**UNITED STATES SECURITIES ANDEXCHANGE COMMISSION**

**Washington, D. C. 20549**

 

**Form 10-Q**

 

**(MarkOne)**

 

| **ý**                                                                                                                                                                                                                                              |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE  SECURITIES EXCHANGE ACT OF 1934**  |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                    |   |                                                                                           |
| **For  the quarter ended July 31, 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                   ** |

 

**Commissionfile number 000-22009**

 

**NEOMAGIC CORPORATION**

(Exactname 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’stelephone 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 at July31, 2003 was 30,611,371

 

 

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**INDEX**

 
| PART I.   CONSOLIDATED CONDENSED FINANCIAL  INFORMATION |
|-------------------------------------------------------------------|
|                                                              |   |
| Item 1.                                                           | Unaudited Consolidated  Condensed Financial Statements: |
|                                                              |   |
|                                                              | Consolidated  Condensed Statements of Operations  Three and Six months ended July 31, 2003 and 2002 |
|                                                              |   |
|                                                              | Consolidated Condensed  Balance Sheets  July 31, 2003 and January 31, 2003 |
|                                                              |   |
|                                                              | Consolidated  Condensed Statements of Cash Flows  Six months ended July 31, 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                                                        |

 

2

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Part I.  Financial Information

Item 1.  Financial Statements

 

**NEOMAGICCORPORATION**

**CONSOLIDATEDCONDENSED STATEMENTS OF OPERATIONS**

(In thousands, except per share data)

(Unaudited)

 
|                                                              |   | **Three  Months Ended** |   | **Six Months  Ended** |   |
|-------------------------------------------------------------------|--------|-------------------------|--------|-----------------------|--------|
|                                                              |   | **July 31,  2003**      |   | **July 31,  2002**    |   | **July 31,  2003** |   | **July 31,  2002** |   |
| Net  sales                                                        |   | $                       | 222    |                  | $      | 494 |   | $ | 846 |   | $ | 856 |   |
|                                                              |   |                    |   |                  |   |   |   |   |   |
| Cost  of sales (1)                                                |   | 419                     |   | 720                   |   | 1,007 |   | 1,305 |   |
|                                                              |   |                    |   |                  |   |   |   |   |   |
| Gross  loss                                                       |   | (197                    | )      | (226                  | )      | (161 | ) | (449 | ) |
|                                                              |   |                    |   |                  |   |   |   |   |   |
| Operating  expenses:                                              |   |                    |   |                  |   |   |   |   |   |
| Research  and development (2)                                     |   | 4,490                   |   | 5,495                 |   | 9,509 |   | 12,469 |   |
| Sales,  general and administrative (3)                            |   | 1,767                   |   | 2,341                 |   | 3,544 |   | 5,709 |   |
| Special  charges                                                  |   | —                  |   | 2,200                 |   | — |   | 3,600 |   |
| Total  operating expenses                                         |   | 6,257                   |   | 10,036                |   | 13,053 |   | 21,778 |   |
|                                                              |   |                    |   |                  |   |   |   |   |   |
| Loss  from operations                                             |   | (6,454                  | )      | (10,262               | )      | (13,214 | ) | (22,227 | ) |
|                                                              |   |                    |   |                  |   |   |   |   |   |
| Other  income (expense), net:                                     |   |                    |   |                  |   |   |   |   |   |
| Income,  net of expenses, from the sale of DVD assets             |   | —                  |   | —                |   | — |   | 1,580 |   |
| Interest  income and other income                                 |   | 168                     |   | 672                   |   | 379 |   | 1,280 |   |
| Interest  expense                                                 |   | (73                     | )      | —                |   | (160 | ) | — |   |
|                                                              |   |                    |   |                  |   |   |   |   |   |
| Loss  before income taxes                                         |   | (6,359                  | )      | (9,590                | )      | (12,995 | ) | (19,367 | ) |
|                                                              |   |                    |   |                  |   |   |   |   |   |
| Income  tax expense (benefit)                                     |   | 6                       |   | (339                  | )      | 6 |   | (6,339 | ) |
|                                                              |   |                    |   |                  |   |   |   |   |   |
| Net  loss                                                         |   | $                       | (6,365 | )                     | $      | (9,251 | ) | $ | (13,001 | ) | $ | (13,028 | ) |
|                                                              |   |                    |   |                  |   |   |   |   |   |
| Basic  and diluted net loss per share                             |   | $                       | (0.21  | )                     | $      | (0.33 | ) | $ | (0.43 | ) | $ | (0.46 | ) |
|                                                              |   |                    |   |                  |   |   |   |   |   |
| Weighted  average common shares outstanding for basic and diluted |   | 30,457                  |   | 28,167                |   | 30,367 |   | 28,102 |   |

 

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(1)               Includes $9 and $0in amortization of deferred stock compensation for the three months ended July31, 2003 and 2002, respectively, and $15 and $0 for the six months ended July31, 2003 and 2002, respectively.

 

(2)               Includes $90 and$137 in amortization of deferred stock compensation for the three months endedJuly 31, 2003 and 2002, respectively, and $157 and $762 for the six monthsended July 31, 2003 and 2002, respectively.

 

(3)               Includes $52 and$150 in amortization of deferred stock compensation for the three months endedJuly 31, 2003 and 2002, respectively, and $87 and $763 for the six months endedJuly 31, 2003 and 2002, respectively.

 

See accompanyingnotes to consolidated condensed financial statements.

 

3

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**NEOMAGICCORPORATION**

**CONSOLIDATEDCONDENSED BALANCE SHEETS**

(In thousands)

 
|                                             |   | **July 31,  2003** |   | **January  31,  2003 (1)** |   |
|--------------------------------------------------|--------|--------------------|--------|----------------------------|--------|
|                                             |   | **(Unaudited)**    |   |                       |   |
| **ASSETS**                                       |   |               |   |                       |   |
|                                             |   |               |   |                       |   |
| Current assets:                                  |   |               |   |                       |   |
| Cash and cash equivalents                        |   | $                  | 12,599 |                       | $      | 37,428 |   |
| Short-term investments                           |   | 38,680             |   | 29,657                     |   |
| Accounts  receivable, net                        |   | 164                |   | 118                        |   |
| Inventory                                        |   | 665                |   | 535                        |   |
| Employee  note receivable                        |   | —             |   | 1,200                      |   |
| Other  current assets                            |   | 1,064              |   | 1,210                      |   |
| Total  current assets                            |   | 53,172             |   | 70,148                     |   |
|                                             |   |               |   |                       |   |
| Property,  plant and equipment, net              |   | 4,669              |   | 5,840                      |   |
| Long-term  investments                           |   | 2,168              |   | —                     |   |
| Employee  notes receivable                       |   | 100                |   | 100                        |   |
| Intangibles,  net                                |   | 4,014              |   | 4,349                      |   |
| Other  assets                                    |   | 425                |   | 511                        |   |
|                                             |   |               |   |                       |   |
| Total  assets                                    |   | $                  | 64,548 |                       | $      | 80,948 |   |
|                                             |   |               |   |                       |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**   |   |               |   |                       |   |
|                                             |   |               |   |                       |   |
| Current  liabilities:                            |   |               |   |                       |   |
| Accounts  payable                                |   | $                  | 2,014  |                       | $      | 2,864 |   |
| Compensation  and related benefits               |   | 1,188              |   | 1,393                      |   |
| Income  taxes payable                            |   | 3,650              |   | 3,633                      |   |
| Current  portion of capital lease obligations    |   | 1,649              |   | 1,363                      |   |
| Other  accruals                                  |   | 184                |   | 1,287                      |   |
| Total  current liabilities                       |   | 8,685              |   | 10,540                     |   |
|                                             |   |               |   |                       |   |
| Capital  lease obligations                       |   | 1,603              |   | 2,521                      |   |
|                                             |   |               |   |                       |   |
| Commitments  and contingencies                   |   |               |   |                       |   |
|                                             |   |               |   |                       |   |
| Stockholders’  equity:                      |   |               |   |                       |   |
| Common  stock                                    |   | 31                 |   | 30                         |   |
| Additional  paid-in-capital                      |   | 88,979             |   | 89,237                     |   |
| Deferred  compensation                           |   | (356               | )      | (4                         | )      |
| Accumulated  other comprehensive income (loss)   |   | (8                 | )      | 9                          |   |
| Accumulated  deficit                             |   | (34,386            | )      | (21,385                    | )      |
| Total  stockholders’ equity                 |   | 54,260             |   | 67,887                     |   |
|                                             |   |               |   |                       |   |
| Total  liabilities and stockholders’ equity |   | $                  | 64,548 |                       | $      | 80,948 |   |

 

----

(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.

 

See accompanying notes toconsolidated condensed financial statements.

 

4

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**NEOMAGICCORPORATION**

**CONSOLIDATEDCONDENSED STATEMENTS OF CASH FLOWS**

(In thousands)

(Unaudited)

 
|                                                                          |   | **Six Months  Ended** |       |
|-------------------------------------------------------------------------------|--------|-----------------------|------------|
|                                                                          |   | **July 31,  2003**    |       | **July 31,  2002** |   |
| **Operating  activities:**                                                    |   |                  | ** ** |   | ** ** |
| Net loss                                                                      |   | $                     | (13,001    | ) | $ | (13,028 | ) |
| Adjustments  to reconcile net loss to net cash used for operating activities: |   |                  |       |   |   |
| Depreciation  and amortization                                                |   | 1,752                 |       | 1,544 |   |
| Loss  on disposal of property, plant and equipment                            |   | 3                     |       | — |   |
| Loss  on restructuring of wafer purchase agreement                            |   | —                |       | 3,600 |   |
| Income,  from the sale of DVD assets                                          |   | —                |       | (1,580 | ) |
| Amortization  of deferred compensation                                        |   | 260                   |       | 1,525 |   |
| Changes  in operating assets and liabilities:                                 |   |                  |       |   |   |
| Accounts  receivable                                                          |   | (46                   | )          | (172 | ) |
| Inventory                                                                     |   | (130                  | )          | (176 | ) |
| Income  tax receivable                                                        |   | —                |       | (6,273 | ) |
| Other  current assets                                                         |   | 146                   |       | 453 |   |
| Restricted  cash                                                              |   | —                |       | 15,000 |   |
| Other  assets                                                                 |   | 86                    |       | 47 |   |
| Accounts  payable                                                             |   | (850                  | )          | 234 |   |
| Compensation  and related benefits                                            |   | (205                  | )          | 476 |   |
| Income  taxes payable                                                         |   | 17                    |       | (409 | ) |
| Tax  benefit from employee options                                            |   | 86                    |       | — |   |
| Other  accruals                                                               |   | (1,103                | )          | (514 | ) |
| Net  cash provided by (used in) operating activities                          |   | (12,985               | )          | 727 |   |
|                                                                          |   |                  |       |   |   |
| **Investing  activities:**                                                    |   |                  | ** ** |   | ** ** |
| Net  proceeds from the sale of DVD assets                                     |   | —                |       | 1,580 |   |
| Purchases  of property, plant, equipment and intangibles                      |   | (249                  | )          | (764 | ) |
| Purchases  of short-term investments                                          |   | (38,114               | )          | (25,987 | ) |
| Maturities  of short-term investments                                         |   | 26,906                |       | 32,350 |   |
| Net  cash provided by (used in) investing activities                          |   | (11,457               | )          | 7,179 |   |
|                                                                          |   |                  |       |   |   |
| **Financing  activities:**                                                    |   |                  | ** ** |   | ** ** |
| Payments  on capital lease obligations                                        |   | (632                  | )          | — |   |
| Net  proceeds from issuance of common stock                                   |   | 245                   |       | 488 |   |
| Net  cash provided by (used in) financing activities                          |   | (387                  | )          | 488 |   |
|                                                                          |   |                  |       |   |   |
| Net  increase (decrease) in cash and cash equivalents                         |   | (24,829               | )          | 8,394 |   |
| Cash  and cash equivalents at beginning of period                             |   | 37,428                |       | 38,996 |   |
| Cash  and cash equivalents at end of period                                   |   | $                     | 12,599     |   | $ | 47,390 |   |
| Supplemental  schedules of cash flow information:                             |   |                  |       |   |   |
| Cash  paid during the period for:                                             |   |                  |       |   |   |
| Interest                                                                      |   | $                     | 152        |   | $ | — |   |
| Taxes                                                                         |   | $                     | 46         |   | $ | 417 |   |

 

See accompanying notes to consolidated condensedfinancial statements.

 

5

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**NEOMAGICCORPORATION**

**NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIALSTATEMENTS**

 

**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”). All inter-company accounts and transactions havebeen eliminated. Certain information and footnote disclosures, normallyincluded in financial statements prepared in accordance with generally acceptedaccounting principles, have been condensed or omitted pursuant to such rulesand regulations.  In the opinion of theCompany, the financial statements reflect all adjustments, consisting only ofnormal recurring adjustments, necessary for a fair presentation of thefinancial position at July 31, 2003, the operating results for the three andsix months ended July 31, 2003 and 2002, and the cash flows for the six monthsended July 31, 2003 and 2002.  Thesefinancial statements and notes should be read in conjunction with the Company’saudited financial statements and notes thereto for the year ended January 31,2003, included in the Company’s Form 10-K filed with the Securities andExchange Commission.

 

The results of operationsfor the three and six months ended July 31, 2003 are not necessarily indicativeof the results that may be expected for the year ending January 31, 2004.

 

The second fiscalquarters of 2004 and 2003 ended on July 27, 2003 and July 28, 2002, respectively.  For ease of presentation, the accompanyingfinancial statements have been shown as ending on the last day of the calendarmonth of July.

 

**2.**                   **Recent Accounting Pronouncements**

 

In November of 2002, theEITF reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF Issue No.00-21 provides guidance on how to account for arrangements that involve thedelivery or performance of multiple products, services and/or rights to useassets.  The provisions of EITF IssueNo. 00-21 will apply to revenue arrangements entered into in fiscal periodsbeginning after June 15, 2003.  TheCompany is currently evaluating the effect that the adoption of EITF Issue No.00-21 will have on its results of operations and financial condition.

 

In January of 2003, theFASB issued FIN No. 46,  “Consolidationof Variable Interest Entities.” FIN No. 46 requires a variable interest entityto be consolidated by a company if that company is subject to a majority of therisk of loss from the variable interest entity’s activities or entitled toreceive a majority of the entity’s residual returns or both. The consolidationrequirements of FIN No. 46 apply immediately to variable interest entitiescreated after January 31, 2003. The consolidation requirements apply to olderentities in the first fiscal year or interim period beginning after June 15,2003. The Company has not yet determined what effect, if any, the adoption ofFIN No. 46 will have on the Company’s financial position or results of operations.

 

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

 

On December 31, 2002, theFASB issued Statement of Financial Accounting Standards No. 148, “Accountingfor Stock-Based Compensation – Transition and Disclosure” (SFAS 148).  SFAS 148 amends FASB Statement No. 123, “Accountingfor Stock-Based Compensation,” to provide alternative methods of transition tothe fair value method of accounting for stock-based employee compensation.  In addition, SFAS 148 amends the disclosureprovisions of Statement 123 to require disclosure in the summary of

 

6

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significant accountingpolicies of the effects of an entity’s accounting policy with respect tostock-based employee compensation on reported net income and earnings per sharein annual and interim financial statements. SFAS 148 is effective for fiscal years ending after December 15, 2002,with earlier application permitted.

 

At July 31, 2003, theCompany had several stock-based employee compensation plans, including stockoption plans and an employee stock purchase plan. The Company accounts forthese plans under the intrinsic value method. The following table illustratesthe effect on net loss and earnings per share if the Company had applied thefair value recognition method:

 
|                                                                                                                             |   | **Three Months  Ended  July 31,** |   | **Six Months  Ended  July 31,** |   |
|----------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|---------------------------------|--------|
| **(in thousands, except per share amounts)**                                                                                     |   | **2003**                          |   | **2002**                        |   | **2003** |   | **2002** |   |
| Net  loss, as reported                                                                                                           |   | $                                 | (6,365 | )                               | $      | (9,251 | ) | $ | (13,001 | ) | $ | (13,028 | ) |
| Add:  Stock-based employee compensation expense included in reported net loss, net  of related tax effects                       |   | 151                               |   | 287                             |   | 259 |   | 1,525 |   |
| Less:  Total stock-based compensation expense determined under the fair value method  for all awards, net of related tax effects |   | (741                              | )      | (1,381                          | )      | (1,512 | ) | (3,233 | ) |
| Pro  forma net loss                                                                                                              |   | (6,955                            | )      | (10,345                         | )      | (14,254 | ) | (14,736 | ) |
| Reported  basic and diluted loss per share                                                                                       |   | $                                 | (0.21  | )                               | $      | (0.33 | ) | $ | (0.43 | ) | $ | (0.46 | ) |
| Pro  forma basic and diluted loss per share                                                                                      |   | $                                 | (0.23  | )                               | $      | (0.37 | ) | $ | (0.47 | ) | $ | (0.52 | ) |

 

In the three and sixmonths ended July 31, 2003 and 2002, respectively, the fair value of eachoption grant was estimated on the date of the grant using the Black-Scholesoption-pricing model using a dividend yield of 0% and the following additionalweighted-average assumptions:

 
|                              |   | **Option Plans**                |   | **Stock Purchase Plan**        |   |
|-----------------------------------|--------|---------------------------------|--------|--------------------------------|--------|
|                              |   | **Three Month Ended  July 31,** |   | **Six Months Ended  July 31,** |   | **Three Months Ended  July 31,** |   | **Six Months Ended  July 31,** |   |
|                              |   | **2003**                        |   | **2002**                       |   | **2003** |   | **2002** |   | **2003** |   | **2002** |   | **2003** |   | **2002** |   |
| Risk-free  interest rates         |   | 2.9                             | %      | 3.3                            | %      | 1.8 | % | 3.67 | % | 1.3 | % | 2.2 | % | 1.3 | % | 2.2 | % |
| Volatility                        |   | 0.97                            |   | 0.70                           |   | 0.61 |   | 0.63 |   | 0.81 |   | 0.71 |   | 0.81 |   | 0.71 |   |
| Expected  life of option in years |   | 5.0                             |   | 4.14                           |   | 2.44 |   | 4.27 |   | 0.50 |   | 0.49 |   | 0.50 |   | 0.49 |   |

 

The Black-Scholes optionvaluation model was developed for use in estimating the fair value of tradedoptions that have no vesting restrictions and are fully transferable.  In addition, option valuation models requirethe input of highly subjective assumptions including the expected stock pricevolatility.  Because the Company’semployee stock options have characteristics significantly different from thoseof traded options, and because changes in the subjective input assumptions canmaterially affect the fair value estimate, in management’s opinion, theexisting models do not necessarily provide a reliable single measure of itsemployee stock options.

 

7

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**4.**                   **Loss Per Share**

 

Thefollowing data show the amounts used in computing loss per share and the effecton the weighted-average number of shares of diluted potential common stock.

 

Per share information calculated on this basis is asfollows:

 
|                                                                                    |   | **Three Months Ended  July 31,** |   | **Six Months Ended  July 31,** |   |
|-----------------------------------------------------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
| **(in thousands, except per share amounts)**                                            |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
| Numerator:                                                                              |   |                             |   |                           |   |   |   |   |   |
|                                                                                    |   |                             |   |                           |   |   |   |   |   |
| Net loss                                                                                |   | $                                | (6,365 | )                              | $      | (9,251 | ) | $ | (13,001 | ) | $ | (13,028 | ) |
|                                                                                    |   |                             |   |                           |   |   |   |   |   |
| Denominator:                                                                            |   |                             |   |                           |   |   |   |   |   |
| Denominator for basic  and diluted loss per share - weighted average shares outstanding |   | 30,457                           |   | 28,167                         |   | 30,367 |   | 28,102 |   |
|                                                                                    |   |                             |   |                           |   |   |   |   |   |
| Basic and diluted loss  per share                                                       |   | $                                | (.21   | )                              | $      | (.33 | ) | $ | (.43 | ) | $ | (.46 | ) |

 

For the three months ended July 31, 2003 and July 31,2002 and for the six months ended July 31, 2003 and July 31, 2002,respectively, basic earnings per share and diluted earnings per share are thesame due to the net loss for those periods. During the three months ended July 31, 2003 and 2002, respectively, theCompany excluded options to purchase 581,764 and 1,100,939 shares of commonstock.  During the six months ended July31, 2003 and 2002, respectively, the Company excluded options to purchase411,763 and 1,059,260 shares of common stock.

 

**5.**                   **Divestitures**

 

InApril 2000, pursuant to an asset purchase agreement, the Company sold theprincipal assets of its DVD product group, primarily consisting 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 previously contingenton the Company’s performance of certain obligations related to the transfer oflicenses 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 upon completingthe transfer of licenses with third parties to the Buyer, and recorded as theamount as a gain in the consolidated condensed statement of operations for thefiscal year ended January 31, 2003.

 

**6.**                   **Inventories**

 

Inventories are stated atthe lower of cost or market value. Cost is determined by the first-in,first-out method.  The Company writesdown the inventory value for estimated excess and obsolete inventory, based onmanagement’s assessment of future demand and market conditions.  If actual future demand or

 

8

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market conditionsare less favorable than those projected by management, additional inventorywrite-downs may be required.

 
| **Inventory consists of:  (in thousands)** |   | **July 31,  2003** |   | **January  31,  2003** |   |
|--------------------------------------------|--------|--------------------|--------|------------------------|--------|
|                                       |   |               |   |
| Raw materials                              |   | $                  | 109    |                   | $      | 117 |   |
| Work  in process                           |   | 3                  |   | 102                    |   |
| Finished  goods                            |   | 553                |   | 316                    |   |
| Total                                      |   | $                  | 665    |                   | $      | 535 |   |

 

**7.**                   **Accumulated Other Comprehensive Income**

 

Total accumulated othercomprehensive income (loss) was $(8) thousand at July 31, 2003 and $9 thousandat January 31, 2003.  Accumulated othercomprehensive income (loss) consists entirely of unrealized gains (losses) onavailable for sale securities.

 

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

 

Thefollowing table provides a summary of the carrying amount of intangible assetsthat will continue to be amortized:

 

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

 
| **July 31, 2003**               |   | **Cost** |   | **Accumulated  Amortization** |   | **Net** |   |
|---------------------------------|--------|----------|--------|-------------------------------|--------|---------|--------|
| Licensed  intellectual property |   | $        | 3,275  |                          | $      | (111    | )      | $ | 3,164 |   |
| Core technology                 |   | 1,800    |   | (950                          | )      | 850     |   |
|                            |   | $        | 5,075  |                          | $      | (1,061  | )      | $ | 4,014 |   |

 
| **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 for other intangible assets was$183 thousand and $439 thousand for the three months ended July 31, 2003 and2002, respectively. Amortization expense for other intangible assets was $366thousand and $1,002 thousand for the six months ended July 31, 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 July 31, 2003:

 

| **Fiscal years ending January 31,  (in thousands)** |   |   |   |
|-----------------------------------------------------|--------|--------|--------|
| 2004                                                |   | $      | 846    |   |
| 2005                                                |   | 1,642  |   |
| 2006                                                |   | 1,047  |   |
| 2007                                                |   | 479    |   |
| Total                                               |   | $      | 4,014  |   |

 

9

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**9.**                   **Obligations under Capital Leases**

 

Infiscal 2003, the Company entered into capital leases to finance softwarelicenses used in the design of semiconductors. Obligations under capital leasesrepresent the present value of future payments under the lease agreements.Property, plant and equipment include the following amounts for leases thathave been capitalized:

 
| **(in thousands)**                |   | **July 31,  2003** |   | **January  31,  2003** |   |
|-----------------------------------|--------|--------------------|--------|------------------------|--------|
| Software  under capital lease     |   | $                  | 4,073  |                   | $      | 4,073 |   |
| Accumulated  amortization         |   | (1,059             | )      | (381                   | )      |
| Net  software under capital lease |   | $                  | 3,013  |                   | $      | 3,692 |   |

 

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

 

Future minimum payments under the capital leasesconsist of the following, as of July 31, 2003:

 
| **Fiscal year ending January 31,  (in thousands)** |   |   |   |
|----------------------------------------------------|--------|--------|--------|
| 2004                                               |   | $      | 869    |   |
| 2005                                               |   | 1,910  |   |
| 2006                                               |   | 829    |   |
| Total  minimum lease payments                      |   | 3,608  |   |
| Less:  amount representing interest                |   | (356   | )      |
| Present  value of net minimum lease payments       |   | 3,252  |   |
| Less:  current portion                             |   | (1,649 | )      |
| Long-term portion                                  |   | $      | 1,603  |   |

 

**10.**            **Contingencies**

 

As ageneral matter, the semiconductor industry is characterized by substantiallitigation, regarding patent and other intellectual property rights.  In December 1998, the Company filed alawsuit in the United States District Court for the District of Delawareseeking damages and an injunction against Trident Microsystems, Inc.  The suit alleges that Trident’s embeddedDRAM graphics accelerators infringe certain patents held by the Company.  In January 1999, Trident filed a counterclaim against the Company alleging an attempted monopolization in violation ofantitrust laws, arising from NeoMagic’s filing of the patent infringementaction against Trident. The Court ruled that there was no infringement byTrident. The Company filed an appeal in the United States Court of Appeals, forthe Federal Circuit.  On April 17, 2002,the United States Court of Appeals for the Federal Circuit affirmed the lowercourt’s judgment of non-infringement on one patent and vacated the court’sjudgment of non-infringement on another patent, thereby remanding it to the lowercourt for further 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 in favorof Trident. NeoMagic has 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.  As the Company cannot reasonably estimate the outcome of theclaim, no accrual has been recorded for the potential loss contingency relatingto the Trident counter-suit.

 

10

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

 

TheCompany generally sells products with a limited warranty of product quality anda limited indemnification of customers against intellectual propertyinfringement claims related to the Company’s products. The Company accrues forknown warranty and indemnification issues if a loss is probable and can bereasonably estimated, and accrues for estimated incurred but unidentifiedissues based on historical activity. The accrual and the related expense forknown issues were not significant as of and for the six months period endedJuly 31, 2003 and 2002. Due to product testing, the short time between productshipment and the detection and correction of product failures, and a lowhistorical rate of payments on indemnification claims, the accrual based onhistorical activity and the related expense were not significant as of and forthe six months period ended July 31, 2003 and 2002.

 

**Part I.**              **FinancialInformation**

 

# **Item 2.**           Management’sDiscussion and Analysis of Financial Condition and Results of Operations

 

When used in thisdiscussion, the words “expects,” “anticipates,” “believes” and similarexpressions are intended to identify forward-looking statements.  Such statements reflect management’s currentintentions and expectations. Examples of such forward-looking statementsinclude statements regarding future revenues, expenses, losses and cash flows,capital requirements, the launch of new products and research and developmentactivities.  However, actual events andresults could vary significantly based on a variety of factors including, butnot limited to: customer acceptance of new NeoMagic products, the marketacceptance of handheld system products developed and marketed by customers thatuse the Company’s products, the Company’s ability to execute product andtechnology development plans on schedule, and the Company’s ability to accessadvanced manufacturing technologies in sufficient capacity without significantcash pre-payments or investment.  Thesefactors along with those set forth below under “Factors that May AffectResults,” are subject to risks and uncertainties that could cause actualresults to differ materially from those projected. These forward-lookingstatements speak only as of the date hereof. The Company expressly disclaimsany obligation or undertaking to release publicly any updates or revisions toany forward-looking statements contained herein, to reflect any changes in theCompany’s expectations with regard thereto or any changes in events, conditionsor circumstances on which any such statement is based.

 

# **Overview**

 

NeoMagicdesigns, develops and sells high performance applications processors marketedunder the MiMagicTM name.  The MiMagicfamily is designed to enable sophisticated multimedia functionality within alow-power, high performance system-on-chip (SOC).  The MiMagic Applications Processors are targeted atmultimedia-enabled mobile phones and wireless personal digital assistants(PDAs).  In the past, the Companyprovided semiconductor solutions for the notebook PC multimedia accelerator marketplace.  In calendar 2000, the Company exited thismarket and is now focused solely on developing, manufacturing and sellingapplications processors for the handheld systems market.  The Company is now generating revenues fromthis product effort.  In the next fewquarters, the Company expects customers to introduce new handheld systems thatuse the MiMagic chips.  The Companylaunched its newest product, the MiMagic 6, in June 2003.  The Company believes that the MiMagic 6provides the highest multimedia processing performance among low power applicationsprocessors available today.

 

NeoMagichas established strategic relationships with third-party manufacturing partnersto produce semiconductor products for the Company.  Pursuant to these strategic relationships, NeoMagic designs theoverall product, including the logic and analog circuitry, and themanufacturing partners

 

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manufacture thewafers, perform testing and package the products.  NeoMagic has core competencies in integrating logic, analog andmemory as well as developing graphics, video, 3D and other multimediatechnologies.  By combining these corecompetencies with drivers, middleware, operating system software, and powermanagement, NeoMagic develops solutions that facilitate the mobilization ofmultimedia applications.

 

NeoMagicintroduced its first applications processor, the MiMagic 3 (NMS7210), in June2002.  This product is currentlyshipping to customers with consumer electronic end markets that include mobilephones, video recorders and MP3 players. The Company expects this product to continue shipping through calendar2004.

 

NeoMagicintroduced the MiMagic 5 Applications Processor (NMS9200) in November 2002, andbegan sampling the product in February 2003. The Company expects to start revenue shipments in late fiscal 2004.

 

TheMiMagic 6 Application Processor (NMS9600) was launched in June of 2003.  The MiMagic 6 is based on NeoMagic’sAssociative Processor Array, or APA, which forms its multimedia engine.  Existing applications processor solutionsuse a sequential processing flow that typically operates on each individualdata element in sequence, relying on ever-faster processor clock cycles to gainperformance.  This requires large amountsof power and creates performance bottlenecks. Conversely, APA merges processing and memory.  APA processes multiple bits of data in parallel, in a singleclock cycle, thus boosting performance while using less power.  Because of this, the MiMagic 6 is able toperform an order of magnitude more operations per clock cycle than aconventional applications processor at the same power.  With that computational horsepower, theMiMagic 6 is able to provide value-add capabilities like zoom, low-light and bright-lightadjustment and advanced 3-D gaming features, without adding transistors. Withits ability to handle large amounts of data simultaneously and at lower clockrates, the APA platform is targeted at sophisticated multimedia data such asimages, video and graphics. The Company expects to begin shipping productsamples to our potential customers in late fiscal 2004.

 

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 second fiscal quarters of 2004 and 2003 ended on July 27, 2003 andJuly 28, 2002, respectively.  For easeof presentation, the accompanying financial statements have been shown asending on the last day of the calendar month of July.

 

**Results of 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 relateddisclosure of contingent assets and liabilities. On an on-going basis, the Companyevaluates its estimates, including those related to goodwill, intangibleassets, and long-lived assets, inventories, income taxes, and contingencies andlitigation.   The Company bases itsestimates on historical experience and on various other assumptions that arebelieved to be reasonable under the circumstances, the results of which formthe basis for making judgments about the amount and timing of revenue andexpenses and the carrying values of assets and liabilities that are not readilyapparent from other sources. Actual results may differ from these estimatesunder different assumptions or conditions.

 

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**Goodwill,Intangible Assets and Long Lived Assets**

 

NeoMagichas significant tangible and intangible assets on its balance sheet, includingother purchased intangibles related to acquisitions.

 

In assessing therecoverability of intangible assets with indefinite lives, the Company mustmake assumptions about the estimated future cash flows and other factors todetermine the fair value of these assets. Assumptions about future revenue and cash flows require significantjudgment because of the current state of the economy, the fluctuation of actualrevenue, and the timing of expenses.

 

As a result of adoptingStatement of Accounting Standards (SFAS) 142, “Goodwill and Other IntangibleAssets,” on February 1, 2002, the Company discontinued the amortization ofgoodwill. Instead, goodwill was reviewed for impairment upon adoption of SFAS142 and again in the third quarter of fiscal 2002 because indicators ofimpairment were present.  In addition,on adoption of SFAS 142, the Company reclassified certain intangibles with netbook value $0.4 million, consisting of assembled workforce and acquisitioncosts, which are no longer defined as an acquired intangible under SFAS 142, togoodwill.  Accordingly, there was noamortization of assembled workforce and acquisition costs recognized duringfiscal 2003.

 

Uponadoption of SFAS 142, the Company was required to complete the two-steptransitional goodwill impairment test. The Company completed step one of thetransitional impairment test during the second quarter of fiscal 2003 anddetermined that there were indicators of impairment, as the carrying value ofthe reporting unit exceeded the fair value derived from the marketcapitalization model. The second step of the transitional impairment test todetermine the amount of impairment was completed in the third quarter of fiscal2003 by comparing fair value to carrying value, with any excess of carryingvalue over fair value being recorded as an impairment loss. Based on theresults of the second transitional impairment test, the Company recorded anon-cash charge of $4.2 million, to reduce the carrying value of its goodwillto zero, which was reflected as a cumulative effect of an accounting change inthe fiscal 2003 consolidated statements of operations.

 

For goodwill, the annualimpairment evaluation includes a comparison of the carrying value of thereporting unit  (including goodwill) tothat reporting unit’s fair value.  Ifthe reporting unit’s estimated fair value exceeds the reporting unit’s carryingvalue, no impairment of goodwill exists. If the fair value of the reporting unit does not exceed the unit’s carryingvalue, then an additional analysis is performed to allocate the fair value ofthe reporting 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 impairmentevaluation for indefinite life intangible assets includes a comparison of theasset’s carrying value to the asset’s fair value. When the carrying valueexceeds fair value an impairment charge is recorded for the amount of thedifference.  An intangible asset isdetermined to have an indefinite useful life when there are no legal,regulatory, contractual, competitive, economic or any other factors that maylimit the period over which the asset is expected to contribute directly orindirectly to the future cash flows of the Company.  For such assets, in each reporting period, the Company alsoevaluates whether events and circumstances continue to support the use of anindefinite useful life. If it is determined that the circumstances have changedand the intangible asset is determined to have a finite useful life, the assetwill be amortized prospectively over the estimated remaining useful life andaccounted for in the same manner as intangible assets that are subject toamortization.

 

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Intangible assets arecarried and reported at acquisition cost, net of accumulated amortizationsubsequent to acquisition. The acquisition cost is amortized over estimateduseful lives, which range from 2 to 3 years. Changes in circumstances such asthe passage of new laws or changes in regulations, technological advances,changes to the Company’s business model, or changes in the capital strategycould result in the actual useful lives differing from initial estimates.  In those cases where the Company determinesthat the useful life of a long-lived asset should be revised, the Company willdepreciate the net book value in excess of the estimated residual value overits revised remaining useful life. Factors such as changes in the planned useof equipment, customer attrition, contractual amendments, or mandatedregulatory requirements could result in shortened useful lives of intangibleassets.

 

Long-lived assets andasset groups are evaluated for impairment whenever events or changes incircumstances indicate that the carrying amount of such assets may not berecoverable, or at least annually, in accordance with SFAS 144.  The estimated future cash flows are basedupon, among other things, assumptions about expected future operatingperformance and may differ from actual cash flows.  Long-lived assets evaluated for impairment are grouped with otherassets to the lowest level for which identifiable cash flows are largelyindependent of the cash flows of other groups of assets and liabilities.  If the sum of the projected undiscountedcash flows  (excluding interest) is lessthan the carrying value of the assets, the assets will be written down to theestimated fair value in the period in which the determination is made.

 

During the first quarterof fiscal 2003, the Company wrote-off licensed intangible properties with a netbook value of $0.5 million relating to licensed intellectual property that willno longer be used.

 

During the third andfourth quarters of fiscal 2003, the Company also determined that certainintangible assets purchased as part of the LinkUp Systems Corporationacquisition completed in December 2001 were impaired and recorded a totalimpairment charge of $1.0 million.

 

### **Inventory Valuation**

 

The Company’s inventoryvaluation policy stipulates that at the end of each reporting period wewrite-down or write-off our inventory for estimated obsolescence orunmarketable inventory. The amount of the write-down or write-off is equal tothe difference between the cost of the inventory and the estimated market valueof the inventory based upon reasonable assumptions about future demand andmarket conditions. If actual market conditions are less favorable than thoseprojected by management, additional inventory write-downs or write-offs may berequired. Additionally, as we introduce product enhancements and new products,demand for our existing products in inventory may decrease.

 

### **Revenue Recognition**

 

The Company recognizesrevenue from product sales when the products are shipped to customers; otherthan distributors, title has transferred, and no significant obligationsremain. In addition, the Company requires the following: (i) execution of awritten customer order, (ii) delivery of the product, (iii) fee is fixed ordeterminable, and (iv) collectibility of the proceeds is probable. TheCompany’s shipment terms are FOB shipping point.

 

With respect to productsshipped to distributors, the Company generally defers recognition of productrevenue until the distributors sell their products to their customers. Onoccasion, however, the Company will sell products with “End of Life” status toits distributors under special arrangements without any price protection orreturn privileges for which the Company recognizes revenue upon transfer oftitle, based on shipping terms.

 

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At the end of eachaccounting period, the Company makes a determination of certain factorsincluding sales returns and allowances, which could affect the amount ofrevenue recorded for the period. Sales returns provisions includeconsiderations for known but unprocessed sales returns and estimation forunknown returns based on historical experiences.

 

### **Deferred Taxes**

 

The Company records avaluation allowance to reduce its deferred tax assets to the amount that ismore likely than not to be realized. Based on the uncertainty of future pre-taxincome, the Company has fully reserved its deferred tax assets. In the eventthe Company was to determine that it would be able to realize its deferred taxassets in the future, an adjustment to the deferred tax asset would increaseincome in the period when such determination was made. The Company has alsoprovided reserves for certain potential tax liabilities. If such amountsultimately prove to be unnecessary, the resulting reversal of such reserveswould result in tax benefits being recorded in the period when the reserves areno longer deemed necessary.

 

**Net Sales**

 

Net sales were $222thousand and $494 thousand for the three months ended July 31, 2003 and 2002,respectively, compared to $846 thousand and $856 thousand for the six monthsended July 31, 2003 and 2002, respectively. Net sales decreased in the three and six months ended July 31, 2003 dueto customer delays in bringing their MiMagic 3 programs to commercialproduction.

 

Sales to customerslocated outside the United States (including sales to the foreign operations ofcustomers with headquarters in the United States, and foreign systemmanufacturers that sell to United States-based OEMs) accounted for 74% and 94%of net sales in the three months ended July 31, 2003 and 2002,respectively.  Sales to customerslocated outside the United States accounted for 87% and 89% of net sales in thesix months ended July 31, 2003 and 2002, respectively. All sales transactionswere denominated in United States dollars.

 

Four customers (three of which were distributors)accounted for 33%, 18%, 17% and 15% of net sales for the three months endedJuly 31, 2003.  Three customers (all ofwhich were distributors) accounted for 46%, 27% and 16% of net sales for thethree months ended July 31, 2002.  Fourcustomers (all of which were distributors) accounted for 30%, 26%, 15% and 13%of net sales for the six months ended July 31, 2003.  Three customers (all of which were distributors) accounted for28%, 26% and 25% of net sales for the six months ended July 31, 2002.

 

**Gross Loss**

 

Grossloss was $197 thousand and $226 thousand for the three months ended July 31,2003 and 2002, respectively.  Gross losswas $161 thousand and $449 thousand in the six months ended July 31, 2003 and2002, respectively.  The negative grossmargins in the three and six month periods ended July 31, 2003 are due to underabsorption of manufacturing overhead resulting from low production levels.  In addition, in the first quarter of fiscal2004 the Company began reviewing the percentage of time spent by manufacturingemployees between production and development. The Company allocated $51thousand and $111 thousand of wage costs related to development efforts toresearch and development expenses in the three and six months ended July 31,2003.  The Company amortized $112thousand and $224 thousand, of developed technology in the three and six monthsended July 31, 2002.  Developedtechnology was fully written off as of January 31, 2003.

 

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## **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 photomask costsand pre-production wafer costs. Research and development expenses were $4.5 million and $5.5 million forthe three months ended July 31, 2003 and 2002, respectively. Research anddevelopment expenses were $9.5 million and $12.5 million for the six monthsended July 31, 2003 and 2002, respectively. These expenses include amortization of deferred compensation of $0.1million and $0.1 million for the three months ended July 31, 2003 and 2002,respectively, and $0.2 million and $0.8 million for the six months ended July31, 2003 and 2002, respectively.  Thedecrease of $1.0 million for the three months ended July 31, 2003 is primarilyrelated to lower labor costs, lower amortization of acquired and licensedintangibles, and lower software maintenance costs.  The decrease of $3.0 million for the six months ended July 31,2003 is primarily related to lower labor costs, lower amortization of deferredcompensation, lower amortization of acquired and licensed intangibles, lowersoftware maintenance costs, and lower mask expenses offset somewhat byincreased consulting expenses. Included in the expenses for the six monthsended July 31, 2002, were expenses of $0.5 million to write off certainlicensed intellectual property. The Company has made, and intends to continueto make, significant investments in research and development as it focuses ondeveloping products for the handheld systems market.

 

# **Sales,General and Administrative Expenses**

 

Sales, general and administrative expenses were $1.8 millionand $2.3 million for the three months ended July 31, 2003 and 2002,respectively. Sales, general and administrative expenses were $3.5 million and$5.7 million for the six months ended July 31, 2003 and 2002, respectively.These expenses include amortization of deferred compensation of $0.1 millionand $0.2 million for the three months ended July 31, 2003 and 2002,respectively, and $0.1 million and $0.8 million for the six months ended July31, 2003 and 2002, respectively. Sales, general and administrative expensesdecreased in absolute dollars for the three and six months ended July 31, 2003primarily due to lower labor costs and lower amortization of deferredcompensation.

 

**Special Charges**

 

In January 2001, theCompany extended its wafer supply agreement with Infineon Technologies AG ofGermany (“Infineon”) through fiscal 2004 to ensure future wafer supply for theCompany’s new product efforts.  The termsof the agreement provided that NeoMagic would make use of Infineon’s 0.20micron and 0.17 micron embedded DRAM (eDRAM) process technologies.  The agreement also provided for access toadditional manufacturing capacity and to more advanced process technologies tobe developed by Infineon. NeoMagic provided $15.0 million in guarantees towardsits wafer purchases over the term of the agreement.  The amount of guarantee was included as restricted cash on theCompany’s Consolidated Balance Sheet, as of January 31, 2002. Due touncertainties over Infineon’s continued eDRAM product development, the Companydecided not to use Infineon’s eDRAM technology for its future production. Basedon negotiations between NeoMagic and Infineon on restructuring the wafer supplyagreement with the intent to release NeoMagic from the related guarantee, theCompany recorded $3.6 million in charges, which reflects the value of the finalsettlement in fiscal 2003.  The $3.6million charge is composed of a $1.5 million cash payment and the issuance of$2.1 million in common stock.  TheCompany booked $1.4 million of this charge in the first quarter of fiscal 2003based on discussions with Infineon at that time and booked $2.2 million in thesecond quarter of fiscal 2003 to reflect the final settlement.

 

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

 

InApril 2000, pursuant to an asset purchase agreement, the Company sold theprincipal assets of its DVD product group, primarily consisting 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 the amount as a gain in the consolidated condensed statement ofoperations for the fiscal year ended January 31, 2003.

 

**Interest and Other Income**

 

TheCompany earns interest on its cash equivalents, short-term investments, andlong-term investments.  Interest andother income was $0.2 million and  $0.7million for the three months ended July 31, 2003 and 2002, respectively.  Interest and other income was $0.4 millionand $1.3 million for the six months ended July 31, 2003 and 2002, respectively.The decrease for the three and six months ended July 31, 2003 in interest andother income is primarily due to significantly lower interest rates and tolower average cash, short-term investment and long-term investment balances.

 

**Interest Expense**

 

Interest expense was $73 thousand and  $0 for the three months ended July 31, 2003and 2002, respectively. Interest expense was $160 thousand and $0 for the sixmonths ended July 31, 2003 and 2002, respectively.  Interest expense for the three and six months ended July 31, 2003is due to new capital leases entered into in the latter half of fiscal 2003.

 

**Income Taxes**

 

The Company recorded a $6million tax benefit for the three months ended April 30, 2002, primarilyrelated to changes in the federal tax law. The Job Creation and Worker Assistance Act of 2002 was enacted on March9, 2002 and contained provisions extending the net loss carry-back period fromthree to five years.  This changepermitted the Company to utilize net operating losses incurred in fiscal 2001to recover taxes paid in prior periods. The $6 million benefit representsadditional refunds that the Company claimed on the 2001 net operating losscarry-back due to the change in tax law.

##  

## **Liquidity and Capital Resources**

 

The Company’s cash, cashequivalents, short-term investments and long-term investments decreased $13.7million in the six months ended July 31, 2003 to $53.4 million at July 31,2003, from $67.1 million at January 31, 2003.

 

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Cash and cash equivalentsused in operating activities for the six months ended July 31, 2003 was $13.0million, compared to $0.7 million of net cash provided by operating activities forthe six months ended July 31, 2002.  Thecash used in operating activities stems primarily from a net loss of $13.0million, increases in inventory and accounts receivable, as well as decreasesin accounts 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 sixmonths ended July 31, 2003, was $11.5 million, compared to $7.2 million of netcash provided by investing activities for the six months ended July 31, 2002.Net cash used in investing activities related primarily to net purchases ofshort-term investments of $11.2 million and fixed asset purchases of $0.3million.

 

Net cash used in financing activities was $0.4 millionfor the six months ended July 31, 2003, compared to $0.5 million of net cashprovided by financing activities for the six months ended July 31, 2002. Thenet cash used in financing activities represents payments on capital leaseobligations offset somewhat by proceeds from the issuance of common stock.

 

AtJuly 31, 2003, the Company’s principal sources of liquidity included cash, cashequivalents, short-term investments, and long-term investments of $53.4million.  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 expenditure requirementsthrough the next twelve months. After this period, capital requirements willdepend on many factors, including general economic conditions, the rate of netsales growth, the timing and extent of spending to support research anddevelopment programs, the timing of any new product introductions andenhancements to existing products, and market acceptance of the Company’sproducts.  To the extent that existingcash, cash equivalents and short-term investment balances and any cash fromoperations are insufficient to fund the Company’s future activities, theCompany 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 May1996, the Company moved its principal headquarters to a new facility in SantaClara, California, under a non-cancelable operating lease that expired in April2003. In January 1998, the Company entered into a second non-cancelable operatinglease for the building adjacent to its principal headquarters.  This lease had a co-terminus provision withthe original lease, which expired in April 2003.  In March 2002, the Company extended the term for 45,000 squarefeet under this lease for another seven years with a termination date of April2010.  The Company leases offices inIndia and Israel under operating leases that expire at various times throughDecember 2006.

 

TheCompany leases software licenses under capital leases. Refer to note 9 of theconsolidated condensed financial statements for additional information.

 

Thefuture minimum payments relating to the software leases and the facility leasesare included in the contractual obligations table below.

 

The following summarizes the Company’s contractualobligations at July 31, 2003, and the effect such obligations are expected tohave on our liquidity and cash flow (in thousands).

 

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|                               |   | **2004** |       | **2005** |       | **2006** |       | **2007** |       | **2008** |       | **Thereafter** |       | **Total** |       |
|------------------------------------|--------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| **CONTRACTUAL  OBLIGATIONS**       |   |     | ** ** |     | ** ** |     | ** ** |     | ** ** |     | ** ** |           | ** ** |      | ** ** |
| Operating leases                   |   | $        | 578        |     | $          | 1,137    |       | $        | 1,089      |     | $          | 1,116          |       | $         | 1,046      |   | $ | 2,450 |   | $ | 7,416 |   |
| Capital leases                     |   | 869      |       | 1,910    |       | 829      |       | —   |       | —   |       | —         |       | 3,608     |       |
| Non-cancelable purchase orders     |   | 545      |       | —   |       | —   |       | —   |       | —   |       | —         |       | 545       |       |
|                               |   |     |       |     |       |     |       |     |       |     |       |           |       |      |       |
| Total contractual cash obligations |   | $        | 1,992      |     | $          | 3,047    |       | $        | 1,918      |     | $          | 1,116          |       | $         | 1,046      |   | $ | 2,450 |   | $ | 11,569 |   |
|                                    |        |          |            |          |            |          |            |          |            |          |            |                |            |           |            |  |  |  |  |  |  |  |  |

 

Asdescribed in note 11, the warranty liabilities are not material as of July 31,2003.

 

**Factors that May Affect Future Results**

 

# **WeExpect to Continue to Incur Significant Losses in Fiscal 2004**

 

The Company has beenincurring substantial losses as it invests heavily in new product developmentin advance of achieving significant customer sales.  This is expected to continue in fiscal year 2004.  The Company’s ability to achieve cash flowbreakeven is likely to depend on the success of its MiMagic 5 and its MiMagic6, which has recently been announced. 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 quarterly and annual results ofoperations are affected by a variety of factors that could materially adverselyaffect net sales, gross margin and operating results.  These factors include, among others, the ability of the Companyto increase its customer base and its sales, the abilities of manufacturingsubcontractors to make adequate and timely deliveries, access to advancedproduction process technologies from manufacturing subcontractors, and recruitingand retaining employees including those with engineering expertise in newdisciplines. In particular, the Company’s new product development efforts andcustomer engagements in System-on-Chip integration and supporting multimediatechnologies such as MPEG-4 streaming video represent new endeavors andconsequently carry greater risks of successful and timely execution. Any one ormore of these factors could result in the Company failing to achieve itsexpectations as to future revenues and profits.  Furthermore, the majority of the Company’s sales werehistorically made, and are expected to continue to be made, on the basis ofpurchase orders rather than pursuant to long-term purchase agreements, whichincreases the difficulty of forecasting sales. The Company may be unable to adjust spending sufficiently in a timelymanner to compensate for any unexpected sales shortfall, which could materiallyadversely affect quarterly operating results. Accordingly, the Company believes that period-to-period comparisons ofits operating results should not be relied upon as an indication of futureperformance.  In addition, the resultsof any quarterly period are not indicative of results to be expected for a fullfiscal year.  In future quarters, theCompany’s operating results may be below the expectations of public marketanalysts or investors.

 

# **OurFinancial Results could be Affected by Changes in Accounting Rules**

 

In August 2001, the FASBissued SFAS 144, “Accounting for the Impairment or Disposal of Long-LivedAssets.” SFAS 144 requires us to perform impairment analysis on our long-livedassets, other than goodwill, to be held and used, whenever events or changes incircumstances indicate the carrying amount may not be recoverable. Animpairment loss will be recognized if the carrying amount of a long-lived assetexceeds its fair value. SFAS 144 retains the fundamental provisions of SFAS 121related to (i) the recognition and measurement of the impairment of long-livedassets to be held and used, and (ii) the measurement of long-lived assets to bedisposed of by sale. As SFAS 144 excludes goodwill, certain long-lived assetsmay be subject to impairment charges sooner than they would have been recordedunder SFAS

 

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121, which SFAS 144 replaces. During the third and fourth quarter offiscal 2003, we recorded impairment charges of $873 thousand and $170 thousand,respectively, related to our long-lived assets as a result of our SFAS 144analysis. If economic conditions in our industry continue to deteriorate andadversely affect our business, we could be required to record additionalimpairment charges related to our long-lived assets, which could have amaterial adverse effect on our results of operations and financial condition.

 

Our financial results could be affected by potentialchanges in the accounting rules governing the recognition of stock-basedcompensation expense. We measure compensation expense for our employee stockplans under the intrinsic value method of accounting prescribed by AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued to Employees.” Inaddition, we provide pro forma disclosures of our operating results in ourNotes to Consolidated Financial Statements as if the fair value method ofaccounting had been applied in accordance with SFAS No. 123, “Accounting forStock-Based Compensation.” Had we accounted for our compensation expense underthe fair value method of accounting prescribed by SFAS 123, the charge wouldhave been significant, totaling $5.6 million, $6.7 million and $6.3 millionduring fiscal 2003, 2002 and 2001, respectively. Currently, the U. S. Congress,the Securities and Exchange Commission and the Financial Accounting StandardsBoard are considering changes to accounting rules concerning the recognition ofstock option compensation expense. If one or more of these proposals areimplemented, we and other companies may be required to measure compensationexpense using the fair value method, which would adversely affect our resultsof operations by reducing our income or increasing our losses by an amountequal to such stock option charges.

 

**We have a Limited Customer Base**

 

Four customers accounted for 33%, 18%, 17% and 15% ofnet sales for the three months ended July 31, 2003.  Three customers accounted for 46%, 27% and 16% of net sales forthe three months ended July 31, 2002. Four customers accounted for 30%, 26%, 15% and 13% of net sales for thesix months ended July 31, 2003.  Threecustomers accounted for 28%, 26%, and 25% of net sales for the six months endedJuly 31, 2002.  The Company expects thata small number of customers will account for a substantial portion of its netsales for the foreseeable future. Furthermore, the majority of the Company’s sales was historically made,and is expected to continue to be made, on the basis of purchase orders ratherthan pursuant to long-term purchase agreements.  As a result, the Company’s business, financial condition andresults of operations could be materially adversely affected by the decision ofa single customer to cease using the Company’s products, or by a decline in thenumber of handheld systems sold by a single customer.

 

**We May Lose Our Customer Base**

 

The Company’s products are designed to afford thehandheld systems manufacturer significant advantages with respect to productperformance, power consumption and size. To the extent that other future developments in components orsubassemblies incorporate one or more of the advantages offered by theCompany’s products, the market demand for the Company’s products may benegatively impacted.

 

**We Face Intense Competition in OurMarkets**

 

The market for applications processors is intenselycompetitive and is characterized by rapid technological change, evolvingindustry standards and declining average selling prices.  NeoMagic believes that the principal factorsof competition in this market are imaging performance, price, features, powerconsumption, size and software support. The ability of the Company to compete successfully in the applicationsprocessor market depends on a number of factors including, success in designingand subcontracting the manufacture of new products that implement newtechnologies, product quality and reliability, price, ramp of production of theCompany’s products for particular system manufacturers,

 

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customer demand and acceptance of more sophisticatedmultimedia functionality 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 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 industrystandards for a significant period of time, the Company could miss crucialOEM/ODM design cycles, which could result in a material adverse effect on theCompany’s business, financial condition and results of operations.

 

NeoMagic competeswith both domestic and international companies, most of which have substantiallygreater financial and other resources than the Company with which to pursueengineering, manufacturing, marketing and distribution of their products.  The Company’s principal competitors includeIntel’s StrongARM and XScale product lines, ST Microsystem’s Nomadik line,certain of Samsung’s S3C chips, Nvidia’s Katana line and Texas Instruments’OMAP product line, as well as a number of vertically integrated electronicsfirms who are developing their own solutions. NeoMagic may also face increased competition from new entrants into thehandheld systems semiconductor market including companies currently atdevelopmental stages.

 

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

 

**Our Products May be Incompatible with Evolving IndustryStandards and Market Trends**

 

The Company’s ability to compete in the future willalso depend on its ability to identify and ensure compliance with evolvingindustry standards and market trends. Unanticipated changes in market trends and industry standards couldrender the Company’s products incompatible with products developed by majorhardware manufacturers and software developers. As a result, the Company couldbe required to invest significant time and resources to redesign its productsor obtain license rights to technologies owned by third parties in order toensure compliance 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 in compliancewith prevailing market trends and industry standards for a significant periodof time, the Company could miss crucial OEM design cycles, which could resultin a material adverse effect on the Company’s business, financial condition andresults of operations.

 

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

 

The Company is 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,

 

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the Company believes that significantexpenditures for research and development will continue to be required in thefuture.

 

TheCompany must anticipate the features and functionality that consumers andinfrastructure providers will demand, incorporate those features andfunctionality into products that meet the exacting design requirements ofequipment manufacturers, price its products competitively and introduce theproducts to the market on a timely basis. The success of new productintroductions is dependent on several factors, including proper new productdefinition, timely completion and introduction of new product designs, theability to create or acquire intellectual property, the ability of strategicmanufacturing partners to effectively design and implement the manufacture ofnew products, quality of new products, differentiation of new products fromthose of the Company’s competitors and market acceptance of the Company’s andits customers’ products. There can be no assurance that the products the Companyexpects to introduce will incorporate the features and functionality demandedby system manufacturers and consumers, will be successfully developed, or willbe introduced within the appropriate window of market demand, nor can there beassurance that customers who utilize the Company’s semiconductor products willachieve the levels of market success with their own system products that theymay 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 newproducts in markets in which the Company has little history.  In the event that there are delays inproduction of current products, or in the completion of development of futureproducts, including the products currently under development for introductionover the next 12 to 18 months, the Company’s potential future business,financial condition, 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-Party Manufacturers to Produce OurProducts**

 

TheCompany’s products require wafers manufactured with state-of-the-artfabrication equipment and techniques. The Company currently utilizes severalfoundries for wafer fabrication. The Company expects that, for the foreseeablefuture, some of its products will be manufactured by a single source.  Since, in the Company’s experience, the leadtime needed to establish a strategic relationship with a new wafer fabricationpartner is at least 12 months, and the estimated time for a foundry to switchto a new product line ranges from four to nine months, there may be no readilyavailable alternative source of supply for specific products. A manufacturingdisruption experienced by the Company’s manufacturing partners, the failure ofthe Company’s manufacturing partners to dedicate adequate resources to theproduction of the Company’s products, or the financial instability of theCompany’s manufacturing partners would have a material adverse effect on theCompany’s business, financial condition and results of operations.  Furthermore, in the event that thetransition to the next generation of manufacturing technologies by theCompany’s manufacturing partner is unsuccessful, the Company’s business,financial condition and results of operations would be materially and adverselyaffected.

 

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

 

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acceptable cost.  Additionally,there can be no assurance that the Company’s manufacturing partners willcontinue to devote adequate resources to the production of the Company’sproducts or continue to advance the process design technologies on which themanufacturing of the Company’s products are based.

 

**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 alternative subcontractors.  Any problems associated with the delivery,quality or cost of the assembly and test of the Company’s products could have amaterial adverse effect on the Company’s business, financial condition andresults of operations.

 

**We May Encounter Inventory Excess orShortage**

 

The Company has wafer supply relationships withseveral foundries to support the Company’s product efforts.  Normally, the Company places bindingpurchase orders two to three months prior to wafer shipment.  The Company orders wafers for deliveries inadvance and with the additional time to assemble and test wafers, the Companycan have orders for finished goods that will not be available for up to fourmonths into the future. If the Company does not have sufficient demand for itsproducts and cannot cancel its current and future commitments without materialimpact, the Company may experience excess inventory, which will result in awrite-off affecting gross margin and results of operations.  If the Company cancels a purchase order, itmust pay cancellation penalties based on the status of work in process or theproximity of the cancellation to the delivery date.  The Company must place purchase orders for wafers before itreceives purchase orders from its own customers.  This limits the Company’s ability to react to fluctuations indemand for its products, which can be unexpected and dramatic, and fromtime-to-time will cause the Company to have an excess or shortage of wafers fora particular product.                As aresult of the long lead-time for manufacturing wafers and the increase in “justin time” ordering by manufacturers, semiconductor companies such as the Companyfrom time-to-time must take charges for excess inventory. The Company did infact incur such charges in fiscal 2001 of $9.2 million. Significant write-offsof excess inventory have had and could continue to have a material adverseeffect 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 of semiconductors is an extremelycomplex process, which typically includes hundreds of process steps.  Minute levels of contaminants in themanufacturing environment, defects in masks used to print circuits on a wafer,utilization of equipment with variations and numerous other factors can cause asubstantial percentage of wafers to be rejected or a significant number of dieon each wafer to be nonfunctional.  Manyof these problems are difficult to diagnose and time consuming or expensive toremedy.  As a result, semiconductorcompanies often experience problems in achieving acceptable wafer manufacturingyields, which are represented by the number of good die as a proportion of thetotal number of die on any particular wafer. The Company often purchases wafers, not die, and pays an agreed uponprice for wafers meeting certain acceptance criteria.  Accordingly, the Company bears the risk of the yield of good diefrom wafers purchased meeting the acceptance criteria. The Company experiencedsuch yield problems in fiscal 2000, which materially adversely affected theCompany’s net sales, gross margins and results of operations in fiscal 2000 and2001.

 

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Semiconductormanufacturing yields are a function of both product design, which is developedlargely by the Company, and process technology, which is typically proprietaryto the manufacturer.  Historically, theCompany has experienced lower yields on new products.  Since low yields may result from either design or processtechnology failures, yield problems may not be effectively determined orresolved until an actual product exists that can be analyzed and tested toidentify process sensitivities relating to the design rules that are used.  As a result, yield problems may not beidentified until well into the production process, and resolution of yieldproblems would require cooperation by and communication between the Company andthe manufacturer.  This risk iscompounded by the offshore location of the Company’s manufacturers, increasingthe effort and time required identifying, communicating and resolvingmanufacturing yield problems.  As theCompany’s relationships with new manufacturing partners develop, yields couldbe adversely affected due to difficulties associated with adopting theCompany’s technology and product design to the proprietary process technologyand design rules of each manufacturer. Any significant decrease in manufacturing yields could result in anincrease in the Company’s per unit product cost and could force the Company toallocate its available product supply among its customers, potentiallyadversely impacting customer relationships as well as revenues and grossmargins.  There can be no assurance thatthe Company’s manufacturers will achieve or maintain acceptable manufacturingyields in the future.

 

**Uncertainty and Litigation Risk Associated with Patents andProtection of Proprietary Rights**

 

The Company relies in part on patents to protect itsintellectual property. As of July 31, 2003, the Company has been issued 68patents, each covering certain aspects of the design and architecture of theCompany’s products.  Additionally, theCompany has numerous patent applications pending.  There can be no assurance that the Company’s pending patentapplications, 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’sability to do business.  In addition,there can be no assurance that others will not independently develop similarproducts, duplicate the Company’s products or design around any patents thatmay be issued 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 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 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 States Courtof 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 oral arguments oncross-motions for summary judgment on the matter.  In May 2003, the lower court ruled in favor of Trident. NeoMagichas filed a notice of re-consideration with the court. Management believes theCompany has valid defenses against Trident’s claims. There can be no assuranceas to the results of the patent infringement suit and the counter-suit forantitrust filed by Trident.

 

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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, financial condition and results ofoperations.  In the event of any adverseruling in any such matter, the Company could be required to pay substantialdamages, which could include treble damages, cease the manufacturing, use andsale of infringing products, discontinue the use of certain processes, or toobtain a license under the intellectual property rights of the third partyclaiming infringement.  There can be noassurance, however, that a license would be available on reasonable terms or atall.  Any limitations on the Company’sability to market its products, or delays and costs associated with redesigningits products or payments of license fees to third parties, or any failure bythe Company to develop or license a substitute technology on commerciallyreasonable terms could have a material adverse effect on the Company’sbusiness, financial condition and results of operations.

 

**We Depend on International Sales and Suppliers**

 

Export sales have been a critical part of theCompany’s business.  Sales to customerslocated outside the United States (including sales to the foreign operations ofcustomers with headquarters in the United States and foreign systemmanufacturers that sell to United States-based OEMs) accounted for 74% and 94%of net sales in the three months ended July 31, 2003 and 2002,respectively.  Export sales accountedfor 87% and 89% of net sales in the six months ended July 31, 2003 and 2002,respectively.  The Company expects thatnet sales derived from international sales will continue to represent asignificant portion of its total net sales. Letters of credit issued by customers have supported a portion of theCompany’s international sales.  To date,the Company’s international sales have been denominated in United Statesdollars.  Increases in the value of theU.S. dollar relative to the local currency of the Company’s customers couldmake the Company’s products relatively more expensive than competitors’products sold in the customer’s local 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.

 

International sales andmanufacturing 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.  Moreover, the laws of certain foreigncountries in which the Company’s products may be developed, manufactured orsold, may not protect the Company’s intellectual property rights to the sameextent as do the laws of the United States, thus increasing the possibility ofpiracy of the Company’s products and intellectual property.  There can be no assurance that one or moreof these risks will not have a material adverse effect on the Company’sbusiness, financial condition and results of operations.

 

**We May Need Additional Capital**

 

The Company requires substantial working capital tofund its business, particularly to finance inventories and accounts receivableand for capital expenditures.  TheCompany believes that its existing capital resources will be sufficient to meetthe Company’s capital requirements through the next 12 months, although theCompany could be required, or could elect, to seek to raise additional capitalin the future.  The Company’s futurecapital requirements will depend on many factors, including the rate of netsales

 

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growth, timing and extent of spending to support research anddevelopment programs in new and existing areas of technology, expansion ofsales and marketing support activities, and timing and customer acceptance ofnew products. The Company may 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.

 

**We are Dependent on Qualified Personnel**

 

The Company’s futuresuccess depends in part on the continued service of its key engineering, sales,marketing, manufacturing, finance and executive personnel, and its ability toidentify, hire and retain additional personnel.  There is strong competition for qualified personnel in thesemiconductor industry, and there can be no assurance that the Company will beable to continue to attract and retain qualified personnel necessary for thedevelopment of its business.  TheCompany has experienced the loss of certain key personnel and also reducedpersonnel in its restructuring.  If theCompany’s headcount is not appropriate for its future direction and the Companyfails to recruit key personnel critical to its future direction in a timelymanner, it may have a material adverse effect on the Company’s business,financial condition and results of operations.

 

**Our Stock Price May Be Volatile**

 

The market price of theCompany’s Common Stock, like that of other semiconductor companies, has beenand is likely to continue to be, highly volatile.  The market has from time-to-time experienced significant priceand volume fluctuations that may be unrelated to the operating performance ofparticular companies.  The market priceof the Company’s Common Stock could be subject to significant fluctuations inresponse to various factors, including quarter-to-quarter variations in theCompany’s anticipated or actual operating results, announcements of newproducts, technological innovations or setbacks by the Company or itscompetitors, general conditions in the semiconductor and PC industries,unanticipated shifts in the handheld systems market or industry standards, lossof key customers, changes in DRAM pricing, litigation commencement ordevelopments, changes in or the failure by the Company to meet estimates of theCompany’s performance by securities analysts, market conditions for hightechnology stocks in general, and other events or factors.  In future quarters, the Company’s operatingresults may be below the expectations of public market analysts orinvestors.  Since the Company’s declinein revenues, gross margins and operating results, the market price of theCommon Stock has been and is expected to be for some time in the future,materially adversely affected.

 

There may not be anactive, 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 cash equivalents, short-terminvestments, and long-term investments are exposed to financial market risk dueto fluctuations in interest rates, which may affect our interest income.  As of July 31, 2003, the Company’s cashequivalents, short-term investments, and long-term investments earned interestat an average rate of 1.3%.  Due to theshort-term nature of the Company’s investment portfolio, operating results orcash flows are vulnerable to sudden changes in market interest rates.  Assuming a decline of 10% in the marketinterest rates at July 31, 2003, with consistent cash balances, interest incomewould be adversely affected by approximately $18,000 per quarter.  The Company does not use its investmentportfolio for trading or other speculative purposes.

 

# **ForeignCurrency Exchange Risk**

 

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

 

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

 

**Evaluation of Disclosure Controls and Procedures**

 

The Company’s management, with the participation ofthe Company’s Chief Executive Officer and Chief Financial Officer, hasevaluated the effectiveness of the Company’s disclosure controls and procedures(as such term is defined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”)) as of the end of theperiod covered by this report.  Based onsuch evaluation, the Company’s Chief Executive Officer and Chief FinancialOfficer have concluded that, as of the end of such period, the Company’sdisclosure controls and procedures are effective in recording, processing,summarizing and reporting, on a timely basis, information required to bedisclosed by the Company in the reports that it files or submits under theExchange Act.

 

**Changes in Internal Controls Over Financial Reporting**

 

There was no change in theCompany’s internal controls over financial reporting that occurred during theperiod covered by this report that has materially affected, or is reasonablylikely to materially affect, our internal controls over financial reporting.

 

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**PartII.   Other Information**

 

***Item 1***.   Legal Proceedings

 

As a general matter, the semiconductor industry ischaracterized by substantial litigation, regarding patent and other intellectualproperty rights.  In December 1998, theCompany filed a lawsuit in the United States District Court for the District ofDelaware seeking damages and an injunction against Trident Microsystems, Inc.  The suit alleges that Trident’s embeddedDRAM graphics accelerators infringe certain patents held by the Company.  In January 1999, Trident filed a counterclaim against the Company alleging an attempted monopolization in violation ofantitrust laws, arising from NeoMagic’s filing of the patent infringement actionagainst Trident. The Court ruled that there was no infringement by Trident. TheCompany filed an appeal in the United States Court of Appeals, for the FederalCircuit.  On April 17, 2002, the UnitedStates Court of Appeals for the Federal Circuit affirmed the lower court’sjudgment of non-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 oral arguments oncross-motions for summary judgment on the matter.  In May 2003, the lower court ruled in favor of Trident. NeoMagichas filed a notice of re-consideration with the court. Management believes theCompany has valid defenses against Trident’s claims. There can be no assuranceas to the results of the patent infringement suit and the counter-suit forantitrust 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

 

TheAnnual Meeting of Stockholders was held on July 3, 2003. Of the 30,301,855shares outstanding as of May 16, 2003 (the record date), 22,824,292 shares(75%) were present or represented by proxy at the meeting.  The matters voted upon at the meeting andresults of the voting with respect to those matters were as follows:

 

1)                    Election ofDirectors

 
|                |   | **Votes For** |   | **Withheld** |   |
|---------------------|--------|---------------|--------|--------------|--------|
| Prakash  C. Agarwal |   | 21,150,342    |   | 1,673,949    |   |
| Brian  P. Dougherty |   | 21,165,716    |   | 1,658,575    |   |
| James  Lally        |   | 21,077,966    |   | 1,746,325    |   |
| Paul  Richman       |   | 19,279,818    |   | 3,544,473    |   |
| Anil  Gupta         |   | 21,079,106    |   | 1,745,185    |   |
| Carl  Stork         |   | 21,180,276    |   | 1,644,015    |   |
| Vinit  Sethi        |   | 20,088,042    |   | 2,736,249    |   |

 

2)                    Proposalto amend the 1997 Employee Stock Purchase Plan to provide for an increase inthe number of shares of Common Stock available for issuance under the Plan by700,000 shares.

 
| **Votes For** |   | **Against** |   | **Abstain** |   | **Broker  non-votes** |   |
|---------------|--------|-------------|--------|-------------|--------|-----------------------|--------|
| 21,735,889    |   | 1,049,176   |   | 39,226      |   | 1                     |   |

 

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3)                    Proposal toapprove the 2003 Stock Plan.

 
| **Votes For** |   | **Against** |   | **Abstain** |   | **Broker  non-votes** |   |
|---------------|--------|-------------|--------|-------------|--------|-----------------------|--------|
| 18,461,702    |   | 4,323,739   |   | 38,851      |   | 0                     |   |

 

4)                    Proposal toratify the appointment of Ernst & Young LLP as the Company’s independentauditors for the fiscal year ending January 31, 2004.

 
| **Votes For** |   | **Against** |   | **Abstain** |   | **Broker  non-votes** |   |
|---------------|--------|-------------|--------|-------------|--------|-----------------------|--------|
| 22,372,408    |   | 409,911     |   | 41,973      |   | 0                     |   |

 

5)                    In theirdiscretion the proxies are authorized to vote upon such other matter or matterswhich may properly come before the meeting or any adjournment or adjournments thereof.

 
| **Votes For** |   | **Against** |   | **Abstain** |   | **Broker  non-votes** |   |
|---------------|--------|-------------|--------|-------------|--------|-----------------------|--------|
| 18,673,982    |   | 3,966,071   |   | 184,237     |   | 2                     |   |

 

***Item 5.***   Other Information

Not applicable.

 

***Item 6.  ***Exhibits and Reports onForm 8-K

(a)          Exhibits

The exhibits listed inthe accompanying Exhibit Index on page 31 are filed or incorporated byreference as part of this Report on Form 10-Q.

 

(b)         Reports on Form 8-K

On May 15, 2003, theCompany filed a report on Form 8-K reporting the financial results for thequarter ending 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) |   |
|                  |   |   |
|                  | September 10, 2003 |   |

 

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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 dated December 19, 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.                                    |
| 31.1       |   |   |   | Certification of the  Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-14 and  15d-14 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002  dated August 15, 2003. |
| 31.2       |   |   |   | Certification of the  Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14 and  15d-14 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002  dated August 15, 2003. |
| 32.1       |   |   |   | Certification by the  Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as                                                                                                                    |

 

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|   |   |   |   | adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                      |
|--------|--------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------|
| 32.2   |   |   |   | Certification by the  Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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

(2)               Incorporated byreference to the Company’s Form 10-Q for the period ended October 31, 1997.

(3)               Incorporated byreference to the Company’s Form 10-K for the year ended January 31, 1998.

(4)               Incorporated byreference to the Company’s Form 10-K for the year ended January 31, 1999.

(5)               Incorporated byreference to the Company’s Form 10-K for the year ended January 31, 2001.

(6)               Incorporated byreference to the Company’s Form 10-K for the year ended January 31, 2002.

(7)               Incorporated byreference to the Company’s Form 10-Q for the quarter ended July 31, 2002.

(8)               Incorporated byreference to the Company’s Form 10-Q for the quarter ended October 31, 2002.

(9)               Incorporated byreference to the Company’s Form 8-A filed December 23, 2002.

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

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

 

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