- --------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarter ended July 31, 2000 OR
_ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to __________
Commission file number 333-20031
NEOMAGIC CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0344424
[ State or other jurisdiction [I.R.S. Employer Identification No.]
of incorporation or organization]
3250 Jay Street
Santa Clara, California 95054
[Address of principal executive offices] [Zip Code]
(408) 988- 7020
Registrant's telephone number, including area code
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months ( or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
The number of shares of the Registrant's Common Stock, $.001 par value,
outstanding at July 31, 2000 was 25,802,059
- --------------------------------------------------------------------------------
Page 1 of 24
NEOMAGIC CORPORATION
FORM 10-Q
INDEX
PAGE
PART I. CONSOLIDATED CONDENSED FINANCIAL INFORMATION
Item 1. Unaudited Consolidated Condensed Financial Statements:
Consolidated Condensed Statements of Operations
Six months ended July 31, 2000 and 1999 3
Consolidated Condensed Balance Sheets
July 31, 2000 and January 31, 2000 4
Consolidated Condensed Statements of Cash Flows
Six months ended July 31, 2000 and 1999 5
Notes to Unaudited Consolidated Condensed Financial Statements 6-8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9-22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 2. Changes in Securities 23
Item 3. Defaults Upon Senior Securities 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 5. Other Information 23
Item 6. Exhibits and Reports on Form 8-K 23
Signatures 24
Page 2 of 24
Part I. Financial Information
Item I. Financial Statements
NEOMAGIC CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
Three Months Ended Six Months Ended
-------------------------- ------------------------
July 31, July 31, July 31, July 31,
2000 1999 2000 1999
-------------------------- ------------------------
Net sales $ 31,908 $ 60,320 $ 70,785 $ 132,717
Cost of sales 19,458 42,232 60,445 87,841
-------------------------- ------------------------
Gross margin 12,450 18,088 10,340 44,876
Operating expenses:
Research and development 4,853 10,856 12,627 20,581
Sales, general and administrative 3,556 4,212 8,386 9,361
In-process research and development -- -- -- 5,348
Amortization of deferred compensation 841 148 893 293
-------------------------- ------------------------
Total operating expenses 9,250 15,216 21,906 35,583
-------------------------- ------------------------
Income (loss) from operations 3,200 2,872 (11,566) 9,293
Other income (expense), net:
Income net of expenses from sale of DVD assets (250) -- 4,994 --
Interest and other income 1,556 932 2,505 1,716
Interest expense (65) (218) (262) (470)
-------------------------- ------------------------
Income (loss) before income taxes 4,441 3,586 (4,329) 10,539
Income tax provision (benefit) 1,780 1,076 (1,727) 4,768
-------------------------- ------------------------
Net income (loss) $ 2,661 $ 2,510 $ (2,602) $ 5,771
-------------------------- ------------------------
-------------------------- ------------------------
Basic net income (loss) per share $ .10 $ .10 $ (.10) $ .24
Diluted net income (loss) per share $ .10 $ .10 $ (.10) $ .22
Weighted average common shares outstanding 25,736 24,460 25,651 24,468
Weighted average common shares outstanding, assuming
dilution 25,779 26,073 25,651 25,854
See accompanying notes to consolidated condensed financial statements.
Page 3 of 24
NEOMAGIC CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS
(In thousands)
July 31, January 31,
2000 2000
------------ -----------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 71,536 $ 33,097
Short-term investments 31,268 63,429
Accounts receivable, net 11,295 18,989
Inventory 1,303 13,184
Other current assets 5,417 2,170
------------ -----------
Total current assets 120,819 130,869
Property, plant and equipment, net 7,075 10,370
Deferred tax asset 1,034 1,034
Other assets 4,558 6,863
------------ -----------
Total assets $ 133,486 $ 149,136
------------ -----------
------------ -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable 4,992 21,240
Compensation and related benefits 1,933 2,986
Income taxes payable 1,897 2,207
Other accruals 5,568 2,334
Obligations under capital leases -- 154
------------ -----------
Total current liabilities 14,390 28,921
Commitments and contingencies
Stockholders' equity:
Common stock 26 25
Additional paid-in-capital 77,801 70,682
Notes receivable from stockholders (520) (525)
Deferred compensation (6,716) (1,074)
Retained earnings 48,505 51,107
------------ -----------
Total stockholders' equity 119,096 120,215
------------ -----------
Total liabilities and stockholders' equity $ 133,486 $ 149,136
------------ -----------
------------ -----------
See accompanying notes to consolidated condensed financial statements.
Page 4 of 24
NEOMAGIC CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Six Months Ended
---------------------------
July 31, July 31,
2000 1999
-------- --------
OPERATING ACTIVITIES:
Net income (loss) $ (2,602) $ 5,771
Adjustments to reconcile net income (loss) to net cash provided by
(used for) operating activities:
Depreciation and amortization 2,613 2,336
Loss on disposal of property, plant and equipment 268 --
Amortization of deferred compensation 910 297
Write-off of in-process research and development -- 5,348
Gain on sale of DVD assets (4,994) --
Changes in operating assets and liabilities:
Accounts receivable 7,694 621
Inventory 11,881 (4,029)
Other current assets (996) (1,134)
Other assets (183) (1,054)
Accounts payable (16,248) (5,010)
Compensation and related benefits (1,053) (610)
Income taxes payable (310) 2,250
Other accruals 984 1,483
-------- --------
Net cash provided by (used for) operating activities (2,036) 6,269
-------- --------
-------- --------
INVESTING ACTIVITIES:
Proceeds from the sale of DVD assets (net of selling expenses of 2,539) 8,591 --
Purchases of property, plant and equipment (695) (5,721)
Purchases of short-term investments (28,670) (73,120)
Maturities of short-term investments 60,831 84,455
Purchase of Optical Drive Development Group -- (3,901)
Purchase of ACL -- (6,523)
-------- --------
Net cash provided by (used in) investing activities 40,057 (4,810)
-------- --------
-------- --------
FINANCING ACTIVITIES:
Payments on lease obligation (154) (231)
Repayment on note receivable from stockholders 5 --
Net proceeds from issuance of common stock 567 1,319
-------- --------
Net cash provided by financing activities 418 1,088
-------- --------
-------- --------
Net increase in cash and cash equivalents 38,439 2,547
Cash and cash equivalents at beginning of period 33,097 36,631
-------- --------
Cash and cash equivalents at end of period $ 71,536 $ 39,178
-------- --------
-------- --------
Supplemental schedules of cash flow information:
Cash paid during the period for:
Interest $ 262 $ 470
Taxes $ -- $ 2,506
See accompanying notes to consolidated condensed financial statements.
Page 5 of 24
NEOMAGIC CORPORATION
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
1. Basis of Presentation:
The unaudited consolidated condensed financial statements have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission and include the accounts of NeoMagic Corporation and its wholly owned
subsidiaries collectively ("NeoMagic" or the "Company"). Certain information and
footnote disclosures, normally included in financial statements prepared in
accordance with generally accepted accounting principles, have been condensed or
omitted pursuant to such rules and regulations. In the opinion of the Company,
the financial statements reflect all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of the financial
position at July 31, 2000 and January 31, 2000, the operating results for the
three and six months ended July 31, 2000 and 1999, and the cash flows for the
six months ended July 31, 2000 and 1999. These financial statements and notes
should be read in conjunction with the Company's audited financial statements
and notes thereto for the year ended January 31, 2000, included in the Company's
Form 10-K filed with the Securities and Exchange Commission.
The results of operations for the six months ended July 31, 2000 are
not necessarily indicative of the results that may be expected for the year
ending January 31, 2001.
The second fiscal quarters of 2001 and 2000 ended on July 30, 2000 and
August 1, 1999, respectively. For ease of presentation, the accompanying
financial statements have been shown as ending on the last day of the calendar
month of July.
2. Inventory:
Inventory is stated at the lower of cost or market value. Cost is
determined by the first-in, first-out method.
July 31, January 31,
Inventory consists of: 2000 2000
----------------------------
(in thousands)
Raw materials $ 713 $ 3,035
Work in process 5 3,085
Finished goods 585 7,064
----------------------------
Total $ 1,303 $13,184
----------------------------
----------------------------
3. Earnings Per Share:
The Company follows the provisions of Statement of Financial Accounting
Standards No. 128 ("SFAS No. 128"), "Earnings per Share." Basic net earnings
(loss) per share is computed by dividing net income (loss) by the weighted
average number of common shares outstanding during the period. Diluted net
income per share is calculated using the weighted average number of common and
dilutive common equivalent shares outstanding (if applicable) during the period.
Dilutive common equivalent shares consist of stock options. Employee stock
options are included for the three month period ended July 31, 2000, but are
excluded from the computation of diluted net income per share for the six month
period ended July 31, 2000, because the effect would have been antidilutive.
Page 6 of 24
Per share information calculated on this basis is as follows:
(in thousands, except per share amounts) Three Months Ended Six Months Ended
July 31, July 31,
---------------------------- -------------------------
2000 1999 2000 1999
---------------------------- -------------------------
Numerator:
Net income (loss) $ 2,661 $ 2,510 $ (2,602) $ 5,771
Denominator:
Denominator for basic earnings (loss)
per share-weighted average shares outstanding 25,736 24,460 25,651 24,468
Effect of dilutive securities:
Employee stock options 43 1,613 n/a 1,386
---------------------------- -------------------------
Denominator for diluted earnings (loss)
per share 25,779 26,073 25,651 25,854
---------------------------- -------------------------
---------------------------- -------------------------
Basic earnings (loss) per share $ .10 $ .10 $ (.10) $ .24
Diluted earnings (loss) per share $ .10 $ .10 $ (.10) $ .22
4. Risks and Uncertainties:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Third-party suppliers currently manufacture all of the Company's
wafers, each under the terms of wafer supply agreements. A manufacturing
disruption experienced by any of the Company's manufacturing partners or the
failure of one of the Company's manufacturing partners to devote adequate
resources to the production of the Company's products would have a material
adverse effect on the Company's business, financial condition and results of
operations.
Under the wafer supply agreements, the Company must provide rolling
12-month forecasts of anticipated purchases and place binding purchase orders
three to four months in advance. With the additional time to assemble and test
wafers and finished goods, the Company can have orders outstanding that will not
be available for delivery to customers for up to six months from the date the
purchase order is placed. This limits the Company's ability to react to
fluctuations in demand for its products, which can be unexpected and dramatic.
To the extent the Company cannot accurately forecast the number of wafers
required, it may have either a shortage or an excess supply of wafers, which
could have an adverse effect on the Company's financial condition and results of
operations. At July 31, 2000, the Company had no outstanding purchase orders
with its manufacturing partners for the delivery of wafers. The Company has
announced that it expects declines in revenues, gross margins, and results of
operations for fiscal 2001 based on its exit from the multimedia accelerator
business. Accordingly, the Company placed end of life orders with its
manufacturing partners, and as a result incurred cancellation charges of $2.6
million in the first quarter of fiscal 2001. Also, in the first quarter of
fiscal 2001, the Company reserved an additional $6.9 million for excess
inventory and $2.4 million for lower of cost or market considerations based on
expectations of its customers' end-of-life requirements for its notebook PC
graphics products. During the second quarter of fiscal 2001, stronger than
anticipated demand for the Company's products resulted in the release of
inventory reserves of $2.2 million related to products sold in the quarter for
which reserves had been previously provided. The Company is monitoring its
inventory levels for product on hand, and current inventories are reserved for
end-of-life product.
Page 7 of 24
5. Divestitures:
In April 2000, pursuant to an asset purchase agreement, the Company
sold the principal assets of the DVD product group to LSI Logic (Buyer). The
assets primarily consisted of fixed assets and intangible assets. In exchange
for the assets sold to the Buyer, NeoMagic received $11.7 million in a lump-sum
cash payment. An additional $2.3 million is contingent on the Company's
performance of certain obligations related to the transfer of licenses with
third parties to the Buyer. The Company wrote-off approximately $3.6 million in
capitalized intellectual property, fixed assets and prepaid expenses related to
the DVD product group which was transferred to the Buyer. In addition, the
Company accrued approximately $1.6 million in transaction costs and
approximately $2.3 million in retention packages for the affected employees
during the first quarter. During the second quarter the Company incurred
additional costs of $0.3 million which is recorded in Income net of expenses
from sale of DVD assets on the Consolidated Condensed Statements of Operations
for the three and six months ended July 31, 2000, and 1999, respectively. As a
result, the Company recorded a pre-tax gain of approximately $5.0 million on the
sale, which is recorded in Income net of expenses from sale of DVD assets on the
Consolidated Condensed Statements of Operations for the six months ended July
31, 2000.
6. Recently Issued Accounting Pronouncements:
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, ("SFAS 133") "Accounting for
Derivative Instruments and Hedging Activities." The Standard will require
companies to record all derivatives held on the balance sheet at fair value.
Derivatives that are not hedges must be adjusted to fair value through income.
If the derivative is a hedge, changes in the fair value of the derivative is
either offset against the change in fair value of the hedged assets,
liabilities, or firm commitments through earnings, or recognized in other
comprehensive income until the value related to the ineffective portion of a
hedge, if any, is recognized in earnings. The Company expects to adopt SFAS 133
as of the beginning of its fiscal year 2002. The effect of adoption of the
Standard is currently being evaluated, but is not expected to have a material
effect on the Company's financial position or results of operations.
In March 2000, the FASB issued Interpretation No. 44, Accounting for
Certain Transactions involving Stock Compensation, an interpretation of APB
Opinion No. 25. This interpretation clarifies the application of Opinion 25 for
certain issues including: (a) the definition of employee for purposes of
applying Opinion 25, (b) the criteria for determining whether a plan qualifies
as a noncompensatory plan, (c) the accounting consequence of various
modifications to the terms of a previously fixed stock option or award and (d)
the accounting for an exchange of stock compensation awards in a business
combination. In general, this Interpretation was effective July 1, 2000. We do
not expect the adoption of Interpretation No. 44 to have a material effect on
our consolidated financial position or results of operations.
Page 8 of 24
PART I. FINANCIAL INFORMATION
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
When used in this discussion, the words "expects," "anticipates,"
"believes" and similar expressions are intended to identify forward-looking
statements. Such statements reflect management's current expectations. However,
actual events and results could vary significantly based on a variety of factors
including, but not limited to: the rate of decline in shipments of existing
product to current NeoMagic customers, the abilities of manufacturing
subcontractors to make adequate and timely deliveries, recruiting and retaining
employees including those with engineering expertise in new disciplines, and
other issues. In particular, the company's product development efforts in
System-on-Chip integration, MPEG-4, and broadband wireless represent new
endeavors and consequently carry greater risks of successful and timely
execution and market acceptance. Additional risk factors are listed in the
company's Form 10-K filing for the fiscal year ended January 31, 2000.
OVERVIEW
The Company designed, developed and marketed high-performance
semiconductor solutions for sale to original equipment manufacturers of mobile
computing products including notebook PCs, and over the last several years,
began development of digital cameras and DVD drives. In April 2000, the Company
successfully concluded the sale of the DVD product group to LSI Logic. The
Company pioneered the first commercially available high-performance silicon
technology that integrated DRAM, complex logic and analog circuits into a single
chip. The Company's proprietary MagicWare(TM) technology eliminates the need to
drive signals off-chip to discrete memory, achieving its performance advantage
while actually lowering the power consumption and extending the battery life for
smaller, lighter weight portable devices. The first commercial application for
the Company's technology was in the design, development and marketing of
multimedia accelerators for sale to notebook computer manufacturers. The
Company's MagicGraph128 and MagicMedia256 families of pin-compatible multimedia
accelerators incorporate 128-bit and 256-bit memory buses, respectively.
All of the Company's net sales to date were derived from sales of its
multimedia accelerator products, and the Company expects this trend to continue
through fiscal 2001. The Company generally recognizes revenue upon title passage
for product sales directly to customers. The Company's policy is to defer
recognition of revenue of shipments to distributors until the distributors sell
the product. Historically, a majority of the Company's sales have been to a
limited number of customers. The Company expects that a substantial portion of
sales of its products will be to a limited number of customers for the
foreseeable future. The customers contributing significant amounts of net sales
have varied and will continue to vary depending on the timing and success of new
product introductions by NeoMagic and its customers.
The Company's products require semiconductor wafers manufactured with
state-of-the-art fabrication equipment and technology. NeoMagic currently has
strategic relationships with Mitsubishi Electric Corporation, Infineon
Technologies, formerly Siemens Aktiengesellschaft Semiconductor Group, and has
also purchased wafers from Toshiba Corporation during fiscal 2000 to produce its
semiconductor wafers and uses other independent contractors to perform assembly,
packaging and testing. The Company's foundry relationships are formalized in
separate wafer supply agreements. These relationships enable the Company to
concentrate its resources on product design and development, where NeoMagic
believes it has greater competitive advantages, and to eliminate the high cost
of owning and operating a semiconductor wafer fabrication facility. The Company
depends on these suppliers to allocate to the Company a portion of their
manufacturing capacity sufficient to meet the Company's needs, to produce
products of acceptable
Page 9 of 24
quality and at acceptable manufacturing yields and to deliver those products to
the Company on a timely basis. The Company purchases wafers and pays an agreed
price for wafers meeting certain acceptance criteria. All of the Company's
products are assembled and tested by independent vendors. To date, the majority
of the Company's wafer purchases, which constitute a majority of its cost of
sales, have been priced in Japanese yen. As a result, exchange rate fluctuations
can affect the Company's gross margin. The Company experienced such fluctuations
during fiscal 2000 which negatively impacted the Company's gross margin and
earnings. The Company has in the past hedged its exposure to fluctuations in the
exchange rate between the Japanese yen and the United States dollar by
purchasing forward contracts and options and may continue to do so in the
future.
Under its wafer supply agreements, the Company is obligated to provide
rolling 12-month forecasts of anticipated purchases and place binding purchase
orders up to three to four months prior to shipment. If the Company cancels a
purchase order, the Company must pay cancellation penalties based on the status
of work in process or the proximity of the cancellation to the delivery date.
Forecasts of monthly purchases may not increase or decrease by more than a
certain percentage from the previous month's forecast without the manufacturer's
consent. Thus, the Company must forecast and place purchase orders for wafers
long before it receives purchase orders from its own customers. This limits the
Company's ability to react to fluctuations in demand for its products, which can
be unexpected and dramatic and from time-to-time will cause the Company to have
an excess or a shortage of wafers for a particular product, which could cause
the Company to take charges for excess inventory or miss revenue opportunities.
In connection with the exit from the multimedia accelerator business, the
Company placed end of life orders with its manufacturing partners, and as a
result incurred cancellation charges of $2.6 million in the April 2000 quarter.
Prior to fiscal 1997, the Company was primarily engaged in research and
development and testing of its products. Accordingly, the majority of its
operating expenses were related to research and development activities. In
fiscal 1997, in connection with the commencement of commercial sales of its
products, the Company accelerated its investment in sales, marketing,
manufacturing and administrative infrastructures. Throughout fiscal 2000, the
Company continued to devote resources to research and development efforts as
well as to make additional investments in sales, marketing, manufacturing and
administrative infrastructures to support the increased sales. The Company
expects to continue to devote substantial resources to research and development
efforts for the foreseeable future. However, given the Company's projections for
downward revenue and its corresponding cost control efforts, research and
development expenses are expected to decrease in absolute dollars in fiscal
2001. All of the Company's research and development costs have been expensed as
incurred.
On April 20, 2000 NeoMagic announced a change in strategy, ceasing
further development efforts in its existing notebook multimedia product line,
and focusing future development efforts on technologies and products to enable
multimedia communications. After the close of the last fiscal year, management
determined that rebuilding the Company's position in the notebook PC graphics
market would require at least two successful generations of products, consuming
significant time and resources. However, prospects for future opportunities in
this market were limited by the recently accelerated trends in the overall PC
market towards lower average unit pricing, and integration of the graphics
functions into core logic ICs with shared memory architectures. The Company was
confronted with the prospect of using its cash reserves and talent to rebuild
its position in what management viewed as a declining market opportunity. These
factors led management to change the Company's direction, while it is in a
position of significant cash reserves and minimal debt.
The company undertook a significant resizing of its operations, and
reduced its workforce by approximately 50% in the first quarter of fiscal 2001
compared to the end of the fourth quarter of fiscal
Page 10 of 24
2000. Included in this total are employees of the Company's DVD product line,
which was sold to LSI Logic Corporation in a transaction which was announced on
April 14, 2000.
In May 2000, the Company granted stock options to employees and
recorded deferred stock compensation within stockholders equity of $6.7
million, representing the difference between the fair market value of the
common stock at the date of grant and the exercise price of these options at
the date of grant. Amortization of deferred compensation was $860,000 and
$150,000 for the three months ended July 31, 2000 and 1999, respectively.
These amounts include amortization of deferred compensation charged to cost
of sales of $19,000 and $2,000 for the three months ended July 31, 2000 and
1999, respectively. Amortization of deferred compensation was $910,000 and
$297,000 for the six months ended July 31, 2000 and 1999, respectively. These
amounts include amortization of deferred compensation charged to cost of
sales of $17,000 and $4,000 for the six months ended July 31, 2000 and 1999,
respectively. The remaining deferred stock compensation will be amortized
over the vesting period of the related options, generally two to four years.
The amount of deferred stock compensation to be expensed in future periods
could decrease if options are forfeited for which accrued but unvested
compensation has been recorded. The amount of deferred stock compensation
expense could increase for additional stock options granted to employees at
less than fair value.
Going forward the Company expects a multi-quarter decline in its
existing business, as it focuses on technology and product developments in its
new direction. During the first quarter of fiscal 2001 the Company restructured
its operations to protect its financial strength. In the second quarter of
fiscal 2001, the Company set the basic parameters of its new direction,
commenced significant engineering activities, and began engaging major players
in the first of its new product areas. The Company will continue to refine and
evolve its product plans over the next few quarters, while adding key staff with
new skills. While the Company expects a net loss for the fiscal year as a whole,
it is managing its spending prudently and expects to end the fiscal year with
more than $90 million in cash. The Company remains on its plan to drive the
first of its new product efforts for market entry and revenues beginning in the
second half of next year.
The Company's fiscal year end is January 31. Any references herein
to a fiscal year refers to the year ended January 31 of such year. The second
fiscal quarters of 2001 and 2000 ended on July 30, 2000 and August 1, 1999,
respectively. For ease of presentation, the accompanying financial statements
have been shown as ending on the last day of the calendar month of July.
Page 11 of 24
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain financial
data as a percentage of net sales:
Three Months Ended Six Months Ended
-------------------- ------------------
July 31, July 31,
2000 1999 2000 1999
---- ---- ---- ----
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 61.0 70.0 85.4 66.2
Gross margin 39.0 30.0 14.6 33.8
Operating expenses:
Research and development 15.3 18.0 17.8 15.5
Sales, general and administrative 11.1 7.0 11.8 7.1
Acquired in process research and development -- -- -- 4.0
Amortization of deferred compensation 2.6 .2 1.3 .2
Total operating expenses 29.0 25.2 30.9 26.8
Income (loss) from operations 10.0 4.8 (16.3) 7.0
Income net of expenses from sale of DVD assets (.8) -- 7.1 --
Interest and other income 4.9 1.5 3.5 1.3
Interest expense (.2) (.4) (.4) (.4)
Income (loss) before income taxes 13.9 5.9 (6.1) 7.9
Provision (benefit) for income taxes 5.6 1.8 (2.4) 3.6
Net income (loss) 8.3% 4.1% (3.7)% 4.3%
NET SALES
The Company's net sales to date have been generated from the sale of
its multimedia accelerators. The Company's products are used in, and its
business has been dependent upon, the notebook personal computer industry
with sales primarily in Asia, Japan, and the United States. Net sales were
$31.9 million, including cancellation charges from customers of $2.3 million,
for the three months ended July 31, 2000, compared to $60.3 million for the
three months ended July 31, 1999. Net sales were $70.8 million for the six
months ended July 31, 2000, compared to $132.7 million for the six months
ended July 31, 1999. Net sales decreased primarily due to end of life
announcements for the Company's multimedia products and declining market
share. The Company expects that net sales, for the remainder of fiscal 2001
will continue to decline substantially based on the current availability of
product and customer demand for end of life product.
Sales to customers located outside the United States (including
sales to the foreign operations of customers with headquarters in the United
States, and foreign system manufacturers that sell to United States-based
OEMs) accounted for 84.4% and 81.0% of net sales in the three months ended
July 31, 2000 and 1999, respectively. Export sales accounted for 84.6% and
81.1% of net sales in the six months ended July 31, 2000 and 1999,
respectively. The Company expects that export sales will continue to
represent a significant portion of net sales, although there can be no
assurance that export sales as a percentage of net sales will remain at
current levels. All sales transactions were denominated in United States
dollars.
Four customers accounted for 34%, 19%, 16% and 13% of net sales for the
three months ended July 31, 2000. Five customers accounted for 20%, 14%, 13%,
12%, and 10% of net sales in the three months ended July 31, 1999. Four
customers accounted for 27%, 22%, 16% and 14% of net sales for the six months
ended July 31, 2000. Four customers accounted for 21%, 14%, 14% and 10% of net
sales for the six months ended July 31, 1999. These sales consisted almost
exclusively of graphic chips, and accordingly the Company does not expect these
sales to remain significant beyond the next several quarters. The
Page 12 of 24
Company expects a significant portion of its future sales to remain concentrated
with a limited number of strategic customers. There can be no assurance that the
Company will be able to retain its strategic customers, or that such customers
will not cancel or reschedule orders, or in the event orders are canceled, that
such orders will be replaced by other orders. In addition, sales to any
particular customer may fluctuate significantly from quarter to quarter. The
occurrence of any such events or the loss of a strategic customer could have a
material adverse effect on the Company's operating results.
GROSS MARGIN
Gross margin was $12.5 million and $18.1 million for the three months
ended July 31, 2000 and 1999, respectively. The gross margin percentages
increased to 39.0% for the three months ended July 31, 2000 from 30.0% for the
three months ended July 31, 1999. Gross margin was $10.3 million and $44.9
million for the six months ended July 31, 2000 and 1999, respectively. The gross
margin percentages decreased to 14.6% for the six months ended July 31, 2000
from 33.8% for the six months ended July 31, 1999. The increase in gross margin
percentage in the second quarter of fiscal 2001 was primarily due to the release
of inventory reserves of $2.2 million specifically related to products sold in
the quarter which had previously been reserved. The sale of these products
resulted from stronger than anticipated demand for the Company's end-of-life
products. The decrease in gross margin percentage in the first quarter of fiscal
2001 was due primarily to inventory write-offs and reserves and cancellation
penalties to our manufacturing partners of $11.9 million related to
restructuring the business.
The Company announced in February 2000 that it expected declines in
revenues, gross margins, and results of operations for fiscal 2001 based on
restructuring the business and the delay of the introduction of its new
products. As a result of the restructuring, the Company's existing products
experienced sharp declines in demand and a portion of the Company's inventories
on hand and on order at April 30, 2000 were not sellable in sufficient
quantities and at acceptable prices which necessitated inventory write-offs for
excess quantities, cancellation penalties to its manufacturing partners and
lower of cost or market considerations. These write-offs had a material adverse
effect on gross margins and results of operations for the three months ended
April 30, 2000 and the six months ended July 31, 2000.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses include compensation and associated
costs relating to development personnel, operating system software costs and
prototyping costs, which are comprised of photomask costs and pre-production
wafer costs. Research and development expenses were $4.9 million and $10.9
million for the three months ended July 31, 2000 and 1999, respectively.
Research and development expenses were $12.6 million and $20.6 million for the
six months ended July 31, 2000 and 1999, respectively. The Company has made, and
intends to continue to make, significant investments in research and development
to remain competitive by developing new and enhanced products to serve its
identified markets. Because the Company's projections for downward revenue will
result in corresponding cost control, research and development expenses are
expected to decrease in absolute dollars in fiscal 2001.
SALES, GENERAL AND ADMINISTRATIVE EXPENSES
Sales, general and administrative expenses were $3.6 million and $4.2
million for the three months ended July 31, 2000 and 1999, respectively. Sales,
general and administrative expenses were $8.4 million and $9.4 million for the
six months ended July 31, 2000 and 1999, respectively. Sales, general and
administrative expenses decreased in absolute dollars due primarily to lower
outside commissions on lower sales, and the Company's ongoing cost reduction
efforts offset in part by $0.8 million of employee related severance expenses
incurred in the first quarter of fiscal 2001 in connection with restructuring
the business.
Page 13 of 24
Sales, general and administrative expenses increased as a percentage of sales
due to the decline in sales. Because the Company's projections for downward
revenue will result in decreased commissions and cost control, sales, general
and administrative expenses are expected to decrease in absolute dollars in
fiscal 2001.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT
The Company incurred approximately $5.3 million of charges for acquired
in-process research and development ("IPRD") in connection with its fiscal 2000
acquisitions of the Optical Drive Storage Group from Mitel Semiconductor and
Associative Computers, Ltd., (" ACL"). The amount allocated to the acquired
in-process research and development was determined using the income approach,
which discounts expected future cash flows from each of the technologies under
development to their net present value, at an appropriate risk-adjusted rate of
return. The technologies under development were analyzed to determine their
technological accomplishments; the existence and utilization of core
technologies; the existence of any alternative future uses; their technological
feasibility; and the stage of completion of the development activities,
including the efforts required to complete the remaining development activities.
The technologies under development were classified as developed technology, IPRD
completed, IPRD to be completed or future development activities. Projected
future net cash flows attributable to each of these categories were discounted
to their net present value using a discount rate which was derived based on the
Company's estimated weighted average cost of capital plus a risk premium to
account for the inherent uncertainty surrounding the successful completion of
each project and the associated estimated cash flows. The IPRD charge includes
only the fair value of IPRD completed. The technologies underlying the IPRD
amounts were deemed to have no alternative future uses. The fair value assigned
to developed technology is included in other assets, and no value was assigned
to the IPRD to be completed or future development activities. The Company
believes that these fair values do not exceed the amount a third party would pay
for each such in-process technology. Failure to timely deliver commercially
viable products to the market, or to achieve market acceptance or the revenue
and expense forecasts could have a significant impact on the financial results
and operations of the acquired businesses.
The total charge for IPRD for the Optical Drive Storage Group
transaction, completed in February 1999, was approximately $2.0 million. The
technologies acquired from this group were mixed signal analog and digital video
disk ("DVD") optical storage read-channel technologies. The Optical Drive
Storage Group's development efforts were estimated to be approximately 50%
complete at the date of the acquisition. NeoMagic planned to integrate these
technologies with its embedded DRAM technologies and develop products for the
DVD Notebook, DVD Desktop and DVD Player/Recorder markets. Prior to the
acquisition, the Optical Drive Storage Group had generated no revenues. Revenue
from commercially viable products for these markets was not anticipated until
late calendar 2000 or in 2001. The discount rates used for the IPRD technologies
and developed technologies were 40% and 25%, respectively.
The total charge for IPRD for the ACL transaction, completed in
February 1999, was approximately $3.3 million. The technologies acquired from
ACL were associative array (parallel) processing architectures that enabled high
speed computing. ACL's development efforts were estimated to be approximately
42% complete at the date of the acquisition. NeoMagic planned to integrate these
technologies with its embedded DRAM technologies and develop products for the
digital camera and camcorder markets. Prior to the acquisition, ACL had
generated no revenues. Revenues from commercially viable products for the above
markets were not anticipated until late calendar 2001. The discount rates used
for the IPRD technologies and developed technologies were each 50%.
Except for the Company's plans to no longer pursue the development
activities acquired from the Optical Drive Storage Group, (DVD group) there have
been no significant changes in the assumptions used
Page 14 of 24
in the IPRD analyses relating to the timing of expected future revenues or the
amount of development expenses and efforts expected to be required to bring the
in process research and development technologies to completion and to achieve
such revenues. The Company successfully concluded the sale of the DVD group to
LSI Logic in April, 2000. The gain from the sale of the DVD group of $5.0
million is included in Income net of expenses from the sale of DVD assets on the
Consolidated Condensed Statements of Operations.
AMORTIZATION OF DEFERRED COMPENSATION
In May 2000, the Company granted stock options to employees and
recorded deferred stock compensation within stockholders equity of $ 6.7
million, representing the difference between the fair market value of the
common stock at the date of grant and the exercise price of these options at
the date of grant. Amortization of deferred compensation was $860,000 and
$150,000 for the three months ended July 31, 2000 and 1999, respectively.
These amounts include amortization of deferred compensation charged to cost
of sales of $19,000 and $2,000 for the three months ended July 31, 2000 and
1999, respectively. Amortization of deferred compensation was $910,000 and
$297,000 for the six months ended July 31, 2000 and 1999, respectively. These
amounts include amortization of deferred compensation charged to cost of
sales of $17,000 and $4,000 for the six months ended July 31, 2000 and 1999,
respectively.
INCOME NET OF EXPENSES FROM SALE OF DVD ASSETS
In April 2000, pursuant to an asset purchase agreement, the Company
sold the principal assets of the DVD product group to LSI Logic (Buyer). The
assets primarily consisted of fixed assets and intangible assets. In exchange
for the assets sold to the Buyer, NeoMagic received $11.7 million in a lump-sum
cash payment. An additional $2.3 million is contingent on the Company's
performance of certain obligations related to the transfer of licenses with
third parties to the Buyer. The Company wrote-off approximately $3.6 million in
capitalized intellectual property, fixed assets and prepaid expenses related to
the DVD product group which was transferred to the Buyer. In addition, the
Company accrued approximately $1.9 million in transaction costs and
approximately $2.3 million in retention packages for the affected employees. As
a result, the Company recorded a pre-tax gain of approximately $5.0 million on
the sale, which is recorded in Income net of expenses from sale of DVD assets on
the Consolidated Condensed Statements of Operations.
INTEREST AND OTHER INCOME
The Company earns interest on its cash and short-term investments.
Interest and other income was $1.6 million and $0.9 million for the three months
ended July 31, 2000 and 1999, respectively. Interest and other income was $2.5
million and $1.7 million for the six months ended July 31, 2000 and 1999,
respectively. The increase in interest and other income stemmed from higher
interest income earned on higher cash and short-term investment balances offset
in part by a loss on disposal of assets of $0.3 million in the first quarter of
fiscal 2001 related to restructuring the business.
INTEREST EXPENSE
The Company pays interest and bank commissions on wafer purchases and
interest on its leases. Interest expense was $65,000 and $218,000 for the three
months ended July 31, 2000 and 1999, respectively. Interest expense was $262,000
and $470,000 for the six months ended July 31, 2000 and 1999, respectively. The
decrease in interest expense from fiscal 2000 to fiscal 2001 reflects lower
interest and bank commission on reduced purchases and sales and lower capital
lease balances.
Page 15 of 24
INCOME TAXES
The Company's effective tax rate for the three months ended July 31,
2000 was 40% compared to an effective tax rate of 30%, excluding the effect of
the in-process research and development charge of $5.3 million for the three
months ended July 31, 1999. The Company's effective tax rate for the six months
ended July 31, 2000 was a tax benefit of 40%, compared to an effective tax rate
of 30% for the six months ended July 31, 1999. This rate varies from the
statutory rate of 35% due to the effect of the research and development credit.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash, cash equivalents and short-term investments
increased $6.3 million in the six months ended July 31, 2000 to $102.8 million
from $96.5 million at January 31, 2000. The increase in cash, cash equivalents
and short-term investments stems primarily from cash provided from investing
activities, and to a lesser extent, cash provided by financing activities,
offset in part by cash used for operating activities.
Cash and cash equivalents used for operating activities for the six
months ended July 31, 2000 was $2.0 million, compared to $6.3 million of net
cash provided by operating activities for the six months ended July 31, 1999.
The cash used for operating activities stems primarily from a net loss of $2.6
million, a decrease in accounts payable, compensation and related benefits, and
income taxes payable, and an increase in other current assets, offset in part by
decreases in accounts receivable and inventory and by an increase in other
accruals.
Net cash provided by investing activities for the six months ended July
31, 2000, was $40.1 million, compared to $4.8 million of net cash used in
investing activities for the six months ended July 31, 1999. Net cash provided
by investing activities related primarily to net proceeds from the sale of the
DVD group of $8.6 million and net maturities of short-term investments of $32.2
million, partially offset by purchases of property, plant and equipment.
Continued operation of the Company's business may require higher levels of
capital equipment purchases, technology investments, foundry investments and
other payments to secure manufacturing capacity. The timing and amount of future
investments will depend primarily on the level of the Company's future revenues.
Net cash provided by financing activities was $0.4 million for the six
months ended July 31, 2000, compared to $1.1 million of net cash provided by
financing activities for the six months ended July 31, 1999. The net cash
provided by financing activities primarily represents net proceeds from the
issuance of common stock offset in part by payments on lease obligations.
At July 31, 2000, the Company's principal sources of liquidity included
cash, cash equivalents and short-term investments of $102.8 million. The Company
believes that it will not generate cash from operations over the upcoming twelve
months, and believes the current cash, cash equivalents and short-term
investments will satisfy the Company's projected working capital and capital
expenditure requirements through the next twelve months. Investments will
continue in new product development in new and existing areas of technology. The
Company's future capital requirements will depend on many factors including the
rate of net sales, the timing and extent of spending to support research and
development programs, the timing of any new product introductions and
enhancements to existing products, and market acceptance of the Company's
products.
Page 16 of 24
IMPACT OF CURRENCY EXCHANGE RATES
Because the Company has purchased the majority of its wafers under
purchase contracts denominated in yen, significant appreciation in the value
of the yen relative to the value of the U.S. dollar would make the wafers
relatively more expensive to the Company, which would have a material adverse
effect on the Company's business, financial condition and results of
operations. The Company generally enters into foreign currency forward
contracts to minimize short-term foreign currency fluctuation exposures
related to these firm purchase commitments. The Company does not use
derivative financial instruments for speculative or trading purposes. The
Company's accounting policies for these instruments are based on the
Company's designation of such instruments as hedging transactions. The
criteria the Company uses for designating an instrument as a hedge include
its effectiveness in risk reduction and one-to-one matching of derivative
instruments to underlying transactions. There were no foreign exchange
contracts outstanding as of July 31, 2000.
Notwithstanding the measures the Company has adopted, due to the
unpredictability and volatility of currency exchange rates and currency
controls, there can be no assurance that the Company will not experience
currency losses in the future, nor can the Company predict the effect of
exchange rate fluctuations upon future operating results. The Company
experienced such fluctuations during fiscal 2000 which negatively impacted
the Company's gross margin and results of operations.
FACTORS THAT MAY AFFECT RESULTS
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
NeoMagic's quarterly and annual results of operations are affected by
a variety of factors that could materially adversely affect net sales, gross
margin and operating results. These factors include, among others, the rate
of decline in shipments of existing product to current NeoMagic customers,
the abilities of manufacturing subcontractors to make adequate and timely
deliveries, access to advanced production process technologies from
manufacturing subcontractors, recruiting and retaining employees including
those with engineering expertise in new disciplines, and other issues. In
particular, the Company's product development efforts in System-on-Chip
integration, MPEG-4, and broadband wireless represent new endeavors and
consequently carry greater risks of successful and timely execution. Any one
or more of these factors could result in the Company failing to achieve its
expectations as to future revenues and profits. The Company may be unable to
adjust spending sufficiently in a timely manner to compensate for any
unexpected sales shortfall, which could materially adversely affect quarterly
operating results. Accordingly, the Company believes that period-to-period
comparisons of its operating results should not be relied upon as an
indication of future performance. In addition, the results of any quarterly
period are not indicative of results to be expected for a full fiscal year.
In future quarters, the Company's operating results may be below the
expectations of public market analysts or investors. Since the Company's
announcement of its expectation of declining revenues, gross margins and
operating results, the market price of the Common Stock has been and is
expected to be for some time in the future, materially adversely affected.
INVENTORY RISK
Under its wafer supply agreements with Mitsubishi Electric and
Infineon, the Company is obligated to provide rolling 12-month forecasts of
anticipated purchases and to place binding purchase orders three to four
months prior to shipment from the suppliers. The Company expects that its
revenues will decline significantly from the prior year's revenue and
accordingly is monitoring its inventory levels for product on hand. The
Company orders wafers for deliveries at least 3-4 months in advance and with
the additional time
Page 17 of 24
to assemble and test wafers, the Company can have orders for finished goods that
will be available up to six months into the future. If the Company does not have
sufficient demand for its products and cannot cancel its current and future
commitments without material impact, the Company may experience excess
inventory, which will result in a write-off affecting gross margin and results
of operations. If the Company cancels a purchase order, it must pay cancellation
penalties based on the status of work in process or the proximity of the
cancellation to the delivery date. Forecasts of monthly purchases may not
increase or decrease by more than a certain percentage from the previous month's
forecast without the manufacturer's consent. Thus, the Company must make
forecasts and place purchase orders for wafers long before it receives purchase
orders from its own customers. This limits the Company's ability to react to
fluctuations in demand for its products, which can be unexpected and dramatic,
and from time-to-time will cause the Company to have an excess or shortage of
wafers for a particular product. Also, many of the Company's customers are
moving to "just in time" relationships with their vendors, which can shift the
risk of carrying inventory back to the supplier. As a result of the long
lead-time for manufacturing wafers and the increase in "just in time" ordering
by PC manufacturers, semiconductor companies such as the Company from
time-to-time must take charges for excess inventory. Significant write-offs of
excess inventory could have a material adverse effect on the Company's financial
condition and results of operations. Conversely, failure to order sufficient
wafers would cause the Company to miss revenue opportunities and, if
significant, could impact sales by the Company's customers, which could
adversely affect the Company's customer relationships and thereby materially
adversely affect the Company's business, financial condition and results of
operations. At July 31, 2000, the Company had no outstanding purchase orders
with its manufacturing partners for the delivery of wafers. The Company has
announced that it expects declines in revenues, gross margins, and results of
operations for fiscal 2001 based on its exit from the multimedia accelerator
business. Accordingly, the Company placed end of life orders with its
manufacturing partners, and as a result incurred cancellation charges of $2.6
million in the first quarter of fiscal 2001. Also, in the first quarter of
fiscal 2001, the Company reserved an additional $6.9 million for excess
inventory and $2.4 million for lower of cost or market considerations based on
expectations of its customers' end-of-life requirements for its notebook PC
graphics products. During the second quarter of fiscal 2001, stronger than
anticipated demand for the Company's products resulted in the release of
inventory reserves of $2.2 million specifically related to products sold in the
quarter which had previously been reserved. The Company is monitoring its
inventory levels for product on hand, and current inventories are reserved for
end-of-life product.
MANUFACTURING YIELDS
The fabrication of semiconductors is a complex and precise process.
Because NeoMagic's products feature the integration of large DRAM memory with
analog and logic circuitry on a single chip, a manufacturer must obtain
acceptable yields of both the memory and logic portions of such products,
compounding the complexity of the manufacturing process. As a result, the
Company may face greater manufacturing challenges than its competitors. Minute
levels of contaminants in the manufacturing environment, defects in masks used
to print circuits on a wafer, difficulties in the fabrication process or other
factors can cause a substantial percentage of wafers to be rejected or a
significant number of die on each wafer to be nonfunctional. Many of these
problems are difficult to diagnose and time consuming or expensive to remedy. As
a result, semiconductor companies often experience problems in achieving
acceptable wafer manufacturing yields, which are represented by the number of
good die as a proportion of the total number of die on any particular wafer. The
Company purchases wafers, not die, and pays an agreed upon price for wafers
meeting certain acceptance criteria. Accordingly, the Company bears the risk of
the yield of good die from wafers purchased meeting the acceptance criteria. The
Company experienced such yield problems which materially adversely affected the
Company's net sales, gross margins and results of operations in fiscal 2001.
Page 18 of 24
Semiconductor manufacturing yields are a function of both product
design, which is developed largely by the Company, and process technology, which
is typically proprietary to the manufacturer. Historically, the Company has
experienced lower yields on new products. Since low yields may result from
either design or process technology failures, yield problems may not be
effectively determined or resolved until an actual product exists that can be
analyzed and tested to identify process sensitivities relating to the design
rules that are used. As a result, yield problems may not be identified until
well into the production process, and resolution of yield problems would require
cooperation by and communication between the Company and the manufacturer. This
risk is compounded by the offshore location of the Company's manufacturers,
increasing the effort and time required identifying, communicating and resolving
manufacturing yield problems. As the Company develops relationships with new
manufacturing partners and introduces new products, yields could be adversely
affected due to difficulties associated with adopting the Company's technology
and product design to the proprietary process technology and design rules of
each manufacturer. Any significant decrease in manufacturing yields could result
in an increase in the Company's per unit product cost and could force the
Company to allocate its available product supply among its customers,
potentially adversely impacting customer relationships as well as revenues and
gross margins. There can be no assurance that the Company's manufacturers will
achieve or maintain acceptable manufacturing yields in the future. The inability
of the Company to achieve planned yields from its manufacturer for its newest
product, the MagicMedia256XL+, has had, and is expected to continue to have, a
material adverse effect on the Company's net sales, gross margins and results of
operations in fiscal 2001.
DEPENDENCE ON NEW PRODUCT DEVELOPMENT, NEW MARKETS, RAPID TECHNOLOGICAL CHANGE
During the first fiscal quarter the Company decided to change its
primary market and business. The Company closed all new product development
efforts in multimedia ICs for notebook computers. The Company's other new
product plans and development efforts were reconsidered as well.
The Company has decided to pursue opportunities related to streaming
video and multimedia communications over the internet. New product planning
during the first quarter focused on handheld internet appliances and MPEG-4
video compression technology. Additional planning efforts were begun in the area
of broadband cellular communications. The Company's future business, financial
condition and results of operations will depend to a significant extent on its
ability to develop new products that address these market opportunities. As a
result, the Company believes that significant expenditures for research and
development will continue to be required in the future. Handheld internet
appliances, MPEG4 streaming video, and broadband cellular communications are
relatively new technologies, and are characterized by rapidly changing
infrastructure, evolving industry standards and uncertain average selling
prices. The Company must anticipate the features and functionality that
consumers and infrastructure providers will demand, incorporate those features
and functionality into products that meet the exacting design requirements of
equipment manufacturers, price its products competitively, and introduce the
products to the market on a timely basis. The success of new product
introductions is dependent on several factors, including proper new product
definition, timely completion and introduction of new product designs, the
ability of strategic manufacturing partners to effectively design and implement
the manufacture of new products, quality of new products, differentiation of new
products from those of the Company's competitors and market acceptance of
NeoMagic's and its customers' products. There can be no assurance that the
products the Company expects to introduce will incorporate the features and
functionality demanded by system manufacturers and consumers, will be
successfully developed, or will be introduced within the appropriate window of
market demand.
The Company intends to continue relying in part upon the integration of
large DRAM with analog and logic circuitry on a single chip as a primary means
of product differentiation. The integration of large DRAM memory with analog and
logic circuitry on a single chip is highly complex and is critical to the
Page 19 of 24
Company's success. Because of the complexity of its products, however, NeoMagic
has experienced delays from time to time in completing development and
introduction of new products. In addition, the Company is now embarked on the
development of new products in markets in which the company has no history. In
the event that there are delays in the completion of development of future
products, including the products currently under development for introduction
over the next 12 to 18 months, the Company's potential future business,
financial condition, and results of operations will be materially adversely
affected. Although the development cycles for the memory and logic portions of
the Company's products have been relatively synchronized to date, there can be
no assurance that this synchronization will continue in the future. In addition,
there can be no assurance that fundamental advances in either the memory or
logic components of the Company's products will not significantly increase the
complexity inherent in the design and manufacture of the Company's products,
rendering the Company's product technologically infeasible or uncompetitive. The
time required for competitors to develop and introduce competing products may be
shorter and manufacturing yields may be better than those experienced by the
Company.
The Company is no longer pursuing new product development or new sales
opportunities in its notebook multimedia product line, and anticipates a rapid
decline in revenues from sales of its existing products in this market. The
Company does not anticipate completing new product developments in other markets
prior to the decline of its multimedia product revenues. This situation will
have a material adverse effect on the Company's business, financial condition
and results of operations in fiscal 2001.
UNCERTAINTY REGARDING PATENTS AND PROTECTION OF PROPRIETARY RIGHTS
The Company relies in part on patents to protect its intellectual
property. The Company has been issued numerous patents worldwide, each covering
certain aspects of the design and architecture of the Company's multimedia
accelerators. In fiscal 2000, the Company also acquired and/or licensed
intellectual properties, the majority of which were in the areas of mixed signal
analog design and array-based processing as part of the February 1999
acquisitions of the Optical Drive Development Group and ACL. Additionally, the
Company and its newly acquired businesses have patent applications pending.
There can be no assurance that the Company's pending patent applications, or any
future applications will be approved. Further, there can be no assurance that
any issued patents will provide the Company with significant intellectual
property protection, competitive advantages, or will not be challenged by third
parties, or that the patents of others will not have an adverse effect on the
Company's ability to do business. In addition, there can be no assurance that
others will not independently develop similar products, duplicate the Company's
products or design around any patents that may be issued to the Company.
The Company also relies on a combination of mask work protection,
trademarks, copyrights, trade secret laws, employee and third-party
nondisclosure agreements and licensing arrangements to protect its intellectual
property. Despite these efforts, there can be no assurance that others will not
independently develop substantially equivalent intellectual property or
otherwise gain access to the Company's trade secrets or intellectual property,
or disclose such intellectual property or trade secrets, or that the Company can
meaningfully protect its intellectual property. A failure by the Company to
meaningfully protect its intellectual property could have a material adverse
effect on the Company's business, financial condition and results of operations.
As a general matter, the semiconductor industry is characterized by
substantial litigation, regarding patent and other intellectual property rights.
In December 1998, the Company filed a lawsuit in the United States District
Court for the District of Delaware against Trident Microsystems, Inc. The suit
alleges that Trident's embedded DRAM graphics accelerators infringe certain
patents held by the Company. In January 1999, Trident filed a counter claim
against the Company alleging an attempted monopolization in violation of
antitrust laws, arising from NeoMagic's filing of the patent infringement action
against Trident in
Page 20 of 24
December. The Court has stayed all litigation concerning Trident's antitrust
claim pending resolution of NeoMagic's claim for patent infringement. The patent
infringement claim is scheduled for trial to commence on November 6, 2000.
Management believes the Company has valid defenses against Trident's claims.
Any patent litigation, whether or not determined in the Company's favor
or settled by the Company, would at a minimum be costly and could divert the
efforts and attention of the Company's management and technical personnel from
productive tasks, which could have a material adverse effect on the Company's
business, financial condition and results of operations. There can be no
assurance that current or future infringement claims by third parties or claims
for indemnification by other customers or end users of the Company's products
resulting from infringement claims will not be asserted in the future or that
such assertions, if proven to be true, will not materially adversely affect the
Company's business, financial condition and results of operations. In the event
of any adverse ruling in any such matter, the Company could be required to pay
substantial damages, which could include treble damages, cease the
manufacturing, use and sale of infringing products, discontinue the use of
certain processes, or to obtain a license under the intellectual property rights
of the third party claiming infringement. There can be no assurance, however,
that a license would be available on reasonable terms or at all. Any limitations
on the Company's ability to market its products, or delays and costs associated
with redesigning its products or payments of license fees to third parties, or
any failure by the Company to develop or license a substitute technology on
commercially reasonable terms could have a material adverse effect on the
Company's business, financial condition and results of operations.
DEPENDENCE ON INTERNATIONAL SALES AND SUPPLIERS
Export sales are a critical part of the Company's business. Sales
to customers located outside the United States (including sales to the
foreign operations of customers with headquarters in the United States and
foreign system manufacturers that sell to United States-based OEMs) accounted
for 84.4% and 81.0% of the Company's net sales for the three months ended
July 31, 2000 and 1999, respectively. Export sales accounted for 84.6% and
81.1% of net sales in the six months ended July 31, 2000 and 1999,
respectively. The Company expects that net sales derived from international
sales will continue to represent a significant portion of its total net
sales. Letters of credit issued by customers support a portion of the
Company's international sales. To date, the Company's international sales
have been denominated in United States dollars. Increases in the value of the
U.S. dollar relative to the local currency of the Company's customers could
make the Company's products relatively more expensive than competitors'
products sold in the customer's local currency.
International manufacturers produce all of the Company's wafers. In
addition, many of the assembly and test services used by the Company are
procured from international sources. Under the Company's wafer supply
agreements with Mitsubishi Electric, wafers are priced in Japanese yen. As a
result, the Company's costs of goods sold are subject to fluctuations in the
yen-dollar exchange rates. The Company has in the past hedged its exposure to
fluctuations in foreign currency exchange rate by purchasing foreign exchange
contracts and may continue to do so in the future. However, there can be no
assurance that such hedging will be adequate. The Company experienced such
fluctuations during fiscal 2000 which negatively impacted the Company's gross
margin and results of operations. Significant wafer or assembly and test
service price increases, fluctuations in currency exchange rates or the
Company's inability to fully hedge against currency exchange rate
fluctuations could continue to have a material and sudden adverse effect on
the Company's business, financial condition and results of operations.
Page 21 of 24
International sales and manufacturing operations are subject to a variety
of risks, including fluctuations in currency exchange rates, tariffs, import
restrictions and other trade barriers, unexpected changes in regulatory
requirements, longer accounts receivable payment cycles, potentially adverse tax
consequences and export license requirements. In addition, the Company is
subject to the risks inherent in conducting business internationally including
foreign government regulation, political and economic instability, and
unexpected changes in diplomatic and trade relationships. Moreover, the laws of
certain foreign countries in which the Company's products may be developed,
manufactured or sold, including various countries in Asia, may not protect the
Company's intellectual property rights to the same extent as do the laws of the
United States, thus increasing the possibility of piracy of the Company's
products. There can be no assurance that one or more of these risks will not
have a material adverse effect on the Company's business, financial condition
and results of operations.
DEPENDENCE ON QUALIFIED PERSONNEL
The Company's future success depends in part on the continued service
of its key engineering, sales, marketing, manufacturing, finance and executive
personnel, and its ability to identify, hire and retain additional personnel.
There is intense competition for qualified personnel in the semiconductor
industry, and there can be no assurance that the Company will be able to
continue to attract and retain qualified personnel necessary for the development
of its business. The Company's restructuring placed increased demands on the
Company's resources and will likely require the addition of new management
personnel and the development of additional expertise by existing management
personnel. The Company has experienced the loss of certain personnel and also
reduced personnel in its restructuring. If the Company's headcount is not
appropriate for its future direction and the Company fails to recruit key
personnel critical to its future direction in a timely manner, it may have a
material adverse effect on the Company's business, financial condition and
results of operations.
Page 22 of 24
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
In December 1998, the Company filed a lawsuit in the United States
District Court for the District of Delaware against Trident Microsystems, Inc.
The suit alleges that Trident's embedded DRAM graphics accelerators infringe
certain patents held by the Company. In January 1999, Trident filed a counter
claim against the Company alleging an attempted monopolization in violation of
antitrust laws, arising from NeoMagic's filing of the patent infringement action
against Trident in December. The Court has stayed all litigation concerning
Trident's antitrust claim pending resolution of NeoMagic's claim for patent
infringement. The patent infringement claim is scheduled for trial to commence
on November 6, 2000. 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 and the counter-suit for antitrust filed by Trident.
ITEM 2. Changes in Securities
None.
ITEM 3. Defaults Upon Senior Securities
None.
ITEM 4. Submission of Matters to a Vote of Security Holders
None.
ITEM 5. Other Information
Not applicable.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
EXHIBIT
NUMBER DESCRIPTION
27.1 Financial Data Schedule
(b) Reports on Form 8-K
The Company did not file any reports on Form 8-K during the three
months ended July 31, 2000.
Page 23 of 24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NEOMAGIC CORPORATION
(Registrant)
Stephen T. Lanza
----------------
STEPHEN T. LANZA
Chief Financial Officer
(Principal Financial and Accounting Officer)
September 13, 2000
Page 24 of 24