products sold in the customer’slocal currency.

 

Internationalmanufacturers have produced, and are expected to continue to produce for theforeseeable future, all of the Company’s wafers.  In addition, many of the assembly and test services used by theCompany are procured from international sources.  Wafers are priced in U.S. dollars under the Company’s purchaseorders with its manufacturing suppliers.

 

Internationalsales and manufacturing operations are subject to a variety of risks, includingfluctuations in currency exchange rates, tariffs, import restrictions and othertrade barriers, unexpected changes in regulatory requirements, longer accountsreceivable payment cycles, potentially adverse tax consequences and exportlicense requirements.  In addition, theCompany is subject to the risks inherent in conducting business internationallyincluding foreign government regulation, political and economic instability,and unexpected changes in diplomatic and trade relationships, and thepossibility of reduced sales to our customers or interruption to ourmanufacturing processes, in Asia that may arise from the current Severe AcuteRespiratory Syndrome (“SARS”) epidemic. Moreover, the laws of certain foreign countries in which the Company’sproducts may be developed, manufactured or sold, may not protect the Company’sintellectual property rights to the same extent as do the laws of the UnitedStates, thus increasing the possibility of piracy of the Company’s products andintellectual property.  There can be noassurance that one or more of these risks will not have a material adverseeffect on the Company’s business, financial condition and results ofoperations.

 

**We May Need Additional Capital**

 

The Companyrequires substantial working capital to fund its business, particularly tofinance inventories and accounts receivable and for capital expenditures.  The Company believes that its existingcapital resources will be sufficient to meet the Company’s capital requirementsthrough the next 12 months, although the Company could be required, or couldelect, to seek to raise additional capital in the future.  The Company’s future capital requirementswill depend on many factors, including the rate of net sales growth, timing andextent of spending to support research and development programs in new andexisting areas of technology, expansion of sales and marketing supportactivities, and timing and customer acceptance of new products. The Company mayraise additional equity or debt financing in the future.  There can be no assurance that additionalequity or debt financing, if required, will be available on acceptable terms orat all.

 

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**We are Dependent on QualifiedPersonnel**

 

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

 

**Our Stock Price May Be Volatile**

 

The market priceof the Company’s Common Stock, like that of other semiconductor companies, hasbeen and is likely to continue to be, highly volatile.  The market has from time-to-time experiencedsignificant price and volume fluctuations that may be unrelated to theoperating performance of particular companies. The market price of the Company’s Common Stock could be subject tosignificant fluctuations in response to various factors, includingquarter-to-quarter variations in the Company’s anticipated or actual operatingresults, announcements of new products, technological innovations or setbacksby the Company or its competitors, general conditions in the semiconductor andPC industries, unanticipated shifts in the handheld systems market or industrystandards, loss of key customers, changes in DRAM pricing, litigationcommencement or developments, changes in or the failure by the Company to meetestimates of the Company’s performance by securities analysts, marketconditions for high technology stocks in general, and other events orfactors.  In future quarters, theCompany’s operating results may be below the expectations of public marketanalysts or investors.  Since theCompany’s decline in revenues, gross margins and operating results, the marketprice of the Common Stock has been and is expected to be for some time in thefuture, materially adversely affected.

 

There may not bean active, liquid trading market for our common stock. For several weeks inOctober 2002, our common stock traded below the $1 minimum bid pricerequirement of the NASDAQ National Market. If we fail to comply with thecontinued listing requirements of the NASDAQ National Market, including theminimum bid price per share requirement, we may be delisted from trading onsuch market, and thereafter trading in our common stock, if any, would beconducted through the NASDAQ Small Cap Market, the over-the-counter market oron the Electronic Bulletin Board of the National Association of SecuritiesDealers, Inc. There is no guarantee that an active trading market for ourcommon stock will be maintained on the NASDAQ National Market. You may not beable to sell your shares quickly, at the market price or at all if trading inour stock is not active.

 

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**Item 3****.   Quantitative and Qualitative Disclosuresabout Market Risk**

 

# **InterestRate Risk**

 

The Company’s cashequivalents, short-term investments, and restricted cash are exposed tofinancial market risk due to fluctuations in interest rates, which may affectour interest income.  As of April 30,2003, the Company’s cash equivalents, short-term investments, and restrictedcash earned interest at an average rate of 1.5%.  Due to the short-term nature of the Company’s investmentportfolio, operating results or cash flows are vulnerable to sudden changes inmarket interest rates.  Assuming adecline of 10% in the market interest rates at April 30, 2003, with consistentcash balances, interest income would be adversely affected by approximately$22,000 per quarter.  The Company doesnot use its investment portfolio for trading or other speculative purposes.

 

# **ForeignCurrency Exchange Risk**

 

Currently all ofthe Company’s sales and substantially all of its expenses are denominated inU.S. dollars.  As a result, the Companyhas relatively little exposure to foreign currency exchange rate risk.  The Company does not currently enter into forwardexchange contracts to hedge exposures denominated in foreign currencies or anyother derivative financial instruments for trading or speculativepurposes.  However, in the eventexposure to foreign currency risk increases, the Company may choose to hedgethose exposures.

 

**Item 4****.   Disclosure Controls and Procedures**

 

**(a)  Evaluation ofDisclosure Controls and Procedures**

 

Based on their evaluation as of a date within 90 days prior to the filingdate of this Quarterly Report on Form 10-Q, the Company’s principal executiveofficer and principal financial officer have concluded that the Company’sdisclosure controls and procedures (as defined in Rules 13a-14(c) under theSecurities Exchange Act of 1934 (“Exchange Act”) are effective to ensure thatinformation required to be disclosed by the Company in reports that it files orsubmits under the Exchange Act is recorded, processed, summarized and reportedwithin the time periods specified in SEC rules and forms.

 

**(b) Changes in Internal Controls**

 

There were no significant changes in the Company’s internal controls orin other factors that could significantly affect these controls subsequent tothe date of their evaluation. There were no significant deficiencies ormaterial weaknesses, and therefore there were no corrective actions taken.However, the design of any system of controls is based in part upon certainassumptions about the likelihood of future events and there is no certaintythat any design will succeed in achieving its stated goal under all potentialfuture considerations, regardless of how remote.

 

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**Part II****.  Other Information**

 

***Item 1***.          Legal Proceedings

 

As a general matter, thesemiconductor industry is characterized by substantial litigation, regardingpatent and other intellectual property rights. In December 1998, the Company filed a lawsuit in the United StatesDistrict Court for the District of Delaware seeking damages and an injunctionagainst Trident Microsystems, Inc.  Thesuit alleges that Trident’s embedded DRAM graphics accelerators infringecertain patents held by the Company.  InJanuary 1999, Trident filed a counter claim against the Company alleging anattempted monopolization in violation of antitrust laws, arising from NeoMagic’sfiling of the patent infringement action against Trident. The Court ruled thatthere was no infringement by Trident. The Company filed an appeal in the UnitedStates Court of Appeals, for the Federal Circuit.  On April 17, 2002, the United States Court of Appeals for theFederal Circuit affirmed the lower court’s judgment of non-infringement on onepatent 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 onthe matter.  In May 2003, the lowercourt ruled in favor of Trident. NeoMagic filed a notice of re-considerationwith the court. Management believes the Company has valid defenses againstTrident’s claims. There can be no assurance as to the results of the patentinfringement suit and the counter-suit for antitrust filed by Trident.

 

***Item 2.***          Changes in Securities

None.

 

***Item 3.***          Defaults Upon Senior Securities

None.

 

***Item 4.***          Submission of Matters to a Vote of SecurityHolders

None.

 

***Item 5.***          Other Information

Notapplicable.

 

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

(a)   Exhibits

Theexhibits listed in the accompanying Exhibit Index are filed or incorporated byreference as part of this Report on Form 10Q.

 

(b)   Reports on Form 8-K

The Company did not fileany reports on Form 8-K during the three months ended April 30, 2003.

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|   | NEOMAGIC  CORPORATION                                                  |
|--------|------------------------------------------------------------------------|
|   | (Registrant)                                                           |
|   |                                                                   |
|   |                                                                   | /s/ Stephen T.  Lanza |   |
|   | **STEPHEN T. LANZA**                                                   |
|   | Chief Financial  officer  (Principal Financial and Accounting Officer) |
|   |                                                                   |
|   | June 11, 2003                                                          |

 

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CERTIFICATIONS

 

I, Prakash Agarwal, ChiefExecutive Officer of NeoMagic Corporation, certify that:

 

1.             I have reviewed this quarterly report on Form 10-Q ofNeoMagic Corporation;

 

2.             Based on my knowledge, this quarterly report does notcontain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this quarterly report;

 

3.             Based on my knowledge, the financial statements, andother financial information included in this quarterly report, fairly presentin all material respects the financial condition, results of operations andcash flows of the registrant as of, and for, the periods presented in thisquarterly report;

 

4.             The registrant’s other certifying officers and I areresponsible for establishing and maintaining disclosure controls and procedures(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and wehave:

 

a)   designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

 

b)  evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c)  presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.             The registrant’s other certifying officers and I havedisclosed, based on our most recent evaluation, to the registrant’s auditorsand the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

 

a)   all significant deficiencies in the designor operation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b)   any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

6.             The registrant’s other certifying officers and I have indicatedin this quarterly report whether or not there were significant changes ininternal controls or in other factors that could significantly affect internalcontrols subsequent to the date of our most recent evaluation, including anycorrective actions with regard to significant deficiencies and materialweaknesses.

 

 
| Date:  June 11, 2003 | /s/ Prakash Agarwal     |
|---------------------------|-------------------------|
|                      | Prakash Agarwal         |
|                      | Chief Executive Officer |

 

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I, Stephen T. Lanza,Chief Financial Officer of NeoMagic Corporation, certify that:

 

1.             I have reviewed this quarterly report on Form 10-Q ofNeoMagic Corporation;

 

2.             Based on my knowledge, this quarterly report does notcontain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this quarterly report;

 

3.             Based on my knowledge, the financial statements, andother financial information included in this quarterly report, fairly presentin all material respects the financial condition, results of operations andcash flows of the registrant as of, and for, the periods presented in thisquarterly report;

 

4.             The registrant’s other certifying officers and I areresponsible for establishing and maintaining disclosure controls and procedures(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and wehave:

 

a)   designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

 

b)  evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c)  presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.             The registrant’s other certifying officers and I havedisclosed, based on our most recent evaluation, to the registrant’s auditorsand the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

 

a)   all significant deficiencies in the designor operation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b)   any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

6.             The registrant’s other certifying officers and I haveindicated in this quarterly report whether or not there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 

 
| Date:  June 11, 2003 | /s/ Stephen T. Lanza    |
|---------------------------|-------------------------|
|                      | Stephen T. Lanza        |
|                      | Chief Financial Officer |

 

30

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**EXHIBITINDEX**

 

The following Exhibitsare 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.                                                                                                                                                                                        |
| 3.3        |   | (9)    |   | Certificate of  Designation of Rights, Preferences and Privileges of Series A Participating  Preferred Stock.                                                                                  |
| 4.1        |   | (10)   |   | Preferred Stock Rights  Agreement filed December 23, 2002, between the Company and EquiServe Trust  Company, N.A.                                                                              |
| 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.                              |
| 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.                           |
| 99.1       |   |   |   | Certification by  Prakash Agarwal and Stephen T. Lanza pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                              |

 

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(1)          Incorporated byreference to the Company’s registration statement on Form S-1, registration no.333-20031.

(2)   Incorporated by reference to the Company’sForm 10-Q for the period ended October 31, 1997.

(3)   Incorporated by reference to the Company’sForm 10-K for the year ended January 31, 1998.

 

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(4)   Incorporated by reference to the Company’sForm 10-K for the year ended January 31, 1999.

(5)   Incorporated by reference to the Company’sForm 10-K for the year ended January 31, 2001.

(6)   Incorporated by reference to the Company’sForm 10-K for the year ended January 31, 2002.

(7)   Incorporated by reference to the Company’sForm 10-Q for the quarter ended July 31, 2002.

(8)   Incorporated by reference to the Company’sForm 10-Q for the quarter ended October 31, 2002.

(9)   Incorporated by reference to the Company’sForm 8-A filed December 23, 2002.

(10)    Incorporated by reference tothe Company’s Form 8-K filed December 23, 2002.

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

 

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